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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, 2010

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 CAPITAL MARKETS CORPORATION

(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  ¨     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, 2010 was 61,957,152 shares.

 

 

 


Table of Contents

FBR CAPITAL MARKETS CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2010

INDEX

 

     Page
PART I—FINANCIAL INFORMATION   

Item 1.

 

Financial Statements

  
 

Consolidated Financial Statements and Notes—(unaudited)

  
 

Consolidated Balance Sheets—June 30, 2010 and December 31, 2009

   1
 

Consolidated Statements of Operations—Three Months Ended June 30, 2010 and 2009

   2
 

Consolidated Statements of Operations—Six Months Ended June 30, 2010 and 2009

   3
 

Consolidated Statements of Changes in Shareholders’ Equity—Six Months Ended June 30, 2010 and Year Ended December 31, 2009

   4
 

Consolidated Statements of Cash Flows—Six Months Ended June 30, 2010 and 2009

   5
 

Notes to Consolidated Financial Statements

   6

Item 2.

 

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

   21

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

   34

Item 4.

 

Controls and Procedures

   37
PART II—OTHER INFORMATION   

Item 1.

 

Legal Proceedings

   38

Item 1A.

 

Risk Factors

   39

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

   39

Item 6.

 

Exhibits

   39
 

Signature

   40


Table of Contents

PART I

FINANCIAL INFORMATION

 

Item 1. Financial Statements

FBR CAPITAL MARKETS CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

(Unaudited)

 

    June 30,
2010
    December 31,
2009
 

ASSETS

   

Cash and cash equivalents

  $ 187,843      $ 275,506   

Receivables:

   

Investment banking

    9,875        4,846   

Asset management fees

    1,012        958   

Due from affiliates

    666        567   

Other

    6,103        9,380   

Investments:

   

Trading securities, at fair value

    102,368        94,478   

Long-term investments, at fair value

    160        317   

Other long-term investments

    59,155        43,303   

Due from brokers, dealers and clearing organizations

    32,128        96,477   

Goodwill

    5,882        5,882   

Intangible assets, net

    2,815        2,542   

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

    13,859        15,172   

Prepaid expenses and other assets

    12,674        6,897   
               

Total assets

  $ 434,540      $ 556,325   
               

LIABILITIES AND SHAREHOLDERS’ EQUITY

   

Liabilities:

   

Securities sold but not yet purchased, at fair value

  $ 54,319      $ 51,669   

Accrued compensation and benefits

    30,360        72,537   

Accounts payable, accrued expenses and other liabilities

    24,782        22,452   

Due to brokers, dealers and clearing organizations

    36,643        90,168   
               

Total liabilities

    146,104        236,826   
               

Commitments and Contingencies (Note 6)

   

Shareholders’ Equity:

   

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

    —          —     

Common stock, $0.001 par value, 300,000,000 shares authorized, 61,842,248 and 64,064,784 shares issued and outstanding, respectively

    62        64   

Additional paid-in capital

    421,380        429,052   

Employee stock loan receivable, including accrued interest (120,950 and 57,500 shares, respectively)

    (726     (391

Restricted stock units

    30,915        19,979   

Accumulated other comprehensive loss

    (32     (71

Accumulated deficit

    (163,163     (129,134
               

Total shareholders’ equity

    288,436        319,499   
               

Total liabilities and shareholders’ equity

  $ 434,540      $ 556,325   
               

See notes to consolidated financial statements.

 

1


Table of Contents

FBR CAPITAL MARKETS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(Unaudited)

 

     Three Months Ended
June 30,
 
     2010     2009  

Revenues:

    

Investment banking:

    

Capital raising

   $ 37,421      $ 4,273   

Advisory

     3,022        4,383   

Institutional brokerage:

    

Principal transactions

     2,678        9,852   

Agency commissions

     21,606        23,824   

Asset management fees

     3,815        3,232   

Net investment income

     46        1,369   

Interest income, dividends and other

     1,118        395   
                

Total revenues

     69,706        47,328   

Interest expense

     —          —     
                

Revenues, net of interest expense

     69,706        47,328   
                

Non-Interest Expenses:

    

Compensation and benefits

     51,291        35,553   

Professional services

     7,550        4,587   

Business development

     3,921        2,598   

Clearing and brokerage fees

     3,685        3,760   

Occupancy and equipment

     6,129        7,803   

Communications

     5,371        5,192   

Impairment of intangible assets

     —          5,350   

Other operating expenses

     3,914        4,125   
                

Total non-interest expenses

     81,861        68,968   
                

Loss before income taxes

     (12,155     (21,640

Income tax provision

     13,612        104   
                

Net loss

   $ (25,767   $ (21,744
                

Basic loss per share

   $ (0.41   $ (0.40
                

Diluted loss per share

   $ (0.41   $ (0.40
                

Weighted average shares outstanding:

    

Basic (in thousands)

     62,957        54,391   
                

Diluted (in thousands)

     62,957        54,391   
                

See notes to consolidated financial statements.

 

2


Table of Contents

FBR CAPITAL MARKETS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(Unaudited)

 

     Six Months Ended
June 30,
 
     2010     2009  

Revenues:

    

Investment banking:

    

Capital raising

   $ 45,132      $ 8,572   

Advisory

     6,456        7,982   

Institutional brokerage:

    

Principal transactions

     10,548        21,170   

Agency commissions

     41,266        52,176   

Asset management fees

     7,143        6,159   

Net investment income (loss)

     48        (78

Interest income, dividends and other

     3,330        1,250   
                

Total revenues

     113,923        97,231   

Interest expense

     —          252   
                

Revenues, net of interest expense

     113,923        96,979   
                

Non-Interest Expenses:

    

Compensation and benefits

     94,035        72,551   

Professional services

     11,653        9,128   

Business development

     7,772        6,229   

Clearing and brokerage fees

     7,067        7,057   

Occupancy and equipment

     12,621        15,760   

Communications

     10,138        10,353   

Impairment of intangible assets

     —          5,350   

Other operating expenses

     7,333        7,749   
                

Total non-interest expenses

     150,619        134,177   
                

Loss before income taxes

     (36,696     (37,198

Income tax (benefit) provision

     (2,667     713   
                

Net loss

   $ (34,029   $ (37,911
                

Basic loss per share

   $ (0.54   $ (0.67
                

Diluted loss per share

   $ (0.54   $ (0.67
                

Weighted average shares outstanding:

    

Basic (in thousands)

     63,489        56,741   
                

Diluted (in thousands)

     63,489        56,741   
                

See notes to consolidated financial statements.

 

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Table of Contents

FBR CAPITAL MARKETS CORPORATION

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
    Accumulated
Deficit
    Total     Comprehensive
Loss
 

Balances at December 31, 2008

  59,792      $ 60      $ 396,059      $ —        $ 9,309      $ (218   $ (101,483   $ 303,727     
                                                               

Net loss

  —          —          —          —          —          —          (27,651     (27,651   $ (27,651

Contribution from FBR TRS Holdings, Inc

  —          —          34        —          —          —          —          34     

Issuance of common stock, net of forfeitures

  20,940        21        100,852        (391     (1,540     —          —          98,942     

Repurchase of common stock

  (16,667     (17     (73,455     —          —          —          —          (73,472  

Stock compensation expense for options granted to purchase common stock

  —          —          5,562        —          —          —          —          5,562     

Issuance of restricted stock units

  —          —          —          —          12,210        —          —          12,210     

Other comprehensive income:

                 

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

  —          —          —          —          —          147        —          147        147   
                       

Comprehensive loss

                  $ (27,504
                                                                     

Balances at December 31, 2009

  64,065      $ 64      $ 429,052      $ (391   $ 19,979      $ (71   $ (129,134   $ 319,499     
                                                               

Net loss

  —          —          —          —          —          —          (34,029     (34,029   $ (34,029

Issuance of common stock, net of forfeitures

  545        —          4,039        (335     (545     —          —          3,159     

Repurchase of common stock

  (2,768     (2     (14,272     —          —          —          —          (14,274  

Stock compensation expense for options granted to purchase common stock

  —          —          2,561        —          —          —          —          2,561     

Issuance of restricted stock units

  —          —          —          —          11,481        —          —          11,481     

Other comprehensive income:

                 

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

  —          —          —          —          —          39        —          39        39   
                       

Comprehensive loss

                  $ (33,990
                                                                     

Balances at June 30, 2010

  61,842      $ 62      $ 421,380      $ (726   $ 30,915      $ (32   $ (163,163   $ 288,436     
                                                               

See notes to consolidated financial statements.

 

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Table of Contents

FBR CAPITAL MARKETS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

     Six Months Ended
June 30,
 
     2010     2009  

Cash flows from operating activities:

    

Net loss

   $ (34,029   $ (37,911

Adjustments to reconcile net loss to net cash used in operating activities:

    

Depreciation and amortization

     4,014        5,624   

Stock compensation

     11,025        9,300   

Net investment (income) loss from long-term and mortgage-backed securities

     (48     78   

Impairment of intangible assets

     —          5,350   

Other

     791        574   

Changes in operating assets:

    

Receivables:

    

Brokers, dealers and clearing organizations

     64,349        (12,174

Investment banking

     (5,833     (3,041

Asset management fees

     (54     133   

Affiliates

     (99     2,328   

Interest, dividends and other

     3,329        19,685   

Trading securities, at fair value

     (10,365     (28,420

Prepaid expenses and other assets

     (5,777     3,187   

Changes in operating liabilities:

    

Trading securities sold but not yet purchased, at fair value

     9,880        15,799   

Accrued compensation and benefits

     (36,230     (16,967

Accounts payable, accrued expenses and other liabilities

     695        (3,859

Brokers, dealers and clearing organizations

     (53,525     4,704   
                

Net cash used in operating activities

     (51,877     (35,610
                

Cash flows from investing activities:

    

Receipt of principal payments on mortgage-backed securities

     —          2,441   

Proceeds from sales of mortgage-backed securities

     —          450,396   

Purchases of long-term investments

     (32,469     —     

Proceeds from sales of and distributions from investments

     19,559        7,633   

Securities sold but not yet purchased, net

     (7,446     —     

Purchases of furniture, equipment, software, and leasehold improvements

     (2,485     (211

Acquisition of net assets

     (488     —     
                

Net cash (used in) provided by investing activities

     (23,329     460,259   
                

Cash flows from financing activities:

    

Repayments of repurchase agreements, net

     —          (416,037

Repurchases of common stock

     (14,274     (73,561

Proceeds from sales of common stock

     1,817        90,616   
                

Net cash used in financing activities

     (12,457     (398,982
                

Net (decrease) increase in cash and cash equivalents

     (87,663     25,667   

Cash and cash equivalents, beginning of period

     275,506        207,801   
                

Cash and cash equivalents, end of period

   $ 187,843      $ 233,468   
                

Supplemental Cash Flow Information:

    

Cash payments for interest

   $ —        $ 255   

Cash payments for taxes

   $ 5,088      $ 18   

See notes to consolidated financial statements.

 

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Table of Contents

FBR CAPITAL MARKETS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

(Unaudited)

 

1. Basis of Presentation:

The consolidated financial statements of FBR Capital Markets Corporation 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, 2010 and 2009 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, 2009.

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, when available, market information, 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.

Certain amounts in the consolidated financial statements and notes for prior periods 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 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.

 

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Table of Contents

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

Long-term investments, at fair value—The Company’s long-term investments, at fair value, consist of marketable equity securities and, from time-to-time, investment securities—marked-to-market. The Company’s marketable equity securities are classified within Level 1 of the fair value hierarchy as they are valued using quoted market prices from an exchange. From time-to-time, as applicable, investment securities—marked-to-market will consist of warrants and equity securities received in connection with certain capital raising transactions that are held in a broker-dealer subsidiary. Warrants are generally exercisable at the respective offering price of the transaction. Such warrants and equity securities are classified within Level 3 of the fair value hierarchy as the value is determined by management based on valuation models and enterprise value, taking into consideration the financial performance of the companies relative to projections, trends within sectors, underlying business models and expected exit timing and strategy.

Trading securities and securities sold but not yet purchased, at fair value—The Company’s trading securities, at fair value, are securities owned by the Company’s broker-dealer subsidiaries and consist of marketable and non-public equity, convertible and fixed income debt instruments, and listed options. The Company’s securities sold but not yet purchased, at fair value, are trading securities sold by the Company’s broker-dealer subsidiaries and exchange-traded funds sold as part of the Company’s principal investing segment and consist of marketable equity, convertible and fixed income debt instruments, listed options, and exchange-traded funds. The Company classifies marketable equity, listed options, and exchange-traded funds within Level 1 of the fair value hierarchy because quoted market prices are used to value these securities. Convertible and fixed income debt instruments are classified 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. Non-public equity and debt 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 market trading activity, which may be reported by The PORTAL MarketSM, a subsidiary of The NASDAQ Stock Market, Inc.

 

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Fair Value Hierarchy

The following tables set forth, by level within the fair value hierarchy, financial instruments and long-term investments accounted for under ASC 820 as of June 30, 2010 and December 31, 2009. 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,
2010
   Level 1    Level 2    Level 3

Long-term investments, at fair value:

           

Marketable equity securities

   $ 160    $ 160    $ —      $ —  
                           

Trading securities, at fair value:

           

Marketable and non-public equity securities

   $ 13,457    $ 13,306    $ —      $ 151

Listed options

     1,285      1,285      —        —  

Convertible and fixed income debt instruments

     87,626      —        87,623      3
                           

Total

   $ 102,368    $ 14,591    $ 87,623    $ 154
                           

Securities sold but not yet purchased, at fair value:

           

Marketable equity securities and exchange-traded funds

   $ 26,487    $ 26,487    $ —      $ —  

Listed options

     4,458      4,458      —        —  

Convertible and fixed income debt instruments

     23,374      —        23,374      —  
                           

Total

   $ 54,319    $ 30,945    $ 23,374    $ —  
                           

As of June 30, 2010, financial assets measured and reported at fair value on a recurring basis and classified within Level 3 were $154, or 0.04% of the Company’s total assets at that date.

 

     December 31,
2009
   Level 1    Level 2    Level 3

Long-term investments, at fair value:

           

Marketable equity securities

   $ 317    $ 317    $ —      $ —  
                           

Trading securities, at fair value:

           

Marketable and non-public equity securities

   $ 35,941    $ 20,463    $ —      $ 15,478

Listed options

     4,086      4,086      —        —  

Convertible and fixed income debt instruments

     54,451      —        54,448      3
                           

Total

   $ 94,478    $ 24,549    $ 54,448    $ 15,481
                           

Securities sold but not yet purchased, at fair value:

           

Marketable equity securities and exchange-traded funds

   $ 35,530    $ 35,530    $ —      $ —  

Listed options

     1,098      1,098      —        —  

Convertible and fixed income debt instruments

     15,041      —        15,041      —  
                           

Total

   $ 51,669    $ 36,628    $ 15,041    $ —  
                           

As of December 31, 2009, financial assets measured and reported at fair value on a recurring basis and classified within Level 3 were $15,481, 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 and six months ended June 30, 2010 and 2009. Realized and unrealized gains (losses) on trading securities are included in “principal transactions” in the statement of operations. As of June 30, 2010 and 2009, the Company did not have any net unrealized gains (losses) included in accumulated other comprehensive income on Level 3 financial assets.

 

     Three Months
Ended June 30,
 
     2010     2009  

Beginning balance, April 1

   $ 9,441      $ 3,038   

Total net losses (realized/unrealized)

    

Included in earnings

     49        112   

Included in other comprehensive income

     —          —     

Purchases

     52,942        4,509   

Sales

     (62,278     (5,545
                

Ending balance, June 30

   $ 154      $ 2,114   
                

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

   $ 8      $ (51
                
     Six Months
Ended June 30,
 
     2010     2009  

Beginning balance, January 1

   $ 15,481      $ 3,207   

Total net losses (realized/unrealized)

    

Included in earnings

     (90     (2

Included in other comprehensive income

     —          —     

Purchases

     124,621        67,015   

Sales

     (139,858     (68,106
                

Ending balance, June 30

   $ 154      $ 2,114   
                

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

   $ 3      $ (156
                

There were no transfers of securities in to, or out of, Level 3 financial assets during the three and six months ended June 30, 2010.

Long-term Investments, at Fair Value

Long-term investments, at fair value, consisted of the following as of the dates indicated:

 

     June 30,
2010
   December 31,
2009

Long-term investments, at fair value:

     

Marketable equity securities

   $ 160    $ 317
             

As of June 30, 2010 and December 31, 2009, the Company had investments in marketable equity securities held by other than the Company’s broker-dealer subsidiaries that are classified as available-for-sale securities. In accordance with ASC 320, “Investments—Debt and Equity Securities”, these securities are carried at fair value

 

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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, 2010
     Cost
Basis
   Unrealized     Fair Value
      Gains    Losses(1)    

Marketable equity securities

   $ 192    $    (32   $ 160
     December 31, 2009
     Cost
Basis
   Unrealized     Fair Value
      Gains    Losses(1)    

Marketable equity securities

   $ 388    $    (71   $ 317

 

(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. 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, 2010 and 2009, the Company did not record any other-than-temporary impairment losses in the statement of operations relating to marketable equity securities. As of June 30, 2010, the Company held one marketable equity security in an unrealized loss position. Based on the limited duration of the unrealized loss and consideration of market activity during the three months ended June 30, 2010, the Company does not consider this investment to be other-than-temporarily impaired as of June 30, 2010.

During the three and six months ended June 30, 2010, the Company received $206 from sales of marketable equity securities resulting in gross gains of $10. During the three and six months ended June 30, 2009, the Company received $731 from sales of marketable equity securities resulting in gross gains of $57.

During the three and six months ended June 30, 2009, the Company received $450,396 from sales of mortgage-backed securities, which had been previously impaired as of December 31, 2008, resulting in additional gross losses of $1,502.

Trading Securities and Securities Sold but Not Yet Purchased, at Fair Value

Institutional brokerage trading related securities consisted of the following as of the dates indicated:

 

     June 30, 2010    December 31, 2009
     Owned    Sold But
Not Yet
Purchased
   Owned    Sold But
Not Yet
Purchased

Marketable and non-public equity securities and exchange-traded funds

   $ 13,457    $ 26,487    $ 35,941    $ 35,530

Listed options

     1,285      4,458      4,086      1,098

Convertible and fixed income debt instruments

     87,626      23,374      54,451      15,041
                           
   $ 102,368    $ 54,319    $ 94,478    $ 51,669
                           

Securities sold but not yet purchased represent obligations of the Company to deliver the specified security at the contracted price, and thereby create a liability to purchase the security in the market at prevailing prices. These transactions when unrelated to over-allotments result in off-balance-sheet risk as the Company’s ultimate obligation to satisfy the sale of securities sold but not yet purchased may exceed the current value recorded in the consolidated balance sheets.

 

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Other Long-Term Investments

Other long-term investments consisted of the following as of the dates indicated:

 

     June 30,
2010
   December 31,
2009

Non-public equity securities

   $ 57,654    $ 33,662

Investment funds

     1,184      9,329

Note receivable

     317      312
             
   $ 59,155    $ 43,303
             

The Company evaluated its portfolio of non-public equity securities, 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 in non-public equity securities, the Company recorded no impairment losses during the three and six months ended June 30, 2010 and 2009.

During the three and six months ended June 30, 2010, the Company received $623 and $9,130, respectively, from sales of, or distributions from, non-public equity securities, resulting in gross gains of $176 and $179, respectively. During the three and six months ended June 30, 2009, the Company received $1,598 and $1,747, respectively, from sales of, or distributions from, non-public equity securities, resulting in gross gains of $175 and $324, respectively.

During the three and six months ended June 30, 2010, the Company received $4,919 and $8,223, respectively, from the redemption of investments in investment funds. During the three and six months ended June 30, 2009, the Company received $4,346 and $5,154, respectively, from the redemption of investments in investment funds.

 

3. Income Taxes:

During the three and six months ended June 30, 2010, the Company recorded a tax provision of $13,612 and a tax benefit of $(2,667), respectively. During the three and six months ended June 30, 2009, the Company recorded tax provisions of $104 and $713, respectively. The Company’s effective tax rates for the three and six months ended June 30, 2010 were (112.0%) and 7.3%, respectively. The Company’s effective tax rates for the three and six months ended June 30, 2009 were (0.5%) and (1.9%), respectively. The effective tax rates for the three and six months ended June 30, 2010 and 2009 differed from the statutory tax rates primarily due to the full valuation allowance on the deferred tax benefit of the book losses incurred in these periods and as a result of the benefit of tax losses expected to be realized in these periods. Also, the Company’s effective tax rate for the three months ended June 30, 2010 reflects a change in the estimated effective tax rate for the full year from the first quarter of 2010 based on changes in the Company’s forecasted annual taxable and book income.

As of June 30, 2010, 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. (“FBR & Co.”), 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”). Additionally, FBR Capital Markets International, Ltd. (“FBRIL”) is registered with the Financial Services Authority (“FSA”) of the United Kingdom. As such, they are subject to the minimum net capital requirements promulgated by the SEC and FSA. As of June 30, 2010, FBR & Co. had net capital of $42,630, which was $38,987 in excess of its required net capital of $3,643. As of June 30, 2010, FBRIL had net capital in excess of required amounts.

 

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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, 2010 and 2009, 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, 2010
    Three Months Ended
June 30, 2009
 
     Basic     Diluted     Basic     Diluted  

Weighted average shares outstanding:

        

Common stock (in thousands)

     62,957        62,957        54,391        54,391   

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

     —          —          —          —     
                                

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

     62,957        62,957        54,391        54,391   
                                

Net loss applicable to common stock

   $ (25,767   $ (25,767   $ (21,744   $ (21,744
                                

Net loss per common share

   $ (0.41   $ (0.41   $ (0.40   $ (0.40
                                
     Six Months Ended
June 30, 2010
    Six Months Ended
June 30, 2009
 
     Basic     Diluted     Basic     Diluted  

Weighted average shares outstanding:

        

Common stock (in thousands)

     63,489        63,489        56,741        56,741   

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

     —          —          —          —     
                                

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

     63,489        63,489        56,741        56,741   
                                

Net loss applicable to common stock

   $ (34,029   $ (34,029   $ (37,911   $ (37,911
                                

Net loss per common share

   $ (0.54   $ (0.54   $ (0.67   $ (0.67
                                

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,
     2010    2009    2010    2009

Stock Options—Employees and directors

   8,904    6,801    8,904    6,801

Stock Options—Non-employee

   3,256    3,102    3,256    3,102

Restricted Stock, unvested

   854    1,444    854    1,444

Restricted Stock Units, unvested

   9,309    6,194    9,309    6,194
                   
   22,323    17,541    22,323    17,541
                   

 

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6. Commitments and Contingencies:

As of June 30, 2010, 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 and arbitrations 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 or results of operations 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. FBR & Co. has been named as a defendant in a small number of securities claims involving investment banking clients of FBR & Co. as a result of FBR & Co.’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 FBR & Co. 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 FBR & Co. 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 FBR & Co.) 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 now includes 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 FBR & Co. relate 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 seek restitution, unspecified compensatory damages and reimbursement of certain costs and expenses. Although FBR & Co. 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 FBR & Co. receives from TMI. On September 22, 2008, FBR & Co. filed a motion to dismiss the consolidated class action complaint as to FBR & Co. The District Court granted that motion on January 27, 2010. On July 5, 2010, the District Court ruled that it would allow the plaintiffs to file a motion for leave to amend the complaint; the District Court is also allowing plaintiffs to file a motion for reconsideration of the Court’s order dismissing the amended complaint. FBR will oppose those motions. Although these cases involving FBR & Co. 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

 

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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

During the three and six months ended June 30, 2010, the Company repurchased 608,563 and 2,768,385 shares, respectively, of its common stock in open market transactions at a weighted average share price of $4.20 and $5.16 per share, respectively, for a total cost of $2,556 and $14,274, respectively. See subsequent events discussion in Note 11 regarding an increase in the Company’s share repurchase authorization subsequent to June 30, 2010.

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, 2010, the Company recognized compensation expense of $22 and $277, respectively. For the three and six months ended June 30, 2009, the Company recognized compensation (credit) expense of $(71) and $249, respectively.

Partner Leveraged Stock Purchase Program

The Company initiated the Partner Leveraged Stock Purchase Program (“PLSPP”) in December 2009. Under the PLSPP, non-executive officer employees who are members of the Company’s Partnership Group as well as the Company’s Chief Financial Officer and General Counsel were granted the right to purchase shares of the Company’s common stock on four specific offering dates during the fourth quarter of 2009 and the first half of 2010. Each participant was initially granted the right to purchase either 25,000 shares or 50,000 shares. The Company has offered to provide a full recourse loan to each non-executive officer participant for up to 50% of the aggregate purchase price, collateralized by the shares purchased, bearing interest at market rates, and maturing three years from the date of issuance. For each share purchased by the participant, the Company would grant two options (three options in the case of the Company’s Chief Financial Officer and General Counsel) to purchase the Company’s common stock under the FBR Capital Markets Long-Term Incentive Plan (described below) that are subject to a 3-year cliff vesting requirement. For the three and six months ended June 30, 2010, participants purchased 197,900 and 264,535 shares, respectively, for an aggregate purchase price of $904 and $1,286, respectively. As of June 30, 2010, the Company had loans outstanding to participants of $726, including accrued interest.

Stock Compensation Plans

FBR Capital Markets Corporation 2006 Long-Term Incentive Plan (“FBR Capital Markets Long-Term Incentive Plan”)

Under the FBR Capital Markets 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 Capital Markets 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.

 

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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    Six Months Ended
     June 30,
2010
   June 30,
2009
   June 30,
2010
   June 30,
2009

Stock options

   $ 1,044    $ 1,513    $ 2,083    $ 2,663

Restricted shares

   $ 698    $ 1,266    $ 1,820    $ 2,349

RSUs

   $ 3,254    $ 2,204    $ 6,034    $ 3,962

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

 

     Three Months Ended June 30, 2010    Six Months Ended June 30, 2010
     Stock
Options
   Restricted
Shares
   RSUs    Stock
Options
   Restricted
Shares
   RSUs

Stock-based award issuances

     613,260      —        295,839      1,513,530      —        2,511,444

Grant date fair value per share

   $ 1.70    $ —      $ 4.01    $ 2.19    $ —      $ 5.39

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. Due to the relatively short period in which the Company has been publicly-traded, the Company has not based its volatility assumption solely on historical data. The Company has used a combination of its historical volatility, historical industry comparisons, and other market data in order to determine the volatility assumption. The risk-free interest rate is based on the rates of the U.S. Treasury with similar maturities as the expected life of the award. The expected life of the award is based on the length of time from the grant date to the midpoint of the vesting date and the contractual expiration date of the award. The Company uses this methodology for determining expected life as the Company does not have sufficient historical data to estimate an expected life as a majority of the initial stock options issued by the Company since its inception became exercisable in the past year. The dividend yield is based on the expected dividend payout over the expected life of the award. The following weighted average assumptions used for options granted for the period indicated:

 

     Three Months
Ended

June 30, 2010
    Six Months
Ended

June 30, 2010
 

Volatility

   45.0   45.0

Risk-free interest rate

   2.27   2.45

Expected life

   4.1 years      5.1 years   

Dividend yield

   —        —     

The fair value of each RSU with a market condition is estimated on the date of grant using a lattice-pricing model. The methodology for determining the assumptions used for these valuations is similar to those described above for stock options. The assumptions used for 76,000 RSUs with a market condition granted during the six months ended June 30, 2010 were a volatility of 45.0%, risk-free interest rate of 1.43% and an expected term based on the applicable service condition. No RSUs with a market condition were granted during the three months ended June 30, 2010. The assumptions used for 64,002 RSUs with a market condition granted during the three and six months ended June 30, 2009 were a volatility of 56.8%, risk-free interest rate of 1.89% and an expected term based on the applicable service condition.

 

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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, 2010
     Stock
Options
   Restricted
Shares
   RSUs

Unrecognized compensation

   $ 9,303    $ 3,289    $ 27,689

Unvested awards

     5,745,862      853,950      9,309,120

Weighted average vesting period

     3.2 years      1.6 years      3.3 years

In addition, as part of the Company’s satisfaction of incentive compensation earned for past service under the Company’s variable compensation programs, employees may receive RSUs in lieu of cash payments. These RSUs are issued to an irrevocable trust and are not returnable to the Company. In settlement of such accrued incentive compensation, the Company granted the following RSUs for the periods indicated:

 

     Three Months
Ended

June 30, 2010
   Six Months
Ended

June  30, 2010

RSU issuances

     129,190      1,112,884

Aggregate grant date fair value

   $ 611    $ 6,553

 

8. Related Party Transactions:

In October 2009, Arlington Asset Investment Corp. (“Arlington Asset”) and related affiliates (collectively, the Company’s former majority shareholder), sold 14,755,017 shares of the Company’s common stock in an underwritten public offering. As a result of this sale, Arlington Asset no longer maintains an ownership interest in the Company. Subsequent to this sale, the Company’s relationship with Arlington Asset has been limited to subleasing certain office space to Arlington Asset at a market rate. The paragraphs that follow provide additional detail regarding our historical relationship with Arlington Asset, including amounts reflected in our 2009 financial statements.

In July 2006, the Company entered into various inter-company and other contractual arrangements with Arlington Asset and Crestview Partners, L.P., a New York-based private equity firm (“Crestview”), including a professional services agreement and other related party contractual arrangements. In May 2009, the Company entered into a stock repurchase agreement with Arlington Asset (“Repurchase Agreement”) pursuant to which, among other things, the Company repurchased 16,667,000 shares of its common stock at a share price of $4.35. As a result of this transaction, Arlington Asset ceased being the majority shareholder of the Company. Concurrently, the Company and Arlington Asset agreed to terminate various inter-company and other contractual arrangements between them.

Services Agreement

Under the services agreement with Arlington Asset, the Company was to provide or cause one or more of its subsidiaries to provide to Arlington Asset certain services, including various corporate overhead services, for fees based on costs incurred by the Company and its subsidiaries in providing the services. Similarly, Arlington Asset was to provide to the Company and its subsidiaries under the same services agreement certain services, including certain asset management services, for fees based on costs incurred by Arlington Asset in providing the services. The costs being allocated under each of these agreements primarily consisted of total compensation and benefits of the employees providing the services, professional services, including consulting and legal fees, and facility costs for the employees providing the services.

 

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This services agreement was terminated in connection with the Repurchase Agreement in May 2009 and replaced by a transition services agreement pursuant to which the Company agreed to provide Arlington Asset certain services for a fixed dollar amount. The services that the Company agreed to provide included the following: employee benefit services, human resources and financial related services, data and network services and infrastructure, and facilities services, in each case subject to reductions in services (and associated costs) as requested by Arlington Asset. Arlington Asset agreed to use all commercially reasonable efforts to transition away from the services provided by the Company as soon as practicable and, in any event, no later than one year after the date of agreement. As of December 31, 2009, all such services had been transitioned between the entities.

In connection with the services agreement, during the three and six months ended June 30, 2009, the Company’s operating expenses are reported net of $113 and $323, respectively, representing overhead costs allocated to Arlington Asset.

Professional Services Agreement

Under the professional services agreement with 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 September 2008, the Company and Crestview agreed to issue 502,268 options to purchase common shares of the Company to Crestview Advisors L.L.C. in lieu of cash payments for the strategic advisory fee for the period beginning October 1, 2008 through December 31, 2009.

In June 2010, the Company and Crestview agreed to amend the professional services agreement to allow Crestview the ability to elect to receive a portion of their fee in restricted stock and/or options to purchase shares of the Company’s common stock. Based on Crestview’s election, in June 2010, the Company issued 153,846 such options to Crestview Advisors, L.L.C. valued at $200. The remaining $800 of the 2010 strategic advisory fee will be payable in cash. During the three and six months ended June 30, 2010, the Company recognized $250 and $500, respectively, of expense associated with this agreement. During the three and six months ended June 30, 2009, the Company recognized $236 and $472, respectively, of expense associated with this agreement.

Receivables and Payables

From time to time, the Company has made advances to affiliates that were used for general operating purposes and are settled in cash on a regular basis. Receivables from affiliates, including private equity and hedge funds, totaled $666 and $567 as of June 30, 2010 and December 31, 2009, respectively.

 

9. Segment Information:

The Company considers its capital markets, asset management 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. Asset management includes the Company’s fee-based asset management operations. Principal investing includes investments in merchant banking and other long-term investments.

 

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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. The Company’s revenues from foreign operations totaled $2,727 and $2,467 for the three months ended June 30, 2010 and 2009, respectively. The Company’s revenues from foreign operations totaled $5,676 and $5,236 for the six months ended June 30, 2010 and 2009, respectively. The following tables illustrate the financial information for the Company’s segments for the periods indicated:

 

     Three Months Ended June 30, 2010  
     Capital
Markets
    Asset
Management
    Principal
Investing
    Total  

Revenues, net of interest expense:

        

Investment banking

   $ 40,443      $ —        $ —        $ 40,443   

Institutional brokerage

     24,284        —          —          24,284   

Asset management fees

     —          3,815        —          3,815   

Net investment income

     —          —          46        46   

Net interest income, dividends and other

     607        5        506        1,118   
                                

Total

     65,334        3,820        552        69,706   
                                

Operating Expenses:

        

Variable

     28,258        1,924        (13     30,169   

Fixed

     48,962        2,714        16        51,692   
                                

Total

     77,220        4,638        3        81,861   
                                

Pre-tax (loss) income

   $ (11,886   $ (818   $ 549      $ (12,155
                                

Compensation and benefits:

        

Variable

   $ 18,210      $ 1,100      $ (13   $ 19,297   

Fixed

     30,475        1,495        24        31,994   
                                

Total

   $ 48,685      $ 2,595      $ 11      $ 51,291   
                                
     Three Months Ended June 30, 2009  
     Capital
Markets
    Asset
Management
    Principal
Investing
    Total  

Revenues, net of interest expense:

        

Investment banking

   $ 8,657      $ —        $ —        $ 8,657   

Institutional brokerage

     33,444        —          —          33,444   

Asset management fees

     —          3,232        —          3,232   

Net investment income

     —          —          1,369        1,369   

Net interest income, dividends and other

     267        238        121        626   
                                

Total

     42,368        3,470        1,490        47,328   
                                

Operating Expenses:

        

Variable

     17,079        2,306        20        19,405   

Fixed

     40,913        3,017        283        44,213   

Impairment of intangible assets

     —          5,350        —          5,350   
                                

Total

     57,992        10,673        303        68,968   
                                

Pre-tax (loss) income

   $ (15,624   $ (7,203   $ 1,187      $ (21,640
                                

Compensation and benefits:

        

Variable

   $ 11,552      $ 453      $ 11      $ 12,016   

Fixed

     21,987        1,413        137        23,537   
                                

Total

   $ 33,539      $ 1,866      $ 148      $ 35,553   
                                

 

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     Six Months Ended June 30, 2010  
     Capital
Markets
    Asset
Management
    Principal
Investing
    Total  

Revenues, net of interest expense:

        

Investment banking

   $ 51,588      $ —        $ —        $ 51,588   

Institutional brokerage

     51,814        —          —          51,814   

Asset management fees

     —          7,143        —          7,143   

Net investment income

     —          —          48        48   

Net interest income, dividends and other

     1,004        10        2,316        3,330   
                                

Total

     104,406        7,153        2,364        113,923   
                                

Operating Expenses:

        

Variable

     48,070        3,723        18        51,811   

Fixed

     92,734        5,580        494        98,808   
                                

Total

     140,804        9,303        512        150,619   
                                

Pre-tax (loss) income

   $ (36,398   $ (2,150   $ 1,852      $ (36,696
                                

Compensation and benefits:

        

Variable

   $ 31,804      $ 2,113      $ 14      $ 33,931   

Fixed

     56,795        3,001        308        60,104   
                                

Total

   $ 88,599      $ 5,114      $ 322      $ 94,035   
                                
     Six Months Ended June 30, 2009  
     Capital
Markets
    Asset
Management
    Principal
Investing
    Total  

Revenues, net of interest expense:

        

Investment banking

   $ 16,554      $ —        $ —        $ 16,554   

Institutional brokerage

     73,006        —          —          73,006   

Asset management fees

     —          6,159        —          6,159   

Net investment loss

     —          —          (78     (78

Net interest income, dividends and other

     489        350        499        1,338   
                                

Total

     90,049        6,509        421        96,979   
                                

Operating Expenses:

        

Variable

     36,195        4,329        24        40,548   

Fixed

     80,819        6,677        783        88,279   

Impairment of intangible assets

     —          5,350        —          5,350   
                                

Total

     117,014        16,356        807        134,177   
                                

Pre-tax loss

   $ (26,965   $ (9,847   $ (386   $ (37,198
                                

Compensation and benefits:

        

Variable

   $ 26,116      $ 1,006      $ 11      $ 27,133   

Fixed

     42,144        3,137        137        45,418   
                                

Total

   $ 68,260      $ 4,143      $ 148      $ 72,551   
                                

 

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10. Recent Accounting Pronouncements:

In January 2010, the Financial Accounting Standards Board (“FASB”) required additional disclosure requirements for fair value measurements under ASC 820. The new pronouncement requires a reporting entity to disclose the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. In addition, the reconciliation for fair value measurements using significant unobservable inputs (Level 3) should present separately information about purchases, sales, issuances and settlements. Previous disclosure requirements allowed for the net presentation of these activities within a single item on the reconciliation. The adoption did not have a material impact on the Company’s financial statements.

In June 2009, the FASB issued changes to the guidance for accounting for transfers of financial assets. These changes improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. These changes are effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The recognition and measurement provisions of these changes shall be applied to transfers that occur on or after the effective date. The adoption of these changes did not have a material impact on the Company’s financial statements.

In June 2009, the FASB issued changes to the guidance for variable interest entities. These changes are to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. These changes are effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. In January 2010, the FASB issued a deferral of these requirements for asset managers that are not obligated to fund significant losses incurred by the variable interest entities. The adoption of these changes did not have a material impact on the Company’s financial statements.

 

11. Subsequent Events:

In July 2010, 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 5,650,500 shares as no share repurchases have been made subsequent to June 30, 2010.

 

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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 Capital Markets Corporation 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, 2009.

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, 2009. 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, 2009.

Business Environment

The second quarter of 2010 demonstrated the significant uncertainty that still surrounds the strength of the economic recovery. A weak domestic housing market, a high domestic unemployment rate, the effect of the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act, and the global impact of European financial market instability resulting from high debt levels of certain members of the European Union have all contributed to this unsettled economic environment.

As previously disclosed, we expect economic conditions to remain challenging and volatile throughout the year, and our ability to complete investment banking transactions may continue to be negatively affected by uncertainty in the capital markets.

Executive Summary

For the three months ended June 30, 2010, our total revenues, net of interest expense, were $69.7 million, our pre-tax loss was $12.2 million and our net loss was $25.8 million, compared to total net revenues of $47.3 million, a pre-tax loss of $21.6 million and a net loss of $21.7 million for the three months ended June 30, 2009.

Included in the three months ended June 30, 2010 net loss is a $13.6 million tax provision that substantially reverses the tax benefit recorded in the first quarter of 2010 as compared to a $0.1 million tax provision for the second quarter of 2009. Our interim tax provision is recorded pursuant to the requirements of ASC 740, which prescribes an effective tax rate approach for calculating tax provisions in interim periods based on forecasted annual taxable and book income. Changes to our tax provision during interim periods within a year are primarily the result of changes in our projected effective tax rate for the full year.

For the six months ended June 30, 2010, our total revenues, net of interest expense, were $113.9 million, our pre-tax loss was $36.7 million and our net loss was $34.0 million, compared to total net revenues of $97.0 million, a pre-tax loss of $37.2 million and a net loss of $37.9 million for the six months ended June 30, 2009. Included in the six months ended June 30, 2010 net loss is a $2.7 million tax benefit as compared to a $0.7 million tax provision for the six months ended June 30, 2009. Our tax (benefit) provision for the six months ended June 30, 2010 and 2009 is recorded pursuant to an effective tax rate approach for calculating tax provisions in interim periods based on forecasted annual taxable and book income.

Our results for the three and six months ended June 30, 2010 include severance charges of $4.3 million and $5.3 million, respectively. These charges are the result of steps taken that will reduce our annual fixed compensation cost run rate by approximately $15.0 million and better position our cost structure for future periods. These charges reflect headcount reductions of more than 15%, after which total headcount for us will be approximately 500 employees.

 

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The following is an analysis of our operating results by segment for the three and six months ended June 30, 2010 and 2009.

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,
 
     2010     2009  

Revenues, net of interest expense:

    

Investment banking

   $ 40,443      $ 8,657   

Institutional brokerage

     24,284        33,444   

Net interest income, dividends and other

     607        267   
                

Total

     65,334        42,368   
                

Operating Expenses:

    

Variable

     28,258        17,079   

Fixed

     48,962        40,913   
                

Total

     77,220        57,992   
                

Pre-tax loss

   $ (11,886   $ (15,624
                

The pre-tax loss from our capital markets segment decreased from $15.6 million for the three months ended June 30, 2009 to $11.9 million for the three months ended June 30, 2010. The decrease in pre-tax loss is primarily attributable to a $31.7 million increase in our investment banking revenues to $40.4 million for the three months ended June 30, 2010 from $8.7 million for the three months ended June 30, 2009, primarily as a result of fees earned from a June 2010 private placement that in-total raised in excess of $1.2 billion of equity capital.

The increase in investment banking revenues was partially offset by a $9.1 million decrease in institutional brokerage revenues to $24.3 million for the three months ended June 30, 2010 as compared to $33.4 million for the three months ended June 30, 2009. This decrease is primarily attributable to trading losses from our convertible securities and credit trading desks in 2010 as compared to trading gains from our convertible securities trading desk in 2009, as well as decreased revenues from our equities trading desk as a result of a decrease in trading volume during the three months ended June 30, 2010, particularly in June 2010. The trading losses in 2010 were the result of market volatility primarily during April and May 2010. These 2010 trading losses and reduced revenues were partially offset by commission revenues from our credit and listed-options trading desks in the second quarter of 2010 as these businesses were launched during the second half of 2009.

Fixed expenses increased $8.0 million, or 19.7%, in 2010, attributable to severance costs of $3.9 million and an increase in compensation costs, which reflects the addition of senior employees to our investment banking group and the expansion of our trading platform noted above. Variable expenses increased $11.2 million, or 65.5%, in 2010 reflecting increased investment banking activity, including increased transaction related expenses.

 

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     Six Months Ended
June 30,
 
     2010     2009  

Revenues, net of interest expense:

    

Investment banking

   $ 51,588      $ 16,554   

Institutional brokerage

     51,814        73,006   

Net interest income, dividends and other

     1,004        489   
                

Total

     104,406        90,049   
                

Operating Expenses:

    

Variable

     48,070        36,195   

Fixed

     92,734        80,819   
                

Total

     140,804        117,014   
                

Pre-tax loss

   $ (36,398   $ (26,965
                

The pre-tax loss from our capital markets segment increased from $27.0 million for the six months ended June 30, 2009 to a pre-tax loss of $36.4 million for the six months ended June 30, 2010. The increase in pre-tax loss is primarily attributable to an $11.9 million, or 14.7%, increase in fixed expenses as well as in increase in non-compensation variable expenses, primarily investment banking deal expenses that are not proportionate to the increase in revenues. The increase in fixed expenses is attributable to severance costs of $4.9 million and an increase in compensation costs, reflecting the addition of senior employees to our investment banking group and the expansion of our trading platform. Variable expenses increased $11.9 million, or 32.8%, in 2010 as a result of increased investment banking activity, including increased transaction related expenses.

Investment banking revenues increased $35.0 million for the six months ended June 30, 2010 to $51.6 million as compared to $16.6 million for the six months ended June 30, 2009. This increase is a result of increased capital raising activity; including fees earned from a June 2010 private placement that in-total raised in excess of $1.2 billion of equity capital.

The increase in investment banking revenues was partially offset by a $21.2 million decrease in our institutional brokerage revenues, which decreased to $51.8 million for the six months ended June 30, 2010 as compared to $73.0 million for the six months ended June 30, 2009. This decrease is primarily attributable to a reduction in revenues from our convertible securities and equities trading desks in 2010 partially offset by revenues from our credit and listed-options trading desks in the first six months of 2010 following the launch of those two businesses during the second half of 2009. The decrease in institutional brokerage revenues was primarily the result of trading losses from our convertible securities and credit trading desks in 2010 as compared to trading gains from our convertible securities trading desk for the same period in 2009, as well as decreased commission revenues from our convertible securities and equities trading desks as a result of lower trading volumes.

 

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Asset Management

Our asset management segment consists primarily of the management of The FBR Funds, a family of mutual funds. Our mutual fund assets under management decreased 6.7% to $1.4 billion at June 30, 2010 from $1.5 billion at March 31, 2010 and increased 7.7% from $1.3 billion at December 31, 2009. The decrease in mutual fund assets under management during the three months ended June 30, 2010 is primarily the result of a 10% decline in market value, offset partially by net inflows of $30.8 million. The increase in mutual fund assets under management during the six months ended June 30, 2010 is primarily the result of net inflows of $126.4 million, which included the addition of assets from the acquisition of the mutual fund operations of the Armed Forces Benefits Association 5Star Funds, offset partially by a 5% decline in market value. The following tables provide a summary of our results within the asset management segment (dollars in thousands).

 

     Three Months Ended
June 30,
 
     2010     2009  

Revenues, net of interest expense:

    

Asset management fees

   $ 3,815      $ 3,232   

Other

     5        238   
                

Total

     3,820        3,470   
                

Operating Expenses:

    

Variable

     1,924        2,306   

Fixed

     2,714        3,017   

Impairment of intangible assets

     —          5,350   
                

Total

     4,638        10,673   
                

Pre-tax loss

   $ (818   $ (7,203
                

The pre-tax loss from our asset management segment decreased from $7.2 million for the three months ended June 30, 2009 to a pre-tax loss of $0.8 million for the three months ended June 30, 2010. The pre-tax loss for the three months ended June 30, 2009 included a $5.4 million impairment of an intangible asset related to a management contract for a money market mutual fund, which is not comparable to 2010. The decrease in pre-tax loss is a result of decreases in both fixed and variable expenses as well as increased asset management fees. The decreases in fixed and variable expenses were the result of non-compensation cost reduction initiatives, which included the decision to terminate a sub-advisory agreement related to the FBR Focus Fund in August 2009. Fixed expenses for the three months ended June 30, 2010 include $0.4 million of severance that is not comparable to 2009. The increase in asset management fees is a direct result of an increase in our average assets under management during the three months ended June 30, 2010 as compared to the three months ended June 30, 2009.

 

     Six Months Ended
June 30,
 
     2010     2009  

Revenues, net of interest expense:

    

Asset management fees

   $ 7,143      $ 6,159   

Other

     10        350   
                

Total

     7,153        6,509   
                

Operating Expenses:

    

Variable

     3,723        4,329   

Fixed

     5,580        6,677   

Impairment of intangible assets

     —          5,350   
                

Total

     9,303        16,356   
                

Pre-tax loss

   $ (2,150   $ (9,847
                

 

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The pre-tax loss from our asset management segment decreased from $9.8 million for the six months ended June 30, 2009 to a pre-tax loss of $2.2 million for the six months ended June 30, 2010. The pre-tax loss for the six months ended June 30, 2009 included a $5.4 million impairment of an intangible asset related to a management contract for a money market mutual fund, which is not comparable to 2010. The decrease in pre-tax loss is also a result of decreases in both variable and fixed operating expenses, as well as increased asset management fees. The decreases in fixed and variable expenses were the result of non-compensation cost reduction initiatives, which included the decision to terminate a sub-advisory agreement related to the FBR Focus Fund in August 2009 and a reduction in employees associated with the elimination of our private client group in May 2009. Fixed expenses for the six months ended June 30, 2010 include $0.4 million of severance that is not comparable to 2009. The increase in asset management fees was a direct result of an increase in our average assets under management during the first six months of 2010 as compared to the first six months of 2009.

The following table provides details relating to our assets under management (dollars in millions):

 

     June 30, 2010    December 31, 2009
     Gross(1)    Net(2)    Gross(1)    Net(2)

Mutual funds:

           

Equity

   $ 1,273.3    $ 1,269.0    $ 1,325.9    $ 1,317.9

Balanced and fixed income

     104.6      104.5      —        —  

Private equity and hedge funds

     7.5      6.4      10.1      9.3
                           

Total

   $ 1,385.4    $ 1,379.9    $ 1,336.0    $ 1,327.2
                           

 

(1) Gross assets under management represent the amount of actual gross assets of our mutual funds and proprietary investment partnerships, including leverage.
(2) Net assets under management represent gross assets under management, net of any repurchase agreement debt, margin loans, securities sold but not yet purchased, lines of credit and any other liabilities.

Principal Investing

As of June 30, 2010, our principal investing activity consists primarily of investments in merchant banking and long-term equity investments and investments in mutual, hedge and venture funds. The following tables provide a summary of our results within the principal investing segment (dollars in thousands):

 

     Three Months Ended
June 30,
         2010             2009    

Revenues, net of interest expense:

    

Net investment income

   $ 46      $ 1,369

Net interest income, dividends and other

     506        121
              

Total

     552        1,490
              

Operating Expenses:

    

Variable

     (13     20

Fixed

     16        283
              

Total

     3        303
              

Pre-tax income

   $ 549      $ 1,187
              

The pre-tax income from our principal investing segment decreased from $1.2 million for the three months ended June 30, 2009 to $0.5 million for the three months ended June 30, 2010. The decrease in pre-tax income is primarily attributable to the decrease in net investment income, offset partially by an increase in dividend income from merchant banking investments and a decrease in operating expenses. Net investment income during 2009

 

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includes gains from sales of merchant banking positions and the performance of investments in mutual funds that are not comparable to 2010. Beginning in the third quarter of 2009, we have held short positions in certain exchange-traded funds in order to hedge the effects of the performance of our investments in mutual funds. As a result subsequent to the second quarter of 2009, the net investment income (loss) from our mutual funds investments have not been significant.

 

     Six Months Ended
June 30,
 
         2010            2009      

Revenues, net of interest expense:

     

Net investment income (loss)

   $ 48    $ (78

Net interest income, dividends and other

     2,316      499   
               

Total

     2,364      421   
               

Operating Expenses:

     

Variable

     18      24   

Fixed

     494      783   
               

Total

     512      807   
               

Pre-tax income (loss)

   $ 1,852    $ (386
               

The pre-tax income (loss) from our principal investing segment increased from a pre-tax loss of $0.4 million for the six months ended June 30, 2009 to pre-tax income of $1.9 million for the six months ended June 30, 2010. The change in pre-tax income is primarily attributable to the increase in dividend income from merchant banking investments, as well as a change in net investment income (loss). During the first six months of 2009, we sold $454.3 million of mortgage-backed security positions and related hedging assets held as of December 31, 2008 and retired the repurchase agreements financing these positions resulting in net losses of $1.0 million, with no comparable activity in the first six months of 2010. These losses were offset by gains from sales of merchant banking positions and the performance of investments in mutual funds during the six months ended June 30, 2009. In addition, we earned $2.3 million in dividends from two investments in our merchant banking portfolio during the six months ended June 30, 2010, compared to $0.1 million of dividends in the same 2009 period.

Merchant Banking

The total value of our merchant banking portfolio and other long-term investments was $59.3 million as of June 30, 2010. Of this total, $58.1 million was held in the merchant banking portfolio and $1.2 million was held in investment funds.

 

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The following table provides additional detail regarding our merchant banking and other long-term investments as of June 30, 2010 (dollars in thousands):

 

     June 30, 2010
     Number
of Shares
   Original
Cost  Basis/
Principal
   Adjusted
Basis(1)
   Fair Value/
Carrying Value

Long-term investments, at fair value:

           

Merchant banking-marketable equity securities:

           

Cohen & Company, Inc

   32,000    $ 192    $ 192    $ 160
                       

Total long-term investments, at fair value

      $ 192    $ 192    $ 160
                       

Other long-term investments:

           

Merchant banking—non-public securities:

           

Air Lease Corporation(2)

   250,000    $ 5,000    $ 5,000    $ 5,000

Banctec, Inc.(2)

   495,145      2,476      2,476      2,476

Cohen & Company, Inc. (Note)(2)

   n/a      312      317      317

Diana Containerships, Inc.(2)

   1,073,830      15,469      15,469      15,469

Ellington Financial LLC(2)

   1,438,750      27,049      21,581      21,581

NBH Holdings, Inc.(3)

   594,821      11,370      11,370      11,370

Thunderbird Resorts, Inc.(2)

   1,162,507      9,973      1,744      1,744
                       

Total

      $ 71,649    $ 57,957    $ 57,957
                   

Investment funds and other

              1,198
               

Total other long-term investments

            $ 59,155
               

 

(1) Adjusted basis reflects the effects of other-than-temporary impairment charges, if any.
(2) As of June 30, 2010, these securities cannot be traded in a public market (e.g., NYSE or Nasdaq) but may be sold in private transactions.
(3) As of June 30, 2010, the sale of these shares was subject to restrictive covenants.

Results of Operations

Three months ended June 30, 2010 compared to three months ended June 30, 2009

Net loss increased from $21.7 million in the second quarter of 2009 to a net loss of $25.8 million in the second quarter of 2010. The increase in net loss was primarily the result of a $13.6 million tax provision in the second quarter of 2010 compared to a $0.1 million tax provision in the second quarter of 2009. Our pre-tax loss decreased from $21.6 million in the second quarter of 2009 to $12.2 million in the second quarter of 2010 as a result of an increase in net revenues from $47.3 million in 2009 to $69.7 million in 2010. Our results for the second quarter of 2010 include severance charges of $4.3 million as compared to $0.2 million of severance charges in the second quarter of 2009.

The pre-tax loss in our capital markets segment decreased from $15.6 million during the second quarter of 2009 to $11.9 million during the second quarter of 2010 due to an increase in investment banking capital raising revenues, offset partially by a decrease in institutional brokerage revenues and an increase in operating expenses. The pre-tax loss from our asset management segment decreased from $7.2 million during the second quarter of 2009 to $0.8 million during the second quarter of 2010 due primarily to a $5.4 million impairment of an intangible asset related to a money market mutual fund management contract in 2009 that is not comparable to 2010. Pre-tax income from our principal investing segment decreased from $1.2 million during the second quarter of 2009 to $0.5 million during the second quarter of 2010, reflecting a decrease in net investment income, partially offset by an increase in dividend income and a decrease in operating expenses for the second quarter of 2010 as compared to the same period in 2009.

 

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Our net revenues increased 47.4% from $47.3 million during the second quarter of 2009 to $69.7 million during the second quarter of 2010 due to the changes in revenues discussed below.

Capital raising revenues increased from $4.3 million in the second quarter of 2009 to $37.4 million in the second quarter of 2010. Our revenues from private placements during the second quarter of 2010 were $31.7 million which related primarily to one transaction that in-total raised in excess of $1.2 billion of equity capital. There were no comparable transactions in the second quarter of 2009 in which our revenues from private placements were $0.6 million. Also, our aggregate transaction value on public offerings increased from the second quarter of 2009 to the second quarter of 2010.

Advisory revenues decreased 31.8% from $4.4 million in the second quarter of 2009 to $3.0 million generated in the second quarter of 2010. We completed four assignments in the second quarter of 2009 as compared to two assignments in the second quarter of 2010.

Institutional brokerage revenues from agency commissions and principal transactions decreased 27.9% from $33.7 million in the second quarter of 2009 to $24.3 million in the second quarter of 2010. This decrease is primarily attributable to trading losses from our convertible securities and credit trading desks in 2010, as compared to trading gains from our convertible securities trading desk for the same period in 2009 as well as decreased revenues from our equities trading desk as a result of a decrease in trading volume during the three months ended June 30, 2010, particularly in June 2010. The trading losses in 2010 were the result of market volatility primarily during April and May 2010. These 2010 trading losses and reduced revenues were partially offset by commission revenues from our credit and listed-options trading desks in the second quarter of 2010 as these businesses were launched during the second half of 2009.

Asset management fees increased 18.8% from $3.2 million in the second quarter of 2009 to $3.8 million in the second quarter of 2010. The increase is primarily attributable to an increase in average mutual fund assets under management.

Net investment income was $1.4 million in the second quarter of 2009 compared to $0.1 million in the second quarter of 2010. Net investment income during 2009 includes gains from sales of merchant banking positions and the performance of investments in mutual funds that are not comparable to 2010.

Net interest income, dividends and other revenues increased from $0.4 million in the second quarter of 2009 to $1.1 million in the second quarter of 2010. This increase is primarily attributable to an increase in interest income from convertible bonds as a result of an increase in the average convertible bond balance for the three months ended June 30, 2010 and dividend income related to equity investments in our merchant banking portfolio.

Total non-interest expenses increased 18.7% from $69.0 million in the second quarter of 2009 to $81.9 million in the second quarter of 2010. This increase was caused by the changes in non-interest expenses described below.

Compensation and benefits expenses increased 44.1% from $35.6 million in the second quarter of 2009 to $51.3 million in the second quarter of 2010. This increase is primarily due to severance costs of $4.3 million and an increase in fixed compensation reflecting the effects of the addition of senior employees in our investment banking group and the expansion of our trading platform noted above. Variable compensation increased $7.3 million due to the increase in investment banking revenues in 2010.

Professional services expenses increased 65.2% from $4.6 million in the second quarter of 2009 to $7.6 million in the second quarter of 2010 primarily due to increased expenses related to investment banking transactions in the second quarter of 2010 as compared to 2009. Partially offsetting this increase was a decrease in sub-advisory fees related to our management of mutual funds, along with decreased costs related to

 

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consultants. The reduction in sub-advisory fees is the result of our termination of the sub-advisory agreement related to the FBR Focus Fund in August 2009.

Business development expenses increased 50.0% from $2.6 million in the second quarter of 2009 to $3.9 million in the second quarter of 2010. This increase is primarily the result of increased costs associated with our investment banking transactions.

Clearing and brokerage fees decreased 2.6% from $3.8 million in the second quarter of 2009 to $3.7 million in the second quarter of 2010. The decrease is primarily due to a lower volume of trading activity, especially in our convertible securities and equity trading businesses.

Occupancy and equipment expenses decreased 21.8% from $7.8 million in the second quarter of 2009 to $6.1 million in the second quarter of 2010. The decrease in occupancy costs is a result of facility right-sizing initiatives along with other cost reduction initiatives over the past two years.

Communications expenses increased 3.8% from $5.2 million in the second quarter of 2009 to $5.4 million in the second quarter of 2010. The increase in these expenses is primarily due to increased costs related to market data and customer trading services.

During the second quarter of 2009, we recognized a $5.4 million impairment of an intangible asset related to a money market fund managed by us. The impairment was the result of factors such as significantly reduced yields on short-term government investments and the requirement for us to both waive our management fees and reimburse certain expenses of the fund resulting in the management contract becoming unprofitable for us in the period. We also considered the cost structure of this fund, a forecasted continuation of the low rate environment for the fund’s investments and the forecasted ongoing waiver of our management fee in recognizing this impairment charge.

Other operating expenses decreased 4.9% from $4.1 million in the second quarter of 2009 to $3.9 million in the second quarter of 2010. The decrease in expenses is primarily due to a decrease in corporate insurance costs.

Our income tax provision increased from a $0.1 million in the second quarter of 2009 to a $13.6 million in the second quarter of 2010. Our quarterly 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 (112.0)% and (0.5%) in the second quarters of 2010 and 2009, respectively. These tax rates differed from statutory tax rates primarily due to a full valuation allowance on the deferred tax benefits of book losses incurred during these periods and as a result of the benefit of tax losses expected to be realized in these periods. Also, the Company’s tax rate for the three months ended June 30, 2010 reflects a change in the estimated effective tax rate for the full year from the first quarter of 2010 based on changes in our forecasted annual taxable and book income. The Company believes there is potential for volatility in its 2010 effective tax rate from quarter-to-quarter due to the impact of any prospective changes in its forecasted earnings for the year.

Six months ended June 30, 2010 compared to six months ended June 30, 2009

Net loss decreased from $37.9 million in the first six months of 2009 to a net loss of $34.0 million in the first six months of 2010. Income taxes changed from a $0.7 million tax provision in the first half of 2009 to a $2.7 million tax benefit in the first half of 2010. Our pre-tax loss decreased from $37.2 million in the first six months of 2009 to $36.7 million in the first six months of 2010. Our results for the first half of 2010 include severance charges of $5.3 million as compared to $0.8 million of severance charges in the second quarter of 2009.

 

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Pre-tax loss from our capital markets segment increased from $27.0 million in the first six months of 2009 to $36.4 million in the first six months of 2010 due to a decrease in our institutional brokerage revenues and increases in operating expenses, offset partially by increased revenues from investment banking. The pre-tax loss in our asset management segment decreased from $9.8 million in the first six months of 2009 to $2.2 million in the first six months of 2010 due to a $5.4 million impairment of an intangible asset related to a money market mutual fund management contract in 2009 that is not comparable to 2010, as well as reductions in operating expenses. Pre-tax income from our principal investing segment increased from a $0.4 million loss during the first half of 2009 to $1.9 million during the first half of 2010, reflecting an increase in dividend income, partially offset by a decrease in net investment income.

Our net revenues increased 17.4% from $97.0 million during the first six months of 2009 to $113.9 million during the first six months of 2010 due to the changes in revenues and interest expense discussed below.

Capital raising revenues increased from $8.6 million in the first six months of 2009 to $45.1 million in the first six months of 2010. Our revenues from private placements during the first six months of 2010 were $36.5 million compared to $4.8 million during the first six months of 2009. Also, our aggregate transaction value on public offerings increased from the first half of 2009 to the first half of 2010.

Advisory revenues decreased 18.8% from $8.0 million in the first six months of 2009 to $6.5 million generated in the first six months of 2010. We completed eight assignments in the first six months of 2009 as compared to six assignments in the first six months of 2010.

Institutional brokerage revenues from agency commissions and principal transactions decreased 29.3% from $73.3 million in the first six months of 2009 to $51.8 million in the first six months of 2010. The decrease is primarily attributable to a reduction in revenues from our convertible securities and equities trading desks in 2010 partially offset by revenues from our credit and listed-options trading desks in the first six months of 2010 following the launch of these two businesses during the second half of 2009. The decrease in convertible securities and equities trading revenue was primarily the result of decreased volume and volatility in the equity markets. Also contributing to the decrease were trading losses from our convertible securities and credit trading desks in 2010 as compared to trading gains from our convertible securities trading desk for the same period in 2009.

Asset management fees increased 14.5% from $6.2 million in the first six months of 2009 to $7.1 million in the first six months of 2010. The increase is primarily attributable to an increase in average mutual fund assets under management.

Net investment loss was $0.1 million in the first six months of 2009 compared to income of $0.1 million in the first six months of 2010. Net investment income for the first six months of 2010 is related to income from investment funds due to fund performance and the sale of certain merchant banking investments, partially offset by losses on short positions in certain exchange-traded funds that are intended to hedge the fund investments. Net investment loss for the first six months of 2009 includes $1.0 million of realized losses on the sale of mortgage-backed securities and derivative assets, offset by the income from investment funds as a result of fund performance and gains from the sale of certain merchant banking investments.

Net interest income, dividends and other revenues increased from $1.3 million in the first six months of 2009 to $3.3 million in the first six months of 2010. This increase is primarily attributable to increased dividend income from certain merchant banking investments.

Total non-interest expenses increased 12.2% from $134.2 million in the first six months of 2009 to $150.6 million in the first six months of 2010. This increase was caused by the changes in non-interest expenses described below.

 

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Compensation and benefits expenses increased 29.5% from $72.6 million in the first six months of 2009 to $94.0 million in the first six months of 2010. This increase is primarily due to severance costs of $5.3 million, an increase in fixed compensation reflecting the effects of the addition of senior employees in our investment banking group and the expansion of our trading platform noted above. Variable compensation increased $6.8 million due to the increase in investment banking revenues in 2010.

Professional services expenses increased 28.6% from $9.1 million in the first six months of 2009 to $11.7 million in the first six months of 2010 primarily due to increased expenses related to investment banking transactions in the second quarter of 2010 as compared to 2009. Partially offsetting this increase was a decrease in sub-advisory fees related to our management of mutual funds, along with decreased costs related to consultants. The reduction in sub-advisory fees is the result of our termination of the sub-advisory agreement related to the FBR Focus Fund in August 2009.

Business development expenses increased 25.8% from $6.2 million in the first six months of 2009 to $7.8 million in the first six months of 2010. This increase is primarily the result of increased costs associated with our investment banking transactions, offset by a decrease in costs associated with our involvement in what had been known as the PGA Tour’s FBR Open in 2009.

Clearing and brokerage fees remained consistent at $7.1 million for both periods despite the decrease in institutional brokerage revenues due to the initiation of non-exchange traded product lines with higher clearing costs during the second half of 2009, as well as increased costs related to our equity trading activities.

Occupancy and equipment expenses decreased 20.3% from $15.8 million in the first six months of 2009 to $12.6 million in the first six months of 2010. The decrease in occupancy costs is a result of facility right-sizing initiatives along with other cost reduction initiatives over the past two years.

Communications expenses decreased 2.9% from $10.4 million in the first six months of 2009 to $10.1 million in the first six months of 2010. The decrease in these expenses is primarily due to the effects of cost reduction initiatives over the past two years and decreased costs related to market data and customer trading services.

During the first half of 2009, we recognized a $5.4 million impairment of an intangible asset related to a money market fund managed by us. The impairment was the result of factors such as significantly reduced yields on short-term government investments and the requirement for us to both waive our management fees and reimburse certain expenses of the fund resulting in the management contract becoming unprofitable for us in the period. We also considered the cost structure of this fund, a forecasted continuation of the low rate environment for the fund’s investments and the forecasted ongoing waiver of our management fee in recognizing this impairment charge.

Other operating expenses decreased 5.2% from $7.7 million in the first six months of 2009 to $7.3 million in the first six months of 2010. The decrease in expenses is primarily due to a decrease in corporate insurance costs.

Income taxes changed from a $0.7 million tax provision in the first six months of 2009 to a $2.7 million tax benefit in the first six months of 2010. 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 rates were 7.3% and (1.9%) in the first six months of 2010 and 2009. These rates differed from statutory tax rates primarily due to a full valuation allowance on the deferred tax benefits of book losses incurred in these periods and as a result of the benefit of tax losses expected to be realized in these periods. The Company believes there is potential for volatility in its 2010 effective tax rate from quarter-to-quarter due to the impact of any prospective changes in its forecasted earnings for the year.

 

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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, 2010, our cash and cash equivalents totaled $187.8 million representing a net decrease of $87.7 million for the six months ended June 30, 2010. The decrease is attributable to $51.9 million of cash used in operating activities, $23.3 million of cash used in investing activities and $12.5 million of cash used in financing activities. 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 used in our operating activities of $35.6 million during the first six months of 2009, compares to $51.9 million of cash used in operating activities during the first six months of 2010. The cash used in operating activities for the first six months of 2010 reflects net operating losses and our payment of previously accrued compensation associated with prior year operating results partially offset by decreased capital investment in our trading businesses.

Net cash provided by investing activities of $460.3 million during the first six months of 2009 compares to net cash used in investing activities of $23.3 million during the first six months of 2010, reflecting the difference in investing activity during the periods. The first six months of 2009 activity reflects the sale of the remaining mortgage-backed securities held at December 31, 2008, while the first quarter of 2010 activity reflects the purchase and sale of certain merchant banking investments.

Net cash used in financing activities of $399.0 million during the first six months of 2009, compares to net cash used in financing activities of $12.5 million during the first six months of 2010. The 2009 activity reflects the sale of mortgage-backed securities and repayment of related repurchase agreement financings as discussed above, as well as the net effects of repurchase 16.7 million shares of common stock from Arlington Asset Investment Corporation (our former majority shareholder ) and completing a follow-on offering of 20.0 million shares of our common stock. The 2010 activity primarily represents the repurchase of 2.8 million shares of our common stock.

Sources of Funding

We believe that our existing cash and cash equivalents balances (totaling $187.8 million at June 30, 2010) comprised primarily of investments in money market funds investing in short-term U.S. Treasury securities, 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

 

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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, 2010, we had no outstanding borrowings.

Assets

As of June 30, 2010, our principal assets consist of cash and cash equivalents, receivables, securities held for trading purposes, long-term investments and due from brokers, dealers and clearing organizations. As of June 30, 2010 and December 31, 2009, liquid assets consisted primarily of cash and cash equivalents of $187.8 million and $275.5 million, respectively.

The decrease in our total assets to $434.5 million as of June 30, 2010 compared to $556.3 million as of December 31, 2009, is primarily the result of the decrease in cash and cash equivalents and a reduction of $56.5 million in trading-related assets associated with our convertible securities and credit-related trading activities.

As of June 30, 2010, our $59.3 million of long-term investments primarily consist of investments in non-public equity securities. Our investment portfolio is exposed to potential future downturns in the markets and private equity securities are exposed to deterioration of credit quality, defaults, and downward valuations. On a quarterly basis, we review the valuations of our private equity investments carried at cost, for impairment. If and when we determine that a decline in fair value less than our carrying value is “other-than-temporary”, we will reflect the reduction as an investment loss. Similarly, we review our portfolio of marketable equity securities on a quarterly basis. If we determine that a decline in value of an investment in a marketable equity security accounted for as available-for-sale below our cost basis is “other-than-temporary”, the loss will be recognized in the statement of operations during the period in which the liquidation or determination is made.

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 trades in certain sectors of the corporate bond and syndicated loan markets. 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 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 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 by maintaining risk limits for each counterparty with whom we have outstanding bank loan trades. In addition, due to industry standards regarding required standard documentation and settlement procedures, we believe our exposure to default risk is low. The total amount of outstanding unsettled trade receivables and payables related to these instruments was $26.6 million and $36.6 million, respectively, as of June 30, 2010. The remaining components of the due from and to brokers, dealers, and clearing organizations includes receivables related to commissions and receivables and payables related to unsettled trades that are settled on a regular basis.

Regulatory Capital

FBR & Co., our principal U.S. broker-dealer, is registered with the SEC and is a member of the FINRA. Additionally, FBRIL, our U.K. broker-dealer, is registered with the FSA of the United Kingdom. As such, they are subject to the minimum net capital requirements promulgated by the SEC and FSA, respectively. As of

 

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June 30, 2010, FBR & Co. had total regulatory net capital of $42.6 million, which exceeded its required net capital of $3.6 million by $39.0 million. In addition, FBRIL had regulatory capital as defined in excess of required amounts. Regulatory net capital requirements increase when the broker-dealers are involved in underwriting activities based upon a percentage of the amount being underwritten.

Share Repurchases

During the three and six months ended June 30, 2010, we repurchased 608,563 and 2,768,385 shares, respectively, of our common stock in open market transactions at weighted average share prices of $4.20 and $5.16 per share, respectively, for a total cost of $2.6 million and $14.3 million, respectively. In July 2010, the Board of approved a 5,000,000 share increase to the number of shares of our common stock that we are authorized to repurchase.

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, 2010 was approximately $519 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.

 

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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, 2010. The table shows data reflecting that the actual lowest 5 percentile daily trading revenues during the six months ended June 30, 2010 was $137 thousand. Over the same period, the worst one-day trading revenues were $105 thousand which is below the $665 thousand daily trading loss implied by the average one-day VaR for the first six months of 2010.

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, 2010. The fair value of the $13.5 million of trading portfolio equity securities held would increase or decrease to $14.9 million and $12.2 million, respectively, and the fair value of the $59.3 million of long-term investments would increase or decrease to $65.2 million and $53.4 million respectively.

Except to the extent that we sell our marketable equity securities or other long term 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 equity method investments as well as trading securities 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

 

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June 30, 2010 and December 31, 2009, we have recorded no liabilities with regard to this right. During the six months ended June 30, 2010 and 2009, 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.

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, 2010, 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, 2010, 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).

 

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PART II

OTHER INFORMATION

 

Item 1. Legal Proceedings

As of June 30, 2010, except as described below, we were 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 our financial condition, results of operations or liquidity. We have been named as a defendant in a small number of civil lawsuits and arbitrations relating to our various businesses. In addition, we are 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 our financial condition or results of operations 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 our financial condition, results of operations or liquidity.

Many aspects of our 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. FBR & Co. has been named as a defendant in a small number of securities claims involving investment banking clients of FBR & Co. as a result of FBR & Co.’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 FBR & Co. 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 FBR & Co. is required to make as a result of litigation. There can be no assurance that such indemnification or contribution will ultimately be available to us 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 FBR & Co.) 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 now includes 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 FBR & Co. relate 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 million. The plaintiffs seek restitution, unspecified compensatory damages and reimbursement of certain costs and expenses. Although FBR & Co. 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 FBR & Co. receives from TMI. On September 22, 2008, FBR & Co. filed a motion to dismiss the consolidated class action complaint as to FBR & Co. The District Court granted that motion on January 27, 2010. On July 5, 2010, the District Court ruled that it would allow the plaintiffs to file a motion for leave to amend the complaint; the District Court is also allowing plaintiffs to file a motion for reconsideration of the Court’s order dismissing the amended complaint. FBR is opposing those motions. Although these cases involving FBR & Co. 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 our 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

 

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and actions by government agencies and self regulatory organizations involving the securities industry, including class actions that seek substantial damages. We are also subject to the risk of litigation, including litigation that may be without merit. As we intend to actively defend such litigation, significant legal expenses could be incurred. An adverse resolution of any future litigation against us could materially affect its financial condition, operating results and liquidity.

 

Item 1A. Risk Factors

As of June 30, 2010, 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, 2009.

 

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 2010:

 

     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, 2010

   —      $ —      —      1,259,063

May 1 to May 31, 2010

   529,986      4.20    529,986    729,077

June 1 to June 30, 2010

   78,577      4.18    78,577    650,500
                     

Total

   608,563    $ 4.20    608,563    650,500
                     

 

(1) These shares were repurchased under the October 6, 2008 directive adopted by the Board of Directors of the Company allowing for the repurchase of up to 10,000,000 shares. As of June 30, 2010, 650,500 shares were allowed for repurchase under this directive. As announced on July 28, 2010, 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 as no share repurchases have been made subsequent to June 30, 2010.

 

Item 6. Exhibits

 

Exhibit
Number

  

Exhibit Title

12.01    Statement regarding Computation of Ratio of Earnings to Fixed Charges.
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.

 

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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 Capital Markets Corporation
Date: August 9, 2010     By:   /s/     BRADLEY J. WRIGHT        
      Bradley J. Wright
      Executive Vice President, Chief Financial Officer
      (Principal Financial Officer)
Date: August 9, 2010     By:   /s/     ROBERT J. KIERNAN        
      Robert J. Kiernan
      Senior Vice President, Controller and
      Chief Accounting Officer
      (Principal Accounting Officer)

 

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