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Friedman, Billings, Ramsey Group, Inc. (NYSE:FBR)

Q4 2007 Earnings Call

February 21, 2008 9:00 am ET

Executives

Paul Baettie – Director IR

Eric Billings – Chairman, CEO

Rock Tonkel – President, COO

Analysts

Bernard [Bosmovik] – Blackrock

Operator

Good morning, my name is May and I will be your conference operator today. At this time, I would like to welcome everyone to the FBR Group’s fourth quarter year end 2007 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you have already done so, please press star two at this time. Then press star one again to ensure your question is registered. Thank you Mr. Beattie, you may begin your conference.

Paul Baettie

Thank you, good morning, this is Paul Baettie, Director of Investor Relations of Friedman, Billings, Ramsey Group. Before we begin this morning’s call, I would like to remind everyone that statements concerning future performance, developments, events, market forecasts, revenues, expenses, earnings, run rates and any other guidance on present or future periods constitute forward looking statements. These forward looking statements are subject to a number of factors, risks and uncertainties that might cause actual results to differ materially from stated expectations or current circumstances.

These factors include but are not limited to the effective demand for public offerings, activity in the secondary securities markets, interest rates, our cost of borrowing, interest spreads, mortgage pre payment speeds, mortgage delinquencies and defaults, the risks associated with merchant banking investments, the realization of gains and losses on principal investments, available technology, competition for business and personnel and general economic, political and market conditions. Additional information concerning these factors that could cause results to differ materially is contained in FBR Group’s annual report on form 10K and in quarterly reports on form 10Q. I would now like to turn the call over to Eric Billings, Chairman and Chief Executive Officer of FBR Group. Also joining us this morning are FBR Group’s President and Chief Operating Officer, Rock Tonkel and Kurt Harrington, Chief Financial Officer of FBR Group.

Eric Billings

Thank you Paul. As you’ve seen in the release, FBR Group lost $270.4 million in the fourth quarter. Net of two non cash items, the tangible loss was $92.4 million. The $178 million of non cash items were attributable to a $108 million write down of goodwill and the $70 million accounting treatment of losses at First NLC Services that will be recovered pursuant to GAAP rules upon discharge of the FNLC bankruptcy expected sometime in the next six months. During 2007, recognizing the severe environment we were in, we aggressively moved to reduce our exposure to non agency assets. While this has been a very painful chapter, the most important facts today relate to where we stand as we entered 2008.

At year end, adjusted for the GAAP recovery of the $70 million in FNLC losses, we had $523 million of long term capital at the REIT level. Approximately $370 million of it invested in cash and highly liquid agency securities. While whole loan mortgages on balance sheet, securitization residuals have been eliminated. Remaining non prime securities are self liquidating investments valued at less than $30 million at year end. Cash flows received thus far in the first quarter 2008 have reduced this amount to $25 million. This amount constitutes approximately 1% of our total assets. As we disclosed on this call last quarter, we are deploying capital to our core business, the conservative substantially hedged agency mortgage backed security strategy.

Average investment in the fourth quarter totaled $1.1 billion in this strategy. As a result of a significantly steepening yield curve, capital being deployed in this course strategy is expected to yield net spreads on average of more than 175 basis points on a hedged basis. Looking at the year ahead, the $300 million of cash we had available at year end combined with cash generated from the ongoing disposition of our remaining non agency assets will be deployed to further build an agency portfolio consisting of agency MBS ARM securities.

In this current market environment, investing in hybrid agency portfolio leveraged eight to ten times with the spread of 175 basis points while utilizing SWAPs to hedge approximately 50% of the amortizing liability balance and purchasing out of the money caps will result in an attractive return on invested capital approaching 20%. We believe the attractiveness of this agency MBS asset is due to the degree and extent of the difficulties being felt all across the global financial system.

We expect this stress and broad fallout from credit market, the credit market meltdown will continue for longer than conventional wisdom might suggest making our agency strategy even more appealing. Importantly, we have $372 million of net operating loss carry forwards, plus $268 million of capital loss carry forwards. We are actively examining alternatives to most effectively use these highly valuable tax assets whose future cash value could be as much as $270 million. Included in this exploration are a number of strategic alternatives which could potentially maximize the economic value of these loss carry forwards.

Turning now to FBR Capital Markets, our 52% ownership interest has a book value of $263 million and yesterday that company reported full year earnings of $5.2 million compared to a loss of approximately $10 million in 2006. Pretax earnings for Capital Markets in 2007 were $25.3 million. The company’s income tax expense was unusually high, primarily because of $8 million in non cash tax reversals relating to restricted stock vesting activity. In the aggregate, FBR Capital Markets grew book value per share from $7.57 to $7.91 or approximately 5% during the year.

We are enthusiastic about the continued growth of our FBR Capital Markets franchise. Investment banking revenues despite the virtual shutdown of capital markets in the fourth quarter increased 51% year over year. Both its sales and trading and M&A advisory units had record years. FBR Capital Markets continues to win mandates across its range of industry groups and we are very optimistic about its ability to continue building upon its leading position among middle market issuers.

Over the last five years, FBR Capital Markets has ranked the number one leading underwriter of initial equity capital for small and mid cap companies in the United States. The potential for growth in FBR Capital Markets, FBR Group’s near elimination of non prime exposure, the over $600 million in tax loss carry forwards, combined with attractive risk adjusted returns available in our core agency investment strategy, positions FBR in a way that permits us to focus once again on building the business, growing capital, increasing earnings and delivering growth and shareholder value. I will now open the call to questions.

Question-and-Answer Session

Operator

At this time if you would like to ask a question, please press star one on your telephone keypad. Again that’s star then the number one. We will pause for just a moment to compile the Q&A roster. Your first question comes from the line of Bernard [Bosmovik] from Blackrock

Bernard [Bosmovik] – Blackrock

Hey guys, good morning. Just a quick question for you, how much you know non agency MBS is on the balance sheet at 12/31?

Rock Tonkel

Bernard this is Rock, non agency MBS assets are about $280 million plus the non prime you see in the release, total of that is under $300 million. The non agencies are primarily triple A’s. The amount other than the $30 million that we talked about at year end which is now down to $25, the amount above that in non agency is all triple A.

Bernard [Bosmovik] – Blackrock

Okay so the $280 is mostly triple A?

Rock Tonkel

Primarily in triple A interest in prime deals and some alt A.

Bernard [Bosmovik] – Blackrock

Okay and then on the merchant banking, I think you had said last quarter but just to double check, the subprime related investments, I thought you said you were kind of out of those so like what’s left in the merchant banking portfolio?

Rock Tonkel

There’s no subprime exposure remaining in the merchant portfolio. The total portfolio is 53, of that almost half of that is publicly traded securities we expect to liquidate here over the next couple of quarters. The remainder are 144A securities, across insurance and some real estate and across these industries.

Bernard [Bosmovik] – Blackrock

Got it. Okay and just on the carry forwards you guys talked about, I mean you talked about some strategic alternatives you’re looking at, can you just give us a sense for kind of what some of those might be?

Eric Billings

We really are not going to comment on specific strategic alternatives that we’re looking at but at the time we make any decisions we will disclose those.

Bernard [Bosmovik] – Blackrock

Okay got it and then just lastly on kind of haircuts, I guess you’re basically just doing the, it sounds like your plan for the non agency MBS is to sell that and then deploy it into the agency MBS sort of carry product it just sounds like tell me if I’m reading that wrong, but what sorts of haircuts are you seeing and just in general have there been any changes of late?

Rock Tonkel

To the extent there have been changes, frankly they’ve been reduced haircuts we’ve seen over the last 60 days. We’re down now in the range of you know 3-5 and more likely the 3% range on agency.

Eric Billings

And on the non agency as you said the triple A’s are amortizing down at a fairly normal pace and we redeploy that into the agency asset. You know obviously if we have an opportunity to sell those at you know par value which could certainly should occur on triple A assets sometime in the not too distant future, we would probably come out of those and redeploy all of that equity of about $38 million that’s in the triple A’s into the agency strategy. But either way, we think they’re very good assets, we have a very good return on those triple A’s and they are amortizing down normally.

Bernard [Bosmovik] – Blackrock

Right and any sort of marks on the non agency stuff would flow through AOCI, is that, had they been kind of, like what was the mark in the fourth quarter on that stuff?

Rock Tonkel

Very small.

Bernard [Bosmovik] – Blackrock

Okay and last question just do you guys have a target leverage for the agency leveraging strategy?

Rock Tonkel

Well as we said in the release we highlighted the returns available in an 8-10 times leverage scenario, we think in that range is reasonable in this environment.

Bernard [Bosmovik] – Blackrock

Okay, thanks guys.

Operator

Again, if you would like to ask a question, please press star one on your telephone keypad. There are no further questions at this time, do you have any closing remarks?

Eric Billings

No, thank you very much for joining us and we look forward to speaking to you all next quarter.

Operator

This concludes today’s conference, you may now disconnect.

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