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 year ended December 31, 2007.

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 year ended December 31, 2007.

Business Environment

As an investment banking, institutional sales, trading and research and asset management firm, our businesses are materially affected by conditions in the U.S. financial markets, general U.S. economic conditions and, to a lesser degree, global economic conditions. The decreased level of capital markets activities during the first nine months of 2008 as compared to the comparable 2007 period exhibited the effects of the current uncertainty in economic conditions due to continuing negative economic trends. Our investment banking revenues have been adversely affected by the continued mortgage and credit market dislocation that began in the latter half of 2007, and we may be further impacted should there be continued or further credit market dislocations or a sustained market downturn. Other factors contributing to the current weak economic conditions are an increasing unemployment rate coupled with decreases in home prices and deterioration in consumer confidence.

On October 3, 2008, President George Bush signed into law the Emergency Economic Stabilization Act of 2008 (the "EESA"). The legislation was adopted in response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions. The U.S. Treasury and banking regulators are implementing a number of programs under this legislation to address capital and liquidity issued in the banking system. It is too early to predict the actual impact that the EESA will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced.

We believe the remainder of 2008 is going to continue to be a difficult business environment, with continued dampened capital markets activity, both domestically and internationally. Our growth outlook is dependent in part on the extent and severity of the financial market dislocation, and results from fiscal and monetary policy actions, and the overall market value of U.S. equities. For further discussions on how markets conditions may affect our businesses, see "Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2007.

Executive Summary

Our revenues consist primarily of: underwriting and placement fees for capital raising and advisory fees in investment banking; agency commissions and principal transaction mark-ups and mark-downs in institutional brokerage; base management fees and incentive allocations and fees in asset management; and dividend income, earnings from investment funds, net interest income and gains and losses in principal investing.

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. The following tables provide a summary of our results within the capital markets segment (dollars in thousands):

                                                    Three Months Ended
                                                       September 30,
                                                     2008          2007
             Revenues, net of interest expense:
             Investment banking                   $   12,761     $ 66,171
             Institutional brokerage                  36,165       26,747
             Net interest income                         403        2,452
             Other                                      (165 )         21

             Total                                    49,164       95,391

             Operating Expenses:
             Variable                                 27,660       47,808
             Fixed                                    54,855       46,730

             Total                                    82,515       94,538

             Pre-tax (loss) income                $  (33,351 )   $    853

The pre-tax income from our capital markets segment decreased from $0.9 million for the third quarter of 2007 to a pre-tax loss of $33.4 million for the third quarter of 2008. This decrease is primarily attributable to a $53.4 million decrease in investment banking revenues during the third quarter of 2008, reflecting a lower volume of capital raising activity and a decrease in advisory revenues. The lower volume of capital raising activity during the third quarter of 2008 reflects the continued effect that the dislocation in credit markets, which began in August 2007, has had on U.S. equity markets and equity underwriting activity. Our institutional brokerage sales and trading revenues increased to $36.2 million for the quarter ended September 30, 2008 as compared to $26.7 million for the quarter ended September 30, 2007. This increase in institutional brokerage sales and trading revenues is attributable to both the expansion of our sales and trading platform and the increased volatility in the market due to the current economic environment. Variable expenses decreased $20.1 million, or 42.1%, which is attributable to reduced compensation expense related to the decrease in net revenues. The increase in fixed and other compensation expenses of $8.1 million reflects the net effect of increased costs attributable to our international operations, increased stock-based compensation, and $3.2 million in severance costs associated with a reduction in our workforce.

                                                     Nine Months Ended
                                                       September 30,
                                                    2008          2007
             Revenues, net of interest expense:
             Investment banking                   $  90,899     $ 292,989
             Institutional brokerage                101,853        83,809
             Net interest income                      1,844         7,720
             Other                                     (438 )       1,169

             Total                                  194,158       385,687

             Operating Expenses:
             Variable                               105,261       186,316
             Fixed                                  159,917       140,461

             Total                                  265,178       326,777

             Pre-tax (loss) income                $ (71,020 )   $  58,910

The pre-tax income from our capital markets segment decreased from $58.9 million for the nine months ended September 30, 2007 to a pre-tax loss of $71.0 million for the nine months ended September 30, 2008. This decrease is primarily attributable to a $202.1 million decrease in investment banking revenues during the first nine months of 2008, reflecting a lower volume of capital raising activity and a decrease in advisory revenues. The lower volume of capital raising activity during the first nine months of 2008 reflects the continued effect that the dislocation in credit markets, which began in August 2007, has had on U.S. equity markets and equity underwriting activity. Our institutional brokerage sales and trading revenues increased to $101.9 million for the nine months ended September 30, 2008 as compared to $83.8 million for the nine months ended September 30, 2007. This increase in institutional brokerage sales and trading revenues is attributable to both the expansion of our sales and trading platform and the increased volatility in the market due to the current economic environment. Variable expenses decreased $81.1 million, or 43.5%, which is attributable to reduced compensation expense related to the decrease in net revenues. The decrease in variable expenses was offset partially by an $19.5 million increase in fixed expenses that is attributable to the build-out of the our international operations, increased stock-based compensation, and $6.5 million in severance costs associated with a reduction in our workforce.

Asset Management

Our asset management segment consists of managing a broad range of pooled investment vehicles, including mutual funds, hedge funds, venture capital and private equity funds and separate accounts. Our total net assets under management were $1.7 billion at September 30, 2008, decreasing from $1.9 billion at June 30, 2008 and decreasing from $2.5 billion as of December 31, 2007. Net assets under management decreased 10.5%, or $0.2 billion, during the third quarter of 2008 based on fund performance and net redemptions representing 52% and 48% of the decrease, respectively. The following tables provide a summary of our results within the asset management segment (dollars in thousands):

                                                    Three Months Ended
                                                       September 30,
                                                     2008          2007
             Revenues, net of interest expense:
             Base management fees                 $    3,710     $  6,119
             Incentive allocations and fees               -            82
             Other                                       261          472

             Total                                     3,971        6,673

             Operating Expenses:
             Variable                                  2,890        4,406
             Fixed                                     5,053        4,315

             Total                                     7,943        8,721

             Pre-tax loss                         $   (3,972 )   $ (2,048 )

The pre-tax loss from our asset management activities increased to a pre-tax loss of $4.0 million in the third quarter of 2008 compared to a pre-tax loss of $2.0 million in the third quarter of 2007. We recorded $3.7 million in base management fees (including mutual fund administrative fees) for the three months ended September 30, 2008, as compared to $6.1 million for the three months ended September 30, 2007. The decrease in management fees during the third quarter of 2008 reflects the effects of the decrease in average assets under management for the quarter compared to prior year. Operating expenses increased as a result of increases in fixed expenses attributable to initiatives to expand our mutual fund marketing activities offset by a decrease in variable costs, including sub-advisory fees.

                                                    Nine Months Ended
                                                      September 30,
                                                    2008          2007
             Revenues, net of interest expense:
             Base management fees                 $  12,507     $ 18,007
             Incentive allocations and fees              -           302
             Other                                    1,176        1,937

             Total                                   13,683       20,246

             Operating Expenses:
             Variable                                 9,396       12,228
             Fixed                                   15,717       12,633

             Total                                   25,113       24,861

             Pre-tax loss                         $ (11,430 )   $ (4,615 )

The pre-tax loss from our asset management activities increased to a pre-tax loss of $11.4 million in the first nine months of 2008 compared to a pre-tax loss of $4.6 million in the first nine months of 2007. We recorded $12.5 million in base management fees (including mutual fund administrative fees) for the nine months ended September 30, 2008, as compared to $18.0 million for the nine months ended September 30, 2007. The decrease in management fees during the first nine months of 2008 reflects the effects of the decrease in average assets under management for the nine months compared to prior year. Operating expenses increased as a result of increases in fixed expenses attributable to initiatives to expand our mutual fund marketing activities offset by a decrease in variable costs, including sub-advisory fees.

The following tables provide detail relating to our assets under management (dollars in millions):

                                                  September 30, 2008
                                                 Gross(1)     Net(2)
                Managed accounts                $    276.8   $   276.8
                Hedge and offshore funds              29.6        27.5
                Mutual funds:
                Equity                             1,320.0     1,314.2
                Fixed income and money market        113.2       112.9
                Private equity funds                  17.2        16.2

                Total                           $  1,756.8   $ 1,747.6

                                                  December 31, 2007
                                                Gross(1)     Net(2)
                Managed accounts                $   347.1   $   347.1
                Hedge and offshore funds             52.1        50.7
                Mutual funds:
                Equity                            1,870.5     1,859.3
                Fixed income and money market       176.0       175.3
                Private equity funds                 23.8        22.6

                Total                           $ 2,469.5   $ 2,455.0

(1) Gross assets under management represent the amount of actual gross assets of our proprietary investment partnerships and mutual funds, 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 September 30, 2008, our principal investing segment consists of investments in merchant banking and long-term investments, agency-backed mortgage-backed securities 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
                                                       September 30,
                                                     2008          2007
             Revenues, net of interest expense:
             Net investment (loss) income         $   (10,494 )   $ 1,723
             Net interest income                        2,749       2,219
             Other                                        165         166

             Total                                     (7,580 )     4,108

             Operating Expenses:
             Variable                                      90          61
             Fixed                                      1,689         821

             Total                                      1,779         882

             Pre-tax (loss) income                $    (9,359 )   $ 3,226

The pre-tax income from our principal investing activities decreased from $3.2 million in the third quarter of 2007 to a loss of $9.4 million in the third quarter of 2008. The decrease in pre-tax income is primarily attributable to the recognition of other-than-temporary impairments of $9.1 million on certain merchant banking investments and other long-term investments offset by a $0.5 million increase in net interest income on our liquid capital. The other-than-temporary impairment losses recorded in the third quarter of 2008 reflect the Company's assessment of the severity and duration of unrealized losses related to various merchant banking and long-term investments in equity securities. The recognition of these other-than-temporary impairment losses during the third quarter of 2008 is a result of recent economic and market conditions and the Company's assessment of these conditions, as well as other company-specific factors, relative to the various investments.

                                                     Nine Months Ended
                                                       September 30,
                                                     2008          2007
              Revenues, net of interest expense:
              Net investment (loss) income         $ (13,542 )   $  4,108
              Net interest income                      5,263        8,423
              Other                                      527          354

              Total                                   (7,752 )     12,885

              Operating Expenses:
              Variable                                   171          345
              Fixed                                    2,513        2,319

              Total                                    2,684        2,664

              Pre-tax (loss) income                $ (10,436 )   $ 10,221

The pre-tax income from our principal investing activities decreased from $10.2 million in the first nine months of 2007 to a pre-tax loss of $10.4 million in the first nine months of 2008. The decrease in pre-tax income is primarily attributable to the net investment loss incurred in the nine months ended September 30, 2008,

reflecting the recognition of other-than-temporary impairments of certain merchant banking and other long-term investments, as compared to gains on investment funds and gains recognized from the sale of agency mortgage-backed securities, during the first nine months of 2007. The other-than-temporary impairment losses recorded in the nine months ended September 30, 2008 reflect the Company's assessment of the severity and duration of unrealized losses related to various merchant banking and long-term investments in equity securities. The recognition of these other-than-temporary impairment losses during 2008 is a result of economic and market conditions during the period and the Company's assessment of these conditions, as well as other company-specific factors, relative to the various investments. In addition, the decrease in net interest income on our liquid capital contributed to the decrease in pre-tax income. This decrease in net interest income is attributable to the year-over-year decrease in money market rates and lower average interest bearing cash and investment balances in the nine months ended September 30, 2008 compared to the same period in 2007, resulting from the deployment of capital into our merchant banking portfolio during 2007 and our operating losses.

Merchant Banking

The total value of our merchant banking portfolio and other long-term investments was $65.7 million as of September 30, 2008. Of this total, $46.2 million was held in the merchant banking portfolio, $15.7 million was held in investment funds and $3.8 million was held in other long-term investments. The following table provides additional detail regarding the Company's merchant banking and other long-term investments as of September 30, 2008 (dollars in thousands):

                Merchant Banking and Other Long-Term Investments



                                                             September 30, 2008
                                           Number        Original      Adjusted       Fair Value/
                                          of Shares     Cost Basis       Basis      Carrying Value
Long-term investments, at fair value:
Merchant banking-marketable equity
securities:
Grubb & Ellis Company(1)                    236,558    $      1,519    $     639    $           639
Thornburg Mortgage, Inc.                     56,550               6            6                 99

Total                                                  $      1,525    $     645    $           738

Other investments                                                                             1,513

Total long-term investments, at fair
value                                                                               $         2,251

Other long-term investments:
Merchant banking-non-public
securities:
Cohen Financial(1)(2)                       112,892    $      5,000    $   1,129    $         1,129
Cypress Sharpridge Investments,
Inc.(1)(2)                                   89,600           2,500          896                896
Ellington Financial LLC(2)                1,438,750          27,049       27,049             27,049
FSI Realty Trust(1)(2)                      376,344           3,500          470                470
Muni Funding of America, LLC(1)(2)          375,000           3,488        2,625              2,625
Star Asia Finance, Limited(1)(2)            650,000           4,220        1,300              1,300
Thornburg Mortgage, Inc.(3)                     N/A           5,043        5,043              5,043
Thunderbird Resorts, Inc.(2)                836,320           7,000        7,000              7,000

Total                                                  $     57,800    $  45,512    $        45,512

Investment funds                                                                             15,660
Other investments                                                                             2,283

Total other long-term investments                                                   $        63,455

(1) Adjusted basis reflects the effects of other-than-temporary impairment charges.

(2) As of September 30, 2008 these shares cannot be traded in a public market (e.g., NYSE or Nasdaq) but may be sold in private transactions.

(3) Represents an investment in senior subordinated debt securities and warrants to purchase Thornburg Mortgage, Inc. common stock.

Liquid Capital

From time to time, we may invest our liquid capital in highly rated liquid investments such as money market funds, U.S. Government securities and agency-backed mortgage-backed securities. These investments have been and will be made with the intention of redeploying this capital into supporting current strategies and new endeavors in capital markets, asset management, and merchant banking as these opportunities present themselves.

We currently have invested a portion of our excess liquid capital in residential mortgage-backed securities, all of which are floating-rate collateralized mortgage obligations, guaranteed as to principal and interest by U.S. government-sponsored entities. The market value of these securities, however, is not guaranteed by these entities. Our deployment of capital into these investments has been based on our current near-term liquidity requirements and our assessment of our ability and intent to hold these securities to withstand interim market value fluctuations due to market and interest rate risks. See "Liquidity and Capital Resources" and "Item 3. Quantitative and Qualitative Disclosures about Market Risk-Interest Rate Risk".

We have invested in short-term liquid investments as well as agency-backed mortgage-backed securities. Our mortgage-backed securities investment strategy is based on investing in floating-rate agency-backed collateralized mortgage obligations for which the principal and interest payments are guaranteed by a U.S. government agency or a U.S. government-sponsored entity and financed partially by repurchase agreement borrowings. For the three months ended September 30, 2008 and 2007, we recorded net interest income of $2.7 million and $2.2 million, respectively, from liquid capital invested in our principal investing segment. For the nine months ended September 30, 2008 and 2007, we recorded net interest income of $5.3 million and $8.4 million, respectively, from liquid capital invested in our principal investing segment.

Results of Operations

Three months ended September 30, 2008 compared to three months ended September 30, 2007

Net income decreased from $0.3 million in the third quarter of 2007 to a loss of $28.5 million in the third quarter of 2008. The decrease in net income was primarily the result of the performance of our capital markets segment where, due to the decrease in capital raising revenues, pre-tax income decreased from $0.9 million in the third quarter of 2007 to a loss of $33.4 million in the third quarter of 2008. In addition, pre-tax income from our principal investing segment decreased from $3.2 million in the third quarter of 2007 to a loss of $9.4 million in the third quarter of 2008, reflecting the recognition of other-than-temporary impairments charges on merchant banking and other long-term investments. The pre-tax loss from our asset management segment increased from $2.0 million in the third quarter of 2007 to a $4.0 million pre-tax loss in this segment during the third quarter of 2008 as a result of a decrease in average assets under management and increased fixed costs. Our provision for income taxes was $1.8 million in the third quarter of 2007 as compared to a tax benefit of $18.1 million in the third quarter of 2008.

The Company's net revenues decreased 57.1% from $106.2 million in the third quarter of 2007 to $45.6 million in the third quarter of 2008 due to the changes in revenues, net of interest expense discussed below.

Capital raising revenues decreased 86.3% from $49.7 million in the third quarter of 2007 to $6.8 million in the third quarter of 2008. The lower volume of capital raising activity was spread across all of the Company's industry sectors reflecting the effects of the continued dislocation in U.S. financial markets and the resulting decrease in capital raising activity. We were the lead/sole manager on three public offering transactions raising $719.2 million in the . . .