Overview

Friedman, Billings, Ramsey Group, Inc. invests on a leveraged basis in residential mortgage-backed securities (MBS), either issued by a U.S. Government agency, or guaranteed as to principal and interest by U.S. Government agencies or U.S. Government-sponsored entities (agency-backed MBS). We also invest in both MBS issued by private organizations (private-label MBS) and net interest margin securities and we make merchant banking investments, subject to maintaining our exemption from regulation as an investment company under the Investment Company Act of 1940, as amended (1940 Act).

In addition to our principal investing business described above, as of December 31, 2008, we beneficially owned 57% of the outstanding shares of common stock of FBR Capital Markets Corporation (FBR Capital Markets), a publicly-traded holding company (NASDAQ: FBCM) for various subsidiaries that conduct capital markets (investment banking and institutional brokerage), asset management and merchant banking businesses. These subsidiaries include Friedman, Billings, Ramsey & Co., Inc. (FBR & Co.), Friedman, Billings, Ramsey International, Ltd. (FBRIL), FBR Investment Management, Inc. (FBRIM) and FBR Fund Advisors, Inc. (FBR Fund Advisors). FBR Capital Markets is managed under the direction of its board of directors, a majority of whom are independent of both us and FBR Capital Markets. As a result of our ownership of a majority of the issued and outstanding shares of common stock of FBR Capital Markets, our financial statements reflect our proportionate interest in the results of operations of FBR Capital Markets and its subsidiaries.

When we use the terms "FBR," "we" "us" "our" and "the Company," we mean Friedman, Billings, Ramsey Group, Inc. and its consolidated subsidiaries. We historically have conducted most of our principal investing activities at the parent company level and through a qualified REIT subsidiary (QRS) (principal investing). Historically, we have operated in a manner that qualifies us to be taxed as a real estate investment trust (REIT) for federal income tax purposes and we conducted our investment banking and institutional brokerage activities (capital markets), and investment management and advisory activities (asset management) in our former taxable REIT subsidiaries (TRSs). In order to use the net operating losses incurred at the parent level to offset anticipated taxable income of our former TRSs, our Board of Directors decided to revoke our REIT election effective as of January 1, 2009. As a result, we are currently taxed as a C corporation for federal income tax purposes. Our Company operates primarily in the United States and Europe.

Because of the continued deterioration of the non-prime mortgage market, on January 18, 2008, First NLC filed a voluntary petition for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code in order to effectuate an orderly liquidation of First NLC's assets and on May 9, 2008, First NLC filed a notice of conversion with the bankruptcy court to convert First NLC's petition for bankruptcy protection from a petition under Chapter 11 of the United States Bankruptcy Code to a petition under Chapter 7 of the United States Bankruptcy Code. As a result, on January 18, 2008, the Company deconsolidated First NLC and recognized its investment in First NLC under the cost-method thereafter.

In addition, the Company recorded a non-cash reversal of its $73.0 million negative investment in First NLC because the Company has no continuing involvement with First NLC. As a result of the bankruptcy and based on the Company's review of its relationship with First NLC and an opinion of the Company's counsel to the effect that First NLC's creditors would not be able to pierce the corporate veil between First NLC and the Company, the Company believes it has no remaining guarantees of the debt or any other obligation of First NLC, and it is considered remote that the Company would have any further obligations related to First NLC.

On October 23, 2008, we announced our plan to downsize the MBS portfolio in order to reduce exposure to deteriorating market conditions while at the same time generating additional cash to fund the extinguishment of long-term debt. We also announced that we have retained financial advisors to evaluate strategic alternatives for

the purpose of maximizing the value of our assets and liabilities including all of the trust preferred debt. Potential strategic alternatives include the sale of the Company or the assets or the distribution of the assets to shareholders. Consistent with this strategy, during the twelve months ended December 31, 2008, we extinguished approximately $65.8 million of long-term debt at a gain of approximately $39.1 million and disposed of approximately $1.6 billion of MBS from our MBS portfolio at a net loss of approximately $108.6 million. Subsequent to December 31, 2008 and through March 13, 2009, we extinguished an additional $201.7 million of long-term debt at a gain of approximately $131.5 million and disposed of an additional $56.1 million of MBS from our our MBS portfolio at a loss of $1.1 million, substantially completing the current phase of our strategy announced on October 23, 2008.

On February 23, 2009, we announced that we have begun doing business under the name "Arlington Asset Investment Corporation" and that we will seek shareholder approval at our next annual meeting of shareholders of a proposal to amend our charter to change our corporate name from "Friedman, Billings, Ramsey Group, Inc." to "Arlington Asset Investment Corporation." The Company had notified the NYSE of the name change and received the approval to change the ticker symbol to "AI" from "FBR" on February 24, 2009. The Company will issue a press release when the symbol change becomes effective.

Business Environment

Our MBS portfolio is affected by general U.S. residential real estate fundamentals and the overall U.S. economic environment. In particular, our MBS investing strategy and the performance of our MBS portfolio is influenced by the specific characteristics of these markets, including prepayment rates, interest rates and the interest rate yield curve. Our results of operations with respect to our MBS portfolio primarily depend on, among other things, the level of our interest income and the amount and cost of borrowings we may obtain by pledging our investment portfolio as collateral for the borrowings. Our interest income, which includes the amortization of purchase premiums and accretion of discounts, varies primarily as a result of changes in prepayment speeds of the securities in our MBS portfolio. Our borrowing cost varies based on changes in interest rates and changes in the amount we can borrow which is generally based on the fair value of the MBS portfolio and the advance rate the lenders are willing to lend against the collateral provided.

Concerns about increased mortgage delinquencies and foreclosures, declining home prices and rising unsold home inventory have caused many investors to question the underlying risk and value of mortgage-related assets across the ratings spectrum. Since the middle of 2007, commercial banks, investment banks and insurance companies have announced extensive losses from exposure to the U.S. mortgage market. These losses have reduced financial industry capital leading to reduced liquidity for mortgage assets, more volatile valuations of mortgage assets and in some cases forced selling of mortgage assets. As a result, repurchase financing for MBS, including agency-backed MBS, has been more volatile.

The liquidity crisis could adversely affect one or more of our lenders and could cause one or more of our lenders to be unwilling or unable to provide us with additional financing. This could potentially increase our financing costs and reduce liquidity. If one or more major market participants fails, it could negatively impact the marketability of all fixed income securities, including agency-backed MBS, and this could negatively impact the value of the securities in our MBS portfolio. Furthermore, if many of our lenders are unwilling or unable to provide us with additional financing, we could be forced to sell securities in our MBS portfolio at an inopportune time when prices are depressed.

The payment of principal and interest on the agency-backed MBS that we invest in is guaranteed by Ginnie Mae, Freddie Mac or Fannie Mae. The payment of principal and interest on agency-backed MBS issued by Ginnie Mae is guaranteed by the full faith and credit of the U.S. government, while payment of principal and interest on agency-backed MBS issued by Freddie Mac or Fannie Mae is not guaranteed by the U.S. government. Any failure to honor its guarantee of agency-backed MBS by Freddie Mac or Fannie Mae or any downgrade of securities issued by Freddie Mac or Fannie Mae by the rating agencies could cause a significant decline in the value of and cash flow from, any agency-backed MBS we own that are guaranteed by such entity.

Due to increased market concerns about Fannie Mae and Freddie Mac's ability to withstand future credit losses associated with securities held in their investment portfolios, and on which they provide guarantees, without the direct support of the federal government, the government passed the Housing and Economic Recovery Act of 2008, or the HERA, on July 30, 2008. As a result of this legislation, Fannie Mae and Freddie Mac have been placed into the conservatorship of the Federal Housing Finance Agency, or FHFA, their federal regulator, pursuant to its powers under the HERA. As the conservator of Fannie Mae and Freddie Mac, the FHFA now controls and directs the operations of Fannie Mae and Freddie Mac and may (i) take over the assets of and operate Fannie Mae and Freddie Mac with all the powers of the shareholders, the directors, and the officers of Fannie Mae and Freddie Mac and conduct all business of Fannie Mae and Freddie Mac; (ii) collect all obligations and money due to Fannie Mae and Freddie Mac; (iii) perform all functions of Fannie Mae and Freddie Mac which are consistent with the conservator's appointment; (iv) preserve and conserve the assets and property of Fannie Mae and Freddie Mac; and (v) contract for assistance in fulfilling any function, activity, action or duty of the conservator. A primary focus of this new legislation is to increase the availability of mortgage financing by allowing Fannie Mae and Freddie Mac to continue to grow their guarantee business without limit, while limiting net purchases of agency-backed MBS to a modest amount through the end of 2009. Beginning in 2010, Fannie Mae and Freddie Mac will gradually reduce their agency security portfolios.

In addition to FHFA becoming the conservator of Fannie Mae and Freddie Mac, the U.S. Department of Treasury, or the U.S. Treasury, has taken three additional actions: (i) the U.S. Treasury and FHFA have entered into separate preferred stock purchase agreements with Fannie Mae and Freddie Mac pursuant to which the U.S. Treasury will ensure that each of Fannie Mae and Freddie Mac maintains a positive net worth; (ii) the U.S. Treasury has established a new secured lending credit facility available until December 2009 to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, which is intended to serve as a liquidity backstop; and (iii) the U.S. Treasury has initiated a temporary program to purchase RMBS issued by Fannie Mae and Freddie Mac.

Initially, Fannie Mae and Freddie Mac each issued $1.0 billion of senior preferred stock to the U.S. Treasury and warrants to purchase 79.9% of the fully-diluted common stock outstanding of each government sponsored entity, or GSE, at a nominal exercise price. Pursuant to these agreements, each of Fannie Mae's and Freddie Mac's mortgage and agency security portfolio may not exceed $850 billion as of December 31, 2009, and will decline by 10% each year until such portfolio reaches $250 billion. Given the highly fluid and evolving nature of these events, it is unclear how our business will be impacted. Although the U.S. Treasury has committed capital to Fannie Mae and Freddie Mac, there can be no assurance that these actions will be adequate for their needs. If these actions are inadequate, Fannie Mae and Freddie Mac could continue to suffer losses and could fail to honor their guarantees and other obligations which could materially adversely affect our business, operations and financial condition.

The Emergency Economic Stabilization Act of 2008, or EESA, was enacted on October 3, 2008. The EESA provides the U.S. Secretary of the Treasury with the authority to establish a Troubled Asset Relief Program, or TARP, to purchase from financial institutions up to $700 billion of residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008. In addition, it may purchase other financial instruments that the U.S. Secretary of the Treasury, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability. The EESA also provides for a program that would allow companies to insure their troubled assets.

On October 14, 2008, the U.S. Treasury announced the voluntary Capital Purchase Program, or the CPP, which was implemented under authority provided in the EESA. Under the CPP, the U.S. Treasury will purchase up to $250 billion of senior preferred shares in qualifying U.S. controlled banks, savings associations, and certain bank and savings and loan holding companies engaged only in financial activities, that elect to participate by November 14, 2008. Nine of the largest banks in the United States, as well as other financial institutions, have accepted investments under the CPP. The U.S. Treasury has also taken under consideration the expansion of the CPP to non-financial institutions, including life or other insurance companies. As of January 30, 2009, the U.S.

Treasury Department has made $195.3 billion of investments, receiving preferred stock and warrants from participating institutions.

In addition, during 2008, the U.S. Federal Reserve, or the Federal Reserve, also initiated a number of other programs aimed at improving broader financial markets, such as establishing a $1.8 trillion commercial paper funding facility and a $200 billion facility to finance consumer asset-backed securities. In addition, in order to provide further liquidity to financial institutions, the Federal Reserve has provided primary dealers with access to the Federal Reserve's discount window and, in instances of distress, arranged financing for certain entities.

On November 25, 2008, the Federal Reserve announced that it will initiate a program to purchase $100 billion in direct obligations of Fannie Mae, Freddie Mac and the Federal Home Loan Banks and $500 billion in agency-backed MBS backed by Fannie Mae, Freddie Mac and Ginnie Mae. The Federal Reserve stated that its actions are intended to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally. The purchases of direct obligations began during the first week of December 2008, and the purchases of agency-backed MBS are expected to begin shortly. The Federal Reserve's program to purchase agency-backed MBS could cause an increase in the price of agency-backed MBS, which would negatively impact the net interest margin with respect to new agency-backed MBS we may purchase.

During 2008, the U.S. government, through the FHA and the Federal Deposit Insurance Corporation, or the FDIC, also initiated programs in an effort to restore confidence and functioning in the banking system and attempt to reduce foreclosures through loan modifications. To assist the banking system, the FDIC will now insure deposits up to $250,000 up from $100,000 through December 31, 2009, provide finite guarantees on qualified bank debt and, in limited cases, provide loan guarantees to certain financial institutions. Additionally, in an attempt to reduce foreclosures, the FDIC encouraged uniform guidelines for loan modifications, which include reduction of interest rate, extension of maturity and balance reductions.

There can be no assurance that the programs and proposals recently initiated and announced by the U.S. Treasury or Federal Reserve will have a beneficial impact on the financial markets. To the extent the market does not respond favorably to these programs and proposals or the initiatives do not function as intended, our business may not receive any positive impact from the legislation. In addition, the U.S. Treasury, Federal Reserve and other governmental and regulatory bodies have taken or are considering taking other actions to address the financial crisis. We cannot predict whether or when such actions may occur or what impact, if any, such actions could have on our business, results of operations and financial condition.

As an investment banking, institutional sales, trading and research, asset management, and investment 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 2008 as compared to the comparable 2007 period exhibited the effects of the uncertainty in economic conditions due to continuing negative economic trends. Our investment banking revenues and MBS valuations have been adversely affected by the continued mortgage and credit market dislocation that began in the latter half of 2007 and continued through 2008, and we may be further impacted should there be continued or further credit market dislocations or a sustained market downturn. With trading volume in the MBS market diminishing, price discovery is difficult which has resulted in a widening of the bid/ask spreads. However, as investors continue to liquefy their positions, they have been forced to accept prices that are well below "pre-credit squeeze" levels. 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.

We believe the general business environment will continue to be challenging, with continued dampened capital markets activity, both domestically and internationally, and potential tightening in interest rate spreads. Our growth outlook is dependent in part on the extent and severity of the financial market dislocation, results from fiscal and monetary policy actions, the overall market value of U.S. equities and liquidity. The underpinnings of these growth assumptions also form our view on prospective investment banking, institutional sales, trading and research, asset management and investment activities. For further discussions on how markets conditions may affect our businesses see "Risk Factors."

Executive Summary

Our revenues consist primarily of: underwriting and placement fees for capital raising and advisory fees in investment banking; agency commissions and principal transactions mark-ups and mark-downs in institutional brokerage; base management fees and incentive allocations and fees in asset management; and net interest income, earnings from investment funds and dividend income, net interest income and gains and losses in principal investing. The current year net loss reflects the effects of the difficult environment most of our business segments have endured as a result of the severe deterioration of global economic conditions. These conditions have had a significant negative impact on our 2008 operating results including the limited number of capital raising transactions completed within the financial services industry and our firm, resulting in a reduction in our investment banking revenues and the negative impact on our portfolio of equity investments, resulting in other-than-temporary impairments on much of our investment portfolio. In addition, our 2008 results include the impact of several actions taken by us during the year to position the Company for improved results in future periods. These include severance and other costs associated with a 25 percent reduction in employees during 2008 to better align our cost structure to current market conditions. In addition, we reduced the amount of liquid capital invested in our MBS portfolio, in order to reduce our exposure to leveraged investments and to generate additional cash to fund the extinguishment of long-term debt, resulting in realized losses and other-than-temporary impairment losses as of December 31, 2008. These actions along with adjustments to our variable expense structure and addition of new employees and lines of business which complement our core strengths will reduce our cost structure, provide additional avenues to generate revenues and reduce the risk on our liquid capital as the Company moves forward.

Consistent with the strategy announced on October 23, 2008, the Company extinguished $65.8 million of long-term debt for a gain of $39.1 million and the Company further reduced its MBS portfolio by $1.6 billion at a net loss of $209.5 million, which included $100.9 million in previously recognized other-than-temporary impairment. Subsequent to December 31, 2008, the Company continued to extinguish an additional $201.7 million of long-term debt at a gain of $131.5 million and further reduced its MBS portfolio by $56.1 million, at a loss of $1.1 million, substantially completing the current phase of our strategy announced on October 23, 2008. In addition, FBR Capital Markets also liquidated its remaining MBS portfolio of $454.3 million and related interest rate caps and repurchase agreements, recognizing an aggregate net investment loss of $1.0 million. The Company also liquidated $550.0 million of its U.S. Treasury bond holdings and related repurchase agreements, recognizing no gain or loss from the transaction.

For the year ended December 31, 2008, our total revenues, net of interest expenses, were $(197.0) million compared to $107.2 million in 2007. The 2008 net loss of $417.5 million, or $2.76 loss per share, compared to a net loss of $658.6 million, or $3.94 loss per share, in 2007. The components of the net losses by segment are as follows (dollars in thousands):

                                                          For the year ended December 31,
                                                        2008            2007            2006
Capital Markets, net of intersegment elimination     $ (110,052 )    $   23,192      $  (34,376 )
Asset Management                                        (14,862 )        (7,016 )       (11,080 )
Principal Investment                                   (496,124 )      (328,758 )      (144,044 )
Mortgage Banking                                         (4,815 )      (426,374 )       (18,169 )

Operating loss                                         (625,853 )      (738,956 )      (207,669 )
Gain on subsidiary share activity                         7,809         104,062         121,511
Gain on extinguishment of long-term debt                 39,083              -               -
Gain on disposition of subsidiary                        73,039              -               -

Loss before income taxes and minority interest         (505,922 )      (634,894 )       (86,158 )
Income tax (benefit) provision                           (1,592 )        22,932         (14,682 )
Minority interest in (losses) earnings of
consolidated subsidiary                                 (86,867 )           774          (2,751 )

Net loss                                             $ (417,463 )    $ (658,600 )    $  (68,725 )

For the year ended December 31, 2008, the Company did not declare or pay any dividends. The Company had declared dividends of $0.15 per share for the year ended December 31, 2007. The Company's book value per share decreased to $0.09 as of December 31, 2008 compared to $2.61 as of December 31, 2007. The reduction in book value per share reflects the impact from the net loss in 2008.

The following provides analysis of our operating segments and their activities.

Principal Investing

As of December 31, 2008, our principal investing activity consisted primarily of investments in a leveraged portfolio of agency-backed MBS, U.S Treasury bonds, merchant banking investments and investments in hedge and venture funds.

We periodically evaluate the rates of return that can be achieved in each investment category and for each individual investment in which we participate. Historically, based on market conditions, our MBS investments have provided us with higher relative risk-adjusted rates of return than most other investment opportunities we have evaluated. Consequently, we have maintained a high allocation of our assets and capital in this sector.

We intend to continue to evaluate investment opportunities against the returns available in each of our investment alternatives and endeavor to allocate our assets and capital with an emphasis toward the highest risk- adjusted return available. This strategy may cause us to have different allocations of capital in different environments.

Mortgage-Backed Securities

We also invest in agency-backed and, to a lesser extent, private-label MBS. The Company recorded net interest income of $29.3 million from MBS held in our principal investment portfolio during 2008 compared to $35.7 million during 2007.

During 2008, the Company liquidated approximately $3.1 billion of MBS securities at a net loss of approximately $255.9 million, which included $100.9 million in previously recognized other-than-temporary impairment, to reduce leverage during the unprecedented credit market disruption and uncertainty in the asset-backed financing market and liquidity.

The following table summarizes, as of December 31, 2008, our portfolio of MBS, including principal receivable, by issuer (dollars in thousands):

                                            Face Amount     Fair Value
               Agency-backed: Fannie Mae   $     535,909   $    528,408
               Private-label                     188,493         65,886

               Total                       $     724,402   $    594,294

Merchant Banking and Other Long-Term Investments

The total value of FBR's merchant banking portfolio and other long-term investments was $55.0 million as of December 31, 2008. Of this total, $36.2 million was held in the merchant banking portfolio, $14.7 million was held in alternative asset funds, and $4.1 million was held in other long-term investments. Net unrealized losses in the merchant banking portfolio included in Accumulated Other Comprehensive Income (AOCI) totaled $0.2 million as of December 31, 2008.

In 2008, we recorded $39.0 million in other-than-temporary impairment write-downs on certain merchant banking investments. These write-downs were recorded as part of the Company's quarterly assessments of unrealized losses in its portfolio of marketable equity securities for potential other-than-temporary impairments and its related assessment of cost method investments. The Company . . .