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FBRC > SEC Filings for FBRC > Form 10-Q on 9-May-2014All Recent SEC Filings

Show all filings for FBR & CO.

Form 10-Q for FBR & CO.


9-May-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the consolidated financial condition and results of operations of FBR & Co. and its subsidiaries (collectively, "we", "us", "our" or the "Company") should be read in conjunction with the unaudited consolidated financial statements and the notes thereto appearing elsewhere in this report on Form 10-Q and the audited consolidated financial statements and notes thereto appearing in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

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, 2013. 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, 2013.

Business Environment

In the first quarter of 2014, U.S. equity markets were up slightly following very strong performance for the full year 2013. Volatility remained low as investors were seemingly unconcerned with political disruptions in Europe and the Middle East and with a winter slowdown in economic activity domestically. Equity capital markets activity was quite strong as a result of a higher number of issuers seeking capital events and healthy levels of risk tolerance on the part of investors supported by consistently low volatility. During the first quarter there were 65 IPOs completed in the U.S., more than double the number in last year's first quarter. Total domestic equity issuance was $49.6 billion, compared to $56.5 billion in the first quarter of last year. In addition, equity trading volumes were up 9% year-over-year.

Overall, competition in our business remains intense. Large banks continue to tie lending activity to capital markets mandates and electronic or high-frequency trading continues to capture a significant share of trading volume. Both of these dynamics put pressure on high-touch, idea-driven firms like FBR. Institutional investors continue to narrow the list of broker-dealers with whom they maintain trading relationships, leading to consolidation of smaller firms and to the need for mid-size firms to work intensely to demonstrate relevance through quality and scale of research offerings in order to grow relationships.

We believe capital markets conditions remain favorable as positive fund flows and extraordinary low interest rates have combined to provide significant support to equity prices and high-yield bond prices. Over the last 18 months, investors have been increasingly focused on higher risk assets due to strong market performance and in order to achieve targeted investment returns. This move toward risk continues to be underpinned by the accommodating stance of the Federal Reserve. While the Federal Reserve has begun to reduce the monthly amount of its bond purchases, the market continues to benefit from a combination of low interest rates and significant bond market support. We believe that normalization of these policies is likely to lead to increased market volatility as markets adjust to consequent changes in interest rates and fund flows.

Executive Summary

For the first quarter of 2014 our revenues, net of interest expense, were $54.4 million, our pre-tax income was $9.0 million and our net income was $5.6 million. This compares to first quarter 2013 revenues of $117.9 million, pre-tax income from continuing operations of $35.9 million, and net income from continuing operations of $34.4 million. Our first quarter 2013 net income was $35.2 million and included $0.8 million of net income from discontinued operations.

The difference in our first quarter 2014 operating results compared to 2013 is due almost entirely to the difference in investment banking revenue in these periods. Our first quarter 2014 investment banking revenue of $36.6 million compares to $101.3 million in 2013. The reduction in investment banking revenues in 2014 reflects


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the differences in the nature and size of the capital raising transactions completed in these periods. Our institutional brokerage revenue was $15.1 million in the first quarter of 2014 compared to $13.7 million in 2013, and our net revenues from principal investing were $2.4 million in both of the respective periods. Our non-compensation fixed expenses were $10.6 million in the first quarter of 2014 compared to $11.1 million in 2013. Our compensation and benefits expense as a percentage of net revenues was 57.6% in 2014 compared to 56.3% in 2013.

The following is an analysis of our operating results by segment for the first quarters of 2014 and 2013.

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, healthcare, insurance, real estate, and technology, media and telecommunications sectors. By their nature, our capital markets business activities are highly competitive and are subject to market conditions, 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 table provides a summary of our results within the capital markets segment (dollars in thousands).

                                                     Three Months Ended
                                                          March 31,
                                                     2014          2013
            Revenues:
            Investment banking                     $  36,639     $ 101,290
            Institutional brokerage                   15,091        13,705
            Interest income, dividends and other         248           528

            Total                                     51,978       115,523

            Operating Expenses:
            Variable                                  19,544        57,316
            Fixed                                     24,808        23,711

            Total(1)                                  44,352        81,027

            Pre-tax income                         $   7,626     $  34,496

(1) For the three months ended March 31, 2014 and 2013, total operating expenses includes the allocation of corporate overhead costs of $5,502 and $7,132, respectively.

The pre-tax income from our capital markets segment decreased to $7.6 million for the first quarter of 2014 from $34.5 million for the first quarter of 2013. The decrease in our pre-tax income is primarily attributable to a $64.7 million decrease in investment banking revenue in 2014. The impact of the decreased revenues was offset partially by a $37.8 million decrease in variable expenses. Specifically, variable expenses, including $16.1 million of variable compensation, decreased to $19.5 million in 2014 from $57.3 million in 2013 as a result of the decrease in revenues. Our total compensation and benefits costs as a percentage of revenues in this segment was 59.1% in 2014 compared to 56.7% in 2013. Fixed expenses increased $1.1 million, or 4.6%, in 2014 as a result of an increase in our average headcount in the first quarter of 2014 compared to 2013.

Investment banking revenues decreased $64.7 million to $36.6 million during the first quarter of 2014 from $101.3 million in the first quarter of 2013. Our investment banking revenue in 2014 was generated from 16 client transactions representing $2.6 billion in transaction volume. Included in those transactions and representing $28.0 million of our capital raising revenue were two sole managed institutional private placements. In comparison, our investment banking revenue in 2013 was generated from 18 client transactions representing $6.2


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billion in transaction volume. Included in those transactions and representing $81.0 million of our capital raising revenue were two sole managed institutional private placements that raised in excess of $1.2 billion of equity capital for the issuers. One of these private placements, representing $38.3 million of that revenue was executed in the second quarter of 2012; however the issuer did not receive the required regulatory approvals necessary for us to recognize this revenue until the first quarter of 2013.

Our institutional brokerage revenues increased $1.4 million to $15.1 million for the first quarter of 2014 from $13.7 million for the first quarter of 2013. The increase in revenue in 2014 reflects the impact of the fourth quarter 2013 group hire of 32 institutional brokerage sales, trading and research professionals on our brokerage activities in 2014 as well as our continued investment in research.

Principal Investing

As of March 31, 2014, our principal investing activity consists of investments
in non-registered investment funds, marketable equity securities, non-public
equity securities, corporate debt investments and short-sales of U.S. Treasury
securities. The following table provides a summary of our results within the
principal investing segment (dollars in thousands):



                                                   Three Months Ended
                                                       March  31,
                                                    2014          2013
             Revenues:
             Net investment income               $    3,834      $ 2,098
             Interest, dividends & other                223          305

             Total revenues                           4,057        2,403
             Interest expense                         1,677           -

             Revenues, net of interest expense        2,380        2,403

             Operating Expenses:
             Variable                                   219          650
             Fixed                                      772          342

             Total(1)                                   991          992

             Pre-tax income                      $    1,389      $ 1,411

(1) For the three months ended March 31, 2014 and 2013, total operating expenses includes the allocation of corporate overhead costs of $107 and $138, respectively.

The pre-tax income from our principal investing segment was $1.4 million for both the first quarter of 2014 and 2013 reflecting comparable net revenues and expenses in both periods. Net investment income for the first quarter of 2014 includes $1.6 million of net unrealized gains from investment funds, $0.7 million of unrealized gains from equity trading securities held for investment purposes and $1.5 million of unrealized gains from short-sales of U.S. Treasury securities. Total revenues in the first quarter of 2014 were partially offset by $1.7 million of interest expense related to short-sales of U.S. Treasury securities. Our 2013 net investment income includes $1.3 million of net unrealized gains from investment funds, $1.3 million of unrealized gains from trading securities held for investment purposes, and a $0.5 million impairment loss related to an available-for sale investment security.


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Investments

The total value of our principal investments was $103.5 million as of March 31, 2014. Of this total, $77.9 million was held in non-registered investment funds that primarily invest in fixed income securities, $23.0 million was held in marketable and non-public equity securities, warrants and fixed income securities, at fair value, and $2.7 million was held in non-public investments recorded at cost. The following table provides additional detail regarding our principal investments as of March 31, 2014 (dollars in thousands):

                                                                    Carrying Value/
                                                                      Fair  Value
Investments, at fair value:
Investment funds, at fair value                                    $          77,854
Marketable and non-public equity securities and warrants,
at fair value                                                                 23,009

Total                                                              $         100,863
Investments, at cost:
Non-public equity securities                                                   2,681

Total investments                                                  $         103,544

In addition to these assets, during the first quarter of 2014, as part of the Company's investing activities, the Company entered into two short-sales of $100 million face value each, 4.50% U.S. Treasury securities. These positions are included in securities sold but not yet purchased on the Company's balance sheet as of March 31, 2014. These two securities mature in November 2015 and February 2016, respectively. Proceeds from these short-sales, as well as related margin requirements, are held in a collateral account and are included in due from brokers, dealers and clearing organizations on the Company's balance sheet at March 31, 2014. The Company is obligated to fund the fixed-rate coupon interest on these securities while the short-positions are outstanding.

As of March 31, 2014, the $77.9 million of investment funds reflected investments in 16 non-registered investment funds that are valued at net asset value ("NAV") as determined by the fund administrators. The Company classifies these investments within Level 3 of the fair value hierarchy as the underlying securities held by these investment companies are primarily corporate and asset-backed fixed income securities and restrictions exist on the redemption of amounts invested by the Company. As a practical expedient, the Company relies on the NAV of these investments as their fair value. The NAVs that have been provided by investees are derived from the fair values of the underlying investments as of the reporting date. Considering the general lack of transparency necessary to conduct an independent assessment of the fair value of the securities underlying each of the NAVs provided by the fund administrators, our quarterly reporting process includes a number of assessment processes to assist the Company in the evaluation of the information provided by fund managers and fund administrators. These assessment processes include, but are not limited to regular review and discussion of each fund's performance with its manager and regular evaluation of performance against applicable benchmarks.

Discontinued Operations

The Company completed the sale of the FBR Funds, a family of mutual funds, in October 2012. Subsequent to the sale closing, the Company has had no continuing involvement in the management of these funds. As a result of this sale transaction, the Company has reported the results of its asset management operations as discontinued operations.

In accordance with the asset sale agreement, the Company received an initial payment upon closing in October 2012 and a subsequent payment upon the first anniversary of closing in October 2013, in each case based on a percentage of assets under management for the applicable funds. Additionally, the gain recorded on the asset sale in 2012 included an estimate of the contingent payment to be received in 2013. The Company valued this contingent payment at each reporting date during 2013, through the first anniversary of the closing in October 2013. These valuations were based on the Company's consideration of various factors outside of its


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control that could have had a significant effect on the value of prospective assets under management. For example, uncertainties related to fund performance, market conditions as well as investor demand for equity mutual funds. Other considerations included the Company's historical asset levels and potential asset attrition as a result of the sale transaction.

The Company's net income from discontinued operations during the first quarter of 2013 reflects the estimated change in value during the period of the contingent payment that was due from this sale and recorded as a receivable at December 31, 2012. The increase in value during 2013 was due primarily to market appreciation of the funds during the period subsequent to the sale. The tax provision recognized in 2013 related primarily to state taxes on income that could not be offset by either net operating loss or capital loss carryforwards. Based on the Company's receipt of the applicable contingent sale proceeds during the fourth quarter of 2013, there are no comparable discontinued operations results in 2014.

The results related to our asset management operations reflected in the consolidated statement of operations for the three months ended March 31, 2013, are presented in the following table (dollars in thousands).

                                                             Three Months Ended
                                                                 March 31,
                                                                    2013
  Revenues                                                  $                 -
  Gain on sale of assets, net                                                848
  Expenses                                                                     8

  Income from discontinued operations before income taxes                    840
  Income tax provision                                                        34

  Income from discontinued operations, net of taxes         $                806

Results of Operations

Three months ended March 31, 2014 compared to three months ended March 31, 2013

We generated net income of $5.6 million in the first quarter of 2014 compared to $35.3 million in the first quarter of 2013. This decrease in net income was primarily the result of a $64.7 million decrease in investment banking revenue in 2014 compared to 2013. Our net income for the first quarter of 2014 includes a $3.4 million tax provision compared to a $1.5 million tax provision in the first quarter of 2013.

Pre-tax income in our capital markets segment decreased to $7.6 million during the first quarter of 2014 from $34.5 million during the first quarter of 2013. This decrease in pre-tax income is due to the decrease in investment banking revenue discussed above. Pre-tax income in our principal investing segment was $1.4 million in both 2014 and 2013 on comparable amounts of net revenues. Our net income for the first quarter of 2013 also includes $0.8 million of net income from discontinued operations.

Revenues, net of Interest Expense

Our revenues, net of interest expense, decreased 53.9% to $54.4 million during the first quarter of 2014 from $117.9 million during the first quarter of 2013 due to the changes in revenues and interest expense discussed below.

Capital raising revenues decreased 66.6% to $33.3 million in the first quarter of 2014 from $99.7 million in the first quarter of 2013. In the first quarter of 2014, we completed 9 client transactions, including two sole-managed private placements that generated $28.0 million of revenue in the period. In the first quarter of 2013, we completed 14 client transactions, including two sole-managed private placements that generated $81.0 million of revenue in the period and raised in excess of $1.2 billion of equity for the issuers.


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Advisory revenues increased 106.3% to $3.3 million in the first quarter of 2014 from $1.6 million in the first quarter of 2013. We completed seven M&A and advisory assignments in the first quarter of 2014 compared to four assignments in the first quarter of 2013.

Institutional brokerage revenues increased 10.2% to $15.1 million in the first quarter of 2014 from $13.7 million in the first quarter of 2013. The increase in revenue in 2014 reflects the impact of the fourth quarter 2013 group hire of 32 institutional brokerage sales, trading and research professionals on our brokerage activities in 2014 as well as our continued investment in research.

Net investment income increased 81.0% to $3.8 million in the first quarter of 2014 compared to $2.1 million in the first quarter of 2013. Net investment income for the first quarter of 2014 includes $1.6 million of net unrealized gains from investment funds, $0.7 million of realized and unrealized gains from trading securities held for investment purposes and $1.5 million of unrealized gains from short-sales of U.S. Treasury securities. These 2014 revenues were partially offset by $1.7 million of interest expense discussed below. Our 2013 net investment income includes $1.3 million of net unrealized gains from investment funds, $1.3 million of unrealized gains from trading securities held for investment purposes, and a $0.5 million impairment loss related to an available for sale investment security.

Interest income, dividends and other revenues decreased 37.5% to $0.5 million in the first quarter of 2014 from $0.8 million in the first quarter of 2013. These revenues include interest from convertible and fixed income securities held on our trading desks as well as interest and dividends generated from our investing activities. The decrease in 2014 revenue was the result of differences in our trading desk and investment positions in these periods.

During the first quarter of 2014, we incurred $1.7 million of interest expense related to two short-sales of $100 million face value each, 4.50% U.S. Treasury securities. The Company did not incur any interest expense during the first quarter of 2013.

Non-Interest Expenses

Total non-interest expenses decreased 44.8% to $45.3 million in the first quarter of 2014 from $82.0 million in the first quarter of 2013. The decrease was caused by the changes in non-interest expenses discussed below.

Compensation and benefits expenses decreased 52.9% to $31.3 million in the first quarter of 2014 from $66.4 million in the first quarter of 2013 as a result of a $37.1 million decrease in variable compensation. The reduction in variable compensation is due to the decrease in investment banking revenue in 2014 compared to the prior year. This decrease was partially offset by a $2.0 million increase in fixed compensation in 2014 compared to 2013 as a result of a higher average headcount in the first quarter of 2014 compared to the first quarter of 2013.

Professional services expenses decreased 17.1% to $2.9 million in the first quarter of 2014 from $3.5 million in the first quarter of 2013. This decrease is primarily due to a decrease in legal and consulting costs associated with investment banking activity.

Business development expenses increased 14.3% to $2.4 million in the first quarter of 2014 from $2.1 million in the first quarter of 2013. This increase is primarily due to an increase in travel costs related to business promotion, partially offset by a reduction in travel costs related to investment banking transactions.

Clearing and brokerage fees decreased 25.0% to $1.2 million in the first quarter of 2014 from $1.6 million in the first quarter of 2013. The decrease in these costs is due primarily to the impact of cost reduction initiatives directed at reducing our brokerage execution costs.


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Occupancy and equipment expenses decreased slightly to $3.2 million in the first quarter of 2014 from $3.3 million in the first quarter of 2013. The decrease in occupancy costs is primarily the result of reductions in depreciation expense associated with reduced capital expenditures over the past several years.

Communications expenses decreased slightly to $2.9 million in the first quarter of 2014 from $3.0 million in the first quarter of 2013. The decrease in these expenses is primarily due to decreased costs related to market data and customer trading services as a result of cost reduction initiatives. The impact of these cost reductions was partially offset by an increase in our average headcount in the first quarter of 2014 compared to the first quarter of 2013.

Other operating expenses decreased 31.8% to $1.5 million in the first quarter of 2014 from $2.2 million in the first quarter of 2013. The decrease in these expenses is primarily due to a $0.5 million charge related to an arbitration settlement in the first quarter of 2013 that is not comparable to 2014 as well reduced SIPC charges in 2014 as a result of the decrease in our revenues.

We recognized a tax provision of $3.4 million in the first quarter of 2014 compared to a $1.5 million provision in the first quarter of 2013. Our quarterly tax provision is determined pursuant to ASC 740, which requires using an estimated annual effective tax rate based on the forecasted taxable income for the full year. Our effective tax rates for the first quarters of 2014 and 2013 were 37.8% and 4.1%, respectively. Our 2014 tax rate differed from statutory tax rates primarily due to capital loss carryforwards subject to a valuation allowance that are projected to be utilized during the year. The Company's 2013 tax rate differed from statutory tax rates primarily due to the effects of recording a full valuation allowance on the Company's net deferred tax assets as of March 31, 2013. The annual estimated effective tax rate for the three months ended March 31, 2013 also incorporated the benefit of net operating losses expected to be utilized during 2013.

As of March 31, 2013, the Company provided a full valuation allowance against its net deferred tax assets since, based on the application of the criteria in ASC 740, it concluded that it was more likely than not that the benefits of these assets would not be realized in the future. Pursuant to the criteria in ASC 740, the Company reviews its valuation allowance related to its deferred tax assets on a quarterly basis assessing the positive and negative evidence to determine if it is more likely than not that some or all of the deferred tax assets will be realized. Based on its assessment as of June 30, 2013, the Company determined that the release of a significant component of this valuation allowance was appropriate. As of June 30, 2013 and subsequently, as described below, the Company's valuation allowance for its deferred tax assets relates to capital loss carryforwards and net unrealized losses on investments.

At December 31, 2013, the Company's net deferred tax assets totaled $49.2 million and were partially offset by valuation allowance of $18.3 million. This valuation allowance related to capital loss carryforwards and net unrealized losses on investments and was determined based on the Company's application of the guidance in ASC 740 and its conclusion that that it was more likely than not that the benefits of these assets would not be realized in the future. Based on . . .

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