Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                     

Commission file number: 000-50230

 

 

ARLINGTON ASSET INVESTMENT CORP.

(Exact name of Registrant as specified in its charter)

 

 

 

Virginia   54-1873198

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

1001 Nineteenth Street North

Arlington, VA

  22209
(Address of Principal Executive Offices)   (Zip Code)

(703) 373-0200

(Registrant’s Telephone Number, Including Area Code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes   x     No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes   ¨     No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨   Accelerated filer   x   Non-accelerated filer   ¨   Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):    Yes   ¨     No   x

Number of shares outstanding of each of the registrant’s classes of common stock, as of October 30, 2009:

 

Title

 

Outstanding

Class A Common Stock

  7,353,972 shares

Class B Common Stock

  566,112 shares

 

 

 


Table of Contents

ARLINGTON ASSET INVESTMENT CORP.

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2009

INDEX

 

          Page

PART I—FINANCIAL INFORMATION

  

Item 1.

  

Consolidated Financial Statements and Notes—(unaudited)

   3
  

Consolidated Balance Sheets—September 30, 2009 and December 31, 2008

   3
  

Consolidated Statements of Operations—Three Months Ended September 30, 2009 and 2008

   4
  

Consolidated Statements of Operations—Nine Months Ended September 30, 2009 and 2008

   5
  

Consolidated Statements of Changes in Equity—Nine Months Ended September 30, 2009 and Year Ended December 31, 2008

   6
  

Consolidated Statements of Cash Flows—Nine Months Ended September 30, 2009 and 2008

   7
  

Notes to Consolidated Financial Statements

   8

Item 2.

  

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

   25

Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

   38

Item 4.

  

Controls and Procedures

   40

PART II—OTHER INFORMATION

  

Item 1.

  

Legal Proceedings

   43

Item 1A.

  

Risk Factors

   43

Item 6.

  

Exhibits

   44
  

Signatures

   45

 

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PART I

FINANCIAL INFORMATION

 

Item 1. Consolidated Financial Statements and Notes—(unaudited)

ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

 

     September 30,
2009
    December 31,
2008
 

ASSETS

    

Cash and cash equivalents

   $ 13,299      $ 254,653   

Receivables:

    

Interest

     1,111        1,378   

Other

     60        32,571   

Investments:

    

Mortgage-backed securities, at fair value

     173,895        594,294   

U.S. Treasury bonds, at fair value

     —          550,000   

Equity investments, at fair value

     87,497        —     

Trading securities, at fair value

     —          17,954   

Long-term and other investments

     2,563        54,976   

Derivative assets, at fair value

     —          264   

Intangible assets, net

     —          8,943   

Furniture, equipment, software and leasehold improvements, net of accumulated depreciation and amortization of $160 and $40,265, respectively

     114        24,442   

Prepaid expenses and other assets

     4,786        20,816   
                

Total assets

   $ 283,325      $ 1,560,291   
                

LIABILITIES AND EQUITY

    

Liabilities:

    

Repurchase agreements

   $ 100,000      $ 1,063,040   

Trading account securities sold, but not yet purchased, at fair value

     —          8,325   

Derivative liabilities, at fair value

     —          56   

Interest payable

     129        2,064   

Accrued compensation and benefits

     7,360        47,259   

Due to clearing broker

     —          3,009   

Accounts payable, accrued expenses and other liabilities

     22,041        38,925   

Long-term debt

     16,816        254,357   
                

Total liabilities

     146,346        1,417,035   
                

Commitments and Contingencies (Note 7)

    

Equity:

    

Preferred stock, $0.01 par value, 25,000,000 shares authorized, none issued and outstanding

     —          —     

Class A common stock, $0.01 par value, 450,000,000 shares authorized, 7,354,075 and 7,382,265 shares issued and outstanding, respectively (1)

     74        74   

Class B common stock, $0.01 par value, 100,000,000 shares authorized, 566,115 and 578,584 shares issued and outstanding, respectively (1)

     6        6   

Additional paid-in capital (1)

     1,505,787        1,494,642   

Accumulated other comprehensive income (loss), net of taxes

     289        (118

Accumulated deficit

     (1,369,177     (1,481,021
                

Total Arlington Asset shareholders’ equity

     136,979        13,583   

Noncontrolling interest

     —          129,673   
                

Total equity

     136,979        143,256   
                

Total liabilities and equity

   $ 283,325      $ 1,560,291   
                

 

(1)

Reflects the impact of 1-for-20 reverse stock split effective October 6, 2009. See Note 11, Subsequent Events.

See notes to consolidated financial statements.

 

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ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(Unaudited)

 

    Three Months Ended
September 30,
 
  2009     2008  

Revenues:

   

Capital markets

  $ —        $ 50,694   

Principal investment:

   

Interest

    3,719        23,173   

Net investment income (loss)

    19,737        (153,110

Dividends

    —          158   

Other

    —          739   
               

Total revenues (loss)

    23,456        (78,346

Interest expense

    310        25,387   
               

Revenues (loss), net of interest expense

    23,146        (103,733
               

Non-Interest Expenses:

   

Compensation and benefits

    2,735        61,111   

Professional services

    878        10,442   

Business development

    16        5,262   

Clearing and brokerage fees

    —          3,834   

Occupancy and equipment

    94        8,282   

Communications

    100        5,773   

Other operating expenses

    1,163        6,668   
               

Total non-interest expenses

    4,986        101,372   
               

Operating income (loss)

    18,160        (205,105
               

Other Income (Loss):

   

Loss on subsidiary share transactions

    (116     —     

Gain on extinguishment of long-term debt

    27,982        4,078   

Other loss

    (4     (4
               

Income (loss) before income taxes

    46,022        (201,031

Income tax provision (benefit)

    3,585        (18,123
               

Net income (loss)

    42,437        (182,908

Less: Net loss attributable to the noncontrolling interest of consolidated subsidiary

    —          (13,886
               

Net income (loss) attributable to Arlington Asset shareholders

  $ 42,437      $ (169,022
               

Basic earnings (loss) per share attributable to Arlington Asset (1)

  $ 5.51      $ (22.34
               

Diluted earnings (loss) per share attributable to Arlington Asset (1)

  $ 5.38      $ (22.34
               

Weighted average shares outstanding (in thousands) :

   

Basic (1)

    7,705        7,565   
               

Diluted (1)

    7,895        7,565   
               

 

(1)

Reflects the impact of 1-for-20 reverse stock split effective October 6, 2009. See Note 11, Subsequent Events.

See notes to consolidated financial statements.

 

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ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(Unaudited)

 

    Nine Months Ended
September 30,
 
  2009     2008  

Revenues:

   

Capital markets

  $ 81,075      $ 207,766   

Principal investment:

   

Interest

    7,600        70,867   

Net investment income (loss)

    15,754        (173,311

Dividends

    108        497   

Other

    —          3,095   
               

Total revenues

    104,537        108,914   

Interest expense

    3,656        70,895   
               

Revenues, net of interest expense

    100,881        38,019   
               

Non-Interest Expenses:

   

Compensation and benefits

    73,466        192,035   

Professional services

    12,871        33,401   

Business development

    13,139        24,368   

Clearing and brokerage fees

    5,950        10,857   

Occupancy and equipment

    13,573        26,051   

Communications

    8,964        18,046   

Other operating expenses

    10,099        19,107   
               

Total non-interest expenses

    138,062        323,865   
               

Operating loss

    (37,181     (285,846
               

Other Income (Loss):

   

Loss on subsidiary share transactions

    (10,028     (189

Gain on extinguishment of long-term debt

    160,435        4,078   

Other (loss) income

    (11     73,030   
               

Income (loss) before income taxes

    113,215        (208,927

Income tax provision (benefit)

    12,830        (28,903
               

Net income (loss)

    100,385        (180,024

Less: Net loss attributable to the noncontrolling interest of consolidated subsidiary

    (11,459     (31,053
               

Net income (loss) attributable to Arlington Asset shareholders

  $ 111,844      $ (148,971
               

Basic earnings (loss) per share attributable to Arlington Asset (1)

  $ 14.58      $ (19.71
               

Diluted earnings (loss) per share attributable to Arlington Asset (1)

  $ 14.28      $ (19.71
               

Weighted average shares outstanding (in thousands) :

   

Basic (1)

    7,673        7,557   
               

Diluted (1)

    7,830        7,557   
               

 

(1)

Reflects the impact of 1-for-20 reverse stock split effective October 6, 2009. See Note 11, Subsequent Events.

See notes to consolidated financial statements.

 

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ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Dollars in thousands)

(Unaudited)

 

    Class A
Common
Stock

(#) (1)
    Class A
Amount
($) (1)
  Class B
Common
Stock

(#) (1)
    Class B
Amount
($) (1)
  Additional
Paid-In
Capital (1)
    Accumulated
Other
Comprehensive
Income (Loss)
    Accumulated
Deficit
    Noncontrolling
Interest
    Total     Comprehensive
Income (Loss)
 

Balances, December 31, 2007

  6,963,323      $ 70   630,812      $ 6   $ 1,470,244      $ (13,071   $ (1,063,558   $ 243,061      $ 636,752     
                                                                 

Net loss

  —          —     —          —       —          —          (417,463     (86,867     (504,330   $ (504,330

Conversion of Class B shares to Class A shares

  52,229        —     (52,228     —       —          —          —          —          —          —     

Issuance of Class A common stock

  393,381        4   —          —       506        —          —          —          510        —     

Forfeitures of Class A common stock

  (20,702     —     —          —       (1,739     —          —          —          (1,739     —     

Repurchase of Class A common stock

  (5,966     —     —          —       (48     —          —          —          (48     —     

Stock compensation expense for stock options

  —          —     —          —       108        —          —          —          108        —     

Amortization of Class A common shares issued as stock-based awards

  —          —     —          —       14,408        —          —          —          14,408        —     

Equity in issuance of subsidiary common shares to employees

  —          —     —          —       11,163        —          —          —          11,163        —     

Net decrease in equity related to subsidiary stock compensation transactions

  —          —     —          —       —          —          —          (26,430     (26,430     —     

Other comprehensive income:

                   

Net change in unrealized loss on available-for-sale investment securities, (net of taxes of -0-)

  —          —     —          —       —          (227     —          (91     (318     (318

Net change in unrealized gain on cash flow hedges (net of taxes of $-0-)

  —          —     —          —       —          13,180        —          —          13,180        13,180   
                         

Comprehensive loss

                    $ (491,468
                                                                       

Balances, December 31, 2008

  7,382,265      $ 74   578,584      $ 6   $ 1,494,642      $ (118   $ (1,481,021   $ 129,673      $ 143,256     

Net income (loss)

  —          —     —          —       —          —          111,844        (11,459     100,385      $ 100,385   

Conversion of Class B shares to Class A shares

  12,469        —     (12,469     —       —          —          —          —          —          —     

Issuance of Class A common stock

  1,816        —     —          —       364        —          —          —          364        —     

Retirement of Class A common stock

  (27,500     —     —          —       (275     —          —          —          (275     —     

Forfeitures of Class A common stock

  (14,975     —     —          —       (194     —          —          —          (194     —     

Stock compensation expense for stock options

  —          —     —          —       23        —          —          —          23        —     

Amortization of Class A common shares issued as stock-based awards

  —          —     —          —       6,169        —          —          —          6,169        —     

Equity in issuance of subsidiary common shares to employees

  —          —     —          —       5,058        —          —          —          5,058        —     

Elimination of noncontrolling interest resulting from sale of majority stake in subsidiary

  —          —     —          —       —          —          —          (118,269     (118,269     —     

Other comprehensive income:

                   

Net change in unrealized (loss) gain on available-for-sale investment securities, (net of taxes of $-0-)

  —          —     —          —       —          407        —          55        462        462   
                         

Comprehensive income

                    $ 100,847   
                                                                       

Balances, September 30, 2009

  7,354,075      $ 74   566,115      $ 6   $ 1,505,787      $ 289      $ (1,369,177   $ —        $ 136,979     
                                                                 

 

(1)

Reflects the impact of 1-for-20 reverse stock split effective October 6, 2009. See Note 11, Subsequent Events.

See notes to consolidated financial statements.

 

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ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

     Nine Months Ended
September 30,
 
   2009     2008  

Cash flows from operating activities:

    

Net income (loss)

   $ 100,385      $ (180,024

Non-cash items included in net income (loss):

    

Gain on extinguishment of long-term debt

     (160,435     —     

Net investment (income) loss from investments, mortgage-backed securities, incentive allocations and fees

     (14,749     178,055   

Depreciation and amortization

     4,718        7,710   

Gain on disposition of subsidiary

     —          (73,040

Other

     23,792        32,569   

Changes in operating assets:

    

Receivables:

    

Interest

     (51     1,139   

Other

     (898     (364,309

Due from/to clearing broker

     (7,132     (24,227

Trading securities, at fair value

     (26,517     (6,035

Prepaid expenses and other assets

     6,313        4,023   

Changes in operating liabilities:

    

Trading account securities sold but not yet purchased, at fair value

     12,339        4,395   

Accounts payable, accrued expenses and other liabilities

     2,988        (23,565

Accrued compensation and benefits

     (15,165     (10,740
                

Net cash used in operating activities

     (74,412     (454,049
                

Cash flows from investing activities:

    

Purchases of mortgage-backed securities

     (397,767     (2,266,616

Receipt of principal payments on mortgage-backed securities

     15,105        210,827   

Proceeds from sales of mortgage-backed securities

     806,408        1,107,155   

Proceeds from U.S. treasury bond maturities

     550,000        —     

Purchases of long-term investments

     —          (7,287

Proceeds from sales of and distributions from long-term investments

     14,166        31,618   

Deconsolidation of FBR Capital Markets cash balance

     (122,752     —     

Other

     (937     (3,758
                

Net cash provided by (used in) investing activities

     864,223        (928,061
                

Cash flows from financing activities:

    

Repayments of long-term debt

     (75,769     (3,630

(Repayments of) proceeds from repurchase agreements, net

     (963,040     920,084   

Repurchase of subsidiary stock

     (73,300     —     

Proceeds from subsidiary stock transactions

     80,944        458   
                

Net cash (used in) provided by financing activities

     (1,031,165     916,912   
                

Net decrease in cash and cash equivalents

     (241,354     (465,198

Cash and cash equivalents, beginning of period

     254,653        692,360   
                

Cash and cash equivalents, end of period

   $ 13,299      $ 227,162   
                

Supplemental Cash Flow Information:

    

Cash payments for interest

   $ 3,592      $ 66,957   

Cash payments for taxes

   $ 1,623      $ 667   

See notes to consolidated financial statements.

 

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ARLINGTON ASSET INVESTMENT CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

(Unaudited)

 

1. Basis of Presentation:

The consolidated financial statements of Arlington Asset Investment Corp. (Arlington Asset), formerly known as Friedman, Billings, Ramsey Group, Inc. (FBR Group), and its subsidiaries (unless the context otherwise provides, collectively, the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instructions to Form 10-Q. Therefore, they do not include all information required by GAAP for complete financial statements. The interim financial statements reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the results for the periods presented. All significant intercompany accounts and transactions have been eliminated in consolidation. The results of operations for the three and nine months ended September 30, 2009 are not necessarily indicative of the operating results for the entire year or any other subsequent interim period. The Company’s unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with (i) the Company’s audited consolidated financial statements and notes thereto included in Annual Report on Form 10-K for the year ended December 31, 2008 and (ii) FBR Capital Markets Corporation’s audited consolidated financial statements and notes thereto included in its Annual Report on Form 10-K for the year ended December 31, 2008.

Prior to May 20, 2009, the Company consolidated the results of its former subsidiary, FBR Capital Markets Corporation (FBR Capital Markets) because the Company’s wholly-owned subsidiary, FBR TRS Holdings, Inc. (FBR TRS Holdings), owned approximately 56% of the outstanding shares of FBR Capital Markets’ common stock. The Company liquidated 16,667,000 and 1,500,000 shares of FBR Capital Markets common stock on May 20, and June 19, 2009, respectively, resulting in remaining holdings representing an approximately 39% and 24% interest in FBR Capital Markets, respectively. The sale of 16,667,000 shares on May 20, 2009 was to FBR Capital Markets. As a result, effective May 20, 2009, the Company no longer had majority control of FBR Capital Markets and therefore, deconsolidated the results of FBR Capital Markets’ activities in preparing the Company’s unaudited condensed consolidated financial statements. In addition, on July 15, 2009, the Company liquidated an additional 411,032 shares of FBR Capital Markets stock at a price of $4.42 per share in connection with the over-allotment option that was granted to the underwriters under the underwriting agreement entered into on June 15, 2009.

Historically, the Company has conducted its business within four reportable segments: capital markets, asset management, principal investing and mortgage banking operations. In January 2008, as a result of the filing of a voluntary petition for bankruptcy protection by First NLC Financial Services, LLC (First NLC), the Company deconsolidated First NLC, which included the origination and sale of non-conforming residential mortgage loans and was previously reported as the mortgage banking segment. Due to organizational changes effective January 1, 2009, the Company’s chief operating decision maker reviewed financial information within two reportable segments: capital markets and principal investing. The capital markets segment included the operations of FBR Capital Markets and its subsidiaries, and included the asset management and principal investing operations by FBR Capital Markets, which were previously reported separately. Accordingly, as of January 1, 2009, the Company had reflected the change in segment reporting in accordance with the criteria for segment reporting as set forth in amended accounting principles related to disclosures about segments of an enterprise and related information. As a result of the Company’s sale of its majority ownership interest in and resulting deconsolidation of FBR Capital Markets on May 20, 2009, the capital markets segment is no longer a reportable segment subsequent to May 20, 2009.

On January 1, 2009, the Company adopted amended accounting principles related to noncontrolling interests in consolidated financial statements. This amendment clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial

 

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statements. Accordingly, the Company reclassified its noncontrolling interest in its former subsidiary, FBR Capital Markets, as a component of equity in the consolidated financial statements for the applicable periods.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although the Company bases its estimates and assumptions on historical experience, when available, market information and on various other factors that it believes to be reasonable under the circumstances, management exercises significant judgment in the final determination of its estimates. Actual results may differ materially from those estimates.

Certain amounts in the consolidated financial statements and notes for prior periods have been reclassified to conform to the current period presentation. These reclassifications had no effect on the results of operations of the Company.

 

2. Financial Instruments and Long-Term Investments:

Fair Value of Financial Instruments

The Company adopted amended accounting principles related to fair value measurements as of January 1, 2008. This amendment defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, not adjusted for transaction costs. This amendment also establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels giving the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3) as described below:

 

Level 1 Inputs      Unadjusted quoted prices in active markets for identical assets or liabilities that is accessible by the Company;
Level 2 Inputs      Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly; and
Level 3 Inputs      Unobservable inputs for the asset or liability including significant assumptions of the Company and other market participants.

The Company determines fair values for the following assets and liabilities discussed below in accordance with amended accounting principles related to fair value measurements:

Mortgage-backed securities, at fair value —The Company’s agency mortgage-backed securities (MBS), which are generally guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae, and AAA-rated private label MBS are generally classified within Level 2 of the fair value hierarchy as they are valued using quoted market prices provided by a broker or dealer, or alternative pricing sources with reasonable levels of price transparency. The independent brokers and dealers providing market prices are those who make markets in these financial instruments.

The Company classifies certain other non-agency MBS within Level 3 of the fair value hierarchy because they trade infrequently and, therefore, have little or no price transparency. These Level 3 MBS include private label MBS, residual interests in securitizations of non-prime mortgage loans, and collateralized mortgage obligations (CMOs). The Company utilizes present value techniques based on estimated cash flows of the instrument taking into consideration various assumptions derived by management and used by other market participants. These assumptions are corroborated by evidence such as historical data, risk characteristics, transactions in similar instruments, and completed or pending transactions, when available.

 

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Long-term investments, at fair value —The Company’s long-term investments, at fair value, consist of marketable equity securities and a residual interest in a securitization. The Company’s marketable equity securities are classified within Level 1 of the fair value hierarchy as they are valued using quoted market prices. The residual interest in a securitization is classified within Level 3 of the fair value hierarchy and valued as discussed above.

Trading securities and trading account securities sold but not yet purchased, at fair value —Historically, the Company’s trading securities and trading account securities sold but not yet purchased, at fair value, were securities owned or sold by FBR Capital Markets’ broker-dealer subsidiaries and consisted of marketable and non-public equity and convertible debt securities. The Company classified marketable equity securities within Level 1 of the fair value hierarchy if quoted market prices were used to value the securities. Convertible debt securities were generally classified within Level 2 of the fair value hierarchy as they were valued using quoted market prices provided by a broker or dealer, or alternative pricing services that provided a reasonable level of price transparency. Non-public equity and debt securities were classified within Level 3 of the fair value hierarchy if enterprise values were used to value the securities. In determining the enterprise value, the Company relied on FBR Capital Markets’ management and its analysis of various financial, performance and market factors to estimate the value, including where applicable market trading activity, which were sometimes reported by The PORTAL Market SM , a subsidiary of The NASDAQ Stock Market, Inc.

Derivative instruments —In the normal course of the Company’s operations, the Company is a party to various financial instruments that are accounted for as derivatives in accordance with amended accounting principles related to accounting for derivative instruments and hedging activities. These derivatives are generally classified within Level 2 of the fair value hierarchy because they are valued using broker or dealer quotations which are model based calculations based on market-based inputs, including, but not limited to, contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs.

Equity investments, at fair value —The Company’s equity investments, at fair value, consist of its investment in FBR Capital Markets which is classified within Level 1 of the fair value hierarchy as it is valued using quoted market prices. With the sale of FBR Capital Markets stock on May 20, 2009 and resulting deconsolidation, the Company elected to adopt the provisions of amended accounting principles related to the fair value option for financial assets and financial liabilities to its remaining investment in FBR Capital Markets stock. In accordance with the provisions of this amendment, the Company records unrealized gains and losses resulting from the change in the fair value of FBR Capital Markets stock in earnings, as a component of investment income or loss, in the respective reporting period.

Other —Cash and cash equivalents, restricted cash, interest receivable, reverse repurchase agreements, repurchase agreements, accounts payable, accrued expenses and other liabilities are reflected in the consolidated balance sheets at their amortized cost, which approximates fair value because of the short-term nature of these instruments.

 

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The estimated fair values of the Company’s financial instruments are as follows:

 

     September 30, 2009    December 31, 2008
     Carrying
Amount
   Estimated
Fair Value
   Carrying
Amount
   Estimated
Fair Value

Financial assets:

           

Cash and cash equivalents

   $ 13,299    $ 13,299    $ 254,653    $ 254,653

Non-interest bearing receivables

     60      60      32,571      32,571

MBS

     173,895      173,895      594,294      594,294

U.S. Treasury bonds

     —        —        550,000      550,000

Trading securities

     —        —        9,629      9,629

Equity, long-term and other investments

     90,060      90,060      54,976      54,976

Derivative assets

     —        —        264      264

Financial liabilities:

           

Repurchase agreements

     100,000      100,000      1,063,040      1,063,040

Long-term debt

     16,816      16,816      254,357      254,357

Derivative liabilities

     —        —        56      56

Fair Value Hierarchy

The following tables set forth by level within the fair value hierarchy financial instruments accounted for under amended accounting principles related to fair value measurements as of September 30, 2009 and December 31, 2008. As required by this amendment, assets and liabilities that are measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

Items Measured at Fair Value on a Recurring Basis

 

     September 30, 2009
     Total    Level 1    Level 2    Level 3

Mortgage-backed securities, at fair value:

           

Agency

   $ 118,149    $ —      $ 118,149    $ —  

Other private label

     55,746      —        —        55,746
                           

Total

     173,895      —        118,149      55,746

Equity investments, at fair value:

           

FBR Capital Markets

     87,497      87,497      —        —  
                           

Total

   $ 261,392    $ 87,497    $ 118,149    $ 55,746
                           

 

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The total financial assets measured and reported at fair value on a recurring basis and classified within Level 3 were $55,746, or 19.68% of the Company’s total assets as of September 30, 2009.

 

     December 31, 2008
     Total     Level 1     Level 2     Level 3

Mortgage-backed securities, at fair value:

        

Agency

   $ 528,408      $ —        $ 528,408      $ —  

Other private label

     65,886        —          —          65,886
                              

Total

     594,294        —          528,408        65,886

U.S. Treasury bonds, at fair value:

     550,000        550,000        —          —  
                              

Long-term investments, at fair value:

        

Marketable equity securities

     1,043        1,043        —          —  
                              

Trading securities and trading account securities sold, but not yet purchased, at fair value:

        

Marketable and non-public equity securities

     3,919        976        —          2,943

Convertible and fixed income debt securities

     14,035        —          13,771        264

Marketable equity securities sold short but not yet purchased

     (8,325     (8,325     —          —  
                              

Total

     9,629        (7,349     13,771        3,207

Derivative instruments, at fair value:

        

Assets

     264        —          264        —  

Liabilities

     (56     —          (56     —  
                              

Net

     208        —          208        —  
                              

Total

   $ 1,155,174      $ 543,694      $ 542,387      $ 69,093
                              

The total financial assets measured and reported at fair value on a recurring basis and classified within Level 3 were $69,093, or 4.43% of the Company’s total assets as of December 31, 2008.

Level 3 Financial Assets and Liabilities

Items Measured at Fair Value on a Recurring Basis

The tables below set forth a summary of changes in the fair value and gains and losses of the Company’s Level 3 financial assets and liabilities that are measured at fair value on a recurring basis, for the three and nine months ended September 30, 2009 and 2008.

 

     Three Months Ended September 30, 2009
     MBS    Long-Term
Investments
   Other    Total

Beginning balance, July 1, 2009

   $ 29,944    $ —      $ —      $ 29,944

Total net gains (losses) (realized/unrealized)

           

Included in earnings

     3,151      —        —        3,151

Included in other comprehensive income

     685      —        —        685

Net transfers in

     —        —        —        —  

Net purchases, issuances, settlements, principal payoffs, and amortization/accretion of premium/discount

     21,966      —        —        21,966
                           

Ending balance, September 30, 2009

   $ 55,746    $ —      $ —      $ 55,746
                           

The amount of net gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting date

   $ 244    $ —      $ —      $ 244
                           

 

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     Three Months Ended September 30, 2008  
     MBS     Long-Term
Investments
    Other     Total  

Beginning balance, July 1, 2008

   $ 4,634      $ 7,831      $ 16,462      $ 28,927   

Total net losses (realized/unrealized)

        

Included in earnings

     (1,233     (549     (776     (2,558

Included in other comprehensive income

     —          —          —          —     

Net transfers in

     204,477        —          —          204,477   

Net purchases, issuances, settlements, principal payoffs, and amortization/accretion of premium/discount

     —          (590     (468     (1,058
                                

Ending balance, September 30, 2008

   $ 207,878      $ 6,692      $ 15,218      $ 229,788   
                                

The amount of net gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to assets still held at the reporting date

   $ (10,119   $ (2   $ (562   $ (10,683
                                
     Nine Months Ended September 30, 2009  
     MBS     Long-Term
Investments
    Other     Total  

Beginning balance, January 1, 2009

   $ 65,886      $ —        $ 3,207      $ 69,093   

Total net gains (losses) (realized/unrealized)

        

Included in earnings

     4,981        —          (117     4,864   

Included in other comprehensive income

     727        —          —          727   

Net transfers in

     —          —          —          —     

Net purchases, issuances, settlements, principal payoffs, and amortization/accretion or premium/discount

     (15,848     —          (192     (16,040

Deconsolidation of FBR Capital Markets

     —          —          (2,898     (2,898
                                

Ending balance, September 30, 2009

   $ 55,746      $ —        $ —        $ 55,746   
                                

The amount of net gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting date

   $ 561      $ —        $ —        $ 561   
                                
     Nine Months Ended September 30, 2008  
     MBS     Long-Term
Investments
    Other     Total  

Beginning balance, January 1, 2008

   $ 10,638      $ 19,049      $ 18,567      $ 48,254   

Total net losses (realized/unrealized)

        

Included in earnings

     (7,002     (10,006     (2,893     (19,901

Included in other comprehensive income

     —          —          —          —     

Net transfers in

     204,477        —          —          204,477   

Net purchases, issuances, settlements, principal payoffs, and amortization/accretion of premium/discount

     (235     (2,351     (456     (3,042
                                

Ending balance, September 30, 2008

   $ 207,878      $ 6,692      $ 15,218      $ 229,788   
                                

The amount of net gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to assets still held at the reporting date

   $ (87,436   $ (8,660   $ (2,426   $ (98,522
                                

 

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Gains and losses included in earnings for the three and nine months ended September 30, 2009 and 2008 are reported in the following income statement line descriptions as follows:

 

     Principal
investment-Net
investment
income (loss)
    Capital
markets
    Principal
investment-Net
investment
income (loss)
    Capital
markets
 
     Three Months Ended September 30,     Nine Months Ended September 30,  
     2009    2008     2009    2008     2009    2008     2009     2008  

Total gains (losses) included in earnings for the period

   $ 3,151    $ (1,233   $ —      $ (1,325   $ 4,981    $ (15,642   $ (117   $ (4,259
                                                             

Change in unrealized gains relating to assets still held at reporting date

   $ 244    $ (10,119   $ —      $ (564   $ 561    $ (96,075   $ —        $ (2,447
                                                             

Items Measured at Fair Value on a Non-Recurring Basis

In addition, the Company also measures certain financial assets at fair value on a non-recurring basis. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets. Due to the nature of these financial assets, enterprise values are primarily used to value these financial assets. In determining the enterprise value, the Company analyzes various financial, performance and market factors to estimate fair value, including where applicable, market trading activity. As a result, these financial assets are classified within Level 3 of the fair value hierarchy.

For the three months ended September 30, 2009 and 2008, the Company recognized the following change in carrying value of those assets measured at fair value on a non-recurring basis:

 

     Fair Value Measurements at September 30, 2009    Three months ended
September 30, 2009
     Total        Level 1        Level 2        Level 3      Gains (Losses)

Non-public equity securities

   $ 452    $ —      $ —      $ 452    $       (86)
                                
     Fair Value Measurements at September 30, 2008    Three months ended
September 30, 2008
     Total        Level 1        Level 2        Level 3      Gains (Losses)

Non-public equity securities

   $ 23,283    $ —      $ —      $ 23,283    $(14,205)
                                

For the nine months ended September 30, 2009 and 2008, the Company recognized the following change in carrying value of those assets measured at fair value on a non-recurring basis:

 

     Fair Value Measurements at September 30, 2009    Nine months ended
September 30, 2009
     Total        Level 1        Level 2        Level 3      Gains (Losses)

Non-public equity securities

   $ 452    $ —      $ —      $ 452    $  (1,086)
                                
     Fair Value Measurements at September 30, 2008    Nine months ended
September 30,
2008
     Total        Level 1        Level 2        Level 3      Gains (Losses)

Non-public equity securities

   $ 28,533    $ —      $ —      $ 28,533    $(20,919)
                                

 

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Mortgage-Backed Securities, at Fair Value

Mortgage-backed securities, at fair value (1) (2) , consisted of the following as of the dates indicated:

 

    September 30, 2009   December 31, 2008
    Balance   Net
Unamortized
Premium
(Discount)
    Percent     WAL   Weighted
Average
Rating
  Balance   Net
Unamortized
Premium
(Discount)
  Percent     WAL   Weighted
Average
Rating

Fannie Mae

  $ 117,738   $ 3,765      67.70   3.94   AAA   $ 528,408   $   —     88.90   2.24   AAA

Freddie Mac

    411     —        0.20   0.08   AAA     —       —     —        —     —  

Private-label

    55,746     (70,100   32.10   4.63   CCC     65,886     —     11.10   4.34   BB
                                             
  $ 173,895   $ (66,335   100.00       $ 594,294   $   —     100.00    
                                             

 

(1)

The Company’s MBS portfolio is primarily comprised of agency MBS. The weighted-average coupon of the MBS portfolio at September 30, 2009 and December 31, 2008 was 5.34% and 2.44%, respectively.

(2)

As of September 30, 2009 and December 31, 2008, $106,501 and $568,493, respectively, each representing fair value of the Company’s MBS investments were pledged as collateral for repurchase agreements.

Equity investments, at Fair Value

Equity investments, at fair value, consisted of the following as of the dates indicated:

 

     September 30,
2009
   December 31,
2008

FBR Capital Markets (1)

   $ 87,497    $ —  
             

 

(1)

The fair value is based on the closing price of $5.93 at September 30, 2009.

Long-Term and Other Investments

The Company’s long-term and other investments consist of marketable equity investments, which are valued at fair value on a recurring basis and other long-term investments, which are fair valued on a non-recurring basis. The Company’s long-term and other investments consisted of the following as of the dates indicated:

 

     September 30,
2009
   December 31,
2008

Long-term marketable equity investments

   $ —      $ 1,043

Non-public equity securities

     1,479      38,203

Preferred equity investment

     —        1,000

Investments funds

     1,084      14,730
             
   $ 2,563    $ 54,976
             

The Company’s available-for-sale securities consist primarily of MBS and equity investments in publicly traded companies. In accordance with amended accounting principles related to accounting for certain investments in debt and equity securities, the securities are carried at fair value with resulting unrealized gains and losses reflected as other comprehensive income or loss. Gross unrealized gains and losses on these securities were the following as of the dates indicated:

 

     September 30, 2009
   Amortized
Cost/
Cost Basis
   Unrealized     Fair Value
      Gains    Losses    

Mortgage-backed securities (1)

   $ 173,606    $ 849    $ (560   $ 173,895
                            

 

(1)

The amortized cost of MBS includes unamortized net discounts of $66,335 at September 30, 2009.

 

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     December 31, 2008
   Amortized
Cost/
Cost Basis
   Unrealized     Fair Value
      Gains    Losses    

Mortgage-backed securities (1)

   $ 594,286    $ 8    $ —        $ 594,294

Marketable equity securities

     1,260      —        (217     1,043
                            
   $ 595,546    $ 8    $ (217   $ 595,337
                            

 

(1)

The amortized cost of MBS includes no unamortized premiums/discounts at December 31, 2008.

The following table provides further information regarding the duration of unrealized losses as of September 30, 2009:

 

     Continuous Unrealized Loss Position for
   Less Than 12 Months    12 Months or More
   Amortized
Cost
   Unrealized
Losses
    Fair
Value
   Amortized
Cost
   Unrealized
Losses
   Fair
Value

Mortgage-backed securities

   $ 127,005    $ (560   $ 126,445    $ —      $ —      $ —  

The Company recorded no other-than-temporary impairments on MBS investments during the three and nine months ended September 30, 2009. For the three and nine months ended September 30, 2008, the Company recorded other-than-temporary impairment losses of $110,433 and $116,617, respectively, related to continued deterioration in credit quality on certain MBS investments with an original cost basis of $2,194,066 and $2,199,983, respectively.

For the three and nine months ended September 30, 2009, the Company recorded no other-than-temporary impairment losses on marketable equity securities. There are no marketable equity securities in unrealized loss positions as of September 30, 2009. For the three and nine months ended September 30, 2008, the Company recorded other-than-temporary impairment losses of $2,072 on marketable equity securities with an original cost basis of $4,863. During the nine months ended September 30, 2008, the Company also recognized other-than-temporary impairment losses of $8,640 in a residual interest in a securitization of non-prime mortgage loans. No such losses were recognized for the three months ended September 30, 2008.

For investments carried at cost, at each reporting date, the Company evaluates its portfolio of such investments for impairment, including consideration of the severity and duration of factors affecting the fair value of these investments. During the three months ended September 30, 2009 and 2008, the Company recorded other-than-temporary impairment losses of $86 and $14,205, respectively, in the consolidated statements of operations, reflecting the Company’s evaluation of the estimated fair value of private equity investments with a remaining cost basis of $452 and $23,283, respectively. During the nine months ended September 30, 2009 and 2008, the Company recorded other-than-temporary impairment losses of $1,086 and $20,918, respectively, in the consolidated statements of operations, reflecting the Company’s evaluation of the estimated fair value of private equity investments with a remaining cost basis of $452 and $28,533, respectively.

During the three months ended September 30, 2009, the Company received $232,065 from sales of MBS, resulting in gross gains and losses of $2,907 and $1,471, respectively, and received $407 from sales of marketable equity securities, resulting in gross gains of $114 and no losses. During the three months ended September 30, 2008, the Company received $703,697 from sales of MBS, resulting in no gains and gross losses of $24,474, respectively. There were no sales of the Company’s marketable equity securities during the three months ended September 30, 2008.

During the nine months ended September 30, 2009, the Company received $806,408 from sales of MBS, resulting in gross gains and losses of $4,253 and $3,055, respectively, and received $1,138 from sales of marketable equity securities, resulting in gross gains of $170 and no losses, respectively. During the nine months

 

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ended September 30, 2008, the Company received $1,107,155 from sales of MBS, resulting in gross gains and losses of $357 and $24,557, respectively, and received $19,065 from sales of marketable equity securities, resulting in gross gains of $1,483 and no losses, respectively.

3. Borrowings:

Repurchase Agreements

The following table provides information regarding the Company’s outstanding repurchase agreement borrowings as of the dates indicated:

 

     September 30,
2009
    December 31,
2008
 

Outstanding balance

   $ 100,000      $ 1,063,040   

Value of assets pledged as collateral:

    

Agency mortgage-backed securities

     106,501        528,111   

Non-agency mortgage-backed securities

     —          40,381   

U.S. Treasury bonds

     —          550,000   

Weighted-average rate

     0.33     0.44

Weighted-average term to maturity

     14.0 days        14.3 days   
     September 30,
2009
    September 30,
2008
 

Weighted-average outstanding balance during the three months ended

   $ 100,575      $ 2,993,800   

Weighted-average rate during the three months ended

     0.44     2.53

Weighted-average outstanding balance during the nine months ended

   $ 78,863      $ 2,367,642   

Weighted-average rate during the nine months ended

     0.69     2.87

As of September 30, 2009, the Company had no amount at risk greater than 10% of equity. As of December 31, 2008, the amount at risk related to $334,908 of repurchase agreements with Barclays Capital Inc. was $28,069, or 19.59% of the Company’s equity with a weighted average maturity of 26 days.

Long-term Debt

As of September 30, 2009 and December 31, 2008, the Company had $15,000 and $251,689, respectively, of outstanding long-term debt (Trust Preferred securities) issued by FBR TRS Holdings. The Trust Preferred securities accrue and require payments of interest quarterly at an annual rate of three-month London Interbank Offer Rate (LIBOR) plus 2.25% to 3.00%. The weighted average interest rate on these long-term debentures was 3.26% and 5.65% as of September 30, 2009 and December 31, 2008, respectively. These borrowings mature between 2033 and 2035, and are redeemable, in whole or in part, without penalty, currently or in 2010. During the three and nine months ended September 30, 2009, the Company did not issue additional long-term debentures.

During the three and nine months ended September 30, 2009, the Company extinguished $35,000 and $236,689 of Trust Preferred securities, respectively, at a gain of $27,982 and $160,435, respectively. During the three and nine months ended September 30, 2008, the Company extinguished $6,750 of Trust Preferred securities at a gain of $4,078.

4. Income Taxes:

Prior to January 1, 2009, FBR Group was organized and operated in a manner that allowed it to qualify as a real estate investment trust (REIT) for tax purposes. As a REIT, FBR Group was not subjected to federal income tax on earnings distributed to its shareholders. The Company filed a notification with the Internal Revenue Service to revoke its REIT status as of January 1, 2009. As a result, income generated at the parent company

 

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level, along with all of its consolidated subsidiaries, will be subject to federal, state and local income taxes for 2009 and future tax years at regular corporate tax rates, to the extent that it is not offset by net operating loss carry-forwards (NOLs) and net capital loss carry-forwards (NCLs).

The total income tax provision recorded for the three and nine months ended September 30, 2009 was $3,585 and $12,830, respectively. The total income tax benefit recorded for the three and nine months ended September 30, 2008 was $18,123 and $28,903, respectively. The Company generated pre-tax book income (loss) of $46,022 and ($44,207) in the three months ended September 30, 2009 and 2008, respectively. In the nine months ending September 30, 2009 and 2008, the Company generated pre-tax book income (loss) of $113,215 and ($22,751), respectively. The 2008 balances include only the former taxable REIT subsidiaries, including FBR TRS Holdings and FBR Capital Markets.

The Company’s effective tax rate for the nine months ended September 30, 2009 and 2008 was 11.4% and 127.0%, respectively. The effective tax rate for the nine months ended September 30, 2008 represents tax only on the former taxable REIT subsidiaries. The effective tax rate during these periods differed from statutory tax rates primarily due to the full valuation allowance on the tax benefit of the book losses incurred in the current period, recognition of a liability for unrecognized tax benefits, and the expected tax liability related to domestic operations due to projected taxable income for 2009 that will be subject to alternative minimum tax. The effective tax rate for the nine months ended September 30, 2008 differed from statutory tax rates due to the effects of amended accounting principles related to share-based payment, as restricted stock awards vested at share prices lower than original grant date prices. The Company expects to realize a portion of the tax benefits of the federal and state net NOLs in 2009, which are reflected in the Company’s projected effective tax rate for the year. The Company will continue to provide a valuation allowance against the other deferred tax assets since the Company believes that it is more likely than not that the benefits will not be realized in the future. The Company will continue to assess the need for a valuation allowance at each reporting date.

The Company adopted amended accounting principles related to accounting for uncertainty in income taxes effective January 1, 2007. The total unrecognized tax benefit as of January 1, 2007, that, if recognized, would affect the Company’s effective tax rate was immaterial. The Company estimates that, as of September 30, 2009, the range within which unrecognized tax benefits related to the recognition of income between members of the consolidated group is $-0- to approximately $14,500, of which the Company has reserved $11,306. The Company continues to record interest and penalties in other operating expenses in the statements of operations. The total amount of accrued interest refund and penalties as of the date of adoption was immaterial.

5. Earnings Per Share:

Basic earnings per share includes no dilution and is computed by dividing net income or loss available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share include the impact of dilutive securities such as stock options and unvested shares of restricted stock. The following table presents the computations of basic and diluted earnings per share, adjusted for the 1-for-20 reverse stock split effective October 6, 2009, for the periods indicated:

 

     Three Months Ended September 30,  
     2009    2008  
     Basic    Diluted    Basic     Diluted  

Weighted average shares outstanding (in thousands):

          

Common stock

     7,705      7,705      7,565        7,565   

Stock options and unvested restricted stock

     —        190      —          —     
                              

Weighted average common and common equivalent shares outstanding

     7,705      7,895      7,565        7,565   
                              

Net income (loss) applicable to common stock

   $ 42,437    $ 42,437    $ (169,022   $ (169,022
                              

Earnings (loss) per common share

   $ 5.51    $ 5.38    $ (22.34   $ (22.34
                              

 

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     Nine Months Ended September 30,  
     2009    2008  
     Basic    Diluted    Basic     Diluted  

Weighted average shares outstanding (in thousands):

          

Common stock

     7,673      7,673      7,557        7,557   

Stock options and unvested restricted stock

     —        157      —          —     
                              

Adjusted weighted average common and common equivalent shares outstanding

     7,673      7,830      7,557        7,557   
                              

Net income (loss) applicable to common stock

   $ 111,844    $ 111,844    $ (148,971   $ (148,971
                              

Earnings (loss) per common share

   $ 14.58    $ 14.28    $ (19.71   $ (19.71
                              

As of September 30, 2009 and 2008, there were 10,312 and 35,812, as adjusted for 1-for-20 reverse stock split, of options to purchase shares of common stock outstanding, respectively. See Note 8 for additional information regarding outstanding restricted stock and Note 11 for additional information regarding the reverse stock split.

 

6. Investment in FBR Capital Markets:

As discussed above, the Company historically consolidated the results of operations of its former subsidiary, FBR Capital Markets, because the Company’s wholly-owned subsidiary, FBR TRS Holdings, owned approximately 56% of the outstanding shares of FBR Capital Markets’ common stock. The Company liquidated 16,667,000 and 1,500,000 shares of FBR Capital Markets common stock on May 20, and June 19, 2009, respectively, resulting in remaining holdings representing an approximately 39% and 24% interest in FBR Capital Markets, respectively. As a result, effective May 20, 2009, the Company no longer had majority control of FBR Capital Markets and therefore, deconsolidated the results of FBR Capital Markets’ activities in preparing the Company’s consolidated financial statements.

With the sale of FBR Capital Markets stock on May 20, 2009 and resulting deconsolidation, the Company elected to adopt the provisions of amended accounting principles related to the fair value option for financial assets and financial liabilities to apply fair value accounting for the remaining shares of its FBR Capital Markets stock. In accordance with this amendment, the Company records unrealized gains and losses resulting from the change in the fair value of FBR Capital Markets stock in earnings, as a component of investment income or loss, in the respective reporting period. The provisions of this amendment require a disclosure of summarized financial information of FBR Capital Markets in the Company’s consolidated financial statements. The table below presents summarized financial information of FBR Capital Markets for the periods indicated:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2009     2008     2009     2008  

FBR Capital Markets’ statement of operations data:

        

Total revenues

   $ 71,440      $ 50,694      $ 168,671      $ 207,766   

Revenues, net of interest expense

     71,440        45,555        168,419        200,089   

Loss before income taxes

     (6,958     (46,682     (44,156     (92,886

Net loss

     (6,970     (28,560     (44,881     (63,983

On July 15, 2009, the Company liquidated an additional 411,032 shares of FBR Capital Markets stock at a price of $4.42 per share in connection with the over-allotment option that was granted to the underwriters under the underwriting agreement entered into on June 15, 2009. On October 20, 2009, the Company also entered into an underwriting agreement to sell the remaining interest in FBR Capital Markets. See Note 11, Subsequent Events, for additional information regarding subsequent sales of FBR Capital Markets stock.

 

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On January 1, 2009, the Company adopted amended accounting principles related to noncontrolling interests in consolidated financial statements. This amendment clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. Noncontrolling interest (formerly reported as minority interest) represents shares of common stock of FBR Capital Markets held by third-party investors. Accordingly, the Company reclassified its noncontrolling interest in its former subsidiary, FBR Capital Markets, as a component of equity in the consolidated financial statements for the applicable periods.

 

7. Commitments and Contingencies:

Litigation

Except as described below, as of September 30, 2009, the Company was not a defendant or a plaintiff in any lawsuits or arbitrations or involved in any governmental or self-regulatory organization (SRO) matters that are expected to have a material adverse effect on the Company’s financial condition, results of operations or liquidity. The Company is a defendant in a small number of civil lawsuits and arbitrations (together, litigation) relating to its businesses. There can be no assurance that these matters individually or in aggregate will not have a material adverse effect on the Company’s financial condition or results of operations in a future period. However, based on management’s review with counsel, resolution of these matters is not expected to have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

Shareholders’ Derivative Actions

On September 16, 2008, a shareholder derivative action captioned Kornfeld, et al. v. Billings, et al. , No. 08-1144, was filed in the Circuit Court of Arlington County, Virginia, by Bill Kornfeld and Edward Lapinski. The Company was named as a nominal defendant along with certain current and former officers and directors as individual defendants. The complaint asserts claims under Virginia law against the individual defendants for breach of fiduciary duty and against certain of the individual defendants for unjust enrichment in connection with certain decisions concerning executive compensation. The Company’s Board of Directors established a special committee to conduct a review and evaluation of the plaintiffs’ allegations and make a final decision concerning whether maintenance of the litigation was in the Company’s best interests. The special committee concluded that the litigation was not in the Company’s best interest. On December 8, 2008, the Company moved to dismiss the shareholder derivative action based on the special committee’s recommendation and the individual defendants filed demurrers. On March 5, 2009, the court denied the individual defendants’ demurrers, granted the plaintiffs’ motion for certain discovery and denied the Company’s motion to dismiss with leave to renew the motion following discovery. On July 24, 2009, the plaintiffs filed an amended complaint. The amended complaint contains allegations similar to those in the original complaint and adds a cause of action against certain of the individual defendants for waste. On August 14, 2009, the Company filed an answer to the amended complaint and the individual defendants filed a demurrer to the amended complaint. The likely outcome of this action or its likely impact on the Company’s results of operations at this time cannot be predicted.

On July 20, 2009, counsel to Bill Kornfeld and Edward Lapinski, two purported shareholders of the Company sent a letter to the Company, demanding that the Board of Directors remedy alleged breaches of fiduciary duty by the directors in connection with the sale of a portion of the Company’s FBR Capital Markets stock to FBR Capital Markets on May 20, 2009. The letter alleges that this sale was completed pursuant to an inappropriate process and resulted in an inadequate price. The letter states that the shareholders will file a lawsuit bringing derivative claims if the Company’s Board does not take the demanded action within a reasonable period of time. The Board of Directors has established a special committee of independent directors to investigate the claims made in the demand letter.

 

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Other Litigation

On April 7, 2009, the United States Bankruptcy Court for the Southern District of Florida, West Palm Beach Division (Bankruptcy Court) entered a final order (Final Order) approving the Company’s completed settlement agreement with the Trustee of the First NLC bankruptcy estate. The settlement agreement with the Trustee releases all claims that the Trustee or the bankruptcy estate of First NLC may have against the Company and its officers, directors, employees and affiliates in exchange for the payment by the Company of approximately $4,000, which the Company accrued for as of December 31, 2008. Under the settlement agreement, the Company and each of the officers, directors, employees and affiliates released all claims against the Trustee and the First NLC bankruptcy estate. The Company remitted the settlement payment on April 20, 2009 following the Final Order.

 

8. Equity:

Dividends

There were no dividends declared for the three and nine month period ended September 30, 2009. Pursuant to the Company’s variable dividend policy, the Board of Directors, in its sole discretion, may reinstate the payment of cash dividends when appropriate in the future. No dividends were declared or paid during 2008.

Stock Compensation Plans

Restricted Stock

From time to time, the Company grants shares of the its restricted Class A common stock to employees under the Company’s Long-Term Incentive Plan that vest ratably over a three-year period or cliff-vest after two to three years for various purposes based on continued employment over these specified periods. During the three and nine months ended September 30, 2009, the Company did not grant any shares of such restricted Class A common stock. During the three and nine months ended September 30, 2008 the Company granted 122 and 387,816 shares, adjusted for 1-for-20 reverse stock split effective October 6, 2009, respectively, of such restricted Class A common stock at weighted average share price of $35.60 and $58.20, adjusted for 1-for-20 reverse stock split effective October 6, 2009, per share, respectively.

As of September 30, 2009 and December 31, 2008, a total of 264,501 and 411,819 shares, adjusted for 1-for-20 reverse stock split effective October 6, 2009, respectively, of such restricted Class A common stock were outstanding with total unrecognized compensation cost related to unvested shares of $5,192 and $11,382, respectively. The total unrecognized cost is expected to be recognized over a weighted average period of 1.4 years.

For the three months ended September 30, 2009 and 2008, the Company recognized $1,516 and $3,870 of compensation expense related to its restricted stock, respectively. For the nine months ended September 30, 2009 and 2008, the Company recognized $5,848 and $9,511 of compensation expense related to its restricted stock, respectively.

Share Repurchases

In April 2003, the Company’s Board of Directors authorized a share repurchase program in which the Company may repurchase up to 700,000 shares of the Company’s Class A common stock from time to time. In 2007, the Company’s Board of Directors authorized an additional share repurchase program in which the Company may repurchase up to 5,000,000 shares of the Company’s Class A common stock. During the three and nine months ended September 30, 2009, the Company had no share repurchases and had the authority to repurchase 3,811,863 shares.

 

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Shareholder Rights Plan

On June 1, 2009, the Company’s Board of Directors adopted a shareholder rights plan (Rights Plan) and declared a dividend of one preferred share purchase right (each, a Right) for each outstanding share of the Company’s Class A common stock and Class B common stock. No shareholder approval was required for adoption of the Rights Plan, however, the Company plans to submit the Rights Plan to its shareholders for approval on or before June 4, 2010.

The Board adopted the Rights Plan in an effort to protect against a possible limitation on the Company’s ability to use its NOLs, NCLs and built-in losses under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended (the Code). The Company’s ability to use its NOLs, NCLs and built-in losses would be limited if there was an “ownership change” under Section 382 of the Code. The Rights Plan was adopted to dissuade any person or group from acquiring 4.9% or more of the Company’s outstanding Class A common stock (each, an Acquiring Person) without the approval of the Board and triggering an “ownership change” as defined by Section 382.

Initially, the Rights will generally not be exercisable and will be attached to and automatically trade with the Class A common stock and Class B common stock. The Rights will separate from the Class A common stock and Class B common stock and a “distribution date” will occur, with certain exceptions and upon a determination of the Company’s Board of Directors, upon the earlier of (i) 10 business days after a public announcement by the Company that a person or group has become an Acquiring Person and (ii) 10 business days after the commencement of a tender or exchange offer by a person or group for 4.9% or more of the Class A common stock. Shareholders who owned 4.9% or more of the Company’s outstanding Class A common stock at the time of adoption of the Rights Plan will not trigger the Rights Plan so long as they do not (i) acquire any additional shares of Class A common stock or (ii) fall under 4.9% ownership of Class A common stock and then re-acquire additional shares so that they own 4.9% or more of the Class A common stock.

Subject to the terms, provisions and conditions of the Rights Plan, and taking into account our 1-for-20 reverse stock split that was effected on October 6, 2009 (see Note 11, Subsequent Events), if the Rights become exercisable, each Right would represent the right to purchase from the Company one ten-thousandth of a share of Series A Junior Preferred Stock for a purchase price of $3.00 each, subject to adjustment in accordance with the terms of the Rights Plan. Each post-split share of Class A and Class B common stock is now associated with, and now trades with, 20 Rights. If issued, each 20 fractional shares of preferred stock would give the shareholder approximately the same dividend, voting and liquidation rights as does one share of the Company’s Class A common stock. However, prior to exercise, a Right does not give its holder any rights as a shareholder of the Company, including without limitation any dividend, voting or liquidation rights.

The Rights and the Rights Plan will expire on the earliest of (i) June 4, 2019, (ii) the time at which the Rights are redeemed pursuant to the Rights Plan, (iii) the time at which the Rights are exchanged pursuant to the Rights Plan, (iv) the repeal of Sections 382 and 383 of the Code or any successor statute if the Board determines that the Rights Plan is no longer necessary for the preservation of the applicable tax benefits, (v) the beginning of a taxable year of the Company to which the Board determines that no applicable tax benefits may be carried forward and (vi) the close of business on June 4, 2010 if approval of the Rights Plan by the Company’s shareholders has not been obtained.

 

9. Segment Information:

Historically, the Company has conducted its business within four reportable segments: capital markets, asset management, principal investing and mortgage banking operations. In January 2008, as a result of filing a voluntary petition for bankruptcy protection by First NLC, the Company deconsolidated First NLC, which included the origination and sale of non-conforming residential mortgage loans and was previously reported as the mortgage banking segment. Due to organizational changes effective January 1, 2009, the Company’s chief operating decision maker reviewed financial information within two reportable segments: capital markets and principal investing. The capital markets segment included the operations of FBR Capital Markets, the Company’s former subsidiary, and its

 

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subsidiaries, and included the asset management and principal investing operations by FBR Capital Markets, which were previously reported separately. Accordingly, as of January 1, 2009, the Company had reflected the change in segment reporting in accordance with the criteria for segment reporting as set forth in amended accounting principle related to disclosures about segments of an enterprise and related information. As a result of the Company’s sale of its majority ownership interest in and resulting deconsolidation of FBR Capital Markets on May 20, 2009, the capital markets segment is no longer a reportable segment subsequent to May 20, 2009.

The Company has developed systems and methodologies to allocate overhead costs to its business units and, accordingly, presents segment information consistent with internal management reporting. Revenue generating transactions between the individual segments have been included in the net revenue and pre-tax income of each segment. The following table illustrates the financial information for the Company’s segments for the periods indicated. The column labeled “Other” includes financial information for the Company’s historical mortgage banking segment, which the Company no longer separately reports.

 

     Principal
Investing
    Capital
Markets
    Other     Consolidated
Totals
 

Three months ended September 30, 2009

        

Net revenues

   $ 23,146      $ —        $ —        $ 23,146   

Operating income

     18,160        —          —          18,160   

Three months ended September 30, 2008

        

Net revenues

     (149,978     45,555        690        (103,733

Operating loss

     (157,728     (46,682     (695     (205,105

Nine months ended September 30, 2009

        

Net revenues (1)

     20,057        80,824        —          100,881   

Operating loss (1)

     (11,598     (25,583     —          (37,181

Nine months ended September 30, 2008

        

Net revenues

     (164,505     200,089        2,435        38,019   

Operating loss

     (189,150     (92,886     (3,810     (285,846

 

(1)

Net revenues and operating loss for the capital markets segment reflects the results of FBR Capital Markets’ activities prior to the deconsolidation on May 20, 2009.

 

10. Recent Accounting Pronouncements:

In June 2009, the FASB issued amended accounting principles related to accounting for transfers of financial assets. This amendment improves financial reporting by eliminating the exceptions for qualified special-purpose entities from the consolidation guidance and the exception that permitted sale accounting for certain mortgage securitizations when a transferor has not surrendered control over the transferred financial assets. In addition, comparability and consistency in accounting for transferred financial assets will be improved through clarifications of the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. This guidance is effective January 1, 2010 for the Company. Earlier application is prohibited and it must be applied to transfers occurring on or after the effective date. The Company is evaluating the impact of adoption of the amendment on its consolidated financial statements.

In June 2009, the FASB issued amended accounting principles related to the consolidation of variable-interest entities. This amendment replaces the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and the obligation to absorb losses of the entity or the right to receive benefits from the entity. An approach that is expected to be primarily qualitative will be more effective for identifying which enterprise has a controlling financial interest in a variable interest entity. The amendment is effective as of January 1, 2010 for the Company. The Company is evaluating the impact of adoption of the amendment on its consolidated financial statements.

 

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In June 2009, the FASB has issued guidance related to the FASB Accounting Standards Codification and the hierarchy of generally accepted accounting principles. This guidance establishes the FASB Accounting Standards Codification™ (Codification or ASC) as the single source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The Codification supersedes all existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification will become non-authoritative.

Following the Codification, the Board will not issue new standards in the form of Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates, which will serve to update the Codification, provide background information about the guidance and provide the basis for conclusions on the changes to the Codification.

GAAP is not intended to be changed as a result of the FASB’s Codification project, but it will change the way the guidance is organized and presented. As a result, these changes will have a significant impact on how companies reference GAAP in their financial statements and in their accounting policies for financial statements issued for interim and annual periods ending after September 15, 2009. The Company implemented the Codification in this quarterly report.

 

11. Subsequent Events:

The Company evaluated subsequent events through November 9, 2009, the date the financial statements were issued.

On October 1, 2009, the Company announced a 1-for-20 reverse split of its Class A and Class B common stock in accordance with the previously approved shareholder authorization. The reverse stock split was effective October 6, 2009. Upon the effectiveness of the reverse stock split, each twenty shares of issued and outstanding common stock were converted into one share of common stock. The Company did not issue fractional shares and shareholders received a cash payment for fractional shares based on the split-adjusted average price of the Class A common stock before the effective time. The reverse split reduced the number of shares of the Company’s common stock outstanding from approximately 160 million to approximately 8 million. Proportional adjustments were made to outstanding stock options and other equity incentive awards and equity compensation plans. The number of authorized shares of common stock did not change.

On October 28, 2009, the Company announced the closing on the sale of 14,755,017 shares of FBR Capital Markets common stock at $6.00 per share in an underwritten public offering. Proceeds to the Company, after the underwriting discount but before expenses, were $84,104. The net price per share after the underwriting discount to the Company of $5.70, is less than the carrying value of the FBR Capital Markets stock of $5.93 at September 30, 2009, and will result in the Company recording a pre-tax book loss of $3,394 during the quarter ending December 31, 2009. These shares represented the Company’s remaining interest in FBR Capital Markets.

 

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

The following analysis of the unaudited condensed consolidated financial condition and results of operations of Arlington Asset Investment Corp. (Arlington Asset), formerly known as Friedman Billings Ramsey Group, Inc. (FBR Group) and its subsidiaries, including FBR Capital Markets Corporation (FBR Capital Markets) (unless the context otherwise provides, collectively, “we”, “us”, “our” or the “Company”), should be read in conjunction with (i) the Company’s audited consolidated financial statements and notes thereto included in Annual Report on Form 10-K for the year ended December 31, 2008 and (ii) FBR Capital Markets’ audited consolidated financial statements and notes thereto included in its Annual Report on Form 10-K for the year ended December 31, 2008.

The Company’s unaudited condensed consolidated financial statements include the results of its former subsidiary, FBR Capital Markets through May 20, 2009. Prior to May 20, 2009, the Company’s wholly-owned subsidiary, FBR TRS Holdings, Inc. (FBR TRS Holdings), owned approximately 56% of the outstanding shares of FBR Capital Markets. The Company liquidated 16,667,000 and 1,500,000 shares of FBR Capital Markets common stock on May 20 and June 19, 2009, respectively, resulting in remaining holdings representing an approximately 39% and 24% interest in FBR Capital Markets, respectively. The sale of 16,667,000 shares on May 20, 2009 was to FBR Capital Markets. As a result, effective May 20, 2009, the Company no longer had majority control of FBR Capital Markets and therefore, deconsolidated the results of FBR Capital Markets’ activities in preparing the Company’s consolidated financial statements. In addition, on July 15, 2009, the Company liquidated an additional 411,032 shares of FBR Capital Markets stock at a price of $4.42 per share in connection with the over-allotment option that was granted to the underwriters under the underwriting agreement entered into on June 15, 2009.

The discussion of the Company’s consolidated financial condition and results of operations below may contain forward-looking statements. These statements, which reflect management’s beliefs and expectations, are subject to risks and uncertainties that may cause actual results to differ materially. For a discussion of the risks and uncertainties that may affect the Company’s future results, please see “Forward-Looking Statements” immediately following Item 4 of this report on Form 10-Q.

Business Strategy

The sale of FBR Capital Markets stock is in furtherance of the strategic shift the Company has initiated to focus on a principal investing strategy by monetizing our investment in FBR Capital Markets. Given recent dislocations in the capital markets, the Company seeks to benefit from potential high current cash returns available on mortgage investments. The Company plans to deploy the net cash proceeds for investments that offer current income as well as capital appreciation potential, and which may utilize the Company’s net operating loss carry-forwards (NOLs) and net capital loss carry-forwards (NCLs). The Company expects future investments to include non-agency residential mortgage-backed securities (MBS) and residential MBS guaranteed by a U.S. Government agency or U.S. Government-sponsored entity, among others. The Company may also consider opportunities for financial service operating businesses potentially in the form of a bank charter, and will seek to continue strengthening its balance sheet by converting long-term debt to equity through the extinguishment of the remaining $15.0 million Trust Preferred securities at a discount to face value.

Executive Summary

As discussed above, we liquidated an additional 411,032 shares of FBR Capital Markets stock at a price of $4.42 per share on July 15, 2009 in connection with the over-allotment option that was granted to the underwriters under the underwriting agreement entered into on June 15, 2009. We have continued our efforts to divest our holdings in FBR Capital Markets to further fund the principal investing strategy. Accordingly, on October 28, 2009, the Company announced the closing on the sale of 14,755,017 shares of FBR Capital Markets common stock at $6.00 per share in an underwritten public offering. Proceeds to the Company, after the

 

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underwriting discount but before expenses, were $84.1 million. The net price per share after the underwriting discount to the Company of $5.70, is less than the carrying value of the FBR Capital Markets stock of $5.93 at September 30, 2009, and will result in the Company recording a pre-tax book loss of $3.4 million during the quarter ending December 31, 2009. These shares represented the Company’s remaining interest in FBR Capital Markets.

During the quarter ended September 30, 2009, we recorded $18.1 million in unrealized gains resulting from the change in the fair value of FBR Capital Markets stock as a component of investment income on the income statement.

Our efforts to continue the extinguishment of the remaining Trust Preferred securities resulted in an additional extinguishment of $35.0 million of Trust Preferred securities at a gain of $28.0 million for the three months ended September 30, 2009. As of September 30, 2009, we have $15.0 million in remaining Trust Preferred securities.

The results of the Company’s operations, without the results of FBR Capital Markets’ operations, as compared to the results of consolidated operations as reported, for the three and nine months ended September 30, 2009 are as follows (dollars in thousands):

Pro Forma Results of Operations, Excluding FBR Capital Markets’ Operations

 

     Three Months Ended
September 30, 2009
    Nine Months Ended
September 30, 2009
 
   Pro forma     As Reported     Pro forma     As Reported  

Revenues:

        

Capital markets

   $ —        $ —        $ —        $ 81,075   

Principal investment:

        

Interest

     3,719        3,719        7,600        7,600   

Net investment income

     19,737        19,737        15,754        15,754   

Dividends

     —          —          108        108   
                                

Total revenues

     23,456        23,456        23,462        104,537   

Interest expense

     310        310        3,405        3,656   
                                

Revenues, net of interest expense

     23,146        23,146        20,057        100,881   
                                

Non-Interest Expenses:

        

Compensation and benefits

     2,735        2,735        13,238        73,466   

Professional services

     878        878        5,997        12,871   

Business development

     16        16        7,900        13,139   

Clearing and brokerage fees

     —          —          —          5,950   

Occupancy and equipment

     94        94        416        13,573   

Communications

     100        100        247        8,964   

Other operating expenses

     1,163        1,163        3,857        10,099   
                                

Total non-interest expenses

     4,986        4,986        31,655        138,062   
                                

Operating income (loss)

     18,160        18,160        (11,598     (37,181
                                

Other Income (Loss):

        

Loss on subsidiary share transactions

     (116     (116     (10,028     (10,028

Gain on extinguishment of long-term debt

     27,982        27,982        160,435        160,435   

Other loss

     (4     (4     (11     (11
                                

Income before income taxes and noncontrolling interest

     46,022        46,022        138,798        113,215   

Income tax provision

     3,585        3,585        12,029        12,830   
                                

Net income

   $ 42,437      $ 42,437      $ 126,769      $ 100,385   
                                

 

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With the Company’s sale of its majority ownership interest in and resulting deconsolidation of FBR Capital Markets activities effective May 20, 2009, the Company’s consolidated financial statements for the periods subsequent to May 20, 2009 no longer include the results of operations of FBR Capital Markets.

Beginning in the second quarter and continuing in the third quarter of 2009, we have continued our efforts to re-build our mortgage-backed securities (MBS) portfolio. Our strategy is to be selective in identifying non-agency senior MBSs that could provide attractive loss-adjusted yield on an unlevered basis. As of September 30, 2009, the Company had $55.7 million in unlevered non-agency MBS. We are also continuing to invest in agency MBS on a leveraged basis. As of September 30, 2009, the Company had $118.1 million in its agency MBS portfolio. We will 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.

Principal Investing

Mortgage-Backed Securities

The Company recorded net interest income of $3.6 million and $7.7 million from MBS held in its principal investment portfolio for the three months ended September 30, 2009 and 2008, respectively. The Company recorded net interest income of $7.2 million and $22.6 million from MBS held in its principal investment portfolio for the nine months ended September 30, 2009 and 2008, respectively. The decrease in net interest income during the three and nine months ended September 30, 2009 is due mainly to the decrease in the average balance of MBS investments held in our portfolio offset by the increase in the average yield.

Merchant Banking and Other Investments

The total value of our merchant banking portfolio and other investments was $90.1 million as of September 30, 2009. Of this total, $87.5 million represents an investment in FBR Capital Markets, $1.5 million was held in the merchant banking portfolio and $1.1 million was held in alternative asset funds. There were no unrealized losses in the merchant banking portfolio included in accumulated other comprehensive income (AOCI) as of September 30, 2009.

During the three and nine months ended September 30, 2009, we recorded $0.5 million and $2.0 million, respectively, in other-than-temporary impairment write-downs as part of the Company’s quarterly assessments of unrealized losses in its merchant banking and other investment portfolio.

 

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Results of Operations

Three months ended September 30, 2009 compared to three months ended September 30, 2008

The Company had net income of $42.4 million in the third quarter of 2009 versus a net loss of $169.0 million in the third quarter of 2008. Net income (loss) included the following results of operations by segment (dollars in thousands):

 

     For the quarter ended
September 30,
 
     2009    2008  

Capital markets

   $ —      $ (46,682

Principal investing

     18,160      (157,728

Other

     —        (695
               

Operating income (loss)

     18,160      (205,105

Gain on extinguishment of long-term debt and other losses

     27,862      4,074   
               

Income (loss) before income taxes and noncontrolling interest

     46,022      (201,031

Income tax provision (benefit)

     3,585      (18,123

Noncontrolling interest in losses of consolidated subsidiary

     —        (13,886
               

Net income (loss) attributable to Arlington Asset shareholders

   $ 42,437    $ (169,022
               

Net income for the third quarter of 2009 is primarily due to the gain on extinguishment of long-term debt and investment income from fair value changes in our investment in FBR Capital Markets common stock. Net loss for the third quarter of 2008 was primarily the result of other-than-temporary impairment losses recorded on our MBS investments and losses generated by FBR Capital Markets.

The Company’s revenues, net of interest expense, increased to $23.1 million in the third quarter of 2009 from $(103.7) million in the third quarter of 2008 due to the changes in revenues and interest expense described below.

Revenues from our principal investment activities, net of related interest expense, totaled $23.3 million in the third quarter of 2009 as compared to a loss of $145.0 million in the third quarter of 2008. The change in net revenues is primarily the result of the recognition of other-than-temporary impairment losses related to the Company’s MBS portfolio during the third quarter of 2008. No other-than-temporary impairments were recognized in the third quarter of 2009 related to the MBS portfolio. In addition, the Company recognized net investment income on the fair value change of our investment in FBR Capital Markets common stock for the third quarter of 2009. These investment gains were partially offset by a decrease in MBS interest income resulting from lower average MBS balances. Revenues from our principal investment activities included the following (dollars in thousands):

 

     For the quarter ended
September 30,
 
   2009    2008  

Net interest income

   $ 3,605    $ 7,949   

Net investment income (loss)—principal investing

     19,737      (153,110

Dividend income

     —        158   
               

Principal investment income (loss)

   $ 23,342    $ (145,003
               

 

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The components of net interest income from principal investing segment are summarized in the following table (dollars in thousands):

 

     Three months ended
September 30, 2009
    Three months ended
September 30, 2008
 
     Average
Balance
   Income
(Expense)
    Yield
(Cost)
    Average
Balance
   Income 
(Expense)
    Yield
(Cost)
 

Mortgage-backed securities (1)

   $ 166,271    $ 3,717      8.94   $ 2,525,719    $ 22,923      3.63

Other (2)

        2             250     
                                  
        3,719             23,173     
              

Repurchase agreements

   $ 100,575      (114   (0.45 )%    $ 2,189,574      (14,259   (2.55 )% 

Derivative contracts (3)

        —               (965  
                                  
   $ 100,575      (114   (0.45 )%    $ 2,189,574      (15,224   (2.78 )% 
                                  

Net interest income/spread

      $ 3,605      8.49      $ 7,949      0.85
                                  

 

(1)

The average balance and the yield are calculated based upon the adjusted par value which includes the effects of any other-than-temporary impairments recorded by the Company. The yield based on unadjusted par value was 7.09% and 3.59% for the three months ended September 30, 2009 and 2008, respectively.

(2)

Includes interest income on cash and other miscellaneous interest-earning assets.

(3)

Includes the effect of derivative instruments accounted for as cash flow hedges.

As shown in the table above, net interest income decreased by $4.3 million to $3.6 million during the three months ended September 30, 2009 compared to $7.9 million during the three months ended September 30, 2008. This decrease in interest income was primarily due to a lower average balance on the MBS portfolio.

The Company recognized net investment income of $19.7 million during the third quarter 2009 compared to a net investment loss of $153.1 million in the third quarter 2008. The following table summarizes the components of net investment income (loss) (dollars in thousands):

 

     Three months ended
September 30,
 
     2009     2008  

Available for sale and cost method securities—other-than-temporary impairments

   $ (86   $ (118,720

Fair value change in investment in FBR Capital Markets stock

     18,149        —     

Losses from investments funds

     (399     (1,448

Realized gains (losses) on sale of available for sale investments, net

     1,822        (24,474

Other net investment income (loss)

     251        (8,468
                

Net investment income (loss)

   $ 19,737      $ (153,110
                

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 assessment of cost method investments, the Company recorded $0.1 million of other-than-temporary impairment losses during the three months ended September 30, 2009 as compared to $16.3 million for the same period in 2008.

Fair value change in investment in FBR Capital Markets stock reflects the change in fair value of FBR Capital Markets stock during the quarter ended September 30, 2009.

Loss from investment funds reflects the earnings from and valuation adjustment of investments in proprietary investment partnerships and other managed investments.

 

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Other net investment income (loss) primarily includes net gains and losses from the changes in the fair value of investments in our MBS portfolio and derivative transactions.

Principal investing interest revenue decreased 84.1% to $3.7 million in the third quarter of 2009 from $23.2 million in the third quarter of 2008. Net investment income increased to $19.7 million in the third quarter of 2009 from a loss of $153.1 million in the third quarter of 2008. The decrease in interest income year over year was a result of the lower average balance in the MBS portfolio as a result of the downsizing effort to reduce exposure to deteriorating market conditions while at the same time generating additional cash to fund the extinguishment of long-term debt in the first quarter of 2009. The change in net investment income (loss) is primarily the result of increase in fair value of our investment in FBR Capital Markets’ common stock and no recognition of other-than-temporary impairment losses related to the Company’s MBS portfolio during the third quarter of 2009.

Interest expense, related primarily to long-term debt issued through FBR TRS Holdings, decreased 98.8% to $0.3 million in the third quarter of 2009 from $25.4 million in the third quarter of 2008 as a result of a decrease in outstanding principal balances due to the extinguishment during the first and third quarters of 2009 and lower LIBOR based interest rates associated with these floating rate borrowings.

Total non-interest expenses decreased 95.1% to $5.0 million in the third quarter of 2009 from $101.4 million in the third quarter of 2008. The decrease was primarily attributable to the deconsolidation of FBR Capital Markets’ activities during the second quarter of 2009 and the results of the cost reduction efforts taken during the last year.

The Company had an income tax provision of $3.6 million in the third quarter of 2009 as compared to an income tax benefit of $18.1 million in the third quarter of 2008. The decrease is due primarily to the recording of the tax provision due to the discrete period reporting of the tax effects of the gain recognized from the extinguishment of debt during the first and third quarters of 2009. Our effective tax rate was 6.7% in the third quarter of 2009 as compared to 41.0% in the third quarter of 2008. For the third quarter of 2009, our deferred tax assets continue to reflect a full valuation allowance as the Company believes it is more likely than not that the benefits will not be realized in the future.

Subsequent to the deconsolidation of FBR Capital Markets effective May 20, 2009, the Company no longer records activities related to the noncontrolling interest of consolidated subsidiary. $13.9 million of net loss attributable to the noncontrolling interest of consolidated subsidiary for the third quarter of 2008 represents minority interest holders’ share of losses of FBR Capital Markets during that period.

 

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Results of Operations

Nine months ended September 30, 2009 compared to nine months ended September 30, 2008

Net income increased to $111.8 million in the nine months ended September 30, 2009 from a loss of $149.0 million in the nine months ended September 30, 2008. Net income included the following results of operations by segment (dollars in thousands):

 

     Nine Months Ended
September 30,
 
     2009     2008  

Capital Markets

   $ (25,583   $ (92,886

Principal Investment

     (11,598     (189,150

Other

     —          (3,810
                

Operating loss

     (37,181     (285,846

Net income from extinguishment of debt, subsidiary share transactions and other

     150,396        76,919   
                

Income (loss) before taxes and noncontrolling interest

     113,215        (208,927

Income tax provision (benefit)

     12,830        (28,903

Noncontrolling interest in losses of consolidated subsidiary

     (11,459     (31,053
                

Net income (loss) attributable to Arlington Asset shareholders

   $ 111,844      $ (148,971
                

Net income for the first nine months of 2009 is primarily due to the gain on extinguishment of long-term debt and investment income from fair value changes in our investment in FBR Capital Markets common stock. Net loss for the first nine months of 2008 was primarily the result of other-than-temporary impairment losses recorded on our MBS investments and losses generated by FBR Capital Markets.

The Company’s revenues, net of interest expense, increased to $100.9 million in the first nine months of 2009 from $38.0 million in the first nine months of 2008 due to the changes in revenues and interest expense described below.

Revenues from our principal investment activities, net of related interest expense, totaled $23.0 million in the first nine months of 2009 as compared to a loss of $147.9 million in the first nine months of 2008. The change in net revenues is primarily the result of the recognition of other-than-temporary impairment losses related to the Company’s MBS portfolio and a residual interest in a securitization of non-prime mortgage loans during the first nine months of 2008. No other-than-temporary impairments were recognized in the first nine months of 2009 related to MBS or a residual interest in a securitization. In addition, the Company recognized net investment income on the fair value change of our investment in FBR Capital Markets common stock subsequent to May 20, 2009. These investment gains were partially offset by a decrease in MBS interest income resulting from lower average MBS balances. Revenues from our principal investment activities included the following (dollars in thousands):

 

     Nine Months Ended
September 30,
 
     2009    2008  

Net interest income

   $ 7,186    $ 24,924   

Net investment income (loss)—principal investing

     15,754      (173,311

Dividend income

     108      497   
               

Principal investment income (loss)

   $ 23,048    $ (147,890
               

 

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The components of net interest income from mortgage investments are summarized in the following table (dollars in thousands):

 

     Nine Months Ended September 30,  
     2009     2008  
     Average
Balance
   Income
(Expense)
    Yield
(Cost)
    Average
Balance
   Income
(Expense)
    Yield
(Cost)
 

Mortgage-backed securities (1)

   $ 116,639    $ 7,579      8.66   $ 2,246,956    $ 68,551      4.07

Other (2)

        21             2,316     
                                  
        7,600             70,867     
                          

Repurchase agreements

   $ 78,863      (414   (0.70 )%    $ 1,971,449      (44,023   (2.93 )% 

Derivative contracts (3)

        —               (1,920  
                                  
   $ 78,863      (414   (0.70 )%    $ 1,971,449      (45,943   (3.11 )% 
                                  

Net interest income/spread

      $ 7,186      7.96      $ 24,924      0.96
                                  

 

(1)

The average balance and the yield are calculated based upon the adjusted par value which includes the effects of any other-than-temporary impairments recorded by the Company. The yield based on unadjusted par value was 5.72% and 4.02% for the nine months ended September 30, 2009 and 2008, respectively.

(2)

Includes interest income on cash and other miscellaneous interest-earning assets.

(3)

Includes the effect of derivative instruments accounted for as cash flow hedges.

As shown in the table above, net interest income decreased by $17.7 million to $7.2 million during the nine months ended September 30, 2009 from $24.9 million during the nine months ended September 30, 2008. This decrease was primarily due to a lower average balance on the MBS portfolio.

The Company recognized net investment income of $15.8 million during the first nine months of 2009 compared to a net investment loss of $173.3 million in the first nine months of 2008. The following table summarizes the components of net investment income (loss) (dollars in thousands):

 

     Nine Months Ended
September 30,
 
     2009     2008  

Available for sale and cost method securities—other-than-temporary impairments

   $ (1,086   $ (131,334

Fair value change in investment in FBR Capital Markets stock

     14,123        —     

Loss from investment funds

     (946     (2,736

Realized gains (losses) on sale of available for sale investments, net

     1,586        (20,686

Residual interest in securitization—other-than-temporary impairments

     —          (8,640

Other net investment income (loss)

     2,077        (9,915
                

Net investment income (loss)

   $ 15,754      $ (173,311
                

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 assessment of cost method investments, the Company recorded $1.1 million of other-than-temporary impairment losses during the nine months ended September 30, 2009 as compared to $23.0 million for the same period in 2008. In addition, the Company recorded $8.6 million in other-than-temporary impairment losses on a residual interest in a securitizations during the nine months ended September 30, 2008.

Fair value change in investment in FBR Capital Markets stock reflects the change in fair value of FBR Capital Markets stock subsequent to the May 20, 2009 deconsolidation.

 

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Loss from investment funds reflects the Company’s earnings from and valuation adjustment of investments in proprietary investment partnerships and other managed investments.

Other net investment income (loss) primarily includes net gains and losses from the changes in the fair value of investments in our MBS portfolio and derivative transactions.

Principal investing interest revenue decreased 89.3% to $7.6 million in the first nine months of 2009 from $70.9 million in the first nine months of 2008. The decrease in interest income year over year was a result of the lower average balance in the MBS portfolio as a result of the downsizing effort to reduce exposure to deteriorating market conditions while at the same time generating additional cash to fund the extinguishment of long-term debt in the first quarter of 2009. Net investment income increased to $15.8 million in the first nine months of 2009 from a loss of $173.3 million in the first nine months of 2008. The change in net investment income is primarily the result of a gain recognized on the fair value change of FBR Capital Markets’ common stock subsequent to the deconsolidation on May 20, 2009 and no recognition of other-than-temporary impairment losses related to the Company’s MBS portfolio and a residual interest in a securitization of non-prime loans during the first nine months of 2009.

Interest expense, related primarily to long-term debt issued through FBR TRS Holdings decreased 94.8% to $3.7 million in the first nine months of 2009 from $70.9 million in the first nine months of 2008 as a result of a decrease in the outstanding principal balances due to the extinguishment during the first and third quarters of 2009 and also due to the decrease in interest rates associated with these floating rate borrowings.

Total non-interest expenses decreased 57.4% to $138.1 million in the first nine months of 2009 from $323.9 million in the first nine months 2008. The decrease was primarily attributable to the deconsolidation of FBR Capital Markets’ activities during the second quarter of 2009 and results of the cost reduction efforts taken during the last year.

The Company had an income tax provision of $12.8 million in the first nine months of 2009 as compared to an income tax benefit of $28.9 million in the first nine months of 2008. Our tax provision in 2009 related to the gain on extinguishment of debt as compared to the tax benefits related to taxable losses generated by our former taxable REIT subsidiaries in 2008. Our effective tax rate relating to this activity was 11.4% in the first nine months of 2009 as compared to 127.0% in the first nine months of 2008. For the nine months ended September 30, 2008, our tax benefit reflects a full valuation allowance on tax benefits related to operating losses at FBR TRS Holdings and related release of valuation allowance related to the disposition of First NLC.

Net loss attributable to the noncontrolling interest of consolidated subsidiary of $11.5 million represents minority interest holders’ share of losses of FBR Capital Markets through May 20, 2009 as compared to $31.1 million for the first nine months of 2008.

Liquidity and Capital Resources

Liquidity is a measurement of our ability to meet potential cash requirements including ongoing commitments to repay borrowings, fund investments, and for other general business purposes. Our primary sources of funds for liquidity consist of short-term borrowings ( e.g ., repurchase agreements), principal and interest payments on MBS, dividends on equity securities, proceeds from sales of MBS, and credit provided by banks. Potential future sources of liquidity for us also include existing cash balances, borrowing capacity through margin accounts and repurchase agreements and future issuances of common stock, preferred stock or debt securities.

Liquidity, or ready access to funds, is essential to our business. Failures of similar businesses have often been attributable in large part to insufficient liquidity. Liquidity is of particular importance to our business and perceived liquidity issues may affect our clients’ and counterparties’ willingness to engage in transactions with

 

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us. Our liquidity could be impaired due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects us or third parties. Further, our ability to sell assets may be impaired if other market participants are seeking to sell similar assets at the same time.

The Company manages its short-term liquidity with its MBS portfolio and related repurchase agreements. In the current environment, MBS may be liquidated within relatively short time periods to provide additional liquidity, although there is no assurance we would get favorable pricing in connection with any such sales. We also intend to manage our liquidity risk by managing our investment strategy, determining the appropriate allocation of investment portfolio between levered and unlevered positions.

Cash Flows

As of September 30, 2009, the Company’s cash and cash equivalents totaled $13.3 million, representing a net decrease in the balance of $241.4 million for the nine months ended September 30, 2009. The cash used in operating activities of $74.4 million was attributable primarily to a reduction in cash related to operating activities of FBR Capital Markets. The cash provided by investing activities of $864.2 million relates primarily to proceeds from sales and principal receipts of MBS and proceeds from the maturity of U.S. Treasury bonds offset by cash used in the purchase of MBS and deconsolidation of FBR Capital Markets during the second quarter of 2009. The cash used in financing activities of $1.0 billion relates primarily to repayments of repurchase agreements used to finance a portion of the MBS sold and U.S. Treasury bonds that matured.

Assets

On September 30, 2009, our principal liquid assets consist of MBS, investment in FBR Capital Markets, and cash and cash equivalents. The Company’s total assets decreased from $1.6 billion at December 31, 2008 to $283.3 million as of September 30, 2009. The decrease in total assets reflects the decrease of MBS and U.S. Treasury bonds and the effects of the deconsolidation of FBR Capital Markets during the second quarter of 2009.

The following table provides additional detail regarding the Company’s merchant banking and other investments as of September 30, 2009 (dollars in thousands):

 

     September 30, 2009
     Number of
Shares/Units
   Cost/Adjusted
Basis
   Fair Value/
Carrying Value

Other investments:

        

Merchant banking—non-marketable securities

        

Cypress Sharpridge Investments, Inc. (1)

   5,176    $ 52    $ 52

Thunderbird Resorts, Inc. (1)

   358,423      452      452

Other

        975      975
                

Total merchant banking investments

      $ 1,479      1,479
            

Investment in FBR Capital Markets, at fair value

           87,497

Investment funds

           1,084
            

Total other investments

         $ 90,060
            

 

(1)

Cost/adjusted basis reflects the effects of other-than-temporary impairment charges.

 

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Sources of Funding

We believe that our existing cash balances, net investments, cash flows from operations, borrowing capacity, other sources of liquidity and execution of our financing strategies should be sufficient to meet our cash requirements. We have obtained, and believe we will be able to continue to obtain, short-term financing in amounts and at interest rates consistent with our financing objectives. We may seek debt or equity financings, in public or private transactions, to provide capital for corporate purposes and/or strategic business opportunities, including possible acquisitions, joint ventures, alliances or other business arrangements which could require substantial capital outlays. Our policy is to evaluate strategic business opportunities, including acquisitions and divestitures, as they arise. There can be no assurance that we will be able to generate sufficient funds from future operations, or raise sufficient debt or equity on acceptable terms, to take advantage of investment opportunities that become available. Should our needs ever exceed these sources of liquidity, we believe that most of our investments could be sold, in most circumstances, to provide cash, although such sales may not be on terms we consider to be favorable.

As of September 30, 2009, the Company’s liabilities totaled $146.3 million. Our indebtedness consisted of repurchase agreements and long-term debentures (Trust Preferred securities). These Trust Preferred securities accrue and require payments of interest quarterly at annual rates of three-month LIBOR plus 2.25% to 3.00%, mature in 24 to 26 years, and are redeemable, in whole or in part, without penalty, currently or within two years. As of September 30, 2009, we had $15.0 million of Trust Preferred securities, and the weighted average interest rate on these securities was 3.26%.

Our repurchase agreements for our MBS include provisions contained in the standard master repurchase agreement as published by the Bond Market Association and may be amended and supplemented in accordance with industry standards for repurchase facilities. As provided in the standard master repurchase agreement, upon the occurrence of an event of default or a termination event the applicable counterparty has the option to terminate all repurchase transactions under such counterparty’s repurchase agreement and to demand immediate payment of any amount due from us to the counterparty.

Under our repurchase agreements, we may be required to pledge additional assets to our repurchase agreement counterparties in the event the estimated fair value of the existing pledged collateral under such agreements declines and such lenders demand additional collateral (i.e., a margin call), which may take the form of additional securities or cash. Margin calls on repurchase agreements collateralized by our MBS investments primarily result from events such as declines in the value of the underlying mortgage collateral caused by factors such as rising interest rates or prepayments.

To date, we have not had any margin calls on our repurchase agreements that we were not able to satisfy with either cash or additional pledged collateral. However, should we encounter increases in interest rates, prepayments or delinquency levels, margin calls on our repurchase agreements could lead to a material adverse change in our liquidity position.

In the event that market conditions are such that we are unable to obtain financing for our investments in MBS in amounts and at interest rates consistent with our financing objectives, to the extent deemed appropriate, we may use cash to finance our investments or we may liquidate such investments. Accordingly, depending on market conditions, the Company may incur significant losses on any such sales of MBS.

The following table provides information regarding the Company’s outstanding repurchase agreement borrowings (dollars in thousands):

 

     September 30,
2009
    December 31,
2008
 

Outstanding balance

   $ 100,000      $ 1,063,040   

Weighted-average rate

     0.33     0.44

Weighted-average term to maturity

     14.0 days        14.3 days   

 

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Dividends

During the three and nine month period ended September 30, 2009, no dividends were declared or paid. Pursuant to our variable dividend policy, our Board of Directors, in its sole discretion, may reinstate the payment of cash dividends when appropriate in the future. No dividends were declared or paid during 2008.

Shareholder Rights Plan

On June 1, 2009, the Company’s Board of Directors adopted a shareholder rights plan (Rights Plan) and declared a dividend of one preferred share purchase right (each, a Right) for each outstanding share of the Company’s Class A common stock and Class B common stock. No shareholder approval was required for adoption of the Rights Plan, however, the Company plans to submit the Rights Plan to its shareholders for approval on or before June 4, 2010.

The Board adopted the Rights Plan in an effort to protect against a possible limitation on the Company’s ability to use its NOLs, NCLs and built-in losses under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended (the Code). The Company’s ability to use its NOLs, NCLs and built-in losses would be limited if there was an “ownership change” under Section 382 of the Code. The Rights Plan was adopted to dissuade any person or group from acquiring 4.9% or more of the Company’s outstanding Class A common stock (each, an Acquiring Person) without the approval of the Board and triggering an “ownership change” as defined by Section 382.

Initially, the Rights will generally not be exercisable and will be attached to and automatically trade with the Class A common stock and Class B common stock. The Rights will separate from the Class A common stock and Class B common stock and a “distribution date” will occur, with certain exceptions and upon a determination of the Company’s Board of Directors, upon the earlier of (i) 10 business days after a public announcement by the Company that a person or group has become an Acquiring Person and (ii) 10 business days after the commencement of a tender or exchange offer by a person or group for 4.9% or more of the Class A common stock. Shareholders who owned 4.9% or more of the Company’s outstanding Class A common stock at the time of adoption of the Rights Plan will not trigger the Rights Plan so long as they do not (i) acquire any additional shares of Class A common stock or (ii) fall under 4.9% ownership of Class A common stock and then re-acquire additional shares so that they own 4.9% or more of the Class A common stock.

Subject to the terms, provisions and conditions of the Rights Plan, and taking into account our 1-for-20 reverse stock split that was effected on October 6, 2009, if the Rights become exercisable, each Right would represent the right to purchase from the Company one ten-thousandth of a share of Series A Junior Preferred Stock for a purchase price of $3.00 each, subject to adjustment in accordance with the terms of the Rights Plan. Each post-split share of Class A and Class B common stock is now associated with, and now trades with, 20 Rights. If issued, each 20 fractional shares of preferred stock would give the shareholder approximately the same dividend, voting and liquidation rights as does one share of the Company’s Class A common stock. However, prior to exercise, a Right does not give its holder any rights as a shareholder of the Company, including without limitation, any dividend, voting or liquidation rights.

The Rights and the Rights Plan will expire on the earliest of (i) June 4, 2019, (ii) the time at which the Rights are redeemed pursuant to the Rights Plan, (iii) the time at which the Rights are exchanged pursuant to the Rights Plan, (iv) the repeal of Sections 382 and 383 of the Code or any successor statute if the Board determines that the Rights Plan is no longer necessary for the preservation of the applicable tax benefits, (v) the beginning of a taxable year of the Company to which the Board determines that no applicable tax benefits may be carried forward and (vi) the close of business on June 4, 2010 if approval of the Rights Plan by the Company’s shareholders has not been obtained.

 

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Recent Developments

On October 1, 2009, the Company announced a 1-for-20 reverse split of its Class A and Class B common stock in accordance with the previously approved shareholder authorization. The reverse stock split is effective October 6, 2009. Upon the effectiveness of the reverse stock split, each twenty shares of issued and outstanding common stock were converted into one share of common stock. The Company did not issue fractional shares and shareholders received a cash payment for fractional shares based on the split-adjusted average price of the Class A common stock before the effective time. The reverse split reduced the number of shares of the Company’s common stock outstanding from approximately 160 million to approximately 8 million. Proportional adjustments were made to outstanding stock options and other equity incentive awards and equity compensation plans. The number of authorized shares of common stock did not change.

On October 28, 2009, the Company announced the closing on the sale of 14,755,017 shares of FBR Capital Markets common stock at $6.00 per share in an underwritten public offering. Proceeds to the Company, after the underwriting discount but before expenses, were $84.1 million. The net price per share after the underwriting discount to the Company of $5.70, is less than the carrying value of the FBR Capital Markets stock of $5.93 at September 30, 2009, and will result in the Company recording a pre-tax book loss of $3.4 million during the quarter ending December 31, 2009. These shares represented the Company’s remaining interest in FBR Capital Markets.

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market Risk

Market risk generally represents the risk of loss through a change in realizable value that can result from a change in the prices of equity securities, a change in the value of financial instruments as a result of changes in interest rates, a change in the volatility of interest rates or a change in the credit rating of an issuer. We are exposed to the following market risks as a result of our investments in MBS and equity investments. The Company may utilize forward sales to mitigate market risk related to our agency MBS portfolio. As of September 30, 2009, none of the investments mentioned in this Item 3 is held for trading purposes.

Credit Risk

We are also exposed to mortgage credit risk related to our MBS portfolio. Mortgage credit risk is the risk that a borrower will fail to make timely payments on a mortgage or an issuer will fail to make timely payments on a security we own, exposing us to the risk of credit losses and credit-related expenses. While the agency MBS has less credit risk due to the guarantee by U.S. government, we have increased credit risk related to our private-label MBS. To mitigate the credit risk in private-label MBS, we invest in private-label MBS with credit enhancements which reduce the exposure. However, the continued deterioration in the housing market, coupled with the increasing mortgage loan delinquencies and credit losses in the U.S. mortgage market may not prevent us from incurring losses and negatively affecting our financial position.

Interest Rate Risk

Leveraged MBS

The Company is primarily subject to interest-rate risk as a result of its principal investment activities. Through its principal investment activities, the Company primarily invests in MBS and finances those investments with repurchase agreements which are interest rate sensitive financial instruments. The Company is exposed to interest rate risk that fluctuates based on changes in the level or volatility of interest rates and mortgage prepayments and in the shape and slope of the yield curve. The Company historically hedged a portion of its exposure to interest rate fluctuations primarily through the use of interest rate swaps, interest rate caps, and Eurodollar futures and put option contracts. The Company held no such hedging instruments as of September 30, 2009.

The Company’s primary risk is related to changes in both short and long-term interest rates, which affect the Company in several ways. As interest rates increase, the market value of the MBS may be expected to decline, prepayment rates may be expected to go down, and duration may be expected to extend. If interest rates decline, the reverse is true for MBS.

The table that follows shows the expected change in fair value for the Company’s current MBS under several hypothetical interest-rate scenarios. Interest rates are defined by the U.S. Treasury yield curve. The changes in rates are assumed to occur instantaneously. It is further assumed that the changes in rates occur uniformly across the yield curve and that the level of LIBOR changes by the same amount as the yield curve. Actual changes in market conditions are likely to be different from these assumptions.

Changes in value are measured as percentage changes from their respective values presented in the column labeled “Value at September 30, 2009.” Management’s estimate of change in value for MBS is based on the same assumptions it uses to manage the impact of interest rates on the portfolio. Actual results could differ significantly from these estimates. For MBS, the estimated change in value of the MBS reflects an effective duration of 3.42 in a rising interest rate environment and 2.16 in a declining interest rate environment.

The effective durations are based on observed market value changes, as well as management’s own estimate of the effect of interest rate changes on the fair value of the investments including assumptions regarding prepayments based, in part, on age of and interest rate on the mortgages and the mortgages underlying the MBS,

 

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embedded derivates in the MBS, prior exposure to refinancing opportunities and an overall analysis of historical prepayment patterns under a variety of past interest rate conditions (dollars in thousands, except per share amounts).

 

     Value at September 30, 2009  
          100 Basis Point
Increase in
Interest Rates
   Percent
Change
    100 Basis Point
Decrease in
Interest Rates
   Percent
Change
 

Assets

             

Mortgage-backed securities

   $ 173,895    $ 167,950    (3.42 )%    $ 177,648    2.16

Other

     109,430      109,430    —          109,430    —     
                         

Total assets

   $ 283,325    $ 277,380    (2.10 )%    $ 287,078    1.32
                         

Liabilities

             

Repurchase agreements

   $ 100,000    $ 100,000    —        $ 100,000    —     

Other

     46,346      46,346    —          46,346    —     
                         

Total liabilities

     146,346      146,346    —          146,346    —     

Equity

     136,979      131,034    (4.34 )%      140,732    2.74
                         

Total liabilities and equity

   $ 283,325    $ 277,380    (2.10 )%    $ 287,078    1.32
                         

Book value per share—total equity (1)

   $ 17.84    $ 17.06    (4.34 )%    $ 18.33    2.74
                         

 

(1)

Reflects the impact of 1-for-20 reverse stock split effective October 6, 2009. See Note 11, Subsequent Events.

As shown above, the Company’s MBS portfolio generally will benefit less from a decline in interest rates than it will be adversely affected by a same-scale increase in interest rates.

 

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Equity Price Risk

The Company is exposed to equity price risk as a result of its investments in marketable equity securities and equity method investments. Equity price risk changes as the volatility of equity prices changes or the values of corresponding equity indices change.

While it is impossible to project exactly what factors may affect the prices of equity sectors and how much the effect might be, the table below illustrates the impact a ten percent increase and a ten percent decrease in the price of the equities held by the Company would have on the value of the total assets and the book value of the Company as of September 30, 2009 (dollars in thousands, except per share amounts).

 

    Value at September 30, 2009  
        10% Increase in Price     Percent
Change
    10% Decrease in Price     Percent
Change
 

Assets

         

Investment in FBR Capital Markets

  $ 87,497      $ 96,247      10.00   $ 78,747      (10.00 )% 

Equity method investments

    2,563        2,819      10.00     2,307      (10.00 )% 

Other

    193,265        193,265      —          193,265      —     
                           

Total assets

  $ 283,325      $ 292,331      3.18   $ 274,319      (3.18 )% 
                           

Liabilities

  $ 146,346      $ 146,346      —        $ 146,346      —     
                           

Equity

         

Common stock

    1,584        1,584      —          1,584      —     

Paid-in-capital

    1,504,283        1,504,283      —          1,504,283      —     

Accumulated other comprehensive income

    289        289      —          289      —     

Accumulated deficit

    (1,369,177     (1,360,171   (0.66 )%      (1,378,183   0.66
                           

Total equity

    136,979        145,985      6.58     127,973      (6.58 )% 
                           

Total liabilities and equity

  $ 283,325      $ 292,331      3.18   $ 274,319      (3.18 )% 
                           

Book value per share (1)

  $ 17.84      $ 19.01      6.58   $ 16.67      (6.58 )% 
                           

 

(1)

Reflects the impact of 1-for-20 reverse stock split effective October 6, 2009. See Note 11, Subsequent Events.

Except to the extent that the Company sells its marketable equity securities, excluding its shares of FBR Capital Markets stock, or other long-term investments, or a decrease in their fair value is deemed to be other-than-temporary, an increase or decrease in the fair value of those assets will not directly affect the Company’s earnings. However, an increase or decrease in the value of equity method investments and our investment in FBR Capital Markets stock will directly affect the Company’s earnings.

 

Item 4. Controls and Procedures

As of the end of the period covered by this report on Form 10-Q, our management, with the participation of our Chief Executive Officer, Eric F. Billings, and our Chief Financial Officer, Kurt R. Harrington, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) pursuant to Rule 13a-15(b) of the Exchange Act. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures, as of September 30, 2009, are effective.

 

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With the deconsolidation and the sale of its interest in FBR Capital Markets, the Company is no longer sharing financial and administrative services with FBR Capital Markets. The Company has established an independent information technology infrastructure and implemented a new accounting system during the quarter ended September 30, 2009. Although certain procedures and processes have been changed during the quarter ended September 30, 2009, these changes have not materially affected, or are not reasonably likely to materially affect, our internal control over financial reporting.

Forward-Looking Statements

This report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Some of the forward-looking statements can be identified by the use of forward-looking words such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “estimates” or “anticipates” or the negative of those words or other comparable terminology. Such statements include, but are not limited to, those relating to the effects of growth, our principal investment activities, levels of assets under management and our current equity capital levels. Forward-looking statements involve risks and uncertainties. You should be aware that a number of important factors could cause our actual results to differ materially from those in the forward-looking statements. These factors include, but are not limited to:

 

   

the revocation of our status as a real estate investment trust (REIT) for federal income tax purposes effective as of January 1, 2009 and our ability to use NOLs and NCLs to reduce our taxable income;

 

   

our ability to forecast our tax attributes, which are based upon various facts and assumptions, and our ability to protect and use our net operating losses and net capital losses to offset future taxable income and gains, including whether our recently adopted shareholder rights plan will be effective in preventing an ownership change that would significantly limit our ability to utilize such losses;

 

   

the federal conservatorship of Fannie Mae and Freddie Mac and related efforts, along with any changes in laws and regulations affecting the relationship between Fannie Mae and Freddie Mac and the federal government;

 

   

mortgage loan modification programs and future legislative action;

 

   

the availability and terms of, and our ability to deploy, capital and our ability to grow our business through an investment strategy focused on investing primarily in agency MBS, including collateralized mortgage obligations, on a leveraged basis;

 

   

the overall environment for interest rates, changes in interest rates, interest rate spreads, the yield curve and prepayment rates;

 

   

current conditions in the residential mortgage market and further adverse developments in that market;

 

   

current economic conditions and further adverse developments in the overall economy;

 

   

potential risk attributable to our mortgage-related or merchant banking investment portfolios, including changes in fair value;

 

   

our use of leverage and our dependence on repurchase agreements and other short-term borrowings to finance our mortgage-related investments;

 

   

changes in our investment, hedging and leverage strategies, changes in our asset allocation and changes in our operational policies, all of which may be changed by us without shareholder approval;

 

   

competition for investment opportunities, including competition from the U.S. Treasury for investments in agency-backed MBS;

 

   

competition for qualified personnel;

 

   

available technologies;

 

   

malfunctioning or failure in our operations and infrastructure;

 

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the effect of government regulation and of general economic conditions on our business;

 

   

fluctuating quarterly operating results;

 

   

our ability to retain key professionals;

 

   

risk from strategic investments or acquisitions and joint ventures or our entry into new business areas;

 

   

failure to maintain effective internal controls;

 

   

changes in laws and regulations and industry practices that may adversely affect our businesses;

 

   

the loss of our exemption from registration as an investment company under the Investment Company Act of 1940, as amended;

 

   

volatility of the securities markets; and

 

   

activity in the secondary securities markets.

We will not necessarily update the information presented in this Form 10-Q if any of these forward-looking statements turn out to be inaccurate. For a more detailed discussion of the risks affecting our business, any of which could cause our actual results to differ materially from those in the forward-looking statements, see our Annual Report on Form 10-K for the year ended December 31, 2008, including the section entitled “Risk Factors” in that report, and any other reports or documents we file with the SEC from time to time.

 

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PART II

OTHER INFORMATION

 

Item 1. Legal Proceedings

On September 16, 2008, a shareholder derivative action captioned Kornfeld, et al. v. Billings, et al. , No. 08-1144, was filed in the Circuit Court of Arlington County, Virginia, by Bill Kornfeld and Edward Lapinski. The Company was named as a nominal defendant along with certain current and former officers and directors as individual defendants. The complaint asserts claims under Virginia law against the individual defendants for breach of fiduciary duty and against certain of the individual defendants for unjust enrichment in connection with certain decisions concerning executive compensation. Our Board of Directors established a special committee to conduct a review and evaluation of the plaintiffs’ allegations and make a final decision concerning whether maintenance of the litigation was in the Company’s best interests. The special committee concluded that the litigation was not in the Company’s best interest. On December 8, 2008, the Company moved to dismiss the shareholder derivative action based on the special committee’s recommendation and the individual defendants filed demurrers. On March 5, 2009, the court denied the individual defendants’ demurrers, granted the plaintiffs’ motion for certain discovery and denied the Company’s motion to dismiss with leave to renew the motion following discovery. On July 24, 2009, the plaintiffs filed an amended complaint. The amended complaint contains allegations similar to those in the original complaint and adds a cause of action against certain of the individual defendants for waste. On August 14, 2009, the Company filed an answer to the amended complaint and the individual defendants filed a demurrer to the amended complaint. The likely outcome of this action or its likely impact on the Company’s results of operations at this time cannot be predicted.

On July 20, 2009, counsel to Bill Kornfeld and Edward Lapinski, two purported shareholders of the Company sent a letter to the Company, demanding that the Board of Directors remedy alleged breaches of fiduciary duty by the directors in connection with the sale of a portion of the Company’s FBR Capital Markets stock to FBR Capital Markets on May 20, 2009. The letter alleges that this sale was completed pursuant to an inappropriate process and resulted in an inadequate price. The letter states that the shareholders will file a lawsuit bringing derivative claims if the Company’s Board does not take the demanded action within a reasonable period of time. The Board of Directors has established a special committee of independent directors to investigate the claims made in the demand letter.

 

Item 1A. Risk Factors

In addition to the risk factors disclosed in “Part I—Item 1A. Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, set forth in this section is an additional risk factor we believe applicable to our business.

Our shareholder rights plan could inhibit a change in our control.

On June 1, 2009, our Board implemented a Rights Plan in an effort to protect against a possible limitation on our ability to use our NOLs, NCLs and built-in losses by dissuading investors from aggregating ownership of our Class A common stock and triggering an “ownership change” for purposes of Sections 382 and 383 of the Code. The Rights Plan may not be successful in preventing an “ownership change” within the meaning of Sections 382 and 383 of the Code, and we may lose all or most of the anticipated tax benefits associated with our prior losses. Under the terms of the Rights Plan, in general, if a person or group acquires or commences a tender or exchange offer for beneficial ownership of 4.9% or more of the outstanding shares of our Class A common stock upon a determination by our Board of Directors, all of our other Class A and Class B common shareholders will have the right to purchase securities from us at a discount to such securities’ fair market value, thus causing substantial dilution to the acquiring person. The Rights Plan may have the effect of inhibiting or impeding a change in control not approved by our Board and, notwithstanding its purpose, could adversely affect our shareholders’ ability to realize a premium over the then-prevailing market price for our common stock in connection with such a transaction. In addition, since our Board can prevent the Rights Plan from operating, in the event our Board approves of an acquiring person, the Rights Plan gives our Board significant discretion over whether a potential acquirer’s efforts to acquire a large interest in us will be successful. Consequently, the Rights Plan may not succeed in protecting anticipated tax benefits and could impede transactions that would otherwise benefit our shareholders.

 

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Item 6. Exhibits

 

Exhibit
Number

  

Exhibit Title

  3.1    Amended and Restated Articles of Incorporation of the Company, as amended.
  3.2    Bylaws of Company, as amended (incorporated by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q filed on August 10, 2009).
10.1    Underwriting Agreement, dated October 22, 2009, among the Company, FBR Capital Markets Corporation and FBR Capital Markets & Co. and Barclays Capital Inc. as representatives of the several underwriters named in Schedule I thereto (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 29, 2009).
31.01    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended, adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.02    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended, adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.01    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.02    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Arlington Asset Investment Corp.
By:  

/ S /    K URT R. H ARRINGTON        

  Kurt R. Harrington
  Executive Vice President, Chief Financial Officer, and Chief Accounting Officer
  (Principal Financial Officer)

Date: November 9, 2009

 

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EXHIBIT INDEX

 

Exhibit
Number

  

Exhibit Title

  3.1    Amended and Restated Articles of Incorporation of the Company, as amended.
  3.2    Bylaws of Company, as amended (incorporated by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q filed on August 10, 2009).
10.1    Underwriting Agreement, dated October 22, 2009, among the Company, FBR Capital Markets Corporation and FBR Capital Markets & Co. and Barclays Capital Inc. as representatives of the several underwriters named in Schedule I thereto (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 29, 2009).
31.01    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended, adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.02    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended, adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.01    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.02    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

46

Exhibit 3.1

ARTICLES OF AMENDMENT OF THE

AMENDED AND RESTATED ARTICLES OF INCORPORATION OF

ARLINGTON ASSET INVESTMENT CORP.

I.

The name of the corporation is Arlington Asset Investment Corp. (the “Corporation”).

II.

The amendment (the “Amendment”) adopted is as follows:

Article III of the Corporation’s Amended and Restated Articles of Incorporation is amended by inserting the following as Section 3.3 after Section 3.2 in the Corporation’s Amended and Restated Articles of Incorporation:

“3.3 Reverse Stock Split. As of 5:00 p.m., Eastern Time, on Tuesday, October 6, 2009 (the “Effective Time”), each twenty (20) shares of the Corporation’s Class A Common Stock and each twenty (20) shares of the Corporation’s Class B Common Stock, issued and outstanding immediately prior to the Effective Time, shall automatically be combined into one validly issued, fully paid and non-assessable share of Class A Common Stock and one validly issued, fully paid and non-assessable share of Class B Common Stock, respectively, without any further action by the Corporation or the holder thereof, subject to the treatment of fractional share interests as described below (the “Reverse Stock Split”).

A shareholder who otherwise would be entitled to receive a fractional share interest as a result of the Reverse Stock Split shall, with respect to such fractional share interest, be entitled to receive cash (without interest or deduction) from the Corporation in lieu of such fractional share interest, upon receipt by the Corporation’s transfer agent of such shareholder’s properly completed and duly executed transmittal letter and, where shares are held in certificated form, the surrender of such shareholder’s Old Certificates (as defined below), in an amount equal to the product of (i) the fractional share interest otherwise issuable to such shareholder as a result of the Reverse Stock Split, multiplied by (ii) the product of (A) the volume weighted average price of the Corporation’s Class A Common Stock on the five trading days prior to the Effective Time, as reported by the New York Stock Exchange, multiplied by (B) 20.

Each certificate that immediately prior to the Effective Time represented shares of the Corporation’s Class A Common Stock or Class B Common Stock, as the case may be (the “Old Certificates”), shall thereafter represent that number of shares of Class A Common Stock or Class B Common Stock, as the case may be, into which the shares of Class A Common Stock or Class B Common Stock, as the case may be, represented by the Old Certificates shall have been combined, subject to the elimination of fractional share interests as described above.


III.

The foregoing Amendment was proposed by the Corporation’s Board of Directors, which found adoption of the Amendment to be in the Corporation’s best interest and directed that the Amendment be submitted to a vote at a meeting of the Corporation’s shareholders on June 1, 2009.

IV.

On April 30, 2009, notice of the meeting of the Corporation’s shareholders, accompanied by a copy of this Amendment, was given in the manner provided in the Virginia Stock Corporation Act to each of the Corporation’s shareholders of record.

V.

The designation, number of outstanding shares, and number of votes entitled to be cast by each voting group entitled to vote separately on the Amendment was:

 

Designation

   Number of
Outstanding Shares
   Number of Votes
Entitled to be Cast

Common Stock, $0.01 par value per share, Class A and Class B

   158,957,361    181,701,947

The total number of votes cast for and against the Amendment by each voting group entitled to vote separately on the Amendment was:

 

Voting Group

   Votes “FOR”    Votes “AGAINST”

Common Stock, $0.01 par value per share, Class A and Class B

   137,135,413    29,435,020

The total number of votes cast for the Amendment by each voting group was sufficient for approval of the Amendments by the voting group.

VI.

Pursuant to Section 13.1-606 of the Virginia Stock Corporation Act, this Amendment shall become effective at 5:00 p.m., Eastern Time, on Tuesday, October 6, 2009.

[Signature Page Follows]

 

2


IN WITNESS WHEREOF , the undersigned corporation has caused these Articles of Amendment to be executed by its duly authorized Chairman of the Board and Chief Executive Officer as of this 2 nd day of October, 2009.

 

ARLINGTON ASSET INVESTMENT CORP.,

a Virginia corporation

By:   / S / J. R OCK T ONKEL , J R .
Name:   J. Rock Tonkel, Jr.
Title:   President and Chief Operating Officer

 

3


ARTICLES OF AMENDMENT OF THE

AMENDED AND RESTATED ARTICLES OF INCORPORATION OF

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.

I.

The name of the corporation is Friedman, Billings, Ramsey Group, Inc. (the “Corporation”).

II.

The amendment (the “Name Change Amendment”) adopted is as follows:

Article I, Section 1.1 of the Corporation’s Amended and Restated Articles of Incorporation is deleted in its entirety, and the following Article I, Section 1.1 is inserted in full to be and read as follows:

“1.1 Name. The name of the Corporation is Arlington Asset Investment Corp. (the “Corporation”).”

III.

The Name Change Amendment was proposed by the Corporation’s Board of Directors, which found adoption of such amendment to be in the Corporation’s best interest and directed that such amendment be submitted to a vote at a meeting of the Corporation’s shareholders on June 1, 2009.

IV.

On April 30, 2009, notice of the meeting, accompanied by a copy of the Name Change Amendment, was given in the manner provided in the Virginia Stock Corporation Act to each of the Corporation’s shareholders of record.

V.

The designation, number of outstanding shares, and number of votes entitled to be cast by each voting group entitled to vote separately on the Name Change Amendment was:

 

Designation

  

Number of

Outstanding Shares

  

Number of Votes

Entitled to be Cast

Common Stock, $0.01 par value per share, Class A and Class B    158,957,361    181,701,947


The total number of votes cast for and against the Name Change Amendment by each voting group entitled to vote separately on such amendment was:

 

Voting Group

  

Votes “FOR”

  

Votes “AGAINST”

Common Stock, $0.01 par value per share, Class A and Class B    142,055,673    24,514,760

The total number of votes cast for the Name Change Amendment by each voting group was sufficient for approval of such amendment by the voting group.

VI.

Pursuant to Section 13.1-606 of the Virginia Stock Corporation Act, the Name Change Amendment shall become effective at 12:01 a.m. (Eastern Time) on June 10, 2009.

 

5


IN WITNESS WHEREOF , the undersigned corporation has caused these Articles of Amendment to be executed by its duly authorized Chairman of the Board and Chief Executive Officers as of this 5 th day of June, 2009.

 

FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.,

a Virginia corporation

By:  

/s/ Eric F. Billings

  Eric F. Billings
 

Chairman of the Board and

Chief Executive Officer


COMMONWEALTH OF VIRGINIA

STATE CORPORATION COMMISSION

AT RICHMOND, JUNE 8, 2009

The State Corporation Commission has found the accompanying articles submitted on behalf of

Arlington Asset Investment Corp. (formerly Friedman, Billings, Ramsey Group, Inc.)

to comply with the requirements of law, and confirms payment of all required