This Year's Christmas Gift: FBR Group | Value Investing News

This Year's Christmas Gift: FBR Group

    
    Friedman, Billings, Ramsey Group (NYSE: FBR) is a Virginia based financial services company structured as a REIT; part investment bank, part asset manager, part principal trader, and part mortgage banker.  They've fallen prey to the credit market upheaval. Sound familiar? 

     FBR is the typical sob story in the recent credit market upheaval; a former highflying financial in the post-crash low interest rate environment falls hard as things go wrong. From 2002-2004 FBR rode high with strong results investing in agency mortgage backed securities (MBS put out by Freddie Mac, Fannie Mae, and Ginnie Mae) as well as its niche investment bank– FBR’s I-bank ranks (then and now) as the #1 IPO underwriter for firms under $1 Billion in market cap. They earned over $2.00 a share in 2004 and the walls came crashing down in 2005. They began struggling with bad results from non-agency MBS investments as the yield curve inverted in 2005, followed by an involvement in originating, underwriting and securitizing sub-prime mortgages right before the party ended in late 2006.   They've lost over $600 million since.  Remember Bud Fox being carried out of the trading room crying at the end of Wall Street?  That's approximately how FBR's management felt following 2006.  Everything had gone wrong.

   All their woes combined to form a "lollapalooza" effect, as Charlie Munger would say; lots of things going bad at the same time. FBR Group's stock, which once hit $30 a share in 2004- a market cap of over $4.5b- is now sitting at a mere $2.75; a reverse 10-bagger in Lynch phrenology.  They have completed 2 offerings of their Capital Markets unit, one a private placement, one a public offering (Nasdaq: FBCM).  FBR Group, the REIT, is left with $33m FBCM shares at today's prices worth about $320 million.  As a 52% owner, they consolidate FBR Capital Markets for accounting purposes, and the 48% minority interest is subtracted from earnings to get to Net Income, likewise with book value.

 

But What's Left?

 

    FBR has been cleaning out the garage all year.  From Q2 to Q3, FBR sold off $5.8 billion in MBS, and paid down the financing that backed it, resulting in a deleveraging from a 13:1 asset to equity ratio, to 7:1 in the 3Q.  They took losses of about $53 million on the sales.  Their exposure to any MBS investments made in the past has been reduced to $470 million from over $6.5 billion. First NLC, their ill-fated sub-prime mortgage banking operation, has been recapitalized, and 80% of it sold off to a private equity interest.  This leaves FBR with a small portion of FNLC's equity (20%) and no remaining downside exposure except $12 million in equity.  They have exited the subprime mortgage origination business.  What's left is $3.2 billion of mostly securitized whole loans, backed by non-recourse financing. Non-recourse financing means that the lenders cannot go after FBR besides the collateral posted (in this case the mortgage loans). As such, they have no real economic exposure left there, although if the loans were to be written down FBR could take a hit, but total the exposure there is under $100 million.  Those loans have already been heavily written down as it stands.

 

Santa, Bring me Something Cheap!

 

   The thesis surrounding FBR Group really could not be simpler.  The value here reminds me of when Warren Buffett made a comment about the judge who said he couldn't "define" obscenity but said: "I know it when I see it." 

     At first glance, FBR is selling for just under book value. However, we need to get around the GAAP accounting.  FBCM is a public company with a current market cap as of 12/11/07 is $640 million, so FBR Group's 33 million shares are worth about $332 million at market.  They could sell this portion off tomorrow and net $332 million in cash. Let’s say they did this and stopped consolidating:

 

FBR Group Market Cap -                                    $470 Million

52% Interest in FBCM -                                      $332 Million

Market Value of Remaining Business-                  $138 Million

 

Tangible Equity at REIT Level -                            $580 million

Equity Attributable to 52% FBCM Interest -          $270 Million

Net Tangible Equity at REIT Level -                      $310 Million

 

Current Market Value as a % of Tangible Equity -      45%

 
    This means we are paying a whopping $138 million for the rest of FBR Group's business!  For $138 million, we get $310 million of tangible common equity net of FBR Cap Markets; thus we are buying FBR at 45% of its book value.  The productive assets are cash ($300m) and long term equity investments ($180m), as well as their residual interests in mortgage loans, and the $470 million of MBS left.  It's hard to lose any money when we effectively buy $310 million of already heavily written down tangible equity, which is mostly cash, for $138 million.  If you want to get really creative, you could short .52 shares of FBCM for every FBR share to create a stub, and basically arbitrage their market values.  However, FBCM is almost as cheap as FBR, and the stub wouldn't let you benefit in the whole upside, which I think is big.

    As for the ongoing business plan, in the most recent conference call, management stated that they are prepared to take $500 million of their cash and liquid securities and invest it in brand new Agency MBS, getting away from the non-Agency stuff that has plagued them in the recent past.  They plan to lever at 8-10x, so they should pick up maybe $4 billion of new MBS.  Hopefully, these new investments will fare better than those of recent memory- one good development regarding the credit market problems is that interest rate spreads have gone up.  Their current net interest spread (the difference between the % at which they borrow and the yield their MBS) is .42%, but they figure to invest their new cash at a 1% spread.  That should an instant $40-$50 million boost to revenues, which in addition to the end of write-downs and possible valuation increases in their existing portfolio creates solid earnings.

    FBR owns some earnings of their former wholly owned, now 52%, subsidiary FBR Capital Markets, a thriving business that includes investment banking, research, and asset management. Capital Markets is the largest underwriter of small company IPO's in the U.S., and manages a well respected family of mutual funds.  Chuck Akre runs the newly renamed FBR Focus Fund, which has returned 20% yearly in the past 5 years, far outpacing the S&P. FBR Capital Markets' revenue was up 70% year over year in the most recent quarter.

    I think they can earn over $100 million in year or 18 months, about $.60/sh.  Placing a modest multiple of 12 on that, the shares are worth $7.20. That’s 2.6x the current share price of $2.75.  This is a company that once earned $350 million in 2004.  With a higher multiple, or modestly higher upside to earnings, we can see that there is big potential in a turnaround.

 

 The Last Words

 

   With all that said, we don't even need to figure out what FBR Group will earn to see the value here.  Subprime is gone, and those losing MBS investments have been cut down by 92%.  FBR’s leverage has decreased from about 13:1 to 7:1, and liquidity runs high.  They’re flush with cash and ready to try for a new future. It might not work out, but we as investors have very little, if any, to lose at this price.  $500 million is being reinvested on our behalf in what is a buyer’s credit market.  Those who are willing to buy in this awful credit market are at an advantage to those who are trying to sell.

    The business takes some figuring out and some digging. In fact, I don’t claim to know exactly what they will earn, or just how well they’ll do in the future.  This is not a wonderful business, this is not Wells Fargo; all I know is that FBR has been beaten down badly and mispriced.  In addition, the dividend has been set to .20/share as of this year, paid quarterly.  Even as they were selling off MBS in hoards, cutting subprime exposure, and generally being decimated, they have paid a dividend; most recently $.05 a share paid in October.  Not much, but at $2.75/share that amounts to an annual yield over 7%.

    One note of comfort- CEO Eric Billings owns about 4.8% of the company, mostly through super-voting class B shares. LIkewise, President, J. Rock Tonkel owns 1.5 million shares.  With these stakes, we see that management isn't just playing with Monopoly money, they are incentivized to act like owners.(note: insider ownership formerly stated much lower, now corrected)  Analysts don’t even cover the REIT any more. They’ve been buying back shares and have 27 million shares left to repurchase under the current plan (note: increased to 100mm recently, so now 77 million left to repurchase). FBR Capital Markets is buying back shares too, which increases FBR Group’s proportional ownership.

    If FBR interests you, go through some annual reports, and, very importantly, their most recent quarterly reports and conference calls.  They’ll provide you with the vital information you need about this year’s developments which have transformed the company.  Do your own homework and decide if you like what you see.  If you are interested, be patient with FBR, it will take time to come back.  Once the write downs are over and the cash invested, we should see some solid positive earnings, and the stock will rise.

 

NOTE: Myself and another investor are looking into forming an investor group to get in contact with the management of FBR and get some more insight into the company.  If you are interested in participating in the group, please contact me via e-mail.  Thank you.

Full Disclosure: Author owns a position in FBR.  He can be contacted at jeff.annello@gmail.com

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Comments

"samuael clemens" over at gurufocus.com had some important things to point out, and some questions, which I responded to.  Just wanted to point those out and my response, in case anyone else had similar thoughts:

Re: FBR Group
Posted by: samuael clemens (IP Logged)
Date: December 14, 2007 12:16PM

Your analysis of FBR makes sense but here are a few things to remember about this opportunity:

1. In Q3, the residual value of the loan portfolio was written down by $90mm, as the commercial paper market collapsed. FBR also took a $57mm write down on their MBS portfolio (these are hard to sell or securitize now). They also took a $27mm write down on FNLC. That's a total of $174mm of writedowns, so the tangible book value is now $136, not $310. Add to that the value of their FBCM stake (33mm shares*$9.3=$307), and you have $443mm, vs. market cap of $405, or less than 10% discount. It is interesting because this is trough earnings cycle and they certainly could go back to making lots more money when the crisis dissipates, but not without risk. Consider:

2. Their MBS portfolio is levered. Those are ARM and Hybrid securities and further write downs are possible.

3. They still have exposure to FNLC loans of $203mm. Although this is fresh production under the new tightened lending guidelines, the markets have dried up and until it can be sold or securitized the company is exposed to them.

4. Loans held for sale are non conforming ARM's secured by single family homes, those are borrowers who could not go to Freddie or Fannie.

My response:

"Re: FBR Group
Posted by: JLAnnello (IP Logged)
Date: December 14, 2007 12:45PM

Samueal- Thanks for the Reply, but you are missing a few things here:

FBR did not take $57m in write downs for the third quarter on their current MBS portfolio- they sold off $5.8b in MBS, and the net loss there was $57m. The value they got for the MBS- the financing they had to pay off = (57M) The losses on their current MBS portfolio only amounted to $4m for the quarter.

From the 10-Q in Q3-

"During the three months ended September 30, 2007, the Company received $5,745,511 from sales of MBS resulting in gross gains and losses of $3,025 and $(60,762), respectively"

The write down of FNLC was previously announced in the 2Q earnings call- the $27m they lost there was due to the planned recap, and the loss on that operation. Their exposure to FNLC is now $12m as an equity investment. This we knew going into Q3

Indeed, they took a writedown of $140m on their mortgage portfolio- that port. has been written down a bunch of times already. Says management: "We eliminated ongoing economic exposure to our on-balance sheet securitized mortgage loan portfolio or our residual interests by writing down that portfolio to zero." This loan portfolio remains the only thing that worries me at all.

You also made mistakes calculating their equity- you took their current tangible equity(Q3) and then wrote down the $57m, $140m, and $27m. Those are already written down into the Q3 equity. You double-counted the write downs.

Management in the 3Q conference call:

"$310 million of tangible common equity, not including $270 million of common tangible equity attributable to our 52% ownership of FBR Capital Markets. Based on yesterday’s closing price, FBR Group’s 33 million shares of FBR Capital Markets are worth approximately $400 million."

Look at the 10-Q for Q3- $698mm in Equity- $252mm due to the minority interest in FBCM-$119mm for goodwill and intangibles= $328mm of tangible equity, not $136 as you state.

Since, as I showed, the market values the core FBR Group business at $130 M, the margin of safety is intact that I proved in my article.

The current MBS are levered, this is correct. However, they went from $6.2b in MBS, down to $470m. The writedowns they took in late 2006 and so far in 2007 were in the sell-off. On a sale of of $5.8b worth of MBS, they only lost $57mm. That's less than 1%. On their current portfolio of MBS, this quarters write downs amounted to $4m on a base of $474mm- again less than 1%. If the writedowns skyrocket to 5% of the current MBS portfolio's total levered value, they'd only lose another $23mm. I'm not worried there.

The point is, there is equity above and beyond the market price. As long as they make it through the storms, their earnings will recover significantly. As I've showed, they have tangible assets to keep them alive, and not much else to write down. Even if current BV halves, its value will still be greater than the current value the market is placing on FBR minus interest in FBCM."

Nice article this really needs to be published on Billytickets new forum where its brillance can be appreciated by a more mature sophisticated group of people who actually invest real money http://www.atfreeforum.com/billyticketswin/viewtopic.php?mforum=billytic...

Billytickets is a very pompous man but I do admit his stock picks are deadly.Wish I listened to him about Delta Financial instead of Mohnish Pabrai

Do you know more about the $400+mm MBS securities they own ? 10-Q says the average coupon was 6+% on this portfolio which means its likely all subprime or Alt-A hybrid ARM's as that would be too high a coupon for Prime mortgages ...............

I also see in the 10-Q ( http://www.sec.gov/Archives/edgar/data/1209028/000119312507242627/d10q.htm ) that the cost basis for the securitized MBS is $475mm and they are carrying them at 'fair value' of $470mm or just a 1% writedown .

I can assure you that even if every single security were AAA rated and from absolute best performing deals in existence that anything that does not say FNMA or FHLMC in front of the deal name is down 5% minimum and probably more like 10% . All one has to do is look at TMA and where their super Prime MBS got repriced down about 10% killing them .

Look at ETFC recently liquidating a portfolio of $3bln in subprime MBS getting paid $800mm and recognizing a $2.2bln loss . There are ALOT of people closing their eyes pretending things are worth ALOT more than they are .

Am i missing something ?

how about that $108mm in goodwill on books at end of Q3 2007 ? shouldn't that reprice to zero ?

also , i see they $492mm in reverse repo borrowing from Wall Street which is probably all these private label MBS bonds ................. if Street gets really desperate , they will make repo rates and haircuts so large that FBR will probably have to bring some back home greatly reducing that cash balance but they DO appear to have cash but as they said in their conference call , they want to start using that cash to buy alot of agency MBS and build up some 'almost riskless' spread income .

The one positive about all their bonds on repo with Street is nobody is mismarking repos .......... thus if they are able to fund this stuff with Street , maybe the prices are close to reality . Its guys like banks funding ABS portfolios with depositor money like ETFC does where you can have 75% losses on portfolios held at PAR since nobody is verfying t heir prices .

lastly , is it corrrect to assume that if they show 3.256bln in loans held for sale vs 3.142bln in securitizations that the difference is 114mm of residuals ......... wonder where they have it marked . it can't be worth anymore than pennies on the dollar on low credit loans ............

what FBR needs to do is get everything not FNMA/FHLMC either sold or written down to zero . all equity investments , all FBCM stock , EVERYTHING off the books . Then whatever cash left over ? use it to buy FNMA and FHLMC bonds on leverage .

ANH got crucified having a huge agency portfolio and just 2-3% in non-agency bonds ........ when they finally wrote off the non-agency bonds to zero and could look at Street and say 'we are 100% agency MBS' , stock ran fom $4 to $8+ quickly ..........................

most equity PM can't delve through non-agency bonds anymore . they have no faith on any prices unless its a US Treasury or a FNMA / FHLMC / GNMA bond .

that $470mm of MBS securities is footnoted as single A or better ................... most single A rated private label are trading well under 50 cents on the dollar ( if you can get a bid )

i'd guess this $470mm is the absolute worst of the $6bln they once owned otherwise why would they keep it ? they gotta know getting all this dog squeeze off books to free up capital to buy agency bonds like they plan to do is the way to go but then again there were bound to be a few hundred million bad bonds out of $6+bln they had not long ago .........

Hey there-

 If you look at their recent developments- the loans they securitized are now gone.  Zero exposure to mortgage loans.

 

As for the MBS portfolio- yes the market is not great right now.  But what you are assuming is that FBR needs to sell them.  Their balance sheet has been so de-levered at this point, that they can afford ( and at this point are) just holding those MBS on their balance sheet, and collected interest spread.  They may or may not mark them down as they try to sell but remember what I said- in Q3 during the toughest times we've seen yet, they were able to sell $5.8 billion of them and only took a loss of $57m.  They could get rid of the last 8% of their MBS at a smaller loss than that.  Lets say even in a bad case they lose $60m trying to sell only $470m worth of MBS- that leaves hundreds of millions in equity.  Otherwise, they can hold them.  They have much more cash on the bal. sheet than MBS.  They are not very highly leveraged, and much less so now that the $3.1b in loans and related financing are gone.   They are not a hedge fund with investors pulling out, or short term paper coming due which would force a fire sale on the small amount of remaining MBS.  They have several hundred million in permanent capital.

As for goodwill- I didn't even add it in to my calculation of value so i could care less what it is worth on the b. sheet.

Sit and wait on this- the story is getting better.

no , FBR in fact DOES need to sell these to make the potential unknown losses go away . you may have faith losses are $60mm worst case but i can assure you single A rated CDO are trading under 50 cents on the dollar and these bonds they kept were probably kept because losses are huge !

on just the $200mm of loans they held from FNLC , they lost $18mm on the first $153mm hey sold and on the remaining $48mm they still have , they estimate they will lose another $20mm ! thats 42% loss on that last $48mm ............. . ....... based on way they sold the loans ( best stuff first , worst stuff retained for later sale ) , i suggest you better ramp up your loss estimate on the MBS from 12% to at least 25% or maybe more .

and that big cash stash they have could drop a bunch as they sell bonds on repo and have to eat the lossses .

worse ? instead of using all that spare cash to buy assets and lever up they instead plan to buy up to 100mm of their shares back ..........while a nice idea , it won't do a thing for earnings ............ they instead need to get all the non-agency stuff off the books ( only way to know what real NAV is at FBR) and then take remaining cash and lever up 13x1 with FNMA and FHLMC MBS and wait fo more rate cuts .

by going 100% agency , their book value will seen as 'real' and price appreciation can take place as earnings ramp up from a levered portfolio in arate cutting environ .

Couple notes:

"but i can assure you single A rated CDO are trading under 50 cents on the dollar and these bonds they kept were probably kept because losses are huge !"

FBR doesn't own any interest in CDO's- so any comments pertaining to them are irrelevant.  We have no idea why these bonds have yet to be sold- therefore we're speculating by saying "losses are huge."  Bottom line is, they do have value, and up until this point, FBR has survived by selling off mass quantities of the stuff on their books.  Their recent announcements show that they got rid of one MAJOR liability:

"As a result of the sale, $3.1 billion of securitized loans held for sale and $3.1 billion of related securitization financing have been eliminated from the Company’s balance sheet."

They also sold 3/4 of the non-securitized portion at a loss of $18mm and the rest will be sold at a loss of $20mm.  Obviously they were terrible loans, and I'm not really surprised there at the losses.  Thus, no more sub prime mortgages left. One half of the liability equation is solved, at a loss of $38mm.  Goodwill will be written down in a related matter, but that doesnt mean much to me, because I never included it in the value calculation.

The share repurchase looks great to me- they cut the dividend to conserve cash and have decided the ridiculously low stock price is ripe for repurchase- I agree.  You say that it won't improve earnings- but why should it?  A good capital allocator will repurchase shares when they are an undervalued asset- which they are right now- not to merely improve EPS.  This doesn't sound like a company going down the tubes to me- it sounds like a company trying to turn around and doing a good job of getting rid of bad assets and buying new ones.

Once again, you've also assumed that FBR HAS to get rid of those remaining MBS immediately.  That's not true.  Eventually, yeah, they'd like to sell them off I'm sure.  At this point, they can take their time.  Over the past year, as they went bad, there was no indication that the repo financing was being pulled, or that FBR was under pressure to meet demands from their repo lenders.  They might take losses on them eventually- but not yet and not in unmanageable amounts.  They can afford to wait.

Lastly, don't ignore their statements regarding strategic alternatives for the future- I see either a complete spinoff of FBR Capital Markets, some privitization actions, or something else shareholder enhancing.

Don't suffer from short term-ism- the company is OK and we need to wait this out.  They know of their troubles, and have been forthcoming with losses.  The beginning of 08 will probably yield some important events.

One note: I made a mistake on the management ownership.  The CEO actually owns almost 5% of the company through supervoting Class B stock- something I overlooked in the proxy.  Even better for us- more alignment of interests.

 

 

<< FBR doesn't own any interest in CDO's- so any comments pertaining to them are irrelevant. >>

nonsense . CDO or CMO , its all the same garbage . if it doesn't say FNMA or Freddie in front of the bond name , its trash in today's world of spiraling delinquincies/foreclosures and illiquidity of anything that has a private label . Many of these private label CMO/CDO are reliant on guarantees from MBI/ABK/ACA/etc and i assume i don't have to tell you where they are going .......................

<< Bottom line is, they do have value >>

the bottom line is you have no clue what the value is and the fact you can't prove their value is PRECISELY why it has to be sold as the book value of FBR is a complete guess . The fact they will take a 40+% loss on the small portion of loans not sold initially shows FBR has a tendency to hold on to the worst stuff and sell the portion that gets the best bids . All they will tell you on that $400+mm of MBS bonds they own is they are single A rated or better . My guess is the losses could easily be $200mm if the majority of that stuff is below AAA rating .

lets assume they lose more like $150mm if they liquidate these bonds .......... i'd actually find FBR appealing at that juncture if they completely removed the unknown factor and company was almost trading at a cash per share value .

look at CMO and NLY .....both own nothing but agency MBS bonds and both trading at like 50-60% premiums to book value .............. thats what happens when you clear out all the dog squeeze on your balance sheets and only own stuff whose value is known precisely .

anything worth over a penny technically has 'value' but right now , that 400+mm of MBS bonds ( whether theeeeey are CDO or CMO meaningless ) is a wild assed guess as to precisely what the REAL value is .

<< You say that it won't improve earnings- but why should it? A good capital allocator will repurchase shares when they are an undervalued asset- which they are right now- not to merely improve EPS. >>

nonsense . how will FBR ever show improved earnings if it doesn't have the capital to invest in agency only MBS and leverage up . its stock is NOT cheap until it starts showing positive earnings and that won't happen til it gets the crap off the books and is able to use its true cash position to buy safe agency bonds and really leverage up . Using its prescious cash to buy back the stock in a company that has lost money in 5 of last 6 quarters is pathetic . It should be used to buy risk free assets ( as well as FBR needs to fire a ton of folks as its bigger brothers on Wall Street are doing )

this is precisely what the old FB did when it existed as a seperate REIT . buy risk free FNM/FRE bonds and lever it up ......then they destroyed FB combining it with broker dealer and now it has a poison of unknown potency in its system and until they get rid of it , its diseased .

<< Once again, you've also assumed that FBR HAS to get rid of those remaining MBS immediately. >>

only works if they write these bonds down to zero and market can look at them as having nothing but upside . sure , they can sit on them and use their cash to prop up the stock with a buyback but if they lose money the next quarter , stock will be back under $3 in a flash .

<< Lastly, don't ignore their statements regarding strategic alternatives for the future- I see either a complete spinoff of FBR Capital Markets, some privitization actions, or something else shareholder enhancing. >>

if they wrote off the MBS portfolio to zero and sold all their FBCM ( would raise another $325mm ) and used that cash horde to buy agency bonds , i'd buy 100,000 shares of FBR immediately . the problem is management at both FBR and FBCM is one and the same and thus they won't do something for FBR that would be great because it would hurt their FBCM holdings they all own as well . classic conflict of interest you can't ignore .

You make a few valid points about their current status that I can address, but my last point will be my last on this issue.

First here, you say:

"nonsense . CDO or CMO , its all the same garbage . if it doesn't say FNMA or Freddie in front of the bond name , its trash in today's world of spiraling delinquincies/foreclosures and illiquidity of anything that has a private label . Many of these private label CMO/CDO are reliant on guarantees from MBI/ABK/ACA/etc and i assume i don't have to tell you where they are going"

FBR doesn't own C anything. CDO, CLO, CMO, they don't own any complex derivatives, I'm not sure why you think they do.  Please find them on the balance sheet for me or in the 10-Q.

First things first, the last conference call management said, very bluntly:

"With the measures taken during the third quarter to significantly reduce our risk profile, we are now ready to begin deploying our capital in an appropriately hedged agency mortgage-backed securities strategy. Based on the current yield curve, the spread on capital invested in this agency MBS strategy is approximately 100 basis points. On a hedged basis with our anticipated leverage of eight to ten times, we believe the return on invested capital from this strategy should approximate 15%."

I'm not sure why you assume that they don't plan to begin investing in Agency MBS.  They won't use every available penny to buy back stock- just the excess.  You speak as if FBR has said that they will use every dollar in the bank to buy stock merely because they increased the shares available under the repurchase plan. 

They may not have positive earnings- but there is cash coming in the door.  The writedowns will eventually end, and the revenue will turn into earnings if they do as stated above.  You have to give them time.  Look at what has been done so far this year- they have cleared 92% of their MBS portfolio off the books, as well as every tie to sub prime mortgages.  Management has not been sitting on the couch eating potato chips. 

Like I said above, you have to be wary of short term ism.  Just because they haven't written down to zero doesnt mean they won't.  Just because they haven't figured out all their problems yet doesn't mean they won't.  The real questions are:

Will they get rid of all the toxic stuff? (Answer is yes, they have done much of it already)

-if true-

Will they be around once its all gone?  My proposition is that there is enough value there that the answer is yes.

The MBS may be worth less by the time they sell em- yeah- that's why we buy at 45% of the current BV.   Say the do lose another $150mm or so, it'll be terrible but BV left will still be right about where we bought (320-150=170mm). That's how margin of safety works.

If you agree that the company won't go bankrupt, then eventually earnings must turn around when they buy what you call "risk free" (which they certainly are not) assets such as bonds issued by the agencies.  There is no question that, barring a privitization or other major corporate action, they will go back to investing in AMBS.

As for a conflict of interest- not sure how that is possible.  FBR owns 52% of FBCM so anything good for FBCM is good for FBR.  It's that simple.  If FBCM's earnings go up, so do FBR's.

Last thing: You say:

"only works if they write these bonds down to zero and market can look at them as having nothing but upside . sure , they can sit on them and use their cash to prop up the stock with a buyback but if they lose money the next quarter , stock will be back under $3 in a flash ."

Who cares?  Sure, they might lose money next quarter, heck they probably will because of already announced write downs getting rid of all their mortgage loans.  The market will see what it does.  If my 2 questions above are both yes, earnings will be back sometime in the next 2 years.  I'm willing to wait.

My final point on the matter is thus; if you just look at this situation for what it is, yeah, the consensus is that FBR sucks right now, they keep losing money, and they screwed up.  All true.  Management did a poor job.  But, as Buffett says, "You pay a high price for a cheery consensus." 

Once the market sees "nothing but upside" the stock will have already risen. If you can get in for about $100mm in market value, then when the upside comes, you'll own it when it rises.  There's enough bare bones value there to let them survive.  The bad credit market wont last forever.

 

<< FBR doesn't own C anything. >>

what do you think the $471mm in private MBS label securities they own are ? please be specific . this is not a trick question . what structure do these securities exist in ?

here is the last 10-Q : http://www.sec.gov/Archives/edgar/data/1209028/000119312507242627/d10q.htm

do you notice they have this $471mm in private label securities footnoted ? what does footnote say ?

why doesn't FBR give us a more detailed breakout of these securities ? like give us the names or the exact break out of whats AAA vs AA vs A rated ?

<< The MBS may be worth less by the time they sell em- yeah- that's why we buy at 45% of the current BV. >>

see , thats your problem . you keep believing that BV they give you but you don't look at that $471mm in single A or higher rated private label securities and question anything .

by the way , do you see on page 10 where FBR owned $5.9bln in GNM , FNMA <,and FHLMC bonds at year end 2006 but all those bonds are now gone ? thats because the market for them has remained strong and liquid ....... conversely , they had $945mm of private label securities ( betcha $100 they are either CMO or CDO ..... we can call company together to get confirmation ) at year end 2006 and now still have $471mm of that dog doo .

so riddle me this : they plan to start buying lots of agency MBS bonds with that cash horde they own which simply replaces what they had on the books at year end 2006 ......right ? isn't this a 'back to the future' strategy at FBR ?

be rest assured , FBR sold $400+mm of the private label MBS and kept the balance because the bids were too rotten to contemplate and they still have $471mm of the worst still on books ........ and that will sit around their necks like an albatross bleeding them via margin calls and keeping market wondering whats in that ........... and how much lower it would be if it was sold to 'best bid' ...............

so they need to keep some cash aside to meet further margin calls on this $471mm in private label on repo .

then they want to spend a few hundred million buying back their stock ......

that leaves how much to buy agency MBS and start generating real earnings again ?

its a strategy that will fail unless private label MBS bonds stage an impressive comeback ........... oh , and did you see news on Bloomberg today that defaults on private MBS securities secured by bond insurer's hit an alltime record high today ?

i understand why FBR still probably owns this $471mm in private label MBS bonds ....the bids are probably so horrible that they think it foolish to sell into a black hole . the problem is they are taking up a good part of the BV at FBR and the information being provided by FBR on these bonds is absolutely bare bones minimum at a time they should be drowning us with info on these bonds as they make up the bulk of the balance sheet now .......as an aside , the $118mm in trust pfds and other equity investments they hold are all down lower in value on the publicly traded ones and the same or worse on private ones .

at end of day , you are simply guessing on what FBR is worth in that you can't place anything beyond a guess on what that $471mm of bonds are worth based on what FBR gives you .

when they liquidate their equity investments and their private label bonds , then we will know for sure what real BV is .

I'm glad we can agree on everything else besides the MBS stuff- that's good, and believe I appreciate the discussion; many good points.

I've said before and I'll say it again, the calculation of BV is not a precise one- and in reality is probably lower than it was stated in the Q3 report.  I bet its less than what I put out there for sure.  So I will absolutely concede that I don't know what they BV is.  What I will say is that the price we bought at is near what I think is a reasonable minimum for their BV.  The minimum value of FBR's stock market value is the 52% interest in FBCM which is at this point about $328mm.  FBR's value, including its FBCM stake, is 476mm, which gives us a bottom value realistically.  FBCM is already under 10x earnings.  If FBCM goes up, FBR will too.  Just some stuff to point out there, none terribly relevant.

Second, if they owned interest in a CDO or CMO, they would have pointed that out.  They own asset backed securities, not collateralized debt obligations.  Those are different classes of security, and that would be indicated in their documents.

The remaining MBS are not great, that's for sure.  However, FBR has not run into problems up until now by owning them.  It's hard to imagine their value getting any lower.  If we can agree on that point, that the private label MBS are probably near their bottom value, then they have nowhere to go but up.  Even if they don't go up, but merely hold their very beaten down value, it seems that FBR is not facing margin calls from the repo lenders.  They haven't until this point, and I see no logical reason they should in the coming future.  They haven't been "bleeding FBR like an albatross."   FBR has other sources of permanent capital, as you mentioned. 

In fact, FBR management has done a great job de-leveraging the hell out of their balance sheet over the past year.  They have indicated they think the stock is way undervalued- they'd like to purchase the shares back at this price. The CEO and CFO own about 6-7% of the company; as I indicated something I originally missed.  It is in their interest to see FBR survive and thrive.  If I have learned anything, its that incentivized management works wonders. 

Who knows what the exact value of FBR is?  Trying to pinpoint it is missing the forest for the trees- as long as FBR makes in through this, then eventually either earnings recover or some corporate action creates value.  I am leaning towards the latter.  Maybe not next quarter.  Maybe not in 9 months.  Eventually, though, I think the bet is in the stockholders favor.  I concede that I don't know what the exact BV or value is- I do know the stock is very very cheap and has a ton of upside and not as much downside.  Give them some time to work with this tough market.

 

<< Who knows what the exact value of FBR is? >>

precisely . thus until they get the private label MBS off their books , its all a guess and nobody should invest in anything that is a 'guess' ........

looking at how hard FBR getting smacked today ( down 8% ) simply on First NLC filing for bankruptcy , it tells me tht if they sold the private label bonds and took a hit FAR larger than the $12mm they will not recover from First NLC investment that FBR could go wayyyy lower .

and that 52% stake in FBCM is now down another 13% since you first used its valuation in why one should buy FBR too ..........

FBR needs to sell its private label MBS as well as sell its FBCM and only then will we know what cash they have left to lever up in agency MBS bonds and actually move forward .

I disagree that you cannot invest in an uncertain business.  My point in the business is that regardless of how big the writedown is on the MBS, they'll be fine and keep moving/ eventually recover.  It also does not "need" to sell FBCM, that is an important stake to them, they manage that company.

Good luck. 

rather than talk about all the unknowns at FBR , allow me to show you a stock i bought today and been watching for months . Company is Linn Energy ( symbol is LINE ) . Its a very simple company in that its an energy MLP . They buy long reserve life high quality oil and gas assets and then sell the production forward 4-5-6 years to lock in cashflow and then expand the dividend by the accretiveness of the acquisition .

LINE did it right in beginning by making acquisitions paid for via credit facility borrowings and then additional shares sold opportunistically to replace the debt . In 2007 as prices for energy soared , LINE felt the need to make a rash of acquisitions before prices for good energy properties exploded . To do this , they issued tens of millions of PIPE deals to allow them to rapidly raise cash and pay for the acquisitions . LINE manageent assumed the accretiveness of these deals would allow dividend growth and allow them to register the shares later in 2007 / early 2008 without negative effects .

As we know , markets started dropping in 2nd half of 2007 and investors in LINE figured as they watched LINE drop like all MLP were doing that the PIPE investors were in deep pain and likely to dump their shares once they became public . So LINE dropped from almost $40 to $20 in last 6-7-8 months despite energy prices rising and LINE raising its dividend over 10% recently .

In short , everything that can go right for LINE fundamentally is doing so . It bought alot of oil/gas assets at decent prices , the production sold forward locking in huge cashflow for next 4-5-6yrs and its grown its dividend . Whats not gone right is the stock markets in general and the assumption that the buyers of 50-60mm PIPEs in LINE would sit tight as their shares became public . Instead , PIPE holders have dumped as fast as they can when their shares were finally in their accounts to point LINE is now trading at $19.75 today ( where i bought a 1+% position finally ) and is paying a dividend yield of 12.75% ( with tax benefits too because its an MLP ) .

LINE management has told us all the remaining PIPE shares will be registered and publicly tradeable by end of Q1 2008 ( with bulk done by end of Feb ) . I suspect the selling pressure of late is folks looking to sell assuming the PIPE holders will drive things even lower . The problem is that its now so low and so cheap that it could draw the attention of somebody big .

Typically , a fully hedged MLP should trade to a yield of 50-75% of unhedged energy plays ( like SJT ) but currently because of LINE selling pressure , its trading to same yield as unhedged Royalty Trusts . I believe LINE comparables trade at 8% max currently which LINE would have to rise to $31 to be equivalent ( where LINE was in late October ) .

Balance sheet is clean . Cashflows are great . Their hedges are all there in black and white . As Fed cuts rates , people are out searching for non-financial high yield and LINE is now among the highest publicly traded in USA . Its selling is unrelated to fundamentals and simply the end result of a huge error by LINE management as to how much PIPE equity they could really isssue and their haste to buy really good oil and gas assets before somebody else got them .

I see LINE as far more transparent than FBR , substantial cashflow / yield , and its low price driven by market technicals and disconnected from fear of all companies that hold questionable financial assets .

Consider it my late Xmas gift back to you :)

Sounds like a good possible investment.  Good luck to you!

In case any one comes across this article, I want you to know that I was in no way correct about this investment.  bond_daddy and the other detractors ended up being pretty spot on here, and my analysis was simply off.  I sold my shares at about $2.00 today and it's probably for the best.

 

Management has been saying, q after q, that things will improve, here's our plan, etc etc.  None of it is being implemented correctly and they seem to have a consistent rosy outlook that is inconsistent with reality.

 

My assessment of the stability of their assets was also incorrect.  The write downs continued after my purchases and it seems earnings power is very much impaired.  With the shares at 1.90, and 2.20 in tangible book value, the invesment is no longer very compelling.  It's not incredibly cheap nor is it well run.  My estimate of value eroded and my margin of safety crumbled.

 

So, to those that brought up many points that subsequently became true, the credit goes to you.  This was a dud of a Christmas present.