FBR Agrees to Buy Lender for $88 Million

First NLC Focuses on Originating Sub-Prime Mortgages

Friedman, Billings, Ramsey Group Inc. of Arlington agreed yesterday to buy a Florida mortgage lender in an effort to improve the profit on its large portfolio of mortgage assets.

FBR agreed to pay $88 million in stock and cash to acquire First NLC Financial Services LLC, which makes mortgage loans in 38 states and sells the loans to investors. Most of the loans are first mortgages to "sub-prime" borrowers -- that is, borrowers with problem credit histories or other higher-risk factors that require underwriting criteria different from a traditional single-family mortgage. First NLC originated $3.8 billion of such loans in 2004, said Eric F. Billings, co-chief executive of FBR.

FBR already owns and manages a $10 billion-plus portfolio of mortgage-backed securities, in addition to operating an investment bank that raises money for companies and manages money and securities brokerage for institutional clients.

The purchase of First NLC is intended to diversify and boost the profit of FBR's mortgage investment operation, company officials said yesterday. It also, for the first time, would put the company in the business of directly making loans.

Yesterday's announcement follows FBR's hiring last week of several top traders of mortgage-backed securities from Freddie Mac. Both moves are part of FBR's strategy of creating a fully integrated mortgage operation.

The risk of loss on sub-prime loans is higher than on traditional mortgages, but they can be vastly more profitable because of the higher interest rate charged. Sub-prime lending has grown substantially in recent years for several reasons, but primarily because improved credit-scoring technology allows the underlying risks in large portfolios of sub-prime mortgage loans to be accurately priced, which allows Wall Street to sell them to investors. This has created the kind of ready source of cash for sub-prime loans that the traditional mortgage market, through Fannie Mae and Freddie Mac, has benefited from for more than a generation. The sub-prime market is expected to grow more quickly than the traditional mortgage market over the next 10 years.

The growth of the sub-prime market, however, has included instances of abuse by some lenders, several of which have been the targets of civil or criminal action for charging poor borrowers exorbitant fees, interest rates or both.

Billings of FBR said First NLC has not been a target of these "predatory lending" allegations. "We did great due diligence on that matter and are very mindful of it," he said.

FBR plans to take the loans originated by First NLC, pool them and turn them into asset-backed securities. FBR would retain ownership of part of these loan pools. Assuming FBR can manage the risks associated with owning and managing sub-prime loans, the profit on the business will be significantly higher than FBR's existing mortgage investment activities, said Richard J. Hendrix, chief operating officer. To help manage the risk, FBR plans to purchase private mortgage insurance on a large portion of the portfolio.

FBR is the country's leading stock underwriter of companies in the field of sub-prime or nonconforming lending.

"They are as, if not more, knowledgeable than anyone in the industry in the nonconforming business, so you have to give them the benefit of the doubt," said Todd Halky, who follows FBR for Sandler O'Neill & Partners LP. "The success will all depend on how prudently they manage the portfolio."

Halky said the move was "forward thinking" because the profitability growth of FBR's existing portfolio of mortgage assets will probably slow in the coming years as interest rates stabilize.

First NLC is owned by Sun Capital Partners Inc., a private-equity investment firm, also based in Florida. The deal is expected to close in the first quarter.