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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
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 001-08007
FREMONT GENERAL CORPORATION
(Exact name of Registrant as specified in its charter)
NEVADA 95-2815260
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2425 OLYMPIC BOULEVARD
SANTA MONICA, CALIFORNIA 90404
(Address of principal executive offices)
(Zip Code)
(310) 315-5500
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former Name or Former Address, if Changed Since Last Report)
Indicate by check mark whether the Registrant: (1) has filed all reports
required 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 is a large accelerated filer,
an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of
the Exchange Act.):
Large Accelerated Filer [X] Accelerated Filer [ ] Non-Accelerated Filer [ ]
Indicate by check mark whether the Registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock:
SHARES OUTSTANDING
CLASS APRIL 28, 2006
Common Stock, $1.00 par value 77,885,542
--------------------------------------------------------------------------------
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
INDEX
PART I - FINANCIAL INFORMATION
PAGE NO.
ITEM 1. Financial Statements
Consolidated Balance Sheets
March 31, 2006 (Unaudited) and December 31, 2005......... 3
Consolidated Statements of Income
Three Months Ended March 31, 2006 and 2005 (Unaudited)... 4
Consolidated Statements of Changes in Stockholders' Equity
March 31, 2006 and 2005 (Unaudited) ..................... 5
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2006 and 2005 (Unaudited) .. 6
Consolidated Statements of Comprehensive Income
Three Months Ended March 31, 2006 and 2005 (Unaudited) .. 7
Notes to Consolidated Financial Statements (Unaudited).... 8
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 44
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk. 68
ITEM 4. Controls and Procedures.................................... 69
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings.......................................... 70
ITEM 1A. Risk Factors............................................... 72
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds. 72
ITEM 3-5. Not applicable
ITEM 6. Exhibits................................................... 73
Signatures ........................................................... 74
2
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2006 2005
------------ ------------
(UNAUDITED)
(THOUSANDS OF DOLLARS)
ASSETS
Cash and cash equivalents ................................................... $ 590,553 $ 768,643
Investment securities classified as available-for-sale at fair value ........ 19,672 17,527
Federal Home Loan Bank ("FHLB") stock at cost ............................... 174,511 136,018
Loans held for sale - net ................................................... 6,612,783 5,423,109
Loans held for investment - net ............................................. 5,202,026 4,603,063
Mortgage servicing rights - net ............................................. 45,337 46,022
Residual interests in securitized loans at fair value ....................... 90,236 170,723
Accrued interest receivable ................................................. 54,179 42,123
Real estate owned ........................................................... 31,983 33,872
Premises and equipment - net ................................................ 66,919 65,203
Deferred income taxes ....................................................... 103,099 83,235
Other assets ................................................................ 94,154 94,575
------------ ------------
TOTAL ASSETS .............................................................. $ 13,085,452 $ 11,484,113
============ ============
LIABILITIES
Deposits:
Savings accounts .......................................................... $ 933,604 $ 1,103,993
Money market deposit accounts ............................................. 639,413 446,274
Certificates of deposit ................................................... 7,683,963 7,051,726
------------ ------------
9,256,980 8,601,993
Warehouse lines of credit ................................................... 713,521 -
Federal Home Loan Bank advances ............................................. 1,198,000 949,000
Senior Notes due 2009 ....................................................... 172,396 175,305
Junior Subordinated Debentures .............................................. 103,093 103,093
Other liabilities ........................................................... 263,477 297,916
------------ ------------
TOTAL LIABILITIES ......................................................... 11,707,467 10,127,307
Commitments and contingencies ............................................... - -
STOCKHOLDERS' EQUITY
Preferred stock, par value $ .01 per share - Authorized: 2,000,000
shares; none issued ....................................................... - -
Common stock, par value $1 per share - Authorized: 150,000,000 shares;
Issued and outstanding: (2006 - 77,886,000 and 2005 - 77,497,000) ......... 77,497 77,497
Additional paid-in capital .................................................. 324,638 341,800
Retained earnings ........................................................... 989,265 966,112
Deferred compensation ....................................................... (26,141) (43,357)
Accumulated other comprehensive income ...................................... 12,726 14,754
------------ ------------
TOTAL STOCKHOLDERS' EQUITY ................................................ 1,377,985 1,356,806
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................................ $ 13,085,452 $ 11,484,113
============ ============
The accompanying notes are an integral part of these statements.
3
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
------------------------
2006 2005
--------- ---------
(THOUSANDS OF DOLLARS,
EXCEPT PER SHARE DATA)
INTEREST INCOME:
Interest and fee income on loans:
Residential ............................................................. $ 139,670 $ 111,011
Commercial .............................................................. 109,534 66,392
Other ................................................................... 87 99
--------- ---------
249,291 177,502
Interest income - other ................................................... 23,579 4,422
--------- ---------
272,870 181,924
INTEREST EXPENSE:
Deposits .................................................................. 90,685 49,356
FHLB advances ............................................................. 20,656 7,506
Warehouse lines of credit ................................................. 1,637 219
Senior Notes .............................................................. 3,546 3,650
Junior Subordinated Debentures ............................................ 2,320 2,320
Other ..................................................................... 36 121
--------- ---------
118,880 63,172
Net interest income ......................................................... 153,990 118,752
Provision for loan losses ................................................... 3,881 1,036
--------- ---------
Net interest income after provision for loan losses ......................... 150,109 117,716
NON-INTEREST INCOME:
Net gain (loss) on whole loan sales and securitizations
of residential real estate loans ........................................ (15,176) 108,360
Loan servicing income ..................................................... 21,349 13,741
Mortgage servicing rights amortization and impairment provision ........... (8,044) (4,904)
Impairment on residual assets ............................................. - (1,218)
Other ..................................................................... 3,206 3,927
--------- --------
1,335 119,906
NON-INTEREST EXPENSE:
Compensation and related .................................................. 59,410 59,280
Occupancy ................................................................. 7,630 6,935
Other ..................................................................... 31,256 20,229
--------- --------
98,296 86,444
INCOME BEFORE INCOME TAXES .................................................. 53,148 151,178
Income tax expense .......................................................... 21,461 61,076
--------- --------
NET INCOME .................................................................. $ 31,687 $ 90,102
========= ========
PER SHARE DATA:
Basic ..................................................................... $ 0.43 $ 1.26
Diluted ................................................................... 0.42 1.22
CASH DIVIDENDS DECLARED PER COMMON SHARE .................................... $ 0.11 $ 0.07
The accompanying notes are an integral part of these statements.
4
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN RETAINED DEFERRED COMPREHENSIVE
STOCK CAPITAL EARNINGS COMPENSATION INCOME TOTAL
-------- ---------- --------- ------------ ------------- -----------
(THOUSANDS OF DOLLARS)
BALANCE AT DECEMBER 31, 2004 .................. $ 77,241 $ 330,328 $ 663,580 $ (58,916) $ 1,415 $ 1,013,648
Net income .................................. - - 90,102 - - 90,102
Cash dividends declared - $0.07 per share ... - - (5,352) - - (5,352)
Conversion of LYONs ......................... 2 40 - - - 42
Retirement of common stock .................. (13) (47) - 60 - -
Shares issued, acquired or allocated
for employee benefit plans ................ 625 13,984 - (37,603) - (22,994)
Amortization of restricted stock ............ - - - 4,797 - 4,797
Shares allocated to ESOP .................... - (1,368) - 25,869 - 24,501
Change in cost of common stock held in trust. - - - (6,067) - (6,067)
Net change in unrealized gain on
investments and residual interests,
net of deferred taxes ..................... - - - - (891) (891)
Excess tax benefits relating to share-
based payments ............................ - 2,382 - - - 2,382
Other adjustments ........................... - (4,151) - 4,151 - -
-------- ----------- --------- ------------ ------------- -----------
BALANCE AT MARCH 31, 2005 $ 77,855 $ 341,168 $ 748,330 $ (67,709) $ 524 $ 1,100,168
======== =========== ========= ============ ============= ===========
BALANCE AT DECEMBER 31, 2005 .................. $ 77,497 $ 341,800 $ 966,112 $ (43,357) $ 14,754 $ 1,356,806
Net income .................................. - - 31,687 - - 31,687
Cash dividends declared - $0.11 per share ... - - (8,534) - - (8,534)
Reclassification of deferred compensation
for restricted stock ...................... - (20,902) - 20,902 - -
Shares issued, acquired or allocated
for employee benefit plans ................ - (250) - (25,679) - (25,929)
Amortization of restricted stock ............ - 3,747 - - - 3,747
Shares allocated to ESOP .................... - (1,370) - 24,315 - 22,945
Change in cost of common stock held in trust. - - - (2,759) - (2,759)
Net change in unrealized gain on
investments and residual interests,
net of deferred taxes ..................... - - - - (2,028) (2,028)
Excess tax benefits relating to share-
based payments ............................ - 2,050 - - - 2,050
Other adjustments ........................... - (437) - 437 - -
-------- ----------- --------- ------------ ------------- -----------
BALANCE AT MARCH 31, 2006 ..................... $ 77,497 $ 324,638 $ 989,265 $ (26,141) $ 12,726 $ 1,377,985
======== =========== ========= ============ ============= ===========
The accompanying notes are an integral part of these statements.
5
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-------------------------------
2006 2005
------------ ------------
(THOUSANDS OF DOLLARS)
OPERATING ACTIVITIES
Net income ................................................................. $ 31,687 $ 90,102
Adjustments to reconcile net income to net cash used in operating
activities:
Provision for loan losses ................................................ 3,881 1,036
Provision for premium recapture, repurchase and valuation reserves
of residential real estate loans held for sale ......................... 33,232 14,277
Premium refunds .......................................................... (4,053) (5,081)
Change in mortgage servicing rights ...................................... (7,359) (7,637)
Change in residual interests in securitized loans ........................ 77,220 (2,285)
Cash from residual interests in securitized loans ........................ 14,711 4,253
Provision for deferred income taxes ...................................... (18,492) 8,710
Depreciation, amortization, accretion and impairment of retained
interests ............................................................... (997) 12,703
Compensation expense related to deferred compensation plans .............. 5,419 4,127
Change in accrued interest ............................................... (12,056) (1,049)
Change in other assets ................................................... 7,531 (20,023)
Change in accounts payable and other liabilities ......................... (30,282) 8,689
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES BEFORE LOANS HELD FOR
SALE ACTIVITY ........................................................ 100,442 107,822
Originations of residential loans held for sale .......................... (8,539,144) (7,761,672)
Sale of and payments received from loans held for sale ................... 7,257,655 7,059,158
Loan payments received for residential real estate loans held for sale ... 72,271 57,346
------------ -------------
NET CASH USED IN OPERATING ACTIVITIES ................................. (1,108,776) (537,346)
INVESTING ACTIVITIES
Originations and advances funded for loans held for investment ............. (1,025,339) (825,099)
Payments received from and sales of loans held for investment .............. 425,438 493,032
Maturities or repayments of investment securities available-for-sale ....... 68 98
Net purchases of FHLB stock ................................................ (38,493) (49,964)
Purchases of premises and equipment ........................................ (6,595) (6,482)
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES ................................. (644,921) (388,415)
FINANCING ACTIVITIES
Deposits accepted, net of repayments ....................................... 654,987 214,168
Warehouse lines borrowings, net of repayments .............................. 713,521 -
FHLB repayments, net of advances ........................................... 249,000 552,000
Extinguishment of Senior Notes ............................................. (2,963) -
Dividends paid ............................................................. (7,717) (5,309)
Excess tax benefits related to share-based payments ........................ 2,050 2,382
Purchase of company common stock for deferred compensation plans ........... (33,271) (30,286)
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES ............................. 1,575,607 732,955
Decrease in cash and cash equivalents ........................................ (178,090) (192,806)
Cash and cash equivalents at beginning of period ........................ 768,643 904,975
------------ ------------
Cash and cash equivalents at end of period ................................... $ 590,553 $ 712,169
============ ============
The accompanying notes are an integral part of these statements.
6
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------
2006 2005
-------- --------
(THOUSANDS OF DOLLARS)
Net income .................................................................. $ 31,687 $ 90,102
Other comprehensive income (loss):
Net change in unrealized gains (losses) during the period:
Residual interests in securitized loans ................................. (5,366) (1,478)
Investment securities ................................................... 1,966 (8)
-------- --------
(3,400) (1,486)
Less income tax (benefit) ................................................. (1,372) (595)
-------- ---------
Other comprehensive net income ........................................ (2,028) (891)
-------- ---------
Total comprehensive net income .............................................. $ 29,659 $ 89,211
======== =========
The accompanying notes are an integral part of these statements.
7
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1: BASIS OF PRESENTATION
Fremont General Corporation ("Fremont General" or when combined with its
subsidiaries "the Company" or "we") is a financial services holding company.
Fremont General's financial services operations are consolidated within Fremont
General Credit Corporation ("FGCC"), which is engaged in commercial and
residential (consumer) real estate lending nationwide through its California
industrial bank subsidiary, Fremont Investment & Loan ("FIL"). FIL's deposits
are insured by the Federal Deposit Insurance Corporation ("FDIC") up to the
maximum legal limits.
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP"). The consolidated financial statements include the accounts and
operations of Fremont General and its subsidiaries including those variable
interest entities where the Company is the primary beneficiary. All intercompany
balances and transactions have been eliminated in consolidation.
The preparation of the consolidated financial statements in conformity with
GAAP requires management to make estimates and assumptions that materially
affect the reported amounts of assets and liabilities and the disclosure of
contingent liabilities at the date of the financial statements and revenues and
expenses during the reporting period. Actual results could differ from those
estimates. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for the fair presentation of the
interim financial statements have been included. The operating results for the
three month period ended March 31, 2006 are not necessarily indicative of the
results that may be expected for the year ended December 31, 2006.
The unaudited interim consolidated financial statements should be read in
conjunction with the consolidated financial statements and related notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2005. Certain prior period amounts have been reclassified to conform to the
current period presentation.
NOTE 2: RECENT ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004),
"Share-Based Payment" ("SFAS No. 123(R)"). This amended standard requires all
entities to recognize compensation expense over the related vesting period in an
amount equal to the fair value of share-based payments granted to employees. The
Company adopted SFAS No. 123(R) as of January 1, 2006 on the modified
prospective basis without any
8
significant impact on the Company's financial position or results of operations.
The primary impact of adopting SFAS No. 123(R) on the Company's financial
statements was the reclassification of the deferred compensation balance as of
December 31, 2005 ($20.9 million) related to its nonvested restricted shares to
additional paid-in capital. (See Note 17)
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3"
("SFAS No. 154"). SFAS No. 154 changes the requirements for the accounting and
reporting of a change in accounting principle. SFAS No. 154 requires a change in
accounting principle to be retrospectively applied as of the beginning of the
first period presented in the financial statements as if that principle had
always been used, unless it is impracticable to do so. SFAS No. 154 applies to
all voluntary changes in accounting principles as well as to changes required by
accounting pronouncements that do not include specific transaction provisions.
The Company adopted SFAS No. 154 as of January 1, 2006 without any significant
impact on the Company's financial position or results of operations.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments -- an amendment of FASB Statements No. 133 and 140"
("SFAS No. 155"). SFAS No. 155 requires companies to evaluate their interests in
securitized financial assets and determine whether the interests are
freestanding derivatives or hybrid financial instruments that may be subject to
bifurcation. SFAS No. 155 provides companies with relief from having to
separately determine the fair value of an embedded derivative that would
otherwise be required to be bifurcated from its host contract in accordance with
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities."
SFAS No. 155 also clarifies that concentrations of credit risk in the form of
subordination are not embedded derivatives and amends SFAS No. 140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," to eliminate the prohibition on a qualifying special-purpose
entity from holding a derivative financial instrument that pertains to a
beneficial interest other than another derivative financial instrument. SFAS No.
155 is effective for all financial instruments acquired or issued after January
1, 2007. The Company does not believe the adoption of SFAS No. 155 will have a
significant impact on the Company's financial position or results of operations.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets - an amendment of FASB Statement No. 140" ("SFAS No. 156").
SFAS No. 156 requires entities to separately recognize a servicing asset or
liability when undertaking an obligation to service a financial asset under a
servicing contract in certain situations, including a transfer of the servicer's
financial assets that meets the requirements for sale accounting. Any such
servicing assets or liabilities are required to be initially
9
measured at fair value, if practicable.
The Company currently values the mortgage servicing rights assets ("MSRs")
associated with its residential real estate whole loan sales and securitizations
(where servicing is retained) at the lower of cost or market. Likewise, the
Company currently calculates its gain on whole loan sales and securitizations by
allocating the carrying value of the existing held for sale loans to the assets
retained based on their relative fair values at the date of the sale or
securitization. The provisions of SFAS No. 156 may affect the future carrying
value of the MSRs as well as the Company's gain on sale and securitizations;
however, the Company does not believe the adoption of SFAS No. 156 will result
in a significant impact on its financial position or results of operations. SFAS
No. 156 is effective for the Company's fiscal year beginning January 1, 2007.
NOTE 3: CASH AND CASH EQUIVALENTS
Cash and cash equivalents are summarized in the following table as of the
dates indicated:
MARCH 31, DECEMBER 31,
2006 2005
--------- -----------
(THOUSANDS OF DOLLARS)
Cash on hand ................................................................ $ 276 $ 239
Non-interest bearing deposits in other financial institutions ............... 241,025 98,141
FHLB shareholder transaction account ........................................ 69,816 214,237
Federal Reserve account ..................................................... 3,427 2,829
U.S. Government Agency money market fund .................................... 150,000 350,000
Prime investment money market fund .......................................... 43,665 37,225
Market interest rate account ................................................ 10 17
Commercial paper ............................................................ 82,334 65,955
--------- -----------
Total cash and cash equivalents ............................................. $ 590,553 $ 768,643
========= ===========
The FHLB shareholder transaction account represents a short-term
interest-bearing transaction account with the Federal Home Loan Bank of San
Francisco. The Company's cash and cash equivalent balances were unrestricted as
of March 31, 2006 and December 31, 2005.
10
NOTE 4: INVESTMENT SECURITIES CLASSIFIED AS AVAILABLE-FOR-SALE
The amortized cost, unrealized gains, unrealized losses and fair value of
the Company's investment securities as of March 31, 2006 were as follows:
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(THOUSANDS OF DOLLARS)
Mortgage-backed securities
Agency .......................................... $ 768 $ 6 $ - $ 774
Private issue ................................... 16,930 1,968 - 18,898
--------- ---------- ---------- --------
Total available-for-sale securities ............. $ 17,698 $ 1,974 $ - $ 19,672
========= ========== ========== ========
There were no realized gains or losses on the available-for-sale securities
during the three months ended March 31, 2006. Unrealized gains or losses are
included in other comprehensive income. The private issue securities are
mortgage-backed securities retained from one of the Company's 2005 residential
real estate loan securitization transactions.
NOTE 5: LOANS HELD FOR SALE
Loans held for sale consist solely of residential real estate loans
(primarily first trust deeds, but also second trust deeds) which are aggregated
prior to their sale and are carried at the lower of aggregate cost or estimated
fair value. Estimated fair values are based upon current secondary market prices
for loans with similar coupons, maturities and credit quality.
The Company's residential real estate loans have loan terms for up to
thirty years and are typically secured by first deeds of trust on single-family
residences. The Company's residential real estate loans held for sale typically
have a significant concentration (generally 80% or higher) of "hybrid" loans
which have a fixed rate of interest for an initial period (generally two years)
after origination, after which the interest rate is adjusted to a rate equal to
the sum of six-month LIBOR and a margin as set forth in the mortgage note. The
interest rate then adjusts at each six-month interval thereafter, subject to
various initial, periodic and lifetime interest rate caps and floors. The loans
are generally made to borrowers who do not satisfy all of the credit,
documentation and other underwriting standards prescribed by conventional
mortgage lenders and loan buyers, such as Fannie Mae and Freddie Mac, and are
commonly referred to as "sub-prime" or "non-prime."
11
The following table details the loans held for sale as of the dates indicated:
MARCH 31, DECEMBER 31,
2006 2005
----------- -----------
(THOUSANDS OF DOLLARS)
Loan principal balance:
1st trust deeds .......................................................... $ 5,945,287 $ 4,792,976
2nd trust deeds .......................................................... 662,574 611,104
----------- -----------
6,607,861 5,404,080
Net deferred direct origination costs ...................................... 53,641 51,782
----------- -----------
6,661,502 5,455,862
Valuation reserve .......................................................... (48,719) (32,753)
----------- -----------
Loans held for sale - net .................................................. $ 6,612,783 $ 5,423,109
=========== ===========
Loans held for sale on non-accrual status .................................. $ 26,562 $ 16,736
=========== ===========
Since most of the loans that are held for sale are sold within sixty days
of origination, the amount of loans held for sale that are classified as
non-accrual or become real estate owned, is generally small. A valuation reserve
is maintained for certain non-performing loans and other loans held for sale
based upon the Company's estimate of inherent losses. Provisions for the
valuation reserve are charged against gain on sale of loans.
In the ordinary course of business, as the loans held for sale are sold,
the Company makes standard industry representations and warranties about the
loans. The Company may have to subsequently repurchase certain loans due to
defects that occurred in the origination of the loans. Such defects are
categorized as documentation errors, underwriting errors, or fraud. In addition,
the Company is generally required to repurchase loans that experience first
payment defaults. If there are no such defects or early payment defaults, the
Company has no commitment to repurchase loans sold or securitized. During the
first quarter of 2006, the Company repurchased a total of $78.7 million in
loans, as compared to $35.6 million for the first quarter of 2005. In addition,
the Company re-priced $29.0 million and $40.5 million in loans for the first
quarter of 2006 and 2005, respectively. Re-priced loans are loans that are
subject to repurchase but which are settled at a reduced price. The Company
maintains a reserve for the estimated losses expected to be realized when the
repurchased loans are sold; this reserve is included in other liabilities and
totaled $23.3 million and $14.6 million as of March 31, 2006 and December 31,
2005, respectively. Provisions for the repurchase reserve are charged against
gain on sale of loans.
The Company also maintains a reserve for premium recapture that represents
the estimate of potential refunds of premiums received on previously completed
loan sales (due to early loan prepayments
12
or for certain loans repurchased from prior sales) that may occur under the
provisions of the various agreements entered into for the sale of loans held for
sale; this reserve totaled $2.9 million and $4.3 million as of March 31, 2006
and December 31, 2005, respectively, and is included in other liabilities. The
gross premium percentage realized on whole loan sales and securitizations
decreased to 1.21% from 1.37% for the quarters ended March 31, 2006 and December
31, 2005, respectively. The decrease in the premium recapture reserve is
directionally consistent with the decrease in the gross premium percentage
realized from the prior quarter. Provisions for the premium recapture reserve
are charged against gain (loss)on sale of loans.
NOTE 6: LOANS HELD FOR INVESTMENT
Loans held for investment consists of the Company's commercial real estate
loans. Commercial real estate loans, which are primarily variable rate
(generally based upon six-month LIBOR and a margin), represent loans secured
primarily by first mortgages on properties such as multi-family (condominium),
office, retail, industrial, land development, mixed-use and lodging. The
commercial real estate loans are primarily comprised of bridge and construction
loans of relatively short duration (rarely more than five years in length of
term and often shorter, such as two to three years).
As of March 31, 2006, the Company had $3.43 billion in unfunded commitments
for existing loans and $516.7 million in unfunded commitments for loans not yet
booked, as compared to $3.40 billion and $410.5 million, respectively, as of
December 31, 2005. Due to the variability in the timing of the funding of these
unfunded commitments, and the extent to which they are ultimately funded, these
amounts should not generally be used as a basis for predicting future
outstanding loan balances.
Commercial real estate loans are reported net of participations to other
financial institutions or investors in the amount of $266.0 million and $138.2
million as of March 31, 2006 and December 31, 2005, respectively. The Company's
commercial real estate loans also include mezzanine loans (second mortgage
loans, which are subordinate to the senior or first mortgage loans) in the
amounts of $5.7 million and $5.6 million as of March 31, 2006 and December 31,
2005, respectively.
13
The geographic dispersion of the Company's commercial real estate portfolio
is as follows:
MARCH 31, DECEMBER 31,
GEOGRAPHIC DISTRIBUTION 2006 2005
--------- -----------
California ....................................... 22.9% 25.5%
Florida .......................................... 14.0% 11.5%
New York ......................................... 13.3% 14.7%
Virginia ......................................... 7.6% 6.6%
Arizona .......................................... 7.4% 6.7%
Hawaii ........................................... 4.3% 4.4%
District of Columbia ............................. 4.2% 4.2%
Illinois ......................................... 3.9% 4.3%
All other states ................................. 22.4% 22.1%
--------- -----------
100.0% 100.0%
========= ===========
The loans in the portfolio were distributed by property type as follows as
of the dates indicated:
MARCH 31, DECEMBER 31,
2006 2005
-------- -----------
Multi-family - Condominiums ...................... 52% 48%
Land Development ................................. 15% 15%
Office ........................................... 13% 14%
Retail ........................................... 6% 7%
Industrial ....................................... 4% 4%
Commercial Mixed-Use ............................. 3% 5%
Multi-family - Other ............................. 3% 3%
Special Purpose .................................. 2% 2%
Hotels & Lodging ................................. 2% 2%
-------- ----------
100% 100%
======== ==========
14
The Company does not currently carry any residential real estate loans held
for investment. The following tables further detail the net loans held for
investment as of the dates indicated:
MARCH 31, 2006
-----------------------------------------
COMMERCIAL
REAL ESTATE OTHER TOTAL
----------- ------ -----------
(THOUSANDS OF DOLLARS)
Loans outstanding ............................................... $ 5,671,332 $ 8,043 $ 5,679,375
Participations sold ............................................. (265,982) - (265,982)
----------- ------- -----------
Loans outstanding, net of participations sold ................... 5,405,350 8,043 5,413,393
Unamortized deferred origination fees and costs ................. (50,578) - (50,578)
----------- ------- -----------
Loans outstanding before allowance for loan losses .............. 5,354,772 8,043 5,362,815
Allowance for loan losses ....................................... (160,713) (76) (160,789)
----------- ------- -----------
Loans held for investment - net ................................. $ 5,194,059 $ 7,967 $ 5,202,026
=========== ======= ===========
DECEMBER 31, 2005
------------------------------------------
COMMERCIAL
REAL ESTATE OTHER TOTAL
----------- ------ -----------
(THOUSANDS OF DOLLARS)
Loans outstanding ............................................... $ 4,940,460 $ 8,589 $ 4,949,049
Participations sold ............................................. (138,165) - (138,165)
----------- ------- -----------
Loans outstanding, net of participations sold ................... 4,802,295 8,589 4,810,884
Unamortized deferred origination fees and costs ................. (50,984) - (50,984)
---------- ------- -----------
Loans outstanding before allowance for loan losses .............. 4,751,311 8,589 4,759,900
Allowance for loan losses ....................................... (156,755) (82) (156,837)
---------- ------- -----------
Loans held for investment - net ................................. $ 4,594,556 $ 8,507 $ 4,603,063
=========== ======= ===========
In cases where a borrower experiences financial difficulties and the
Company makes certain concessionary modifications to contractual terms
(typically a reduction of the interest rate charged), the loan is classified as
a restructured (accruing) loan if the loan is performing in accordance with the
agreed upon modified loan terms and projected cash proceeds are deemed
sufficient to repay both principal and interest. Restructured loans are
presented as such in the period of restructure and the three subsequent
quarters. The following table sets forth information regarding the Company's
commercial real estate loans on non-accrual status and restructured loans on
accrual status.
15
MARCH 31, DECEMBER 31,
2006 2005
-------- -----------
(THOUSANDS OF DOLLARS)
Non-accrual commercial real estate loans held for investment ................ $ 42,885 $ 29,290
========= ===========
Restructured commercial real estate loans on accrual status ................. $ 7,619 $ 12,309
========= ===========
The Company employs a documented and systematic methodology in determining
the adequacy of its allowance for loan losses, which assesses the risk of losses
inherent in the portfolio, and represents the Company's estimate of probable
inherent losses in the loan portfolio as of the date of the financial
statements. Establishment of the allowance for loan losses involves determining
reserves for individual loans that have been deemed impaired and for groups of
loans that are evaluated collectively. Reviews are performed to set allowance
allocations for loans that have been individually evaluated and identified as
loans which have probable losses; reserve requirements are attributable to
specific weaknesses evidenced by various factors such as a deterioration in the
quality of the collateral securing the loan, payment delinquency or other events
of default. Performing loans that currently exhibit no significant identifiable
weaknesses or impairment are evaluated on a collective basis. The allowance for
loan losses methodology incorporates management's judgment concerning the
expected effects of economic events on portfolio performance, as well as the
potential impact of concentration factors (such as property types, geographic
regions and loan sizes). While the Company's methodology utilizes historical and
other objective information, the establishment of the allowance for loan losses
is to a significant extent based upon the judgment and experience of the
Company's management. The Company believes that the allowance for loan losses is
adequate as of March 31, 2006 to cover probable losses embedded in the loan
portfolio; however, future changes in circumstances, economic conditions or
other factors, including the effect of the Company's various loan
concentrations, could cause the Company to increase or decrease the allowance
for loan losses as necessary. Activity in the allowance for loan losses is
summarized in the following table:
16
THREE MONTHS ENDED
MARCH 31,
------------------------
2006 2005
--------- ---------
(THOUSANDS OF DOLLARS)
Beginning balance .................................................. $ 156,837 $ 171,525
Provision for loan losses .......................................... 3,881 1,036
Charge-offs ........................................................ - (3,983)
Recoveries ......................................................... 71 3,363
--------- ---------
Ending balance ..................................................... $ 160,789 $ 171,941
========= =========
At March 31, 2006 and December 31, 2005, the recorded investment in loans
(excluding loans held for sale) considered to be impaired was $42.9 million and
$29.3 million, respectively, all of which were on a non-accrual basis. The
Company's policy is to consider a loan impaired when, based on current
information and events, it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. Evaluation of a loan's impairment is based on the present value of
expected cash flows or the fair value of the collateral, if the loan is
collateral dependent. As a result of charge-offs, these impaired loans do not
necessarily have a related specific allowance for loan loss allocated to them.
However, there were $42.9 million and $29.3 million of loans considered impaired
that have allocated specific allowances that totaled $3.3 million and $2.3
million at March 31, 2006 and December 31, 2005, respectively. The average net
investment in impaired loans held for investment was $32.4 million and $75.0
million for the three months ended March 31, 2006 and 2005, respectively.
Interest income that was recognized on the cash basis of accounting on loans
classified as impaired was $0 and $35,000 for the three months ended March 31,
2006 and 2005, respectively. Interest income foregone for loans on non-accrual
status that had not performed in accordance with their original terms was $1.1
million and $2.5 million, for the three months ended March 31, 2006 and 2005,
respectively.
In addition to its allowance for loan losses, the Company maintains an
allowance for unfunded commercial real estate loan commitments on existing loans
and, to a lesser degree, loans not yet funded; this allowance totaled $4.2
million and $4.0 million as of March 31, 2006 and December 31, 2005,
respectively, and is included in other liabilities.
17
NOTE 7: REAL ESTATE OWNED
The Company's real estate owned ("REO") consists of property acquired
through or in lieu of foreclosure on loans secured by real estate. REO is
reported in the financial statements at the lower of cost or estimated
realizable value (net of estimated costs to sell). REO consisted of the
following types of property as of the dates indicated:
MARCH 31, DECEMBER 31,
2006 2005
-------- -----------
(THOUSANDS OF DOLLARS)
Commercial real estate ........................... $ 27,868 $ 30,198
Residential real estate .......................... 4,115 3,674
-------- -----------
Real estate owned ................................ $ 31,983 $ 33,872
======== ===========
NOTE 8: MORTGAGE SERVICING RIGHTS
At the time of securitization or sale of loans on a whole loan basis with
servicing rights retained, the Company analyzes whether the benefits of
servicing are greater than or less than adequate compensation and, as a result,
records where appropriate, a mortgage servicing rights asset or liability
("MSR"), respectively. The estimated fair value of the Company's mortgage
servicing rights at March 31, 2006 and December 31, 2005 was $51.1 million and
$57.4 million, respectively. The following tables summarize the activity in the
Company's mortgage servicing rights asset as of the periods indicated:
18
THREE MONTHS ENDED
MARCH 31,
----------------------
2006 2005
-------- --------
(THOUSANDS OF DOLLARS)
Beginning balance .......................................................... $ 46,022 $ 20,044
Additions from securitization transactions ............................... - 7,637
Loans sold - servicing retained .......................................... 7,359 -
Amortization ............................................................. (8,044) (4,485)
-------- --------
Ending balance before valuation allowance .................................. 45,337 23,196
Valuation allowance
Beginning balance ........................................................ - (2,042)
Provision for temporary impairment ....................................... - (420)
-------- --------
Ending balance ........................................................... - (2,462)
-------- --------
Mortgage servicing rights - net ............................................ $ 45,337 $ 20,734
======== ========
Estimated fair value ....................................................... $ 51,122 $ 20,734
======== ========
The fair value of the MSRs is derived from the net positive cash flows
associated with the servicing agreements. The Company determines the fair value
of the MSRs at the time of securitization and at each reporting date by the use
of a cash flow model that incorporates prepayment speeds, discount rate and
other key assumptions management believes are consistent with assumptions other
major market participants use in valuing the MSRs.
The key economic assumptions used in subsequently measuring the fair value
of the Company's MSRs as of the dates indicated are as follows:
MARCH 31, DECEMBER 31,
2006 2005
-------- -----------
Weighted-average life (years) ..................... 1.5 1.6
Weighted-average annual prepayment speed .......... 49.0% 46.9%
Weighted-average annual discount rate ............. 15.0% 15.0%
As servicer, the Company is required to make certain advances on specific
loans it is servicing, to the extent such advances are deemed collectible by the
Company from collections related to the individual loan. The total amount
outstanding of such servicing advances was $19.5 million and $15.3 million at
March 31, 2006 and December 31, 2005, respectively, and is included in other
assets.
19
NOTE 9: RESIDUAL INTERESTS IN SECURITIZED LOANS
Residual interests in loan securitizations are recorded as a result of the
sale of residential real estate loans through a securitization transaction and
the subsequent issuance of net interest margin securities ("NIMs") to monetize
the residual interest from the original securitization transaction.
Residual interests represent the discounted expected future residual cash
flows from the securitizations that inure to the Company's benefit subject to
prepayment, delinquency, net credit losses and other factors. The following
table summarizes the activity of the Company's residual interests:
THREE MONTHS ENDED
MARCH 31,
-----------------------
2006 2005
--------- --------
(THOUSANDS OF DOLLARS)
Beginning balance at fair value ............................................. $ 170,723 $ 15,774
Additions to / (sales) of residual interests ................................ (77,220) 2,285
Interest accretion .......................................................... 16,809 1,338
Cash received ............................................................... (14,710) (4,253)
Fair value adjustments ...................................................... (5,366) (1,477)
Permanent impairment ........................................................ - (1,218)
--------- --------
Residual interests in securitized loans at fair value ....................... $ 90,236 $ 12,449
========= ========
Included in the $170.7 million beginning balance of residual interests was
one "pre-NIM" residual interest with an estimated fair value of $118.3 million
from a securitization transaction completed in December 2005. The Company, in
January 2006, completed a NIM transaction of this one "pre-NIM" residual
interest, resulting in a reduction of $77.2 million in the balance of the
residual interests. The Company did not enter into any other securitization or
NIM transactions during the first quarter of 2006.
Loans sold through securitization transactions are done so on a
non-recourse basis to off-balance sheet qualifying special-purpose entities
("QSPEs"), except for representations and warranties customary within the
mortgage banking industry. In a NIM transaction, the certificates representing
the residual interest in certain excess cash flows from the original
securitization transaction are transferred to a QSPE, which issues
interest-bearing securities. The net proceeds from the sale of these NIM
securities, along with a residual interest certificate, represent the
consideration received by the Company. The residual interest certificate
retained from a NIM transaction is subordinate to the NIM securities issued
until the NIM securities are paid in full. The residual interests retained from
the NIM transactions are classified as
20
"available-for-sale" securities and are measured at fair value; any unrealized
gains or losses from adjustments to the estimated fair value, net of taxes, are
reported as part of accumulated other comprehensive income, which is a separate
component of stockholders' equity.
In the original securitizations and NIM transactions, a two-tier structure
is utilized in which the loans are first sold to a special purpose corporation
(referred to as the Depositor), which then transfers the loans to the QSPE. The
Company's only ownership interest from its securitization transactions is
reflected in the retained residual interests from the NIM transactions of $90.2
million as detailed above.
The following table summarizes delinquencies and credit losses as of March
31, 2006 for the loans underlying the Company's 11 outstanding securitization
transactions (thousands of dollars):
Original principal amount of loans securitized .................. $ 10,606,000
Current principal amount of loans securitized ................... $ 6,681,448
Current delinquent principal amount (over 60 days) .............. $ 336,424
Inception to date credit losses (net of recoveries) ............. $ 13,731
The Company determines the estimated fair values of the residual interests
retained from the NIM transactions by discounting the expected net cash flows to
be received utilizing the cash-out method. The Company uses the forward LIBOR
curve for estimating interest rates on the adjustable rate loans and the
variable rate securities, and utilizes other assumptions (primarily for losses,
prepayment speeds and delinquencies) that management believes are consistent
with assumptions other major market participants would use to appropriately
estimate the fair value of similar residual interests. The Company continually
evaluates the various assumptions utilized in estimating the fair value of the
retained residual interests and updates them as deemed necessary based upon the
development of historical vintage data. Such residual interest valuations
remain, however, subject to volatility due to fluctuations in the performance of
the underlying collateral and in the accuracy of the assumptions utilized by the
Company.
21
Key economic assumptions used in subsequently measuring the fair value of
the Company's residual interests as of the dates indicated are as follows:
MARCH 31, DECEMBER 31,
2006 2005
-------- -----------
Weighted-average life (years) ............................................... 1.5 1.6
Weighted-average annual prepayment speed .................................... 48.0% 46.0%
Weighted-average lifetime credit losses ..................................... 4.4% 4.4%
Weighted-average annual discount rate ....................................... 20.0% 20.0%
NOTE 10: DERIVATIVE FINANCIAL INSTRUMENTS
The Company utilizes derivative financial instruments in connection with
its interest rate risk management activities. In accordance with its interest
rate risk strategy, the Company currently utilizes a combination of forward
sales commitments and Eurodollar futures contracts to hedge its residential real
estate loans held for sale and a certain portion of its unfunded pipeline of
conditional loan approvals. These derivatives are intended to offset the changes
in the value of the Company's loans held for sale and its unfunded conditional
loan approvals as interest rates change. The Company's forward sales commitments
represent obligations to sell loans at a specific price and date in the future;
therefore, the value of these commitments increase as interest rates increase.
Short Eurodollar futures contracts are standardized exchange-traded contracts,
the values of which are tied to spot Eurodollar rates at specified future dates.
The value of these futures contracts increase when interest rates rise.
Conversely, the value of the forward sales commitments and the short Eurodollar
positions decrease when interest rates decrease, while the related loans are
expected to increase in value. The values of the loans, the forward sales
commitments and the Eurodollar positions may not move in corresponding amounts
and time frames and may result in a negative or positive impact on earnings in
any given period. In accordance with Statement of Financial Accounting Standards
No. 133, Accounting for Derivatives and Hedging Activities, as amended and
interpreted ("SFAS No. 133"), the Company's derivative financial instruments are
reported at their fair values.
At March 31, 2006, the Company's commitments to sell forward residential
real estate loans to third party investors in whole loan sales transactions were
approximately $2.67 billion at various rates and terms. The Company
distinguishes commitments to sell forward loans in two categories, allocated and
unallocated. At March 31, 2006, allocated and unallocated forward sale
commitments notional amounts were $1.67 billion and $1.00 billion, respectively.
Allocated forward sales commitments are contractual
22
sales agreements whereby a specific pool of loans is agreed upon to be sold to
specific buyers at a contractually agreed upon date and price. In accordance
with SFAS No. 133, the Company may, under certain circumstances, designate and
account for its allocated forward sales commitments as fair value hedges
designated to specific pools of loans that have been contractually agreed upon
for sale; however, as of March 31, 2006, no hedges were designated as such.
Unallocated forward sales commitments are agreements that provide a fixed price
on a pool of loans not yet specified. These commitments are treated as economic
hedges (and are not currently designated as accounting hedges) and are
classified as free-standing derivatives. Changes in the fair value of both the
unallocated and allocated forward sales commitments are reported as a component
of gain (loss) on sale of residential real estate loans and as either other
assets or liabilities, as applicable.
At March 31, 2006, the Company had a pipeline of loans in process of
approximately $1.95 billion in new residential real estate loans. The Company
does not guarantee interest rates to potential borrowers when an application is
received. Because these loans are generally subject to the potential borrower
accepting and meeting the conditions of the loan approval, the Company estimates
its effective net pipeline position at $1.21 billion, as adjusted for expected
loan fallout. The Company conditionally quotes interest rates to potential
borrowers, which are then subject to adjustment by the Company if any such
conditions are not satisfied. As such, the Company ascribes no value to its
conditional loan approvals as there are no interest rate-lock commitments on the
loans.
The Company's Eurodollar futures contracts are currently treated as
economic hedges and are not currently designated as accounting hedges and are
classified as free-standing derivatives. As of March 31, 2006, the Company had
in place short Eurodollar futures positions covering loan principal of $3.36
billion and $278.5 million for its loans held for sale and its unfunded loan
pipeline, respectively. Eurodollar futures are utilized in an effort to offset
the changes in value related to the loan inventory and pipeline without the
necessity of restricting certain loan inventory or pipeline loans to a specific
forward sale commitment. The Company's Eurodollar futures positions are settled
each day based on their ending fair values; as such, the Company does not
reflect any asset or liability position for these derivatives. The Company
records these daily fair value changes and settlements as a component of the
gain or loss on sale of residential real estate loans. The Company's Eurodollar
futures contracts are collateralized by maintenance of a margin account which
had a balance of $15.8 million as of March 31, 2006.
The estimated fair values of the Company's derivatives were as follows
(included in other assets or liabilities, as applicable, in the consolidated
balance sheets) as of the dates indicated:
23
MARCH 31, DECEMBER 31,
2006 2005
-------- -----------
(THOUSANDS OF DOLLARS)
Forward sales commitments .......................................... $ 2,438 $ (1,479)
Interest rate cap contract ......................................... - (340)
Other .............................................................. - 418
-------- -----------
$ 2,438 $ (1,401)
======== ===========
The changes in fair value of the derivative instruments from the prior
period are recorded as part of the net gain (loss) on whole loan sales and
securitizations. (See Note 11)
NOTE 11: GAIN (LOSS) ON WHOLE LOAN SALES AND SECURITIZATION OF RESIDENTIAL
REAL ESTATE LOANS
The Company routinely sells and securitizes residential mortgage loans into
the secondary market. Gains or losses are recognized at the date of settlement
and when the Company has transferred control over the loans to either a
transaction-specific securitization trust or to a third-party purchaser. The
amount of gain or loss for loan sales or securitizations is based upon the
difference between the net sales proceeds received, including any retained
interests, and the allocated carrying amount of the loans (which includes the
costs directly incurred with the origination of the loans, net of origination
points and fees received, which are deferred and recognized when the loans are
sold). The Company maintains a valuation reserve for certain non-performing
loans and other loans held for sale based on the Company's estimate of inherent
losses. The Company also records a repurchase reserve for the estimated losses
expected to be realized for any repurchased loans when they are resold. The
provisions for both of these reserves are recorded as adjustments to the
Company's gain (loss)on sale. The provision for premium recapture is the
provision for the return of premium on loans sold which prepay early per the
terms of each sales contract; this amount includes some interest adjustment. The
following table presents the detailed components of the net gain or loss on
whole loan sales and securitizations:
24
THREE MONTHS ENDED
MARCH 31,
----------------------------
2006 2005
----------- -----------
(THOUSANDS OF DOLLARS)
Whole loan sales of residential real estate loans ........................... $ 7,257,655 $ 5,849,309
Securitizations of residential real estate loans ............................ - 1,209,849
----------- -----------
Total loan sales and securitizations - net of repurchases ................... $ 7,257,655 $ 7,059,158
=========== ===========
Gross premium recognized on Tier I loan sales and securitizations ........... $ 87,933 $ 204,876
Losses on Tier II sales ..................................................... (13,989) (3,180)
----------- -----------
73,944 201,696
Net gain on derivative instruments .......................................... 14,596 17,188
----------- -----------
88,540 218,884
Net direct loan origination costs ........................................... (67,767) (96,193)
Provision for premium recapture ............................................. (3,496) (4,270)
----------- -----------
17,277 118,421
Provision for valuation and repurchase reserves ............................. (32,453) (10,061)
----------- -----------
Net gain (loss) on sale ..................................................... $ (15,176) $ 108,360
=========== ===========
The net gain on derivative instruments included in the net gain (loss) on
sale of residential real estate loans consists of the following items:
THREE MONTHS ENDED
MARCH 31,
----------------------
2006 2005
------- --------
(THOUSANDS OF DOLLARS)
Eurodollar futures:
Net realized gain ....................................................... $ 11,541 $ 20,532
Transaction expenses and other .......................................... (445) (525)
-------- --------
11,096 20,007
Change in fair value of:
Forward sales commitments ............................................... 3,918 1,878
Other ................................................................... (418) (187)
-------- --------
Net gain on derivative instruments ........................................ $ 14,596 $ 21,698
======== ========
25
NOTE 12: LOAN SERVICING INCOME
In addition to the securitized loans that it services, the Company also
services loans sold to other financial institutions on an interim basis (until
servicing is transferred to another party) and on a to maturity basis (servicing
retained). The following table presents the components of loan servicing income
for the Company:
THREE MONTHS ENDED
MARCH 31,
----------------------
2006 2005
-------- --------
(THOUSANDS OF DOLLARS)
Servicing fee income:
Securitization transactions ............................................... $ 8,796 $ 4,380
Interim ................................................................... 6,452 6,507
Loans sold - servicing retained ........................................... 1,352 830
Ancillary income (1) :
Securitization transactions ............................................... 1,766 847
Interim ................................................................... 815 696
Loans sold - servicing retained ........................................... 325 181
Other:
Securitization transactions ............................................... 1,687 292
Loans sold - servicing retained ........................................... 156 8
-------- --------
Loan servicing income ....................................................... $ 21,349 $ 13,741
======== ========
(1) Ancillary income represents all service-related contractual fees retained
by the Company and consists primarily of late payment charges.
26
NOTE 13: INCOME TAXES
The major components of income tax expense are summarized in the following
table:
THREE MONTHS ENDED
MARCH 31,
-----------------------
2006 2005
--------- --------
(THOUSANDS OF DOLLARS)
Federal:
Current ................................................................... $ 32,787 $ 40,329
Deferred .................................................................. (14,391) 9,673
--------- --------
18,396 50,002
--------- --------
State:
Current ................................................................... 7,166 12,037
Deferred .................................................................. (4,101) (963)
--------- --------
3,065 11,074
--------- --------
Total income tax expense .................................................... $ 21,461 $ 61,076
========= ========
The Company has accrued the expected maximum tax and interest exposure for
tax matters that are either in the process of resolution or have been identified
as having the potential for adjustment. These matters primarily consist of
issues relating to the discontinued insurance operations, the apportionment of
income to various states and the deduction of certain expenses.
The deferred income tax balance includes the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and for income tax purposes. The components of the Company's
deferred tax assets are summarized in the following table:
27
MARCH 31, DECEMBER 31,
2006 2005
--------- -----------
(THOUSANDS OF DOLLARS)
Deferred tax assets:
Mark-to-market on loans held for sale ..................................... $ 43,677 $ 23,355
Allowance for loan losses ................................................. 71,588 69,650
Compensation related items ................................................ 25,468 29,270
State income and franchise taxes .......................................... 6,309 13,467
Other - net ............................................................... 916 2,283
--------- -----------
Total deferred tax assets ............................................... 147,958 138,025
Deferred tax liabilities:
Loan origination costs .................................................... (21,630) (31,550)
Mortgage servicing ........................................................ (23,229) (23,240)
--------- -----------
Total deferred tax liabilities ......................................... (44,859) (54,790)
--------- -----------
Net deferred tax asset ...................................................... $ 103,099 $ 83,235
========= ===========
In assessing the realization of deferred income tax assets, the Company
considers whether it is more likely than not that the deferred income tax assets
will be realized. The ultimate realization of deferred income tax assets depends
on the ability to recover previously paid taxes through loss carrybacks and the
generation of future taxable income during the periods in which temporary
differences become deductible. In the Company's opinion, the deferred tax assets
will be fully realized and no valuation allowance is necessary as the Company
has the ability to generate sufficient future taxable income to realize the tax
benefits.
NOTE 14: DEBT - FREMONT GENERAL CORPORATION
The debt of Fremont General is detailed in the following table; none of the
Fremont General debt is guaranteed by FIL:
MARCH 31, DECEMBER 31,
2006 2005
--------- -----------
(THOUSANDS OF DOLLARS)
Senior Notes due 2009, less discount
(2006 - $884; 2005 - $975) ................................................ $ 172,396 $ 175,305
Junior Subordinated Debentures .............................................. 103,093 103,093
--------- -----------
$ 275,489 $ 278,398
========= ============
28
During the first quarter of 2006, Fremont General repurchased $3 million
par value of the 7.875% Senior Notes due 2009 with a carrying value of $3
million resulting in a pre-tax gain of $22,000.
Fremont General's 9% Junior Subordinated Debentures are the sole asset of
Fremont General Financing I, a statutory business trust (the "Trust") and
wholly-owned subsidiary of Fremont General. The Trust issued, and has
outstanding, $100 million of 9% Trust Originated Preferred SecuritiesSM (the
"Preferred Securities") which represent preferred undivided beneficial interests
in the Trust. The Junior Subordinated Debentures are subordinate and junior to
all senior indebtedness of Fremont General. Payment of distributions out of cash
held by the Trust, and payments on liquidation of the Trust or the redemption of
the Preferred Securities are guaranteed by Fremont General to the extent that
the Trust has funds available to make such payments.
Under FASB Interpretation No. 46 (Revised December 2003), "Consolidation of
Variable Interest Entities," Fremont General is not considered the primary
beneficiary of the Trust. Therefore, instead of the Preferred Securities, the
Junior Subordinated Debentures are reflected on the Company's balance sheets.
NOTE 15: DEPOSITS, FHLB ADVANCES, FEDERAL RESERVE AND WAREHOUSE LINES OF
CREDIT - FIL
FIL utilizes the issuance of deposits, which are insured up to the maximum
legal limit by the Federal Deposit Insurance Corporation, Federal Home Loan Bank
("FHLB") advances, Federal Reserve and warehouse lines of credit in funding its
operations.
As of March 31, 2006, the weighted-average interest rate for savings and
money market deposit accounts was 3.68% and for certificates of deposit it was
4.37%. The weighted-average interest rate for all deposits at March 31, 2006 was
4.25%.
Certificates of deposit as of March 31, 2006 are detailed by maturity and
rates as follows:
MATURING BY WEIGHTED
AMOUNT MARCH 31, AVERAGE RATE
----------- ----------- ------------
(THOUSANDS
OF DOLLARS)
$ 7,585,006 2007 4.36%
46,013 2008 4.20%
36,306 2009 5.62%
15,527 2010 6.07%
1,111 2011 4.56%
----------- ------------
$ 7,683,963 4.37%
=========== ============
29
Of the total certificates of deposit outstanding at March 31, 2006, $1.49
billion were obtained through brokers.
Interest expense on deposits is summarized as follows:
THREE MONTHS ENDED
MARCH 31,
----------------------
2006 2005
-------- --------
(THOUSANDS OF DOLLARS)
Savings and money market deposit accounts ................................... $ 13,900 $ 9,840
Certificates of deposit ..................................................... 76,955 39,601
Penalties for early withdrawal .............................................. (170) (85)
-------- --------
$ 90,685 $ 49,356
======== ========
Total interest payments on deposits were $92.5 million and $48.5 million,
for the three month periods ended March 31, 2006 and 2005, respectively.
FIL is a member of the FHLB system and, as such, maintains a credit line
with the FHLB of San Francisco that is based upon a percentage of its total
regulatory assets, subject to collateralization requirements and certain
collateral sub-limits. Advances are primarily collateralized by residential
loans held for sale, and to a lesser extent, by certain commercial loans held
for investment. The maximum amount of credit which the FHLB will extend varies
from time to time in accordance with their policies. FIL's maximum financing
availability, based upon its level of regulatory assets and subject to the
amount and type of collateral pledged and their respective advance rates, was
$3.96 billion as of March 31, 2006. At March 31, 2006 and December 31, 2005, FIL
had an approximate maximum borrowing capacity based upon its pledged loan
collateral of $3.14 billion and $1.99 billion, respectively, with outstanding
borrowings of $1.20 billion and $949.0 million, respectively, from the FHLB of
San Francisco. All borrowings mature within one year. FIL pledged loans with a
carrying value of $3.54 billion and $2.22 billion at March 31, 2006 and December
31, 2005, respectively, to secure the current and any future borrowings. FIL's
borrowing capacity can be used to borrow under various FHLB loan programs,
including adjustable and fixed-rate financing, for periods ranging from one day
to 30 years, with a variety of interest rate structures available. The
weighted-average interest rate on the amount outstanding at March 31, 2006 was
4.50%. The borrowing capacity has no commitment fees or cost, requires minimum
levels of investment in FHLB stock (FIL receives dividend income on its
investment in FHLB stock), can be withdrawn by the FHLB if there is any
significant change in the financial or operating condition of FIL and is
conditional upon FIL's compliance with certain agreements covering advances,
collateral maintenance, eligibility and documentation
30
requirements. At March 31, 2006 and December 31, 2005, FIL was in compliance
with all requirements of its FHLB credit facility.
Total interest payments on advances from the FHLB were $23.7 million and
$7.5 million, for the three month periods ended March 31, 2006 and 2005,
respectively.
FIL has a line of credit with the Federal Reserve Bank of San Francisco
("Federal Reserve") and, at March 31, 2006 and December 31, 2005, had a
borrowing capacity, based upon collateral pledged, of $424.0 million and $442.3
million, respectively, with no outstanding borrowings at March 31, 2006 or
December 31, 2005. FIL pledged loans with a carrying value of $565.3 million and
$589.7 million at March 31, 2006 and December 31, 2005, respectively, to the
Federal Reserve. This line of credit may be utilized when all other sources of
funds are not reasonably available and any such advances are made with the
expectation that they will be repaid when the availability of the usual source
of funds is restored, usually the next business day.
FIL has established four separate warehouse lines of credit to facilitate
the funding of residential real estate loans prior to their sale or
securitization. The total funding capacity available at March 31, 2006 under the
four facilities was $3.00 billion, of which $2.25 billion was committed. There
was $713.5 million outstanding on one of the facilities at March 31, 2006.
Borrowings, if any, under each of the facilities are secured by loans held for
sale as pledged by FIL. Each of the facilities is subject to certain conditions,
including, but not limited to, financial and other covenants including the
maintenance of certain capital and liquidity levels. At March 31, 2006, FIL was
in compliance with all financial and other covenants related to these
facilities.
31
NOTE 16: OTHER LIABILITIES
The following table details the composition of the Company's other
liabilities as of the dates indicated:
MARCH 31, DECEMBER 31,
2006 2005
--------- -----------
(THOUSANDS OF DOLLARS)
Deferred compensation obligation ........................................... $ 57,238 $ 50,300
State income tax liability ................................................. 32,322 27,860
Accounts payable ........................................................... 28,497 35,379
Premium recapture and repurchase reserves .................................. 26,274 18,815
Accrued incentive compensation ............................................. 24,274 56,553
Borrower escrow collections payable ........................................ 22,522 23,620
Federal income tax liability ............................................... 18,595 (12,586)
Interest payable ........................................................... 13,577 18,241
Borrower principal and interest due investors .............................. 10,148 13,209
Accrued Employee Stock Ownership Plan expense .............................. 5,084 29,596
Other ...................................................................... 24,946 36,929
--------- -----------
Total other liabilities .................................................... $ 263,477 $ 297,916
========= ===========
NOTE 17: SHARE-BASED PAYMENTS
Company stock award plans provide a long term compensation opportunity for
officers and certain key employees of the Company. Stock options and awards of
rights to purchase shares of the Company's common stock, generally in the form
of restricted stock awards may be granted under the Company's stockholder
approved 1997 Stock Plan (the "1997 Plan"). At March 31, 2006, a total of
1,796,777 restricted shares of the Company's common stock were then subject to
outstanding awards granted and an additional 2,826,035 shares of the Company's
common stock were then available for new award grants under the 1997 Plan. The
Company also maintains the 1995 Restricted Stock Award Plan (the ("1995 Plan"),
which expired under its terms in November 2005. As of March 31, 2006, there were
105,950 restricted shares of the Company's common stock subject to outstanding
awards granted. There are no shares available for grant under the 1995 Plan.
Prior to January 1, 2006, the Company accounted for stock awards granted under
the 1997 Plan under the recognition and measurement provisions of APB Opinion
No. 25, "Accounting for Stock Issued to Employees" and related Interpretations
("APB No. 25"), as permitted by FASB Statement No. 123, "Accounting for
Stock-Based Compensation." Effective January 1, 2006, the Company adopted the
fair value recognition provisions of FASB Statement No. 123(R), "Share-Based
Payment" ("SFAS No. 123(R)"), using the modified prospective transition method
therefore results for prior periods have not been restated. The primary impact
of adopting SFAS No. 123(R) on the
32
Company's financial statements was the reclassification of the deferred
compensation balance, as of December 31, 2005 ($20.9 million) related to its
nonvested restricted shares to additional paid-in capital.
STOCK OPTIONS:
The Company also maintains the Amended 1989 Non-Qualified Stock Option Plan
(the "1989 Plan"). During the years 1989 to 1997, non-qualified stock options
were granted at exercise prices equal to the fair value of the stock on the date
of grant. Grantees vested at the rate of 25% per year beginning on the first
anniversary of the grants that expire after ten years. Stock option grants were
accounted for in accordance with the intrinsic value method and, accordingly, no
compensation expense was recognized. For the applicable years, additional
disclosure was provided regarding the pro forma effects on earnings per share
calculated as if the recognition and measurements provisions of the fair value
method had been adopted. The Company had 468,000 non-qualified option shares
outstanding and exercisable as of March 31, 2006 with an intrinsic value of $7.0
million, an exercise price of $14.94 and expire February 13, 2007. No options
were granted, forfeited, expired or exercised during the first quarter of 2006.
Shares issued upon option exercise may come from new shares or existing shares
held in the Company's employee benefits trust. There are no shares available for
grant under the 1989 Plan. (See Note 18)
RESTRICTED STOCK AWARDS:
Under both APB No. 25 and SFAS No. 123(R), the Company recognizes
compensation expense related to its restricted stock awards based on the fair
value of the shares awarded as of the grant date. Compensation expense for the
restricted stock awards is recognized on a straight-line basis over the
requisite service period (generally two to ten years). The compensation expense
that has been charged against income for share-based compensation was $3.3
million and $4.0 million for the three months ended March 31, 2006 and 2005,
respectively. The total income tax benefit recognized in the income statement
for share-based compensation arrangements was $1.4 million and $1.6 million for
the three months ended March 31, 2006 and 2005, respectively.
Prior to the adoption of SFAS No. 123(R), the Company reported all cash
flows resulting from the tax benefits associated with tax deductions in excess
of the compensation expense recognized for restricted stock awards as operating
cash flows in the Consolidated Statement of Cash Flows. Under SFAS No. 123(R)
the Company now reports such excess tax benefits as financing cash inflows.
Under the Company's Executive Officer Annual Bonus Plan, which is
stockholder-approved, for the one-year period beginning January 1, 2006 through
December 31, 2006 (the "2006 Annual Plan") the Company may grant selected
officers awards of restricted shares of Company common stock upon
33
achievement of certain predetermined pre-tax earnings targets for the 2006
calendar year. At the end of the one-year performance period, upon determination
of the extent to which the 2006 pre-tax earnings targets have been achieved,
participants under the 2006 Annual Plan will be paid bonuses in the form of
cash, at 100% of the amount of the cash bonus earned, plus an award of shares of
restricted common stock equal to 100% of the amount of the cash bonus earned in
accordance with the 2006 Annual Plan. If such earnings targets are not met, no
compensation cost is recognized and any previously recognized compensation cost
is reversed. As a result of adopting SFAS No. 123(R), the Company accounts for
these awards as liability instruments where the service period precedes the
grant date. No restricted stock awards were granted under the 2006 Bonus Plan
during the first quarter of 2006.
A summary of the status of the Company's nonvested restricted stock awards
as of March 31, 2006 and changes during the three month period then ended is
presented below:
WEIGHTED-AVERAGE
GRANT DATE
NUMBER OF SHARES FAIR VALUE
---------------- ----------------
Nonvested at January 1, 2006 ................................ 2,959,053 $ 13.79
Granted ..................................................... 388,379 22.67
Vested ...................................................... (1,444,705) 12.48
Forfeited ................................................... - -
---------------- ----------------
Nonvested at March 31, 2006 ................................. 1,902,727 $ 16.60
================ ================
The fair value of nonvested shares is determined based on the closing trade
price of the Company's shares on the grant date. As of March 31, 2006, there was
$26 million of total unrecognized compensation cost related to nonvested
share-based compensation arrangements. That cost is expected to be recognized
over a weighted-average period of 2.3 years. The weighted-average grant date
fair value of the restricted stock awards granted during the three months ended
March 31, 2006 and 2005 was $22.67 and $23.08, respectively. The total fair
value of shares vested was $33.6 million and $31.6 million for the three months
ended March 31, 2006 and 2005, respectively.
Awards of restricted common stock include dividend rights and
non-preferential dividends are paid on nonvested restricted shares of Company
common stock. Dividends declared on restricted stock awards granted are not
subject to vesting. Outstanding nonvested restricted shares of Company common
stock are generally subject to accelerated vesting if there is a change in
control of the Company (as defined in the restricted stock award agreements or
Employment or Management Continuity Agreements, if applicable).
34
NOTE 18: DEFERRED COMPENSATION
The Company periodically contributes cash to an employee benefits trust
("GSOP") in order to pre-fund contributions to various employee benefit plans
(e.g., 401(K) match, Employee Stock Ownership Plan contribution, etc.). The
Company consolidates the GSOP under the provisions of Financial Accounting
Standards Board Interpretation No. 46R, "Consolidation of Variable Interest
Entities." The GSOP uses the contributed cash to acquire shares of the Company's
common stock and the shares held by the GSOP are recorded at fair value and
treated as treasury stock for purposes of calculating the Company's basic and
diluted earnings per share.
The Company also maintains a Supplemental Executive Retirement Plan
("SERP") and Excess Benefit Plan ("EBP"); both of which are deferred
compensation plans designed to provide certain employees the ability to receive
benefits that would be otherwise lost under the Company's qualified retirement
plans due to statutory or other limits on salary deferral and matching
contributions.
The following table details the composition of the Company's deferred
compensation balance as of the periods indicated:
MARCH 31, DECEMBER 31,
2006 2005
-------- -----------
(THOUSANDS OF DOLLARS)
SERP and EBP ....................................................... $ 19,590 $ 16,831
GSOP ............................................................... 6,551 5,624
Unamortized restricted stock awards ................................ - 20,902
-------- -----------
Total deferred compensation ........................................ $ 26,141 $ 43,357
======== ===========
Under the provisions of SFAS No. 123(R), which the Company adopted as of
January 1, 2006, companies may no longer account for unrecognized compensation
costs related to nonvested stock awards as deferred compensation. SFAS No.
123(R) requires that any existing balance of deferred compensation as of the
adoption date be reclassified to additional paid-in capital. Because the Company
adopted SFAS No. 123(R) on the modified prospective basis, results from prior
periods have not been restated to conform to the current presentation. (See Note
17)
35
NOTE 19: INDUSTRIAL BANK REGULATORY CAPITAL
FIL is subject to various regulatory capital requirements under California
and Federal regulations. Failure to meet minimum capital requirements can result
in regulatory agencies initiating certain mandatory and possibly additional
discretionary actions that, if undertaken, could have a direct material effect
on the consolidated financial statements. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, FIL must meet specific
capital guidelines that involve quantitative measures of its assets, liabilities
and certain off-balance sheet items as calculated under regulatory accounting
practices. FIL's capital amounts, its ability to pay dividends and other
requirements and classifications are also subject to qualitative judgments by
its regulators about components, risk weightings and other factors. Banking
institutions that are experiencing or anticipating significant growth are
generally expected to maintain capital ratios above minimum levels.
As of March 31, 2006, FIL's regulatory capital exceeded all minimum
requirements to which it is subject and the most recent notification from the
FDIC categorized FIL as "well-capitalized". To be categorized as
well-capitalized, the institution must maintain capital ratios as set forth in
the following table. There have been no conditions or events since that
notification that management believes have changed FIL's categorization as
well-capitalized. FIL's actual regulatory amounts and the related standard
regulatory minimum ratios required to qualify as well-capitalized are detailed
in the table below.
MARCH 31, 2006 DECEMBER 31, 2005
-------------------- --------------------
MINIMUM ACTUAL MINIMUM ACTUAL
REQUIRED RATIO REQUIRED RATIO
-------- ------ -------- ------
Tier-1 Leverage Capital .................. 5.00% 12.07% 5.00% 12.59%
Risk-Based Capital:
Tier-1 ................................. 6.00% 12.80% 6.00% 14.15%
Total .................................. 10.00% 14.05% 10.00% 15.52%
Regulatory capital is assessed for adequacy by three measures: Tier-1
Leverage Capital, Tier-1 Risk-Based Capital and Total Risk-Based Capital. FIL's
Tier-1 Leverage Capital includes common stockholder's equity, a certain portion
of its mortgage servicing rights not includable in regulatory capital and other
adjustments. Tier-1 Leverage Capital is measured with respect to average assets
during the quarter. The Tier-1 Risk-Based Capital ratio is calculated as a
percent of risk-weighted assets at the end of the quarter. FIL's Total
Risk-Based Capital includes the allowable amount of its allowance for loan
losses (the allowable amount includable is limited to 1.25% of gross
risk-weighted assets). The Total Risk-Based
36
Capital ratio is calculated as a percent of risk-weighted assets at the end of
the quarter.
During the third quarter of 2005, the Company identified that its
interpretation for the calculation of risk-weighted assets was not complete.
Previously, the Company had not incorporated the unfunded portion of its
commercial real estate loan commitments into its risk-weighted assets
calculation. As of March 31, 2006, and for all prior periods presented, the
Company has included the risk-weighted effect of these unfunded commitments into
its Tier-1 Risk-Based and Total Risk-Based Capital ratios. Included in these
unfunded commitments are amounts for loan transactions for which the unfunded
portion is not currently available to the borrower based upon the level of
progress of the underlying commercial real estate project. The impact upon the
Tier-1 Risk-Based and Total Risk-Based Capital ratios in prior periods did not
change FIL's categorization as well-capitalized and there is no impact upon the
Tier-1 Leverage ratio.
The following table details the calculation of the respective capital
amounts at FIL as of the dates indicated:
MARCH 31, DECEMBER 31,
2006 2005
----------- -----------
(THOUSANDS OF DOLLARS)
Common stockholder's equity at FIL .......................................... $ 1,539,024 $ 1,550,049
Less: Unrealized gains on available-for-sale securities ..................... (1,184) (364)
----------- -----------
Total Tier-1 Capital ........................................................ 1,537,840 1,549,685
Add: Allowable portion of the allowance for loan losses .................... 150,399 149,735
----------- -----------
Total Risk-Based Capital (Tier-1 and Tier-2) ................................ $ 1,688,239 $ 1,699,420
=========== ===========
NOTE 20: COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET ACTIVITIES
The Company is a defendant in a number of legal actions arising in the
ordinary course of business and from the discontinuance of the insurance
operations. Management and its legal counsel are of the opinion that the
settlement of these actions, individually or in the aggregate, will not have a
material effect on the Company's business, financial position or results of
operations.
37
FREMONT INDEMNITY COMPANY (IN LIQUIDATION) V. FREMONT GENERAL CORPORATION ET
AL.:
On June 2, 2004, the State of California Insurance Commissioner John
Garamendi (the "Commissioner"), as statutory liquidator of Fremont Indemnity
Company ("Fremont Indemnity"), filed suit in Los Angeles Superior Court against
Fremont General alleging the improper utilization by Fremont General of certain
net operating loss deductions ("NOLs") allegedly belonging to its Fremont
Indemnity subsidiary (the "Fremont Indemnity case"). This complaint involves
issues that were considered resolved in an agreement among the California
Department of Insurance, Fremont Indemnity and Fremont General (the "Letter
Agreement"). The Letter Agreement, dated July 2, 2002, was executed on behalf of
the California Department of Insurance by the Honorable Harry Low, the State of
California Insurance Commissioner at that time. Fremont General has honored all
of its obligations under the Letter Agreement. On July 16, 2004, the
Commissioner filed a First Amended Complaint ("FAC") adding a cause of action
for concealment of an alleged reinsurance dispute and is seeking to rescind the
Letter Agreement.
On January 25, 2005, Fremont General's motions to dismiss the lawsuit
brought by the Commissioner, on behalf of Fremont Indemnity, against Fremont
General were argued and heard before the Superior Court of the State of
California (the "Court"). On January 26, 2005, the Court issued its rulings
dismissing all the causes of action in the FAC without leave to amend, except
for the cause of action for alleged concealment by Fremont General of a
potential reinsurance dispute, which was dismissed with leave to amend. The
Court also found that Fremont General had properly utilized the NOLs in
accordance with the Letter Agreement. In addition, the Court rejected the
Commissioner's request for findings that Fremont General's use of the NOLs and
worthless stock deduction were voidable preferences and/or fraudulent transfers.
The Court also rejected the Commissioner's request for injunctive relief to
force Fremont General to amend its prior consolidated income tax returns to
remove and forgo the worthless stock deduction for its investment in Fremont
Indemnity.
On May 2, 2005, the Commissioner filed a Second Amended Complaint ("SAC")
with regard to the 7th cause of action on behalf of Fremont Indemnity against
Fremont General alleging intentional misrepresentation, concealment and
promissory fraud, which induced the Commissioner to first enter into the Letter
Agreement. On July 15, 2005, the Court dismissed the SAC with 20 days leave to
amend. On August 4, 2005, the Commissioner filed a Third Amended Complaint
("TAC") again alleging intentional misrepresentation, concealment and promissory
fraud.
On November 22, 2005, the Court dismissed the remaining cause of action in
the TAC, finding that the "Plaintiff still failed to plead any affirmative
misrepresentation which is actionable." The Court also found
38
that the "pleading is inadequate as to damage allegations." This ruling by the
Court dismisses the only remaining cause of action in the lawsuit originally
brought by the Commissioner on behalf of Fremont Indemnity against Fremont
General, first reported on June 17, 2004. The Commissioner has filed a Notice of
Appeal to the Court's dismissal of the complaint. The Company continues to
believe that this lawsuit is without merit.
FREMONT INDEMNITY COMPANY (IN LIQUIDATION AS SUCCESSOR IN INTEREST TO COMSTOCK
INSURANCE COMPANY) V. FREMONT GENERAL CORPORATION ET AL.:
The Commissioner filed an additional and separate complaint against Fremont
General on behalf of Fremont Indemnity as successor in interest to Comstock
Insurance Company ("Comstock"), a former affiliate of Fremont Indemnity, which
was subsequently merged into Fremont Indemnity. This case alleged similar causes
of action regarding the usage of the NOLs as in the Fremont Indemnity case as
well as improper transactions with other insurance subsidiaries and affiliates
of Fremont Indemnity. This matter was deemed a related case to the Fremont
Indemnity case. On April 22, 2005, the Court dismissed, without leave to amend,
the entire complaint. This ruling does not address or necessarily have legal
effect on the related Fremont Indemnity case. The Commissioner has filed an
Appeal to the Court's dismissal of the complaint. The Company continues to
believe that this lawsuit is without merit.
GERLING GLOBAL REINSURANCE CORPORATION OF AMERICA V. FREMONT GENERAL CORPORATION
ET AL.:
On July 27, 2005, Gerling Global Reinsurance Corporation of America
("Gerling") filed a lawsuit in Federal District Court (the "Court") against
Fremont General arising out of a reinsurance treaty between Gerling and Fremont
Indemnity alleging 1) Fraud/Intentional Misrepresentation and Concealment; 2)
Breach of Fiduciary Duty; 3) Willful and Wanton Misconduct; 4) Negligent
Misrepresentation; 5) Gross Negligence; 6) Tortuous Interference with Contract;
7) Unjust Enrichment; and 8) Breach of Contract for allegedly improper
underwriting practices by Fremont Indemnity during 1998 and 1999. In October
2005, Gerling filed a First Amended Complaint ("FAC") alleging 1)
Fraud/Intentional Misrepresentation and Concealment; 2) Inducement to Breach and
Breach of Fiduciary Duty and Duty of Utmost Good Faith; 3) Willful and Wanton
Misconduct; 4) Negligent Misrepresentation; 5) Gross Negligence; 6) Tortuous
Interference with Contract; 7) Unjust Enrichment; and 8) Inducement to Breach
and Breach of Contract.
On December 12, 2005, the Company's Motion to Dismiss the FAC was argued
and heard before the Court. On December 15, the Court issued its Order
dismissing with prejudice Gerling's Third through Sixth Causes of Action, which
asserted claims for Willful and Wanton Misconduct, Negligent Misrepresentation,
39
Gross Negligence and Tortuous Interference with Contract, and also dismissed
with prejudice that part of Gerling's Eighth Cause of Action that alleged
Inducement to Breach of Contract. The Court also dismissed the Breach of
Contract claim, but granted Gerling leave to replead that claim.
In January 2006, Gerling filed a Second Amended Complaint ("SAC") alleging
1) Fraud/Intentional Misrepresentation and Concealment; 2) Breach of Fiduciary
Duty and Duty of Utmost Good Faith; 3) Unjust Enrichment; and 4) Breach of
Contract. On March 6, 2006, Fremont General's Motion to Dismiss this SAC were
argued and heard before the Court. On its own motion, the Court converted the
Motion to Dismiss to a Motion for Summary Judgment and ordered that it be reset
for hearing following limited discovery on the statute of limitations issues
raised in the Motion. The Company continues to believe that this lawsuit is
without merit.
The Company retains the right in its securitization transactions to call
the securities when the outstanding balance of loans in the securitization trust
declines to a specific level, typically 10% of the original balance. Management
expects that it may exercise its clean-up call option. The loans acquired via
the clean-up call may be then either sold or put into the Company's loan
portfolio. While it is expected that most loans acquired in a clean-up call can
be sold for gains or retained as attractive portfolio investments, a portion of
the loans are expected to be non-performing and thus, it is possible that
non-performing loans may increase temporarily between the time of the call
exercise and the disposition of the loans.
NOTE 21: OPERATIONS BY REPORTABLE SEGMENT
The Company manages its operations based on the types of products and
services offered by each of its strategic business units. Based on that approach
the Company has grouped its products and services into two reportable segments
-- Commercial and Residential Real Estate.
The Commercial Real Estate segment originates its commercial real estate
loans, which are primarily bridge and construction facilities, on a nationwide
basis. These loans, which are held for investment, generate net interest income
on the difference between the rates charged on the loans and the cost of
borrowed funds.
The Residential Real Estate segment originates non-prime or sub-prime loans
nationally through independent brokers on a wholesale basis. These loans are
then primarily sold to third party investors on a servicing-released or
servicing-retained basis, or, to a lesser extent, securitized. Net interest
income is
40
recognized on these loans during the period that the Company holds them for
sale. In addition, servicing income is realized on the loans that are
originated.
Management measures and evaluates each of these segments based on total
revenues generated, net interest income and pre-tax operating results. The
results of operations include certain allocated corporate expenses as well as
interest expense charged back to the segments for the use of funds generated by
the Company's corporate and retail banking operations. Interest expense is
allocated among the residential and commercial segments using treasury rates
matched to the terms of the respective loans plus a spread to cover the expenses
of the retail banking operations.
Certain expenses that are centrally managed at the corporate level such as
provision for income taxes and other general corporate expenses are excluded
from the measure of segment profitability reviewed by management. Therefore, the
Company has included these expenses along with the results of the Company's
retail banking operation, which does not meet the definition of a reportable
segment, in the Corporate and Retail Banking category. Historical periods have
been restated to conform to this presentation.
41
Intersegment eliminations shown in the table below relate to the credit
allocated to the retail banking operations for operating funds provided to the
two reportable segments.
RESIDENTIAL COMMERCIAL CORPORATE AND INTERSEGMENT TOTAL
REAL ESTATE REAL ESTATE RETAIL BANKING ELIMINATIONS CONSOLIDATED
----------- ----------- -------------- ------------ ------------
(THOUSANDS OF DOLLARS)
Three months ended March 31, 2006
Total revenues ...................................... $ 153,625 $ 111,056 $ 94,231 $ (84,707) $ 274,205
Net interest income ................................. 77,498 58,955 17,537 - 153,990
Provision for loan losses ........................... (4) 3,891 (6) - 3,881
Net gain on whole loan sales and securitizations
of residential real estate loans .................. (15,176) - - - (15,176)
Mortgage servicing rights amortization .............. (8,044) - - - (8,044)
Compensation ........................................ 32,770 6,626 20,014 - 59,410
Other non-interest expense .......................... 12,432 4,404 14,420 - 31,256
Income before income taxes .......................... 7,912 43,635 1,601 - 53,148
Total consolidated assets ........................... 6,780,237 5,255,369 1,049,846 - 13,085,452
Three months ended March 31, 2005
Total revenues ...................................... $ 229,234 $ 69,621 $ 59,689 $ (56,714) $ 301,830
Net interest income ................................. 70,304 41,181 7,267 - 118,752
Provision for loan losses ........................... (5) 1,041 - - 1,036
Net gain on whole loan sales and securitizations
of residential real estate loans .................. 108,360 - - - 108,360
Mortgage servicing rights amortization .............. (4,485) - - - (4,485)
Compensation ........................................ 35,023 6,663 17,594 - 59,280
Other non-interest expense .......................... 10,715 (1,644) 11,158 - 20,229
Income before income taxes .......................... 133,738 36,904 (19,464) - 151,178
Total consolidated assets ........................... 6,148,271 3,680,252 1,129,076 - 10,957,599
42
NOTE 22: EARNINGS PER SHARE
Earnings per share have been computed based on the weighted-average number
of shares. The following tables set forth the computation of basic and diluted
earnings per share:
THREE MONTHS ENDED
MARCH 31,
----------------------
2006 2005
-------- --------
(THOUSANDS OF SHARES
AND DOLLARS, EXCEPT
PER SHARE DATA)
Net income
(numerator for basic earnings per share) .................................. $ 31,687 $ 90,102
Effect of dilutive securities:
LYONs ..................................................................... - 4
-------- --------
Net income available to common stockholders after assumed
conversions (numerator for diluted earnings per share) .................... $ 31,687 $ 90,106
======== ========
Weighted-average shares
(denominator for basic earnings per share) ................................ 73,513 71,368
Effect of dilutive securities using the treasury stock method
for restricted stock and stock options:
Employee benefit plans .................................................. 1,158 1,008
Restricted stock ........................................................ 410 1,272
Stock options ........................................................... 99 106
LYONs ................................................................... - 35
-------- --------
Dilutive potential common shares ............................................ 1,667 2,421
-------- --------
Adjusted weighted-average shares and assumed conversions
(denominator for diluted earnings per share) .............................. 75,180 73,789
======== ========
Basic earnings per share .................................................... $ 0.43 $ 1.26
======== ========
Diluted earnings per share .................................................. $ 0.42 $ 1.22
======== ========
For additional disclosures regarding stock options and restricted stock see
Note 17.
43
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Fremont General Corporation ("Fremont General" or when combined with its
subsidiaries "the Company" or "we") is a holding company which is engaged in
lending operations through its indirectly wholly-owned subsidiary, Fremont
Investment & Loan ("FIL"). FIL is a California industrial bank. Fremont General
is not a "bank holding company" as defined for regulatory purposes.
FIL has two primary lending operations, commercial and residential, both
operating on a nationwide basis. FIL's commercial real estate lending operation
includes nine regional offices and, as of March 31, 2006, had loans outstanding
in 31 states. The residential real estate lending platform originated loans from
46 states through its five regional loan production centers as of March 31,
2006. FIL funds its lending operations primarily through deposit accounts
sourced in California that are insured up to the maximum legal limit by the
Federal Deposit Insurance Corporation ("FDIC") and, to a lesser extent, advances
from the Federal Home Loan Bank ("FHLB") of San Francisco. As such, FIL is
regulated by the FDIC and the Department of Financial Institutions of the State
of California ("DFI"). FIL raises its retail deposits in California
(predominately Southern California) through a network of 21 branches and a
centralized call center. FIL will also utilize its warehouse lines of credit
from time to time to fund part of its residential real estate loan production.
FIL's residential real estate lending operation originates first, and to a
lesser degree, second mortgage loans on a wholesale basis through a network of
independent mortgage brokers. FIL offers mortgage products that are designed for
borrowers who do not generally satisfy the credit, documentation or other
underwriting standards prescribed by conventional mortgage lenders and loan
buyers, such as Fannie Mae (Federal National Mortgage Association) and Freddie
Mac (Federal Home Loan Mortgage Corporation) and are commonly referred to as
"non-prime" or "sub-prime". These borrowers generally have considerable equity
in the properties securing their loans, but have impaired or limited credit
profiles or higher debt-to-income ratios than conventional mortgage lenders
allow. The borrowers also include individuals who, due to self-employment or
other circumstances, have difficulty documenting their income through
conventional means. FIL seeks to mitigate its exposure to credit risk through
underwriting standards that strive to balance appropriate loan to collateral
valuations with a borrower's credit profile. All of the residential real estate
loans that FIL originates are currently either sold in whole loan sales to
various financial institutions, or to a lesser extent, securitized and sold to
various investors. The Company has retained some of these loans as held for
investment in prior periods and may do so again in the future.
FIL's commercial real estate lending operation provides first mortgage
financing on various types of commercial properties. The loans that FIL
originates are substantially all held for investment, with some
44
loans participated out to limit credit exposures. Loans are originated through
broker and borrower relationships and the borrowers are typically mid-size
developers and owners seeking a loan structure that provides limited recourse
and is short-term, providing bridge or construction financing for comprehensive
construction, renovation, conversion, repositioning and lease-up of existing or
new properties. To manage the credit risk involved in this lending, FIL is
focused on the value and quality of the collateral and the quality and
experience of the parties with whom it does business. The size of loan
commitments originated generally range from $20 million to $100 million, with
some loans for larger amounts.
The Company's two operating lines of business are generally designed to be
somewhat counter-cyclical and to provide balance in varying economic cycles;
however, this balance may not be achieved as both of the Company's operating
businesses are influenced by the overall condition of the economy, in particular
the interest rate environment, and various market conditions. As a result, the
Company is subject to experiencing cyclicality in volume, gain (or loss) on the
sale of loans, net interest income, loan losses and earnings. The Company
strives to manage its operations so as to optimize operational efficiency and to
maintain risks within acceptable parameters. The Company's lending operations
generate income as follows:
o All of the residential real estate loans originated are currently sold for
varying levels of gain or loss through whole loan sales to other financial
institutions, and to a lesser degree, to various investors through
securitization transactions. A held for sale valuation reserve, a loan
repurchase reserve and a premium recapture reserve are maintained and
adjusted through provisions (which are either an expense or a credit to
income) that are recognized in the consolidated statements of income. Net
interest income is recognized on these loans during the period that the
Company holds them for sale. The Company also recognizes interest income on
the residual interests it retains from its securitization transactions.
Servicing income is realized on the loans sold into the Company's
securitizations and on whole loan sales when servicing is retained, as well
as on an interim basis for loans sold on a servicing released basis to
other financial institutions. When servicing is retained either through a
securitization or a whole loan sale with servicing retained, a mortgage
servicing rights ("MSR") asset is typically established; the MSR is
amortized to expense over the expected life of the related servicing
income.
o Commercial real estate loans, which are held for investment, generate net
interest income on the difference between the rates charged on the loans
and the cost of borrowed funds. The majority of commercial real estate
loans originated are adjustable interest rate loans based upon six-month
LIBOR and an applicable margin. An allowance for loan losses is maintained
through provisions (expense) that are recognized in the consolidated
statements of income.
The principal market risks the Company faces are interest rate risk and
liquidity risk. Interest rate risk is the risk that the valuation of the
Company's interest sensitive assets and liabilities and its net interest income
will change due to changes in interest rates. Liquidity risk, which is the
ability of the Company to access the necessary funding and capital resources, in
a cost-effective manner, to fund its loan originations
45
or to sell its loans held for sale. Liquidity risk also entails the risk of
changes in secondary market conditions, which can negatively impact the pricing
realized by the Company on the loans it sells or securitizes. The Company
endeavors to mitigate interest rate risk by attempting to match the rate reset
(or repricing) characteristics of its assets with its liabilities. The Company
utilizes forward loan sale commitments to lock in liquidity execution and to
hedge its loans held for sale, Eurodollar futures to hedge a portion of its loan
pipeline and its loans held for sale, and interest rate caps to hedge execution
of its securitization transactions. Residential and commercial mortgage lending
requires significant cash to fund loan originations; the Company strives to
maintain certain liquidity levels, both in available funds and in funding
capacity, to ensure its ability to meet its funding objectives without
constraint. The Company is dependent upon the securitization market for the sale
of its residential real estate loans as it either securitizes the loans directly
or many of its whole loan buyers purchase the loans with the intent to
securitize. The secondary or securitization market is dependent upon many
factors that can change the demand and thus impact the pricing the Company
realizes on the sale of its residential real estate loans. The level of demand
and general market conditions in the secondary market can significantly effect
the level of gain or loss realized by the Company in the sale of these loans.
The objective of the interest rate and liquidity risk management activities is
to reduce the risk of operational disruption and to reduce the volatility in
income caused by changes in interest rates and market conditions; however, the
mortgage banking industry is inherently subject to income volatility due to the
effect of interest rate variations on loan production volume, premiums realized
on loan sales and securitizations, and loan prepayment patterns, which in turn
affects the valuation of the Company's loans held for sale, residual interests
and MSRs, as well as the amount of loan servicing income realized.
This discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and notes thereto presented under Item 1, and
the Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2005.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's discussion and analysis of its financial condition and
results of operations are based upon its consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America ("GAAP"). The preparation of these
financial statements requires the Company to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses. On an
on-going basis, the Company evaluates its estimates, which are based on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
The Company has identified four accounting policies as being critical
because they require more significant judgment and estimates about matters that
may differ from the estimates determined under
46
different assumptions or conditions. These critical accounting policies relate
to the gain or loss on whole loan sales and securitizations, allowance for loan
losses, derivatives and income taxes. The critical accounting policies and
estimates are further discussed in Management's Discussion and Analysis in the
Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
EARNINGS PERFORMANCE
The Company reported net income of $31.7 million for the first quarter of
2006. This is compared to net income of $90.1 million for the first quarter of
2005. The Company reported income before income taxes of $53.1 million for the
first quarter of 2006 as compared to $151.2 million for the first quarter of
2005. The income before income taxes for the first quarter of 2006 of $53.1
million represents a decrease of 64.8% from the results for the first quarter of
2005. This decrease in income during the first quarter of 2006 is primarily a
result of the Company recognizing a loss on the sale of its residential real
estate loans. In addition, the Company incurred higher non-interest expenses.
These were partially offset by increased levels of net interest income and loan
servicing income.
NET INTEREST INCOME
The Company recorded net interest income for the first quarter of 2006 of
$154.0 million as compared to $118.8 million for the first quarter of 2005. The
increase in net interest income is primarily a result of an increase in the
level of average interest-earning assets. Total average interest-earning assets
increased 21.6% to $12.6 billion during the first quarter of 2006, as compared
to $10.4 billion during the first quarter of 2005. This increase is primarily
the result of significantly higher levels of commercial and residential real
estate loans held for investment and sale. In addition, the Company's residual
interests in securitized loans also increased substantially; these residual
interests typically realize a higher yield than the Company's other
interest-earning assets, thus positively impacting net interest income and net
interest income margin. The net interest income margin as a percentage of
average interest-earning assets increased to an annualized 4.95% for the first
quarter of 2006 from 4.64% for the first quarter of 2005. Net interest income is
impacted by the volume, mix and rate of interest-earning assets and
interest-bearing liabilities.
The following tables identify the consolidated interest income, interest
expense, average interest-earning assets and interest-bearing liabilities, and
net interest margins, as well as an analysis of changes in net interest income
due to volume and rate changes, for the first three months of 2006 and 2005:
47
THREE MONTHS ENDED MARCH 31,
----------------------------------------------------------------------
2006 2005
-------------------------------- --------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST
------------ --------- ----- ------------ --------- -----
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Interest-earning assets (1):
Commercial real estate loans ...................... $ 5,032,346 $ 109,534 8.83% $ 3,621,587 $ 66,392 7.43%
Residential real estate loans (2) ................. 6,946,567 139,758 8.16% 6,227,301 111,109 7.24%
Residual interests in securitized loans ........... 104,360 16,809 65.32% 15,257 1,338 35.57%
Cash equivalents and investment securities ........ 538,600 6,769 5.10% 517,109 3,085 2.42%
------------ --------- ----- ------------ --------- -----
Total interest-earning assets ........... $ 12,621,873 $ 272,870 8.77% $ 10,381,254 $ 181,924 7.11%
============ ========= ===== ============ ========= =====
Interest-bearing liabilities:
Time deposits ..................................... $ 7,422,836 $ 76,809 4.20% $ 5,896,354 $ 39,567 2.72%
Savings deposits .................................. 1,579,925 13,876 3.56% 1,750,069 9,789 2.27%
FHLB advances ..................................... 1,923,956 20,656 4.35% 1,346,347 7,506 2.26%
Warehouse lines of credit ......................... 85,358 1,637 7.78% - 219 -
Senior Notes due 2009 ............................. 176,180 3,546 8.05% 181,450 3,650 8.05%
LYONs ............................................. - - - 574 7 4.95%
Junior Subordinated Debentures .................... 103,093 2,320 9.00% 103,093 2,320 9.00%
Other ............................................. 23,225 36 0.63% 23,982 114 1.93%
------------ --------- ----- ------------ --------- -----
Total interest-bearing liabilities ...... $ 11,314,573 $ 118,880 4.26% $ 9,301,869 $ 63,172 2.75%
============ ========= ===== ============ ========= =====
Net interest income ................................. $ 153,990 $ 118,752
========= =========
Percent of average interest-earning assets:
Interest income ................................... 8.77% 7.11%
Interest expense .................................. 3.82% 2.47%
----- -----
Net interest margin ............................... 4.95% 4.64%
===== =====
(1) Average loan balances include non-accrual loan balances.
(2) Includes loans held for sale and other.
48
THREE MONTHS ENDED MARCH 31,
2006 COMPARED TO 2005
-------------------------------------
CHANGE DUE TO
-----------------------
VOLUME (1) RATE TOTAL
---------- --------- ---------
(THOUSANDS OF DOLLARS)
Cash equivalent and investment securities .................................. $ 413 $ 3,271 $ 3,684
Loans and residual interests ............................................... 59,505 27,757 87,262
--------- --------- ---------
Total increase in interest income .......................................... 59,918 31,028 90,946
--------- --------- ---------
Time deposits .............................................................. (15,796) (21,446) (37,242)
Savings deposits ........................................................... 1,494 (5,581) (4,087)
FHLB advances .............................................................. (6,201) (6,949) (13,150)
Warehouse lines of credit .................................................. (1,418) - (1,418)
Senior Notes due 2004 and 2009 ............................................. 104 - 104
LYONs ...................................................................... 7 - 7
Junior Subordinated Debentures ............................................. - - -
Other ...................................................................... 1 77 78
--------- --------- --------
Total (increase) in interest expense ....................................... (21,809) (33,899) (55,708)
--------- --------- --------
Increase / (decrease) in net interest income ............................... $ 38,109 $ (2,871) $ 35,238
========= ========= ========
(1)Changes in rate/volume are allocated to change in volume.
NON-INTEREST INCOME
WHOLE LOAN SALES AND SECURITIZATIONS OF RESIDENTIAL REAL ESTATE LOANS
The Company realized a $15.2 million loss on the sale of its residential
real estate loans during the first quarter of 2006; this is compared to a $108.4
million gain in the first quarter of 2005. The loss on sale is primarily
attributable to a decrease in the gross premiums received on loan sales during
the first quarter of 2006 and increased levels of provisions for loan valuation
and repurchase reserves, as compared to the first quarter of 2005. The net gain
(loss) percentage (the net gain or loss after direct costs, net gains or losses
on derivative instruments, provisions for premium recapture and valuation and
repurchase reserves, divided by net loans sold) on these sales and
securitizations decreased to (0.21)% in the first quarter of 2006 from 1.55% in
the first quarter of 2005.
A total of $7.25 billion in loans were sold during the first quarter of
2006, as compared to loan sales and securitizations of $7.06 billion during the
first quarter of 2005. The average gross premium on loans sold during the first
quarter of 2006 was 1.21% as compared to an average of 2.91% for the first
quarter of 2005. The decrease in gross premiums is a result of lower interest
rate margins (reflecting increased price competition in the non-prime mortgage
origination market) and soft secondary market conditions. The loans sold during
the first quarter of 2006 were sold pursuant to forward loan sale commitments
entered into during the fourth quarter of 2005, when secondary market conditions
were weak. In addition, pricing for second mortgages in the secondary market
declined during the first quarter of 2006. The Company's direct
49
costs of loan origination associated with loans sold decreased during the first
quarter of 2006 to 0.93% from 1.36% in the first quarter of 2005 as a result of
lower costs incurred for broker and account executive compensation. The Company
reported provisions for valuation and repurchase reserves for the first quarter
of 2006 of $32.5 million (or 0.45%) of total net loan sales and securitizations,
as compared to $10.1 million (or 0.14%) for the first quarter of 2005. The
increased provisions for loan valuation and repurchase reserves is primarily due
to increased loan repurchase trends and lower values for second mortgages. The
Company continually evaluates the loss estimates utilized for its valuation and
repurchase reserves based upon its analysis of historical and current data and
the mix of loan characteristics.
The Company realized a net gain of $14.6 million on its derivative
instruments utilized to hedge the impact of interest rate volatility on its
residential real estate lending activities during the first quarter of 2006.
This net gain primarily resulted from an increase in the underlying interest
rate indices (primarily the two-year swap rate) which conversely had a negative
impact upon the gross loan sale premiums realized during the same period.
The Company's gross loan premiums, loan repurchase and valuation reserves
and the gain or loss on derivative instruments have exhibited, and are expected
to continue to exhibit, variability (often significant) based on various
economic, credit and interest rate environments, as well as on the Company's
loan sale and hedging activity levels and their timing.
The following table provides the amounts of loans sold during the
respective periods and additional detail on the net gain (loss) on whole loan
sales and securitizations:
50
THREE MONTHS ENDED
MARCH 31,
---------------------------
2006 2005
----------- -----------
(THOUSANDS OF DOLLARS)
Whole loan sales of residential real estate loans ........................... $ 7,257,655 $ 5,849,309
Securitizations of residential real estate loans ............................ - 1,209,849
----------- -----------
Total loan sales and securitizations - net of repurchases ................... $ 7,257,655 $ 7,059,158
=========== ===========
Gross premium recognized on Tier I loan sales and securitizations ........... $ 87,933 $ 204,876
Losses on Tier II sales ..................................................... (13,989) (3,180)
----------- -----------
73,944 201,696
Net gain on derivative instruments .......................................... 14,596 17,188
----------- -----------
88,540 218,884
Net direct loan origination costs ........................................... (67,767) (96,193)
Provision for premium recapture ............................................. (3,496) (4,270)
----------- -----------
17,277 118,421
Provision for valuation and repurchase reserves ............................. (32,453) (10,061)
----------- -----------
Net gain (loss) on sale ................................................. $ (15,176) $ 108,360
=========== ===========
Net gain (loss) on sale ..................................................... $ (15,176) $ 108,360
Origination expenses allocated during the period of origination ............. (27,463) (36,304)
----------- -----------
Net operating gain (loss) on sale ....................................... $ (42,639) $ 72,056
=========== ===========
Gross premium recognized on Tier I loan sales and securitizations ........... 1.21 % 2.91 %
Losses on Tier II sales ..................................................... (0.19)% (0.05)%
----------- -----------
1.02 % 2.86 %
Net gain on derivative instruments .......................................... 0.20 % 0.25 %
----------- -----------
1.22 % 3.11 %
Net direct loan origination costs ........................................... (0.93)% (1.36)%
Provision for premium recapture ............................................. (0.05)% (0.06)%
----------- -----------
0.24 % 1.69 %
Provision for valuation and repurchase reserves ............................. (0.45)% (0.14)%
----------- -----------
Net gain (loss) on sale ................................................. (0.21)% 1.55 %
=========== ===========
Net gain (loss) on sale ..................................................... (0.21)% 1.55 %
Origination expenses allocated during the period of origination ............. (0.38)% (0.51)%
----------- -------------
Net operating gain (loss) on sale ...................................... (0.59)% 1.04 %
=========== ============
o Percentages are of total loan sales and securitizations, net of repurchases, during the period indicated.
o Tier II loans do not meet the criteria for a Tier I sale due to delinquency status, documentation issues
or loan program exceptions for which the Company typically receives lower premiums.
o Provision for premium recapture is the provision for the return of premium on loans sold which prepay early
per the terms of each sales contract; includes some interest adjustment.
o Provision for valuation and repurchase reserves represents adjustments to the valuation allowance for the
Company's held for sale loans and adjustments to the Company's repurchase reserve for the effect of loans
estimated to be repurchased and the related return premiums.
o Origination expenses represent indirect expenses related to the origination of residential real estate loans
during the period of origination and which are not deferred for GAAP. These expenses are included in non-interest
expense in the consolidated statements of income during the period incurred. There is no directly comparable GAAP
financial measure to "Origination expenses allocated during the period of origination", the components of which
are calculated in accordance with GAAP.
o Net operating gain on sale is a supplement to, and not a substitute for, the information presented in the
consolidated statements of income as prepared in accordance with GAAP. The Company utilizes this additional
information as part of its management of the total costs and efficiency of its loan origination platform.
Furthermore, our definition of the indirect origination expenses may not be comparable to similarly titled
measures reported by other companies. Because these expenses are estimates that are based on loans sold during the
current period utilizing actual costs from prior periods, these costs may fluctuate from period to period reflecting
changes in the volume of loans sold, originated and the actual indirect expenses incurred during the period of loan
origination. The net operating gain on sale amount does not include net interest income on residential real estate
loans held for sale or any fair value adjustments on the Company's residual interests in securitized loans.
51
LOAN SERVICING AND OTHER NON-INTEREST INCOME
The components of the Company's loan servicing income, MSR amortization and
impairment and other non-interest income for the first quarter of 2006 and 2005
are indicated in the following table:
THREE MONTHS ENDED
MARCH 31,
----------------------
2006 2005
-------- --------
(THOUSANDS OF DOLLARS)
Loan Servicing Income:
Servicing fee income:
Securitization transactions ............................................ $ 8,796 $ 4,380
Interim .............................................................. 6,452 6,507
Loans sold - servicing retained ...................................... 1,352 830
-------- --------
16,600 11,717
Ancillary income ....................................................... 2,906 1,724
Other .................................................................. 1,843 300
-------- --------
$ 21,349 $ 13,741
======== ========
MSR Amortization and Impairment:
MSR amortization ......................................................... $ (8,044) $ (4,485)
MSR impairment provision ................................................. - (419)
-------- --------
$ (8,044) $ (4,904)
======== ========
Other Non-Interest Income:
Prepayment fees:
Commercial real estate ................................................. $ 642 $ 961
Residential real estate ................................................ 641 562
Commercial real estate transaction fees .................................. 1,018 2,063
Net gain on extinguishment of debt ....................................... 22 -
All other ................................................................ 883 341
-------- --------
$ 3,206 $ 3,927
======== ========
Loan servicing income (which is all related to residential real estate),
increased from $13.7 million in the first quarter of 2005 to $21.3 million for
the first quarter of 2006. The increase was due to increased residential real
estate loan origination volume, which resulted in an increase in loan
securitization activity in prior periods and higher levels of interim servicing
during the first quarter of 2006 as compared to the first quarter of 2005.
Although the Company did not enter into a securitization transaction during the
first quarter of 2006, the higher levels of MSRs over prior periods resulted in
an increase in the amortization (expense) of the MSRs in the first quarter of
2006 versus 2005.
The Company was servicing $23.2 billion in principal balance of residential
loans as of March 31, 2006 as compared to $18.8 billion as of March 31, 2005 and
reflects the increase in loan servicing volume during the prior twelve months.
The Company intends to continue to service its loans held for sale and
52
those loans it securitizes, and continues to service some loans sold to other
parties for more than on an interim basis.
The following is a breakdown of the loans being serviced by categorization
as of the dates indicated:
MARCH 31, DECEMBER 31,
2006 2005
-------- -----------
(MILLIONS OF DOLLARS)
Loans in securitizations .................................................... $ 6,681 $ 7,381
Loans held for sale ......................................................... 6,602 5,412
Loans sold and servicing retained ........................................... 1,904 1,082
Loans sold and serviced on an interim basis ................................. 7,991 8,377
-------- -----------
$ 23,178 $ 22,252
======== ===========
PROVISION FOR LOSSES
For the first quarter of 2006 the Company recognized a $3.9 million
provision expense as compared to a $1.0 million expense for the first quarter of
2005. The provision expense increase was primarily a result of the increase
between the quarters in the commercial real estate loans held for investment
partially offset by the decreased levels of net charge-offs and non-accrual and
classified (substandard) commercial real estate portfolio loans. In addition,
the Company has continued to reduce its exposure to commercial real estate loans
secured by hotel and lodging properties which have been the majority of the
non-accrual loans and net charge-offs in prior periods. The net charge-off
amounts and ratios (to average loans outstanding) for the commercial real estate
portfolio were $(67,000) or (0.01)% for the first quarter of 2006 and $621,000
or 0.07% for the first quarter of 2005. The provision for loan losses represents
the current period expense (or credit to income) associated with maintaining an
appropriate allowance for loan losses. The loan loss provision or credit for
each period is dependent upon many factors, including loan growth, net
charge-offs, changes in the composition and concentrations (geographic,
industry, loan structure and individual loan) of the loan portfolio, the number
and balances of non-accrual loans, delinquencies, the levels of restructured
loans, assessment by management of the inherent risk in the portfolio, the value
of the underlying collateral on classified loans and the general economic
conditions in the commercial real estate markets in which the Company lends.
Periodic fluctuations in the provision for loan losses and the allowance for
loan losses result from management's on-going assessment of their adequacy.
53
NON-INTEREST EXPENSE
Non-interest expense increased from $86.4 million in the first quarter of
2005 to $98.3 million for the first quarter of 2006; an increase of
approximately 14%. Increases in legal, professional, information technology
expenses and foreclosed real estate costs resulted in the non-interest expense
increase. Compensation expense increased from $59.3 million for the first
quarter of 2005 to $59.4 million for the first quarter of 2006. A decrease in
the compensation expense related to residential real estate sales compensation
was largely matched by a decrease in the capitalization level of direct loan
origination costs. An overall increase in base compensation was largely offset
by a decrease in incentive and benefits costs (such as management incentive
compensation, employee stock ownership, 401(K) and other related accruals).
Compensation and non-compensation related operating expenses are detailed in the
following tables:
THREE MONTHS ENDED
MARCH 31,
------------------------
2006 2005
--------- ---------
(THOUSANDS OF DOLLARS)
Compensation and related .................................................... $ 59,410 $ 59,280
Occupancy ................................................................... 7,630 6,935
Other ....................................................................... 31,256 20,229
--------- ---------
Total non-interest expense .................................................. $ 98,296 $ 86,444
========= =========
THREE MONTHS ENDED
MARCH 31,
------------------------
2006 2005
--------- ---------
(THOUSANDS OF DOLLARS)
Total compensation and related .............................................. $ 115,712 $ 124,550
Deferral of loan origination costs (1) ...................................... (56,302) (65,270)
--------- ---------
Compensation and related .................................................... $ 59,410 $ 59,280
========= =========
(1) Incremental direct costs associated with the origination of loans are
deferred when incurred. For residential real estate loans, when the
related loan is sold, the deferred costs are included as a component of
net gain on sale.
54
Other non-interest expense categories for the three months ended March
31, 2006 and 2005 are summarized below:
THREE MONTHS ENDED
MARCH 31,
----------------------
2006 2005
-------- --------
(THOUSANDS OF DOLLARS)
Legal, professional and other outside services .............................. $ 6,737 $ 5,448
Information technology ...................................................... 4,421 3,321
Printing, supplies and postage .............................................. 3,422 3,605
Advertising promotion ....................................................... 3,918 2,702
Auto and travel ............................................................. 2,084 2,130
Leasing and loan expense .................................................... 2,826 1,953
Net real estate owned expenses .............................................. 1,096 (4,830)
Telephone ................................................................... 1,058 861
All other ................................................................... 5,694 5,039
-------- --------
Total other expenses ........................................................ $ 31,256 $ 20,229
======== ========
INCOME TAXES
Income tax expense of $21.5 million and $61.1 million for the quarters
ended March 31, 2006 and 2005, represent effective tax rates of 40.4% on income
before income taxes of $53.1 million and $151.2 million for the same respective
periods. The effective tax rates for both periods presented are different than
the Federal enacted tax rate of 35% due mainly to various apportioned state
income tax provisions.
REVIEW OF FINANCIAL CONDITION
LOANS HELD FOR SALE
The Company's residential real estate loans held for sale have increased to
$6.61 billion at March 31, 2006 from $5.42 billion at December 31, 2005. During
the first quarter of 2006, residential real estate loan originations totaled
$8.54 billion as compared to $7.76 billion for the first quarter of 2005. The
following table details the loans held for sale as of the dates indicated:
55
MARCH 31, DECEMBER 31,
2006 2005
----------- -----------
(THOUSANDS OF DOLLARS)
Loan principal balance:
1st trust deeds .......................................................... $ 5,945,287 $ 4,792,976
2nd trust deeds ........................................................... 662,574 611,104
----------- -----------
6,607,861 5,404,080
Net deferred direct origination costs ....................................... 53,641 51,782
----------- -----------
6,661,502 5,455,862
Less: Valuation reserve .................................................... (48,719) (32,753)
----------- -----------
Loans held for sale - net ................................................... $ 6,612,783 $ 5,423,109
=========== ===========
Loans held for sale on non-accrual status ................................... $ 26,562 $ 16,736
=========== ===========
During the latter half of 2005, the Company implemented pricing strategies
designed to reduce the production volume of interest-only loans, while at the
same time a 40-year amortization (due in 30 years) first mortgage product was
introduced. The interest-only loans generally provide for no principal
amortization for up to the first five years and are available on the 2/28 and
3/27 (e.g., 2 years fixed rate, then 28 years adjustable rate) products. The
second lien products are all fixed rate loans. The following tables profile the
loan origination volume for the periods indicated:
56
THREE MONTHS ENDED
MARCH 31,
----------------------------
2006 2005
----------- -----------
(THOUSANDS OF DOLLARS,
EXCEPT PERCENTS)
Loan origination volume by lien position:
Firsts .................................................................... $ 7,789,657 $ 7,160,431
Seconds ................................................................... 749,487 601,241
----------- -----------
$ 8,539,144 $ 7,761,672
=========== ===========
For first lien volume only:
Average loan size ......................................................... $ 261,679 $ 234,016
Weighted-average coupon ................................................... 8.35% 7.05%
Average bureau credit score (FICO) ........................................ 619 621
Average loan-to-value (LTV) ............................................... 79.8% 81.0%
Type of product:
ARMs:
30 Year:
2/28 ................................................................ 57.4% 86.4%
3/27 ................................................................ 0.7% 3.0%
5/25 ................................................................ 0.2% 0.9%
----------- -----------
58.3% 90.3%
40/30:
2/28 ................................................................ 34.9% 0.0%
3/27 ................................................................ 0.5% 0.0%
5/25 ................................................................ 0.2% 0.0%
----------- -----------
35.6% 0.0%
----------- -----------
Total ARMs .......................................................... 93.9% 90.3%
=========== ===========
Fixed rate:
30 Year ................................................................. 4.8% 9.7%
40/30 ................................................................... 1.3% 0.0%
----------- -----------
Total fixed rate ...................................................... 6.1% 9.7%
------------ -----------
100.0% 100.0%
=========== ===========
Loan purpose:
Purchase ................................................................ 45.0% 45.3%
Refinance ............................................................... 55.0% 54.7%
----------- -----------
100.0% 100.0%
=========== ===========
For second lien volume only:
Average loan size ......................................................... $ 65,366 $ 47,042
Weighted-average coupon ................................................... 11.01% 10.06%
Average bureau credit score (FICO) ........................................ 653 648
Purpose:
Purchase ................................................................ 79.5% 78.0%
Refinance ............................................................... 20.5% 22.0%
First & Second Mortgages - Origination by geographic dispersion:
California ................................................................ 25.6% 30.2%
Florida ................................................................... 13.6% 9.7%
New York .................................................................. 12.0% 11.0%
Maryland .................................................................. 7.4% 4.9%
New Jersey ................................................................ 7.3% 6.9%
All other states .......................................................... 34.1% 37.3%
----------- -----------
100.0% 100.0%
=========== ============
57
THREE MONTHS ENDED
MARCH 31,
------------------
2006 2005
----- -----
Interest-only loans:
As a percentage of first lien volume ...................................... 10.57% 25.40%
Average bureau credit score (FICO) ........................................ 645 645
Weighted-average coupon ................................................... 7.63% 6.33%
Average loan-to-value (LTV) ............................................... 81.2% 81.7%
LOANS HELD FOR INVESTMENT AND ALLOWANCE ACTIVITY
The Company's net loans held for investment before the allowance for loan
losses was approximately $5.36 billion at March 31, 2006, as compared to $4.76
billion at December 31, 2005. Commercial real estate loans are reported net of
participations to other financial institutions or investors in the amount of
$266.0 million and $138.2 million as of March 31, 2006 and December 31, 2005,
respectively. The following table shows the total commercial real estate new
loan commitment volume, net of participations, for the periods indicated:
THREE MONTHS ENDED
MARCH 31,
---------------------------
2006 2005
----------- ----------
(THOUSANDS OF DOLLARS)
Senior loans ............................................................... $ 1,088,899 $ 1,060,673
Mezzanine loans ............................................................. - -
----------- -----------
$ 1,088,899 $ 1,060,673
=========== ===========
Average senior loan commitment size originated .............................. $ 25,926 $ 30,305
=========== ===========
58
The following table shows the Company's loans held for investment in the
various financing categories and the percentages of the total represented by
each category:
MARCH 31, 2006 DECEMBER 31, 2005
--------------------------- ---------------------------
AMOUNT % OF TOTAL AMOUNT % OF TOTAL
----------- ---------- ----------- ----------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
COMMERCIAL REAL ESTATE LOANS:
Construction ............................................. $ 3,145,093 58 % $ 2,448,428 51 %
Bridge ................................................... 1,821,681 34 % 1,887,073 39 %
Permanent ................................................ 361,937 7 % 389,681 8 %
Single tenant credit ..................................... 76,639 1 % 77,113 2 %
----------- -------------- ----------- -------------
5,405,350 100 % 4,802,295 100 %
Other ...................................................... 8,043 0 % 8,589 0 %
----------- ---------- ----------- ----------
5,413,393 100 % 4,810,884 100 %
Deferrred fees and costs ................................... (50,578) (1)% (50,984) (1)%
Allowance for loan losses .................................. (160,789) (3)% (156,837) (3)%
----------- ---------- ----------- ----------
Loans held for investment .................................. $ 5,202,026 96 % $ 4,603,063 96 %
=========== ========== =========== ==========
As of March 31, 2006, approximately 22.9%, 14.0% and 13.3% of the Company's
commercial real estate loans outstanding were secured by properties located
within California, Florida and New York, respectively; no other state
represented greater than 8% of the loan portfolio. The real estate securing
these loans includes a wide variety of property and project types including
multi-family, office, retail, industrial, land development, lodging and
mixed-use properties. The loans in the portfolio were distributed by property
type as follows as of the dates indicated:
MARCH 31, DECEMBER 31,
2006 2005
-------- ----------
Multi-family - Condominiums ...................... 52% 48%
Land Development ................................. 15% 15%
Office ........................................... 13% 14%
Retail ........................................... 6% 7%
Industrial ....................................... 4% 4%
Commercial Mixed-Use ............................. 3% 5%
Multi-family - Other ............................. 3% 3%
Special Purpose .................................. 2% 2%
Hotels & Lodging ................................. 2% 2%
-------- -----------
100% 100%
======== ===========
59
The commercial real estate loan portfolio as of March 31, 2006, is
stratified by loan size as follows (thousands of dollars, except percents and
number of loans):
TOTAL LOANS # OF AVERAGE
LOAN SIZE OUTSTANDING % LOANS LOAN SIZE
-------------------------------- ----------- --- ----- ----------
$0 - $ 1 million $ 2,534 0% 66 $ 38
> $1 million - $ 5 million 159,262 3% 48 3,318
> $5 million - $10 million 567,461 10% 77 7,370
> $10 million - $15 million 420,038 8% 35 12,001
> $15 million - $20 million 689,080 13% 39 17,669
> $20 million - $30 million 1,103,252 20% 46 23,984
> $30 million - $40 million 772,959 14% 22 35,135
> $40 million - $50 million 579,054 11% 13 44,543
> $50 million 1,111,710 21% 15 74,114
----------- --- ----- ----------
$ 5,405,350 100% 361 $ 14,973
=========== === ===== ==========
As of March 31, 2006, the average loan size was $15.0 million (or $18.3
million when loans under $1 million are excluded) and the average loan-to-value
ratio was approximately 72%, using the most current available appraised values
and current loan balances outstanding.
The commercial real estate loan portfolio includes 15 separate loans with
outstanding balances in excess of $50 million as of March 31, 2006. The
Company's largest single individual loan outstanding (net of participation) at
March 31, 2006 was $99.8 million with a total loan commitment of $99.8 million.
The Company's largest net commitment for a single loan at March 31, 2006 was
$131.3 million (with $92.6 million outstanding); this commitment represents the
maximum potential loan amount to the borrower; however, the amount available to
borrow is generally subject to certain levels of completion or other factors on
the underlying property. As of March 31, 2006, there were seven groups of loans
(separate loans on different properties) with common investors or equity
sponsors for which the aggregate outstanding principal balance of the separate
loans exceeded $100 million. The largest concentration is from one affiliated
investment fund and totals $158.1 million in loan principal outstanding with
$224.2 million in total loan commitment and is comprised of five separate loans.
All five of the loans under this concentration were performing as of March 31,
2006.
The following tables provide additional information related to the
Company's commercial real estate non-accrual loans, foreclosed assets,
restructured loans on accrual status and accruing loans past due 90 days or
more, as well as reflect the related net loss experience and allowance for loan
loss reconciliation applicable to the loans held for investment as of and for
the respective periods ended as shown below:
60
MARCH 31, DECEMBER 31,
2006 2005
-------- -----------
(THOUSANDS OF DOLLARS,
EXCEPT PERCENTS)
Commercial Real Estate:
Non-accrual loans held for investment ("HFI") ............................... $ 42,885 $ 29,290
Real estate owned / foreclosed assets ....................................... 27,868 30,198
-------- -----------
Total non-performing assets ................................................. $ 70,753 $ 59,488
======== ===========
Accruing loans receivable past due 90 days or more .......................... $ - $ -
======== ===========
Restructured loans on accrual status ........................................ $ 7,619 $ 12,309
======== ===========
Non-accrual loans to total loans HFI ........................................ 0.80% 0.62%
Allowance for loan losses to total loans HFI ................................ 3.00% 3.29%
Allowance for loan losses to non-performing assets .......................... 227.3% 263.6%
THREE MONTHS ENDED MARCH 31, 2006
------------------------------------------------------
COMMERCIAL RESIDENTIAL
REAL ESTATE REAL ESTATE OTHER TOTAL
----------- ----------- ----- ---------
(THOUSANDS OF DOLLARS)
Beginning allowance for loan losses .................. $ 156,755 $ - $ 82 $ 156,837
Provision for loan losses ............................ 3,891 (4) (6) 3,881
Charge-offs .......................................... - - - -
Recoveries ........................................... 67 4 - 71
--------- ----------- ----- ---------
Ending allowance for loan losses ..................... $ 160,713 $ - $ 76 $ 160,789
========= =========== ===== =========
Net (charge-offs)/recoveries ......................... $ 67 $ 4 $ - $ 71
========= =========== ===== =========
Net loan charge-offs to average commercial
real estate loans held for investment .............. (0.01)%
=========
THREE MONTHS ENDED MARCH 31, 2005
------------------------------------------------------
COMMERCIAL RESIDENTIAL
REAL ESTATE REAL ESTATE OTHER TOTAL
----------- ----------- ----- ---------
(THOUSANDS OF DOLLARS)
Beginning allowance for loan losses .................. $ 171,471 $ - $ 54 $ 171,525
Provision for loan losses ............................ 1,041 (1) (4) 1,036
Charge-offs .......................................... (3,983) - - (3,983)
Recoveries ........................................... 3,362 1 - 3,363
--------- ----------- ----- ---------
Ending allowance for loan losses ..................... $ 171,891 $ - $ 50 $ 171,941
========= =========== ===== =========
Net (charge-offs)/recoveries .......................... $ (621) $ 1 $ - $ (620)
========= =========== ===== =========
Net loan charge-offs to average commercial
real estate loans held for investment .............. 0.07 %
=========
61
There were five non-accrual commercial real estate loans held for
investment (the largest having a balance of $16.9 million) totaling $42.9
million, or 0.8% of the total loans held for investment, as of March 31, 2006.
At December 31, 2005, there were five non-accrual commercial real estate loans
totaling $29.3 million, or 0.6%. There were no loans on accrual status as of
March 31, 2006 or December 31, 2005, which were 90 days or more past due.
REO related to commercial real estate loans was $27.9 million at March 31,
2006, consisting of seven properties (the largest having a balance of $11.1
million), which were acquired through or in lieu of foreclosure on loans secured
by real estate. At December 31, 2005, there were seven REO properties totaling
$30.2 million.
The level of non-performing assets fluctuates and specific loans can have a
material impact upon the total. Consideration must be given that, due to the
secured nature of the Company's loans and the presence of larger-balance loans,
the classification, and the timing thereof, of an individual loan as non-accrual
or REO can have a significant impact upon the level of total non-performing
assets, without necessarily a commensurate increase in loss exposure.
The allowance for loan losses, as a percentage of total loans held for
investment decreased to 3.00% as of March 31, 2006, as compared to 3.29% as of
December 31, 2005. In the first quarter of 2006, the Company incurred zero net
loan charge-offs and realized $71,000 in recoveries of loan balances previously
charged-off, as compared to $620,000 in total net charge-offs for the first
quarter of 2005. The net charge-off ratio for commercial real estate loans for
the first three months of 2006 was (0.01)% as compared to 0.07% for the first
three months of 2005. Loans secured by hotel and lodging properties represented
58% and 86% of the total commercial real estate loans on non-accrual status as
of March 31, 2006 and December 31, 2005, respectively.
62
LIQUIDITY AND CAPITAL RESOURCES
The commercial and residential real estate lending activities are financed
primarily through deposit accounts offered by FIL and which are insured by the
FDIC. FIL offers certificates of deposit and savings and money market deposit
accounts (insured by the FDIC to the legal maximum) through its 21 branches in
California. FIL minimizes the costs associated with its accounts by not offering
traditional checking, safe deposit boxes, ATM access and other traditional
retail services. Deposits totaled $9.26 billion at March 31, 2006 and are
summarized as to type as follows:
NUMBER OF TOTAL
ACCOUNTS DEPOSITS
--------- -----------
(THOUSANDS
OF DOLLARS)
Savings and money market deposit accounts ......................... 34,428 $ 1,573,017
Certificates of deposit:
Retail .......................................................... 129,268 6,190,337
Brokered ........................................................ N/M 1,493,626
-----------
$ 9,256,980
===========
N/M = not meaningful.
Additional financing is available to FIL through advances from the Federal
Home Loan Bank of San Francisco ("FHLB"). FIL maintains a credit line with the
FHLB which has a maximum financing availability that is based upon a percentage
of its regulatory assets, to which the actual borrowing capacity is subject to
collateralization and certain collateral sub-limits. The financing by the FHLB
is available at varying rates and terms. FIL's maximum financing availability
from the FHLB, based upon its level of regulatory assets, was approximately
$3.96 billion as of March 31, 2006. At March 31, 2006, FIL's actual borrowing
capacity, based upon the amount of collateral pledged and the applicable advance
rates, was $3.14 billion, with $1.20 billion in outstanding advances. The
weighted-average interest rate on the FHLB advances outstanding at March 31,
2006 was 4.50%. The borrowing capacity of FIL from the FHLB varies from time to
time and is dependent upon the amount and timing of loans pledged. FIL pledged
loans with a carrying value of $3.54 billion at March 31, 2006 to secure current
and any future borrowings. FIL also has a line of credit with the Federal
Reserve Bank of San Francisco, and at March 31, 2006 had a borrowing capacity,
based upon collateral pledged, of $424.0 million, with no amounts outstanding.
To expand the capacity and flexibility of funding its residential real
estate loan origination volume, the Company has four "warehouse" lines of credit
with well-established financial institutions. While the Company has historically
utilized these facilities on an infrequent basis, they may be used to fund loans
prior to their sale or securitization. At March 31, 2006, these four facilities
totaled $3.0 billion in total borrowing capacity of which $2.25 billion is on a
committed basis. Borrowing availability is created under the facilities through
the pledging of residential real estate loans held for sale. There was $713.5
million
63
outstanding on one of the facilities at March 31, 2006. Each of the facilities
is subject to certain conditions, including but not limited to financial and
other covenants. The Company was in compliance with all covenants and
requirements of these facilities as of March 31, 2006. The four facilities are
summarized as follows:
o $1 billion master repurchase facility ($500 million committed) with Goldman
Sachs Mortgage Company expiring in February 2007, secured by certain
residential real estate loans held for sale, interest at one-month LIBOR
plus a margin of 0.40%.
o $1 billion master loan and security facility ($1 billion committed) with
Greenwich Capital Financial Products expiring in September 2006, secured by
certain residential real estate loans held for sale, interest at one-month
LIBOR plus a margin of 0.40%.
o $500 million master repurchase facility ($500 million committed) with
Credit Suisse First Boston Mortgage Capital expiring in May 2006, secured
by certain residential real estate loans held for sale, interest at
overnight LIBOR plus a margin of 0.35%.
o $500 million master repurchase facility ($250 million committed) with
Lehman Brothers Bank expiring in December 2006, secured by certain
residential real estate loans held for sale, interest at one-month LIBOR
plus a margin of 0.40%.
The Company's residential loan disposition strategy is to primarily utilize
whole loan sales and, to a lesser extent, securitizations. The Company attempts
to build multiple whole loan sale relationships to achieve diversity and enhance
market liquidity. During the first three months of 2006, the Company had
transacted whole loan sales with eight different financial institutions, the
largest institution representing 27.3% of the total whole loan sales volume
during this period.
As a holding company, Fremont General currently pays its operating
expenses, interest expense, taxes, obligations under its various employee
benefit plans, and stockholders' dividends, and meets its other obligations
primarily from its cash on hand, dividends from Fremont General Credit
Corporation ("FGCC"), intercompany tax payments and benefit plan reimbursements
from FIL. During 2002 and 2003, Fremont General had significant net operating
loss carryforwards which were used to offset taxable income generated by FIL. As
a result, intercompany payments of federal income tax obligations from FIL,
which were otherwise payable to taxing authorities, were available for use by
Fremont General for general working capital purposes. The last of the net
operating loss carryforwards were fully utilized during 2003 and only current
operating losses at Fremont General will offset taxable income generated by FIL;
as a result, during 2004 and 2005, Fremont General paid most of the federal
income taxes it received from FIL to the federal taxing authorities. Dividends
of $7.7 million and $5.3 million were paid on Fremont General's
64
common stock in the quarters ended March 31, 2006 and 2005, respectively;
however, no assurance can be given that future common stock dividends will be
declared.
During 2005 and 2006, FIL transferred by dividend all of its residual
interests in securitized loans to FGCC, which is an intermediate holding company
wholly-owned by Fremont General. The residual interests at FGCC as of March 31,
2006 had an estimated fair value of $90.2 million. All of the retained residual
interests in securitized loans currently reside at FGCC. The purpose of these
dividends was to create an additional source of cash flow to Fremont General to
the extent of cash received from the residual interests.
There exist certain Federal Income Tax and California Franchise Tax matters
pending resolution, of which Fremont General is not yet able to make a
determination of their ultimate liability, but does not believe that the actual
outcomes of these matters will adversely impact its liquidity. It is expected
that the final resolution of these matters may take several years.
During the first quarter of 2006, Fremont General purchased $3.0 million
(at par value) of its 7.875% Senior Notes due 2009; the cost was approximately
$3.0 million.
Fremont General has cash and cash equivalents of $80.7 million at March 31,
2006 and no debt maturities until March of 2009.
OFF-BALANCE SHEET ACTIVITIES
During the first quarter of 2006, the Company did not complete any
securitization transactions; however in prior periods, the Company securitized a
certain amount of its residential real estate loans. Securitization is a process
of transforming the loans into securities, which are sold to investors. The
loans are first sold to a special purpose corporation, which then transfers them
to a qualifying special-purpose entity (a "QSPE") which is legally isolated from
the Company. The QSPE, in turn, issues interest-bearing securities, commonly
known as asset-backed securities, that are secured by the future cash flows to
be derived from the securitized loans. The QSPE uses the proceeds from the
issuance of the securities to pay the purchase price of the securitized loans.
The Company does not utilize unconsolidated special-purpose entities as a
mechanism to remove non-performing assets from the consolidated balance sheets.
Securitization is used by the Company to provide an additional source of
liquidity. The QSPEs are not consolidated into the Company's financial
statements since they meet the criteria established by SFAS No. 140, "Accounting
for the Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities." In general, those criteria require the QSPE to be isolated and
distinct from the transferor (the Company), to be limited to permitted
activities and have defined limits on the assets it can hold and the permitted
sales, exchanges or distributions of its assets.
65
The investors and the QSPEs do not have any recourse to the Company if the
cash flows generated by the securitized loans are inadequate to service the
securities issued by the QSPEs. At the close of each securitization, the Company
removes from its balance sheet the carrying value of the loans securitized and
adds to its balance sheet the estimated fair value of the assets obtained in
consideration for the loans which generally include the cash received (net of
transaction expenses), retained junior class securities (referred to as residual
interests) and mortgage servicing rights.
FORWARD LOOKING STATEMENTS
This report may contain "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, and are made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements and the currently reported results are based upon our current
expectations and beliefs concerning future developments and their potential
effects upon us. These statements and our results reported herein are not
guarantees of future performance or results and there can be no assurance that
actual developments and economic performance will be as anticipated by us.
Actual developments and/or results may differ significantly and adversely from
our expected or currently reported results as a result of significant risks,
uncertainties and factors, often beyond our control (as well as the various
assumptions utilized in determining our expectations), and which include, but
are not limited to, the following:
o the variability of general and specific economic conditions and trends, and
changes in, and the level of, interest rates;
o the impact of competition in the non-prime residential lending market and
in the commercial real estate lending market on our ability to adequately
price, underwrite and originate our loans;
o the impact of competition and pricing environments on loan and deposit
products and the resulting effect upon our net interest margin and net gain
on sale;
o changes in our ability to originate loans, and any changes in the cost and
volume of loans originated as a result thereof;
o the effectiveness of our interest risk management, including hedging, on
our funded and unfunded loans;
o the ability to access the necessary capital resources in a cost-effective
manner to fund loan originations, the condition of the whole loan sale and
securitization markets and the timing of sales and securitizations;
66
o our ability to sell or securitize the residential real estate loans we
originate;
o the demand for, and the pricing and valuation of, existing and future
loans, and the net premiums realized upon the sale of such loans;
o our ability to sell certain of the commercial real estate loans and
foreclosed real estate in our portfolio and the net proceeds realized upon
the sale of such;
o the impact of changes in the commercial and residential real estate
markets, and changes in the fair values of our assets and loans, including
the value of the underlying real estate collateral;
o the ability to effectively manage our growth in assets and volume,
including our lending concentrations, and to maintain acceptable levels of
credit quality;
o the ability to collect and realize the amounts outstanding, and the timing
thereof, of loans and foreclosed real estate;
o the ability to appropriately estimate an adequate level for the allowance
for loan losses, the valuation reserve for loans held for sale, the loan
repurchase reserve and the premium recapture reserve, as well as the fair
value of the retained mortgage servicing rights and residual interests in
securitizations;
o changes in various economic and other factors which influence the timing
and ultimate realization of the cash flows supporting our estimate of fair
value for our residual interests in securitized loans and mortgage
servicing rights;
o the effect of certain determinations or actions taken by, or the inability
to secure regulatory approvals from, the Federal Deposit Insurance
Corporation, the Department of Financial Institutions of the State of
California or other regulatory bodies on various matters;
o our ability to maintain cash flow sufficient for us to meet our debt
service and other obligations;
o the ability to maintain effective compliance with laws and regulations and
control expenses, particularly in periods of significant growth for us;
o the impact and cost of adverse state and federal legislation and
regulations, litigation, court decisions and changes in the judicial
climate;
o the impact of changes in federal and state tax laws and interpretations,
including tax rate changes, and the effect of any adverse outcomes from the
resolution of issues with taxing authorities;
o the ability to maintain an effective system of internal and financial
disclosure controls, and to identify and remediate any control
deficiencies, under the requirements of Section 404 of the Sarbanes-Oxley
Act of 2002; and
67
o other events, risks and uncertainties discussed elsewhere in this Form 10-K
and from time to time in our other reports, press releases and filings with
the Securities and Exchange Commission.
We undertake no obligation to publicly update such forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
The Company is subject to market risk resulting primarily from the impact
of fluctuations in interest rates upon balance sheet financial instruments such
as loans, residual interests, mortgage servicing rights, debt and derivatives.
Changes in interest rates can affect loan interest income, gains or losses on
the sale and securitization of residential real estate loans, interest expense,
loan origination volume, net investment income and total stockholders' equity.
The level of gain or loss on the sale and securitization of residential real
estate loans is highly dependent upon the level of loan origination volume, the
premium paid by the purchasers of such loans and the gain or loss realized from
hedging activities. Each of these factors, in turn, are highly dependent upon
changes in, and the level of, interest rates and other economic factors. The
Company may experience a decrease in the amount of gain it realizes should
significant interest rate volatility occur or if other economic factors have a
negative impact on the value and volume of the loans the Company originates. The
objective of the asset and liability management activities is to provide an
acceptable level of net interest and investment income and to seek cost
effective sources of capital, while maintaining acceptable levels of interest
rate and liquidity risk. There is no exposure to foreign currency or commodity
price risk.
The Company is subject to interest rate risk resulting from differences
between the rates on, and repricing characteristics of, interest-earning loans
held for investment (and loans held for sale) and the rates on, and repricing
characteristics of, interest-bearing liabilities used to finance these loans
such as deposits and debt. Interest rate gaps may arise when assets are funded
with liabilities having different repricing intervals or different market
indices to which the instruments' interest rate is tied and to this degree,
earnings will be sensitive to interest rate changes. Additionally, interest rate
gaps could develop between the market rate and the interest rate on loans in the
loan portfolio, which could result in borrowers' prepaying their loan
obligations. The Company attempts to match the characteristics of interest rate
sensitive assets and liabilities to minimize the effect of fluctuations in
interest rates. For the Company's financial instruments, the expected maturity
date does not necessarily reflect the net market risk exposure because certain
instruments are subject to interest rate changes before expected maturity. With
respect to the Company's residential real estate loans held for sale and its
unfunded loan pipeline, the Company attempts to minimize its interest rate risk
exposure through forward loan sale commitments and other
68
financial instruments, such as Eurodollar futures contracts. These financial
instruments meet the definition of a derivative under generally accepted
accounting principles and, accordingly, they are recorded in the consolidated
financial statements at fair value.
The Company is reliant upon the secondary mortgage market for execution of
its whole loan sales and securitizations of residential real estate loans. While
the Company strives to maintain adequate levels of liquidity support and capital
to withstand certain disruptions in the secondary mortgage market, a significant
disruption or change in the level of demand could adversely impact the
Company's ability to fund, sell, securitize or finance its residential real
estate loan origination volume, leading to reduced gains (or losses) on sale and
a corresponding decrease in revenue and earnings. A deterioration in performance
of the residential real estate loans after being sold in whole loan sales and
securitizations could adversely impact the availability and pricing of such
future transactions.
Quantitative and qualitative disclosures about the Company's market risk
are included in the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 2005. There have been no material changes in such risks or in
the Company's asset and liability management activities during the three months
ended March 31, 2006.
ITEM 4. CONTROLS AND PROCEDURES
As of March 31, 2006, the Company evaluated the effectiveness of the design
and operation of the Company's disclosure controls and procedures. The
evaluation was performed under the supervision and with the participation of the
Company's management, including the Chief Executive Officer ("CEO") and Chief
Financial Officer ("CFO"). Based on that evaluation, the Company's management,
including the CEO and CFO, have concluded that the Company's disclosure controls
and procedures were effective as of March 31, 2006.
There have been no changes in the Company's internal controls over
financial reporting that occurred in the last fiscal quarter that have
materially affected, or are reasonably likely to materially affect, the
Company's internal controls over financial reporting.
69
PART II - OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
The Company is a defendant in a number of legal actions arising in the
ordinary course of business and from the discontinuance of the insurance
operations. Management and its legal counsel are of the opinion that the
settlement of these actions, individually or in the aggregate, will not have a
material effect on the Company's business, financial position or results of
operations.
FREMONT INDEMNITY COMPANY (IN LIQUIDATION) V. FREMONT GENERAL CORPORATION ET
AL.:
On June 2, 2004, the State of California Insurance Commissioner John
Garamendi (the "Commissioner"), as statutory liquidator of Fremont Indemnity
Company ("Fremont Indemnity"), filed suit in Los Angeles Superior Court against
Fremont General alleging the improper utilization by Fremont General of certain
net operating loss deductions ("NOLs") allegedly belonging to its Fremont
Indemnity subsidiary (the "Fremont Indemnity case"). This complaint involves
issues that were considered resolved in an agreement among the California
Department of Insurance, Fremont Indemnity and Fremont General (the "Letter
Agreement"). The Letter Agreement, dated July 2, 2002, was executed on behalf of
the California Department of Insurance by the Honorable Harry Low, the State of
California Insurance Commissioner at that time. Fremont General has honored all
of its obligations under the Letter Agreement. On July 16, 2004, the
Commissioner filed a First Amended Complaint ("FAC") adding a cause of action
for concealment of an alleged reinsurance dispute and is seeking to rescind the
Letter Agreement.
On January 25, 2005, Fremont General's motions to dismiss the lawsuit
brought by the Commissioner, on behalf of Fremont Indemnity, against Fremont
General were argued and heard before the Superior Court of the State of
California (the "Court"). On January 26, 2005, the Court issued its rulings
dismissing all the causes of action in the FAC without leave to amend, except
for the cause of action for alleged concealment by Fremont General of a
potential reinsurance dispute, which was dismissed with leave to amend. The
Court also found that Fremont General had properly utilized the NOLs in
accordance with the Letter Agreement. In addition, the Court rejected the
Commissioner's request for findings that Fremont General's use of the NOLs and
worthless stock deduction were voidable preferences and/or fraudulent transfers.
The Court also rejected the Commissioner's request for injunctive relief to
force Fremont General to amend its prior consolidated income tax returns to
remove and forgo the worthless stock deduction for its investment in Fremont
Indemnity.
On May 2, 2005, the Commissioner filed a Second Amended Complaint ("SAC")
with regard to the 7th cause of action on behalf of Fremont Indemnity against
Fremont General alleging intentional misrepresentation, concealment and
promissory fraud, which induced the Commissioner to first enter into the Letter
Agreement. On July 15, 2005, the Court dismissed the SAC with 20 days leave to
amend. On August 4, 2005, the Commissioner filed a Third Amended Complaint
("TAC") again alleging intentional misrepresentation, concealment and promissory
fraud.
70
On November 22, 2005, the Court dismissed the remaining cause of action in
the TAC, finding that the "Plaintiff still failed to plead any affirmative
misrepresentation which is actionable." The Court also found that the "pleading
is inadequate as to damage allegations." This ruling by the Court dismisses the
only remaining cause of action in the lawsuit originally brought by the
Commissioner on behalf of Fremont Indemnity against Fremont General, first
reported on June 17, 2004. The Commissioner has filed a Notice of Appeal to the
Court's dismissal of the complaint. The Company continues to believe that this
lawsuit is without merit.
FREMONT INDEMNITY COMPANY (IN LIQUIDATION AS SUCCESSOR IN INTEREST TO COMSTOCK
INSURANCE COMPANY) V. FREMONT GENERAL CORPORATION ET AL.:
The Commissioner filed an additional and separate complaint against Fremont
General on behalf of Fremont Indemnity as successor in interest to Comstock
Insurance Company ("Comstock"), a former affiliate of Fremont Indemnity, which
was subsequently merged into Fremont Indemnity. This case alleged similar causes
of action regarding the usage of the NOLs as in the Fremont Indemnity case as
well as improper transactions with other insurance subsidiaries and affiliates
of Fremont Indemnity. This matter was deemed a related case to the Fremont
Indemnity case. On April 22, 2005, the Court dismissed, without leave to amend,
the entire complaint. This ruling does not address or necessarily have legal
effect on the related Fremont Indemnity case. The Commissioner has filed an
Appeal to the Court's dismissal of the complaint. The Company continues to
believe that this lawsuit is without merit.
GERLING GLOBAL REINSURANCE CORPORATION OF AMERICA V. FREMONT GENERAL CORPORATION
ET AL.:
On July 27, 2005, Gerling Global Reinsurance Corporation of America
("Gerling") filed a lawsuit in Federal District Court (the "Court") against
Fremont General arising out of a reinsurance treaty between Gerling and Fremont
Indemnity alleging 1) Fraud/Intentional Misrepresentation and Concealment; 2)
Breach of Fiduciary Duty; 3) Willful and Wanton Misconduct; 4) Negligent
Misrepresentation; 5) Gross Negligence; 6) Tortuous Interference with Contract;
7) Unjust Enrichment; and 8) Breach of Contract for allegedly improper
underwriting practices by Fremont Indemnity during 1998 and 1999. In October
2005, Gerling filed a First Amended Complaint ("FAC") alleging 1)
Fraud/Intentional Misrepresentation and Concealment; 2) Inducement to Breach and
Breach of Fiduciary Duty and Duty of Utmost Good Faith; 3) Willful and Wanton
Misconduct; 4) Negligent Misrepresentation; 5) Gross Negligence; 6) Tortuous
Interference with Contract; 7) Unjust Enrichment; and 8) Inducement to Breach
and Breach of Contract.
On December 12, 2005, the Company's Motion to Dismiss the FAC was argued
and heard before the Court. On December 15, the Court issued its Order
dismissing with prejudice Gerling's Third through Sixth Causes of Action, which
asserted claims for Willful and Wanton Misconduct, Negligent Misrepresentation,
Gross Negligence and Tortuous Interference with Contract, and also dismissed
with prejudice that part of Gerling's Eighth Cause of Action that alleged
Inducement to Breach of Contract. The Court also dismissed the Breach of
Contract claim, but granted Gerling leave to replead that claim.
71
In January 2006, Gerling filed a Second Amended Complaint ("SAC") alleging
1) Fraud/Intentional Misrepresentation and Concealment; 2) Breach of Fiduciary
Duty and Duty of Utmost Good Faith; 3) Unjust Enrichment; and 4) Breach of
Contract. On March 6, 2006, Fremont General's Motion to Dismiss this SAC were
argued and heard before the Court. On its own motion, the Court converted the
Motion to Dismiss to a Motion for Summary Judgment and ordered that it be reset
for hearing following limited discovery on the statute of limitations issues
raised in the Motion. The Company continues to believe that this lawsuit is
without merit.
ITEM 1A: RISK FACTORS
We included a discussion of our Risk Factors in our Annual Report on Form
10-K for the year ended December 31, 2005. There has been no material change in
such risks during the three months ended March 31, 2006.
ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ISSUER PURCHASES OF EQUITY SECURITIES
------------------------------------------------------------------------------------------------------------------------------
(c) TOTAL NUMBER (d) MAXIMUM NUMBER
(a )TOTAL (b) AVERAGE OF SHARES (OR UNITS) (OR APPROXIMATE DOLLAR
NUMBER OF PRICE PAID PURCHASED AS PART VALUE) OF SHARES (OR
SHARES PER SHARE OF PUBLICLY UNITS) THAT MAY YET BE
(OR UNITS) (OR UNIT) ANNOUNCED PLANS PURCHASED UNDER THE
PERIOD PURCHASED (1) (1) OR PROGRAMS PLANS OR PROGRAMS (2)
----------------------------------- ------------- ------------ ------------------- -----------------------
January 1-31, 2006 1,430,985 $ 23.23 1,430,985
------------------------------------------------------------------------------------------------------------------------------
February 1-28, 2006 984 $ 23.78 984
------------------------------------------------------------------------------------------------------------------------------
March 1-31, 2006 263 $ 21.48 263
------------------------------------------------------------------------------------------------------------------------------
Total 1,432,232 $ 23.23 1,432,232 2,852,774
==============================================================================================================================
(1) Shares of common stock acquired by the Company from participants through
purchases of shares under certain employee benefits plans at fair value.
(2) A repurchase program for four million shares was announced to the public
on February 27, 2003, and a repurchase program for four million shares
was announced to the public on May 19, 2005.
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ITEM 6: EXHIBITS
EXHIBIT
NO. DESCRIPTION
------- ----------------------------------------------------------------------
3.1 Restated Articles of Incorporation of Fremont General Corporation.
(Incorporated by reference to Exhibit 3.1 to the Registrant's
Quarterly Report on Form 10-Q, for the period ended June 30, 1998,
Commission File Number 1-8007.)
3.2 Certificate of Amendment of Articles of Incorporation of Fremont
General Corporation. (Incorporated by reference to Exhibit 3.2 to the
Registrant's Annual Report on Form 10-K, for the fiscal year ended
December 31, 1998, Commission File Number 1-8007.)
3.3(a) Amended and Restated Bylaws of Fremont General Corporation.
(Incorporated by reference to Exhibit 3.3 to the Registrant's Annual
Report on Form 10-K, for the fiscal year ended December 31, 1995,
Commission File Number 1-8007.)
3.3(b) Fremont General Corporation Bylaw Amendment Adopted by the Board of
Directors on November 20, 2003. (Incorporated by reference to Exhibit
3.3(b) to the Registrant's Annual Report on Form 10-K, for the fiscal
year ended December 31, 2003, Commission File Number 1-8007.)
3.3(c) Fremont General Corporation Bylaw Amendment Adopted by the Board of
Directors on March 16, 2004. (Incorporated by reference to Exhibit
3.3(c) to the Registrant's Quarterly Report on Form 10-Q, for the
period ended June 30, 2004, Commission File Number 1-8007.)
4.1 Form of Stock Certificate for Common Stock of the Registrant.
(Incorporated by reference to Exhibit 4.1 to the Registrant's Annual
Report on Form 10-K, for the fiscal year ended December 31, 2000,
Commission File Number 1-8007.)
4.2 Indenture with respect to the 9% Junior Subordinated Debentures among
the Registrant, the Trust and Bank of New York (originated with First
Interstate Bank of California), a New York Banking Corporation, as
trustee. (Incorporated by reference to Exhibit 4.3 to the Registrant's
Annual Report on Form 10-K, for the fiscal year ended December 31,
1995, Commission File Number 1-8007.)
4.3 Amended and Restated Declaration of Trust with respect to the 9% Trust
Originated Preferred Securities among the Registrant, the Regular
Trustees, Chase Bank (USA), a Delaware banking corporation, as
Delaware trustee, and JPMorgan Chase Bank, National Association, as
Institutional Trustee. (Incorporated by reference to Exhibit 4.5 to
the Registrant's Annual Report on Form 10-K, for the fiscal year ended
December 31, 1995, Commission File Number 1-8007.)
4.4 Preferred Securities Guarantee Agreement between the Registrant JP
Morgan Chase Bank, National Association, as Preferred Guarantee
Trustee. (Incorporated by reference to Exhibit 4.6 to the Registrant's
Annual Report on Form 10-K, for the fiscal year ended December 31,
1995, Commission File Number 1-8007.)
4.5 Common Securities Guarantee Agreement by the Registrant. (Incorporated
by reference to Exhibit 4.7 to the Registrant's Annual Report on Form
10-K, for the fiscal year ended December 31, 1995, Commission File
Number 1-8007.)
4.6 Form of Preferred Securities. (Included in Exhibit 4.5). (Incorporated
by reference to Exhibit 4.8 to the Registrant's Annual Report on Form
10-K, for the fiscal year ended December 31, 1995, Commission File
Number 1-8007.)
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
With respect to long-term debt instruments, the Registrant undertakes to
provide copies of such agreements upon request by the Commission.
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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.
FREMONT GENERAL CORPORATION
Date: May 10, 2006 /s/ LOUIS J. RAMPINO
-------------------------------
Louis J. Rampino
President and Chief Executive Officer
Date: May 10, 2006 /s/ PATRICK E. LAMB
-------------------------------
Patrick E. Lamb
Senior Vice President, Chief Financial
Officer, Chief Accounting Officer and
Treasurer (Principal Accounting Officer)
74