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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 SEPTEMBER 30, 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 OCTOBER 31, 2006
Common Stock, $1.00 par value 77,862,000
--------------------------------------------------------------------------------
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
INDEX
PART I - FINANCIAL INFORMATION
PAGE NO.
--------
Item 1. Financial Statements
Consolidated Balance Sheets
September 30, 2006 (Unaudited) and December 31, 2005 .... 3
Consolidated Statements of Income
Three and Nine Months Ended September 30, 2006
and 2005 (Unaudited) .................................... 4
Consolidated Statements of Changes in Stockholders'
Equity September 30, 2006 and 2005 (Unaudited) .......... 5
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2006 and 2005
(Unaudited) ............................................. 6
Consolidated Statements of Comprehensive Income
Three and Nine Months Ended September 30, 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 ...................... 50
Item 3. Quantitative and Qualitative Disclosures About
Market Risk .............................................. 80
Item 4. Controls and Procedures .................................... 81
PART II - OTHER INFORMATION
Item 1. Legal Proceedings .......................................... 82
Item 1A. Risk Factors ............................................... 84
Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds .............................................. 85
Item 3-5. Not applicable
Item 6. Exhibits ................................................... 85
Signatures ............................................................ S-1
2
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ ------------
(UNAUDITED)
(THOUSANDS OF DOLLARS)
ASSETS
Cash and cash equivalents ................................................... $ 520,141 $ 768,643
Investment securities classified as available-for-sale at fair value ........ 24,458 17,527
Federal Home Loan Bank stock at cost ........................................ 148,990 136,018
Loans held for sale - net ................................................... 5,543,331 5,423,109
Loans held for investment - net ............................................. 5,963,397 4,603,063
Mortgage servicing rights - net ............................................. 84,883 46,022
Residual interests in securitized loans at fair value ....................... 132,699 170,723
Accrued interest receivable ................................................. 70,834 42,123
Real estate owned - net ..................................................... 6,730 33,872
Premises and equipment - net ................................................ 66,507 65,203
Deferred income taxes ....................................................... 102,989 83,235
Other assets ................................................................ 137,777 94,575
------------ ------------
TOTAL ASSETS .............................................................. $ 12,802,736 $ 11,484,113
============ ============
LIABILITIES
Deposits:
Savings accounts ........................................................... $ 902,311 $ 1,103,993
Money market deposit accounts .............................................. 631,810 446,274
Certificates of deposit .................................................... 8,025,371 7,051,726
------------ ------------
9,559,492 8,601,993
Warehouse lines of credit .................................................... - -
Federal Home Loan Bank advances .............................................. 1,230,000 949,000
Senior Notes due 2009 ........................................................ 165,824 175,305
Junior Subordinated Debentures ............................................... 103,093 103,093
Other liabilities ............................................................ 287,959 297,916
------------ ------------
TOTAL LIABILITIES .......................................................... 11,346,368 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 - 77,862,000 and 2005 - 77,497,000) .......... 77,471 77,497
Additional paid-in capital ................................................... 330,250 341,800
Retained earnings ............................................................ 1,053,627 966,112
Deferred compensation ........................................................ (22,139) (43,357)
Accumulated other comprehensive income ....................................... 17,159 14,754
------------ ------------
TOTAL STOCKHOLDERS' EQUITY ................................................... 1,456,368 1,356,806
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................................... $ 12,802,736 $ 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2006 2005 2006 2005
--------- --------- --------- ---------
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
INTEREST INCOME:
Interest and fee income on loans:
Residential ................................................... $ 135,331 $ 115,007 $ 442,857 $ 351,781
Commercial .................................................... 144,306 81,242 380,366 224,091
Other ......................................................... 100 (342) 279 (158)
--------- --------- --------- ---------
279,737 195,907 823,502 575,714
Interest income - other ........................................... 17,829 12,107 64,542 25,174
--------- --------- --------- ---------
297,566 208,014 888,044 600,888
INTEREST EXPENSE:
Deposits ........................................................ 113,704 70,265 310,774 181,921
FHLB advances ................................................... 26,876 10,411 82,471 30,130
Warehouse lines of credit ....................................... 2,300 929 8,860 3,485
Senior Notes .................................................... 3,388 3,650 10,398 10,951
Junior Subordinated Debentures .................................. 2,320 2,320 6,959 6,959
Other ........................................................... 137 91 386 380
--------- --------- --------- ---------
148,725 87,666 419,848 233,826
Net interest income ............................................... 148,841 120,348 468,196 367,062
Provision for loan losses ......................................... 12,692 (4,071) 28,280 (7,251)
--------- --------- --------- ---------
Net interest income after provision for loan losses ............... 136,149 124,419 439,916 374,313
NON-INTEREST INCOME:
Net gain (loss) on whole loan sales and securitizations
of residential real estate loans ................................ (9,622) 116,044 (16,424) 316,368
Loan servicing income ............................................. 26,427 20,155 71,258 49,841
Mortgage servicing rights amortization and impairment
provision ....................................................... (12,975) (6,588) (29,878) (16,299)
Impairment on residual assets ..................................... - - (5,752) (1,790)
Other ............................................................. 5,915 4,602 14,464 14,569
--------- --------- --------- ---------
9,745 134,213 33,668 362,689
NON-INTEREST EXPENSE:
Compensation and related ........................................ 55,001 61,851 171,660 176,785
Occupancy ....................................................... 8,208 7,412 24,013 21,289
Other ........................................................... 35,983 33,334 91,876 81,682
--------- --------- --------- ---------
99,192 102,597 287,549 279,756
INCOME BEFORE INCOME TAXES ........................................ 46,702 156,035 186,035 457,246
Income tax expense .............................................. 17,177 63,470 72,899 183,809
--------- --------- --------- ---------
NET INCOME ........................................................ $ 29,525 $ 92,565 $ 113,136 $ 273,437
========= ========= ========= =========
EARNINGS PER SHARE:
Basic ........................................................... $ 0.40 $ 1.27 $ 1.53 $ 3.77
Diluted ......................................................... 0.39 1.23 1.49 3.65
CASH DIVIDENDS DECLARED PER COMMON SHARE .......................... $ 0.11 $ 0.08 $ 0.33 $ 0.23
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 .............................. - - 273,437 - - 273,437
Cash dividends declared - $0.23 per
share ................................. - - (17,690) - - (17,690)
Conversion of LYONs ..................... 35 560 - - - 595
Retirement of common stock .............. (95) (936) - 1,031 - -
Shares issued, acquired or allocated
for employee benefit plans ............ 694 14,994 - (32,429) - (16,741)
Amortization of restricted stock ........ - - - 14,507 - 14,507
Shares allocated to ESOP ................ - (1,368) - 25,832 - 24,464
Change in cost of common stock
held in trust ......................... - - - (5,043) - (5,043)
Net change in unrealized gain on
investments and residual interests,
net of deferred taxes ................. - - - - 6,581 6,581
Excess tax benefits relating to
share-based payments ................... - 2,382 - - - 2,382
GSOP fair value adjustment .............. - (3,715) - 3,715 - -
-------- ---------- ----------- ------------ ------------- -----------
Balance at September 30, 2005 ............. $ 77,875 $ 342,245 $ 919,327 $ (51,303) $ 7,996 $ 1,296,140
======== ========== =========== ============ ============= ===========
Balance at December 31, 2005 .............. $ 77,497 $ 341,800 $ 966,112 $ (43,357) $ 14,754 $ 1,356,806
Net income .............................. - - 113,136 - - 113,136
Cash dividends declared - $0.33 per
share ................................. - - (25,621) - - (25,621)
Reclassification of deferred
compensation for restricted stock ..... - (20,902) - 20,902 - -
Retirement of common stock .............. (26) 26 - - - -
Shares issued, acquired or allocated
for employee benefit plans ............ - (1,673) - (23,036) - (24,709)
Amortization of restricted stock ........ - 11,074 - - - 11,074
Shares allocated to ESOP ................ - (1,370) - 24,315 - 22,945
Change in cost of common stock
held in trust ......................... - - - (1,718) - (1,718)
Net change in unrealized gain on
investments and residual interests,
net of deferred taxes ................. - - - - 2,405 2,405
Excess tax benefits relating to
share-based payments .................. - 2,050 - - - 2,050
GSOP failr value adjustment ............. - (755) - 755 - -
-------- ---------- ----------- ------------ ------------- -----------
Balance at September 30, 2006 ............. $ 77,471 $ 330,250 $ 1,053,627 $ (22,139) $ 17,159 $ 1,456,368
======== ========== =========== ============ ============= ===========
The accompanying notes are an integral part of these statements.
5
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------
2006 2005
------------- -------------
(THOUSANDS OF DOLLARS)
OPERATING ACTIVITIES
Net income ................................................................ $ 113,136 $ 273,437
Adjustments to reconcile net income to net cash used in
operating activities:
Provision for loan losses ............................................... 28,280 (7,251)
Provision for premium recapture, repurchase and valuation
reserves of residential real estate loans held for sale ............... 140,276 42,590
Premium refunds ......................................................... (21,039) (18,537)
Change in mortgage servicing rights ..................................... (68,739) (26,303)
Change in residual interests in securitized loans ....................... 41,994 (8,052)
Cash from residual interests in securitized loans ....................... 33,993 13,362
Provision for deferred income taxes ..................................... (21,269) 34,189
Depreciation, amortization, accretion and impairment of
retained interests .................................................... 17,650 34,308
Compensation expense related to deferred compensation plans ............. 4,872 11,062
Change in accrued interest .............................................. (28,711) (2,095)
Change in other assets .................................................. (34,043) (9,995)
Change in accounts payable and other liabilities ........................ (31,392) (31,212)
------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES BEFORE LOANS HELD
FOR SALE ACTIVITY ................................................... 175,008 305,503
Originations of residential loans held for sale ......................... (25,838,207) (26,616,134)
Sale of and payments received from loans held for sale .................. 25,305,503 26,086,153
Loan payments received for residential real estate loans held for sale .. 333,379 210,639
------------- -------------
NET CASH USED IN OPERATING ACTIVITIES ................................. (24,317) (13,839)
INVESTING ACTIVITIES
Originations and advances funded for loans held for investment .......... (3,068,122) (2,630,208)
Payments received from and sales of loans held for investment ........... 1,711,609 1,991,056
Investment securities available for sale:
Purchases ............................................................. (4,352) -
Maturities or repayments .............................................. 210 284
Net purchases of FHLB stock ............................................. (12,972) (54,426)
Purchases of premises and equipment ..................................... (16,064) (19,266)
------------- -------------
NET CASH USED IN INVESTING ACTIVITIES ................................. (1,389,691) (712,560)
FINANCING ACTIVITIES
Deposits accepted, net of repayments .................................... 957,499 893,732
FHLB advances, net of repayments ........................................ 281,000 (261,000)
Extinguishment of Senior Notes and LYONs ................................ (9,636) (30)
Dividends paid .......................................................... (24,806) (16,867)
Excess tax benefits related to share-based payments ..................... 2,050 2,382
Purchase of company common stock for deferred compensation plans ........ (40,601) (31,873)
------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITIES ............................. 1,165,506 586,344
Decrease in cash and cash equivalents ....................................... (248,502) (140,055)
Cash and cash equivalents at beginning of period ........................ 768,643 904,975
------------- --------------
Cash and cash equivalents at end of period .................................. $ 520,141 $ 764,920
============= ==============
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ------------------------
2006 2005 2006 2005
-------- -------- --------- ---------
(THOUSANDS OF DOLLARS)
Net income ........................................................ $ 29,525 $ 92,565 $ 113,136 $ 273,437
Other comprehensive income (loss):
Net change in unrealized gains (losses) during the period:
Residual interests in securitized loans ....................... (4,023) 6,346 2,010 10,978
Investment securities ......................................... (149) (2) 1,909 (11)
-------- -------- --------- ---------
(4,172) 6,344 3,919 10,967
Less income tax expense (benefit) ............................... (1,656) 2,538 1,514 4,386
-------- -------- --------- ---------
Other comprehensive net income (loss) ............................. (2,516) 3,806 2,405 6,581
-------- -------- --------- ---------
Total comprehensive net income .................................... $ 27,009 $ 96,371 $ 115,541 $ 280,018
======== ======== ========= ==========
The accompanying notes are an integral part of these statements.
7
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 and nine month periods ended September 30, 2006 are not necessarily
indicative of the results that may be expected for the year ending 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.
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 significant impact on the Company's financial
position or results of operations.
8
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 measured at fair
value, if practicable.
9
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.
In July 2006, the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN
No. 48"). FIN No. 48 clarifies the accounting for uncertainty in income taxes
recognized in an entity's financial statements in accordance with SFAS No. 109,
"Accounting for Income Taxes." FIN No. 48 prescribes a two-step approach for the
recognition and measurement of a tax position taken or expected to be taken in
an entity's tax return. The first step in the evaluation of a tax position is
recognition: The Company must determine whether it is more likely than not that
a given tax position will be sustained upon examination, including resolution of
any related appeals or litigation processes, based on the technical merits of
the position. In this evaluation the Company must presume that the position will
be examined by the appropriate taxing authority that would have full knowledge
of all relevant information. The second step is measurement: A tax position
meeting the more-likely-than-not recognition threshold is recorded at the
largest amount of benefit that is greater than fifty percent likely of being
realized upon ultimate settlement. The Company is currently evaluating the
impact of adopting FIN No. 48; however, the Company does not believe the
adoption will have a significant impact on its financial position or results of
operations. FIN No. 48 is effective for the Company's fiscal year beginning
January 1, 2007.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a framework for
measuring fair value in accordance with GAAP and provides for expanded
disclosures concerning fair value measurements. SFAS No. 157 retains the
exchange price notion in earlier definitions of fair value; however, focuses on
the price that would be received to sell the asset or paid to transfer the
liability at the measurement date (an exit price), not the price that would be
paid to acquire the asset or received to assume the liability (an entry price).
SFAS No. 157 also establishes a fair value hierarchy used to classify the source
of information used by the entity in fair value measurements. That is,
assumptions developed based on market data obtained from independent sources
(observable inputs) versus the entity's own assumptions about market assumptions
developed based on the best information available in the circumstances
(unobservable inputs).
10
The Company is currently evaluating the impact of adopting SFAS No. 157;
however, the Company does not believe the adoption will have a significant
impact on its financial position or results of operations. SFAS No. 157 is
effective for the Company's fiscal year beginning January 1, 2008.
In September 2006, the United States Securities and Exchange Commission
issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year
Misstatements When Quantifying Misstatements in Current Year Financial
Statements" ("SAB No. 108"). SAB No. 108 provides guidance on how the effects of
the carryover or reversal of prior year misstatements should be considered in
quantifying a current year misstatement. Specifically, SAB No. 108 indicates
that registrants should use both a balance sheet (iron curtain) approach as well
as an income statement (rollover) approach when quantifying and evaluating the
materiality of a misstatement. SAB No. 108 contains guidance on correcting
errors under this dual approach as well as transition guidance for correcting
errors existing in prior years.
The Company adopted the provisions of SAB No. 108 as of and for the quarter
ended September 30, 2006 without any impact on the Company's financial position
or results of operations.
NOTE 3: CASH AND CASH EQUIVALENTS
Cash and cash equivalents are summarized in the following table as of the
dates indicated:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS)
Cash on hand ................................................................ $ 258 $ 239
Non-interest bearing deposits in other financial institutions ............... 92,283 98,141
FHLB shareholder transaction account ........................................ 304,441 214,237
Federal Reserve account ..................................................... 1,531 2,829
Short-term money market funds ............................................... 31,268 37,242
U.S. Government Agency money market fund .................................... - 350,000
Short-term commercial paper ................................................. 90,360 65,955
------------ -----------
Total cash and cash equivalents ............................................. $ 520,141 $ 768,643
============ ===========
The FHLB shareholder transaction account represents a short-term
interest-bearing account with the Federal Home Loan Bank of San Francisco. The
Company's commercial paper holdings have ratings of A1 / P1 or better. The
short-term money market funds have AAA / Aaa money market fund ratings. The
Company's cash and cash equivalent balances were unrestricted as of September
30, 2006 and December 31, 2005.
11
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 September 30, 2006 were as follows:
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(THOUSANDS OF DOLLARS)
Mortgage-backed securities
Agency ........................................................... $ 667 $ - $ 15 $ 652
Private issue .................................................... 21,874 2,028 96 23,806
--------- ---------- ---------- --------
Total available-for-sale securities ................................ $ 22,541 $ 2,028 $ 111 $ 24,458
========= ========== ========== ========
There were no realized gains or losses on the available-for-sale securities
during the three and nine months ended September 30, 2006. Unrealized gains or
losses are included in other comprehensive income. The private issue securities
represent two mortgage-backed securities retained from two of the Company's
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 or securitization 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 maturities for up to
thirty years and are typically secured by first deeds of trust on single-family
residences. Many of the loans have principal amortization terms in excess of
thirty years (such as forty and fifty years) or no principal amortization
(interest-only loans). 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."
12
The following table details the loans held for sale as of the dates
indicated:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS)
Loan principal balance:
First trust deeds ........................................................... $ 5,180,894 $ 4,792,976
Second trust deeds .......................................................... 420,430 611,104
------------ -----------
5,601,324 5,404,080
Net deferred direct origination costs ....................................... 38,292 51,782
------------ -----------
5,639,616 5,455,862
Valuation reserve ........................................................... (96,285) (32,753)
------------ -----------
Loans held for sale - net ................................................... $ 5,543,331 $ 5,423,109
============ ===========
Loans held for sale on non-accrual status ................................... $ 49,794 $ 16,736
============ ===========
Tier I loans are the Company's standard loans that are typically sold at a
premium. Tier II loans are those that 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 pricing. The following table shows
the unpaid principal balance of the Tier II loans included in the total loans
held for sale balance indicated above.
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS)
Tier II loans (before valuation reserves):
First trust deeds ......................................................... $ 172,178 $ 113,742
Second trust deeds ........................................................ 80,904 34,351
------------ -----------
$ 253,082 $ 148,093
============ ===========
13
The following table shows the amount of the Tier II loan sales during the
periods indicated:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -------------------------------
2006 2005 2006 2005
----------- ----------- ------------ -------------
(THOUSANDS OF DOLLARS)
Tier II loan sales (principal):
First trust deeds .......................................... $ 400,503 $ 137,322 $ 770,363 $ 292,080
Second trust deeds ......................................... 16,798 6,897 52,272 18,410
----------- ----------- ----------- ------------
$ 417,301 $ 144,219 $ 822,635 $ 310,490
============ ============= =========== ============
Since most of the loans that are held for sale are sold within
approximately 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 based upon the Company's estimate of inherent
valuation impairment. Provisions for the valuation reserve are charged against
gain (loss) on sale of loans. Activity in the valuation reserve is summarized in
the following table for the periods indicated:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- ------------------------
2006 2005 2006 2005
-------- -------- ---------- ---------
(THOUSANDS OF DOLLARS)
Beginning balance .................................................. $ 74,433 $ 54,654 $ 32,753 $ 38,257
Provision .......................................................... 39,820 (20,691) 87,100 (4,015)
Discounted sales ................................................... (61,928) (10,811) (111,416) (20,035)
Charge-offs ........................................................ (4,419) (1,106) (9,289) (3,083)
Transfer from repurchase reserve ................................... 48,379 13,302 97,137 24,224
-------- -------- ---------- ---------
Ending balance ..................................................... $ 96,285 $ 35,348 $ 96,285 $ 35,348
======== ======== ========== =========
The valuation reserve is apportioned as follows as of the dates indicated:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ ------------
(THOUSANDS OF DOLLARS)
First trust deeds .......................................................... $ 30,644 $ 14,512
Second trust deeds ......................................................... 65,641 18,241
------------ ------------
$ 96,285 $ 32,753
============ ============
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
14
categorized as documentation errors, underwriting errors, or fraud. In addition,
the Company is generally required to repurchase loans from previous whole loan
sale transactions that experience first payment defaults. If there are no such
defects or early payment defaults, the Company has no commitment to repurchase
loans that it has sold. During the third quarter of 2006, the Company
repurchased a total of $294.2 million in loans, as compared to $126.7 million
for the third quarter of 2005. In addition, the Company re-priced $51.5 million
in loans during the third quarter of 2006 and did not re-price any loans during
the third quarter of 2005. 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 $34.2
million and $14.6 million as of September 30, 2006 and December 31, 2005,
respectively. This reserve is based upon the expected future repurchase trends
for loans already sold in whole loan sale transactions and the expected
valuation of such loans when repurchased. At the point the loans are
repurchased, the associated reserves are transferred to the valuation reserve.
Provisions for the repurchase reserve are charged against gain (loss) on sale of
loans. The following table summarizes the activity in the repurchase reserve for
the periods indicated.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -------------------------
2006 2005 2006 2005
-------- -------- --------- ---------
(THOUSANDS OF DOLLARS)
Beginning balance .................................................. $ 57,586 $ 10,217 $ 14,556 $ 4,794
Provision .......................................................... 31,184 26,831 141,479 45,022
Charge-offs for loan repricing ..................................... (6,199) - (24,706) (1,846)
Transfer to valuation reserve ...................................... (48,379) (13,302) (97,137) (24,224)
-------- -------- --------- ---------
Ending balance ..................................................... $ 34,192 $ 23,746 $ 34,192 $ 23,746
======== ======== ========= =========
The repurchase reserve is apportioned as follows as of the dates indicated:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS)
First trust deeds ........................................................... $ 22,910 $ 8,104
Second trust deeds .......................................................... 11,282 6,452
------------ -----------
$ 34,192 $ 14,556
============ ===========
The Company also maintains a reserve for premium recapture that represents
the estimate of probable refunds of premiums received on previously completed
loan sales (either due to early loan prepayments or for certain loans
repurchased from prior sales) that are expected to occur under the
15
provisions of the various agreements entered into for the sale of loans held for
sale; this reserve totaled $6.3 million and $4.3 million as of September 30,
2006 and December 31, 2005, respectively, and is included in other liabilities.
Provisions for the premium recapture reserve are charged against gain (loss) on
sale of loans. The following table summarizes the activity in the premium
recapture reserve for the periods indicated:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -------------------------
2006 2005 2006 2005
-------- -------- --------- ---------
(THOUSANDS OF DOLLARS)
Beginning balance ................................................. $ 10,661 $ 10,555 $ 4,259 $ 7,516
Provision for premium recapture on repurchased loans .............. 2,858 2,908 12,629 8,450
Provision for standard premium recapture .......................... 2,855 4,765 10,484 13,168
Refunds ........................................................... (10,041) (7,631) (21,039) (18,537)
-------- -------- --------- ---------
Ending balance .................................................... $ 6,333 $ 10,597 $ 6,333 $ 10,597
======== ======== ========= =========
The following table reconciles the loan valuation, repurchase and premium
recapture provisions to the amounts included in the Company's gain (loss) on
sale of loans for the periods indicated. (See Note 11)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -------------------------
2006 2005 2006 2005
-------- -------- --------- ---------
(THOUSANDS OF DOLLARS)
Provision for repurchase reserve ................................... $ 31,184 $ 26,831 $ 141,479 $ 45,022
Provision for valuation reserve .................................... 39,820 (20,691) 87,100 (4,015)
Provision for premium recapture on repurchased loans ............... 2,858 2,908 12,629 8,450
Provision for standard premium recapture ........................... 2,855 4,765 10,484 13,168
Other .............................................................. (445) (327) (996) (3,284)
-------- -------- --------- ---------
Total provision for valuation, repurchase and premium
recapture reserves ............................................... $ 76,272 $ 13,486 $ 250,696 $ 59,341
======== ======== ========= =========
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 either one, three or six-month LIBOR and a margin),
represent loans secured primarily by first mortgages on properties such as
condominium (construction and conversion), office, retail, industrial,
multi-family, 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). These loans are funded throughout
the term as the construction progresses.
16
As of September 30, 2006, the Company had $4.21 billion in unfunded
commitments for existing loans and $536.4 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 $220.6 million and $138.2
million as of September 30, 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 $10.1 million and $5.6 million as of September 30, 2006 and
December 31, 2005, respectively.
The geographic dispersion of the Company's commercial real estate loan
balances outstanding is as follows:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
California .................................................................. 19.3% 25.5%
Florida ..................................................................... 15.0% 11.5%
New York .................................................................... 11.9% 14.7%
Virginia .................................................................... 9.6% 6.6%
Arizona ..................................................................... 7.2% 6.7%
Hawaii ...................................................................... 6.2% 4.4%
Maryland .................................................................... 4.7% 3.2%
Illinois .................................................................... 4.6% 4.3%
All other states ............................................................ 21.5% 23.1%
------------ -----------
100.0% 100.0%
============ ===========
17
The loan balances in the portfolio were distributed by property type as
follows as of the dates indicated:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
Multi-family - Condominiums:
Construction .............................................................. 32% 27%
Conversion ................................................................ 23% 21%
------------ -----------
55% 48%
Land Development ............................................................ 14% 15%
Office ...................................................................... 9% 14%
Retail ...................................................................... 6% 7%
Special Purpose ............................................................. 5% 2%
Commercial Mixed-Use ........................................................ 4% 5%
Multi-family - Other ........................................................ 3% 3%
Industrial .................................................................. 3% 4%
Hotels & Lodging ............................................................ 1% 2%
------------ -----------
100% 100%
============ ===========
The Company does not currently hold residential real estate loans held
for investment. The following tables further detail the net loans held for
investment as of the dates indicated:
SEPTEMBER 30, 2006
-------------------------------------------
COMMERCIAL
REAL ESTATE OTHER TOTAL
----------- ------- -----------
(THOUSANDS OF DOLLARS)
Loans outstanding .......................................................... $ 6,417,142 $ 8,643 $ 6,425,785
Participations sold ........................................................ (220,640) - (220,640)
----------- ------- -----------
Loans outstanding, net of participations sold .............................. 6,196,502 8,643 6,205,145
Unamortized deferred origination fees and costs ............................ (56,521) - (56,521)
----------- ------- -----------
Loans outstanding before allowance for loan losses ......................... 6,139,981 8,643 6,148,624
Allowance for loan losses .................................................. (185,145) (82) (185,227)
----------- ------- -----------
Loans held for investment - net ............................................ $ 5,954,836 $ 8,561 $ 5,963,397
=========== ======= ===========
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
=========== ======= ===========
18
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.
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS)
Non-accrual commercial real estate loans held for investment ............... $ 36,478 $ 29,290
============ ===========
Restructured commercial real estate loans on accrual status ................ $ - $ 12,309
============ ===========
The Company employs a documented and systematic methodology in estimating
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 current economic events and trends on portfolio performance,
as well as the 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 appropriate as of September 30, 2006 to cover inherent 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:
19
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2006 2005 2006 2005
--------- --------- --------- ---------
(THOUSANDS OF DOLLARS)
Beginning balance ................................................. $ 172,688 $ 159,956 $ 156,837 $ 171,525
Provision for loan losses ......................................... 12,692 (4,071) 28,280 (7,251)
Charge-offs ....................................................... (190) - (190) (12,180)
Recoveries ........................................................ 37 2,828 300 6,619
--------- --------- --------- ---------
Ending balance .................................................... $ 185,227 $ 158,713 $ 185,227 $ 158,713
========= ========= ========= =========
At September 30, 2006 and December 31, 2005, the recorded investment in
loans (excluding loans held for sale) considered to be impaired was $36.5
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 $36.5 million and $29.3 million of loans considered impaired
that have allocated specific allowances that totaled $4.1 million and $2.3
million at September 30, 2006 and December 31, 2005, respectively. The average
net investment in impaired loans held for investment was $36.6 million and $20.8
million for the three months ended September 30, 2006 and 2005, respectively.
The company did not recognize any interest income on the cash basis of
accounting for loans considered impaired for the three months ended September
30, 2006 and 2005. Interest income that was recognized on the cash basis of
accounting on loans classified as impaired was $0 and $35,000 for the nine
months ended September 30, 2006 and 2005, respectively. Interest income foregone
for loans on non-accrual status that had not performed in accordance with their
original terms was $1.0 million and $1.1 million for the three months ended
September 30, 2006 and 2005, respectively and, $3.1 million and $5.4 million,
for the nine months ended September 30, 2006 and 2005, respectively.
The Company's policy for determining past due or delinquency status is
based on contractual terms except where loans are contractually matured but
continue to make current interest payments. At September 30, 2006 the Company
had two loans which were cross-collateralized and totaled $75.0 million which
were both contractually matured; these loans, however, continued to make current
interest payments and were therefore not considered delinquent and continued to
be reported on an accrual basis. The loans have sufficient collateral to
discharge the debt and management reasonably expects repayment of a significant
portion of the loan amount outstanding and renewal of one of the loans during
the fourth quarter of 2006.
20
In addition to its allowance for loan losses, the Company maintains an
allowance for unfunded commercial real estate loan commitments on its existing
loans. This allowance totaled $5.0 million and $4.0 million as of September 30,
2006 and December 31, 2005, respectively, and is included in other liabilities.
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:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS)
Commercial real estate ..................................................... $ 2,649 $ 31,595
Residential real estate .................................................... 4,384 3,714
------------ -----------
Real estate owned before valuation reserve ................................. 7,033 35,309
Valuation reserve (303) (1,437)
------------ -----------
Real estate owned - net .................................................... $ 6,730 $ 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 September 30, 2006 and December 31, 2005 was $91.0 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:
21
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -------------------------
2006 2005 2006 2005
--------- --------- --------- ---------
(THOUSANDS OF DOLLARS)
Beginning balance ................................................. $ 62,739 $ 24,525 $ 46,022 $ 20,044
Additions from:
Securitization transactions ................................... 20,852 6,511 27,785 20,539
Whole loan sales - servicing retained ......................... 14,267 5,764 40,954 5,764
Amortization .................................................... (12,975) (5,574) (29,878) (15,121)
--------- --------- --------- ---------
Ending balance before valuation allowance ......................... 84,883 31,226 84,883 31,226
Valuation allowance:
Beginning balance ............................................... - (2,207) - (2,043)
Provision for temporary impairment .............................. - (1,014) - (1,178)
--------- --------- --------- ---------
Ending balance .................................................. - (3,221) - (3,221)
--------- --------- --------- ---------
Mortgage servicing rights - net ................................... $ 84,883 $ 28,005 $ 84,883 $ 28,005
========= ========= ========= =========
Estimated fair value .............................................. $ 90,967 $ 30,320 $ 90,967 $ 30,320
========= ========= ========= =========
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:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
Weighted-average life (years) ............................................... 1.4 1.6
Weighted-average annual prepayment speed .................................... 47.0% 46.9%
Weighted-average annual discount rate ....................................... 15.0% 15.0%
As a 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 $55.9 million and $22.5 million at
September 30, 2006 and December 31, 2005, respectively, and is included in other
assets.
22
NOTE 9: RESIDUAL INTERESTS IN SECURITIZED LOANS
Residual interests in loan securitizations retained by the Company 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 retained residual interests:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -------------------------
2006 2005 2006 2005
--------- -------- --------- ---------
(THOUSANDS OF DOLLARS)
Beginning balance at fair value ................................... $ 107,535 $ 16,784 $ 170,723 $ 15,774
Additions to residual interests ................................... 22,642 4,300 35,226 8,052
Sales of residual interests ....................................... - - (77,220) -
Interest accretion ................................................ 8,946 4,262 41,705 8,569
Cash received ..................................................... (2,401) (3,470) (33,993) (13,362)
Fair value adjustments ............................................ (4,023) 6,345 2,010 10,978
Permanent impairment .............................................. - - (5,752) (1,790)
--------- -------- --------- ---------
Ending balance at fair value ...................................... $ 132,699 $ 28,221 $ 132,699 $ 28,221
========= ======== ========= =========
Included in the $170.7 million balance of residual interests at December
31, 2005 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.
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 are
classified as "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
23
of stockholders' equity. Impairment that is considered other-than-temporary is
recorded as a reduction of other non-interest income. During the second quarter
of 2006, the Company recognized permanent impairment on two of its retained
residual interests due primarily to utilization of more accurate pre-payment fee
assumptions. 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 following table summarizes delinquencies and credit losses as of
September 30, 2006 for the loans underlying the Company's 14 outstanding
securitization transactions (thousands of dollars):
Original principal amount of loans securitized ............................. $ 14,674,212
Current principal amount of loans securitized .............................. $ 9,094,691
Current delinquent principal amount (over 60 days) ......................... $ 604,802
Inception to date credit losses (net of recoveries) ........................ $ 35,839
The Company determines the estimated fair values of the residual interests
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.
Key economic assumptions used in subsequently measuring the fair value of
the Company's residual interests as of the dates indicated are as follows:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
Weighted-average life (years) .............................................. 1.6 1.6
Weighted-average annual prepayment speed ................................... 46.7% 46.0%
Weighted-average lifetime credit losses .................................... 4.8% 4.4%
Weighted-average annual discount rate ...................................... 20.0% 20.0%
24
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 September 30, 2006, the Company's commitments to sell forward
residential real estate loans to third party investors in whole loan sales
transactions were approximately $2.4 billion at various rates and terms. The
Company distinguishes commitments to sell forward loans in two categories,
allocated and unallocated. At September 30, 2006, allocated and unallocated
forward sale commitments notional amounts were $1.4 billion and $1.0 billion,
respectively. Allocated forward sales commitments are contractual 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 September 30, 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.
25
At September 30, 2006, the Company had a pipeline of loans in process of
approximately $1.4 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 approximately $811 million, 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 September 30, 2006, the Company
had in place short Eurodollar futures positions covering loan principal of $2.7
billion and $342.4 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 (loss) on sale of residential real estate loans. The Company's Eurodollar
futures contracts are collateralized by maintenance of a margin account which is
included in other assets and had a balance of $10.3 million as of September 30,
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:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS)
Forward sales commitments .................................................. $ (5,335) $ (1,479)
Interest rate cap contract ................................................. - (340)
Other ...................................................................... - 418
------------ -----------
$ (5,335) $ (1,401)
============ ===========
The changes in fair value of the derivative instruments are recorded as
part of the net gain (loss) on whole loan sales and securitizations. (See Note
11)
26
NOTE 11: GAIN (LOSS) ON WHOLE LOAN SALES AND SECURITIZATION OF RESIDENTIAL
REAL ESTATE LOANS
The Company routinely sells and securitizes its 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 its loans held for sale based
on the Company's estimate of inherent valuation impairment. 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 net gain (loss). 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 (loss) on whole loan sales and securitizations:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -------------------------------
2006 2005 2006 2005
----------- ----------- ------------ -------------
(THOUSANDS OF DOLLARS)
Gross whole loan sales (Firsts) .............................. $ 5,084,883 $ 7,602,299 $ 19,920,066 $ 21,100,380
Gross whole loan sales (Seconds) ............................. 277,469 760,737 1,850,049 1,970,332
Loans sold into securitizations (Firsts) ..................... 2,620,790 993,936 3,561,359 3,154,867
Loans sold into securitizations (Seconds) .................... 464,889 38,789 506,853 70,575
----------- ----------- ------------ ------------
8,448,031 9,395,761 25,838,327 26,296,154
Less: Repurchases ........................................... (294,170) (126,676) (532,824) (210,001)
----------- ----------- ------------ ------------
Total loan sales and securitizations - net of repurchases .... $ 8,153,861 $ 9,269,085 $ 25,305,503 $ 26,086,153
=========== =========== ============ ============
Gross premium recognized on Tier I loan sales and
securitizations ............................................ $ 148,536 $ 217,024 $ 448,784 $ 693,245
Net gain (loss) on derivative instruments .................... (20,402) 24,218 (4,208) 15,833
----------- ----------- ------------ ------------
128,134 241,242 444,576 709,078
Net direct loan origination costs ............................ (61,484) (111,712) (210,304) (333,369)
Provisions for valuation, repurchase and premium
recapture reserves ......................................... (76,272) (13,486) (250,696) (59,341)
----------- ----------- ------------ ------------
Net gain (loss) on sale .................................. $ (9,622) $ 116,044 $ (16,424) $ 316,368
=========== =========== ============ ============
27
The net gain (loss) on derivative instruments included in the net gain
(loss) on whole loan sales and securitizations of residential real estate loans
consists of the following items:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2006 2005 2006 2005
--------- -------- --------- --------
(THOUSANDS OF DOLLARS)
Eurodollar futures:
Net realized gain (loss) ........................................ $ (20,242) $ 16,084 $ (7,945) $ 14,245
Transaction expenses and other .................................. (446) 4,785 (1,423) 4,328
--------- -------- --------- --------
(20,688) 20,869 (9,368) 18,573
Change in fair value of:
Forward sales commitments ....................................... (9,103) 6,435 (3,856) (2,895)
Other ........................................................... 9,389 (3,086) 9,016 155
--------- -------- --------- --------
Net gain (loss) on derivative instruments ......................... $ (20,402) $ 24,218 $ (4,208) $ 15,833
========= ======== ========= ========
The Company realized a $9.4 million gain related to the positive change in
fair value of two interest rate swap contracts related to its two securitization
transactions completed during the third quarter of 2006. The Company purchased
the swap contracts prior to the securitization transaction closing dates and
therefore realized the benefits of the changes in fair value between the time
the swaps were purchased and when they were included as part of the
consideration in the securitizations.
28
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2006 2005 2006 2005
-------- -------- --------- --------
(THOUSANDS OF DOLLARS)
Servicing fee income:
Securitization transactions ....................................... $ 8,441 $ 6,108 $ 25,415 $ 15,701
Interim ........................................................... 5,592 9,807 19,216 24,083
Loans sold - servicing retained ................................... 5,363 897 9,280 2,369
Ancillary income (1):
Securitization transactions ....................................... 1,924 1,269 5,413 3,043
Interim ........................................................... 659 889 2,276 2,326
Loans sold - servicing retained ................................... 930 156 1,732 476
Other (2):
Securitization transactions ....................................... 2,590 906 6,246 1,657
Loans sold - servicing retained ................................... 928 123 1,680 186
-------- -------- -------- --------
Loan servicing income ............................................... $ 26,427 $ 20,155 $ 71,258 $ 49,841
======== ======== ======== ========
(1) Ancillary income represents all service-related contractual fees retained by the Company and consists primarily of late
payment charges.
(2) Other servicing income consists primarily of interest income earned on the principal balance of serviced loans that prepay
early before the principal is remitted to the trust (for securitization transactions) or investor (for whole loan sales).
29
NOTE 13: INCOME TAXES
The major components of income tax expense are summarized in the following
table:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- -------------------------
2006 2005 2006 2005
-------- -------- --------- ---------
(THOUSANDS OF DOLLARS)
Federal:
Current ........................................................... $ 16,412 $ 42,141 $ 80,281 $ 122,114
Deferred .......................................................... 56 10,134 (16,968) 29,190
-------- -------- --------- ---------
16,468 52,275 63,313 151,304
-------- -------- --------- ---------
State:
Current ........................................................... 230 8,488 13,887 27,506
Deferred .......................................................... 479 2,707 (4,301) 4,999
-------- -------- -------- ---------
709 11,195 9,586 32,505
-------- -------- -------- ---------
Total income tax expense ............................................ $ 17,177 $ 63,470 $ 72,899 $ 183,809
======== ======== ======== =========
The Company has accrued the expected 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. During the third
quarter of 2006, the Company successfully resolved several state tax matters and
reduced its accrual relating to these matters by $2.7 million.
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:
30
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS)
Deferred tax assets:
Mark-to-market on loans held for sale ..................................... $ 51,745 $ 23,355
Allowance for loan losses ................................................. 81,211 69,650
Compensation related items ................................................ 22,689 29,270
State income and franchise taxes .......................................... 8,274 13,467
Other - net ............................................................... - 2,283
------------ -----------
Total deferred tax assets ............................................... 163,919 138,025
Deferred tax liabilities:
Loan origination costs .................................................... (20,778) (31,550)
Mortgage servicing ........................................................ (39,514) (23,240)
Other - net ............................................................... (638) -
------------ -----------
Total deferred tax liabilities .......................................... (60,930) (54,790)
------------ -----------
Net deferred tax asset ...................................................... $ 102,989 $ 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.
31
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:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS)
Senior Notes due 2009, less discount
(2006 - $706; 2005 - $975) ............................................... $ 165,824 $ 175,305
Junior Subordinated Debentures ............................................. 103,093 103,093
------------ -----------
$ 268,917 $ 278,398
============ ===========
During the third quarter of 2006, Fremont General repurchased $3.8 million
par value of the 7.875% Senior Notes due 2009 with a carrying value of $3.7
million resulting in a pre-tax gain of $30,000. For the nine months ended
September 30, 2006, Fremont General repurchased $9.8 million par value of 7.875%
Senior Notes due 2009 with a carrying value of $9.7 million resulting in a
pre-tax gain of $67,000. There were no repurchases of 7.875% Senior Notes due
2009 through the first nine months of 2005.
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.
32
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 September 30, 2006, the weighted-average interest rate for
savings and money market deposit accounts was 3.81% and for certificates of
deposit it was 5.10%. The weighted-average interest rate for all deposits at
September 30, 2006 was 4.89%.
Certificates of deposit as of September 30, 2006 are detailed by maturity
and rates as follows:
MATURING BY WEIGHTED
AMOUNT SEPTEMBER 30, AVERAGE RATE
----------- ------------- ------------
(THOUSANDS
OF DOLLARS)
$ 7,911,463 2007 5.09%
45,705 2008 4.88%
57,400 2009 5.77%
1,893 2010 4.43%
8,910 2011 5.30%
----------- ------------
$ 8,025,371 5.10%
=========== ============
Of the $8.03 billion in total certificates of deposit outstanding at
September 30, 2006, $1.26 billion were obtained through brokers.
Interest expense on deposits is summarized as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -------------------------
2006 2005 2006 2005
--------- -------- --------- ---------
(THOUSANDS OF DOLLARS)
Savings and money market deposit accounts ......................... $ 15,917 $ 11,910 $ 44,215 $ 32,678
Certificates of deposit ........................................... 97,973 58,486 267,102 149,602
Penalties for early withdrawal .................................... (186) (131) (543) (359)
--------- -------- --------- ---------
$ 113,704 $ 70,265 $ 310,774 $ 181,921
========= ======== ========= =========
33
Total interest payments on deposits were $114.8 million and $71.0 million,
for the three months ended September 30, 2006 and 2005, respectively, and $305.1
million and $179.4 million for the nine months ended September 30, 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
$4.96 billion as of September 30, 2006. At September 30, 2006 and December 31,
2005, FIL had an approximate maximum borrowing capacity based upon its pledged
loan collateral of $3.01 billion and $1.99 billion, respectively, with
outstanding borrowings of $1.23 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 $3.38 billion and $2.22 billion at September 30,
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
September 30, 2006 was 5.17%. 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 requirements. At September
30, 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 $23.0 million and
$10.4 million, for the three months ended September 30, 2006 and 2005,
respectively, and $81.5 million and $30.1 million for the nine months ended
September 30, 2006 and 2005, respectively.
FIL has a line of credit with the Federal Reserve Bank of San Francisco
("Federal Reserve") and, at September 30, 2006 and December 31, 2005, had a
borrowing capacity, based upon collateral pledged, of $297.7 million and $442.3
million, respectively, with no outstanding borrowings at September 30, 2006 or
December 31, 2005. FIL pledged loans with a carrying value of $397.0 million and
$589.7 million at September 30, 2006 and December 31, 2005, respectively, to the
Federal Reserve. This line of credit may
34
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 September 30, 2006 under
the four facilities was $3.00 billion, of which $2.25 billion was committed.
There were no amounts outstanding on any of the facilities at September 30,
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 September
30, 2006, FIL was in compliance with all financial and other covenants related
to these facilities. 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 2007, 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 expiring in August 2007, 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%.
35
NOTE 16: OTHER ASSETS AND LIABILITIES
The following table details the composition of the Company's other assets
and other liabilities as of the dates indicated:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS)
OTHER ASSETS
Servicing advances .......................................................... $ 55,936 $ 5,508
Assets held in SERP ......................................................... 32,008 24,110
Prepaid expenses ............................................................ 13,902 10,159
CRA related investments and loans ........................................... 10,852 9,707
Eurodollar margin account ................................................... 10,281 18,786
Funds due from loans not boarded ............................................ 3,211 3,509
Goodwill .................................................................... 2,685 2,685
Interest rate cap contract .................................................. - 13,805
Other ....................................................................... 8,902 6,306
------------ -----------
Total other assets .......................................................... $ 137,777 $ 94,575
============ ===========
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS)
OTHER LIABILITIES
Deferred compensation obligation ........................................... $ 48,949 $ 50,300
Loan repurchase reserve .................................................... 34,192 14,556
Accrued incentive compensation ............................................. 29,792 56,553
Borrower escrow collections payable ........................................ 28,187 23,620
Federal and state(s) income tax liability .................................. 25,816 15,274
Accounts payable ........................................................... 25,030 35,379
Accrued interest payable ................................................... 24,333 18,241
Borrower principal and interest due investors .............................. 16,651 13,209
Accrued ESOP expense ....................................................... 13,052 29,596
Forward sales commitments (derivative mark) ................................ 5,335 1,479
Premium repurchase reserve ................................................. 3,670 1,748
Premium recapture reserve .................................................. 2,663 2,511
Other ...................................................................... 30,289 35,450
------------ -----------
Total other liabilities .................................................... $ 287,959 $ 297,916
============ ===========
36
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 2006 Performance Incentive
Plan (the "2006 Plan") that was approved by the Company's stockholders on May
18, 2006. Awards were granted under the Company's stockholder approved 1997
Stock Plan (the "1997 Plan") until May 18, 2006 when the stockholders approved
the 2006 Plan. Effective as of May 18, 2006, no additional grants will be made
under the 1997 Plan. At September 30, 2006, a total of 17,822 restricted shares
of the Company's common stock were subject to outstanding awards granted and an
additional 8,808,213 shares of the Company's common stock were available for new
award grants under the 2006 Plan. At September 30, 2006, a total of 1,755,413
restricted shares of the Company's common stock were subject to outstanding
awards granted under the 1997 Plan. As of September 30, 2006, 2,867,399, shares
that had been available for awards under the 1997 Plan now are available for
award grant purposes under the 2006 Plan. As awards outstanding under the 1997
Plan are cancelled, forfeited, or otherwise terminate without having been
exercised or having vested, they will become available for award grant purposes
under the 2006 Plan. During the first nine months of 2006 there were awards of
388,379 shares of restricted stock under the 1997 Plan, and awards of 17,822
shares of restricted stock under the 2006 Plan.
The Company also maintains the 1995 Restricted Stock Award Plan (the "1995
Plan"), which expired under its terms in November 2005. As of September 30,
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 and 1995 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 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.
37
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 September 30, 2006, with an intrinsic value of
$7.0 million, an exercise price of $14.94 and an expiration date of February 13,
2007. No options were granted, forfeited, expired or exercised during the first
nine months 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 $3.9 million for the three months ended September 30, 2006 and 2005,
respectively, and $9.8 million and $12.1 million for the nine months ended
September 30, 2006 and 2005, respectively. The total income tax benefit
recognized in the income statement for share-based compensation arrangements was
$636,000 and $468,000 for the three months ended September 30, 2006 and 2005,
respectively, and $1.9 million and $1.6 million for the nine months ended
September 30, 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
38
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. The award of shares of restricted common
stock would be made pursuant to the 2006 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 Annual Plan during the first nine months of 2006.
A summary of the status of the Company's nonvested restricted stock awards
as of September 30, 2006 and changes during the nine month period then ended is
presented below:
WEIGHTED-AVERAGE
NUMBER GRANT DATE
OF SHARES FAIR VALUE
--------- ----------------
Nonvested at December 31, 2005 .............................................. 2,959,053 $ 13.79
Granted ..................................................................... 406,201 22.57
Vested ...................................................................... (1,444,705) 12.48
Forfeited ................................................................... (41,364) 19.96
----------- ----------------
Nonvested at September 30, 2006 ............................................. 1,879,185 $ 16.56
=========== ================
The fair value of nonvested shares is determined based on the closing trade
price of the Company's shares on the grant date as determined in accordance with
the 1997 Plan and/or the 2006 Plan. As of September 30, 2006, there was $18.2
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 1.8 years. The weighted-average grant date fair value
of the restricted stock awards granted during the nine months ended September
30, 2006 and 2005 was $22.57 and $23.05, respectively. The total fair value of
shares vested was $33.6 million and $31.6 million for the nine months ended
September 30, 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
39
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).
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. Assets held in the SERP and EBP include both Company stock as
well as other mutual funds. Changes in the fair value of the Company's stock are
included as part of the deferred compensation obligation component of other
liabilities with a corresponding charge (or credit) to compensation expense.
Changes in the fair value of the mutual funds are recorded as part of both other
assets and deferred compensation obligation with corresponding charges (or
credits) to other income and compensation expense, respectively. These
offsetting charges and credits due to the changes in fair value of the mutual
fund assets result in no net impact on income.
The following table details the composition of the Company's deferred
compensation balance as of the dates indicated:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS)
SERP and EBP ................................................................ $ 18,549 $ 16,831
GSOP ........................................................................ 3,590 5,624
Unamortized restricted stock awards ......................................... - 20,902
------------ -----------
Total deferred compensation ................................................. $ 22,139 $ 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
40
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)
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 September 30, 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 ratios and the related
standard regulatory minimum ratios required to qualify as well-capitalized are
detailed in the table below.
SEPTEMBER 30, 2006
---------------------------------------------------
ACTUAL MINIMUM REQUIRED
--------------------- ----------------------
AMOUNT RATIO AMOUNT RATIO
----------- ------ ----------- ------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Tier-1 Leverage Capital ............. $ 1,602,316 12.03% $ 666,080 5.00%
Risk-Based Capital:
Tier-1 ............................ 1,602,316 12.65% 759,754 6.00%
Total ............................. 1,763,279 13.93% 1,266,256 10.00%
DECEMBER 31, 2005
---------------------------------------------------
ACTUAL MINIMUM REQUIRED
---------------------- ----------------------
AMOUNT RATIO AMOUNT RATIO
----------- ------ ----------- -------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Tier-1 Leverage Capital ............. $ 1,549,685 12.59% $ 615,462 5.00%
Risk-Based Capital:
Tier-1 ............................ 1,549,685 14.15% 657,156 6.00%
Total ............................. 1,699,420 15.52% 1,095,261 10.00%
41
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 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 September 30, 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:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS)
Common stockholder's equity at FIL .......................................... $ 1,607,568 $ 1,550,049
Less:
Disallowed portion of mortgage servicing rights ........................... (3,013) -
Unrealized gains on available-for-sale securities ......................... (2,239) (364)
------------ -----------
Total Tier-1 Capital ........................................................ 1,602,316 1,549,685
Add:
Allowable portion of the allowance for loan losses ........................ 160,963 149,735
------------ -----------
Total Risk-Based Capital (Tier-1 and Tier-2) ................................ $ 1,763,279 $ 1,699,420
============ ===========
42
NOTE 20: COMMITMENTS AND CONTINGENCIES
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.
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
43
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 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 an 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.
44
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.
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.
GARAMENDI V. RAMPINO ET AL.
On or about October 12, 2006, the California Insurance Commissioner, as
Liquidator on behalf of Fremont Indemnity, filed a First Amended Complaint
against certain former directors and officers of Fremont Indemnity for Breach of
Fiduciary Duty. The Complaint alleges the defendant's breached their fiduciary
duties by orchestrating and allowing Fremont Indemnity to engage in an
inappropriate underwriting scheme that caused injury to Fremont Indemnity's
reinsurers which in turn injured Fremont Indemnity by settlements it made with
those reinsurers. The allegations in this complaint are substantially the same
as
45
those alleged by Gerling Global in its lawsuit. Although neither the Company
nor any of its affiliates are defendants in this lawsuit, it is indemnifying and
defending these directors and officers pursuant to the indemnification clause in
Fremont General's bylaws. The Company intends to vigorously defend this matter
and believes the lawsuit is without merit.
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 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 LIBOR rates
matched to the terms of the respective underlying 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. The Company
has included these general corporate 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.
46
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 September 30, 2006
Net interest income ................................ $ 57,426 $ 70,819 $ 20,596 $ - $ 148,841
Provision for loan losses .......................... - (12,687) (5) - (12,692)
Net gain (loss) on whole loan sales and
securitizations of residential real estate loans . (9,622) - - - (9,622)
Loan servicing income .............................. 26,427 - - - 26,427
Mortgage servicing rights amortization and
impairment provision ............................. (12,975) - - - (12,975)
Impairment on residual assets ...................... - - - - -
Other non-interest income .......................... 1,089 4,552 274 - 5,915
Compensation ....................................... (30,944) (8,217) (15,840) - (55,001)
Occupancy .......................................... (4,876) (791) (2,541) - (8,208)
Other non-interest expense ......................... (17,296) (2,307) (16,380) - (35,983)
Allocations ........................................ (19,272) (1,258) 20,530 - -
----------- ----------- -------------- ------------ ------------
Income (loss) before income taxes ................ $ (10,043) $ 50,111 $ 6,634 $ - $ 46,702
=========== =========== ============== ============ ============
Total revenues ..................................... $ 148,615 $ 148,861 $ 275,288 $ (265,453) $ 307,311
=========== =========== ============== ============ ===========
Total consolidated assets .......................... $ 5,793,576 $ 6,007,482 $ 1,001,678 $ - $12,802,736
=========== =========== ============== ============ ===========
Three months ended September 30, 2005
Net interest income ................................ $ 60,847 $ 45,812 $ 13,689 $ - 120,348
Provision for loan losses .......................... 5 4,077 (11) - 4,071
Net gain on whole loan sales and securitizations
of residential real estate loans ................. 116,044 - - - 116,044
Loan servicing income .............................. 20,155 - - - 20,155
Mortgage servicing rights amortization and
impairment provision ............................. (6,588) - - - (6,588)
Impairment on residual assets ...................... - - - - -
Other non-interest income .......................... 1,008 3,279 315 - 4,602
Compensation ....................................... (26,809) (11,473) (23,569) - (61,851)
Occupancy .......................................... (4,242) (789) (2,381) - (7,412)
Other non-interest expense ......................... (11,433) (5,871) (16,030) - (33,334)
Allocations ........................................ (13,182) (890) 14,072 - -
----------- ----------- -------------- ------------ -----------
Income (loss) before income taxes ................ $ 135,805 $ 34,145 $ (13,915) $ - 156,035
=========== =========== ============== ============ ===========
Total revenues ..................................... $ 249,544 $ 84,520 $ 86,752 $ (78,589) $ 342,227
=========== =========== ============== ============ ===========
Total consolidated assets .......................... $ 5,819,746 $ 4,000,487 $ 1,181,183 $ - $11,001,416
=========== =========== ============== ============ ===========
47
RESIDENTIAL COMMERCIAL CORPORATE AND INTERSEGMENT TOTAL
REAL ESTATE REAL ESTATE RETAIL BANKING ELIMINATIONS CONSOLIDATED
----------- ----------- -------------- ------------ ------------
(THOUSANDS OF DOLLARS)
Nine months ended September 30, 2006
Net interest income ............................... $ 220,012 $ 194,923 $ 53,261 $ - $ 468,196
Provision for loan losses ......................... 4 (28,284) - - (28,280)
Net gain (loss) on whole loan sales and
securitizations of residential real estate loans . (16,424) - - - (16,424)
Loan servicing income ............................. 71,258 - - - 71,258
Mortgage servicing rights amortization and
impairment provision ............................ (29,878) - - - (29,878)
Impairment on residual assets ..................... (5,752) - - - (5,752)
Other non-interest income ......................... 3,335 10,293 836 - 14,464
Compensation ...................................... (95,323) (21,711) (54,626) - (171,660)
Occupancy ......................................... (13,823) (2,248) (7,942) - (24,013)
Other non-interest expense ........................ (43,557) (1,758) (46,561) - (91,876)
Allocations ....................................... (59,905) (3,769) 63,674 -
------------ ----------- ------------- ------------ ------------
Income (loss) before income taxes ................. $ 29,947 $ 147,446 $ 8,642 $ - $ 186,035
============ =========== ============= ============ ============
Total revenues .................................... $ 504,641 $ 390,659 $ 473,945 $ (447,533) $ 921,712
============ =========== ============= ============ ============
Total consolidated assets ......................... $ 5,793,576 $ 6,007,482 $ 1,001,678 $ - $ 12,802,736
=========== =========== ============= ============ ============
Nine months ended September 30, 2005
Net interest income ............................... $ 202,535 $ 132,680 $ 31,847 $ - $ 367,062
Provision for loan losses ......................... 6 7,250 (5) - 7,251
Net gain on whole loan sales and securitizations
of residential real estate loans ................ 316,368 - - - 316,368
Loan servicing income ............................. 49,841 - - - 49,841
Mortgage servicing rights amortization and
impairment provision ............................ (16,299) - - - (16,299)
Impairment on residual assets ..................... (1,790) - - - (1,790)
Other non-interest income ......................... 2,782 11,058 729 - 14,569
Compensation ...................................... (87,285) (24,034) (65,466) - (176,785)
Occupancy ......................................... (12,453) (2,300) (6,536) - (21,289)
Other non-interest expense ........................ (34,195) (6,914) (40,573) - (81,682)
Allocations ....................................... (34,728) (3,024) 37,752 - -
----------- ----------- ------------- ------------ ------------
Income (loss) before income taxes ................. $ 384,782 $ 114,716 $ (42,252) $ - $ 457,246
=========== =========== ============= ============ ============
Total revenues .................................... $ 711,095 $ 235,148 $ 223,724 $ (206,390) $ 963,577
=========== =========== ============= ============ ============
Total consolidated assets ......................... $ 5,819,746 $ 4,000,487 $ 1,181,183 $ - $ 11,001,416
=========== =========== ============= ============ ============
48
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ------------------------
2006 2005 2006 2005
-------- -------- --------- ---------
(THOUSANDS OF SHARES AND DOLLARS, EXCEPT PER SHARE DATA)
Net income
(numerator for basic earnings per share) ........................ $ 29,525 $ 92,565 $ 113,136 $ 273,437
Effect of dilutive securities:
LYONs ........................................................... - - - 8
-------- -------- --------- ---------
Net income available to common stockholders after assumed
conversions (numerator for diluted earnings per share) ........... $ 29,525 $ 92,565 $ 113,136 $ 273,445
======== ======== ========= =========
Weighted-average shares
(denominator for basic earnings per share) ...................... 74,498 72,962 74,187 72,509
Effect of dilutive securities using the treasury stock method
for restricted stock and stock options:
Employee benefit plans ........................................ 1,221 1,154 1,201 1,107
Restricted stock .............................................. 366 1,311 406 1,120
Stock options ................................................. 16 101 64 98
LYONs ......................................................... - - - 22
-------- -------- --------- ---------
Dilutive potential common shares .................................. 1,603 2,566 1,671 2,347
-------- -------- --------- ---------
Adjusted weighted-average shares and assumed conversions
(denominator for diluted earnings per share) .................... 76,101 75,528 75,858 74,856
======== ======== ========= =========
Basic earnings per share .......................................... $ 0.40 $ 1.27 $ 1.53 $ 3.77
======== ======== ========= =========
Diluted earnings per share ........................................ $ 0.39 $ 1.23 $ 1.49 $ 3.65
======== ======== ========= =========
For additional disclosures regarding stock options and restricted stock see
Note 17.
49
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 an industrial bank. Fremont General is not a
"bank holding company" as defined for regulatory purposes.
FIL has two primary real estate 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 September 30, 2006,
had loans outstanding in 29 states. The residential real estate lending platform
originated loans from 47 states through its five regional loan production
centers as of September 30, 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. 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 22
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 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
50
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 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 credit and market 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 loan 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 either one,
three and six-month LIBOR and an applicable margin. An allowance for loan
losses is maintained through provisions (which are either an expense or a
credit to income) 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 or to sell its loans held
for sale. Liquidity risk also entails the risk of changes in secondary market
51
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.
The Company also utilizes Eurodollar futures to hedge the interest rate risk on
a portion of its loan pipeline and its loans held for sale. 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 on 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, loan credit quality, 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 different assumptions or
conditions. These critical accounting policies relate to the gain or loss on
whole
52
loan sales and securitizations, allowance for loan losses, derivatives and
income taxes. The critical accounting policies and estimates are 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 income before income taxes of $46.7 million for the
third quarter of 2006 as compared to $156.0 million for the third quarter of
2005. For the first nine months of 2006 income before income taxes totaled
$186.0 million as compared to $457.2 million for the first nine months of 2005.
The decrease in income before income taxes for the third quarter and first nine
months of 2006 represent decreases of 70.1% and 59.3% over the results for the
third quarter and first nine months of 2005, respectively.
The decrease in income during the third quarter of 2006, as compared to the
third quarter of 2005, is primarily a result of the Company recognizing a loss
on the sale and securitization of its residential real estate loans during the
third quarter of 2006 of $9.6 million; in comparison, the Company recognized a
gain of $116.0 million during the third quarter of 2005. The loss is primarily a
result of higher provisions for loan valuation, repurchase and premium recapture
reserves and a derivative loss during the third quarter of 2006 (of $20.4
million) versus a gain during the third quarter of 2005 (of $24.2 million). The
provisions for loan valuation, repurchase and premium recapture reserves for the
third quarter of 2006 totaled $76.3 million, as compared to $13.5 million for
the third quarter of 2005. This was partially offset by an increased level of
net interest income during the third quarter of 2006.
The decrease in income during the first nine months of 2006, as compared to
the first nine months of 2005, is primarily a result of the Company recognizing
a loss on the sale and securitization of its residential real estate loans
during the first nine months of 2006 of $16.4 million; in comparison, the
Company recognized a gain of $316.4 million during the first nine months of
2005. The loss is primarily a result of an increased provision for loan
valuation, repurchase and premium recapture reserves during the first nine
months of 2006 of $250.7 million versus a provision totaling $59.3 million
during the first nine months of 2005. The loss was also impacted by lower levels
of gross premium being realized on the sale and securitization of the
residential real estate loans during the first nine months of 2006. This was
partially offset by an increased level of net interest income during the first
nine months of 2006.
The Company reported net income of $29.5 million for the third quarter of
2006. This is compared to net income of $92.6 million for the third quarter of
2005. For the first nine months of 2006, net income totaled $113.1 million, as
compared to $273.4 million for the first nine months of 2005.
53
NET INTEREST INCOME
The Company recorded net interest income for the third quarter and first
nine months of 2006 of $148.8 million and $468.2 million as compared to $120.3
million and $367.1 million for the third quarter and first nine months of 2005,
respectively. The increase in net interest income for both periods in 2006 is
primarily a result of an increase in the level of average interest-earning
assets. Total average interest-earning assets increased to $13.3 billion and
$13.4 billion during the third quarter and first nine months of 2006, as
compared to $11.0 billion for both the third quarter and first nine months of
2005. These increases are primarily the result of significantly higher levels of
outstanding commercial real estate loans held for investment. To a lesser
degree, the average amounts outstanding of residential real estate loans held
for sale and retained residual interests also increased during the respective
periods of 2006 as compared to 2005. The net interest income margin as a
percentage of average interest-earning assets increased to an annualized 4.67%
for the first nine months of 2006 from 4.47% for the first nine months of 2005;
for the third quarter of 2006, the percentage was 4.45%, up from 4.34% for the
third 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 third quarter and first nine months of
2006 and 2005:
54
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------
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 ................... $ 6,059,445 $ 144,306 9.45% $ 3,939,714 $ 81,242 8.18%
Residential real estate loans (2) .............. 6,519,702 135,432 8.24% 6,203,624 114,665 7.33%
Residual interests in securitized loans ........ 121,274 8,945 29.26% 32,570 4,262 51.92%
Cash equivalents and investment securities ..... 568,547 8,883 6.20% 822,940 7,845 3.78%
------------ --------- ------- ------------ --------- ------
Total interest-earning assets .................. $ 13,268,968 $ 297,566 8.90% $ 10,998,848 $ 208,014 7.50%
============= ========= ======= ============ ========= ======
Interest-bearing liabilities:
Time deposits .................................. $ 7,865,020 $ 99,037 5.00% $ 6,537,140 $ 58,384 3.54%
Savings deposits ............................... 1,536,547 14,667 3.79% 1,613,204 11,881 2.92%
FHLB advances .................................. 2,053,337 26,876 5.19% 1,351,626 10,411 3.06%
Warehouse lines of credit ...................... 115,286 2,301 7.92% 59,870 929 6.16%
Senior Notes due 2009 .......................... 168,323 3,388 8.05% 181,450 3,650 8.05%
LYONs .......................................... - - 0.00% - - 0.00%
Junior Subordinated Debentures ................. 103,093 2,320 9.00% 103,093 2,320 9.00%
Other .......................................... 25,064 136 2.15% 30,019 91 1.20%
------------ --------- ------ ------------ --------- ------
Total interest-bearing liabilities ............. $ 11,866,670 $ 148,725 4.97% $ 9,876,402 $ 87,666 3.52%
============= ========= ====== ============ ========= ======
Net interest income ............................ $ 148,841 $ 120,348
========= =========
Percent of average interest-earning assets:
Interest income ................................ 8.90% 7.50%
Interest expense ............................... 4.45% 3.16%
------ ------
Net interest margin ............................ 4.45% 4.34%
====== ======
(1) Average loan balances include non-accrual loan balances.
(2) Includes loans held for sale and other.
55
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------
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 .................. $ 5,554,367 $ 380,365 9.16% $ 3,801,336 $ 224,091 7.88 %
Residential real estate loans (2) ............. 7,172,012 443,136 8.26% 6,467,422 351,623 7.27 %
Residual interests in securitized loans ....... 108,656 41,706 51.32% 22,280 8,569 51.42 %
Cash equivalents and investment securities .... 586,274 22,837 5.21% 702,837 16,605 3.16 %
------------ --------- ------ ------------ --------- ------
Total interest-earning assets ................ $ 13,421,309 $ 888,044 8.85% $ 10,993,875 $ 600,888 7.31 %
============ ========= ====== ============ ========= ======
Interest-bearing liabilities:
Time deposits ................................. $ 7,791,367 $ 267,873 4.60% $ 6,316,905 $ 149,347 3.16 %
Savings deposits .............................. 1,545,762 42,901 3.71% 1,667,349 32,574 2.61 %
FHLB advances ................................. 2,272,447 82,471 4.85% 1,507,165 30,130 2.67 %
Warehouse lines of credit ..................... 175,072 8,860 6.77% 97,187 3,485 4.79 %
Senior Notes due 2009 ......................... 172,137 10,398 8.05% 181,450 10,950 8.05 %
LYONs ......................................... - - - 320 15 6.27 %
Junior Subordinated Debentures ................ 103,093 6,959 9.00% 103,093 6,960 9.00 %
Other ......................................... 24,159 386 2.14% 28,524 365 1.71 %
------------ --------- ----- ------------ --------- ------
Total interest-bearing liabilities ............ $ 12,084,037 $ 419,848 4.65% $ 9,901,993 $ 233,826 3.16 %
============ ========= ===== ============ ========= ======
Net interest income ........................... $ 468,196 $ 367,062
========= =========
Percent of average interest-earning assets:
Interest income ............................... 8.85% 7.31 %
Interest expense .............................. 4.18% 2.84 %
----- ------
Net interest margin ........................... 4.67% 4.47 %
===== ======
(1) Average loan balances include non-accrual loan balances.
(2) Includes loans held for sale and other.
56
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2006 COMPARED TO 2005 2006 COMPARED TO 2005
------------------------------------ --------------------------------------
CHANGE DUE TO CHANGE DUE TO
----------------------- -------------------------
VOLUME(1) RATE TOTAL VOLUME(1) RATE TOTAL
-------- --------- -------- --------- ---------- ----------
(THOUSANDS OF DOLLARS)
Cash equivalent and investment securities ...... $ (3,056) $ 4,094 $ 1,038 $ (3,528) $ 9,760 $ 6,232
Loans and residual interests ................... 63,564 24,950 88,514 196,661 84,263 280,924
-------- --------- -------- ---------- ---------- ----------
Total increase in interest income .............. 60,508 29,044 89,552 193,133 94,023 287,156
-------- --------- --------- ---------- ----------- ----------
Time deposits .................................. (16,721) (23,932) (40,653) (50,693) (67,833) (118,526)
Savings deposits ............................... 732 (3,518) (2,786) 3,375 (13,702) (10,327)
FHLB advances .................................. (9,185) (7,280) (16,465) (27,773) (24,568) 52,341)
Warehouse lines of credit ...................... (1,106) (266) (1,372) (3,942) (1,433) (5,375)
Senior Notes due 2004 and 2009 ................. 262 - 262 552 - 552
LYONs .......................................... - - - 15 - 15
Junior Subordinated Debentures ................. - - - - - -
Other .......................................... 27 (72) (45) 70 (90) (20)
-------- --------- -------- --------- ---------- ---------
Total (increase) in interest expense ........... (25,991) (35,068) (61,059) (78,396) (107,626) (186,022)
-------- --------- -------- --------- ---------- ---------
Increase / (decrease) in net interest income ... $ 34,517 $ (6,024) $ 28,493 $ 114,737 $ (13,603) $ 101,134
======== ========= ======== ========= ========== =========
(1) Changes in rate/volume are allocated to change in volume.
NON-INTEREST INCOME
GAIN OR LOSS ON WHOLE LOAN SALES AND SECURITIZATIONS OF RESIDENTIAL REAL ESTATE
LOANS
The gain on sale of residential real estate loans decreased from $116.0
million in the third quarter of 2005 to a $9.6 million loss for the third
quarter of 2006. For the first nine months of 2006, the Company realized a $16.4
million loss on the sale of its residential real estate loans as compared to a
$316.4 million gain for the first nine months of 2005. The loss on sale during
the first nine months of 2006 is primarily attributable to significantly higher
provisions for loan valuation, repurchase and premium recapture reserves. In
addition, the Company realized a decrease in the gross premiums received on loan
sales, particularly in the first quarter of 2006, and a loss on derivatives for
the first nine months of 2006 of $4.2 million, as compared to a gain of $15.8
million during the first nine months of 2005. The provisions for loan valuation,
repurchase and premium recapture reserves for the first nine months of 2006
totaled $250.7 million, as compared to $59.3 million for the first nine months
of 2005.
The loss on sale during the third quarter of 2006 is primarily attributable
to significantly higher provisions for loan valuation, repurchase and premium
recapture reserves and a hedging loss of $20.4 million. The provisions for loan
valuation, repurchase and premium recapture reserves for the third quarter of
2006 totaled $76.3 million, as compared to $13.5 million for the third quarter
of 2005.
57
The increased provisions for loan valuation, repurchase and premium
recapture reserves is primarily due to increased loan repurchase and re-pricing
trends from previous whole loan sale transactions and lower secondary market
values for second mortgages. These increased loan repurchase and re-pricing
levels, which have been noted industry-wide, are primarily due to increased
levels of early payment delinquencies during 2006 and a greater incidence of
repurchase requests from whole loan purchasers. The Company's loan repurchases
and re-pricings increased to $345.7 million and $691.8 million for the third
quarter and first nine months of 2006, respectively, as compared to $126.7
million and $270.5 million for the third quarter and first nine months of 2005,
respectively. The Company continually evaluates the loss severity and repurchase
frequency estimates utilized for its loan valuation, repurchase and premium
recapture reserves based upon its analysis of historical and current data and
the mix of loan characteristics.
Given these loan repurchase and re-pricing trends, with an objective of
reducing its early payment delinquencies, the Company made modifications in its
loan origination parameters during the second quarter of 2006, including
eliminating or reducing certain higher loan-to-value products (including certain
second mortgage products) and lower FICO bands. The Company has seen positive
initial results based upon its third quarter loan production profile; these
positive results include lower second mortgage loan production, higher FICO
scores, less first time home buyer loans, and lower stated-income documentation
loans. For instance, the Company has eliminated its "combo" loans (a first
mortgage originated in combination with a second mortgage) on stated-income
documentation loans with FICO scores below 640. The Company also modified its
whole loan sale agreements to limit the notification period for repurchase
requests (generally a buyer has a window of 90 days from the completion of the
sale to notify the Company of any qualifying loans that it is requesting to be
repurchased) and to extend the qualifying first payment measurement period (the
period has been moved to 45 days from 30 days - thus a payment is not considered
delinquent through and up to 45 days). While it is too soon for the Company to
quantify the level of improvement on its provisioning, if any, the Company
believes that it is reasonable to expect to see a positive impact of these
changes during the the first quarter of 2007.
A total of $8.2 billion in loans were sold (including loans sold via
securitization) during the third quarter of 2006, as compared to loan sales and
securitizations of $9.3 billion during the third quarter of 2005. For the first
nine months of 2006, a total of $25.3 billion in loans were sold (including
loans sold via securitization), as compared to loan sales of $26.1 billion for
the first nine months of 2005. The average gross premium on Tier 1 loan sales
and securitizations during the third quarter of 2006 was 1.82% as compared to an
average of 2.34% for the third quarter of 2005. For the first nine months of
2006, the average gross premium on Tier 1 loan sales and securitizations was
1.77% as compared to an average of 2.66% for the first nine months of 2005. The
decrease in gross premiums during the first nine months of 2006 is primarily a
result of lower interest rate margins (reflecting increased price competition in
the non-prime mortgage origination market) and secondary market conditions,
particularly for loans sold into the first quarter of 2006. The level of loans
securitized during the third quarter of 2006 was $3.09 billion as compared to
$1.03 billion for the third quarter of 2005; this higher level of securitization
activity lowers the total recognized gross premium levels as the Company records
a lower premium on these transactions, but
58
for which it does not have any loan repurchase requirements. Included in the
$3.09 billion of securitizations during the third quarter of 2006 was a second
mortgage only pool of approximately $287.8 million upon which the Company
realized a price below par, but the Company does not have any repurchase
obligation in connection with this transaction. In addition, during the third
quarter of 2006, the Company sold approximately $1.06 billion of loans on a
whole loan basis with a provision that a certain amount of first payment
defaults would not be subject to repurchase; in exchange for this, the Company
realized approximately 40 basis points less in gross premium on the transaction.
The Company entered into this agreement in an effort to limit future provisions
for loan valuation, repurchase and premium recapture reserves. The Company's
direct costs of loan origination associated with loans sold decreased during the
third quarter and first nine months of 2006 to 0.76% and 0.83%, respectively
from 1.20% and 1.27% for the same periods in 2005 primarily as a result of lower
costs incurred for broker and account executive compensation.
The Company realized net losses of $20.4 million and $4.2 million on the
derivative instruments it utilized to hedge the impact of interest rate
volatility on its residential real estate lending activities during the third
quarter and first nine months of 2006, respectively. These net losses primarily
resulted from a decrease 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 periods. These net losses are compared to
net gains on derivatives of $24.2 million and $15.8 million during the third
quarter and first nine months 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 from 1.26% in the third quarter of 2005 to (0.13)%
in the third quarter of 2006. For the first nine months of 2006 the Company
realized a net loss percentage on these sales of (0.07)% as compared to a net
gain percentage of 1.23% for the first nine months of 2005.
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.
59
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:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- -----------------------------
2006 2005 2006 2005
------------ ----------- ------------- -------------
(THOUSANDS OF DOLLARS)
Gross whole loan sales (Firsts) .............................. $ 5,084,883 $ 7,602,299 $ 19,920,066 $ 21,100,380
Gross whole loan sales (Seconds) ............................. 277,469 760,737 1,850,049 1,970,332
Loans sold into securitizations (Firsts) ..................... 2,620,790 993,936 3,561,359 3,154,867
Loans sold into securitizations (Seconds) .................... 464,889 38,789 506,853 70,575
----------- ----------- ------------ ------------
8,448,031 9,395,761 25,838,327 26,296,154
Less: Repurchases ........................................... (294,170) (126,676) (532,824) (210,001)
----------- ----------- ------------ ------------
Total loan sales and securitizations - net of repurchases .... $ 8,153,861 $ 9,269,085 $ 25,305,503 $ 26,086,153
=========== =========== ============ ============
Gross premium recognized on Tier I loan sales and
securitizations ............................................ $ 148,536 $ 217,024 $ 448,784 $ 693,245
Net gain (loss) on derivative instruments .................... (20,402) 24,218 (4,208) 15,833
----------- ----------- ------------ ------------
128,134 241,242 444,576 709,078
Net direct loan origination costs ............................ (61,484) (111,712) (210,304) (333,369)
Provisions for valuation, repurchase and premium
recapture reserves ......................................... (76,272) (13,486) (250,696) (59,341)
----------- ----------- ------------ ------------
Net gain (loss) on sale .................................. $ (9,622) $ 116,044 $ (16,424) $ 316,368
=========== =========== ============ ============
Net gain (loss) on sale ...................................... $ (9,622) $ 116,044 $ (16,424) $ 316,368
Origination expenses allocated during the period of
origination ................................................ (36,710) (30,381) (103,373) (108,535)
----------- ----------- ------------ ------------
Net operating gain (loss) on sale ........................ $ (46,332) $ 85,663 $ (119,797) $ 207,833
============ =========== ============ ============
Gross premium recognized on Tier I loan sales and
securitizations ............................................ 1.82 % 2.34 % 1.77 % 2.66 %
Net gain (loss) on derivative instruments .................... (0.25)% 0.26 % (0.02)% 0.06 %
----------- ----------- ------------ ------------
1.57 % 2.60 % 1.75 % 2.72 %
Net direct loan origination costs ............................ (0.76)% (1.20)% (0.83)% (1.27)%
Provisions for valuation, repurchase and premium
recapture reserves ........................................ (0.94)% (0.14)% (0.99)% (0.22)%
----------- ----------- ------------ ------------
Net gain (loss) on sale .................................. (0.13)% 1.26 % (0.07)% 1.23 %
=========== =========== ============ ============
Net gain (loss) on sale ...................................... (0.13)% 1.26 % (0.07)% 1.23 %
Origination expenses allocated during the period of
origination ................................................ (0.45)% (0.33)% (0.41)% (0.42)%
----------- ----------- ------------ --------------
Net operating gain (loss) on sale ........................ (0.58)% 0.93 % (0.48)% 0.81 %
=========== =========== ============ ============
o Percentages are of total loan sales and securitizations, net of
repurchases, during the period indicated.
o Tier I loans are the Company's standard loans that are typically sold at a
premium. Tier II loans are those that 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 pricing.
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 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 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.
60
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 third quarter and first nine
months of 2006 and 2005 are indicated in the following table:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2006 2005 2006 2005
---------- -------- --------- ---------
(THOUSANDS OF DOLLARS)
Loan Servicing Income:
Servicing fee income:
Securitization transactions ................................... $ 8,441 $ 6,108 $ 25,415 $ 15,701
Interim ....................................................... 5,592 9,807 19,216 24,083
Loans sold - servicing retained ............................... 5,363 897 9,280 2,369
--------- -------- --------- ---------
19,396 16,812 53,911 42,153
Ancillary income .................................................. 3,513 2,314 9,421 5,845
Other ............................................................. 3,518 1,029 7,926 1,843
--------- -------- --------- ---------
$ 26,427 $ 20,155 $ 71,258 $ 49,841
========= ======== ========= =========
MSR Amortization and Impairment:
MSR amortization ................................................ $ (12,975) $ (5,574) $ (29,878) $ (15,121)
MSR impairment provision ........................................ - (1,014) - (1,178)
--------- -------- --------- ---------
$ (12,975) $ (6,588) $ (29,878) $ (16,299)
========= ======== ========= =========
Other Non-Interest Income:
Prepayment fees:
Commercial real estate ........................................ $ 1,011 $ 467 $ 2,910 $ 1,848
Residential real estate ....................................... 633 706 2,115 1,980
Commercial real estate transaction fees ......................... 2,719 973 6,558 6,809
Net gain on extinguishment of debt .............................. 31 - 68 -
All other ....................................................... 1,521 2,456 2,813 3,932
--------- -------- --------- ---------
$ 5,915 $ 4,602 $ 14,464 $ 14,569
========= ======== ========= =========
Loan servicing income (which is all related to residential real estate),
increased from $20.2 million in the third quarter of 2005 to $26.4 million for
the third quarter of 2006. For the first nine months of 2006 loan servicing
income was $71.3 million versus $49.8 million for the first nine months of 2005.
These increases were due to an increased level of loans being serviced to
maturity, either in the Company's sponsored securitizations or for whole loan
sales to other financial institutions in which the Company retained the
servicing rights. As of September 30, 2006, the Company was servicing a total of
$15.1 billion in loans to maturity, as compared to a total of $6.1 billion at
September 30, 2005. This increase is a result of the Company's decision to
increase its servicing to maturity portfolio and the resulting increase in the
amount of securitizations and whole loan sales with servicing retained that have
been entered into since September 30, 2005. With the increased levels of
securitizations and whole loan sales with servicing retained being entered into,
the level of interim servicing decreased. The additional loan securitization
activity also created a higher level of MSRs, which resulted in an increase in
the amortization (expense)
61
of the MSRs in 2006 versus 2005. The Company intends to continue to service
those loans it securitizes, as well as some loans sold to other parties for more
than on an interim basis (servicing retained).
The following is a breakdown of the total amount of loans outstanding being
serviced by categorization as of the dates indicated:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(MILLIONS OF DOLLARS)
Loans in securitizations .................................................... $ 9,095 $ 7,381
Loans sold and servicing retained ........................................... 6,034 1,082
------------ -----------
Loans being serviced to maturity ............................................ 15,129 8,463
Loans held for sale ......................................................... 5,610 5,412
Loans sold and serviced on an interim basis ................................. 3,512 8,377
------------ -----------
$ 24,251 $ 22,252
============ ===========
PROVISION FOR LOSSES
For the third quarter of 2006 the Company recognized a $12.7 million
provision expense as compared to a $4.1 million credit to income for the third
quarter of 2005. For the first nine months of 2006, the provision expense was
$28.3 million versus a $7.3 million credit to income for the first nine months
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 recent prior periods. The net
charge-off amounts and ratios (to average loans outstanding) for the commercial
real estate portfolio were $153,000 or 0.01% for the third quarter of 2006 and
$(2.8) million or (0.28)% for the third quarter of 2005.
For the first nine months of 2006 the net charge-off amounts and ratios
were $(106,000) or 0.00% as compared to $5.6 million or 0.20% for the first nine
months 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
estimated on the basis of 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.
62
NON-INTEREST EXPENSE
Non-interest expense decreased from $102.6 million during the third quarter
of 2005 to $99.2 million for the third quarter of 2006. For the first nine
months of 2006, non-interest expense increased to $287.5 million as compared to
$279.8 million for the first nine months of 2005.
Compensation expense decreased from $61.9 million and $176.8 million during
the third quarter and first nine months of 2005 to $55.0 million and $171.7
million for the third quarter and first nine months of 2006, respectively.
Decreases in compensation expense related to residential real estate sales
compensation were partially offset by decreases in the capitalization level of
direct loan origination costs. Overall increases in base compensation were
largely offset by decreases in incentive and benefits costs (such as management
incentive compensation, employee stock ownership, 401(K) and other related
accruals). Increased expense levels for legal, professional and other outside
services, information technology and leasing and loan expense were the primary
reason for an increase in the other component of non-interest expense. Occupancy
expense has increased as the Company has expanded certain of its facilities,
such as its new loan servicing center in Texas.
63
Compensation and non-compensation related operating expenses are detailed
in the following tables:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2006 2005 2006 2005
--------- --------- --------- ---------
(THOUSANDS OF DOLLARS)
Compensation and related .......................................... $ 55,001 $ 61,851 $ 171,660 $ 176,785
Occupancy ......................................................... 8,208 7,412 24,013 21,289
Other ............................................................. 35,983 33,334 91,876 81,682
--------- --------- --------- ---------
Total non-interest expense ........................................ $ 99,192 $ 102,597 $ 287,549 $ 279,756
========= ========= ========= =========
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2006 2005 2006 2005
--------- --------- --------- ---------
(THOUSANDS OF DOLLARS)
Total compensation and related .................................... $ 106,605 $ 133,665 $ 342,225 $ 384,018
Deferral of loan origination costs (1) ............................ (51,604) (71,814) (170,565) (207,233)
--------- --------- --------- ---------
Compensation and related .......................................... $ 55,001 $ 61,851 $ 171,660 $ 176,785
========= ========= ========= =========
(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.
Other non-interest expense categories for the third quarter and first nine
months ended September 30, 2006 and 2005 are summarized below (note that gains
on the sale of REO properties are included herein as an offset):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2006 2005 2006 2005
--------- -------- -------- --------
(THOUSANDS OF DOLLARS)
Legal, professional and other outside services ...................... $ 10,207 $ 8,375 $ 26,486 $ 21,150
Information technology .............................................. 6,181 4,844 15,193 12,113
Printing, supplies and postage ...................................... 4,215 4,131 12,226 11,726
Advertising and promotion ........................................... 2,778 2,915 8,939 8,357
Auto and travel ..................................................... 2,485 2,178 6,920 6,445
Leasing and loan expense ............................................ 3,952 1,945 9,708 5,249
Net real estate owned expenses ...................................... 436 (389) (6,805) (5,024)
Telephone ........................................................... 1,675 1,142 5,061 3,299
All other ........................................................... 4,054 8,193 14,148 18,367
-------- -------- -------- --------
Total other expenses ................................................ $ 35,983 $ 33,334 $ 91,876 $ 81,682
======== ======== ======== ========
64
INCOME TAXES
Income tax expense of $17.2 million and $63.5 million for the quarters
ended September 30, 2006 and 2005, represent effective tax rates of 36.8% and
40.7%, respectively, on income before income taxes of $46.7 million and $156.0
million for the same respective periods. During the third quarter of 2006, the
Company recorded a reduction of its state income tax expense of $2.7 million as
a result of the resolution of various state tax matters for the 1995 to 2001 tax
years. For the nine months ended September 30, 2006 and 2005, income tax expense
of $72.9 million and $183.8 million, represent effect tax rates of 39.2% and
40.2% on income before income taxes of $186.0 million and $457.2 million for the
same respective periods. The effective tax rates for all 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
$5.54 billion at September 30, 2006 from $5.42 billion at December 31, 2005.
During the third quarter of 2006, residential real estate loan originations
totaled $7.76 billion as compared to $9.61 billion for the third quarter of
2005. During the first nine months of 2006 residential real estate loan
originations totaled $25.84 billion as compared to $26.62 billion for the first
nine months of 2005. The following table details the loans held for sale as of
the dates indicated:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS)
Loan principal balance:
1st trust deeds .......................................................... $ 5,180,894 $ 4,792,976
2nd trust deeds ........................................................... 420,430 611,104
------------ -----------
5,601,324 5,404,080
Net deferred direct origination costs ....................................... 38,292 51,782
------------ -----------
5,639,616 5,455,862
Less: Valuation reserve .................................................... (96,285) (32,753)
------------ -----------
Loans held for sale - net ................................................... $ 5,543,331 $ 5,423,109
============ ===========
Loans held for sale on non-accrual status ................................... $ 49,794 $ 16,736
============ ===========
Tier II loans (before valuation reserves):
1st trust deeds ............................................................. $ 172,178 $ 113,742
2nd trust deeds ............................................................. 80,904 34,351
------------ -----------
$ 253,082 $ 148,093
============ ===========
o Tier II loans do not meet the criteria of a Tier I loan due to delinquency
status, documentation issues or loan program exceptions for which the
Company typically receives lower premiums.
65
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. Additionally, a 50-year amortization (due in 30 years) first
mortgage product was introduced during the third quarter of 2006. 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:
66
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ------------------------------
2006 2005 2006 2005
----------- ----------- ------------ ------------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Loan origination volume by lien position:
Firsts ................................................... $ 7,276,675 $ 8,710,006 $ 23,725,512 $ 24,303,516
Seconds .................................................. 483,469 900,777 2,112,695 2,312,618
----------- ----------- ------------ ------------
$ 7,760,144 $ 9,610,783 $ 25,838,207 $ 26,616,134
=========== =========== ============ ============
For first lien volume only:
Average loan size ...................................... $ 272,637 $ 251,371 $ 264,522 $ 242,511
Weighted-average coupon ................................ 8.31% 7.32% 8.34% 7.18 %
Average bureau credit score (FICO) ..................... 627 622 623 622
Average loan-to-value (LTV) ............................ 80.2% 80.5% 80.0% 80.8 %
Type of product:
ARMs:
30 Year:
2/28 ............................................. 36.7% 89.6% 48.8% 87.3 %
3/27 ............................................. 2.6% 2.2% 1.3% 2.7 %
5/25 ............................................. 0.4% 0.7% 0.2% 0.8 %
----------- ----------- ------------ ------------
39.7% 92.5% 50.3% 90.8 %
40/30:
2/28 ............................................. 20.2% 0.8% 31.1% 0.3 %
3/27 ............................................. 0.9% 0.0% 0.6% 0.0 %
5/25 ............................................. 0.1% 0.0% 0.1% 0.0 %
----------- ----------- ------------ ------------
21.2% 0.8% 31.8% 0.3 %
50/30:
2/28 ............................................. 18.3% 0.0% 5.6% 0.0 %
3/27 ............................................. 2.2% 0.0% 0.7% 0.0 %
5/25 ............................................. 0.1% 0.0% 0.1% 0.0 %
----------- ----------- ------------ ------------
20.6% 0.0% 6.4% 0.0 %
----------- ----------- ------------ ------------
Total ARMs ....................................... 81.5% 93.3% 88.5% 91.1 %
=========== =========== ============ ============
Fixed rate:
30 Year ............................................ 11.6% 6.7% 7.8% 8.9 %
40/30 .............................................. 3.8% 0.0% 2.7% 0.0 %
50/30 .............................................. 3.1% 0.0% 1.0% 0.0%
----------- ----------- ------------ ------------
Total fixed rate ................................. 18.5% 6.7% 11.5% 8.9 %
----------- ----------- ------------ -------------
100.0% 100.0% 100.0% 100.0 %
=========== =========== ============ =============
Loan purpose:
Purchase ............................................. 36.6% 51.0% 43.5% 48.8 %
Refinance ............................................ 63.4% 49.0% 56.5% 51.2 %
----------- ----------- ------------ -------------
100.0% 100.0% 100.0% 100.0 %
=========== =========== ============ =============
Documentation Type:
Full ................................................. 60.3% 58.1% 55.4% 60.3 %
Stated ............................................... 38.3% 40.5% 43.4% 37.4 %
Other ................................................ 1.4% 1.4% 1.2% 2.3 %
----------- ----------- ------------ -------------
100.0% 100.0% 100.0% 100.0 %
=========== =========== ============ =============
67
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2006 2005 2006 2005
-------- -------- -------- --------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
For second lien volume only:
Average loan size ................................................ $ 71,699 $ 55,279 $ 67,042 $ 51,337
Weighted-average coupon .......................................... 11.14% 10.18% 11.16% 10.09%
Average bureau credit score (FICO) ............................... 664 648 655 649
Purpose:
Purchase ....................................................... 76.1% 80.8% 79.8% 79.9%
Refinance ...................................................... 23.9% 19.2% 20.2% 20.1%
Percentage of second liens to first liens (in units) ............... 25.3% 47.0% 35.1% 45.0%
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2006 2005 2006 2005
------ ------ ------ ------
First & Second Mortgages - Origination by
geographic dispersion:
California .......................................... 27.1% 26.8% 26.0% 28.2%
Florida ............................................. 13.7% 11.6% 14.2% 10.7%
New York ............................................ 11.0% 11.2% 11.5% 11.1%
Maryland ............................................ 7.5% 6.6% 7.4% 5.8%
New Jersey .......................................... 5.1% 6.8% 6.3% 6.8%
All other states .................................... 35.6% 37.0% 34.6% 37.4%
------ ------ ------ ------
100.0% 100.0% 100.0% 100.0%
====== ====== ======= ======
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2006 2005 2006 2005
------ ------ ------ ------
Interest-only loans:
As a percentage of first lien volume ................... 7.6% 25.7% 9.8% 26.1%
Average bureau credit score (FICO) ..................... 654 643 648 644
Weighted-average coupon ................................ 7.49% 6.72% 7.57% 6.52%
Average loan-to-value (LTV) ............................ 82.1% 81.5% 81.5% 81.6%
68
LOANS HELD FOR INVESTMENT AND ALLOWANCE ACTIVITY
The Company's net loans held for investment before the allowance for loan
losses was approximately $6.15 billion at September 30, 2006, as compared to
$4.76 billion at December 31, 2005. The increase in the Company's loans held for
investment is a result of increased levels of loan commitment origination in
2005 and the first nine months of 2006, as well as a reduction in the rate of
loan paydowns. Commercial real estate loans are reported net of participations
to other financial institutions or investors in the amount of $220.6 million and
$138.2 million as of September 30, 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2006 2005 2006 2005
----------- ------------ ----------- ------------
(THOUSANDS OF DOLLARS)
Senior loans .................................................... $ 1,382,697 $ 1,556,154 $ 3,916,699 $ 3,773,889
Mezzanine loans .................................................. - - - -
----------- ----------- ----------- -----------
$ 1,382,697 $ 1,556,154 $ 3,916,699 $ 3,773,889
=========== =========== =========== ===========
Average senior loan commitment size originated ................... $ 65,843 $ 37,051 $ 41,667 $ 32,534
=========== =========== =========== ===========
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:
SEPTEMBER 30, DECEMBER 31, 2005
--------------------------- ---------------------------
AMOUNT % OF TOTAL AMOUNT % OF TOTAL
----------- ---------- ----------- ----------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Commercial real estate loans:
Construction ............................................. $ 3,915,591 63 % $ 2,448,428 51 %
Bridge ................................................... 1,799,517 29 % 1,887,073 39 %
Permanent ................................................ 405,637 7 % 389,681 8 %
Single tenant credit ..................................... 75,757 1 % 77,113 2 %
----------- ---------- ----------- ----------
6,196,502 100 % 4,802,295 100 %
Other ...................................................... 8,643 0 % 8,589 0 %
----------- ---------- ----------- ----------
6,205,145 100 % 4,810,884 100 %
Deferrred fees and costs ................................... (56,521) (1)% (50,984) (1)%
Allowance for loan losses .................................. (185,227) (3)% (156,837) (3)%
----------- ---------- ----------- ----------
Loans held for investment - net ............................ $ 5,963,397 96 % $ 4,603,063 96 %
=========== ========== =========== ===========
69
As of September 30, 2006, approximately 19.3%, 15.0% and 11.9% 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 10% of the loan portfolio. The real estate securing
these loans includes a wide variety of property and project types including
condominiums (construction and conversion), multi-family-other, 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:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
Multi-family - Condominiums:
Construction ................................................. 32% 27%
Conversion ................................................... 23% 21%
----------- -----------
55% 48%
Land Development ............................................... 14% 15%
Office ......................................................... 9% 14%
Retail ......................................................... 6% 7%
Special Purpose ................................................ 5% 2%
Commercial Mixed-Use ........................................... 4% 5%
Multi-family - Other ........................................... 3% 3%
Industrial ..................................................... 3% 4%
Hotels & Lodging ............................................... 1% 2%
----------- ------------
100% 100%
=========== ============
The commercial real estate loan portfolio as of September 30, 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 ....................... $ 2,255 0% 70 $ 32
> $1 million - $ 5 million ....................... 117,726 2% 39 3,019
> $5 million - $10 million ....................... 474,732 8% 67 7,086
> $10 million - $15 million ....................... 685,195 11% 55 12,458
> $15 million - $20 million ....................... 491,142 8% 28 17,541
> $20 million - $30 million ....................... 1,138,965 18% 47 24,233
> $30 million - $40 million ....................... 1,060,889 17% 30 35,363
> $40 million - $50 million ....................... 432,835 7% 10 43,284
> $50 million ........................................ 1,792,763 29% 26 68,952
------------ --- ----- ---------
$ 6,196,502 100% 372 $ 16,657
============ === ===== =========
70
As of September 30, 2006, the average loan size was $16.7 million (or $20.5
million when loans under $1 million are excluded) and the average loan-to-value
ratio was approximately 73%, using the most current available appraised values
and current loan balances outstanding. The following table details the
commercial real estate loan portfolio as of September 30, 2006 by property
collateral type and as to outstanding balances and total commitment amounts:
AVERAGE
TOTAL LOANS TOTAL LOAN AVERAGE AVERAGE LOAN TO
PROPERTY TYPE OUTSTANDING % COMMITMENTS % LOAN BALANCE COMMITMENT COMMITMENT %
---------------------------- ----------- --- ------------ --- ------------ ---------- ------------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Multi-Family - Condominiums:
Conversion ....................... $ 1,447,071 23% $ 1,731,788 16% $ 28,374 $ 33,957 84%
Construction ..................... 1,945,810 32% 4,972,770 48% 21,620 55,253 39%
----------- --- ------------ --- ------------ ---------- ------------
3,392,881 55% 6,704,558 64% 24,063 47,550 51%
Land Development ................... 901,142 14% 1,244,965 12% 16,384 22,636 72%
Office ............................. 552,925 9% 665,605 6% 18,431 22,187 83%
Retail ............................. 387,699 6% 566,235 5% 14,912 21,778 69%
Special Purpose .................... 340,591 5% 352,624 3% 24,328 25,187 97%
Commercial Mixed-Use ............... 219,796 4% 388,371 4% 16,907 29,875 57%
Multi-Family - Other ............... 207,337 3% 256,386 3% 2,880 3,561 81%
Industrial ......................... 125,841 3% 159,116 2% 8,989 11,365 79%
Hotels & Lodging ................... 68,290 1% 68,290 1% 9,756 9,756 100%
----------- --- ------------ --- ------------ ----------- ------------
$ 6,196,502 100% $ 10,406,150 100% $ 16,657 $ 27,974 60%
=========== === ============ === ============ =========== ============
The commercial real estate loan portfolio includes 26 separate loans with
outstanding balances in excess of $50 million as of September 30, 2006. The
Company's largest single individual loan outstanding (net of participation) at
September 30, 2006 was $100.5 million with a total loan commitment of $130.0
million. The Company's largest net commitment for a single loan at September 30,
2006 was $150.0 million (with $13.2 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. At September 30, 2006, the Company
had two loans collateralized by the same building property; each loan was for
certain floors and purpose (one for condominiums and one for office space). The
combined total loan commitment of the two loans was $156.6 million with a
combined total outstanding loan balance of $142.5 million. As of September 30,
2006, there were nine 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 $206.6 million
in loan principal outstanding with $220.8 million in total loan commitment and
is comprised of four separate loans. All four of the loans under this
concentration were performing as of September 30, 2006.
71
The Company's commercial real estate loans are substantially all
variable-rate loans based upon an index (such as one-month LIBOR) and a spread.
As of September 30, 2006, the average spread above the applicable index was
3.36%. All of the variable-rate loans have interest rate floors in terms of a
minimum rate of interest to be charged; at September 30, 2006, the average
interest rate floor was 6.45%. As of September 30, 2006, the commercial real
estate loans outstanding had the following indexes in place (before addition of
the applicable spread):
ADJUSTABLE RATE:
One-month LIBOR ...................... 19.4%
Three-month LIBOR .................... 5.8%
Six-month LIBOR ...................... 73.2%
Fixed Rate ........................... 1.6%
------
100.0%
======
The following tables provide additional information related to the
Company's commercial real estate non-accrual loans, foreclosed assets,
delinquencies, 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 (note that
as of September 30, 2006, the delinquent loans 30 days past due is comprised of
two loans (one of which subsequently paid off in full during October 2006) and
the delinquent loans 60 days or greater past due are comprised of two loans):
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ -----------
(THOUSANDS OF DOLLARS,
EXCEPT PERCENTS)
Commercial Real Estate:
Non-accrual loans held for investment ("HFI") ............................... $ 36,478 $ 29,290
Real estate owned / foreclosed assets ....................................... 2,555 30,198
------------ -----------
Total non-performing assets ................................................. $ 39,033 $ 59,488
============ ===========
Accruing loans receivable past due 90 days or more .......................... $ - $ -
============ ===========
Restructured loans on accrual status ........................................ $ - $ 12,309
============ ===========
Delinquent loans 60 days past due or greater ................................ 0.51% 0.80%
Non-accrual loans to total loans HFI ........................................ 0.59% 0.62%
Allowance for loan losses to total loans HFI ................................ 3.01% 3.29%
72
THREE MONTHS ENDED SEPTEMBER 30, 2006
----------------------------------------------------
COMMERCIAL RESIDENTIAL
REAL ESTATE REAL ESTATE OTHER TOTAL
----------- ----------- ----- ---------
(THOUSANDS OF DOLLARS)
Beginning allowance for loan losses ............................. $ 172,611 $ - $ 77 $ 172,688
Provision for loan losses ....................................... 12,687 - 5 12,692
Charge-offs ..................................................... (190) - - (190)
Recoveries ...................................................... 37 - - 37
----------- ----------- ----- ---------
Ending allowance for loan losses ................................ $ 185,145 $ - $ 82 $ 185,227
=========== =========== ===== =========
Net charge-offs ................................................. $ (153) $ - $ - $ (153)
============ =========== ===== =========
Annualized net loan charge-offs to average
commercial real estate loans held for investment ................ 0.01%
===========
THREE MONTHS ENDED SEPTEMBER 30, 2005
----------------------------------------------------
COMMERCIAL RESIDENTIAL
REAL ESTATE REAL ESTATE OTHER TOTAL
------------ ----------- ----- ---------
(THOUSANDS OF DOLLARS)
Beginning allowance for loan losses ............................. $ 159,909 $ - $ 47 $ 159,956
Provision for loan losses ....................................... (4,077) (5) 11 (4,071)
Charge-offs ..................................................... - - - -
Recoveries ...................................................... 2,823 5 - 2,828
------------ ----------- ----- ---------
Ending allowance for loan losses ................................ $ 158,655 $ - $ 58 $ 158,713
============ =========== ===== =========
Net recoveries .................................................. $ 2,823 $ 5 $ - $ 2,828
============ =========== ===== =========
Annualized net loan charge-offs to average commercial
real estate loans held for investment ......................... (0.28)%
============
73
NINE MONTHS ENDED SEPTEMBER 30, 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 ....................................... 28,284 (4) - 28,280
Charge-offs ..................................................... (190) - - (190)
Recoveries ...................................................... 296 4 - 300
----------- ----------- ----- ---------
Ending allowance for loan losses ................................ $ 185,145 $ - $ 82 $ 185,227
=========== =========== ===== =========
Net recoveries .................................................. $ 106 $ 4 $ - $ 110
=========== =========== ===== =========
Annualized net loan charge-offs to average
commercial real estate loans held for investment .............. 0.00%
===========
NINE MONTHS ENDED SEPTEMBER 30, 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 ....................................... (7,250) (6) 5 (7,251)
Charge-offs ..................................................... (12,180) - - (12,180)
Recoveries ...................................................... 6,613 6 - 6,619
----------- ----------- ----- ---------
Ending allowance for loan losses ................................ $ 158,654 $ - $ 59 $ 158,713
=========== =========== ===== =========
Net charge-offs / recoveries .................................... $ (5,567) $ 6 $ - $ (5,561)
=========== =========== ===== =========
Annualized net loan charge-offs to average
commercial real estate loans held for investment .............. 0.20%
===========
There were three non-accrual commercial real estate loans held for
investment (the largest having a balance of $16.9 million) totaling $36.5
million, or 0.6% of the total loans held for investment, as of September 30,
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 September 30, 2006 or December 31, 2005, which were 90 days or more past due.
REO related to commercial real estate loans was $2.6 million at September
30, 2006, consisting of two properties, 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.
74
The allowance for loan losses, as a percentage of total loans held for
investment decreased to 3.01% as of September 30, 2006, as compared to 3.29% as
of December 31, 2005. In the third quarter of 2006, the Company incurred
$190,000 net loan charge-offs and realized $37,000 in recoveries of loan
balances previously charged-off, as compared to $2.8 million in total net
recoveries for the third quarter of 2005. The net charge-off ratio for
commercial real estate loans for the first nine months of 2006 was 0.00% as
compared to 0.20% for the first nine months of 2005. Loans secured by hotel and
lodging properties represented 60% and 86% of the total commercial real estate
loans on non-accrual status as of September 30, 2006 and December 31, 2005,
respectively.
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 22 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 $9.56 billion at September 30, 2006 and are
summarized as to type as follows:
NUMBER OF TOTAL
ACCOUNTS DEPOSITS
--------- -----------
(THOUSANDS
OF DOLLARS)
Savings and money market deposit accounts ......................... 35,792 $ 1,534,121
Certificates of deposit:
Retail .......................................................... 139,938 6,766,684
Brokered ........................................................ n/m 1,258,687
-----------
$ 9,559,492
===========
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
$4.96 billion as of September 30, 2006. At September 30, 2006, FIL's actual
borrowing capacity, based upon the amount of collateral pledged and the
applicable advance rates, was $3.01 billion, with $1.23 billion in outstanding
advances. The weighted-average interest rate on the FHLB advances outstanding at
September 30, 2006 was 5.17%. 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 $3.38 billion at September 30, 2006
to secure current and any future borrowings. FIL also
75
has a line of credit with the Federal Reserve Bank of San Francisco and at
September 30, 2006, had a borrowing capacity, based upon collateral pledged, of
$297.7 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 September 30, 2006, these four
facilities totaled $3.00 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 were no amounts outstanding on any of the facilities at September 30,
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 September 30, 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 2007, 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 expiring in August 2007, 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 nine months of 2006, the Company had
transacted whole loan sales with 15 different financial institutions, the
largest institution representing 17.9% 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
76
("FGCC"), intercompany tax payments and benefit plan reimbursements from FIL.
Dividends of $8.5 million and $6.2 million were paid on Fremont General's common
stock in the quarters ended September 30, 2006 and 2005, respectively. For the
nine month periods ended September 30, 2006 and 2005 dividends of $24.8 million
and $16.9 million, respectively, were paid on Fremont General common stock;
however, no assurance can be given that future common stock dividends will be
declared.
During 2005 and 2006, FIL had transferred by dividend substantially 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 September 30, 2006 had an estimated fair value of $108.3 million. The
retained residual interests in securitized loans at FIL had an estimated fair
value at September 30, 2006 of $24.4 million. 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, if any, but does not believe that the
actual outcomes of these matters will adversely impact its liquidity or
earnings. It is expected that the final resolution of these matters may take
several years.
During the third quarter and first nine months of 2006, Fremont General
purchased $3.8 million and $9.8 million (both at par value), respectively, of
its 7.875% Senior Notes due 2009; the costs were approximately $3.7 million and
$9.7 million, respectively.
Fremont General has cash and cash equivalents of $53.1 million at September
30, 2006 and no debt maturities until March of 2009.
OFF-BALANCE SHEET ACTIVITIES
In the third quarter of 2006, the Company continued to securitize 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."
77
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.
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,
credit quality 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;
78
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
o other events, risks and uncertainties discussed elsewhere in this Form 10-Q
and from time to time in our other reports, press releases and filings with
the Securities and Exchange
79
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 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.
80
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 nine months
ended September 30, 2006.
ITEM 4. CONTROLS AND PROCEDURES
As of September 30, 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 September 30, 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.
81
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.
82
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 an 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.
83
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.
GARAMENDI V. RAMPINO ET AL.
On or about October 12, 2006, the California Insurance Commissioner, as
Liquidator on behalf of Fremont Indemnity, filed a First Amended Complaint
against certain former directors and officers of Fremont Indemnity for Breach of
Fiduciary Duty. The Complaint alleges the defendant's breached their fiduciary
duties by orchestrating and allowing Fremont Indemnity to engage in an
inappropriate underwriting scheme that caused injury to Fremont Indemnity's
reinsurers which in turn injured Fremont Indemnity by settlements it made with
those reinsurers. The allegations in this complaint are substantially the same
as those alleged by Gerling Global in its lawsuit. Although neither the Company
nor any of its affiliates are defendants in this lawsuit, it is indemnifying and
defending these directors and officers pursuant to the indemnification clause in
Fremont General's bylaws. The Company intends to vigorously defend this matter
and believes the 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 nine months ended September 30, 2006.
84
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) (2) OR PROGRAMS PLANS OR PROGRAMS (3)
----------------------------------- ------------- ------------ ------------------- -----------------------
July 1-31, 2006 330,463 $ 17.21 324,213
------------------------------------------------------------------------------------------------------------------------------
August 1-31, 2006 2,014 $ 15.55 2,014
------------------------------------------------------------------------------------------------------------------------------
September 1-30, 2006 102,353 $ 14.19 102,353
------------------------------------------------------------------------------------------------------------------------------
Total 434,830 $ 16.49 428,580 2,417,671
==============================================================================================================================
(1) Shares of common stock acquired by the Company through purchases of shares on the open market at fair value, from
participants through purchases of shares under certain employee benefit plans at fair value and reacquisition of shares
under its restricted stock program at $0 per share.
(2) Excluding the purchase of 6,250 restricted stock shares, the average price per share was $16.73 for the three months
ended September 30, 2006. The restricted stock shares were reqcquired at $0 per share under the terms of the Company's
stock award plan upon termination of employment of participants(s) thereunder.
(3) 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.
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 StateNew 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.)
85
EXHIBIT
NO. DESCRIPTION
------- ----------------------------------------------------------------------
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.)
10.1 Amendment to Extend the Term of the Management Continuity Agreement
for Alan W. Faigin. (Incorporated by reference to Exhibit 10.1 to the
Registrant's Form 8-K, date of report of August 2, 2006 Commission
File Number 1-8007.)
10.2 Amendment to Extend the Term of the Management Continuity Agreement
for Patrick E. Lamb. (Incorporated by reference to Exhibit 10.2 to the
Registrant's Form 8-K, date of report of August 2, 2006 Commission
File Number 1-8007.)
10.3 Amendment to Extend the Term of the Management Continuity Agreement
for Kyle R. Walker. (Incorporated by reference to Exhibit 10.3 to the
Registrant's Form 8-K, date of report of August 2, 2006 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.
86
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: November 8, 2006 /s/ LOUIS J. RAMPINO
-------------------------------
Louis J. Rampino
President and Chief Executive Officer
Date: November 8, 2006 /s/ PATRICK E. LAMB
-------------------------------
Patrick E. Lamb
Senior Vice President, Chief Financial
Officer, Chief Accounting Officer and
Treasurer (Principal Accounting Officer)
S-1