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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, 2002
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 1-8007
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.)
2020 Santa Monica Blvd.
Santa Monica, California 90404
(Address of principal executive offices)
(Zip Code)
(310) 315-5500
(Registrant's telephone number, including area code)
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 the number of shares outstanding of each of the issuer's classes
of common stock:
SHARES OUTSTANDING
CLASS OCTOBER 31, 2002
Common Stock, $1.00 par value 75,245,406
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FREMONT GENERAL CORPORATION
INDEX
PART I - FINANCIAL INFORMATION
PAGE NO.
--------
Item 1. Financial Statements
Consolidated Balance Sheets
September 30, 2002 and December 31, 2001 ............. 3
Consolidated Statements of Operations
Three and Nine Months Ended September 30, 2002
and 2001 ............................................. 4
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2002 and 2001 ........ 5
Notes to Consolidated Financial Statements on
Form 10-Q ............................................ 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 12
Item 3. Quantitative and Qualitative Disclosure About
Market Risk .......................................... 24
Item 4. Controls and Procedures ................................ 25
PART II - OTHER INFORMATION
Items 1-5. Not applicable
Item 6. Exhibits and Reports on Form 8-K ....................... 26
Signatures .......................................................... 28
Certifications ...................................................... 29
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2002 2001
----------- -----------
(UNAUDITED)
(THOUSANDS OF DOLLARS)
ASSETS
Cash and cash equivalents .................................................. $ 170,452 $ 151,204
Investment securities available for sale at fair value
(cost: 2002 - $360,144; 2001- $341,721) .................................. 360,279 341,903
Loans receivable ........................................................... 3,971,612 3,757,222
Loans held for sale ........................................................ 1,229,572 755,367
Residual interests in securitized loans at fair value ...................... 24,376 41,840
Accrued interest receivable ................................................ 27,618 25,042
Deferred income taxes ...................................................... 276,037 316,169
Other assets ............................................................... 45,039 63,739
Assets held for discontinued insurance operations .......................... 1,918,123 2,556,519
----------- -----------
TOTAL ASSETS ............................................................. $ 8,023,108 $ 8,009,005
=========== ===========
LIABILITIES
Deposits:
Savings accounts ......................................................... $ 820,605 $ 767,137
Money market deposit accounts ............................................ 251,682 195,946
Certificates of deposit:
Under $100,000 ......................................................... 2,409,826 2,619,576
$100,000 and over ...................................................... 916,219 673,763
----------- -----------
4,398,332 4,256,422
Federal Home Loan Bank ("FHLB") advances ................................... 820,000 309,000
Senior Notes due 2004 ...................................................... 76,616 150,051
Senior Notes due 2009 ...................................................... 188,577 188,330
Liquid Yield Option Notes due 2013 ("LYONs") ............................... 3,049 4,187
Other liabilities .......................................................... 117,988 114,859
Liabilities of discontinued insurance operations ........................... 1,876,316 2,528,383
----------- -----------
TOTAL LIABILITIES ........................................................ 7,480,878 7,551,232
Company-obligated mandatorily redeemable preferred
securities of subsidiary Trust holding solely Company
junior subordinated debentures ("Capital Securities") .................... 100,000 100,000
STOCKHOLDERS' EQUITY
Common Stock, par value $1 per share-- Authorized:
150,000,000 shares; Issued and outstanding:
(2002 - 75,172,000 and 2001 - 70,795,000) ............................... 75,172 70,795
Additional paid-in capital ................................................. 288,683 276,024
Retained earnings .......................................................... 131,859 64,129
Deferred compensation ...................................................... (53,572) (53,293)
Accumulated other comprehensive income ..................................... 88 118
----------- -----------
TOTAL STOCKHOLDERS' EQUITY ............................................... 442,230 357,773
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............................... $ 8,023,108 $ 8,009,005
=========== ===========
See notes to consolidated financial statements on Form 10-Q.
3
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- ------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(RESTATED) (RESTATED)
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
INTEREST INCOME:
Interest and fee income on loans ............................ $ 111,309 $ 102,539 $ 317,621 $ 304,881
Interest income on investment securities .................... 1,211 3,443 3,457 12,555
--------- --------- --------- ---------
112,520 105,982 321,078 317,436
INTEREST EXPENSE:
Deposits .................................................... 35,721 51,252 109,809 166,852
FHLB advances .............................................. 4,672 2,083 9,079 3,502
Senior Notes, LYONs and Capital Securities .................. 7,966 9,400 25,746 28,287
--------- --------- --------- ---------
48,359 62,735 144,634 198,641
Net interest income ........................................... 64,161 43,247 176,444 118,795
Provision for loan losses ..................................... 33,764 19,136 70,188 30,985
--------- --------- --------- ---------
Net interest income after provision for loan losses ........... 30,397 24,111 106,256 87,810
NON-INTEREST INCOME:
Net gain on sale of residential real estate loans ........... 54,914 15,163 96,149 27,651
Net gains on whole loan sales - other ....................... 4 773 78 2,018
Other ....................................................... 3,746 4,744 12,044 12,240
--------- --------- --------- ---------
58,664 20,680 108,271 41,909
NON-INTEREST EXPENSE:
Compensation ................................................ 21,397 14,316 55,804 42,935
Occupancy ................................................... 2,119 2,067 6,325 6,122
Expenses and losses (recoveries) on real estate owned ....... 4,433 (107) 9,766 1,935
Other ....................................................... 10,046 5,983 23,481 17,328
--------- --------- --------- ---------
37,995 22,259 95,376 68,320
Income before income taxes .................................... 51,066 22,532 119,151 61,399
Income tax expense ............................................ 21,232 7,535 48,864 22,694
--------- --------- --------- ---------
Net income from continuing operations ......................... 29,834 14,997 70,287 38,705
Discontinued insurance operations, net of tax ................. - (378) - 2,280
Extraordinary gains on extinguishment of debt, net of tax ..... 662 1,380 1,804 4,345
--------- --------- --------- ---------
Net income .................................................... $ 30,496 $ 15,999 $ 72,091 $ 45,330
========= ========= ========= =========
PER SHARE DATA:
BASIC:
Net income from continuing operations ....................... $ 0.44 $ 0.23 $ 1.05 $ 0.60
Discontinued insurance operations ........................... - - - 0.03
Extraordinary gains on extinguishment of debt ............... 0.01 0.02 0.03 0.07
--------- --------- --------- ---------
Net income .................................................. $ 0.45 $ 0.25 $ 1.08 $ 0.70
========= ========= ========= =========
DILUTED:
Net income from continuing operations ....................... $ 0.40 $ 0.21 $ 0.97 $ 0.55
Discontinued insurance operations ........................... - - - 0.03
Extraordinary gains on extinguishment of debt ............... 0.01 0.02 0.03 0.06
--------- --------- --------- ---------
Net income .................................................. $ 0.41 $ 0.23 $ 1.00 $ 0.64
========= ========= ========= =========
CASH DIVIDENDS ................................................ $ 0.02 $ 0.02 $ 0.06 $ 0.06
WEIGHTED AVERAGE SHARES (IN THOUSANDS):
Basic ....................................................... 67,292 65,112 66,697 64,839
Diluted ..................................................... 73,967 70,696 72,416 70,504
See notes to consolidated financial statements on Form 10-Q.
4
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
2002 2001
------------ ------------
(RESTATED)
(THOUSANDS OF DOLLARS)
OPERATING ACTIVITIES
Net income from continuing operations .................................... $ 70,287 $ 38,705
Adjustments to reconcile net income from continuing
operations to net cash provided by operating activities:
Provision for loan losses .............................................. 70,188 30,985
Net decrease in residual interests in securitized loans ................ 17,464 8,351
Deferred income tax expense ............................................ 40,149 24,313
Depreciation and amortization .......................................... 13,666 9,075
Change in other assets and liabilities ................................. 11,107 (5,533)
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES ............................ 222,861 105,896
INVESTING ACTIVITIES
Loan originations and advances funded .................................... (5,846,924) (3,731,912)
Receipts from repayments and bulk sales of loans ......................... 5,100,423 2,990,802
Investment securities available for sale:
Purchases .............................................................. (348,844) (315,067)
Maturities or repayments ............................................... 330,421 272,342
Capital contributions to discontinued insurance operations ............... (10,934) (6,000)
Purchases of property and equipment ...................................... (3,025) (752)
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES .................................. (778,883) (790,587)
FINANCING ACTIVITIES
Net increase in deposits ................................................. 141,910 334,377
Proceeds from FHLB advances .............................................. 511,000 260,000
Extinguishment of Senior Notes and LYONs ................................ (71,830) (21,634)
Dividends paid on common stock ........................................... (5,690) (5,647)
(Increase) decrease in deferred compensation plans ....................... (120) 346
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES .............................. 575,270 567,442
Increase (decrease) in cash and cash equivalents ........................... 19,248 (117,249)
Cash and cash equivalents at beginning of year ........................... 151,204 236,352
------------ ------------
Cash and cash equivalents at end of period ................................. $ 170,452 $ 119,103
============ ============
See notes to consolidated financial statements on Form 10-Q.
5
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ON FORM 10-Q
(UNAUDITED)
NOTE A - BASIS OF PRESENTATION OF FINANCIAL STATEMENTS
These statements have been prepared in accordance with accounting
principles generally accepted in the United States and, accordingly, adjustments
(consisting of normal accruals) have been made as management considers necessary
for fair presentations. For further information, refer to the consolidated
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended December 31, 2001. The consolidated statements
of operations and cash flows for the period through September 30, 2001 have been
restated to reflect the discontinuance of the Company's property and casualty
insurance operations.
NOTE B - LOANS RECEIVABLE
Loans receivable consist of commercial and residential real estate loans
and syndicated commercial loans. Commercial real estate loans, which are
primarily variable rate, represent loans secured generally by first mortgages on
properties such as office, retail, industrial, hotels/motels, multi-family and
commercial mixed-use properties. Commercial real estate loans are reported net
of participations to other financial institutions or investors in the amount of
$114.7 million, $118.0 million and $116.6 million as of September 30, 2002,
December 31, 2001 and September 30, 2001, respectively. Residential real estate
loans have loan terms for up to thirty years and are generally secured by first
deeds of trust on single-family residences. Syndicated commercial loans are
commercial variable rate senior loans and are generally secured by substantially
all of the assets of the borrower.
Loans held for sale consist solely of residential real estate loans which
are aggregated prior to their sale and are carried at the lower of aggregate
amortized cost or market.
NOTE C - DEPOSITS AND FHLB ADVANCES
Certificates of deposits as of September 30, 2002 are detailed by maturity
and rates as follows (thousands of dollars):
MATURING BY WEIGHTED
AMOUNT SEPTEMBER 30, AVERAGE RATE
----------- ------------ -------------
$ 2,708,354 2003 2.91%
439,523 2004 4.27%
35,384 2005 6.14%
92,451 2006 5.49%
68 2007 5.38%
50,265 2008 5.36%
-----------
$ 3,326,045
===========
Of the total certificates of deposit at September 30, 2002, $648.6 million
were obtained through brokers.
6
The Federal Home Loan Bank ("FHLB") advances are collateralized by loans
pledged to the FHLB. The following table details the FHLB amounts outstanding at
September 30, 2002 by maturities and rates (thousands of dollars):
MATURING BY WEIGHTED
AMOUNT SEPTEMBER 30, AVERAGE RATE
--------- ------------- ------------
$ 300,000 2003 2.07%
505,000 2004 3.25%
15,000 2005 2.49%
---------
$ 820,000
=========
NOTE D - DISCONTINUED OPERATIONS
In the fourth quarter of 2001, the Company discontinued its property and
casualty insurance operation, primarily represented by the underwriting of
workers' compensation insurance policies. Consequently, the property and
casualty insurance operation is accounted for as a discontinued operation using
the liquidation basis of accounting as prescribed under Accounting Principles
Board Opinion No. 30, "Reporting the Results of Operations." As of September 30,
2002, the Company believes that the loss and loss adjustment expenses reserves
of the discontinued insurance operations are adequate. The Company intends to
allow the liabilities related to this business to run-off and estimates that the
dedicated assets supporting these operations, and all related future cash
inflows, will be adequate to fund future policy obligations and related
expenses. Discontinued insurance operations also include the Company's
discontinued assumed treaty and facultative reinsurance, and life insurance
businesses.
The dedicated assets supporting the discontinued insurance operations and
related liabilities are summarized in the following table:
7
SEPTEMBER 30, DECEMBER 31,
2002 2001
----------- -----------
(THOUSANDS OF DOLLARS)
ASSETS
Cash and invested assets, at amortized cost ............................... $ 828,716 $ 1,248,303
Premiums receivable ....................................................... 73,630 121,871
Reinsurance recoverables:
Property and casualty insurance - paid losses ........................... 64,113 60,407
Property and casualty insurance - unpaid losses ......................... 742,605 856,652
Assumed reinsurance and life insurance paid and unpaid losses ........... 63,905 75,317
Other assets .............................................................. 145,154 193,969
----------- -----------
Total ................................................................. $ 1,918,123 $ 2,556,519
=========== ===========
LIABILITIES
Reserves for loss and loss adjustment expenses (net of discount):
Property and casualty insurance ......................................... $ 1,653,201 $ 2,203,349
Assumed reinsurance ..................................................... 83,679 103,563
Life insurance benefits and liabilities ................................... 44,638 59,906
Other liabilities ......................................................... 94,798 161,565
----------- -----------
Total ................................................................. $ 1,876,316 $ 2,528,383
=========== ===========
NOTE E - TOTAL COMPREHENSIVE INCOME
The components of total comprehensive income are summarized in the
following table:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
(RESTATED) (RESTATED)
(THOUSANDS OF DOLLARS)
Net income ..................................................... $ 30,496 $ 15,999 $ 72,091 $ 45,330
Other comprehensive income (loss):
Net change in unrealized gains (losses)
during the period ............................................ (25) (42) (47) 116
Less deferred income tax expense (benefit) ................... (9) (15) (17) 40
-------- -------- -------- --------
Other comprehensive income (loss) .......................... (16) (27) (30) 76
-------- -------- -------- --------
Total comprehensive income ..................................... $ 30,480 $ 15,972 $ 72,061 $ 45,406
======== ======== ======== ========
8
NOTE F - OPERATIONS BY REPORTABLE SEGMENT
The Company's business is engaged in one reportable segment, financial
services. Additionally, there are certain corporate revenues and expenses,
comprised primarily of investment income, interest expense and certain general
and administrative expenses, that are not allocated to its reportable segment or
to the discontinued insurance operations.
The following data for the three and nine months ended September 30, 2002
and 2001 provide certain information necessary for reportable segment
disclosure:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- ------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(RESTATED) (RESTATED)
(THOUSANDS OF DOLLARS)
NET INTEREST INCOME
Financial services ............................................ $ 71,927 $ 52,041 $ 201,447 $ 144,954
Unallocated corporate ......................................... (7,766) (8,794) (25,003) (26,159)
--------- --------- --------- ---------
Total consolidated ........................................... $ 64,161 $ 43,247 $ 176,444 $ 118,795
========= ========= ========= =========
INCOME (LOSS) BEFORE INCOME TAXES
Financial services ............................................ $ 68,045 $ 36,012 $ 164,328 $ 101,086
Unallocated corporate ......................................... (16,979) (13,480) (45,177) (39,687)
--------- --------- --------- ---------
Total consolidated ........................................... $ 51,066 $ 22,532 $ 119,151 $ 61,399
========= ========= ========= =========
9
NOTE G - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share for the three and nine months ended September 30, 2002 and
2001:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
(RESTATED) (RESTATED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income from continuing operations
(numerator for basic earnings per share) ..................... $ 29,834 $ 14,997 $ 70,287 $ 38,705
Effect of dilutive securities:
LYONs ........................................................ 23 31 86 92
-------- -------- -------- --------
Net income from continuing operations available to common
stockholders after assumed conversions
(numerator for diluted earnings per share) ................... $ 29,857 $ 15,028 $ 70,373 $ 38,797
======== ======== ======== ========
Weighted-average shares
(denominator for basic earnings per share) ................... 67,292 65,112 66,697 64,839
Effect of dilutive securities:
Restricted stock ............................................. 6,470 5,291 5,514 5,372
LYONs ........................................................ 205 293 205 293
------- -------- -------- --------
Dilutive potential common shares ............................... 6,675 5,584 5,719 5,665
------- -------- -------- --------
Adjusted weighted-average shares and assumed
conversions (denominator for diluted earnings per share) ..... 73,967 70,696 72,416 70,504
======== ======== ======== ========
Basic earnings per share from continuing operations ............ $ 0.44 $ 0.23 $ 1.05 $ 0.60
======== ======== ======== ========
Diluted earnings per share from continuing operations .......... $ 0.40 $ 0.21 $ 0.97 $ 0.55
======== ======== ======== ========
10
NOTE H - EXTRAORDINARY ITEM - GAIN ON EXTINGUISHMENT OF DEBT
The Company extinguished debt that resulted in gains reported as an
extraordinary item in the accompanying Consolidated Statements of Operations.
These gains are summarized in the following table:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- --------- --------
2002 2001 2002 2001
--------- -------- --------- --------
(THOUSANDS OF DOLLARS)
7.70% SENIOR NOTES DUE 2004:
Par Value of debt extinguished ................................. $ 23,000 $ 3,000 $ 73,815 $ 3,000
Gain on extinguishment, net of tax ............................. 662 318 1,757 318
7.875% SENIOR NOTES DUE 2009:
Par Value of debt extinguished ................................. $ - $ 6,500 $ - $ 26,000
Gain on extinguishment, net of tax ............................. - 1,062 - 4,027
LIQUID YIELD OPTION NOTES DUE 2013:
Principal amount at maturity extinguished ...................... $ - $ - $ 2,269 $ -
Gain on extinguishment, net of tax ............................. - - 47 -
NOTE I - NEW ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections." SFAS No. 145 rescinds SFAS No. 4, "Reporting Gains and
Losses from Extinguishment of Debt," which required all gains and losses from
extinguishment of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. As a result, the criteria
in Accounting Principles Board ("APB") Opinion No. 30, "Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions,"
("APB No. 30") will now be used to classify those gains and losses. Any gain or
loss on extinguishment of debt that was classified as an extraordinary item in
the prior periods presented, that does not meet the criteria in APB No. 30 for
classification as an extraordinary item, shall be reclassified. The Company will
adopt SFAS No. 145 as of January 1, 2003. The Company has not yet determined the
impact this statement will have on its financial position or results of
operations.
Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets". The adoption of SFAS No.
144 did not have a material impact on the Company's financial position or
results of operations.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 the current
expectations and beliefs of Fremont General Corporation ("Fremont") and its
subsidiaries (combined "the Company") concerning future developments and their
potential effects upon the Company. These statements and the Company's currently
reported results 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 the Company. Actual developments and/or results may differ
significantly and adversely from the Company's expected or currently reported
results as a result of significant risks, uncertainties and factors beyond the
Company's control (as well as the various assumptions utilized in determining
the Company's expectations) which include, but are not limited to, the
following:
o the variability of general and specific economic conditions and
trends;
o changes in, and the level of, interest rates;
o the impact of competition and pricing environments on loan and deposit
products and the resulting effect upon the Company's net interest
margin and net gain on sale;
o changes in the Company's ability to originate loans, and any changes
in the cost and volume of loans originated as a result;
o the ability to access the necessary capital resources in a
cost-effective manner to fund loan originations and the condition of
the whole loan sale and securitization markets;
o the ability of the Company to sell or securitize the residential real
estate loans it originates, the pricing of existing and future loans,
and the net premiums realized upon the sale of such loans;
o the ability of the Company to sell certain of the commercial real
estate loans and foreclosed real estate in its portfolio and the net
proceeds realized upon the sale of such;
o changes in the fair values of the Company's assets and loans,
including the value of the underlying real estate collateral;
o the impact of changes in the commercial and residential real estate
markets, particularly in California;
o adverse development of, and the variability in determining, the
allowance for loan losses and claims and policy reserves;
o the ability to collect and realize the amounts outstanding, and the
timing thereof, of loans, foreclosed real estate, premiums receivable
and reinsurance recoverables;
o the occurrence of catastrophic events;
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 and the California Department of Insurance (or
other regulatory bodies) on various matters;
o the ability of the Company to maintain cash flow sufficient for it to
meet its debt service and other obligations;
o the consequences and cost of adverse state and federal legislation and
regulations;
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 of the Company to utilize the net operating loss
carryforwards currently held;
o changes in the frequency and severity of claims;
o the impact of litigation, adverse court decisions and changes in the
judicial climate;
o changes in the medical and rehabilitation cost control environment;
o increases in asbestos and environmental claims and payments;
o increases in fraud and abuse; and
o other events, risks and uncertainties discussed elsewhere in this Form
10-Q and from time to time in Fremont's other reports, press releases
and filings with the Securities and Exchange Commission.
The Company undertakes no obligation to publicly update such
forward-looking statements.
12
GENERAL
Fremont General Corporation ("Fremont" or when combined with its
subsidiaries "the Company") is a financial services holding company. The
Company's financial services segment is consolidated within Fremont General
Credit Corporation ("FGCC"), which is engaged in commercial and consumer real
estate lending nationwide through its California-chartered industrial bank
subsidiary, Fremont Investment & Loan ("FIL"). Additionally, there are certain
corporate revenues and expenses, comprised primarily of investment income,
interest expense and certain general and administrative expenses, that are not
allocated by Fremont to FGCC or to the discontinued insurance operations.
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,
2001.
RESULTS OF OPERATIONS
The Company reported net income of $30,496,000 for the third quarter of
2002. This was comprised of net income from continuing operations of $29,834,000
and an after-tax gain on the extinguishment of debt of $662,000. This is
compared to net income from continuing operations of $14,997,000 for the third
quarter of 2001.
The following table presents a summary of the Company's income before taxes
and net income for the periods ended September 30, 2002 and 2001, respectively:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2002 2001 2002 2001
--------- --------- -------- ---------
(RESTATED) (RESTATED)
(THOUSANDS OF DOLLARS)
Income (loss) before taxes:
Financial services .......................................... $ 68,045 $ 36,012 $ 164,328 $ 101,086
Unallocated corporate interest and other expenses ........... (16,979) (13,480) (45,177) (39,687)
--------- --------- --------- ---------
Income before taxes from continuing operations ................ 51,066 22,532 119,151 61,399
Income tax expense ............................................ 21,232 7,535 48,864 22,694
--------- --------- --------- ---------
Net income from continuing operations ......................... 29,834 14,997 70,287 38,705
Discontinued insurance operations, net of tax ................. - (378) - 2,280
Extraordinary gains on extinguishment of debt, net of tax .... 662 1,380 1,804 4,345
--------- --------- --------- ---------
Net income $ 30,496 $ 15,999 $ 72,091 $ 45,330
========= ========= ========= =========
The Company's financial services operation recorded income before taxes of
$68.0 million for the third quarter of 2002 as compared to $36.0 million for the
third quarter of 2001. The increase in income before taxes for the third quarter
of 2002 represents an 89% increase over the results for the third quarter of
2001 and is a result of significantly increased levels of net interest income
and net gain on the sale of residential real estate loans, offset by a higher
provision for loan losses. The net interest income for the third quarter of 2002
was $71.9 million as compared
13
to $52.0 million for the third quarter of 2001. The increase in net interest
income is primarily a result of an increase in the net interest income margin
(as a percentage of average interest-earning assets). The net interest income
margin improved to an annualized 5.08% for the third quarter of 2002 from 4.33%
for the third quarter of 2001. The net gain on the sale of residential real
estate loans, net of reductions in the carrying valuations of loans held for
sale, increased from $15.2 million in the third quarter of 2001 to $54.9 million
for the third quarter of 2002. This increase is primarily attributable to
significant increases in the volume of loans sold in the two comparable quarters
and in the net premiums realized for the loans sold. A total of $1.65 billion in
loans were sold during the third quarter of 2002, as compared to loan sales of
$816.3 million during the third quarter of 2001. The provision for loan losses
increased to $33.8 million for the third quarter of 2002 as compared to $19.1
million for the third quarter of 2001. The Company's loans receivable (excluding
loans held for sale), before the allowance for loan losses, were approximately
$4.11 billion at September 30, 2002, as compared to $3.86 billion at both
December 31, 2001 and September 30, 2001.
The unallocated corporate interest and other expense loss before taxes for
the quarter ended September 30, 2002, was $17.0 million as compared to $13.5
million for the same period in 2001. The increase for the third quarter of 2002,
as compared to the third quarter of 2001, is a result of lower investment income
(due to the lower interest rate environment existing during the third quarter of
2002 and lower invested balances), lower amounts of recognized management fees
from the workers' compensation insurance subsidiaries and higher incentive
compensation expense, offset by lower interest and other general expenses. In
addition, during the third quarter of 2002, $1.4 million in other expense was
recognized upon the termination of a split-dollar life insurance plan (this plan
provided insurance coverage for substantially all of the officers and management
of the Company and was replaced by term life coverage).
The Company's property and casualty insurance operation (which was
primarily the underwriting of workers' compensation insurance policies) was
classified as discontinued during the fourth quarter of 2001 and is now
accounted for as a discontinued operation using the liquidation basis of
accounting. Accordingly, the Company's operating results have been restated to
reflect reporting in this manner for all periods presented. The Company
recognized net income of $2.28 million from the property and casualty insurance
operations for the first nine months of 2001 prior to their classification as
discontinued. Discontinued insurance operations also include the Company's
discontinued assumed treaty and facultative reinsurance, and life insurance
businesses. The Company believes that the loss and loss adjustment expense
reserves of the discontinued insurance operations are adequate, on a discounted
basis, as of September 30, 2002, and that the assets of these operations, and
all related future cash inflows, will be adequate to fund all future policy
obligations and related expenses.
During the quarter ended September 30, 2002, the Company extinguished $23.0
million in principal amount of its publicly traded 7.70% Senior Notes due 2004
and recognized an after-tax gain of $662,000. The after-tax gain from these
extinguishments is reported as an extraordinary item in the accompanying
Consolidated Statements of Operations.
14
Income tax expense of $21.2 million and $7.5 million for the quarters ended
September 30, 2002 and 2001, respectively, represents effective tax rates of
41.6% and 33.4%, respectively, on income before taxes from continuing operations
of $51.1 million and $22.5 million for the same respective periods. The
effective tax rates for both periods presented are different than the federal
enacted tax rate of 35%, due mainly to various state income tax provisions
within the Company's financial services operation. The rate for the third
quarter of 2001 was significantly lower than the rate for the third quarter of
2002 primarily due to certain necessary adjustments made during the
classification of the Company's property and casualty insurance operations into
discontinued status.
FINANCIAL SERVICES OPERATION
The following table summarizes the Company's financial services segment
earnings for the respective quarters indicated:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(THOUSANDS OF DOLLARS)
FINANCIAL SERVICES
Interest and fee income on loans .............................. $ 111,309 $ 102,539 $ 317,621 $ 304,881
Interest income on investment securities ...................... 1,011 2,837 2,714 10,427
--------- --------- --------- ---------
Total interest income ...................................... 112,320 105,376 320,335 315,308
Interest expense .............................................. 40,393 53,335 118,888 170,354
--------- --------- --------- ---------
Net interest income ........................................ 71,927 52,041 201,447 144,954
Provision for loan losses ..................................... 33,764 19,136 70,188 30,985
--------- --------- --------- ---------
Net interest income after provision for loan losses ........ 38,163 32,905 131,259 113,969
Net gain on sale of residential real estate loans ............. 54,914 15,163 96,149 27,651
Other non-interest income ..................................... 3,750 4,517 11,792 12,271
Operating expenses ............................................ (28,782) (16,573) (74,872) (52,805)
--------- --------- --------- ---------
Income before taxes ........................................... $ 68,045 $ 36,012 $ 164,328 $ 101,086
========= ========= ========= =========
The following table shows loans receivable outstanding (excluding loans
held for sale) in the various financing categories as of the dates indicated:
15
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
2002 2001 2001
----------- ----------- ------------
(THOUSANDS OF DOLLARS)
Commercial real estate loans:
Bridge .................................................... $ 1,646,866 $ 1,653,970 $ 1,524,130
Permanent ................................................. 1,358,313 1,320,993 1,235,143
Construction .............................................. 338,582 263,587 398,067
Single tenant credit ...................................... 298,970 307,320 311,338
----------- ----------- -----------
3,642,731 3,545,870 3,468,678
Residential real estate loans ............................... 433,839 195,643 190,217
Syndicated commercial loans ................................. 41,472 113,504 206,869
Other - consumer loans ...................................... 4,711 22,555 11,928
----------- ----------- -----------
4,122,753 3,877,572 3,877,692
Deferred fees and costs ..................................... (13,512) (16,171) (17,558)
----------- ----------- -----------
Loans receivable before allowance for loan losses ......... 4,109,241 3,861,401 3,860,134
Allowance for loan losses ................................... (137,629) (104,179) (88,155)
----------- ----------- -----------
Loans receivable, net of allowance for loan losses ........ $ 3,971,612 $ 3,757,222 $ 3,771,979
=========== =========== ===========
Residential real estate loans held for sale ................. $ 1,229,572 $ 755,367 $ 641,853
=========== =========== ===========
As of September 30, 2002, approximately 48% of the Company's commercial
real estate loans outstanding were secured by properties located within
California; no other state represented greater than 7% of the loan portfolio.
The Company's largest single commercial real estate loan outstanding at
September 30, 2002 was $47.6 million. The largest net commitment for a single
loan at September 30, 2002 was $56.5 million. In addition, the portfolio has one
concentration by common investor or sponsor base that is in excess of $75
million. This concentration, which totals $83.1 million at September 30, 2002,
is from two affiliated investment funds (affiliated by common advisor) and is
comprised of four separate loans, each of which was performing as of September
30, 2002.
The following table stratifies the commercial real estate portfolio by loan
amounts outstanding as of September 30, 2002 (in thousands of dollars, except
percents and number of loans):
NUMBER TOTAL LOANS
LOAN SIZE RANGE OF LOANS OUTSTANDING %
---------------------------- -------- --------------------
$0 - $5 million ............................... 387 $ 734,428 20%
> $5 million - $10 million .................... 122 860,493 24%
> $10 million - $15 million ................... 46 568,783 16%
> $15 million - $20 million ................... 27 469,363 13%
> $20 million - $30 million ................... 25 629,925 17%
> $30 million - $40 million ................... 10 332,114 9%
> $40 million ................................. 1 47,625 1%
-------- ----------- ---
618 $ 3,642,731 100%
======== =========== ===
16
The following tables identify the interest income, interest expense,
average interest-earning assets and interest-bearing liabilities, and net
interest margins for the Company's financial services operation for the periods
indicated:
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------------------------------
2002 2001
--------------------------------------- ---------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST (1) BALANCE INTEREST COST (1)
----------- --------- --------- ----------- --------- -------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Interest-earning assets (2) :
Commercial real estate loans ......... $ 3,522,057 $ 70,725 7.97% $ 3,354,947 $ 77,745 9.19%
Residential real estate loans (3) .... 1,890,211 40,052 8.41 871,188 20,215 9.21
Syndicated commercial loans .......... 47,741 532 4.42 252,847 4,579 7.18
Investment securities ................ 158,422 1,011 2.53 286,259 2,837 3.93
----------- --------- ----------- ---------
Total interest-earning assets ....... $ 5,618,431 $ 112,320 7.93% $ 4,765,241 $ 105,376 8.77%
=========== ========= =========== =========
Interest-bearing liabilities:
Time deposits ........................ $ 3,358,064 $ 28,684 3.39% $ 3,293,261 $ 43,160 5.20%
Savings deposits ..................... 1,087,393 7,037 2.57 816,658 8,091 3.93
Debt with FHLB ....................... 612,914 4,630 3.00 205,864 2,060 3.97
Other ................................ 8,345 42 2.00 4,716 24 2.02
----------- --------- ----------- ---------
Total interest-bearing liabilities .. $ 5,066,716 $ 40,393 3.16% $ 4,320,499 $ 53,335 4.90%
=========== ========= =========== =========
Net interest income .................... $ 71,927 $ 52,041
========= =========
Percent of average interest-earning
assets(1):
Interest income ...................... 7.93% 8.77%
Interest expense ..................... 2.85% 4.44%
--------- ---------
Net interest margin ................. 5.08% 4.33%
========= =========
17
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------------------------------
2002 2001
--------------------------------------- ----------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST (1) BALANCE INTEREST COST (1)
----------- ---------- -------- ----------- --------- -------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Interest-earning assets (2) :
Commercial real estate loans ......... $ 3,492,511 $ 212,848 8.15% $ 3,190,674 $ 233,248 9.77%
Residential real estate loans (3) .... 1,589,704 102,296 8.60 766,471 54,036 9.43
Syndicated commercial loans .......... 69,197 2,476 4.78 286,177 17,597 8.22
Investment securities ................ 139,546 2,715 2.60 280,814 10,427 4.96
----------- --------- ----------- ---------
Total interest-earning assets ....... $ 5,290,958 $ 320,335 8.09% $ 4,524,136 $ 315,308 9.32%
=========== ========= =========== =========
Interest-bearing liabilities:
Time deposits ........................ $ 3,273,184 $ 88,120 3.60% $ 3,253,991 $ 142,449 5.85%
Savings deposits ..................... 1,058,897 21,688 2.74 726,591 24,402 4.49
Debt with FHLB ....................... 448,660 8,993 2.68 111,988 3,440 4.11
Other ................................ 5,787 87 2.01 4,185 63 2.01
----------- --------- ----------- ---------
Total interest-bearing liabilities .. $ 4,786,528 $ 118,888 3.32% $ 4,096,755 $ 170,354 5.56%
=========== ========= =========== =========
Net interest income .................... $ 201,447 $ 144,954
========= =========
Percent of average interest-earning
assets(1):
Interest income ...................... 8.09% 9.32%
Interest expense ..................... 3.00% 5.04%
--------- -----------
Net interest margin ................. 5.09% 4.28%
========= ===========
(1) Annualized.
(2) Average loan balances include non-accrual loan balances and exclude residual interests in securitized loans.
(3) Includes loans held for sale and other consumer loans.
The Company's net interest margin as a percentage of average
interest-earning assets increased to 5.08% in the third quarter of 2002 as
compared to 4.33% for the third quarter of 2001. The increase in the Company's
net interest margin is due primarily to higher net spreads between the
commercial and residential real estate loans yields and the effective cost of
funds employed to fund these assets, as well as the effect of a higher yielding
mix of interest-earning assets (i.e. an increased average balance of higher
yielding residential loans and lower average balances of lower yielding
syndicated commercial loans and investment securities). Interest yields on
deposits and Federal Home Loan Bank ("FHLB") borrowings declined on a
quarter-to-quarter comparison more than the yields on commercial and residential
real estate loans did. This is due in part to the presence of interest rate
floors (i.e. the total of the variable base rate, such as six-month LIBOR, plus
the related spread on a commercial real estate loan will not contractually drop
below a certain absolute level, such as 7%) on a significant number of the
Company's commercial real estate loans, as well as various economic and market
factors.
The following tables report the non-performing asset classifications,
accruing loans past due 90 days or more, loan loss experience and allowance for
loan losses reconciliation of the financial services operation as of or for the
respective periods ended:
18
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
2002 2001 2001
----------- ---------- -----------
(THOUSANDS OF DOLLARS)
Non-accrual loans receivable:
Commercial real estate loans ............................ $ 68,231 $ 68,921 $ 75,357
Residential real estate loans - portfolio ............... 5,328 2,531 2,723
Residential real estate loans - held for sale ........... 5,312 16,639 11,119
Syndicated commercial loans ............................. 11,663 3,397 5,331
Other ................................................... - 104 96
-------- --------- ---------
90,534 91,592 94,626
Real estate owned ("REO"):
Commercial real estate loans ............................ 2,999 19,329 7,478
Residential real estate loans - portfolio ............... 425 4,260 6,962
Residential real estate loans - held for sale ........... 5,304 - -
-------- --------- ---------
8,728 23,589 14,440
-------- --------- ---------
Total non-performing assets ("NPA") ....................... $ 99,262 $ 115,181 $ 109,066
======== ========= =========
Accruing loans past due 90 days or more:
Commercial real estate loans ............................ $ 1,093 $ 15,586 $ 12,373
Residential real estate loans ........................... - - 142
Other ................................................... 2 4 5
-------- --------- ---------
$ 1,095 $ 15,590 $ 12,520
======== ========= =========
NPA to total loans receivable, loans held
for sale ("HFS") and REO .................................. 1.86% 2.48% 2.41%
Accruing loans past due 90 days or more
to total loans receivable and HFS ......................... 0.02% 0.34% 0.28%
19
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- ----------------------
2002 2001 2002 2001
--------- -------- --------- ---------
(THOUSANDS OF DOLLARS)
Beginning allowance for loan losses .......................... $ 117,914 $ 73,134 $ 104,179 $ 67,599
Provision for loan losses .................................... 33,764 19,136 70,188 30,985
Reclass of allowance for loan commitments .................... (3,259) - (3,259) -
Charge-offs:
Commercial real estate loans ............................... (7,492) (1,829) (20,519) (3,800)
Residential real estate loans .............................. - (58) (57) (639)
Syndicated commercial loans ................................ (4,999) (2,914) (14,618) (6,769)
Other-consumer ............................................. - - - -
--------- -------- --------- ---------
Total charge-offs ......................................... (12,491) (4,801) (35,194) (11,208)
--------- -------- --------- ---------
Recoveries:
Commercial real estate loans ............................... 1,694 662 1,695 662
Residential real estate loans .............................. 7 24 11 117
Syndicated commercial loans ................................ - - - -
Other-consumer ............................................. - - 9 -
--------- -------- --------- ---------
Total recoveries .......................................... 1,701 686 1,715 779
--------- -------- --------- ---------
Net charge-offs .............................................. (10,790) (4,115) (33,479) (10,429)
--------- -------- --------- ---------
Ending allowance for loan losses ............................. $ 137,629 $ 88,155 $ 137,629 $ 88,155
========= ======== ========= =========
Allowance for loan losses to total loans receivable .......... 3.35% 2.28% 3.35% 2.28%
Net loan charge-offs to average total loans
receivable (excluding HFS)* ................................ 1.04% 0.42% 1.12% 0.37%
* Annualized
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
2002 2001 2001
------------ ---------- -----------
(THOUSANDS OF DOLLARS)
Allocation of allowance for loan losses:
Commercial real estate loans ............................... $ 118,885 $ 92,676 $ 76,816
Residential real estate loans .............................. 15,802 7,534 6,120
Syndicated commercial loans ................................ 2,950 3,986 5,219
Other-consumer ............................................. (8) (17) -
---------- ---------- ---------
Total allowance for loan losses .......................... $ 137,629 $ 104,179 $ 88,155
========== ========== =========
Non-performing assets decreased to $99.3 million, or 1.86% of total loans
receivable, loans held for sale and real estate owned at September 30, 2002,
from $115.2 million or 2.48% at December 31, 2001 and $109.1 million at
September 30, 2001. In addition, there were $1.1 million in loans, on accrual
status at September 30, 2002 that were 90 days or greater past due. The level of
non-performing assets fluctuates and specific loans can have a material impact
upon the total. During the third quarter of 2002, there were no loans
restructured as to their terms and included in accrual status at September 30,
2002. There were two loans that were restructured during the third quarter of
2001, with a total balance of $1.6 million at September 30, 2001. These two
loans, with a total balance of $1.5 million as of
20
September 30, 2002, were performing within their contractual terms and were in
accrual status at September 30, 2002. At June 30, 2002, there were six
commercial real estate loans with a total balance of $56.8 million included in
accrual status that were modified during the second quarter of 2002 in
connection with loan restructurings. During the first quarter of 2002, there
were five commercial real estate loans, with a total outstanding balance of
$103.2 million at March 31, 2002, that were restructured and included in accrual
status. Of the eleven loans restructured during the first six months of 2002,
three (total balance of $56.4 million) were paid off in full during the second
quarter of 2002, and one (total balance of $5.2 million) was transferred to
non-accrual status during the third quarter of 2002. The remaining seven loans,
with a total balance of $98.9 million as of September 30, 2002, were performing
within their contractual terms and were in accrual status at September 30, 2002.
The Company incurred $1.2 million in charge-offs related to the restructuring of
the eleven loans during 2002 and no charge-offs were recognized on the loans
restructured during 2001.
The provision for loan losses for the quarter ended September 30, 2002
increased to $33.8 million, as compared to $19.1 million in the same period of
2001. The allowance for loan losses, as a percentage of total loans receivable,
excluding loans held for sale, increased to 3.35% as of September 30, 2002, as
compared to 2.28% at September 30, 2001. The increase in the provision for loan
losses during the third quarter of 2002, as compared to the third quarter of
2001, is primarily due to an increased level of net loan charge-offs in the
third quarter of 2002 and an observed decline in general economic conditions.
Net charge-offs in the third quarter of 2002 totaled $10.8 million, as compared
to $4.1 million for the third quarter of 2001. The increase is a result of
increased net charge-offs for commercial real estate and syndicated commercial
loans. The net charge-offs for commercial real estate and syndicated commercial
loans increased during 2002 primarily as a reflection of the effect of the
economic downturn, as well as a concerted effort by the Company to reduce
non-performing asset levels through asset sales.
DISCONTINUED INSURANCE OPERATIONS
The Company and Employers Insurance Company of Nevada ("EICN") executed a
definitive agreement, effective July 1, 2002, for the acquisition by EICN of the
on-going business, policy production organization and facilities of the
Company's workers' compensation insurance operation. EICN will operate the new
business under the name Fremont Employers Insurance Company, which is a
wholly-owned subsidiary of EICN. Substantially all of the existing loss reserves
and related assets of the discontinued workers' compensation insurance operation
that existed as of June 30, 2002, will remain with the Company.
In July 2002, Fremont executed a definitive agreement with the California
Department of Insurance ("DOI") that would allow the Company to self-administer
the run-off of policies currently in force by paying claims and operating
expenses in the ordinary course of business and also preserve the Company's net
operating loss carryforwards attributable to its discontinued workers'
compensation insurance subsidiary. The agreement also obligates Fremont to make
certain additional capital contributions to its discontinued workers'
compensation insurance subsidiary. Fremont is obligated to contribute $13.25
million each year for three years beginning with 2002. Beginning in 2005 and
through 2008, Fremont has a contingent obligation to make capital contributions
of up to
21
$13.25 million each year. These contingent capital contributions are subject to
payment only if in any subject year the statutory surplus and loss and loss
adjustment expense reserves of the discontinued workers' compensation insurance
subsidiary are deemed to be inadequate by the DOI. Any amount not paid in any
one of these years shall be a deferred contingent liability and subject to
payment in any future year if any deficiency arises, however, the amount of
contribution for any one year, including any deferred contingent liability,
shall not exceed $13.25 million. The total amount of potential contributions is
$92.75 million, of which $53.0 (comprised of $13.25 million for each of the four
years 2005 through 2008) million is contingent. If conservation proceedings
related to the Company's discontinued workers' compensation insurance subsidiary
were entered into prior to March 1, 2004, no further contributions would be
required of the Company. However, if conservation proceedings were entered into
on March 1, 2004 or subsequent, the Company would not be relieved of the
contribution obligations as outlined above. This new agreement supersedes and
terminates the November 27, 2000 agreement with the DOI in all respects. During
2002, Fremont has contributed, as per the agreement's schedule, a total of
$13.25 million to its discontinued workers' compensation insurance subsidiary.
The capital contributions made to the discontinued workers' compensation
insurance subsidiary increase the net investment in the Company's discontinued
insurance operations. As of September 30, 2002, the net investment in the
discontinued insurance operations was $41.8 million and the Company has $29.8
million of direct capital contribution obligations remaining (comprised of the
final 2002 contribution of $3.3 million, which was made on November 1, 2002, and
$13.25 million for each of 2003 and 2004), as well as $53 million of contingent
capital contribution obligations. The Company's investment in its discontinued
insurance operations is evaluated for impairment periodically, however, a
primary factor in determining whether any impairment has occurred are the
results of the annual actuarial reserve study, the next of which is to be
performed as of December 31, 2002. Should the financial position of the
discontinued insurance operations experience a significant deterioration, the
investment may be deemed to be impaired, in part or in whole, and subsequently,
a write down of some or all of the $41.8 million net investment would be
necessary. In addition, dependent upon the level of deterioration in the
financial condition of the discontinued insurance operations, the Company may
need to record an additional impairment loss for some or all of the capital
contributions not yet made as of September 30, 2002, including those considered
contingent. Any such write down or loss would be reported by the Company as a
net of tax charge (which would be reported in the consolidated statements of
operations below net income from continuing operations) in the period of such
determination. Thus, if the actuarial reserve study as of December 31, 2002 were
to reveal significant deterioration, the Company would recognize a charge for
the fourth quarter of 2002 to the extent of the resulting impairment. If the
level of deterioration as of December 31, 2002 was to such an extent that
warranted fully impairing the current net investment and accruing a loss for all
future capital contributions, both direct and contingent, the Company estimates
that this scenario would then result in the incurring of a net of tax charge in
the range of $75 - $80 million, which would be reported in the consolidated
statements of operations below net income from continuing operations. Any gains
from the liquidation of the discontinued insurance operations would be recorded
only at such time as their realization is certain.
22
The Company's net investment in its discontinued insurance operations may
be negatively impacted by such developments as adverse loss and loss adjustment
expense reserve development, failure by one or more of the Company's reinsurers
to meet their obligations in a timely and complete manner, less than expected
realization of premiums receivable and other receivables and assets, adverse
legislative and regulatory actions, including conservation of the discontinued
insurance operations by regulatory authorities, and significant realized losses
and lower than projected income in the discontinued insurance operations'
investment portfolio. Certain of the Company's reinsurers have asserted disputes
in regards to their payment of amounts due. While the Company's reinsurers have
certain amounts of funds on deposit with the DOI to secure all or part of their
obligations, any adverse outcomes in the Company's collection actions against
one or more of its reinsurers or the insolvency of one or more of the Company's
reinsurers may result in a deterioration of the financial position of the
discontinued insurance operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's industrial bank subsidiary finances its lending activities
primarily through Federal Deposit Insurance Corporation ("FDIC") insured
customer deposits, which totaled $4.4 billion at September 30, 2002. The
industrial bank is also eligible for financing through the FHLB, which financing
is available at various rates and terms. At September 30, 2002, the industrial
bank had borrowing availability with the FHLB of $1.33 billion, of which $820
million was borrowed and outstanding. In addition, the industrial bank has a
line of credit with the Federal Reserve Bank of San Francisco ("FRB") with a
borrowing availability of $197.1 million at September 30, 2002. There were no
amounts outstanding under the line of credit with the FRB at September 30, 2002.
The Company believes it has sufficient liquidity and capital resources to fund
its financial services operation for the foreseeable future.
The discontinued insurance operations have several sources of funds to meet
its obligations, primarily its investment securities portfolio and recoveries
from reinsurance contracts. The Company invests in fixed income and preferred
equity securities with an objective of providing a reasonable return while
limiting credit and liquidity risk. The Company believes it has adequate levels
of liquidity and invested assets to meet ongoing obligations to policyholders
and claimants and to cover ordinary operating expenses.
As a holding company, Fremont pays its operating expenses, meets its other
obligations and pays interest and stockholders' dividends primarily from its
cash on hand and intercompany-tax payments from its industrial bank subsidiary,
and to a lesser degree from dividends from FGCC. Dividends of $1.4 million were
paid on Fremont's common stock in each of the quarters ending September 30, 2002
and 2001, however, the Company can give no assurance that future common stock
dividends will be declared. As a result of the substantial operating losses
incurred by the Company's property and casualty insurance operations during
2000, and by agreement with the DOI, Fremont does not expect to receive any
dividends from its property and casualty insurance operations for the
foreseeable future. Fremont is obligated for certain capital contributions to
its discontinued workers' compensation insurance subsidiary - see "Discontinued
Insurance Operations" for further information. Should the Company's discontinued
workers' compensation insurance subsidiary come under regulatory conservation,
or similar arrangement, this may cause an
23
event of default under the Company's Senior Notes outstanding. If an event of
default is declared under the Senior Notes, the outstanding principal may become
immediately due and payable. The Company's current financial position would not
enable it to meet such an obligation and, as a result, the Company and the
holders of its Senior Notes may pursue various alternatives. Such actions could
have a significant adverse impact upon the Company's liquidity and the holders
of its various securities.
Fremont has available to it significant federal tax net operating loss
carryforwards, which may be utilized to reduce or eliminate future tax payments.
As a result, intercompany payments of federal tax obligations from the
industrial bank, which would otherwise be payable to taxing authorities, are
available for use by Fremont for general working capital purposes, including the
extinguishment of debt. The Company currently pays various state taxes,
primarily California Franchise Taxes, as there are no significant state net
operating loss carryforwards available to it for offset. The Company's
discontinued insurance operations are generally subject to state premium taxes,
and not income taxes, and thus no significant state net operating loss
carryforwards were generated. The Company has certain California Franchise Tax
issues pending resolution. The Company does not believe that the ultimate
outcome of these matters, which are expected to take several years to resolve,
will have a material effect on the Company's financial position or liquidity.
Fremont General Corporation has cash and short term investments of $39.7
million at September 30, 2002 and no debt maturities until March of 2004 and
believes that, with its other available sources of liquidity, it will have
sufficient means to satisfy its liquidity needs for at least the next twelve
months.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to market risk resulting primarily from fluctuations
in interest rates arising from balance sheet financial instruments such as
investments, loans and debt. Changes in interest rates will affect the Company's
net investment income, loan interest, net gain on the sale of residential real
estate loans, interest expense and total stockholders' equity. The level of net
gain on the sale of residential real estate loans is highly dependent upon the
level of loan origination volume and the net premium paid by the purchasers of
such loans. Both the volume and net premium, 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 net gain it realizes should
significant interest rate increases 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 Company's asset and liability management activities is to
provide the highest 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. The Company currently owns no derivative financial
instruments and, consequently, is not subject to market risk for such
off-balance sheet financial instruments. Furthermore, the Company does not have
exposure to foreign currency or commodity price risk. 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,
2001. 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, 2002.
24
ITEM 4. CONTROLS AND PROCEDURES
As of September 30, 2002, 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, concluded that the Company's disclosure controls and
procedures were effective as of September 30, 2002. There have been no
significant changes in the Company's internal controls or in other factors that
could significantly affect internal controls subsequent to September 30, 2002
through the date of the filing of this Form 10-Q.
25
PART II - OTHER INFORMATION
ITEM 1: Legal Proceedings.
None.
ITEM 2: Changes in Securities and Use of Proceeds.
None.
ITEM 3: Defaults Upon Senior Securities.
None.
ITEM 4: Submission of Matters to a Vote of Security Holders.
None.
ITEM 5: Other Information.
None.
ITEM 6: Exhibits, Financial Statement Schedules and Reports on
Form 8-K
(a) 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 Amended and Restated By-Laws 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.)
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 Liquid Yield Option Notes Due 2013
between the Registrant and Deutsche Bank Trust Company of
America (formerly Bankers Trust Company). (Incorporated by
reference to Exhibit 4.4 to the Registrant's Registration
Statement on Form S-3 filed on October 1, 1993, Registration
Number 33-68098.)
4.3 Indenture among the Registrant, the Trust and Bank of New
York (originated with First Interstate Bank of California),
a New York Banking Corporation, as trustee. (Incorporated by
reference to Exhibit 4.3 to the Registrant's Annual Report
on Form 10-K, for the fiscal year ended December 31, 1995,
Commission File Number 1-8007.)
26
EXHIBIT
NO. DESCRIPTION
------- -----------
4.4 Amended and Restated Declaration of Trust among the
Registrant, the Regular Trustees, The Chase Manhattan Bank
(USA), a Delaware banking corporation, as Delaware trustee,
and The Chase Manhattan Bank, N.A., a national banking
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.)
4.5 Preferred Securities Guarantee Agreement between the
Registrant and The Chase Manhattan Bank, N.A., a national
banking 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.)
4.6 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.)
4.7 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* Long Term Incentive Compensation Plan of 2002
- ---------
* Management or compensatory plans or arrangements.
(b) Reports on Form 8-K filed during the quarterly period ended September
30, 2002:
A Current Report on Form 8-K filed July 16, 2002 reported
definitive agreements related to the Registrant's
discontinued workers' compensation insurance business.
27
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 12, 2002 /s/ LOUIS J. RAMPINO
---------------------------------------
Louis J. Rampino, President,
Chief Operating Officer and Director
Date: November 12, 2002 /s/ PATRICK E. LAMB
---------------------------------------
Patrick E. Lamb, Senior Vice President,
Controller and Chief Accounting Officer
(Principal Accounting Officer)
28
CERTIFICATIONS
I, James A. McIntyre, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Fremont General
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a.) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b.) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
c.) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a.) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
b.) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 12, 2002
/s/ JAMES A. McINTYRE
- -----------------------
James A. McIntyre
Chairman of the Board and Chief Executive Officer
29
I, Wayne R. Bailey, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Fremont General
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a.) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b.) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
c.) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a.) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
b.) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 12, 2002
/s/ WAYNE R. BAILEY
- --------------------
Wayne R. Bailey
Executive Vice President, Treasurer and
Chief Financial Officer
30