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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
COMMISSION FILE NUMBER 1-8007
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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 NUMBER)
2020 SANTA MONICA BOULEVARD,
SANTA MONICA, CALIFORNIA 90404
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 315-5500
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
COMMON STOCK, $1.00 PAR VALUE
LIQUID YIELD OPTION(TM) NOTES DUE 2013 (ZERO COUPON-SUBORDINATED)
FREMONT GENERAL FINANCING I -- 9% TRUST ORIGINATED PREFERRED SECURITIES(SM)
(TITLE OF EACH CLASS)
NEW YORK STOCK EXCHANGE
(NAME OF EACH EXCHANGE ON WHICH REGISTERED)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of February 26, 1999:
COMMON STOCK, $1.00 PAR VALUE -- $989,835,000
The number of shares outstanding of each of the issuer's classes of common
stock as of February 26, 1999:
COMMON STOCK, $1.00 PAR VALUE -- 70,056,000 SHARES
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the proxy statement for the 1999 annual meeting of stockholders
are incorporated by reference into Part III of this report.
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FREMONT GENERAL CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
PAGE
----
PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 23
Item 3. Legal Proceedings........................................... 23
Item 4. Submission of Matters to a Vote of Security Holders......... 23
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 24
Item 6. Selected Financial Data..................................... 25
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 27
Item 7(a). Quantitative and Qualitative Disclosures About Market
Risk........................................................ 47
Item 8. Financial Statements and Supplementary Data (Index to
Consolidated Financial Statements and Financial Statement
Schedules on Page 54)....................................... 47
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 47
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 48
Item 11. Executive Compensation...................................... 48
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 48
Item 13. Certain Relationships and Related Transactions.............. 48
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 49
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ITEM 1. BUSINESS
The following business section contains 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. The Company's actual results could differ
materially from those projected in these forward-looking statements as a result
of certain risks and uncertainties, including those factors set forth in this
"Item 1. Business" section and elsewhere in this Form 10-K including, but not
limited to, "Competition," "Loss and Loss Adjustment Expense Reserves,"
"Analysis of Loss and Loss Adjustment Expense Development," "Investment
Portfolio," "Competition and Economic Conditions," "Discontinued Operations,"
"Regulation," and "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations."
GENERAL
Fremont General Corporation is an insurance and financial services holding
company operating select businesses nationally in niche markets. The reported
assets of Fremont General Corporation and its subsidiaries ("Fremont" or "the
Company") as of December 31, 1998 were $7.4 billion, with 1998 pre-tax earnings
of $196.7 million. Fremont's business strategy includes achieving income balance
and geographic diversity among its business units in order to limit its exposure
to industry, market and regional concentrations. The Company's business strategy
also includes growing its business through new business development and
acquisitions. The Company's stock is traded on the New York Stock Exchange under
the symbol "FMT".
The Company's businesses are managed within two reportable segments:
property and casualty insurance and financial services. These segments offer two
basic financial products; policies of insurance (property and casualty
insurance), and loans (financial services). They are managed separately and use
different pricing, distribution, and operating methods. Fremont evaluates the
performance of its reportable segments based on income before taxes using
accounting policies which are the same as those described in the summary of
significant accounting policies. (See Note A of Notes to Consolidated Financial
Statements.) Additionally, there are certain corporate revenues and expenses,
comprised primarily of investment income, interest expense and certain general
and administrative expenses, that Fremont does not allocate to its segments.
Substantially all of Fremont's property and casualty insurance operation is
represented by the underwriting of workers' compensation insurance policies,
which are distributed primarily through non-exclusive independent insurance
agents and brokers nationwide. The Company's property and casualty segment
posted income before taxes of $169.2 million, $144.7 million and $117.6 million
for the years ended December 31, 1998, 1997 and 1996, respectively, on revenues
of $729.7 million, $738.1 million and $596.8 million for the same respective
periods. Fremont's financial services operation consists of operating units that
conduct collateralized lending activities on a national basis. Lending
activities include: commercial and residential real estate lending; commercial
working capital lines of credit ("commercial finance"); the Company's interest
in large commercial loans originated and serviced by other financial
institutions ("syndicated loans"); and insurance premium financing. The
financial services business is developed through the Company's own marketing
representatives and referrals from various financial intermediaries and
financial institutions. Fremont's financial services operation earned $55.5
million, $42.3 million and $36.6 million in income before taxes for the years
ended December 31, 1998, 1997 and 1996, respectively, on revenues of $305.9
million, $235.5 million and $197.6 million for the same respective periods. (See
Note O of Notes to Consolidated Financial Statements.)
Fremont's workers' compensation insurance business currently has major
market positions in California, Illinois, Arizona, Idaho, Alaska, Indiana,
Montana, Utah and Wisconsin. At December 31, 1998, the Company had premiums
inforce in thirty-nine states and the District of Columbia. The Company would
have ranked as the seventh largest writer, in direct premiums, of workers'
compensation insurance in the United States for the year ended December 31,
1997, according to A.M. Best, if the results of Fremont's September 1, 1998
acquisition of UNICARE Specialty Services, Inc. ("Unicare") were included. For
the years ended December 31, 1998, 1997, and 1996, the Company had workers'
compensation insurance net premiums earned of $551 million, $571 million, and
$457 million, respectively. Over the last four years, the Company has focused on
creating a broad national platform upon which to build its business, while
providing geographic
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diversity to mitigate potential fluctuations in earnings from cyclical downturns
in various regional economies. (See "Property and Casualty Insurance Operation"
and Note B of Notes to Consolidated Financial Statements.) A.M. Best rates the
Company's workers' compensation insurance subsidiaries on a consolidated basis
as "A-" (Excellent); this rating was reaffirmed on October 21, 1998. An "A-"
rating is A.M. Best's fourth highest rating category out of fifteen rating
categories ranging from "A++" (Superior) to "F" (In Liquidation).
Fremont's financial services operation originates loans on a national
basis. The Company also purchases pools of loans from time to time that meet our
new loan origination underwriting guidelines. Fremont's lending is done
primarily on a senior and secured basis and it seeks to minimize its credit
exposure through conservative loan underwriting and a comprehensive system of
collateral monitoring. The Company continues to focus on loan origination by
broadening its existing distribution channels and creating new distribution
channels. The outstanding loan portfolio of Fremont's financial services
operation has grown from $1.5 billion at December 31, 1994 to $3.0 billion at
December 31, 1998. (See "Financial Services Operation.")
By engaging in geographically diverse businesses nationwide, the Company
believes it has achieved stability and provided opportunities for growth in its
operating results. Since the year ended December 31, 1994 to the year ended
December 31, 1998, the Company's income before taxes grew at a compound annual
rate of approximately 25% to $196.7 million for 1998. The Company's book value
increased from $351.0 million at December 31, 1994 to $950.9 million at December
31, 1998.
Management believes that ownership of Fremont's Common Stock by employees
has been an important element in the Company's success by enabling the Company
to attract and retain the best available personnel for positions of substantial
responsibility and to provide additional incentive and motivation to such
individuals to promote the success of the Company. As of December 31, 1998,
officers and directors of the Company, their families and the Company's benefit
plans beneficially owned approximately 28% of the Company's outstanding Common
Stock.
Fremont General Corporation, a Nevada corporation, was incorporated in
1972. Its corporate office is located at 2020 Santa Monica Boulevard, Suite 600,
Santa Monica, California 90404 and its phone number is (310)315-5500.
PROPERTY AND CASUALTY INSURANCE OPERATION
Fremont Compensation Insurance Group, through its subsidiaries ("Fremont
Compensation"), primarily underwrites workers' compensation insurance, and had
premiums inforce in thirty-nine states and the District of Columbia as of
December 31, 1998. Over the last four years, the Company's focus on creating a
broad national platform through acquisitions and new business development has
resulted in Fremont Compensation becoming one of the largest workers'
compensation insurers in the United States. The Company continues to underwrite
a significant amount of premium in California and Illinois. Using the Company's
estimated annual premiums on policies in effect at December 31, 1998, 1997 and
1996 (referred to as "inforce premium"), the percentage of the Company's inforce
premium in California and Illinois totaled 65%, 61%, and 75%, respectively.
Fremont also maintains leading market positions in Alaska, Arizona, Idaho,
Indiana, Montana, Utah and Wisconsin. The Company believes this geographic
diversity has mitigated potential fluctuations in earnings from cyclical
downturns in various regional economies. A.M. Best rates the Company's workers'
compensation insurance subsidiaries on a consolidated basis as "A-" (Excellent).
Workers' compensation insurance is a government-mandated ("statutory")
system which requires every employer to either purchase insurance or self-insure
in order to provide its employees with medical care and other specified benefits
for work-related injuries or illnesses. Compensation is payable regardless of
which party was at fault. Most employers provide for this potential liability by
purchasing workers' compensation insurance from insurance carriers. There are
four types of benefits payable under workers' compensation policies: medical
benefits, vocational rehabilitation benefits, disability benefits and death
benefits. The amounts of disability and death benefits payable for claims are
established by statute, vocational rehabilitation benefits are provided with
certain limitations in some jurisdictions, including California, and no dollar
limitation is set forth for medical benefits. (See "Regulation -- Insurance
Regulation.")
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Premiums. Workers' compensation insurance premiums are based upon the
policyholder's payroll and the nature of their business and may be affected
significantly by changes in general economic conditions which impact employment
and wage levels, as well as by government regulation. Insurance premiums are
also subject to supervision and regulation by the state insurance authority in
each state. Most of the states in which Fremont does business, including
California and Illinois, operate under an open rating system. In an open rating
system, workers' compensation insurers are provided with advisory premium rates
(expected losses and expenses) or loss costs (expected losses only) which vary
by job classification. Each insurance company determines its own rates based in
part upon its particular loss experience and operating costs. Insurance
companies generally set their premium rates below such advisory premium rates.
Illinois has been operating under an open rating system since 1982. California
adopted an open rating system effective January 1, 1995 through the repeal of
the minimum rate law. Before January 1, 1995, California operated under a
minimum rate law, whereby premium rates established by the California Department
of Insurance were the minimum rates which could be charged by an insurance
carrier. (See "Regulation -- Insurance Regulation.") The repeal of the minimum
rate law resulted in lower premiums and lower profitability on the Company's
California workers' compensation insurance policies due to increased price
competition. (See "Competition.")
Underwriting and Loss Control. Prior to insuring a workers' compensation
account, Fremont's underwriting department reviews the employer's prior loss
experience, safety record, credit history, operations, geographic location and
employment classifications. The Company generally avoids industries and
businesses involving hazardous conditions or high exposure to multiple injuries
resulting from a single occurrence. Fremont targets accounts that appear to have
a strong work ethic among employees, long-term employees, and a genuine interest
in the adoption of and adherence to loss control standards.
Fremont's loss control department participates in the initial underwriting
process and also provides on-going services to policyholders based on individual
needs and potential risk exposure. In the initial underwriting phase, the
underwriter will review both the loss experience and description of operations
and where there is a concern about the potential hazards or claim trends, a loss
control consultant will be requested to pre-screen the account prior to policy
issuance. This pre-screening process involves meeting with the employer's
management to assess the extent to which management is committed to safety in
the workplace, surveying the employer's operations, reviewing past loss patterns
and evaluating the safety program.
After the policy is issued, the loss control department will provide
service calls to the insured based on both regulatory requirements and specific
needs to assist the employer in developing and maintaining safety programs and
procedures, review periodic loss reports, identify weaknesses in the employer's
loss prevention procedures and assist in correcting these weaknesses. In some
states, loss control must target those employers who have a high claim
frequency, and provide specific services to assist in accident prevention.
Accident and claim records maintained by the Company are also reviewed by the
loss control department and service calls are initiated when adverse claim
trends develop. Any insured who requests loss control service is provided this
service free of charge. Accident prevention services include physical surveys
for hazard recognition, safety program evaluation, loss trend analysis and
employee training.
Policyholders' Dividends. Since 1995, Fremont's workers' compensation
insurance policies have been predominately written as non-participating and,
therefore, do not include provisions for the insurer to declare and pay
dividends to a policyholder after the expiration of the policy. Prior to 1995,
Fremont's California policies were predominately written as participating,
thereby obligating the Company to consider the payment of dividends to a
policyholder, based upon the policyholder's loss experience, the Company's
overall loss experience and competitive conditions. This shift in policy type is
due primarily to the increased competition in the California market which
resulted from the repeal of the minimum rate law, effective January 1, 1995.
(See "Premiums" and "Regulation -- Insurance Regulation.") This shift to
non-participating policies has continued and is a characteristic element of the
competitive environment.
Claims Administration. Fremont's policy is to settle valid claims promptly
and to work closely with policyholders to return injured workers to the job
quickly, while avoiding litigation if possible. Claims personnel communicate
frequently with policyholders, injured employees and medical providers. The Com-
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pany's policy is to control the number of cases assigned to its claims
personnel, to identify and investigate questionable claims and to produce early
and cost-effective case settlements of valid claims. As part of its "zero
tolerance" program, Fremont refuses to settle any claim that it believes to be
fraudulent. The Company, where permitted, utilizes its own non-lawyer hearing
representatives in most claims adjudicated administratively and has found this
practice to be significantly less expensive than using legal counsel.
Fremont provides rehabilitation programs for injured workers and
aggressively pursues the containment of medical costs through its subsidiary,
Fremont Health Corporation. This subsidiary provides services to the Company's
claims personnel which are designed to reduce medical costs and return injured
workers to the job quickly. Such services include integrated medical case
management; a network of directly-contracted group of preferred providers who
have unique experience in industrial medicine; a review of medical bills using
both internal and outsourced resources; medical peer review panels of
credentialed regional medical providers; and comprehensive return-to-work
programs designed to return injured workers back to work as quickly as medical
treatment standards permit. The integrated case management service involves
nurses employed by Fremont Health who work closely with the claims personnel to
provide prompt and aggressive medical treatment to mitigate the effects of the
workers' injuries.
Competition. The insurance industry is characterized by competition on the
basis of price and service. Prior to January 1, 1995, minimum premium rates were
prescribed for workers' compensation insurance in California by the Department
of Insurance, and competition for underwriting such insurance in California had
been based principally upon an insurance carrier's financial strength and
history of paying policyholders' dividends. Secondary considerations included
loss control and claims administration, the ability to respond promptly to
agents and brokers, and commission schedules for agents and brokers. The repeal
of the California minimum rate law, effective January 1, 1995, has resulted in
increased price competition which has adversely affected the Company's results
of operations for its workers' compensation insurance business in California.
(See "Regulation -- Insurance Regulation.") Beginning in 1997, however, Fremont
observed a moderation of price competition in California. Over the past several
years, the Company has also observed a reduction in the number of competitors
resulting from mergers and acquisitions of companies into other entities, as
well as from companies electing to discontinue the underwriting of workers'
compensation insurance. Fremont expanded its workers' compensation operation
through the acquisition on August 1, 1997 of Industrial Indemnity Holdings, Inc.
("Industrial"), which underwrites workers' compensation insurance in most
western states. Excluding California, these western states have collectively
exhibited relatively stable competitive environments. In Illinois, price
competition has also impacted the Company's results of operations. The advisory
premium rates in Illinois, which are established by the National Council on
Compensation Insurance and which workers' compensation insurance companies in
Illinois tend to follow, decreased 0.2%, 7.9%, and 10.0% effective January 1,
1999, 1998 and 1997, respectively. Beginning in the fourth quarter of 1997,
however, the Company observed some moderation of price competition in Illinois.
It is uncertain whether this moderation will continue. Although the acquisition
of Industrial, as well as the acquisition of Illinois-based Casualty Insurance
Company ("Casualty") on February 22, 1995, has provided Fremont with major
market positions in several states outside of California, based on the
competitive nature of the insurance industry and the inherent risks associated
with the Company entering into a new geographic market, there can be no
assurance that the Company will continue to maintain its market share in the
future. Furthermore, state regulatory changes could affect competition in the
states where the Company transacts insurance business. Although Fremont is one
of the largest writers of workers' compensation insurance in several states,
including California and Illinois, certain of the Company's competitors are
larger and have greater resources than the Company.
Marketing. Fremont markets its workers' compensation insurance products
through more than 2,700 non-exclusive independent insurance agents and brokers,
many of whom have been associated with Fremont for more than 15 years. At
December 31, 1998, the ten largest agents accounted for approximately 23% of the
Company's workers compensation insurance premiums. The largest producer
accounted for 4%.
Reinsurance Ceded. Reinsurance is ceded primarily to reduce the liability
on individual risks and to protect against catastrophic losses. Fremont follows
the industry practice of reinsuring a portion of its risks. For this coverage,
the Company pays the reinsurer a portion of the premiums received on all
policies.
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Fremont maintains excess of loss reinsurance treaties with various
reinsurers for each of its insurance lines. Under the current workers'
compensation reinsurance treaties, various reinsurers assume liability on that
portion of the loss that exceeds $50,000 per occurrence, up to a maximum of
$399,950,000 per occurrence. Prior to January 1, 1998, the Company's excess of
loss reinsurance for its workers' compensation insurance business assumed
liability on that portion of the loss that exceeded $1 million per occurrence,
up to a maximum of $399 million per occurrence. (See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Property and Casualty Insurance Operation -- Premiums.") For
medical malpractice insurance, excess of loss reinsurance covers claims and
losses above $1 million, up to a maximum of $5 million. On January 1, 1998, the
Company entered into reinsurance and assumption agreements with a reinsurer
whereby substantially all of the assets and liabilities related to the Company's
medical malpractice policies were ceded to a reinsurer. (See "Medical
Malpractice Insurance.") Although reinsurance makes the assuming reinsurer
liable to the insurer to the extent of the reinsurance ceded, it does not
legally discharge an insurer from its primary liability for the full amount of
the policy liability. All of the foregoing reinsurance is with non-affiliated
reinsurers. The Company believes that the terms of its reinsurance contracts are
consistent with industry practice and, based on its understanding of the
reinsurers' financial condition and reputations in the reinsurance marketplace,
that its reinsurers are financially sound. Fremont encounters disputes from time
to time with its reinsurers, which, if not settled, are typically resolved in
arbitration.
Most of Fremont's treaties are for annual terms. However, for the treaties
which became effective January 1, 1998 and under which the reinsurers assume
liability on that portion of the loss that exceeds $50,000 per occurrence, up to
a maximum of $950,000, the terms are for a period of two years, expiring January
1, 2000. In general, the reinsurance agreements are of the treaty variety and
cover all underwritten risks of types specified in the treaties. As of December
31, 1998, Great Southern Insurance Company, Reliance Insurance Company and
Constitution Reinsurance Corporation were the only reinsurers that accounted for
more than 10% of the Company's total reinsurance recoverables on paid and unpaid
losses.
Medical Malpractice Insurance. Fremont's medical malpractice insurance
operation underwrote primarily standard professional liability insurance on a
"claims made" basis, through non-exclusive independent brokers mainly in
California. On January 1, 1998, the Company entered into reinsurance and
assumption agreements with a reinsurer whereby substantially all of the assets
and liabilities related to the medical malpractice policies were ceded to the
reinsurer. These reinsurance agreements are part of several other agreements
which collectively resulted in the sale of Fremont's medical malpractice
operations effective January 1, 1998. The effect on operations from these
agreements was not material, and revenue and operating income from medical
malpractice operations were not significant in 1997 or 1996.
Operating Data. Set forth below is certain information pertaining to
Fremont's property and casualty insurance business as determined in accordance
with generally accepted accounting principles ("GAAP") for the years indicated.
(See "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations" for a discussion of certain of this information.)
YEAR ENDED DECEMBER 31,
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1998 1997 1996 1995 1994
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(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Net premiums earned................. $552,078 $601,183 $486,860 $606,917 $433,584
Net investment income and
other(1).......................... 148,040 102,645 92,254 85,912 52,471
Underwriting profit (loss).......... 21,195 42,022 25,339 (2,820) 8,794
Income before taxes................. 169,235 144,667 117,593 83,092 61,265
Loss ratio........................ 60.8% 64.7% 68.9% 76.0% 63.1%
Expense ratio..................... 34.5% 27.5% 25.9% 24.5% 23.4%
Policyholders' dividend ratio..... 0.9% 0.8% -- -- 11.5%
-------- -------- -------- -------- --------
Total combined ratio...... 96.2% 93.0% 94.8% 100.5% 98.0%
======== ======== ======== ======== ========
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(1) Includes net realized investment gains (losses) and interest expense.
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Statutory Combined Ratio. The following table reflects the combined ratios
of Fremont's workers' compensation insurance business determined in accordance
with statutory accounting practices, together with the workers' compensation
industry-wide combined ratios after policyholders' dividends, as compiled by
A.M. Best, for the years indicated.
YEAR ENDED DECEMBER 31,
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1998 1997 1996 1995 1994
------------- ------ ----- ------ ------
Workers' Compensation:
Company....................... 113.4%(2) 96.6%(3) 97.9% 100.1%(4) 98.5%
Industry(1)................... not available 100.8% 99.7% 97.0% 101.4%
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(1) Nationwide statutory combined ratio information for the workers'
compensation insurance industry for 1994 through 1997 is from A.M. Best's
Aggregates & Averages, Property-Casualty (1995 through 1998 editions).
(2) Includes the statutory results for Unicare for the period January 1, 1998
through August 31, 1998, which was prior to the Company's acquisition of
Unicare on September 1, 1998. The significant increase in the statutory
combined ratio in 1998 as compared to 1997 is due primarily to significant
increases in the liability for losses and LAE for Unicare, which occurred
prior to its acquisition by the Company.
(3) Includes the statutory results for Industrial for the period January 1, 1997
through July 31, 1997, which was prior to the Company's acquisition of
Industrial on August 1, 1997.
(4) Includes the statutory results for Casualty for the period January 1, 1995
through February 21, 1995, which was prior to the Company's acquisition of
Casualty on February 22, 1995.
Premium-to-Surplus Ratio. Regulatory authorities regard the
premium-to-surplus ratio as an important indicator of operating leverage. A
lower ratio indicates a greater ability on the part of the insurer to withstand
abnormal loss experience. Guidelines established by the National Association of
Insurance Commissioners ("NAIC") provide that a property and casualty insurer's
premium-to-surplus ratio is satisfactory if it is below 3 to 1.
The following table sets forth the Company's consolidated ratio of net
property and casualty premiums written during the period to policyholders'
surplus on a statutory basis at the end of the period, for the periods
indicated:
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1998(1) 1997(2) 1996 1995(3) 1994
-------- -------- -------- -------- --------
(THOUSANDS OF DOLLARS, EXCEPT RATIOS)
Net premiums written during the year........ $644,218 $820,532 $473,123 $683,711 $425,631
Policyholders' surplus at end of year....... 646,828 548,280 399,893 299,408 235,294
Ratio....................................... 1.0x 1.5x 1.2x 2.3x 1.8x
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(1) Includes net written premium for Unicare for the period January 1, 1998
through August 31, 1998, which was prior to the Company's acquisition of
Unicare on September 1, 1998.
(2) Includes net written premium for Industrial for the period January 1, 1997
through July 31, 1997, which was prior to the Company's acquisition of
Industrial on August 1, 1997.
(3) Includes net written premium for Casualty for the period January 1, 1995
through February 21, 1995, which was prior to the Company's acquisition of
Casualty on February 22, 1995.
Loss and Loss Adjustment Expense Reserves. In many cases, significant
periods of time, ranging up to several years or more, may elapse between the
occurrence of an insured loss, the reporting of the loss to the insurer, and the
insurer's payment of that loss. To recognize liabilities for future unpaid
losses, insurers establish reserves, which are balance sheet liabilities,
representing estimates of future amounts needed to pay claims with respect to
insured events that have occurred. Reserves are also established for loss
adjustment expense reserves ("LAE") representing the estimated expenses of
settling claims, including legal and other fees, and general expenses of
administering the claims adjustment process.
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Reserves for losses and LAE ("loss reserves") are based not only on
historical experience but also on management's judgment of the effects of
matters such as future economic and social forces likely to impact the insurer's
experience with the type of risk involved, circumstances surrounding individual
claims, and trends that may affect the probable number and nature of claims
arising from losses not yet reported. Consequently, loss reserves are inherently
subject to a number of highly variable circumstances.
Loss reserves are revalued periodically using a variety of actuarial and
statistical techniques for producing current estimates of expected claim costs.
Claim frequency and severity and other economic and social factors are
considered in the reevaluation process. A provision for inflation in the
calculation of estimated future claim costs is implicit since reliance is placed
on both actual historical data, which reflect past inflation, and on other
factors which are judged to be appropriate modifiers of past experience.
Adjustments to liabilities are reflected in operating results for the periods to
which they are made.
Reconciliation of Loss and Loss Adjustment Expense Reserves. The following
table shows the GAAP reconciliation of the estimated liability for losses and
LAE for Fremont's property and casualty insurance subsidiaries (excluding
discontinued operations) and the effect on income for each of the three years
indicated.
RECONCILIATION OF RESERVES FOR LOSSES AND LAE
YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
---------- ---------- ----------
(THOUSANDS OF DOLLARS)
Reserves for losses and LAE, net of reinsurance
recoverable, at beginning of year........................ $1,809,395 $1,010,886 $1,185,706
Incurred losses and LAE:
Provision for insured events of the current year, net of
reinsurance........................................... 348,897 441,524 334,657
Increase (decrease) in provision for insured events of
prior years, net of reinsurance....................... (13,447) (52,323) 750
---------- ---------- ----------
Total incurred losses and LAE.................... 335,450 389,201 335,407
Payments:
Losses and LAE, net of reinsurance, attributable to
insured events of:
Current year.......................................... (245,177) (253,323) (108,247)
Prior years........................................... (590,197) (386,469) (401,980)
---------- ---------- ----------
Total payments................................... (835,374) (639,792) (510,227)
---------- ---------- ----------
Subtotal......................................... 1,309,471 760,295 1,010,886
Liability for losses and LAE for companies acquired during
the year................................................. 287,645 1,049,100 --
---------- ---------- ----------
Reserves for losses and LAE, net of reinsurance
recoverable, at end of year.............................. 1,597,116 1,809,395 1,010,886
Reinsurance recoverable for losses and LAE, at end of
year..................................................... 701,002 353,928 245,459
---------- ---------- ----------
Reserves for losses and LAE, gross of reinsurance
recoverable, at end of year.............................. $2,298,118 $2,163,323 $1,256,345
========== ========== ==========
Analysis of Loss and Loss Adjustment Expense Development. The following
table shows the cumulative amount paid against the previously recorded liability
at the end of each succeeding year and the cumulative development of the
estimated liability for the ten years ending December 31, 1998. Conditions and
trends that have affected the development of these reserves and payments in the
past will not necessarily recur in the future. Accordingly, management does not
believe that it is appropriate to use this cumulative history to project future
performance.
The re-estimated liability portion of the following table shows the year by
year development of the previously estimated liability at the end of each
succeeding year. The re-estimated liabilities are increased or
7
10
decreased as more information becomes known about the frequency and severity of
claims for individual years. The increases or decreases are reflected in the
current year's operating earnings. Each column shows the reserve held at the
indicated calendar year-end and cumulative data on re-estimated liabilities for
the year and all prior years making up those calendar year end liabilities. The
effect on income of the charge (credit) during the current period (i.e., the
difference between the estimated liability at December 31 and the liability
estimated one year later) is shown in the previous table above for each of the
three most recent years as "Increase (decrease) in provision for insured events
of prior years."
8
11
CHANGES IN HISTORICAL RESERVES FOR LOSS AND LAE FOR THE LAST TEN YEARS
GAAP BASIS AS OF DECEMBER 31, 1998
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------
1988 1989 1990 1991 1992 1993 1994 1995
-------- -------- -------- -------- -------- -------- -------- ----------
(THOUSANDS OF DOLLARS)
Reserves for Loss and LAE,
net of reinsurance
recoverable.............. $406,823 $647,559 $652,284 $627,103 $633,394 $644,190 $610,510 $1,185,706
Net reserve re-estimated as
of:
One year later......... 396,091 636,039 624,953 668,107 629,268 626,956 611,892 1,186,456
Two years later........ 377,080 607,253 647,959 660,729 615,747 633,333 632,397 1,116,673
Three years later...... 356,961 607,492 638,879 651,482 621,348 641,166 644,485 1,116,103
Four years later....... 350,736 599,052 627,194 654,403 626,174 659,968 641,581
Five years later....... 375,550 593,527 631,165 659,050 685,517 656,549
Six years later........ 373,514 596,808 634,628 717,517 681,811
Seven years later...... 375,364 600,646 675,661 714,447
Eight years later...... 380,467 630,176 672,560
Nine years later....... 399,852 627,227
Ten years later........ 396,987
Net cumulative redundancy
(deficiency)............. 9,836 20,332 (20,276) (87,344) (48,417) (12,359) (31,071) 69,603
Cumulative amount of
reserve paid, net of
reserve recoveries,
through:
One year later......... 125,563 226,101 245,777 257,951 240,552 236,774 241,667 401,980
Two years later........ 211,529 374,876 403,105 419,638 402,048 392,237 397,640 662,943
Three years later...... 263,229 461,366 495,707 521,729 499,924 484,474 495,825 812,174
Four years later....... 291,817 514,890 550,404 583,013 558,935 545,574 548,109
Five years later....... 320,511 547,535 585,094 623,022 600,071 580,503
Six years later........ 339,998 567,871 608,802 652,990 624,813
Seven years later...... 351,805 583,580 629,321 670,625
Eight years later...... 362,802 597,623 641,031
Nine years later....... 373,790 605,926
Ten years later........ 379,801
Net reserve -- December 31..........................................................................................
Reinsurance recoverable.............................................................................................
Gross reserve -- December 31........................................................................................
Net re-estimated reserve............................................................................................
Re-estimated reinsurance recoverable................................................................................
Gross re-estimated reserve..........................................................................................
Gross cumulative redundancy (deficiency)............................................................................
YEAR ENDED DECEMBER 31,
------------------------------------
1996 1997 1998
---------- ---------- ----------
(THOUSANDS OF DOLLARS)
Reserves for Loss and LAE,
net of reinsurance
recoverable.............. $1,010,886 $1,809,395 $1,597,116
Net reserve re-estimated as
of:
One year later......... 958,563 1,795,948 --
Two years later........ 955,644
Three years later......
Four years later.......
Five years later.......
Six years later........
Seven years later......
Eight years later......
Nine years later.......
Ten years later........
Net cumulative redundancy
(deficiency)............. 55,242 13,447 --
Cumulative amount of
reserve paid, net of
reserve recoveries,
through:
One year later......... 386,469 590,197 --
Two years later........ 607,273
Three years later......
Four years later.......
Five years later.......
Six years later........
Seven years later......
Eight years later......
Nine years later.......
Ten years later........
---------- ---------- ----------
Net reserve -- December 31. $1,010,886 $1,809,395 $1,597,116
Reinsurance recoverable.... 245,459 353,928 701,002
---------- ---------- ----------
Gross reserve -- December 3 $1,256,345 $2,163,323 $2,298,118
========== ========== ==========
Net re-estimated reserve... $ 955,644 $1,795,950
Re-estimated reinsurance
recoverable.............. 269,925 423,308
---------- ----------
Gross re-estimated reserve. $1,225,569 $2,219,258
========== ==========
Gross cumulative redundancy
(deficiency)............. $ 30,776 $ (55,935)
========== ==========
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The Company is required to maintain reserves to cover its estimated
ultimate liability for losses and LAE with respect to reported and unreported
claims incurred as of the end of each accounting period. These reserves do not
represent an exact calculation of liabilities, but rather are estimates
involving actuarial projections at a given time of what the Company expects the
ultimate settlement and administration of claims will cost based on facts and
circumstances then known, predictions of future events, estimates of future
trends in claims' frequency and severity and judicial theories of liability, as
well as other factors. The Company regularly reviews its reserving techniques,
overall reserve position and its reinsurance. In light of present facts and
current legal interpretations, management believes that adequate provision has
been made for loss reserves. In making this determination, management has
considered its claims experience to date, loss development history for prior
accident years, estimates of future trends of claims frequency and severity, and
various external factors such as judicial theories of liability. However,
establishment of appropriate reserves is an inherently uncertain process, and
there can be no certainty that currently established reserves will prove
adequate in light of subsequent actual experience. Subsequent actual experience
has resulted and could result in loss reserves being too high or too low. Future
loss development could require reserves for prior periods to be increased, which
would adversely impact earnings in future periods.
In 1998, Fremont decreased its losses and LAE reserves for 1997 and prior
accident years by $13.4 million. This decrease resulted primarily from the
combined effects of a decrease in 1997 and prior accident year losses and LAE
reserves under certain assigned risk plans that the Company is required to
participate in, and an increase in the discount established for certain accident
and health permanent disability and death reserves. (See
"Regulation -- Insurance Regulation" and Note A of Notes to Consolidated
Financial Statements.)
In 1997, Fremont decreased its losses and LAE reserves for 1996 and prior
accident years by $52.3 million. This reserve decrease relates primarily to loss
and LAE reserves on workers' compensation policies written in the Company's
mid-west region and represents the recognition of a decrease in the frequency of
reported claims on the 1996 and 1995 accident years. Additionally, the Company's
management believes that its implementation of more effective claims handling
procedures in the mid-west region has contributed to the reduction in LAE
reserves on the 1996 and prior accident years during calendar year 1997. Fremont
is not able to determine with certainty the specific cause or causes of
increases and decreases in claims experience that led to these changes in
reserves but has reached its own conclusion based on a review of its internal
data and a subjective evaluation of external factors. The following discussion
is a summary of the principal considerations that the Company evaluated in
determining workers' compensation insurance reserves adjustments in 1997.
The Company acquired Casualty on February 22, 1995. This acquisition
provided Fremont a significant presence in several mid-western states, primarily
Illinois. By the end of 1995, the Company observed a significant reduction in
the frequency of reported claims on the 1995 accident year as compared to
Casualty's historical experience prior to 1995. Also during 1995, Fremont had
been active in assimilating the operations of Casualty into its existing
operating environment, which included, among other things, implementing more
effective claims handling procedures. Therefore, the Company could not determine
with certainty whether or not the observed lower frequency in reported claims
was a one-time event occurring as a result of these changes in claims handling
procedures. In 1997, Fremont observed the continued trend in lower reported
claim experience on the 1996 and 1995 accident years, which also had been
confirmed in the industry through an evaluation of industry data. Appropriate
reserve adjustments were, therefore, made by the Company in recognition of this
confirmed trend in lower loss experience on the 1996 and 1995 accident years for
the mid-west region.
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13
INVESTMENT PORTFOLIO
Fremont manages its investments internally. The following portfolio
information reflects the Company's continuing operations.
The following table reflects the amortized cost and fair value of fixed
maturity investments and non-redeemable preferred equity securities by major
category, as well as the amortized cost and fair value of cash and short-term
investments on the dates indicated.
DECEMBER 31, 1998 DECEMBER 31, 1997
------------------------ ------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
---------- ---------- ---------- ----------
(THOUSANDS OF DOLLARS)
Available for sale:
United States Treasury securities and
obligations of other US government
agencies and corporations............ $ 87,615 $ 89,328 $ 165,847 $ 168,788
Obligations of states and
political subdivisions............... 240,067 247,222 99,876 101,899
Redeemable preferred stock.............. 38,035 38,306 27,618 28,350
Mortgage-backed securities.............. 355,747 369,246 560,015 575,360
Corporate securities
Banks................................ -- -- 9,374 9,573
Financial............................ 275,335 282,617 373,630 388,999
Transportation....................... 27,211 30,149 7,139 9,270
Industrial........................... 573,575 589,904 591,587 611,637
---------- ---------- ---------- ----------
Total........................... 1,597,585 1,646,772 1,835,086 1,893,876
Non-redeemable preferred stock.......... 489,714 500,376 356,223 378,832
---------- ---------- ---------- ----------
Total........................... $2,087,299 $2,147,148 $2,191,309 $2,272,708
========== ========== ========== ==========
Short-term investments.................... $ 222,719 $ 222,719 $ 164,626 $ 164,626
Cash...................................... 79,875 79,875 64,987 64,987
As of December 31, 1998, substantially all of the investments in the
portfolio were rated investment grade by Standard and Poor's, Moody's, Duff and
Phelps and Fitch's rating services. Of these investments, 77% were rated A or
higher, 19% were rated BBB and 4% were rated BB. As of December 31, 1998, these
investment securities had an approximate fair value of $2.1 billion, which was
higher than amortized cost by approximately $60 million. Fremont does not
currently plan or intend to invest in securities rated below investment grade.
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14
The following table reflects average cash and average amortized cost of
investment assets of the Company for the periods indicated.
YEAR ENDED DECEMBER 31,
-----------------------------------------
1998 1997 1996
----------- ----------- -----------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Average cash and investment assets:
Cash................................................. $ 87,125 $ 53,666 $ 40,467
Investment assets.................................... 2,345,464 1,970,602 1,752,181
---------- ---------- ----------
Total........................................ $2,432,589 $2,024,268 $1,792,648
========== ========== ==========
Investment yield earned on (excluding realized gains
and losses):
Cash and investment assets........................... 7.96% 7.48% 7.06%
Investment assets only............................... 8.25% 7.68% 7.22%
Investment yield earned on (including realized gains
and losses):
Cash and investment assets........................... 7.93% 7.38% 6.97%
Investment assets only............................... 8.23% 7.58% 7.13%
Fremont has designated its entire portfolio as investments that would be
available for sale in response to changing market conditions, liquidity
requirements, interest rate movements and other investment factors. At December
31, 1998 and 1997, the Company held securities having an amortized cost of
$2.087 billion and $2.191 billion, respectively, as available for sale. (See
Notes A and C of Notes to Consolidated Financial Statements.)
The following table sets forth maturities in the fixed maturity investment
portfolio at December 31, 1998:
AMORTIZED
COST PERCENTAGE
---------- ----------
(THOUSANDS OF DOLLARS,
EXCEPT PERCENTS)
One year or less............................................ $ 30,773 2%
Over 1 year through 5 years................................. 99,845 6
Over 5 years through 10 years............................... 611,549 39
Over 10 years............................................... 499,671 31
Mortgage-backed securities.................................. 355,747 22
---------- ---
Totals............................................ $1,597,585 100%
========== ===
FINANCIAL SERVICES OPERATION
The operations of the financial services segment are consolidated within
Fremont General Credit Corporation, which is engaged in collateralized lending
to businesses and individuals. The Company's financial services loan portfolio
as of the dates indicated is summarized in the following table by loan type.
YEAR ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
(THOUSANDS OF DOLLARS)
Commercial and residential real estate loans........... $2,110,545 $1,426,567 $1,113,950
Commercial finance loans............................... 485,508 400,475 429,217
Syndicated loans....................................... 360,150 146,790 128,959
Premium finance loans.................................. 58,319 54,257 53,661
---------- ---------- ----------
Loans receivable before allowance for possible loan
losses............................................... 3,014,522 2,028,089 1,725,787
Less allowance for possible loan losses................ (56,346) (44,402) (37,747)
---------- ---------- ----------
Loans receivable, net................................ $2,958,176 $1,983,687 $1,688,040
========== ========== ==========
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Commercial and Residential Real Estate Lending
The real estate lending operations of Fremont currently consists of more
than 4,000 residential real estate accounts and 500 commercial real estate
accounts. The real estate lending activities are primarily conducted through a
California thrift and loan ("the thrift") and are financed mainly through
deposit accounts (53,000 accounts at December 31, 1998), which are insured by
the Federal Deposit Insurance Corporation ("FDIC"). (See "Regulation -- Thrift
and Loan Regulation.") The thrift's deposits are serviced through 14 branch
offices in California. (Fremont's insurance premium finance loans and certain of
its syndicated loans are also financed by the thrift. See "Syndicated Loans" and
"Insurance Premium Financing.") The loan portfolio of the real estate lending
operation has grown from $807.5 million at the end of 1994 to $2.1 billion at
the end of 1998, due primarily to increased loan originations and, to a lesser
extent, the purchase of loan portfolios from other financial institutions.
Loan Origination and Acquisition. Fremont originates real estate loans
nationwide through independent loan brokers, through its own marketing
representatives and through bulk purchase. (Bulk purchases totaled $116.2
million in 1998 and were immaterial in 1997 and 1996.) The Company originates
commercial real estate loans primarily for its own portfolio rather than for
resale to third parties. For residential real estate loans, Fremont has a
program, which began in 1995 and was expanded in 1997, of selling certain
residential real estate loans to other financial institutions. This allowed the
Company an opportunity to become more selective in its residential real estate
loan portfolio. Additionally, this program has allowed Fremont to offer a
broader range of residential real estate loans to its customers, primarily
through independent brokers. In 1998, $746.5 million of residential real estate
loans were sold for cash, all without recourse to the Company, to various other
entities. Due to market disruption and oversupply, Fremont observed that prices
for these loans began to decrease in late 1998. The Company, rather than sell
the loans at prices lower than what it believed was the economic benefit to be
derived, began a program to retain these benefits by either retaining the loans
in its portfolio or by securitizing them. On March 23, 1999, the Company's
thrift issued, through the Fremont Home Loan Owner Trust 1999-1, its first
securitization of these loans in the amount of approximately $415 million. This
trust issued notes collateralized by a pool of these first lien residential
mortgage loans. The notes are subject to an unconditional and irrevocable
guarantee of timely payment of interest and ultimate payment of loan principal
provided by a financial guarantee insurance policy (issued by Financial Security
Assurance Inc.) Servicing of the loans will be provided by Fairbanks Capital
Corporation. These notes have been rated AAA by Standard and Poor's and Aaa by
Moody's.
The commercial real estate loan originations are primarily secured by first
deeds of trust on income-producing properties mainly in California and, to a
lesser degree, Illinois, Texas, and many other states. The real estate securing
these loans include a wide variety of property types including office, retail,
industrial and multi-family properties. Loans include short-term bridge
facilities for the rehabilitation and lease-up of existing properties, as well
as five to ten year permanent loans and single tenant loans. The majority of the
commercial real estate loans originated are adjustable rate loans and generally
range between $1 million to $15 million. As of December 31, 1998, the average
loan size was $2.8 million and the approximate average loan-to-value ratio was
65.7%, using the most current available appraised values and current balances
outstanding. The total amount of commercial real estate loans outstanding at
December 31, 1998 was $1.6 billion, or 51.8% of the Company's financial services
loan portfolio. Loans secured by commercial real estate are generally considered
to entail a higher level of risk than loans secured by residential real estate.
Although the properties securing Fremont's commercial real estate loans
generally have good operating histories, there can be no assurance that such
properties will continue to generate sufficient funds to allow their owners to
make full and timely mortgage loan payments. At December 31, 1998, the Company
had 13 non-performing commercial real estate loans totaling approximately $9.0
million and no commercial real estate owned.
Fremont also originates residential real estate loans secured by
single-family residences mainly in California, with smaller amounts originated
in Illinois, Washington, Utah, and many other states. At December 31, 1998,
single family residential real estate loans represented $549.4 million, or 18.2%
of Fremont's financial services loan portfolio. Substantially all of these loans
are secured by first deeds of trust. These loans generally have principal
amounts below $350,000, have maturities generally of thirty years and are
13
16
approved in accordance with lending policies approved by the thrift's Board of
Directors, which include standards covering, among other things, collateral
value, loan to value and customer debt ratio. These loans generally are "hybrid"
loans which have a fixed rate of interest for an initial period after
origination, typically two to three years, and then the interest rate will be
adjusted to a rate equal to the sum of six month LIBOR and a margin as set forth
in the mortgage note. This interest rate will then be adjusted at each six-month
interval thereafter, subject to various lifetime and periodic rate caps and
floors. These loans have been originated using underwriting standards that are
less stringent than the Federal National Mortgage Association's guidelines and
are commonly known as "sub-prime" loans. To mitigate the higher potential for
credit losses that accompanies these types of borrowers, Fremont focuses on its
loan origination on the higher grades of loans in this category and attempts to
maintain underwriting standards that require conservative loan to collateral
valuations. At December 31, 1998, the average single-family loan amount was
$107,000, and the approximate average loan-to-value ratio was 75.5%, using
appraised values at the time of loan origination and current balances
outstanding. At December 31, 1998, Fremont had 109 non-performing residential
real estate loans totaling approximately $11.4 million and residential real
estate owned of approximately $3.8 million.
The total amount of commercial and residential real estate loans
outstanding on properties located outside of California at December 31, 1998 was
$328 million and $179 million, respectively. (See "Regulation -- Thrift and Loan
Regulation -- California Law.")
Funding Sources. The Company finances its real estate loans primarily
through funds from the thrift's depositors and its capital. Additional financing
is available to the thrift from the Federal Home Loan Bank of San Francisco
("FHLB"). Fremont offers certificates of deposit and installment investment
certificates (which are similar to passbook accounts and money market accounts)
insured by the FDIC to the legal maximum through its 14 branches in California.
The Company has typically offered higher interest rates to its depositors than
do most full service financial institutions. At the same time, it has minimized
the cost of maintaining these accounts by not offering non-interest bearing or
unlimited withdrawal transaction accounts or services such as checking, safe
deposit boxes, money orders, ATM access and other traditional retail services.
Fremont generally effects deposit withdrawals by issuing checks rather than
disbursing cash, which minimizes operating costs associated with handling and
storing cash. Deposits totaled $2.1 billion at December 31, 1998. The financing
by the FHLB became available to the thrift in January 1995. This financing is
available at varying rates and terms. As of December 31, 1998, $474 million was
available under the facility and $115 million was outstanding. The Company may
also, from time to time, securitize certain of its real estate loan assets. (See
"Loan Origination and Acquisition.")
The table below summarizes the Company's certificates of deposit as of
December 31, 1998 which are stated in amounts of $100,000 or more, by maturity
and by type.
CERTIFICATES OF DEPOSIT $100,000 OR MORE, MATURING
---------------------------------------------------------------------
3 MONTHS OVER 3 THROUGH OVER 6 THROUGH OVER
OR LESS 6 MONTHS 12 MONTHS 12 MONTHS TOTAL
-------- -------------- -------------- --------- --------
(THOUSANDS OF DOLLARS)
Retail......................... $45,644 $26,117 $19,866 $ 5,980 $ 97,607
IRA's.......................... 2,041 2,627 5,596 2,229 12,493
Brokered....................... 5,838 11,347 -- 77,407 94,592
------- ------- ------- ------- --------
Total................ $53,523 $40,091 $25,462 $85,616 $204,692
======= ======= ======= ======= ========
Commercial Finance
Fremont provides working capital loans, primarily secured by accounts
receivable, inventory, machinery and equipment to small and middle market
companies on a nationwide basis. At December 31, 1998, commercial finance loans
represented $485.5 million, or 16.1% of the Company's financial services loan
portfolio. Loan originations are developed primarily by referrals from various
financial intermediaries and financial institutions. Commercial finance loans
made by the Company are primarily on a revolving short-term basis (generally two
or three years) and secured by assets which primarily include accounts
receivable, inventory, machinery and equipment and other types of collateral. In
addition, Fremont also makes term loans
14
17
secured primarily by equipment and real estate. The term loans originated in
conjunction with revolving loans are cross-collateralized (i.e., the same
collateral is used to support both the term loans and all the related revolving
loans) and coterminous with the related revolving loan made to the same
borrower. The term to maturity for the term loans is generally five to seven
years; however, certain term loans are "balloon loans" that amortize over a
longer period and therefore do not amortize fully before their respective
maturities. As of December 31, 1998, the average outstanding commercial finance
loan balance was $2.0 million. Loans outstanding to a single borrower generally
range in size from $1 million to $5 million.
The major avenue of growth for the commercial finance operation remains the
establishment of new lending relationships. Fremont has a national presence with
regional offices in Santa Monica, Chicago, New York and Atlanta, as well as
several other marketing offices across the country. To provide a stable source
of funds to facilitate the continued expansion of its commercial finance lending
business, the Company, in 1993, established the Fremont Small Business Loan
Master Trust ("Fremont Trust"). The purpose of the Fremont Trust is to
securitize commercial finance loans originated by the Company (the "asset
securitization program"). The Fremont Trust is a master trust that can issue
multiple series of asset-backed certificates that represent undivided interests
in the Fremont Trust's assets (primarily commercial finance loans), which
Fremont will continue to service after securitization. As of December 31, 1998,
the Fremont Trust had an aggregate of $235 million in senior series of
certificates and an aggregate of $39 million in subordinated series of
certificates outstanding. The interest rate on the certificates, set monthly,
ranged from LIBOR plus 0.23% to LIBOR plus 0.95% at December 31, 1998. The
securities issued in this program have a scheduled maturity of two to four
years, but could mature earlier depending on fluctuations in the outstanding
balances of loans in the portfolio and other factors. As of December 31, 1998,
up to $265 million in additional publicly offered term asset-backed certificates
may be issued pursuant to a shelf registration statement to fund future growth
in the commercial finance loan portfolio. In December 1995, a commercial paper
facility was established as part of the asset securitization program. This
facility, which expires in December 2000, provides for the issuance of up to
$150 million in commercial paper, dependent upon the level of assets within the
asset securitization program. As of December 31, 1998, $25 million in commercial
paper was outstanding under this facility. Commercial finance loans are also
financed under an unsecured revolving line of credit with a syndicated bank
group that presently permits borrowings of up to $438 million, which includes a
revolving credit facility of $350 million and a term loan of $88 million. The
revolving credit facility converts to a term loan in August 2000, with ultimate
maturity in June 2002. The term loan matures July 2001. The balance outstanding
at December 31, 1998 of the revolving credit facility and the term loan was $264
million and $88 million, respectively, with a weighted average interest rate of
5.74%. This credit line is primarily used to finance loans that are not included
in the Company's asset securitization program.
Fremont's commercial finance customer base consists primarily of small to
middle-market manufacturers and distributors that generally require financing
for working capital and debt restructuring. At December 31, 1998, the Company
had approximately 250 commercial finance loans outstanding in 35 states. At such
date, approximately 34.2% of total commercial finance loans outstanding were
made to companies based in California, and no other state accounted for more
than 6.5% of total commercial finance loans outstanding.
Commercial finance loans are asset-based revolving loans which permit a
company to borrow from the lender at any time during the term of the loan
agreement, up to the lesser of a maximum amount set forth in the loan agreement
or a percentage of the value of the collateral which primarily secures such
loans. Under an asset-based lending agreement, the borrower retains the credit
and collection risk with respect to the collateral in which the lender takes a
security interest. Cash collections are received as often as daily by or on
behalf of the borrower after the loan is initially made. These collections are
paid to the lender to reduce the loan balance.
While consideration is given to the net worth and profitability of a
client, asset-based loans are generally extended to borrowers who do not have
bank sources of credit readily available and are based on the estimated
liquidation value of the collateral pledged to secure the loan. The largest
percentage of realized losses has resulted from fraud or collateral
misrepresentations by the borrower. Fremont seeks to protect itself against this
risk through a comprehensive system of collateral monitoring and control.
Fremont's auditors perform auditing procedures of a borrower's books and records
and physically inspects the collateral prior to approval
15
18
and funding, as well as approximately every 90 to 120 days during the term of
the loan. Over the past four years, the majority of Fremont's loans that have
been liquidated have been fully repaid, as the Company attempts to work closely
with the borrower through the liquidation to ensure repayment of the loan. The
Company seeks to limit its credit exposure by maintaining conservative
collateral valuations and perfection of its security interests.
Syndicated Loans
Fremont has interests in large syndicated loans which are originated and
serviced by other financial institutions. Syndicated loans generally carry lower
yields than the Company's commercial finance loans since the borrowers under
syndicated loans tend to be larger companies whose credit quality is generally
higher than borrowers under the Company's commercial finance loans. These loans
are senior obligations of the borrowers and are secured by various assets of the
borrower and, if applicable, its subsidiaries. The syndicated loans are variable
rate loans and are originated on both a revolving and fixed-term basis. The term
loans are generally issued with terms not in excess of ten years. The Company
finances these loans using thrift deposits, as well as financing through an
unsecured revolving line of credit with a syndicated bank group, which is also
used to finance Fremont's commercial finance loans that are not financed by the
Fremont Trust. (See "Commercial Finance.") The syndicated loan portfolio has
grown to $360.2 million at December 31, 1998, or 11.9% of the financial services
loan portfolio, from $146.8 million at December 31, 1997. This growth has been
achieved primarily from development of the customer base through referrals from
various financial institutions. As of December 31, 1998, the average outstanding
syndicated loan balance was $5.1 million. Loans outstanding to a single borrower
generally range in size from $5 million to $10 million.
Insurance Premium Financing
The Company finances property and casualty insurance premiums for small
businesses. Fremont funds this activity in the thrift, mainly through deposits.
This premium finance loan portfolio is collateralized by the unearned premiums
of the underlying insurance policies. At December 31, 1998, insurance premium
finance loans represented $58.3, million or 1.9% of Fremont's financial services
loan portfolio. (See "Regulation -- Thrift and Loan Regulation -- California
Law.")
Competition and Economic Conditions
During periods when economic conditions are unfavorable, Fremont's
financial services businesses may not be able to originate new loan products or
maintain credit quality at previously attained levels. This may negatively
affect the Company's net finance income and levels of non-performing assets and
net charge-offs. Changes in market interest rates, or in the relationships
between various interest rates, could cause the Company's interest margins to
vary and may result in significant changes in the prepayment patterns of
Fremont's finance receivables, which could adversely affect the Company's
results of operations and financial condition.
Fremont's financial services businesses maintain reserves for credit losses
on its portfolio of finance receivables in amounts that Fremont believes is
sufficient to provide adequate protection against potential losses. The Company
attempts to minimize the impact that adverse economic developments could have on
Fremont's financial services loan portfolio by concentrating primarily on
lending on a senior and secured basis and by carefully monitoring the underlying
collateral that secures these loans. Although the Company believes that its
level of reserves is sufficient to cover potential credit losses, Fremont's
reserves could prove to be inadequate due to unanticipated adverse changes in
economic conditions or discrete events that adversely affect specific borrowers,
industries or markets. Any of these changes could impair Fremont's ability to
realize the expected value of the collateral securing certain of its finance
receivables.
Fremont's financial services businesses compete in markets that are highly
competitive and are characterized by factors that vary based upon product and
geographic region. The markets in which the Company competes are typically
characterized by a large number of competitors who compete based primarily upon
price, terms and loan structure. Fremont primarily competes with banks,
mortgage, insurance, and
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finance companies, many of which are larger and have greater financial resources
than Fremont. The competitive forces of these markets could aversely affect the
Company's net finance income, loan origination volume or net credit losses.
LIFE INSURANCE
Prior to January 1, 1996, the Company offered life insurance products,
including annuities, credit life and disability insurance and term life
insurance for consumers, through a subsidiary. Effective December 31, 1995 and
January 1, 1996, the Company entered into reinsurance and assumption agreements
with a reinsurer whereby assets and liabilities related to certain life
insurance and annuity policies were ceded to the reinsurer. These reinsurance
agreements are part of several other agreements which have collectively resulted
in the substantial reduction of the Company's life insurance operations. The
Company continues to remain primarily obligated for approximately $128 million
in statutory reserve value of annuities which, at December 31, 1998, have been
fully co-insured with Great Southern Insurance Company. The effect on operations
from these agreements was not material, and revenue and operating income from
this subsidiary were not significant in 1998, 1997 or 1996.
DISCONTINUED OPERATIONS
Fremont's discontinued operations consist primarily of assumed treaty and
facultative reinsurance business that was discontinued between 1986 and 1991. In
1990, the Company established a management group to actively manage the
liquidation of this business. The liabilities associated with this business are
long term in duration and, therefore, the Company continues to be subject to
claims being reported. Claims under these reinsurance treaties include
professional liability, product liability and general liability which include
environmental claims.
The discontinued operations' assets at December 31, 1998 consisted of $186
million in cash and investment grade fixed income securities, reinsurance
recoverables of $50 million and other assets totaling $7 million. Fremont
estimates that the dedicated assets supporting these operations and all future
cash inflows will be adequate to fund future obligations. However, should those
assets ultimately prove to be insufficient, the Company believes that its
property and casualty subsidiaries would be able to provide whatever additional
funds might be needed to complete the liquidation without having a material
adverse effect on the Company's consolidated financial position or results of
operations. (See Note N of Notes to Consolidated Financial Statements.) The
discontinued operations have investment portfolios which resemble the portfolios
in the ongoing operations with regard to asset allocation, performance and
maturities.
REGULATION
Insurance Regulation
Fremont's workers' compensation insurance operations now have premiums
inforce in thirty-nine states and the District of Columbia. Insurance companies
are subject to supervision and regulation by the state insurance authority in
each state in which they transact business. Such supervision and regulation
relate to numerous aspects of an insurance company's business and financial
condition. The primary purpose of such supervision and regulation is the
protection of policyholders rather than investors or shareholders of an insurer.
The extent of such regulation varies, but generally derives from state statutes
that delegate regulatory, supervisory and administrative authority to state
insurance departments. Accordingly, the authority of the state insurance
departments includes the establishment of minimum solvency standards which must
be met and maintained by insurers, the licensing to do business of insurers and
agents, restrictions on investments by insurers, establishing premium rates for
certain property and casualty insurance, and life and disability insurance,
establishing the provisions which insurers must make for current losses and
future liabilities and the approval of policy forms. Additionally, most states
require issuers to participate in assigned risk plans which provide insurance
coverage to individuals or entities who are unable to obtain coverage from
existing insurers in those states. The net profit or loss incurred in the
administration of these plans is allocated back to participant insurers based on
the insurers' relative market share (i.e., insurance premiums) in each state.
State
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insurance departments also conduct periodic examinations of the affairs of
insurance companies and require the filing of annual and other reports relating
to the financial condition of insurance companies. Fremont's multistate
insurance operations require, and will continue to require, significant
resources of the Company in order to continue to comply with the regulations of
each state in which it transacts business.
Workers' Compensation Regulation. A significant portion of Fremont's
workers' compensation insurance premiums is derived from policies issued in
California and Illinois. Illinois began operating under an open rating system in
1982 and California began operating under such a system effective January 1,
1995. In an open rating system, workers' compensation companies are provided
with advisory premium rates (expected losses and expenses) or loss costs
(expected losses only) which vary by job classification. Each insurance company
determines its own rates based in part upon its particular loss experience and
operating costs. Insurance companies generally set their premium rates below
such advisory premium rates. Before January 1, 1995, California operated under a
minimum rate law, whereby premium rates established by the California Department
of Insurance were the minimum rates which could be charged by an insurance
carrier. The repeal of the minimum rate law on January 1, 1995 resulted in lower
premiums and lower profitability in the Company's California workers'
compensation insurance business due to increased price competition. Fremont's
acquisition of Casualty, with policies written primarily outside of California,
lessened the impact of the repeal of the minimum rate law in 1995 by providing
geographic diversity, which mitigated the impact of these regulatory changes in
California.
Beginning in 1995, Fremont's policies were predominately written as
non-participating, which does not include provisions for policyholder dividend
consideration. Prior to January 1, 1995, the Company's policies, which were
written primarily in California, were primarily written as participating, which
obligated Fremont to consider policyholder dividend payments. This shift in
policy type is due primarily to the increased competition in the California
market which resulted from the repeal of the minimum rate law, effective January
1, 1995. The shift to non-participating policies has continued and is a
characteristic element of the competitive environment. In addition, Fremont's
subsidiaries are required, with respect to their workers' compensation line of
business, to maintain on deposit investments meeting specified standards that
have an aggregate market value equal to the Company's loss reserves.
Insurance Guaranty Association Laws. Under insolvency or guaranty fund laws
in most states in which the Company's insurance subsidiaries operate, insurers
doing business in those states can be assessed, up to the prescribed limits, for
losses incurred by policyholders as a result of the insolvency of other
insurance companies. The amount and timing of such assessments are beyond the
control of Fremont and generally have not had an adverse impact on Fremont's
earnings in years in which such assessments have been made. Premiums written
under workers' compensation policies are subject to assessment only with respect
to covered losses incurred by the insolvent insurer under workers' compensation
policies. The Company believes it does not face any material exposure to
guaranty fund assessments.
Holding Company Regulation. The Company is subject to the California
Insurance Holding Company System Regulatory Act (the "Holding Company Act").
This act, and similar laws in other states, require the Company to periodically
file information with the California Department of Insurance and other state
regulatory authorities, including information relating to its capital structure,
ownership, financial condition and general business operations. Certain
transactions between an insurance company and its affiliates, including sales,
loans or investments which in any twelve month period aggregate at least 5% of
its admitted assets or 25% of its statutory capital and surplus, also are
subject to prior approval by the Department of Insurance.
The Holding Company Act also provides that the acquisition or change of
"control" of a California domiciled insurance company or of any person who
controls such an insurance company cannot be consummated without the prior
approval of the Insurance Commissioner. In general, a presumption of "control"
arises from the ownership of voting securities and securities that are
convertible into voting securities, that in the aggregate, constitute 10% or
more of the voting securities of a California insurance company or of a person
that controls a California insurance company, such as Fremont General
Corporation. The Liquid Yield Option(TM) Notes ("LYONs") constitute a security
convertible into the voting Common Stock of the Company, and the shares of
Common Stock into which a holder's LYONs are convertible and
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21
any other securities convertible into Common Stock must be aggregated with any
other shares of Common Stock of the holder for purposes of determining the
percentage ownership. Additionally, the Company's 9% Trust Originated Preferred
Securities(SM), which were sold on March 1, 1996 by a wholly-owned subsidiary,
are a non-voting security and only represent an interest in the assets of this
subsidiary. A person seeking to acquire "control," directly or indirectly, of
Fremont must generally file with the Insurance Commissioner an application for
change of control containing certain information required by statute and
published regulations and provide a copy of the application to the Company. The
Holding Company Act also effectively restricts Fremont from consummating certain
reorganizations or mergers without prior regulatory approval.
The Holding Company Act also limits the ability of Fremont's insurance
subsidiaries to pay dividends to the Company. The act permits a property and
casualty insurance company to pay dividends in any year which, together with
other dividends or other distributions made within the preceding twelve months,
do not exceed the greater of 10% of its statutory surplus or 100% of its net
income as of the end of the preceding year, subject to certain limitations.
Larger dividends are payable only upon prior regulatory approval. Applicable
regulations further require that an insurer's statutory surplus following a
dividend or other distribution be reasonable in relation to its outstanding
liabilities and adequate to its financial needs. Based upon restrictions
presently in effect, the maximum amount available for payment of dividends by
the Company's property and casualty subsidiaries during 1999 without prior
regulatory approval is approximately $235.3 million. In addition, insurance
regulations require that the Department of Insurance be given fifteen days
advance notice of any dividend payment.
Other Regulations. The NAIC adopted a formula to calculate risk based
capital ("RBC") of property and casualty insurance companies for inclusion in
annual statements. The purpose of the RBC model is to help state regulatory
authorities monitor the capital adequacy of property and casualty insurance
companies by measuring several major areas of risk facing property and casualty
insurers including underwriting, credit and investment risks. Companies having
less statutory surplus than the RBC model calculates will be required to
adequately address these risk factors and will be subject to varying degrees of
regulatory intervention, depending on the level of capital inadequacy. As of
December 31, 1998 the Company's insurance subsidiaries engaged in continuing
operations exceed all RBC levels requiring any regulatory intervention.
Thrift and Loan Regulation
Fremont's thrift is subject to supervision and regulation by the Department
of Financial Institutions of the State of California (the "DFI") and, as an
insured institution, by the FDIC. None of the Company's subsidiaries are
regulated or supervised by the Office of Thrift Supervision, which regulates
savings and loan institutions. Fremont General Corporation is generally not
directly regulated or supervised by the DFI, the FDIC, the Federal Reserve Board
or any other bank regulatory authority, except with respect to guidelines
concerning its relationship with the thrift subsidiary. Such guidelines include
(i) general regulatory and enforcement authority of the DFI and the FDIC over
transactions and dealings between Fremont General Corporation and the thrift,
(ii) specific limitations regarding ownership of the capital stock of the parent
company of any thrift and loan company, and (iii) specific limitations regarding
the payment of dividends from the thrift as discussed below. The thrift is
examined on a regular basis by both agencies.
Federal and state regulations prescribe certain minimum capital
requirements and, while the thrift is currently in compliance with such
requirements, the Company could in the future be required to make additional
investments in the thrift in order to maintain compliance with such
requirements. Federal and state regulatory authorities have the power to
prohibit or limit the payment of dividends by the thrift. Fremont does not
believe that the restrictions on the thrift's ability to pay dividends imposed
by federal or state law will adversely affect the ability of Fremont General
Corporation to meet its obligations. Future changes in government regulation and
policy could adversely affect the thrift and loan industry, including the
Company's thrift.
California Law. The thrift and loan business conducted by Fremont's thrift
is governed by the California Industrial Loan Law and the rules and regulations
of the Commissioner of the DFI which, among other things, regulate the
collateral requirements and maximum maturities of the various types of loans
that are
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permitted to be made by California-chartered industrial loan companies, i.e.,
industrial banks, thrift and loan, investment and loan, or premium financing
companies.
Subject to restrictions imposed by applicable California law, the thrift is
permitted to make secured and unsecured consumer and non-consumer loans. The
maximum term for repayment of loans made by thrift and loan companies is forty
years depending upon collateral and priority of secured position, except that
loans with repayment terms in excess of approximately thirty years may not in
the aggregate exceed 5% of total outstanding loans and obligations of the
thrift. Consumer loans secured by real property with terms in excess of three
years must be repayable in substantially equal periodic payments unless such
loans are covered under the Garn-St. Germain Depository Institutions Act of 1982
(primarily single-family residential loans). Non-consumer loans may be repayable
in unequal periodic payments during their respective terms. California law
limits lending activities outside of California by thrift and loan companies to
no more than 20% of total assets and upon application to and consent by the
Commissioner, 40% of total assets. Loans for purchase or refinance of single or
multi-family residential property, which are saleable in the secondary market,
evidenced by the Commissioner and held for 90 days or less, are exempt from the
out of state lending limits.
California law contains extensive requirements for the diversification of
the loan portfolios of thrift and loan companies. A thrift and loan with
outstanding investment certificates may not, among other things, make any one
loan secured primarily by improved real property which exceeds 20% of its
paid-up and unimpaired capital stock and surplus not available for dividends;
may not lend an amount in excess of 5% of its paid-up and unimpaired capital
stock and surplus not available for dividends upon the security of the stock of
any one corporation, which stock collateral may not be greater than 10% of the
stock of said corporation; may not make loans to, or hold the obligations of,
any one person as primary obligor in an aggregate principal amount exceeding 20%
of its paid-up and unimpaired capital stock and surplus not available for
dividends; and may, subject to certain exceptions, have no more than 70% of its
total assets in loans which have remaining terms to maturity in excess of seven
years and are secured solely or primarily by real property. Additionally, loans
having a principal balance in excess of $10,000 and secured primarily by real
property are limited to a maximum loan to value of 90%, with certain exceptions
which include: (i) government insured or guaranteed loans, (ii) loans made to
facilitate sale of real property owned resulting from foreclosure or deeds in
lieu thereof, (iii) restructured loans, (iv) loans saleable in the secondary
market, or (iv) loans held for less than 90 days. At December 31, 1998, the
thrift was in compliance with all of these requirements.
Effective January 1, 1999, the California legislature clarified the law and
expressly authorized a thrift and loan company to issue credit cards and to
acquire or hold obligations resulting from the use of credit cards. It was also
in that legislation that the words "industrial bank" were authorized to be used
in the name of a thrift and loan company and the Industrial Loan Law to be
referred to as the Industrial Banking Law.
A thrift and loan generally may not make any loans to, or hold an
obligation of, any of its directors or officers or any director or officer of
its holding company or affiliates, except in specified cases and subject to
regulation by the DFI. Further, a thrift and loan may not make any loan to, or
hold an obligation of, any of its shareholders or any shareholder of its holding
company or affiliates, except that this prohibition does not apply to persons
who own less than 10% of the stock of a holding company or affiliate which is
listed on a national securities exchange, such as Fremont General Corporation.
Any person who wishes to acquire (i) 10% or more of the voting securities of a
California thrift and loan company, or (ii) 10% or more of the voting securities
of a holding company of a California thrift and loan company, such as Fremont,
must obtain the prior approval of the DFI. The LYONs are not voting securities
of the Company, but the shares of Common Stock into which such LYONs are
convertible constitute voting securities of the Company. Additionally, Fremont's
9% Trust Originated Preferred Securities(SM), which were sold on March 1, 1996
by a wholly-owned subsidiary, are a non-voting security and only represent an
interest in the assets of this subsidiary. Fremont's thrift must also obtain
prior written approval from the DFI before it may open or relocate any branch or
loan production office or close a branch office.
The Industrial Loan Law prohibits an industrial loan company from having
deposits at any time in an aggregate sum in excess of 20 times the aggregate
amount of its paid-up unimpaired capital and amounts of its
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unimpaired surplus declared by its by-laws not to be available for cash
dividends. The Company's thrift currently has an authorized ratio of deposits to
such capital of 17 to 1.
Federal Law. The thrift's deposits are insured by the FDIC to the full
extent permitted by law. As an insurer of deposits, the FDIC issues regulations,
conducts examinations, requires the filing of reports and generally supervises
the operations of institutions to which it provides deposit insurance. Fremont's
thrift is subject to the rules and regulations of the FDIC to the same extent as
other financial institutions which are insured by that entity. The approval of
the FDIC is required prior to any merger, consolidation or change in control or
the establishment or relocation of any branch office of the thrift. This
supervision and regulation is intended primarily for the protection of the
insured deposit funds. Prior written notice to the FDIC is required to close a
branch office. No approval, however, is required to open, relocate, or close a
loan production office.
The thrift is subject to federal risk-based capital adequacy guidelines
which provide a measure of capital adequacy and are intended to reflect the
degree of risk associated with both on- and off-balance sheet items, including
residential real estate loans sold with recourse, legally binding loan
commitments and standby letters of credit. A financial institution's risk-based
capital ratio is calculated by dividing its qualifying capital by its
risk-weighted assets. Financial institutions are generally expected to meet a
minimum ratio of qualifying total capital to risk-weighted assets of 8%, of
which at least 4% of qualifying total capital must be in the form of core
capital ("Tier 1") -- common stock, noncumulative perpetual preferred stock,
minority interests in equity capital accounts of consolidated subsidiaries and
allowed mortgage servicing rights, less all intangible assets other than allowed
mortgage servicing rights and eligible purchased credit card relationships.
Supplementary capital ("Tier 2") consists of the allowance for loan and lease
losses up to 1.25% of risk-weighted assets, cumulative perpetual preferred
stock, long-term preferred stock (original maturity of at least 20 years),
perpetual preferred stock, hybrid capital instruments, term subordinated debt
and intermediate term preferred stock (original average maturity of five years
or more). The maximum amount of Tier 2 capital which may be recognized for
risk-based capital purposes is limited to 100% of Tier 1 capital (after any
deductions for disallowed intangibles). The aggregate amount of term
subordinated debt and intermediate term preferred stock that may be treated as
Tier 2 capital is limited to 50% of Tier 1 capital. Certain other limitations
and restrictions also apply. At December 31, 1997, the Tier 2 capital of the
thrift consisted of approximately $17.0 million of allowance for possible loan
losses. As of December 31, 1998, the thrift's allowance for possible loan losses
for Tier 2 capital increased to $25.5 million. The following table presents the
thrift's risk-based capital position at the dates indicated:
DECEMBER 31, 1998 DECEMBER 31, 1997
-------------------------- --------------------------
PERCENT OF PERCENT OF
RISK-WEIGHTED RISK-WEIGHTED
AMOUNT ASSETS AMOUNT ASSETS
---------- ------------- ---------- -------------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Tier 1 capital............................. $ 186,520 9.17% $ 131,126 9.69%
Minimum requirement........................ 81,371 4.00 54,135 4.00
---------- ----- ---------- -----
Excess........................... $ 105,149 5.17% $ 76,991 5.69%
========== ===== ========== =====
Total capital.................... $ 212,048 10.42% $ 148,106 10.94%
Minimum requirement........................ 162,743 8.00 108,269 8.00
---------- ----- ---------- -----
Excess........................... $ 49,305 2.42% $ 39,837 2.94%
========== ===== ========== =====
Risk-weighted assets....................... $2,034,280 $1,353,366
========== ==========
The FDIC has adopted a 3% minimum leverage ratio which is intended to
supplement risk-based capital requirements and to ensure that all financial
institutions continue to maintain a minimum level of core capital. A minimum
leverage ratio of 3% is required for institutions which have been determined to
be the highest of five categories used by regulators to rate financial
institutions. All other institutions (including the Company's thrift) will
likely be required to maintain leverage ratios of at least 1% to 2% above the 3%
minimum. It is improbable, however, that an institution with a 3% core
capital-to-total assets ratio would be rated in the highest category since a
strong capital position is so closely tied to the rating system. Therefore, the
"minimum" leverage ratio is, for all practical purposes, significantly above 3%.
The following table presents
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the thrift's leverage ratio (the ratio of Tier 1 capital to the quarterly
average total assets) at the dates indicated:
DECEMBER 31, 1998 DECEMBER 31, 1997
-------------------------- --------------------------
PERCENT OF PERCENT OF
AVERAGE TOTAL AVERAGE TOTAL
AMOUNT ASSETS AMOUNT ASSETS
---------- ------------- ---------- -------------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Tier 1 capital............................... $ 186,520 8.81% $ 131,126 8.55%
Minimum requirement.......................... 63,510 3.00% 47,439 3.00%
---------- -------- ---------- --------
Excess............................. $ 123,010 5.81% $ 83,687 5.55%
========== ======== ========== ========
Average total assets for the quarter ended
December 31,............................... $2,117,009 $1,581,284
========== ==========
The FDIC has designated Fremont's thrift as a "well-capitalized"
institution under the regulations promulgated under the Federal Deposit
Insurance Corporation Improvement Act of 1991. A "well-capitalized" institution
has a total risk-based capital ratio of at least 10%, has a Tier 1 risk-based
capital ratio of at least 6.0%, has a leverage ratio of at least 5.0% and is not
subject to any written agreement, order, capital directive or prompt corrective
action directive issued by the FDIC under Section 8 or Section 38 of the Federal
Deposit Insurance Act to meet and maintain a specific capital level for any
capital measure. The total risk-based capital ratio is the ratio of qualifying
total capital to risk-weighted assets and the Tier 1 risk-based capital ratio is
the ratio of Tier 1 capital to risk-weighted assets.
As a "well-capitalized" institution, the thrift's annual FDIC insurance
premiums currently are 1.2 cents per $100 of eligible domestic deposits in 1998.
The insurance premium payable is subject to semi-annual adjustment. The FDIC, by
the first day of the month preceding each semi-annual period, is required to
notify each insured institution of its assessment risk-classification upon which
the insurance premium assessment for the following period will be based. The
FDIC has the authority to assess to all insured institutions collectively,
additional premiums to cover losses and expenses associated with insuring
deposits maintained at financial institutions and for other purposes it deems
necessary.
Limitations on Dividends. Under California law, a thrift is not permitted
to declare dividends on its capital stock unless it has at least $750,000 of
unimpaired capital plus additional capital of $50,000 for each branch office
maintained. In addition, no distribution of dividends is permitted unless: (i)
such distribution would not exceed a thrift's retained earnings; (ii) any
payment would not result in violation of the approved maximum capital to thrift
investment certificate ratio; or (iii) in the alternative, after giving effect
to the distribution, the sum of a thrift and loan's qualified assets would be
not less than 125% of certain of its liabilities, or with certain exceptions,
current assets would be not less than current liabilities. In addition, a thrift
and loan is prohibited from paying dividends from that portion of capital which
its board of directors has declared restricted for dividend payment purposes. In
policy statements, the FDIC has advised insured institutions that the payment of
cash dividends in excess of current earnings from operations is inappropriate
and may be cause for supervisory action. Under the Financial Institutions
Supervisory Act and the Financial Institutions Reform, Recovery and Enforcement
Act of 1989, federal regulators also have authority to prohibit financial
institutions from engaging in business practices which are considered to be
unsafe or unsound. It is possible that, depending upon the financial condition
of the Company's thrift and other factors, such regulators could assert that the
payment of dividends in some circumstances might constitute unsafe or unsound
practices and could prohibit payment of dividends even though technically
permissible.
Fremont's thrift is also subject to federal consumer protection laws,
including the Truth In Savings Act, the Truth in Lending Act, the Community
Reinvestment Act and the Real Estate Settlement Procedures Act.
Commercial Finance
Fremont's commercial finance subsidiary is licensed by the California
Finance Lenders Law by the California Department of Financial Institutions as a
commercial finance lender and a personal property broker and holds certain other
licenses.
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Intercompany Transactions
The payment of stockholders' dividends and the advancement of loans to
Fremont General Corporation by its subsidiaries are and may continue to be
subject to certain statutory and regulatory restrictions.
EMPLOYEES
At December 31, 1998, the Company had 3,320 employees, none of whom is
represented by a collective bargaining agreement. Fremont believes its relations
with employees are good.
ITEM 2. PROPERTIES
Substantially all facilities used by the Company are leased.
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries and affiliates are parties to various
legal proceedings, which in some instances include claims for punitive damages,
most of which are considered routine and incidental to their business. Fremont
believes that ultimate resolution or settlement of such matters will not have a
material adverse effect on its consolidated financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the New York Stock Exchange
("NYSE") under the trading symbol "FMT." The following table sets forth the high
and low sales prices of the Company's Common Stock adjusted retroactively for a
two-for-one stock split effected on December 10, 1998 as reported as composite
transactions on the NYSE and the cash dividends declared on the Company's Common
Stock during each quarter presented.
DIVIDENDS
HIGH LOW DECLARED
------ ----- ----------
1998
1st Quarter.................................... 31 1/16 24 5/32 $0.075
2nd Quarter.................................... 30 5/16 24 1/4 0.075
3rd Quarter.................................... 30 3/32 18 7/8 0.075
4th Quarter.................................... 25 11/16 18 0.080
------
Total................................ $0.305
======
1997
1st Quarter.................................... 16 5/16 14 $0.075
2nd Quarter.................................... 20 1/8 13 3/16 0.075
3rd Quarter.................................... 24 1/8 18 3/8 0.075
4th Quarter.................................... 27 21/32 21 5/32 0.075
------
Total................................ $0.300
======
On December 31, 1998, the closing sale price of the Company's Common Stock
on the NYSE was $25.1875 per share. There were 1,454 stockholders of record as
of December 31, 1998.
The Company has paid cash dividends in every quarter since its initial
public offering in 1977. While the Company intends to continue to pay dividends,
the decision to do so is made quarterly by the Board of Directors and is
dependent on the earnings of the Company, management's assessment of future
capital needs, and other factors. As a holding company, Fremont General's
ability to pay dividends to its stockholders is partially dependent on dividends
from its subsidiaries. The ability of several of these subsidiaries to
distribute dividends is subject to regulation under California law. (See Note K
to Consolidated Financial Statements.)
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ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
1998(1) 1997(2) 1996 1995(3) 1994
----------- --------- --------- --------- ---------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS AND PER SHARE DATA)
INCOME STATEMENT DATA:
Property and casualty premiums earned.... $ 552,078 $601,183 $486,860 $606,917 $433,584
Loan interest............................ 234,828 194,412 163,765 162,992 113,382
Net investment income.................... 192,815 149,729 123,531 119,523 76,821
Realized investment gains (losses)....... (605) (1,964) (1,658) 1 (315)
Other revenue............................ 58,481 30,935 23,306 34,381 29,676
---------- -------- -------- -------- --------
Total revenues................... $1,037,597 $974,295 $795,804 $923,814 $653,148
========== ======== ======== ======== ========
Property and casualty income............. $ 169,235 $144,667 $117,593 $ 83,092 $ 61,265
Financial services income................ 55,506 42,286 36,589 35,737 28,014
Other interest and corporate expense..... (28,029) (28,060) (25,873) (18,502) (7,708)
---------- -------- -------- -------- --------
Income before taxes...................... 196,712 158,893 128,309 100,327 81,571
Income tax expense....................... (63,748) (50,601) (41,021) (32,305) (25,759)
---------- -------- -------- -------- --------
Net income............................... $ 132,964 $108,292 $ 87,288 $ 68,022 $ 55,812
========== ======== ======== ======== ========
GAAP RATIOS FOR PROPERTY AND CASUALTY
SUBSIDIARIES:
Loss ratio............................... 60.8% 64.7% 68.9% 76.0% 63.1%
Expense ratio............................ 34.5% 27.5% 25.9% 24.5% 23.4%
Policyholder dividends ratio............. 0.9% 0.8% -- -- 11.5%
---------- -------- -------- -------- --------
Combined ratio........................... 96.2% 93.0% 94.8% 100.5% 98.0%
========== ======== ======== ======== ========
PER SHARE DATA:
Cash dividends declared.................. $ 0.305 $ 0.30 $ 0.30 $ 0.252 $ 0.227
Stockholders' equity:
Including FASB 115(4)................. 13.60 12.04 9.95 9.81 6.91
Excluding FASB 115(4)................. 13.04 11.28 9.90 9.38 8.20
Net income:
Basic................................. 2.09 1.90 1.77 1.34 1.10
Diluted............................... 1.90 1.62 1.37 1.09 0.91
WEIGHTED AVERAGE SHARES USED TO CALCULATE
PER SHARE DATA:
Basic.................................... 63,529 57,059 49,315 50,782 50,609
Diluted.................................. 70,082 68,585 67,206 66,626 66,062
25
28
DECEMBER 31,
--------------------------------------------------------------
1998(1) 1997(2) 1996 1995(3) 1994
---------- ---------- ---------- ---------- ----------
(THOUSANDS OF DOLLARS)
BALANCE SHEET DATA:
Total assets....................... $7,369,612 $6,090,627 $4,307,512 $4,477,399 $3,134,390
Fixed income and other
investments..................... 2,386,757 2,442,813 1,484,310 1,937,890 888,918
Loans receivable................... 2,958,176 1,983,687 1,688,040 1,499,043 1,440,774
Claims and policy liabilities...... 2,571,027 2,460,550 1,579,325 1,971,719 1,012,704
Short-term debt.................... 165,702 26,290 16,896 72,191 176,325
Long-term debt..................... 913,006 691,068 636,456 693,276 468,390
Trust Originated Preferred
Securities(SM)(5)............... 100,000 100,000 100,000 -- --
Stockholders' equity:
Including FASB 115(4)........... 950,912 832,815 559,117 498,090 351,013
Excluding FASB 115(4)........... 912,010 779,906 556,488 476,491 416,378
- ---------------
(1) The Company acquired UNICARE Specialty Services, Inc. on September 1, 1998.
(2) The Company acquired Industrial Indemnity Holdings, Inc. on August 1, 1997.
(3) The Company acquired Casualty Insurance Company on February 22, 1995.
(4) Effective January 1994, FASB 115 changed the accounting treatment afforded
the Company's investment portfolio wherein unrealized gains and losses on
securities designated by the Company as available for sale are included net
of deferred taxes, as a component of stockholders' equity.
(5) Company-obligated mandatorily redeemable preferred securities of subsidiary
Trust holding solely Company junior subordinated debentures.
26
29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations ("MD & A") contains 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. The Company's actual results could differ
materially from those projected in these forward-looking statements as a result
of certain risks and uncertainties, including those factors set forth in this MD
& A section and elsewhere in this Form 10-K including, but not limited to "Item
1. Business."
GENERAL
Fremont General Corporation is an insurance and financial services holding
company operating select businesses nationally in niche markets. The reported
assets of Fremont General Corporation and its subsidiaries ("Fremont" or "the
Company") as of December 31, 1998 were $7.4 billion, with 1998 pre-tax earnings
of $196.7 million. Fremont's business strategy includes achieving income balance
and geographic diversity among its business units in order to limit its exposure
to industry, market and regional concentrations. The Company's business strategy
also includes growing its business through new business development and
acquisitions. The Company's stock is traded on the New York Stock Exchange under
the symbol "FMT."
The Company's businesses are managed within two reportable segments:
property and casualty insurance and financial services. These segments offer two
basic financial products; policies of insurance (property and casualty
insurance), and loans (financial services). They are managed separately and use
different pricing, distribution, and operating methods. Fremont evaluates the
performance of its reportable segments based on income before taxes using
accounting policies which are the same as those described in the summary of
significant accounting policies. (See Note A of Notes to Consolidated Financial
Statements.) Additionally, there are certain corporate revenues and expenses,
comprised primarily of investment income, interest expense and certain general
and administrative expenses, that Fremont does not allocate to its segments.
Substantially all of Fremont's property and casualty insurance operations
are represented by the underwriting of workers' compensation insurance policies.
The Company began its workers' compensation insurance operation in 1959 and
continues to derive the majority of its revenues from this business. Fremont's
workers' compensation insurance business has grown through internal expansion,
as well as through the acquisition of other workers' compensation insurance
companies and currently has major market positions in California, Illinois,
Arizona, Idaho, Alaska, Indiana, Montana, Utah and Wisconsin. At December 31,
1998 the Company had premiums inforce in thirty-nine states and the District of
Columbia.
Consistent with its business strategy, the Company's workers' compensation
insurance business has grown dramatically since 1994 through acquisitions. On
September 1, 1998, Fremont acquired Unicare from Wellpoint Health Networks, Inc.
Unicare underwrites workers' compensation insurance primarily in California,
with a smaller presence in Georgia, Texas, and Indiana. On August 1, 1997, the
Company acquired Industrial from Talegen Holdings, Inc. ("Talegen"), a
subsidiary of Xerox Corporation. Industrial, which specializes in underwriting
workers' compensation insurance, has a strong presence in the western United
States dating back over seventy years. (See Note B of Notes to Consolidated
Financial Statements.) On February 22, 1995, the Company acquired Casualty, the
largest underwriter of workers' compensation insurance in Illinois, with
additional operations in several other mid-western states. Over the last four
years, the Company has focused on creating a broad national platform upon which
to build its business, while providing geographic diversity to mitigate
potential fluctuations in earnings from cyclical downturns in various regional
economies. (See "Results of Operations -- Property and Casualty Insurance
Operation.")
The operations of Fremont's financial services segment are consolidated
within Fremont General Credit Corporation ("FGCC"), which is engaged in
collateralized lending to businesses and individuals. Lending activities
include: commercial and residential real estate lending, commercial finance,
syndicated loans and insurance premium financing. Fremont's financial services
business is developed through the Company's own marketing representatives and
referrals from various financial intermediaries and financial institutions. The
Company's financial services loan portfolio has grown significantly from $1.5
billion at December 31, 1994 to $3.0 billion at December 31, 1998. (See
"Financial Services Operation.")
27
30
The real estate lending operations of Fremont currently consists of more
than 4,000 residential real estate accounts and 500 commercial real estate
accounts. The real estate lending activities are primarily conducted through a
California thrift and loan ("the thrift") and are financed mainly through
deposit accounts (53,000 accounts at December 31, 1998), which are insured by
the Federal Deposit Insurance Corporation ("FDIC"). (See "Item 1.
Business -- Regulation -- Thrift and Loan Regulation.") The thrift's deposits
are serviced through 14 branch offices in California. (Fremont's insurance
premium finance loans and certain of its syndicated loans are also financed by
the thrift.) Fremont originates real estate loans nationwide through independent
loan brokers and through its own marketing representatives. For commercial real
estate loans, principal amounts primarily range between $1 million to $15
million and for residential real estate loans, principal amounts are generally
below $350,000. The residential real estate loans are originated using
underwriting standards that are less stringent than the Federal National
Mortgage Association's guidelines and are commonly known as "sub-prime" loans.
To mitigate the higher potential for credit losses that accompanies these types
of borrowers, Fremont focuses on its loan origination on the higher grades of
loans in this category and attempts to maintain underwriting standards that
require conservative loan to collateral valuations. The Company's operating
strategy is to grow its loan portfolio through origination of new loans and
acquisition of loan portfolios that meet its underwriting guidelines applied to
origination of new loans. The loan portfolio of the real estate lending
operation grew from $807.5 million at the end of 1994 to $2.1 billion at the end
of 1998, due primarily to increased loan originations and, to a lesser extent,
the purchase of loan portfolios from other financial institutions. (See "Item 1.
Business -- Financial Services Operation -- Commercial and Residential Real
Estate Lending.")
Fremont provides commercial finance loans, primarily secured by accounts
receivable, inventory, and machinery and equipment, to small and middle market
companies on a nationwide basis. The total commercial finance loan portfolio was
$485.5 million at December 31, 1998. Loan originations are developed primarily
by referrals from various financial intermediaries and financial institutions.
(See "Item 1. Business -- Financial Services Operation -- Commercial Finance.")
The lending market continues to be competitive for small to middle market
commercial borrowers. As a result, Fremont's commercial finance loans have
experienced decreasing yields.
Fremont has interests in large syndicated loans which are originated and
serviced by other financial institutions. Syndicated loans generally carry lower
yields than the Company's commercial finance loans since the borrowers under
syndicated loans tend to be larger companies whose credit quality is generally
higher than borrowers under the Company's commercial finance loans. These loans
are secured by various assets of the borrower and, if applicable, of its
subsidiaries. The syndicated loans are variable rate loans and are originated on
both a revolving and fixed-term basis. The term loans are generally issued with
terms not in excess of ten years. The Company finances these loans using thrift
deposits, as well as financing through an unsecured revolving line of credit
with a syndicated bank group, which is also used to finance Fremont's commercial
finance loans that are not financed under the Company's asset securitization
program. (See "Liquidity and Capital Resources.") The syndicated loan portfolio
has grown to $360.2 million at December 31, 1998 from $146.8 million at December
31, 1997. This growth has been achieved primarily from development of the
customer base through referrals from various financial institutions. (See "Item
1. Business -- Financial Services Operation -- Syndicated Loans.")
Fremont provides insurance premium finance loans, primarily to small
businesses, which finances property and casualty insurance premiums. These loans
are collateralized by the unearned premiums of the underlying insurance
policies. At December 31, 1998, the insurance premium finance loan portfolio
totaled $58.3 million.
The ability of the Company to continue to originate loans, and of borrowers
to repay outstanding loans, may be impaired by adverse changes in local,
regional, or national economic conditions. Such events could also significantly
reduce the demand for loans and impair the value of the underlying collateral.
If the collateral were to prove inadequate, Fremont's results of operations
could be adversely affected.
By engaging in several selected businesses nationwide which are
geographically diverse, Fremont believes it has achieved stability and provided
opportunities for growth in its operating results. Since the year ended
28
31
December 31, 1994 to the year ended December 31, 1998, the Company's income
before taxes grew at a compound annual rate of approximately 25% to $196.7
million for 1998. Fremont's book value increased from $351.0 million at December
31, 1994 to $950.9 million at December 31, 1998.
Prior to January 1, 1996, the Company offered life insurance products,
including annuities, credit life and disability insurance and term life
insurance for consumers, through a subsidiary. On December 31, 1995 and on
January 1, 1996, the Company entered into reinsurance and assumption agreements
with a reinsurer whereby assets and liabilities related to certain life
insurance and annuity policies were ceded to the reinsurer. These reinsurance
agreements are part of several other agreements which have collectively resulted
in the substantial reduction of the Company's life insurance operations. The
Company continues to remain primarily obligated for approximately $128 million
of account value of annuities which, at December 31, 1998, have been fully
co-insured with Great Southern Insurance Company. The effect on operations from
these agreements was not material, and revenue and operating income from this
subsidiary were not significant in 1998, 1997 or 1996.
Between 1986 and 1991, Fremont discontinued its domestic treaty reinsurance
business, its other primary and excess property and casualty insurance
operations and the underwriting of all remaining assumed reinsurance. In 1990, a
single management group was put in charge of all discontinued operations, and it
is the intention of the Company to complete the liquidation of these operations
by the commutation of liabilities and as claims are paid. (See "Item 1.
Business -- Discontinued Operations" and Note N of Notes to Consolidated
Financial Statements.)
RESULTS OF OPERATIONS
Fremont has achieved growth in net income during the three years ended
December 31, 1998 by providing diverse insurance and financial services to
primarily small and medium-sized businesses nationwide. Higher revenues and net
income were also achieved through the acquisitions of Unicare, Industrial and
Casualty. The following table presents information for each of the three years
in the period ended December 31, 1998 with respect to the Company's core
business segments.
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- -------- --------
(THOUSANDS OF DOLLARS)
Revenues:
Property and casualty........................... $ 729,728 $738,072 $596,841
Financial services.............................. 305,886 235,474 197,601
Unallocated corporate revenue................... 1,983 749 1,362
---------- -------- --------
Total................................... $1,037,597 $974,295 $795,804
========== ======== ========
Income (Loss) Before Taxes:
Property and casualty........................... $ 169,235 $144,667 $117,593
Financial services.............................. 55,506 42,286 36,589
Unallocated corporate loss...................... (28,029) (28,060) (25,873)
---------- -------- --------
Total................................... $ 196,712 $158,893 $128,309
========== ======== ========
The Company generated revenues of $1.04 billion for 1998, as compared to
revenues of $974 million and $796 million for 1997 and 1996, respectively.
Higher revenues in 1998 as compared to 1997 resulted from higher financial
services revenues, offset partially by lower revenues in the property and
casualty segment. The lower property and casualty revenues were due primarily to
the net effects of higher workers' compensation insurance premiums and
investment income resulting from the acquisitions of Unicare on September 1,
1998 and Industrial on August 1, 1997, more than offset by additional ceded
reinsurance premiums which have the result of lowering premium revenues. These
additional ceded reinsurance premiums were due mainly to additional excess of
loss reinsurance purchased for Fremont's workers' compensation insurance
business which became effective January 1, 1998. The acquisition of Industrial
resulted in higher revenues in the property and casualty insurance segment in
1997 as compared to 1996. (See "Property and Casualty Insurance Opera-
29
32
tion.") Higher revenues in the financial services segment in 1998 and 1997 as
compared to the respective prior year were achieved primarily from increased
loan interest revenues which resulted from significant growth in the average
financial services loan portfolio. Additionally, higher financial services
revenues in 1998 resulted from gains on sales of residential real estate loans.
(See "Financial Services Operation.") Realized investment losses were $0.6
million, $2.0 million, and $1.7 million for 1998, 1997 and 1996, respectively.
Fremont posted net income of $133.0 million or $1.90 diluted earnings per
share for 1998, as compared to $108.3 million or $1.62 diluted earnings per
share and $87.3 million or $1.37 diluted earnings per share for 1997 and 1996,
respectively. Income before taxes for 1998 was $196.7 million as compared to
$158.9 million and $128.3 million for 1997 and 1996, respectively, representing
an increase of 24% in 1998 and 1997.
The property and casualty insurance operation posted income before taxes of
$169.2 million for 1998, as compared to $144.7 million and $117.6 million for
1997 and 1996, respectively. The increase of 17% in income before taxes in 1998
as compared to 1997 is due primarily to the inclusion of a full year of
Industrial's operating results and lower losses incurred resulting from the
additional reinsurance purchased by the Company which became effective January
1, 1998. The increase in income before taxes of 23% in 1997 as compared to 1996
was due primarily to the recognition of continued lower claim frequency, mainly
in the mid-west region and the acquisition of Industrial. The combined ratio for
1998 was 96.2% as compared to 93.0% and 94.8% for 1997 and 1996, respectively.
Up until January 1, 1998 the Company maintained a small medical malpractice
insurance operation within the property and casualty insurance segment. On
January 1, 1998, the Company entered into reinsurance and assumption agreements
with a reinsurer whereby substantially all of the assets and liabilities related
to the medical malpractice policies were ceded to the reinsurer. These
reinsurance agreements are part of several other agreements which collectively
result in the sale of the Company's medical malpractice operations effective
January 1, 1998. The effect on the Company's results of operations from these
agreements was not material. Revenues from medical malpractice operations were
$32.6 million and $31.6 million for 1997 and 1996, respectively.
The financial services segment posted income before taxes of $55.5 million
for 1998, as compared to $42.3 million and $36.6 million for 1997 and 1996,
respectively. The 31% increase in 1998 is due mainly to the general growth in
the average financial services loan portfolio to $2.4 billion in 1998 from $1.9
billion in 1997, as well as gains on residential real estate loan sales. The 16%
increase in income before taxes in 1997 as compared to 1996 was due mainly to
the growth in the average financial services loan portfolio, as well as to
continued improvements in Fremont's loan charge-off experience. (See "Financial
Services Operation.")
Unallocated corporate revenues consisted primarily of investment income,
while unallocated corporate expenses consisted primarily of interest expense and
general and administrative expense. The unallocated corporate loss before income
taxes was $28.0 million, $28.1 million and $25.9 million for 1998, 1997 and
1996, respectively. The unallocated corporate loss before tax was flat in 1998
as compared to 1997 due primarily to the net effects of lower interest expense,
offset by higher general and administrative expenses. The increase in
unallocated corporate loss in 1997 as compared to 1996 was due primarily to
lower investment income and higher general and administrative expense.
Income tax expense of $63.7 million, $50.6 million and $41.0 million for
1998, 1997 and 1996, respectively, represents an effective tax rate of 32% each
year on pretax income of $196.7 million, $158.9 million and $128.3 million for
the corresponding periods. The Company's effective tax rates for all years
presented are lower than the enacted federal income tax rate of 35%, due
primarily to tax exempt investment income which reduces the Company's taxable
income.
30
33
Property and Casualty Insurance Operation
The following table represents information with respect to Fremont's
property and casualty insurance operation:
YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
-------- -------- --------
(THOUSANDS OF DOLLARS)
Revenues................................... $729,728 $738,072 $596,841
Expenses................................... 560,493 593,405 479,248
-------- -------- --------
Income Before Taxes........................ $169,235 $144,667 $117,593
======== ======== ========
Revenues from the property and casualty insurance operation consists
primarily of workers' compensation insurance premiums earned and net investment
income. Expenses consist primarily of loss and loss adjustment expenses, policy
acquisition costs and other operating costs and expenses.
Premiums. Premiums earned from the Company's property and casualty
insurance operation were $552.1 million for 1998, as compared to $601.2 million
and $486.9 million for 1997 and 1996, respectively. The lower insurance premiums
in 1998 were due mainly to the offsetting effects of higher workers'
compensation insurance premiums resulting from the acquisitions of Unicare and
Industrial, more than offset by additional ceded reinsurance premiums. These
additional ceded reinsurance premiums were due primarily to additional excess of
loss reinsurance purchased for the Company's workers' compensation insurance
business, which became effective January 1, 1998. Fremont purchased the
additional reinsurance in an effort to further reduce the volatility of
operating results which occurs through fluctuations in loss costs. This
additional reinsurance reduced the point at which reinsurers assume liability
("attachment point") from $1 million per loss occurrence to $50,000 per loss
occurrence. The higher premiums in 1997 were due primarily to the acquisition of
Industrial. With this acquisition, Fremont further broadened the geographic
diversity of its premium writings to include a significant presence in certain
western states that the Company previously had little or no premium writings in
prior to the Industrial acquisition. (See "Item 1. Business -- Property and
Casualty Insurance Operation" and "Variability of Operating Results" and
"Workers' Compensation Regulation.")
Net Investment Income. Net investment income within the property and
casualty insurance operation was $178.3 million, $138.9 million and $111.6
million in 1998, 1997 and 1996, respectively. Significantly higher invested
assets, due primarily to the acquisitions of Unicare and Industrial, resulted in
increased investment income in 1998 as compared to 1997. The acquisition of
Industrial also was the main contributor to higher net investment income in 1997
as compared to 1996. (See "Item 1. Business -- Investment Portfolio.")
Loss and Loss Adjustment Expense. The property and casualty loss and loss
adjustment expenses ("LAE") were $335.5 million, $389.2 million and $335.4
million in 1998, 1997 and 1996, respectively. In addition, the ratio of these
losses and LAE to property and casualty insurance premiums earned ("loss ratio")
was 60.8%, 64.7% and 68.9% in 1998, 1997 and 1996, respectively. The decrease in
the loss ratio in 1998 as compared to 1997 is due predominately to the
additional reinsurance purchased by Fremont and which became effective January
1, 1998, offset partially by higher loss ratios in 1998 associated with
Industrial. (See "Item 1. Business -- Property and Casualty Insurance
Operation -- Reinsurance Ceded" and "Premiums.") The decrease in the loss ratio
in 1997 is due mainly to the recognition of a decrease in the frequency of
reported claims on the 1996 and 1995 accident years in the Company's mid-west
region, offset partially by higher loss ratios associated with Industrial on the
1997 accident year. Additionally, the Company's management believes that its
implementation of more effective claims handling procedures in the mid-west
region has contributed to the reduction in loss and loss adjustment expenses
during calendar year 1997 and relating to the 1996 and prior accident years. The
Company is not able to determine with certainty the specific cause or causes of
increases and decreases in reported claims experience, but has reached its own
conclusions based on a review of its internal data and a subjective evaluation
of external factors. (See "Item 1. Business -- Property and Casualty Insurance
Operation -- Loss and Loss Adjustment Expense Reserves.")
31
34
The Company regularly reviews its reserving techniques, overall reserve
position and reinsurance. In light of present facts and current legal
interpretations, management believes that adequate provisions have been made for
loss reserves. In making this determination, management has considered its
claims experience to date, loss development history for prior accident years and
estimates of future trends of claims frequency and severity. However,
establishment of appropriate reserves is an inherently uncertain process, and
there can be no certainty that currently established reserves will prove
adequate in light of subsequent actual experience. Subsequent actual experience
has resulted, and could result, in loss reserves being too high or too low.
Future loss development could require reserves for prior periods to be
increased, which would adversely impact earnings in future periods.
Policy Acquisition Costs and Other Operating Costs and Expenses. The ratio
of policy acquisition costs and other operating costs and expenses to premiums
earned is referred to as the expense ratio, which was 34.5%, 27.5% and 25.9% in
1998, 1997 and 1996, respectively. The increase in this ratio in 1998 as
compared to 1997 is due mainly to a lower premium base in 1998 resulting from
the additional reinsurance purchased by Fremont that became effective January 1,
1998. (See "Premiums.") The increase in this ratio in 1997 is due primarily to
higher agents' commission costs and higher operating costs and expenses.
Dividends to Policyholders. The policyholder dividends ratio for the
Company's property and casualty insurance operation was 0.9% and 0.8% in 1998,
and 1997, respectively. There were no dividends accrued in 1996. The Company
believes that these ratios are low by industry standards. The low ratios are due
primarily to the type of workers' compensation insurance policies written by the
Company. Fremont's workers' compensation insurance policies are predominately
written as non-participating, which means that they do not include provisions
for dividend consideration. The dividends accrued in 1998 and 1997 were due
mainly to the acquisition of Industrial. (See "Item 1. Business -- Property and
Casualty Insurance Operation -- Policyholders' Dividends.")
Variability of Operating Results. The Company's profitability can be
affected significantly by many factors including competition, the severity and
frequency of claims, interest rates, legislation and regulations, court
decisions, the judicial climate, and general economic conditions and trends, all
of which are outside of Fremont's control. In addition, Fremont's results of
operations may be affected by the Company's ability to assess and integrate
successfully the operations of acquired companies. These factors have
contributed, and in the future could contribute, to significant variation of
results of operations in different aspects of the Company's business from
quarter to quarter and year to year. With respect to the workers' compensation
insurance business, changes in economic conditions can lead to reduced premium
levels due to lower payrolls as well as increased claims due to the tendency of
workers who are laid off to submit workers' compensation claims. Legislative and
regulatory changes can also contribute to variable operating results for
workers' compensation insurance businesses. For example, in 1995, the Company
experienced the negative impact of lower premiums and lower profitability on
Fremont's California workers' compensation business due to increased price
competition resulting from legislation enacted in California in July 1993 which,
among other things, repealed the minimum rate law effective January 1, 1995.
Additionally, price competition in Illinois, where the Company has a significant
presence, continues to adversely impact the Company's profitability, where
overall average decreases of 0.2%, 7.9%, and 10.0% in advisory premium rates,
which workers' compensation insurance companies in Illinois tend to follow,
became effective January 1, 1999, 1998 and 1997, respectively. (See "Workers'
Compensation Regulation.") The acquisition of Industrial has mitigated the
adverse effects of this price competition in Illinois by providing Fremont with
a broader geographic diversity of its premium writings. Industrial has a
significant presence in the western United States, in addition to California.
The Company anticipates that its results of operations and financial condition
will continue to be adversely affected by the continued price competition in
Illinois and California. Also, the establishment of appropriate reserves
necessarily involves estimates, and reserve adjustments have caused significant
fluctuations in operating results from year to year.
Fremont's workers' compensation insurance business competes in a market
characterized by competition on the basis of price and service. In addition,
state regulatory changes could affect competition in the states where the
Company transacts business. Although the Company is one of the largest writers
of workers'
32
35
compensation insurance in the nation, certain of its competitors are larger and
have greater resources than Fremont. The Company cannot be certain that it will
continue to maintain its market share in the future.
Workers' Compensation Regulation. The Company's workers' compensation
insurance operations are concentrated in California and Illinois, with
additional writings in 37 other states and the District of Columbia. Insurance
companies are subject to supervision and regulation by the state insurance
authority in each state in which they transact business. Such supervision and
regulation relate to the numerous aspects of an insurance company's business and
financial condition. The primary purpose of such supervision and regulation is
the protection of policyholders rather than the investors or stockholders of an
issuer. Fremont's multistate insurance operations require, and will continue to
require, the Company to devote significant resources to comply with the
regulations of each state in which the Company transacts business.
At December 31, 1998, approximately 65% of the Company's workers'
compensation insurance policies inforce were in California and Illinois.
Illinois began operating under an open rating system in 1982 and California
began operating under such a system effective January 1, 1995. In an open rating
system, workers' compensation companies are provided with advisory premium rates
(expected losses and expenses) or loss costs (expected losses only) which vary
by job classification. Each insurance company determines its own rates based in
part upon its particular loss experience and operating costs. Insurance
companies generally set their premium rates below such advisory rates. This
characteristic has resulted in continued price competition in Illinois, where
overall average decreases in advisory premium rates of 0.2%, 7.9%, and 10.0%
became effective January 1, 1999, 1998 and 1997, respectively. Before January 1,
1995, California operated under a minimum rate law, whereby premium rates
established by the California Department of Insurance were the minimum rates
which could be charged by an insurance carrier. The repeal of the minimum rate
law has resulted in lower premiums and lower profitability on the Company's
California workers' compensation insurance policies due to increased price
competition. Most of the states in which Fremont writes premiums operate under
some form of open rating system. (See "Item 1.
Business -- Regulation -- Insurance Regulation.")
Financial Services Operation
The financial services operation of FGCC is principally engaged in
commercial and residential real estate lending, commercial finance, syndicated
loans and insurance premium financing. Revenues consist principally of interest
income and, to a lesser extent, fees and other income.
The following table presents information with respect to Fremont's
financial services operation:
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
(THOUSANDS OF DOLLARS)
Revenues........................................... $305,886 $235,474 $197,601
Expenses........................................... 250,380 193,188 161,012
-------- -------- --------
Income Before Taxes................................ $ 55,506 $ 42,286 $ 36,589
======== ======== ========
Revenues increased 30% and 19% in 1998 and 1997, respectively, due
primarily to greater loan interest revenue attributable to growth in the average
financial services loan portfolio. The average financial services loan portfolio
grew in 1998 to $2.4 billion from $1.9 billion and $1.6 billion in 1997 and
1996, respectively. Additionally, higher revenues resulted in 1998 from
increased gains on residential real estate loan sales. These loan sales are
pursuant to a program, initiated by the Company in 1995 and expanded in 1997, of
selling certain residential real estate loans to other financial institutions.
This has allowed Fremont an opportunity to become more selective in its
residential real estate loan portfolio, as well as to offer a broader range of
residential real estate loans to its customers, primarily through independent
brokers. These loan sales are made without recourse to the Company or its
subsidiaries. Due to market disruption and oversupply, Fremont observed that
prices for these loans began to decrease in late 1998. The Company, rather than
sell the loans at prices lower than what it believed was the economic benefit to
be derived, began a program to retain these benefits by either retaining the
loans in its portfolio or by securitizing them. On March 23, 1999, the
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Company's thrift issued, through the Fremont Home Loan Owner Trust 1999-1, its
first securitization of these loans in the amount of approximately $415 million.
This trust issued notes collateralized by a pool of these first lien residential
mortgage loans. The notes are subject to an unconditional and irrevocable
guarantee of timely payment of interest and ultimate payment of loan principal
provided by a financial guarantee insurance policy (issued by Financial Security
Assurance Inc.) Servicing of the loans will be provided by Fairbanks Capital
Corporation. These notes have been rated AAA by Standard and Poor's and Aaa by
Moody's.
Income before taxes in the financial services operation was $55.5 million,
$42.3 million and $36.6 million for 1998, 1997 and 1996, respectively. The 31%
and 16% increases in income before taxes in 1998 and 1997 respectively, are
mainly due to the previously described growth in the average financial services
loan portfolio, as well as lower loan loss provisions relative to loans
receivable, which resulted from improved loan loss experience, partially offset
by increases in operating expenses. Additionally, in 1998 higher income before
taxes resulted from the increased gains on residential real estate loan sales.
The following table identifies the interest income, interest expense,
average interest-bearing assets and liabilities, and interest margins for
Fremont's financial services operation:
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------ ------------------------------ ------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
---------- -------- ------ ---------- -------- ------ ---------- -------- ------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Interest bearing assets(1):
Commercial real estate
loans...................... $1,220,115 $120,718 9.89% $ 954,181 $ 93,973 9.85% $ 749,912 $ 72,732 9.70%
Residential real estate
loans...................... 417,872 39,182 9.38 322,597 30,896 9.58 210,330 20,214 9.61
Commercial finance loans..... 416,264 45,700 10.98 436,528 49,255 11.28 446,124 51,368 11.51
Syndicated loans............. 249,440 22,170 8.89 144,981 14,155 9.76 138,385 13,534 9.78
Insurance premium finance
loans...................... 62,050 7,058 11.37 53,640 6,133 11.43 52,681 5,917 11.23
Investments.................. 235,397 12,716 5.40 183,842 10,186 5.54 198,419 10,538 5.31
---------- -------- ---------- -------- ---------- --------
Total interest bearing
assets..................... $2,601,138 $247,544 9.52% $2,095,769 $204,598 9.76% $1,795,851 $174,303 9.71%
========== ======== ========== ======== ========== ========
Interest bearing liabilities:
Time deposits................ $1,339,116 $ 76,215 5.69% $1,030,787 $ 60,055 5.83% $ 755,160 $ 43,351 5.74%
Savings deposits............. 388,355 20,245 5.21 268,344 13,610 5.07 247,648 12,268 4.95
Securitization obligation.... 287,386 17,588 6.12 301,545 18,551 6.15 295,827 18,035 6.10
Debt with banks.............. 268,834 17,170 6.39 216,869 14,406 6.64 243,292 15,703 6.45
Debt from affiliates......... 53,813 3,279 6.09 49,735 2,810 5.65 57,174 2,796 4.89
Other........................ 2,245 90 4.01 5,325 312 5.86 3,353 191 5.70
---------- -------- ---------- -------- ---------- --------
Total interest bearing
liabilities................ $2,339,749 $134,587 5.75% $1,872,605 $109,744 5.86% $1,602,454 $ 92,344 5.76%
========== ======== ========== ======== ========== ========
Net interest income............ $112,957 $ 94,854 $ 81,959
======== ======== ========
Net yield...................... 4.34% 4.53% 4.56%
- ---------------
(1) Average loan balances include non-accrual loan balances.
The margin between the Company's interest income and expense ("net yield")
decreased in 1998 and 1997 as compared to the respective prior year, due mainly
to the offsetting effects of a decrease in the net yields on commercial finance
loans and increases in syndicated loans which generally carry lower net yields,
offset partially by an increase in the net yields on real estate loans. Net
yields decreased on commercial finance loans due primarily to a continuation of
the competitive environment. While the overall net yield on real estate loans
increased, this was the combined result of increases in the net yields on
commercial real estate loans, partially offset by decreases in the net yields on
residential real estate loans.
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Loans Receivable and Reserve Activity. The following table shows loans
receivable in the various financing categories and the percentages of the total
represented by each category:
DECEMBER 31,
------------------------------------------------------------
1998 1997 1996
------------------ ------------------ ------------------
% OF % OF % OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
---------- ----- ---------- ----- ---------- -----
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Term loans:
Commercial and residential real
estate loans................... $2,110,301 70% $1,426,482 70% $1,113,950 65%
Commercial finance loans.......... 168,040 5 115,912 6 156,658 9
Syndicated loans.................. 168,170 6 42,101 2 13,438 1
Insurance premium finance loans... 58,563 2 54,342 3 53,661 3
---------- --- ---------- --- ---------- ---
Total term loans.......... 2,505,074 83 1,638,837 81 1,337,707 78
Revolving loans:
Commercial finance loans.......... 317,468 11 284,563 14 272,559 16
Syndicated loans.................. 191,980 6 104,689 5 115,521 6
---------- --- ---------- --- ---------- ---
Total revolving loans..... 509,448 17 389,252 19 388,080 22
---------- --- ---------- --- ---------- ---
Total loans............. 3,014,522 100 2,028,089 100 1,725,787 100
Less allowance for possible loan
losses............................ 56,346 2 44,402 2 37,747 2
---------- --- ---------- --- ---------- ---
Loans receivable.................. $2,958,176 98% $1,983,687 98% $1,688,040 98%
========== === ========== === ========== ===
The following table illustrates the maturities of Fremont's loans
receivable:
MATURITIES AT DECEMBER 31, 1998
---------------------------------------------
1 TO 24 25 TO 60 OVER 60
MONTHS MONTHS MONTHS TOTAL
---------- -------- -------- ----------
(THOUSANDS OF DOLLARS)
Term loans -- variable rate............ $ 624,190 $806,181 $639,391 $2,069,762
Term loans -- fixed rate............... 134,201 85,062 216,049 435,312
Revolving loans -- variable rate....... 509,448 -- -- 509,448
---------- -------- -------- ----------
Total................................ $1,267,839 $891,243 $855,440 $3,014,522
========== ======== ======== ==========
The Company monitors the relationship of fixed and variable rate loans and
interest bearing liabilities in order to minimize interest rate risk.
During 1997, the Company began originating both commercial and residential
real estate loans outside of California. The Company intends to seek portfolio
growth outside of California in order to achieve greater geographic diversity in
its loan portfolio and thereby lessen Fremont's exposure to regional economic
conditions. The total amount of commercial and residential real estate loans
outstanding on properties located outside of California at December 31, 1998 was
$328 million and $179 million, respectively.
During periods when economic conditions are unfavorable, Fremont's
financial services businesses may not be able to originate new loan products or
maintain credit quality at previously attained levels. This may negatively
affect the Company's net finance income and levels of non-performing assets and
net charge-offs. Changes in market interest rates, or in the relationships
between various interest rates, could cause the Company's interest margins to
vary and may result in significant changes in the prepayment patterns of
Fremont's finance receivables, which could adversely affect the Company's
results of operations and financial condition.
Fremont's financial services businesses maintain reserves for credit losses
on its portfolio of finance receivables in amounts that Fremont believes is
sufficient to provide adequate protection against potential losses. The Company
attempts to minimize the impact that adverse economic developments could have on
Fremont's finance services loan portfolio by concentrating primarily on lending
on a senior and secured basis and by carefully monitoring the underlying
collateral that secures these loans. Although the Company believes
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that its level of reserves is sufficient to cover potential credit losses,
Fremont's reserves could prove to be inadequate due to unanticipated adverse
changes in economic conditions or discrete events that adversely affect specific
borrowers, industries or markets. Any of these changes could impair Fremont's
ability to realize the expected value of the collateral securing certain of its
finance receivables.
Fremont's financial services businesses compete in markets that are highly
competitive and are characterized by factors that vary based upon product and
geographic region. The markets in which the Company competes are typically
characterized by a large number of competitors who compete based primarily upon
price, terms and loan structure. Fremont primarily competes with banks,
mortgage, insurance, and finance companies, many of which are larger and have
greater financial resources than Fremont. The competitive forces of these
markets could adversely affect the Company's net finance income, loan
origination volume or net credit losses.
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The following table describes the asset classifications, loss experience
and reserve reconciliation of the financial services operation as of or for the
periods ended as shown below:
DECEMBER 31,
---------------------------------------
1998 1997 1996
----------- ----------- -----------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Non-accrual loans.......................................... $ 22,520 $ 31,525 $ 19,785
Accrual loans 90 days past due............................. 1,264 927 1,355
Real estate owned ("REO").................................. 4,918 9,571 10,016
---------- ---------- ----------
Total non-performing assets................................ $ 28,702 $ 42,023 $ 31,156
========== ========== ==========
Beginning allowance for possible loan losses............... $ 44,402 $ 37,747 $ 31,781
Provision for loan losses.................................. 11,059 12,319 13,885
Reserves established with portfolio acquisitions........... 3,465 -- 1,830
Charge-offs:
Commercial and residential real estate loans............. 1,238 2,752 5,667
Commercial finance loans................................. 2,049 3,384 5,401
Syndicated loans......................................... -- -- --
Insurance premium finance loans.......................... 132 822 74
---------- ---------- ----------
Total charge-offs........................................ 3,419 6,958 11,142
---------- ---------- ----------
Recoveries:
Commercial and residential real estate loans............. 695 1,246 1,352
Commercial finance loans................................. 116 12 20
Syndicated loans......................................... -- -- --
Insurance premium finance loans.......................... 28 36 21
---------- ---------- ----------
Total recoveries......................................... 839 1,294 1,393
---------- ---------- ----------
Net charge-offs............................................ 2,580 5,664 9,749
---------- ---------- ----------
Ending allowance for possible loan losses.................. $ 56,346 $ 44,402 $ 37,747
========== ========== ==========
Allocation of allowance for possible loan losses:
Commercial and residential real estate loans............. $ 40,097 $ 32,966 $ 24,759
Commercial finance loans................................. 8,983 7,723 8,595
Syndicated loans......................................... 6,798 3,338 3,338
Insurance premium finance loans.......................... 468 375 1,055
---------- ---------- ----------
Total allowance for possible loan losses................. $ 56,346 $ 44,402 $ 37,747
========== ========== ==========
Total loans receivable..................................... $3,014,522 $2,028,089 $1,725,787
Average total loans receivable............................. 2,365,741 1,906,448 1,594,918
Net charge-offs to average total loans receivable.......... 0.11% 0.30% 0.61%
Non-performing assets to total loans receivable............ 0.95% 2.07% 1.81%
Allowance for possible loan losses to total loans
receivable............................................... 1.87% 2.19% 2.19%
Allowance for possible loan losses to non-performing
assets................................................... 196.31% 105.66% 121.15%
Allowance for possible loan losses to non-accrual loans and
accrual loans 90 days past due........................... 236.91% 136.82% 178.56%
Non-performing assets decreased to $28.7 million at December 31, 1998 from
$42.0 million at December 31, 1997, despite total loans receivable increasing to
$3.0 billion at December 31, 1998 from $2.0 billion at December 31, 1997. The
increase in non-performing assets in 1997 as compared to 1996 is generally
consistent with the increase in total loans receivable to $2.0 billion at
December 31, 1997 from $1.7 billion at December 31, 1996.
The lower provision for loan losses over the three years ended December 31,
1998 is due primarily to improved loan loss experience. Additionally, a lower
loan loss provision occurred in 1997 as the Company was adversely impacted in
1996 by a specific loan loss provision associated with one commercial finance
loan.
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Substantially all of the charge-offs on commercial finance loans in 1996 were
related to this loan. The Company's overall improved loan loss experience is
evidenced by the decreases in the ratio of net charge-offs to average total
loans receivable over the three years ended December 31, 1998, as well as the
decrease of the ratio of non-performing assets to total loans receivable from
1997 to 1998 in the preceding table. Additionally, the reductions in the
charge-off ratio occurred during a period in which loans receivable increased.
MARKET RISK
Fremont is subject to market risk resulting primarily from fluctuations in
interest rates arising from balance sheet financial instruments such as
investments, loans and debt. In the property and casualty insurance operation,
the greatest interest rate risk exposure occurs where the interest rate of the
financial instrument is fixed in nature and there is a difference between the
fixed rate of the financial instrument and the market rate. The greatest
interest rate risk exposure in the financial services operation occurs when
interest rate gaps arise wherein assets are funded with liabilities having
different repricing intervals or different market indices to which the
instruments' interest rates are tied. Changes in interest rates will affect the
Company's net investment income, loan interest, interest expense and total
stockholders' equity. The objective of Fremont's asset and liability management
activities is to provide the highest level of net interest income and to seek
cost effective sources of capital, while maintaining acceptable levels of
interest rate and liquidity risk. The Company has designated its entire
investment portfolio as investments that would be available for sale in response
to changing market conditions, liquidity requirements, interest rate movements
and other investment factors. (See "Item 1. Business -- Investment Portfolio.")
Fremont 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.
PROPERTY AND CASUALTY INSURANCE OPERATION -- INTEREST RATE RISK
The property and casualty insurance operation has exposure to changes in
long-term interest rates due mainly to the significant investment in the
available-for-sale investment portfolio. Fluctuations in these interest rates
affect the carrying value of the fixed rate investments resulting in
fluctuations in unrealized gains and losses on investments, which also affects
the Company's stockholders' equity. For an investment in a fixed rate bond, a
rise in market interest rates for bonds with a similar remaining term and face
amount will result in a decline in the fair value of the fixed rate bond. The
converse situation applies as well.
The following table presents principal cash flows of the investment
portfolio by expected maturity dates. The weighted-average interest rate is
based on expected maturities for fixed interest rate investments. For variable
interest rate investments, the weighted-average interest rate is based on
implied forward rates from appropriate annual spot rate observations as of the
reporting date.
PROPERTY AND CASUALTY INSURANCE OPERATION
INTEREST RATE SENSITIVITY
PRINCIPAL AMOUNT MATURING IN:
------------------------------------------------------------------------- FAIR VALUE AT
1999 2000 2001 2002 2003 THEREAFTER TOTAL 12/31/98
-------- ------- ------- ------ ------- ---------- ---------- -------------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Interest rate sensitive assets:
Securities available for sale:
Fixed interest rate
investments................... $232,072 $75,226 $27,393 $7,322 $28,954 $1,541,880 $1,912,847 $1,969,110
Weighted-average interest
rate........................ 7.80% 6.18% 5.58% 4.02% 7.81% 7.28% 7.27%
Variable interest rate
investments................... $ 1,211 $ 1,339 $ 1,477 $1,582 $52,101 $ 87,075 $ 144,785 $ 140,817
Weighted-average interest
rate........................ 7.23% 7.23% 7.23% 7.23% 6.55% 5.02% 5.66%
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FINANCIAL SERVICES OPERATION -- INTEREST RATE RISK
Fremont's financial services operation is subject to interest rate risk
resulting from differences between the rates on, and repricing characteristics
of, interest-earning loans receivable and the rates on, and repricing
characteristics of, interest-bearing liabilities used to finance its loans such
as thrift 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
Company's financial services loan portfolio, which could result in borrowers'
prepaying their loan obligations to Fremont. While the Company attempts to match
the characteristics of interest rate sensitive assets and liabilities to
minimize the effect of fluctuations in interest rates, Fremont does not
currently utilize derivative financial instruments to meet these objectives. For
the financial services operation, 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.
The following table provides information about the assets and liabilities
of the Company's financial services operation that are sensitive to changes in
interest rates. For loans, investments, thrift deposits and other liabilities
with contractual maturities, the table presents principal cash flows and related
weighted-average interest rates by contractual maturity, adjusted for estimated
loan prepayments based upon historical behaviors of its financial services loan
portfolio. Thrift deposits that have no contractual maturity are presented as
maturing in 1999.
FINANCIAL SERVICES OPERATION
INTEREST RATE SENSITIVITY
PRINCIPAL AMOUNT MATURING IN:
------------------------------------------------------------------------------- FAIR VALUE AT
1999 2000 2001 2002 2003 THEREAFTER TOTAL DECEMBER 31, 1998
---------- -------- -------- -------- ------- ---------- ---------- ------------------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Interest rate sensitive
assets:
Variable rate
Commercial real estate
loans............... $ 456,289 $373,563 $261,848 $129,556 $69,747 $28,171 $1,319,174 $1,319,517
Weighted-average
interest rate..... 9.04% 8.91% 9.02% 8.98% 8.96% 8.23% 8.97%
Residential real
estate loans........ $ 202,338 $127,644 $ 74,297 $ 43,093 $22,701 $21,893 $ 491,966 $ 513,344
Weighted-average
interest rate..... 9.55% 8.89% 8.43% 8.21% 8.26% 8.60% 8.99%
Commercial finance
loans............... $ 476,346 -- -- -- -- $ 9,162 $ 485,508 $ 485,508
Weighted-average
interest rate..... 10.60% -- -- -- -- 4.07% 10.17%
Syndicated loans...... $ 285,392 $ 5,832 $ 6,348 $ 6,909 $ 7,519 $48,822 $ 360,822 $ 360,822
Weighted-average
interest rate..... 8.44% 8.00% 8.00% 8.00% 8.00% 8.00% 8.35%
Investments........... $ 29,897 $ 8,202 $ 7,870 $ 5,525 $ 3,231 $ 3,737 $ 58,462 $ 58,462
Weighted-average
interest rate..... 5.41% 6.12% 6.12% 6.12% 6.12% 6.12% 5.75%
Fixed rate
Commercial real estate
loans............... $ 69,922 $ 49,617 $ 37,128 $ 22,600 $14,440 $62,404 $ 256,111 $ 257,532
Weighted-average
interest rate..... 9.32% 8.79% 9.53% 8.72% 8.33% 8.00% 8.82%
Residential real
estate loans........ $ 7,585 $ 6,948 $ 5,802 $ 4,845 $ 4,045 $20,212 $ 49,437 $ 51,482
Weighted-average
interest rate..... 10.41% 10.28% 10.30% 10.32% 10.35% 10.58% 10.44%
Premium finance and
other loans......... $ 58,225 -- -- -- -- -- $ 58,225 $ 58,225
Weighted-average
interest rate..... 11.73% -- -- -- -- -- 11.73%
Investments........... $ 70,204 -- -- -- $60,594 -- $ 130,798 $ 130,798
Weighted-average
interest rate..... 4.41% -- -- -- 4.87% -- 4.62%
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PRINCIPAL AMOUNT MATURING IN:
------------------------------------------------------------------------------- FAIR VALUE AT
1999 2000 2001 2002 2003 THEREAFTER TOTAL DECEMBER 31, 1998
---------- -------- -------- -------- ------- ---------- ---------- ------------------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Interest rate sensitive
liabilities:
Variable rate thrift
deposits.............. $ 504,543 -- -- -- -- -- $ 504,543 $ 504,543
Weighted-average
interest rate..... 5.21% -- -- -- -- -- 5.21%
Commercial paper.... $ 24,985 -- -- -- -- -- $ 24,985 $ 24,985
Weighted-average
interest rate... 5.30% -- -- -- -- -- 5.30%
Securitization
obligation........ $ 274,260 -- -- -- -- -- $ 274,260 $ 274,260
Weighted-average
interest rate..... 5.92% -- -- -- -- -- 5.92%
Debt with banks..... $ 351,500 -- -- -- -- -- $ 351,500 $ 351,500
Weighted-average
interest rate..... 5.74% -- -- -- -- -- 5.74%
Debt from
affiliates.......... $ 51,265 -- -- -- $20,000 -- $ 71,265 $ 71,265
Weighted-average
interest rate..... 6.47% -- -- -- 6.07% -- 6.36%
Fixed rate
Thrift deposits....... $1,410,847 $ 78,373 $ 36,924 $ 5,631 $52,355 $46,166 $1,630,296 $1,633,756
Weighted-average
interest rate..... 5.44% 5.54% 5.76% 6.09% 5.63% 5.86% 5.48%
Debt with Federal Home
Loan Bank........... $ 115,000 -- -- -- -- -- $ 115,000 $ 115,000
Weighted-average
interest rate..... 4.83% -- -- -- -- -- 4.83%
FREMONT GENERAL CORPORATION (PARENT-ONLY) -- INTEREST RATE RISK
Fremont General Corporation is also subject to interest rate exposure
related to LIBOR and United States prime interest rates because of its long-term
debt and other obligations with both fixed and variable interest rates. For
fixed rate obligations, Fremont General Corporation runs the risk that if market
rates decline, the related required payments will exceed those based on the
current market rates. For obligations with variable interest rates, fluctuations
in the market rates will directly affect interest expense.
The following table provides information about interest rate sensitive
assets and liabilities of Fremont General Corporation. For short-term
investments with variable interest rates, the table presents principal cash
flows by expected maturity dates. The weighted-average interest rates are based
on implied forward rates as derived from appropriate annual spot rate
observations as of the reporting date.
FREMONT GENERAL CORPORATION (PARENT ONLY)
INTEREST RATE SENSITIVITY
PRINCIPAL AMOUNT MATURING IN:
------------------------------------------------------------------- FAIR VALUE AT
1999 2000 2001 2002 2003 THEREAFTER TOTAL DECEMBER 31, 1998
------- ------ ------ -------- ---- ---------- -------- -----------------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
Interest rate sensitive assets:
Fixed interest rate short-term
investments...................... $18,894 -- -- -- -- -- $ 18,894 $ 18,894
Weighted-average interest rate... 5.56% -- -- -- -- -- 5.56%
Interest rate sensitive liabilities:
Fixed interest rate debt
borrowings....................... -- -- -- -- -- $ 13,527 $ 13,527 $ 11,938
Weighted-average interest rate... -- -- -- -- -- 5.00% 5.00%
Variable interest rate debt
borrowings....................... $ 717 $1,946 $1,946 $301,945 -- -- $306,554 $306,554
Weighted-average interest rate... 6.47% 6.47% 6.47% 5.76% -- -- 5.78%
Fixed interest rate
Company-obligated mandatorily
redeemable preferred securities
of subsidiary Trust holding
solely Company junior
subordinated debentures.......... -- -- -- -- -- $100,000 $100,000 $104,500
Weighted-average interest rate... -- -- -- -- -- 9.00% 9.00%
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LIQUIDITY AND CAPITAL RESOURCES
The property and casualty insurance operation must have cash and liquid
assets available to meet their obligations to policyholders in accordance with
contractual obligations, in addition to having the funds available to meet
ordinary operating costs. The operation has several sources of funds to meet its
obligations, including cash flow from operations, recoveries from reinsurance
contracts and investment securities. By statute, the majority of the cash from
the operation is required to be invested in investment grade securities to
provide protection for policyholders. Fremont invests in fixed income and
preferred equity securities with an objective of providing a reasonable return
while limiting credit and liquidity risk. The Company's investment portfolio had
an unrealized gain of $59.8 million and $81.4 million at December 31, 1998 and
1997, respectively.
The Company's thrift and loan subsidiary, which is engaged in commercial
and residential real estate lending, syndicated loans and insurance premium
financing, finances its lending activities primarily through customer deposits,
which have grown to $2.13 billion at December 31, 1998 from $1.49 billion at
December 31, 1997. The thrift is also eligible for financing through the Federal
Home Loan Bank of San Francisco, which financing is available at varying rates
and terms. As of December 31, 1998, $474 million was available under the
facility of which $115 million was outstanding.
Fremont's commercial finance loans are funded primarily through its asset
securitization program, an unsecured revolving line of credit with a syndicated
bank group and its capital. The asset securitization program was established in
1993 to provide a stable and cost effective source of funds to facilitate the
expansion of this business. As of December 31, 1998, an aggregate of $235
million in senior series of certificates and an aggregate of $39 million in
subordinated series of certificates were outstanding. The interest rate on the
certificates, set monthly, ranged from LIBOR plus 0.23% to LIBOR plus 0.95% at
December 31, 1998. The securities issued in this program have a scheduled
maturity of two to four years, but could mature earlier depending on
fluctuations in the outstanding balances of loans in the portfolio and other
factors. As of December 31, 1998, up to $265 million in additional publicly
offered term asset-backed certificates may be issued pursuant to a shelf
registration statement to fund future growth in the commercial finance loan
portfolio. In February 1996, $135 million of the senior series certificates
("Series C") were issued. The proceeds were used, in conjunction with existing
cash, to retire $200 million in Series A certificates, which were outstanding as
of December 31, 1995. In April 1997, $109 million in certificates ("Series D")
were issued, comprised of $100 million in senior certificates and $9 million in
subordinated certificates. The Series D certificates were issued to retire $100
million in maturing Series B certificates. In December 1995, a commercial paper
facility was established as part of the asset securitization program. This
facility, which expires in December 2000, provides for the issuance of up to
$150 million in commercial paper, dependent upon the level of assets within the
asset securitization program. As of December 31, 1998, $25 million in commercial
paper was outstanding under this facility. Commercial finance loans are also
financed under an unsecured revolving line of credit with a syndicated bank
group that presently permits borrowings of up to $438 million, which includes a
revolving credit facility of $350 million and a term loan of $88 million. The
revolving credit facility converts to a term loan in August 2000, with ultimate
maturity in June 2002. The term loan matures July 2001. This facility is also
used to finance certain syndicated loans. The balance outstanding at December
31, 1998 of the revolving credit facility and the term loan was $264 million and
$88 million, respectively, with a weighted average interest rate of 5.74%. This
credit line is primarily used to finance assets which are not included in the
Company's asset securitization program. (See "Item 1. Business -- Financial
Services Operation -- Commercial Finance.")
As a holding company, Fremont General Corporation ("the holding company")
pays its operating expenses, meets its other obligations and pays stockholders'
dividends from its cash on hand, management fees paid by its subsidiaries and
dividends paid by its subsidiaries. Stockholders' dividends declared aggregated
$20.9 million, $18.9 million and $15.8 million during 1998, 1997 and 1996,
respectively. Several of Fremont's subsidiaries are subject to certain statutory
and regulatory restrictions and various agreements, principally loan agreements,
that restrict their ability to distribute dividends to the holding company. The
holding company expects that during the next few years dividends from its
subsidiaries will consist of dividends from its property and casualty insurance
subsidiaries and dividends on preferred stock of its financial services
subsidiaries. The
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maximum amount available for payment of dividends by the property and casualty
insurance subsidiaries at December 31, 1998 without prior regulatory approval is
approximately $235.3 million.
To facilitate general corporate operations, Fremont General Corporation
maintains a revolving line of credit with a syndicated bank group that currently
permits borrowings of up to $400 million, of which $300 million was outstanding
as of December 31, 1998. On March 17, 1999, Fremont General Corporation issued
$425 million of Senior Notes consisting of $200 million of 7.70% Senior Notes
due 2004 and $225 million of 7.875% Senior Notes due 2009. The notes were
offered in a private placement to qualified institutional buyers and a limited
number of institutional accredited investors and have not been registered under
the Securities Act; however, Fremont General Corporation intends to do so during
1999. Net proceeds from the notes were used to repay all indebtedness
outstanding under the revolving line of credit and for general corporate
purposes, including working capital.
On August 1, 1997, the Company completed the acquisition of Industrial
which resulted in the ultimate disbursement of funds totaling $434 million,
comprised of $355 million in purchase price, as adjusted pursuant to certain
audit and settlement provisions in the purchase agreement, $79 million in the
pay-off of an outstanding debt obligation that Industrial owed to Talegen, and
$9.5 million in costs incurred in connection with the acquisition. The
disbursement of cash used to fund the acquisition included $219 million in
borrowings under the Company's existing line of credit and the remainder from
internally generated funds. (See "General.")
During 1998, an aggregate $21.0 million principal amount at maturity of
Liquid Yield Option(TM) Notes due October 12, 2013 (Zero Coupon-Subordinated)
("LYONs") were converted into 809,000 shares of Fremont General Corporation's
Common Stock. The effect of these conversions was an increase in stockholders'
equity and a decrease in long-term debt of $10 million. During 1997, an
aggregate $266.7 million principal amount at maturity of LYONs were converted
into 10.3 million shares of Fremont General Corporation's Common Stock. The
effect of the conversions was an increase in stockholders' equity and a decrease
in long-term debt of $117 million. During 1996, an aggregate $72.5 million
principal amount at maturity of LYONs were converted into 2.8 million shares of
Fremont General Corporation's Common Stock. The effect of the 1996 conversions
was an increase in stockholders' equity and a decrease in long-term debt of $31
million.
On March 1, 1996, Fremont General Financing I, a statutory business trust
(the "Trust") and consolidated wholly-owned subsidiary of the holding company,
sold $100 million of 9% Trust Originated Preferred Securities(SM) ("the
Preferred Securities") in a public offering. The Preferred Securities represent
preferred undivided beneficial interests in the assets of the Trust. The
proceeds from the sale of the Preferred Securities were invested in 9% Junior
Subordinated Debentures of the holding company ("the Junior Subordinated
Debentures"). The proceeds from the sale of the Junior Subordinated Debentures
were used to repay approximately $50 million in revolving bank line of credit
indebtedness, with the remainder used for general corporate purposes. The $100
million Junior Subordinated Debentures are the sole asset of the Trust. The
Preferred Securities will be redeemed upon maturity of the Junior Subordinated
Debentures in 2026, subject to the election available to Fremont General
Corporation to extend the maturity up to 2045, and they may be redeemed, in
whole or in part, at any time on or after March 31, 2001 and under certain
specified circumstances. The Junior Subordinated Debentures are subordinate and
junior to all senior indebtedness of the holding company. 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 Corporation.
Net cash used in operating activities of continuing operations was $199.7
million, $18.0 million and $96.0 million for 1998, 1997 and 1996, respectively.
Net cash used in continuing operations increased in 1998 as compared to 1997,
due primarily to a higher reduction in claims and policy liabilities and an
increase in premiums receivable and agents' balances, offset partially by an
increase in net income and an increase in the provision for deferred income
taxes. The higher reduction in claims and policy liabilities is due mainly to an
increase in 1998 in reinsurance recoverables on unpaid losses resulting from the
additional excess of loss reinsurance purchased by Fremont and which became
effective January 1, 1998. (See "Results of Operations -- Property and Casualty
Insurance Operation -- Premiums.") Additionally, the higher provision for
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deferred income taxes is due predominately to this higher reduction in claims
and policy liabilities. The decrease in net cash used in operating activities in
1997 as compared to 1996 was due primarily to an increase in net income and a
decrease in other assets and an increase in other liabilities. The significant
decrease in other assets was due mainly to a $45 million collection on a
policyholder receivable classified in other assets and the increase in other
liabilities was due mainly to increases in accrued federal income taxes payable.
Net cash provided by (used in) investing activities was $(721.4) million,
$(393.2) million and $229.8 million for 1998, 1997 and 1996, respectively. The
decrease in net cash provided by (used in) investing activities is due primarily
to increases in loan originations and bulk purchases funded, net of repayments
and a smaller decrease in short-term investments. This was partially offset by
increases in investment sales, maturities and calls, net of purchases and a
decrease in the purchase of subsidiaries. The increase in loan originations and
bulk purchases funded is consistent with the general growth in Fremont's
financial services loan portfolio. The decrease in the purchase of subsidiaries
occurs as the 1998 acquisition of Unicare at $110 million in purchase price was
smaller than the 1997 acquisition of Industrial. The decrease in net cash
provided by (used in) investing activities in 1997 as compared to 1996 was due
mainly to the August 1, 1997 acquisition of Industrial; an increase in
investment purchases, net of sales, maturities and short-term investment
activity; and an increase in loan originations, net of repayments. The increase
in loan originations is consistent with the general growth in the Company's
financial services' loan portfolio. The decrease in short-term investments was
due primarily to the investing of the acquired short-term investment portfolio
of Industrial into long-term investments.
Net cash provided by (used in) financing activities was $936.1 million,
$420.8 million, and $(118.0) million in 1998, 1997 and 1996, respectively. The
increase in net cash provided by (used in) financing activities in 1998 as
compared to 1997 is due mainly to increases in short-term and long-term debt
proceeds, net of repayments and an increase in thrift deposits. These increases
resulted primarily from the financing of the general growth of the Company's
financial services loan portfolio. Net cash provided by (used in) financing
activities increased in 1997 as compared to 1996, due primarily to an increase
in long-term debt proceeds, net of short-term and long-term repayments; an
increase in thrift deposits; and the payment in 1996 of $363.4 million in the
settlement of certain reinsurance and assumption agreements that substantially
reduced the Company's life insurance activities to an immaterial level. The
increase in long-term debt proceeds, net of repayments, was due mainly to $140
million in net additional borrowings used in conjunction with the acquisition of
Industrial. Partially offsetting these increases in financing activities were
decreases in annuity receipts, net of contract withdrawals, which is consistent
with the Company's substantial reduction in life insurance activities in 1996.
Additionally, the Company's financing activities in 1996 were significantly
impacted by the proceeds of $100 million from the sale of the Preferred
Securities, which were issued on March 1, 1996.
The amortized cost of Fremont's invested assets were $2.33 billion and
$2.36 billion at December 31, 1998 and 1997, respectively. The modest decrease
in invested assets is due mainly to the offsetting effects of higher ceded
reinsurance premium payments resulting from the additional excess of loss
reinsurance purchased by Fremont that became effective January 1, 1998, offset
partially by an increase in invested assets resulting from the acquisition of
Unicare.
The Company's property and casualty premium to surplus ratio for the year
ended December 31, 1998 was 1.0 to 1, which is within industry guidelines. The
FDIC has established certain capital and liquidity standards for its member
institutions, and Fremont's thrift was in compliance with these standards as of
December 31, 1998. (See "Item 1. Business -- Regulation -- Thrift and Loan
Regulation.") In December 1998, an additional $33 million was contributed to the
capital of this subsidiary in response to the growth in the thrift's loan
portfolio during 1998.
The Company believes that its existing cash, its bank lines of credit,
revenues from operations and other available sources of liquidity will be
sufficient to satisfy its liquidity needs for the next several years.
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YEAR 2000 READINESS DISCLOSURE
Problems may arise from computer software programs and operating systems
that use only two digits to designate the calendar year in a date code field.
For example, where the date December 21, 2000, is encoded as "12/21/00" instead
of "12/21/2000." Based on this two-digit format for date coding, computers with
date-sensitive programs could recognize the year 2000 as "00" and incorrectly
assume that the year is 1900. Similar problems can arise for systems dependent
upon embedded chips that are encoded to only use or recognize two digits when
referring to a calendar year. Additionally, problems may arise from the
computer's inability to process (including calculating, comparing, sequencing,
displaying, or storing), transmit, or receive date data from, into, and between
the 20th and 21st centuries, and during the years 1999 and 2000, and leap year
calculations. Fremont refers to these problems as the "Year 2000 Problem." The
Company considers the Year 2000 Problem a critical business continuity issue and
has categorized the Year 2000 Problem into the following four areas:
Office facilities and equipment -- Will the telephones, facsimile
machines, copy machines, elevators, air conditioning and heating systems,
and other utility systems used by Fremont in its leased and owned
facilities function properly in the year 2000 and beyond?
Key business partners, vendors, other suppliers -- Will Fremont's key
business partners, major vendors, and other suppliers face significant
disruption to the goods and services provided to the Company due to Year
2000 Problems?
Customers -- Will Fremont's revenues be significantly adversely
affected by customers' inability to remediate successfully their own Year
2000 Problems?
Internal Computer systems -- Considered the most important area to
resolve, will the Company's computer systems operate properly in the year
2000 and beyond?
The following discussion establishes the extent of work performed, or to be
performed, and results obtained as of January 31, 1999 in addressing the impact
of the Year 2000 Problem on the above-described areas.
Office facilities and equipment:
The Company has evaluated all of its telephone systems to determine the
extent of any Year 2000 Problems. The majority of the Company's telephone
systems have been rendered Year 2000 compliant. The remaining non-compliant
systems are expected to be compliant by June 30, 1999.
Regarding the Company's leased facilities, we have inquired from facility
owners the extent of any Year 2000 Problems (if any) as they relate to the
elevator, air conditioning/heating, and other utility systems in these
facilities. Fremont has evaluated representations rendered by these facility
owners for most of the Company's leased facilities. Based on the representations
received through January 31, 1999, Fremont anticipates no significant disruption
from these various facility-related systems due to the Year 2000 Problem.
Further, with respect to Fremont's owned facilities, an evaluation of the extent
of any Year 2000 Problems relating to these facilities' utility and elevator
systems has been made and no significant disruptions (if any) to the Company's
operations from these systems are anticipated.
Finally, with regard to office equipment such as facsimile and copy
machines, Fremont considers the risk minimal as to any significant cost or
disruption to its operations resulting from a Year 2000 Problem impacting any of
its office equipment (excluding telephone and computer systems). Accordingly, no
significant work is currently being planned in this area.
Key business partners, vendors, other suppliers:
Fremont has identified its key business partners, such as its critical
banking, employee benefits, reinsurance, auditors, outside legal counsel, and
other professional service relationships. The Company has been surveying all of
these relationships as to their Year 2000 compliance, and will develop
appropriate contingency plans in its effort to avoid significant disruption to
Fremont's operations. The Company
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anticipates this process to be completed by June 30, 1999. Many surveys have
already been received and evaluated in the areas of employee benefits and
reinsurance. Based on the evaluations received to date, most of these business
partners have stated that they anticipate their Year 2000 compliance and testing
to be completed in early 1999.
In addition to key business partners, the Company's suppliers and vendors
are concentrated into the areas of office supplies, office furniture and
equipment, and computer hardware and software. With the exception of computer
software, Fremont believes that there are many alternative suppliers for their
office supply and furniture needs, as well as several alternative sources for
computer hardware. Accordingly, the risk of a significant disruption to the
Company's operations due to a supplier's inability to resolve its Year 2000
Problems is considered minimal since Fremont could select an alternate supplier.
(With regard to computer software, refer to the separate discussion on the
Company's internal computer systems.) In an effort to identify which suppliers
may have Year 2000 compliance difficulties, the Company has identified its more
significant suppliers/vendors and has been surveying them as to their Year 2000
compliance status. The results of these surveys will be evaluated and
appropriate contingency plans will be developed if considered necessary. Fremont
expects this process to be completed by June 30, 1999.
Customers:
In the financial services operation, Fremont's revenues could be impacted
should a customer/borrower be unable to pay interest and/or principal when due
because of the customers' inability to resolve its Year 2000 Problems. Regarding
commercial and residential real estate loans, the risk of a significant impact
to operating results is considered minimal since Fremont would utilize the
collateral securing existing loans to mitigate any loan losses. Additionally for
commercial real estate loans, the borrower's Year 2000 risk is further limited
by the multiple tenant nature of most of the properties under collateral. The
Company has focused its attention on those commercial properties that are single
tenant, which are comprised of approximately fifty loans as of January 31, 1999.
Fremont has been surveying these customers to determine their Year 2000
compliance. For commercial finance loans, the Company has been surveying its
entire customer base to ascertain whether or not any significant Year 2000
issues exist with existing borrowers. With regard to new loan customers, the
Company has adopted additional review procedures for both real estate and
commercial finance loans to determine the extent of an applicant's Year 2000
compliance. Based on the results obtained to date, Fremont does not anticipate
any significant impact to its financial services revenues due to the Year 2000
Problem. For Fremont's thrift deposits, the Company's effort to mitigate the
risk of significant depositor withdrawals has been pursued through an
educational program, as recommended by the FDIC, aimed at informing current and
prospective depositors as to the thrift's Year 2000 compliance efforts and
results.
In its property and casualty insurance operation, Fremont has determined
the extent of procedures to employ in ascertaining the potential impact to its
insurance premium revenues resulting from an insured's or agent's inability to
resolve their Year 2000 Problems. The procedures primarily relate to surveying
the Company's major insureds and agents as to the extent of any Year 2000
Problems which would significantly impact their operations. Fremont anticipates
completing these procedures by June 30, 1999 and will develop appropriate
contingency plans should a significant Year 2000 Problem be identified from
these surveys.
Internal computer systems:
As of January 31, 1999, significant Year 2000 compliance issues remain only
within Fremont's property and casualty insurance operation. The Company's
computer-based systems ("Systems") supporting the financial services operation,
administrative systems (personnel, payroll and accounting) and treasury systems
(cash management and investment portfolio management) have all been rendered
substantially Year 2000 compliant.
Within the financial services segment, substantially all operations utilize
application Systems that are vendor supported. For commercial and residential
real estate lending, all current application Systems are substantially Year 2000
compliant. Additionally, these application Systems have been tested internally
to validate their Year 2000 compliance, with no significant errors identified or
left unresolved. Similarly, the
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application Systems for commercial finance lending and syndicated loans, while
substantially compliant in their present form, will be fully compliant after
upgrading to the current version of the software, which is already available and
installed at several of the vendor's clients. Fremont intends to install the
software upgrades and test these Systems to verify the vendors' representations.
The Company expects to complete these procedures by June 30, 1999.
With regard to the property and casualty insurance operation, the Company
developed an action plan in 1996 to render its workers' compensation Systems
Year 2000 compliant. Based on an evaluation of the progress made as of January
31, 1999, Fremont believes that its Systems that support its California
operations are Year 2000 compliant (including testing), and the Company
estimates that the Systems that support its non-California operations, excluding
those Systems supporting recently acquired Industrial, will be Year 2000
compliant and tested by March 31, 1999. Industrial's Systems are expected to be
converted to Year 2000 compliant Systems by September 30, 1999. The property and
casualty insurance operation will be moving onto new Systems that will, after
full implementation, be the workers' compensation operation's new nationwide
claims and policy handling platform. The costs to be incurred by Fremont in
completing these Year 2000 initiatives are not expected to have a material
impact on the Company's results of operations (1998 costs of approximately $4.5
million).
Regarding administrative and back-office operations, Fremont believes that
its personnel, payroll, accounting, and treasury Systems are Year 2000
compliant. The Company intends to test these Systems by June 30, 1999 to verify
the vendors' representations.
In addition to its various application Systems, Fremont maintains several
PC-based client/server network infrastructures. The majority of these
installations were established within the past five years. Substantially all of
these networks use the most current versions of network operating and data
transmission software, all of which are believed to be Year 2000 compliant. The
Company is in the process of testing vendors' representations as to Year 2000
compliance of installed network software. These processes are anticipated to be
completed by March 31, 1999 with no significant Year 2000 Problems expected.
Additionally, the Company has inventoried all of its PC hardware. Substantially
all of the PC hardware is believed to be Year 2000 compliant and the Company
anticipates that any non-compliant PC hardware will be rendered Year 2000
compliant by June 30, 1999.
Management of the Company continues to monitor the progress of its Year
2000 compliance initiatives and will continue to allocate resources necessary to
resolve significant Year 2000 Problems as they are identified. Based on the
progress of the work performed through January 31, 1999, Fremont anticipates
that its office facilities and equipment; key business partners, vendors and
other suppliers; major customers; and internal computer systems will be
substantially Year 2000 compliant before December 31, 1999. For all mission
critical Systems, Fremont is developing appropriate contingency plans in the
event an unanticipated Year 2000 Problem occurs. These plans are expected to be
completed by September 30, 1999.
Risk factors:
Due to the dependence of Fremont's insurance services and financial
services businesses on computer technology to operate its businesses, and the
dependence of the insurance and financial services industries on computer
technology, the nature and impact of Year 2000 processing failures on the
Company's businesses could be material. Fremont believes its mission critical
Systems will be substantially Year 2000 compliant by September 30, 1999. The
Company cannot assure you that its Year 2000 compliance efforts will be
completed in a timely manner or that the Company's Year 2000 compliance efforts
will be successful even if these compliance efforts are completed in a timely
manner. It is difficult to predict with certainty what will happen in connection
with the Year 2000 Problem after December 31, 1999. Despite Fremont's best
efforts to mitigate and remediate its Year 2000 Problem, if key business
partners, vendors and other suppliers, facility owners, or customers have
over-estimated their own Year 2000 readiness, or been less than truthful or
forthcoming in their Year 2000 readiness disclosure, Fremont will be forced to
implement certain of its contingency plans, and may be jeopardized with respect
to its own Year 2000 compliance status. In this scenario, it is possible that
Fremont may experience unfavorable business factors and expenditures in excess
of
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budget which could result in a negative effect on results of operations in one
or all of the Company's businesses, depending upon the specific nature of the
problem or problems.
Worst-case scenarios (events the Company does not anticipate will occur)
might involve the inability of several of the Company's workers' compensation
insurance operation's major insureds, and/or agents, to resolve their respective
Year 2000 Problem. If this were to occur, effects could include the loss of
business that might be material to Fremont. Furthermore, negative economic
conditions precipitated by the Year 2000 Problem could adversely impact the
financial services operation's ability to originate loans or maintain credit
quality at previously attained levels and could negatively affect Fremont's net
finance income, levels of non-performing assets and net charge-offs. Fremont's
operations are highly dependent on the ability of its banking business partners
to process its financial transactions. If the Company's key banking business
partners, as well as the banking industry in general, fail to resolve their
respective Year 2000 Problems, if any, serious consequences to Fremont could
result including the disruption to its normal pattern of cash flows, or
increased risk for possible legal actions for breach of contract or other harm.
These consequences could adversely affect the Company's results of operations
and financial condition. While the Company does not anticipate any of these
scenarios to occur, in making its own Year 2000 Readiness Disclosure statements,
Fremont has relied upon the honesty and forthrightness of its key business
partners, vendors and other suppliers, facility owners and customers in making
their respective Year 2000 readiness representations to the Company.
Readers are cautioned that forward-looking statements contained in this
Year 2000 Readiness Disclosure section should be read in conjunction with the
Company's cautionary statements at the beginning of this section. (See "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations.")
ITEM 7.(A) QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information set forth under the subheadings "Market Risk," "Property
and Casualty Insurance Operations -- Interest Rate Risk," "Financial Services
Operations -- Interest Rate Risk," and "Fremont General Corporation
(Parent-only) -- Interest Rate Risk" in the Company's Management's Discussion
and Analysis is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements, including supplementary
data, are set forth in the "Index" on page 54 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information set forth under the subheadings "Election of Directors,"
"Executive Officers" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Company's Proxy Statement for the 1999 Annual Meeting of
Stockholders is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under the subheadings "Election of Directors,"
"Compensation of Directors," "Executive Officers," "Summary Compensation Table,"
"Summary Compensation Table -- Explanations," "Option Exercises and Year-End
Values," "Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End
Option Values Table," "Long-Term Incentive Plans -- Awards in Last Fiscal Year,"
"Employment Agreements" and "Retirement and Other Benefit Plans, A-I" in the
Company's definitive Proxy Statement for the 1999 Annual Meeting of Stockholders
is incorporated herein by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth under the subheading "Principal and Management
Stockholders" in the Company's definitive Proxy Statement for the 1999 Annual
Meeting of Stockholders is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information immediately following the captions "Election of Directors"
and "Employment Agreements" in the Company's definitive Proxy Statement for the
1999 Annual Meeting of Stockholders is incorporated herein by reference.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1)and (a)(2) and (d) FINANCIAL STATEMENTS AND SCHEDULES. Reference is made
to the "Index -- Consolidated Financial Statements and
Financial Statements Schedules -- Annual Report on
Form 10-K filed as part of this Annual Report."
(a)(3) and (c) EXHIBITS.
EXHIBIT
NUMBER DESCRIPTION
------- -----------
2.1 Stock Purchase Agreement by and among Talegen Holdings,
Inc., Fremont Indemnity Company and Fremont General
Corporation dated as of May 16, 1997 including exhibits
thereto. (Filed as Exhibit No. 2.1 to Current Report on Form
8-K, as of August 1, 1997, Commission File Number 1-8007,
and incorporated herein by reference.)
2.2 Tax Allocation and Indemnification Agreement, dated as of
May 16, 1997 by and among Xerox Financial Services, Inc.,
Talegen Holdings, Inc., Industrial Indemnity Holdings, Inc.,
Fremont General Corporation, and Fremont Indemnity
Corporation, a California corporation. (Filed as Exhibit No.
2.2 to Current Report on Form 8-K, as of August 1, 1997,
Commission File Number 1-8007, and incorporated herein by
reference.)
3.1 Restated Articles of Incorporation of Fremont General
Corporation. (Filed as Exhibit No. 3.1 to Quarterly Report
on Form 10-Q, for the period ended June 30, 1998, Commission
File Number 1-8007, and incorporated herein by reference.)
3.2 Certificate of Amendment of Articles of Incorporation of
Fremont General Corporation.
3.3 Amended and Restated By-Laws of Fremont General Corporation.
(Filed as Exhibit No. 3.3 to Annual Report on Form 10-K, for
the fiscal year ended December 31, 1995, Commission File
Number 1-8007, and incorporated herein by reference.)
4.1 Form of Stock Certificate for Common Stock of the
Registrant. (Filed as Exhibit No. (1) Form 8-A filed on
March 17, 1993, Commission File Number 1-8007, and
incorporated herein by reference.)
4.2 Indenture with respect to Liquid Yield Option Notes Due 2013
between the Registrant and Bankers Trust Company. (Filed as
Exhibit No. 4.4 to Registration Statement on Form S-3 filed
on October 1, 1993, and incorporated herein by reference.)
4.3 Indenture among the Registrant, the Trust and First
Interstate Bank of California, a California banking
corporation, as trustee. (Filed as Exhibit No. 4.3 to Annual
Report on Form 10-K, for the fiscal year ended December 31,
1995, Commission File Number 1-8007, and incorporated herein
by reference.)
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. (Filed as Exhibit No.
4.5 to Annual Report on Form 10-K, for the fiscal year ended
December 31, 1995, Commission File Number 1-8007, and
incorporated herein by reference.)
4.5 Preferred Securities Guarantee Agreement between the
Registrant and The Chase Manhattan Bank, N.A., a national
banking association, as Preferred Guarantee Trustee. (Filed
as Exhibit No. 4.6 to Annual Report on Form 10-K, for the
fiscal year ended December 31, 1995, Commission File Number
1-8007, and incorporated herein by reference.)
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EXHIBIT
NUMBER DESCRIPTION
------- -----------
4.6 Common Securities Guarantee Agreement by the Registrant.
(Filed as Exhibit No. 4.7 to Annual Report on Form 10-K, for
the fiscal year ended December 31, 1995, Commission File
Number 1-8007, and incorporated herein by reference.)
4.7 Form of Preferred Securities. (Included in Exhibit 4.5).
(Filed as Exhibit No. 4.8 to Annual Report on Form 10-K, for
the fiscal year ended December 31, 1995, Commission File
Number 1-8007, and incorporated herein by reference.)
4.8 Form of 9% Junior Subordinated Debenture. (Included in
Exhibit 4.3). (Filed as Exhibit No. 4.9 to Annual Report on
Form 10-K, for the fiscal year ended December 31, 1995,
Commission File Number 1-8007, and incorporated herein by
reference.)
4.9 Indenture dated as of March 1, 1999 between the Registrant
and The First National Bank of Chicago, as trustee.
4.10 Registration Rights Agreement among the Registrant and
Merrill Lynch, Pierce, Fenner & Smith Incorporated, Credit
Suisse First Boston Corporation, Goldman, Sachs & Co., and
Warburg Dillon Read LLC.
4.11 Form of Fremont General Corporation 7.70% Senior Notes due
2004.
4.12 Form of Fremont General Corporation 7.875% Senior Notes due
2004.
10.1(a) Fremont General Corporation Employee Stock Ownership Plan as
amended. (Filed as Exhibit No. 10.1 to Annual Report on Form
10-K, for the fiscal year ended December 31, 1995,
Commission File Number 1-8007, and incorporated herein by
reference.)
10.1(b) Amendment Number Two to the Fremont General Corporation
Employee Stock Ownership Plan. (Filed as Exhibit No. 10.1
(b) to Annual Report on Form 10-K, for the fiscal year ended
December 31, 1997, Commission File Number 1-8007, and
incorporated herein by reference.)
10.1(c) Amendment Number Three to the Fremont General Corporation
Employee Stock Ownership Plan. (Filed as Exhibit No. 10.1(c)
to Quarterly Report on Form 10-Q, for the period ended
September 30, 1998, Commission File Number 1-8007, and
incorporated herein by reference.)
10.1(d) Amendment Number Four to the Fremont General Corporation
Employee Stock Ownership Plan.
10.2 Amended and Restated Trust Agreement for Fremont General
Corporation Employee Stock Ownership Plan. (Filed as Exhibit
No. 10.2 to Annual Report on Form 10-K, for the fiscal year
ended December 31, 1995, Commission File Number 1-8007, and
incorporated herein by reference.)
10.3(a) Fremont General Corporation and Affiliated Companies
Investment Incentive Plan. (Filed as Exhibit No. 10.3 to
Annual Report on Form 10-K, for the fiscal year ended
December 31, 1995, Commission File Number 1-8007, and
incorporated herein by reference.)
10.3(b) Amendments Number One, Two and Three to the Fremont General
Corporation and Affiliated Companies Investment Incentive
Plan. (Filed as Exhibit No. 10.3 (b) to Quarterly Report on
Form 10-Q, for the period ended September 30, 1997,
Commission File Number 1-8007, and incorporated herein by
reference.)
10.3(c) Amendment Number Four to the Fremont General Corporation and
Affiliated Companies Investment Incentive Plan. Filed as
Exhibit No. (10.3 to Annual Report on Form 10-K, for the
Fiscal Year Ended December 31, 1997, Commission File Number
1-8007, and incorporated herein by reference.)
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EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.3(d) Amendment Number Five to the Fremont General Corporation and
Affiliated Companies Investment Incentive Plan. (Filed as
Exhibit No. 10.3(d) to Quarterly Report on Form 10-Q, for
the period ended September 30, 1998, Commission File Number
1-8007, and incorporated herein by reference.)
10.4(a) Trust Agreement for Investment Incentive Plan. (Filed as
Exhibit No. (10)(xi) to Annual Report on Form 10-K, for the
Fiscal Year Ended December 31, 1993, Commission File Number
1-8007, and incorporated herein by reference.)
10.4(b) Amendment to Trust Agreement for Investment Incentive Plan.
(Filed as Exhibit No. 10.4 to Annual Report on Form 10-K,
for the fiscal year ended December 31, 1995, Commission File
Number 1-8007, and incorporated herein by reference.)
10.5 Supplemental Retirement Plan of the Company, as restated
January 1, 1997. (Filed as Exhibit No. 10.5 to Quarterly
Report on Form 10-Q, for the period ended September 30,
1997, Commission File Number 1-8007, and incorporated herein
by reference.)
10.5(b) Amendment Number Two to the Fremont General Corporation
Supplemental Retirement Plan of the Company.
10.6 Trust Agreement for Supplemental Retirement Plan of the
Company, as amended. (Filed as Exhibit No. 10.6 to Annual
Report on Form 10-K, for the fiscal year ended December 31,
1995, Commission File Number 1-8007, and incorporated herein
by reference.)
10.7(a) Senior Supplemental Retirement Plan, as restated January 1,
1997. (Filed as Exhibit No. 10.7 to Quarterly Report on Form
10-Q, for the period ended September 30, 1997, Commission
File Number 1-8007, and incorporated herein by reference).
10.7(b) First Amendment to the Fremont General Corporation Senior
Supplemental Retirement Plan.
10.8(a) Fremont General Corporation Excess Benefit Plan Restated
effective as of January 1, 1997 and First Amendment dated
December 21, 1998.
10.8(b) Trust Agreement for Excess Benefit Plan. (Filed as Exhibit
No. 10.8 to Annual Report on Form 10-K, for the fiscal year
ended December 31, 1995, Commission File Number 1-8007, and
incorporated herein by reference.)
10.9 Amended Non-Qualified Stock Option Plan of 1989 and related
agreements of the Company. (Filed as Exhibit No. 10.9 to
Annual Report on Form 10-K, for the fiscal year ended
December 31, 1996, Commission File Number 1-8007, and
incorporated herein by reference.)
10.10 1997 Stock Plan and related agreements. (Filed as Exhibit
No. 10.10 to Quarterly Report on Form 10-Q, for the period
ended June 30, 1997, Commission File Number 1-8007, and
incorporated herein by reference.)
10.11(a) Long-Term Incentive Compensation Plan of the
Company -- Senior Executive Plan. (Filed as Exhibit No.
10.10(a) on Form 10-Q for the period ended September 30,
1996, Commission File Number 1-8007, and incorporated herein
by reference.)
10.11(b) Long-Term Incentive Compensation Plan of the Company (Filed
as Exhibit No. 10.10 (b) on Form 10-Q for the period ended
September 30, 1996, Commission File Number 1-8007, and
incorporated herein by reference.)
51
54
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.12 1995 Restricted Stock Award Plan As Amended and forms of
agreement thereunder. (Filed as Exhibit No. 4.1 to
Registration Statement on Form S-8/S-3 File No. 333-17525
which was filed on December 9, 1997, and incorporated herein
by reference.)
10.13 Fremont General Corporation Employee Benefits Trust
Agreement ("Grantor Trust") dated September 7, 1995 between
the Company and Merrill Lynch Trust Company of California.
(Filed as Exhibit No. 10.12 to Annual Report on Form 10-K,
for the fiscal year ended December 31, 1995, Commission File
Number 1-8007, and incorporated herein by reference.)
10.14(a) Employment Agreement between the Company and James A.
McIntyre dated January 1, 1994. (Filed as Exhibit No.
(10)(i) to Quarterly Report on Form 10-Q for the period
ended March 31, 1994, Commission File Number 1-8007, and
incorporated herein by reference.)
10.14(b) First Amendment to Employment Agreement between the Company
and James A. McIntyre dated August 1, 1996. (Filed as
Exhibit No. 10.10 to Quarterly Report on Form 10-Q, for the
period ended June 30, 1997, Commission File Number 1-8007,
and incorporated herein by reference.)
10.14(c) Second Amendment to Employment Agreement between the Company
and James A. McIntyre dated August 8, 1997. (Filed as
Exhibit No. 10.14 (c) to Quarterly Report on Form 10-Q, for
the period ended September 30, 1997, Commission File Number
1-8007, and incorporated herein by reference.)
10.15(a) Employment Agreement between the Company and Louis J.
Rampino dated February 8, 1996. (Filed as Exhibit No. 10.14
(a) to Annual Report on Form 10-K, for the fiscal year ended
December 31, 1995, Commission File Number 1-8007, and
incorporated herein by reference.)
10.15(b) Employment Agreement between the Company and Wayne R. Bailey
dated February 8, 1996. (Filed as Exhibit No. 10.14 to
Annual Report on Form 10-K, for the fiscal year ended
December 31, 1995, Commission File Number 1-8007, and
incorporated herein by reference.)
10.16 Management Continuity Agreement between the Company and
Raymond G. Meyers dated February 8, 1996. (Filed as Exhibit
No. 10.15 to Annual Report on Form 10-K, for the fiscal year
ended December 31, 1995, Commission File Number 1-8007, and
incorporated herein by reference.)
10.17 1998 Management Incentive Compensation Plan of the Company.
(Filed as Exhibit No. 10.17 to Annual Report on Form 10-K,
for the fiscal year ended December 31, 1997, Commission File
Number 1-8007, and incorporated herein by reference.)
10.18 Continuing Compensation Plan for Retired Directors. (Filed
as Exhibit No. 10.17 to Annual Report on Form 10-K, for the
fiscal year ended December 31, 1995, Commission File Number
1-8007, and incorporated herein by reference.)
10.19 Credit Agreement among Fremont General Corporation, Various
Lending Institutions and the Chase Manhattan Bank, N.A., As
Agent dated August 1, 1997. (Filed as Exhibit No. 10.20 to
Quarterly Report on Form 10-Q, for the period ended
September 30, 1997, Commission File Number 1-8007, and
incorporated herein by reference).
52
55
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.20 Credit Agreement $15,000,000 by and among Merrill Lynch
Trust Company of California as trustee for the Fremont
General Corporation Employee Stock Ownership Trust. The Plan
Committee (hereinafter described) on behalf of the Fremont
General Corporation Employee Stock Ownership Plan, Fremont
General Corporation, and First Interstate Bank of California
August 10, 1995. (Filed as Exhibit No. (10)(viii) to
Quarterly Report on Form 10-Q for the period ended September
30, 1995, and incorporated herein by reference.)
10.21(a) Second Amended and Restated Credit Agreement among Fremont
Financial Corporation, Various Lending Institutions, Wells
Fargo Bank N.A. and Fleet Bank National Association as
Co-Agents, and The Chase Manhattan Bank as Agent, dated as
of June 23, 1997. (Filed as Exhibit No. 10.22(a) to
Quarterly Report on Form 10-Q/A Amendment No. 1, for the
period ended September 30, 1998, Commission File Number
1-8007, and incorporated herein by reference).
10.21(b) First Amendment and Consent dated as of October 21, 1997, to
the Second Amended and Restated Credit Agreement among
Fremont Financial Corporation, Various Lending Institutions,
Wells Fargo Bank N.A. and Fleet Bank National Association as
Co-Agents, and The Chase Manhattan Bank as Agent. (Filed as
Exhibit No. 10.22(b) to Quarterly Report on Form 10-Q/A
Amendment No. 1, for the period ended September 30, 1998,
Commission File Number 1-8007, and incorporated herein by
reference).
21 Subsidiaries of the Company
23 Consent of Ernst & Young LLP Independent Auditors
27 Financial Data Schedule
(b) REPORT ON FORM 8-K. None.
53
56
FREMONT GENERAL CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULES
ANNUAL REPORT ON FORM 10-K
------------------------
INDEX
PAGES
-----
Report of Independent Auditors.............................. 55
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1998 and
1997................................................... 56
Consolidated Statements of Income for the years ended
December 31, 1998, 1997 and 1996....................... 57
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996....................... 58
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1998, 1997 and 1996........... 59
Notes to Consolidated Financial Statements................ 60
Schedules:
II -- Condensed Financial Information of Registrant...... 82
III -- Supplementary Insurance Information................ 85
IV -- Reinsurance........................................ 86
V -- Valuation and Qualifying Accounts................... 87
VI -- Supplemental Information Concerning
Property/Casualty Insurance Operations................. 88
All other schedules are omitted because of the absence of conditions under
which they are required or because the necessary information is provided in the
consolidated financial statements or notes thereto.
54
57
REPORT OF INDEPENDENT AUDITORS
Stockholders and Board of Directors
Fremont General Corporation
We have audited the accompanying consolidated balance sheets of Fremont
General Corporation and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of income, stockholders' equity and cash flows
for each of the three years in the period ended December 31, 1998. Our audits
also included the financial statement schedules listed in the Index at Item
14(a). These financial statements and schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Fremont
General Corporation and subsidiaries at December 31, 1998 and 1997, and the
consolidated results of their operations and cash flows for each of the three
years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedules, when considered in relation to the basic financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
ERNST & YOUNG LLP
Los Angeles, California
March 22, 1999
55
58
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
------------------------
1998 1997
---------- ----------
(THOUSANDS OF DOLLARS)
ASSETS
Securities available for sale at fair value:
Fixed maturity investments (cost: 1998 -- $1,597,585;
1997 -- $1,835,086)..................................... $1,646,772 $1,893,876
Non-redeemable preferred stock (cost: 1998 -- $489,714;
1997 -- $356,223)....................................... 500,376 378,832
---------- ----------
Total securities available for sale................ 2,147,148 2,272,708
Loans receivable............................................ 2,958,176 1,983,687
Short-term investments...................................... 222,719 164,626
Other investments........................................... 16,890 5,479
---------- ----------
TOTAL INVESTMENTS AND LOANS........................ 5,344,933 4,426,500
Cash........................................................ 79,875 64,987
Accrued investment income................................... 44,038 42,038
Premiums receivable and agents' balances.................... 184,355 146,144
Reinsurance recoverable on paid losses...................... 15,801 20,287
Reinsurance recoverable on unpaid losses.................... 829,002 522,928
Deferred policy acquisition costs........................... 44,996 38,014
Costs in excess of net assets acquired...................... 164,467 149,321
Deferred income taxes....................................... 145,410 148,757
Other assets................................................ 273,157 275,144
Assets held for discontinued operations..................... 243,578 256,507
---------- ----------
TOTAL ASSETS....................................... $7,369,612 $6,090,627
========== ==========
LIABILITIES
Claims and policy liabilities:
Losses and loss adjustment expenses....................... $2,298,118 $2,163,323
Life insurance benefits and liabilities................... 136,973 180,976
Unearned premiums......................................... 119,774 78,625
Dividends to policyholders................................ 16,162 37,626
---------- ----------
TOTAL CLAIMS AND POLICY LIABILITIES................ 2,571,027 2,460,550
Reinsurance premiums payable and funds withheld............. 46,124 13,049
Other liabilities........................................... 277,938 250,877
Thrift deposits............................................. 2,134,839 1,492,985
Short-term debt............................................. 165,702 26,290
Long-term debt.............................................. 913,006 691,068
Liabilities of discontinued operations...................... 210,064 222,993
---------- ----------
TOTAL LIABILITIES.................................. 6,318,700 5,157,812
Commitments and contingencies
Company-obligated mandatorily redeemable preferred
securities of subsidiary Trust holding solely Company
junior subordinated debentures............................ 100,000 100,000
STOCKHOLDERS' EQUITY
Common Stock, par value $1 per share -- Authorized:
150,000,000 shares;
Issued and outstanding: (1998 -- 69,939,000 and
1997 -- 34,571,000)..................................... 69,939 34,571
Additional paid-in capital.................................. 308,369 323,065
Retained earnings........................................... 620,612 508,533
Deferred compensation....................................... (86,910) (86,263)
Accumulated other comprehensive income...................... 38,902 52,909
---------- ----------
TOTAL STOCKHOLDERS' EQUITY......................... 950,912 832,815
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY......... $7,369,612 $6,090,627
========== ==========
See notes to consolidated financial statements.
56
59
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
----------------------------------------------
1998 1997 1996
-------------- ------------ ------------
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
REVENUES
Property and casualty premiums earned..................... $ 552,078 $601,183 $486,860
Loan interest............................................. 234,828 194,412 163,765
Net investment income..................................... 192,815 149,729 123,531
Realized investment losses................................ (605) (1,964) (1,658)
Other revenue............................................. 58,481 30,935 23,306
---------- -------- --------
TOTAL REVENUES.................................. 1,037,597 974,295 795,804
EXPENSES
Losses and loss adjustment expenses....................... 335,450 389,201 335,407
Policy acquisition costs.................................. 123,393 115,899 96,177
Provision for loan losses................................. 11,059 12,319 13,885
Other operating costs and expenses........................ 205,481 150,847 107,260
Dividends to policyholders................................ 4,735 4,734 --
Interest expense.......................................... 160,767 142,402 114,766
---------- -------- --------
TOTAL EXPENSES.................................. 840,885 815,402 667,495
---------- -------- --------
Income before taxes....................................... 196,712 158,893 128,309
Income tax expense........................................ 63,748 50,601 41,021
---------- -------- --------
NET INCOME...................................... $ 132,964 $108,292 $ 87,288
========== ======== ========
PER SHARE DATA:
Net Income:
Basic................................................... $ 2.09 $ 1.90 $ 1.77
Diluted................................................. 1.90 1.62 1.37
See notes to consolidated financial statements.
57
60
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
----------- ----------- -----------
(THOUSANDS OF DOLLARS)
OPERATING ACTIVITIES
Net income.............................................. $ 132,964 $ 108,292 $ 87,288
Adjustments to reconcile net income to net cash provided
by operating activities:
Change in premiums receivable and agents' balances and
reinsurance recoverable on paid losses............. (21,241) 1,194 4,043
Change in accrued investment income................... (1,871) 3,879 3,602
Change in claims and policy liabilities............... (412,526) (212,274) (211,482)
Amortization of policy acquisition costs.............. 123,393 115,899 96,177
Policy acquisition costs deferred..................... (130,214) (121,004) (93,478)
Provision for deferred income taxes................... 33,583 18,360 24,798
Provision for loan losses............................. 11,059 12,319 13,885
Depreciation and amortization......................... 40,318 33,524 26,592
Net amortization on fixed maturity investments........ (25,991) (20,250) (21,976)
Realized investment losses............................ 605 1,964 1,658
Change in other assets and liabilities................ 50,176 40,145 (27,116)
----------- ----------- -----------
NET CASH USED IN OPERATING ACTIVITIES.............. (199,745) (17,952) (96,009)
INVESTING ACTIVITIES
Securities available for sale:
Purchases of securities............................... (1,122,255) (3,736,527) (1,527,408)
Sales of securities................................... 865,642 3,446,093 1,679,631
Securities matured or called.......................... 389,253 62,288 52,806
Decrease in short-term and other investments............ 275,197 469,559 239,684
Loan originations and bulk purchases funded............. (2,651,041) (980,837) (644,193)
Receipts from repayments and bulk sales of loans........ 1,665,493 672,871 441,311
Acquisition of companies, less cash acquired............ (109,989) (303,033) --
Purchases of property and equipment..................... (33,727) (23,617) (12,035)
----------- ----------- -----------
NET CASH PROVIDED BY (USED IN) INVESTING
ACTIVITIES....................................... (721,427) (393,203) 229,796
FINANCING ACTIVITIES
Proceeds from short-term debt........................... 126,995 -- 14,929
Repayments of short-term debt........................... (13,300) (5,052) (72,191)
Proceeds from long-term debt............................ 298,000 274,260 79,058
Repayments of long-term debt............................ (41,228) (170,750) (111,004)
Net increase in thrift deposits......................... 641,854 378,633 188,040
Annuity contract receipts............................... 714 1,386 132,550
Annuity contract withdrawals............................ (47,288) (32,637) (44,184)
Settlement under life insurance reinsurance
agreements............................................ -- -- (363,415)
Proceeds from sale of Preferred Securities.............. -- -- 100,000
Dividends paid.......................................... (20,476) (17,838) (15,016)
Stock options exercised................................. 1,453 13,129 1,428
Increase in deferred compensation plans................. (10,664) (20,367) (28,163)
----------- ----------- -----------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES....................................... 936,060 420,764 (117,968)
----------- ----------- -----------
INCREASE IN CASH........................................ 14,888 9,609 15,819
Cash at beginning of year............................. 64,987 55,378 39,559
----------- ----------- -----------
CASH AT END OF YEAR................................ $ 79,875 $ 64,987 $ 55,378
=========== =========== ===========
See notes to consolidated financial statements.
58
61
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN RETAINED DEFERRED COMPREHENSIVE
STOCK CAPITAL EARNINGS COMPENSATION INCOME TOTAL
------- ---------- -------- ------------ ------------- --------
(THOUSANDS OF DOLLARS)
Balance at January 1, 1996..... $25,393 $110,103 $347,607 $ (6,612) $ 21,599 $498,090
Net income for 1996.......... -- -- 87,288 -- -- 87,288
Cash dividends to
stockholders.............. -- -- (15,759) -- -- (15,759)
Conversion of LYONs.......... 1,399 29,127 -- -- -- 30,526
Stock options exercised...... 57 (1,654) -- 3,025 -- 1,428
Shares issued or acquired for
employee benefit plans.... 1,244 31,291 -- (64,918) -- (32,383)
Amortization of restricted
stock..................... -- -- -- 5,277 -- 5,277
ESOP shares allocated less
additional shares
purchased................. -- 9 -- 4,210 -- 4,219
Other adjustments............ -- (424) -- (175) -- (599)
Net change in unrealized gain
(loss) on investments, net
of deferred taxes......... -- -- -- -- (18,970) (18,970)
------- -------- -------- -------- -------- --------
Balance at December 31, 1996... 28,093 168,452 419,136 (59,193) 2,629 559,117
Net income for 1997.......... -- -- 108,292 -- -- 108,292
Cash dividends to
stockholders.............. -- -- (18,895) -- -- (18,895)
Conversion of LYONs.......... 5,144 112,051 -- -- -- 117,195
Stock options exercised...... 1,334 21,158 -- 37 -- 22,529
Shares acquired or allocated
for employee benefit
plans..................... -- 8,234 -- (34,207) -- (25,973)
Amortization of restricted
stock..................... -- -- -- 7,536 -- 7,536
ESOP shares allocated........ -- 617 -- 7,043 -- 7,660
Other adjustments............ -- 12,553 -- (7,479) -- 5,074
Net change in unrealized gain
(loss) on investments, net
of deferred taxes......... -- -- -- -- 50,280 50,280
------- -------- -------- -------- -------- --------
Balance at December 31, 1997... 34,571 323,065 508,533 (86,263) 52,909 832,815
Net income for 1998.......... -- -- 132,964 -- -- 132,964
Cash dividends to
stockholders.............. -- -- (20,885) -- -- (20,885)
Two-for-one stock split...... 34,952 (34,952) -- -- -- --
Conversion of LYONs.......... 423 9,224 -- -- -- 9,647
Stock options exercised...... 52 1,557 -- 577 -- 2,186
Retirement of Common Stock... (59) (2,691) -- 2,750 -- --
Shares acquired or allocated
for employee benefit
plans..................... -- 10,157 -- (23,287) -- (13,130)
Amortization of restricted
stock..................... -- -- -- 9,592 -- 9,592
ESOP shares allocated........ -- 3,379 -- 3,906 -- 7,285
Other adjustments............ -- (1,370) -- 5,815 -- 4,445
Net change in unrealized gain
(loss) on investments, net
of deferred taxes......... -- -- -- -- (14,007) (14,007)
------- -------- -------- -------- -------- --------
Balance at December 31, 1998... $69,939 $308,369 $620,612 $(86,910) $ 38,902 $950,912
======= ======== ======== ======== ======== ========
See notes to consolidated financial statements.
59
62
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Fremont General Corporation is a nationwide insurance and financial
services holding company operating select businesses in niche markets. The
insurance business of Fremont ("the Company") includes one of the largest
underwriters of workers' compensation insurance in the nation. The Company's
financial services business includes: commercial and residential real estate
lending; the Company's interest in large commercial loans originated and
serviced by other financial institutions ("syndicated loans"); commercial
working capital lines of credit ("commercial finance") and insurance premium
financing. Real estate lending represents over 68% of loan interest revenues
(1997 -- 64%; 1996 -- 56%) and represents both commercial and residential
lending secured by real estate located primarily in California. Syndicated and
commercial finance accounts for substantially all of the remaining loan interest
revenues and represents asset-based loans to companies nationwide (25% in
California), primarily secured by accounts receivable, inventory, and machinery
and equipment.
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles which, as to the
subsidiary insurance companies, differ from statutory accounting practices
prescribed or permitted by regulatory authorities. The significant accounting
policies followed by the Company that materially affect financial reporting are
summarized below.
Consolidation: The consolidated financial statements include the accounts
and operations, after intercompany eliminations, of Fremont General Corporation
and all subsidiaries. (See Note N for the accounting treatment of discontinued
operations.)
Use of Estimates: The preparation of the financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Investments: Fixed maturity investments represent bonds and redeemable
preferred stocks that mature more than one year after the purchase date.
Non-redeemable preferred stocks are equity securities, the majority of which do
not include adjustable dividend yield provisions.
Premiums and discounts on investments in securities are primarily amortized
using the interest method over the estimated lives of the investments. The
estimated lives of such investments are determined based upon the current
expectations of future cash flows. Adjustments for other-than-temporary market
declines are recorded when determination of loss is probable and is reflected
with a write-down of amortized cost to net realizable value. Short-term
investments are carried at cost, which approximates their fair value. Realized
investment gains and losses are included as a component of revenues based on
specific identification of the investment sold.
Loans: Loans are stated net of unearned income and allowance for possible
loan losses. The allowance is increased by provisions charged against operations
and reduced by loan amounts charged off by management. Allowances for credit
losses are based on discounted cash flows using the loans' effective interest
rate or the fair value of the collateral for collateral dependent loans. The
allowance is maintained at a level considered adequate to provide for inherent
losses on loans based on management's evaluation of the loan portfolio. While
management uses all available information to estimate the level of the allowance
for credit losses, future additions may be necessary based on changes in the
amounts and timing of future cash flows expected due to changes in collateral
values supporting loans, general economic conditions and borrowers' financial
conditions.
Management classifies loans as non-accrual when the collection of future
interest is not assured by the borrower's financial condition and the value of
underlying collateral and guarantees securing the loan. Subsequent collections
on non-accrual loans are applied as a reduction of principal. The Company's
charge-off policy is based on a monthly loan-by-loan review.
60
63
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Loans in process of foreclosure, repossessed assets, and in-substance
foreclosures are included in the financial statements at the lower of cost or
estimated realizable value (net of estimated costs to sell). Estimated
realizable values are based on management's evaluation of numerous factors,
including appraisals, sales of comparable assets and estimated market
conditions.
Furniture and Equipment: Furniture and equipment are included in other
assets and are stated at cost, less accumulated depreciation. Leasehold
improvements are amortized over the terms of the lease. Generally, depreciation
is computed by the straight-line method over periods ranging from two to twelve
years.
Premium Income: Revenues from property and casualty premiums are recognized
proportionately over the terms of the related policies. Direct property and
casualty premiums earned but not billed at the end of each accounting period are
estimated and accrued, and differences between such estimates and final billings
are included in current operations. Premiums receivable and agents' balances and
reinsurance recoverable on paid and unpaid losses include allowances for
doubtful accounts of $8,304,000 and $7,048,000 at December 31, 1998 and 1997,
respectively.
Losses and Loss Adjustment Expenses: The estimated liabilities for losses
and loss adjustment expenses include the accumulation of estimates for losses
and claims reported prior to the balance sheet dates, estimates (based primarily
on projections of historical developments) of claims incurred but not reported
and estimates of expenses for investigating and adjusting all incurred and
unadjusted claims. Amounts reported are estimates of the ultimate costs of
settlement, net of subrogation and salvage recoveries, which are necessarily
subject to the impact of future changes in economic and social conditions.
Management believes that, given the inherent variability in any such estimates,
the aggregate reserves are within a reasonable and acceptable range of adequacy.
Reserves are continually monitored and reviewed, and as settlements are made or
reserves adjusted, differences are included in current operations.
Included in the loss and loss adjustment expense liability recorded on the
consolidated balance sheet at December 31, 1998 and 1997 is $80,547,000 and
$87,013,000, respectively, of workers' compensation accident and health
permanent disability and death reserves which have been discounted at 5%. These
reserves arose from the acquisition in 1995 of Casualty Insurance Company
("Casualty"). The Company has continued the practice previously adopted by
Casualty of discounting permanent disability loss reserves for both statutory
accounting practices and generally accepted accounting principles.
Unearned Premiums: Property and casualty insurance unearned premiums are
calculated using the monthly pro rata basis.
Life Insurance Benefits and Liabilities: Policyholder contract liabilities
for universal life and investment-type products represent the premiums received
plus accumulated interest, less mortality and other administrative charges under
the contracts and before applicable surrender charges. Policy benefits and
claims that are charged to expense include benefit claims incurred in excess of
related policy account balances. (See Note F.)
Deferred Policy Acquisition Costs: Commissions, premium taxes and certain
sales and underwriting expenses are capitalized and amortized as premiums are
earned over the terms of the related property and casualty policies. Anticipated
investment income is considered in determining if premium deficiencies exist.
Dividends to Policyholders: Dividends, if applicable, to policyholders on
workers' compensation insurance contracts are accrued during the period in which
the related premiums are earned.
Thrift Deposits: Thrift deposits consist of certificates of deposit at the
Company's California thrift and loan subsidiary. Such balances are credited with
interest at rates ranging from 2.57% to 8.68% at December 31, 1998. The
estimated fair value of the thrift deposits was $2,138,300,000 at December 31,
1998.
Intangibles: The excess of the costs of acquisitions over net assets
acquired (net of accumulated amortization: 1998 -- $28,282,000;
1997 -- $21,125,000) is being amortized over various periods ranging
61
64
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
primarily from 7 to 25 years, which represents the estimated life of the
intangible assets associated with such acquisitions. Additionally, the trade
names acquired in the acquisitions of Industrial Indemnity Holdings, Inc.
("Industrial") and Casualty (net of accumulated amortization:
1998 -- $3,635,000; 1997 -- $1,571,000) are being amortized over 40 years. (See
Note B regarding intangibles related to acquisitions.)
Credit Risk: Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of temporary cash investments,
fixed maturity securities, preferred stocks, real estate and commercial finance
loans and reinsurance recoverables. The Company places its temporary cash
investments with high credit quality financial institutions and limits the
amounts of credit exposure to any one financial institution. Concentrations of
credit risk with respect to investments in fixed maturities, preferred stocks,
commercial finance loans and syndicated loans are limited due to the large
number of such investments and their distribution across many different
industries and geographic regions. Concentration of credit risk with respect to
thrift and loan finance receivables is limited due to the large number of
borrowers; however, the majority of the thrift and loan finance receivables are
from borrowers within the state of California. To minimize its exposure to
significant losses from reinsurance insolvencies, the Company evaluates the
financial condition of its reinsurers and monitors concentrations of credit risk
arising from similar geographic regions, activities, or economic characteristics
of the reinsurers. As of December 31, 1998, Great Southern Insurance Company,
Reliance Insurance Company and Constitution Reinsurance Corporation were the
only reinsurers that accounted for more than 10% of total reinsurance
recoverables on paid and unpaid losses. The remaining reinsurance recoverables
were spread over 205 reinsurers.
Fair Values of Financial Instruments: The Company uses various methods and
assumptions in estimating its fair value disclosures for financial instruments.
For fixed maturity investments and preferred stocks, fair values are determined
from certain valuation services, as well as from quoted market prices. Loans
receivable with variable rates, as well as thrift deposits for passbook and
money market type accounts, are deemed to be at fair value. The fair values of
thrift certificates of deposits, real estate loans and other fixed rate loans
are estimated using discounted cash flow analyses, using interest rates
currently being offered for similar accounts or loans to borrowers with similar
credit ratings.
For short-term debt, the carrying amount of the Company's borrowings
approximates fair value. The fair value of the Company's long-term debt and
mandatorily redeemable preferred securities of a subsidiary Trust is based on
quoted market prices for securities actively traded. For long-term debt not
actively traded, and for bank borrowings, the fair value is estimated using
discounted cash flow analyses, based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements.
62
65
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The carrying amounts and fair values of the Company's financial instruments
at December 31, 1998 are summarized in the following table:
ESTIMATED
CARRYING FAIR
AMOUNT VALUE
---------- ----------
(THOUSANDS OF DOLLARS)
ASSETS
Fixed maturity investments (Note C)......................... $1,646,772 $1,646,772
Non-redeemable preferred stock (Note C)..................... 500,376 500,376
Loans receivable (Note D)................................... 2,958,176 2,983,364
LIABILITIES
Thrift deposits (Note A).................................... 2,134,839 2,138,300
Short-term debt (Note H).................................... 165,702 165,702
Long-term debt (Note I)..................................... 913,006 918,535
Company-obligated mandatorily redeemable preferred
securities of subsidiary Trust holding solely Company
junior subordinated debentures (Note J)................... 100,000 104,500
Insurance related financial instruments, other than those classified as
investment contracts, are exempt from fair value disclosure requirements. The
carrying amount of reinsurance paid recoverables approximates their fair value
as they are expected to be realized within one year.
Reclassifications: Certain 1997 and 1996 amounts have been reclassified to
conform to the 1998 presentation.
NOTE B -- ACQUISITION
On September 1, 1998, the Company completed the acquisition of Unicare
Specialty Services, Inc., ("Unicare") the workers' compensation insurance
subsidiary of WellPoint Health Networks Inc., one of the nation's largest
publicly traded managed care companies, for $110 million in cash. At acquisition
date, Unicare's assets approximated $425 million, including $348 million in
investment securities. Liabilities assumed approximated $332 million, including
$293 million of loss reserves. The purchase price included $17 million of costs
in excess of net assets acquired that is being amortized over 25 years.
Unicare's operating results are included in the Company's consolidated statement
of income from the date of acquisition. The impact of the Unicare acquisition on
the Company's results of operations for the year ended December 31, 1998 was not
material.
On August 1, 1997, the Company completed the acquisition of Industrial
Indemnity Holdings, Inc. ("Industrial") from Talegen Holdings, Inc., a
subsidiary of Xerox Corporation ("Talegen"). Industrial specializes in
underwriting workers' compensation insurance with a strong presence in the
western United States dating back over 70 years. The acquisition was treated as
a purchase for accounting purposes. The adjusted purchase price paid by the
Company consisted of $355 million in cash and $9.5 million in acquisition costs
bringing the total cost of the acquisition to $364.5 million. Additionally,
pursuant to the terms of the acquisition agreement, the Company paid off a $79
million outstanding debt obligation that Industrial owed to Talegen. The
purchase price included $92.7 million of costs in excess of net assets acquired
that is being amortized over 25 years and approximately $61.8 million of an
intangible asset for the trade name that is being amortized over 40 years.
The operating results of Industrial are included in the Company's
consolidated statement of income from the date of acquisition. The following
unaudited pro forma consolidated data present operating results of the Company
as if the acquisition of Industrial had occurred January 1, 1997 and 1996,
respectively. The pro
63
66
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
forma results are not intended to be indicative of the consolidated results of
operations that would have been reported if the acquisition had occurred at the
dates indicated or of the consolidated results of future operations.
YEAR ENDED DECEMBER 31,
------------------------
1997 1996
-------- --------
(MILLIONS OF DOLLARS,
EXCEPT PER SHARE DATA)
Revenues.................................................... $1,168 $1,100
Net income.................................................. 114 92
Per share data:
Net income
Basic..................................................... $ 2.00 $ 1.87
Diluted................................................... 1.71 1.44
NOTE C -- INVESTMENTS
The amortized cost and fair values of the fixed maturity investments and
non-redeemable preferred stock by major category are summarized in the following
table:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
(THOUSANDS OF DOLLARS)
At December 31, 1998
United States Treasury securities and
obligations of other US government
agencies and corporations............... $ 87,615 $ 1,773 $ 60 $ 89,328
Obligations of states and political
subdivisions............................ 240,067 7,155 -- 247,222
Redeemable preferred stock................. 38,035 271 -- 38,306
Mortgage-backed securities................. 355,747 14,553 1,054 369,246
Corporate securities
Financial............................... 275,335 11,383 4,101 282,617
Transportation.......................... 27,211 2,938 -- 30,149
Industrial.............................. 573,575 34,751 18,422 589,904
---------- ------- ------- ----------
Total.............................. 1,597,585 72,824 23,637 1,646,772
Non-redeemable preferred stock............. 489,714 17,185 6,523 500,376
---------- ------- ------- ----------
Total.............................. $2,087,299 $90,009 $30,160 $2,147,148
========== ======= ======= ==========
64
67
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
(THOUSANDS OF DOLLARS)
At December 31, 1997
United States Treasury securities and
obligations of other US government
agencies and corporations............... $ 165,847 $ 2,972 $ 31 $ 168,788
Obligations of states and political
subdivisions............................ 99,876 2,023 -- 101,899
Redeemable preferred stock................. 27,618 732 -- 28,350
Mortgage-backed securities................. 560,015 15,356 11 575,360
Corporate securities
Banks................................... 9,374 199 -- 9,573
Financial............................... 373,630 16,939 1,570 388,999
Transportation.......................... 7,139 2,131 -- 9,270
Industrial.............................. 591,587 25,801 5,751 611,637
---------- ------- ------- ----------
Total.............................. 1,835,086 66,153 7,363 1,893,876
Non-redeemable preferred stock............. 356,223 22,758 149 378,832
---------- ------- ------- ----------
Total.............................. $2,191,309 $88,911 $ 7,512 $2,272,708
========== ======= ======= ==========
The amortized cost and fair value of fixed maturity investments at December
31, 1998 by contractual maturity, are summarized in the following table:
AMORTIZED FAIR
COST VALUE
---------- ----------
(THOUSANDS OF DOLLARS)
One year or less.......................................... $ 30,773 $ 30,816
Over 1 year through 5 years............................... 99,845 100,909
Over 5 years through 10 years............................. 611,549 626,000
Over 10 years............................................. 499,671 519,801
Mortgage-backed securities................................ 355,747 369,246
---------- ----------
Totals.......................................... $1,597,585 $1,646,772
========== ==========
The contractual maturities in the foregoing table may differ from actual
maturities because certain borrowers have the right to sell or repay obligations
with or without call or prepayment penalties.
Proceeds from sales of securities and related realized gains and losses are
summarized in the following table:
YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
-------- ---------- ----------
(THOUSANDS OF DOLLARS)
Proceeds from sales............................. $865,642 $3,446,093 $1,679,631
Gross realized gains............................ 7,469 51,413 10,012
Gross realized losses........................... 8,074 53,377 11,670
65
68
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Investment income by major category of investments is summarized in the
following table:
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
(THOUSANDS OF DOLLARS)
Fixed maturities................................... $144,158 $111,798 $ 85,352
Non-redeemable preferred stock..................... 34,976 29,343 25,545
Short-term......................................... 16,061 10,804 14,646
Other.............................................. 324 299 147
-------- -------- --------
195,519 152,244 125,690
Investment expenses................................ 2,704 2,515 2,159
-------- -------- --------
Net investment income.................... $192,815 $149,729 $123,531
======== ======== ========
The Company relies on external rating agencies to establish quality ratings
for its investments. The Company only purchases securities that are rated
investment grade by at least one rating agency, but may hold investments that
are subsequently downgraded to non-investment grade. As of December 31, 1998,
all investments held by the Company are current as to principal and interest,
with no investment in default. Included in investments is $28,158,000 of fixed
maturity investments and $91,465,000 of non-redeemable preferred stock of
Citigroup Inc. and its subsidiaries, that in total exceeds 10% of stockholders'
equity at December 31, 1998. Using Standard and Poor's, Moody's, Duff and Phelps
and Fitch's rating services, the quality mix of the Company's investment
portfolio at December 31, 1998 is summarized in the following table:
AAA (including US government obligations)................... 32%
AA.......................................................... 15
A........................................................... 30
BBB......................................................... 19
BB.......................................................... 4
---
100%
===
The par value of fixed maturity investments and cash totaling
$1,364,680,000 at December 31, 1998 were on deposit with regulatory authorities
in compliance with legal requirements related to the insurance operations.
The Company currently holds no derivative financial instruments.
NOTE D -- LOANS RECEIVABLE
Loans receivable consist of commercial and residential real estate loans,
syndicated loans, commercial finance loans and insurance premium notes
receivable. Commercial and residential real estate loans are secured by real
property. Syndicated loans represent the Company's interest in large commercial
loans originated and serviced by other financial institutions. Commercial
finance loans are asset-based loans that are secured by the borrowers' eligible
trade accounts receivable, inventory, machinery and equipment, and real estate.
Insurance premium notes receivable are collateralized by security interests in
return premiums.
Commercial and residential real estate loans have terms ranging from one to
thirty years. Finance charges are recognized as revenue over the life of the
loan using the interest method. Loan origination fees and the related costs are
deferred and amortized over the life of the loan using the interest method. The
loans are net of allowance for possible loan losses of $40,097,000 and
$32,966,000 at December 31, 1998, and 1997, respectively. Included in loans
receivable are real estate loans which have been placed on non-accrual status
totaling $20,851,000 and $24,139,000 at December 31, 1998 and 1997,
respectively. Real estate acquired in foreclosure, which is classified under
other assets, totaled $3,848,000 and $8,021,000 at December 31, 1998
66
69
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and 1997, respectively, and is recorded at the lower of the carrying value of
the loan or the estimated fair value less disposal costs.
Commercial finance loans are stated at the unpaid balance of cash advanced
net of allowance for possible loan losses of $8,983,000 and $7,723,000 at
December 31, 1998 and 1997, respectively. The amount of cash advanced under
these loans is based on stated percentages of the borrowers' eligible
collateral. Interest on the commercial loans is computed on the basis of daily
outstanding balances times the contractual interest rate and is reported as
earned income on the accrual method. Total loan balances on which income
recognition has been suspended were $1,669,000 (six loans) and $7,386,000 (seven
loans) at December 31, 1998 and 1997, respectively.
Syndicated loans are variable rate senior loans originated on both a
revolving and fixed-term basis, generally not in excess of ten years. These
loans are secured by various assets of the borrower, and, if applicable, of its
subsidiaries. The loans are net of allowance for possible loan losses of
$6,798,000 and $3,338,000 at December 31, 1998 and 1997, respectively. There
were no syndicated loans on non-accrual status at either December 31, 1998 or
1997.
Insurance premium notes receivable mature within one year. Interest income
on these notes is recognized using the rule-of-seventy-eight method which
results in approximately level interest rate yield over the life of the notes.
Activity in the allowance for possible loan losses is summarized in the
following table:
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
------- ------- --------
(THOUSANDS OF DOLLARS)
Balance, beginning of year........................... $44,402 $37,747 $ 31,781
Provision for loan losses............................ 11,059 12,319 13,885
Recoveries........................................... 839 1,294 1,394
Charge-offs.......................................... (3,419) (6,958) (11,143)
Reserves established with portfolio acquisitions..... 3,465 -- 1,830
------- ------- --------
Balance, end of year................................. $56,346 $44,402 $ 37,747
======= ======= ========
At December 31, 1998, the recorded investment in loans that are considered
to be impaired was $22,520,000, 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 collectibility 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 reserve for credit losses allocated to them.
However, $19,711,000 of loans considered impaired do have an allowance that
totaled $2,582,000. The average net investment in impaired loans was
$25,373,000, $27,391,000 and $26,833,000 for 1998, 1997 and 1996, respectively.
Interest income of $1,401,000 has been recognized on the cash basis of
accounting on loans classified as impaired during the year ended December 31,
1998.
67
70
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The carrying amounts at December 31, 1998 and 1997 and estimated fair
values at December 31, 1998 of loans receivable are summarized in the following
table:
1998 1997
------------------------ ----------
CARRYING ESTIMATED CARRYING
AMOUNT FAIR VALUE AMOUNT
---------- ---------- ----------
(THOUSANDS OF DOLLARS)
Commercial and residential real estate loans... $2,116,910 $2,142,098 $1,433,977
Commercial finance loans....................... 493,804 493,804 402,987
Syndicated loans............................... 362,238 362,238 147,885
Premium finance loans.......................... 58,225 58,225 54,257
---------- ---------- ----------
3,031,177 3,056,365 2,039,106
Purchase discount and deferred fees............ (16,655) (16,655) (11,017)
Allowance for possible loan losses............. (56,346) (56,346) (44,402)
---------- ---------- ----------
Loans receivable, net.......................... $2,958,176 $2,983,364 $1,983,687
========== ========== ==========
NOTE E -- CLAIM LIABILITIES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of the beginning and ending
reserve balances for the Company's claim liabilities for losses and loss
adjustment expenses ("LAE") on a net-of-reinsurance basis to the gross amounts
reported in the Company's consolidated balance sheets.
YEAR ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
(THOUSANDS OF DOLLARS)
Reserves for losses and LAE, net of reinsurance
recoverable, at beginning of year.................... $1,809,395 $1,010,886 $1,185,706
Incurred losses and LAE:
Provision for insured events of the current year, net
of reinsurance.................................... 348,897 441,524 334,657
Increase (decrease) in provision for insured events
of prior years, net of reinsurance................ (13,447) (52,323) 750
---------- ---------- ----------
Total incurred losses and LAE..................... 335,450 389,201 335,407
Payments:
Losses and LAE, net of reinsurance, attributable to
insured events of:
Current year...................................... (245,177) (253,323) (108,247)
Prior years....................................... (590,197) (386,469) (401,980)
---------- ---------- ----------
Total payments.................................. (835,374) (639,792) (510,227)
---------- ---------- ----------
Subtotal..................................... 1,309,471 760,295 1,010,886
Liability for losses and LAE for companies acquired
during the year...................................... 287,645 1,049,100 --
---------- ---------- ----------
Reserves for losses and LAE, net of reinsurance
recoverable, at end of year.......................... 1,597,116 1,809,395 1,010,886
Reinsurance recoverable for losses and LAE, at end of
year................................................. 701,002 353,928 245,459
---------- ---------- ----------
Reserves for losses and LAE, gross of reinsurance
recoverable, at end of year.......................... $2,298,118 $2,163,323 $1,256,345
========== ========== ==========
In 1998, Fremont decreased its losses and LAE reserves for 1997 and prior
accident years by $13.4 million. This decrease resulted primarily from the
combined effects of a decrease in 1997 and prior accident year losses and LAE
reserves under certain assigned risk plans that the Company is required to
68
71
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
participate in, and an increase in the discount established for certain accident
and health permanent disability and death reserves. In 1997, the Company
decreased its losses and LAE reserves for 1996 and prior accident years by $52.3
million. This reserve decrease relates primarily to loss and LAE reserves on
workers' compensation policies written in the Company's mid-west region and
represents the recognition of a decrease in the frequency of reported claims on
the 1996 and 1995 accident years. Additionally, the Company's management
believes that its implementation of more effective claims handling procedures in
the mid-west region has contributed to the reduction in LAE reserves during
calendar year 1997 and relating to the 1996 and prior accident years. The
Company is not able to determine with certainty the specific cause or causes of
increases and decreases in claims experience that led to these changes in
reserves but has reached its own conclusion based on a review of its internal
data and a subjective evaluation of external factors. In 1996 there was
relatively insignificant aggregate development on prior accident years.
NOTE F -- REINSURANCE
In the normal course of business, the Company seeks to reduce the loss that
may arise from catastrophes or other events that cause unfavorable underwriting
results by reinsuring certain levels of risk in various areas of exposure with
other insurance enterprises or reinsurers. Amounts recoverable from reinsurers
are estimated in a manner consistent with the claim liability associated with
the reinsured policy.
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. The failure of reinsurers to honor their obligations could result
in losses to the Company; consequently, allowances are established for amounts
deemed uncollectible. The Company evaluates the financial condition and economic
characteristics of its reinsurers to minimize its exposure to significant losses
from reinsurer insolvencies.
The effect of ceded reinsurance on property and casualty premiums are
summarized in the following table:
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
1998 1997 1996
------------------- ------------------- -------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
-------- -------- -------- -------- -------- --------
(THOUSANDS OF DOLLARS)
Direct............................. $750,301 $717,021 $611,211 $591,506 $462,881 $470,111
Assumed............................ 11,848 13,040 19,647 23,650 18,839 25,075
Ceded.............................. 190,473 177,983 9,766 13,973 7,536 8,326
-------- -------- -------- -------- -------- --------
Net property and casualty
premiums...................... $571,676 $552,078 $621,092 $601,183 $474,184 $486,860
======== ======== ======== ======== ======== ========
The effect of ceded reinsurance on losses and loss adjustment expenses was
a decrease in expenses of $371,378,000, $14,167,000 and $13,617,000 for the
three years ended December 31, 1998, 1997 and 1996, respectively.
The Company entered into reinsurance and assumption agreements with a
reinsurer whereby substantially all of the Company's universal life insurance
and annuity business was ceded to the reinsurer effective December 31, 1995, and
all the annuity business was ceded to the reinsurer effective January 1, 1996.
As a result of these agreements, the Company's life insurance operations have
been substantially reduced with no significant gain or loss recorded. Included
in life insurance benefits and liabilities and reinsurance recoverable on unpaid
losses in the accompanying balance sheet is approximately $128,000,000 related
to one of the reinsurance contracts that continues to be on a co-insurance
basis.
69
72
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE G -- INCOME TAXES
The major components of income tax expense are summarized in the following
table:
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
------- ------- -------
(THOUSANDS OF DOLLARS)
Federal income tax
Current............................................. $27,314 $29,225 $13,233
Deferred............................................ 33,583 18,360 24,798
------- ------- -------
60,897 47,585 38,031
State income tax...................................... 2,851 3,016 2,990
------- ------- -------
Total income tax provision.......................... $63,748 $50,601 $41,021
======= ======= =======
A reconciliation of the effective federal tax rates in the consolidated
statements of income with the prevailing federal income tax rate of 35% is
summarized in the following table:
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
------- ------- -------
(THOUSANDS OF DOLLARS)
Federal income tax at 35%............................. $68,849 $55,613 $44,908
Effects of:
Dividends received deduction........................ (8,857) (5,654) (6,238)
Dividends in stock-based deferred compensation...... (795) (785) (357)
Amortization of costs in excess of net assets
acquired......................................... 3,085 1,810 1,269
Reduction in prior years' tax liabilities........... -- (2,336) --
Other............................................... (1,385) (1,063) (1,551)
------- ------- -------
Federal income tax provision.......................... $60,897 $47,585 $38,031
======= ======= =======
In 1997, the Company reversed $2,336,000 of a previously accrued amount as
a result of the expected favorable resolution of certain tax matters. Net
payments made (net cash received) for federal and state income taxes were
$187,540, $(7,876,000), and $778,000 for 1998, 1997 and 1996, respectively.
70
73
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 as of December 31, 1998 and 1997 are summarized in the
following table:
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(THOUSANDS OF DOLLARS)
Discount on liabilities for losses and loss adjustment
expenses.................................................. $106,120 $116,350
Accrued expenses............................................ 29,256 30,152
Allowance for possible loan losses and other doubtful
accounts.................................................. 25,861 23,200
Employee benefit expenses................................... 19,171 18,352
Unearned premiums........................................... 12,424 11,365
Dividends to policyholders.................................. 3,099 9,374
Other, net.................................................. 3,345 1,448
-------- --------
Deferred income tax asset amounts...................... 199,276 210,241
Net unrealized gain on investments.......................... (20,947) (28,489)
Deferred policy acquisition costs........................... (15,568) (13,301)
Earned but unbilled premiums................................ (10,390) (12,294)
Deferred loan origination costs............................. (5,526) (6,113)
Accrual of market discount.................................. (1,435) (1,287)
-------- --------
Deferred income tax liability amounts.................. (53,866) (61,484)
-------- --------
Net deferred income tax asset.......................... $145,410 $148,757
======== ========
The Company's principal deferred tax assets arise due to the discounting of
liabilities for losses and loss adjustment expenses ("loss reserves") which
delays a portion of the loss reserve deduction for income tax purposes, the
provision for doubtful loan accounts, the accrual of dividends to policyholders,
a portion of the unearned premiums, certain accrued expenses, and certain
employee benefit expenses.
In the Company's opinion, the deferred tax assets will be fully realized
and no valuation allowance is necessary because the Company has the ability to
generate sufficient future taxable income in both the insurance and financial
services segments to realize the tax benefits.
NOTE H -- SHORT-TERM DEBT
Short-term debt is summarized in the following table:
DECEMBER 31,
-----------------------
1998 1997
---------- ---------
(THOUSANDS OF DOLLARS)
Federal Home Loan Board of San Francisco ("FHLB") borrowings
of a subsidiary (weighted average interest rate;
1998 -- 4.83%)............................................ $115,000 $ --
Asset backed commercial paper facility of a subsidiary,
maturity dates through January 4, 1999 (weighted average
interest rate, 1998 -- 5.30%; 1997 -- 6.57%).............. 24,985 12,990
Current portion of long-term debt........................... 25,717 13,300
-------- -------
$165,702 $26,290
======== =======
At December 31, 1998, the thrift and loan subsidiary had a borrowing
capacity with the FHLB of $474 million. This subsidiary has pledged certain
loans to secure any borrowings which are available at varying rates and terms.
The commercial finance subsidiary has liquidity lines of credit totaling
$20,000,000. Interest
71
74
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
is based on the prime lending rate. The lines are renewable annually, and there
were no outstanding advances under these lines of credit at December 31, 1998.
NOTE I -- LONG-TERM DEBT
Long-term debt is summarized in the following table:
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(THOUSANDS OF DOLLARS)
Fremont General Corporation
$400 million Senior Credit Facility....................... $300,000 $240,000
Liquid Yield Option Notes due 2013, less discount
(1998 -- $7,118; 1997 -- $18,976)...................... 6,409 15,525
Note Payable due 2002..................................... 6,554 8,583
Subsidiaries:
$450 million Senior Credit Facility....................... 351,500 166,000
Variable Rate Asset Backed Certificates................... 274,260 274,260
-------- --------
938,723 704,368
Less current portion...................................... 25,717 13,300
-------- --------
$913,006 $691,068
======== ========
In August 1997, the Company amended and restated an agreement on a
$400,000,000 Senior Credit Facility with several banks. Borrowings and
repayments are a minimum of $5,000,000 at the option of the Company until the
maturity date in August 2002. Interest is based on, at the Company's option, the
higher of the Federal Funds rate plus 1/2% or the banks' prime lending rate,
Eurodollar rates plus an applicable margin or by competitive bids by the banks.
All applicable margins are based on the Company's credit rating. The weighted
average interest rate at December 31, 1998 on the outstanding balance of
$300,000,000 was 5.76%. A facility fee ranging from .125% to .300%, dependent on
the Company's credit rating, is charged on the total facility. The facility fee
rate during 1998 was .175%. The stock of a subsidiary insurance holding company
has been pledged as collateral for this loan.
During July 1994, the Fremont General Employee Stock Ownership Plan
("ESOP") borrowed $11,000,000 (see Note L) from a bank due in seven equal annual
installments commencing on April 1, 1996. The maximum principal amount of this
loan was increased to $15 million in August, 1995 and the term was extended to
April 1, 2002. The Note Payable due 2002 is secured by certain shares of the
ESOP and the interest and principal payments are guaranteed by the Company.
Interest is based on, at the Company's option, the bank's prime lending rate,
LIBOR plus 1%, or an applicable certificate of deposit rate. The interest rate
at December 31, 1998 was 6.47% .
In 1993, the Company sold in a public offering an aggregate $373,750,000
principal amount at maturity of Liquid Yield Option Notes due October 12, 2013
(Zero Coupon-Subordinated) (the "LYONs") at an issue price of $372.42 for a
total net proceeds to the Company of approximately $135,000,000. The yield to
maturity is 5% with no periodic payments of interest. Each LYON is convertible
into 38.5735 shares of the Company's Common Stock and is non-callable for five
years. Holders converted aggregate principal amounts of $20,974,000,
$266,744,000 and $72,505,000 of LYONs into 809,000, 10,289,000 and 2,797,000
shares of the Company's Common Stock during 1998, 1997 and 1996, respectively.
The Variable Rate Asset Backed Certificates reflect the sale of
certificates pursuant to an asset securitization program established by the
commercial finance subsidiary of the Company in 1993. As of December 31, 1998,
an aggregate $235 million of senior series and $39 million of subordinated
series of term
72
75
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
asset-backed certificates were outstanding. The interest rate on the
certificates, set monthly, ranged from LIBOR plus 0.23% to LIBOR plus 0.95% at
December 31, 1998. The securities issued in this program have a scheduled
maturity of two to four years but could mature earlier depending on fluctuations
in the outstanding balances of loans in the portfolio and other factors.
The commercial finance subsidiary also has an agreement for a committed
unsecured bank line of credit that presently permits borrowings of up to $438
million. The total commitment includes a revolving credit facility of $350
million expiring June 2002 and a term loan of $88 million maturing July 2001.
The balance outstanding at December 31, 1998 of the revolving credit facility
and the term loan was $264 million and $88 million, respectively, with a
weighted average interest rate of 5.74%.
The carrying amounts and the estimated fair values of long-term borrowings
at December 31, 1998 are summarized in the following table:
CARRYING ESTIMATED
AMOUNT FAIR VALUE
-------- ----------
(THOUSANDS OF DOLLARS)
$400 million Senior Credit Facility......................... $300,000 $300,000
LYONs....................................................... 6,409 11,938
Note Payable due 2002....................................... 6,554 6,554
$450 million Senior Credit Facility......................... 351,500 351,500
Variable Rate Asset Backed Certificates..................... 274,260 274,260
-------- --------
Total long-term borrowings........................ $938,723 $944,252
======== ========
The aggregate amount of maturities on long-term debt and sinking fund
requirements are summarized in the following table (thousands of dollars):
1999.............................................. $ 25,717
2000.............................................. 270,446
2001.............................................. 158,946
2002.............................................. 477,205
2003.............................................. --
Thereafter........................................ 6,409
--------
$938,723
========
Total interest payments on short-term and long-term debt were $151,411,000,
$125,048,000, and $101,515,000 in 1998, 1997 and 1996, respectively.
NOTE J -- COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF
SUBSIDIARY TRUST HOLDING SOLELY COMPANY JUNIOR SUBORDINATED DEBENTURES
In 1996, Fremont General Financing I, a statutory business trust (the
"Trust") and consolidated wholly-owned subsidiary of the Company, sold $100
million of 9% Trust Originated Preferred Securities(SM) ("the Preferred
Securities") in a public offering. The Preferred Securities represent preferred
undivided beneficial interests in the assets of the Trust. The proceeds from the
sale of the Preferred Securities were invested in 9% Junior Subordinated
Debentures of the Company ("the Junior Subordinated Debentures"). The Junior
Subordinated Debentures are the sole asset of the Trust.
The Preferred Securities will be redeemed upon maturity of the Junior
Subordinated Debentures in 2026, subject to the election available to the
Company to extend the maturity up to 2045, and they may be redeemed, in whole or
in part, at any time on or after March 31, 2001 and under certain specified
circumstances.
73
76
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Junior Subordinated Debentures rank pari passu with the Company's
$13,527,000 million aggregate principal amount at maturity of LYONs due 2013,
and subordinate and junior to all senior indebtedness of the Company. (See Note
I.) 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 the Company to the extent that the Trust has funds available to
make such payments. Trust distributions of $9,000,000 in 1998 and 1997,
respectively and $7,375,000 in 1996 were included in interest expense. The
Company has provided for back-up undertakings that, considered together,
constitute a full and unconditional guarantee by the Company of the Trust's
obligations under the Preferred Securities.
NOTE K -- STOCKHOLDERS' EQUITY AND RESTRICTIONS
The Company is authorized to issue up to 2,000,000 shares of $.01 par value
Preferred Stock; however, none has been issued to date.
On November 12, 1998, the Board of Directors approved a two-for-one stock
split of its Common Stock, payable December 10, 1998 to stockholders of record
on November 20, 1998.
During 1996, the Company issued 2,602,000 common shares with a fair value
of approximately $33 million to fund stock-based compensation programs. (See
Note L.)
Consolidated stockholders' equity is restricted by the provisions of
certain long-term debt agreements. At December 31, 1997, the most restrictive
loan covenants require the Company to maintain total stockholders' equity of at
least $475,000,000 before FASB 115 adjustments.
The Company has a stock option plan for the benefit of certain key members
of management. Under the plan, up to 5,362,000 shares are allocable to
participants. Options are granted at exercise prices not less than the fair
value of the stock on the date of grant. Grantees vest at the rate of 25% per
year beginning on the first anniversary of the grant and expire after ten years.
The Company has elected to continue following Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" for measuring
compensation cost and to adopt the additional disclosure provisions of FASB
Statement No. 123 ("FASB 123") "Accounting for Stock-Based Compensation." Pro
forma net income, basic and diluted earnings per share data for the year ended
December 31, 1998, calculated as if the recognition and measurement provisions
of FASB 123 had been adopted, would have been $131,679,000, $2.07 and $1.88,
respectively, compared to reported net income, basic and diluted earnings per
share of $132,964,000, $2.09 and $1.90, respectively. For the year ended
December 31, 1997, the pro forma effect would have increased compensation
expense by $1,127,000 and reduced both basic and diluted earnings per share by
$.02. For 1996, the pro forma effect would have increased compensation expense
with no effect on earnings per share. The pro forma effects are not likely to be
representative of the effects on reported net income for future years because
FASB 123 has not been applied to options granted prior to January 1, 1995.
The Black-Scholes option pricing method was used to value the options as of
the grant date with the following assumptions: risk-free interest rate of 5.68%;
expected life of 7 years; expected volatility of 23% and expected dividend yield
of 1.13%.
74
77
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The stock option activity is summarized in the following table:
WEIGHTED AVERAGE
NUMBER OF SHARES EXERCISE PRICE
---------------- ----------------
Outstanding at January 1, 1996....................... 3,600,084 $5.21
Exercised.......................................... (340,436) 4.01
Forfeited.......................................... (78,706) 7.08
----------
Outstanding at December 31, 1996..................... 3,180,942 5.29
Granted............................................ 1,692,000 14.90
Exercised.......................................... (2,670,194) 4.92
----------
Outstanding at December 31, 1997..................... 2,202,748 13.12
Exercised.......................................... (133,318) 10.90
Forfeited.......................................... (228,572) 14.08
----------
Outstanding at December 31, 1998..................... 1,840,858 13.16
==========
The exercise prices of the option shares outstanding at December 31, 1998
range from $4.44 to $14.94. The weighted average remaining contractual life is
approximately five and one-half years for the 417,858 option shares that range
from $4.44 to $7.84 per share and eight years for the 1,423,000 option shares
that range from $14.00 to $14.94 per share.
The number of shares exercisable at the end of the year and related
weighted average exercise prices are summarized in the following table:
DECEMBER 31,
----------------------------------
1998 1997 1996
-------- -------- ----------
Shares exercisable................................ 757,482 320,178 2,716,318
Related weighted average exercise price........... $ 10.80 $ 7.14 $ 4.93
The portion of the consolidated stockholders' equity represented by the
Company's investment in its insurance subsidiaries and its thrift and loan
subsidiary is subject to various laws and regulations, whereby amounts available
for payment of dividends are restricted. Retained earnings and additional
paid-in capital of the property and casualty companies currently available for
dividend distribution is $235,342,000. No dividends are currently available from
the thrift and loan subsidiary.
Net income and stockholders' equity of domestic insurance subsidiaries, as
filed with regulatory authorities on the basis of statutory accounting
practices, are summarized in the following table:
1998 1997 1996
-------- -------- --------
(THOUSANDS OF DOLLARS)
Statutory net income for the year.................. $100,780 $113,058 $122,988
Statutory stockholder's equity at year end......... 665,262 567,470 438,203
As of January 1, 1998, the Company adopted Financial Accounting Standards
Board Statement No. 130 ("FASB 130"), "Reporting Comprehensive Income." This new
standard establishes new rules for the reporting of comprehensive income and its
components; however, the adoption of this standard had no impact on the
Company's net income or stockholders' equity. FASB 130 requires unrealized gains
or losses on the Company's securities available-for-sale to be included in other
comprehensive income. Prior year financial statements have been reclassified to
conform to these requirements.
Reclassification adjustments avoid double counting in comprehensive income
items that are included in comprehensive income and net income in different
periods. The reclassification adjustment for the year ended December 31, 1998
represents net unrealized gains included in accumulated other comprehensive
income at December 31, 1997. Determination of reclassification adjustments for
1997 and 1996 was not practicable.
75
78
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of total comprehensive income are summarized in the
following table:
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
(THOUSANDS OF DOLLARS)
Net income................................................. $132,964 $108,292 $ 87,288
Other comprehensive income:
Net unrealized gains (losses) on investments, net of tax:
Net change in unrealized gains (losses) during the
period, net of deferred income tax expense (benefit)
(1998 -- $(4,738), 1997 -- $27,074 and
1996 -- $(10,215)).................................. (8,797) 50,280 (18,970)
Less: reclassification adjustment, net of tax
(1998 - $2,805)..................................... (5,210) -- --
-------- -------- --------
Other comprehensive income.......................... (14,007) 50,280 (18,970)
-------- -------- --------
Total comprehensive income................................. $118,957 $158,572 $ 68,318
======== ======== ========
NOTE L -- EMPLOYEE BENEFIT PLANS
The Company sponsors a 401(k) Plan and a leveraged Employee Stock Ownership
Plan ("ESOP"), both of which cover substantially all employees with at least one
year of service. Contribution expense for these plans amounted to $10,536,000,
$10,681,000, and $6,005,000 for 1998, 1997 and 1996, respectively, of which
$4,295,000, $5,844,000 and $3,115,000 related to the ESOP. Cash contributions to
the ESOP, which relate to 1998, 1997 and 1996, were $3,002,000, $2,028,000 and
$3,090,000, respectively. The contributions, which are generally discretionary,
are based on total compensation of the participants.
Shares pledged as collateral under a loan made to the ESOP by a bank (see
Note I) are reported as deferred compensation in the consolidated balance sheet.
The annual contributions made by the Company to the ESOP are used to repay the
loan. As the debt is repaid, shares are released from collateral and are
allocated to participants based on total compensation. Dividends received by the
ESOP on its pledged shares, amounting to $253,000, $325,000 and $391,000 in
1998, 1997 and 1996, respectively, were additionally used to service these
loans. Interest expense was $359,000, $467,000 and $392,000 for 1998, 1997 and
1996, respectively.
In May of 1996, an additional 682,000 shares of the Company's Common Stock
were acquired by the ESOP. Of the 4,813,000 total shares of Company stock owned
by the ESOP at December 31, 1998, 3,985,000 shares are allocated to participants
and 828,000 shares are not allocated to participants and are considered
unearned. Unearned shares acquired prior to January 1, 1993 (264,000 shares as
of December 31, 1998) continue to be accounted for in accordance with the
historical cost approach (AICPA Statement of Position 76-3). Unearned shares
acquired subsequent to December 31, 1992 (564,000 shares as of December 31,
1998) are accounted for in accordance with the current fair value approach
(AICPA Statement of Position 93-6) and are not considered outstanding for
earnings per share purposes. At December 31, 1998, the fair value of the
unearned shares accounted for under the current fair value approach was
$14,203,000.
During 1996, the Company adopted a Restricted Stock Award Plan ("RSAP") for
certain management level employees. The Company purchased an aggregate of
677,000 and 956,000 shares, at an aggregate cost of approximately $16 million
and $22 million, in 1998 and 1997, respectively, to fund this plan. During 1996,
the Company purchased an aggregate of 1,648,000 shares at an aggregate cost of
approximately $20 million and issued 2,489,000 shares with a fair value at the
date of award of approximately $33 million to fund this plan. Amounts awarded
under the RSAP are amortized over 10 years. Amortization expense for the RSAP
amounted to $9,592,000, $7,536,000 and $5,277,000 for 1998, 1997 and 1996,
respectively. Unamortized amounts are reported as deferred compensation in the
consolidated balance sheet.
76
79
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE M -- COMMITMENTS AND CONTINGENCIES
The Company is a defendant in a number of legal actions arising primarily
from claims made under insurance policies or in connection with previous
reinsurance agreements. Those actions have been considered in establishing the
Company's liabilities. Management and its legal counsel are of the opinion that
the settlement of those actions will not have a material effect on the Company's
financial position or results of operations.
An insurance subsidiary of the Company outsourced its data processing
operation to Electronic Data Systems in 1992. Under terms of the contract, this
subsidiary will pay a minimum $7,500,000 per year for a period of ten years,
until 2002.
Total rental expense for 1998, 1997 and 1996, was $16,110,000, $13,019,000,
and $11,120,000, respectively. The Company leases office facilities and certain
equipment under non-cancelable operating leases, the terms of which range from
one to ten years. Certain leases provide for an increase in the basic rental to
compensate the lessor for increases in operating and maintenance costs. The
leases also provide renewal options.
Under present leases, rental commitments are summarized in the following
table (thousands of dollars):
1999.............................................. $ 30,155
2000.............................................. 28,266
2001.............................................. 26,027
2002.............................................. 22,533
2003.............................................. 21,324
Thereafter........................................ 69,148
--------
$197,453
========
NOTE N -- DISCONTINUED OPERATIONS
The Company discontinued all of its assumed reinsurance operations, as well
as certain other insurance operations, during the period 1986 to 1991. These
operations consisted primarily of facultative and treaty reinsurance covering
primary and excess property and casualty insurance coverages. All discontinued
insurance operations are accounted for using the liquidation basis of accounting
whereby all future cash inflows and outflows are considered in determining
whether dedicated assets are sufficient to meet all future obligations.
The Company determines the adequacy of the assets dedicated to fund the
liabilities of discontinued operations by: (i) estimating the ultimate remaining
liabilities; (ii) discounting these liabilities using estimates of payment
patterns and investment yields derived from the dedicated investment portfolio;
and (iii) comparing this discounted estimate of liabilities to the dedicated
assets.
The Company estimates that the dedicated assets (primarily cash, investment
securities and reinsurance recoverables) supporting these operations and all
future cash inflows will be adequate to fund future obligations. However, should
those assets ultimately prove to be insufficient, the Company believes that its
property and casualty subsidiaries would be able to provide whatever additional
funds might be needed to complete the liquidation without having a material
adverse effect on the Company's consolidated financial position or results of
operations.
77
80
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A statement of financial condition of the discontinued operations is
summarized in the following table:
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(THOUSANDS OF DOLLARS)
Assets
Cash and invested assets, at amortized cost............... $185,801 $196,945
Reinsurance recoverables.................................. 50,350 52,166
Other assets.............................................. 7,427 7,396
-------- --------
Total.................................................. $243,578 $256,507
======== ========
Liabilities
Reserves for loss and loss adjustment expenses............ $148,605 $159,595
Deferred income taxes..................................... 40,721 39,815
Reinsurance payable and funds withheld.................... 4,397 6,455
Other liabilities......................................... 16,341 17,128
-------- --------
Total.................................................. $210,064 $222,993
======== ========
The amortized cost and fair value of cash and invested assets of the
discontinued operations as of December 31, 1998 are summarized in the following
table:
AMORTIZED COST FAIR VALUE
-------------- ----------
(THOUSANDS OF DOLLARS)
Fixed maturities........................................... $124,384 $129,782
Non-redeemable preferred stock............................. 51,339 54,649
Cash and other invested assets............................. 10,078 10,078
-------- --------
Cash and invested assets................................. $185,801 $194,509
======== ========
The average maturity of the fixed income portfolio was 5.44 years at
December 31, 1998. The quality mix of the fixed maturity portfolio as of
December 31, 1998 is summarized in the following table:
AAA (including US government obligations)................... 3%
AA.......................................................... 14
A........................................................... 23
BBB......................................................... 35
BB.......................................................... 25
---
100%
===
At December 31, 1998, all investments included in discontinued operations
were current with respect to principal and interest. It is the Company's belief
that the carrying value of the investments will be fully realized.
78
81
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE O -- OPERATIONS BY REPORTABLE SEGMENT
The Company's businesses are managed within two reportable segments:
property and casualty insurance and financial services. Additionally, there are
certain corporate revenues and expenses, comprised primarily of investment
income, interest expense and certain general and administrative expenses, that
the Company does not allocate to its segments.
The following data for the years ended December 31, 1998, 1997 and 1996
provide certain information necessary for reportable segment disclosure, as well
as a reconciliation to total consolidated financial information. For both the
property and casualty and financial services segments, interest revenue is
reported net of interest expense. This net interest revenue is used to assess
segment performance.
YEAR ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
(THOUSANDS OF DOLLARS)
REVENUES
Property and casualty.......................... $ 729,728 $ 738,072 $ 596,841
Financial services............................. 305,886 235,474 197,601
Unallocated corporate.......................... 1,983 749 1,362
---------- ---------- ----------
Total................................ 1,037,597 974,295 795,804
Intersegment:
Property and casualty........................ 1,227 1,235 1,204
Unallocated corporate........................ 36,073 25,643 17,672
---------- ---------- ----------
37,300 26,878 18,876
---------- ---------- ----------
Total revenue........................ 1,074,897 1,001,173 814,680
Reconciling items:
Intersegment revenues........................ (37,300) (26,878) (18,876)
---------- ---------- ----------
Total consolidated................... $1,037,597 $ 974,295 $ 795,804
========== ========== ==========
INCOME (LOSS) BEFORE INCOME TAXES
Property and casualty.......................... $ 169,235 $ 144,667 $ 117,593
Financial services............................. 55,506 42,286 36,589
Unallocated corporate.......................... (23,751) (23,782) (21,645)
---------- ---------- ----------
Total................................ 200,990 163,171 132,537
Reconciling items:
Intercompany dividends....................... (4,278) (4,278) (4,228)
---------- ---------- ----------
Total consolidated................... $ 196,712 $ 158,893 $ 128,309
========== ========== ==========
INTEREST REVENUE, NET OF INTEREST EXPENSE
Property and casualty.......................... $ 151,357 $ 107,165 $ 96,069
Financial services............................. 112,957 94,854 81,958
Unallocated corporate.......................... 1,545 (4,601) (8,100)
---------- ---------- ----------
Total................................ 265,859 197,418 169,927
Reconciling items:
Intersegment elimination..................... 3,721 6,836 4,762
========== ========== ==========
Total consolidated................... $ 269,580 $ 204,254 $ 174,689
========== ========== ==========
AMORTIZATION AND DEPRECIATION EXPENSE
Property and casualty.......................... $ 25,540 $ 16,377 $ 9,680
Financial services............................. 6,993 6,403 4,772
Unallocated corporate.......................... 7,785 10,744 12,140
========== ========== ==========
Total consolidated................... $ 40,318 $ 33,524 $ 26,592
========== ========== ==========
79
82
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
(THOUSANDS OF DOLLARS)
SEGMENT ASSETS
Property and casualty.......................... $3,826,885 $3,353,114 $1,890,695
Financial services............................. 3,258,522 2,436,976 2,122,077
Unallocated corporate.......................... 40,627 44,030 29,540
---------- ---------- ----------
7,126,034 5,834,120 4,042,312
Reconciling items:
Assets held for discontinued operations...... 243,578 256,507 265,200
---------- ---------- ----------
Total consolidated................... $7,369,612 $6,090,627 $4,307,512
========== ========== ==========
NOTE P -- EARNINGS PER SHARE
Earnings per share have been computed based on the weighted average number
of shares adjusted retroactively for a two-for-one split of Common Stock
effected on December 10, 1998. The following table sets forth the computation of
basic and diluted earnings per share:
1998 1997 1996
---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income (numerator for basic earnings per share)........ $132,964 $108,292 $ 87,288
Effect of dilutive securities:
LYONs................................................. 327 2,527 4,547
-------- -------- --------
Income available to common stockholders after assumed
conversions (numerator for diluted earnings per share)... $133,291 $110,819 $ 91,835
======== ======== ========
Weighted-average shares (denominator for basic earnings per
share)................................................... 63,529 57,059 49,315
Effect of dilutive securities:
Restricted stock......................................... 4,729 3,804 2,272
Stock options............................................ 917 374 1,936
LYONs.................................................... 907 7,348 13,683
-------- -------- --------
Dilutive potential common shares........................... 6,553 11,526 17,891
Adjusted weighted-average shares and assumed conversions
(denominator for diluted earnings per share)............. 70,082 68,585 67,206
======== ======== ========
Basic earnings per share................................... $ 2.09 $ 1.90 $ 1.77
======== ======== ========
Diluted earnings per share................................. $ 1.90 $ 1.62 $ 1.37
======== ======== ========
For additional disclosures regarding the LYONs, the stock options and
restricted stock see Notes I, K and L, respectively.
80
83
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE Q -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
THREE MONTH PERIODS ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- -------- ------------- ------------
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
1998
Revenues............................ $263,339 $238,351 $253,075 $282,832
Net income.......................... 31,652 32,583 34,187 34,542
Net income per share:
Basic............................. 0.50 0.51 0.53 0.54
Diluted........................... 0.45 0.47 0.49 0.49
1997
Revenues............................ $194,735 $206,155 $267,272 $306,133
Net income.......................... 24,359 24,938 28,819 30,176
Net income per share:
Basic............................. 0.47 0.45 0.48 0.50
Diluted........................... 0.37 0.37 0.43 0.44
Net income and net income per share increased after the quarter ended June
30, 1997 due primarily to the acquisition of Industrial which was completed on
August 1, 1997. (See Note B.)
NOTE R --SUBSEQUENT EVENTS
On March 17, 1999, Fremont General Corporation ("the holding company")
issued $425 million of Senior Notes consisting of $200 million of 7.70% Senior
Notes due 2004 and $225 million of 7.875% Senior Notes due 2009. The notes were
offered in a private placement to qualified institutional buyers and a limited
number of institutional accredited investors and have not been registered under
the Securities Act; however, Fremont General Corporation intends to do so in
1999. Net proceeds from the notes were used to repay all indebtedness
outstanding under the holding company's bank line of credit and for general
corporate purposes, including working capital.
On March 23, 1999, the Company's thrift and loan subsidiary issued, through
the Fremont Home Loan Owner Trust 1999-1, approximately $415 million in notes
collateralized by a pool of the thrift and loan's first lien residential
mortgage loans. The notes are subject to an unconditional and irrevocable
guarantee of timely payment of interest and ultimate payment of loan principal
provided by a financial guarantee insurance policy (issued by Financial Security
Assurance Inc.). Servicing of the loans will be provided by Fairbanks Capital
Corporation. These notes have been rated AAA by Standard and Poor's and Aaa by
Moody's.
81
84
FREMONT GENERAL CORPORATION (PARENT COMPANY)
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
ASSETS
DECEMBER 31,
------------------------
1998 1997
---------- ----------
(THOUSANDS OF DOLLARS)
Cash........................................................ $ 147 $ 889
Notes receivable from subsidiaries*......................... 345,532 301,609
Investment in subsidiaries*................................. 1,000,392 871,653
Short-term investments...................................... 18,894 15,419
Excess of cost of acquisition of subsidiaries over net
assets acquired........................................... -- 7,221
Other receivables from subsidiaries*........................ 17,348 7,588
Deferred income taxes....................................... 145,410 148,757
Other assets................................................ 22,239 27,592
---------- ----------
TOTAL ASSETS...................................... $1,549,962 $1,380,728
========== ==========
LIABILITIES
Accrued expenses and other liabilities...................... $ 34,004 $ 48,752
Amounts due to subsidiaries*................................ 148,990 131,960
Notes payable to subsidiary*................................ 103,093 103,093
Current portion of long-term debt........................... 717 800
Long-term debt.............................................. 312,246 263,308
---------- ----------
TOTAL LIABILITIES................................. 599,050 547,913
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred Stock, par value $.01 -- authorized 2,000,000
shares; none issued
Common Stock, par value $1 per share -- Authorized:
150,000,000
Issued and outstanding: (1998 -- 69,939,000 and
1997 -- 34,571,000).................................... 69,939 34,571
Additional paid-in capital.................................. 308,369 323,065
Retained earnings........................................... 620,612 508,533
Deferred compensation....................................... (86,910) (86,263)
Accumulated other comprehensive income...................... 38,902 52,909
---------- ----------
TOTAL STOCKHOLDERS' EQUITY........................ 950,912 832,815
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........ $1,549,962 $1,380,728
========== ==========
- ---------------
* Eliminated in consolidation
See notes to condensed financial statements.
82
85
FREMONT GENERAL CORPORATION (PARENT COMPANY)
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
(THOUSANDS OF DOLLARS)
INCOME
Interest income from subsidiaries*......................... $ 22,517 $ 12,086 $ 5,841
Dividends from consolidated subsidiaries*.................. 4,278 4,278 4,228
Net investment income...................................... 1,836 650 1,357
Realized investment gains (losses)......................... 8 34 (2)
Other income*.............................................. 8,139 11,180 8,997
-------- -------- --------
TOTAL INCOME..................................... 36,778 28,228 20,421
EXPENSES
Interest expense........................................... 18,086 12,615 12,151
Interest on notes payable to subsidiary*................... 9,278 9,278 7,603
General and administrative................................. 33,770 30,723 22,868
-------- -------- --------
TOTAL EXPENSES................................... 61,134 52,616 42,622
-------- -------- --------
(24,356) (24,388) (22,201)
Income tax benefit......................................... (13,694) (14,578) (12,213)
-------- -------- --------
Loss before equity in undistributed income of subsidiary
companies................................................ (10,662) (9,810) (9,988)
Equity in undistributed income of subsidiary companies..... 143,626 118,102 97,276
-------- -------- --------
NET INCOME....................................... $132,964 $108,292 $ 87,288
======== ======== ========
- ---------------
* Eliminated in consolidation
See notes to condensed financial statements.
83
86
FREMONT GENERAL CORPORATION (PARENT COMPANY)
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
---------------------------------
1998 1997 1996
--------- --------- ---------
(THOUSANDS OF DOLLARS)
OPERATING ACTIVITIES
Net income.................................................. $ 132,964 $ 108,292 $ 87,288
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed income from continuing
operations of subsidiaries........................... (143,626) (118,102) (97,276)
Change in accrued investment income.................... 2 (3) 2
Change in amounts due to or from subsidiaries.......... (18,051) (76,761) (42,999)
Provision for deferred income taxes.................... 33,583 18,360 24,798
Provision for depreciation and amortization............ 7,562 10,744 12,145
Realized investment (gains) losses..................... (8) (34) 2
Change in other assets and liabilities................. 1,005 73,137 6,999
--------- --------- ---------
NET CASH PROVIDED BY (USED IN) CONTINUING
OPERATIONS...................................... 13,431 15,633 (9,041)
Effect of discontinued operations......................... 3,252 (9,934) (3,161)
--------- --------- ---------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES.... 16,683 5,699 (12,202)
INVESTING ACTIVITIES
Purchases of fixed maturity investments................... (44,653) (11,369) (6,315)
Sales of fixed maturity investments....................... -- 11,403 6,310
Fixed maturity investments matured or called.............. 44,884 -- --
Decrease (increase) in short-term and other investments... (3,476) (9,334) 2,469
Net decrease (increase) in credit lines with
subsidiaries........................................... (43,924) (221,391) 5,092
Purchase of and additional investments in subsidiaries.... (32) (10) (2,000)
Dividend from subsidiary.................................. -- 18,000 --
Purchase of property and equipment........................ (1,917) (1,658) (1,991)
--------- --------- ---------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES.... (49,118) (214,359) 3,565
FINANCING ACTIVITIES
Repayment of short-term debt.............................. (800) (3,092) --
Proceeds from long-term debt.............................. 100,000 265,000 41,058
Repayment of long-term debt............................... (41,228) (35,000) (111,004)
Proceeds from notes due to subsidiaries................... -- -- 100,000
Dividends paid............................................ (20,476) (17,838) (15,016)
Stock options exercised................................... 1,453 13,129 1,428
Decrease (increase) in deferred compensation plans........ (7,256) (14,328) (6,455)
--------- --------- ---------
NET CASH PROVIDED BY
FINANCING ACTIVITIES.............................. 31,693 207,871 10,011
--------- --------- ---------
INCREASE (DECREASE) IN CASH.......................... (742) (789) 1,374
Cash at beginning of year................................. 889 1,678 304
--------- --------- ---------
CASH AT END OF YEAR.................................. $ 147 $ 889 $ 1,678
========= ========= =========
See notes to condensed financial statements.
84
87
FREMONT GENERAL CORPORATION (PARENT COMPANY)
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTE 1 -- BASIS OF PRESENTATION
In the parent company financial statements, the parent's investment in
subsidiaries is stated at cost plus equity in undistributed earnings of
subsidiaries since date of acquisition. Parent company financial statements
should be read in conjunction with the Company's consolidated financial
statements.
NOTE 2 -- SUBSEQUENT EVENT
On March 17, 1999, the parent company issued $425 million of Senior Notes
consisting of $200 million of 7.70% Senior Notes due 2004 and $225 million of
7.875% Senior Notes due 2009. The notes were offered in a private placement to
qualified institutional buyers and a limited number of institutional accredited
investors and have not been registered under the Securities Act; however, the
parent company intends to do so in 1999. Net proceeds from the notes were used
to repay all indebtedness outstanding under the parent company's bank line of
credit and for general corporate purposes, including working capital.
85
88
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
SCHEDULE III -- SUPPLEMENTARY INSURANCE INFORMATION
DECEMBER 31, YEAR ENDED DECEMBER 31,
-------------------------------------------------- ------------------------------------
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H
-------- ----------- ------------ -------- ---------- -------- ---------- ------------
RESERVES
DEFERRED FOR CLAIMS, CLAIMS,
POLICY BENEFITS AND DIVIDENDS NET BENEFITS AND
ACQUISITION SETTLEMENT UNEARNED TO POLICY- PREMIUM INVESTMENT SETTLEMENT
SEGMENT COSTS EXPENSES PREMIUMS HOLDERS REVENUE INCOME EXPENSES
------- ----------- ------------ -------- ---------- -------- ---------- ------------
(THOUSANDS OF DOLLARS)
1998
Life insurance..... $ 350 $ 136,973 $ -- $ -- 453 $ 713 $ --
Property and
casualty......... 44,646 2,298,118 119,774 16,162 552,078 178,263 335,450
------- ---------- -------- ------- -------- -------- --------
$44,996 $2,435,091 $119,774 $16,162 $552,531 $178,976 $335,450
======= ========== ======== ======= ======== ======== ========
1997
Life insurance..... $ 450 $ 180,976 $ -- $ -- $ 696 $ 1,690 $ --
Property and
casualty......... 37,564 2,163,323 78,625 37,626 601,183 138,894 389,201
------- ---------- -------- ------- -------- -------- --------
$38,014 $2,344,299 $78,625 $37,626 $601,879 $140,584 $389,201
======= ========== ======== ======= ======== ======== ========
1996
Life insurance..... $ 550 $ 202,465 $ -- $ -- $ 55 $ 2,989 $ --
Property and
casualty......... 25,001 1,256,345 87,422 33,093 486,860 111,637 335,407
------- ---------- -------- ------- -------- -------- --------
$25,551 $1,458,810 $87,422 $33,093 $486,915 $114,626 $335,407
======= ========== ======== ======= ======== ======== ========
YEAR ENDED DECEMBER 31,
-----------------------------------
COLUMN A COLUMN I COLUMN J COLUMN K
-------- ------------ --------- --------
AMORTIZATION
OF DEFERRED
POLICY OTHER NET
ACQUISITION OPERATING PREMIUMS
SEGMENT COSTS EXPENSES WRITTEN
------- ------------ --------- --------
(THOUSANDS OF DOLLARS)
1998
Life insurance..... $ -- $ 1,314 $ N/A
Property and
casualty......... 123,393 58,146 571,676
-------- ------- --------
$123,393 $59,460 $571,676
======== ======= ========
1997
Life insurance..... $ -- $ 3,093 $ N/A
Property and
casualty......... 115,899 43,551 621,092
-------- ------- --------
$115,899 $46,644 $621,092
======== ======= ========
1996
Life insurance..... $ -- $ 1,971 $ N/A
Property and
casualty......... 96,177 26,555 474,184
-------- ------- --------
$ 96,177 $28,526 $474,184
======== ======= ========
86
89
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
SCHEDULE IV -- REINSURANCE
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
-------- -------- --------- --------- -------- ----------
ASSUMED PERCENTAGE
CEDED TO FROM OF AMOUNT
GROSS OTHER OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
-------- --------- --------- -------- ----------
(THOUSANDS OF DOLLARS, EXCEPT PERCENTS)
YEAR ENDED DECEMBER 31, 1998
Life insurance in force*............ $107,094 $ 69,054 $ -- $ 38,040 0%
======== ======== ======= ========
Premium Revenue
Life insurance premiums........... $ 986 $ 533 $ -- $ 453 0%
Property and casualty............. 717,021 177,983 13,040 552,078 2%
-------- -------- ------- --------
$718,007 $178,516 $13,040 $552,531
======== ======== ======= ========
YEAR ENDED DECEMBER 31, 1997
Life insurance in force*............ $156,866 $100,910 $ -- $ 55,956 0%
======== ======== ======= ========
Premium Revenue
Life insurance premiums........... $ 2,479 $ 1,783 $ -- $ 696 0%
Property and casualty............. 591,505 13,972 23,650 601,183 4%
-------- -------- ------- --------
$593,984 $ 15,755 $23,650 $601,879
======== ======== ======= ========
YEAR ENDED DECEMBER 31, 1996
Life insurance in force*............ $324,368 $257,552 $ -- $ 66,816 0%
======== ======== ======= ========
Premium Revenue
Life insurance premiums........... $ 263 $ 208 $ -- $ 55 0%
Property and casualty............. 469,912 8,326 25,274 486,860 5%
-------- -------- ------- --------
$470,175 $ 8,534 $25,274 $486,915
======== ======== ======= ========
- ---------------
* Balance at end of year.
Intercompany transactions have been eliminated.
87
90
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
SCHEDULE V -- VALUATION AND QUALIFYING ACCOUNTS
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
-------- ---------- ----------------------- ---------- ----------
ADDITIONS
-----------------------
CHARGED TO
BALANCE AT CHARGED TO OTHER BALANCE AT
BEGINNING COSTS AND ACCOUNTS DEDUCTIONS END
DESCRIPTION OF PERIOD EXPENSES DESCRIBE DESCRIBE OF PERIOD
----------- ---------- ---------- ---------- ---------- ----------
(THOUSANDS OF DOLLARS)
YEAR ENDED DECEMBER 31, 1998
Deducted from asset accounts:
Allowance for possible loan
losses........................... $44,402 $11,059 $ 3,465(1) $ 2,580(2) $56,346
Premiums receivable and agents'
balances and reinsurance
recoverable...................... 7,048 1,256 -- -- 8,304
------- ------- -------- -------- -------
Totals........................ $51,450 $12,315 $ 3,465 $ 2,580 $64,650
======= ======= ======== ======== =======
YEAR ENDED DECEMBER 31, 1997
Deducted from asset accounts:
Allowance for possible loan
losses........................... $37,747 $12,319 $ -- $ 5,664(2) $44,402
Premiums receivable and agents'
balances and reinsurance
recoverable...................... 7,401 252 -- 605(2) 7,048
------- ------- -------- -------- -------
Totals........................ $45,148 $12,571 $ -- $ 6,269 $51,450
======= ======= ======== ======== =======
YEAR ENDED DECEMBER 31, 1996
Deducted from asset accounts:
Allowance for possible loan
losses........................... $31,781 $13,885 $ 1,830(1) $ 9,749(2) $37,747
Premiums receivable and agents'
balances and reinsurance
recoverable...................... 11,147 -- -- 3,746(2) 7,401
------- ------- -------- -------- -------
Totals........................ $42,928 $13,885 $ 1,830 $ 13,495 $45,148
======= ======= ======== ======== =======
- ---------------
(1) Reserves established with company and portfolio acquisitions.
(2) Uncollectible accounts written off, net of recoveries and reclassifications.
88
91
FREMONT GENERAL CORPORATION AND SUBSIDIARIES
SCHEDULE VI -- SUPPLEMENTAL INFORMATION CONCERNING PROPERTY/CASUALTY
INSURANCE OPERATIONS
DECEMBER 31, YEAR ENDED DECEMBER 31,
----------------------------------------------- -------------------------------------------
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H
-------- ----------- ----------- -------- -------- -------- ---------- -------------------
CLAIMS AND CLAIM
ADJUSTMENT
RESERVES EXPENSES INCURRED
FOR UNPAID DISCOUNT RELATED TO
DEFERRED CLAIMS IF ANY -------------------
POLICY AND CLAIM DEDUCTED NET (1) (2)
ACQUISITION ADJUSTMENT IN UNEARNED EARNED INVESTMENT CURRENT PRIOR
AFFILIATION WITH REGISTRANT COSTS EXPENSES COLUMN C PREMIUMS PREMIUMS INCOME YEAR YEARS
--------------------------- ----------- ----------- -------- -------- -------- ---------- -------- --------
(THOUSANDS OF DOLLARS)
Fremont Compensation Insurance
Group and Consolidated
Subsidiaries
1998.......................... $44,646 $ 2,298,118 $25,908 $119,774 $552,078 $178,263 $348,897 $(13,447)
1997.......................... $37,564 $ 2,163,323 $19,782 $78,625 $601,183 $138,894 $441,524 $(52,323)
1996.......................... $25,001 $ 1,256,345 $22,658 $87,422 $486,860 $111,637 $334,657 $ 750
YEAR ENDED DECEMBER 31,
-------------------------------------
COLUMN A COLUMN I COLUMN J COLUMN K
-------- ----------- ---------- ----------
AMORTIZA-
TION OF PAID
DEFERRED CLAIMS
POLICY AND CLAIM NET
ACQUISITION ADJUSTMENT PREMIUMS
AFFILIATION WITH REGISTRANT COSTS EXPENSES WRITTEN
--------------------------- ----------- ---------- ----------
(THOUSANDS OF DOLLARS)
Fremont Compensation Insurance
Group and Consolidated
Subsidiaries
1998.......................... $123,393 $835,374 $571,676
1997.......................... $115,899 $639,792 $621,092
1996.......................... $ 96,177 $510,227 $474,184
89
92
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on the 25th day of
March 1999.
FREMONT GENERAL CORPORATION
/s/ JOHN A. DONALDSON
By:
--------------------------------------
John A. Donaldson
Title: Senior Vice President,
Controller and
Chief Accounting Officer
(Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities and on
the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ JAMES A. MCINTYRE Chairman of the Board March 25, 1999
- --------------------------------------------- and Chief Executive Officer
James A. McIntyre (Principal Executive Officer)
/s/ LOUIS J. RAMPINO President, Chief Operating Officer March 25, 1999
- --------------------------------------------- and Director
Louis J. Rampino
/s/ WAYNE R. BAILEY Executive Vice President, Treasurer, March 25, 1999
- --------------------------------------------- Chief Financial Officer and Director
Wayne R. Bailey (Principal Financial Officer)
/s/ JOHN A. DONALDSON Senior Vice President, Controller and March 25, 1999
- --------------------------------------------- Chief Accounting Officer
John A. Donaldson (Principal Accounting Officer)
/s/ HOUSTON I. FLOURNOY Director March 25, 1999
- ---------------------------------------------
Houston I. Flournoy
/s/ C. DOUGLAS KRANWINKLE Director March 25, 1999
- ---------------------------------------------
C. Douglas Kranwinkle
/s/ DAVID W. MORRISROE Director March 25, 1999
- ---------------------------------------------
David W. Morrisroe
/s/ DICKINSON C. ROSS Director March 25, 1999
- ---------------------------------------------
Dickinson C. Ross
90
93
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
2.1 Stock Purchase Agreement by and among Talegen Holdings,
Inc., Fremont Indemnity Company and Fremont General
Corporation dated as of May 16, 1997 including exhibits
thereto. (Filed as Exhibit No. 2.1 to Current Report on Form
8-K, as of August 1, 1997, Commission File Number 1-8007,
and incorporated herein by reference.)
2.2 Tax Allocation and Indemnification Agreement, dated as of
May 16, 1997 by and among Xerox Financial Services, Inc.,
Talegen Holdings, Inc., Industrial Indemnity Holdings, Inc.,
Fremont General Corporation, and Fremont Indemnity
Corporation, a California corporation. (Filed as Exhibit No.
2.2 to Current Report on Form 8-K, as of August 1, 1997,
Commission File Number 1-8007, and incorporated herein by
reference.)
3.1 Restated Articles of Incorporation of Fremont General
Corporation. (Filed as Exhibit No. 3.1 to Quarterly Report
on Form 10-Q, for the period ended June 30, 1998, Commission
File Number 1-8007, and incorporated herein by reference.)
3.2 Certificate of Amendment of Articles of Incorporation of
Fremont General Corporation.
3.3 Amended and Restated By-Laws of Fremont General Corporation.
(Filed as Exhibit No. 3.3 to Annual Report on Form 10-K, for
the fiscal year ended December 31, 1995, Commission File
Number 1-8007, and incorporated herein by reference.)
4.1 Form of Stock Certificate for Common Stock of the
Registrant. (Filed as Exhibit No. (1) Form 8-A filed on
March 17, 1993, Commission File Number 1-8007, and
incorporated herein by reference.)
4.2 Indenture with respect to Liquid Yield Option Notes Due 2013
between the Registrant and Bankers Trust Company. (Filed as
Exhibit No. 4.4 to Registration Statement on Form S-3 filed
on October 1, 1993, and incorporated herein by reference.)
4.3 Indenture among the Registrant, the Trust and First
Interstate Bank of California, a California banking
corporation, as trustee. (Filed as Exhibit No. 4.3 to Annual
Report on Form 10-K, for the fiscal year ended December 31,
1995, Commission File Number 1-8007, and incorporated herein
by reference.)
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. (Filed as Exhibit No.
4.5 to Annual Report on Form 10-K, for the fiscal year ended
December 31, 1995, Commission File Number 1-8007, and
incorporated herein by reference.)
4.5 Preferred Securities Guarantee Agreement between the
Registrant and The Chase Manhattan Bank, N.A., a national
banking association, as Preferred Guarantee Trustee. (Filed
as Exhibit No. 4.6 to Annual Report on Form 10-K, for the
fiscal year ended December 31, 1995, Commission File Number
1-8007, and incorporated herein by reference.)
4.6 Common Securities Guarantee Agreement by the Registrant.
(Filed as Exhibit No. 4.7 to Annual Report on Form 10-K, for
the fiscal year ended December 31, 1995, Commission File
Number 1-8007, and incorporated herein by reference.)
4.7 Form of Preferred Securities. (Included in Exhibit 4.5).
(Filed as Exhibit No. 4.8 to Annual Report on Form 10-K, for
the fiscal year ended December 31, 1995, Commission File
Number 1-8007, and incorporated herein by reference.)
94
EXHIBIT
NUMBER DESCRIPTION
------- -----------
4.8 Form of 9% Junior Subordinated Debenture. (Included in
Exhibit 4.3). (Filed as Exhibit No. 4.9 to Annual Report on
Form 10-K, for the fiscal year ended December 31, 1995,
Commission File Number 1-8007, and incorporated herein by
reference.)
4.9 Indenture dated as of March 1, 1999 between the Registrant
and The First National Bank of Chicago, as trustee.
4.10 Registration Rights Agreement among the Registrant and
Merrill Lynch, Pierce, Fenner & Smith Incorporated, Credit
Suisse First Boston Corporation, Goldman, Sachs & Co., and
Warburg Dillon Read LLC.
4.11 Form of Fremont General Corporation 7.70% Senior Notes due
2004.
4.12 Form of Fremont General Corporation 7.875% Senior Notes due
2004.
10.1(a) Fremont General Corporation Employee Stock Ownership Plan as
amended. (Filed as Exhibit No. 10.1 to Annual Report on Form
10-K, for the fiscal year ended December 31, 1995,
Commission File Number 1-8007, and incorporated herein by
reference.)
10.1(b) Amendment Number Two to the Fremont General Corporation
Employee Stock Ownership Plan. (Filed as Exhibit No. 10.1
(b) to Annual Report on Form 10-K, for the fiscal year ended
December 31, 1997, Commission File Number 1-8007, and
incorporated herein by reference.)
10.1(c) Amendment Number Three to the Fremont General Corporation
Employee Stock Ownership Plan. (Filed as Exhibit No. 10.1(c)
to Quarterly Report on Form 10-Q, for the period ended
September 30, 1998, Commission File Number 1-8007, and
incorporated herein by reference.)
10.1(d) Amendment Number Four to the Fremont General Corporation
Employee Stock Ownership Plan.
10.2 Amended and Restated Trust Agreement for Fremont General
Corporation Employee Stock Ownership Plan. (Filed as Exhibit
No. 10.2 to Annual Report on Form 10-K, for the fiscal year
ended December 31, 1995, Commission File Number 1-8007, and
incorporated herein by reference.)
10.3(a) Fremont General Corporation and Affiliated Companies
Investment Incentive Plan. (Filed as Exhibit No. 10.3 to
Annual Report on Form 10-K, for the fiscal year ended
December 31, 1995, Commission File Number 1-8007, and
incorporated herein by reference.)
10.3(b) Amendments Number One, Two and Three to the Fremont General
Corporation and Affiliated Companies Investment Incentive
Plan. (Filed as Exhibit No. 10.3 (b) to Quarterly Report on
Form 10-Q, for the period ended September 30, 1997,
Commission File Number 1-8007, and incorporated herein by
reference.)
10.3(c) Amendment Number Four to the Fremont General Corporation and
Affiliated Companies Investment Incentive Plan. Filed as
Exhibit No. (10.3 to Annual Report on Form 10-K, for the
Fiscal Year Ended December 31, 1997, Commission File Number
1-8007, and incorporated herein by reference.)
10.3(d) Amendment Number Five to the Fremont General Corporation and
Affiliated Companies Investment Incentive Plan. (Filed as
Exhibit No. 10.3(d) to Quarterly Report on Form 10-Q, for
the period ended September 30, 1998, Commission File Number
1-8007, and incorporated herein by reference.)
95
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.4(a) Trust Agreement for Investment Incentive Plan. (Filed as
Exhibit No. (10)(xi) to Annual Report on Form 10-K, for the
Fiscal Year Ended December 31, 1993, Commission File Number
1-8007, and incorporated herein by reference.)
10.4(b) Amendment to Trust Agreement for Investment Incentive Plan.
(Filed as Exhibit No. 10.4 to Annual Report on Form 10-K,
for the fiscal year ended December 31, 1995, Commission File
Number 1-8007, and incorporated herein by reference.)
10.5 Supplemental Retirement Plan of the Company, as restated
January 1, 1997. (Filed as Exhibit No. 10.5 to Quarterly
Report on Form 10-Q, for the period ended September 30,
1997, Commission File Number 1-8007, and incorporated herein
by reference.)
10.5(b) Amendment Number Two to the Fremont General Corporation
Supplemental Retirement Plan of the Company.
10.6 Trust Agreement for Supplemental Retirement Plan of the
Company, as amended. (Filed as Exhibit No. 10.6 to Annual
Report on Form 10-K, for the fiscal year ended December 31,
1995, Commission File Number 1-8007, and incorporated herein
by reference.)
10.7(a) Senior Supplemental Retirement Plan, as restated January 1,
1997. (Filed as Exhibit No. 10.7 to Quarterly Report on Form
10-Q, for the period ended September 30, 1997, Commission
File Number 1-8007, and incorporated herein by reference).
10.7(b) First Amendment to the Fremont General Corporation Senior
Supplemental Retirement Plan.
10.8(a) Fremont General Corporation Excess Benefit Plan Restated
effective as of January 1, 1997 and First Amendment dated
December 21, 1998.
10.8(b) Trust Agreement for Excess Benefit Plan. (Filed as Exhibit
No. 10.8 to Annual Report on Form 10-K, for the fiscal year
ended December 31, 1995, Commission File Number 1-8007, and
incorporated herein by reference.)
10.9 Amended Non-Qualified Stock Option Plan of 1989 and related
agreements of the Company. (Filed as Exhibit No. 10.9 to
Annual Report on Form 10-K, for the fiscal year ended
December 31, 1996, Commission File Number 1-8007, and
incorporated herein by reference.)
10.10 1997 Stock Plan and related agreements. (Filed as Exhibit
No. 10.10 to Quarterly Report on Form 10-Q, for the period
ended June 30, 1997, Commission File Number 1-8007, and
incorporated herein by reference.)
10.11(a) Long-Term Incentive Compensation Plan of the
Company -- Senior Executive Plan. (Filed as Exhibit No.
10.10(a) on Form 10-Q for the period ended September 30,
1996, Commission File Number 1-8007, and incorporated herein
by reference.)
10.11(b) Long-Term Incentive Compensation Plan of the Company (Filed
as Exhibit No. 10.10 (b) on Form 10-Q for the period ended
September 30, 1996, Commission File Number 1-8007, and
incorporated herein by reference.)
10.12 1995 Restricted Stock Award Plan As Amended and forms of
agreement thereunder. (Filed as Exhibit No. 4.1 to
Registration Statement on Form S-8/S-3 File No. 333-17525
which was filed on December 9, 1997, and incorporated herein
by reference.)
96
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.13 Fremont General Corporation Employee Benefits Trust
Agreement ("Grantor Trust") dated September 7, 1995 between
the Company and Merrill Lynch Trust Company of California.
(Filed as Exhibit No. 10.12 to Annual Report on Form 10-K,
for the fiscal year ended December 31, 1995, Commission File
Number 1-8007, and incorporated herein by reference.)
10.14(a) Employment Agreement between the Company and James A.
McIntyre dated January 1, 1994. (Filed as Exhibit No.
(10)(i) to Quarterly Report on Form 10-Q for the period
ended March 31, 1994, Commission File Number 1-8007, and
incorporated herein by reference.)
10.14(b) First Amendment to Employment Agreement between the Company
and James A. McIntyre dated August 1, 1996. (Filed as
Exhibit No. 10.10 to Quarterly Report on Form 10-Q, for the
period ended June 30, 1997, Commission File Number 1-8007,
and incorporated herein by reference.)
10.14(c) Second Amendment to Employment Agreement between the Company
and James A. McIntyre dated August 8, 1997. (Filed as
Exhibit No. 10.14 (c) to Quarterly Report on Form 10-Q, for
the period ended September 30, 1997, Commission File Number
1-8007, and incorporated herein by reference.)
10.15(a) Employment Agreement between the Company and Louis J.
Rampino dated February 8, 1996. (Filed as Exhibit No. 10.14
(a) to Annual Report on Form 10-K, for the fiscal year ended
December 31, 1995, Commission File Number 1-8007, and
incorporated herein by reference.)
10.15(b) Employment Agreement between the Company and Wayne R. Bailey
dated February 8, 1996. (Filed as Exhibit No. 10.14 to
Annual Report on Form 10-K, for the fiscal year ended
December 31, 1995, Commission File Number 1-8007, and
incorporated herein by reference.)
10.16 Management Continuity Agreement between the Company and
Raymond G. Meyers dated February 8, 1996. (Filed as Exhibit
No. 10.15 to Annual Report on Form 10-K, for the fiscal year
ended December 31, 1995, Commission File Number 1-8007, and
incorporated herein by reference.)
10.17 1998 Management Incentive Compensation Plan of the Company.
(Filed as Exhibit No. 10.17 to Annual Report on Form 10-K,
for the fiscal year ended December 31, 1997, Commission File
Number 1-8007, and incorporated herein by reference.)
10.18 Continuing Compensation Plan for Retired Directors. (Filed
as Exhibit No. 10.17 to Annual Report on Form 10-K, for the
fiscal year ended December 31, 1995, Commission File Number
1-8007, and incorporated herein by reference.)
10.19 Credit Agreement among Fremont General Corporation, Various
Lending Institutions and the Chase Manhattan Bank, N.A., As
Agent dated August 1, 1997. (Filed as Exhibit No. 10.20 to
Quarterly Report on Form 10-Q, for the period ended
September 30, 1997, Commission File Number 1-8007, and
incorporated herein by reference).
10.20 Credit Agreement $15,000,000 by and among Merrill Lynch
Trust Company of California as trustee for the Fremont
General Corporation Employee Stock Ownership Trust. The Plan
Committee (hereinafter described) on behalf of the Fremont
General Corporation Employee Stock Ownership Plan, Fremont
General Corporation, and First Interstate Bank of California
August 10, 1995. (Filed as Exhibit No. (10)(viii) to
Quarterly Report on Form 10-Q for the period ended September
30, 1995, and incorporated herein by reference.)
97
EXHIBIT
NUMBER DESCRIPTION
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10.21(a) Second Amended and Restated Credit Agreement among Fremont
Financial Corporation, Various Lending Institutions, Wells
Fargo Bank N.A. and Fleet Bank National Association as
Co-Agents, and The Chase Manhattan Bank as Agent, dated as
of June 23, 1997. (Filed as Exhibit No. 10.22(a) to
Quarterly Report on Form 10-Q/A Amendment No. 1, for the
period ended September 30, 1998, Commission File Number
1-8007, and incorporated herein by reference).
10.21(b) First Amendment and Consent dated as of October 21, 1997, to
the Second Amended and Restated Credit Agreement among
Fremont Financial Corporation, Various Lending Institutions,
Wells Fargo Bank N.A. and Fleet Bank National Association as
Co-Agents, and The Chase Manhattan Bank as Agent. (Filed as
Exhibit No. 10.22(b) to Quarterly Report on Form 10-Q/A
Amendment No. 1, for the period ended September 30, 1998,
Commission File Number 1-8007, and incorporated herein by
reference).
21 Subsidiaries of the Company
23 Consent of Ernst & Young LLP Independent Auditors
27 Financial Data Schedule