United States Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

 

(Mark One)

 þ Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended March 31, 2007

OR

 o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Transition Period from            to           

Commission File Number 001-08007

Fremont General Corporation

(Exact Name of Registrant as Specified in its Charter)

 

 

Not Applicable

(Former Name or Former Address, if Changed Since Last Report)

 

Indicate by check mark whether the Registrant: (1) has filed all reports required by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  o Yes  þ No

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act.):

 

þ Large Accelerated Filer               o Accelerated Filer               o Non-Accelerated Filer

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes  þ No

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock:

 

Fremont General Corporation and Subsidiaries

 

INDEX

 

 

 

2     FREMONT GENERAL CORPORATION AND SUBSIDIARIES

Item 1. Financial Statements

 

Fremont General Corporation and Subsidiaries

Consolidated Balance Sheets

 

 

The accompanying notes are an integral part of these statements.

 

 

2007 QUARTERLY REPORT     3

Fremont General Corporation and Subsidiaries

Consolidated Statements of Operations (Unaudited)

 

 

The accompanying notes are an integral part of these statements.

 

 

4     FREMONT GENERAL CORPORATION AND SUBSIDIARIES

Fremont General Corporation and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)

 

 

The accompanying notes are an integral part of these statements.

 

 

2007 QUARTERLY REPORT     5

Fremont General Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

 

 

The accompanying notes are an integral part of these statements.

 

 

6     FREMONT GENERAL CORPORATION AND SUBSIDIARIES

Fremont General Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)

 

 

 

2007 QUARTERLY REPORT     7

Fremont General Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

 

NOTE 1 — BASIS OF PRESENTATION

Overview

Fremont General Corporation (“Fremont General” or when combined with its subsidiaries, (the “Company”) is a financial services holding company. Fremont General’s financial services operations are consolidated within Fremont General Credit Corporation (“FGCC”), through its California industrial bank subsidiary, Fremont Investment & Loan (“FIL”). FIL offers certificates of deposit and savings and money market deposit accounts through its 22 retail banking branches in California. FIL’s deposit accounts are insured up to the maximum legal limit by the Federal Deposit Insurance Corporation (“FDIC”). During the three month period ended March 31, 2007, the Company was engaged in the commercial and residential (consumer) real estate lending businesses on a nationwide basis.

 

Concurrently with the filing of this report, the Company is filing its Annual Report on Form 10-K for the fiscal year ended December 31, 2006 and its Quarterly Report on Form 10-Q for the quarter ended June 30, 2007. We urge you to read these reports, which can be obtained from Fremont General’s website at www.fremontgeneral.com, or the SEC’s website at www.sec.gov, or by contacting our Investor Relations Department at 310/315-5500 or by sending an email message to invrel@fmt.com.

 

Exit from Sub-prime Mortgage Business; Cease and Desist Order.  During the first quarter of 2007, the sub-prime market experienced a significant deterioration that included increases in borrower delinquencies and a deterioration of credit that resulted in a substantial increase in the amount of residential loan repurchases and repricings resulting from early payment defaults and breaches of representations and warranties.

 

During the first six months of 2007, the Company recorded provisions of $517.7 million and $256.6 million to its valuation and repurchase reserves, respectively. For further information concerning the changes to these reserves see Note 4.

 

On March 2, 2007, the Company announced that it intended to exit its sub-prime residential real estate lending operations. This move was consistent with regulatory guidelines issued that day, and was prompted by the Company’s receipt on February 27, 2007 of a proposed Cease and Desist Order (the “Order”) from the FDIC calling for the Company to make a variety of changes designed to restrict the level of lending in its sub-prime residential mortgage business as well as the Company’s analysis of the deterioration of the sub-prime residential real estate market. On March 7, 2007, the Company announced that it had ceased entering into new funding commitments with respect to sub-prime mortgage loans, although it would honor remaining outstanding commitments.

 

On March 7, 2007, Fremont General, FGCC and FIL consented to the Order without admitting to the allegations contained in the Order.

 

The Order requires, among other things, that FIL make a variety of changes in its sub-prime residential loan origination business and also calls for certain changes in its commercial real estate lending business. As more fully described elsewhere in this report, the Company has exited its sub-prime residential real estate operations and has sold its commercial real estate lending business and related loan portfolio. In addition, the Order requires that FIL adopt a Capital Adequacy Plan to maintain adequate Tier-1 capital in relation to its risk profile. Further, the Order mandates various specific management requirements, including having and retaining qualified management acceptable to the FDIC and the Department of Financial Institutions of the State of California (“DFI”), and provides for enhanced regulatory oversight over FIL’s operations. The Order is more fully described in a Current Report on Form 8-K filed by the Company on March 7, 2007.

 

Residential Real Estate Transactions.  On March 21, 2007, the Company announced that FIL had entered into whole loan sale agreements to sell approximately $4 billion of its sub-prime residential real estate loans. On April 16, 2007, the Company announced that FIL had entered into an agreement to sell another $2.9 billion of sub-prime residential real estate loans, which represented the majority of the Company’s sub-prime residential loans held for sale that had not yet been sold. The Company is in discussions with various

 

 

8     FREMONT GENERAL CORPORATION AND SUBSIDIARIES

parties with respect to the sale of the Company’s sub-prime residential loan servicing platform and certain other assets. There can be no assurances that the Company will be able to enter into any transaction with respect to such business. In addition, given the significant market challenges that currently exist in the residential real estate sector, even if such transactions are completed, there can be no assurances that the consideration received in such sales will provide substantial benefit to the Company’s operating results or financial position.

 

Subsequent Events

Commercial Real Estate Transaction.  On July 2, 2007, FIL completed the disposition of its commercial real estate lending business and related loan portfolio to iStar Financial Inc. (“iStar”) pursuant to an Asset Purchase Agreement entered into on May 21, 2007. FIL sold its entire $6.27 billion commercial real estate loan portfolio to iStar and received $1.89 billion in cash plus a $4.21 billion participation interest in the sold portfolio. The $1.89 billion in cash represented 30% of the unpaid principal balance of the loan portfolio as of the closing, net of a purchase discount. The $4.21 billion participation interest in the total loan portfolio represented 70% of the unpaid principal balance of the loan portfolio as of the closing, net of a purchase discount. The participation interest bears interest at LIBOR + 150 basis points. FIL’s participation interest in the loan portfolio is governed by a participation agreement pursuant to which FIL is entitled to receive 70% of all principal payments on the loans sold to iStar, including with respect to any portion of the unfunded commitments with respect to such loans that are subsequently funded by iStar. Additionally, iStar purchased a majority of the non-loan assets used in the business for $50 million in cash. In connection with the transaction, iStar assumed all obligations with respect to the loan portfolio after the closing date (including the obligation to fund approximately $3.72 billion of existing unfunded commitments) and the obligations under certain assumed leases and intellectual property contracts. As of the closing date, iStar employed substantially all of the employees previously engaged in the Company’s commercial real estate lending business.

 

Transaction with Gerald J. Ford.  On May 21, 2007, Fremont General and FIL entered into an Investment Agreement with an entity controlled by Gerald J. Ford providing for the acquisition by an investor group led by Mr. Ford of a combination of approximately $80 million in exchangeable non-cumulative preferred stock of FIL and warrants to acquire additional common stock of Fremont General. On September 26, 2007, the Company announced that it had been advised by Mr. Ford that, in light of certain developments pertaining to Fremont General and FIL, Mr. Ford was not prepared to consummate such transactions on the terms set forth in the Investment Agreement. The Company said that, while it does not necessarily agree with the factual positions taken by Mr. Ford, it is in discussions with Mr. Ford concerning revised terms under which an entity controlled by Mr. Ford would proceed with an $80 million investment in exchangeable preferred stock of FIL and receive warrants to acquire additional common stock of Fremont General. There can be no assurances as to whether or when the parties may reach an agreement with respect to revised transaction terms.

 

Discontinued Operations

As more fully described above, in March 2007, the Company decided to exit the residential real estate business and to sell substantially all of the assets related to such business. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), the Company has classified the residential real estate operations as discontinued operations as the cash flow of the business has been eliminated from its ongoing operations and the Company will no longer have any significant continuing involvement in the business. Therefore, the results of operations, financial position and cash flows of the Company’s residential real estate operations are presented separately in the consolidated financial statements and notes as discontinued operations for all periods presented.

 

When an operation meets the criteria for “held for sale accounting” as defined in SFAS No. 144, the operation is evaluated to determine whether the carrying value exceeds its fair value less costs to sell. Any loss resulting from the carrying value exceeding the fair value less costs to sell is recorded in the statement of operations in the period the operation meets the criteria for held for sale accounting. Management judgment is required to both assess the criteria required for held for sale accounting as well as to estimate fair value. Changes in the operation could cause it to no longer qualify for held for sale accounting and changes in fair value could result in an increase or decrease to previously recognized losses. For additional information concerning the Company’s discontinued operations see Note 4.

 

 

2007 QUARTERLY REPORT     9

General

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The consolidated financial statements include the accounts and operations of Fremont General and its subsidiaries including those variable interest entities where the Company is the primary beneficiary. All intercompany balances and transactions have been eliminated in consolidation.

 

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that materially affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of management, all adjustments considered necessary for the fair presentation of the interim financial statements have been included. See Note 4 for additional information concerning the results of the Company’s discontinued operations and Note 7 for information concerning exit costs related to the disposal of the Company’s commercial real estate lending business and related loan portfolio. The operating results for the three month period ended March 31, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.

 

The unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

 

NOTE 2 — RECENT ACCOUNTING STANDARDS

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140” (“SFAS No. 155”). SFAS No. 155 requires companies to evaluate their interests in securitized financial assets and determine whether the interests are freestanding derivatives or hybrid financial instruments that may be subject to bifurcation. SFAS No. 155 provides companies with relief from having to separately determine the fair value of an embedded derivative that would otherwise be required to be bifurcated from its host contract in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 155 also clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives and amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. The Company adopted SFAS No. 155 as of January 1, 2007 without any significant impact on the Company’s financial position or results of operations.

 

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets — an amendment of FASB Statement No. 140” (“SFAS No. 156”). SFAS No. 156 requires entities to separately recognize a servicing asset or liability when undertaking an obligation to service a financial asset under a servicing contract in certain situations, including a transfer of the servicer’s financial assets that meets the requirements for sale accounting. SFAS No. 156 requires that any such servicing asset or liability be initially measured at fair value, if practicable, and then provides the option to either: (1) carry the mortgage servicing rights (“MSRs”) at fair value with changes in fair value recognized in current period earnings; or (2) continue recognizing periodic amortization expense and assess the MSRs for impairment as originally required by SFAS No. 140. The Company adopted SFAS No. 156 effective January 1, 2007 without any impact; electing to continue to record periodic amortization expense as originally required under SFAS No. 140.

 

In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (“FIN No. 48”). FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN No. 48 prescribes a two-step approach for the recognition and measurement of a tax position taken or expected to be taken in an entity’s tax return. The first step in the evaluation of a tax position is recognition: The Company must determine whether it is more likely than not that a given tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In this evaluation the Company must presume that the position will be examined by the appropriate taxing authority that would have full knowledge of all relevant information. The second step is measurement: A tax position meeting the more-likely-than-not recognition threshold is

 

 

10     FREMONT GENERAL CORPORATION AND SUBSIDIARIES

recorded at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. The Company adopted FIN No. 48 effective January 1, 2007 resulting in a charge to beginning retained earnings of $3.4 million. See Note 8 for further information on the impact of adopting FIN No. 48 and other tax related information.

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP and provides for expanded disclosures concerning fair value measurements. SFAS No. 157 retains the exchange price notion in earlier definitions of fair value; however, focuses on the price that would be received to sell the asset or paid to transfer the liability at the measurement date (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price). SFAS No. 157 also establishes a fair value hierarchy used to classify the source of information used by the entity in fair value measurements. That is, assumptions developed based on market data obtained from independent sources (observable inputs) versus the entity’s own assumptions about market assumptions developed based on the best information available in the circumstances (unobservable inputs).

 

The Company is currently evaluating the impact of adopting SFAS No. 157; however, the Company does not believe the adoption will have a significant impact on its financial position or results of operations. SFAS No. 157 is effective for the Company’s fiscal year beginning January 1, 2008.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115” (“SFAS No. 159”). SFAS No. 159 allows entities the option to measure many financial instruments and certain other items at fair value at specified election dates with changes in fair value reported in earnings. The fair value option may be applied on an instrument by instrument basis (with some exceptions), is irrevocable (unless a new election date occurs) and is applied only to entire instruments and not to portions of instruments. The FASB indicated that the objective of this statement is to improve financial reporting by providing entities the opportunity to mitigate volatility in reported earnings that are caused by measuring related assets and liabilities differently, without having to apply complex hedge accounting provisions. The Company is currently evaluating the impact of adopting SFAS No. 159. SFAS No. 159 is effective for the Company’s fiscal year beginning January 1, 2008.

 

NOTE 3 — CASH AND CASH EQUIVALENTS

From December 31, 2006 to March 31, 2007, the Company increased its total cash and cash equivalents by approximately $866.8 million. This increase was funded by a growth in deposits and debt financing during the first three months of 2007. The normal deployment of increased deposits and debt to fund new loan growth was curtailed due to the decision to exit the sub-prime loan origination business during the first quarter of 2007 coupled with the ongoing sale of residential real estate mortgage loans held for sale during the first quarter of 2007.

 

Cash and cash equivalents are summarized in the following table as of the dates indicated:

 

 

The FHLB shareholder transaction account represents a short-term interest-bearing account with the Federal Home Loan Bank of San Francisco. The Company’s commercial paper holdings have ratings of A1 / P1 or better. The short-term money market funds have AAA / Aaa money market fund ratings. As of March 31, 2007, $4.1 million in deposits in other financial institutions were restricted. No other cash and cash equivalents were restricted as of March 31, 2007 and December 31, 2006.

 

 

2007 QUARTERLY REPORT     11

NOTE 4 — DISCONTINUED OPERATIONS

As more fully described in Note 1, in March 2007, the Company decided to exit the residential real estate business and sell substantially all of the assets related to such business. The Company has determined there are no migration of revenues or costs as defined in EITF 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144 in Determining Whether to Report Discontinued Operations” (“EITF 03-13”), since the Company is disposing of substantially all of its residential real estate operations and assets. In addition, although continuing cash flows may occur related to loan repurchases and repricings the Company is obligated to make in subsequent periods under standard industry representations and warranties for its residential real estate whole loan sales, the resolution of these contingencies do not constitute continuing cash flows or continuing involvement as defined in EITF 03-13. Therefore, in accordance with SFAS No. 144, the results of operations, financial position and cash flows of the Company’s residential real estate operations are presented separately in the consolidated financial statements and notes as discontinued operations for all periods presented.

 

Assets and Liabilities of Discontinued Operations

 

The major classifications of assets and liabilities of the Company’s discontinued operations are summarized as follows as of the dates indicated:

 

 

Residential Real Estate Loans Held for Sale and Valuation Reserve:  Residential real estate loans held for sale are aggregated prior to their sale and are carried at the lower of aggregate cost or estimated fair value less costs to sell. Estimated fair values are based upon current secondary market prices for loans with similar coupons, maturities and credit quality. The following tables detail the residential real estate loans held for sale included

 

 

12     FREMONT GENERAL CORPORATION AND SUBSIDIARIES

in discontinued operations and the valuation reserve to adjust the loans to estimated fair value less costs to sell as of the dates indicated:

 

 

 

Loan Repurchase Reserve:  As the residential real estate loans held for sale are sold, the Company makes standard industry representations and warranties about the loans. The Company may have to subsequently repurchase certain loans due to defects that occurred in the origination of the loans. During the first quarter of 2007, the Company repurchased a total of $322.2 million in loans, as compared to $78.7 million for the first quarter of 2006. The following table summarizes the activity in the repurchase reserve within discontinued operations for the periods indicated.

 

 

Premium Repurchase and Recapture Reserve:  The Company also maintains a reserve for premium recapture that represents the estimate of probable refunds of premiums received on previously completed loan sales (either due to early loan prepayments or for certain loans repurchased from prior sales) that are expected to occur under the provisions of the various agreements entered into for the sale of its residential real estate loans held for sale. The following table summarizes the activity in the premium recapture reserve within discontinued operations for the periods indicated:

 

 

 

2007 QUARTERLY REPORT     13

Mortgage Servicing Rights:  The following table summarizes the activity in the Company’s mortgage servicing rights asset within discontinued operations for the periods indicated:

 

 

The key economic assumptions used in subsequently measuring the fair value of the Company’s MSRs as of the dates indicated are as follows:

 

 

Residual Interests in Securitized Loans: The following table summarizes the activity of the Company’s retained residual interests within discontinued operations for the periods indicated:

 

 

The following table summarizes delinquencies and credit losses for the loans underlying the Company’s outstanding securitization transactions as of the dates indicated:

 

 

Key economic assumptions used in subsequently measuring the fair value of the Company’s residual interests as of the dates indicated are as follows:

 

 

 

14     FREMONT GENERAL CORPORATION AND SUBSIDIARIES

Operating Results of Discontinued Operations

 

 

The loss from discontinued operations, net of income taxes, was $602.8 million for the first quarter of 2007, representing a $7.90 diluted loss per share, compared to income from discontinued operations, net of income taxes, of $17.3 million, or $0.23 diluted income per share for the first quarter of 2006.

 

During the first quarter of 2007, the Company recorded a realized loss of $630.7 million related to the sale of $4.19 billion of residential real estate loans held for sale. Expense provisions related to the residential real estate loan valuation, repurchase and premium recapture reserves are included in this loss. In addition, the Company recognized a $38.8 million adjustment to write down the carrying value of the residential real estate held for sale assets to their estimated fair value less costs to sell.

 

During the first three months of 2007 and 2006, the Company recognized $129.9 million and $139.7 million, respectively, in interest income on the residential real estate loan portfolio.

 

During the first three months of 2007, the Company continued to service residential real estate loans recognizing loan servicing income of $32.8 million as compared to $21.3 million during the first three months of 2006. The Company was servicing on a to maturity basis $17.28 billion and $18.12 billion in principal balance of loans as of March 31, 2007 and December 31, 2006, respectively.

 

The loss from discontinued operations includes a $1.6 million charge for one time severance payments paid to employees of the residential real estate loan origination operations and related support staff. In addition, the Company recorded a $10.7 million charge for lease termination costs related to the Company’s residential real estate loan origination offices.

 

During the three months ended March 31, 2007, cash flows related to residential real estate loan originations and proceeds realized on the sale of such loans were $3.88 billion and $3.87 billion, respectively, and during the three months ended March 31, 2006, such cash flows were $8.54 billion and $7.26 billion, respectively. These amounts are included in cash flows from operating activities in the Company’s consolidated statements of cash flows.

 

NOTE 5 — COMMERCIAL REAL ESTATE LOANS HELD FOR SALE

As more fully described in Note 1, on July 2, 2007, FIL completed the sale of its commercial real estate lending business and related loan portfolio to iStar.

 

Commercial real estate loans held for sale were primarily variable rate and were secured primarily by first mortgages on various types of properties. The commercial real estate loans held for sale were primarily comprised of bridge and construction loans of relatively short duration (rarely more than five years in length

 

 

2007 QUARTERLY REPORT     15

of term and often shorter, such as two to three years). These loans were funded throughout the term as the construction progressed.

 

The following table further details the net commercial real estate loans that were classified as held for sale as of March 31, 2007 and held for investment as of December 31, 2006.

 

 

Due to the reclassification of the commercial real estate loan portfolio from held for investment to held for sale in the first quarter of 2007, the Company eliminated the allowance for loan loss and adjusted the carrying value of the loans to their estimated fair value less costs to sell.

 

In cases where a borrower experienced financial difficulties and the Company made certain concessionary modifications to contractual terms (typically a reduction of the interest rate charged), the loan was classified as a restructured (accruing) loan if the loan was performing in accordance with the agreed upon modified loan terms and projected cash proceeds were deemed sufficient to repay both principal and interest. Restructured loans are presented as such in the period of restructure and the three subsequent quarters. The following table sets forth information regarding the Company’s commercial real estate loans on non-accrual status and restructured loans on accrual status.

 

 

The Company’s real estate owned (“REO”) consists of property acquired through or in lieu of foreclosure on loans secured by real estate. REO is reported in the financial statements at the lower of cost or estimated realizable value (net of estimated costs to sell). REO consisted of the following as of the dates indicated.

 

 

As more fully described in Note 1, the Company completed the sale of its entire $6.27 billion commercial real estate loan portfolio to iStar in July 2007, and received cash of $1.89 billion and a 70% participation interest of $4.21 billion in the loans sold. Due to the participation, cash flows from the component will not be eliminated from the Company’s ongoing operations. Because the Company expects significant cash inflows will be received as a result of the continuation of activities between itself and the commercial real estate component, the sale does not result in the classification of the commercial real estate operation as discontinued, as defined by EITF No. 03-13. Based on management’s decision to sell the commercial loan portfolio in the first quarter of 2007, the Company reclassified the commercial real estate loans from held for investment to held for sale.

 

 

16     FREMONT GENERAL CORPORATION AND SUBSIDIARIES

In connection with the sale, approximately 131 employees in the commercial real estate loan origination operation transferred to iStar. In accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” the Company recorded employee severance charges for terminated employees that did not transfer to iStar in the amount of $8,000 and $6.1 million as part of compensation and related costs in the first and second quarters of 2007, respectively. In addition, in the first and second quarters of 2007, the Company incurred $168,000 and $1.1 million, respectively, in other charges related to the sale of the commercial real estate loan origination operation and related loan portfolio. These charges are included in other non-interest expense in the consolidated statements of operations.

 

The major components of income tax expense from continuing operations are summarized in the following table:

 

 

The Company recorded an income tax benefit relating to its discontinued operations of $(79.7) million for 2007 of which $(131.7) million was current and $52.0 million was deferred. Included in the 2007 deferred tax expense was a $192.0 million increase to the deferred tax asset valuation reserve. In 2006, the Company recorded an income tax expense relating to its discontinued operations of $11.9 million of which $44.1 million was current and $(32.2) million was deferred.

 

The deferred income tax balance includes the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and for income tax purposes. The components of the Company’s deferred tax assets are summarized in the following table:

 

 

 

2007 QUARTERLY REPORT     17

The Company has accrued the expected tax and interest exposure for tax matters that are either in the process of resolution or have been identified as having the potential for adjustment. These matters primarily consist of issues relating to the discontinued insurance operations, the apportionment of income to various states and the deduction of certain expenses.

 

In assessing the realization of deferred income tax assets, the Company considers whether it is more likely than not that the deferred income tax assets will be realized. The ultimate realization of deferred income tax assets depends on the ability to recover previously paid taxes through loss carrybacks and the generation of future taxable income during the periods in which temporary differences become deductible. At March 31, 2007, it was the Company’s opinion that it was not likely that the deferred tax asset would be realized and a full valuation reserve was recorded for the net deferred tax asset.

 

The Company adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized an approximate $3.4 million increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings. The total amount of unrecognized tax benefits as of the date of adoption on January 1, 2007 was $22.1 million, all of which would favorably affect the effective tax rate if recognized.

 

The Company records interest expense and penalties related to unrecognized tax benefits as a component of income tax expense. At January 1, 2007, the Company had accrued $1.8 million and $500,000 for the potential payments of interest and penalties.

 

The Internal Revenue Service is currently examining the Company’s 2004 and 2005 income tax returns. The California Franchise Tax Board has examined the Company’s franchise tax returns through the 2004 tax year.

 

The debt of Fremont General is detailed in the following table; none of the Fremont General debt is guaranteed by FIL:

 

 

During the first quarter of 2007, there were no repurchases of either Senior Notes or Junior Subordinated Debentures.

 

FIL utilizes the issuance of deposits, which are insured up to the maximum legal limit by the FDIC, Federal Home Loan Bank (“FHLB”) advances, Federal Reserve and warehouse lines of credit in funding its operations.

 

As of March 31, 2007, the weighted-average interest rate for savings and money market deposit accounts was 4.41% and for certificates of deposit it was 5.26%. The weighted-average interest rate for all deposits at March 31, 2007 was 5.12%.

 

Certificates of deposit as of March 31, 2007 are detailed by maturity and rates as follows:

 

 

 

18     FREMONT GENERAL CORPORATION AND SUBSIDIARIES

Of the $8.95 billion in total certificates of deposit outstanding at March 31, 2007, $2.25 billion were obtained through brokers.

 

Interest expense on deposits is summarized as follows:

 

 

Interest expense is charged back to both the commercial real estate operations as well as the residential real estate (discontinued) operations for the use of funds generated by the Company’s corporate and retail banking operations.

 

Total interest payments on deposits were $117.8 million and $92.5 million, for the three months ended March 31, 2007 and 2006, respectively.

 

In the first quarter of 2007, additional financing was available to FIL through advances from the FHLB. FIL’s credit line with the FHLB had a maximum financing availability that was based on a percentage of FIL’s regulatory assets, to which the actual borrowing capacity was subject to collateralization and certain collateral sublimits and eligibility limitations. In March 2007, following the issuance of the Order and the Company’s exit from the residential real estate lending business, the FHLB limited FIL’s borrowing capacity to existing outstanding debt of $3.67 billion. By March 31, 2007, FIL had utilized $2.30 billion in proceeds from loan sales and $618.1 million in debt from a warehouse lending facility to reduce the outstanding FHLB debt to $800.0 million. As of June 30, 2007, outstanding FHLB debt was zero and all pledged collateral was released by the FHLB to FIL. FIL does not currently maintain pledged collateral with the FHLB.

 

In the first quarter of 2007, FIL pledged eligible commercial real estate loans to the Federal Reserve Bank of San Francisco under the Primary Credit program (the “Program”). There was no outstanding debt at any time during 2007 under the Program. In June 2007, in anticipation of the iStar Transaction, FIL removed all commercial real estate loans pledged as collateral under the Program. As of June 30, 2007, FIL did not maintain any pledged collateral with the Federal Reserve Bank. FIL does not currently maintain pledged collateral with the Federal Reserve Bank.

 

In the first quarter of 2007, in connection with the Company’s exit from the residential real estate lending business, FIL mutually terminated two of four existing warehouse financing lines and elected to allow one financing facility to expire. As of March 31, 2007, outstanding debt on the remaining warehouse facility was $618.0 million. On April 30, 2007 all outstanding debt on this facility was repaid. In June 2007, the remaining warehouse financing facility expired. As of June 30, 2007, FIL did not have any warehouse financing lines.

 

The following tables detail the composition of the Company’s other assets and other liabilities as of the dates indicated: