-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, O+Oc3LBGDiR6Zuhs5itwdTTwxYY1pHCz5BhNZZ9NHVs3aCvz/Hraw2Mrhn7nobpt +hG3KH0MQuELufbQhCZ4Pg== 0000038984-06-000023.txt : 20060809 0000038984-06-000023.hdr.sgml : 20060809 20060809161632 ACCESSION NUMBER: 0000038984-06-000023 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20060630 FILED AS OF DATE: 20060809 DATE AS OF CHANGE: 20060809 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FREMONT GENERAL CORP CENTRAL INDEX KEY: 0000038984 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 952815260 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-08007 FILM NUMBER: 061017811 BUSINESS ADDRESS: STREET 1: 2425 OLYMPIC BOULEVARD STREET 2: 3RD FLOOR CITY: SANTA MONICA STATE: CA ZIP: 90404 BUSINESS PHONE: 3103155500 MAIL ADDRESS: STREET 1: 2425 OLYMPIC BOULEVARD STREET 2: 3RD FLOOR CITY: SANTA MONICA STATE: CA ZIP: 90404 10-Q 1 q22006form10q.txt FORM 10-Q FOR THE PERIOD ENDED JUNE 30, 2006 ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006 OR [ } TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO __________ COMMISSION FILE NUMBER 001-08007 FREMONT GENERAL CORPORATION (Exact name of Registrant as specified in its charter) NEVADA 95-2815260 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2425 OLYMPIC BOULEVARD SANTA MONICA, CALIFORNIA 90404 (Address of principal executive offices) (Zip Code) (310) 315-5500 (Registrant's telephone number, including area code) NOT APPLICABLE (Former Name or Former Address, if Changed Since Last Report) Indicate by check mark whether the Registrant: (1) has filed all reports required by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act.): Large Accelerated Filer [X] Accelerated Filer [ ] Non-Accelerated Filer [ ] Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Indicate the number of shares outstanding of each of the issuer's classes of common stock: SHARES OUTSTANDING CLASS JULY 31, 2006 Common Stock, $1.00 par value 77,861,629 - -------------------------------------------------------------------------------- FREMONT GENERAL CORPORATION AND SUBSIDIARIES INDEX PART I - FINANCIAL INFORMATION PAGE NO. -------- Item 1. Financial Statements Consolidated Balance Sheets June 30, 2006 (Unaudited) and December 31, 2005 .... 3 Consolidated Statements of Income Three and Six Months Ended June 30, 2006 and 2005 (Unaudited) ............................... 4 Consolidated Statements of Changes in Stockholders' Equity June 30, 2006 and 2005 (Unaudited) .......... 5 Consolidated Statements of Cash Flows Six Months Ended June 30, 2006 and 2005 (Unaudited) ........................................ 6 Consolidated Statements of Comprehensive Income Three and Six Months Ended June 30, 2006 and 2005 (Unaudited) ........................................ 7 Notes to Consolidated Financial Statements (Unaudited) ........................................ 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations .................. 47 Item 3. Quantitative and Qualitative Disclosures About Market Risk .......................................... 75 Item 4. Controls and Procedures ................................ 76 PART II - OTHER INFORMATION Item 1. Legal Proceedings ...................................... 77 Item 1A. Risk Factors ........................................... 79 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds .......................................... 79 Item 3. Not applicable Item 4. Submission of Matters to a Vote of Security Holders..... 80 Item 5. Not applicable Item 6. Exhibits ............................................... 81 Signatures ........................................................ S-1 2 FREMONT GENERAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31, 2006 2005 ------------ ------------ (UNAUDITED) (THOUSANDS OF DOLLARS) ASSETS Cash and cash equivalents ................................................... $ 567,296 $ 768,643 Investment securities classified as available-for-sale at fair value ........ 19,966 17,527 Federal Home Loan Bank ("FHLB") stock at cost ............................... 211,500 136,018 Loans held for sale - net ................................................... 6,072,300 5,423,109 Loans held for investment - net ............................................. 5,525,020 4,603,063 Mortgage servicing rights - net ............................................. 62,739 46,022 Residual interests in securitized loans at fair value ....................... 107,535 170,723 Accrued interest receivable ................................................. 62,139 42,123 Real estate owned ........................................................... 3,719 33,872 Premises and equipment - net ................................................ 65,691 65,203 Deferred income taxes ....................................................... 101,870 83,235 Other assets ................................................................ 88,613 94,575 ------------ ------------ TOTAL ASSETS .............................................................. $ 12,888,388 $ 11,484,113 ============ ============ LIABILITIES Deposits: Savings accounts .......................................................... $ 776,832 $ 1,103,993 Money market deposit accounts ............................................. 721,970 446,274 Certificates of deposit ................................................... 8,064,155 7,051,726 ------------ ------------ 9,562,957 8,601,993 Warehouse lines of credit ................................................... - - Federal Home Loan Bank advances ............................................. 1,305,000 949,000 Senior Notes due 2009 ....................................................... 169,484 175,305 Junior Subordinated Debentures .............................................. 103,093 103,093 Other liabilities ........................................................... 311,237 297,916 ------------ ------------ TOTAL LIABILITIES ......................................................... 11,451,771 10,127,307 Commitments and contingencies ............................................... - - STOCKHOLDERS' EQUITY Preferred stock, par value $ .01 per share -- Authorized: 2,000,000 shares; none issued ....................................................... - - Common stock, par value $1 per share -- Authorized: 150,000,000 shares; issued and outstanding: (2006 - 77,868,000 and 2005 - 77,497,000) ........................................................ 77,462 77,497 Additional paid-in capital .................................................. 327,790 341,800 Retained earnings ........................................................... 1,032,639 966,112 Deferred compensation ....................................................... (20,949) (43,357) Accumulated other comprehensive income ...................................... 19,675 14,754 ------------ ------------ TOTAL STOCKHOLDERS' EQUITY ............................................. 1,436,617 1,356,806 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............................. $ 12,888,388 $ 11,484,113 ============ ============
The accompanying notes are an integral part of these statements. 3 FREMONT GENERAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------ ----------------------- 2006 2005 2006 2005 -------- --------- --------- -------- (THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA) INTEREST INCOME: Interest and fee income on loans: Residential ................................................... $ 167,856 $ 125,763 $ 307,526 $ 236,774 Commercial .................................................... 126,526 76,457 236,060 142,849 Other ......................................................... 92 85 179 184 --------- --------- --------- --------- 294,474 202,305 543,765 379,807 Interest income - other ......................................... 23,134 8,645 46,713 13,067 --------- --------- --------- --------- 317,608 210,950 590,478 392,874 INTEREST EXPENSE: Deposits ........................................................ 106,385 62,300 197,070 111,656 FHLB advances ................................................... 34,939 12,213 55,595 19,719 Warehouse lines of credit ....................................... 4,923 2,337 6,560 2,556 Senior Notes .................................................... 3,464 3,651 7,010 7,301 Junior Subordinated Debentures .................................. 2,319 2,319 4,639 4,639 Other ........................................................... 213 168 249 289 --------- --------- --------- --------- 152,243 82,988 271,123 146,160 Net interest income ............................................... 165,365 127,962 319,355 246,714 Provision for loan losses ......................................... 11,707 (4,216) 15,588 (3,180) --------- --------- --------- --------- Net interest income after provision for loan losses ............... 153,658 132,178 303,767 249,894 NON-INTEREST INCOME: Net gain (loss) on whole loan sales and securitizations of residential real estate loans .............................. 8,374 91,964 (6,802) 200,324 Loan servicing income ........................................... 23,482 15,945 44,831 29,686 Mortgage servicing rights amortization and impairment provision ..................................................... (8,859) (4,807) (16,903) (9,711) Impairment on residual assets ................................... (5,752) (572) (5,752) (1,790) Other ........................................................... 5,343 6,040 8,549 9,967 --------- --------- --------- --------- 22,588 108,570 23,923 228,476 NON-INTEREST EXPENSE: Compensation and related ........................................ 57,249 55,654 116,659 114,934 Occupancy ....................................................... 8,175 6,942 15,805 13,877 Other ........................................................... 24,637 28,119 55,893 48,348 --------- --------- --------- --------- 90,061 90,715 188,357 177,159 Income before income taxes ........................................ 86,185 150,033 139,333 301,211 Income tax expense ................................................ 34,261 59,263 55,722 120,339 --------- --------- --------- --------- NET INCOME ........................................................ $ 51,924 $ 90,770 $ 83,611 $ 180,872 ========= ========= ========= ========= PER SHARE DATA: Basic ........................................................... $ 0.70 $ 1.25 $ 1.13 $ 2.50 Diluted ......................................................... 0.68 1.21 1.10 2.43 CASH DIVIDENDS DECLARED PER COMMON SHARE .......................... $ 0.11 $ 0.08 $ 0.22 $ 0.15
The accompanying notes are an integral part of these statements. 4 FREMONT GENERAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
ACCUMULATED ADDITIONAL OTHER COMMON PAID-IN RETAINED DEFERRED COMPREHENSIVE STOCK CAPITAL EARNINGS COMPENSATION INCOME TOTAL -------- ---------- ----------- ------------ ------------- ----------- (THOUSANDS OF DOLLARS) BALANCE AT DECEMBER 31, 2004 ................. $ 77,241 $ 330,328 $ 663,580 $ (58,916) $ 1,415 $ 1,013,648 Net income .................................. - - 180,872 - - 180,872 Cash dividends declared - $0.15 per share ... - - (11,519) - - (11,519) Conversion of LYONs ......................... 35 559 - - - 594 Retirement of common stock .................. (34) (174) - 208 - - Shares issued, acquired or allocated for employee benefit plans ................. 694 15,013 - (35,459) - (19,752) Amortization of restricted stock ............ - - - 9,832 - 9,832 Shares allocated to ESOP .................... - (1,368) - 25,832 - 24,464 Change in cost of common stock held in trust .............................. - - - (5,632) - (5,632) Net change in unrealized gain on investments and residual interests, net of deferred taxes ...................... - - - - 2,774 2,774 Excess tax benefits relating to share- based payments ............................. - 2,382 - - - 2,382 Other adjustments ........................... - (2,766) - 2,766 - - -------- ---------- ----------- ------------ ------------- ----------- Balance at June 30, 2005 ..................... $ 77,936 $ 343,974 $ 832,933 $ (61,369) $ 4,189 $ 1,197,663 ======== ========== =========== ============ ============= =========== BALANCE AT DECEMBER 31, 2005 ................. $ 77,497 $ 341,800 $ 966,112 $ (43,357) $ 14,754 $ 1,356,806 Net income .................................. - - 83,611 - - 83,611 Cash dividends declared - $0.22 per share ... - - (17,084) - - (17,084) Reclassification of deferred compensation for restricted stock ....................... - (20,902) - 20,902 - - Retirement of common stock .................. (35) 35 - - - - Shares issued, acquired or allocated for employee benefit plans ................. - (862) - (20,780) - (21,642) Amortization of restricted stock ............ - 7,386 - - - 7,386 Shares allocated to ESOP .................... - (1,370) - 24,315 - 22,945 Change in cost of common stock held in trust .............................. - - - (2,376) - (2,376) Net change in unrealized gain on investments and residual interests, net of deferred taxes ...................... - - - - 4,921 4,921 Excess tax benefits relating to share- based payments ............................. - 2,050 - - - 2,050 Other adjustments ........................... - (347) - 347 - - -------- ---------- ----------- ------------ ------------- ----------- BALANCE AT JUNE 30, 2006 ..................... $ 77,462 $ 327,790 $ 1,032,639 $ (20,949) $ 19,675 $ 1,436,617 ======== ========== =========== ============ ============= ===========
The accompanying notes are an integral part of these statements. 5 FREMONT GENERAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, -------------------------------- 2006 2005 ------------- ------------- (THOUSANDS OF DOLLARS) OPERATING ACTIVITIES Net income ................................................................ $ 83,611 $ 180,872 Adjustments to reconcile net income to net cash used in operating activities: Provision for loan losses ............................................... 15,588 (3,180) Provision for premium recapture, repurchase and valuation reserves of residential real estate loans held for sale ........................ 125,487 39,588 Premium refunds ......................................................... (10,998) (10,906) Change in mortgage servicing rights ..................................... (33,620) (14,027) Change in residual interests in securitized loans ....................... 64,636 (3,752) Cash from residual interests in securitized loans ....................... 31,592 9,892 Provision for deferred income taxes ..................................... (21,804) 21,349 Depreciation, amortization, accretion and impairment of retained interests .............................................................. 6,071 23,285 Compensation expense related to deferred compensation plans ............. 6,109 10,603 Change in accrued interest .............................................. (20,016) 1,999 Change in other assets .................................................. 13,814 (2,482) Change in accounts payable and other liabilities ........................ (34,901) (27,386) ------------ ------------- NET CASH PROVIDED BY OPERATING ACTIVITIES BEFORE LOANS HELD FOR SALE ACTIVITY ........................................................ 225,569 225,855 Originations of residential loans held for sale ......................... (18,078,063) (17,005,351) Sale of and payments received from loans held for sale .................. 17,151,642 16,817,068 Loan payments received for residential real estate loans held for sale ................................................................... 226,346 130,933 ------------- ------------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES ................... (474,506) 168,505 INVESTING ACTIVITIES Originations and advances funded for loans held for investment ............ (1,943,078) (1,583,933) Payments received from and sales of loans held for investment ............. 1,038,919 1,329,128 Maturities or repayments of investment securities available-for-sale ...... 127 190 Net purchases of FHLB stock ............................................... (75,482) (79,157) Purchases of premises and equipment ....................................... (10,736) (13,328) ------------ ------------- NET CASH USED IN INVESTING ACTIVITIES ................................... (990,250) (347,100) FINANCING ACTIVITIES Deposits accepted, net of repayments ...................................... 960,964 778,756 FHLB repayments, net of advances .......................................... 356,000 (43,000) Extinguishment of Senior Notes and LYONs .................................. (5,933) (30) Dividends paid ............................................................ (16,269) (10,691) Excess tax benefits related to share-based payments ....................... 2,050 2,382 Purchase of company common stock for deferred compensation plans .......... (33,403) (30,982) ------------- ------------- NET CASH PROVIDED BY FINANCING ACTIVITIES ............................... 1,263,409 696,435 Increase (decrease) in cash and cash equivalents ............................ (201,347) 517,840 Cash and cash equivalents at beginning of period .......................... 768,643 904,975 ------------- ------------- Cash and cash equivalents at end of period .................................. $ 567,296 $ 1,422,815 ============= =============
The accompanying notes are an integral part of these tatements. 6 FREMONT GENERAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, --------------------- ---------------------- 2006 2005 2006 2005 -------- -------- -------- --------- (THOUSANDS OF DOLLARS) Net income .......................................................... $ 51,924 $ 90,770 $ 83,611 $ 180,872 Other comprehensive income: Net change in unrealized gains (losses) during the period: Residual interests in securitized loans ......................... 11,399 6,110 6,033 4,632 Investment securities ........................................... 92 (1) 2,058 (9) -------- -------- -------- --------- 11,491 6,109 8,091 4,623 Less income tax expense ........................................... 4,542 2,444 3,170 1,849 -------- -------- -------- --------- Other comprehensive net income ...................................... 6,949 3,665 4,921 2,774 -------- -------- -------- --------- TOTAL COMPREHENSIVE NET INCOME ...................................... $ 58,873 $ 94,435 $ 88,532 $ 183,646 ======== ======== ======== =========
The accompanying notes are an integral part of these statements. 7 FREMONT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1: BASIS OF PRESENTATION Fremont General Corporation ("Fremont General" or when combined with its subsidiaries "the Company" or "we") is a financial services holding company. Fremont General's financial services operations are consolidated within Fremont General Credit Corporation ("FGCC"), which is engaged in commercial and residential (consumer) real estate lending nationwide through its California industrial bank subsidiary, Fremont Investment & Loan ("FIL"). FIL's deposits are insured by the Federal Deposit Insurance Corporation ("FDIC") up to the maximum legal limits. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The consolidated financial statements include the accounts and operations of Fremont General and its subsidiaries including those variable interest entities where the Company is the primary beneficiary. All intercompany balances and transactions have been eliminated in consolidation. The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that materially affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for the fair presentation of the interim financial statements have been included. The operating results for the three and six month periods ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. The unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2005. Certain prior period amounts have been reclassified to conform to the current period presentation. NOTE 2: RECENT ACCOUNTING STANDARDS In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123(R)"). This amended standard requires all entities to recognize compensation expense over the related vesting period in an amount equal to the fair value of share-based payments granted to employees. The 8 Company adopted SFAS No. 123(R) as of January 1, 2006 on the modified prospective basis without any significant impact on the Company's financial position or results of operations. The primary impact of adopting SFAS No. 123(R) on the Company's financial statements was the reclassification of the deferred compensation balance as of December 31, 2005 ($20.9 million) related to its nonvested restricted shares to additional paid-in capital. (See Note 17) In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3" ("SFAS No. 154"). SFAS No. 154 changes the requirements for the accounting and reporting of a change in accounting principle. SFAS No. 154 requires a change in accounting principle to be retrospectively applied as of the beginning of the first period presented in the financial statements as if that principle had always been used, unless it is impracticable to do so. SFAS No. 154 applies to all voluntary changes in accounting principles as well as to changes required by accounting pronouncements that do not include specific transaction provisions. The Company adopted SFAS No. 154 as of January 1, 2006 without any significant impact on the Company's financial position or results of operations. In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments -- an amendment of FASB Statements No. 133 and 140" ("SFAS No. 155"). SFAS No. 155 requires companies to evaluate their interests in securitized financial assets and determine whether the interests are freestanding derivatives or hybrid financial instruments that may be subject to bifurcation. SFAS No. 155 provides companies with relief from having to separately determine the fair value of an embedded derivative that would otherwise be required to be bifurcated from its host contract in accordance with SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 155 also clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives and amends SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired or issued after January 1, 2007. The Company does not believe the adoption of SFAS No. 155 will have a significant impact on the Company's financial position or results of operations. In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140" ("SFAS No. 156"). SFAS No. 156 requires entities to separately recognize a servicing asset or liability when undertaking an obligation to service a financial asset under a servicing contract in certain situations, including a transfer of the servicer's financial assets that meets the 9 requirements for sale accounting. Any such servicing assets or liabilities are required to be initially measured at fair value, if practicable. The Company currently values the mortgage servicing rights assets ("MSRs") associated with its residential real estate whole loan sales and securitizations (where servicing is retained) at the lower of cost or market. Likewise, the Company currently calculates its gain on whole loan sales and securitizations by allocating the carrying value of the existing held for sale loans to the assets retained based on their relative fair values at the date of the sale or securitization. The provisions of SFAS No. 156 may affect the future carrying value of the MSRs as well as the Company's gain on sale and securitizations; however, the Company does not believe the adoption of SFAS No. 156 will result in a significant impact on its financial position or results of operations. SFAS No. 156 is effective for the Company's fiscal year beginning January 1, 2007. In July 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN No. 48"). FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an entity's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes." FIN No. 48 prescribes a two-step approach for the recognition and measurement of a tax position taken or expected to be taken in an entity's tax return. The first step in the evaluation of a tax position is recognition: The Company must determine whether it is more likely than not that a given tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In this evaluation the Company must presume that the position will be examined by the appropriate taxing authority that would have full knowledge of all relevant information. The second step is measurement: A tax position meeting the more-likely-than-not recognition threshold is recorded at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. The Company is currently evaluating the impact of adopting FIN No. 48; however, the Company does not believe the adoption will have a significant impact on its financial position or results of operations. FIN No. 48 is effective for the Company's fiscal year beginning January 1, 2007. 10 NOTE 3: CASH AND CASH EQUIVALENTS Cash and cash equivalents are summarized in the following table as of the dates indicated:
JUNE 30, DECEMBER 31, 2006 2005 --------- ----------- (THOUSANDS OF DOLLARS) Cash on hand ................................................................ $ 271 $ 239 Non-interest bearing deposits in other financial institutions ............... 141,780 98,141 FHLB shareholder transaction account ........................................ 90,540 214,237 Federal Reserve account ..................................................... 53,483 2,829 U.S. Government Agency money market funds ................................... 125,000 350,000 Short-term money market fund ................................................ 72,114 37,242 Commercial paper ............................................................ 84,108 65,955 --------- ----------- Total cash and cash equivalents ............................................. $ 567,296 $ 768,643 ========= ===========
The FHLB shareholder transaction account represents a short-term interest-bearing transaction account with the Federal Home Loan Bank of San Francisco. The Company's cash and cash equivalent balances were unrestricted as of June 30, 2006 and December 31, 2005. NOTE 4: INVESTMENT SECURITIES CLASSIFIED AS AVAILABLE-FOR-SALE The amortized cost, unrealized gains, unrealized losses and fair value of the Company's investment securities as of June 30, 2006 were as follows:
AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ----------- -------- (THOUSANDS OF DOLLARS) Mortgage-backed securities Agency .......................................... $ 727 $ - $ 15 $ 712 Private issue ................................... 17,173 2,081 - 19,254 --------- ---------- ---------- -------- Total available-for-sale securities ............... $ 17,900 $ 2,081 $ 15 $ 19,966 ========= ========== ========== ========
11 There were no realized gains or losses on the available-for-sale securities during the three and six months ended June 30, 2006. Unrealized gains or losses are included in other comprehensive income. The private issue securities are mortgage-backed securities retained from one of the Company's 2005 residential real estate loan securitization transactions. NOTE 5: LOANS HELD FOR SALE Loans held for sale consist solely of residential real estate loans (primarily first trust deeds, but also second trust deeds) which are aggregated prior to their sale and are carried at the lower of aggregate cost or estimated fair value. Estimated fair values are based upon current secondary market prices for loans with similar coupons, maturities and credit quality. The Company's residential real estate loans have loan terms for up to thirty years and are typically secured by first deeds of trust on single-family residences. The Company's residential real estate loans held for sale typically have a significant concentration (generally 80% or higher) of "hybrid" loans which have a fixed rate of interest for an initial period (generally two years) after origination, after which the interest rate is adjusted to a rate equal to the sum of six-month LIBOR and a margin as set forth in the mortgage note. The interest rate then adjusts at each six-month interval thereafter, subject to various initial, periodic and lifetime interest rate caps and floors. The loans are generally made to borrowers who do not satisfy all of the credit, documentation and other underwriting standards prescribed by conventional mortgage lenders and loan buyers, such as Fannie Mae and Freddie Mac, and are commonly referred to as "sub-prime" or "non-prime." The following table details the loans held for sale as of the dates indicated:
JUNE 30, DECEMBER 31, 2006 2005 ----------- ----------- (THOUSANDS OF DOLLARS) Loan principal balance: First trust deeds ......................................................... $ 5,445,702 $ 4,792,976 Second trust deeds ........................................................ 656,118 611,104 ----------- ----------- 6,101,820 5,404,080 Net deferred direct origination costs ....................................... 44,913 51,782 ----------- ----------- 6,146,733 5,455,862 Valuation reserve ........................................................... (74,433) (32,753) ----------- ----------- Loans held for sale - net ................................................... $ 6,072,300 $ 5,423,109 =========== =========== Loans held for sale on non-accrual status ................................... $ 42,299 $ 16,736 =========== ===========
12 Since most of the loans that are held for sale are sold within sixty days of origination, the amount of loans held for sale that are classified as non-accrual or become real estate owned, is generally small. A valuation reserve is maintained for certain non-performing loans and other loans held for sale based upon the Company's estimate of inherent losses. Provisions for the valuation reserve are charged against gain (loss) on sale of loans. Activity in the valuation reserve is summarized in the following table for the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, --------------------- ----------------------- 2006 2005 2006 2005 --------- -------- --------- -------- (THOUSANDS OF DOLLARS) Beginning balance .................................................. $ 48,719 $ 44,008 $ 32,753 $ 38,257 Provision .......................................................... 29,946 9,999 47,280 16,676 Discounted sales ................................................... (32,110) (4,535) (49,488) (9,224) Charge-offs ........................................................ (3,172) (1,283) (4,870) (1,977) Transfer from repurchase reserve ................................... 31,050 6,465 48,758 10,922 --------- -------- -------- -------- Ending balance ..................................................... $ 74,433 $ 54,654 $ 74,433 $ 54,654 ========= ======== ======== ========
The valuation reserve is apportioned as follows as of the dates indicated:
JUNE 30, DECEMBER 31, 2006 2005 -------- ----------- (THOUSANDS OF DOLLARS) First trust deeds .......................................................... $ 28,286 $ 14,512 Second trust deeds ......................................................... 46,147 18,241 -------- ----------- $ 74,433 $ 32,753 ======== ===========
In the ordinary course of business, as the loans held for sale are sold, the Company makes standard industry representations and warranties about the loans. The Company may have to subsequently repurchase certain loans due to defects that occurred in the origination of the loans. Such defects are categorized as documentation errors, underwriting errors, or fraud. In addition, the Company is generally required to repurchase loans from previous whole loan sale transactions that experience first payment defaults. If there are no such defects or early payment defaults, the Company has no commitment to repurchase loans that it has sold. During the second quarter of 2006, the Company repurchased a total of $159.9 million in loans, as compared to $47.7 million for the second quarter of 2005. In addition, the Company re-priced $78.4 million and $21.1 million in loans for the second quarter of 2006 and 2005, respectively. Re-priced loans are loans that are subject to repurchase but which are settled at a reduced 13 price. The Company maintains a reserve for the estimated losses expected to be realized when the repurchased loans are sold; this reserve is included in other liabilities and totaled $57.6 million and $14.6 million as of June 30, 2006 and December 31, 2005, respectively. This reserve is based upon the expected future repurchase trends for loans already sold in whole loan sale transactions and the expected valuation of such loans when repurchased. At the point the loans are repurchased, the associated reserves are transferred to the valuation reserve. Provisions for the repurchase reserve are charged against gain (loss) on sale of loans. The following table summarizes the activity in the repurchase reserve for the periods indicated.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------- ---------------------- 2006 2005 2006 2005 --------- -------- --------- -------- (THOUSANDS OF DOLLARS) Beginning balance .................................................. $ 23,337 $ 6,134 $ 14,556 $ 4,794 Provision .......................................................... 79,750 11,411 110,295 18,191 Charge-offs for loan repricing ..................................... (14,451) (863) (18,507) (1,846) Transfer to valuation allowance .................................... (31,050) (6,465) (48,758) (10,922) --------- -------- --------- -------- Ending balance ..................................................... $ 57,586 $ 10,217 $ 57,586 $ 10,217 ========= ======== ========= =========
The repurchase reserve is apportioned as follows as of the dates indicated:
JUNE 30, DECEMBER 31, 2006 2005 -------- ----------- (THOUSANDS OF DOLLARS) First trust deeds .......................................................... $ 33,824 $ 8,104 Second trust deeds ......................................................... 23,762 6,452 -------- ----------- $ 57,586 $ 14,556 ======== ===========
The Company also maintains a reserve for premium recapture that represents the estimate of potential refunds of premiums received on previously completed loan sales (either due to early loan prepayments or for certain loans repurchased from prior sales) that may occur under the provisions of the various agreements entered into for the sale of loans held for sale; this reserve totaled $10.7 million and $4.3 million as of June 30, 2006 and December 31, 2005, respectively, and is included in other liabilities. The gross premium percentage realized on Tier 1 loan sales and securitizations increased to 2.15% from 1.37% for the quarters ended June 30, 2006 and December 31, 2005, respectively. The increase in the premium recapture reserve is directionally consistent with the increase in the gross premium percentage realized from the prior quarter and the increased level of loan repurchases. Provisions for the premium 14 recapture reserve are charged against gain (loss) on sale of loans. The following table summarizes the activity in the premium recapture reserve for the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, --------------------- ----------------------- 2006 2005 2006 2005 ------- -------- --------- --------- (THOUSANDS OF DOLLARS) Beginning balance .................................................. $ 2,937 $ 7,944 $ 4,259 $ 7,516 Provision for premium recapture on repurchased loans ............... 7,462 3,319 9,771 5,542 Provision for standard premium recapture ........................... 7,207 5,117 7,629 8,403 Refunds ............................................................ (6,945) (5,825) (10,998) (10,906) -------- -------- --------- --------- Ending balance ..................................................... $ 10,661 $ 10,555 $ 10,661 $ 10,555 ======== ======== ========= =========
The following table reconciles the valuation, repurchase and premium recapture provisions to the amounts included in the Company's gain (loss) on sale of loans for the periods indicated.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, --------------------- ---------------------- 2006 2005 2006 2005 -------- -------- ---------- -------- (THOUSANDS OF DOLLARS) Provision for repurchase reserve ................................... $ 79,750 $ 11,411 $ 110,295 $ 18,191 Provision for valuation reserve .................................... 29,946 9,999 47,280 16,676 Adjust for losses on Tier II loan sales (1sts & 2nds) .............. (26,867) (3,225) (40,856) (6,405) Adjust for premium/interest/SFAS #91 on Tier II sales .............. (5,243) (1,310) (8,632) (2,819) Provision for premium recapture on repurchased loans ............... 7,462 3,319 9,771 5,542 Other .............................................................. (260) (931) (617) (1,861) -------- -------- --------- -------- Total provision for valuation and repurchase reserves ............ $ 84,788 $ 19,263 $ 117,241 $ 29,324 ======== ======== ========= ======== Provision for standard premium recapture (1) ....................... $ 7,207 $ 5,117 $ 7,629 $ 8,403 Provision for loans sold at principal only ......................... 5,624 740 8,698 1,724 -------- -------- --------- -------- Total provision for premium recapture ............................ $ 12,831 $ 5,857 $ 16,327 $ 10,127 ======== ======== ========= ======== (1) The standard premium recapture represents the return of premium on loans sold which prepay early per the terms of each whole loan sales agreement.
NOTE 6: LOANS HELD FOR INVESTMENT Loans held for investment consists of the Company's commercial real estate loans. Commercial real estate loans, which are primarily variable rate (generally based upon six-month LIBOR and a margin), represent loans secured primarily by first mortgages on properties such as multi-family (condominium), office, retail, industrial, land development, mixed-use and lodging. The commercial real estate loans are 15 primarily comprised of bridge and construction loans of relatively short duration (rarely more than five years in length of term and often shorter, such as two to three years). As of June 30, 2006, the Company had $3.99 billion in unfunded commitments for existing loans and $916.8 million in unfunded commitments for loans not yet booked, as compared to $3.40 billion and $410.5 million, respectively, as of December 31, 2005. Due to the variability in the timing of the funding of these unfunded commitments, and the extent to which they are ultimately funded, these amounts should not generally be used as a basis for predicting future outstanding loan balances. Commercial real estate loans are reported net of participations to other financial institutions or investors in the amount of $178.1 million and $138.2 million as of June 30, 2006 and December 31, 2005, respectively. The Company's commercial real estate loans also include mezzanine loans (second mortgage loans, which are subordinate to the senior or first mortgage loans) in the amounts of $5.8 million and $5.6 million as of June 30, 2006 and December 31, 2005, respectively. The geographic dispersion of the Company's commercial real estate portfolio is as follows:
JUNE 30, DECEMBER 31, 2006 2005 -------- ----------- California ....................................... 21.1% 25.5% Florida .......................................... 14.8% 11.5% New York ......................................... 11.3% 14.7% Virginia ......................................... 8.1% 6.6% Arizona .......................................... 7.4% 6.7% Pennsylvania ..................................... 4.9% 4.0% Maryland ......................................... 4.6% 3.2% Illinois ......................................... 4.6% 4.3% All other states ................................. 23.2% 23.5% -------- ----------- 100.0% 100.0% ======== ===========
16 The loans in the portfolio were distributed by property type as follows as of the dates indicated:
JUNE 30, DECEMBER 31, 2006 2005 ------- ----------- Multi-family - Condominiums ................... 55% 48% Land Development .............................. 15% 15% Office ........................................ 13% 14% Retail ........................................ 7% 7% Commercial Mixed-Use .......................... 3% 5% Multi-family - Other .......................... 3% 3% Industrial .................................... 2% 4% Special Purpose ............................... 1% 2% Hotels & Lodging .............................. 1% 2% ------ ----------- 100% 100% ====== ===========
The Company does not currently carry any residential real estate loans held for investment. The following tables further detail the net loans held for investment as of the dates indicated:
JUNE 30, 2006 ----------------------------------------- COMMERCIAL REAL ESTATE OTHER TOTAL ----------- ------- ----------- (THOUSANDS OF DOLLARS) Loans outstanding ............................................... $ 5,920,909 $ 8,059 $ 5,928,968 Participations sold ............................................. (178,102) - (178,102) ----------- ------- ------------ Loans outstanding, net of participations sold ................... 5,742,807 8,059 5,750,866 Unamortized deferred origination fees and costs ................. (53,158) - (53,158) ----------- ------- ----------- Loans outstanding before allowance for loan losses .............. 5,689,649 8,059 5,697,708 Allowance for loan losses ....................................... (172,611) (77) (172,688) ----------- ------- ----------- Loans held for investment - net ................................. $ 5,517,038 $ 7,982 $ 5,525,020 =========== ======= ===========
DECEMBER 31, 2005 ----------------------------------------- COMMERCIAL REAL ESTATE OTHER TOTAL ----------- --------- ----------- (THOUSANDS OF DOLLARS) Loans outstanding ............................................... $ 4,940,460 $ 8,589 $ 4,949,049 Participations sold ............................................. (138,165) - (138,165) ----------- ------- ----------- Loans outstanding, net of participations sold ................... 4,802,295 8,589 4,810,884 Unamortized deferred origination fees and costs ................. (50,984) - (50,984) ----------- ------- ----------- Loans outstanding before allowance for loan losses .............. 4,751,311 8,589 4,759,900 Allowance for loan losses ....................................... (156,755) (82) (156,837) ----------- ------- ----------- Loans held for investment - net ................................. $ 4,594,556 $ 8,507 $ 4,603,063 =========== ======= ===========
17 In cases where a borrower experiences financial difficulties and the Company makes certain concessionary modifications to contractual terms (typically a reduction of the interest rate charged), the loan is classified as a restructured (accruing) loan if the loan is performing in accordance with the agreed upon modified loan terms and projected cash proceeds are deemed sufficient to repay both principal and interest. Restructured loans are presented as such in the period of restructure and the three subsequent quarters. The following table sets forth information regarding the Company's commercial real estate loans on non-accrual status and restructured loans on accrual status.
JUNE 30, DECEMBER 31, 2006 2005 --------- ------------ (THOUSANDS OF DOLLARS) Non-accrual commercial real estate loans held for investment ............... $ 39,379 $ 29,290 ========= ============ Restructured commercial real estate loans on accrual status ................ $ - $ 12,309 ========= ============
The Company employs a documented and systematic methodology in determining the adequacy of its allowance for loan losses, which assesses the risk of losses inherent in the portfolio, and represents the Company's estimate of probable inherent losses in the loan portfolio as of the date of the financial statements. Establishment of the allowance for loan losses involves determining reserves for individual loans that have been deemed impaired and for groups of loans that are evaluated collectively. Reviews are performed to set allowance allocations for loans that have been individually evaluated and identified as loans which have probable losses; reserve requirements are attributable to specific weaknesses evidenced by various factors such as a deterioration in the quality of the collateral securing the loan, payment delinquency or other events of default. Performing loans that currently exhibit no significant identifiable weaknesses or impairment are evaluated on a collective basis. The allowance for loan losses methodology incorporates management's judgment concerning the expected effects of economic events on portfolio performance, as well as the potential impact of concentration factors (such as property types, geographic regions and loan sizes). While the Company's methodology utilizes historical and other objective information, the establishment of the allowance for loan losses is to a significant extent based upon the judgment and experience of the Company's management. The Company believes that the allowance for loan losses is adequate as of June 30, 2006 to cover probable losses embedded in the loan portfolio; however, future changes in circumstances, economic conditions or other factors, including the effect of the Company's various loan concentrations, could cause the Company to increase or decrease the allowance for loan losses as necessary. Activity in the allowance for loan losses is summarized in the following table: 18
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------ ------------------------ 2006 2005 2006 2005 --------- --------- --------- --------- (THOUSANDS OF DOLLARS) Beginning balance .................................................. $ 160,789 $ 171,941 $ 156,837 $ 171,525 Provision for loan losses .......................................... 11,707 (4,216) 15,588 (3,180) Charge-offs ........................................................ - (8,197) - (12,180) Recoveries ......................................................... 192 428 263 3,791 --------- --------- --------- --------- Ending balance ..................................................... $ 172,688 $ 159,956 $ 172,688 $ 159,956 ========= ========= ========= =========
At June 30, 2006 and December 31, 2005, the recorded investment in loans (excluding loans held for sale) considered to be impaired was $39.4 million and $29.3 million, respectively, all of which were on a non-accrual basis. The Company's policy is to consider a loan impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Evaluation of a loan's impairment is based on the present value of expected cash flows or the fair value of the collateral, if the loan is collateral dependent. As a result of charge-offs, these impaired loans do not necessarily have a related specific allowance for loan loss allocated to them. However, there were $39.4 million and $29.3 million of loans considered impaired that have allocated specific allowances that totaled $4.3 million and $2.3 million at June 30, 2006 and December 31, 2005, respectively. The average net investment in impaired loans held for investment was $38.6 million and $53.2 million for the three months ended June 30, 2006 and 2005, respectively. Interest income that was recognized on the cash basis of accounting on loans classified as impaired was $0 and $0 for the three months ended June 30, 2006 and 2005, respectively, and $0 and $35,000 for the six months ended June 30, 2006 and 2005, respectively. Interest income foregone for loans on non-accrual status that had not performed in accordance with their original terms was $1.0 million and $1.7 million for the three months ended June 30, 2006 and 2005, respectively and, $2.1 million and $4.3 million, for the six months ended June 30, 2006 and 2005, respectively. In addition to its allowance for loan losses, the Company maintains an allowance for unfunded commercial real estate loan commitments on existing loans and, to a lesser degree, loans not yet funded; this allowance totaled $5.3 million and $4.0 million as of June 30, 2006 and December 31, 2005, respectively, and is included in other liabilities. 19 NOTE 7: REAL ESTATE OWNED The Company's real estate owned ("REO") consists of property acquired through or in lieu of foreclosure on loans secured by real estate. REO is reported in the financial statements at the lower of cost or estimated realizable value (net of estimated costs to sell). REO consisted of the following types of property as of the dates indicated:
JUNE 30, DECEMBER 31, 2006 2005 ------- ----------- (THOUSANDS OF DOLLARS) Commercial real estate ...................................................... $ 299 $ 30,198 Residential real estate ..................................................... 3,420 3,674 ------- ----------- Real estate owned ........................................................... $ 3,719 $ 33,872 ======= ===========
NOTE 8: MORTGAGE SERVICING RIGHTS At the time of securitization or sale of loans on a whole loan basis with servicing rights retained, the Company analyzes whether the benefits of servicing are greater than or less than adequate compensation and, as a result, records where appropriate, a mortgage servicing rights asset or liability ("MSR"), respectively. The estimated fair value of the Company's mortgage servicing rights at June 30, 2006 and December 31, 2005 was $68.3 million and $57.4 million, respectively. The following tables summarize the activity in the Company's mortgage servicing rights asset as of the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------- ------------------------ 2006 2005 2006 2005 -------- -------- --------- -------- (THOUSANDS OF DOLLARS) Beginning balance .......................................... $ 45,337 $ 23,196 $ 46,022 $ 20,044 Additions from securitization transactions ............... 6,933 6,391 6,933 14,027 Loans sold - servicing retained .......................... 19,328 - 26,687 - Amortization ............................................. (8,859) (5,062) (16,903) (9,547) -------- -------- --------- -------- Ending balance before valuation allowance .................. 62,739 24,525 62,739 24,524 Valuation allowance: Beginning balance ........................................ - (2,462) - (2,042) Provision for temporary impairment ....................... - 255 - (164) -------- -------- --------- -------- Ending balance ........................................... - (2,207) - (2,206) -------- -------- --------- -------- Mortgage servicing rights - net ............................ $ 62,739 $ 22,318 $ 62,739 $ 22,318 ======== ======== ========= ======== Estimated fair value ....................................... $ 68,329 $ 22,318 $ 68,329 $ 22,318 ======== ======== ========= ========
20 The fair value of the MSRs is derived from the net positive cash flows associated with the servicing agreements. The Company determines the fair value of the MSRs at the time of securitization and at each reporting date by the use of a cash flow model that incorporates prepayment speeds, discount rate and other key assumptions management believes are consistent with assumptions other major market participants use in valuing the MSRs. The key economic assumptions used in subsequently measuring the fair value of the Company's MSRs as of the dates indicated are as follows:
JUNE 30, DECEMBER 31, 2006 2005 ------- ----------- Weighted-average life (years) ............................................... 1.4 1.6 Weighted-average annual prepayment speed .................................... 48.0% 46.9% Weighted-average annual discount rate ....................................... 15.0% 15.0%
As servicer, the Company is required to make certain advances on specific loans it is servicing, to the extent such advances are deemed collectible by the Company from collections related to the individual loan. The total amount outstanding of such servicing advances was $24.6 million and $15.3 million at June 30, 2006 and December 31, 2005, respectively, and is included in other assets. NOTE 9: RESIDUAL INTERESTS IN SECURITIZED LOANS Residual interests in loan securitizations retained by the Company are recorded as a result of the sale of residential real estate loans through a securitization transaction and the subsequent issuance of net interest margin securities ("NIMs") to monetize the residual interest from the original securitization transaction. Residual interests represent the discounted expected future residual cash flows from the securitizations that inure to the Company's benefit subject to prepayment, delinquency, net credit losses and other factors. The following table summarizes the activity of the Company's retained residual interests: 21
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------- ----------------------- 2006 2005 2006 2005 --------- -------- --------- -------- (THOUSANDS OF DOLLARS) Beginning balance at fair value ................................... $ 90,236 $ 12,449 $ 170,723 $ 15,774 Additions to residual interests ................................... 12,584 1,467 12,584 3,752 Sales of residual interests ....................................... - - (77,220) - Interest accretion ................................................ 15,950 2,969 32,759 4,307 Cash received ..................................................... (16,882) (5,639) (31,592) (9,892) Fair value adjustments ............................................ 11,399 6,110 6,033 4,633 Permanent impairment .............................................. (5,752) (572) (5,752) (1,790) --------- -------- --------- -------- Residual interests in securitized loans at fair value ............. $ 107,535 $ 16,784 $ 107,535 $ 16,784 ========= ======== ========= ========
Included in the $170.7 million beginning balance of residual interests was one "pre-NIM" residual interest with an estimated fair value of $118.3 million from a securitization transaction completed in December 2005. The Company, in January 2006, completed a NIM transaction of this one "pre-NIM" residual interest, resulting in a reduction of $77.2 million in the balance of the residual interests. Loans sold through securitization transactions are done so on a non-recourse basis to off-balance sheet qualifying special-purpose entities ("QSPEs"), except for representations and warranties customary within the mortgage banking industry. In a NIM transaction, the certificates representing the residual interest in certain excess cash flows from the original securitization transaction are transferred to a QSPE, which issues interest-bearing securities. The net proceeds from the sale of these NIM securities, along with a residual interest certificate, represent the consideration received by the Company. The residual interest certificate retained from a NIM transaction is subordinate to the NIM securities issued until the NIM securities are paid in full. The residual interests retained from the NIM transactions are classified as "available-for-sale" securities and are measured at fair value; any unrealized gains or losses from adjustments to the estimated fair value, net of taxes, are reported as part of accumulated other comprehensive income, which is a separate component of stockholders' equity. Impairment that is considered other-than-temporary is recorded as a reduction of other non-interest income. During the second quarter of 2006, the Company recognized permanent impairment on two of its retained residual interests due primarily to utilization of more accurate pre-payment fee assumptions. In the original securitizations and NIM transactions, a two-tier structure is utilized in which the loans are first sold to a special purpose corporation (referred to as the Depositor), which then transfers the loans to the QSPE. The Company's only ownership interest from its securitization transactions is reflected in the retained residual interests from the NIM transactions of $107.5 million as detailed above. 22 The following table summarizes delinquencies and credit losses as of June 30, 2006 for the loans underlying the Company's 12 outstanding securitization transactions (thousands of dollars):
Original principal amount of loans securitized .............................. $ 11,588,533 Current principal amount of loans securitized ............................... $ 6,846,686 Current delinquent principal amount (over 60 days) .......................... $ 430,129 Inception to date credit losses (net of recoveries) ......................... $ 24,368
The Company determines the estimated fair values of the residual interests retained from the NIM transactions by discounting the expected net cash flows to be received utilizing the cash-out method. The Company uses the forward LIBOR curve for estimating interest rates on the adjustable rate loans and the variable rate securities, and utilizes other assumptions (primarily for losses, prepayment speeds and delinquencies) that management believes are consistent with assumptions other major market participants would use to appropriately estimate the fair value of similar residual interests. The Company continually evaluates the various assumptions utilized in estimating the fair value of the retained residual interests and updates them as deemed necessary based upon the development of historical vintage data. Such residual interest valuations remain, however, subject to volatility due to fluctuations in the performance of the underlying collateral and in the accuracy of the assumptions utilized by the Company. Key economic assumptions used in subsequently measuring the fair value of the Company's residual interests as of the dates indicated are as follows:
JUNE 30, DECEMBER 31, 2006 2005 ------- ----------- Weighted-average life (years) .............................................. 1.5 1.6 Weighted-average annual prepayment speed ................................... 48.3% 46.0% Weighted-average lifetime credit losses .................................... 4.5% 4.4% Weighted-average annual discount rate ...................................... 20.0% 20.0%
23 NOTE 10: DERIVATIVE FINANCIAL INSTRUMENTS The Company utilizes derivative financial instruments in connection with its interest rate risk management activities. In accordance with its interest rate risk strategy, the Company currently utilizes a combination of forward sales commitments and Eurodollar futures contracts to hedge its residential real estate loans held for sale and a certain portion of its unfunded pipeline of conditional loan approvals. These derivatives are intended to offset the changes in the value of the Company's loans held for sale and its unfunded conditional loan approvals as interest rates change. The Company's forward sales commitments represent obligations to sell loans at a specific price and date in the future; therefore, the value of these commitments increase as interest rates increase. Short Eurodollar futures contracts are standardized exchange-traded contracts, the values of which are tied to spot Eurodollar rates at specified future dates. The value of these futures contracts increase when interest rates rise. Conversely, the value of the forward sales commitments and the short Eurodollar positions decrease when interest rates decrease, while the related loans are expected to increase in value. The values of the loans, the forward sales commitments and the Eurodollar positions may not move in corresponding amounts and time frames and may result in a negative or positive impact on earnings in any given period. In accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivatives and Hedging Activities, as amended and interpreted ("SFAS No. 133"), the Company's derivative financial instruments are reported at their fair values. At June 30, 2006, the Company's commitments to sell forward residential real estate loans to third party investors in whole loan sales transactions were approximately $3.1 billion at various rates and terms. The Company distinguishes commitments to sell forward loans in two categories, allocated and unallocated. At June 30, 2006, allocated and unallocated forward sale commitments notional amounts were $2.1 billion and $1.0 billion, respectively. Allocated forward sales commitments are contractual sales agreements whereby a specific pool of loans is agreed upon to be sold to specific buyers at a contractually agreed upon date and price. In accordance with SFAS No. 133, the Company may, under certain circumstances, designate and account for its allocated forward sales commitments as fair value hedges designated to specific pools of loans that have been contractually agreed upon for sale; however, as of June 30, 2006, no hedges were designated as such. Unallocated forward sales commitments are agreements that provide a fixed price on a pool of loans not yet specified. These commitments are treated as economic hedges (and are not currently designated as accounting hedges) and are classified as free-standing derivatives. Changes in the fair value of both the unallocated and allocated forward sales 24 commitments are reported as a component of gain (loss) on sale of residential real estate loans and as either other assets or liabilities, as applicable. At June 30, 2006, the Company had a pipeline of loans in process of approximately $1.3 billion in new residential real estate loans. The Company does not guarantee interest rates to potential borrowers when an application is received. Because these loans are generally subject to the potential borrower accepting and meeting the conditions of the loan approval, the Company estimates its effective net pipeline position at $783.0 million, as adjusted for expected loan fallout. The Company conditionally quotes interest rates to potential borrowers, which are then subject to adjustment by the Company if any such conditions are not satisfied. As such, the Company ascribes no value to its conditional loan approvals as there are no interest rate-lock commitments on the loans. The Company's Eurodollar futures contracts are currently treated as economic hedges and are not currently designated as accounting hedges and are classified as free-standing derivatives. As of June 30, 2006, the Company had in place short Eurodollar futures positions covering loan principal of $2.5 billion and $330.4 million for its loans held for sale and its unfunded loan pipeline, respectively. Eurodollar futures are utilized in an effort to offset the changes in value related to the loan inventory and pipeline without the necessity of restricting certain loan inventory or pipeline loans to a specific forward sale commitment. The Company's Eurodollar futures positions are settled each day based on their ending fair values; as such, the Company does not reflect any asset or liability position for these derivatives. The Company records these daily fair value changes and settlements as a component of the gain (loss) on sale of residential real estate loans. The Company's Eurodollar futures contracts are collateralized by maintenance of a margin account which had a balance of $9.2 million as of June 30, 2006. The estimated fair values of the Company's derivatives were as follows (included in other assets or liabilities, as applicable, in the consolidated balance sheets) as of the dates indicated:
JUNE 30, DECEMBER 31, 2006 2005 ------- ----------- (THOUSANDS OF DOLLARS) Forward sales commitments ................................................... $ 3,769 $ (1,479) Interest rate cap contract .................................................. - (340) Other ....................................................................... - 418 ------- ----------- $ 3,769 $ (1,401) ======== ===========
25 The changes in fair value of the derivative instruments from the prior period are recorded as part of the net gain (loss) on whole loan sales and securitizations. (See Note 11) NOTE 11: GAIN (LOSS) ON WHOLE LOAN SALES AND SECURITIZATION OF RESIDENTIAL REAL ESTATE LOAN The Company routinely sells and securitizes its residential mortgage loans into the secondary market. Gains or losses are recognized at the date of settlement and when the Company has transferred control over the loans to either a transaction-specific securitization trust or to a third-party purchaser. The amount of gain or loss for loan sales or securitizations is based upon the difference between the net sales proceeds received, including any retained interests, and the allocated carrying amount of the loans (which includes the costs directly incurred with the origination of the loans, net of origination points and fees received, which are deferred and recognized when the loans are sold). The Company maintains a valuation reserve for certain non-performing loans and other loans held for sale based on the Company's estimate of inherent losses. The Company also records a repurchase reserve for the estimated losses expected to be realized for any repurchased loans when they are resold. The provisions for both of these reserves are recorded as adjustments to the Company's net gain (loss). The provision for premium recapture is the provision for the return of premium on loans sold which prepay early per the terms of each sales contract; this amount includes some interest adjustment. The following table presents the detailed components of the net gain (loss) on whole loan sales and securitizations:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------------- ------------------------------- 2006 2005 2006 2005 ----------- ----------- -------------- ------------- (THOUSANDS OF DOLLARS) Whole loan sales of residential real estate loans ............... $ 8,911,454 $ 8,776,193 $ 16,169,109 $ 14,625,502 Securitizations of residential real estate loans ................ 982,533 981,717 982,533 2,191,566 ----------- ----------- ------------ ------------ Total loan sales and securitizations - net of repurchases ....... $ 9,893,987 $ 9,757,910 $ 17,151,642 $ 16,817,068 =========== =========== ============ ============ Gross premium recognized on Tier I loan sales and securitizations .............................. $ 212,315 $ 271,345 $ 300,248 $ 476,221 Losses on Tier II sales ......................................... (26,867) (3,225) (40,856) (6,405) ----------- ----------- ------------ ------------ 185,448 268,120 259,392 469,816 Net gain (loss) on derivative instruments ....................... 1,598 (25,573) 16,194 (8,385) ----------- ----------- ------------ ------------ 187,046 242,547 275,586 461,431 Net direct loan origination costs ............................... (81,053) (125,463) (148,820) (221,656) Provision for premium recapture ................................. (12,831) (5,857) (16,327) (10,127) ----------- ----------- ------------ ------------ 93,162 111,227 110,439 229,648 Provision for valuation and repurchase reserves ................. (84,788) (19,263) (117,241) (29,324) ----------- ----------- ------------ ------------ Net gain (loss) on sale ......................................... $ 8,374 $ 91,964 $ (6,802) $ 200,324 =========== =========== ============ ============
26 The net gain (loss) on derivative instruments included in the net gain (loss) on whole loan sales and securitizations of residential real estate loans consists of the following items:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------- ----------------------- 2006 2005 2006 2005 ------- --------- --------- -------- (THOUSANDS OF DOLLARS) Eurodollar futures: Net realized gain (loss) .......................................... $ 756 $ (21,786) $ 12,297 $ (1,254) Transaction expenses and other .................................... (532) (517) (977) (1,042) ------- --------- -------- -------- 224 (22,303) 11,320 (2,296) Change in fair value of: Forward sales commitments ......................................... 1,329 (11,208) 5,247 (9,330) Other ............................................................. 45 7,938 (373) 3,241 ------- --------- -------- -------- Net gain (loss) on derivative instruments ........................... $ 1,598 $ (25,573) $ 16,194 $ (8,385) ======= ========= ======== ========
NOTE 12: LOAN SERVICING INCOME In addition to the securitized loans that it services, the Company also services loans sold to other financial institutions on an interim basis (until servicing is transferred to another party) and on a to maturity basis (servicing retained). The following table presents the components of loan servicing income for the Company:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------ --------------------- 2006 2005 2006 2005 -------- --------- -------- -------- (THOUSANDS OF DOLLARS) Servicing fee income: Securitization transactions ...................................... $ 8,178 $ 5,214 $ 16,974 $ 9,593 Interim .......................................................... 7,172 7,768 13,624 14,276 Loans sold - servicing retained .................................. 2,565 641 3,917 1,472 Ancillary income (1) : Securitization transactions ...................................... 1,723 927 3,489 1,774 Interim .......................................................... 802 741 1,617 1,436 Loans sold - servicing retained .................................. 477 140 802 321 Other: Securitization transactions ...................................... 2,089 459 3,656 751 Loans sold - servicing retained .................................. 476 55 752 63 -------- -------- -------- -------- Loan servicing income ............................................ $ 23,482 $ 15,945 $ 44,831 $ 29,686 ======== ======== ======== ======== (1) Ancillary income represents all service-related contractual fees retained by the Company and consists primarily of late payment charges.
27 NOTE 13: INCOME TAXES The major components of income tax expense are summarized in the following table:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------- ------------------------ 2006 2005 2006 2005 -------- -------- --------- --------- (THOUSANDS OF DOLLARS) Federal: Current .......................................................... $ 31,083 $ 39,644 $ 63,869 $ 79,973 Deferred ......................................................... (2,633) 9,383 (17,024) 19,056 -------- -------- --------- --------- 28,450 49,027 46,845 99,029 -------- -------- --------- --------- State: Current .......................................................... 6,491 6,980 13,657 19,017 Deferred ......................................................... (680) 3,256 (4,780) 2,293 -------- -------- --------- --------- 5,811 10,236 8,877 21,310 -------- -------- --------- --------- Total income tax expense ........................................... $ 34,261 $ 59,263 $ 55,722 $ 120,339 ======== ======== ========= =========
The Company has accrued the expected maximum tax and interest exposure for tax matters that are either in the process of resolution or have been identified as having the potential for adjustment. These matters primarily consist of issues relating to the discontinued insurance operations, the apportionment of income to various states and the deduction of certain expenses. 28 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:
JUNE 30, DECEMBER 31, 2006 2005 --------- ----------- (THOUSANDS OF DOLLARS) Deferred tax assets: Mark-to-market on loans held for sale ..................................... $ 44,560 $ 23,355 Allowance for loan losses ................................................. 76,032 69,650 Compensation related items ................................................ 24,622 29,270 State income and franchise taxes .......................................... 7,359 13,467 Other - net ............................................................... 284 2,283 --------- ----------- Total deferred tax assets ............................................... 152,857 138,025 Deferred tax liabilities: Loan origination costs .................................................... (21,116) (31,550) Mortgage servicing ........................................................ (29,871) (23,240) --------- ----------- Total deferred tax liabilities .......................................... (50,987) (54,790) --------- ----------- Net deferred tax asset ...................................................... $ 101,870 $ 83,235 ========= ===========
In assessing the realization of deferred income tax assets, the Company considers whether it is more likely than not that the deferred income tax assets will be realized. The ultimate realization of deferred income tax assets depends on the ability to recover previously paid taxes through loss carrybacks and the generation of future taxable income during the periods in which temporary differences become deductible. In the Company's opinion, the deferred tax assets will be fully realized and no valuation allowance is necessary as the Company has the ability to generate sufficient future taxable income to realize the tax benefits. 29 NOTE 14: DEBT - FREMONT GENERAL CORPORATION The debt of Fremont General is detailed in the following table; none of the Fremont General debt is guaranteed by FIL:
JUNE 30, DECEMBER 31, 2006 2005 --------- ----------- (THOUSANDS OF DOLLARS) Senior Notes due 2009, less discount (2006 - $796; 2005 - $975) ............ $ 169,484 $ 175,305 Junior Subordinated Debentures .............................................. 103,093 103,093 --------- ----------- $ 272,577 $ 278,398 ========= ===========
During the second quarter of 2006, Fremont General repurchased $3 million par value of the 7.875% Senior Notes due 2009 with a carrying value of $3 million resulting in a pre-tax gain of $15,000. For the six months ended June 30, 2006, Fremont General repurchased $6 million par value of 7.875% Senior Notes due 2009 with a carrying value of $6 million resulting in a pre-tax gain of $37,000. There were no repurchases of 7.875% Senior Notes due 2009 through the first six months of 2005. Fremont General's 9% Junior Subordinated Debentures are the sole asset of Fremont General Financing I, a statutory business trust (the "Trust") and wholly-owned subsidiary of Fremont General. The Trust issued, and has outstanding, $100 million of 9% Trust Originated Preferred SecuritiesSM (the "Preferred Securities") which represent preferred undivided beneficial interests in the Trust. The Junior Subordinated Debentures are subordinate and junior to all senior indebtedness of Fremont General. Payment of distributions out of cash held by the Trust, and payments on liquidation of the Trust or the redemption of the Preferred Securities are guaranteed by Fremont General to the extent that the Trust has funds available to make such payments. Under FASB Interpretation No. 46 (Revised December 2003), "Consolidation of Variable Interest Entities," Fremont General is not considered the primary beneficiary of the Trust. Therefore, instead of the Preferred Securities, the Junior Subordinated Debentures are reflected on the Company's balance sheets. 30 NOTE 15: DEPOSITS, FHLB ADVANCES, FEDERAL RESERVE AND WAREHOUSE LINES OF CREDIT - FIL FIL utilizes the issuance of deposits, which are insured up to the maximum legal limit by the Federal Deposit Insurance Corporation, Federal Home Loan Bank ("FHLB") advances, Federal Reserve and warehouse lines of credit in funding its operations. As of June 30, 2006, the weighted-average interest rate for savings and money market deposit accounts was 3.85% and for certificates of deposit it was 4.75%. The weighted-average interest rate for all deposits at June 30, 2006 was 4.61%. Certificates of deposit as of June 30, 2006 are detailed by maturity and rates as follows: MATURING BY WEIGHTED AMOUNT JUNE 30, AVERAGE RATE ----------- ----------- ------------ (THOUSANDS OF DOLLARS) $ 7,957,580 2007 4.74% 50,828 2008 4.40% 52,537 2009 5.80% 956 2010 3.08% 2,254 2011 4.88% ----------- ----------- $ 8,064,155 4.75% =========== ===========
Of the total certificates of deposit outstanding at June 30, 2006, $1.53 billion were obtained through brokers. Interest expense on deposits is summarized as follows:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------- ------------------------- 2006 2005 2006 2005 --------- -------- --------- --------- (THOUSANDS OF DOLLARS) Savings and money market deposit accounts ......................... $ 14,398 $ 10,928 $ 28,298 $ 20,768 Certificates of deposit ........................................... 92,175 51,515 169,130 91,116 Penalties for early withdrawal .................................... (188) (143) (358) (228) --------- -------- --------- --------- $ 106,385 $ 62,300 $ 197,070 $ 111,656 ========= ======== ========= =========
31 Total interest payments on deposits were $101.4 million and $59.9 million, for the three months ended June 30, 2006 and 2005, respectively, and $190.3 million and $108.4 million for the six months ended June 30, 2006 and 2005, respectively. FIL is a member of the FHLB system and, as such, maintains a credit line with the FHLB of San Francisco that is based upon a percentage of its total regulatory assets, subject to collateralization requirements and certain collateral sub-limits. Advances are primarily collateralized by residential loans held for sale, and to a lesser extent, by certain commercial loans held for investment. The maximum amount of credit which the FHLB will extend varies from time to time in accordance with their policies. FIL's maximum financing availability, based upon its level of regulatory assets and subject to the amount and type of collateral pledged and their respective advance rates, was $5.07 billion as of June 30, 2006. At June 30, 2006 and December 31, 2005, FIL had an approximate maximum borrowing capacity based upon its pledged loan collateral of $3.32 billion and $1.99 billion, respectively, with outstanding borrowings of $1.31 billion and $949.0 million, respectively, from the FHLB of San Francisco. All borrowings mature within one year. FIL pledged loans with a carrying value of $3.70 billion and $2.22 billion at June 30, 2006 and December 31, 2005, respectively, to secure the current and any future borrowings. FIL's borrowing capacity can be used to borrow under various FHLB loan programs, including adjustable and fixed-rate financing, for periods ranging from one day to 30 years, with a variety of interest rate structures available. The weighted-average interest rate on the amount outstanding at June 30, 2006 was 5.01%. The borrowing capacity has no commitment fees or cost, requires minimum levels of investment in FHLB stock (FIL receives dividend income on its investment in FHLB stock), can be withdrawn by the FHLB if there is any significant change in the financial or operating condition of FIL and is conditional upon FIL's compliance with certain agreements covering advances, collateral maintenance, eligibility and documentation requirements. At June 30, 2006 and December 31, 2005, FIL was in compliance with all requirements of its FHLB credit facility. Total interest payments on advances from the FHLB were $34.9 million and $12.3 million, for the three months ended June 30, 2006 and 2005, respectively, and $58.6 million and $19.7 million for the six months ended June 30, 2006 and 2005, respectively. FIL has a line of credit with the Federal Reserve Bank of San Francisco ("Federal Reserve") and, at June 30, 2006 and December 31, 2005, had a borrowing capacity, based upon collateral pledged, of $392.2 million and $442.3 million, respectively, with no outstanding borrowings at June 30, 2006 or December 31, 2005. FIL pledged loans with a carrying value of $523.0 million and $589.7 million at June 30, 2006 and December 31, 2005, respectively, to the Federal Reserve. This line of credit may be utilized when all other 32 sources of funds are not reasonably available and any such advances are made with the expectation that they will be repaid when the availability of the usual source of funds is restored, usually the next business day. FIL has established four separate warehouse lines of credit to facilitate the funding of residential real estate loans prior to their sale or securitization. The total funding capacity available at June 30, 2006 under the four facilities was $3.00 billion, of which $2.25 billion was committed. There were no amounts outstanding on any of the facilities at June 30, 2006. Borrowings, if any, under each of the facilities are secured by loans held for sale as pledged by FIL. Each of the facilities is subject to certain conditions, including, but not limited to, financial and other covenants including the maintenance of certain capital and liquidity levels. At June 30, 2006, FIL was in compliance with all financial and other covenants related to these facilities. NOTE 16: OTHER LIABILITIES The following table details the composition of the Company's other liabilities as of the dates indicated:
JUNE 30, DECEMBER 31, 2006 2005 --------- ----------- (THOUSANDS OF DOLLARS) Premium recapture and repurchase reserves ................................... $ 68,247 $ 18,815 Deferred compensation obligation ............................................ 53,683 50,300 State income tax liability .................................................. 31,699 27,860 Accrued incentive compensation .............................................. 27,898 56,553 Accounts payable ............................................................ 26,070 35,379 Borrower escrow collections payable ......................................... 24,252 23,620 Interest payable ............................................................ 22,499 18,241 Federal income tax liability ................................................ 12,380 (12,586) Accrued Employee Stock Ownership Plan expense ............................... 9,423 29,596 Borrower principal and interest due investors ............................... 732 13,209 Other ....................................................................... 34,354 36,929 --------- ----------- Total other liabilities ..................................................... $ 311,237 $ 297,916 ========= ===========
33 NOTE 17: SHARE-BASED PAYMENTS Company stock award plans provide a long term compensation opportunity for officers and certain key employees of the Company. Stock options and awards of rights to purchase shares of the Company's common stock, generally in the form of restricted stock awards may be granted under the 2006 Performance Incentive Plan (the "2006 Plan") that was approved by the Company's stockholders on May 18, 2006. Awards were granted under the Company's stockholder approved 1997 Stock Plan (the "1997 Plan") until May 18, 2006 when the stockholders approved the 2006 Plan. Effective as of May 18, 2006, no additional grants will be made under the 1997 Plan. At June 30, 2006, a total of 17,451 restricted shares of the Company's common stock were subject to outstanding awards granted and an additional 8,808,584 shares of the Company's common stock were available for new award grants under the 2006 Plan. At June 30, 2006, a total of 1,761,663 restricted shares of the Company's common stock were subject to outstanding awards granted under the 1997 Plan. As of June 30, 2006, 2,861,149 shares that had been available for awards under the 1997 Plan now are available for award grant purposes under the 2006 Plan. As awards outstanding under the 1997 Plan are cancelled, forfeited, or otherwise terminate without having been exercised or having vested, they will become available for award grant purposes under the 2006 Plan. During the first six months of 2006, there were awards of 388,379 shares of restricted stock under the 1997 Plan, and awards of 17,451 shares of restricted stock under the 2006 Plan. The Company also maintains the 1995 Restricted Stock Award Plan the ("1995 Plan"), which expired under its terms in November 2005. As of June 30, 2006, there were 105,950 restricted shares of the Company's common stock subject to outstanding awards granted. There are no shares available for grant under the 1995 Plan. Prior to January 1, 2006, the Company accounted for stock awards granted under the 1997 Plan and 1995 Plan under the recognition and measurement provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related Interpretations ("APB No. 25"), as permitted by FASB Statement No. 123, "Accounting for Stock-Based Compensation." Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB Statement No. 123(R), "Share-Based Payment" ("SFAS No. 123(R)"), using the modified prospective transition method therefore results for prior periods have not been restated. The primary impact of adopting SFAS No. 123(R) on the Company's financial statements was the reclassification of the deferred compensation balance, as of December 31, 2005 ($20.9 million) related to its nonvested restricted shares to additional paid-in capital. 34 STOCK OPTIONS: The Company also maintains the Amended 1989 Non-Qualified Stock Option Plan (the "1989 Plan"). During the years 1989 to 1997, non-qualified stock options were granted at exercise prices equal to the fair value of the stock on the date of grant. Grantees vested at the rate of 25% per year beginning on the first anniversary of the grants that expire after ten years. Stock option grants were accounted for in accordance with the intrinsic value method and, accordingly, no compensation expense was recognized. For the applicable years, additional disclosure was provided regarding the pro forma effects on earnings per share calculated as if the recognition and measurements provisions of the fair value method had been adopted. The Company had 468,000 non-qualified option shares outstanding and exercisable as of June 30, 2006, with an intrinsic value of $7.0 million, an exercise price of $14.94 and an expiration date of February 13, 2007. No options were granted, forfeited, expired or exercised during the first six months of 2006. Shares issued upon option exercise may come from new shares or existing shares held in the Company's employee benefits trust. There are no shares available for grant under the 1989 Plan. (See Note 18) RESTRICTED STOCK AWARDS: Under both APB No. 25 and SFAS No. 123(R), the Company recognizes compensation expense related to its restricted stock awards based on the fair value of the shares awarded as of the grant date. Compensation expense for the restricted stock awards is recognized on a straight-line basis over the requisite service period (generally two to ten years). The compensation expense that has been charged against income for share-based compensation was $3.2 million and $4.2 million for the three months ended June 30, 2006 and 2005, respectively, and $6.6 million and $8.3 million for the six months ended June 30, 2006 and 2005, respectively. The total income tax benefit recognized in the income statement for share-based compensation arrangements was $701,000 and $615,000 for the three months ended June 30, 2006 and 2005, respectively, and $1.4 million and $1.1 million for the six months ended June 30, 2006 and 2005, respectively. Prior to the adoption of SFAS No. 123(R), the Company reported all cash flows resulting from the tax benefits associated with tax deductions in excess of the compensation expense recognized for restricted stock awards as operating cash flows in the Consolidated Statement of Cash Flows. Under SFAS No. 123(R) the Company now reports such excess tax benefits as financing cash inflows. Under the Company's Executive Officer Annual Bonus Plan, which is stockholder-approved, for the one-year period beginning January 1, 2006 through December 31, 2006 (the "2006 Annual Plan") the 35 Company may grant selected officers awards of restricted shares of Company common stock upon achievement of certain predetermined pre-tax earnings targets for the 2006 calendar year. At the end of the one-year performance period, upon determination of the extent to which the 2006 pre-tax earnings targets have been achieved, participants under the 2006 Annual Plan will be paid bonuses in the form of cash, at 100% of the amount of the cash bonus earned, plus an award of shares of restricted common stock equal to 100% of the amount of the cash bonus earned in accordance with the 2006 Annual Plan. The award of shares of restricted common stock would be made pursuant to the 2006 Plan. If such earnings targets are not met, no compensation cost is recognized and any previously recognized compensation cost is reversed. As a result of adopting SFAS No. 123(R), the Company accounts for these awards as liability instruments where the service period precedes the grant date. No restricted stock awards were granted under the 2006 Annual Plan during the first six months of 2006. A summary of the status of the Company's nonvested restricted stock awards as of June 30, 2006 and changes during the six month period then ended is presented below:
WEIGHTED-AVERAGE NUMBER GRANT DATE OF SHARES FAIR VALUE ----------- ---------------- Nonvested at December 31, 2005 .............................................. 2,959,053 $ 13.79 Granted ..................................................................... 405,830 22.57 Vested ...................................................................... (1,444,705) 12.48 Forfeited ................................................................... (35,114) 22.61 ----------- ---------------- Nonvested at June 30, 2006 .................................................. 1,885,064 $ 16.52 =========== ================
The fair value of nonvested shares is determined based on the closing trade price of the Company's shares on the grant date as determined in accordance with the 1997 Plan and/or the 2006 Plan. As of June 30, 2006, there was $21.9 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements. That cost is expected to be recognized over a weighted-average period of 2.0 years. The weighted-average grant date fair value of the restricted stock awards granted during the six months ended June 30, 2006 and 2005 was $22.57 and $23.05, respectively. The total fair value of shares vested was $33.6 million and $31.6 million for the six months ended June 30, 2006 and 2005, respectively. Awards of restricted common stock include dividend rights and non-preferential dividends are paid on nonvested restricted shares of Company common stock. Dividends declared on restricted stock awards granted are not subject to vesting. Outstanding nonvested restricted shares of Company common stock 36 are generally subject to accelerated vesting if there is a change in control of the Company (as defined in the restricted stock award agreements or Employment or Management Continuity Agreements, if applicable). NOTE 18: DEFERRED COMPENSATION The Company periodically contributes cash to an employee benefits trust ("GSOP") in order to pre-fund contributions to various employee benefit plans (e.g., 401(K) match, Employee Stock Ownership Plan contribution, etc.). The Company consolidates the GSOP under the provisions of Financial Accounting Standards Board Interpretation No. 46R, "Consolidation of Variable Interest Entities." The GSOP uses the contributed cash to acquire shares of the Company's common stock and the shares held by the GSOP are recorded at fair value and treated as treasury stock for purposes of calculating the Company's basic and diluted earnings per share. The Company also maintains a Supplemental Executive Retirement Plan ("SERP") and Excess Benefit Plan ("EBP"); both of which are deferred compensation plans designed to provide certain employees the ability to receive benefits that would be otherwise lost under the Company's qualified retirement plans due to statutory or other limits on salary deferral and matching contributions. The following table details the composition of the Company's deferred compensation balance as of the dates indicated:
JUNE 30, DECEMBER 31, 2006 2005 -------- ----------- (THOUSANDS OF DOLLARS) SERP and EBP ................................................................ $ 19,207 $ 16,831 GSOP ........................................................................ 1,742 5,624 Unamortized restricted stock awards ......................................... - 20,902 -------- ----------- Total deferred compensation ................................................. $ 20,949 $ 43,357 ======== ===========
Under the provisions of SFAS No. 123(R), which the Company adopted as of January 1, 2006, companies may no longer account for unrecognized compensation costs related to nonvested stock awards as deferred compensation. SFAS No. 123(R) requires that any existing balance of deferred compensation as of the adoption date be reclassified to additional paid-in capital. Because the Company adopted SFAS No. 123(R) on the modified prospective basis, results from prior periods have not been restated to conform to the current presentation. (See Note 17) 37 NOTE 19: INDUSTRIAL BANK REGULATORY CAPITAL FIL is subject to various regulatory capital requirements under California and Federal regulations. Failure to meet minimum capital requirements can result in regulatory agencies initiating certain mandatory and possibly additional discretionary actions that, if undertaken, could have a direct material effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, FIL must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. FIL's capital amounts, its ability to pay dividends and other requirements and classifications are also subject to qualitative judgments by its regulators about components, risk weightings and other factors. Banking institutions that are experiencing or anticipating significant growth are generally expected to maintain capital ratios above minimum levels. As of June 30, 2006, FIL's regulatory capital exceeded all minimum requirements to which it is subject and the most recent notification from the FDIC categorized FIL as "well-capitalized". To be categorized as well-capitalized, the institution must maintain capital ratios as set forth in the following table. There have been no conditions or events since that notification that management believes have changed FIL's categorization as well-capitalized. FIL's actual regulatory amounts and the related standard regulatory minimum ratios required to qualify as well-capitalized are detailed in the table below.
JUNE 30, 2006 DECEMBER 31, 2005 ------------------------- ------------------------ MINIMUM ACTUAL MINIMUM ACTUAL REQUIRED RATIO REQUIRED RATIO -------- -------- -------- ------- Tier-1 Leverage Capital ........................... 5.00% 10.97% 5.00% 12.59% Risk-Based Capital: Tier-1 .......................................... 6.00% 12.64% 6.00% 14.15% Total ........................................... 10.00% 13.90% 10.00% 15.52%
Regulatory capital is assessed for adequacy by three measures: Tier-1 Leverage Capital, Tier-1 Risk-Based Capital and Total Risk-Based Capital. FIL's Tier-1 Leverage Capital includes common stockholder's equity, a certain portion of its mortgage servicing rights not includable in regulatory capital and other adjustments. Tier-1 Leverage Capital is measured with respect to average assets during the quarter. The Tier-1 Risk-Based Capital ratio is calculated as a percent of risk-weighted assets at the end of the quarter. FIL's Total Risk-Based Capital includes the allowable amount of its allowance for loan losses (the allowable amount includable is limited to 1.25% of gross risk-weighted assets). The Total Risk-Based Capital ratio is calculated as a percent of risk-weighted assets at the end of the quarter. 38 During the third quarter of 2005, the Company identified that its interpretation for the calculation of risk-weighted assets was not complete. Previously, the Company had not incorporated the unfunded portion of its commercial real estate loan commitments into its risk-weighted assets calculation. As of June 30, 2006, and for all prior periods presented, the Company has included the risk-weighted effect of these unfunded commitments into its Tier-1 Risk-Based and Total Risk-Based Capital ratios. Included in these unfunded commitments are amounts for loan transactions for which the unfunded portion is not currently available to the borrower based upon the level of progress of the underlying commercial real estate project. The impact upon the Tier-1 Risk-Based and Total Risk-Based Capital ratios in prior periods did not change FIL's categorization as well-capitalized and there is no impact upon the Tier-1 Leverage ratio. The following table details the calculation of the respective capital amounts at FIL as of the dates indicated:
JUNE 30, DECEMBER 31, 2006 2005 ----------- ----------- (THOUSANDS OF DOLLARS) Common stockholder's equity at FIL .......................................... $ 1,591,453 $ 1,550,049 Less: Disallowed portion of mortgage servicing rights ........................... (1,243) - Unrealized gains on available-for-sale securities ......................... (1,462) (364) ----------- ------------- Total Tier-1 Capital ........................................................ 1,588,748 1,549,685 Add: Allowable portion of the allowance for loan losses ..................... 158,647 149,735 ----------- ------------ Total Risk-Based Capital (Tier-1 and Tier-2) ................................ $ 1,747,395 $ 1,699,420 =========== ============
NOTE 20: COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET ACTIVITIES The Company is a defendant in a number of legal actions arising in the ordinary course of business and from the discontinuance of the insurance operations. Management and its legal counsel are of the opinion that the settlement of these actions, individually or in the aggregate, will not have a material effect on the Company's business, financial position or results of operations. 39 FREMONT INDEMNITY COMPANY (IN LIQUIDATION) V. FREMONT GENERAL CORPORATION ET AL.: On June 2, 2004, the State of California Insurance Commissioner John Garamendi (the "Commissioner"), as statutory liquidator of Fremont Indemnity Company ("Fremont Indemnity"), filed suit in Los Angeles Superior Court against Fremont General alleging the improper utilization by Fremont General of certain net operating loss deductions ("NOLs") allegedly belonging to its Fremont Indemnity subsidiary (the "Fremont Indemnity case"). This complaint involves issues that were considered resolved in an agreement among the California Department of Insurance, Fremont Indemnity and Fremont General (the "Letter Agreement"). The Letter Agreement, dated July 2, 2002, was executed on behalf of the California Department of Insurance by the Honorable Harry Low, the State of California Insurance Commissioner at that time. Fremont General has honored all of its obligations under the Letter Agreement. On July 16, 2004, the Commissioner filed a First Amended Complaint ("FAC") adding a cause of action for concealment of an alleged reinsurance dispute and is seeking to rescind the Letter Agreement. On January 25, 2005, Fremont General's motions to dismiss the lawsuit brought by the Commissioner, on behalf of Fremont Indemnity, against Fremont General were argued and heard before the Superior Court of the State of California (the "Court"). On January 26, 2005, the Court issued its rulings dismissing all the causes of action in the FAC without leave to amend, except for the cause of action for alleged concealment by Fremont General of a potential reinsurance dispute, which was dismissed with leave to amend. The Court also found that Fremont General had properly utilized the NOLs in accordance with the Letter Agreement. In addition, the Court rejected the Commissioner's request for findings that Fremont General's use of the NOLs and worthless stock deduction were voidable preferences and/or fraudulent transfers. The Court also rejected the Commissioner's request for injunctive relief to force Fremont General to amend its prior consolidated income tax returns to remove and forgo the worthless stock deduction for its investment in Fremont Indemnity. On May 2, 2005, the Commissioner filed a Second Amended Complaint ("SAC") with regard to the 7th cause of action on behalf of Fremont Indemnity against Fremont General alleging intentional misrepresentation, concealment and promissory fraud, which induced the Commissioner to first enter into the Letter Agreement. On July 15, 2005, the Court dismissed the SAC with 20 days leave to amend. On August 4, 2005, the Commissioner filed a Third Amended Complaint ("TAC") again alleging intentional misrepresentation, concealment and promissory fraud. On November 22, 2005, the Court dismissed the remaining cause of action in the TAC, finding that the "Plaintiff still failed to plead any affirmative misrepresentation which is actionable." The Court also found 40 that the "pleading is inadequate as to damage allegations." This ruling by the Court dismisses the only remaining cause of action in the lawsuit originally brought by the Commissioner on behalf of Fremont Indemnity against Fremont General, first reported on June 17, 2004. The Commissioner has filed a Notice of Appeal to the Court's dismissal of the complaint. The Company continues to believe that this lawsuit is without merit. FREMONT INDEMNITY COMPANY (IN LIQUIDATION AS SUCCESSOR IN INTEREST TO COMSTOCK INSURANCE COMPANY) V. FREMONT GENERAL CORPORATION ET AL.: The Commissioner filed an additional and separate complaint against Fremont General on behalf of Fremont Indemnity as successor in interest to Comstock Insurance Company ("Comstock"), a former affiliate of Fremont Indemnity, which was subsequently merged into Fremont Indemnity. This case alleged similar causes of action regarding the usage of the NOLs as in the Fremont Indemnity case as well as improper transactions with other insurance subsidiaries and affiliates of Fremont Indemnity. This matter was deemed a related case to the Fremont Indemnity case. On April 22, 2005, the Court dismissed, without leave to amend, the entire complaint. This ruling does not address or necessarily have legal effect on the related Fremont Indemnity case. The Commissioner has filed an Appeal to the Court's dismissal of the complaint. The Company continues to believe that this lawsuit is without merit. GERLING GLOBAL REINSURANCE CORPORATION OF AMERICA V. FREMONT GENERAL CORPORATION ET AL.: On July 27, 2005, Gerling Global Reinsurance Corporation of America ("Gerling") filed a lawsuit in Federal District Court (the "Court") against Fremont General arising out of a reinsurance treaty between Gerling and Fremont Indemnity alleging 1) Fraud/Intentional Misrepresentation and Concealment; 2) Breach of Fiduciary Duty; 3) Willful and Wanton Misconduct; 4) Negligent Misrepresentation; 5) Gross Negligence; 6) Tortuous Interference with Contract; 7) Unjust Enrichment; and 8) Breach of Contract for allegedly improper underwriting practices by Fremont Indemnity during 1998 and 1999. In October 2005, Gerling filed a First Amended Complaint ("FAC") alleging 1) Fraud/Intentional Misrepresentation and Concealment; 2) Inducement to Breach and Breach of Fiduciary Duty and Duty of Utmost Good Faith; 3) Willful and Wanton Misconduct; 4) Negligent Misrepresentation; 5) Gross Negligence; 6) Tortuous Interference with Contract; 7) Unjust Enrichment; and 8) Inducement to Breach and Breach of Contract. On December 12, 2005, the Company's Motion to Dismiss the FAC was argued and heard before the Court. On December 15, the Court issued its Order dismissing with prejudice Gerling's Third through Sixth Causes of Action, which asserted claims for Willful and Wanton Misconduct, Negligent Misrepresentation, 41 Gross Negligence and Tortuous Interference with Contract, and also dismissed with prejudice that part of Gerling's Eighth Cause of Action that alleged Inducement to Breach of Contract. The Court also dismissed the Breach of Contract claim, but granted Gerling leave to replead that claim. In January 2006, Gerling filed a Second Amended Complaint ("SAC") alleging 1) Fraud/Intentional Misrepresentation and Concealment; 2) Breach of Fiduciary Duty and Duty of Utmost Good Faith; 3) Unjust Enrichment; and 4) Breach of Contract. On March 6, 2006, Fremont General's Motion to Dismiss this SAC were argued and heard before the Court. On its own motion, the Court converted the Motion to Dismiss to a Motion for Summary Judgment and ordered that it be reset for hearing following limited discovery on the statute of limitations issues raised in the Motion. The Company continues to believe that this lawsuit is without merit. The Company retains the right in its securitization transactions to call the securities when the outstanding balance of loans in the securitization trust declines to a specific level, typically 10% of the original balance. Management expects that it may exercise its clean-up call option. The loans acquired via the clean-up call may be then either sold or put into the Company's loan portfolio. While it is expected that most loans acquired in a clean-up call can be sold for gains or retained as attractive portfolio investments, a portion of the loans are expected to be non-performing and thus, it is possible that non-performing loans may increase temporarily between the time of the call exercise and the disposition of the loans. NOTE 21: OPERATIONS BY REPORTABLE SEGMENT The Company manages its operations based on the types of products and services offered by each of its strategic business units. Based on that approach the Company has grouped its products and services into two reportable segments - -- Commercial and Residential Real Estate. The Commercial Real Estate segment originates its commercial real estate loans, which are primarily bridge and construction facilities, on a nationwide basis. These loans, which are held for investment, generate net interest income on the difference between the rates charged on the loans and the cost of borrowed funds. The Residential Real Estate segment originates non-prime or sub-prime loans nationally through independent brokers on a wholesale basis. These loans are then primarily sold to third party investors on a servicing-released or servicing-retained basis, or, to a lesser extent, securitized. Net interest income is 42 recognized on these loans during the period that the Company holds them for sale. In addition, servicing income is realized on the loans that are originated. Management measures and evaluates each of these segments based on total revenues generated, net interest income and pre-tax operating results. The results of operations include certain allocated corporate expenses as well as interest expense charged back to the segments for the use of funds generated by the Company's corporate and retail banking operations. Interest expense is allocated among the residential and commercial segments using LIBOR rates matched to the terms of the respective underlying loans plus a spread to cover the expenses of the retail banking operations. Certain expenses that are centrally managed at the corporate level such as provision for income taxes and other general corporate expenses are excluded from the measure of segment profitability reviewed by management. The Company has included these general corporate expenses along with the results of the Company's retail banking operation, which does not meet the definition of a reportable segment, in the Corporate and Retail Banking category. Historical periods have been restated to conform to this presentation. Intersegment eliminations shown in the table below relate to the credit allocated to the retail banking operations for operating funds provided to the two reportable segments. 43
RESIDENTIAL COMMERCIAL CORPORATE AND INTERSEGMENT TOTAL REAL ESTATE REAL ESTATE RETAIL BANKING ELIMINATIONS CONSOLIDATED ----------- ----------- -------------- ------------ ------------ (THOUSANDS OF DOLLARS) Three months ended June 30, 2006 Net interest income .............................. $ 85,088 $ 65,149 $ 15,128 $ - $ 165,365 Provision for loan losses ........................ - (11,706) (1) - (11,707) Net gain on whole loan sales and securitizations of residential real estate loans ............... 8,374 - - - 8,374 Loan servicing income ............................ 23,482 - - - 23,482 Mortgage servicing rights amortization and impairment provision ........................... (8,859) - - - (8,859) Impairment on residual assets .................... (5,752) - - - (5,752) Other non-interest income ........................ 1,261 4,220 (138) - 5,343 Compensation and related ......................... (31,609) (6,868) (18,772) - (57,249) Occupancy ........................................ (4,740) (748) (2,687) - (8,175) Other non-interest expense ....................... (13,829) 4,953 (15,761) - (24,637) Allocations ...................................... (21,328) (1,299) 22,627 - - ----------- ----------- -------------- ------------ ------------- Income before income taxes ....................... $ 32,088 $ 53,701 $ 396 $ - $ 86,185 =========== =========== ============== ============ ============= Total revenues ................................... $ 202,401 $ 130,742 $ 104,426 $ (97,373) $ 340,196 =========== =========== ============== ============ ============= Total consolidated assets ........................ $ 6,275,149 $ 5,557,595 $ 1,055,644 $ - $ 12,888,388 =========== =========== ============== ============ ============= Three months ended June 30, 2005 Net interest income .............................. $ 71,384 $ 45,687 $ 10,891 $ - $ 127,962 Provision for loan losses ........................ - 4,213 3 - 4,216 Net gain on whole loan sales and securitizations of residential real estate loans ............... 91,964 - - - 91,964 Loan servicing income ............................ 15,945 - - - 15,945 Mortgage servicing rights amortization and impairment provision ........................... (4,807) - - - (4,807) Impairment on residual assets .................... (572) - - - (572) Other non-interest income ........................ 954 4,552 534 - 6,040 Compensation and related ......................... (25,453) (5,898) (24,303) - (55,654) Occupancy ........................................ (4,028) (728) (2,186) - (6,942) Other non-interest expense ....................... (12,047) (2,687) (13,385) - (28,119) Allocations ...................................... (18,101) (1,472) 19,573 - - ----------- ---------- -------------- ------------ ------------- Income (loss) before income taxes ................ $ 115,239 $ 43,667 $ (8,873) $ - $ 150,033 =========== ========== ============== ============ ============= Total revenues ................................... $ 232,317 $ 81,007 $ 77,283 $ (71,087) $ 319,520 =========== ========== ============== ============ ============= Total consolidated assets ........................ $ 5,549,942 $ 3,609,216 $ 1,840,117 $ - $ 10,999,275 =========== =========== ============== ============ =============
44
RESIDENTIAL COMMERCIAL CORPORATE AND INTERSEGMENT TOTAL REAL ESTATE REAL ESTATE RETAIL BANKING ELIMINATIONS CONSOLIDATED ----------- ----------- -------------- ------------ ------------ (THOUSANDS OF DOLLARS) Six months ended June 30, 2006 Net interest income .............................. $ 162,586 $ 124,104 $ 32,665 $ - $ 319,355 Provision for loan losses ........................ 4 (15,597) 5 - (15,588) Net (loss) on whole loan sales and securitizations of residential real estate loans (6,802) - - - (6,802) Loan servicing income ............................ 44,831 - - - 44,831 Mortgage servicing rights amortization and impairment provision ........................... (16,903) - - - (16,903) Impairment on residual assets .................... (5,752) - - - (5,752) Other non-interest income ........................ 2,246 5,741 562 - 8,549 Compensation and related ......................... (64,379) (13,494) (38,786) - (116,659) Occupancy ........................................ (8,947) (1,457) (5,401) - (15,805) Other non-interest expense ....................... (26,261) 549 (30,181) - (55,893) Allocations ...................................... (40,633) (2,511) 43,144 - - ----------- ----------- -------------- ------------ ------------- Income before income taxes ....................... $ 39,990 $ 97,335 $ 2,008 $ - $ 139,333 =========== =========== ============== ============ ============= Total revenues ................................... $ 356,026 $ 241,798 $ 198,657 $ (182,080) $ 614,401 =========== =========== ============== ============ ============= Total consolidated assets ........................ $ 6,275,149 $ 5,557,595 $ 1,055,644 $ - $ 12,888,388 =========== =========== ============== ============ ============= Six months ended June 30, 2005 Net interest income .............................. $ 141,688 $ 86,868 $ 18,158 $ - $ 246,714 Provision for loan losses ........................ 1 3,173 6 - 3,180 Net gain on whole loan sales and securitizations of residential real estate loans 200,324 - - - 200,324 Loan servicing income ............................ 29,686 - - - 29,686 Mortgage servicing rights amortization and impairment provision ........................... (9,711) - - - (9,711) Impairment on residual assets .................... (1,790) - - - (1,790) Other non-interest income ........................ 1,774 7,779 414 - 9,967 Compensation and related ......................... (60,476) (12,561) (41,897) - (114,934) Occupancy ........................................ (8,211) (1,511) (4,155) - (13,877) Other non-interest expense ....................... (22,762) (1,043) (24,543) - (48,348) Allocations ...................................... (21,546) (2,134) 23,680 - - ----------- ---------- -------------- ------------ ------------- Income (loss) before income taxes ................ $ 248,977 $ 80,571 $ (28,337) $ - $ 301,211 =========== ========== ============== ============ ============= Total revenues ................................... $ 461,551 $ 150,628 $ 136,972 $ (127,801) $ 621,350 =========== ========== ============== ============ ============= Total consolidated assets ........................ $ 5,549,942 $ 3,609,216 $ 1,840,117 $ - $ 10,999,275 =========== =========== ============== ============ =============
45 NOTE 22: EARNINGS PER SHARE Earnings per share have been computed based on the weighted-average number of shares. The following tables set forth the computation of basic and diluted earnings per share:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, --------------------- ------------------------ 2006 2005 2006 2005 -------- -------- -------- --------- (THOUSANDS OF SHARES AND DOLLARS, EXCEPT PER SHARE DATA) Net income (numerator for basic earnings per share) .......................... $ 51,924 $ 90,770 $ 83,611 $ 180,872 Effect of dilutive securities: LYONs ............................................................. - 4 - 8 -------- -------- -------- --------- Net income available to common stockholders after assumed conversions (numerator for diluted earnings per share) ............ $ 51,924 $ 90,774 $ 83,611 $ 180,880 ======== ======== ======== ========= Weighted-average shares (denominator for basic earnings per share) ........................ 74,517 72,759 74,025 72,271 Effect of dilutive securities using the treasury stock method for restricted stock and stock options: Employee benefit plans .......................................... 1,245 1,203 1,195 1,090 Restricted stock ................................................ 440 1,132 426 1,023 Stock options ................................................... 77 87 88 97 LYONs ........................................................... - 33 - 34 -------- -------- -------- --------- Dilutive potential common shares .................................... 1,762 2,455 1,709 2,244 -------- -------- -------- --------- Adjusted weighted-average shares and assumed conversions (denominator for diluted earnings per share) ...................... 76,279 75,214 75,734 74,515 ======== ======== ======== ========= Basic earnings per share ............................................ $ 0.70 $ 1.25 $ 1.13 $ 2.50 ======== ======== ======== ========= Diluted earnings per share .......................................... $ 0.68 $ 1.21 $ 1.10 $ 2.43 ======== ======== ======== =========
For additional disclosures regarding stock options and restricted stock see Note 17. 46 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Fremont General Corporation ("Fremont General" or when combined with its subsidiaries "the Company" or "we") is a holding company which is engaged in lending operations through its indirectly wholly-owned subsidiary, Fremont Investment & Loan ("FIL"). FIL is a California industrial bank. Fremont General is not a "bank holding company" as defined for regulatory purposes. FIL has two primary lending operations, commercial and residential, both operating on a nationwide basis. FIL's commercial real estate lending operation includes nine regional offices and, as of June 30, 2006, had loans outstanding in 29 states. The residential real estate lending platform originated loans from 46 states through its five regional loan production centers as of June 30, 2006. FIL funds its lending operations primarily through deposit accounts sourced in California that are insured up to the maximum legal limit by the Federal Deposit Insurance Corporation ("FDIC") and, to a lesser extent, advances from the Federal Home Loan Bank ("FHLB") of San Francisco. As such, FIL is regulated by the FDIC and the Department of Financial Institutions of the State of California ("DFI"). FIL raises its retail deposits in California (predominately Southern California) through a network of 21 branches and a centralized call center. FIL will also utilize its warehouse lines of credit from time to time to fund part of its residential real estate loan production. FIL's residential real estate lending operation originates first, and to a lesser degree, second mortgage loans on a wholesale basis through a network of independent mortgage brokers. FIL offers mortgage products that are designed for borrowers who do not generally satisfy the credit, documentation or other underwriting standards prescribed by conventional mortgage lenders and loan buyers, such as Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) and are commonly referred to as "non-prime" or "sub-prime". These borrowers generally have considerable equity in the properties securing their loans, but have impaired or limited credit profiles or higher debt-to-income ratios than conventional mortgage lenders allow. The borrowers also include individuals who, due to self-employment or other circumstances, have difficulty documenting their income through conventional means. FIL seeks to mitigate its exposure to credit risk through underwriting standards that strive to balance appropriate loan to collateral valuations with a borrower's credit profile. All of the residential real estate loans that FIL originates are currently either sold in whole loan sales to various financial institutions, or to a lesser extent, securitized and sold to various investors. The Company has retained some of these loans as held for investment in prior periods and may do so again in the future. FIL's commercial real estate lending operation provides first mortgage financing on various types of commercial properties. The loans that FIL originates are substantially all held for investment, with some 47 loans participated out to limit credit exposures. Loans are originated through broker and borrower relationships and the borrowers are typically mid-size developers and owners seeking a loan structure that provides limited recourse and is short-term, providing bridge or construction financing for comprehensive construction, renovation, conversion, repositioning and lease-up of existing or new properties. To manage the credit risk involved in this lending, FIL is focused on the value and quality of the collateral and the quality and experience of the parties with whom it does business. The size of loan commitments originated generally range from $20 million to $100 million, with some loans for larger amounts. The Company's two operating lines of business are influenced by the overall condition of the economy, in particular the interest rate environment, and various market conditions. As a result, the Company is subject to experiencing cyclicality in volume, gain (or loss) on the sale of loans, net interest income, loan losses and earnings. The Company strives to manage its operations so as to optimize operational efficiency and to maintain risks within acceptable parameters. The Company's lending operations generate income as follows: o All of the residential real estate loans originated are currently sold for varying levels of gain or loss through whole loan sales to other financial institutions, and to a lesser degree, to various investors through securitization transactions. A held for sale valuation reserve, a loan repurchase reserve and a premium recapture reserve are maintained and adjusted through provisions (which are either an expense or a credit to income) that are recognized in the consolidated statements of income. Net interest income is recognized on these loans during the period that the Company holds them for sale. The Company also recognizes interest income on the residual interests it retains from its securitization transactions. Servicing income is realized on the loans sold into the Company's securitizations and on whole loan sales when servicing is retained, as well as on an interim basis for loans sold on a servicing released basis to other financial institutions. When servicing is retained either through a securitization or a whole loan sale with servicing retained, a mortgage servicing rights ("MSR") asset is typically established; the MSR is amortized to expense over the expected life of the related servicing income. o Commercial real estate loans, which are held for investment, generate net interest income on the difference between the rates charged on the loans and the cost of borrowed funds. The majority of commercial real estate loans originated are adjustable interest rate loans based upon six-month LIBOR and an applicable margin. An allowance for loan losses is maintained through provisions (which are either an expense or a credit to income) that are recognized in the consolidated statements of income. The principal market risks the Company faces are interest rate risk and liquidity risk. Interest rate risk is the risk that the valuation of the Company's interest sensitive assets and liabilities and its net interest income will change due to changes in interest rates. Liquidity risk, which is the ability of the Company to access the necessary funding and capital resources, in a cost-effective manner, to fund its loan originations or to sell its loans held for sale. Liquidity risk also entails the risk of changes in secondary market conditions, which can negatively impact the pricing realized by the Company on the loans it sells or 48 securitizes. The Company endeavors to mitigate interest rate risk by attempting to match the rate reset (or repricing) characteristics of its assets with its liabilities. The Company utilizes forward loan sale commitments to lock in liquidity execution and to hedge its loans held for sale. The Company also utilizes Eurodollar futures to hedge the interest rate risk on a portion of its loan pipeline and its loans held for sale. Residential and commercial mortgage lending requires significant cash to fund loan originations; the Company strives to maintain certain liquidity levels, both in available funds and in funding capacity, to ensure its ability to meet its funding objectives without constraint. The Company is dependent upon the securitization market for the sale of its residential real estate loans as it either securitizes the loans directly or many of its whole loan buyers purchase the loans with the intent to securitize. The secondary or securitization market is dependent upon many factors that can change the demand and thus impact the pricing the Company realizes on the sale of its residential real estate loans. The level of demand and general market conditions in the secondary market can significantly effect the level of gain or loss realized by the Company on the sale of these loans. The objective of the interest rate and liquidity risk management activities is to reduce the risk of operational disruption and to reduce the volatility in income caused by changes in interest rates and market conditions; however, the mortgage banking industry is inherently subject to income volatility due to the effect of interest rate variations on loan production volume, loan credit quality, premiums realized on loan sales and securitizations, and loan prepayment patterns, which in turn affects the valuation of the Company's loans held for sale, residual interests and MSRs, as well as the amount of loan servicing income realized. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and notes thereto presented under Item 1, and the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2005. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The Company's discussion and analysis of its financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, the Company evaluates its estimates, which are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company has identified four accounting policies as being critical because they require more significant judgment and estimates about matters that may differ from the estimates determined under different assumptions or conditions. These critical accounting policies relate to the gain or loss on whole loan sales and securitizations, allowance for loan losses, derivatives and income taxes. The critical 49 accounting policies and estimates are further discussed in Management's Discussion and Analysis in the Annual Report on Form 10-K for the fiscal year ended December 31, 2005. EARNINGS PERFORMANCE The Company reported income before income taxes of $86.2 million for the second quarter of 2006 as compared to $150.0 million for the second quarter of 2005. For the first six months of 2006 income before income taxes totaled $139.3 million as compared to $301.2 million for the first six months of 2005. The decrease in income before income taxes for the second quarter and first six months of 2006 represent decreases of 42.6% and 53.7% over the results for the second quarter and first six months of 2005, respectively. This decrease in income during the second quarter of 2006 is primarily a result of the Company recognizing a significantly lower gain on the sale and securitization of its residential real estate loans and, to a lesser extent, a higher provision for loan losses. The lower gain is a result of a lower level of gross premium being realized on the Company's loan sales and securitizations and significant increases in the Company's provisions for its loan valuation and repurchase reserves; this was partially offset by the recognition of a small derivative gain during the second quarter of 2006 as compared to a significant derivative loss during the second quarter of 2005. This was partially offset by increased levels of net interest income and loan servicing income. The Company reported net income of $51.9 million for the second quarter of 2006. This is compared to net income of $90.8 million for the second quarter of 2005. For the first six months of 2006, net income totaled $83.6 million, as compared to $180.9 million for the first six months of 2005. NET INTEREST INCOME The Company recorded net interest income for the second quarter and first six months of 2006 of $165.4 million and $319.4 million as compared to $128.0 million and $246.7 million for the second quarter and first six months of 2005, respectively. The increase in net interest income is primarily a result of an increase in the level of average interest-earning assets. Total average interest-earning assets increased 23.5% to $14.3 billion during the second quarter of 2006, as compared to $11.6 billion during the second quarter of 2005. This increase is primarily the result of significantly higher levels of commercial and residential real estate loans held for investment and sale. In addition, the Company's residual interests in securitized loans also increased substantially; these residual interests typically realize a higher yield than the Company's other interest-earning assets, thus positively impacting net interest income and net interest income margin. The net interest income margin as a percentage of average interest-earning assets increased to an annualized 4.78% for the first six months of 2006 from 4.52% for the first six months of 2005. Net interest income is impacted by the volume, mix and rate of interest-earning assets and interest-bearing liabilities. 50 The following tables identify the consolidated interest income, interest expense, average interest-earning assets and interest-bearing liabilities, and net interest margins, as well as an analysis of changes in net interest income due to volume and rate changes, for the second quarter and first six months of 2006 and 2005:
THREE MONTHS ENDED JUNE 30, --------------------------------------------------------------------------- 2006 2005 ---------------------------------- --------------------------------- AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST COST BALANCE INTEREST COST ------------ --------- ----- ----------- --------- ----- (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) Interest-earning assets (1): Commercial real estate loans ................. $ 5,560,025 $ 126,526 9.13% $ 3,864,369 $ 76,457 7.94% Residential real estate loans (2) ............ 8,054,457 167,948 8.36% 6,971,662 125,849 7.24 % Residual interests in securitized loans ...... 100,149 15,949 63.88% 18,823 2,969 63.27 % Cash equivalents and investment securities ... 624,129 7,185 4.62% 752,416 5,675 3.03 % ------------ --------- ------ ------------ --------- ----- Total interest-earning assets .............. $ 14,338,760 $ 317,608 8.88% $ 11,607,270 $ 210,950 7.29 % ============ ========= ===== ============ ========= ===== Interest-bearing liabilities: Time deposits ................................ $ 8,081,385 $ 92,027 4.57% $ 6,510,178 $ 51,396 3.17 % Savings deposits ............................. 1,521,289 14,358 3.79% 1,640,279 10,904 2.67 % FHLB advances ................................ 2,838,626 34,939 4.94% 1,823,463 12,213 2.69 % Warehouse lines of credit .................... 324,244 4,923 6.09% 230,658 2,337 4.06 % Senior Notes due 2009 ........................ 171,994 3,464 8.06% 181,450 3,650 8.05 % LYONs ........................................ - - - 386 7 7.27 % Junior Subordinated Debentures ............... 103,093 2,319 9.00% 103,093 2,320 9.00 % Other ........................................ 24,167 213 3.54% 29,166 161 2.21 % ------------ --------- ----- ------------ --------- ------ Total interest-bearing liabilities ......... $ 13,064,798 $ 152,243 4.67% $ 10,518,673 $ 82,988 3.16 % ============ ========= ====== ============ ========= ====== Net interest income ............................ $ 165,365 $ 127,962 ========= ========= Percent of average interest-earning assets: Interest income .............................. 8.88% 7.29% Interest expense ............................. 4.26% 2.87% ----- ------ Net interest margin .......................... 4.62% 4.42% ===== ====== (1) Average loan balances include non-accrual loan balances. (2) Includes loans held for sale and other.
51
SIX MONTHS ENDED JUNE 30, -------------------------------------------------------------------------- 2006 2005 ---------------------------------- --------------------------------- AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST COST BALANCE INTEREST COST ------------ -------- ----- ------------ -------- ----- (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) Interest-earning assets (1): Commercial real estate loans ................. $ 5,297,643 $ 236,060 8.99% $ 3,743,649 $ 142,849 7.69% Residential real estate loans (2) ............ 7,503,573 307,705 8.27% 6,601,538 236,959 7.24% Residual interests in securitized loans ...... 102,243 32,759 64.61% 17,050 4,307 50.94% Cash equivalents and investment securities ... 581,601 13,954 4.84% 635,183 8,759 2.78% ------------ --------- ----- ------------ --------- ------ Total interest-earning assets .............. $ 13,485,060 $ 590,478 8.83% $ 10,997,420 $ 392,874 7.20% ============ ========= ===== ============ ========= ===== Interest-bearing liabilities: Time deposits ................................ $ 7,753,930 $ 168,836 4.39% $ 6,204,962 $ 90,963 2.96% Savings deposits ............................. 1,550,445 28,234 3.67% 1,694,871 20,693 2.46% FHLB advances ................................ 2,383,818 55,595 4.70% 1,586,223 19,719 2.51% Warehouse lines of credit .................... 205,462 6,560 6.44% 115,966 2,556 4.44% Senior Notes due 2009 ........................ 174,076 7,010 8.05% 181,450 7,301 8.05% LYONs ........................................ - - - 480 15 6.30% Junior Subordinated Debentures ............... 103,093 4,639 9.00% 103,093 4,639 9.00% Other ........................................ 23,699 249 2.12% 27,140 274 2.04% ------------ --------- ----- ------------ ---------- ----- Total interest-bearing liabilities ......... $ 12,194,523 $ 271,123 4.48% $ 9,914,185 $ 146,160 2.97% ============ ========= ===== ============ ========= ===== Net interest income ............................ $ 319,355 $ 246,714 ========= ========= Percent of average interest-earning assets: Interest income .............................. 8.83% 7.20% Interest expense ............................. 4.05% 2.68% ----- ----- Net interest margin .......................... 4.78% 4.52% ===== ===== (1) Average loan balances include non-accrual loan balances. (2) Includes loans held for sale and other.
52
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, 2006 COMPARED TO 2005 2006 COMPARED TO 2005 ------------------------------------- -------------------------------------- CHANGE DUE TO CHANGE DUE TO ---------------------- ----------------------- VOLUME (1) RATE TOTAL VOLUME (1) RATE TOTAL ---------------------- --------- ----------------------- ---------- (THOUSANDS OF DOLLARS) Cash equivalent and investment securities .... $ (1,472) $ 2,982 $ 1,510 $ (1,027) $ 6,222 $ 5,195 Loans and residual interests ................. 74,093 31,055 105,148 133,485 58,924 192,409 --------- -------- --------- --------- ----------- -------- Total increase in interest income ............ 72,621 34,037 106,658 132,458 65,146 197,604 --------- -------- --------- --------- ----------- -------- Time deposits ................................ (17,892) (22,739) (40,631) (33,728) (44,145) (77,873) Savings deposits ............................. 1,123 (4,577) (3,454) 2,630 (10,171) (7,541) FHLB advances ................................ (12,495) (10,231) (22,726) (18,601) (17,275) (35,876) Warehouse lines of credit .................... (1,421) (1,165) (2,586) (2,857) (1,147) (4,004) Senior Notes due 2004 and 2009 ............... 186 - 186 291 - 291 LYONs ........................................ 7 - 7 15 - 15 Junior Subordinated Debentures ............... 1 - 1 - - - Other ........................................ 44 (96) (52) 36 (11) 25 --------- -------- --------- --------- --------- ---------- Total (increase) in interest expense ......... (30,447) (38,808) (69,255) (52,214) (72,749) (124,963) --------- -------- --------- --------- --------- --------- Increase / (decrease) in net interest income . $ 42,174 $ (4,771) $ 37,403 $ 80,244 $ (7,603) $ 72,641 ========= ======== ========= ========= ========= ========= (1) Changes in rate/volume are allocated to change in volume.
NON-INTEREST INCOME WHOLE LOAN SALES AND SECURITIZATIONS OF RESIDENTIAL REAL ESTATE LOANS The gain on sale of residential real estate loans decreased from $92.0 million in the second quarter of 2005 to $8.4 million for the second quarter of 2006. For the first six months of 2006 the Company realized a $6.8 million loss on the sale of its residential real estate loans as compared to a $200.3 million gain for the first six months of 2005. The decrease in the gain on sale during the second quarter of 2006 and the loss on sale for the first six months of 2006 is primarily attributable to a decrease in the gross premiums received on loan sales during the second quarter and first six months of 2006 and significantly increased levels of provisions for loan valuation and repurchase reserves, as compared to the second quarter and first six months of 2005. The net gain (loss) percentage (the net gain or loss after direct costs, net gains or losses on derivative instruments, provisions for premium recapture and valuation and repurchase reserves, divided by net loans sold) on these sales and securitizations decreased from 0.94% in the second quarter of 2005 to 0.10% in the second quarter of 2006. For the first six months of 2006 the Company realized a net loss percentage on these sales of (0.05)% as compared to a net gain percentage of 1.19% for the first six months of 2005. A total of $9.9 billion in loans were sold (including loans sold via securitization) during the second quarter of 2006, as compared to loan sales and securitizations of $9.8 billion during the second quarter of 2005. For the first six months of 2006, a total of $17.2 billion in loans were sold (including loans sold via securitization), as compared to loan sales of $16.8 billion for the first six months of 2005. The average gross premium on Tier 1 loan sales and securitizations during the second quarter of 2006 was 2.15% as compared to an average of 2.78% for the second quarter of 2005. For the first six months of 2006, the 53 average gross premium on Tier 1 loan sales and securitizations was 1.75% as compared to an average of 2.83% for the first six months of 2005. The decrease in gross premiums is a result of lower interest rate margins (reflecting increased price competition in the non-prime mortgage origination market) and secondary market conditions. In addition, pricing for second mortgages in the secondary market continued to decline during the second quarter of 2006. The Company's direct costs of loan origination associated with loans sold decreased during the second quarter and first six months of 2006 to 0.81% and 0.86%, respectively from 1.29% and 1.32% for the same periods in 2005 as a result of lower costs incurred for broker and account executive compensation. The Company also reported higher provisions for valuation and repurchase reserves for the second quarter of 2006 of $84.8 million (or 0.86%) of total net loan sales and securitizations, as compared to $19.3 million (or 0.20%) for the second quarter of 2005. For the first six months of 2006 the Company reported provisions of $117.2 million (or 0.69%) of total net loan sales and securitizations as compared to $29.3 million (or 0.17%) for the first six months of 2005. The increased provisions for loan valuation and repurchase reserves is primarily due to increased loan repurchase re-pricing trends from previous whole loan sale transactions and lower secondary market values for second mortgages. These increased loan repurchase and re-pricing levels, which have been noted industry-wide, are primarily due to increased levels of early payment delinquencies and a greater incidence of repurchase requests from whole loan purchasers. The Company's loan repurchases and re-pricings increased to $238.4 million and $346.1 million for the second quarter and first six months of 2006, respectively, as compared to $67.7 million and $143.8 million for the second quarter and first six months of 2005, respectively. Losses realized on Tier II loan sales increased to $26.9 million and $40.9 million for the second quarter and first six months of 2006, respectively, from $3.2 million and $6.4 million for the second quarter and first six months of 2005. The Company continually evaluates the loss and repurchase frequency estimates utilized for its valuation and repurchase reserves based upon its analysis of historical and current data and the mix of loan characteristics. Given these loan repurchase and re-pricing trends, with an objective of reducing its early payment delinquencies, the Company made modifications in its loan origination parameters during the second quarter of 2006, including eliminating or reducing certain higher loan-to-value products and lower FICO bands. The Company expects to see the impact of these changes during the fourth quarter of 2006 and the first quarter of 2007. The Company realized net gains of $1.6 million and $16.2 million on its derivative instruments utilized to hedge the impact of interest rate volatility on its residential real estate lending activities during the second quarter and first six months of 2006, respectively. These net gains primarily resulted from an increase in the underlying interest rate indices (primarily the two-year swap rate) which conversely had a negative impact upon the gross loan sale premiums realized during the same periods. These net gains are compared to net losses on derivatives of $25.6 million and $8.4 million during the second quarter and first six months of 2005. 54 The Company's gross loan premiums, loan repurchase and valuation reserves and the gain or loss on derivative instruments have exhibited, and are expected to continue to exhibit, variability (often significant) based on various economic, credit and interest rate environments, as well as on the Company's loan sale and hedging activity levels and their timing. The following table provides the amounts of loans sold during the respective periods and additional detail on the net gain (loss) on whole loan sales and securitizations: 55
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, --------------------------- ----------------------------- 2006 2005 2006 2005 ----------- ----------- ------------ ------------- (THOUSANDS OF DOLLARS) Whole loan sales of residential real estate loans ............... $ 8,911,454 $ 8,776,193 $ 16,169,109 $ 14,625,502 Securitizations of residential real estate loans ................ 982,533 981,717 982,533 2,191,566 ----------- ----------- ------------ ------------ Total loan sales and securitizations - net of repurchases ....... $ 9,893,987 $ 9,757,910 $ 17,151,642 $ 16,817,068 =========== =========== ============ ============ Gross premium recognized on Tier I loan sales and securitizations $ 212,315 $ 271,345 $ 300,248 $ 476,221 Losses on Tier II sales ......................................... (26,867) (3,225) (40,856) (6,405) ----------- ----------- ------------ ------------ 185,448 268,120 259,392 469,816 Net gain (loss) on derivative instruments ....................... 1,598 (25,573) 16,194 (8,385) ----------- ----------- ------------ ------------ 187,046 242,547 275,586 461,431 Net direct loan origination costs ............................... (81,053) (125,463) (148,820) (221,656) Provision for premium recapture ................................. (12,831) (5,857) (16,327) (10,127) ------------ ----------- ------------ ------------ 93,162 111,227 110,439 229,648 Provision for valuation and repurchase reserves ................. (84,788) (19,263) (117,241) (29,324) ----------- ----------- ------------ ------------ Net gain (loss) on sale .................................... $ 8,374 $ 91,964 $ (6,802) $ 200,324 =========== =========== ============ ============ Net gain (loss) on sale ......................................... $ 8,374 $ 91,964 $ (6,802) $ 200,324 Origination expenses allocated during the period of origination ................................................. (37,690) (41,850) (66,663) (78,154) ----------- ----------- ------------ ------------ Net operating gain (loss) on sale .......................... $ (29,316) $ 50,114 $ (73,465) $ 122,170 =========== =========== ============ ============ Gross premium recognized on Tier I loan sales and securitizations 2.15 % 2.78 % 1.75 % 2.83 % Losses on Tier II sales ......................................... (0.27)% (0.03)% (0.24)% (0.04)% ----------- ----------- ------------ ------------ 1.88 % 2.75 % 1.51 % 2.79 % Net gain (loss) on derivative instruments ....................... 0.02 % (0.26)% 0.09 % (0.05)% ----------- ----------- ------------ ------------- 1.90 % 2.49 % 1.60 % 2.74 % Net direct loan origination costs ............................... (0.81)% (1.29)% (0.86)% (1.32)% Provision for premium recapture ................................. (0.13)% (0.06)% (0.10)% (0.06)% ----------- ----------- ------------ ------------ 0.96 % 1.14 % 0.64 % 1.36 % Provision for valuation and repurchase reserves ................. (0.86)% (0.20)% (0.69)% (0.17)% ----------- ----------- ------------ ------------ Net gain (loss) on sale .................................... 0.10 % 0.94 % (0.05)% 1.19 % =========== =========== ============ ============ Net gain (loss) on sale ......................................... 0.10 % 0.94 % (0.05)% 1.19 % Origination expenses allocated during the period of origination ................................................. (0.38)% (0.43)% (0.39)% (0.46)% ----------- ----------- ------------ ------------ Net operating gain (loss) on sale .......................... (0.28)% 0.51 % (0.44)% 0.73 % =========== =========== ============ ============ o Percentages are of total loan sales and securitizations, net of repurchases, during the period indicated. o Tier II loans do not meet the criteria for a Tier I sale due to delinquency status, documentation issues or loan program exceptions for which the Company typically receives lower premiums. o Provision for premium recapture is the provision for the return of premium on loans sold which prepay early per the terms of each sales contract; includes some interest adjustment. o Provision for valuation and repurchase reserves represents adjustments to the valuation allowance for the Company's held for sale loans and adjustments to the Company's repurchase reserve for the effect of loans estimated to be repurchased and the related return premiums. o Origination expenses represent indirect expenses related to the origination of residential real estate loans during the period of origination and which are not deferred for GAAP. These expenses are included in non-interest expense in the consolidated statements of income during the period incurred. There is no directly comparable GAAP financial measure to "Origination expenses allocated during the period of origination", the components of which are calculated in accordance with GAAP. o Net operating gain on sale is a supplement to, and not a substitute for, the information presented in the consolidated statements of income as prepared in accordance with GAAP. The Company utilizes this additional information as part of its management of the total costs and efficiency of its loan origination platform. Furthermore, our definition of the indirect origination expenses may not be comparable to similarly titled measures reported by other companies. Because these expenses are estimates that are based on loans sold during the current period utilizing actual costs from prior periods, these costs may fluctuate from period to period reflecting changes in the volume of loans sold, originated and the actual indirect expenses incurred during the period of loan origination. The net operating gain on sale amount does not include net interest income on residential real estate loans held for sale or any fair value adjustments on the Company's residual interests in securitized loans.
LOAN SERVICING AND OTHER NON-INTEREST INCOME The components of the Company's loan servicing income, MSR amortization and impairment and other non-interest income for the second quarter and first six months of 2006 and 2005 are indicated in the following table: 56
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, --------------------- ---------------------- 2006 2005 2006 2005 -------- -------- --------- -------- (THOUSANDS OF DOLLARS) Loan Servicing Income: Servicing fee income: Securitization transactions ....................... $ 8,178 $ 5,214 $ 16,974 $ 9,593 Interim ........................................... 7,172 7,768 13,624 14,276 Loans sold - servicing retained ................... 2,565 641 3,917 1,472 -------- -------- --------- -------- 17,915 13,623 34,515 25,341 Ancillary income .................................... 3,002 1,808 5,908 3,531 Other ............................................... 2,565 514 4,408 814 -------- -------- --------- -------- $ 23,482 $ 15,945 $ 44,831 $ 29,686 ======== ======== ========= ======== MSR Amortization and Impairment: MSR amortization .................................... $ (8,859) $ (5,062) $ (16,903) $ (9,547) MSR impairment provision ............................ - 255 - (164) -------- -------- --------- -------- $ (8,859) $ (4,807) $ (16,903) $ (9,711) ======== ======== ========= ======== Other Non-Interest Income: Prepayment fees: Commercial real estate ............................ $ 1,257 $ 420 $ 1,899 $ 1,381 Residential real estate ........................... 841 712 1,482 1,274 Commercial real estate transaction fees ............. 2,821 3,773 3,839 5,836 Net gain on extinguishment of debt .................. 15 - 37 - All other ........................................... 409 1,135 1,292 1,476 -------- -------- --------- -------- $ 5,343 $ 6,040 $ 8,549 $ 9,967 ======== ======== ========= ========
Loan servicing income (which is all related to residential real estate), increased from $15.9 million in the second quarter of 2005 to $23.5 million for the second quarter of 2006. For the first six months of 2006 loan servicing income was $44.8 million versus $29.7 million for the first six months of 2005. These increases were due to increased residential real estate loan origination volume, which resulted in an increase in loan securitization activity in prior periods and higher levels of interim servicing during the second quarter and first six months of 2006 as compared to the second quarter and first six months of 2005. The additional loan securitization activity also created a higher level of MSRs, which resulted in an increase in the amortization (expense) of the MSRs in 2006 versus 2005. The Company was servicing $24.9 billion in principal balance of residential loans as of June 30, 2006 as compared to $21.0 billion as of June 30, 2005 and reflects the increase in loan servicing volume during the prior twelve months. The Company intends to continue to service those loans it securitizes, as well as and continues to service some loans sold to other parties for more than on an interim basis (servicing retained). The following is a breakdown of the total amount of loans outstanding being serviced by categorization as of the dates indicated: 57
JUNE 30, DECEMBER 31, 2006 2005 -------- ----------- (MILLIONS OF DOLLARS) Loans in securitizations ................................................... $ 6,847 $ 7,381 Loans sold and servicing retained .......................................... 4,347 1,082 -------- ----------- Loans being serviced to maturity ......................................... 11,194 8,463 Loans held for sale ........................................................ 6,106 5,412 Loans sold and serviced on an interim basis ................................ 7,569 8,377 -------- ----------- $ 24,869 $ 22,252 ======== ===========
PROVISION FOR LOSSES For the second quarter of 2006 the Company recognized a $11.7 million provision expense as compared to a $4.2 million credit to income for the second quarter of 2005. For the first six months of 2006, the provision expense was $15.6 million versus a $3.2 million credit to income for the first six months of 2005. The provision expense increase was primarily a result of the increase between the quarters in the commercial real estate loans held for investment partially offset by the decreased levels of net charge-offs and non-accrual and classified (substandard) commercial real estate portfolio loans. In addition, the Company has continued to reduce its exposure to commercial real estate loans secured by hotel and lodging properties which have been the majority of the non-accrual loans and net charge-offs in prior periods. The net charge-off amounts and ratios (to average loans outstanding) for the commercial real estate portfolio were $(192,000) or (0.01)% for the second quarter of 2006 and $7.8 million or 0.81% for the second quarter of 2005. For the first six months of 2006 the net charge-off amounts and ratios were $(259,000) or (0.01)% as compared to $8.4 million or 0.45% for the first six months of 2005. The provision for loan losses represents the current period expense (or credit to income) associated with maintaining an appropriate allowance for loan losses. The loan loss provision or credit for each period is dependent upon many factors, including loan growth, net charge-offs, changes in the composition and concentrations (geographic, industry, loan structure and individual loan) of the loan portfolio, the number and balances of non-accrual loans, delinquencies, the levels of restructured loans, assessment by management of the inherent risk in the portfolio, the value of the underlying collateral on classified loans and the general economic conditions in the commercial real estate markets in which the Company lends. Periodic fluctuations in the provision for loan losses and the allowance for loan losses result from management's on-going assessment of their adequacy. NON-INTEREST EXPENSE Non-interest expense decreased from $90.7 million during the second quarter of 2005 to $90.1 million for the second quarter of 2006. Increases in legal, professional, occupancy, and leasing and loan expense were offset by an overall decrease in net real estate owned expenses. For the first six months of 58 2006, non-interest expense increased to $188.4 million as compared to $177.2 million for the first six months of 2005. The increase was the result of increases in legal, professional, information technology and leasing and loan expense. Compensation expense increased from $55.7 million and $114.9 million during the second quarter and first six months of 2005 to $57.2 million and $116.7 million for the second quarter and first six months of 2006, respectively. Decreases in compensation expense related to residential real estate sales compensation were more than offset by decreases in the capitalization level of direct loan origination costs. Overall increases in base compensation were largely offset by decreases in incentive and benefits costs (such as management incentive compensation, employee stock ownership, 401(K) and other related accruals). Compensation and non-compensation related operating expenses are detailed in the following tables:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------- ------------------------- 2006 2005 2006 2005 --------- --------- ---------- ---------- (THOUSANDS OF DOLLARS) Compensation and related .......................................... $ 57,249 $ 55,654 $ 116,659 $ 114,934 Occupancy ......................................................... 8,175 6,942 15,805 13,877 Other ............................................................. 24,637 28,119 55,893 48,348 --------- --------- ---------- ---------- Total non-interest expense ........................................ $ 90,061 $ 90,715 $ 188,357 $ 177,159 ========= ========= ========== ==========
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------- ------------------------- 2006 2005 2006 2005 --------- --------- ---------- ---------- (THOUSANDS OF DOLLARS) Total compensation and related .................................... $ 119,908 $ 125,803 $ 235,620 $ 250,353 Deferral of loan origination costs (1) ............................ (62,659) (70,149) (118,961) (135,419) --------- --------- ---------- ---------- Compensation and related .......................................... $ 57,249 $ 55,654 $ 116,659 $ 114,934 ========= ========= ========== ========== (1) Incremental direct costs associated with the origination of loans are deferred when incurred. For residential real estate loans, when the related loan is sold, the deferred costs are included as a component of net gain on sale.
Other non-interest expense categories for the second quarter and first six months ended June 30, 2006 and 2005 are summarized below (note that gains on the sale of REO properties are included herein as an offset): 59
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, --------------------- ----------------------- 2006 2005 2006 2005 -------- -------- --------- --------- (THOUSANDS OF DOLLARS) Legal, professional and other outside services ..................... $ 9,542 $ 7,327 $ 16,279 $ 12,775 Information technology ............................................. 4,591 3,948 9,012 7,269 Printing, supplies and postage ..................................... 4,589 3,990 8,011 7,595 Advertising and promotion .......................................... 2,243 2,740 6,161 5,442 Auto and travel .................................................... 2,351 2,137 4,435 4,267 Leasing and loan expense ........................................... 2,930 1,351 5,756 3,304 Net real estate owned expenses ..................................... (8,337) 195 (7,241) (4,635) Telephone .......................................................... 2,328 1,296 3,386 2,157 All other .......................................................... 4,400 5,135 10,094 10,174 -------- -------- --------- --------- Total other expenses ............................................... $ 24,637 $ 28,119 $ 55,893 $ 48,348 ======== ======== ========= =========
INCOME TAXES Income tax expense of $34.3 million and $59.3 million for the quarters ended June 30, 2006 and 2005, represent effective tax rates of 39.8% and 39.5%, respectively, on income before income taxes of $86.2 million and $150.0 million for the same respective periods. For the six months ended June 30, 2006 and 2005, income tax expense of $55.7 million and $120.3 million, represent effect tax rates of 40.0% on income before income taxes of $139.3 million and $301.2 million for the same respective periods. The effective tax rates for all periods presented are different than the Federal enacted tax rate of 35% due mainly to various apportioned state income tax provisions. REVIEW OF FINANCIAL CONDITION LOANS HELD FOR SALE The Company's residential real estate loans held for sale have increased to $6.07 billion at June 30, 2006 from $5.42 billion at December 31, 2005. During the second quarter of 2006, residential real estate loan originations totaled $9.54 billion as compared to $9.24 billion for the second quarter of 2005. During the first six months of 2006 residential real estate loan originations totaled $18.08 billion as compared to $17.01 billion for the first six months of 2005. The following table details the loans held for sale as of the dates indicated: 60
JUNE 30, DECEMBER 31, 2006 2005 ------------ ----------- (THOUSANDS OF DOLLARS) Loan principal balance: 1st trust deeds .......................................................... $ 5,445,702 $ 4,792,976 2nd trust deeds ........................................................... 656,118 611,104 ----------- ----------- 6,101,820 5,404,080 Net deferred direct origination costs ....................................... 44,913 51,782 ----------- ----------- 6,146,733 5,455,862 Less: Valuation reserve .................................................... (74,433) (32,753) ----------- ----------- Loans held for sale - net ................................................... $ 6,072,300 $ 5,423,109 =========== =========== Loans held for sale on non-accrual status ................................... $ 42,299 $ 16,736 =========== ===========
During the latter half of 2005, the Company implemented pricing strategies designed to reduce the production volume of interest-only loans, while at the same time a 40-year amortization (due in 30 years) first mortgage product was introduced. The interest-only loans generally provide for no principal amortization for up to the first five years and are available on the 2/28 and 3/27 (e.g., 2 years fixed rate, then 28 years adjustable rate) products. The second lien products are all fixed rate loans. The following tables profile the loan origination volume for the periods indicated: 61
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, --------------------------- ----------------------------- 2006 2005 2006 2005 ----------- ----------- ------------ ------------ (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) Loan origination volume by lien position: Firsts ......................................... $ 8,659,180 $ 8,433,079 $ 16,448,837 $ 15,593,510 Seconds ........................................ 879,739 810,600 1,629,226 1,411,841 ----------- ----------- ------------ ------------ $ 9,538,919 $ 9,243,679 $ 18,078,063 $ 17,005,351 =========== =========== ============ ============ For first lien volume only: Average loan size .............................. $ 260,552 $ 241,166 $ 261,084 $ 237,829 Weighted-average coupon ........................ 8.36% 7.15% 8.35% 7.10% Average bureau credit score (FICO) ............. 623 624 621 623 Average loan-to-value (LTV) .................... 80.0% 81.0% 79.9% 81.0% Type of product: ARMs: 30 Year: 2/28 ..................................... 51.2% 85.7% 54.1% 86.1% 3/27 ..................................... 0.7% 2.9% 0.7% 2.9% 5/25 ..................................... 0.1% 0.9% 0.2% 0.9% ----------- ----------- ------------ ------------ 52.0% 89.5% 55.0% 89.9% 40/30: 2/28 ................................... 37.0% 0.0% 36.0% 0.0% 3/27 ................................... 0.5% 0.0% 0.5% 0.0% 5/25 ................................... 0.1% 0.0% 0.1% 0.0% ----------- ----------- ------------ ------------ 37.6% 0.0% 36.6% 0.0% ----------- ----------- ------------ ------------ Total ARMs ............................. 89.6% 89.5% 91.6% 89.9% =========== =========== ============ ============ Fixed rate: 30 Year .................................... 7.4% 10.5% 6.2% 10.1% 40/30 ...................................... 3.0% 0.0% 2.2% 0.0% ----------- ----------- ------------ ------------ Total fixed rate ....................... 10.4% 10.5% 8.4% 10.1% ----------- ----------- ------------ ------------ 100.0% 100.0% 100.0% 100.0% =========== =========== ============ ============ Loan purpose: Purchase ..................................... 47.9% 49.5% 46.6% 47.6% Refinance .................................... 52.1% 50.5% 53.4% 52.4% ----------- ----------- ------------ ------------ 100.0% 100.0% 100.0% 100.0% =========== =========== ============ ============ Documentation Type: Full ......................................... 54.4% 61.6% 53.3% 61.5% Stated ....................................... 44.6% 35.4% 45.7% 35.6% Other ........................................ 1.0% 3.0% 1.0% 2.9% ----------- ----------- ------------ ------------ 100.0% 100.0% 100.0% 100.0% =========== =========== ============ ============ For second lien volume only: Average loan size .............................. $ 66,126 $ 50,751 $ 65,774 $ 49,102 Weighted-average coupon ........................ 11.30% 9.99% 11.16% 10.02% Average bureau credit score (FICO) ............. 652 650 653 649 Purpose: Purchase ..................................... 82.2% 80.3% 80.9% 79.3% Refinance .................................... 17.8% 19.7% 19.1% 20.7%
62
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, --------------------------- ----------------------------- 2006 2005 2006 2005 ----------- ----------- ------------ ------------ First & Second Mortgages - Origination by geographic dispersion: California .................................... 25.4% 27.9% 25.5% 29.0% Florida ....................................... 15.0% 10.6% 14.4% 10.2% New York ...................................... 11.5% 11.1% 11.7% 11.0% Maryland ...................................... 7.2% 5.5% 7.3% 5.3% New Jersey .................................... 6.3% 6.8% 6.8% 6.9% All other states .............................. 34.6% 38.1% 34.3% 37.6% ----------- ----------- ------------ ------------ 100.0% 100.0% 100.0% 100.0% =========== =========== ============ ============
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------- -------------------- 2006 2005 2006 2005 ------- ------- ------- ------- Interest-only loans: As a percentage of first lien volume .............................. 10.90% 26.97% 10.74% 26.25% Average bureau credit score (FICO) ................................ 645 645 645 645 Weighted-average coupon ........................................... 7.59% 6.50% 7.61% 6.42% Average loan-to-value (LTV) ....................................... 81.3% 81.6% 81.3% 81.7%
LOANS HELD FOR INVESTMENT AND ALLOWANCE ACTIVITY The Company's net loans held for investment before the allowance for loan losses was approximately $5.70 billion at June 30, 2006, as compared to $4.76 billion at December 31, 2005. The increase in the Company's loans held for investment is a result of increased levels of loan commitment origination in 2005 and the first six months of 2006, as well as a reduction in the rate of loan paydowns. Commercial real estate loans are reported net of participations to other financial institutions or investors in the amount of $178.1 million and $138.2 million as of June 30, 2006 and December 31, 2005, respectively. The following table shows the total commercial real estate new loan commitment volume, net of participations, for the periods indicated: 63
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, --------------------------- --------------------------- 2006 2005 2006 2005 ----------- ----------- ----------- ----------- (THOUSANDS OF DOLLARS) Senior loans .................................................... $ 1,445,103 $ 1,157,062 $ 2,534,002 $ 2,217,735 Mezzanine loans .................................................. - - - - ----------- ----------- ----------- ----------- $ 1,445,103 $ 1,157,062 $ 2,534,002 $ 2,217,735 =========== =========== =========== =========== Average senior loan commitment size originated ................... $ 46,616 $ 28,927 $ 34,712 $ 29,969 =========== =========== =========== ===========
The following table shows the Company's loans held for investment in the various financing categories and the percentages of the total represented by each category:
JUNE 30, 2006 DECEMBER 31, 2005 -------------------------- ------------------------- AMOUNT % OF TOTAL AMOUNT % OF TOTAL ----------- ---------- ---------- ---------- (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) Commercial real estate loans: Construction ............................... $ 3,446,924 60 % $ 2,448,428 51 % Bridge ..................................... 1,927,767 34 % 1,887,073 39 % Permanent .................................. 291,927 5 % 389,681 8 % Single tenant credit ....................... 76,189 1 % 77,113 2 % ----------- --------- ----------- ---------- 5,742,807 100 % 4,802,295 100 % Other ........................................ 8,059 0 % 8,589 0 % ----------- --------- ----------- ---------- 5,750,866 100 % 4,810,884 100 % Deferrred fees and costs ..................... (53,158) (1)% (50,984) (1)% Allowance for loan losses .................... (172,688) (3)% (156,837) (3)% ----------- --------- ----------- ---------- Loans held for investment - net .............. $ 5,525,020 96 % $ 4,603,063 96 % =========== ========= =========== ==========
As of June 30, 2006, approximately 21.1%, 14.8% and 11.3% of the Company's commercial real estate loans outstanding were secured by properties located within California, Florida and New York, respectively; no other state represented greater than 9% of the loan portfolio. The real estate securing these loans includes a wide variety of property and project types including multi-family, office, retail, industrial, land development, lodging and mixed-use properties. The loans in the portfolio were distributed by property type as follows as of the dates indicated: 64
JUNE 30, DECEMBER 31, 2006 2005 ------- ----------- Multi-family - Condominiums ................................................. 55% 48% Land Development ............................................................ 15% 15% Office ...................................................................... 13% 14% Retail ...................................................................... 7% 7% Commercial Mixed-Use ........................................................ 3% 5% Multi-family - Other ........................................................ 3% 3% Industrial .................................................................. 2% 4% Hotels & Lodging ............................................................ 1% 2% Special Purpose ............................................................. 1% 2% ------- ----------- 100% 100% ======= ===========
The commercial real estate loan portfolio as of June 30, 2006, is stratified by loan size as follows (thousands of dollars, except percents and number of loans):
TOTAL LOANS # OF AVERAGE LOAN SIZE OUTSTANDING % LOANS LOAN SIZE - ----------------------------------------------- ----------- --- ----- --------- $0 - $ 1 million ............... $ 3,206 0% 69 $ 46 > $1 million - $ 5 million ............... 136,725 2% 42 3,255 > $5 million - $10 million ............... 560,839 10% 77 7,284 > $10 million - $15 million ............... 618,505 11% 50 12,370 > $15 million - $20 million ............... 407,437 7% 23 17,715 > $20 million - $30 million ............... 1,201,532 21% 50 24,031 > $30 million - $40 million ............... 1,011,783 18% 29 34,889 > $40 million - $50 million ............... 354,473 6% 8 44,309 > $50 million ................................. 1,448,307 25% 21 68,967 ------------ --- ----- ---------- $ 5,742,807 100% 369 $ 15,563 ============ === ===== ==========
As of June 30, 2006, the average loan size was $15.6 million (or $19.1 million when loans under $1 million are excluded) and the average loan-to-value ratio was approximately 73%, using the most current available appraised values and current loan balances outstanding. The following table details the commercial real estate loan portfolio as of June 30, 2006 by property collateral type and as to outstanding balances and total commitment amounts: 65
AVERAGE TOTAL LOANS TOTAL LOAN AVERAGE AVERAGE LOAN TO PROPERTY TYPE OUTSTANDING % COMMITMENTS % LOAN BALANCE COMMITMENT COMMITMENT % - ------------------------------------ ----------- --- ----------- --- ------------ ---------- ------------ (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) Multi-Family - Condominiums ........ $ 3,154,400 55% $ 6,235,225 64% $ 22,531 $ 44,537 51% Land Development ................... 876,428 15% 1,201,231 12% 16,854 23,101 73% Office ............................. 707,480 12% 862,692 9% 21,439 26,142 82% Retail ............................. 368,502 7% 593,365 6% 13,648 21,976 62% Commercial Mixed-Use ............... 190,201 3% 330,434 3% 15,850 27,536 58% Multi-Family - Other ............... 164,574 3% 209,107 2% 2,286 2,904 79% Industrial ......................... 127,310 3% 143,323 2% 9,094 10,237 89% Hotels & Lodging ................... 77,235 1% 77,235 1% 8,582 8,582 100% Special Purpose .................... 76,677 1% 77,607 1% 7,668 7,761 99% ----------- --- ----------- --- ------------ ---------- ------------- $ 5,742,807 100% $ 9,730,219 100% $ 15,563 $ 26,369 59% =========== === =========== === ============ ========== =============
The commercial real estate loan portfolio includes 21 separate loans with outstanding balances in excess of $50 million as of June 30, 2006. The Company's largest single individual loan outstanding (net of participation) at June 30, 2006 was $99.0 million with a total loan commitment of $99.0 million. The Company's largest net commitment for a single loan at June 30, 2006 was $150.0 million (with $7.1 million outstanding); this commitment represents the maximum potential loan amount to the borrower; however, the amount available to borrow is generally subject to certain levels of completion or other factors on the underlying property. At June 30, 2006, the Company had two loans collateralized by the same building property; each loan was for certain floors and purpose (one for condominiums and one for office space). The combined total loan commitment of the two loans was $156.6 million with a combined total outstanding loan balance of $134.5 million. As of June 30, 2006, there were eight groups of loans (separate loans on different properties) with common investors or equity sponsors for which the aggregate outstanding principal balance of the separate loans exceeded $100 million. The largest concentration is from one affiliated investment fund and totals $168.4 million in loan principal outstanding with $224.2 million in total loan commitment and is comprised of five separate loans. All five of the loans under this concentration were performing as of June 30, 2006. 66 The following tables provide additional information related to the Company's commercial real estate non-accrual loans, foreclosed assets, delinquencies, restructured loans on accrual status and accruing loans past due 90 days or more, as well as reflect the related net loss experience and allowance for loan loss reconciliation applicable to the loans held for investment as of and for the respective periods ended as shown below (note that as of June 30, 2006, the delinquent loans 30 days past due is comprised of one loan and the delinquent loans 60 days or greater past due are comprised of three loans):
JUNE 30, DECEMBER 31, 2006 2005 -------- ----------- (THOUSANDS OF DOLLARS, EXCEPT PERCENTS) Commercial Real Estate: Non-accrual loans held for investment ("HFI") ............................... $ 39,379 $ 29,290 Real estate owned / foreclosed assets ....................................... 299 30,198 -------- ----------- Total non-performing assets ................................................. $ 39,678 $ 59,488 ======== =========== Accruing loans receivable past due 90 days or more .......................... $ - $ - ======== =========== Restructured loans on accrual status ........................................ $ - $ 12,309 ======== =========== Delinquent loans 30 days past due * ........................................ 1.04% 0.10% Delinquent loans 60 days pas due or greater * .............................. 0.59% 0.80% Non-accrual loans to total loans HFI ........................................ 0.69% 0.62% Allowance for loan losses to total loans HFI ................................ 3.03% 3.29% Allowance for loan losses to non-performing assets .......................... 435.2% 263.6% * Excludes current but contractfully matured loans.
67
THREE MONTHS ENDED JUNE 30, 2006 --------------------------------------------------- COMMERCIAL RESIDENTIAL REAL ESTATE REAL ESTATE OTHER TOTAL ----------- ----------- ----- --------- (THOUSANDS OF DOLLARS) Beginning allowance for loan losses .............................. $ 160,713 $ - $ 76 $ 160,789 Provision for loan losses ........................................ 11,706 - 1 11,707 Charge-offs ...................................................... - - - - Recoveries ....................................................... 192 - - 192 ----------- ----------- ----- --------- Ending allowance for loan losses ................................. $ 172,611 $ - $ 77 $ 172,688 =========== =========== ===== ========= Net recoveries ................................................... $ 192 $ - $ - $ 192 =========== =========== ===== ========= Annualized net loan charge-offs to average commercial real estate loans held for investment ............................... (0.01)% ===========
THREE MONTHS ENDED JUNE 30, 2005 --------------------------------------------------- COMMERCIAL RESIDENTIAL REAL ESTATE REAL ESTATE OTHER TOTAL ----------- ----------- ----- --------- (THOUSANDS OF DOLLARS) Beginning allowance for loan losses .............................. $ 171,891 $ - $ 50 $ 171,941 Provision for loan losses ........................................ (4,213) - (3) (4,216) Charge-offs ...................................................... (8,197) - - (8,197) Recoveries ....................................................... 428 - - 428 ----------- ----------- ------ --------- Ending allowance for loan losses ................................. $ 159,909 $ - $ 47 $ 159,956 =========== =========== ====== ========= Net charge-offs .................................................. $ (7,769) $ - $ - $ (7,769) =========== =========== ====== ========= Annualized net loan charge-offs to average commercial real estate loans held for investment ...................................... 0.81% ===========
68
SIX MONTHS ENDED JUNE 30, 2006 --------------------------------------------------- COMMERCIAL RESIDENTIAL REAL ESTATE REAL ESTATE OTHER TOTAL ----------- ----------- ----- --------- (THOUSANDS OF DOLLARS) Beginning allowance for loan losses .............................. $ 156,755 $ - $ 82 $ 156,837 Provision for loan losses ........................................ 15,597 (4) (5) 15,588 Charge-offs ...................................................... - - - - Recoveries ....................................................... 259 4 - 263 ----------- ----------- ----- --------- Ending allowance for loan losses ................................. $ 172,611 $ - $ 77 $ 172,688 =========== =========== ===== ========= Net recoveries ................................................... $ 259 $ 4 $ - $ 263 =========== =========== ===== ========= Annualized net loan charge-offs to average commercial real estate loans held for investment ............................... (0.01)% ===========
SIX MONTHS ENDED JUNE 30, 2005 --------------------------------------------------- COMMERCIAL RESIDENTIAL REAL ESTATE REAL ESTATE OTHER TOTAL ----------- ----------- ----- --------- (THOUSANDS OF DOLLARS) Beginning allowance for loan losses .............................. $ 171,471 $ - $ 54 $ 171,525 Provision for loan losses ........................................ (3,172) (1) (7) (3,180) Charge-offs ...................................................... (12,180) - - (12,180) Recoveries ....................................................... 3,790 1 - 3,791 ----------- ----------- ------ --------- Ending allowance for loan losses ................................. $ 159,909 $ - $ 47 $ 159,956 =========== =========== ====== ========= Net (charge-offs) / recoveries ................................... $ (8,390) $ 1 $ - $ (8,389) =========== =========== ====== ========= Annualized net loan charge-offs to average commercial real estate loans held for investment ............................... 0.45% ===========
There were four non-accrual commercial real estate loans held for investment (the largest having a balance of $16.9 million) totaling $39.4 million, or 0.7% of the total loans held for investment, as of June 30, 2006. At December 31, 2005, there were five non-accrual commercial real estate loans totaling $29.3 million, or 0.6%. There were no loans on accrual status as of June 30, 2006 or December 31, 2005, which were 90 days or more past due. REO related to commercial real estate loans was $299,000 at June 30, 2006, consisting of one property, which was acquired through or in lieu of foreclosure on loans secured by real estate. At December 31, 2005, there were seven REO properties totaling $30.2 million. During the second quarter of 2006, the Company sold six of its commercial real estate REO properties, realizing a gain of $8.3 million, which is netted against other non-interest expense. The level of non-performing assets fluctuates and specific loans can have a material impact upon the total. Consideration must be given that, due to the secured nature of the Company's loans and the presence of larger-balance loans, the classification, and the timing thereof, of an individual loan as non- 69 accrual or REO can have a significant impact upon the level of total non-performing assets, without necessarily a commensurate increase in loss exposure. The allowance for loan losses, as a percentage of total loans held for investment decreased to 3.03% as of June 30, 2006, as compared to 3.29% as of December 31, 2005. In the second quarter of 2006, the Company incurred zero net loan charge-offs and realized $192,000 in recoveries of loan balances previously charged-off, as compared to $7.8 million in total net charge-offs for the second quarter of 2005. The net charge-off ratio for commercial real estate loans for the first six months of 2006 was (0.01)% as compared to 0.45% for the first six months of 2005. Loans secured by hotel and lodging properties represented 63% and 86% of the total commercial real estate loans on non-accrual status as of June 30, 2006 and December 31, 2005, respectively. LIQUIDITY AND CAPITAL RESOURCES The commercial and residential real estate lending activities are financed primarily through deposit accounts offered by FIL and which are insured by the FDIC. FIL offers certificates of deposit and savings and money market deposit accounts (insured by the FDIC to the legal maximum) through its 21 branches in California. FIL minimizes the costs associated with its accounts by not offering traditional checking, safe deposit boxes, ATM access and other traditional retail services. Deposits totaled $9.56 billion at June 30, 2006 and are summarized as to type as follows:
NUMBER OF TOTAL ACCOUNTS DEPOSITS --------- ----------- (THOUSANDS OF DOLLARS) Savings and money market deposit accounts .......................... 34,695 $ 1,498,802 Certificates of deposit: Retail ........................................................... 136,174 6,533,710 Brokered ......................................................... N/M 1,530,445 ----------- $ 9,562,957 =========== N/M = not meaningful.
Additional financing is available to FIL through advances from the Federal Home Loan Bank of San Francisco ("FHLB"). FIL maintains a credit line with the FHLB which has a maximum financing availability that is based upon a percentage of its regulatory assets, to which the actual borrowing capacity is subject to collateralization and certain collateral sub-limits. The financing by the FHLB is available at varying rates and terms. FIL's maximum financing availability from the FHLB, based upon its level of regulatory assets, was approximately $5.07 billion as of June 30, 2006. At June 30, 2006, FIL's actual borrowing capacity, based upon the amount of collateral pledged and the applicable advance rates, was $3.32 billion, with $1.31 billion 70 in outstanding advances. The weighted-average interest rate on the FHLB advances outstanding at June 30, 2006 was 5.01%. The borrowing capacity of FIL from the FHLB varies from time to time and is dependent upon the amount and timing of loans pledged. FIL pledged loans with a carrying value of $3.70 billion at June 30, 2006 to secure current and any future borrowings. FIL also has a line of credit with the Federal Reserve Bank of San Francisco and at June 30, 2006, had a borrowing capacity, based upon collateral pledged, of $392.2 million, with no amounts outstanding. To expand the capacity and flexibility of funding its residential real estate loan origination volume, the Company has four "warehouse" lines of credit with well-established financial institutions. While the Company has historically utilized these facilities on an infrequent basis, they may be used to fund loans prior to their sale or securitization. At June 30, 2006, these four facilities totaled $3.00 billion in total borrowing capacity of which $2.25 billion is on a committed basis. Borrowing availability is created under the facilities through the pledging of residential real estate loans held for sale. There were no amounts outstanding on any of the facilities at June 30, 2006. Each of the facilities is subject to certain conditions, including but not limited to financial and other covenants. The Company was in compliance with all covenants and requirements of these facilities as of June 30, 2006. The four facilities are summarized as follows: o $1 billion master repurchase facility ($500 million committed) with Goldman Sachs Mortgage Company expiring in February 2007, secured by certain residential real estate loans held for sale, interest at one-month LIBOR plus a margin of 0.40%. o $1 billion master loan and security facility ($1 billion committed) with Greenwich Capital Financial Products expiring in September 2006, secured by certain residential real estate loans held for sale, interest at one-month LIBOR plus a margin of 0.40%. o $500 million master repurchase facility ($500 million committed) with Credit Suisse First Boston Mortgage Capital expiring in August 2006, secured by certain residential real estate loans held for sale, interest at overnight LIBOR plus a margin of 0.35%. o $500 million master repurchase facility ($250 million committed) with Lehman Brothers Bank expiring in December 2006, secured by certain residential real estate loans held for sale, interest at one-month LIBOR plus a margin of 0.40%. The Company's residential loan disposition strategy is to primarily utilize whole loan sales and, to a lesser extent, securitizations. The Company attempts to build multiple whole loan sale relationships to achieve diversity and enhance market liquidity. During the first six months of 2006, the Company had transacted whole loan sales with 14 different financial institutions, the largest institution representing 18.1% of the total whole loan sales volume during this period. 71 As a holding company, Fremont General currently pays its operating expenses, interest expense, taxes, obligations under its various employee benefit plans, and stockholders' dividends, and meets its other obligations primarily from its cash on hand, dividends from Fremont General Credit Corporation ("FGCC"), intercompany tax payments and benefit plan reimbursements from FIL. Dividends of $8.6 million and $5.4 million were paid on Fremont General's common stock in the quarters ended June 30, 2006 and 2005, respectively. For the six month periods ended June 30, 2006 and 2005 dividends of $16.3 million and $10.7 million, respectively, were paid on Fremont General common stock; however, no assurance can be given that future common stock dividends will be declared. During 2005 and 2006, FIL had transferred by dividend substantially all of its residual interests in securitized loans to FGCC, which is an intermediate holding company wholly-owned by Fremont General. The residual interests at FGCC as of June 30, 2006 had an estimated fair value of $94.6 million. The retained residual interests in securitized loans at FIL had an estimated fair value at June 30, 2006 of $12.9 million. The purpose of these dividends was to create an additional source of cash flow to Fremont General to the extent of cash received from the residual interests. There exist certain Federal Income Tax and California Franchise Tax matters pending resolution, of which Fremont General is not yet able to make a determination of their ultimate liability, but does not believe that the actual outcomes of these matters will adversely impact its liquidity. It is expected that the final resolution of these matters may take several years. During the second quarter and first six months of 2006, Fremont General purchased $3.0 million and $6.0 million (both at par value), respectively, of its 7.875% Senior Notes due 2009; the costs were approximately $3.0 million and $6.0 million, respectively. Fremont General has cash and cash equivalents of $85.2 million at June 30, 2006 and no debt maturities until March of 2009. OFF-BALANCE SHEET ACTIVITIES In the second quarter of 2006, the Company continued to securitize a certain amount of its residential real estate loans. Securitization is a process of transforming the loans into securities, which are sold to investors. The loans are first sold to a special purpose corporation, which then transfers them to a qualifying special-purpose entity (a "QSPE") which is legally isolated from the Company. The QSPE, in turn, issues interest-bearing securities, commonly known as asset-backed securities, that are secured by the future cash flows to be derived from the securitized loans. The QSPE uses the proceeds from the issuance of the securities to pay the purchase price of the securitized loans. The Company does not utilize unconsolidated special-purpose entities as a mechanism to remove non-performing assets from the consolidated balance sheets. 72 Securitization is used by the Company to provide an additional source of liquidity. The QSPEs are not consolidated into the Company's financial statements since they meet the criteria established by SFAS No. 140, "Accounting for the Transfers and Servicing of Financial Assets and Extinguishment of Liabilities." In general, those criteria require the QSPE to be isolated and distinct from the transferor (the Company), to be limited to permitted activities and have defined limits on the assets it can hold and the permitted sales, exchanges or distributions of its assets. The investors and the QSPEs do not have any recourse to the Company if the cash flows generated by the securitized loans are inadequate to service the securities issued by the QSPEs. At the close of each securitization, the Company removes from its balance sheet the carrying value of the loans securitized and adds to its balance sheet the estimated fair value of the assets obtained in consideration for the loans which generally include the cash received (net of transaction expenses), retained junior class securities (referred to as residual interests) and mortgage servicing rights. FORWARD LOOKING STATEMENTS This report may contain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements and the currently reported results are based upon our current expectations and beliefs concerning future developments and their potential effects upon us. These statements and our results reported herein are not guarantees of future performance or results and there can be no assurance that actual developments and economic performance will be as anticipated by us. Actual developments and/or results may differ significantly and adversely from our expected or currently reported results as a result of significant risks, uncertainties and factors, often beyond our control (as well as the various assumptions utilized in determining our expectations), and which include, but are not limited to, the following: o the variability of general and specific economic conditions and trends, and changes in, and the level of, interest rates; o the impact of competition in the non-prime residential lending market and in the commercial real estate lending market on our ability to adequately price, underwrite and originate our loans; o the impact of competition and pricing environments on loan and deposit products and the resulting effect upon our net interest margin and net gain on sale; o changes in our ability to originate loans, and any changes in the cost, credit quality and volume of loans originated as a result thereof; 73 o the effectiveness of our interest risk management, including hedging, on our funded and unfunded loans; o the ability to access the necessary capital resources in a cost-effective manner to fund loan originations, the condition of the whole loan sale and securitization markets and the timing of sales and securitizations; o our ability to sell or securitize the residential real estate loans we originate; o the demand for, and the pricing and valuation of, existing and future loans, and the net premiums realized upon the sale of such loans; o our ability to sell certain of the commercial real estate loans and foreclosed real estate in our portfolio and the net proceeds realized upon the sale of such; o the impact of changes in the commercial and residential real estate markets, and changes in the fair values of our assets and loans, including the value of the underlying real estate collateral; o the ability to effectively manage our growth in assets and volume, including our lending concentrations, and to maintain acceptable levels of credit quality; o the ability to collect and realize the amounts outstanding, and the timing thereof, of loans and foreclosed real estate; o the ability to appropriately estimate an adequate level for the allowance for loan losses, the valuation reserve for loans held for sale, the loan repurchase reserve and the premium recapture reserve, as well as the fair value of the retained mortgage servicing rights and residual interests in securitizations; o changes in various economic and other factors which influence the timing and ultimate realization of the cash flows supporting our estimate of fair value for our residual interests in securitized loans and mortgage servicing rights; o the effect of certain determinations or actions taken by, or the inability to secure regulatory approvals from, the Federal Deposit Insurance Corporation, the Department of Financial Institutions of the State of California or other regulatory bodies on various matters; o our ability to maintain cash flow sufficient for us to meet our debt service and other obligations; o the ability to maintain effective compliance with laws and regulations and control expenses, particularly in periods of significant growth for us; o the impact and cost of adverse state and federal legislation and regulations, litigation, court decisions and changes in the judicial climate; o the impact of changes in federal and state tax laws and interpretations, including tax rate changes, and the effect of any adverse outcomes from the resolution of issues with taxing authorities; o the ability to maintain an effective system of internal and financial disclosure controls, and to 74 identify and remediate any control deficiencies, under the requirements of Section 404 of the Sarbanes-Oxley Act of 2002; and o other events, risks and uncertainties discussed elsewhere in this Form 10-Q and from time to time in our other reports, press releases and filings with the Securities and Exchange Commission. We undertake no obligation to publicly update such forward-looking statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK The Company is subject to market risk resulting primarily from the impact of fluctuations in interest rates upon balance sheet financial instruments such as loans, residual interests, mortgage servicing rights, debt and derivatives. Changes in interest rates can affect loan interest income, gains or losses on the sale and securitization of residential real estate loans, interest expense, loan origination volume, net investment income and total stockholders' equity. The level of gain or loss on the sale and securitization of residential real estate loans is highly dependent upon the level of loan origination volume, the premium paid by the purchasers of such loans and the gain or loss realized from hedging activities. Each of these factors, in turn, are highly dependent upon changes in, and the level of, interest rates and other economic factors. The Company may experience a decrease in the amount of gain it realizes should significant interest rate volatility occur or if other economic factors have a negative impact on the value and volume of the loans the Company originates. The objective of the asset and liability management activities is to provide an acceptable level of net interest and investment income and to seek cost effective sources of capital, while maintaining acceptable levels of interest rate and liquidity risk. There is no exposure to foreign currency or commodity price risk. The Company is subject to interest rate risk resulting from differences between the rates on, and repricing characteristics of, interest-earning loans held for investment (and loans held for sale) and the rates on, and repricing characteristics of, interest-bearing liabilities used to finance these loans such as deposits and debt. Interest rate gaps may arise when assets are funded with liabilities having different repricing intervals or different market indices to which the instruments' interest rate is tied and to this degree, earnings will be sensitive to interest rate changes. Additionally, interest rate gaps could develop between the market rate and the interest rate on loans in the loan portfolio, which could result in borrowers' prepaying their loan obligations. The Company attempts to match the characteristics of interest rate sensitive assets and liabilities to minimize the effect of fluctuations in interest rates. For the Company's financial instruments, the expected maturity date does not necessarily reflect the net market risk exposure because certain instruments are subject to interest rate changes before expected maturity. With respect to the Company's residential real estate loans held for sale and its unfunded loan pipeline, the Company 75 attempts to minimize its interest rate risk exposure through forward loan sale commitments and other financial instruments, such as Eurodollar futures contracts. These financial instruments meet the definition of a derivative under generally accepted accounting principles and, accordingly, they are recorded in the consolidated financial statements at fair value. The Company is reliant upon the secondary mortgage market for execution of its whole loan sales and securitizations of residential real estate loans. While the Company strives to maintain adequate levels of liquidity support and capital to withstand certain disruptions in the secondary mortgage market, a significant disruption or change in the level of demand could adversely impact the Company's ability to fund, sell, securitize or finance its residential real estate loan origination volume, leading to reduced gains (or losses) on sale and a corresponding decrease in revenue and earnings. A deterioration in performance of the residential real estate loans after being sold in whole loan sales and securitizations could adversely impact the availability and pricing of such future transactions. Quantitative and qualitative disclosures about the Company's market risk are included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2005. There have been no material changes in such risks or in the Company's asset and liability management activities during the six months ended June 30, 2006. ITEM 4. CONTROLS AND PROCEDURES As of June 30, 2006, the Company evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures. The evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"). Based on that evaluation, the Company's management, including the CEO and CFO, have concluded that the Company's disclosure controls and procedures were effective as of June 30, 2006. There have been no changes in the Company's internal controls over financial reporting that occurred in the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting. 76 PART II - OTHER INFORMATION ITEM 1: LEGAL PROCEEDINGS The Company is a defendant in a number of legal actions arising in the ordinary course of business and from the discontinuance of the insurance operations. Management and its legal counsel are of the opinion that the settlement of these actions, individually or in the aggregate, will not have a material effect on the Company's business, financial position or results of operations. FREMONT INDEMNITY COMPANY (IN LIQUIDATION) V. FREMONT GENERAL CORPORATION ET AL.: On June 2, 2004, the State of California Insurance Commissioner John Garamendi (the "Commissioner"), as statutory liquidator of Fremont Indemnity Company ("Fremont Indemnity"), filed suit in Los Angeles Superior Court against Fremont General alleging the improper utilization by Fremont General of certain net operating loss deductions ("NOLs") allegedly belonging to its Fremont Indemnity subsidiary (the "Fremont Indemnity case"). This complaint involves issues that were considered resolved in an agreement among the California Department of Insurance, Fremont Indemnity and Fremont General (the "Letter Agreement"). The Letter Agreement, dated July 2, 2002, was executed on behalf of the California Department of Insurance by the Honorable Harry Low, the State of California Insurance Commissioner at that time. Fremont General has honored all of its obligations under the Letter Agreement. On July 16, 2004, the Commissioner filed a First Amended Complaint ("FAC") adding a cause of action for concealment of an alleged reinsurance dispute and is seeking to rescind the Letter Agreement. On January 25, 2005, Fremont General's motions to dismiss the lawsuit brought by the Commissioner, on behalf of Fremont Indemnity, against Fremont General were argued and heard before the Superior Court of the State of California (the "Court"). On January 26, 2005, the Court issued its rulings dismissing all the causes of action in the FAC without leave to amend, except for the cause of action for alleged concealment by Fremont General of a potential reinsurance dispute, which was dismissed with leave to amend. The Court also found that Fremont General had properly utilized the NOLs in accordance with the Letter Agreement. In addition, the Court rejected the Commissioner's request for findings that Fremont General's use of the NOLs and worthless stock deduction were voidable preferences and/or fraudulent transfers. The Court also rejected the Commissioner's request for injunctive relief to force Fremont General to amend its prior consolidated income tax returns to remove and forgo the worthless stock deduction for its investment in Fremont Indemnity. On May 2, 2005, the Commissioner filed a Second Amended Complaint ("SAC") with regard to the 7th cause of action on behalf of Fremont Indemnity against Fremont General alleging intentional misrepresentation, concealment and promissory fraud, which induced the Commissioner to first enter into the Letter Agreement. On July 15, 2005, the Court dismissed the SAC with 20 days leave to amend. On August 4, 2005, the Commissioner filed a Third Amended Complaint ("TAC") again alleging intentional misrepresentation, concealment and promissory fraud. 77 On November 22, 2005, the Court dismissed the remaining cause of action in the TAC, finding that the "Plaintiff still failed to plead any affirmative misrepresentation which is actionable." The Court also found that the "pleading is inadequate as to damage allegations." This ruling by the Court dismisses the only remaining cause of action in the lawsuit originally brought by the Commissioner on behalf of Fremont Indemnity against Fremont General, first reported on June 17, 2004. The Commissioner has filed a Notice of Appeal to the Court's dismissal of the complaint. The Company continues to believe that this lawsuit is without merit. FREMONT INDEMNITY COMPANY (IN LIQUIDATION AS SUCCESSOR IN INTEREST TO COMSTOCK INSURANCE COMPANY) V. FREMONT GENERAL CORPORATION ET AL.: The Commissioner filed an additional and separate complaint against Fremont General on behalf of Fremont Indemnity as successor in interest to Comstock Insurance Company ("Comstock"), a former affiliate of Fremont Indemnity, which was subsequently merged into Fremont Indemnity. This case alleged similar causes of action regarding the usage of the NOLs as in the Fremont Indemnity case as well as improper transactions with other insurance subsidiaries and affiliates of Fremont Indemnity. This matter was deemed a related case to the Fremont Indemnity case. On April 22, 2005, the Court dismissed, without leave to amend, the entire complaint. This ruling does not address or necessarily have legal effect on the related Fremont Indemnity case. The Commissioner has filed an Appeal to the Court's dismissal of the complaint. The Company continues to believe that this lawsuit is without merit. GERLING GLOBAL REINSURANCE CORPORATION OF AMERICA V. FREMONT GENERAL CORPORATION ET AL.: On July 27, 2005, Gerling Global Reinsurance Corporation of America ("Gerling") filed a lawsuit in Federal District Court (the "Court") against Fremont General arising out of a reinsurance treaty between Gerling and Fremont Indemnity alleging 1) Fraud/Intentional Misrepresentation and Concealment; 2) Breach of Fiduciary Duty; 3) Willful and Wanton Misconduct; 4) Negligent Misrepresentation; 5) Gross Negligence; 6) Tortuous Interference with Contract; 7) Unjust Enrichment; and 8) Breach of Contract for allegedly improper underwriting practices by Fremont Indemnity during 1998 and 1999. In October 2005, Gerling filed a First Amended Complaint ("FAC") alleging 1) Fraud/Intentional Misrepresentation and Concealment; 2) Inducement to Breach and Breach of Fiduciary Duty and Duty of Utmost Good Faith; 3) Willful and Wanton Misconduct; 4) Negligent Misrepresentation; 5) Gross Negligence; 6) Tortuous Interference with Contract; 7) Unjust Enrichment; and 8) Inducement to Breach and Breach of Contract. On December 12, 2005, the Company's Motion to Dismiss the FAC was argued and heard before the Court. On December 15, the Court issued its Order dismissing with prejudice Gerling's Third through Sixth Causes of Action, which asserted claims for Willful and Wanton Misconduct, Negligent Misrepresentation, Gross Negligence 78 and Tortuous Interference with Contract, and also dismissed with prejudice that part of Gerling's Eighth Cause of Action that alleged Inducement to Breach of Contract. The Court also dismissed the Breach of Contract claim, but granted Gerling leave to replead that claim. In January 2006, Gerling filed a Second Amended Complaint ("SAC") alleging 1) Fraud/Intentional Misrepresentation and Concealment; 2) Breach of Fiduciary Duty and Duty of Utmost Good Faith; 3) Unjust Enrichment; and 4) Breach of Contract. On March 6, 2006, Fremont General's Motion to Dismiss this SAC were argued and heard before the Court. On its own motion, the Court converted the Motion to Dismiss to a Motion for Summary Judgment and ordered that it be reset for hearing following limited discovery on the statute of limitations issues raised in the Motion. The Company continues to believe that this lawsuit is without merit. ITEM 1A: RISK FACTORS We included a discussion of our Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2005. There has been no material change in such risks during the six months ended June 30, 2006. ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS ISSUER PURCHASES OF EQUITY SECURITIES
- ------------------------------------------------------------------------------------------------------------------------------ (c) TOTAL NUMBER (d) MAXIMUM NUMBER (a )TOTAL (b) AVERAGE OF SHARES (OR UNITS) (OR APPROXIMATE DOLLAR NUMBER OF PRICE PAID PURCHASED AS PART VALUE) OF SHARES (OR SHARES PER SHARE OF PUBLICLY UNITS) THAT MAY YET BE (OR UNITS) (OR UNIT) ANNOUNCED PLANS PURCHASED UNDER THE PERIOD PURCHASED (1) (2) OR PROGRAMS PLANS OR PROGRAMS (3) - ----------------------------------- ------------- ------------ ------------------- ----------------------- April 1-30, 2006 1,387 $ 21.04 1,387 - ------------------------------------------------------------------------------------------------------------------------------ May 1-31, 2006 1,012 $ 22.43 1,012 - ------------------------------------------------------------------------------------------------------------------------------ June 1-30, 2006 39,238 $ 2.08 39,238 - ------------------------------------------------------------------------------------------------------------------------------ Total 41,637 $ 3.21 41,637 2,845,885 ============================================================================================================================== (1) Shares of common stock acquired by the Company from participants through purchases of shares under certain employee benefit plans at fair value and/or reacquisition of shares under its restricted stock program at $0 per share. (2) Excluding the purchase of 35,114 restricted stock shares, the average price per share was $20.47 for the three months ended June 30, 2006. The restricted stock shares were reacquired at $0 per share under the terms of the Company's stock award plan upon termination of employment of participant(s) thereunder. (3) A repurchase program for four million shares was announced to the public on February 27, 2003, and a repurchase program for and an additional four million shares was announced to the public on May 19, 2005.
79 ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. a) The Annual Meeting of Stockholders was held on May 18, 2006. b) The following directors were elected to serve until the next Annual Meeting of Stockholders or until their successors have been elected and qualified: James A. McIntyre Robert F. Lewis Louis J. Rampino Russell K. Mayerfeld Wayne R. Bailey Dickinson C. Ross Thomas W. Hayes c) The results of the voting of the 72,598,301 shares represented at the meeting are summarized in the following table:
VOTES FOR WITHHELD ---------- --------- J. A. McIntyre 70,793,786 1,804,515 L. J. Rampino 70,804,302 1,793,999 W. R. Bailey 70,800,914 1,797,387 T. W. Hayes 72,113,161 485,140 R. F. Lewis 71,669,859 928,442 R. K. Mayerfeld 72,127,800 470,501 D. C. Ross 71,070,682 1,527,619
d) The proposal of the 2006 Performance Incentive Plan was approved. The results of the voting of the 72,598,301 shares represented at the meeting are summarized in the following table: BROKER FOR AGAINST ABSTAINED NON-VOTE ---------- --------- --------- --------- 51,987,798 9,276,414 408,247 10,925,842 e) The appointment of the accounting firm of Ernst & Young LLP as the Corporation's Independent Auditors was ratified. The results of the voting of the 72,598,301 shares represented at the meeting are summarized in the following table: FOR AGAINST ABSTAINED ---------- --------- --------- 71,764,982 798,049 35,270 80 ITEM 6: EXHIBITS EXHIBIT NO. DESCRIPTION - ------- ---------------------------------------------------------------------- 3.1 Restated Articles of Incorporation of Fremont General Corporation. (Incorporated by reference to Exhibit 3.1 to the Registrant's Quarterly Report on Form 10-Q, for the period ended June 30, 1998, Commission File Number 1-8007.) 3.2 Certificate of Amendment of Articles of Incorporation of Fremont General Corporation. (Incorporated by reference to Exhibit 3.2 to the Registrant's Annual Report on Form 10-K, for the fiscal year ended December 31, 1998, Commission File Number 1-8007.) 3.3(a) Amended and Restated Bylaws of Fremont General Corporation. (Incorporated by reference to Exhibit 3.3 to the Registrant's Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007.) 3.3(b) Fremont General Corporation Bylaw Amendment Adopted by the Board of Directors on November 20, 2003. (Incorporated by reference to Exhibit 3.3(b) to the Registrant's Annual Report on Form 10-K, for the fiscal year ended December 31, 2003, Commission File Number 1-8007.) 3.3(c) Fremont General Corporation Bylaw Amendment Adopted by the Board of Directors on March 16, 2004. (Incorporated by reference to Exhibit 3.3(c) to the Registrant's Quarterly Report on Form 10-Q, for the period ended June 30, 2004, Commission File Number 1-8007.) 4.1 Form of Stock Certificate for Common Stock of the Registrant. (Incorporated by reference to Exhibit 4.1 to the Registrant's Annual Report on Form 10-K, for the fiscal year ended December 31, 2000, Commission File Number 1-8007.) 4.2 Indenture with respect to the 9% Junior Subordinated Debentures among the Registrant, the Trust and Bank of New York (originated with First Interstate Bank of California), a New York Banking Corporation, as trustee. (Incorporated by reference to Exhibit 4.3 to the Registrant's Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007.) 4.3 Amended and Restated Declaration of Trust with respect to the 9% Trust Originated Preferred Securities among the Registrant, the Regular Trustees, Chase Bank (USA), a Delaware banking corporation, as Delaware trustee, and JPMorgan Chase Bank, National Association, as Institutional Trustee. (Incorporated by reference to Exhibit 4.5 to the Registrant's Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007.) 4.4 Preferred Securities Guarantee Agreement between the Registrant JP Morgan Chase Bank, National Association, as Preferred Guarantee Trustee. (Incorporated by reference to Exhibit 4.6 to the Registrant's Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007.) 4.5 Common Securities Guarantee Agreement by the Registrant. (Incorporated by reference to Exhibit 4.7 to the Registrant's Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007.) 4.6 Form of Preferred Securities. (Included in Exhibit 4.5). (Incorporated by reference to Exhibit 4.8 to the Registrant's Annual Report on Form 10-K, for the fiscal year ended December 31, 1995, Commission File Number 1-8007.) 10.1 Fremont General Corporation and Affiliated Companies Investment Incentive Plan and Amendments One through Eight. 10.2 Fremont General Corporation 2006 Performance Incentive Plan (Incorporated by reference to Exhibit I of the Registrant's Definitive Proxy Statement on Schedule 14A filed on April 13, 2006). 10.3 Form of Restricted Stock Award Agreement (incorporated by reference from Exhibit 4.2 to the Registrant's Form S-8 Registration Statement with respect to the 2006 Performance Incentive Plan filed on May 18, 2006, Commission File No. 1-8007). 10.4 Form of Nonqualified Stock Option Agreement (Incorporated by reference to the Registrant's Form S-8 Registration Statement with respect to the 2006 Performance Incentive Plan filed on May 18, 2006, Commission File Number 1-8007.) 31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 81 EXHIBIT NO. DESCRIPTION - ------- ---------------------------------------------------------------------- 31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. With respect to long-term debt instruments, the Registrant undertakes to provide copies of such agreements upon request by the Commission. 82 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FREMONT GENERAL CORPORATION Date: August 8, 2006 /s/ LOUIS J. RAMPINO ------------------------------- Louis J. Rampino President and Chief Executive Officer Date: August 8, 2006 /s/ PATRICK E. LAMB ------------------------------- Patrick E. Lamb Senior Vice President, Chief Financial Officer, Chief Accounting Officer and Treasurer (Principal Accounting Officer) S-1 EX-10 2 q2ex101.txt EXHIBIT 10.1 EXHIBIT NO. 10.1 FREMONT GENERAL CORPORATION AND AFFILIATED COMPANIES INVESTMENT INCENTIVE PLAN ORIGINAL EFFECTIVE DATE: FEBRUARY 1, 1986 RESTATEMENT EFFECTIVE DATE: JANUARY 1, 2000 TABLE OF CONTENTS
PAGE ---- ARTICLE I INTRODUCTION ....................................................... 1 ARTICLE II DEFINITIONS ........................................................ 2 2.1 Account or Accounts .................................................... 2 2.2 Adjustment Factor ...................................................... 2 2.3 Administrator or Plan Administrator .................................... 2 2.4 Affiliated Company ..................................................... 2 2.5 Beneficiary ............................................................ 2 2.6 Break in Service ....................................................... 3 2.7 Code ................................................................... 4 2.8 Company ................................................................ 4 2.9 Company Stock .......................................................... 4 2.10 Compensation ........................................................... 4 2.11 Contributions .......................................................... 5 2.12 Disability ............................................................. 5 2.13 Effective Date ......................................................... 5 2.14 Eligible Employees ..................................................... 5 2.15 Employee ............................................................... 6 2.16 Employer ............................................................... 8 2.17 Employer Matching Contributions ........................................ 8 2.18 Employment Commencement Date ........................................... 8 2.19 ERISA .................................................................. 8 2.20 Highly Compensated Employee ............................................ 9 2.21 Hour of Service ........................................................ 9 2.22 Non-Highly Compensated Employee ........................................ 10 2.23 Normal Retirement Date ................................................. 10 2.24 Participant ............................................................ 10 2.25 Participating Employer ................................................. 10 2.26 Plan ................................................................... 10 2.27 Plan Year .............................................................. 10 2.28 Qualified Matching Contributions ....................................... 10 2.29 Qualified Nonelective Contributions .................................... 11 2.30 Reemployment Commencement Date ......................................... 11 2.31 Regulations ............................................................ 11 2.32 Rollover Contribution .................................................. 11 2.33 Salary Deferral Contributions .......................................... 11 2.34 Section 415 Compensation ............................................... 11 2.35 Severance Date ......................................................... 12 2.36 Spouse or Surviving Spouse ............................................. 12 2.37 Trust .................................................................. 12 2.38 Trust Fund ............................................................. 12 2.39 Trustee ................................................................ 12
-i- 2.40 Valuation Date ......................................................... 12 2.41 Year of Service ........................................................ 12 2.42 Other Definitions ...................................................... 13 ARTICLE III ELIGIBILITY ........................................................ 16 3.1 Participation .......................................................... 16 3.2 Reemployment ........................................................... 16 3.3 Change in Employment Status ............................................ 16 3.4 Enrollment of Participants ............................................. 16 3.5 Erroneous Participation ................................................ 16 ARTICLE IV CONTRIBUTIONS ...................................................... 17 4.1 Salary Deferral Contributions .......................................... 17 4.2 Employer Matching Contributions ........................................ 17 4.3 Qualified Nonelective Contributions .................................... 18 4.4 Limitations on Contributions ........................................... 18 4.5 Time and Manner of Payment of Contributions ............................ 18 4.6 Receipt of Assets from Other Plans ..................................... 18 ARTICLE V ACCOUNTS ........................................................... 20 5.1 Participant's Accounts ................................................. 20 5.2 Allocation of Contributions ............................................ 20 5.3 Allocation of Earnings or Losses ....................................... 20 5.4 Section 415 Limitations ................................................ 21 5.5 Discrimination Testing of Salary Deferral Contributions ................ 21 5.6 Distribution of Excess Salary Deferrals ................................ 26 5.7 Discrimination Testing of Employer Matching Contributions .............. 27 5.8 Corrective Procedure for Discriminatory Matching Contributions ......... 30 ARTICLE VI VESTING AND DISTRIBUTION OF ACCOUNTS ............................... 33 6.1 Vested Interest ........................................................ 33 6.2 Forfeitures ............................................................ 34 6.3 Normal Retirement ...................................................... 35 6.4 Death Benefits ......................................................... 35 6.5 Termination of Employment .............................................. 35 6.6 Commencement of Distribution ........................................... 35 6.7 Direct Rollovers and Withholding ....................................... 37 6.8 Form of Benefit ........................................................ 38 6.9 Minimum Distribution Requirements ...................................... 38 6.10 Persons Under Incapacity ............................................... 40 6.11 Location of Participant or Beneficiary Unknown ......................... 40 6.12 Hardship Distribution .................................................. 40 6.13 Loans .................................................................. 41 6.14 Withdrawals at Age Fifty-Nine and One-Half (59 1/2) .................... 42
-ii- 6.15 Withdrawals from Rollover Accounts ..................................... 43 ARTICLE VII ADMINISTRATION ..................................................... 44 7.1 Powers of the Administrator ............................................ 44 7.2 Plan Committee ......................................................... 45 7.3 Domestic Relations Orders .............................................. 45 ARTICLE VIII LEAVES OF ABSENCE AND TRANSFERS .................................... 48 8.1 Military Leave of Absence .............................................. 48 8.2 Other Leaves of Absence ................................................ 48 8.3 Transfers .............................................................. 48 ARTICLE IX TRUST PROVISIONS; INVESTMENT OF CONTRIBUTIONS; VALUATION OF ACCOUNTS 50 9.1 Trust Agreement ........................................................ 50 9.2 Inconsistent Provisions ................................................ 50 9.3 Investment Decision .................................................... 50 9.4 Directed Investments ................................................... 51 9.5 Accounts Not Directed .................................................. 51 9.6 Valuation .............................................................. 51 9.7 Electronic Media ....................................................... 51 ARTICLE X FEES AND EXPENSES .................................................. 53 ARTICLE XI AMENDMENT, TERMINATION OR MERGER ................................... 54 11.1 Amendment .............................................................. 54 11.2 Termination of Plan .................................................... 54 11.3 Plan Mergers and Transfer of Assets or Liabilities ..................... 55 ARTICLE XII ADOPTION OF PLAN BY RELATED ENTITIES ............................... 56 12.1 Adoption of the Plan ................................................... 56 12.2 Withdrawal ............................................................. 56 ARTICLE XIII CLAIMS PROCEDURE ................................................... 57 13.1 Right to File Claim .................................................... 57 13.2 Denial of Claim ........................................................ 57 13.3 Claims Review Procedure ................................................ 57 ARTICLE XIV TOP-HEAVY PROVISIONS ............................................... 59 14.1 Purpose ................................................................ 59 14.2 Definitions ............................................................ 59 14.3 Minimum Allocation ..................................................... 61 14.4 Vesting Schedule ....................................................... 62
-iii- ARTICLE XV MISCELLANEOUS ...................................................... 63 15.1 Legal or Equitable Action .............................................. 63 15.2 Indemnification ........................................................ 63 15.3 No Enlargement of Plan Rights .......................................... 63 15.4 No Enlargement of Employment Rights .................................... 63 15.5 Interpretation ......................................................... 63 15.6 Applicable Law ......................................................... 64 15.7 Non-Alienation of Benefits ............................................. 64 15.8 No Reversion ........................................................... 64 15.9 Conflict ............................................................... 64 15.10 Severability ........................................................... 65 15.11 Conditional Restatement ................................................ 65 APPENDIX A FORM OF BENEFIT DISTRIBUTIONS FOR CERTAIN INDIVIDUALS .............. 1 A.1 Definitions ............................................................ 1 A.2 Automatic Form of Benefit .............................................. 3 A.3 Optional Forms of Benefit .............................................. 3 A.4 Qualified Joint and 50% Survivor Annuity ............................... 4 A.5 Qualified Preretirement Survivor Annuity ............................... 4 A.6 Election of Optional Forms of Benefit .................................. 5 A.7 Special Payment Date ................................................... 7 A.8 Timing of Death Distribution ........................................... 7 APPENDIX B MERGER OF PACIFIC COMPENSATION INSURANCE COMPANY [401(k) PLAN] ..... 1 B.1 Transfer of Account Balances ........................................... 1 B.2 Amount of Account Balance .............................................. 1 B.3 Investment of Account Balance .......................................... 1 B.4 Service Credit ......................................................... 1 B.5 Vesting Schedule ....................................................... 1 B.6 Protected Benefits ..................................................... 2 B.7 Beaver Protected Benefits .............................................. 2 B.8 Spousal Consent ........................................................ 2 APPENDIX C INVESTORS BANCOR ................................................... 1 C.1 Transfer of Account Balances ........................................... 1 C.2 Amount of Account Balance .............................................. 1 C.3 Investment of Account Balance .......................................... 1 C.4 Service Credit ......................................................... 1 C.5. Vesting Schedule ....................................................... 1 C.6 No Protected Benefits .................................................. 2
-iv- APPENDIX D CASUALTY INSURANCE COMPANY ......................................... 1 D.1 Transfer of Account Balances ........................................... 1 D.2 Amount of Account Balance .............................................. 1 D.3 Investment of Account Balance .......................................... 1 D.4 Service Credit ......................................................... 1 D.5 Vesting Schedule ....................................................... 1 D.6 Protected Benefits ..................................................... 2 D.7 Normal Retirement Age .................................................. 2 D.8 After-Tax Contributions ................................................ 2 D.9 Special Withdrawals .................................................... 2 APPENDIX E INDUSTRIAL INDEMNITY HOLDINGS INC .................................. 1 E.1 Service Credit ......................................................... 1 E.2 Protected Benefits ..................................................... 1 APPENDIX F UNICARE ............................................................ 1 F.1 Service Credit ......................................................... 1 F.2 Vesting Schedule ....................................................... 1 EXHIBIT A ANNUAL ADDITION LIMITS ............................................. 1 A.1 Definitions ............................................................ 1 A.2 Annual Addition Limitations ............................................ 1
-v- ARTICLE I INTRODUCTION Fremont General Corporation maintains the Fremont General Corporation and Affiliated Companies Investment Incentive Plan (the "Plan"), consisting of the following provisions, for the exclusive benefit of Participants and their Beneficiaries and for defraying reasonable administrative expenses of the Plan. The Plan was originally established effective as of February 1, 1986, and has subsequently been amended and restated. Effective as of January 1, 2000, except as otherwise stated herein, the Company further amends and restates this Plan. The Plan is intended to be a tax-qualified profit sharing plan and related tax-exempt trust under Code Sections 401(a) and 501(a) and is intended to include a tax-qualified cash or deferred arrangement under Code Section 401(k). -1- EXHIBIT NO. 10.1 ARTICLE II DEFINITIONS Wherever used in this Plan, the following terms shall have the meanings indicated below, unless a different meaning is plainly required by the context. The singular shall include the plural, unless the context indicates otherwise. Headings of sections are used for convenience of reference only, and in case of conflict, the text of the Plan, rather than such headings, shall control: 2.1 ACCOUNT OR ACCOUNTS. "Account" or "Accounts" means a Participant's interest in the Trust Fund, consisting of the Participant's Salary Deferral Contributions Account, Employer Matching Contributions Account, Qualified Matching Contributions Account, Qualified Nonelective Contributions Account, Rollover Account, and such other Account(s) as the Administrator shall determine in its sole and absolute discretion. 2.2 ADJUSTMENT FACTOR. "Adjustment Factor" means the cost-of-living adjustment factor prescribed by the Secretary of the Treasury under Code Section 415(d) (and Section 401(a)(17), if applicable), as applied to such items and in such manner as the Secretary of the Treasury shall provide from time to time. 2.3 ADMINISTRATOR OR PLAN ADMINISTRATOR. "Administrator" or "Plan Administrator" means the Company. 2.4 AFFILIATED COMPANY. "Affiliated Company" means an Employer. 2.5 BENEFICIARY. "Beneficiary" means the person or entity who is entitled to receive any benefits payable from the Plan on account of a Participant's death. If the Participant is married, the Beneficiary is the Participant's Surviving Spouse and no written designation is required. However, a Participant may designate a Beneficiary other than the Participant's Spouse; provided, however: (a) the Participant's Spouse consents in writing to such designation and to the form thereof (on a form acceptable to the Administrator); (b) such Beneficiary designation may not be changed without spousal consent; and (c) the Spouse's consent acknowledges the effect of such Beneficiary designation and is witnessed by a notary public. Such spousal consent shall not be required if it is established to the satisfaction of the Administrator that the consent required under the preceding sentence cannot be obtained because there is no Spouse, the Spouse cannot be located, or such other circumstances as the -2- EXHIBIT NO. 10.1 Secretary of the Treasury may by Regulations prescribe. A Participant's Beneficiary shall be bound by the terms and conditions of the Plan. If there is no valid Beneficiary designation in effect that complies with the foregoing provisions, or if there is no surviving designated Beneficiary, then the Participant's surviving Spouse shall be the Beneficiary. If there is no surviving Spouse, the duly appointed and currently acting personal representative of the Participant's estate (which shall include either the Participant's probate estate or living trust) shall be the Beneficiary. In any case where there is no such personal representative of the Participant's estate duly appointed and acting in that capacity within 90 days after the Participant's death (or such extended period as the Committee determines is reasonably necessary to allow such personal representative to be appointed, but not to exceed 180 days after the Participant's death), then Beneficiary or Beneficiaries shall mean the person or persons who can verify by affidavit or court order to the satisfaction of the Committee that they are legally entitled to receive the benefits specified hereunder. Upon the Committee's written receipt of proof of the dissolution of marriage of a Participant, any designation of the Participant's former spouse as a Beneficiary shall be treated as though the Participant's former spouse had predeceased the Participant, unless (i) the Participant executes another Beneficiary designation that complies with this Section and that clearly names such former spouse as a Beneficiary, or (ii) a court order presented to the Committee prior to distribution on behalf of the Participant explicitly requires the Participant to continue to maintain the former spouse as the Beneficiary. In any case in which the Participant's former spouse is treated under the Participant's Beneficiary designation as having predeceased the Participant, no heirs or other beneficiaries of the former spouse shall receive benefits from the Plan as a Beneficiary of the Participant except as provided otherwise in the Participant's Beneficiary designation. In the event any amount is payable under the Plan to a minor, payment shall not be made to the minor, but instead shall be paid (i) to that person's then living parent(s) to act as custodian, (ii) if that person's parents are then divorced, and one parent is the sole custodial parent, to such custodial parent, or (iii) if no parent of that person is then living, to the guardian of the estate for the minor, or (iv) if there is no guardian of the estate for the minor, to the guardian of the person for the minor to hold the funds for the minor under the Uniform Transfers or Gifts to Minors Act in effect in the jurisdiction in which the minor resides. If no parent is living and the Committee decides not to select another custodian to hold the funds for the minor, then payment shall be made to the duly appointed and currently acting guardian of the estate for the minor or, if no guardian of the estate for the minor is duly appointed and currently acting within 60 days after the date the amount becomes payable, payment shall be deposited with the court having jurisdiction over the estate of the minor. 2.6 BREAK IN SERVICE. "Break in Service" means: (a) A Plan Year during which an Employee does not complete more than 500 Hours of Service. Solely for purposes of determining whether a Break in Service for participation and vesting purposes has occurred in a computation period, an individual who is absent on account -3- EXHIBIT NO. 10.1 of maternity or paternity leave (as described below), or on account of an authorized leave of absence as described in Sections 8.1 and 8.2, shall receive credit for the Hours of Service which would otherwise have been credited to such individual but for such absence, or in any case in which such hours cannot be determined, eight (8) Hours of Service per day of such absence. (b) For purposes of paragraph (a) above, maternity or paternity leave means a period during which an Employee is absent because of (i) the pregnancy of the Employee, (ii) the birth of a child of the Employee, (iii) the placement of a child with the Employee in connection with the Employee's adoption of the child, (iv) the Employee's caring for a child immediately after the birth or placement of the child, or (v) a leave required by the Family Medical Leave Act. 2.7 CODE. "Code" means the Internal Revenue Code of 1986, as amended from time to time, and applicable valid Regulations issued thereunder. Reference to a section of the Code includes such section and any comparable section or sections of any future legislation that amends, supplements or supersedes such section. 2.8 COMPANY. "Company" means Fremont General Corporation, and any successor by merger, consolidation or otherwise. 2.9 COMPANY STOCK. "Company Stock" means common or preferred stock of Fremont General Corporation, or any successor by merger consolidation or otherwise, that meets the requirements of "qualifying employer security" under ERISA Section 407(d)(5). 2.10 COMPENSATION. (a) "Compensation" means all of a Participant's Section 415 Compensation, except as follows. First, Compensation shall not include any amounts earned while the person is not an Eligible Employee. Second, Compensation shall not include FICA paid by the Employer with respect to nonqualified deferred compensation or retirement plans, Excess/SRP distributions, amounts realized from the exercise of nonqualified stock options or when restricted stock held by an employee is no longer subject to substantial risk of forfeiture, reimbursements or other expense allowances or payments, cash or non-cash fringe benefits (including without limitation meals, Rideshare payments, fringe car payments, referral awards, parking, recognition awards and nonperformance based bonuses including holiday bonuses, hiring bonuses, retention bonuses and travel incentive bonuses), moving expenses and relocation payments, deferred compensation or welfare benefits. (b) The annual Compensation of each Employee taken into account under the Plan shall not exceed One Hundred Sixty Thousand Dollars ($160,000) (as adjusted by the -4- EXHIBIT NO. 10.1 Adjustment Factor). The Adjustment Factor in effect for a calendar year applies to any period, not exceeding twelve (12) months, over which Compensation is determined (the "Determination Period") beginning in such calendar year. If a Determination Period consists of fewer than twelve (12) months, the One Hundred Sixty Thousand Dollars ($160,000) annual Compensation limit shall be multiplied by a fraction, the numerator of which is in the number of months in the Determination Period, and the denominator of which is twelve (12). If Compensation for any prior Determination Period is taken into account in determining an Employee's benefits accruing in the current Plan Year, the Compensation for that prior Determination Period is subject to the annual Compensation limit in effect for that prior Determination Period. (c) The determination of the amount of Compensation shall be made by the Participating Employer (or its designee) by which the Employee is employed, in accordance with the records of the Participating Employer, and shall be conclusive. 2.11 CONTRIBUTIONS. "Contributions" means Salary Deferral Contributions, Employer Matching Contributions, Qualified Matching Contributions and Qualified Nonelective Contributions. 2.12 DISABILITY. "Disability" means the inability to engage in any substantial, gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than twelve (12) months, or such other standard as expressed in Code Section 22(e)(3) or any successor provision. The permanence and degree of such impairment shall be supported by medical evidence. 2.13 EFFECTIVE DATE. "Effective Date" means the effective date of this restatement, January 1, 2000, except as otherwise provided herein; provided, however, that any provision of this Plan required as a result of the Small Business Job Protection Act of 1996, the Taxpayer Relief Act of 1997, the Uruguay Round Agreements Act, the Uniformed Services Employment and Reemployment Rights Act of 1994 or any other applicable legislation, shall be effective as of the date required by such legislation. 2.14 ELIGIBLE EMPLOYEES. "Eligible Employees" mean all Employees of the Company and Participating Employers, except: (a) individuals who are classified as temporary Employees by the Employer (Employees who are employed for short-term assignments), provided that a temporary Employee who completes a twelve (12) consecutive month period of employment (measured from the date the temporary Employee completes his or her first Hour of Service or the first day of any subsequent -5- EXHIBIT NO. 10.1 Plan Year) during which he is credited with one thousand (1,000) Hours of Service shall become an Eligible Employee on the first day following such twelve (12) month period of employment. (b) Leased Employees, as defined in Section 2.15; (c) Employees who are non-resident aliens (within the meaning of Code Section 7701(b)(1)(B)) and who receive no earned income (within the meaning of Code Section 911(d)(2)) from the Employer which constitutes income from sources within the United States (within the meaning of Code Section 861(a)(3)); (d) Employees who are covered by a collective bargaining agreement between a union and the Employer or any employers' association under which retirement benefits were the subject of good faith bargaining; (e) individuals described in Section 2.15(b); (f) individuals who are parties to an agreement that provides that they shall not be eligible to participate in the Plan, whether or not such agreement is upheld upon governmental or judicial review; or (g) Employees of an Employer that is not a Participating Employer. 2.15 EMPLOYEE. (a) "Employee" means, subject to subsection (b), any person employed and designated by the Employer as a common law employee of an Employer. (b) (i) An individual shall not be an "Employee" if he meets any of the following: (1) the individual was performing services for any Employer under an agreement, contract, or any other arrangement pursuant to which the individual is characterized or classified by the Employer as an independent contractor or consultant (or an employee of an independent contractor or consultant), (2) the individual's payments for services for any Employer have not been initially treated by any Participating Company as subject to wage withholding under the Code and applicable state law, (3) any individual who was not initially classified by an Employer as a common law employee of an Employer, (4) any individual who was initially classified as a Leased Employee (as defined in subsection (c) below) or (5) any other individual who was leased by an Employer from an entity that is the individual's employer of record, including individuals who are employed pursuant to a written agreement with an agency or other third party for a specific job assignment or project. Notwithstanding subsection (a) above, even if the Company later determines or agrees that the classification or treatment was incorrect and that the individual was or is in fact a common law employee (or the person is subsequently reclassified as a common law employee by a federal, state or local group, organization or agency, or a court), such an individual shall not be an Employee (or Eligible Employee or Participant) either retroactively or prospectively; however, if the Company informs the individual in writing that he is an Employee for purposes of the Plan, he shall be an Employee with respect to service after the date specified in such writing. -6- EXHIBIT NO. 10.1 (ii) Solely for purposes of the requirements of Code section 414(n)(3) (but only to the extent they relate to this Plan), including counting service for eligibility to participate and vesting, "Employee" shall also mean (i) any individual described in the preceding paragraph (ii) who is in fact a common law employee and (ii) Leased Employees. Such a person shall not be an Employee for any other purpose, and accordingly such person shall not be an Eligible Employee. Notwithstanding the foregoing, if such Leased Employees constitute less than twenty percent of the Participating Companies' non-highly compensated work force within the meaning of Code section 414(n)(5)(C)(ii), "Employee" shall not include Leased Employees covered by a plan described in Code section 414(n)(5) unless otherwise provided in the Plan. (iii) By way of example, assume a technician is leased from an entity (or hired as an independent contractor) on May 1, 2000. The Company later determines or agrees that the individual has in fact always been a common law employee and reclassifies him as such (including subjecting him to wage withholding) on June 1, 2002; however, he continues as a technician. Solely for purposes of the requirements of Code section 414(n)(3) (but only to the extent they relate to this Plan), including counting service for eligibility to participate and vesting, this individual will be treated as an Employee on and after May 1, 2000. However, the individual shall not be an Employee (or Eligible Employee or Participant) for any other purpose with respect to employment either prior or subsequent to June 1, 2002, even though other technicians of the Company are treated as Employees. The individual shall not become an Employee (or Eligible Employee or Participant) unless and until the Company informs the individual in writing that he is an Employee for purposes of the Plan. (iv) This subsection (b) sets forth a clarification of the intention of the Company regarding participation in the Plan for any Plan Year, including Plan Years prior to the amendment of this definition of "Employee". (c) A "Leased Employee" shall mean any person who, pursuant to an agreement between the Employer and any other person ("Leasing Organization"), has performed services for the Employer (or for the Employer and related persons determined in accordance with Code Section 414(n)(6)) ("Recipient Employer") on a substantially full-time basis for a period of at least one (1) year, and such services are performed under the primary direction or control by the Recipient Employer. An individual shall not be considered a Leased Employee of the Recipient Employer if both of the following conditions are met: (i) such individual is covered by a money purchase pension plan providing: (A) a non-integrated employer contribution rate of at least ten percent (10%) of compensation, as defined in Code Section 415(c)(3), but including amounts contributed pursuant to a salary reduction agreement which are excludable from the individual's gross income under Code Section 125, 402(e)(3), 402(h), 403(b) or 408(p): (B) immediate participation; -7- EXHIBIT NO. 10.1 (C) full and immediate vesting; and (ii) Leased Employees do not constitute more than twenty percent (20%) of the Recipient Employer's non-highly compensated work force. Contributions or benefits provided to a Leased Employee by the Leasing Organization which are attributable to services performed for the Recipient Employer shall be treated as provided by such Recipient Employer. 2.16 EMPLOYER. "Employer" means (a) the Company; (b) any other corporation which is a member of a controlled group of corporations (as defined under Code Section 414(b)) which includes the Company; (c) any trade or business (whether or not incorporated) which is under common control (as defined under Code Section 414(c)) with the Company; (d) any organization (whether or not incorporated) which is a member of an affiliated service group (as defined under Code Section 414(m)) which includes the Company; and (e) any other organization or entity which is required to be aggregated with the Company; pursuant to Code Section 414(o). No entity shall be an Employer prior to, or after, the period it is so affiliated with the Company. For purposes of the calculation of Annual Additions as set forth in Section 5.4, the determination of whether any entity is an Employer shall be made in accordance with Code Section 415(h). 2.17 EMPLOYER MATCHING CONTRIBUTIONS. "Employer Matching Contributions" means Contributions made by an Employer to the Trust on account of Salary Deferral Contributions attributable to the applicable period, but not including any Contribution and/or allocation made to satisfy the minimum allocation requirements of Section 14.3. 2.18 EMPLOYMENT COMMENCEMENT DATE. "Employment Commencement Date" means the date on which an Employee first performs an Hour of Service for the Employer, within the meaning of Department of Labor Regulation Section 2530.200b-2(a). 2.19 ERISA. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time, and applicable valid Regulations issued thereunder. Reference to a section of ERISA includes such section and any comparable section or sections of any future legislation that amends, supplements or supersedes such section. -8- EXHIBIT NO. 10.1 2.20 HIGHLY COMPENSATED EMPLOYEE. (a) "Highly Compensated Employee" shall, for each Plan Year, mean an Employee in active service who meets any of the following criteria: (i) is, at any time during the current Plan Year or the immediately preceding Plan Year, a five percent (5%) owner (as determined under Code Section 416(i)(1)) of an Employer; or (ii) received aggregate Section 415 Compensation for the immediately preceding Plan Year in excess of Eighty Thousand Dollars ($80,000.00), as adjusted by the Adjustment Factor. (b) For purposes of the foregoing definition, the following provisions shall apply: (i) A former Employee shall be treated as a Highly Compensated Employee if: (A) such Employee was a Highly Compensated Employee when such Employee separated from service; or (B) such Employee was a Highly Compensated Employee at any time after attaining age fifty-five (55). (c) For purposes of this Section, the Section 415 Compensation of each Employee shall be determined on an aggregate basis as if all Employers were a single employer entity paying such Section 415 Compensation. All other determinations under this Section shall be made in accordance with Code Section 414(q). 2.21 HOUR OF SERVICE. "Hour of Service" means: (a) Each hour for which an Employee is directly or indirectly paid, or entitled to payment of wages by an Employer for the performance of duties and for reasons other than the performance of duties; provided that no Hours of Service shall be credited if payment was made or due solely as reimbursement for medical or medically related expenses incurred by the Employee. Hours of Service shall be calculated in accordance with Department of Labor Regulation Sections 2530.200b-2(b) and (c); (b) An Employee on a leave of absence pursuant to Section 8.1 or 8.2 shall be credited with Hours of Service equal to the number of regularly-scheduled working hours included in the period of such leave; (c) Hours of Service shall, for an Employee, include each hour for which back pay, irrespective of mitigation of damages, has been either awarded or agreed to by the Employer. -9- EXHIBIT NO. 10.1 Such Hours of Service shall be credited for the periods to which the award or agreement pertains rather than the periods in which the award, agreement, or payment is made; provided, however, Hours of Service shall not be credited under this paragraph to the extent such credit would duplicate any hours credited above; (d) Hours of Service shall be credited for employment with any Employer; and (e) Each Employee shall be credited with Hours of Service on the basis one hundred ninety (190) Hours of Service for each month in which he or she performs at least one (1) Hour of Service. 2.22 NON-HIGHLY COMPENSATED EMPLOYEE. "Non-Highly Compensated Employee" means an Employee who is not a Highly Compensated Employee. 2.23 NORMAL RETIREMENT DATE. "Normal Retirement Date" means, except as may be otherwise specified in one or more of the Appendices, the date on which a Participant attains age sixty-five (65). 2.24 PARTICIPANT. "Participant" means an Employee or former Employee for whom an Account is maintained under the Plan. 2.25 PARTICIPATING EMPLOYER. `Participating Employer" means the Company and any other Affiliated Company that adopts the Plan for the benefit of its Eligible Employees pursuant to Section 12.1. 2.26 PLAN. "Plan" means the Fremont General Corporation and Affiliated Companies Investment Incentive Plan as set forth in this document and in amendments from time to time made hereto. 2.27 PLAN YEAR. "Plan Year" means the twelve (12) consecutive month period beginning each January 1st and ending each December 31st. 2.28 QUALIFIED MATCHING CONTRIBUTIONS. "Qualified Matching Contributions" means Employer Matching Contributions under this Plan or any other plan of the Employer, which may be treated as Salary Deferral Contributions for purposes of the ADP test as provided by the Regulations. -10- EXHIBIT NO. 10.1 2.29 QUALIFIED NONELECTIVE CONTRIBUTIONS. "Qualified Nonelective Contributions" means discretionary Contributions under this Plan or any other plan of the Employer described in Section 5.5(b)(i)(D), which may be treated as Salary Deferral Contributions for purposes of the ADP test, or as Employer Matching Contributions for purposes of the ACP test, as provided by the Regulations. Notwithstanding the foregoing, Qualified Nonelective Contributions used in calculating the ADP test may not be used in calculating the ACP test. 2.30 REEMPLOYMENT COMMENCEMENT DATE "Reemployment Commencement Date" means the first date, following a Severance Date, on which an Employee again performs one (1) Hour of Service for the Employer. 2.31 REGULATIONS. "Regulations" means the Income Tax Regulations as prescribed by the Secretary of the Treasury from time to time under the Code or Labor Regulations as prescribed by the Secretary of the Labor from time to time under ERISA, as applicable. 2.32 ROLLOVER CONTRIBUTION. "Rollover Contribution" means a qualified rollover contribution as described in Section 4.6(a). 2.33 SALARY DEFERRAL CONTRIBUTIONS. "Salary Deferral Contributions" means Employer Contributions to the Trust on behalf of Participants who elect to make such contributions as described in Section 4.1. For purposes of the ACP test, the Employer may take into account and include as Contribution Percentage Amounts, Salary Deferral Contributions under this Plan or any other plan of the Employer, as provided by the Regulations. The amount of Salary Deferral Contributions made under the Plan and taken into account as Contribution Percentage Amounts for purposes of calculating the Average ACP, subject to such other requirements as may be prescribed by the Secretary of the Treasury, shall be such Salary Deferral Contributions as are needed to meet the ACP test; provided, however, that Salary Deferral Contributions used in calculating the ADP test may not be used in calculating the ACP test. 2.34 SECTION 415 COMPENSATION. (a) "Section 415 Compensation" means all of an Employee's W-2 wages as defined in Code Section 3401(a) for the purposes of income tax withholding at the source but determined without regard to any rules that limit the remuneration included in wages based on the nature or location of the employment or the services performed (such as the exception for agricultural labor in Code Section 3401(a)(2)). Section 415 Compensation includes any elective deferrals (as defined in Code Section 402(g)(3)), and any amount contributed or deferred by the -11- EXHIBIT NO. 10.1 Employer at the election of the Employee and not includable in the gross income of the Employee by reason of Code Section 125 or 457. Section 415 Compensation does not include any deferrals under a nonqualified deferred compensation plan or supplemental executive retirement plan. (b) For purposes of this Section, Compensation for a limitation year is the Compensation defined in subsection (a) actually paid or made available to the Employee during that limitation year. 2.35 SEVERANCE DATE. "Severance Date" means the first to occur of the date on which an Employee terminates employment with the Employer because he or she quits, is discharged, dies or retires. See also Section 6.6(g). 2.36 SPOUSE OR SURVIVING SPOUSE. "Spouse" or "Surviving Spouse" means the spouse or surviving spouse of a Participant; provided, however, that a former spouse shall be treated as the spouse or surviving spouse to the extent provided under a Qualified Domestic Relations Order as described in Section 7.3. 2.37 TRUST. "Trust" means the Trust maintained pursuant to Article IX. 2.38 TRUST FUND. "Trust Fund" means the assets held by the Trustee under the Trust. 2.39 TRUSTEE. "Trustee" means the person(s) or entity named in the Trust Agreement, or any successor or successors thereto, and designated by the Company to act as Trustee of the Trust and to hold the Trust assets in accordance with Article IX. 2.40 VALUATION DATE. "Valuation Date" means the last day of each Plan Year and such other date(s) as the Administrator may designate from time to time. 2.41 YEAR OF SERVICE. "Year of Service" means: (a) A Plan Year during which an Employee is credited with one thousand (1,000) Hours of Service. -12- EXHIBIT NO. 10.1 (b) Each year of service completed by a Participant while he or she was an employee of Beaver Insurance Company, Pacific Compensation Insurance Company, Investors Bancor, Casualty Insurance Company, Workers Compensation and Indemnity Company, Industrial Indemnity Holdings, Inc. or its subsidiaries (including but not limited to American All-Risk Group, Inc. and its subsidiaries), Unicare Specialty Services, Inc., and any other entity heretofore or hereafter designated by the Board of Directors of the Company (the "Board") ("Acquired Companies") shall be deemed a Year of Service under this Plan; provided, however, and except with respect to past service credit granted by the Company or the Plan Administrator on other terms prior to the adoption of this restatement, in order to be entitled to past service credit, an Employee must have been employed by such Acquired Company at the time of its acquisition by or merger with and into the Employer. 2.42 OTHER DEFINITIONS. In addition to the definitions contained in this Section, the following terms are defined in the Section listed:
Section Term ------- ---- 2.41(b) Acquired Companies 5.5(d)(i) Actual Deferral Percentage ("ADP") 5.7(c)(i) Actual Contribution Percentage ("ACP") 5.7(c)(ii) Aggregate Limit 7.3(d)(i) Alternate Payee Exhibit A Annual Additions A.1(a) Annuity Contract A.1(b) Annuity Starting Date 5.7(c)(iii) Average ACP 5.5(d)(ii) Average ADP Appendix B Beaver Merger Date Appendix B Beaver Plan B.7 Beaver Plan Accounts 2.43(b) Board D.5 Buckeye Appendix D CIC 7.2 Committee or Plan Committee D.6 Continental Participants
-13- EXHIBIT NO. 10.1 Appendix D Continental Plan D.7 Continental Plan Normal Retirement Age Appendix D Continental Transfer Date 5.7(c)(iv) Contribution Percentage 5.7(c)(v) Contribution Percentage Amounts 14.2(a) Determination Date 14.2(b) Determination Period 6.7(b)(i) Direct Rollover 6.7(b)(ii) Distributee 7.3(d)(ii) Domestic Relations Order or Order 5.7(c)(vi) Eligible Participant 6.7(b)(iii) Eligible Retirement Plan 6.7(b)(iv) Eligible Rollover Distribution 5.7(e)(vii) Employee Contribution 5.5(d)(iii) Excess 401(k) Contributions 5.7(e)(viii) Excess Matching Contributions 5.6(a)(ii) Excess Salary Deferrals 6.9(e)(i) Five Percent Owner 6.12 Hardship Appendix E II Appendix E Industrial Plan Appendix E Industrial Transfer Date Appendix C Investors Merger Date Appendix C Investors Plan A.1(c) Joint and Last Survivor Life Expectancy 14.2(c) Key Employee 2.15 Leased Employees 2.15 Leasing Organization A.1(d) Life Expectancy 2.6(b) Maternity and Paternity Leave 14.2(d) Non-Key Employee
-14- EXHIBIT NO. 10.1 Appendix B Pacific Merger Date B. 6 Pacific Participants Appendix B Pacific Plan 14.2(e) Permissive Aggregation Group 7.2 Plan Committee or Committee 5.4(g)(x) Projected Annual Benefit B.6, C.6, D.6, E.6, F.6 Protected Benefits 7.3(d)(iii) Qualified Domestic Relations Order A.1(e) Qualified Joint and 50% Survivor Annuity A.1(f) Qualified Joint and 100% Survivor Annuity A.1(g) Qualified Preretirement Survivor Annuity 2.15 Recipient Employer 14.2(f) Required Aggregation Group 6.9(e)(ii) Required Beginning Date 5.6(a)(i) Salary Deferrals 7.3(c)(i) Segregated Amounts A.1(j) Straight Life Annuity 2.14(a) Temporary Employees A.1(k) Term Certain Annuity 14.2(g) Top-Heavy Plan 14.2(h) Top-Heavy Ratio 14.2(i) Valuation Date Appendix D WCIC Appendix F Wellpoint Plans Appendix F Wellpoint Transfer Date
-15- EXHIBIT NO. 10.1 ARTICLE III ELIGIBILITY 3.1 PARTICIPATION. Each Eligible Employee shall become a Participant in the Plan as soon as administratively feasible following his or her Employment Commencement Date or the date he becomes an Eligible Employee, if later. 3.2 REEMPLOYMENT. If an Eligible Employee terminates employment with the Employer and is thereafter reemployed by the Company or a Participating Employer, then the Employee shall become a Participant in the Plan as of his or her Reemployment Commencement Date or the date he becomes an Eligible Employee, if later. 3.3 CHANGE IN EMPLOYMENT STATUS. If a Participant subsequently ceases to be an Eligible Employee, then such Employee shall become a Participant again upon becoming an Eligible Employee once more. If, however, an Employee who is not, and never has been, an Eligible Employee becomes an Eligible Employee, then such Employee shall become a Participant in the Plan as soon as administratively feasible following the date on which the Participant becomes an Eligible Employee. 3.4 ENROLLMENT OF PARTICIPANTS. EACH ELIGIBLE EMPLOYEE SHALL COMPLY WITH SUCH ENROLLMENT PROCEDURES AS THE ADMINISTRATOR MAY PRESCRIBE FROM TIME TO TIME AND SHALL MAKE AVAILABLE TO THE ADMINISTRATOR AND THE TRUSTEE ANY INFORMATION THEY MAY REQUEST. BY VIRTUE OF HIS OR HER PARTICIPATION IN THE PLAN, AN ELIGIBLE EMPLOYEE AGREES, ON HIS OR HER BEHALF AND ON BEHALF OF ALL INDIVIDUALS WHO MAY MAKE ANY CLAIM ARISING OUT OF, RELATING TO, OR RESULTING FROM THAT ELIGIBLE EMPLOYEE'S PARTICIPATION IN THE PLAN, TO BE BOUND BY ALL PROVISIONS OF THE PLAN, THE TRUST AGREEMENT AND OTHER RELATED AGREEMENTS. 3.5 ERRONEOUS PARTICIPATION If any contributions are erroneously made on behalf of an individual who is not entitled to such contributions, then such erroneously made contributions shall be forfeited and: first, returned to the Participating Employer in accordance with Section 15.8, to the extent such contribution is made as a result of a mistake of fact; second, used to pay administrative expenses of the Plan for the Plan Year in which the error is discovered; third, used to offset the Employer's obligation to make contributions, if any, for the Plan Year in which the error occurs and fourth, used to allocate as contributions, if any, for the Plan Year in which the error occurs. -16- EXHIBIT NO. 10.1 ARTICLE IV CONTRIBUTIONS 4.1 SALARY DEFERRAL CONTRIBUTIONS. (a) Subject to the limitations of Sections 5.4 and 5.5, each Participant who is an Eligible Employee may elect, in accordance with the procedures established from time to time by the Administrator, to have a portion of his or her Compensation from each payroll period contributed to his or her Salary Deferral Contributions Account. The Participant's election shall specify the amount of his or her Compensation to be contributed (expressed as a whole percentage), which amount shall not be more than fifteen percent (15%) of the Participant's Compensation for the Plan Year; provided, however, in no event shall the dollar amount contributed on behalf of such Participant for any calendar year exceed the limit prescribed under Code Section 402(g)(1) and (5) and the Regulations thereunder. A Participant may elect to increase, decrease or discontinue Salary Deferral Contributions by filing a new election in such a manner and time as the Administrator shall specify. (b) For purposes of the Plan, and with respect to Salary Deferral Contributions made on behalf of any Participant, such Salary Deferral Contributions shall be allocated to the Participant's Salary Deferral Contributions Account as of a given date within the Plan Year and shall relate to Compensation that would have been received by the Participant in the Plan Year but for the Participant's election to defer such Compensation. 4.2 EMPLOYER MATCHING CONTRIBUTIONS. (a) Each Participating Employer may, subject to the provisions of paragraphs (b) and (c) below, make Employer Matching Contributions to the Trust Fund for each Plan Year. Employer Matching Contributions shall be made in such amount and in such form (i.e., cash or Company Stock, or a combination thereof) as prescribed by the Board. Such amount shall be reduced by forfeitures to the extent set forth in Section 6.2(c). (b) Employer Matching Contributions which would otherwise be made on behalf of a Participant may be reduced to the extent necessary to comply with the limitations of Sections 4.4, 5.4, 5.5 and 5.7. Any amount that cannot be contributed to the Trust because of these limitations shall be retained by the Employer, and the Employer shall have no obligation to contribute such amount to the Trust. (c) The Administrator may, in its sole and absolute discretion, elect to treat all or a portion of Employer Matching Contributions for a Plan Year as Qualified Matching Contributions for purposes of the ADP test. (d) For all purposes under the Plan, Employer Matching Contributions or Qualified Matching Contributions shall be subject to the distribution limitations of Article VI. -17- EXHIBIT NO. 10.1 Amounts allocated to a Participant's Qualified Matching Contributions Account shall not be eligible for hardship distribution under Section 6.12. (e) The Employer Matching Contributions shall be allocated to all Participants, pro rata, based on the Salary Deferral Contributions (not to exceed six percent of the Participant's Compensation) made by the Participant for that Plan Year. 4.3 QUALIFIED NONELECTIVE CONTRIBUTIONS. (a) The Employer may, with respect to a Plan Year, make and allocate Qualified Nonelective Contributions in accordance with Section 5.5(b)(i)(D). (b) No Participant shall have any right to inquire into the amount of the Qualified Nonelective Contributions or the method used in determining the amount of the Qualified Nonelective Contributions. (c) For all purposes of the Plan, Qualified Nonelective Contributions shall be subject to the distribution limitations of Article VI. Amounts allocated to a Participant's Qualified Nonelective Contributions Account shall not be eligible for hardship distribution under Section 6.12. 4.4 LIMITATIONS ON CONTRIBUTIONS. Contributions for any Plan Year shall not exceed the maximum amount allowable as a deduction to the Employer under the provisions of Code Section 404. 4.5 TIME AND MANNER OF PAYMENT OF CONTRIBUTIONS. Contributions shall be paid to the Trustee from time to time as determined by the Administrator in its sole and absolute discretion, subject to the timing requirements of applicable law. Contributions may be accepted from the Company's deferred compensation plans to the extent provided therein. 4.6 RECEIPT OF ASSETS FROM OTHER PLANS. (a) The Trustee may, with the consent of the Administrator, in its sole and absolute discretion, accept a Rollover Contribution of assets previously held under a tax-qualified plan for the benefit of an Employee or a group of Employees. The assets may be (i) received from the Employee in the form of an indirect rollover in accordance with Code Section 402(c) or 408(d)(3); or (ii) transferred in the form of a Direct Rollover (as defined in Section 6.7) from another tax-qualified plan. Such amounts shall be held in a Rollover Account. (b) The Trustee may, with the consent of the Administrator, in its sole and absolute discretion, receive a transfer of assets previously held under a tax-qualified plan for the benefit of an Employee or a group of Employees. Such assets shall be received directly from the trustee of a tax-qualified plan under Code Section 401(a) and related tax-exempt trust under Code -18- EXHIBIT NO. 10.1 Section 501(a). Such amounts shall be held in the Account in this Plan most closely corresponding to the account of the other plan. Amounts attributable to elective contributions (as defined in Regulation Section 1.401(k)-1(g)(3)), including amounts treated as elective contributions which are transferred from another tax-qualified plan in a plan-to-plan transfer (but not a rollover), shall be subject to the distribution limitations provided for in Regulation Section 1.401(k)-1(d). (c) The Administrator shall be fully protected in relying on data, representations, or other information provided by the Employee or by the trustee or custodian of a tax-qualified plan or individual retirement account that transfers assets to it for the purpose of determining that the requirements of paragraph (a) or (b) above have been satisfied. (d) The Trustee shall also accept any assets from the Company's Employee Stock Ownership Plan ("ESOP") that a Participant elects to transfer to this Plan pursuant to the ESOP. Such amounts shall be held in the Rollover Account. -19- EXHIBIT NO. 10.1 ARTICLE V ACCOUNTS 5.1 PARTICIPANT'S ACCOUNTS. For each Participant, a separate Account shall be maintained for each of the following, and for the earnings and expenses attributable thereto: (a) Salary Deferral Contributions. A Participant's Salary Deferral Contributions Account shall be credited with all amounts, if any, attributable to Salary Deferral Contributions pursuant to Section 4.1. (b) Employer Matching Contributions. A Participant's Employer Matching Contributions Account shall be credited with all amounts, if any, attributable to Employer Matching Contributions pursuant to Section 4.2. (c) Qualified Matching Contributions. A Participant's Qualified Matching Contributions Account shall be credited with all amounts, if any, attributable to Qualified Matching Contributions pursuant to Section 4.2. (d) Qualified Nonelective Contributions. A Participant's Qualified Nonelective Contributions Account shall be credited with all amounts, if any, attributable to Qualified Nonelective Contributions pursuant to Section 4.3. (e) Rollover Contributions. A Participant's Rollover Account shall be credited with all amounts transferred to the Plan pursuant to Section 4.6(a) or (d). (f) Other Accounts. Such other Account or Accounts as the Administrator shall deem necessary or appropriate. 5.2 ALLOCATION OF CONTRIBUTIONS. As of each Valuation Date, the Administrator shall allocate to the Accounts of each Participant the Contributions made on his or her behalf, and, if applicable, the rolled over or transferred amounts, since the preceding Valuation Date. 5.3 ALLOCATION OF EARNINGS OR LOSSES. (a) As of each Valuation Date, the Trustee shall determine the net fair market value of all assets of the Trust Fund, and the Trustee shall then report such value to the Administrator. The Administrator shall adjust each Account: first, to reflect any allocations made to, or any distributions or withdrawals made from, such Account since the immediately preceding Valuation Date, to the extent not previously credited or charged thereto, and second, to reflect the earnings allocable to each Account in accordance with paragraph (b) below. If an allocation of -20- EXHIBIT NO. 10.1 Contributions is to be made to the Accounts as of the same Valuation Date, then the adjustments required under this Section shall be made prior to such allocation. (b) The Administrator shall maintain a separate record of all earnings of the Trust Fund attributable to each Participant's Account. For purposes of this Section, the earnings of the Trust Fund shall include any unrealized increase or decrease in the fair market value of the assets of the Trust Fund as determined by the Trustee under the terms of the Trust. Each Participant's Account shall be credited or charged with the earnings attributable to the investments in such Account over the relevant period as of each Valuation Date. Such allocations shall be on the general basis of Account balances on the preceding Valuation Date, as adjusted pursuant to (a) above. Instead of the foregoing, the Administrator may implement a unit accounting methodology. (c) The procedures in this Section 5.3 shall be applied separately to each investment fund in the Trust. 5.4 SECTION 415 LIMITATIONS. Notwithstanding anything else contained herein, the Annual Additions, to all the Accounts of a Participant shall not exceed the lesser of $30,000 (adjusted pursuant to the Adjustment Factor) or 25% of the Participant's Section 415 Compensation from the Company and all Employers during the Plan Year. This Section 5.4 shall be construed and interpreted in accordance with the provisions of Exhibit A attached hereto. 5.5 DISCRIMINATION TESTING OF SALARY DEFERRAL CONTRIBUTIONS. (a) ADP. The anti-discrimination requirements of Code Section 401(k)(3) provide that in each Plan Year one of the following ADP tests must be met: (i) the Average ADP for Eligible Employees who are Highly Compensated Employees for the Plan Year shall not exceed the prior Plan Year's Average ADP for Eligible Employees who were Non-Highly Compensated Employees for the prior Plan Year multiplied by one and twenty-five one-hundredths (1.25); or (ii) the Average ADP for Eligible Employees who are Highly Compensated Employees for the Plan Year shall not exceed the prior Plan Year's Average ADP for Eligible Employees who were Non-Highly Compensated Employees for the prior Plan Year multiplied by two (2), provided that the ADP for Eligible Employees who are Highly Compensated Employees does not exceed the Average ADP for Eligible Employees who were Non-Highly Compensated Employees for the prior Plan Year by more than two (2) percentage points or such lesser amount as the Secretary of the Treasury shall prescribe to prevent the multiple use of this alternative limitation with respect to any Highly Compensated Employee. The Committee will estimate, as soon as practical before the close of the Plan Year and at such other times as the Committee in its discretion determines, the extent, if any, to which Salary Deferral treatment under Section 401(k) of the Code may not be available to any Participant or class -21- EXHIBIT NO. 10.1 of Participants. In accordance with any such estimate, the Committee may modify the limits, or set initial or interim limits, for Salary Deferral Contributions relating to any Participant or class of Participants. These rules may include provisions authorizing the suspension or reduction of Salary Deferral Contributions above a specified dollar amount or percentage of Compensation. (b) Corrective Procedure. (i) Correction of Excess 401(k) Contributions. The Administrator shall, in its sole and absolute discretion, take any and all steps it deems necessary or appropriate to ensure compliance with the limitations of paragraph (a) above, including, without limitation, one or any combination of the following: (A) restricting the amount of Salary Deferral Contributions by Highly Compensated Employees; (B) pursuant to subsection (v) below, distributing Excess 401(k) Contributions to the Highly Compensated Employees who made such Contributions; and/or (C) subject to the Regulations, treating Employer Matching Contributions as Qualified Matching Contributions; and/or (D) The Company, in its discretion, may make a contribution to the Plan, which will be allocated as a fixed dollar amount among the Accounts of some or all non-Highly Compensated Employees (as determined by the Company) who have met the requirements to participate. Such contributions shall be fully (100%) vested at all times, and shall be subject to the withdrawal restrictions which are applicable to Salary Deferral Contributions. Such contributions shall be considered Qualified Non-Elective Contributions. (ii) Calculation of Excess 401(k) Contributions. The amount of Excess 401(k) Contributions for Highly Compensated Employees for a Plan Year shall be calculated by the following method, under which the ADP of the Highly Compensated Employee with the highest ADP is reduced to the extent required to enable the Plan to satisfy the ADP test or to cause such Highly Compensated Employee's ADP to equal the ADP of the Highly Compensated Employee with the next highest ADP. (A) The Salary Deferral Contributions of the Highly Compensated Employee with the highest ADP shall be reduced; such reduction shall continue, as necessary, until such Employee's ADP equals that (those) of the Highly Compensated Employee(s) with the second highest ADP(s). (B) Following the application of the preceding paragraph (A), if it is still necessary to reduce Highly Compensated Employees' Salary Deferral Contributions, the contributions of (or allocations on behalf of, if applicable) Highly Compensated Employees with the highest and second highest ADPs shall be reduced, as necessary, until such Employees' ADP equals that of the Highly Compensated Employee(s) with the third highest ADP. -22- EXHIBIT NO. 10.1 (C) Following the application of paragraph (B), if it is still necessary to reduce Highly Compensated Employees' Salary Deferral Contributions, the procedure, the beginning of which is described in paragraphs (A) and (B), shall continue until no further reductions are necessary. (D) Amounts determined pursuant to paragraphs (A) through (C) above shall be combined. The resulting sum shall be the Excess 401(k) Contributions, and the portion of the total to be allocated to each affected Highly Compensated Employee shall be determined pursuant to paragraph (iii) below. (iii) Allocation of Excess 401(k) Contributions. The amount of Excess 401(k) Contributions to be allocated to a Highly Compensated Employee for a Plan Year shall be determined by the following method: (A) The Salary Deferral Contributions of the Highly Compensated Employee(s) with the highest dollar amounts of Salary Deferral Contributions shall be reduced, as necessary, until either such Employee's dollar amount of Salary Deferral Contributions equals that of the Highly Compensated Employee(s) with the next highest dollar amount of Salary Deferral Contributions, or until no unallocated Excess 401(k) Contributions remain. (B) Following the application of the preceding paragraph (A), if unallocated Excess 401(k) Contributions remain, Salary Deferral Contributions of the Highly Compensated Employees with the highest and second highest dollar amount of Salary Deferral Contributions shall be reduced as necessary, until either such Employees' dollar amount of Salary Deferral Contributions equal those of the Highly Compensated Employee(s) with the third highest dollar amount of Salary Deferral Contributions, or until no unallocated Excess 401(k) Contributions remain. (C) Following the application of the preceding paragraph (B), if unallocated Excess 401(k) Contributions remain, the procedure, the beginning of which is described in paragraphs (A) and (B), shall continue until no further reductions are necessary. (D) Excess 401(k) Contributions in an amount equal to the reduction of Salary Deferral Contributions determined in paragraphs (A) through (C) above with respect to a Highly Compensated Employee shall be allocated to that Highly Compensated Employee and, as determined by the Administrator, distributed pursuant to paragraph (v) below. (iv) Character of Excess 401(k) Contributions. The Excess 401(k) Contributions of a Highly Compensated Employee shall be deemed to consist of Contributions and allocations as determined according to the following order: (A) First, the Employee's Excess 401(k) Contributions shall be deemed to consist of Salary Deferral Contributions if any, which exceed the highest rate or amount at which Salary Deferral Contributions are matched; provided, however, such Contributions shall be offset by any Excess Salary Deferrals distributable to the Employee pursuant to Section 5.6. -23- EXHIBIT NO. 10.1 (B) Second, the Employee's Excess 401(k) Contributions shall be deemed to consist of (1) any Salary Deferral Contributions and (2) any Employer Matching Contributions and Qualified Matching Contributions, each in proportion to the Employee's total Salary Deferral Contributions, Employer Matching Contributions, and Qualified Matching Contributions for the Plan Year; provided, however, any Salary Deferral Contributions characterized as Excess 401(k) Contributions by this paragraph (B) shall be offset by any Excess Salary Deferrals distributable to the Employee pursuant to Section 5.6 and not taken into account under paragraph (b)(iii)(A) above. (C) Third, the Employee's Excess 401(k) Contributions shall be deemed to consist of any allocations of Qualified Nonelective Contributions. (v) Distribution of Excess 401(k) Contributions. If, pursuant to paragraph (b)(i)(B) above, the Administrator elects to distribute Excess 401(k) Contributions, which shall then be treated as Annual Additions (increased by attributable gains and decreased by attributable losses) to Highly Compensated Employees, the Administrator shall make such distributions in accordance with the following timing restrictions: (A) on or before the date which falls two and one-half (2 1/2) months after the last day of the Plan Year for which such Excess 401(k) Contributions were made, to avoid liability for the Federal excise tax, (currently, equal to ten percent (10%) of the undistributed Excess 401(k) Contributions) and state excise tax, if applicable, which will be imposed on Excess 401(k) Contributions distributed after such date; (B) in the event of a complete termination of the Plan during the Plan Year in which there are Excess 401(k) Contributions, such distributions shall be made and as soon as administratively feasible after the date of termination of the Plan, but in no event later than the close of the twelve (12)-month period immediately following such termination; and (C) in any event, such Excess 401(k) Contributions shall be distributed before the last day of the Plan Year next following the Plan Year for which such Excess 401(k) Contributions were made. (vi) Adjustment for Earnings. After the Administrator has determined the aggregate amount and character of Excess 401(k) Contributions to be distributed to a given Highly Compensated Employee, that amount shall be adjusted for earnings (that is, increased to reflect any attributable gains and/or decreased to reflect any attributable losses). Excess 401(k) Contributions shall be adjusted for any earnings up to the end of the Plan Year in which made. The earnings allocable to Excess 401(k) Contributions shall be calculated by the Administrator using any reasonable method for computing the earnings allocable to Excess 401(k) Contributions; provided, however, that the method shall not violate Code Section 401(a)(4), shall be used consistently for all Participants and for all corrective distributions under the Plan for the Plan Year, and is used by the Administrator for allocating earnings to Participants' Accounts. (c) Special Rules. -24- EXHIBIT NO. 10.1 (i) Computation of Section 415 Compensation. For purposes of this Section, a Participant's Section 415 Compensation for the entire Plan Year shall be included, whether or not he or she made Salary Deferral Contributions for the entire Plan Year. (ii) Coordination with Distribution of Excess Salary Deferrals. After calculation of an amount to be distributed to a Participant pursuant to the procedures discussed in paragraphs (b)(iii) and (iv) above, if the Participant in question has also made Excess Salary Deferrals during the calendar year ended within or coincident with the Plan Year, the amount actually distributed to that Participant shall be adjusted to take into account such Excess Salary Deferrals pursuant to Section 5.6 and any relevant Regulations. (iii) Aggregation of Plans. For purposes of determining whether a plan satisfies the ADP test in paragraph (a) of this Section, all elective contributions that are made under two or more plans that are aggregated for purposes of Code Section 401(a)(4) or 410(b) (other than Code Section 410(b)(2)(A)(ii)) shall be treated as made under a single plan. If two or more plans are permissively aggregated for purposes of Code Section 401(k), the aggregated plans shall also satisfy Code Sections 401(a)(4) and 410(b) as though they were a single plan. For Plan Years beginning after December 31, 1989, two or more plans may be aggregated in order to satisfy Code Section 401(k) only if they have the same plan year. (iv) The Committee will not be liable to any Participant (or his Beneficiary, if applicable) for any losses caused by inaccurately estimating or calculating the amount of any Participant's excess Salary Deferral Contributions and earnings attributable thereto. (d) Definitions. (i) Actual Deferral Percentage ("ADP"). "Actual Deferral Percentage" or "ADP" means: (A) with respect to each Eligible Employee, a percentage, calculated as the sum of the amount of (1) Salary Deferral Contributions, (2) Qualified Matching Contributions, and (3) Qualified Nonelective Contributions, made on behalf of such Eligible Employee for the Plan Year (and allocated for purposes of the ADP test), divided by such Employee's Compensation for that Plan Year. If an Eligible Employee makes no Salary Deferral Contributions, and no Qualified Matching or Qualified Nonelective Contributions are taken into account with respect to the Employee, then the ADP of the Employee shall be zero (0); (B) the ADP for any Eligible Employee who is a Highly Compensated Employee for the Plan Year and who is eligible to have Salary Deferral Contributions (and Qualified Nonelective or Qualified Matching Contributions, or both, if treated as Salary Deferral Contributions for purposes of the ADP test), allocated to his or her Accounts under two or more arrangements described in Code Section 401(k), that are maintained by the Employer, shall be determined as if such Salary Deferral Contributions (and, if applicable, such Qualified Nonelective Contributions or Qualified Matching Contributions, or both) were made under a single arrangement. If a Highly Compensated Employee participates in two (2) or more cash or deferred arrangements -25- EXHIBIT NO. 10.1 that have different Plan Years, all cash or deferred arrangements ending with or within the same calendar year shall be treated as a single arrangement. Notwithstanding the foregoing, certain plans shall be treated as separate if mandatorily disaggregated pursuant to Regulations under Code Section 401(k); and (C) for purposes of computing ADPs, an Employee who would be a Participant but for the failure to make Salary Deferral Contributions shall be treated as a Participant on whose behalf no Salary Deferral Contributions are made. (ii) Average ADP. "Average ADP" means the average (expressed as a percentage) of the ADPs for all Eligible Employees in the relevant group. (iii) Excess 401(k) Contributions. "Excess 401(k) Contributions" means with respect to any Plan Year, the excess of (A) the aggregate amount of Employer Contributions actually taken into account in computing the ADP of Highly Compensated Employees for such Plan Year, over (B) the maximum amount of such Contributions permitted by the ADP test. Excess 401(k) Contributions shall be treated as Annual Additions under the Plan for the Plan Year that such Contributions were allocated to the affected Participant's Account. 5.6 DISTRIBUTION OF EXCESS SALARY DEFERRALS. (a) Timing of Distribution and Definitions. A Participant may assign to this Plan any Excess Salary Deferrals made during a taxable year of the Participant by notifying the Administrator in writing of the amount of the Excess Salary Deferrals to be assigned to the Plan on or before March 1 of the year following the Participant's taxable year in which the Excess Salary Deferrals were made. A Participant is deemed to notify the Administrator of any Excess Salary Deferral Contributions that arise by taking into account only those Salary Deferral Contributions made to this Plan and any other plans of the Employer. Notwithstanding any other provision of the Plan, Excess Salary Deferrals, plus any income and minus any loss allocable thereto, shall be distributed no later than April 15 to any Participant to whose account Excess Salary Deferrals were assigned for the preceding taxable year and who claims in accordance with this paragraph (a) Excess Salary Deferrals for such taxable year. (i) "Salary Deferrals" shall, for purposes of this Section, mean any Employer Contributions made to the Plan at the election of the Participant, in lieu of cash compensation, and shall include Contributions made pursuant to a salary reduction agreement or other deferral mechanism. With respect to any taxable year, a Participant's Salary Deferral shall be the sum of all Employer Contributions made on behalf of such Participant pursuant to an election to defer under any qualified cash or deferred arrangement as described in Code Section 401(k), any simplified employee pension cash or deferred arrangement as described in Code Section 402(h)(1)(B), any eligible deferred compensation plan under Code Section 457, any plan as described under Code Section 501(c)(18), and any Employer Contributions made on the behalf of a Participant for the purchase of an annuity contract under Code Section 403(b) pursuant to a salary reduction agreement. Salary Deferrals shall not include any deferrals properly distributed as excess Annual Additions. -26- EXHIBIT NO. 10.1 (ii) "Excess Salary Deferrals" shall, for purposes of this Section, mean those Salary Deferrals that are includable in a Participant's gross income under Code Section 402(g) to the extent such Participant's Salary Deferrals for a taxable year exceed the dollar limitation under such Code Section. For purposes of Section 5.4, Excess Salary Deferrals shall be treated as Annual Additions under the Plan. (b) Determination of Earnings. Excess Salary Deferrals shall be adjusted for any earnings through the end of the taxable year of the Participant for which such Excess Salary Deferrals were made. Furthermore, the earnings allocable to Excess Salary Deferrals shall be calculated by the Administrator using any reasonable method for computing earnings allocable to Excess Salary Deferrals, provided that the method shall not violate Code Section 401(a)(4), shall be used consistently for all Participants and for all corrective distributions under the Plan for the Plan Year, and shall be used by the Administrator for allocating earnings to Participants' Accounts. 5.7 DISCRIMINATION TESTING OF EMPLOYER MATCHING CONTRIBUTIONS. (a) Except as provided in paragraph (b) below, for each Plan Year, Participant's allocations of Employer Matching Contributions for that Plan Year shall satisfy one of the following tests: (i) The Average ACP for Eligible Employees who are Highly Compensated Employees for such Plan Year shall not exceed the prior Plan Year's Average ACP for Eligible Employees who were Non-Highly Compensated Employees for the prior Plan Year multiplied by one and twenty-five one-hundredths (1.25); or (ii) The Average ACP for Eligible Employees who are Highly Compensated Employees for such Plan Year shall not exceed the prior Plan Year's Average ACP for Eligible Employees who were Non-Highly Compensated Employees for the prior Plan Year multiplied by two (2); provided, however, that the Average ACP for Eligible Employees who are Highly Compensated Employees does not exceed the Average ACP for Eligible Employees who were Non-Highly Compensated Employees for the prior Plan Year by more than two (2) percentage points or such lesser amount as the Secretary of the Treasury shall prescribe to prevent the multiple use of this alternative limitation with respect to any Highly Compensated Employee. The Committee will estimate, as soon as practical before the close of the Plan Year and at such other times as the Committee in its discretion determines, the extent, if any, to which the foregoing tests may not be met. In accordance with any such estimate, the Committee may modify the limits, or set initial or interim limits, for Employer Matching Contributions relating to any Participant or class of Participants. These rules may include provisions authorizing the suspension or reduction above a specified dollar amount or percentage of Compensation. (b) Special Rules. (i) Multiple Use. If one or more Highly Compensated Employee(s) participate in both a cash or deferred arrangement and a plan subject to the ACP test maintained by -27- EXHIBIT NO. 10.1 the Employer and the sum of the Average ADP and Average ACP of such Highly Compensated Employee(s) subject to either or both tests exceed(s) the Aggregate Limit, then the Average ACP of such Highly Compensated Employee(s) who also participate(s) in a cash or deferred arrangement shall be reduced in the manner described in Subsection 5.5(b) so that the limit is not exceeded. The amount by which each Highly Compensated Employee's Contribution Percentage Amount is reduced shall be treated as an Excess Matching Contribution. The ADP and ACP of the Highly Compensated Employees are determined after any corrections required to meet ADP and ACP tests and are deemed to be the maximum permitted under such tests for the Plan Year. Multiple use does not occur if either the Average ADP or Average ACP of the Highly Compensated Employees does not exceed one and twenty-five hundredths (1.25) multiplied by the Average ADP and Average ACP of the Non-Highly Compensated Employees. (ii) For purposes of this Section, the Contribution Percentage for any Participant who is eligible to have Contribution Percentage Amounts allocated to his or her account under two or more plans described in Code Section 401(a), or arrangements described in Code Section 401(k) that are maintained by the Employer, shall be determined as if the total of such Contribution Percentage Amounts was made under each plan. If a Highly Compensated Employee participates in two or more cash or deferred arrangements that have different plan years, all cash or deferred arrangements ending with or within the same calendar year shall be treated as a single arrangement. Notwithstanding the foregoing, certain plans shall be treated as separate if mandatorily disaggregated pursuant to Regulations under Code Section 401(m). (iii) For purposes of the ACP test, the Employer may take into account and include as Contribution Percentage Amounts, Salary Deferral Contributions under this Plan or any other plan of the Employer, as provided by the Regulations. The amount of Salary Deferral Contributions made under the Plan and taken into account as Contribution Percentage Amounts for the purposes of calculating the Average ACP, subject to such other requirements as may be described by the Secretary of the Treasury, shall be such Salary Deferral Contributions as are needed to meet the ACP test; provided, however, that Salary Deferral Contributions used in calculating the ADP test may not be used in calculating the ACP test. (iv) In the event that this Plan satisfies the requirements of Code Section 401(m), 401(a)(4) or 410(b) only if aggregated with one or more other plans, or if one or more other plans satisfy the requirements of any such Code Sections only if aggregated with this Plan, then this Section shall be applied by determining the Contribution Percentage of Employees as if all such plans were a single plan. Any adjustments to the Non-Highly Compensated Employee Average ACP for the prior Plan Year shall be made in accordance with Internal Revenue Service Notice 98-1 and any subsequent binding guidance or legislation. Plans may be aggregated in order to satisfy Code Section 401(m) only if they have the same Plan Year. (v) For purposes of determining the ACP test, Employee contributions are considered to have been made in the Plan Year in which contributed to the Trust. Employer Matching Contributions and Qualified Nonelective Contributions are considered made for a Plan -28- EXHIBIT NO. 10.1 Year if made no later than the end of the twelve (12)-month period beginning on the day after the close of the Plan Year. (vi) The Employer shall maintain records sufficient to demonstrate satisfaction of the ACP test and the amount of Qualified Nonelective Contributions or Qualified Matching Contributions, or both, used in such test. (vii) The determination and treatment of the Contribution Percentage of any Participant shall satisfy such other requirements as may be prescribed by the Secretary of the Treasury. (c) Definitions. (i) Actual Contribution Percentage ("ACP"). "Actual Contribution Percentage" or "ACP" means: (A) with respect to each Eligible Employee, a percentage, calculated as the sum of the amount of (1) Employer Matching Contributions, but not Qualified Matching Contributions taken into account for the ADP test; and (2) Qualified Nonelective Contributions, made on behalf of such Eligible Employee for the Plan Year (and allocated for purposes of the ACP test), divided by such Employee's Compensation for that Plan Year. (B) if (1) an Eligible Employee makes no Salary Deferral Contributions, and as a result, no Employer Matching Contributions are made on behalf of such Eligible Employee for the Plan Year; and (2) no Qualified Nonelective Contributions are taken into account with respect to the Employee, then the ACP of the Employee shall be zero (0). (ii) Aggregate Limit. "Aggregate Limit" means the sum of (A) one hundred twenty-five percent (125%) of the greater of the Average ADP of the Non-Highly Compensated Employees for the prior Plan Year or the Average ACP of Non-Highly Compensated Employees under the Plan subject to Code Section 401(m) for the Plan Year beginning with or within the prior Plan Year of the cash or deferred arrangement, and (B) the lesser of two hundred percent (200%) or two (2) plus the lesser of such Average ADP or Average ACP. "Lesser" is substituted for "greater" in "(A)", above, and "greater" is substituted for "lesser" after "two (2) plus the" in "(B)" if it would result in a larger Aggregate Limit. (iii) Average ACP. "Average ACP" means the average of the ACPs of the Eligible Participants in a group. (iv) Contribution Percentage. "Contribution Percentage" means the ratio (expressed as a percentage) of the Participant's Contribution Percentage Amounts to the Participant's Compensation for the Plan Year. (v) Contribution Percentage Amounts. "Contribution Percentage Amounts" means the sum of the Employer Matching Contributions and Qualified Matching -29- EXHIBIT NO. 10.1 Contributions (to the extent not taken into account for purposes of the ADP test) made under the Plan on behalf of the Participant for the Plan Year. Such Contribution Percentage Amounts shall not include Employer Matching Contributions that are forfeited either to correct Excess Matching Contributions or because the Contributions to which they relate are Excess Salary Deferral Contributions, Excess 401(k) Contributions or Excess Matching Contributions. The Employer may elect to include Qualified Nonelective Contributions in the Contribution Percentage Amounts. The Employer may also elect to include Salary Deferral Contributions in the Contribution Percentage Amounts as long as such Salary Deferral Contributions are not necessary to meet the ADP test either prior to or following the exclusion of those Salary Deferral Contributions that are used to meet the ACP test. (vi) Eligible Participant. "Eligible Participant" means any Employee who is eligible to make an Employee contribution, or any Elective Deferral (if the Employer takes such Contributions into account in the calculation of the Contribution Percentage), or to receive Employer Matching Contributions (including forfeitures) or Qualified Matching Contributions. If an Employee contribution is required as a condition of participation in the Plan, any Employee who would be a Participant in the Plan if such Employee made such a contribution shall be treated as an eligible Participant on behalf of whom no Employee contributions are made. (vii) Employee Contribution. "Employee Contribution" means any contribution made to the Plan by or on behalf of a Participant that is included in the Participant's gross income in the year in which made and that is maintained under a separate account to which earnings and losses are allocated. (viii) Excess Matching Contributions. "Excess Matching Contributions" means with respect to any Plan Year, the excess of (A) the aggregate amount of Employer Contributions actually taken into account in computing the Average ACP of Highly Compensated Employees for such Plan Year, over (B) the maximum amount of such Contributions permitted by the ACP test. 5.8 CORRECTIVE PROCEDURE FOR DISCRIMINATORY MATCHING CONTRIBUTIONS. (a) The Administrator shall have the power, in its sole discretion, to take any and all steps it deems necessary or appropriate to ensure compliance with those limitations, including, without limitation: (i) pursuant to paragraph (c) below, distributing vested Excess Matching Contributions to Highly Compensated Employees who received such allocations; (ii) treating as amounts to be reallocated pursuant to paragraph (d) below, the portion of Excess Matching Contributions which consist of unvested allocations of Employer Matching Contributions to the Employer Matching Contributions Accounts of Highly Compensated Employees; and -30- EXHIBIT NO. 10.1 (iii) limiting the amount of Employer Matching Contributions allocated to the Employer Matching Contributions Accounts of Highly Compensated Employees. (b) Notwithstanding any other provisions in this Plan, if, pursuant to paragraph (a)(i) or (ii) above, the Administrator elects to distribute or reallocate Excess Matching Contributions (adjusted for earnings), the Administrator shall take such action(s) (i) on or before the date which falls two and one-half (2 1/2) months after the last day of the Plan Year for which such Excess Matching Contributions were made, if the Employer wishes to avoid liability for the Federal excise tax (currently, equal to ten percent (10%) of undistributed and unreallocated Excess Matching Contributions) and state excise tax, if applicable, which will be imposed on Excess Matching Contributions distributed or reallocated after such date, and (ii) in any event, before the last day of the Plan Year next following the Plan Year for which such Contributions were made. (c) Determination of Amount of Excess Matching Contributions. The amount of Excess Matching Contributions for Highly Compensated Employees for a Plan Year shall be determined by the following method, to enable the Plan to satisfy the ACP test: (i) The allocations of Employer Matching Contributions of the Highly Compensated Employee with the highest Contribution Percentage shall be reduced, as necessary, until such Employee's Contribution Percentage equals those of the Highly Compensated Employee(s) with the second highest Contribution Percentage(s). (ii) Following the application of paragraph (i), if it is still necessary to reduce Highly Compensated Employees' allocations of Employer Matching Contributions, then the Contributions of Highly Compensated Employees with the highest and second highest Contribution Percentages shall be reduced, as necessary, until each affected Employee's Contribution Percentage equals that (those) of the Highly Compensated Employee(s) with the third highest Contribution Percentage(s). (iii) Following the application of paragraph (ii), if it is still necessary to reduce Highly Compensated Employees' allocations of Employer Matching Contributions, then the procedure, the beginning of which is described in paragraphs (i) and (ii), shall continue until no further reductions are necessary. (iv) Amounts determined pursuant to paragraphs (i) through (iii) shall be combined. The resulting sum shall be the Excess Matching Contributions, and the portion of the total to be allocated to each affected Highly Compensated Employee shall be determined pursuant to paragraph (d) below. (d) Allocation of Excess Matching Contributions. The amount of Excess Matching Contributions to be allocated to a Highly Compensated Employee for a Plan Year shall be determined by the following method to enable the Plan to satisfy the ACP test: (i) The allocations of Employer Matching Contributions of the Highly Compensated Employee(s) with the highest dollar amount of Employer Matching Contributions -31- EXHIBIT NO. 10.1 shall be reduced, as necessary, until either such Employee's dollar amount of Employer Matching Contributions equals those of the Highly Compensated Employee(s) with the second highest dollar amount of Employer Matching Contributions or until no unallocated Excess Matching Contributions remain. (ii) Following the application of paragraph (i), if unallocated Excess Matching Contributions remain, Employer Matching Contributions of Highly Compensated Employees with the highest and second highest dollar amount of Employer Matching Contributions shall be reduced, as necessary, until either each affected Employee's dollar amount of Employer Matching Contributions equals that (those) of the Highly Compensated Employee(s) with the third highest dollar amount of Employer Matching Contributions, or until no unallocated Excess Matching Contributions remain. (iii) Following the application of paragraph (ii), if unallocated Excess Matching Contributions remain, the procedure, the beginning of which is outlined in paragraphs (i) and (ii), shall continue until no further reductions are necessary. (iv) Excess Matching Contributions in an amount equal to the reductions of Employer Matching Contributions determined in paragraphs (i) through (iii) above with respect to a Highly Compensated Employee shall be allocated to that Highly Compensated Employee and, as determined by the Administrator, distributed pursuant to paragraph (e) below. (e) Distribution of Excess Matching Contributions. After the procedure outlined in paragraph (d) is completed, all amounts of Excess Matching Contributions shall be distributed to the respective Highly Compensated Employees to whose Accounts the Excess Matching Contributions were made. (f) Adjustment for Earnings. After the Administrator has determined the aggregate amount and character, of Excess Matching Contributions to be distributed to a given Highly Compensated Employee, the amount to be distributed shall be adjusted to reflect earnings. The earnings to be distributed shall be calculated by the Administrator using any reasonable method for computing earnings allocable to Excess Matching Contributions; provided, however, that the method shall not violate Code Section 401(a)(4), shall be used consistently for all Participants and for all corrective distributions under the Plan for the Plan Year, and shall be used by the Administrator for allocating earnings to Participants' Accounts. (g) Special Rule. Any amount distributed to a Highly Compensated Employee pursuant to this Section shall not be subject to any of the consent rules for Participants and Spouses contained in Article VI or any Appendix. Similarly, any such distribution shall not make the Employee liable for the Federal taxes applicable to early withdrawals under Code Section 72(t) or excess distributions under Code Section 4981A. (h) The Committee will not be liable to any Participant (or his Beneficiary, if applicable) for any losses caused by inaccurately estimating or calculating the amount of any Participant's excess Employer Matching Contributions and earnings attributable thereto. -32- EXHIBIT NO. 10.1 ARTICLE VI VESTING AND DISTRIBUTION OF ACCOUNTS 6.1 VESTED INTEREST. (a) A Participant's interest in his or her Salary Deferral Contributions Account, Qualified Matching Contributions Account, Qualified Nonelective Contributions Account and Rollover Account under this Plan shall be at all times fully vested and nonforfeitable. A Participant's interest in his or her Employer Matching Contributions Account shall be fully vested and nonforfeitable at the Participant's Normal Retirement Date (if he is an Employee at that time), on the death or Disability (in either case, if he is an Employee at that time), upon termination of the Plan, and otherwise only to the following extent: (i) Except as specified in one or more of the Appendices, if a Participant's initial date of hire with the Company is prior to February 1, 1986, the Participant's interest in his or her Matching Contributions Account shall be 100% vested at all times. (ii) Except as specified in one or more of the Appendices, if a Participant's initial date of hire with the Company is after January 31, 1986 and before December 1, 1988 or the Participant is an Employee at any time on or after January 1, 2001, the Participant's interest in his or her Matching Contributions Account shall be subject to the following vesting Schedule:
Years of Service Vested Percentage ---------------- ----------------- Less than 1 year 0% 1 year but less than 2 years 20% 2 years but less than 3 years 40% 3 years but less than 4 years 60% 4 years but less than 5 years 80% 5 years or more 100%
(iii) Except as specified in one or more of the Appendices, if a Participant's initial date of hire with the Company is after November 30, 1988 and the Participant is not an Employee at any time on or after January 1, 2001, the Participant's interest in his or her Matching Contributions Account shall be subject to the following vesting Schedule:
Years of Service Vested Percentage ---------------- ----------------- Less than 1 year 0% 1 year but less than 2 years 10% 2 years but less than 3 years 20% 3 years but less than 4 years 30% 4 years but less than 5 years 40% 5 years but less than 6 years 60% 6 years but less than 7 years 80% 7 years or more 100%
-33- EXHIBIT NO. 10.1 (b) Except as provided in Section 6.2, in the case of an Employee who has a Break in Service, both the pre-break and post-break Years of Service will count in vesting both the pre-break and post-break Employer derived Account balance. (c) If the Plan is amended in any way that directly or indirectly reduces a Participant's nonforfeitable percentage, or if the Plan is deemed amended by an automatic change to a Top-Heavy vesting schedule, each Participant (i) who has completed three (3) Years of Service with the Employer and (ii) whose Account(s) would have vested more rapidly prior to the amendment, may irrevocably elect during the election period to have the nonforfeitable percentage of his or her Accounts calculated without regard to such amendment. For purposes of this Section, the election period shall begin the date the amendment is adopted, and shall end on the date sixty (60) days after the later of (i) the date the amendment is adopted, (ii) the date the amendment becomes effective, or (iii) the date the Participant is issued written notice of the amendment by the Employer or the Administrator. 6.2 FORFEITURES. (a) Following the Participant's Severance Date, the nonvested portion of the Participant's Account balance shall be treated as a forfeiture as of the date on which the distribution occurs. For purposes of this Section, if the value of a Participant's vested Account balance is zero (0), then the Participant shall be deemed to have received a distribution of such vested Account balance. (b) If a Participant receives a distribution in accordance with the requirements of Section 6.6 and then resumes employment with the Company or a Participating Employer, then the Participant's Employer Matching Contributions Account balance shall be restored to the amount on the date of distribution; provided, however, the Participant repays to the Plan the full amount of the distribution before the earlier of five (5) years after the Participant's Reemployment Commencement Date, or the date the Participant incurs five (5) consecutive one (1)-year Breaks in Service following the date of the distribution. If a Participant is deemed to receive a distribution of zero dollars pursuant to paragraph (a) above, and the Participant resumes employment covered under this Plan before the date the Participant incurs five (5) consecutive one (1)-year Breaks in Service, then, upon the Participant's Reemployment Commencement Date, the Account balance of the Participant shall be restored to the amount on the date of such deemed distribution. (c) Any amounts forfeited pursuant to this Section, Section 5.4 or Section 5.8 shall be applied first, to restore accounts pursuant to paragraph (b) above, second to reduce the Employer's Employer Matching Contributions, and third, to pay administrative expenses under the Plan. 6.3 NORMAL RETIREMENT. A Participant may retire as of any day on or after his or her Normal Retirement Date. In such event, the Participant's Accounts shall be distributed in accordance with Sections 6.6 through 6.8 or, if applicable, the Appendices. -34- EXHIBIT NO. 10.1 6.4 DEATH BENEFITS. If a Participant or former Participant dies before the entire vested balance of his or her Accounts has been distributed (whether or not the Participant has elected to commence benefits), then the vested balance in his or her Accounts shall be paid to the Participant's Beneficiary in accordance with Sections 6.6 through 6.8 or, if applicable, the Appendices. 6.5 TERMINATION OF EMPLOYMENT. Following a Participant's Severance Date for reasons other than retirement on or after his or her Normal Retirement Date or death, the vested balance of the Participant's Accounts shall be distributed in accordance with Sections 6.6 through 6.8 or, if applicable, the Appendices. 6.6 COMMENCEMENT OF DISTRIBUTION. (a) Subject to Sections 6.7 through 6.9 below and any applicable Appendices, following a Participant's Severance Date, the vested portion of the Participant's Accounts shall be distributed at a date designated by the Administrator, which designation (except as provided below) shall be determined in accordance with the Administrator's customary procedures. (b) Effective for distributions made on or after March 22, 1999, if the Participant's vested Account balance does not exceed Five Thousand Dollars ($5,000) at the time of the distribution, then the Participant shall receive a lump sum distribution of the entire vested portion of such Account balance and the nonvested portion shall be treated as a forfeiture. (c) Effective for distributions made on or after March 22, 1999, if the Participant's vested Account balance exceeds Five Thousand Dollars ($5,000) at the time of distribution, then the Participant, (or if the Participant is deceased, the Participant's Spouse if the Spouse is the Beneficiary) must consent prior to the distribution being made. (i) Such consent shall be in writing (or pursuant to electronic media as set forth in Section 9.7) and must be made within the ninety (90)-day period ending on the distribution. If the Participant or, if applicable, the Participant's Spouse, does not consent to the distribution, the Participant's vested Account balance shall be held in the Trust Fund until the date the Participant (or Spouse, if applicable) later consents, the Required Beginning Date or the death of the Participant (if there is a non-spousal Beneficiary). (ii) If a Participant's consent to a distribution is required hereunder, then at least thirty (30) days and not more than ninety (90) days prior to the distribution the Administrator shall provide the Participant (or, if applicable, the Participant's Spouse) with a notice of the right to elect immediate distribution or the right to defer distribution until the Participant's Normal Retirement Date. However, if a distribution is one for which Code Sections 401(a)(11) and 417 do not apply, such distribution may commence less than thirty (30) days after the notice required under Regulation Section 1.411(a)-11(c) is given, provided that: (1) the Administrator clearly informs the Participant that the Participant has a right to -35- EXHIBIT NO. 10.1 a period of at least thirty (30) days after receiving the notice to consider the decision of whether or not to elect a distribution (and, if applicable, a particular distribution option); and (2) the Participant, after receiving the notice, affirmatively elects a distribution and waives the thirty (30)-day period by written notice. (iii) No consent is required to distribute a death benefit to a non-spousal Beneficiary. If the Participant dies before distribution has commenced and there is a non-spousal beneficiary, such benefits shall be distributed upon such Beneficiary's election, but not later than the date set forth in Section 6.9(a)(iii). (d) Unless the Participant elects otherwise by providing the Administrator with an executed written notice specifying the Participant's benefit under the Plan and the commencement date for distribution of the Participant's Accounts, then distributions to a Participant shall commence no later than sixty (60) days following the close of the Plan Year in which occurs the latest of: (i) the date the Participant attains his or her Normal Retirement Date; (ii) the tenth (10th) anniversary of the date on which the Participant first commences participation in the Plan; or (iii) the Participant's Severance Date. Notwithstanding the foregoing, the failure of a Participant (and, where applicable, the Participant's Spouse) to consent to a distribution while a benefit is immediately distributable within the meaning of this Section, shall be deemed to be an election to defer commencement of payment of any benefit. (e) Notwithstanding the foregoing, neither the consent of the Participant nor the Participant's Spouse shall be required to the extent that a distribution is required to satisfy Code Section 401(a)(9) or 415. In addition, upon termination of this Plan, to the extent the Plan does not offer an annuity option (purchased from a commercial provider) and if the Employer or any entity within the same controlled group as the Employer does not maintain another defined contribution plan (other than an employee stock ownership plan as defined in Code Section 4975(e)(7)), then the Participant's Account balance shall, without the Participant's consent, be distributed to the Participant. However, if any entity within the same controlled group as the Employer maintains another defined contribution plan (other than an employee stock ownership plan as defined in Code Section 4975(e)(7)), then the Participant's Account balance shall be transferred, without the Participant's consent, to the other plan if the Participant does not consent to an immediate distribution. (f) Notwithstanding anything to the contrary herein, the balance in each Participant's Accounts shall begin to be distributed not later than the Participant's Required Beginning Date regardless of whether the Participant has consented to such a distribution. -36- EXHIBIT NO. 10.1 (g) Notwithstanding any provision of the Plan to the contrary, no distribution to a Participant shall be permitted in connection with a termination of employment if Section 401(k) of the Code prohibits a distribution of Salary Deferral Contributions. See also Section 8.3. In addition, no distribution shall be made to a Participant in connection with a termination of employment due to some type of corporate transaction if the Participant's Accounts are transferred to a tax-qualified plan of the acquiring entity. If a distribution is prohibited by either of the foregoing rules, the Participant shall not be treated as having a Severance Date. 6.7 DIRECT ROLLOVERS AND WITHHOLDING. (a) General Rule. If the Distributee of any Eligible Rollover Distribution elects to have the Eligible Rollover Distribution paid directly to an Eligible Retirement Plan, and specifies the Eligible Retirement Plan to which the Eligible Rollover Distribution is to be paid, then the Eligible Rollover Distribution will be paid to that Eligible Retirement Plan in a Direct Rollover. (b) Definitions. (i) Direct Rollover. "Direct Rollover" means an Eligible Rollover Distribution paid directly to an Eligible Retirement Plan for the benefit of a Distributee. (ii) Distributee. "Distributee" means an Employee, Surviving Spouse of a deceased Employee, or a Spouse entitled to payment under a Qualified Domestic Relations Order. (iii) Eligible Retirement Plan. "Eligible Retirement Plan" means: (A) with respect to any Distributee, an individual retirement account described in Code Section 408(a) or an individual retirement annuity (other than an endowment contract) described in Code Section 408(b); or (B) in addition to paragraph (A) and solely with respect to a Distributee who is an Employee or a Spouse or former Spouse of an Employee who is a Participant, or a Spouse entitled to payment under a Qualified Domestic Relations Order, a qualified trust described in Code Section 401(a) or an annuity plan described in Code Section 403(a). (iv) Eligible Rollover Distribution. "Eligible Rollover Distribution" means any distribution of all or any portion of the balance to the credit of the Distributee, except that an Eligible Rollover Distribution shall not include: (A) any distribution that is one of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the Distributee or the joint lives (or joint life expectancies) of the Distributee and the Distributee's designated Beneficiary, or for a specified period of ten (10) years or more; (B) any distribution to the extent such distribution is required under Code Section 401(a)(9); (C) any distribution made on account of hardship as specified in Section 6.12; and (D) the portion of any distribution that is not includable in gross income (determined without regard to the exclusion for net unrealized appreciation with respect to Employer securities). -37- EXHIBIT NO. 10.1 (c) Withholding. If a Participant does not elect to have an Eligible Rollover Distribution transferred directly to an Eligible Retirement Plan, or in the case of any distribution which is not an Eligible Rollover Distribution, the Trustee shall deduct the required withholding. 6.8 FORM OF BENEFIT. Unless otherwise specified in one or more of the Appendices, benefits shall be paid to the Participant or the Participant's Beneficiary in the form of a single lump sum. Except as provided in the Appendices attached hereto, distributions shall be in the form of cash and, to the extent the Participant's Account is invested in Company Stock at the time of distribution, whole shares of Company Stock, with any fractional shares distributed in the form of cash. However, the Participant may elect an all cash distribution, in which case the Company Stock in his Account shall be sold and the net proceeds shall be distributed in cash. 6.9 MINIMUM DISTRIBUTION REQUIREMENTS. (a) General Rules. (i) Subject to any applicable Appendices, the requirements of this Section shall apply to any distribution of a Participant's interest and will take precedence over any inconsistent provision of this Plan. (ii) All distributions required under this Section shall be determined and made in accordance with the proposed Regulations under Code Section 401(a)(9), including the minimum distribution incidental benefit requirement of proposed Regulation Section 1.401(a)(9)-2. (iii) If the Participant dies before distribution of his or her interest begins and the Beneficiary is not the spouse of the Participant, distribution of the Participant's entire interest shall be completed by December 31st of the calendar year containing the fifth (5th) anniversary of the Participant's death. If the Beneficiary is the Participant's spouse, then subsection (b) shall apply. (b) Required Beginning Date. The entire interest of a Participant shall be distributed no later than the Participant's Required Beginning Date regardless of whether the Participant specified a contrary commencement date. (c) Distributions. Required distributions shall be made in a single-sum. (d) Definitions. (i) Five Percent Owner. "Five Percent Owner" means a Participant who, for purposes of this Section, is a five percent owner as defined in Code Section 416(i) (determined in accordance with Code Section 416 but without regard to whether the Plan is Top-Heavy) at any time during the Plan Year ending with or within the calendar year in which such Participant attains age sixty-six and one-half (66 1/2) or any subsequent Plan Year. -38- EXHIBIT NO. 10.1 (ii) Required Beginning Date. "Required Beginning Date" means: (A) for Five Percent Owners. The first day of April following the later of: (1) the calendar year in which the Participant attains age seventy and one-half (70 1/2), or (2) the earlier of the calendar year with or within which ends the Plan Year in which the Participant becomes a Five Percent Owner, or the calendar year in which the Participant's Severance Date occurs. Once begun, distributions to a Five Percent Owner under this Section must continue to be distributed, even if the Participant ceases to be a Five Percent Owner in a subsequent year. (B) for Non-Five Percent Owners. (1) Participants who are not Five Percent Owners, but who attain age seventy and one-half (70 1/2) prior to January 1, 1996. The first day of April of the calendar year following the calendar year in which the Participant attains age seventy and one-half (70 1/2). (2) Participants who are not Five Percent Owners and who attain age seventy and one-half (70 1/2) between January 1, 1996 and December 31, 1998. The first day of April of the calendar year following the calendar year in which the Participant attains age seventy and one-half (70 1/2); provided, however, that an Employee whose Severance Date has not occurred may irrevocably elect, in writing, to defer distribution until that Employee's Severance Date. (3) Participants who are not Five Percent Owners and who attain age seventy and one-half (70 1/2) after December 31, 1998. The first day of April of the calendar year following the calendar year in which the later of attainment of age seventy and one-half (70 1/2) or the Participant's Severance Date occurs. 6.10 PERSONS UNDER INCAPACITY. In the event any amount is payable under the Plan to a person for whom a conservator has been legally appointed, the payment shall be distributed to the duly appointed and currently acting conservator, without any duty on the part of the Committee to supervise or inquire into the application of any funds so paid. Payment to the legal conservator shall fully discharge the Trustee, Administrator and Plan from further liability on account thereof. See also the definition of Beneficiary regarding payment to minors. -39- EXHIBIT NO. 10.1 6.11 LOCATION OF PARTICIPANT OR BENEFICIARY UNKNOWN. If a Participant or Beneficiary who is entitled to a distribution cannot be located and the Administrator has made reasonable efforts to locate the Participant or Beneficiary, then the Participant's or Beneficiary's interest shall be forfeited and used: first, to restore any amounts previously forfeited under this Section; second, to pay administrative expenses of the Plan for the Plan Year in which the forfeiture occurs; and third, to offset the Employer's obligation to make Employer Matching Contributions for the Plan Year in which the forfeiture occurs. If the Participant or Beneficiary makes a written claim for the Account(s) subsequent to the forfeiture, then the Employer shall cause the Account(s) to be reinstated from forfeitures. 6.12 HARDSHIP DISTRIBUTION. (a) Upon hardship of a Participant, the Trustee shall, at the direction of the Administrator, make a distribution from the Participant's Salary Deferral Contributions Account (not including earnings). A Participant shall be entitled to a hardship distribution only if the distribution is both (i) made on account of an immediate and heavy financial need of the Participant (as defined in paragraph (b)), and (ii) is necessary to satisfy such financial need (as defined in paragraph (c)). The Participant shall furnish the Administrator with satisfactory proof that the hardship distribution meets the requirements of paragraphs (b) and (c). (b) An immediate and heavy financial need shall be deemed to include any one or more of the following: (i) expenses incurred or necessary for medical care described in Code Section 213(d) for the Participant, his or her Spouse, or any dependents of the Participant (as defined in Code Section 152); (ii) costs (excluding mortgage payments) relating to the purchase of a principal residence for the Participant; (iii) payment of tuition and related educational fees for the next twelve (12) months of post-secondary education for the Participant, his or her Spouse, children, or dependents; or (iv) the need to prevent the eviction of the Participant from his or her principal residence or foreclosure on the mortgage of the Participant's principal residence. In no event may the hardship distribution exceed the amount necessary to satisfy the financial obligations resulting from the hardship, plus any Federal, state or local income taxes and penalties reasonably anticipated to result from such hardship distribution. (c) A distribution will be considered as necessary to satisfy an immediate and heavy financial need of the Participant if the Administrator relies on the Participant's representation that the need cannot be relieved: -40- EXHIBIT NO. 10.1 (i) through reimbursement or compensation by insurance or otherwise; (ii) by reasonable liquidation of the Participant's assets, to the extent such liquidation would not itself increase the amount of the need; (iii) by cessation of Salary Deferral Contributions under the Plan; or (iv) by other distributions or loans from the Plan or any other tax-qualified retirement plan, or by borrowing from commercial sources on reasonable commercial terms, to the extent such amounts would not themselves increase the amount of the need. (d) If required in accordance with one or more of the Appendices, a Participant shall obtain the consent of his or her Spouse, if any, to receive a hardship distribution. Spousal consent shall be obtained no earlier than the beginning of the ninety (90)-day period that ends on the date on which the hardship distribution is to be made. The consent must be in writing, acknowledge the effect of the distribution, and be witnessed by a Plan representative or notary public. 6.13 LOANS. (a) The Administrator may authorize a loan or loans to currently employed Participants, or parties in interest (as defined in ERISA Section 3(14)) who are Participants or Beneficiaries, provided that: (i) such loans are available to all such Participants and Beneficiaries on a reasonably equivalent basis; (ii) such loans are not made available to Highly Compensated Employees, officers or shareholders in an amount greater than the amount made available to other Employees; (iii) such loans bear a reasonable rate of interest; (iv) such loans are adequately secured; and (v) a Participant's or Beneficiary's aggregate outstanding loans shall not exceed the lesser of fifty percent (50%) of the present value of the Participant's or Beneficiary's vested Account balances or the maximum permitted by Section 72(p) of the Code. (b) If required in accordance with one or more of the Appendices to the Plan, a Participant shall obtain the consent of his or her Spouse, if any, to use of the Account balance as security for the loan. Spousal consent shall be obtained no earlier than the beginning of the ninety (90) day period that ends on the date on which the loan is to be so secured. The consent must be in writing, acknowledge the effect of the loan, and be witnessed by a Plan representative or notary public. Such consent shall thereafter be binding with respect to the consenting Spouse or any subsequent Spouse with respect to that loan. A new consent shall be required if the Account balance is used for renegotiation, extension, renewal, or other revision of the loan. -41- EXHIBIT NO. 10.1 (c) In the event of default, foreclosure on the note and attachment of security shall not occur until a distributable event occurs in the Plan. (d) Notwithstanding any other provision of this Plan, the portion of the Participant's vested Account balance used as a security interest held by the Plan by reason of a loan outstanding to the Participant shall be taken into account for purposes of determining the amount of the Account balance payable at the time of distribution, but only if the reduction is used as repayment of the loan. If less than one hundred percent (100%) of the Participant's vested Account balance (determined without regard to the preceding sentence) is payable to the Surviving Spouse, then the Account balance shall be adjusted by first reducing the vested Account balance by the amount of the security used as repayment of the loan, and then determining the benefit payable to the Surviving Spouse. (e) All such loans shall be available without regard to any individual's race, color, religion, sex, age or national origin. All such loans shall further be subject to ERISA, the Code, the regulations and rulings under ERISA and the Code, and to such terms and conditions not inconsistent therewith (and subject to this Section) as determined by the Administrator. (f) The Administrator shall adopt written policies and guidelines which establish and detail the terms of Plan loans hereunder, and which shall be deemed a part of this Plan. Such policies and guidelines may be amended by the Administrator from time to time, in its sole and absolute discretion and in accordance with its customary procedures. 6.14 WITHDRAWALS AT AGE FIFTY-NINE AND ONE-HALF (59 1/2). (a) A Participant may withdraw all or a part of the vested portion of his or her Accounts at any time subsequent to attainment of age fifty-nine and one-half (59 1/2), provided, however, that if required in accordance with one or more of the Appendices, the Participant shall obtain the consent of his or her Spouse, if any, for amounts withdrawn from the vested portion of the Participant's Account. If required, Spousal consent shall be obtained no earlier than the beginning of the ninety (90) day period that ends on the date on which the withdrawal is to be made. The consent must be made in writing, acknowledge the effect of the withdrawal, and be witnessed by a Plan representative or notary public. (b) If a Participant receives a distribution under this Section from his or her partially vested Employer Matching Contributions Account, at any relevant time following the distribution, the Participant's vested interest in his or her Employer Matching Contributions Account shall be calculated in accordance with the following formula: X = P (AB + D) - D. For purposes of this formula, "P" is the Participant's current vesting percentage at the relevant time, "AB" is the value of the Participant's Employer Matching Contributions Account at the relevant time, and "D" is the amount of the distribution. -42- EXHIBIT NO. 10.1 6.15 WITHDRAWALS FROM ROLLOVER ACCOUNTS. A Participant may withdraw all or a part of his or her Rollover Account. -43- EXHIBIT NO. 10.1 ARTICLE VII ADMINISTRATION 7.1 POWERS OF THE ADMINISTRATOR. (a) The Administrator shall file all reports and distribute to Participants and Beneficiaries reports and other information required under ERISA. (b) In addition to the powers of the Administrator specified elsewhere in the Plan, the Administrator shall be responsible for the general administration and interpretation of the Plan and for carrying out its provisions and shall have such powers as may be necessary to discharge its duties hereunder, including, but not by way of limitation, the following powers and duties: (i) full and complete discretionary authority to construe and interpret the terms of the Plan, make factual determinations, and to determine eligibility and the amount, manner and time of payment of any benefits hereunder; (ii) to monitor the Plan's compliance with the limitations of Sections 5.4, 5.5 and 5.7 throughout the Plan Year. The Administrator shall maintain such records as it deems necessary to demonstrate compliance with these Sections; (iii) to prescribe procedures to be followed by Employees in filing applications for benefits; (iv) to make a determination as to the right of any person to a benefit and to afford any person dissatisfied with such determination the right to a hearing; (v) to request and receive from Employees such information as necessary for the proper administration of the Plan, including but not limited to, such information as the Administrator may reasonably require to determine each Participant's eligibility to participate in the Plan and the benefits payable to each Participant upon his or her death, retirement, disability or termination of employment; (vi) to prepare and distribute, in such manner as it determines to be appropriate, explanations of the terms and conditions of the Plan; and (vii) to direct the Trustee as to the method in which, and persons to whom, Plan assets shall be distributed. (c) The Administrator shall have sole and absolute discretion to construe and interpret the terms and provisions of this Plan and any issue arising out of, relating to, or resulting from the administration and operation of the Plan and to make factual determinations, which interpretation, construction or determination shall be final and binding on all parties, including, but -44- EXHIBIT NO. 10.1 not limited to, the Employer and any Participant or Beneficiary or their successors and assigns, except as otherwise required by law. When making a determination or calculation, the Administrator shall be entitled to rely upon information furnished by the Employer or anyone acting on behalf of the Employer. (d) The Administrator shall have the power to (i) establish a funding and investment policy; (ii) select additional or alternative investment funds or vehicles; (iii) receive and review reports on the financial condition of the Trust Fund and statements of the receipts and disbursements of the Trust Fund from the Trustee; and (iv) appoint or employ one or more Investment Managers (as defined in ERISA Section 3(38)) to manage all or any part of the assets of the Plan for which the Administrator has investment discretion. 7.2 PLAN COMMITTEE. (a) The Administrator has established a committee (the "Committee") to discharge the duties of the Administrator under the Plan. An individual may be a member of the Committee regardless of whether such individual is or may be a Participant in the Plan. The Administrator or its delegate may, in its sole and absolute discretion, change the composition of the Committee (including, without limitation, the number of members of the Committee) from time to time. The Committee and each of its members shall be indemnified by the Employer to the extent set forth in Section 15.2. (b) The Committee is authorized at the expense of the Company to employ such legal counsel as it may deem advisable to assist in the performance of its duties hereunder. Expenses and fees in connection with the administration of the Plan and the Trust shall be paid from the Trust assets to the fullest extent permitted by law, unless the Company determines otherwise. The Committee shall have the authority to delegate any authority and duty hereunder to such other person or persons as determined by the Committee, and each reference hereunder to the Committee includes such delegates. Formal action by the Committee is not required to accomplish such delegation. 7.3 DOMESTIC RELATIONS ORDERS. (a) Notification. Upon receipt of a Domestic Relations Order, the Administrator shall promptly notify the affected Participant and each Alternate Payee of the receipt of such order and the procedures established by the Administrator for determining whether such Order satisfies the requirements for recognition as a Qualified Domestic Relations Order. Such notice shall also advise each Alternate Payee of his or her right to designate a representative to receive communications from the Administrator concerning the disposition of the Domestic Relations Order. Within a reasonable time after providing such notification, the Administrator shall, pursuant to such procedures, determine whether or not the Order is a Qualified Domestic Relations Order and shall notify the Participant and each Alternate Payee (or his or her representative) of such determination. -45- EXHIBIT NO. 10.1 (b) Procedures. The Administrator shall establish reasonable procedures for determining the qualified status of Domestic Relations Orders and for effecting distributions pursuant to all such Orders which are determined to be Qualified Domestic Relations Orders. (c) Payment. (i) During the period in which the qualified status of a Domestic Relations Order is pending, the Administrator shall defer the payment of all Plan benefits affecting the Participant which are in dispute and shall separately account for all amounts which would otherwise be payable to the Alternate Payee (the "Segregated Amounts") during such period were the Order determined to be a Qualified Domestic Relations Order. (ii) If the Administrator determines, within eighteen (18) months after the date the first payment to the Alternate Payee would otherwise be required pursuant to the terms of the Order, that such Order is a Qualified Domestic Relations Order, then the Administrator shall establish an Account to hold the Segregated Amounts (including any earnings thereon) on behalf of such Alternate Payee and such Alternate Payee shall then be treated as a Participant for purposes of such Account. To the extent such Qualified Domestic Relations Order provides for the payment of the entire balance of the Segregated Amounts (including any earnings thereon) to the Alternate Payee prior to the Participant's Severance Date, then the Administrator shall make such payment in accordance with such Order, notwithstanding that the affected Participant's Severance Date has not occurred, nor has the affected Participant actually attained his or her earliest retirement age (as defined Code Section 414(p)) at that time. Such payment shall be made in any form in which benefits under the Plan may be distributed to the affected Participant and/or his or her Beneficiaries. (iii) If the Administrator determines, within such eighteen (18) month period under paragraph (ii), that such Order is not a Qualified Domestic Relations Order, or if the qualified status of such Order cannot be determined prior to the expiration of such eighteen (18) month period, then the Administrator shall authorize the payment of the Segregated Amounts (including any earnings thereon) to the person or person who would have been entitled to such Segregated Amounts had the Order not been issued. If such person is the Participant, then the previously Segregated Amounts shall remain part of the Trust and shall not be distributed until the Participant becomes entitled to benefits under the Plan in accordance with the provisions of Article VI or any applicable Appendix. Should there be a subsequent determination that the Order is in fact a Qualified Domestic Relations Order, then such determination shall be applied on a prospective basis only. (d) Definitions. (i) Alternate Payee. "Alternate Payee" means any Spouse, former Spouse, child or other dependent of a Participant who is recognized by a Domestic Relations Order as having a right to all or a portion of the benefits payable under the Plan to the Participant. (ii) Domestic Relations Order or Order. "Domestic Relations Order" or "Order" means any judgment, decree or order (including approval of a property settlement -46- EXHIBIT NO. 10.1 agreement) which provides or otherwise conveys, pursuant to applicable state domestic relations laws (including community property laws), child support, alimony payments or marital property rights to an Alternate Payee. (iii) Qualified Domestic Relations Order. "Qualified Domestic Relations Order" means any Domestic Relations Order that meets the following requirements: (A) such Order establishes (or otherwise recognizes the existence of) the right of an Alternate Payee to receive all or a portion of the benefits otherwise payable under the Plan to a Participant; (B) such Order specifies (1) the name and last known mailing address of the Participant, date of birth and Social Security number, (2) the name and last known mailing address of each Alternate Payee covered by such Order and his or her date of birth and Social Security number, (3) the amount or percentage of the Participant's benefits under the Plan payable to each such Alternate Payee or the manner in which such amount or percentage is to be calculated, and (4) any other requirement set forth in ERISA Section 206(d)(3) or Code Section 414(p); and (C) such Order does not require the Plan to (1) provide any type or form of benefit or option not otherwise available under the Plan, (2) provide increased benefits under the Plan, or (3) pay benefits to an Alternate Payee which are required to be paid to another Alternate Payee pursuant to any Qualified Domestic Relations Orders previously issued with respect to the Plan. A Domestic Relations Order shall not be considered to be in violation of the requirement of paragraph (C)(1) merely because such Order requires the payment of benefits to an Alternate Payee before the date of the affected Participant's actual Severance Date or specifically provides for payment prior to the date the Participant attains his or her Earliest Retirement Age. Accordingly, such payments shall be made as if the Participant's Severance Date occurred on the date on which benefits are to enter pay status under the Order. (e) Hold Procedures. Notwithstanding any contrary Plan provision, prior to the receipt of a Domestic Relations Order, the Administrator may place a hold (as defined below) upon such portion of a Participant's Account, at such time and for such reasonable period of time as the Administrator may determine, if the Administrator receives notice that (1) a Domestic Relations Order is being sought by the Participant, his or her Spouse, former Spouse, child or other dependent (within the meaning of Code Section 152), and (2) the Participant's Account is likely to be a source of payment under such Order. For purposes of this paragraph, a "hold" means that no withdrawals, loans or other distributions may be made with respect to a Participant's Account. The Administrator shall notify a Participant if a hold is placed upon his or her Account pursuant to this paragraph. -47- EXHIBIT NO. 10.1 ARTICLE VIII LEAVES OF ABSENCE AND TRANSFERS 8.1 MILITARY LEAVE OF ABSENCE. So long as the Uniformed Services Employment and Reemployment Rights Act of 1994 or any similar law, shall remain in force, providing for re-employment rights for all persons in military service, as therein defined, an Employee who leaves the employment of the Employer for military service in the Armed Forces of the United States, as defined in such act from time to time in force, shall, for all purposes of this Plan, be considered as having been in the employment of the Employer, with the time of the Participant's service in the military credited to his or her service under the Plan; provided, however, that upon such Employee being discharged from the military service of the United States, the Employee must apply for reemployment with the Employer and take all other necessary action to be entitled to, and to be otherwise eligible for, re-employment rights, as provided by the Uniformed Services Employment and Reemployment Rights Act of 1994 or any similar law from time to time in force. Notwithstanding any provision of this Plan to the contrary, contributions, benefits and service credit with respect to qualified military service shall be provided in accordance with Code Section 414(u). 8.2 OTHER LEAVES OF ABSENCE. For all purposes of this Plan, an Employee on an Employer-approved leave of absence not described in Section 8.1 shall be considered as having continued in the employment of the Employer for the period of such leave. However, this provision shall not give rise to any imputed Compensation. 8.3 TRANSFERS. (a) In the event that: (i) a Participant who was an Eligible Employee is transferred to employment with an Employer which is not a Participating Employer or to employment with the Employer in a status other than as an Eligible Employee (including employment as an independent contractor of the Employer); (ii) a person is transferred from employment with an Employer which is not a Participating Employer (or from service with the Employer in a status other than Employee) to employment with the Employer in Employee status or Eligible Employee status; or (iii) a person was employed by an Employer which is not a Participating Employer, terminated his or her employment and was subsequently employed by the Employer as an Employee; -48- EXHIBIT NO. 10.1 (b) then the following provisions shall apply: (i) transfer to employment with: (A) an Employer which is not a Participating Employer or (B) the Employer not as an Eligible Employee (or not as an Employee), shall not be considered termination of employment with the Employer, and such transferred person shall continue to be entitled to the benefits provided in the Plan, as modified by this Section; (ii) no amounts earned from an Employer at a time when it is not a Participating Employer or from the Employer not as an Eligible Employee shall constitute Compensation hereunder; (iii) no service for an Employer at a time when such individual is not an Employee shall be counted for purposes of eligibility and vesting hereunder, unless agreed to by the Company or required pursuant to a closing agreement entered into by the Employer and the Internal Revenue Service; (iv) termination of employment with an Employer which is not a Participating Employer (or cessation of employment with the Employer) by a person entitled to benefits under this Plan (other than to transfer to employment with another Employer) shall be considered as termination of employment with the Employer; and (v) all other terms and provisions of this Plan shall fully apply to such person and to any benefits to which he or she may be entitled hereunder. -49- EXHIBIT NO. 10.1 ARTICLE IX TRUST PROVISIONS; INVESTMENT OF CONTRIBUTIONS; VALUATION OF ACCOUNTS 9.1 TRUST AGREEMENT. The Administrator may at any time select and appoint a Trustee to hold the assets of the Plan, and the Company shall, on behalf of itself and all other related entities which have adopted the Plan pursuant to the provisions of Article XII, enter into a Trust Agreement with the Trustee to provide for the investment, management and control of the assets of the Plan. The Trust Agreement shall be a part of the Plan, and the Trust Fund shall be administered by the Trustee in accordance with the terms and provisions of the Trust Agreement. 9.2 INCONSISTENT PROVISIONS. To the extent the provisions of the Plan and any Trust Agreement in effect under the Plan prove to be inconsistent or otherwise in conflict with respect to the rights, duties or obligations of the Trustee, the provisions of the Trust Agreement shall control. 9.3 INVESTMENT DECISION. The decision as to the investment of an Account shall be made by the Participant, and the Trustee shall have no responsibility for determining how an Account is to be invested or whether the investment directions communicated to the Trustee comply with the terms of the Plan. The Plan may acquire Company Stock; there is no limit on the amount of Company Stock that may be acquired or held under the Plan. Notwithstanding the foregoing, to the extent the Account is held in the form of Company Stock, the following rules shall apply: (a) if the Administrator determines that any election out of qualifying employer securities might violate applicable securities laws or create a liability for Participants under such laws or is for any other reason known to the Administrator contrary to the best interests of Participants (including Participants subject to Section 16 of the Securities Exchange Act of 1934, as amended ("Section 16")), the Administrator may, in its sole and absolute discretion, suspend or limit the right of any Participant to make such an investment election. The Administrator may (but need not) adopt such rules and/or take such actions or implement such measures and/or limitations as it deems desirable in order to comply with Section 16. Neither the Administrator, the Board, the Committee, the Trustee nor the Plan shall have any liability to any Participant in the event that any Participant has any liability under SEC Section 16 due to any action taken or rule so adopted, the failure to take any action to adopt any rule, any Plan provision (or lack thereof), any transaction in the Plan or otherwise; and (b) rights to sell and vote Company Stock shall be administered in accordance with the Trust Agreement and the Company's insider trading policy. -50- EXHIBIT NO. 10.1 9.4 DIRECTED INVESTMENTS. (a) Each Participant shall have the right to direct the investment of any or all of his or her Accounts among such investments as are authorized by the Administrator, as follows: subject to such procedural guidelines as the Administrator shall from time to time establish, each Participant may file an investment direction (in such manner and in such form as prescribed from time to time by the Administrator) that specifies the manner in which his or her Accounts are to be invested. Notwithstanding the foregoing, no Participant may direct any assets of his or her Accounts to purchase life insurance, and further, no Participant may divest the Company stock held in his or her Account, if any, in violation of the policies and guidelines established by the Administrator from time to time, in its sole and absolute discretion. The Administrator shall prescribe when investment directions shall be effective and time periods within which such investment directions must be filed. An investment direction shall continue to apply until a subsequent direction is filed and is deemed effective by the Administrator. The Administration may require that directions be filed with the Administrator or such other party as determined by the Administrator. (b) The Plan is intended to constitute a plan described in Section 404(c) of ERISA, and the regulations thereunder. As a result, with respect to elections described in the Plan and any other exercise of control by a Participant or his Beneficiary over assets in the Participant's Accounts, such Participant or Beneficiary shall be solely responsible for such actions and neither the Trustee, the Committee, the Company, an investment manager nor any other person or entity which is otherwise a Fiduciary shall be liable for any loss or liability which results from such Participant's or Beneficiary's exercise of control. 9.5 ACCOUNTS NOT DIRECTED. Notwithstanding anything herein to the contrary, if a Participant fails to designate the manner in which his or her Accounts shall be invested, then the Participant's Accounts shall be invested in the manner determined by the Administrator and announced to Participants. 9.6 VALUATION. On the last day of each Plan Year, or more frequently as determined by the Administrator in its sole and absolute discretion, the assets of the Trust shall be valued at fair market value and each Account shall be proportionately adjusted to reflect earnings and/or expenses, if the system of accounting does not directly accomplish all such adjustments. 9.7 ELECTRONIC MEDIA. (a) To the fullest extent permitted by law, the Administrator may require or permit Participant (or Beneficiary, as the context may require) elections and/or consents under this Plan to be made by means of such electronic media as the Administrator may prescribe. Similarly, to the fullest extent permitted by law, the Administrator may give any notices by electronic media and may permit enrollments, contribution and investment elections, beneficiary designations, rollover elections and general plan inquiries to be made by electronic media. For purposes of this -51- EXHIBIT NO. 10.1 Plan, electronic media shall include, without limitation, email, internet, intranet, automated telephone systems and customer representative systems. In any case in which the Administrator provides for the use of electronic media for any particular purpose, any requirement in the Plan requiring a written form or notice for that purpose shall be void. (b) A Participant's consent to distribution, request for a withdrawal or loan, or other form of election permitted, by electronic media under this Plan or by the Administrator, together (if applicable) with the cashing of any check subsequently issued by this Plan (whether or not endorsed), shall constitute written consent for purposes of this Plan (including, without limitation and in the case of loans, agreement to the terms of the loan and the related promissory note), the Code (including, without limitation, Section 411(a)(11), and ERISA (including, without limitation, Section 203(e)). (c) Reasonable efforts will be used to process electronic media consents and elections made under this Plan. Notwithstanding the preceding sentence or anything else in this Plan to the contrary, neither the Company, the Administrator, the Trustee nor any other person guarantees that any consent or election will be so processed. The Administrator may adopt new or alternative rules for electronic media consents and elections as it deems appropriate in its sole and complete discretion (including, without limitation, eliminating any electronic media system and re-implementing a requirement of written forms, establishing the effective date and the notice date for any type of consent or election and limiting the number of any particular elections that may be made by a Participant during any specified period). In order to be effective, each consent and/or election must be made on such other rules as the Administrator may prescribe. -52- EXHIBIT NO. 10.1 ARTICLE X FEES AND EXPENSES All reasonable fees and expenses of the Administrator and/or the Trustee incurred in the performance of their duties hereunder or under the Trust, as well as all other administrative expenses of the Plan, shall, to the extent permitted by law, be deemed to be an expense of the Trust, and, accordingly, the Trustee is authorized to charge the same to the Accounts of the Participants, and unless allocable to the Accounts of specific Participants, such expenses shall be charged against the respective Accounts of all or a reasonable group of Participants in such manner as the Trustee shall determine, subject to approval by the Company. Notwithstanding the foregoing, any or all of such expenses may be paid by the Employer to the extent determined by the Company. -53- EXHIBIT NO. 10.1 ARTICLE XI AMENDMENT, TERMINATION OR MERGER 11.1 AMENDMENT. (a) The Administrator, acting through the Board shall have full power and authority to amend the provisions of the Plan at any time or times, either prospectively or retroactively, to such extent and in such manner as the Board shall deem advisable, in accordance with its normally established procedures. The Board may delegate such power, in whole or in part, to one or more committees (comprised of officers or other managerial personnel of the Employer) to whom administrative responsibilities may be delegated under the Plan. (b) The Committee is expressly given the full power and authority to adopt and to provide a certificate evidencing the execution of any amendment to the Plan which satisfies one of the following requirements: (i) the amendment is designed to clarify any provision of the Plan; (ii) the amendment is designed to bring the Plan into compliance with applicable law; (iii) the amendment is designed to ensure the continued tax-qualified status of the Plan; or (iv) the amendment does not have a significant financial impact on the Employer; (c) An amendment shall become effective, in accordance with its terms as to all Participants and all other persons having or claiming an interest under the Plan, upon the effective date specified in the instrument evidencing such amendment. However, no such amendment shall change the duties, responsibilities or liabilities of the Trustee hereunder without the written consent of such Trustee or, except as provided by law, operate to: (i) cause any part of the Trust to revert to or be recoverable by the Employer or to be used for, or diverted to, purposes other than the exclusive benefit of Participants and their Beneficiaries (or for defraying the reasonable administrative expenses of the Plan); (ii) reduce the then outstanding balances in the Accounts of Participants; or (iii) affect, reduce or eliminate any benefits which are protected benefits pursuant to Code Section 411(d)(6) and the Regulations thereunder. 11.2 TERMINATION OF PLAN. The Company may terminate this Plan at any time for any reason by resolution adopted by the Board, but, except as provided by law, the Trust may not thereby be diverted from the exclusive benefit of the Participants, their Beneficiaries, survivors or estates, or for defraying the reasonable -54- EXHIBIT NO. 10.1 administrative expenses of the Plan, nor revert to the Employer, nor may an allocation or contribution theretofore made be changed thereby. Upon termination or partial termination of the Plan or complete discontinuance of Employer Contributions under it, the Accounts of each affected Participant shall be nonforfeitable. The Administrator shall distribute each Participant's Accounts to the Participant pursuant to Sections 6.6 through 6.8 as soon as is administratively practicable after the termination. 11.3 PLAN MERGERS AND TRANSFER OF ASSETS OR LIABILITIES. (a) The Board delegates to the Committee the full power and authority to effect from time to time, upon such terms and conditions as the Committee deems appropriate, the merger of any and all tax-qualified defined contribution plans and related trusts maintained by entities acquired by the Company into the Plan and Trust (or a transfer of assets and liabilities from another plan to the Plan with respect to a group of employees acquired by the Company) and to take any and all such action, and prepare, execute, and deliver all such documents as may be necessary or advisable to effect any and all such plan and trust mergers and plan to plan transfers. (b) Nothing contained herein shall prevent the merger or consolidation of the Plan with, or transfer of assets or liabilities of the Plan to, another plan meeting the requirements of Code Section 401(a) or the transfer to the Plan of assets or liabilities of another such plan so qualified under the Code. Any such merger, consolidation or transfer shall be accompanied by the transfer of such existing records and information as may be necessary to properly allocate such assets among Participants, including without limitation any tax or other information necessary for the Participants or persons administering the plan which is receiving such assets. The terms of such merger, consolidation or transfer must be such that (if this Plan had then terminated), the requirements of this Article would be satisfied and each Participant would receive a benefit immediately after the merger, consolidation or transfer equal to or greater than the benefit he or she would have received if the Plan had terminated immediately before the merger, consolidation or transfer. (c) The Committee may, in its discretion, authorize a plan to plan transfer from this Plan, provided such a transfer will meet the requirements of Section 414(l) of the Code and that all other actions legally required are taken. In the event of a transfer of assets from the Plan pursuant to this subsection, any corresponding benefit liabilities shall also be transferred. The Committee has full power and authority to take any and all such action, and prepare, execute, and deliver all such documents as may be necessary or advisable to effect any and all such transfers. -55- EXHIBIT NO. 10.1 ARTICLE XII ADOPTION OF PLAN BY RELATED ENTITIES 12.1 ADOPTION OF THE PLAN. An Affiliated Company may become a Participating Employer with the approval of the Committee. 12.2 WITHDRAWAL. (a) A Participating Employer may withdraw from the Plan at any time by giving advance written notice of its intention to withdraw to the Company and to the Administrator. Any Participating Employer that ceases to be an Affiliated Company shall be deemed to have withdrawn from the Plan at the time of such disaffiliation. (b) If the Board of Directors of the Company so directs, upon the receipt of notice of any such withdrawal, the Trustee shall set aside from the Trust Fund such cash, securities and other property as it shall deem to be equal in value to the Participating Employer's equitable share. If the Board so directs, the Trustee shall also turn over the Participating Employer's equitable share to a trustee designated by the Participating Employer, and the cash, securities and other property shall thereafter be held and invested as a separate trust of the Participating Employer and shall be used and applied according to the terms of a new trust agreement between the Participating Employer and the trustee so designated. Except as permitted by law, neither the segregation of the Trust Fund assets upon the withdrawal of a Participating Employer nor the execution of a new trust agreement shall operate to permit any part of the corpus or income of the Trust Fund to be used for or diverted to purposes other than for the exclusive benefit of Participants, former Participants and Beneficiaries (or for defraying the reasonable administrative expenses of the Plan). (c) If the former Participating Employer remains an Affiliated Company, distribution shall not be made to a Participant until the Participant terminates employment with the Employer and all other Affiliated Companies. In lieu thereof, the Plan shall be administered in accordance with its terms provided that no additional contributions shall be made on behalf of said Participants. See Section 8.3. If the Participating Employer is no longer an Affiliated Company, then, subject to Section 6.6(g), distributions may be made. -56- EXHIBIT NO. 10.1 ARTICLE XIII CLAIMS PROCEDURE 13.1 RIGHT TO FILE CLAIM. Every Participant or Beneficiary shall be entitled to file with the Administrator a claim for benefits under the Plan. The claim shall be in writing. 13.2 DENIAL OF CLAIM. If the claim is denied by the Administrator, in whole or in part, the claimant shall be furnished within ninety (90) days after the Administrator's receipt of the claim (or within one hundred eighty (180) days after such receipt if special circumstances require an extension of time) a written notice of denial of such claim containing the following: (a) specific reason or reasons for denial; (b) specific reference to pertinent Plan provisions on which the denial is based; (c) a description of any additional material or information necessary for the claimant to perfect the claim, and an explanation of why the material or information is necessary; and (d) an explanation of the claims review procedure. 13.3 CLAIMS REVIEW PROCEDURE. (a) Review may be requested at any time within sixty (60) days following the date the claimant received written notice of the denial of his or her claim. For purposes of this Section, any action required or authorized to be taken by the claimant may be taken by a representative authorized in writing by the claimant to act on his or her behalf. The Administrator shall afford the claimant a full and fair review of the decision denying the claim and, if so requested, shall: (i) permit the claimant to review any documents that are pertinent to the claim; and (ii) permit the claimant to submit to the Administrator issues and comments in writing. (b) The decision on review by the Administrator shall be in writing and shall be issued within sixty (60) days following receipt of the request for review. The period for decision may, however, be extended to a date not later than one hundred twenty (120) days after such receipt if the Administrator determines that special circumstances require extension. The decision on -57- EXHIBIT NO. 10.1 review shall include specific reasons for the decision and specific references to the pertinent Plan provisions on which the decision of the Administrator is based. -58- EXHIBIT NO. 10.1 ARTICLE XIV TOP-HEAVY PROVISIONS 14.1 PURPOSE. This Article is intended to insure that the Plan complies with Code Section 416. If the Plan is or becomes Top-Heavy in any Plan Year, the provisions of this Section will supersede any conflicting provision in the Plan. 14.2 DEFINITIONS. For purposes of this Article, the following definitions shall apply: (a) Determination Date. "Determination Date" means for any Plan Year, the last day of the preceding Plan Year. (b) Determination Period. "Determination Period" means the Plan Year containing the Determination Date and the four (4) preceding Plan Years. (c) Key Employee. "Key Employee" means any Employee or former Employee (and the beneficiaries of such Employee) who at any time during the determination period was (i) an officer of the Employer if such individual's annual Section 415 Compensation exceeds fifty percent (50%) of the dollar limitation in effect under Code Section 415(b)(1)(A); (ii) an owner (or considered an owner under Code Section 318) of one of the ten (10) largest interests in the Employer if such individual's Section 415 Compensation exceeds one hundred percent (100%) of the dollar limitation in effect under Code Section 415(c)(1)(A); (iii) a five percent (5%) owner of the Employer; or (iv) a one percent (1%) owner of the Employer who has an annual Section 415 Compensation of more than One Hundred Sixty Thousand Dollars ($160,000) (as adjusted by the Adjustment Factor). For purposes of this Section, the determination of Section 415 Compensation shall be based only on Section 415 Compensation which is actually paid. A determination of who constitutes a Key Employee shall be made in accordance with Code Section 416(i)(1). (d) Non-Key Employee. "Non-Key Employee" means any Employee who is not a Key Employee, including Employees who are former Key Employees. (e) Permissive Aggregation Group. "Permissive Aggregation Group" means the Required Aggregation Group of plans plus any other plan or plans of the Employer which, when considered as a group with the Required Aggregation Group, would continue to satisfy the requirements of Code Sections 401(a)(4) and 410. -59- EXHIBIT NO. 10.1 (f) Required Aggregation Group. "Required Aggregation Group" means: (i) each tax-qualified plan of the Employer in which at least one (1) Key Employee participates or participated at any time during the Determination Period (regardless of whether the plan has terminated); and (ii) any other tax-qualified plan of the Employer which enables a plan described in paragraph (i) above to meet the requirements of Code Section 401(a)(4) or 410. (g) Top-Heavy Plan. "Top-Heavy Plan" means this Plan, if for any Plan Year any of the following conditions exists: (i) if the Top-Heavy Ratio for this Plan exceeds sixty percent (60%) and this Plan is not part of any Required Aggregation Group or Permissive Aggregation Group of plans; (ii) if this Plan is a part of a Required Aggregation Group of plans but not part of a Permissive Aggregation Group and the Top-Heavy Ratio for the Permissive Aggregation Group exceeds sixty percent (60%); or (iii) if this Plan is a part of a Required Aggregation Group and part of a Permissive Aggregation Group of plans and the Top-Heavy Ratio for the Permissive Aggregation Group exceeds sixty percent (60%). (h) Top-Heavy Ratio. "Top-Heavy Ratio" means: (i) if the Employer maintains one or more defined contribution plans (including any simplified employee pension plan) and the Employer has not maintained any defined benefit plan which during the five (5) year period ending on the Determination Date(s) has or has had accrued benefits, the Top-Heavy Ratio for this Plan alone or for the Required or Permissive Aggregation Group as appropriate is a fraction, the numerator of which is the sum of the Account balances of all Key Employees as of the Determination Date(s) (including any part of any Account balance distributed in the five (5) year period ending on the Determination Date(s)), and the denominator of which is the sum of Account balances (including any part of any Account balance distributed in the five (5) year period ending on the Determination Date(s)), both computed in accordance with Code Section 416. Both the numerator and denominator of the Top-Heavy Ratio are increased to reflect any contribution not actually made as of the Determination Date, but which is required to be taken into account on that date under Code Section 416. (ii) if the Employer maintains one or more defined contribution plans (including any simplified employee pension plan) and the Employer maintains or has maintained one or more defined benefit plans which during the five (5) year period ending on the Determination Date(s) has or has had any accrued benefits, the Top-Heavy Ratio for any Required or Permissive Aggregation Group as appropriate is a fraction, the numerator of which is the sum of Account balances under the aggregated defined contribution plan or plans for all Key Employees, determined in accordance with paragraph (i) above, and the present value of accrued benefits under the aggregated defined benefit plan or plans for all Key Employees as of the Determination Date(s), and the denominator of which is the sum of Account balances under the aggregated defined contribution plan or plans for all participants, determined in accordance with paragraph (i) above, and the present value of accrued benefits under the -60- EXHIBIT NO. 10.1 aggregated defined benefit plan or plans for all participants as of the Determination Date(s), all determined in accordance with Code Section 416. The accrued benefits under a defined benefit plan in both the numerator and denominator of the Top-Heavy Ratio are increased for any distribution of an accrued benefit made in the five (5) year period ending on the Determination Date. (iii) for purposes of paragraphs (i) and (ii) above, the value of Account balances and the present value of accrued benefits shall be determined as of the most recent Valuation Date that falls within or ends with the twelve (12) month period ending on the Determination Date, except as provided in Code Section 416 for the first and second plan years of a defined benefit plan. The Account balances and accrued benefits of a participant (1) who is not a Key Employee but who was a Key Employee in a prior year, or (2) who has not been credited with at least one (1) Hour of Service with any Employer maintaining the Plan at any time during the five (5) year period ending on the Determination Date shall be disregarded. The calculation of the Top-Heavy Ratio, and the extent to which distributions, rollovers, and transfers are taken into account shall be made in accordance with Code Section 416. When aggregating plans the value of Account balances and accrued benefits shall be calculated with reference to the Determination Dates that fall within the same calendar year. The accrued benefit of a Participant other than a Key Employee shall be determined under (1) the method, if any, that uniformly applies for accrual purposes under all defined benefit plans maintained by the Employer, or (2) if there is no such method, as if such benefit accrued not more rapidly than the slowest accrual rate permitted under the fractional rule of Code Section 411(b)(1)(C). (i) Valuation Date. "Valuation Date" means the last day of the Plan Year, as of which Account balances or accrued benefits are valued for purposes of calculating the Top-Heavy Ratio. 14.3 MINIMUM ALLOCATION. (a) Except as otherwise provided in paragraphs (b) and (c) below, in any Plan Year that this Plan is Top-Heavy, Employer Contributions (other than Salary Deferral Contributions and Employer Matching Contributions included in the ADP, ACP and multiple use tests described in Sections 5.5 and 5.7) allocated to the Accounts of each Participant who is a Non-Key Employee, shall be not less than the lesser of (i) three percent (3%) of the Non-Key Employee's Section 415 Compensation, or (ii) in the case where the Employer has no defined benefit plan which designates this Plan to satisfy Code Section 401, the largest percentage of Contributions and forfeitures (if applicable), as a percentage of the first One Hundred Sixty Thousand Dollars ($160,000) (as adjusted by the Adjustment Factor) of Section 415 Compensation, allocated on behalf of any Key Employee for that Plan Year. The minimum allocation shall be determined without regard to any Social Security contribution. This minimum contribution shall be made even though, under other -61- EXHIBIT NO. 10.1 provisions of this Plan, the Participant would not otherwise be entitled to receive an allocation or would have received a lesser allocation for the Plan Year because of (i) the Participant's failure to complete one thousand (1,000) Hours of Service (or any equivalent provided in the Plan) or (ii) Section 415 Compensation less than a stated amount. (b) The provisions in paragraph (a) above shall not apply to any Participant who was not employed by the Employer on the last day of the Plan Year. (c) The provisions in paragraph (a) above shall not apply to any Participant to the extent the Participant is covered under any other plan or plans of the Employer if that Participant received the minimum allocation under one of the other plans. If the Participant did not receive the minimum allocation under this Plan or any other plan, the Participant shall receive the minimum under the Company's Employee Stock Ownership Plan, rather than this Plan. (d) The minimum allocation required (to the extent required to be nonforfeitable under Code Section 416(b)) may not be forfeited under Code Section 411(a)(3)(B) or (D). 14.4 VESTING SCHEDULE. (a) If the vesting schedule for Matching and Discretionary Contributions in Section 6.1 results in vesting which is slower, in any respect, than the vesting schedule set forth below, then for any Plan Year in which the Plan is Top-Heavy, the following vesting schedule shall apply to any such Matching and/or Discretionary Contributions made for that Plan Year to the extent it is better than the vesting schedule otherwise applicable to the Participant:
Years of Service Vested Percentage ---------------- ----------------- Less than 1 year 0% 1 but less than 2 10% 2 but less than 3 20% 3 but less than 4 40% 4 but less than 5 60% 5 but less than 6 80% 6 years or more 100%
(b) The minimum vesting schedule applies to all benefits accrued within the meaning of Code Section 411(a)(7) except those attributable to Employee contributions, including benefits accrued before the effective date of Code Section 416 and benefits before the Plan became Top-Heavy. Further, no decrease in a Participant's nonforfeitable percentage may occur in the event the Plan's status as Top-Heavy changes for any Plan Year. However, this Section does not apply to the Account balances of any Employee who does not have an Hour of Service after the Plan has initially become Top-Heavy and such Employee's Account balance attributable to Employer Contributions and forfeitures will be determined without regard to this Section. -62- EXHIBIT NO. 10.1 ARTICLE XV MISCELLANEOUS 15.1 LEGAL OR EQUITABLE ACTION. If any legal or equitable action with respect to the Plan is brought by or maintained against any person, and the results of such action are adverse to that person, attorney's fees and all other direct and indirect expenses and costs incurred by the Employer, the Administrator, the Committee, the Trustee or the Trust for defending or bringing such action shall, to the extent permitted by law, be charged against the interest, if any, of such person under the Plan. 15.2 INDEMNIFICATION. The Company indemnifies and holds harmless the Administrator and each member of the Committee, from and against any and all liabilities, demands, claims, losses, taxes, expenses, including reasonable attorney's fees, both direct and indirect, arising by reason of any action, inaction or conduct in their official capacity in the administration of this Plan or Trust or both, including all expenses reasonably incurred in their defense, if the Employer fails to provide such defense; provided, however, that the Administrator or the Committee member shall not be indemnified and held harmless if his or her action, inaction or conduct arises from his or her gross negligence or willful misconduct, or otherwise in willful violation of the law. The indemnification provisions of this Section shall not relieve the Administrator or any member of the Committee from any liability such person may have under ERISA for breach of a fiduciary duty. 15.3 NO ENLARGEMENT OF PLAN RIGHTS. It is a condition of the Plan, and each Participant by participating herein expressly agrees, that he or she shall look solely to the assets of the Trust for the payment of any benefit under the Plan. 15.4 NO ENLARGEMENT OF EMPLOYMENT RIGHTS. Nothing appearing in or done pursuant to the Plan shall be construed to give any person a legal or equitable right or interest in the assets of the Trust or distribution therefrom, nor against the Employer, except as expressly provided herein, or to create or modify any contract of employment between the Employer and any Employee or to obligate the Employer to continue the services of any Employee. 15.5 INTERPRETATION. The headings contained in this Plan and in the table of contents to the Plan are for reference purposes only, and if they conflict with the text, the text shall control The masculine pronoun shall include the feminine pronoun and the singular the plural, where the context so indicates. -63- EXHIBIT NO. 10.1 15.6 APPLICABLE LAW. This Plan shall be construed, administered and governed in all respects in accordance with ERISA, the Code and other pertinent Federal laws and in accordance with the laws of the State of California (irrespective of the choice of law principles of the State of California as to all matters) to the extent not preempted by ERISA; provided, however, that if any provision is susceptible to more than one interpretation, such interpretation shall be given thereto as is consistent with the Plan being a tax-qualified plan and related trust under Code Sections 401(a) and 501(a). 15.7 NON-ALIENATION OF BENEFITS. Except as otherwise provided by law, no person entitled to any benefits under the Plan shall have the right to alienate, hypothecate or encumber his or her interest in such benefits and such benefits shall not in any way be subject to the claims of his or her creditors or liable to attachment, execution or other process of law. The preceding sentence shall not apply to (a) federal tax levies and executions on federal tax judgments, (b) payments made from the Accounts of a Participant in satisfaction of the rights of Alternate Payees pursuant to a Qualified Domestic Relations Order under Section 7.3, (c) enforcement of any security interests or offset rights applicable to the Account of a Participant pursuant to the loan provisions of Section 6.13), or (d) any amount that the Participant is ordered or required to pay under a judgment, order, decree or settlement described in ERISA Section 206(d)(4). 15.8 NO REVERSION. Notwithstanding any other provision of the Plan, no part of the assets in the Trust shall revert to the Employer, and no part of such assets, other than that amount required to pay taxes or reasonable administrative expenses of the Plan, shall be used for any purpose other than exclusive benefit of Employees or their Beneficiaries. However, the Employer may request a return, and the Plan shall make such return, of an amount to the Employer under any of the following circumstances: (a) If the amount was all or part of an Employer Contribution which was made as a result of a mistake of fact and the amount contributed is returned to the Employer within one (1) year after the date on which the mistaken payment of the contribution was made; or (b) All Employer Contributions are conditioned on deductibility under Code Section 404. If this condition is not satisfied, the amount shall be returned to the Employer within one (1) year after the date on which the deduction is disallowed. 15.9 CONFLICT. In the event of any conflict between the provisions of this Plan and the terms of any contract or agreement issued thereunder or with respect thereto, the provisions of the Plan shall control. -64- EXHIBIT NO. 10.1 15.10 SEVERABILITY. If any provision of the Plan, or the application thereof to any person or circumstance, is deemed invalid or unenforceable by a court of competent jurisdiction, then the remainder of this Plan, or the application of such term or provision to persons or circumstances other than those as to whom it is held invalid or unenforceable, shall not be affected thereby, and each provision of the Plan shall be valid and enforceable to the fullest extent permitted by law. 15.11 CONDITIONAL RESTATEMENT. This Plan (and related Trust) is restated on the express condition that it shall be considered by the Internal Revenue Service as continuing to qualify under Code Sections 401(a), 401(k), 401(m) and 501(a). In the event that the Internal Revenue Service determines that the Plan does not continue to qualify under the Code, then the restatement of the Plan shall be of no effect. The Board or an authorized officer of the Company may, however (but shall not be required to do so), make any retroactive amendments to the Plan, as so restated, which the Internal Revenue Service may require as a condition for its determination that the Plan continues to qualify under Code Sections 401(a), 401(k), 401(m) and 501(a). -65- EXHIBIT NO. 10.1 IN WITNESS WHEREOF, this document is executed on ____________________, 2001. FREMONT GENERAL CORPORATION By: ___________________________________ Its: ___________________________________ -66- APPENDIX A FORM OF BENEFIT DISTRIBUTIONS FOR CERTAIN INDIVIDUALS The provisions of this Appendix A shall apply only to those Participants specified in Appendix B (or any other Appendix that makes appropriate reference to this Appendix A) and, shall govern distributions made to those Participants (or their surviving Spouses or Beneficiaries) from Accounts maintained on their behalf under the Plan and referred to in such Appendices. Except for Participants specified in the Appendices, no other Participants (or surviving spouses or Beneficiaries thereof) shall be entitled to any of the benefit distribution forms provided under this Appendix A. Except as expressly provided in this Appendix and all subsequent Appendices, the provisions of this Plan, including but not limited to Article VI thereof, shall govern distributions made to such Participants (or their surviving Spouses or Beneficiaries). Notwithstanding any provision of this Appendix A to the contrary, (1) Sections A.2, A.4-A.6 (other than Section A.6(a)) and A.7 shall not apply if the Participant has never elected an annuity option, and (2) this Appendix A shall cease to apply November 1, 2001. However, if a Participant elected an annuity option prior to November 1, 2001, this Appendix A shall continue to be in effect, but the Participant may not elect a benefit option in Section A.3(b) or (d). A.1 DEFINITIONS. For purposes of applying the provisions of this Appendix "A" and the subsequent Appendices, as applicable, the following definitions shall be in effect: (a) Annuity Contract. "Annuity Contract" means a paid-up, non-transferable annuity contract issued by an insurance company qualified to do business in the State of California. Any annuity benefits to which a Participant (or his or her surviving Spouse or Beneficiary) is entitled under this Plan shall be provided under an Annuity Contract purchased by the Administrator with the balance credited to the Participant's Accounts at the time of such purchase. The amount of such monthly benefit shall be determined in accordance with the annuity purchase rates in effect at the time for the Annuity Contract. The purchase of the Annuity Contract shall be effected immediately prior to the date benefits are to commence under the Plan, and the purchased Annuity Contract shall be distributed to the Participant as soon as administratively practicable. (b) Annuity Starting Date. "Annuity Starting Date" means the first day of the first period for which an amount is payable as an annuity or, in the case of a benefit not payable in the form of an annuity, the first day on which all the events have occurred which entitle the Participant to such benefit. (c) Joint and Last Survivor Life Expectancy. "Joint and Last Survivor Life Expectancy" shall have the meaning assigned to such term in Section 6.9(d)(iii). (d) Life Expectancy. "Life Expectancy," for purposes of this Appendix, means the life expectancy calculated for the Participant or his or her surviving Spouse in accordance with the expected return multiples in Tables V and VI of Regulation Section 1.72-9. Unless otherwise A-1 EXHIBIT NO. 10.1 elected by the Participant (or, if applicable, his/her Spouse) prior to the time the distribution of benefits is required to begin under the Plan, life expectancies shall be recalculated annually. Such election shall be irrevocable as to the Participant (or his/her Spouse) and shall apply to all subsequent years. However, the life expectancy of a non-spouse Beneficiary shall not be recalculated. (e) Qualified Joint and 50% Survivor Annuity. "Qualified Joint and 50% Survivor Annuity" means an immediate annuity for the life of the Participant with a survivor annuity for the remaining life of the surviving Spouse equal to fifty percent (50%) of the annuity payable during the joint lives of the Participant and his/her Spouse. Such annuity shall be the actuarial equivalent of the balance credited to the Participant's Accounts at the time the Annuity Contract is purchased. (f) Qualified Joint and 100% Survivor Annuity. "Qualified Joint and 100% Survivor Annuity" means an immediate annuity for the life of the Participant with a survivor annuity for the remaining life of the surviving Spouse equal to one hundred percent (100%) of the annuity payable during the joint lives of the Participant and his/her Spouse. Such annuity shall be the actuarial equivalent of the balance credited to the Participant's Accounts at the time the Annuity Contract is purchased. (g) Qualified Preretirement Survivor Annuity. "Qualified Preretirement Survivor Annuity" means an annuity for the life of the surviving Spouse of a Participant who dies before his or her Annuity Starting Date which is the actuarial equivalent of the balance credited to the Participant's Accounts at the time the Annuity Contract is purchased. (h) Required Beginning Date. "Required Beginning Date" shall have the meaning assigned to such term in Section 6.9(b). (i) Normal Retirement Age. "Normal Retirement Age" means the age specified in this Plan. (j) Straight Life Annuity. "Straight Life Annuity" means an annuity payable for the life of the Participant which is the actuarial equivalent of the balance credited to the Participant's Accounts at the time the Annuity Contract is purchased. (k) Term Certain Annuity. "Term Certain Annuity" means payments, no less frequently than annually, for a specified period as determined by the Participant, not to extend beyond the life or the life expectancy of the Participant or the Life Expectancy of the Participant and his or her Beneficiary. If based on the life of the Participant, upon the death of the Participant prior to the end of the period specified by the Participant, such payments shall continue to the Participant's Beneficiary for the remainder of the specified period. A-2 EXHIBIT NO. 10.1 A.2 AUTOMATIC FORM OF BENEFIT. If a Participant has never elected an annuity option, the rules in this Section A.2 shall not apply. If a Participant elects or has previously elected an annuity option, the following rules apply: (a) The automatic form of benefit for any Participant who is married on his/her Annuity Starting Date shall be the Qualified Joint and 50% Survivor Annuity. (b) The automatic form of benefit for any Participant who is not married on his/her Annuity Starting Date shall be the Straight Life Annuity. (c) The automatic form of benefit for any married Participant who dies before his or her Annuity Starting Date shall be the Qualified Preretirement Survivor Annuity. The surviving Spouse may elect to have such benefit commence at any time prior to the date the Participant would have attained age seventy and one-half (70 1/2) and may also elect to receive the actuarial equivalent of such benefit in any of the optional forms specified in Section A.3 below. (d) The automatic form of benefit for any unmarried Participant who dies before his or her Annuity Starting Date shall be a distribution of his or her Accounts to his or her Beneficiary in a lump-sum. The Beneficiary may, however, elect any of the optional forms specified in Section A.3 below. However, if the balance credited to the Participant's Accounts at the time distribution is to commence does not exceed Five Thousand Dollars ($5,000), then the vested balance of those Accounts shall be paid to the Participant in one (1) lump sum payment. A.3 OPTIONAL FORMS OF BENEFIT. In lieu of the automatic form of benefit provided under the Plan or Section A.2 above, the Participant may, subject to the requirements of Sections A.4 through A.6, if applicable, elect to receive the benefit distribution in any of the following optional forms: (a) Single lump sum payment; (b) Term Certain Annuity; (c) Qualified Joint and 100% Survivor Annuity; or (d) Monthly, quarterly, semi-annual or annual installments over the Joint and Last Survivor Life Expectancy of the Participant and his or her Beneficiary, determined as of the benefit commencement date. The amount to be distributed in each installment shall be determined by dividing the unpaid balance of the Participant's Accounts at the time of distribution by the remaining number of installments (including the current installment) to be paid over the designated period. (e) The forms set forth in Section A.2(a), (b) or (d) shall not be considered annuity options. A-3 EXHIBIT NO. 10.1 A.4 QUALIFIED JOINT AND 50% SURVIVOR ANNUITY. (a) Written Explanation. If the balance credited to the Participant's Accounts at the time distribution is to commence exceeds Five Thousand Dollars ($5,000), then the Administrator shall furnish to the Participant and his or her Spouse a written explanation of the following: (i) the terms and conditions of the Qualified Joint and 50% Survivor Annuity, including the circumstances under which it will be provided; (ii) the Participant's right to make, and the effect of, an election to waive the Qualified Joint and 50% Survivor Annuity; (iii) the rights of the Spouse with respect to such election, including the Spouse's right to limit his or her consent to a specific Beneficiary or a specific form of benefit; and (iv) the right to revoke an election and the effect of such a revocation. The Administrator shall furnish the written explanation by a method reasonably calculated to reach the attention of the Participant no less than thirty (30) days and no more than ninety (90) days before the Annuity Starting Date. (b) Request for Additional Information. After the written explanation of the Qualified Joint and 50% Survivor Annuity is given, a Participant or his or her Spouse may make a written request for additional information. Upon receipt of the written request for additional information, the Administrator shall provide a written explanation in nontechnical language which will explain the terms and conditions of the Qualified Joint and 50% Survivor Annuity and the financial effect upon the Participant's benefit (in terms of dollars per benefit payment) of electing not to have benefits distributed in accordance with the Qualified Joint and 50% Survivor Annuity. The written explanation must be personally delivered or mailed (first class mail, postage prepaid) to the Participant and his/her Spouse within thirty (30) days after the date of the written request. The Administrator does not need to comply with more than one such request by a Participant or his or her Spouse. (c) Election to Waive Qualified Joint and 50% Survivor Annuity. An election to waive the Qualified Joint and 50% Survivor Annuity may not be made by the Participant (and if the Participant is married on his or her Annuity Starting Date, the Participant's Spouse (or, if either the Participant or the Spouse has died, the survivor)) before the date he or she is provided with notice of the ability to waive the Qualified Joint and 50% Survivor Annuity. A Participant's (and, if applicable, his or her Spouse) election to waive the Qualified Joint and 50% Survivor Annuity can be made during the ninety (90)-day period ending on the Annuity Starting Date. Spousal consent shall be in the form and manner prescribed in Section A.6(c). A.5 QUALIFIED PRERETIREMENT SURVIVOR ANNUITY. (a) Written Explanation. The Administrator shall furnish to the Participant a written explanation of the following: (i) the terms and conditions of the Qualified Preretirement Survivor Annuity, including the circumstances under which it will be provided; (ii) the Participant's right to make, and the effect of, an election to waive the Qualified Preretirement Survivor Annuity; (iii) the rights of the Spouse with respect to such election, including the Spouse's right to limit his/her consent only to a specific Beneficiary; and (iv) the right to make, and the effect of a revocation of an existing election. The Administrator shall furnish the written explanation by a A-4 EXHIBIT NO. 10.1 method reasonably calculated to reach the attention of the Participant within the applicable period. The applicable period for a Participant is whichever of the following periods ends last: (i) the period beginning one (1) year before the date the individual becomes a Participant and ending one (1) year after such date; or (ii) the period beginning one (1) year before the date the Participant's Spouse is first entitled to a Qualified Preretirement Survivor Annuity and ending one (1) year after such date. If such notice is given before the period beginning with the first day of the Plan Year in which the Participant attains age thirty-two (32) and ending with the close of the Plan Year preceding the Plan Year in which the Participant attains age thirty-five (35), an additional notice shall be given within such period. If a Participant ceases to be an Employee before attaining age thirty-five (35), an additional notice shall be given within the period beginning one (1) year before the date the Participant ceases to be an Employee and ending one (1) year after such date. (b) Request for Additional Information. After the written explanation of the Qualified Preretirement Survivor Annuity is given, a Participant or his or her Spouse may make a written request for additional information. Upon receipt of a timely request for additional information, the Administrator shall provide a written explanation in nontechnical language which will explain the terms and conditions of the Qualified Preretirement Survivor Annuity and the financial effect upon the Spouse's benefit (in terms of dollars per benefit payment) of electing not to have benefits distributed in accordance with the Qualified Preretirement Survivor Annuity. The written explanation must be personally delivered or mailed (first class mail, postage prepaid) to the Participant or his or her Spouse within thirty (30) days from the date of the written request. The Administrator does not need to comply with more than one such request by a Participant or his or her Spouse. (c) Election to Waive Qualified Preretirement Survivor Annuity. An election to waive the Qualified Preretirement Survivor Annuity may not be made by the Participant before the date he or she is provided with the notice of the ability to waive the Qualified Preretirement Survivor Annuity. A Participant's election to waive the Qualified Preretirement Survivor Annuity which is made before the first day of the Plan Year in which he or she reaches age thirty-five (35) shall become invalid on such date. However, an election made by a Participant after he or she ceases to be an Employee will not become invalid on the first day of the Plan Year in which he or she reaches age thirty-five (35) with respect to death benefits payable from that part of his or her Accounts attributable to Contributions made before he or she ceased Employee status. If a Survivor Annuity is waived, a lump sum shall be paid to the Participant's Beneficiary. A.6 ELECTION OF OPTIONAL FORMS OF BENEFIT. (a) Written Explanation. If the balance credited to the Participant's Accounts at the time distribution is to commence exceeds Five Thousand Dollars ($5,000), then the Administrator shall furnish to the Participant and his or her Spouse a written explanation of the A-5 EXHIBIT NO. 10.1 optional forms of retirement benefit provided under the Plan, including (without limitation): (i) the material features and relative values of each automatic and optional form, and (ii) the right of the Participant and his/her Spouse to defer distribution until the benefit is no longer immediately distributable. (b) Election. The Administrator shall furnish the written explanation by a method reasonably calculated to reach the attention of the Participant no less than thirty (30) days and no more than ninety (90) days before the Annuity Starting Date. If the Participant should, after having received the written explanation of the Qualified Joint and 50% Survivor Annuity, affirmatively elect a form of distribution other than the Qualified Joint and 50% Survivor Annuity or the Qualified Preretirement Survivor Annuity, then the election shall be valid only if the consent requirements of Section A.6(c) are met. (c) Consent. (i) Requirement of Consent. Any benefit which is immediately distributable or payable in a form other than a Qualified Joint and 50% Survivor Annuity or a Qualified Preretirement Survivor Annuity requires the written consent of the Participant and his other Spouse prior to distribution. Spousal consent will not be required if the Participant establishes to the satisfaction of the Administrator that the consent of the Spouse cannot be obtained because there is no Spouse or the Spouse cannot be located. Neither the consent of the Participant nor the Participant's Spouse shall be required to the extent that a distribution is required to satisfy Code Section 401(a)(9) or 415. A benefit is immediately distributable if any part of the benefit could be distributed to the Participant (or surviving Spouse) before the Participant attains (or would have attained if not deceased) Retirement Age or, if later, age sixty-two (62). (ii) Form of Consent. The consent of the Participant and, if applicable his or her Spouse must be made in writing and witnessed by a Plan representative or notary public. In the event the Spouse elects to waive the Qualified Joint and 50% Survivor Annuity, the Spouse shall have the right to limit such consent only to a specific Beneficiary or a specific form of distribution. The Spouse can relinquish one or both of those rights. In the event the Spouse elects to waive the Qualified Preretirement Survivor Annuity, the Spouse shall also have the right to limit such consent only to a specific Beneficiary but can relinquish that right. In each instance, the Spouse's consent must acknowledge the effect of the waiver, including: (A) the Spouse had the right to limit his/her consent only to a specific Beneficiary or, if applicable, to a specific form of benefit; (B) the Spouse voluntarily relinquished one or both of those rights; and (C) the Spouse understands the effect such consent has upon the benefits which would otherwise be payable to him or her under the automatic forms of benefit in effect under the Plan. Unless the consent of the Spouse expressly permits designations by the Participant without a requirement of further consent by that Spouse, the Spouse's consent shall be limited to the form of benefit, if applicable, and the Beneficiary or Beneficiaries named in the election. A Spouse's consent shall not be valid with respect to any other Spouse. A Participant may revoke the prior election without his/her Spouse's consent. However, any new election to receive a distribution in any form other than in an automatic form, as specified in Section B.2, will require spousal consent unless the Spouse's consent expressly permits such election by the A-6 EXHIBIT NO. 10.1 Participant without further consent by that Spouse. The Spouse's consent may be revoked at any time within the Participant's election period. (iii) Timing of Consent. The consent of the Participant or his or her Spouse to a benefit which is immediately distributable must not be made before the date the Participant and his or her Spouse are provided with the notice of the ability to defer the distribution and the explanation of the optional benefit forms. Not less than thirty (30) days nor more than ninety (90) days prior to the date specified for distribution, the Participant (and, if applicable, his or her Spouse) shall be provided with written information relating to his or her right to defer such distribution in accordance with the guidelines set forth in this Appendix. A.7 SPECIAL PAYMENT DATE. The Participant may elect an Annuity Starting Date which is less than thirty (30) days after the written explanation under Sections B.4 and B.6 is furnished to the Participant and his/her Spouse, provided the following requirements are met: (i) the Administrator provides information to the Participant clearly indicating that the Participant has a right to at least a thirty (30)-day period in which to consider whether to waive the Qualified Joint and 50% Survivor Annuity and consent to another form of distribution; (ii) the Participant is permitted to revoke an affirmative distribution election at least until the Annuity Starting Date or, if later, at any time prior to the expiration of the seven (7) day period beginning with the day after the explanation of the Qualified Joint and 50% Survivor Annuity is provided to the Participant; (iii) the Annuity Starting Date must be a date after the date that the explanation is provided to the Participant, but may be a date before the date that an affirmative distribution election is made by the Participant; and (iv) the distribution must not actually commence before the expiration of the foregoing seven (7)-day period. A.8 TIMING OF DEATH DISTRIBUTION. Distribution shall generally be made at such time and in such manner as set forth in Section 6.4 except as follows: (a) If the Participant dies after distribution of his or her interest has begun on his or her Required Beginning Date, the remaining portion of such interest shall continue to be distributed at least as rapidly as under the method of distribution being used prior to the Participant's death. (b) If the Participant dies before distribution of his or her interest begins on his or her Required Beginning Date, then the election period of the Beneficiary (including the surviving Spouse) shall begin on the date the Participant dies and end on the date benefits to such Beneficiary or Spouse must begin pursuant to the provisions of this Section. Distribution of the Participant's entire interest shall be completed by December 31 of the calendar year containing the fifth (5th) anniversary of the Participant's death, except to the extent that an election is made to receive distributions in accordance with clause (i) or (ii) below: (i) to the extent any portion of the Participant's interest is payable to a Beneficiary, distribution may be made over the life or over a period certain not greater than the Life Expectancy of that Beneficiary, with such distribution to commence on or before December 31 of the calendar year immediately following the calendar year in which the Participant died; or A-7 EXHIBIT NO. 10.1 (ii) to the extent the distribution is to be made to the Participant's surviving Spouse, the date such distribution must begin in accordance with clause (i) above shall not be earlier than the later of: (i) December 31 of the calendar year immediately following the calendar year in which the Participant died, and (ii) December 31 of the calendar year in which the Participant would have attained age seventy and one-half (70 1/2). (c) If the Participant has not made an election by his or her death, the Participant's Beneficiary must elect the method of distribution no later than the earlier of: (i) December 31 of the calendar year in which distributions would be required to begin under this Section, or (ii) December 31 of the calendar year containing the fifth (5th) anniversary of the date of the Participant's death. (d) If the Participant has no Beneficiary, or if the Beneficiary does not elect a method of distribution, distribution of the Participant's entire interest must be completed by December 31 of the calendar year containing the fifth (5th) anniversary of the Participant's death. (e) For purposes of paragraphs (b) and (c) above, if the surviving Spouse dies after the Participant but before payments to such Spouse begin, the provisions of the applicable paragraph (b) or (c) shall be applied as if the surviving Spouse were the Participant. A-8 EXHIBIT NO. 10.1 APPENDIX B MERGER OF PACIFIC COMPENSATION INSURANCE COMPANY [401(K) PLAN] The Pacific Compensation Insurance Company 401(k) Plan (the "Pacific Plan") was merged with and into the Fremont General Corporation and Affiliated Companies Investment Incentive Plan (the "Fremont Plan"), effective on or about March 31, 1991 (the "Pacific Merger Date"). Previously, the retirement plan sponsored by Beaver Insurance Company (the "Beaver Plan") was merged with and into the Pacific Plan, effective as of February 1991 (the "Beaver Merger Date"). The merger of the Pacific Plan and the Fremont Plan was effected in accordance with the following provisions: B.1 TRANSFER OF ACCOUNT BALANCES. The outstanding account balances under the Pacific Plan were transferred to the Fremont Plan through a direct transfer from the trust fund for the Pacific Plan to the Trust Fund for the Fremont Plan effected on the Pacific Merger Date. B.2 AMOUNT OF ACCOUNT BALANCE. The account balance credited to each individual under the Pacific Plan immediately prior to the Merger Date was credited to the account maintained for such individual under the Fremont Plan immediately after the Pacific Merger Date. Accordingly, the account balance maintained under the Fremont Plan for each individual who was a participant in the Pacific Plan on the Merger Date was, immediately after the Pacific Merger Date, credited with a dollar amount equal to that individual's account balance under the Pacific Plan immediately prior to the Pacific Merger Date. B.3 INVESTMENT OF ACCOUNT BALANCE. The account balances transferred from the Pacific Plan to the Fremont Plan were invested in accordance with each Participant's new investment directive. In the absence of such directives, the transferred account balances were invested in such Fund or Funds as the Administrator deemed appropriate, in its sole and absolute discretion. B.4 SERVICE CREDIT. Each Participant in the Fremont Plan, for eligibility and vesting purposes under the Fremont Plan, was credited with all Service credited to such Participant for eligibility and vesting purposes under the Pacific Plan immediately prior to the Pacific Merger Date; provided, however, in order to be entitled to past service credit, a Participant must have been employed by Pacific Compensation Insurance Company as of the Pacific Merger Date. B.5 VESTING SCHEDULE. The following vesting schedules shall apply to each Participant who was hired by Pacific or Beaver prior to the Pacific Merger Date: (a) If a Participant's initial date of hire with Pacific or Beaver was prior to February 1, 1986, the Participant's interest in his or her Matching Contributions Account shall be 100% vested at all times B-1 EXHIBIT NO. 10.1 (b) If a Participant's initial date of hire with Pacific or Beaver was after January 31, 1986 and before December 1, 1988, the Participant's interest in his or her Matching Contributions Account shall be subject to the following vesting Schedule:
Years of Service Vested Percentage ---------------- ----------------- Less than 1 year 0% 1 year but less than 2 years 20% 2 years but less than 3 years 40% 3 years but less than 4 years 60% 4 years but less than 5 years 80% 5 years or more 100%
(c) If a Participant's initial date of hire with Pacific or Beaver was after November 30, 1988, the Participant's interest in his or her Matching Contributions Account shall be subject to the following vesting Schedule:
Years of Service Vested Percentage ---------------- ----------------- Less than 1 year 0% 1 year but less than 2 years 10% 2 years but less than 3 years 20% 3 years but less than 4 years 30% 4 years but less than 5 years 40% 5 years but less than 6 years 60% 6 years but less than 7 years 80% 7 years or more 100%
B.6 PROTECTED BENEFITS. The terms and provisions of the Fremont Plan govern the rights, benefits and entitlements of all Participants and any other individuals with an interest in any outstanding account balance under the surviving Fremont Plan. The terms and provisions of the Pacific Plan, as of the Pacific Merger Date, were extinguished and ceased to have any force or effect. However, any benefits accrued under the Pacific Plan prior to the Pacific Merger Date were, and shall, to the extent those benefits are protected benefits under Code Section 411(d)(6) (the "Protected Benefits"), be preserved under the Fremont Plan and shall not in any way be affected, reduced or eliminated as a result of the merger of the Fremont Plan and the Pacific Plan. Except as outlined in Sections B.7 and B.8, no Protected Benefits exist for Participants who held account balances in the Pacific Plan as of the Pacific Merger Date ("Pacific Participants") which are not included in the Fremont Plan. B.7 BEAVER PROTECTED BENEFITS. The normal form of benefit for Participant account balances in the Beaver Plan as of the Beaver Merger Date ("Beaver Plan Accounts") shall be as specified in Section A.2 of Appendix A. B.8 SPOUSAL CONSENT. All distributions from Beaver Plan Accounts that may be made pursuant to one or more of the distributable events in Sections 6.12 through 6.15 of the Fremont Plan and this Appendix are subject to Appendix A. B-2 EXHIBIT NO. 10.1 APPENDIX C INVESTORS BANCOR The Investors Bancor 401(k) Plan (the "Investors Plan") was merged with and into the Fremont General Corporation and Affiliated Companies Investment Incentive Plan (the "Fremont Plan") effective on or about January 1, 1990. (the "Investors Merger Date"). The merger of the Investors Plan and the Fremont Plan was effected in accordance with the following provisions: C.1 TRANSFER OF ACCOUNT BALANCES. The outstanding account balances under the Investors Plan were transferred to the Fremont Plan through a direct transfer from the trust fund for the Investors Plan to the Trust Fund for the Fremont Plan effected on the Investors Merger Date. C.2 AMOUNT OF ACCOUNT BALANCE. The account balance credited to each individual under the Investors Plan immediately prior to the Investors Merger Date was credited to the Account maintained for such individual under the Fremont Plan immediately after the Investors Merger Date. Accordingly, the account balance maintained under the Fremont Plan for each individual who was a participant in the Investors Plan on the Merger Date was, immediately after the Investors Merger Date, credited with a dollar amount equal to that individual's account balance under the Investors Plan immediately prior to the Investors Merger Date. C.3 INVESTMENT OF ACCOUNT BALANCE. The account balances transferred from the Investors Plan to the Fremont Plan were invested in accordance with each Participant's new investment directive. In the absence of such directives, the transferred account balances were invested in such Fund or Funds as the Administrator deems appropriate, in its sole and absolute discretion. C.4 SERVICE CREDIT. Each Participant in the Fremont Plan shall, for eligibility and vesting purposes under the Fremont Plan, be credited with all Service credited to such Participant for eligibility and vesting purposes under the Investors Plan immediately prior to the Merger Date; provided, however, in order to be entitled to past service credit, a Participant must have been employed by Investors Bancor as of the Investors Merger Date. C.5. VESTING SCHEDULE. The following vesting schedule shall apply to each Participant who was hired by Investors prior to the Investors Merger Date:
Years of Service Vested Percentage ---------------- ----------------- Less than 2 years 0% 2 years but less than 3 years 25% 3 years but less than 4 years 50% 4 years but less than 5 years 75% 5 years or more 100%
C-1 EXHIBIT NO. 10.1 C.6 NO PROTECTED BENEFITS. The terms and provisions of the Fremont Plan shall govern the rights, benefits and entitlements of all Participants and any other individuals who have an interest in any outstanding account balance under the surviving Fremont Plan. The terms and provisions of the Investors Plan shall, as of the Investors Merger Date, be extinguished and cease to have any force or effect. C-2 EXHIBIT NO. 10.1 APPENDIX D CASUALTY INSURANCE COMPANY Certain assets of the Incentive Savings Plan of The Continental Corporation (the "Continental Plan") were transferred, in a trustee-to-trustee transfer, to the Fremont General Corporation and Affiliated Companies Investment Incentive Plan (the "Fremont Plan") on or about February 22, 1995 (the "Continental Transfer Date"). The assets transferred represented account balances for employees of Casualty Insurance Company ("CIC") and its subsidiary, Worker's Compensation Indemnity Company of California ("WCIC") ("Continental Participants"). The transfer of the Continental Plan assets to the Fremont Plan was effected in accordance with the following provisions: D.1 TRANSFER OF ACCOUNT BALANCES. The outstanding account balances under the Continental Plan were transferred to the Fremont Plan through a direct transfer from the trust fund for the Continental Plan to the Trust Fund for the Fremont Plan effected on the Continental Transfer Date. D.2 AMOUNT OF ACCOUNT BALANCE. The account balance credited to each individual under the Continental Plan immediately prior to the Continental Transfer Date was credited to the Account maintained for such individual under the Fremont Plan immediately after the Continental Transfer Date. Accordingly, the account balance maintained under the Fremont Plan for each Continental Participant was, immediately after the Continental Transfer Date, credited with a dollar amount equal to that individual's account balance under the Continental Plan immediately prior to the Continental Transfer Date. D.3 INVESTMENT OF ACCOUNT BALANCE. The account balances transferred from the Continental Plan to the Fremont Plan were invested in accordance with each Continental Participant's new investment directive. In the absence of such directives, the transferred account balances were invested in such Fund or Funds as the Administrator deemed appropriate, in its sole and absolute discretion. D.4 SERVICE CREDIT. Each Continental Participant, for eligibility and vesting purposes under the Fremont Plan, shall be credited with all service credited to such Participant for eligibility and vesting purposes under the Continental Plan immediately prior to the Continental Transfer Date; provided, however, in order to be entitled to past service credit, a Continental Participant must have been employed by CIC, WCIC or The Buckeye Union Insurance Company (former parent company of CIC, referred to as "Buckeye") as of the Continental Transfer Date. D.5 VESTING SCHEDULE: The following vesting schedule shall apply to each Continental Participant who was hired by CIC, WCIC or Buckeye prior to the Continental Transfer Date: D-1 EXHIBIT NO. 10.1
Years of Service Vested Percentage ---------------- ----------------- Less than 1 year 0% 1 but less than 2 years 20% 2 but less than 3 years 40% 3 but less than 4 years 60% 4 but less than 5 years 80% 5 years or more 100%
D.6 PROTECTED BENEFITS. The terms and provisions of the Fremont Plan shall govern the rights, benefits and entitlements of all Participants and any other individuals who have an interest in any outstanding account balance under the surviving Fremont Plan. The terms and provisions of the Continental Plan shall, as of the Continental Transfer Date, with respect to the assets transferred, be extinguished and cease to have any force or effect. However, any benefits accrued under the Continental Plan prior to the Continental Transfer Date shall, to the extent those benefits are protected benefits under Code Section 411(d)(6) (the "Protected Benefits"), be preserved under the Fremont Plan and shall not in any way be affected, reduced or eliminated as a result of the transfer. Except as outlined in Sections D.7, D.8 and D.9, no Protected Benefits exist for Participants who held account balances in the Continental Plan as of the Continental Transfer Date ("Continental Participants") which are not included in the Fremont Plan. D.7 NORMAL RETIREMENT AGE. A Continental Participant employed by CIC, WCIC or Buckeye prior to January 1, 1988 shall become one hundred percent (100%) vested in his or her Employer Matching Contributions Account on attainment of age sixty (60) (the "Continental Plan Normal Retirement Age"). D.8 AFTER-TAX CONTRIBUTIONS. After-tax contribution accounts for Continental Participants transferred to the Fremont Plan shall be maintained and distributed in accordance with the provisions of the Fremont Plan and Section D.9. D.9 SPECIAL WITHDRAWALS. Once in any twelve (12) consecutive month period a Continental Participant may, by written request to the Administrator, withdraw funds from his or her Continental Plan after-tax account and the vested portion of his or her Continental Plan employer contribution account. The minimum withdrawal amount is One Thousand Dollars ($1,000); provided however, that a Continental Participant may request a withdrawal of less than the specified amount if the request is for either (a) the Continental Participant's entire after-tax account, or (b) the Continental Participants entire after tax account and the vested portion of the Continental Participant's employer contribution account. Such withdrawals must be made first, from the Continental Participant's after tax account, until exhausted, and then, from the vested portion of the Continental Participant's employer contribution account. D-2 APPENDIX E INDUSTRIAL INDEMNITY HOLDINGS INC. On or about August 2, 1997 (the "Industrial Transfer Date"), Fremont General Corporation employed certain former employees of Industrial Indemnity Holdings, Inc. ("II") in connection with a corporate transaction. While II participated in The Industrial Plan for the benefit of its employees, there was no plan-to-plan transfer. Direct rollovers were permitted. E.1 SERVICE CREDIT. Each Participant in the Fremont Plan, for eligibility and vesting purposes under the Fremont Plan, shall be credited with all service credited to such Participant for eligibility and vesting purposes under the Industrial Plan immediately prior to the Industrial Transfer Date; provided, however, and except with respect to past service credit granted by the Company or the Administrator on other terms prior to January 1, 1998, in order to be entitled to past service credit, a Participant must have been employed by II as of the Industrial Transfer Date. E.2 PROTECTED BENEFITS. There are no Protected Benefits for Participants who held account balances in the Industrial Plan as of the Industrial Transfer Date. E-1 APPENDIX F UNICARE On or about September 1, 1998 (the "Wellpoint Transfer Date"), Fremont acquired certain employees of Unicare Specialty Services, Inc. in connection with a corporate transaction. While Unicare participated in the Salary Deferral Savings Program of Wellpoint Health Networks, Inc. and/or the Wellpoint Health Networks, Inc. Pension Accumulation Plan (the "Wellpoint Plans"), there was no plan-to-plan transfer. Direct rollovers were permitted. F.1 SERVICE CREDIT. Each Participant in the Fremont Plan, for eligibility and vesting purposes under the Fremont Plan, shall be credited with all service credited to such Participant for eligibility and vesting purposes under the Wellpoint Plans immediately prior to the Wellpoint Transfer Date; provided, however, in order to be entitled to past service credit, a Participant must have been employed by Unicare as of the Wellpoint Transfer Date. F.2 VESTING SCHEDULE. There are no Protected Benefits for Participants who held account balances in the Wellpoint Plans as of the Wellpoint Transfer Date. F-1 EXHIBIT A ANNUAL ADDITION LIMITS Section 5.4 of the Plan shall be construed in accordance with this Exhibit A. Unless the context clearly requires otherwise, words and phrases used in this Exhibit A shall have the same meanings that are assigned to them under the Plan. A.1 DEFINITIONS. As used in this Exhibit A, the following terms shall have the meanings specified below. "Annual Additions" shall mean the sum credited to a Participant's Accounts for any Plan Year of (i) Company contributions, (ii) voluntary contributions, (iii) forfeitures, (iv) amounts credited after March 31, 1984 to an individual medical account, as defined in Section 415(l)(2) of the Code which is part of a defined benefit plan maintained by the Company, and (v) amounts derived from contributions paid or accrued after December 31, 1985, in taxable years ending after such date, which are attributable to post-retirement medical benefits allocated to the separate account required with respect to a Key Employee (as defined in Section 14.2(c) of the Plan) under a welfare benefit plan (as defined in Section 419(e) of the Code) maintained by the Company. "Defined Contribution Plan" means a plan described in Section 414(i) and 414(k)(2) of the Code. A.2 ANNUAL ADDITION LIMITATIONS. (a) In the event that contributions that would otherwise be contributed or allocated to the Participant's Accounts under this Plan or other Defined Contribution Plans would cause the Annual Additions for the Limitation Year to exceed the limits of Section 5.4, then the amount contributed or allocated shall be reduced so that the Annual Additions for the Limitation Year equal the limit in Section 5.4. In the event the limitations of Section 5.4 of the Plan are exceeded and the conditions specified in Treasury Regulations Section 1.415-6(b)(6) are met, then the Annual Additions to the accounts of a Participant that exceed the limitations of Section 5.4 shall be reduced in the following priority: (i) First, any Salary Deferral Contributions (including, if applicable, the gains thereon) made on the Participant's behalf which were not the subject of any Employer Matching Contributions shall be distributed to the Participant as a current cash payment, subject to applicable Federal and state withholding taxes; (ii) Then, any Salary Deferral Contributions (including, if applicable, the gains thereon) made on the Participant's behalf which were entitled to Employer Matching Contributions shall be distributed to the Participant as a current cash payment, subject to applicable Federal and state withholding taxes, and no Employer Matching Contributions shall be made with respect to the distributed Salary Deferral Contributions. Accordingly, the Participant's Employer Matching Contributions for such Plan Year are to be reduced as follows: Exhibit A-1 (A) To the extent the Employer Matching Contributions have not already been made to the Plan on the Participant's behalf, the reduction shall be effected by making an appropriate reduction in the aggregate amount of Employer Matching Contributions required for such Plan Year to take into account the distributed Salary Deferral Contributions no longer eligible for Employer Matching Contributions; or (B) To the extent the Employer Matching Contributions have already been allocated to the Participant's Employer Matching Contributions Account for the Plan Year coincident with such Limitation Year, then such Employer Matching Contributions (to the extent attributable to the distributed Salary Deferral Contributions) shall, together with the earnings thereon (if applicable), be withdrawn from the Participant's Employer Matching Contributions Account and reapplied to the satisfaction of any Employer Matching Contributions still to be made on behalf of other Participants eligible for Employer Matching Contributions for such Plan Year. Any Employer Matching Contributions withdrawn from the Participant's Employer Matching Contributions Account and not so reapplied shall be held unallocated in a suspense account and shall be used to reduce future Contributions for each succeeding Plan Year until the suspense account is reduced to zero (0). No profits or losses attributable to the assets of the Trust shall be allocated to the suspense account, nor shall any Contributions to the Plan (other than Salary Deferral Contributions) be made by the Employer while there is an outstanding balance in such suspense account. Upon the termination of the Plan, any outstanding balance in the suspense account shall revert to the Employer or, if applicable, the Participating Employer who made such Employer Matching Contributions to the Trust; (b) If any Company or any Affiliated Company contributes amounts, on behalf of Participants covered by the Plan, to other Defined Contribution Plans, the limitation on Annual Additions shall be applied to Annual Additions in the aggregate to the Plan and such other plans. Reduction of Annual Additions, where required, shall be accomplished by first reducing the Participant's allocable share of contributions and forfeitures under the other Defined Contribution Plan in accordance with the applicable provisions of such other plan and then, if necessary, taking the actions in subsection (a) above. (c) The compensation limitation of Section 5.4 of the Plan shall not apply to any contribution for medical benefits (within the meaning of Section 419A(f)(2)) after separation from service which is treated as an Annual Addition. Exhibit A-2 AMENDMENT NUMBER ONE TO THE FREMONT GENERAL CORPORATION INVESTMENT INCENTIVE PLAN (2000 RESTATEMENT) Effective as of January 1, 2000, the Fremont General Corporation Investment Incentive Plan (the "Plan") is amended to provide that: FIRST: Section 2.20 is amended in its entirety to provide as follows: "2.20 SECTION 415 COMPENSATION (a) `Section 415 Compensation' means all of an Employee's W-2 wages as defined in Code Section 3401(a) for the purposes of income tax withholding at the source but determined without regard to any rules that limit the remuneration included in wages based on the nature or location of the employment or the services performed (such as the exception for agricultural labor in Code Section 3401(a)(2)). Section 415 Compensation includes any elective deferrals (as defined in Code Section 402(g)(3)), and any amount contributed or deferred by the Employer at the election of the Employee and not includable in the gross income of the Employee by reason of Code Section 125, 457, or, effective January 1, 2001, 132(f)(4). Section 415 Compensation does not include any deferrals under a nonqualified deferred compensation plan or supplemental executive retirement plan. (b) For purposes of this Section, Compensation for a limitation year is the Compensation defined in subsection (a) actually paid or made available to the Employee during the limitation year. (c) This definition of Section 415 Compensation shall be applicable effective as of January 1, 1998." SECOND: The following new sentence is added at the end of Section 6.7(b)(iv): "'Eligible Rollover Distributions' shall not include hardship withdrawals made after December 31, 1998." THIRD: The first sentence of Section 2.15(c) is amended in its entirety to read as follows: "Effective January 1, 1997, a `Leased Employee' shall mean any person who, pursuant to an agreement between the Employer and any other person (`Leasing Organization'), has performed services for the Employer (or for the Employer and related persons determined in accordance with Code Section 414(n)(6)) (`Recipient Employer') on a substantially full-time basis for a period of at least one (1) year and such services are performed under the primary direction or control by the Recipient Employer." FOURTH: The following subsection (d) is added to Section 2.20: "(d) This definition of `Highly Compensated Employee' shall be effective for Plan Years beginning on or after January 1, 1997, except that for purposes of determining if an Employee was a Highly Compensated Employee in 1997, this definition will be treated as having been in effect in 1996." FIFTH: The effective date for Sections 5.5(a) and 5.7(a) (each regarding prior Plan Year testing) and Section 5.5(b)(iii) is January 1, 1997. SIXTH: Section 5.8(c) is amended in its entirety to provide as follows: "(c) Determination of Amount of Excess Matching Contributions. Effective January 1, 1997, the amount of Excess Matching Contributions for Highly Compensated Employees for a Plan year shall be determined by the following method, to enable the Plan to satisfy the ACP test: (i) The allocations of Employer Matching Contributions of the Highly Compensated Employee with highest dollar amount of Employer Matching Contributions shall be reduced, as necessary, until such Employee's Employer Matching Contributions equal those of the Highly Compensated Employee(s) with the second highest dollar amount of Employer Matching Contributions. (ii) Following the application of paragraph (i), if it is still necessary to reduce Highly Compensated Employees' allocations of Employee Matching Contributions, then the Employer Matching Contributions of Highly Compensated Employees with the highest and second highest dollar amount of Employer Matching Contributions shall be reduced, as necessary, until each affected Employee's Employer Matching Contribution equals that (those) of the Highly Compensated Employee(s) with the third highest dollar amount of Employer Matching Contributions. (iii) Following the application of (ii), if it is still necessary to reduce Highly Compensated Employees' allocations of Employer Matching Contributions, then the procedure, the beginning of which is described in paragraphs (i) and (ii), shall continue until no further reductions are necessary. (iv) Amounts determined pursuant to paragraphs (i) through (iii) shall be combined. The resulting sum shall be the Excess Matching Contributions, and the portion of the total to be allocated to each affected Highly Compensated Employee shall be determined pursuant to paragraph (d) below." Fremont General Corporation Dated: January __, 2002 By:_____________________________________ Raymond G. Meyers Senior Vice President AMENDMENT NUMBER TWO TO THE FREMONT GENERAL CORPORATION INVESTMENT INCENTIVE PLAN (2000 RESTATEMENT) Effective as of January 1, 2002, the Fremont General Corporation Investment Incentive Plan (the "Plan") is amended to provide that: FIRST: Section 6.6(g) is amended in its entirety to provide as follows: "(g) Notwithstanding any provision of the Plan to the contrary, no distribution to a Participant shall be permitted in connection with a termination of employment if Section 401(k) of the Code prohibits a distribution of Salary Deferral Contributions or if Section 401(k) of the Code (as in effect prior to 2002) would have prohibited distribution. See also Section 8.3. In addition, no distribution shall be made to a Participant in connection with a termination of employment due to some type of corporate transaction if the Participant's Accounts are transferred to a tax-qualified plan of the acquiring entity." SECOND: The following new Section 8.3(c) is added: "(c) Notwithstanding anything herein to the contrary, Employees transferred to Cambridge Integrated Service Group, Inc. pursuant to an outsourcing transaction in 2000 or 2001 shall be eligible to take a distribution pursuant to Section 6.6 effective January 1, 2002. Unless and until an individual described in the preceding sentence takes a distribution, he shall continue to vest in his Accounts under the Plan as long as he continues to work for Cambridge Integrated Service Group, Inc. If he is not fully vested and elects to take a distribution, he shall be subject to the terms of Section 6.2." Fremont General Corporation Dated: December __, 2001 By:_____________________________________ Raymond G. Meyers Senior Vice President AMENDMENT NUMBER THREE TO THE FREMONT GENERAL CORPORATION INVESTMENT INCENTIVE PLAN (2000 RESTATEMENT) Effective beginning with the Plan Year 2002, the Fremont General Corporation Investment Incentive Plan (the "Plan") is amended to add the following new Section 4.1(c): "(c) Notwithstanding the foregoing, Participants who are eligible to make Salary Deferral Contributions under this Plan and who have attained age 50 before the close of the Plan Year shall be eligible to make catch-up contributions in accordance with, and subject to the limitations of, Section 414(v) of the Code. Such catch-up contributions shall not be taken into account for purposes of the provisions of the Plan implementing the required limitations of Sections 402(g) and 415 of the Code. The Plan shall not be treated as failing to satisfy the provisions of the Plan implementing the requirements of Section 401(k)(3), 401(k)(11), 401(k)(12), 410(b), or 416 of the Code, as applicable, by reason of making such catch-up contributions." Fremont General Corporation Dated: December __, 2001 By:_____________________________________ Raymond G. Meyers Senior Vice President AMENDMENT NUMBER FOUR TO THE FREMONT GENERAL CORPORATION AND AFFILIATED COMPANIES INVESTMENT INCENTIVE PLAN (2000 RESTATEMENT) WHEREAS, Fremont General Corporation (the "Company") maintains the Fremont General Corporation and Affiliated Companies Investment Incentive Plan (as amended and restated effective as of January 1, 2000 and as subsequently amended) (the "Plan"); and WHEREAS, the Company has the right to amend the Plan; WHEREAS, the Company desires to amend the Plan to reflect certain changes in the law made by the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") and to adopt provisions reflecting final regulations governing minimum required distributions; WHEREAS, the Company desires to amend the Plan to qualify for the safe harbor nondiscrimination provisions of Internal Revenue Code Sections 401(k)(12) and 401(m)(11); NOW, THEREFORE, the Plan is amended, effective as January 1, 2002, except as otherwise provided: FIRST: Section 2.10(b) is amended in its entirety to provide as follows: "(b) The annual Compensation of each Participant taken into account in determining allocations for any Plan Year beginning after December 31, 2001, shall not exceed $200,000, as adjusted for cost-of-living increases in accordance with Section 401(a)(17)(B) of the Code. Annual Compensation means Compensation during the Plan Year or such other consecutive 12-month period over which Compensation is otherwise determined under the Plan (the Determination Period). The cost-of-living adjustment in effect for a calendar year applies to annual Compensation for the Determination Period that begins with or within such calendar year." SECOND: Section 4.1(a) is amended in its entirety as follows: "(a) Subject to the limitations of Section 5.4 and 5.5, each Participant who is an Eligible Employee may elect, in accordance with the procedures established from time to time by the Administrator, to have a portion of his or her Compensation from each payroll period contributed to his or her Salary Deferral Contributions Account. The Participant's election shall specify the amount of his or her Compensation to be contributed (expressed as a whole percentage), which amount shall not be more than fifteen percent (15%) of the Participant's Compensation for the Plan Year; provided, however, in no event shall the dollar amount contributed on behalf of such Participant under this Plan, or any other qualified plan maintained by the Employer during any taxable year, be in excess of the dollar limitation contained in Code Section 402(g) in effect for such taxable year, except to the extent permitted under Section 4.1(c) of the Plan and Code Section 414(v), if applicable." THIRD: Effective January 1, 2003, Section 4.2 is amended in its entirety as follows: "4.2 Employer Matching Contributions (a) Each Participating Employer shall make Employer Matching Contributions to the Trust Fund either in Company Stock or in cash for the Matching Contributions Account of each Participant who has made a salary deferral election. The Employer Matching Contribution for each Participant shall be in the amount of one dollar for every dollar the Participant elects as a Salary Deferral Contribution up to the first 6% of Compensation deferred by the Participant. (b) Employer Matching Contributions which would otherwise be made on behalf of a Participant may be reduced to the extent necessary to comply with the limitations of Sections 4.4, 5.4, 5.5 and 5.7. Any amount that cannot be contributed to the Trust because of these limitations shall be returned by the Employer, and the Employer shall have no obligation to contribute such amount to the Trust." FOURTH: Section 4.6(a) is amended in its entirety to provide as follows: "(a) The Trustee may, with the consent of the Administrator, in its sole and absolute discretion, accept a Rollover Contribution of assets previously held under the following plans: (1) a qualified plan described in Code Section 401(a) or 403(a), excluding after-tax employee contributions; (2) an annuity contract described in Code Section 403(b), excluding after-tax employee contributions; or (3) an eligible plan under Code Section 457(b) which is maintained by a state, political subdivision of a state, or any agency or instrumentality of a state or political subdivision of a state. Additionally, the Trustee may, with the consent of the Administrator, in its sole and absolute discretion, accept a Rollover Contribution of the portion of a distribution from an individual retirement account or annuity described in Code Section 408(a) or 408(b) that is eligible to be rolled over and would otherwise be includible in gross income. The assets may be (i) received from the Employee in the form of an indirect rollover in accordance with Code Section 402(c) or 408(d)(3); or (ii) transferred in the form of a Direct Rollover (as defined in Section 6.7) from another plan. Such amounts shall be held in a Rollover Account." FIFTH: Section 5.4 is amended in its entirety as follows: "5.4 Section 415 Limitations. Notwithstanding anything else contained herein, except to the extent permitted under Section 4.1(c) of the Plan and Section 414(v) of the Code, if applicable, the Annual Additions that may be contributed or allocated to a Participant's Account under the Plan for any limitation year shall not exceed the lesser of: (1) $40,000, as adjusted for increases in the cost-of-living under Code Section 415(d); or (2) 100% of the Participant's Compensation, within the meaning of Code Section 415(c)(3), for the limitation year. The compensation limit referred to in this Section 5.4 shall not apply to any contribution for medical benefits after separation from service (within the meaning of Code Section 401(h) or Section 419A(f)(2)) which is otherwise treated as an Annual Addition." SIXTH: Effective January 1, 2003, the following new Section 5.5(e) is added: "(e) The provisions of this Section 5.5 shall not apply to Plan Years beginning on or after January 1, 2003; the Plan is intended to comply with the safe harbor provisions of Code Section 401(k)(12) on and after such dates." SEVENTH: The following new Section 5.7(b)(viii) is added as follows: "(viii) This Section 5.7(b) shall not apply for Plan Years beginning after December 31, 2001." EIGHTH: Effective January 1, 2003, the following new Section 5.7(d) is added: "(d) The provisions of this Section 5.7 shall not apply to Plan Years beginning on or after January 1, 2003; the Plan is intended to comply with the safe harbor provisions of Code Section 401(m)(11) on and after such dates." NINTH: Effective January 1, 2003, the following new Section 6.1(a)(iv) is added: "(iv) Notwithstanding the foregoing, if a Participant is an Employee at any time on or after January 1, 2003, the Participant's interest in his or her Matching Contributions Account shall be 100% vested." TENTH: The following new Section 6.7(b)(iii)(C) is added as follows: "(C) Effective January 1, 2002, an Eligible Retirement Plan shall also mean an annuity contract described in Code Section 403(b) and an eligible plan under Code Section 457(b) which is maintained by a state, political subdivision of a state, or any agency or instrumentality of a state or political subdivision of a state and which agrees to separately account for amounts transferred into such plan from this Plan. The definition of Eligible Retirement Plan shall also apply in the case of a distribution to a surviving spouse, or to a spouse or former spouse who is the alternate payee under a qualified domestic relation order, as defined in Code Section 414(p)." ELEVENTH: Effective January 1, 2003, Section 6.9(a)(ii) is amended in its entirety to provide as follows: "(ii) All distributions required under this Section 6.9 shall be determined and made in accordance with the Treasury Regulations under Code Section 401(a)(9). Notwithstanding any other provision of this Section 6.9, distributions may be made under a designation made before January 1, 1984, in accordance with Section 242(b)(2) of the Tax Equity and Fiscal Responsibility Act (TEFRA) and the provisions of the Plan that relate to Section 242(b) of TEFRA." TWELFTH: Effective January 1, 2003, Section 6.9(a)(iii) is amended in its entirety to provide as follows: "(iii) If the Participant dies before distribution is made, the Participant's entire interest will be distributed no later than as follows: (A) If the Participant's surviving spouse is the Participant's sole designated Beneficiary, then, except as provided elsewhere in this Section 6.9, distributions to the surviving spouse will be made by December 31 of the calendar year immediately following the calendar year in which the Participant died, or by December 31 of the calendar year in which the Participant would have attained age 70 1/2, if later. (B) If there is no designated Beneficiary as of September 30 of the year following the year of the Participant's death, the Participant's entire interest will be distributed by December 31 of the calendar year containing the fifth anniversary of the Participant's death. (C) If the Participant's surviving spouse is the Participant's sole designated Beneficiary and the surviving spouse dies after the Participant but before distribution to the surviving spouse, this Section 6.9(a)(iii), other than Section 6.9(a)(iii)(A), will apply as if the surviving spouse were the Participant. For purposes of this Section 6.9(a)(iii), unless Section 6.9(a)(iii)(C) applies, distributions are considered to be made on the Participant's Required Beginning Date. If Section 6.9(a)(iii)(C) applies, distributions are considered to be made on the date distributions are required to be made to the surviving spouse under Section 6.9(a)(iii)(A). The individual who is designated as the Beneficiary under Section 2.5 of the Plan is the designated beneficiary under Code Section 401(a)(9) and Section 1.401(a)(9)-4, Q&A-1, of the Treasury Regulations." THIRTEENTH: Effective January 1, 2003, 6.9(d)(ii) is amended in its entirety as follows: "(ii) Required Beginning Date. The Required Beginning Date means April 1 of the calendar year following the later of (a) the calendar year in which the Participant attains age seventy and a half (70 1/2), or (b) the calendar year in which the Employee's Severance Date occurs. In the case of a Participant who is a five percent (5%) owner (as defined in Section 416 of the Code) with respect to the Plan ending in the calendar year in which the Participant turns 70 1/2, the Required Beginning Date shall be April 1 of the calendar year following the calendar year in which the Participant turns 70 1/2." FOURTEENTH: Effective January 1, 2003, the following new Section 6.9(e) is added: "(e) All distributions required under this Section 6.9 will be determined and made in accordance with the Treasury regulations under Code Section 401(a)(9). The requirements of this Section 6.9 will take precedence over any inconsistent provisions of the Plan provided that this Section 6.9 shall not be considered to allow a Participant or Beneficiary to delay a distribution or elect an optional form of benefit not otherwise provided in the Plan." FIFTEENTH: Section 14.2(c) is amended in its entirety to provide as follows: "(c) Key employee. `Key Employee' means any Employee or former Employee (including any deceased Employee) who at any time during the Plan Year that includes the determination date was an officer of the Employer having annual Compensation greater than $130,000 (as adjusted under Code Section 416(i)(1) for Plan Years beginning after December 31, 2002), a 5-percent owner of the Employer, or a 1-percent owner of the Employer having annual Compensation of more than $150,000. For this purpose, annual compensation means compensation within the meaning of Code Section 415(c)(3). The determination of who is a key employee will be made in accordance with Code Section 416(i)(1) and the applicable regulations and other guidance of general applicability issued thereunder." SIXTEENTH: The following new Section 14.2(h)(iv) is added as follows: "(iv) Notwithstanding the foregoing, effective January 1, 2002, this Section 14.2(h)(iv) shall apply for purposes of determining the present values of accrued benefits and the amounts of account balances of Employees as of the determination date. (1) Distributions during year ending on the determination date. The present values of accrued benefits and the amounts of account balances of an Employee as of the determination date shall be increased by the distributions made with respect to the Employee under the Plan and any plan aggregated with the Plan under Code Section 416(g)(2) during the 1-year period ending on the determination date. The preceding sentence shall also apply to distributions under a terminated plan which, had it not been terminated, would have been aggregated with the Plan under Code Section 416(g)(2)(A)(i). In the case of a distribution made for a reason other than separation from service, death, or disability, this provision shall be applied by substituting `5-year period' for `1-year period.' (2) Employees not performing services during year ending on the determination date. The accrued benefits and accounts of any individual who has not performed services for the Employer during the 1-year period ending on the determination date shall not be taken into account." SEVENTEENTH: The following is added at the end of Section 14.3(a): "Notwithstanding the foregoing, Employer Matching Contributions shall be taken into account for purposes of satisfying the minimum contribution requirements of Code Section 416(c)(2) and the Plan. The preceding sentence shall apply with respect to Employer Matching Contributions under the Plan or, if the Plan provides that the minimum contribution requirement shall be met in another plan, such other plan. Employer Matching Contributions that are used to satisfy the minimum contribution requirements shall be treated as matching contributions for purposes of the actual contribution percentage test and other requirements of Section 401(m) of the Code." EIGHTEENTH: The following new Section 14.5 is added: "14.5 Safe Harbor Status. Notwithstanding the foregoing, the top-heavy requirements of Section 416 of the Code and this Article XIV shall not apply in any year beginning after December 31, 2002, in which the Plan consists solely of a cash or deferred arrangement which meets the requirements of Section 401(k)(12) of the Code and matching contributions with respect to which the requirements of Section 401(m)(11) of the Code are met." IN WITNESS WHEREOF, this Amendment Number Four is hereby adopted this ____ day of _________________, 2002. ________________________________________ By______________________________________ AMENDMENT NUMBER FIVE TO THE FREMONT GENERAL CORPORATION AND AFFILIATED COMPANIES INVESTMENT INCENTIVE PLAN (2000 RESTATEMENT) WHEREAS, Fremont General Corporation (the "Company") maintains the Fremont General Corporation and Affiliated Companies Investment Incentive Plan (as amended and restated effective as of January 1, 2000 and as subsequently amended) (the "Plan"); and WHEREAS, the Company has the right to amend the Plan; WHEREAS, the Company desires to amend the Plan to clarify the provisions regarding minor children as beneficiaries under the Plan; NOW, THEREFORE, the Plan is amended as follows: The last sentence of the last paragraph of Section 2.5 is deleted in its entirety. IN WITNESS WHEREOF, this Amendment Number Five is hereby adopted this 1st day of August, 2003. ------------------------ By: Raymond G. Meyers Senior Vice President AMENDMENT NUMBER SIX TO THE FREMONT GENERAL CORPORATION AND AFFILIATED COMPANIES INVESTMENT INCENTIVE PLAN (2000 RESTATEMENT) WHEREAS, Fremont General Corporation (the "Company") maintains the Fremont General Corporation and Affiliated Companies Investment Incentive Plan (as amended and restated effective as of January 1, 2000 and as subsequently amended) (the "Plan"); and WHEREAS, the Company has the right to amend the Plan; WHEREAS, the Company desires to amend the Plan to reflect the Working Families Tax Relief Act of 2004; NOW, THEREFORE, effective January 1, 2005, the Plan is amended as follows: Section 6.12(b)(iii) is amended in its entirety to read as follows: "(iii) payment of tuition and related educational fees for the next twelve (12) months of post-secondary education for the Participant, his or her Spouse, children or dependents (as defined in Code Section 152); or" IN WITNESS WHEREOF, this Amendment Number Six is hereby adopted effective as of January 1, 2005. ------------------------- By: Raymond G. Meyers Senior Vice President AMENDMENT NUMBER SEVEN TO THE FREMONT GENERAL CORPORATION AND AFFILIATED COMPANIES INVESTMENT INCENTIVE PLAN (2000 RESTATEMENT) WHEREAS, Fremont General Corporation (the "Company") maintains the Fremont General Corporation and Affiliated Companies Investment Incentive Plan (as amended and restated effective as of January 1, 2000 and as subsequently amended) (the "Plan"); and WHEREAS, the Company has the right to amend the Plan; WHEREAS, the Company desires to amend the Plan to provide for automatic rollover provisions under Section 401(a)(31)(B) of the Internal Revenue Code; NOW, THEREFORE, effective March 28, 2005, the Plan is amended as follows: FIRST: Section 6.6(b) is amended in its entirety to provide as follows: "(b) Effective for distributions made on or after March 22, 1999, if the Participant's vested Account balance is equal to or less than Five Thousand Dollars ($5,000) at the time of the distribution, then the Participant shall receive a mandatory distribution of the entire vested portion of such Account balance and the nonvested portion shall be treated as a forfeiture. In the event of a mandatory distribution greater than $1,000, in accordance with the provisions of this Section, if the Participant does not elect to have such distribution paid directly to an eligible retirement plan specified by the participant in a direct rollover or to receive the distribution directly, then the Plan Administrator will pay the distribution in a direct rollover to an individual retirement plan designated by the Plan Administrator. In the event the mandatory distribution is equal to or less than $1,000, in accordance with the provisions of this Section, if the Participant does not elect to have such distribution paid directly to an eligible retirement plan specified by the participant in a direct rollover, then the Plan will make such distribution to the Participant directly. Notwithstanding anything herein to the contrary, if a distribution notice sent to a terminated Participant is returned twice to the Plan Administrator or the Trustee as undeliverable, the foregoing distribution procedures shall not apply and the Participant's Account shall remain in the Plan until requested by the Participant or until otherwise determined by the Plan Administrator." SECOND: Section 6.6(c) is amended in its entirety to provide as follows: (c) Effective for distributions made on or after March 22, 1999, if the Participant's vested Account balance exceeds Five Thousand Dollars ($5,000) at the time of distribution, then the Participant must consent prior to the distribution being made. (i) Such consent shall be in writing (or pursuant to electronic media as set forth in Section 9.7) and must be made within the ninety (90)-day period ending on the distribution. If the Participant does not consent to the distribution, the Participant's vested Account balance shall be held in the Trust Fund until the earlier of the date the Participant later consents, the Required Beginning Date or the death of the Participant (if there is a non-spousal Beneficiary). (ii) If a Participant's consent to a distribution is required hereunder, then at least thirty (30) days and not more than ninety (90) days prior to the distribution, the Administrator shall provide the Participant with a notice of the right to elect immediate distribution or the right to defer distribution until the Participant's Normal Retirement Date. However, if a distribution is one for which Code Section 401(a)(11) and 417 do not apply, such distribution may commence less than thirty (30) days after the notice required under Regulation Section 1.411(a)-11(c) is given, provided that: (1) the Administrator clearly informs the Participant that the Participant has a right to a period of at least thirty (31) days after receiving the notice to consider the decision of whether or not to elect a distribution (and, if applicable, a particular distribution option); and (2) the Participant, after receiving the notice, affirmatively elects a distribution and waives the thirty (30)-day period by written notice. THIRD: The following new Section 6.6(h) is added: (h) (i) If (1) a Participant dies before distribution under this Plan; (2) the Participant's Spouse is the Beneficiary; and (3) the Participant's vested Account balance does not exceed Five Thousand Dollars ($5,000) at the time of the distribution, then the Participant's Spouse shall receive a lump sum distribution of the entire vested portion of such Account balance and the nonvested portion shall be treated as a forfeiture. 2 (ii) If (1) a Participant dies before distribution under this Plan; (2) the Participant's Spouse is the Beneficiary; and (3) the Participant's vested Account balance exceeds Five Thousand Dollars ($5,000) at the time of distribution, then, except as otherwise provided in Section 6.9, the Participant's Spouse must consent prior to the distribution being made. Such distribution shall be a lump sum distribution of the entire vested portion of the Participant's Account balance and the nonvested portion shall be treated as a forfeiture. Any consent provided under this section shall be made in accordance with Section 6.6(c). (iii) If (1) a Participant dies before distribution under this Plan and (2) the Participant's Beneficiary is someone other than the Participant's Spouse, then no consent is required and such non-Spousal Beneficiary shall receive a lump sum distribution of the entire vested portion of the Participant's Account balance and the nonvested portion shall be treated as a forfeiture. FOURTH: The following sentence is added to the end of Section 6.8: "Notwithstanding the foregoing, for mandatory distributions described in Section 6.6(b), the entire distribution shall be in the form of cash unless prior to the distribution the Participant makes a timely election to receive the portion of the Account held in Company Stock in kind." IN WITNESS WHEREOF, this Amendment Number Seven is hereby adopted effective as of the date set forth above. By_________________________ Name: Raymond G. Meyers Title: Senior Vice President 3 AMENDMENT NUMBER EIGHT TO THE FREMONT GENERAL CORPORATION AND AFFILIATED COMPANIES INVESTMENT INCENTIVE PLAN (2000 RESTATEMENT) WHEREAS, Fremont General Corporation (the "Company") maintains the Fremont General Corporation and Affiliated Companies Investment Incentive Plan (as amended and restated effective as of January 1, 2000 and as subsequently amended) (the "Plan"); and WHEREAS, the Company has the right to amend the Plan; WHEREAS, the Company desires to amend the Plan to update the provisions concerning hardship distributions due to recent changes in applicable regulations under Section 401(k) of the Internal Revenue Code; NOW, THEREFORE, effective January 1, 2006, the Plan is amended as follows: Section 6.12(b) is amended in its entirety to provide as follows: "(b) An immediate and heavy financial need shall be deemed to include any one or more of the following: (i) expenses for (or necessary to obtain) medical care that would be deductible under Code Section 213(d) (determined without regard to whether the expenses exceed 7.5% of adjusted gross income); (ii) costs directly related to the purchase of a principal residence for the Participant (excluding mortgage payments); (iii) payment of tuition, related educational fees, and room and board expenses, for up to the next twelve (12) months of post-secondary education for the Participant, or the Participant's Spouse, children, or dependents (as defined in Code Section 152, and, for taxable years beginning on or after January 1, 2005, without regard to Code Sections 152(b)(1), (b)(2), and (d)(1)(B)); (iv) payments necessary to prevent the eviction of the Participant from the Participant's principal residence or foreclosure on the mortgage on that residence; (v) payments for burial or funeral expenses for the Participant's deceased parent, Spouse, children, or dependents (as defined in Code Section 152, and, for taxable years beginning on or after January 1, 2005, without regard to Code Section 152(d)(1)(B)); or (vi) expenses for the repair of damage to the Participant's principal residence that would qualify for the casualty deduction under Code Section 165 (determined without regard to whether the loss exceeds 10% of adjusted gross income). In no event may the hardship distribution exceed the amount necessary to satisfy the financial obligations resulting from the hardship, plus any Federal, state, or local income taxes and penalties reasonably anticipated to result from such hardship distribution." IN WITNESS WHEREOF, this Amendment Number Eight is hereby adopted effective as of the date set forth above. By: _________________________ Name: Raymond G. Meyers Title: Senior Vice President Dated: March 21, 2006 2 EX-31 3 q2ex311.txt EXHIBIT 31.1 EXHIBIT 31.1 CERTIFICATIONS I, Louis J. Rampino, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Fremont General Corporation (the "Registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report; 4. The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have: a.) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b.) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c.) Evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d.) Disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter (the Registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and 5. The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the audit committee of the Registrant's board of directors (or persons performing the equivalent functions): a.) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and b.) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. /s/ LOUIS J. RAMPINO ----------------------------------------- Louis J. Rampino President and Chief Executive Officer Date: August 8, 2006 EX-31 4 q2ex312.txt EXHIBIT 31.2 EXHIBIT 31.2 CERTIFICATIONS I, Patrick E. Lamb, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Fremont General Corporation ("the Registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report; 4. The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have: a.) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b.) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c.) Evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d.) Disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter (the Registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and 5. The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the audit committee of the Registrant's board of directors (or persons performing the equivalent functions): a.) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and b.) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. /s/ PATRICK E. LAMB ----------------------------------------- Patrick E. Lamb Senior Vice President, Chief Financial Officer, Chief Accounting Officer and Treasurer (Principal Accounting Officer) Date: August 8, 2006 EX-32 5 q2ex321.txt EXHIBIT 32.1 EXHIBIT 32.1 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The undersigned, Louis J. Rampino, the President and Chief Executive Officer and Patrick E. Lamb, the Senior Vice President, Chief Financial Officer, Chief Accounting Officer and Treasurer of Fremont General Corporation (the "Company"), pursuant to 18 U.S.C. ss.1350, hereby certify that, to the best of our knowledge: (i) the Quarterly Report on Form 10-Q for the period ended June 30, 2006 of the Company (the "Report") fully complies with the requirements of section 13(a) and 15(d) of the Securities Exchange Act of 1934; and (ii) the financial statements and disclosures contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: August 8, 2006 /s/ LOUIS J. RAMPINO ----------------------------------------- Louis J. Rampino, President and Chief Executive Officer /s/ PATRICK E. LAMB ----------------------------------------- Patrick E. Lamb Senior Vice President, Chief Financial Officer, Chief Accounting Officer and Treasurer (Principal Accounting Officer) -----END PRIVACY-ENHANCED MESSAGE-----