SIGNATURE GROUP HOLDINGS, INC. – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations

SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Certain statements in this report, including, without limitation, matters discussed under Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations," should be read in conjunction with the financial statements, related notes, and other detailed information included in Signature Group Holdings, Inc.'s ("Signature," formerly Fremont General Corporation ("Fremont"), or "Company", "we," "us" or "our") Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (the "Annual Report"). We are including this cautionary statement to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Statements that are not historical fact are forward-looking statements. Certain of these forward-looking statements can be identified by the use of words such as "believes," "anticipates," "expects," "intends," "plans," "projects," "estimates," "assumes," "may," "should," "will," or other similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors, which could cause actual results, performance or achievements to differ materially from future results, performance or achievements. These forward-looking statements are based on our current beliefs, intentions and expectations. These statements are not guarantees or indicative of future performance. Important assumptions and other important factors that could cause actual results to differ materially from those forward-looking statements include, but are not limited to, those factors, risks and uncertainties described in the Annual Report under the caption "Risk Factors" and in our other filings with the Securities and Exchange Commission ("SEC").

All forward looking statements set forth herein are qualified by these cautionary statements and are made only as of the date hereof. We undertake no obligation to update or revise the information contained herein, including without limitation any forward-looking statements whether as a result of new information, subsequent events or circumstances, or otherwise, unless otherwise required by law.

OVERVIEW

Signature is a diversified business and financial services enterprise that intends to generate strong, risk-adjusted return on equity while protecting shareholder capital. We presently operate in two primary business lines: (i) Special Situation Lending; and (ii) Strategic Acquisitions, which are more fully discussed herein. In July 2011, we made the first material acquisition in our Strategic Acquisitions business line, acquiring 100% of the common stock of North American Breaker Company, Inc. ("NABCO"), a national market leader in the supply of circuit breakers to wholesale distributors serving various commercial, industrial and residential applications. Additionally, we maintain and are managing certain legacy assets and liabilities related to Fremont's former businesses, which include a portfolio of subprime residential real estate mortgages, residential real estate, commercial real estate investments, litigation claims under fidelity insurance bonds held by Fremont (the "Legacy Assets") and are reported as discontinued operations.

After a nearly two year reorganization process, Fremont emerged from bankruptcy proceedings and filed Amended and Restated Articles of Incorporation with the Office of the Secretary of the State for the State of Nevada on June 11, 2010 (the "Effective Date"), which, among other things, changed Fremont's name to Signature Group Holdings, Inc. Previously, on May 25, 2010, the Bankruptcy Court had entered an order, as amended (the "Confirmation Order"), confirming Signature Group Holdings, LLC's Fourth Amended Chapter 11 Plan of Reorganization of Fremont General Corporation, Joined by James McIntyre as Co-Plan Proponent, dated May 11, 2010, as amended (the "Plan").

During the bankruptcy period, Fremont's operations focused on maximizing the value of its assets, which included the liquidation and sale of certain assets, and minimizing its costs and liabilities through the negotiation and resolution of litigation, loan repurchase claims and other claims. In particular, Fremont managed its remaining residential and commercial loan portfolios, commercial real estate investments and other assets. Accordingly, the Company's results of operations include reorganization items, which are direct costs incurred by Fremont operating as a debtor-in-possession during bankruptcy proceedings. These items include professional fees, trustee fees and other expenses directly related to the bankruptcy filing, gains or losses resulting from activities of the reorganization process offset by interest earned on cash accumulated while in bankruptcy.

Operating Segments. The presentation set forth below in this Management's Discussion and Analysis and in the Company's unaudited consolidated financial statements present the Company's financial condition and results of operations by operating segment. Continuing operations includes our two primary business lines: (i) Special Situation Lending and (ii) Strategic Acquisitions. We have four primary operating segments, Special Situation Lending, Strategic Acquisitions - Distribution, Strategic Acquisitions - Consumer Products and Discontinued Operations.

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Special Situation Lending In our Special Situation Lending business line, we focus on providing senior secured and junior secured debt financing to middle market companies in the form of newly originated commercial and industrial loans, leases, and real estate mortgages in healthy and distressed situations. We also look to acquire similarly structured debt instruments as well as, on occasion, corporate bonds, trade claims, and other structured debt instruments, which may be performing, sub-performing or non-performing. Generally, debt obligations acquired will be made at a discount to par value, or unpaid principal balance.

Strategic Acquisitions In our Strategic Acquisitions business line, we provide capital to middle market companies whereby we obtain a significant equity interest in a company either through the direct purchase of a controlling interest, and in some cases all or substantially all of its equity, or through a structured debt transaction that results in our obtaining a significant equity interest from a debt-for-equity conversion, bankruptcy or foreclosure event, or other transactions. We may also acquire specialized assets such as product or brand licenses, royalty streams, subscriber bases or divisions of larger companies. Our acquisitions may involve companies operating in healthy or distressed situations. Currently, our Strategic Acquisitions business line includes two acquired businesses that are identified as our Strategic Acquisitions - Distribution and Strategic Acquisitions - Consumer Products operating segments.

Discontinued Operations Discontinued operations presents the financial condition and results of operations for the assets, liabilities, businesses and operations that were sold or discontinued by Fremont prior to the Effective Date. The assets and liabilities primarily include a portfolio of subprime residential real estate mortgages, residential real estate, commercial real estate investments and liabilities associated with the former lending and retail banking businesses. We also hold subordinated securities and residual interests resulting from Fremont's prior residential real estate loan securitization activity, which may result in future cash flow. These assets and liabilities are being managed to maximize cash recoveries and value for our shareholders and are expected to be redeployed into our long term business strategy over time. Refer to Note 16 ? Discontinued Operations in the Notes to Unaudited Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q for more information about the Company's Discontinued Operations.

Corporate and Other Corporate and other costs primarily represent corporate administrative expenses related to those administrative, financial and human resource activities that are not allocated to operations and are excluded from segment results of operations. These costs are not allocated to the segments, as management excludes such costs when assessing the performance of the segments.

Material Weakness in Internal Control Over Financial Reporting. As of September 30, 2011, the Company's internal control over financial reporting was not effective and it was determined that the material weakness identified as of December 31, 2010 had not been fully remediated. The Company is currently working to remediate the material weakness in its internal control over financial reporting. See Item 4, "Controls and Procedures" of this Form 10-Q for more information about the Company's assessment of its internal control over financial reporting and the related material weakness, as well as the Company's continuing efforts to remediate such weakness. Notwithstanding the assessment that the Company's internal control over financial reporting was not effective and that there was a material weakness as discussed in Part I, Item 4 of this Form 10-Q, the Company believes that the financial statements contained in this Form 10-Q and discussed in Management's Discussion and Analysis, fairly and accurately present the financial position, results of operations and cash flows for each of the periods presented, in all material respects.

CRITICAL ACCOUNTING POLICIES

The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States of America ("GAAP"). The Company's accounting policies are fundamental to understanding management's discussion and analysis of results of operations and financial condition. Several of our policies are critical as they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and affect the reported amount of assets and liabilities and revenues and expenses included in the consolidated financial statements. Circumstances and events that differ significantly from those underlying the Company's estimates, assumptions and judgments could cause the actual amounts reported to differ significantly from these estimates.

The Company's critical accounting policies include those that address (i) accounting for reorganizations, (ii) discontinued operations, (iii) gain (loss) on loans held for sale, (iv) fair value measurements, (v) guarantees (repurchase reserve), (vi) common stock warrant liability, (vii) real estate owned, and (viii) income taxes. See Part II, Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations in the Annual Report for more information about the Company's critical accounting policies. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. We believe that our estimates and assumptions are reasonable under the circumstances; however, actual results may differ significantly from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and our results of operations for the reporting periods.

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As a result of implementing our business plan through the Special Situation Lending and Strategic Acquisitions business lines, the following changes were made to the Company's critical accounting policies during the three and nine months ended September 30, 2011 to also address:

Business Combinations Business combinations are accounted for using the acquisition method, whereby the assets and liabilities of the acquired business are recorded at their estimated fair values at the date of acquisition. The excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. The excess of the estimated fair values of the net assets acquired over the purchase price is recorded as a gain on acquisition. Any changes in the estimated fair values of the net assets recorded for acquisitions prior to the finalization of more detailed analysis, but not to exceed a reasonable period of time (generally one year from the date of acquisition), will change the amount of the purchase price allocable to goodwill or gain on acquisition.

The Company estimates and records the acquisition date estimated fair value of contingent consideration, if any, as part of purchase price consideration. Additionally, each reporting period, the Company estimates changes in the fair value of contingent consideration and any change in fair value is recognized in the Company's consolidated statements of operations. An increase in the expected earn-out will result in a charge to operations in the quarter that the anticipated fair value of contingent consideration increases, while a decrease in the expected earn-out will result in a credit to operations in the quarter that the anticipated fair value of contingent consideration decreases. The estimate of the fair value of contingent consideration requires subjective assumptions to be made about future operating results, discount rates, and probabilities assigned to various potential operating result scenarios. Future revisions to these assumptions could materially change the estimate of the fair value of contingent consideration and, therefore, materially affect the Company's future financial results.

Acquisition costs are expensed as incurred. The results of operations of acquired businesses are included in the Company's consolidated financial statements from the acquisition date.

Goodwill and Intangible Assets Identifiable intangible assets with finite lives are amortized over their estimated useful lives, which represent the period over which the asset is expected to contribute directly or indirectly to future cash flows. Intangible assets with finite lives are reviewed for impairment whenever events and circumstances indicate the carrying value of such assets may not be recoverable. Goodwill and intangible assets with indefinite lives are tested for impairment on an annual basis, or sooner if an indicator of impairment is present. Tests for impairment or recoverability require significant management judgment, and future events affecting cash flows and market conditions could result in impairment losses.

Revenue Recognition Revenues from product sales are recognized upon transfer of ownership, including passage of title to the customer and transfer of the risk of loss related to those goods. Revenues are reported on a net sales basis, which is computed by deducting from gross sales amounts related to product returns, discounts and allowances.

Inventories

Inventories consist of manufactured goods and goods acquired for resale and are stated at the lower of cost or market. Inventory costs are determined on a first-in, first-out basis for our Strategic Acquisitions - Consumer Products segment and on a moving average historical cost for our Strategic Acquisitions - Distributions segment.

Purchased Credit-Impaired Loans Purchased credit-impaired loans are loans acquired at a discount to face value where, at the acquisition date, based on the credit quality of the borrower, the Company expects to collect less than the contractual amounts due under the terms of the loan. The excess of the cash flows expected to be collected over the initial investment is referred to as the accretable yield and is recognized in interest income over the expected life of the loans using the effective yield method. The excess of contractual cash flows over cash flows expected to be collected at acquisition is referred to as the non-accretable difference and is not recognized as an adjustment of yield, loss accrual, or valuation allowance. Subsequent increases in cash flows expected to be collected are recognized prospectively through adjustment of the loan's yield over its remaining life. Subsequent decreases in cash flows expected to be collected are evaluated to determine whether the loan is impaired.

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There were no other changes in our critical accounting policies from those disclosed in the Annual Report.

CONSOLIDATED FINANCIAL PERFORMANCE REVIEW

General

During the third quarter of 2011, we completed the first material strategic acquisition of an operating business. On July 29, 2011, we acquired 100% of the common stock of NABCO pursuant to the terms of a Stock Purchase Agreement by and among Signature, NABCO and the two shareholders of NABCO (the "NABCO Acquisition"). Headquartered in Burbank, California, NABCO is a nationwide quick-turn supplier of circuit breakers that maintains a significant depth of certified, new product inventory utilized in various commercial, industrial and residential applications, including products that have been discontinued by the manufacturer and are no longer broadly available. NABCO operates from five distribution centers across the country to offer customers quick and reliable nationwide delivery in the repair and replacement niche. Prior to the NABCO Acquisition, NABCO had approximately $26.3 million in sales and $4.8 million in net income for its year ended December 31, 2010, and approximately $14.8 million in sales and $3.7 million in net income (unaudited) for its six months ended June 30, 2011. For additional information about the NABCO Acquisition and historical financial results of NABCO prior to the NABCO Acquisition, see our Current Report on Form 8-K filed with the SEC on August 1, 2011 and the Amendment No. 1 to this Form 8-K filed with the SEC on October 12, 2011. NABCO's historical financial results and performance prior to the NABCO Acquisition is not an indication of the future performance of the NABCO business and should not be relied upon for such purpose. The total consideration paid at the closing of the transaction was $36.9 million, which included a cash payment of approximately $23.4 million, the issuance of $5.0 million in subordinated, unsecured promissory notes (the "Seller Notes"), the issuance of Signature common stock with a fair value of $1.8 million, the assumption of $3.1 million in liabilities and a $3.5 million estimated liability for contingent consideration. At the date of acquisition, the Company identified temporary differences between the book and tax bases of the acquired identifiable assets and assumed liabilities and recorded a deferred tax liability, net of deferred tax assets, of $2.7 million. The recognition of this $2.7 million net deferred tax liability resulted in an income tax benefit to the Company resulting from a reduction of a portion of the Company's valuation allowance against its net deferred tax assets. As a result of this transaction, Signature's consolidated operations reflect substantial changes from prior reporting periods.

Three Months Ended September 30, 2011

The following is a summary of significant operating results for the three months ended September 30, 2011.

   · Net earnings attributable to Signature Group Holdings, Inc. of $1.3 million     for the three months ended September 30, 2011, as compared to a loss of $9.5     million for the comparable period in 2010.     ? Earnings from continuing operations of $2.6 million for the three months ended     September 30, 2011, as compared to a loss of $3.5 million for the comparable     2010 period.     ? Loss from discontinued operations, net of income taxes of $1.4 million for the     three months ended September 30, 2011, as compared to $6.0 million for the     comparable 2010 period.      · Revenues of $6.6 million for the three months ended September 30, 2011, as     compared to $62 thousand for the comparable 2010 period.      · Expenses of $10.8 million for the three months ended September 30, 2011, as     compared to $3.0 million for the comparable 2010 period.      · Other income (expense) of $4.2 million for the three months ended September     30, 2011, as compared to $0.2 million for the comparable 2010 period.      · Reorganization items, net of $63 thousand for the three months ended September     30, 2011, as compared to $0.8 million for the comparable 2010 period.      · Income tax benefit of $2.7 million for the three months ended September 30,     2011, as compared to zero for the comparable 2010 period.   

Nine Months Ended September 30, 2011

The following is a summary of significant operating results for the nine months ended September 30, 2011.

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  Table of Contents    · Net loss attributable to Signature Group Holdings, Inc. of $9.1 million for     the nine months ended September 30, 2011, as compared to $31.5 million for the     comparable period in 2010.     ? Loss from continuing operations of $5.0 million for the nine months ended     September 30, 2011, as compared to $19.2 million for the comparable 2010     period.     ? Loss from discontinued operations, net of income taxes of $4.2 million for the     nine months ended September 30, 2011, as compared to $12.3 million for the     comparable 2010 period.      · Revenues of $7.9 million for the nine months ended September 30, 2011, as     compared to $0.2 million for the comparable 2010 period.      · Expenses of $19.4 million for the nine months ended September 30, 2011, as     compared to $9.1 million for the comparable 2010 period.      · Other income of $5.2 million for the nine months ended September 30, 2011, as     compared to $0.5 million for the comparable 2010 period.      · Reorganization items, net of $1.4 million for the nine months ended September     30, 2011, as compared to $10.8 million for the comparable 2010 period.      · Income tax benefit of $2.8 million for the nine months ended September 30,     2011, as compared to zero for the comparable 2010 period.