1st Franklin Financial 10-Q 2008 Q1 Quarterly report

1^st

FRANKLIN

FINANCIAL

CORPORATION

QUARTERLY

REPORT TO INVESTORS

AS OF AND FOR THE

THREE MONTHS ENDED

MARCH 31, 2008

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview:

The following narrative is Management’s discussion and analysis of the foremost factors that influenced our operating results and financial condition as of and for the three-month periods ended March 31, 2008 and 2007.  This analysis and the accompanying interim financial information should be read in conjunction with the audited consolidated financial statements included in the Company’s December 31, 2007 Annual Report.  Results achieved in any interim period are not necessarily reflective of the results to be expected for the full year period.

The Company:

1^ST Franklin Financial Corporation and its consolidated subsidiaries (the “Company” or “we”) are engaged in the consumer finance business, primarily in making consumer loans to individuals in relatively small amounts for short periods of time.  Other lending-related activities include the purchase of sales finance contracts from various dealers and the making of first and second mortgage loans on real estate to homeowners.  As of March 31, 2008, the Company’s business was operated through a network of 243 branch offices located in Alabama, Georgia, Louisiana, Mississippi, South Carolina and Tennessee.

We also offer optional credit insurance coverage to our customers when making a loan.  Such coverage may include credit life insurance, credit accident and health insurance, and/or credit property insurance.  Customers may request credit life insurance coverage to help assure any outstanding loan balance is repaid if the customer dies before the loan is repaid or they may request accident and health insurance coverage to help continue loan payments if the customer becomes sick or disabled for an extended period of time.  Customers may also choose property insurance coverage to protect the value of loan collateral against damage, theft or destruction.  We write these various insurance products as an agent for a non-affiliated insurance company.  Under various agreements, our wholly-owned insurance subsidiaries, Frandisco Life Insurance Company and Frandisco Property and Casualty Insurance Company, reinsure the in surance coverage on our customers written on behalf of this non-affiliated insurance company.

The Company's operations are subject to various state and federal laws and regulations.  We believe our operations are in compliance with applicable state and federal laws and regulations.

Financial Condition:

The first quarter of each year is typically the slowest in terms of loan originations generated by the Company.  Loan liquidations normally exceed new loans originated resulting in a decline in loans outstanding.  This was the same scenario experienced by the Company during the first quarter of 2008.  Our net loan portfolio declined $10.3 million (4%) at March 31, 2008 compared to December 31, 2007.  Additions made to the allowance for loan losses also contributed to the decrease in the net loan portfolio.  The allowance is an offset in the portfolio to reserve for losses which Management believes is inherent in current loans outstanding at March 31, 2008.

Cash and cash equivalents decreased $1.4 million (5%) as of the end of the first quarter of 2008 compared to December 31, 2007.  Funds were used to reduce amounts outstanding under our bank credit line by $10.8 million during the quarter.  Disbursements of the Company’s annual employee incentive bonus and profit sharing contributions in February 2008 also contributed to the decrease in our cash position.  

There was a $4.7 million increase in investment securities held by the Company’s insurance subsidiaries at March 31, 2008 compared to December 31, 2007.  This investment of

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surplus funds generated by our insurance subsidiaries accounted for the majority of the increase.  The Company's investment portfolio consists mainly of U.S. Treasury bonds, government agency bonds and various municipal bonds.  A significant portion of these investment securities have been designated as “available for sale” (82% as of March 31, 2008 and 77% as of December 31, 2007) with any unrealized gain or loss, net of deferred income taxes, accounted for as accumulated other comprehensive income in the equity section of the Company’s balance sheet.  The remainder of the Company’s investment portfolio represents securities carried at amortized cost and designated as “held to maturity,” as Management has both the ability and intent to hold these securities to maturity.

The Company held cash in restricted accounts of approximately $2.3 million and $2.2 million at March 31, 2008 and December 31, 2007, respectively.  These restricted accounts are held by the Company’s insurance subsidiaries in order to meet certain deposit requirements applicable to insurance companies in the State of Georgia and to meet the reserve requirements contained in the Company’s reinsurance agreements.

Other assets decreased $.8 million (5%) at March 31, 2008 compared to December 31, 2007.  The decrease was primarily due to a $1.2 million decrease in receivables due from the non-affiliated insurance company the Company writes credit insurance through.

Senior debt of the Company decreased $17.9 million (10%) as of March 31, 2008 compared to December 31, 2007.  This decline was mainly due to a $10.8 million reduction in borrowings against the Company’s bank credit line.  Also contributing to the decrease in senior debt was a decline in sales and outstanding amounts of the Company’s commercial paper and senior demand note debt securities.  The Company believes that, during this period, many investors opted to purchase and hold certain of the Company’s other securities, including subordinated debentures, which offer different terms which may have included higher interest rates.

During February 2008, the Company disbursed the prior year’s annual incentive bonus and annual profit sharing contributions to employees.  Both of these disbursements had previously been accrued for as of December 31, 2007.  These disbursements were the primary cause of the $2.7 million (15%) reduction in accrued expenses and other liabilities as of March 31, 2008 compared to December 31, 2007.  

As noted above, the Company experienced an increase in sales of its subordinated debentures during the first quarter of 2008.  The increase resulted in an additional $10.0 million (11%) in outstanding debentures as of March 31, 2008 compared to amounts outstanding at December 31, 2007.

Results of Operations:

Total revenues generated during the three-month periods ended March 31, 2008 and March 31, 2007 were $34.2 million and $31.2 million, respectively, representing a 10% increase.  Although revenues were higher, net income declined during the same comparable period mainly due to higher borrowing costs, increases the Company’s loan loss provision and higher personnel expenses.  These increases in expenses are discussed in more detail later in this narrative.  

Net Interest Margin

Our net interest margin improved during the three-month period ended March 31, 2008 as compared to the same period a year ago.  The margin, which reflects the difference between earnings on the Company’s loan and investment portfolios and interest incurred on the Company’s senior and subordinated debt, increased $2.1 million (11%) during the comparable periods.  Higher levels of average loan receivables and investment securities held by the Company resulted in an increase in interest income of $2.5 million (11%) during the three-month period just ended, which led to the higher margin.    

The aforementioned increase in our net interest income was partially offset by an increase in interest expense.  Average debt outstanding during the three-month period just ended

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was $269.1 million compared to $243.6 million during the same three-month period a year ago.  In addition to the increase in average debt, average borrowing rates rose to 6.04% during the period just ended compared to 5.68% a year ago.  The increase in debt and borrowing rates caused interest expense to increase $.4 million (11%) during the 2008 comparable period.

Management projects that average net receivables will continue to grow through the remainder of the year, and earnings are expected to increase accordingly.  In addition, based on currently available information and recent trends in market interest rates, we believe that average borrowing rates will decline during the remainder of the year due to recent decreases in market interest rates.  

Insurance Income

An increase in credit insurance in-force resulted in a $.4 million growth in net insurance income during the three-month period just ended compared to the same period a year ago.

Provision for Loan Losses

The Company continually reviews its loan portfolio and maintains an allowance for loan losses that in Management’s opinion is appropriate to cover probable losses in the portfolio.  The provision for loan losses reflects the expense to the Company to maintain an appropriate allowance.  

The current challenging economic conditions are having a greater impact on operating results during the current year as compared to 2007.  Rising prices for consumer goods and services appears to be putting pressure on our loan customers.  As a result, the Company has experienced an increase in bankruptcy filings among its loan customers and higher net charge offs to date in 2008.  Our provision for loan losses grew $1.4 million (36%) to $5.2 million during the three-month period just ended as compared to the same period a year ago primarily due to the higher loan losses.  The increase in the provision was also due to additions made to the allowance for loan losses to cover probable losses inherent in the current portfolio.

Other Operating Expenses

Overall other operating expenses increased $1.6 million (9%) during the three-month period ended March 31, 2008 compared to the same period a year ago.  The majority of the increase was due to higher personnel expense.  An increase in our employee base due to new office openings and merit salary increases effective February 2008 were the main factors causing a $1.4 million (13%) increase in personnel expense during the three-month period ended March 31, 2008.  Also contributing were increases in accruals for incentive bonuses, employee benefits and employee medical claims.

A $.3 million (11%) increase in occupancy expense also contributed to the increase in other operating expenses.  Increases in office maintenance, utilities, depreciation of fixed assets and rent expense were factors causing the increase.

Income Taxes:

The Company has elected to be treated as an S Corporation for income tax reporting purposes.  Taxable income or loss of an S Corporation is included in the individual tax returns of the shareholders of the Company, rather then being taxed at the corporate level.  Notwithstanding this election, however, income taxes continue to be reported for, and paid by, the Company's insurance subsidiaries as they are not allowed to be treated as S corporations, and for the Company’s state taxes in Louisiana, which does not recognize S Corporation status.  Deferred income tax assets and liabilities are recognized and provisions for current and deferred income taxes continue to be recorded by the Company’s subsidiaries.  The deferred income tax assets and liabilities are due to certain temporary differences between reported income and expenses for financial statement and income tax purposes.  

Effective income tax rates were 19% and 17% during the three-month periods ended

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March 31, 2008 and 2007, respectively.  The higher rate experienced during the current year period was due to less income at the S Corporation level which was passed to the shareholders of the Company for tax reporting, whereas income earned at the insurance subsidiary level was taxed at the corporate level.  The S Corporation reported less income during the current period just ended as compared to the same comparable period a year ago.

Quantitative and Qualitative Disclosures About Market Risk:

As previously discussed, higher interest rates have continued to impact the Company’s interest costs through March 31, 2008.  Subsequent thereto, market rates have begun a downward trend and, should they remain constant or continue on this trend, are expected to have a lesser impact on the interest margin during the remainder of the year.  Please refer to the market risk analysis discussion contained in our annual report on Form 10-K as of and for the year ended December 31, 2007 for a more detailed analysis of our market risk exposure.

Liquidity and Capital Resources:

As of March 31, 2008 and December 31, 2007, the Company had $28.4 million and $29.8 million, respectively, invested in cash and short-term investments readily convertible into cash with original maturities of three months or less.

The Company’s investments in marketable securities can be converted into cash, if necessary.  As of March 31, 2008 and December 31, 2007, respectively, 97% and 96% of the Company’s cash and cash equivalents and investment securities were maintained in its insurance subsidiaries.  State insurance regulations limit the use an insurance company can make of its assets.  Dividend payments to the Company by its wholly owned insurance subsidiaries are subject to annual limitations and are restricted to the greater of 10% of policyholders’ surplus or statutory earnings before recognizing realized investment gains of the individual insurance subsidiaries.  At December 31, 2007, Frandisco Property and Casualty Insurance Company and Frandisco Life Insurance Company had policyholders’ surpluses of $38.7 million and $40.6 million, respectively.  The maximum aggregate amount of dividends these subsidiaries can pay to the Company in 2008 without prior approval of the Georgia Insurance Commissioner is approximately $9.0 million.

Liquidity requirements of the Company are financed through the collection of receivables and through the sale of short- and long-term debt securities.  The Company’s continued liquidity is therefore dependent on the collection of its receivables and the sale of debt securities that meet the investment requirements of the public.  In addition to its securities sales, the Company has an external source of funds available under a credit agreement with Wachovia Bank, N.A. and BMO Capital Markets Financing, Inc. The credit agreement provides for unsecured borrowings of up to $50.0 million, subject to certain limitations, and is scheduled to expire on December 15, 2009.  Any amounts then outstanding will be due and payable on such date.  The credit agreement contains covenants customary for financing transactions of this type.  At March 31, 2008, the Company was in compliance with all covenants.  Available borrowings under the agreement were $44.1 million and $33.3 million at March 31, 2008 and December 31, 2007, respectively, at interest rates of 4.75% and 6.75%, respectively.  Management believes the Company’s liquidity position is adequate to fund ongoing needs for the foreseeable future.

The Company was subject to the following contractual obligations and commitments at March 31, 2008:
	04/01/08 thru 12/31/08	2009	2010	2011	2012	2013 & Beyond	Total
	(in Millions)
Credit Line *	$ .2	$ 6.2	$ -	$ -	$ -	$ -	$ 6.4
Bank Commitment Fee *	.2	.4	-	-	-	-	.6
Senior Notes *	49.4	-	-	-	-	-	49.4
Commercial Paper *	112.0	-	-	-	-	-	112.0

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	04/01/08 thru 12/31/08	2009	2010	2011	2012	2013 & Beyond	Total
	(in Millions)
Subordinated Debt *	6.9	9.7	36.3	54.6	21.1	-	128.6
Operating Leases	3.8	3.4	2.6	1.7	.8	.1	12.4
Software Service Contract **	1.8	2.4	2.4	2.4	2.4	4.7	16.1
Data Communication Lines Contract **	1.2	-	-	-	-	-	1.2
Total	$ 175.5	$ 22.1	$ 41.3	$ 58.7	$ 24.3	$ 4.8	$ 326.7
* Note:    Includes estimated interest at current rates ** Note:    Based on current usage

Critical Accounting Policies:

The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States and conform to general practices within the financial services industry. The Company’s more critical accounting and reporting policies include the allowance for loan losses, revenue recognition and insurance claims reserve.  

Allowance for Loan Losses:

The allowance for loan losses is based on the Company's previous loss experience, a review of specifically identified loans where collection is doubtful and Management's evaluation of the inherent risks and changes in the composition of the Company's loan portfolio.  Specific provision for loan losses is made for impaired loans based on a comparison of the recorded carrying value in the loan to either the present value of the loan’s expected cash flow, the loan’s estimated market price or the estimated fair value of the underlying collateral.

Revenue Recognition:

Accounting principles generally accepted in the United States require that an interest yield method be used to calculate the income recognized on accounts which have precomputed charges.  An interest yield method is used by the Company on each individual precomputed account to calculate income for on-going precomputed accounts; however, state regulations often allow interest refunds to be made according to the Rule of 78’s method for payoffs and renewals.  Since the majority of the Company's precomputed accounts are paid off or renewed prior to maturity, the result is that most of the precomputed accounts effectively yield on a Rule of 78's basis.

Precomputed finance charges are included in the gross amount of certain direct cash loans, sales finance contracts and certain real estate loans.  These precomputed charges are deferred and recognized as income on an accrual basis using the effective interest method.  Some other cash loans and real estate loans, which do not have precomputed charges, have income recognized on a simple interest accrual basis.  Income is not accrued on a loan that is more than 60 days past due.

Loan fees and origination costs are deferred and recognized as adjustments to the loan yield over the contractual life of the related loan.  

The property and casualty credit insurance policies written by the Company, as agent for a non-affiliated insurance company, are reinsured by the Company’s property and casualty insurance subsidiary.  The premiums on these policies are deferred and earned over the period of insurance coverage using the pro-rata method or the effective yield method, depending on whether the amount of insurance coverage generally remains level or declines.

The credit life and accident and health insurance policies written by the Company, as agent for a non-affiliated insurance company, are reinsured by the Company’s life insurance subsidiary.  The premiums are deferred and earned using the pro-rata method for level-term life insurance policies and the effective yield method for decreasing-term life policies.  Premiums on

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accident and health insurance policies are earned based on an average of the pro-rata method and the effective yield method.

Insurance Claims Reserves:

Included in unearned insurance premiums and commissions on the consolidated statements of financial position are reserves for incurred but unpaid credit insurance claims for policies written by the Company and reinsured by the Company’s wholly-owned insurance subsidiaries.  These reserves are established based on generally accepted actuarial methods.  In the event that the Company’s actual reported losses for any given period are materially in excess of the previous estimated amounts, such losses could have a material adverse effect on the Company’s results of operations.

Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position or consolidated results of operations.

Recent Accounting Pronouncements:

In June 2006, the Financial Accounting Standards Board (the “FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), an interpretation of FASB No. 109, “Accounting for Income Taxes”.  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements by prescribing how companies should recognize, measure, present and disclose uncertain tax positions that have been taken on a tax return.  The Company adopted FIN 48 effective January 1, 2007 and there was no material impact on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements and does not require any new assets or liabilities to be measured at fair value.  SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and accordingly, the Company adopted SFAS No. 157 effective January 1, 2008.  The adoption of this new accounting principle did not have a material effect on its financial position, results of operations or cash flows, but did result in additional disclosures being added to the footnotes to the consolidated financial statements (See Note 4).

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115” (“SFAS No. 159”), which permits companies to choose to measure many financial instruments and certain other items at fair value.  SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.  The Company has no current plans to elect the fair value option for any specific financial instruments or other items.  Accordingly, the adoption of this new accounting pronouncement as of January 1, 2008 did not have a material impact on the Company’s financial position, results of operations or cash flows.

Forward Looking Statements:

Certain information in this discussion and other statements contained in this Quarterly Report, which are not historical facts, may be forward-looking statements within the meaning of the federal securities laws.  Such forward-looking statements involve known and unknown risks and uncertainties.  The Company's results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained herein.  Possible factors which could cause future results to differ from expectations include, but are not limited to, adverse general economic conditions, including the changes in interest rate environment, unexpected reductions in the size or collectibility of amounts in our loan portfolio, reduced sales of our securities, federal and state regulatory changes affecting consumer finance companies, unfavorable outcomes in legal proceedings and other factors reference d elsewhere in our filings with the Securities and Exchange Commission from time to time.  The Company undertakes no obligation to update any forward-looking statements, except as required by law.

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1st FRANKLIN FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
	March 31,	December 31,
	2008	2007
	(Unaudited)
ASSETS
CASH AND CASH EQUIVALENTS	$ 28,383,389	$ 29,831,129
RESTRICTED CASH	2,299,343	2,187,022
LOANS: Direct Cash Loans Real Estate Loans Sales Finance Contracts Less: Unearned Finance Charges Unearned Insurance Premiums and Commissions Allowance for Loan Losses Net Loans	290,081,192  25,532,022  30,387,977  346,001,191  38,216,792  20,834,571  20,635,085  266,314,743	303,678,240 25,052,160 31,747,131 360,477,531 40,720,500 23,066,730 20,035,085 276,655,216
INVESTMENT SECURITIES: Available for Sale, at fair market Held to Maturity, at amortized cost	67,632,620  15,101,990  82,734,610	60,060,798 18,021,418 78,082,216
OTHER ASSETS	14,874,928	15,698,052
TOTAL ASSETS	$ 394,607,013	$ 402,453,635
LIABILITIES AND STOCKHOLDERS' EQUITY
SENIOR DEBT	$ 164,424,063	$ 182,372,949
ACCRUED EXPENSES AND OTHER LIABILITIES	15,609,739	18,274,446
SUBORDINATED DEBT	101,925,445	91,965,714
Total Liabilities	281,959,247	292,613,109
STOCKHOLDERS' EQUITY:
Preferred Stock; $100 par value	--	--
Common Stock Voting Shares; $100 par value; 2,000 shares authorized; 1,700 shares outstanding Non-Voting Shares; no par value; 198,000 shares authorized; 168,300 shares outstanding	170,000  --	170,000 --
Accumulated Other Comprehensive Income	1,302,011	970,603
Retained Earnings	111,175,755	108,699,923
Total Stockholders' Equity	112,647,766	109,840,526
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$ 394,607,013	$ 402,453,635
See Notes to Consolidated Financial Statements

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1st FRANKLIN FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
	Quarter Ended
	March 31
	(Unaudited)
	2008	2007
INTEREST INCOME	$ 24,488,272	$ 22,028,308
INTEREST EXPENSE	4,030,343	3,647,063
NET INTEREST INCOME	20,457,929	18,381,245
Provision for Loan Losses	5,177,717	3,806,625
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES	15,280,212	14,574,620
NET INSURANCE INCOME Premiums Insurance Claims and Expenses	8,714,521  1,729,797  6,984,724	8,168,207  1,537,864  6,630,343
OTHER REVENUE	1,029,734	975,965
OTHER OPERATING EXPENSES: Personnel Expense Occupancy Expense Other Total	12,211,226  2,567,589  4,716,905  19,495,720	10,780,605  2,316,588  4,754,820  17,852,013
INCOME BEFORE INCOME TAXES	3,798,951	4,328,915
Provision for Income Taxes	723,118	716,016
NET INCOME	3,075,832	3,612,899
RETAINED EARNINGS, Beginning of Period	108,699,923	97,950,753
Distributions on Common Stock	600,000	5,854
RETAINED EARNINGS, End of Period	$111,175,755	$101,557,798
BASIC EARNINGS PER SHARE: 170,000 Shares Outstanding for all Periods (1,700 voting, 168,300 non-voting)	$18.09	$21.25
See Notes to Consolidated Financial Statements

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1ST FRANKLIN FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
	Three Months Ended
	March 31,
	(Unaudited)
	2008	2007
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$ 3,075,832	$ 3,612,899
Adjustments to reconcile net income to net cash provided by operating activities: Provision for Loan Losses Depreciation and Amortization Prepaid Income Taxes Other, net Decrease in Miscellaneous Assets Decrease in Other Liabilities   Net Cash Provided	5,177,717    594,738    (64,155)  58,950    1,652,541    (3,371,067)      7,124,556	3,806,625    485,002    (41,167)     38,596    1,694,352    (3,215,633)     6,380,674
CASH FLOWS FROM INVESTING ACTIVITIES:
Loans originated or purchased Loan payments Increase in restricted cash Purchases of marketable debt securities Redemptions of marketable debt securities Fixed asset additions, net Net Cash Provided	(54,941,826)   60,104,582    (112,321)   (10,754,740)   6,453,000    (731,836)   16,859	(49,329,881)   51,357,542    (75,721)   (4,015,785)   2,876,000    (529,353)   282,802
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in senior debt Subordinated debt issued Subordinated debt redeemed Dividends / Distributions Net Cash Used	(17,948,886)   12,997,505    (3,037,774)   (600,000)   (8,589,155)	(12,848,212)   13,429,683    (6,550,005)   (5,854)   (5,974,388)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	(1,447,740)	689,088
CASH AND CASH EQUIVALENTS, beginning	29,831,129	24,028,767
CASH AND CASH EQUIVALENTS, ending	$ 28,383,389	$ 24,717,855
Cash paid during the period for:      Interest      Income Taxes	$ 4,157,995    49,010	$ 3,662,141    31,208
See Notes to Consolidated Financial Statements

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-NOTES TO UNAUDITED FINANCIAL STATEMENTS-
Note 1 – Basis of Presentation
	The accompanying unaudited interim financial information of 1st Franklin Financial Corporation and subsidiaries (the "Company") should be read in conjunction with the audited consolidated financial statements of the Company and notes thereto as of December 31, 2007 and for the year then ended included in the Company's December 31, 2007 Annual Report.
	In the opinion of Management of the Company, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the Company's financial position as of March 31, 2008 and December 31, 2007 and the results of its operations and cash flows for the three months ended March 31, 2008 and 2007. While certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission, the Company believes that the disclosures herein are adequate to make the information presented not misleading.
	The results of operations for the three months ended March 31, 2008 are not necessarily indicative of the results to be expected for the full fiscal year.
	The computation of earnings per share is self-evident from the Consolidated Statements of Income and Retained Earnings.
	Recent Accounting Pronouncements: In June 2006, the Financial Accounting Standards Board (the “FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), an interpretation of FASB No. 109, “Accounting for Income Taxes”.  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements by prescribing how companies should recognize, measure, present and disclose uncertain tax positions that have been taken on a tax return.  The Company adopted FIN 48 effective January 1, 2007 and there was no material impact on its consolidated financial statements during fiscal years 2007 or 2008. In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements and does not require any new assets or liabilities to be measured at fair value.  SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and accordingly, the Company adopted SFAS No. 157 effective January 1, 2008.  The adoption of this new accounting principle did not have a material effect on its financial position, results of operations or cash flows, but did result in additional disclosures being added to the footnotes to the consolidated financial statements. In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115” (“SFAS No. 159”), which permits companies to choose to measure many financial instruments and certain other items at fair value.  SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.  The Company chose not to elect the fair value option for any specific financial instruments or other items.  Accordingly, the adoption of this new accounting pronouncement as of January 1, 2008 did not have a material impact on the Company’s financial position, results of operations or cash flows.

Note 2 – Allowance for Loan Losses
	An analysis of the allowance for loan losses for the three-month periods ended March 31, 2008 and 2007 is shown in the following table:
		Three Months Ended  March 31, 2008	Three Months Ended  March 31, 2007
	Beginning Balance Provision for Loan Losses Charge-offs Recoveries Ending Balance	$ 20,035,085  5,177,717  (6,638,512) 1,760,795  $ 20,635,085	$ 18,085,085  3,806,625  (5,348,493) 1,541,868  $ 18,085,085

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Note 3 – Investment Securities
	Debt securities available for sale are carried at estimated fair market value.  Debt securities designated as "Held to Maturity" are carried at amortized cost based on Management's intent and ability to hold such securities to maturity.  The amortized cost and estimated fair market values of these debt securities were as follows:
		As of March 31, 2008		As of December 31, 2007
		Amortized Cost	Estimated Fair Market Value	Amortized Cost	Estimated Fair Market Value
	Available for Sale: U.S. Treasury securities and obligations of U.S. government corporations and agencies Obligations of states and political subdivisions Corporate securities	$ 6,514,864 59,532,880 130,316 $ 66,178,060	$ 6,655,064 60,143,971 833,585 $ 67,632,620	$ 9,015,878 49,869,070 130,316 $ 59,015,264	$ 9,081,620 50,084,797 894,381 $ 60,060,798
		As of March 31, 2008		As of December 31, 2007
		Amortized Cost	Estimated Fair Market Value	Amortized Cost	Estimated Fair Market Value
	Held to Maturity: U.S. Treasury securities and obligations of U.S. government corporations and agencies Obligations of states and political subdivisions	$ 2,915,005 12,186,985 $ 15,101,990	$ 2,950,333 12,440,256 $ 15,390,589	$ 4,715,540 13,305,878 $ 18,021,418	$ 4,717,003 13,431,564 $ 18,148,567

Gross unrealized losses on investment securities totaled $158,647 and $165,724 at March 31, 2008 and December 31, 2007, respectively.  The following table provides an analysis of investment securities in an unrealized loss position for which other-than-temporary impairments have not been recognized as of March 31, 2008:
	Less than 12 Months		12 Months or Longer		Total
	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses
Available for Sale:
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$ --	$ --	$ --	$ --	$ --	$ --
Obligations of states and political subdivisions	10,018,785	134,718	2,419,749	20,861	12,438,534	155,579
Total	10,018,785	134,718	2,419,749	20,861	12,438,534	155,579

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		Less than 12 Months		12 Months or Longer		Total
		Fair Value	Unrealized Losses	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses
	Held to Maturity:
	U.S. Treasury securities and obligations of U.S. government corporations and agencies	--	--	--	--	--	--
	Obligations of states and political subdivisions	--	--	685,188	3,068	685,188	3,068
	Total	--	--	685,188	3,068	685,188	3,068
	Overall Total	$ 10,018,785	$ 134,718	$ 3,104,937	$ 23,929	$ 13,123,722	$ 158,647
The table above represents 34 investments held by the Company, the majority of which are rated AAA by Standard & Poor’s, which is the highest rating given by this service.  The unrealized losses on the Company’s investments listed in the above table were primarily the result of interest rate increases.  The total impairment was less than 1.21% of the fair value of the affected investments at March 31, 2008.  Based on the ratings of these investments, the Company’s ability and intent to hold these investments until a recovery of fair value and after considering the severity and duration of the impairments, the Company does not consider the impairment of these investments to be other-than-temporary at March 31, 2008.

Note 4 – Fair Value

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements and does not require any new assets or liabilities to be measured at fair value.  SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and, accordingly, the Company adopted this pronouncement effective January 1, 2008. Under SFAS No. 157, fair value is the price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  The following fair value hierarchy is used in selecting inputs used to determine the fair value of an asset or liability, with the highest priority given to Level 1, as these are the most transparent or reliable. Level 1 - Quoted prices for identical instruments in active markets. Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets. Level 3 - Valuations derived from valuation techniques in which one or more significant inputs are unobservable. The Company is responsible for the valuation process and as part of this process may use data from outside sources in establishing fair value.  The Company performs due diligence to understand the inputs or how the data was calculated or derived.  The Company corroborates the reasonableness of external inputs in the valuation process.

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Assets measured at fair value as of March 31, 2008 are available-for-sale investment securities which are summarized below:
		Fair Value Measurements at Reporting Date Using
		Quoted Prices
		In Active	Significant
		Markets for	Other	Significant
		Identical	Observable	Unobservable
		Assets	Inputs	Inputs
Description	3/31/2008	(Level 1)	(Level 2)	(Level 3)
Available-for-sale      investment securities	$ 67,632,620	$ 833,585	$ 66,799,035	$         --

Note 5 – Commitments and contingencies
	The Company is involved in various legal proceedings incidental to its business from time to time.  In the opinion of Management, the ultimate resolution of any such known claims or lawsuits is not expected to have a material effect on the Company's financial position, liquidity or results of operations.

Note 6 – Income Taxes

Effective income tax rates were 19% and 17% during the three-month periods ended March 31, 2008 and 2007, respectively.  The Company has elected to be treated as an S Corporation for income tax reporting purposes.  Taxable income or loss of an S Corporation is included in the individual tax returns of the stockholders of the Company, rather than being taxed at the corporate level.  Notwithstanding this election, income taxes are reported for the Company's insurance subsidiaries, as they are not allowed by law to be treated as S Corporation, as well as for the Company in Louisiana, which does not recognize S Corporation status.  The tax rates of the Company’s insurance subsidiaries are below statutory rates due to (i) certain benefits provided by law to life insurance companies, which reduce the effective tax rates and (ii) investments in tax exempt bonds held by the Company’s property insurance subsidiary.

Note 7 – Other Comprehensive Income

Comprehensive income was $3.4 million for the three-month period ended March 31, 2008 as compared to $3.7 million for the same period in 2007. Accumulated other comprehensive income consisted solely of unrealized gains and losses on investment securities available for sale, net of applicable deferred taxes.  The Company recorded $.3 million and $.1 million in other comprehensive income during the three-month periods ended March 31, 2008 and 2007, respectively.

Note 8 – Line of Credit

The Company has an external source of funds through available borrowings under a credit agreement. The credit agreement provides for maximum borrowings of $50.0 million or 80% of the Company’s net finance receivables (as defined in the credit agreement), whichever is less.  The Company’s credit agreement has a commitment termination date of December 15, 2009 and contains covenants customary for financing transactions of this type.  At March 31, 2008, the Company was in compliance with all covenants.  Available borrowings under the agreement were $44.1 million and $33.3 million at March 31, 2008 and December 31, 2007, respectively.

Note 9 – Related Party Transactions
	The Company engages from time to time in other transactions with related parties.  Please refer to the disclosure contained under the heading “Certain Relationships and Related Transactions” contained  in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2007 for additional information on related party transactions.

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Note 10 - Segment Financial Information

The Company has six reportable segments.  Division I through Division V and Division VII.  Each segment is comprised of a number of branch offices that are aggregated based on vice president responsibility and geographic location.  Division I is comprised of offices located in South Carolina.  Offices in North  Georgia comprise Division II, Division III is comprised of offices in South Georgia, and Division VII is comprised of offices in West Georgia.  Division IV represents our Alabama offices and Tennessee, and our offices in Louisiana and Mississippi encompass Division V.  Division VI is reserved for future use.

Accounting policies of the segments are the same as those described in the summary of significant accounting policies.  Performance is measured based on objectives set at the beginning of each year and include various factors such as segment profit, growth in earning assets and delinquency and loan loss management.  All segment revenues result from transactions with third parties.  The Company does not allocate income taxes or corporate headquarter expenses to the segments.

The following table summarizes assets, revenues and profit by business segment.  A reconciliation to consolidated net income is also provided.  

	Division	Division	Division	Division	Division	Division
	I	II	III	IV	V	VII	Total
	(in Thousands)
Segment Revenues:
3 Months ended 3/31/08	$ 4,130	$ 4,844	$ 6,657	$ 5,826	$ 5,418	$ 5,427	$ 32,302
3 Months ended 3/31/07	3,755	4,147	6,534	5,220	4,762	5,008	29,426
Segment Profit:
3 Months ended 3/31/08	$ 760	$ 1,907	$ 2,440	$ 1,777	$ 1,855	$ 2,277	$ 11,016
3 Months ended 3/31/07	652	1,452	2,656	1,983	1,535	1,980	10,258
Segment Assets:
3/31/08	$ 39,020	$ 46,672	$ 62,146	$ 60,191	$ 43,462	$ 51,593	$ 303,084
3/31/07	35,055	40,246	60,546	54,009	39,690	47,310	276,856
			3 Months Ended 3/31/08 (in 000's)	3 Months Ended 3/31/07 (in 000's)
Reconciliation of Profit:
Profit per segments			$ 11,016	$ 10,258
Corporate earnings (losses) not allocated			1,931	1,747
Corporate expenses not allocated			(9,148)	(7,676)
Income taxes not allocated			(723)	(716)
Net income			$ 3,076	$ 3,613

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BRANCH OPERATIONS
Ronald E. Byerly	Vice President
Dianne H. Moore	Vice President
Ronald F. Morrow	Vice President
J. Patrick Smith, III	Vice President
Virginia K. Palmer	Vice President
Michael J. Whitaker	Vice President
Shirley A. Blalock	Area Vice President

REGIONAL OPERATIONS DIRECTORS
Sonya Acosta	Loy Davis	Judy Landon	Marty Miskelly
Bert Brown	Glenn Drawdy	Sharon Langford	Larry Mixson
Keith Chavis	Patricia Dunaway	Jeff Lee	Mike Olive
Joe Cherry	Shelia Garrett	Mike Lee	Hilda Phillips
Janice Childers	Brian Gray	Tommy Lennon	Henrietta Reathford
Rick Childress	Harriet Healey	Jimmy Mahaffey	Michelle Rentz
Bryan Cook	Jack Hobgood	Judy Mayben	Gaines Snow
Jeremy Cranfield	Bruce Hooper	Brian McSwain	Marc Thomas
Joe Daniel	Jerry Hughes	Roy Metzger	Lynn Vaughan

BRANCH OPERATIONS
ALABAMA
Adamsville	Bessemer	Enterprise	Huntsville (2)	Opp	Scottsboro
Albertville	Center Point	Fayette	Jasper	Oxford	Selma
Alexander City	Clanton	Florence	Moody	Ozark	Sylacauga
Andalusia	Cullman	Fort Payne	Moulton	Pelham	Troy
Arab	Decatur	Gadsden	Muscle Shoals	Prattville	Tuscaloosa
Athens	Dothan (2)	Hamilton	Opelika	Russellville (2)	Wetumpka
GEORGIA
Adel	Canton	Dahlonega	Glennville	Madison	Statesboro
Albany	Carrollton	Dallas	Gray	Manchester	Stockbridge
Alma	Cartersville	Dalton	Greensboro	McDonough	Swainsboro
Americus	Cedartown	Dawson	Griffin (2)	Milledgeville	Sylvania
Athens (2)	Chatsworth	Douglas (2)	Hartwell	Monroe	Sylvester
Bainbridge	Clarkesville	Douglasville	Hawkinsville	Montezuma	Thomaston
Barnesville	Claxton	East Ellijay	Hazlehurst	Monticello	Thomson
Baxley	Clayton	Eastman	Helena	Moultrie	Tifton
Blairsville	Cleveland	Eatonton	Hinesville (2)	Nashville	Toccoa
Blakely	Cochran	Elberton	Hogansville	Newnan	Valdosta (2)
Blue Ridge	Colquitt	Fitzgerald	Jackson	Perry	Vidalia
Bremen	Commerce	Flowery Branch	Jasper	Pooler	Villa Rica
Brunswick	Conyers	Forsyth	Jefferson	Richmond Hill	Warner Robins
Buford	Cordele	Fort Valley	Jesup	Rome	Washington
Butler	Cornelia	Gainesville	LaGrange	Royston	Waycross
Cairo	Covington	Garden City	Lavonia	Sandersville	Waynesboro
Calhoun	Cumming	Georgetown	Lawrenceville	Savannah	Winder
LOUISIANA
Alexandria	Eunice	Houma	Leesville	Natchitoches	Pineville
Crowley	Franklin	Jena	Marksville	New Iberia	Prairieville
Denham Springs	Hammond	Lafayette	Morgan City	Opelousas	Slidell

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DeRidder
BRANCH OPERATIONS
(Continued)
MISSISSIPPI
Batesville	Columbus	Hattiesburg	Jackson	New Albany	Ripley
Bay St. Louis	Corinth	Hazlehurst	Kosciusko	Newton	Senatobia
Brookhaven	Forest	Hernando	Magee	Oxford	Starkville
Booneville	Grenada	Houston	McComb	Pearl	Tupelo
Carthage	Gulfport	Iuka	Meridian	Picayune	Winona
Columbia
SOUTH CAROLINA
Aiken	Cheraw	Florence	Lexington	North Charleston	Summerville
Anderson	Chester	Gaffney	Lugoff	North Greenville	Sumter
Barnwell	Clemson	Greenville	Manning	Orangeburg	Union
Batesburg-    Leesvile	Columbia	Greenwood	Marion	Rock Hill	Walterboro
Boiling Springs	Conway	Greer	Moncks Corner	Seneca	Winnsboro
Cayce	Dillon	Lancaster	Newberry	Simpsonville	York
Charleston	Easley	Laurens	North Augusta	Spartanburg
TENNESSEE
Bristol	Elizabethton	Kingsport	Lenoir City	Sparta

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DIRECTORS
Ben F. Cheek, III Chairman and Chief Executive Officer 1st Franklin Financial Corporation	C. Dean Scarborough Realtor
Ben F. Cheek, IV Vice Chairman 1st Franklin Financial Corporation	Dr. Robert E. Thompson Retired Physician
A. Roger Guimond Executive Vice President and Chief Financial Officer 1st Franklin Financial Corporation	Keith D. Watson Vice President and Corporate Secretary Bowen & Watson, Inc.
John G. Sample, Jr. Senior Vice President and Chief Financial Officer Atlantic American Corporation

EXECUTIVE OFFICERS

Ben F. Cheek, III

Chairman and Chief Executive Officer

Ben F. Cheek, IV

Vice Chairman

Virginia C. Herring

President

A. Roger Guimond

Executive Vice President and Chief Financial Officer

J. Michael Culpepper

Executive Vice President and Chief Operating Officer

C. Michael Haynie

Executive Vice President - Human Resources

Kay S. Lovern

Executive Vice President – Strategic and Organization Development

Lynn E. Cox

Vice President / Corporate Secretary and Treasurer

LEGAL COUNSEL

Jones Day

1420 Peachtree Street, N.E.

Suite 800

Atlanta, Georgia  30309-3053

AUDITORS

Deloitte & Touche LLP

191 Peachtree Street, N.E.

Atlanta, Georgia  30303

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