SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarterly Period Ended Commission File Number:
March 31, 2003 0-24133
FRANKLIN FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
Tennessee 62-1376024
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
230 Public Square, Franklin, Tennessee 37064
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (615)790-2265
Not applicable
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(Former name, former address and formal fiscal year, if changed since last
report)
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Yes [X] No [ ]
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
Common Stock, No Par Value 8,354,099
- -------------------------- --------------------------
Class Outstanding at May 7, 2003
PART I. - FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands)
March 31, December 31,
2003 2002
--------- ------------
ASSETS
Cash and cash equivalents $ 33,924 28,061
Federal funds sold -- 18,922
Investment securities available-for-sale, at fair value 44,575 68,325
Mortgage-backed securities available-for-sale, at fair value 229,577 189,647
Investment securities held-to-maturity, fair value $4,712
at March 31, 2003 and $8,137 December 31, 2002 4,633 8,043
Mortgage-backed securities held-to-maturity, fair value
$189 at March 31, 2003 and $198 at December 31, 2002 176 185
Federal Home Loan and Federal Reserve Bank stock, restricted 4,149 4,113
Loans held for sale 23,034 19,432
Loans 529,666 538,263
Allowance for loan losses (5,935) (5,761)
--------- -------
Loans, net 523,731 532,502
--------- -------
Premises and equipment, net 9,398 9,691
Accrued interest receivable 3,833 3,713
Mortgage servicing rights 4,247 3,749
Foreclosed assets, net 1,865 1,555
Other assets 4,221 3,295
--------- -------
Total assets $ 887,363 891,233
========= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Noninterest-bearing $ 94,158 78,507
Interest-bearing 640,873 679,865
--------- -------
Total deposits 735,031 758,372
Repurchase agreements 200 200
Long-term debt and other borrowings 94,255 76,382
Accrued interest payable 1,467 1,478
Other liabilities 4,279 6,253
--------- -------
Total liabilities 835,232 842,685
--------- -------
Stockholders' equity:
Common stock, No par value. Authorized 500,000,000 shares; issued 8,274,507
and 7,968,022 at March 31, 2003 and December 31, 2002,
respectively 14,665 12,659
Accumulated other comprehensive gain, net of tax 1,956 2,807
Unearned compensation related to outstanding
restricted stock awards (132) (147)
Retained earnings 35,642 33,229
--------- -------
Total stockholders' equity 52,131 48,548
--------- -------
$ 887,363 891,233
========= =======
See Notes to Unaudited Consolidated Financial Statements
2
FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited and in thousands except for per share data)
Three Months Ended
March 31,
2003 2002
--------- ---------
Interest income:
Interest and fees on loans $ 8,588 8,365
Taxable securities 2,937 3,869
Tax-exempt securities 287 227
Federal funds sold 61 17
--------- ---------
Total interest income 11,873 12,478
--------- ---------
Interest expense:
Certificates of deposit over $100,000 1,244 1,579
Other deposits 1,765 1,905
Federal Home Loan Bank advances 830 840
Other borrowed funds 221 281
--------- ---------
Total interest expense 4,060 4,605
--------- ---------
Net interest income 7,813 7,873
Provision for loan losses 920 650
--------- ---------
Net interest income after provision for loan losses 6,893 7,223
Other income:
Service charges on deposit accounts 648 690
Mortgage banking activities 1,365 822
Other service charges, commissions and fees 159 173
Commissions on sale of annuities and brokerage activity 27 131
Gain on sale of mortgage loans 492 52
Gain on sale of investment securities 377 81
--------- ---------
Total other income 3,068 1,949
--------- ---------
Other expenses:
Salaries and employee benefits 3,134 2,869
Occupancy expense 516 523
Mortgage banking 564 353
Furniture and equipment 309 341
Communications and supplies 150 151
Advertising and marketing 110 106
FDIC and regulatory assessments 75 65
Foreclosed assets, net 22 226
Merger expenses 9 --
Other 574 543
--------- ---------
Total other expenses 5,463 5,177
--------- ---------
Income before income taxes 4,498 3,995
Income taxes 1,608 1,385
--------- ---------
NET INCOME $ 2,890 2,610
========= =========
NET INCOME PER SHARE - BASIC $ 0.35 0.33
========= =========
NET INCOME PER SHARE - DILUTED $ 0.33 0.30
========= =========
Dividends declared per share 0.05775 0.0550
Weighted average shares outstanding:
Basic 8,143 7,859
Diluted 8,845 8,655
See Notes to Unaudited Consolidated Financial Statements
3
FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock Comprehensive Retained
Shares Amount Income (Loss) Earnings
-----------------------------------------------------------
BALANCE - JANUARY 1, 2003 7,968 12,659 33,229
Comprehensive income:
Net Income 2,890 2,890
Other comprehensive income, net of tax:
Unrealized holding losses on securities
arising (net of tax of $665) (1,085)
Less: Reclassification adjustment for gains
included in net income (net of $143 tax) 234
Other comprehensive income (851)
Comprehensive income 2,039
Exercise of stock options and issuance of common stock 307 1,950
Tax benefit of stock options exercised 56
Issuance of restricted stock -- --
Cash dividend declared; $.05575 per share (477)
BALANCE - MARCH 31, 2003 8,275 14,665 35,642
Accumulated Unamortized
Other Cost of
Comprehensive Restricted
Income (Loss) Stock Awards Total
-----------------------------------------
BALANCE - JANUARY 1, 2003 2,807 (147) 48,548
Comprehensive income:
Net Income 2,890
Other comprehensive income, net of tax:
Unrealized holding losses on securities
arising (net of tax of $665)
Less: Reclassification adjustment for gains
included in net income (net of $143 tax)
Other comprehensive income (851) (851)
Comprehensive income
Exercise of stock options and issuance of common stock 15 1,965
Tax benefit of stock options exercised 56
Issuance of restricted stock -- -
Cash dividend declared; $.05575 per share (477)
BALANCE - MARCH 31, 2003 1,956 (132) 52,131
See Notes to Unaudited Consolidated Financial Statements
4
FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
Three Months Ended
March 31,
2003 2002
--------- ---------
Cash flows from operating activities:
Net income $ 2,890 2,610
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation, amortization and accretion 912 (114)
Provision for loan losses 920 650
Loans originated for sale (67,863) (35,167)
Proceeds from sale of loans 68,722 40,928
Gain on sale of investment securities (377) (81)
(Gain) on sale of loans (513) (52)
Loss on foreclosed assets 19 226
Gain on sale of premises and equipment (1) --
Increase in accrued interest receivable (120) (285)
Decrease in accrued interest payable (11) (412)
(Decrease) increase in other liabilities (1,494) 1,065
Increase in other assets (2,073) (2,019)
Tax benefit of stock options exercised (56) --
--------- ---------
Net cash provided by operating activities 955 7,349
--------- ---------
Cash flows from investing activities:
Decrease (increase) in federal funds sold 18,922 (276)
Proceeds from sale of securities available-for-sale 17,777 15,333
Proceeds from maturities of securities available-for-sale 63,215 14,650
Proceeds from maturities of securities held-to-maturity 3,451 490
Purchases of securities available-for-sale (98,361) (32,459)
Purchase of securities held-to-maturity -- (3,841)
Purchase of Federal Home Loan and Federal Reserve stock (36) (38)
Net decrease (increase) in loans 3,782 (33,691)
Proceeds from sale of foreclosed assets 68 272
Purchases of premises and equipment, net (2) (64)
--------- ---------
Net cash provided by (used in) investing activities 8,816 (39,624)
--------- ---------
Cash flows from financing activities
Net proceeds from issuance of common stock 2,021 230
Dividends paid (460) (431)
(Decrease) increase in deposits (23,341) 27,697
Increase in other borrowings 17,872 3.040
--------- ---------
Net cash (used in) provided by financing activities (3,908) 30,536
--------- ---------
Net increase (decrease) in cash and cash equivalents 5,863 (1,739)
Cash and cash equivalents at beginning of period 28,061 23,665
--------- ---------
Cash and cash equivalents at end of period $ 33,924 21,926
--------- ---------
Cash payments for interest $ 4,071 5,017
Cash payments for income taxes $ 195 134
--------- ---------
See Notes to Unaudited Consolidated Financial Statements
5
FRANKLIN FINANCIAL CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Franklin
Financial Corporation and Subsidiaries (the "Company") have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Form
10-Q. Accordingly, they do not include all the information and footnotes
required by accounting principles generally accepted in the United States of
America for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the three-month
period ended March 31, 2003 are not necessarily indicative of the results that
may be expected for the year ending December 31, 2003. For further information,
refer to the consolidated financial statements and footnotes thereto included in
the Company's Annual Report on Form 10-K for the year ended December 31, 2002.
NOTE B - SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies of the Company are included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2002. During the
three months ended March 31, 2003, there were no significant changes to those
accounting policies.
STOCK-BASED COMPENSATION
At March 31, 2003, the Company has three stock-based employee compensation
plans, which are described more fully in Note 14 to the Consolidated Financial
Statements included in the Company's 2002 Annual Report on Form 10-K. The
Company accounts for those plans under the recognition and measurement
principles of Accounting Principles Board ("APB") Opinion No. 25, Accounting for
Stock Issued to Employee and related interpretations. The Company calculates
compensation expense on the restricted stock plan as the difference between the
market price of the underlying stock on the date of the grant and the purchase
price, if any, and recognizes such amount on a straight-line basis over the
restriction period in which the restricted stock is earned by the recipient. No
stock-based employee compensation cost is reflected in net income for the
Company's two stock option plans, as all options granted under those plans had
an exercise price equal to the market value of the underlying common stock on
the date of grant.
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provision of SFAS No. 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation.
No options were granted during the three months ended March 31, 2003.
MARCH 31, MARCH 31,
2003 2002
--------- --------
Net earnings available to stockholders:
As reported $ 2,890 $ 2,610
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects -- (1,906)
--------- --------
Pro forma $ 2,890 $ 704
========= ========
2003 2002
Basic earnings per share
As reported $ 0.35 $ 0.33
Pro forma -- 0.09
Diluted earnings per share available to
stockholders:
As reported $ 0.33 $ 0.30
Pro forma -- 0.08
In calculating the pro forma disclosures, the fair value of the options granted
is estimated as of the date granted using the Black-Scholes option pricing model
with the following weighted average assumptions:
2003 2002
---- ----------
Dividend yield - 1.7%
Expected volatility - 38%
Risk-free interest rate range - 5.3 to 5.4%
Expected life - 7-10 years
The weighted-average fair value of options, calculated using the Black-Scholes
option pricing model, granted during the three months ended March 31, 2003 and
2002 is $0 and $6.75 per share, respectively.
NOTE C - DIVIDENDS
In March 2003, the Company's Board of Directors declared a $.05775 per share
cash dividend payable on April 2, 2003.
NOTE D - SEGMENTS
The Company's reportable segments are determined based on management's internal
reporting approach, which is by operating subsidiaries. The reportable segments
of the Company are comprised of the Franklin National Bank ("Bank") segment,
excluding its subsidiaries, and the Mortgage Banking segment, Franklin Financial
Mortgage.
The Bank segment provides a variety of banking services to individuals and
businesses through its branches in Brentwood, Franklin, Fairview, Nashville and
Spring Hill, Tennessee. Its primary deposit products are demand deposits,
savings deposits, and certificates of deposit, and its primary lending products
are commercial business, construction, real estate mortgage and consumer loans.
The Bank segment primarily earns interest income from loans and investments in
securities. It earns other income primarily from deposit and loan fees.
The Mortgage Banking segment originates, purchases and sells residential
mortgage loans. It sells loan originations into the secondary market, but
retains much of the applicable servicing. As a result of the retained servicing,
the Mortgage Banking segment capitalizes mortgage servicing rights and amortizes
these rights over the estimated lives of the associated loans. Its primary
sources of revenue are fees and servicing income, but it also reports interest
income earned on warehouse balances waiting for funding. The segment originates
retail mortgage loans in the Nashville and Chattanooga, Tennessee metropolitan
areas. It also purchases wholesale mortgage loans through correspondent
relationships with other banks.
The "All Other" segment consists of the Company's insurance and securities
subsidiaries and the bank holding company operations which do not meet the
quantitative threshold for separate disclosure. The revenue earned by the
insurance and securities subsidiaries is reported in other income in the
consolidated financial statements and
6
the revenue earned by the bank holding company consists of intercompany
transactions that are eliminated in consolidation.
No transactions with a single customer contributed 10% or more of the Company's
total revenue. The accounting policies for each segment are the same as those
used by the Company. The segments include overhead allocations and intercompany
transactions that were recorded at estimated market prices. All intercompany
transactions have been eliminated to determine the consolidated balances. The
results of the two reportable segments of the Company are included in the
following table.
THREE MONTHS ENDED MARCH 31, 2003
MORTGAGE
(In thousands) BANK BANKING ALL OTHER ELIMINATIONS CONSOLIDATED
-------- -------- --------- ------------ ------------
Total interest income $ 11,684 $ 225 $ 677 $ (713) $ 11,873
Total interest expense 3,867 33 451 (291) 4,060
-------- ------- -------- -------- --------
Net interest income 7,817 192 226 (422) 7,813
Provision for loan losses 920 -- -- -- 920
-------- ------- -------- -------- --------
Net interest income
after provision 6,897 192 226 (422) 6,893
-------- ------- -------- -------- --------
Total other income 1,131 1,851 2,995 (2,909) 3,068
Total other expense 3,906 1,407 472 (322) 5,463
-------- ------- -------- -------- --------
Income before taxes 4,122 636 2,749 (3,009) 4,498
Provision for income taxes 1,473 232 (97) -- 1,608
-------- ------- -------- -------- --------
Net income (loss) $ 2,649 $ 404 $ 2,846 $ (3,009) $ 2,890
======== ======= ======== ======== ========
OTHER SIGNIFICANT ITEMS
Total assets $856,388 $28,593 $ 92,247 $(89,865) $887,363
Depreciation, amortization
and accretion 516 363 33 -- 912
REVENUES FROM EXTERNAL CUSTOMERS
Total interest income $ 11,648 $ 225 $ -- $ -- $ 11,873
Total other income 1,131 1,851 86 -- 3,068
-------- ------- -------- -------- --------
Total income $ 12,779 $ 2,076 $ 86 $ -- $ 14,941
======== ======= ======== ======== ========
REVENUES FROM AFFILIATES
Total interest income $ 36 $ -- $ 677 $ (713) $ --
Total other income -- -- 2,909 (2,909) --
-------- ------- -------- -------- --------
Total income $ 36 $ -- $ 3,586 $ (3,622) $ --
======== ------- ======== ======== --------
7
THREE MONTHS ENDED MARCH 31, 2002
MORTGAGE
(In thousands) BANK BANKING ALL OTHER ELIMINATIONS CONSOLIDATED
-------- -------- --------- ------------ ------------
Total interest income $ 12,285 $ 233 $ 674 $ (714) $ 12,478
Total interest expense 4,397 43 492 (327) 4,605
-------- ------- -------- -------- --------
Net interest income 7,888 190 182 (387) 7,873
Provision for loan losses 650 -- -- -- 650
-------- ------- -------- -------- --------
Net interest income
after provision 7,238 190 182 (387) 7,223
-------- ------- -------- -------- --------
Total other income 862 875 2,849 (2,637) 1,949
Total other expense 4,010 953 536 (322) 5,177
-------- ------- -------- -------- --------
Income before taxes 4,090 112 2,495 (2,702) 3,995
Provision for income taxes 1,432 38 (85) -- 1,385
-------- ------- -------- -------- --------
Net income $ 2,658 $ 74 $ 2,580 $ (2,702) $ 2,610
======== ======= ======== ======== ========
OTHER SIGNIFICANT ITEMS
Total assets $747,196 $19,036 $ 78,065 $(75,905) $768,392
Depreciation, amortization
and accretion (315) 166 35 -- (114)
REVENUES FROM EXTERNAL CUSTOMERS
Total interest income $ 12,245 $ 233 $ -- $ -- $ 12,478
Total other income 862 875 212 -- 1,949
-------- ------- -------- -------- --------
Total income $ 13,107 $ 1,108 $ 212 $ -- $ 14,427
======== ======= ======== ======== ========
REVENUES FROM AFFILIATES
Total interest income $ 40 $ -- $ 674 $ (714) $ --
Total other income -- -- 2,637 (2,637) --
-------- ------- -------- -------- --------
Total income $ 40 $ -- $ 3,311 $ (3,351) $ --
======== ======= ======== ======== ========
8
NOTE E - LOANS
In addition to the disclosures included in the Company's Annual Report on Form
10-K for the year ended December 31, 2002 related to loans and allowance for
loan losses, the following represents information regarding non-accrual loans
and loans past due 90 days or more still accruing interest.
March 31, 2003 March 31, 2002 December 31, 2002
-------------- -------------- -----------------
(in thousands)
Loans accounted for on a non-accrual basis $5,362 $756 $5,218
Accruing loans which are contractually past due
90 days or more as to principal and interest
payments 604 812 2,459
9
NOTE F - MORTGAGE BANKING
The Company's mortgage banking subsidiary has net worth requirements with the
U.S. Department of Housing and Urban Development and Federal Home Loan Mortgage
Corporation of $250,000. The Company exceeded this requirement as of March 31,
2003 and December 31, 2002.
Changes in the balance of mortgage servicing rights, net, were as follows:
Three Months Ended March 31,
2003 2002
--------- ----------
(In Thousands)
Balance - beginning of period $ 3,749 $ 2,254
Additions 850 410
Amortization (352) (152)
Impairment adjustment -- --
------- -------
Balance - end of period $ 4,247 $ 2,512
======= =======
Accumulated amortization of mortgage servicing rights was approximately
$2,577,000 and $2,224,000 at March 31, 2003 and December 31, 2002, respectively.
At March 31, 2003, the weighted-average amortization period of the Company's
mortgage servicing rights was 5.7 years. Projected amortization expense for the
gross carrying value of mortgage servicing rights at March 31, 2003 is estimated
to be as follows (in thousands):
Remainder of 2003 $ 1,144
2004 1,357
2005 1,151
2006 506
2007 218
2008 114
After 2008 62
--------------
Gross carrying value of mortgage servicing rights $ 4,552
==============
NOTE G - DEFINITIVE AFFILIATION AGREEMENT
On July 23, 2002, the Company signed a definitive affiliation agreement, as
amended on September 9, 2002 and December 10, 2002, which provides for the
acquisition of the Company by Fifth Third Bancorp ("Fifth Third") through a
merger of the Company with and into a wholly-owned subsidiary of Fifth Third.
The Board of Directors of the Company approved the definitive affiliation
agreement and the transactions contemplated thereby.
On March 27, 2003, the Company entered into an additional amendment to the
affiliation agreement to extend its termination date to June 30, 2004. As
consideration for this amendment, Fifth Third agreed to amend the exchange ratio
to provide shareholders of the Company shares of Fifth Third common stock valued
at a fixed price of $31.00 per share of the Company, plus any increase in the
book value per share (excluding certain items as defined in the amendment) of
the Company's common stock from March 31, 2003 through the most recent quarter
end prior to the closing. Further, in the event that Fifth Third is not granted
regulatory approval for the
10
merger on or before May 31, 2004, the Company will have the right to terminate
the agreement and to receive a termination fee of $27 million from Fifth Third.
NOTE H - CONTINGENCIES AND GUARANTEES
CONTINGENCIES
The Company is involved in various legal proceedings in the normal course of
business. On August 24, 2000, Jerrold S. Pressman filed a complaint in the U.S.
District Court for the Middle District of Tennessee, against Franklin National
Bank and Gordon E. Inman, Chairman of the Board of the Company and the Bank,
alleging breach of contract, tortuous interference with contract, fraud, and
civil conspiracy in connection with the denial of a loan to a potential borrower
involved in a real estate transaction. The Bank and Mr. Inman filed their
answers in this matter on September 18, 2000, and a motion for Summary Judgment
on October 10, 2000. The Court denied the Bank's motion for Summary Judgment on
February 15, 2001. On July 27, 2001, the Bank and Mr. Inman filed a second
motion for Summary Judgment. The Court granted in part and denied in part the
Bank and Mr. Inman's motion for Summary Judgment on October 5, 2001. The case
was set for trial to begin on March 5, 2002; however, on February 22, 2002, the
Court, on its own Motion, continued the trial until September 10, 2002. Mr.
Pressman's amended complaint seeks compensatory damages in an amount not to
exceed $20 million and punitive damages in an amount not to exceed $40 million
from each defendant. On September 3, 2002, the Court granted Mr. Pressman's
motion to Continue Trial and set February 25, 2003, to begin the trial. A bench
trial on the merits of the case was held between February 25 and March 7, 2003.
On April 30, 2003, the United States District Judge issued an Order in which a
judgment was entered for the Defendants Franklin National Bank and Mr. Inman on
all of Mr. Pressman's claims. On May 2, 2003, Mr. Pressman filed a Notice of
Appeal to the United States Court of Appeals for the Sixth Circuit. A Proof
Brief of Appellee Franklin National Bank will be timely filed with the Court. No
provision has been made in the accompanying consolidated financial statements
for the ultimate resolution of this matter.
There are also other legal actions in which the Company is a defendant.
Management under the advice of legal counsel believe the Company also has
meritorious defenses against these claims and intends to defend such actions
vigorously. No provision has been made in the consolidated financial statements
for the ultimate resolution of these matters.
GUARANTEES
In the ordinary course of business, the Company sells mortgage loans without
recourse that may have to be subsequently repurchased due to defects that
occurred during the origination of the loan. The defects are categorized as
documentation errors, underwriting errors, early payment defaults and fraud.
When a loan sold to an investor without recourse fails to perform, the investor
will typically review the loan to determine whether defects in the origination
process occurred. If a defect is identified, the Company may be required to
either repurchase the loan or indemnify the investor for losses sustained. If
there are no defects, the Company has no commitment to repurchase the loan. The
requirement to repurchase the loan or indemnify the investor is generally
limited to 90 days from the date the related mortgage loan is sold to the
investor. As of March 31, 2003, these guarantees totaled $67.5 million. No
reserve has been established at March 31, 2003 to cover the potential exposure
related to these guarantees as the Company does not believe the ultimate loss
related to this exposure is material to the consolidated financial statements.
The Company maintains insurance for general liability, director and officer
liability and property. Certain policies are subject to deductibles. In addition
to the insurance coverage provided, the Company will indemnify certain officers
and directors for actions taken on behalf of the Company.
11
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The Bank represents virtually all of the assets of the Company. The Bank,
located in Franklin, Tennessee, opened in December of 1989 and continues to
experience substantial growth. The Bank has nine full service branches. In
August 1996, the Bank opened an insurance subsidiary, Franklin Financial
Insurance. In October 1997, the Bank opened a financial services subsidiary,
Franklin Financial Securities. The financial services subsidiary offers
financial planning and securities brokerage services through Legg Mason
Financial Partners. In December 1997, the Bank began operating its mortgage
division as a separate subsidiary, Franklin Financial Mortgage. In August 1998,
the mortgage subsidiary opened a retail mortgage origination office in
Chattanooga, Tennessee. Franklin Financial Mortgage originates, sells and
services wholesale and retail mortgage loans. In September 2000, the Company
formed Franklin Capital Trust I, a Delaware business trust and wholly owned
subsidiary of the Company, for the purpose of issuing Trust Preferred Securities
to the public. In December 2000, the Company received approval from the Federal
Reserve Bank to convert from a bank holding company to a financial holding
company to allow the Company additional avenues for growth opportunities. In May
2001, the Company's stock began trading on the NASDAQ National Market under the
symbol "FNFN".
12
RECENT DEVELOPMENTS
On July 23, 2002, the Company entered into a definitive Affiliation Agreement
(the "Agreement") which provides for the acquisition of the Company by Fifth
Third Bancorp, an Ohio corporation ("Fifth Third") through the merger of the
Company with and into a wholly owned subsidiary of Fifth Third. The original
Agreement provided that each shareholder of the Company would receive, on a
tax-free basis, between 0.3832 and 0.4039 shares of common stock of Fifth Third
for each share of Company common stock owned, with the exact ratio to be
determined based on the average closing price of the common stock of Fifth Third
for the ten consecutive trading days ending on the fifth trading day preceding
the closing of the merger.
On September 9, 2002 and December 10, 2002, the parties amended the Agreement to
extend the deadlines for certain regulatory and other filings by Fifth Third and
to extend the termination date for the Agreement to April 1, 2003. The reasons
for the delay related to an investigation by various banking regulators and a
moratorium imposed by the banking regulators prohibiting acquisitions by Fifth
Third, including the pending acquisition of the Company. On March 27, 2003,
Fifth Third announced that it entered into a written agreement with the Federal
Reserve Bank of Cleveland and the Ohio Department of Commerce, Division of
Financial Institutions arising out of the previously discussed regulatory review
of Fifth Third. The written agreement outlines a series of steps to address and
strengthen Fifth Third's risk management processes and internal controls. These
steps include independent third party reviews and the submission of written
plans in a number of areas. These areas include Fifth Third's management,
corporate governance, internal audit, account reconciliation procedures and
policies, information technology, and strategic planning.
On March 27, 2003, the Company entered into Amendment No. 3 to the Agreement to
extend the termination date of the Agreement to June 30, 2004. In this
amendment, Fifth Third agreed to amend the exchange ratio in the merger to
provide that the Company's shareholders would receive Fifth Third common stock
valued at a fixed price of $31.00 per share of Franklin common stock. In
addition, the Company's shareholders would receive the benefit of any increase
in the book value per share (excluding certain items) of the Company's common
stock from March 31, 2003 through the most recent quarter end prior to closing.
In the event that the Board of Governors of the Federal Reserve System has not
granted regulatory approval for the merger on or before May 31, 2004, the
Company has the right to terminate the Agreement and to receive a termination
fee of $27 million from Fifth Third.
The closing of the transaction is subject to the approval of the Company's
shareholders and normal regulatory approvals. The terms of the Agreement and the
amendments thereto are more fully described in the Company's Current Reports on
Form 8-K as filed with the Securities and Exchange Commission on July 25, 2002
(which report also contains a copy of the Affiliation Agreement), September 10,
2002, December 18, 2002 and March 27, 2003. The above description of the
Agreement and the amendments thereto is qualified in its entirety by reference
to the Agreement and the amendments, which are attached as exhibits to the
Company's Current Reports on Form 8-K.
CRITICAL ACCOUNTING POLICIES
Various elements of our accounting policies, by their nature, are inherently
subject to estimation techniques, valuation assumptions and other subjective
assessments. In particular, we have identified two policies that, due to the
judgments, estimates and assumptions inherent in those policies, are critical to
an understanding of our consolidated financial statements. These policies relate
to the methodology for the determination of our allowance for loan and lease
losses and to the valuation of our mortgage servicing rights.
13
The allowance for loan losses is maintained at a level which, in management's
judgment, is adequate to absorb credit losses inherent in the loan portfolio.
The amount of the allowance is based on management's evaluation of the
collectibility of the loan portfolio, including the nature of the portfolio,
credit concentrations, trends in historical loss experience, specific impaired
loans, and economic conditions. Allowances for impaired loans are generally
determined based on collateral values or the present value of estimated cash
flows. A loan is considered impaired when management has determined it is
possible that all amounts due according to the contractual terms of the loan
agreement will not be collected. The allowance is increased by a provision for
loan losses, which is charged to expense and reduced by charge-offs, net of
recoveries.
Servicing assets on loans sold are measured by allocating the previous carrying
amount between the assets sold and the retained interests based on their
relative fair values at the date of transfer. Our mortgage servicing rights are
related to in-house originations serviced for others. The initial amount
recorded as mortgage servicing rights is essentially the difference between the
amount that can be realized when loans are sold, with servicing released, as
compared to loans sold, with servicing retained. Mortgage servicing rights are
amortized in proportion to, and over the period of, estimated net servicing
revenues. Impairment of mortgage servicing rights is assessed based on the fair
value of those rights.
These policies and the judgments, estimates and assumptions are described in
greater detail in subsequent sections of "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and in Note 1 to the
Consolidated Financial Statements included in the Company's 2001 Annual Report
on Form 10-K. We believe that the judgments, estimates and assumptions used in
the preparation of our consolidated financial statements are appropriate given
the factual circumstances at the time. However, given the sensitivity of our
consolidated financial statements to these critical accounting policies, the use
of other judgments, estimates and assumptions could result in actual results
differing from those estimates.
FINANCIAL CONDITION
Total assets decreased $3.9 million, or 0.4%, since December 31, 2002, to a
total of $887.4 million at March 31, 2003. The decrease in assets is primarily
due to a $23.3 million decrease in deposits, offset be a $17.9 million increase
in long-term debt and other borrowings and net income of $2.9 million. Total
deposits were $735.0 million at March 31, 2003, a decrease of $23.3 million, or
3.1%, since December 31, 2002. The decrease in deposits is primarily due to the
decrease in brokered deposits of $57.4 million, or 57.3%, since December 31,
2002. The Bank's growth in noninterest-bearing deposits has been strong
during the first quarter of 2003 with a $15.7 million, or 19.9%, increase since
December 31, 2002.
The Bank's loan demand has slowed slightly as demonstrated by the decrease in
gross loans of $5.0 million, or 0.9%, since December 31, 2002. Loans held for
sale increased $3.6 million, or 18.5% since December 31, 2002. The allowance for
loan losses increased $174,000, or 3.0%, since December 31, 2002, to $5.9
million, or approximately 1.07% of total loans, at March 31, 2003. The Company
has seen significant growth in construction and commercial real estate loans,
which carry a higher reserve factor. Management believes that the level of the
allowance for loan losses is adequate at March 31, 2003. Management reviews in
detail the level of the allowance for loan losses on a quarterly basis. The
allowance is below the Bank's peer group average as a percentage of loans,
however the Bank's past due loans, at 1.71% of total loans at March 31, 2003,
have historically been below peer group average. At March 31, 2003, the Bank had
non-accrual loans of $5.4 million compared to non-accrual loans of $5.2 million
at December 31, 2002. The Bank has one large relationship of $4.7 million that
was placed on non-accrual status during the third quarter of 2002. Management
feels the Bank has adequate reserves or collateral on this loan relationship.
Assets have been repossessed on this outstanding debt and an appraisal is in
process by an independent third party. At March 31, 2003, the Bank had loans
that were specifically classified as impaired of approximately $18.9 million
compared to $19.2 million at December 31, 2002. The allowance for loan losses
related to impaired loans was $1.2 million at March 31, 2003 compared
14
to $698,000 at December 31, 2002. The average carrying value of impaired loans
was approximately $19.0 million for the three-month period ended March 31, 2003.
Interest income of approximately $220,000 was recognized on these impaired loans
during the three-month period ended March 31, 2003.
At March 31, 2003 the fair value of securities classified as available-for-sale
exceeded the cost of the securities by $3.3 million. At December 31, 2002 the
fair value of securities classified as available-for-sale exceeded the cost of
the securities by $4.5 million. As a result, an unrealized gain net of taxes of
$2.0 million and $2.8 million at March 31, 2003 and December 31, 2002,
respectively, is included in "Accumulated Other Comprehensive Income" in the
stockholders' equity section of the balance sheet. The unrealized gain is
primarily due to economic market conditions causing the Bank's securities to be
valued above current market values.
Securities available-for-sale increased $16.2 million, or 6.3%, during the three
months ended March 31, 2003. The increase was due to excess funds being invested
in the investment portfolio due to slower loan growth during the first quarter
of 2003 and securities called within the held-to-maturity portfolio being
reinvested as available-for-sale. Securities held-to-maturity decreased $3.4
million, or 41.6%, due to zero coupon agency securities being called during the
first quarter of 2003. Net premises and equipment decreased by $293,000, or
3.0%, since December 31, 2002 primarily due to depreciation expense. Accrued
interest receivable increased $120,000, or 3.2%, since December 31, 2002. This
increase is due to the combined increase of $7.7 million in loans and securities
since December 31, 2002, offset partially by lower interest rates. Foreclosed
assets increased $310,000, or 19.9%, since December 31, 2002.
Accrued interest payable decreased $11,000, or 0.7%, since December 31, 2002.
The decrease is due to a decrease in interest-bearing deposits. Long-term debt
and other borrowings increased $17.9 million, or 23.4%, since December 31, 2002
due to temporary federal funds purchased of $19.4 million, offset partially by
the Company's $1.5 million repayment on its line of credit to a correspondent
bank. Other liabilities decreased $1.9 million, or 30.7%, since December 2002.
Stockholders' equity increased $3.5 million, or 7.3%, from December 31, 2002 to
March 31, 2003. The increase is primarily attributable to $2.9 million in net
income offset partially by an $851,000 decrease in other accumulated
comprehensive income and $478,000 in dividends declared. Stockholders' equity
also increased due to a $2.0 million increase in common stock resulting from the
exercise of stock options. Unearned compensation of $132,000 was also recorded
due to the issuance of restricted stock. The restricted stock was issued as part
of the Company's Key Employee Restricted Stock Plan and vests over a period of
four years. The unearned compensation is being amortized on a straight-line
basis over the four-year vesting period of the restricted stock.
LIQUIDITY AND CAPITAL RESOURCES
Management continuously monitors the Bank's liquidity, and strives to maintain
an asset/liability mix that provides the highest possible net interest margin
without taking undue risk with regard to asset quality or liquidity. Liquidity
management involves meeting the funds flow requirements of customers who may
withdraw funds on deposit or have a need to obtain funds to meet their credit
needs. Banks in general must maintain adequate cash balances to meet daily cash
flow requirements as well as satisfy the reserves required by applicable
regulations. The cash balances held are one source of liquidity. Other sources
of liquidity are provided by the investment portfolio, federal funds purchased,
Federal Home Loan Bank advances, sales of loan participations, loan payments,
brokered and public funds deposits and the Company's ability to borrow funds, as
well as issue new capital.
Management believes that liquidity is at an adequate level with cash and due
from banks of $33.9 million at March 31, 2003. Loans and securities scheduled to
mature within one year exceeded $268.6 million at March 31, 2003, which should
provide further liquidity. In addition, approximately $274.2 million of
securities are
15
classified as available-for-sale and could be sold to help meet liquidity needs
should they arise. The Company has a line of credit of $5.0 million with a
lending institution and the Bank is approved to borrow up to $10.0 million in
funds from the Federal Home Loan Bank through overnight advances and $65.0
million in federal funds lines to assist with capital and liquidity needs. The
Company had $900,000 in borrowings against its line of credit and the Bank had
$19.4 million in federal funds purchased at March 31, 2003. In February and
August, 1998 the Bank entered into long term convertible Federal Home Loan Bank
advances with a ten year maturity and a one year call option totaling $6.0
million. During the fourth quarter of 1999, these advances converted to variable
rate advances, which reprice quarterly based on 90-day LIBOR. As part of the
leverage program, during the third quarter of 2000 the Bank entered into three
long-term convertible Federal Home Loan Bank advances. One advance of $25.0
million has a ten year maturity with a three year call option. The other two
advances totaling $27.0 million have a five year maturity with a one year call
option. After the three and one year call options, these advances may be
converted by the Federal Home Loan Bank from a fixed to a variable rate. The
Bank has the right to repay the advances on the date of conversion to a variable
rate without penalty. The Bank has $200,000 outstanding in repurchase agreements
to further develop its relationship with customers. The Bank has approximately
$42.7 million in brokered deposits at March 31, 2003. The majority of these
brokered deposits are $100,000 or less, but they are generally considered to be
more volatile than the Bank's core deposit base.
Approximately $73.3 million in loan commitments are expected to be funded within
the next six months. Approximately $34.2 million of these commitments are in the
mortgage banking segment. Furthermore, the Bank has approximately $92.5 million
of other loan commitments, primarily unused lines and letters of credit, which
may or may not be funded. Commitments may be funded by core or brokered
deposits, cashflow from the securities portfolio or other funding sources which
the Bank maintains. The mortgage banking segment has $42.5 million in
commitments to sell loans at March 31, 2003.
Management monitors the Company's asset and liability positions in order to
maintain a balance between rate- sensitive assets and rate-sensitive liabilities
and at the same time maintain sufficient liquid assets to meet expected
liquidity needs. Management believes that the Company's liquidity is adequate at
March 31, 2003 and that liquidity will remain adequate over future periods.
Other than as set forth above, there are no known trends, commitments, events or
uncertainties that will result in or are reasonably likely to result in the
Company's liquidity increasing or decreasing in any material way. The Company is
not aware of any current recommendations by the regulatory authorities, which if
they were to be implemented, would have a material adverse effect on the
Company's liquidity, capital resources or results of operations.
Net cash flow provided by operating activities was $1.0 million for the first
three months of 2003. The sale of loans exceeded loans originated for sale by
$859,000 for the three months ended March 31, 2003. The majority of this change
in cash flow is due to slightly less loan originations as compared to the sale
of loans in the mortgage banking segment during the three months ended March 31,
2003. The increase in cash flow was partially offset by an increase in other
assets of $2.1 million and a decrease in other liabilities of $1.6 million for
the three months ended March 31, 2003.
Net cash provided by investing activities was $8.8 million for the three months
ended March 31, 2003, which was largely due to the banking segment. The decrease
in the change in net loans was $3.8 million for the first three months of 2003.
Federal funds sold also decreased by $18.9 million. The cash provided by
investing
16
activities was offset partially by an increase in the net investment portfolio
of $13.9 million for the three months ended March 31, 2003.
Net cash used in financing activities was $4.0 million for the first three
months of 2003. The decrease in cash flow is primarily due to a decrease in
deposits of $23.3 million in the first three months of 2003 offset partially by
an increase in other borrowings of $17.9 million.
Equity capital exceeded regulatory requirements at March 31, 2003, at 7.6% of
average assets. The Company's and the Bank's minimum capital requirements and
compliance with the same are shown in the following table.
LEVERAGE CAPITAL TIER 1 CAPITAL TOTAL RISK-BASED CAPITAL
--------------------- -------------------- ------------------------
REGULATORY REGULATORY REGULATORY
MINIMUM ACTUAL MINIMUM ACTUAL MINIMUM ACTUAL
---------- ------ ---------- ------ ---------- --------
Company 3.0% 7.6% 4.0% 10.9% 8.0% 11.9%
Bank 3.0% 7.0% 4.0% 10.1% 8.0% 11.4%
RESULTS OF OPERATIONS
The Company had net income of $2.9 million in the first quarter of 2003 compared
to net income of $2.6 million for the same period in 2002. Net income for the
first quarter ended March 31, 2003 increased $280,000, or 10.7%. Net income per
basic and diluted share was $0.35 and $0.33, respectively, for the first quarter
of 2003 compared to $0.33 and $0.30 for the first quarter of 2002.
Total interest income decreased $605,000, or 4.8%, in the three months ended
March 31, 2003 compared to the same period in 2002. Total interest expense
decreased $545,000, or 11.8%, for the three months ended March 31, 2003 compared
to the same period in 2002. The decrease in total interest income is primarily
attributable to lower interest rates offset partially by an increase in average
earning assets of $72.7 million, or 9.6%, for the first quarter of 2003
compared to the first quarter of 2002. The decrease in total interest income is
primarily due to the banking segment. The decrease in total interest expense is
primarily due to the decrease in interest rates offset by an increase in average
interest-bearing deposits of $87.0 million, or 15.2%, at March 31, 2003 as
compared to the same period in 2002. The banking segment continues to experience
strong deposit rate competition. The Company had a net interest margin of 3.76%
for the first quarter of 2003 compared to 4.44% for the same period in 2002. The
decrease in net interest margin is due to repricing loans starting to match
against deposits that have previously repriced at lower interest rates. As
short-term interest rates decrease, a significant portion of the Bank's loan
portfolio reprices immediately. The Bank currently has a relatively short-term
certificate of deposit portfolio which has supported the net interest margin in
the declining rate environment, but with the extended low rate environment, loan
repricings are occurring at a faster rate than repricing of deposits.
The provision for loan losses was $920,000 and $650,000 for the three months
ended March 31, 2003 and 2002, respectively. While the Bank's asset quality
remains good, increases in the provision for loan losses continue to be needed
as a result of growth in the Bank's loan portfolio. Net charge-offs were
$746,000, or .14%, of average loans outstanding at March 31, 2003 compared to
net charge-offs of $326,000, or .07%, of average loans outstanding at March 31,
2002. The Bank has a $4.7 million problem loan relationship which resulted in a
portion of the increase in the provision for loan losses.
Total other income was $3.1 million in the first quarter of 2003, an increase of
$1.1 million, or 57.4%, from $2.0 million for the same period in 2002. The
increase was largely attributable to an increase of $543,000, or 66.1%, in
mortgage banking activities and an increase of $440,000 in the gain on the sale
of mortgage loans.
17
Gain on sale of investment securities increased $296,000, or 365.4%. Mortgage
servicing rights income contributed $853,000 for the three months ended March
31, 2003 to the total income for the mortgage banking segment. The increase in
the gain on the sale of mortgage loans is partially attributable to a $121,000
positive fair value adjustment on mortgage loan commitments.
Total other expenses increased $286,000, or 5.5%, during the first quarter of
2003 as compared to the same period in 2002. Salaries and employee benefits
increased $265,000, or 9.2%. Salaries and employee benefits expense for the
mortgage banking segment was $702,000 for the three months ended March 31, 2003
compared to $457,000 for the same period in 2002. The increase is attributable
to an increase in commission expense from $171,000 in the first three months of
2002 to $356,000 in the first three months of 2003 due to the increase in
mortgage loan originations and an increase in support staff areas. Mortgage
banking expenses increased $211,000, or 60.0%, from the first three months of
2002 to the first three months of 2003 primarily due to increases in mortgage
correspondent pricing and mortgage servicing rights amortization related to the
increase in loan originations. During the first quarter of 2003, the Company
recorded $9,000 of merger expenses related to the pending merger with Fifth
Third Bancorp. The merger expenses were recognized for investment banking,
attorney and accounting fees. Other expenses have increased as a result of the
overall growth of the banking segment.
ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 143, Accounting for
Asset Retirement Obligations. SFAS No. 143 requires entities to record the fair
value of a liability for an asset retirement obligation in the period in which
it is incurred and requires that the amount recorded as a liability be
capitalized by increasing the carrying amount of the related long-lived asset.
Subsequent to initial measurement, the liability is accreted to the ultimate
amount anticipated to be paid, and is also adjusted for revisions to the timing
or amount of estimated cash flows. The capitalized cost is depreciated over the
useful life of the related asset. Upon settlement of the liability, an entity
either settles the obligation for its recorded amount or incurs a gain or loss.
SFAS No. 143 is required to be adopted for fiscal years beginning after June 15,
2002, with earlier application encouraged. The adoption of SFAS No. 143 on
January 1, 2003 did not have a material impact on the Company's consolidated
financial position or results of operations.
18
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities, which is effective for exit or disposal activities
initiated after December 31, 2002. SFAS No. 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring). SFAS No. 146 requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. SFAS No. 146 is effective for exit or
disposal activities initiated after December 31, 2002 and did not have a
material impact on the Company's consolidated financial position or results of
operations as of and for the quarter ended March 31, 2003.
In November 2002, the FASB issued Interpretation ("FIN") No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No.
5, 57 and 107 and Rescission of FASB Interpretation No. 34. This interpretation
requires that upon issuance of a guarantee, the entity must recognize a
liability for the fair value of the obligation it
19
assumes under that obligation. This interpretation is intended to improve the
comparability of financial reporting by requiring identical accounting for
guarantees issued with separately identified consideration and guarantees issued
without separately identified consideration. The initial recognition and
measurement provisions of FIN No. 45 are to be applied prospectively to
guarantees issued or modified after December 31, 2002. The interpretation's
disclosure requirements were effective for the Company as of December 31, 2002.
Significant guarantees that have been entered into by the Company at March 31,
2003 and December 31, 2002 are disclosed in Note H to the consolidated financial
statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation,
to provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. SFAS No. 148 is effective for
annual and interim periods beginning after December 15, 2002. As the Company has
elected not to change to the fair value based method of accounting for
stock-based employee compensation, the adoption of SFAS No. 148 did not have an
impact on the Company's consolidated financial position or results of
operations.
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest
Entities. FIN No. 46 addresses consolidation by business enterprises of variable
interest entities that have certain characteristics. This Interpretation applies
immediately to variable interest entities created in January 31, 2003 and to
variable interest entities in which an enterprise obtains an interest after that
date. It applies in the first fiscal year beginning after June 15, 2003 to
variable interest entities in which an enterprise holds a variable interest that
it acquired before February 1, 2003. The Company has not yet determined the
impact, if any, the adoption of FIN No. 46 will have on its consolidated
financial position and results of operations.
In April 2003, the FASB issued SFAS No. 149, Amendment to Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is applied prospectively and is effective for contracts
entered into or modified after June 30, 2003, except for SFAS No. 133
implementation issues that have been effective for fiscal quarters that began
prior to June 15, 2003 and certain provisions relating to forward purchases and
sales on securities that do not yet exist. The adoption on April 1, 2003 of the
components of SFAS No. 149 which address SFAS No. 133 implementation issues
that have been effective for fiscal quarters that began prior to June 15, 2003
did not have a material impact on the Company's consolidated interim financial
position and results of operations. The Company has not yet completed the
process of evaluating the impact, if any, the adoption of the remaining
components of SFAS No. 149 will have on its consolidated financial position or
results of operations.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements in this Form 10-Q contain "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995, which
statements generally can be identified by the use of forward-looking
terminology, such as "may," "will," "expect," "estimate," "anticipate,"
believe," "target," "plan," "project," or "continue" or the negatives thereof or
other variations thereon or similar terminology, and are made on the basis of
management's plans and current analyses of the Company, its business and the
industry as a whole. These forward looking statements are subject to risks and
uncertainties, including, but not limited to, economic conditions, competition,
interest rate sensitivity and exposure to regulatory and legislative changes.
The above factors, in some cases, have affected, and in the future could affect,
the Company's financial performance and could cause actual results for fiscal
2003 and beyond to differ materially from those expressed or implied in such
forward-looking statements. The Company does not undertake to publicly update or
revise its forward-looking statements even if experience or future changes make
it clear that any projected results expressed or implied therein will not be
realized.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's financial performance is subject to risk from interest rate
fluctuations. This interest rate risk arises due to differences between the
amount of interest-earning assets and the amount of interest-bearing liabilities
subject to repricing over a specified period and the amount of change in
individual interest rates. The liquidity and maturity structure of the Company's
assets and liabilities are important to the maintenance of
20
acceptable net interest income levels. An increasing interest rate environment
negatively impacts earnings as the Company's rate sensitive liabilities
generally reprice faster than its rate sensitive assets. Conversely, in a
decreasing interest rate environment, earnings are positively impacted. This
potential asset/liability mismatch in pricing is referred to as "gap" and is
measured as rate sensitive assets divided by rate sensitive liabilities for a
defined time period. A gap of 1.0 means that assets and liabilities are
perfectly matched as to repricing within a specific time period and interest
rate movements will not affect net interest margin, assuming all other factors
hold constant. Management has specified gap guidelines for a one-year time
horizon between 0.7 and 1.3. At March 31, 2003, the Company had a gap ratio of
0.9 for the one-year period ending March 31, 2004.
A 200 basis point decrease in the general level of interest rates spread evenly
during the next twelve months is estimated to cause an increase in net interest
income of $168,000 as compared to net interest income if interest rates were
unchanged during the next twelve months. In comparison, a 200 basis point
increase in the general level of interest rates spread evenly during the next
twelve months is estimated to cause a decrease in net interest income of
$168,000, as compared to net interest income if rates were unchanged during the
next twelve months.
As discussed above, this level of variation is within the Company's acceptable
limits. This simulation analysis assumed that savings and checking interest
rates had a low correlation to changes in market rates of interest and that
certain asset prepayments changed as refinancing incentives evolved. Further, in
the event of a change in such magnitude in interest rates, the Company's asset
and liability management committee would likely take actions to further mitigate
its exposure to the change. However, given the uncertainty of specific
conditions and corresponding actions, which would be required, the analysis
assumed no change in the Company's asset/liability composition.
ITEM 4 - CONTROLS AND PROCEDURES
Management has developed and implemented a policy and procedures for
reviewing disclosure controls and procedures and internal controls on a
quarterly basis. On April 30, 2003 (the evaluation date related to this
quarterly report on Form 10-Q for the quarterly period ended March 31, 2003)
management, including the Company's principal executive and financial officers,
evaluated the effectiveness of the design and operation of disclosure controls
and procedures, and, based on its evaluation, the Company's principal executive
and financial officers have concluded that these controls and procedures are
operating effectively. There were no significant changes in the Company's
internal controls or in other factors that could significantly affect these
controls subsequent to the date of management's evaluation. Management noted no
significant deficiencies in the design or operation of the Company's internal
controls and the Company's auditors were so advised.
Disclosure controls and procedures are the Company's controls and other
procedures that are designed to ensure that information required to be disclosed
by the Company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported, within the time periods specified
in the Securities and Exchange Commission's rules and forms. Disclosure controls
and procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by the Company in the reports
that it files under the Exchange Act is accumulated and communicated to
management, including the principal executive and financial officers, as
appropriate to allow timely decisions regarding required disclosure.
21
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings in the normal course of
business. On August 24, 2000, Jerrold S. Pressman filed a complaint in the U.S.
District Court for the Middle District of Tennessee, against Franklin National
Bank and Gordon E. Inman, Chairman of the Board of the Company and the Bank,
alleging breach of contract, tortuous interference with contract, fraud, and
civil conspiracy in connection with the denial of a loan to a potential borrower
involved in a real estate transaction. The Bank and Mr. Inman filed their
answers in this matter on September 18, 2000, and a motion for Summary Judgment
on October 10, 2000. The Court denied the Bank's motion for Summary Judgment on
February 15, 2001. On July 27, 2001, the Bank and Mr. Inman filed a second
motion for Summary Judgment. The Court granted in part and denied in part the
Bank and Mr. Inman's motion for Summary Judgment on October 5, 2001. The case
was set for trial to begin on March 5, 2002; however, on February 22, 2002, the
Court, on its own Motion, continued the trial until September 10, 2002. Mr.
Pressman's amended complaint seeks compensatory damages in an amount not to
exceed $20 million and punitive damages in an amount not to exceed $40 million
from each defendant. On September 3, 2002, the Court granted Mr. Pressman's
motion to Continue Trial and set February 25, 2003, to begin the trial. A bench
trial on the merits of the case was held between February 25 and March 7, 2003.
On April 30, 2003, the United States District Judge issued an Order in which a
judgment was entered for the Defendants Franklin National Bank and Mr. Inman on
all of Mr. Pressman's claims. On May 2, 2003, Mr. Pressman filed a Notice of
Appeal to the United States Court of Appeals for the Sixth Circuit. A Proof
Brief of Appellee Franklin National Bank will be timely filed with the Court. No
provision has been made in the accompanying consolidated financial statements
for the ultimate resolution of this matter.
Except as set forth above, there are no material pending legal proceedings to
which the Company or the Bank is a party or of which any of their properties are
subject; nor are there material proceedings known to the Company to be
contemplated by any governmental authority; nor are there material proceedings
known to the Company, pending or contemplated, in which any director, officer,
or affiliate or any principal security holder of the Company, or any associate
of any of the foregoing is a party or has an interest adverse to the Company or
the Bank.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
EXHIBIT NO. DESCRIPTION OF EXHIBIT
99.1 Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K.
On March 27, 2003 the Company filed a Form 8-K regarding an amendment
to the Affiliation Agreement between the Company and Fifth Third
Bancorp.
22
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.
FRANKLIN FINANCIAL CORPORATION
Dated: May 15, 2003 By: /s/ Gordon E. Inman
------------ -------------------
Gordon E. Inman,
President and Chief
Executive Officer (principal
executive officer)
Dated: May 15, 2003 By: /s/ Lisa L. Musgrove
------------ --------------------
Lisa L. Musgrove, Senior Vice
President and Chief Financial
Officer (principal financial
officer)
23
CERTIFICATIONS
I, Gordon E. Inman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Franklin Financial
Corporation;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures 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 quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this quarter
report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls;
and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/ Gordon E. Inman
-------------------------------------------
Gordon E. Inman
President and Chief Executive Officer
24
CERTIFICATIONS
I, Lisa L. Musgrove, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Franklin Financial
Corporation;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures 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 quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this quarter
report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls;
and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/ Lisa L. Musgrove
-------------------------------------------
Lisa L. Musgrove
Senior Vice President and Chief Financial
Officer
25
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- ----------- ----------------------
99.1 Certification Pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
26