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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________.
COMMISSION FILE NO. 0-50078
FRANKLIN BANCORP, INC.
(Exact name of registrant as specified in its charter)
UNITED STATES 38-2606280
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
24725 WEST TWELVE MILE ROAD
SOUTHFIELD, MICHIGAN 48034
(Address of principal executive office) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (248) 358-4710
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
requirement 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 Exchange Act). Yes No X
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
CLASS OUTSTANDING AT AUGUST 12, 2003
----- ------------------------------
Common stock, $1.00 par value. 3,702,139
FRANKLIN BANCORP, INC.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Statements of Financial Condition at June 30, 2003 (unaudited) and
December 31, 2002...........................................................................................4
Consolidated Statements of Operations for the six months and three months ended June 30, 2003
and 2002 (unaudited)........................................................................................5
Consolidated Statements of Comprehensive Income/(Loss) for the six months and three months ended
June 30, 2003 and 2002 (unaudited)..........................................................................6
Consolidated Statements of Shareholders' Equity for the six months ended June 30, 2003 and 2002
(unaudited).................................................................................................7
Consolidated Statements of Cash Flows for the six months ended June 30, 2003
and 2002 (unaudited)........................................................................................8
Notes to Consolidated Financial Statements (unaudited)...............................................................9
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................13
Comparison of six months ended June 30, 2003 to six months ended June 30, 2002......................................13
Comparison of three months ended June 30, 2003 to three months ended June 30, 2002..................................17
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk..................................................18
ITEM 4. Controls and procedures.....................................................................................18
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings...........................................................................................19
ITEM 4. Submission of Matters to a Vote of Security Holders.........................................................19
ITEM 6. Exhibits and Reports on Form 8-K............................................................................20
Signatures..........................................................................................................21
-2-
[GRANT THORNTON LOGO]
Report of Independent Certified Public Accountant
Board of Directors and Stockholders
Franklin Bancorp, Inc.
We have reviewed the accompanying consolidated statements of financial condition
of Franklin Bancorp, Inc. and subsidiary as of June 30, 2003, and the related
consolidated statements of operations, comprehensive (loss) income,
shareholders' equity and cash flows for the six-month and three-month periods
ended June 30 and March 31, 2003 and 2002, respectively. These interim financial
statements are the responsibility of the company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with generally
accepted auditing standards, the objective of which is the expression of an
opinion regarding the financial statements taken as a whole. Accordingly, we do
not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying interim financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
/S/ GRANT THORNTON LLP
Southfield, Michigan
August 13, 2003
-3-
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Franklin Bancorp, Inc.
Consolidated Statements of Financial Condition
At
---------------------------------
June 30, 2003 December 31, 2002
------------- -----------------
ASSETS (UNAUDITED)
Cash and due from banks $ 27,155,859 $ 18,171,153
Interest-earning deposits 614,250 3,580,028
Time deposits with Federal Home Loan Bank 49,256,049 9,050,162
------------- -------------
Cash and cash equivalents 77,026,158 30,801,343
Securities available for sale 124,398,168 149,836,545
Federal Home Loan Bank stock, at cost 5,946,700 5,868,900
Federal Reserve Bank stock, at cost 932,750 1,541,500
Loans 308,491,266 333,345,726
Allowance for loan losses (5,068,741) (5,926,813)
------------- -------------
Net loans 303,422,525 327,418,913
Real estate owned 2,231,813 2,004,449
Premises and equipment, net 3,485,086 3,026,171
Bank Owned Life Insurance (BOLI) 10,049,094 9,799,009
Other assets 8,679,819 12,181,487
------------- -------------
Total assets $ 536,172,113 $ 542,478,317
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ 424,190,864 $ 429,129,830
Borrowings 65,000,000 65,000,000
Other liabilities 1,736,092 2,706,792
------------- -------------
Total liabilities 490,926,956 496,836,622
Shareholders' equity:
Common stock -- par value $1; authorized 6,000,000 shares,
Issued and outstanding 3,691,600 shares
(3,647,593 shares at December 31, 2002) 3,691,600 3,647,593
Additional paid in capital 27,491,285 27,154,384
Retained earnings 11,775,199 12,413,704
Accumulated other comprehensive income 2,287,073 2,426,014
------------- -------------
Total shareholders' equity 45,245,157 45,641,695
------------- -------------
Total liabilities and shareholders' equity $ 536,172,113 $ 542,478,317
============= =============
See Notes to Consolidated Financial Statements
-4-
Consolidated Statements of Operations (unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ----------------------------
2003 2002 2003 2002
Interest income
Interest on loans $ 5,603,032 $ 6,269,294 $ 11,282,746 $ 12,693,297
Interest on securities 773,153 1,643,538 1,824,747 3,294,068
Other interest and dividends 654,292 611,831 1,213,164 1,163,898
------------ ------------ ------------ ------------
Total interest income 7,030,477 8,524,663 14,320,657 17,151,263
Interest expense
interest on deposits 787,080 1,280,753 1,752,049 2,490,043
Interest on other borrowings 720,996 721,788 1,438,747 1,501,228
------------ ------------ ------------ ------------
Total interest expense 1,508,076 2,002,541 3,190,796 3,991,271
------------ ------------ ------------ ------------
Net interest income 5,522,401 6,522,122 11,129,861 13,159,992
Provision for loan losses 625,653 500,000 1,251,306 975,000
------------ ------------ ------------ ------------
Net interest income after provision for loan losses 4,896,748 6,022,122 9,878,555 12,184,992
Non interest income
Deposit account service charges 769,157 792,546 1,525,214 1,578,526
Net gain on sale of securities - 320,408 455,511 320,408
Net (loss) on sale of other assets 77,303 4,875 - (1,602)
Other 455,557 410,659 860,976 825,669
------------ ------------ ------------ ------------
Total non interest income 1,302,017 1,528,488 2,841,701 2,723,001
Non interest expense
Compensation and benefits 2,318,364 2,319,918 3,091,200 4,727,903
Severance compensation 215,162 130,319 2,974,902 130,319
Occupancy and equipment 798,221 797,009 1,548,923 1,584,947
Defaulted loan expense 327,840 143,049 458,501 232,231
Other 1,500,895 1,437,395 4,719,430 2,723,650
------------ ------------ ------------ ------------
Total non interest expense 5,160,482 4,827,690 12,792,956 9,399,050
------------ ------------ ------------ ------------
Income/(loss) before Federal income tax provision 1,038,283 2,722,920 (72,700) 5,508,943
Federal income tax provision/(benefit) 311,503 676,067 (21,797) 1,397,499
------------ ------------ ------------ ------------
Net income/(loss) before preferred stock dividends 726,780 2,046,853 (50,903) 4,111,444
Preferred stock dividend of subsidiary - 450,225 - 900,450
------------ ------------ ------------ ------------
Net income/(loss) 726,780 1,596,628 $ (50,903) $ 3,210,994
============ ============ ============ ============
Income/(loss) per common share
Average common shares outstanding:
Basic 3,685,136 3,631,768 3,675,912 3,625,947
Diluted 3,762,263 3,779,187 3,758,250 3,767,692
Income/(loss) per common share:
Basic $ 0.20 $ 0.44 $ (0.01) $ 0.89
Diluted $ 0.19 $ 0.42 $ (0.01) $ 0.85
-5-
FRANKLIN BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE
INCOME/(LOSS) (unaudited)
Six Months Ended Three Months Ended
June 30, June 30,
------------------------ ----------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income/(loss) $ (50,903) $3,210,994 $ 726,780 $1,596,628
Other comprehensive income/(loss), net of tax
Unrealized gains on securities:
Unrealized holding gains/(losses)
arising during the period 161,696 1,068,159 549,748 1,794,844
Less: reclassification adjustment for
gains included in net income 300,637 211,469 - 211,469
---------- ---------- ---------- ----------
Other comprehensive income/(loss) (138,941) 856,690 549,748 1,583,375
Comprehensive income/(loss) $ (189,844) $4,067,684 $1,276,528 $3,180,003
See Notes to Consolidated Financial Statements.
-6-
Franklin Bancorp, Inc.
Consolidated Statements of Shareholders' Equity (unaudited)
Six Months Ended
June 30,
---------------------------
2003 2002
---- ----
COMMON STOCK
Balance at beginning of period $ 3,647,593 $ 3,607,542
Exercise of options 44,007 27,289
------------ ------------
BALANCE AT END OF PERIOD 3,691,600 3,634,831
ADDITIONAL PAID IN CAPITAL
Balance at beginning of period 27,154,384 27,839,246
Exercise of options 336,901 311,547
------------ ------------
BALANCE AT END OF PERIOD 27,491,285 28,150,793
RETAINED EARNINGS
Balance at beginning of period 12,413,704 9,722,876
Net income/(loss) (50,903) 3,210,994
Cash dividend on common stock ($.08 per share) (587,602) (542,926)
------------ ------------
BALANCE AT END OF PERIOD 11,775,199 12,390,944
ACCUMULATED OTHER COMPREHENSIVE INCOME/(LOSS)
Balance at beginning of period 2,426,014 1,009,795
Change in accumulated other comprehensive income/(loss) (138,941) 856,690
------------ ------------
BALANCE AT END OF PERIOD 2,287,073 1,866,485
------------ ------------
TOTAL SHAREHOLDERS' EQUITY $ 45,245,157 $ 46,043,053
============ ============
See Notes to Consolidated Financial Statements.
-7-
Consolidated Statements of Cash Flows (unaudited)
Six Months Ended
----------------------------
June 30,
2003 2002
------------ ------------
Cash flows from operating activities
Net income/(loss) $ (50,903) $ 3,210,994
Adjustments to reconcile net income to cash provided by operating activities:
Provision for loan losses 1,251,306 975,000
Depreciation and amortization 566,045 564,854
Realized gain on sale of securities, net and other assets 434,410 320,408
Increase in cash surrender value of life insurance (250,085) (306,198)
Net deferral of loan origination costs/fees (167,517) (24,848)
Decrease in accrued interest receivable 170,211 255,760
Amortization and accretion on securities 646,566 (439,047)
Decrease/(increase) in prepaid expenses and other assets 3,484,546 (1,486,751)
Increase/(decrease) in accrued interest payable, deferred taxes and other liabilities (970,700) (748,946)
------------ ------------
Total adjustments 5,164,782 (889,768)
------------ ------------
Net cash provided by/(used in) operating activities 5,113,879 2,321,226
Cash flows from investment activities
Purchase of securities available for sale (21,972,475) (17,158,621)
Proceeds from sales of securities available for sale 5,192,400 8,455,371
Proceeds from maturities and paydowns of securities available for sale 41,778,873 18,620,884
Net decrease/(increase) in loans 20,519,368 (6,218,532)
Purchase (sale) of Federal Reserve Bank/Federal Home Loan Bank stock (530,950) -
Proceeds from the sale of real estate owned 2,315,440 462,557
Capital expenditures (1,046,061) (431,480)
------------ ------------
Net cash provided by investment activities 46,256,595 3,730,179
Cash flows from financing activities
Net (decrease)/increase in deposits (4,938,966) 27,999,957
Decrease in short term borrowings and subordinated capital notes - (14,605,696)
Exercise of common stock options 380,908 338,836
Cash dividends paid on common stock (587,602) (542,926)
------------ ------------
Net cash (used in)/provided by financing activities (5,145,660) 13,190,171
------------ ------------
Net increase in cash and cash equivalents 46,224,815 19,241,577
Beginning cash and cash equivalents 30,801,343 24,456,994
------------ ------------
Ending cash and cash equivalents $ 77,026,158 $ 43,698,571
============ ============
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest $ 3,242,194 $ 4,015,408
Federal income taxes - 1,277,839
Non-cash investing and financing activities:
Transfer from loans to real estate owned (net) 2,058,197 1,922,216
See Notes to Consolidated Financial Statements.
-8-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Basis of Presentation and Significant Accounting Policies:
The accompanying consolidated financial statements of Franklin Bancorp,
Inc. ("Franklin", the "Corporation" or the "Bancorp") have been prepared in
accordance with the instructions for Form 10-Q. Accordingly, they do not include
all information and footnotes necessary for a fair presentation of consolidated
financial condition, results of operations and cash flows in conformity with
generally accepted accounting principles. The statements do, however, include
all adjustments (consisting of normal recurring accruals) which management
considers necessary for a fair presentation of the interim periods.
This Form 10-Q is written with the presumption that the users of the
interim financial statements have read or have access to the Bancorp's Annual
Report on Form 10-K, which contains the latest audited financial statements and
notes thereto, together with Management's Discussion and Analysis of Financial
Condition and Results of Operations as of December 31, 2002 and for the year
then ended. Therefore, only material changes in financial condition and results
of operations are discussed in the remainder of Part I.
The results of operations for the three month or the six month period ended
June 30, 2003 are not necessarily indicative of the results to be expected for
the year ended December 31, 2003.
The Consolidated Statement of Financial Condition as of December 31, 2002
has been derived from the audited Consolidated Statement of Financial Condition
as of that date.
Stock Options
At June 30, 2003, the Corporation had two stock-based employee compensation
plans and two stock based director compensation plans. The Corporation accounts
for those plans under the recognition and measurement principles of APB Opinion
No. 25, Accounting for Stock Issued to Employees, and related Interpretations.
No stock-based employee compensation is reflected in net income, as all options
granted under those plans have an exercise price greater than or equal to the
market value of the underlying common stock on the date of grant. The
Corporation granted options on 30,295 shares during the quarter ended June 30,
2003. The effect on net income (loss) and (loss) earnings per share if the
Corporation had applied the fair value recognition provisions of FASB Statement
No. 123, Accounting for Stock-Based Compensation, as amended by FASB Statement
No. 148, to stock-based employee compensation was less than $.01 in each of the
periods presented.
Recent Accounting Pronouncements
In April 2003 the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 149 which amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities under SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. This statement
clarifies under what circumstances a contract with an initial net investment
meets the characteristic of a derivative discussed in paragraph 6(b) of SFAS No.
133, clarifies when a derivative contains a financing component, amends the
definition of an underlying to conform to language used in FASB Interpretation
No. 45, and amends certain other existing pronouncements. This statement is
effective for contracts entered into or modified after June 30, 2003. It is not
expected that the provisions of Statement No. 149 will have a material impact on
the financial position or results of operations of the Corporation.
In May 2003 the FASB issued SFAS No. 150, which establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. It requires
that an issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). This statement is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. It is to be implemented by reporting the cumulative effect of a change
in accounting principle for financial instruments created before the issuance
date of the Statement and still existing at the beginning of the interim period
of adoption. It is not expected that provisions of Statement No. 150 will have a
material impact on the financial position or results of operations of the
Corporation.
Franklin Bancorp, Inc.
Notes to Consolidated Financial Statements (unaudited)
Note 2. Earnings Per Share:
Net income/(loss) per share is computed based on the
weighted-average number of shares outstanding,
including the dilutive effect of stock options, as follows:
Six Months Ended Three Months Ended
June 30, June 30,
-------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
NUMERATOR
Net income/(loss) $ (50,903) $ 3,210,994 $ 726,780 $ 1,596,628
Numerator for basic and diluted earnings per share
Income/(loss) available for common shareholders $ (50,903) $ 3,210,994 $ 726,780 $ 1,596,628
DENOMINATOR
Denominator for basic earnings per share -
weighted average share outstanding 3,675,912 3,625,947 3,685,136 3,631,768
Employee stock options 82,338 141,745 77,127 147,419
----------- ----------- ----------- -----------
Denominator for basic earnings per share -
adjusted weighted average share outstanding 3,758,250 3,767,692 3,762,263 3,779,187
Basic earnings per share $(0.01) $0.89 $0.20 $0.44
Diluted earnings per share (0.01) 0.85 0.19 0.42
-10-
Note 3. Loans, Nonperforming Assets and Allowance for Loan Losses:
The following table summarizes changes in the allowance for loan and
lease losses arising from loans being charged off, recoveries on loans which had
previously been charged off, and the provision for loan losses.
Six Months Ended
June 30,
2003 2002
---------- ----------
Balance at beginning of period $5,926,813 $4,863,948
Provision for loan losses 1,251,306 975,000
CHARGE-OFFS:
Commercial 1,115,172 509,452
Commercial mortgage 1,481,926
Consumer 717,900 936,971
Residential mortgage 23,072
Overdraft 23,335 41,994
Lease financing 67,174
---------- ----------
Total charge-offs 3,361,405 1,555,591
RECOVERIES:
Commercial 252,062 72,552
Commercial mortgage 462,569
Consumer 473,086 420,614
Residential mortgage 6,000 601
Overdraft 17,266 11,896
Lease financing 41,044 177,602
---------- ----------
Total recoveries 1,252,027 683,265
---------- ----------
Net charge-offs 2,109,378 872,326
---------- ----------
Balance at end of period $5,068,741 $4,966,622
========== ==========
Allowance as a percentage of:
Loans 1.64% 1.50%
Nonperforming loans 129.54% 91.25%
Nonperforming assets 82.48% 62.54%
Net charge-offs (annualized) 120.15% 284.68%
Net charge-offs to average loans outstanding (annualized) 1.37% 0.54%
-11-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 3. Loans, Nonperforming Assets and Allowance for Loan Losses:
The following table summarizes the non-performing loans and assets arising
from loans being placed on non-accrual status, loans being deemed to be
non-performing and assets that the Bank currently owns:
NONPERFORMING ASSETS ANALYSIS
At
--------------------------------------------
June 30, December 31, June 30,
2003 2002 2002
---- ---- ----
NONACCRUAL LOANS
Commercial $2,418,000 $ 338,547 $2,054,796
Commercial mortgage 698,000 3,104,793 2,435,939
Residential mortgage 1,313,654 664,875
Consumer 797,000 75,993 277,914
Lease financing - - 9,372
---------- ---------- ----------
Total nonaccrual loans 3,913,000 4,832,987 5,442,896
REAL ESTATE OWNED
Commercial mortgage 540,326 540,326 676,475
Residential mortgage - 1,464,123 101,678
---------- ---------- ----------
Total real estate owned 540,326 2,004,449 778,153
Real estate in redemption 1,691,486 485,534 1,708,297
Other repossessed assets - - 11,900
---------- ---------- ----------
Total nonperforming assets $6,144,812 $7,322,970 $7,941,246
========== ========== ==========
The carrying values of impaired loans are periodically adjusted to
reflect cash payments, revised estimates of future cash flows and increases
in the present value of expected cash flows due to the passage of time.
Cash payments are reported as reductions in carrying value, while increases
or decreases due to changes in estimates of future payments and due to the
passage of time are reported as a valuation allowance and in gain or loss
on sale of real estate owned.
-12-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Except for the historical information contained herein, the matters
discussed in this report may be deemed to be forward-looking statements that
involve risk and uncertainties. Words or phrases "will likely result", "are
expected to", "will continue", "is anticipated", "estimate", "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Factors
which could cause results to differ include those listed below and other risks
detailed from time to time in the Bancorp's Securities Exchange Act of 1934
reports, including the report on Form 10-K for the year ended December 31, 2002.
These forward-looking statements represent the Bancorp's judgment as of the date
of this report. The Bancorp disclaims, however, any intent or obligation to
update these forward-looking statements.
Future factors include, but are not limited to, changes in interest rates
and interest rate relationships; demand for products and services; the degree of
competition by traditional and non-traditional competitors; changes in banking
regulations; changes in tax laws; changes in prices, levies and assessments; the
impact of technological advances and issues; governmental and regulatory policy
changes; the outcomes of pending and future litigation and contingencies; trends
in customer behavior as well as their ability to repay loans; and changes in the
national economy. These are representative of the future factors that could
cause a difference between an ultimate actual outcome and a preceding
forward-looking statement.
COMPARISON OF SIX MONTHS ENDED JUNE 30, 2003 TO SIX MONTHS ENDED JUNE 30,
2002:
NET INTEREST INCOME
Interest income decreased by $2.8 million, along with interest expense
which decreased by $.8 million, resulting in a decrease in net interest income
of $2.0 million or 15.4%. The net interest margin was 4.67% and 5.30% for the
six months ended June 30, 2003 and 2002, respectively. Interest income earned on
the loan portfolio decreased $1.4 million or 11.1% compared to the year earlier
period. The largest decrease in interest income came from securities and other
investments, with a decrease of $1.5 million. The decrease in interest income
was primarily the result of the overall decrease in interest rates over the last
twelve months and the decline in average earning asset balances of $20.3 million
or 2.6%. Average balances for outstanding loans decreased by $9.2 million or
2.8% when comparing the six months ended June 30, 2003 to June 30, 2002. Average
balances for securities decreased $25.3 million or 22.5%, for the six months
ended June 30, 2003 compared to June 30, 2002. Offsetting some of these
decreases was an increase in the average balance of $12.8 million in the Federal
Home Loan Bank time deposit account, a short-term investment vehicle.
Interest expense is comprised of interest on deposits and interest on other
borrowings, primarily Federal Home Loan Bank advances. Interest on deposits
decreased $737,995 or 29.6% when comparing the six months ended June 30, 2003 to
June 30, 2002. Both the decline in market interest rates and the shift of
deposit balances to non-interest bearing accounts caused the reduction. The
Federal Home Loan Bank advances carried fixed rates during these periods. The
interest on other borrowings declined $62,481 or 0.04% for the prior comparative
period.
-13-
The following schedules present the daily average amount outstanding for
each major category of interest earning assets, Non-earning assets, interest
bearing liabilities, and non-interest bearing liabilities. This schedule also
presents an analysis of interest income and interest expense for the periods
indicated. All interest income is reported on a fully taxable equivalent (FTE)
basis using a 34% tax rate. Nonaccruing loans, for the purpose of the following
computations, are included in the average loan amounts outstanding.
AVERAGE BALANCES/NET INTEREST INCOME/AVERAGE RATES
(Dollar amounts in thousands) 2003 2002
------------------------------------ ------------------------------------
Tax Average Tax Average
Average Equivalent Yield\ Average Equivalent Yield\
Six months ended June 30 Balance Interest Rate Balance Interest Rate
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST EARNING ASSETS:
Loans $ 313,080 $ 11,283 7.31% $ 322,238 $ 12,693 7.88%
Taxable investment securities 76,468 1,630 4.26 104,799 3,149 6.01
Non-taxable investment securities 10,577 296 5.60 7,520 259 6.88
Interest bearing deposits 22,154 229 2.07 9,332 80 1.71
Other 52,413 984 3.75 51,103 1,058 4.14
---------- -------- --------- --------
Total earning assets 474,692 14,422 6.08 494,992 17,239 6.97
NON EARNING ASSETS
Allowance for loan losses (5,647) (4,779)
Cash and due from banks 22,755 21,733
Accrued income and other assets 37,671 31,422
---------- ---------
Total assets $ 529,471 $ 543,368
========== =========
INTEREST BEARING LIABILITIES
Interest-bearing deposits 182,881 936 1.17 170,977 2,490 2.91
FHLB advances 65,659 1,439 4.38 66,015 1,444 4.37
Other 50,633 816 3.22 71,730 57 0.16
---------- -------- --------- --------
Total interest bearing liabilities 299,173 3,191 2.16 308,722 3,991 2.59
-------- --------
NONINTEREST BEARING LIABILITIES AND
SHAREHOLDERS' EQUITY
Demand deposits 182,655 169,722
Other 2,516 1,582
Preferred stock of subsidiary - 19,500
Shareholders' equity 45,127 43,842
---------- ---------
Total liabilities and shareholders' equity $ 529,471 $ 543,368
========== =========
Interest rate spread 3.92 4.38
Net interest income (FTE) 11,231 13,248
Less: FTE adjustment 101 88
-------- --------
Net interest income $ 11,130 $ 13,160
======== ========
Contribution to net interest margin from
Non-interest bearing sources of funds 0.75 0.92
----- -----
Net interest margin (FTE) 4.67% 5.30%
-14-
NON INTEREST INCOME
Total non interest income increased by $118,700 or 4.36% for the six months
ended June 30, 2003 when compared to the same period ended 2002. There was a
decrease in deposit account service charges of $53,312 or 3.38% off set by
securities gains which increased by $135,103 to $455,511 or 42.2% when comparing
the six months ended June 30, 2003 to the same period ended June 30, 2002. These
changes can be attributed to competitive pricing and current market forces
regarding deposit account service charges along with the Bank's conservative
approach to securities trading. If the local economy begins to improve, the Bank
will expect to see an increase in deposit account service charges with expected
increases in the average balances of business checking accounts.
Operating fee income (defined as non interest income excluding gains or
losses on sales of securities, loans, real estate owned and repossessed assets)
decreased slightly by $118,005 for the six months ended June 30, 2003 compared
to the same period in 2002.
NON INTEREST EXPENSE
Non-interest expenses were $12.8 million for the six months ended June 30,
2003 compared to $9.4 million for the same period ended June 30, 2002. Increases
in severance compensation and in expenses associated with the new Troy branch
accounted for $2.8 million and $361,000, respectively, of the $3.4 million
increase.
INCOME TAXES
The income tax benefit for the first half of 2003 totaled $21,797
compared to an income tax provision of $1,397,499 for the same period a year
ago. The effective tax rate was 30.0% for the first six months of 2003, compared
to 32.5% for the same quarter of 2002.
FINANCIAL CONDITION
Total assets were $536.2 million at June 30, 2003 compared to $542.5
million at December 31, 2002. When comparing average balances for the six month
periods ending June 30, 2003 and 2002, cash and cash equivalents increased $13.8
million and represented 8.4% and 5.7%, respectively, of total assets. However,
cash and cash equivalents increased by $46.2 million from December 31, 2002 to
June 30, 2003. The majority of these funds are invested on a short term basis in
the Federal Home Loan Bank time deposit account. Cash and cash equivalents have
increased because both investment and lending opportunities have been
unattractive or unavailable during this six month period.
INVESTMENTS
Investment balances decreased $25.4 million or 17.0% from December 31, 2002
to June 30, 2003 as securities matured throughout the period. The Bank continues
to maintain a conservative approach to its investment acquisitions. Market
conditions during the first half of 2003 have provided limited opportunities to
invest for a term and at a yield that management considered attractive.
LOANS
Net loan balances decreased $24.0 million or 7.3% from December 31, 2002 to
June 30, 2003. Commercial real estate and commercial loans were the categories
showing growth.
Franklin continues to aggressively manage its credit risk during the
current sluggish economic period. As a result, total non-performing assets
declined to $6.1 million at June 30, 2003, down from $7.3 million at December
31, 2002 and $8.7 million at March 31, 2003.
ALLOWANCE FOR LOAN LOSSES
At June 30, 2003, Franklin's allowance for loan and lease losses (ALLL) as a
percentage of loans outstanding was 1.64% compared to 1.50% at June 30, 2002.
Franklin increased its provision for the six months ended June 30, 2003 to
$1,251,306 compared to $975,000 for the six months ended June 30, 2002. During
the first half of 2003, Franklin had net charge-offs of $2.1 million compared to
$872,000 for the first six months of 2002. The majority of the increase in net
charge-offs was related to two commercial loan relationships which were
charged-off during the six months ended June 30, 2003. Management expects to see
a decline in the rate of net charge off activity within these loan portfolios
during the remainder of 2003 if the economy rebounds.
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Management reviews the adequacy of the ALLL quarterly and establishes
appropriate levels of allowance based on various factors, including historical
charge-off levels, evaluation of impaired loans in accordance with the provision
of FASB Statement No. 114, and its view of how economic conditions may affect
the ability of borrowers to repay their loans. Management believes the current
level of ALLL is adequate. Any adjustments, if necessary, are reported in the
allowance for loan losses and the related provision for loan losses in the
period in which they become known.
LIQUIDITY
Franklin competes aggressively for business demand and money market
deposits in southeastern Michigan; which comprise Franklin's primary liquidity
source. Franklin's principal sources of funds for its lending and investment
activities have consisted of deposits, principal repayment on loans, and, to a
lesser extent, Federal Home Loan Bank advances and repurchase agreements.
Principal uses of funds for Franklin include the origination of loans and the
repayment of maturing deposit accounts and other borrowings. The Bank
anticipates it will have sufficient funds available to meet current loan
commitments, as well as its other future liquidity needs. The liquid asset level
increased during the first six months of 2003 by $46.2 million as a result of
the decrease in loans and investments by a greater amount than the decrease in
deposits.
DEPOSITS AND BORROWED FUNDS
During the six month period ended June 30, 2003, Franklin experienced a
decrease in total deposits of $4.9 million. Commercial demand deposits were the
principal source of growth in deposits with an increase of $9.5 million, which
was more than offset by the decrease in time deposits of $13.9 million and a
decrease in the money fund accounts of $1.5 million.
REGULATORY CAPITAL
The following table compares the Bank's regulatory capital requirements
and ratios at June 30, 2003 and December 31, 2002.
TIER 1 TIER 1 TOTAL
(In thousands) LEVERAGE RISK-BASED RISK-BASED
- -----------------------------------------------------------------------------------------------------------
Regulatory capital balances at June 30, 2003 $ 42,958 $ 42,958 $ 48,027
Required regulatory capital (well capitalized) 26,563 24,363 40,606
---------- ---------- ----------
Capital in excess of well capitalized $ 16,395 $ 18,595 $ 7,421
========== ========== ==========
Capital ratios at June 30, 2003 8.09% 10.58% 11.83%
Capital ratios at December 31, 2002 7.55 10.63 11.89
Regulatory capital ratios--"well capitalized" definition 5.00 6.00 10.00
The increase in the Tier 1 Leverage Ratio from December 31, 2002 to June
30, 2003 was the result of decreases in risk weighted assets. The Bank remains
well capitalized with a Tier 1 Leverage ratio of 8.09% at June 30, 2003.
The changes in Tier 1 and Total Risk-based Ratios are a reduction of 5
basis points and an decrease of 6 basis points, respectively, as a result of a
decrease in regulatory equity capital of $256,000, and a decrease in total
regulatory capital of $277,000 when compared to December 31, 2002. This decrease
in total regulatory capital at June 30, 2003 is due to the net loss in the first
six months of 2003, dividends paid and a reduction in the allowance for loan
losses from the December 31, 2002 balance.
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COMPARISON OF THREE MONTHS ENDED JUNE 30, 2003 TO THREE MONTHS ENDED
JUNE 30, 2002
The trends and comparisons for the quarters ended June 30, 2003 and 2002
are substantially similar to those of the six month periods ended on the same
respective dates. This portion of Management's Discussion and Analysis of
Financial Condition and Results of Operations is written with the presumption
that the reader has read the preceding. Therefore, only material changes in
financial condition and results of operations are discussed in the remainder of
Item 2.
NET INTEREST INCOME
The decrease in net interest income of $1.1 million in the second quarter
of 2003 compared to the second quarter of 2002 is a result of declining interest
rates and a shift in earning asset composition from loans and securities to
short term interest bearing deposits. Interest expense on other borrowings
increased from 36% to 48% of total interest expense as the balance of the fixed
rate borrowings from the Federal Home Loan Bank remained stable while the rates
and balances of interest bearing deposits declined, which resulted in less of a
decline in interest expense than interest income. This resulted in a drop in the
Bank's net interest income when comparing the quarters. Therefore, a positive
gap position in a declining rate environment will generally result in reduced
net interest income unless volume increases are able to compensate.
PROVISION FOR LOAN LOSSES
The provision for loan losses of $625,653 in the second quarter of 2003 was
$125,653 greater than the provision in 2002's second quarter. The provision for
loan losses will vary from quarter to quarter as the changes in the assessment
of the adequacy of the allowance for loan losses and net charge offs during the
period will determine the amount of provision required.
NON INTEREST INCOME
Non interest income in the second quarter of 2003 had no gains on the sale
of securities, while the second quarter of 2002 included $320,408 of gains on
the sale of securities.
NON INTEREST EXPENSE
Non interest expense increased by $332,792 in the second quarter of 2003
compared to the same quarter in 2002. The expenses related to the new Troy
branch of approximately $227,000 and outside service expenses of approximately
$281,005 were the primary causes of the increase. Severance expenses were
$84,843 higher in the second quarter of 2003 than in the second quarter of 2002.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Net interest income, as the predominant source of revenue, is closely
monitored, measured and protected through active asset liability management.
Combinations of risk measurement tools are used to accomplish this including
static analysis, "shock" analysis, repricing schedules and duration analysis.
In the normal course of business, assets and liabilities are not perfectly
matched, relative to their maturities and hence, repricing opportunities. The
natural difference between assets and repricing liabilities is the "gap", or
exposure to a potentially adverse impact on net interest income. Management also
monitors the impact on the market value of equity and the impact on net interest
income at risk in its interest rate shock analysis.
When comparing the June 30, 2003 and December 31, 2002 12 month gap model,
the increase in the positive gap can be attributed primarily to a decrease in
loans and investment securities along with an increase in time deposits with the
Federal Home Loan Bank, which have a shorter duration. That increase in assets
that reprice in 12 months or less is compounded by a decrease in time deposits
and an increase in commercial demand deposits. Management also modified its gap
model to distribute the repricing points for the Bank's money market deposit
accounts. This distribution moved $50 million from the 12 month or less
repricing bucket into the 1 to 5 year repricing buckets. Management believes
that this modification to its gap model more accurately reflects the reaction to
interest rate fluctuations relative to non-maturity deposits. Management expects
to remain in a positive gap position throughout the remainder of 2003 given the
current repricing structure of the Bank's balance sheet.
The Bank has noted a decrease in its net interest margin resulting from the
current decline in short term market rates. During the second quarter of 2003,
the Federal Reserve lowered the targeted fed funds rate from the prior quarter.
In the short term, the Bank expects a tightening of its net interest margin as a
result of the reduction in the yield on interest bearing assets decreasing more
rapidly than interest bearing liabilities; however if interest rate rise, a
significant portion of the earning assets should reprice upward while the growth
in noninterest bearing deposits will tend to hold down funding costs, which will
result in improvement in the margin.
In determining interest rate risk exposure, numerous additional factors and
assumptions are built into the analysis. Prepayments, competition, economic
forecast, yield curve assumptions are all factors that can affect net interest
income. Management builds in assumptions based on both historical experience and
predictions to create a more accurate assessment of the true portfolio position.
The goal is to achieve proper balance and alignment between assets and
liabilities not only to protect net interest income but also fully capitalize on
the effect of anticipated future fluctuations.
ITEM 4. CONTROLS AND PROCEDURES
a. The term "disclosure controls and procedures" is defined in
Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act
of 1934 (the "Exchange Act"). These rules refer to the
controls and other procedures of a company that are designed
to ensure that information required to be disclosed by a
company in the reports that it files under the Exchange Act is
recorded, processed, summarized and reported within required
time periods. Our Chief Executive Officer and our Chief
Financial Officer have evaluated the effectiveness of our
disclosure controls and procedures as of the end of the period
covered by the report (the "Evaluation Date"), and have
concluded that, as of the Evaluation Date, our disclosure
controls and procedures are effective in providing them with
material information relating to the Corporation known to
others within the Corporation which is required to be included
in our periodic reports filed under the Exchange Act.
b. There have been no changes in the Corporation's internal
controls over financial reporting that occurred during the
period this Form 10-Q was being prepared that has materially
affected, or is reasonably likely to materially affect, the
Corporation's internal control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Bank is subject to various claims and legal proceedings arising out of
the normal course of business,none of which in the opinion of management is
expected to have a material effect on the Bank's operations of financial
position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of the Shareholders of the Corporation was held on June 17,
2003 in Birmingham, Michigan for the purpose of electing one director for a
three year term expiring in 2006 and upon the election and qualification of his
successor and for the purpose of approving the Amended and Restated 1994 Key
Executive Incentive Stock Option Plan.
The results of the voting were as follows:
Name of Director Votes for Votes withheld
---------------- --------- --------------
Richard J. Lashley 3,352,560 134,452
The names of the other directors and their remaining terms are as
follows:
Name of Director Term
---------------- ----
Irving R. Beimler 2004
David F. Simon 2004
Dean A. Friedman 2005
John W. Palmer 2005
David L. Shelp 2005
Also, on July 9, 2003, Walter J. Aspatore was appointed a director to serve
until the 2006 annual meeting of shareholders and until the election and
qualification of his successor.
The following are the results with respect to the Amended and Restated
1994 Key Executive Incentive Stock Option Plan
For Against Abstain
--- ------- -------
3,067,907 397,038 22,067
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.20 Employment agreement of Craig L. Johnson dated as of
June 16, 2003.
10.21 Employment agreement of Leonard B. Carleton dated as
of June 16, 2003.
10.22 Change in Control Agreement of Ronald J. Carr
10.23 Change in Control Agreement of Michael A. King
10.24 Amended and Restated 1994 Key Executive Incentive
Stock Option Agreement
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) Reports on Form 8-K.
On April 4, 2003, the Corporation filed a Form 8-K disclosing in Item 5
thereof the resignation of an executive officer and the continuation in office
of another executive officer.
On May 5, 2003, the Corporation filed a Form 8-K disclosing in Item 5
thereof the announcement of a cash dividend and the appointment of two new
executive officers of Franklin Bank, National Association, and disclosing in
Item 9 thereof, and including as an exhibit, the press release announcing its
results of operations for the first quarter ended March 31, 2003.
On June 24, 2003, the Corporation filed a Form 8-K disclosing in Item 5
thereof the appointment of two new executive officers.
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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 BANCORP, INC.
August 14, 2003 By: /s/ David L. Shelp
---------------------------
(David L. Shelp, President and CEO)
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EXHIBIT INDEX
10.20 Employment agreement of Craig L. Johnson dated as of June 16, 2003.
10.21 Employment agreement of Leonard B. Carleton dated as of June 16, 2003.
10.22 Change in Control Agreement of Ronald J. Carr
10.23 Change in Control Agreement of Michael A. King
10.24 Amended and Restated 1994 Key Executive Incentive Stock Option Agreement
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Certification of Principal Executive Officer and Principal Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
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