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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 SEPTEMBER 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)
MICHIGAN 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 NOVEMBER 6, 2003
----- -------------------------------
Common stock, no par value. 3,722,870
FRANKLIN BANCORP, INC.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Statements of Financial Condition at September 30, 2003 (unaudited) and
December 31, 2002................................................................................................4
Consolidated Statements of Income for the nine months and three months ended
September 30, 2003 and 2002 (unaudited)..........................................................................5
Consolidated Statements of Comprehensive Income/(Loss) for the nine months and three months ended
September 30, 2003 and 2002 (unaudited)..........................................................................6
Consolidated Statements of Shareholders' Equity for the nine months ended September 30, 2003
and 2002 (unaudited).............................................................................................7
Consolidated Statements of Cash Flows for the nine months ended September 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 nine months ended September 30, 2003 to nine months
ended September 30, 2002........................................................................................13
Comparison of three months ended September 30, 2003 to three months
ended September 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
[GRANT THORNTON LOGO]
Report of Independent Certified Public Accountant
Board of Directors and Stockholders
Franklin Bancorp, Inc.
We have reviewed the accompanying consolidated statement of financial condition
of Franklin Bancorp, Inc. and subsidiary as of September 30, 2003, and the
related consolidated statements of operations and comprehensive income for the
three and nine month periods ended September 30, 2003 and 2002 and consolidated
statements of shareholders' equity and cash flows for the nine month period
ended September 30, 2003. 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.
Southfield, Michigan
October 22, 2003
-3-
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FRANKLIN BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
At
-----------------------------------------
September 30, 2003 December 31, 2002
------------------ -----------------
ASSETS (unaudited)
Cash and due from banks $ 21,494,754 $ 18,171,153
Interest-earning deposits 783,107 3,580,028
Time deposits with Federal Home Loan Bank 31,570,621 9,050,162
--------------- ---------------
Cash and cash equivalents 53,848,482 30,801,343
Securities available for sale 112,315,199 149,836,544
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 336,087,199 333,345,726
Allowance for loan losses (4,466,450) (5,926,813)
--------------- ---------------
Net loans 331,620,749 327,418,913
Real estate owned 1,905,835 2,004,449
Premises and equipment, net 3,304,218 3,026,171
Bank Owned Life Insurance (BOLI) 11,009,463 9,799,009
Other assets 7,500,647 12,181,487
--------------- ---------------
Total assets $ 528,384,043 $ 542,478,316
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ 416,713,944 $ 429,129,830
Borrowings 65,000,000 65,000,000
Other liabilities 1,822,066 2,706,791
--------------- ---------------
Total liabilities 483,536,010 496,836,621
Shareholders' equity:
Common stock - no par value; stated value $1 per share;
authorized 6,000,000 shares, Issued and
outstanding 3,718,870 shares (3,647,593 shares
at December 31, 2002) 3,718,870 3,647,593
Additional paid in capital 27,783,381 27,154,384
Retained earnings 11,906,191 12,413,704
Accumulated other comprehensive income 1,439,591 2,426,014
--------------- ---------------
Total shareholders' equity 44,848,033 45,641,695
--------------- ---------------
Total liabilities and shareholders' equity $ 528,384,043 $ 542,478,316
-4-
Franklin Bancorp, Inc.
Consolidated Statements of Income (unaudited)
Three Months Ended Nine Months Ended
September 30 September 30
---------------------------------- ----------------------------------
2003 2002 2003 2002
---- ---- ---- ----
Interest income
Interest on loans $ 5,191,672 $ 6,357,729 $ 16,474,418 $ 19,051,026
Interest on securities 636,166 1,389,756 2,460,913 4,683,824
Other interest and dividends 634,241 677,330 1,847,405 1,841,228
------------ ------------ ------------ ------------
Total interest income 6,462,079 8,424,815 20,782,736 25,576,078
Interest expense
interest on deposits 719,052 1,255,225 2,471,101 3,745,267
Interest on other borrowings 728,723 729,103 2,167,470 2,230,331
------------ ------------ ------------ ------------
Total interest expense 1,447,775 1,984,328 4,638,571 5,975,598
------------ ------------ ------------ ------------
Net interest income 5,014,304 6,440,487 16,144,164 19,600,480
Provision for loan losses 1,025,653 300,000 2,276,959 1,275,000
------------ ------------ ------------ ------------
Net interest income after provision for loan losses 3,988,651 6,140,487 13,867,205 18,325,480
Non interest income
Deposit account service charges 777,566 814,187 2,302,780 2,392,713
Net gain on sale of securities - 327,948 455,511 648,356
Net (loss) on sale of other assets - (40,000) - (41,602)
Other 376,156 420,978 1,165,687 1,246,647
------------ ------------ ------------ ------------
Total non interest income 1,153,722 1,523,113 3,923,978 4,246,114
Non interest expense
Compensation and benefits 2,314,687 2,389,274 7,095,143 7,117,177
Severance compensation 2,637 69,516 2,977,539 199,835
Occupancy and equipment 836,998 805,591 2,440,218 2,390,538
Defaulted loan expense 179,649 214,149 638,150 446,380
Other 1,356,105 2,010,821 4,260,537 4,734,472
------------ ------------ ------------ ------------
Total non interest expense 4,690,076 5,489,351 17,411,587 14,888,402
------------ ------------ ------------ ------------
Income before Federal income tax provision 452,296 2,174,249 379,596 7,683,192
Federal income tax provision 25,132 502,646 3,335 1,900,145
------------ ------------ ------------ ------------
Net income before preferred stock dividends 427,164 1,671,603 376,261 5,783,047
Preferred stock dividend of subsidiary - 450,225 - 1,350,675
------------ ------------ ------------ ------------
Net income $ 427,164 $ 1,221,378 $ 376,261 $ 4,432,372
============ ============ ============ ============
Net income per common share
Average common shares outstanding
Basic 3,709,083 3,635,331 3,687,546 3,629,075
Diluted 3,794,077 3,774,348 3,769,369 3,769,934
Net income per common share
Basic $ 0.12 $ 0.34 $ 0.10 $ 1.22
Diluted $ 0.11 $ 0.32 $ 0.10 $ 1.18
See Notes to Consolidated Financial Statements
-5-
Consolidated Statements of Comprehensive
Income/(Loss) (unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income $ 427,164 $1,221,378 $ 376,261 $4,432,372
Other comprehensive income/(loss), net of tax
Unrealized gains/(losses) on securities:
Unrealized holding gains/(losses) arising
during the period (847,482) 1,126,002 (685,786) 2,303,100
Less: reclassification adjustment for gains
included in net income - 327,948 300,637 648,356
---------- ---------- ---------- ----------
Other comprehensive income/(loss) (847,482) 798,054 (986,423) 1,654,744
---------- ---------- ---------- ----------
Comprehensive income/(loss) $ (420,318) $2,019,432 $ (610,162) $6,087,116
========== ========== ========== ==========
See Notes to Consolidated Financial Statements.
-6-
Franklin Bancorp, Inc.
Consolidated Statements of Shareholders' Equity (unaudited)
Nine Months Ended
September 30,
------------------------------------
2003 2002
---- ----
COMMON STOCK
Balance at beginning of period $ 3,647,593 $ 3,607,542
Exercise of options 71,277 28,789
------------ ------------
BALANCE AT END OF PERIOD 3,718,870 3,636,331
ADDITIONAL PAID IN CAPITAL
Balance at beginning of period 27,154,384 27,839,246
Exercise of options 628,997 405,864
------------ ------------
BALANCE AT END OF PERIOD 27,783,381 28,245,110
RETAINED EARNINGS
Balance at beginning of period 12,413,704 9,722,876
Net income 376,261 4,432,372
Cash dividend on common stock ($.24 per share in 2003) (883,774) (833,712)
------------ ------------
BALANCE AT END OF PERIOD 11,906,191 13,321,536
ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME
Balance at beginning of period 2,426,014 1,009,795
Change in accumulated other comprehensive income/(loss) (986,423) 1,654,744
------------ ------------
BALANCE AT END OF PERIOD 1,439,591 2,664,539
------------ ------------
TOTAL SHAREHOLDERS' EQUITY $ 44,848,033 $ 47,867,516
============ ============
-7-
Consolidated Statements of Cash Flows (unaudited) Nine Months Ended
September 30,
-------------------------------------
2003 2002
---- ----
Cash flows from operating activities
Net income $ 376,261 $ 4,432,372
Adjustments to reconcile net income to cash provided by
operating activities:
Provision for loan losses 2,276,959 1,275,000
Depreciation and amortization 897,551 861,598
Realized gain on sale of securities, net and other assets (455,511) (689,959)
Increase in cash surrender value of life insurance (380,455) (454,192)
Net deferral of loan origination costs/fees 29,856 60,632
Decrease in accrued interest receivable 714,643 426,800
Amortization and accretion on securities 913,948 (577,030)
Decrease in prepaid expenses and other assets 3,999,306 2,023,142
Decrease in accrued interest payable, deferred taxes and other
liabilities (884,726) (318,351)
------------ ------------
Total adjustments 7,111,571 2,607,640
------------ ------------
Net cash provided by operating activities 7,487,832 7,040,012
Cash flows from investment activities
Purchase of securities available for sale (30,836,248) (46,671,223)
Proceeds from sales of securities available for sale 5,192,400 27,874,409
Proceeds from maturities and paydowns of securities available
for sale 61,670,914 23,148,073
Increase in loans (8,343,382) (10,999,884)
(Purchase) sale of Federal Reserve Bank/Federal Home Loan
Bank stock 530,950 (19,500)
Purchase of cash value life insurance (830,000) -
Proceeds from the sale of real estate owned 1,949,656 462,557
Capital expenditures (1,175,598) (694,644)
------------ ------------
Net cash provided by investment activities 28,158,692 (6,900,212)
Cash flows from financing activities
Net (decrease)/increase in deposits (12,415,886) 34,304,628
Decrease in short term borrowings and subordinated capital
notes - (14,605,696)
Exercise of common stock options 700,274 434,653
Cash dividends paid on common stock (883,773) (833,712)
------------ ------------
Net cash (used in)/provided by financing activities (12,599,385) 19,299,873
------------ ------------
Net increase in cash and cash equivalents 23,047,139 19,439,673
------------ ------------
Beginning cash and cash equivalents 30,801,343 24,456,994
------------ ------------
Ending cash and cash equivalents $ 53,848,482 $ 43,896,667
============ ============
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest $ 4,697,222 $ 6,001,413
Federal income taxes - 1,927,839
Non-cash investing and financing activities:
Transfer from loans to real estate owned (net) 1,834,731 2,086,302
-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.
The results of operations for the three month or the nine month period
ended September 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 September 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 did not grant options on shares during the
quarter ended September 30, 2003. 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, the effect on net income per
share of stock-based employee compensation was less than $.01 per share 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 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 September 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.
-9-
Franklin Bancorp, Inc.
Notes to Consolidated Financial Statements (unaudited)
Note 2. Earnings Per Share:
Net income per share is computed based on the weighted-average number of
shares outstanding, including the dilutive effect of stock options, as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ------------------------------
2003 2002 2003 2002
---- ---- ---- ----
NUMERATOR
Net income $ 427,164 $1,221,378 $ 376,261 $4,432,372
Numerator for basic and diluted earnings per share
Income available for common shareholders 427,164 $1,221,378 $ 376,261 $4,432,372
DENOMINATOR
Denominator for basic earnings per share -
weighted average share outstanding 3,709,083 3,635,331 3,687,546 3,629,075
Employee stock options 84,994 139,017 81,823 140,859
Denominator for diluted earnings per share -
adjusted weighted average share outstanding 3,794,077 3,774,348 3,769,369 3,769,934
Basic earnings per share $ 0.12 $ 0.34 $ 0.10 $ 1.22
Diluted earnings per share 0.11 0.32 0.10 1.18
-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.
September 30,
-------------------------------
2003 2002
---- ----
Balance at beginning of period $5,926,813 $4,863,948
Provision for loan losses 2,276,959 1,275,000
CHARGE-OFFS
Commercial 1,346,371 722,561
Commercial mortgage 2,656,641
Consumer 1,219,574 1,343,446
Residential mortgage 432,971
Overdraft 35,887 58,686
Lease financing -- 68,334
---------- ----------
Total charge-offs 5,691,443 2,193,027
RECOVERIES
Commercial 568,854 129,648
Commercial mortgage 473,819
Consumer 815,432 770,039
Residential mortgage 12,000 --
Overdraft 28,884 15,341
Lease financing 55,132 197,587
---------- ----------
Total recoveries 1,954,121 1,112,615
---------- ----------
Net charge-offs 3,737,322 1,080,412
---------- ----------
Balance at end of period $4,466,450 $5,058,536
========== ==========
Allowance as a percentage of
Loans 1.33% 1.52%
Nonperforming loans 136.54% 90.00%
Nonperforming assets 85.40% 64.44%
Net charge-offs (annualized) 89.63% 351.15%
Net charge-offs to average loans outstanding (annualized) 1.60% 0.45%
-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 on non-accrual status, loans being deemed to be non-performing and
real estate assets acquired in satisfaction of debt that the Bank currently
owns:
NONPERFORMING ASSETS ANALYSIS
At
--------------------------------------------------
September 30, December 31, September 30,
2003 2002 2002
---- ---- ----
NONACCRUAL LOANS
Commercial $1,029,700 $ 338,547 $2,364,036
Commercial mortgage 1,441,493 3,104,793 2,329,761
Residential mortgage 599,987 1,313,654 834,766
Consumer 200,020 75,993 91,872
---------- ---------- ----------
Total nonaccrual loans 3,271,200 4,832,987 5,620,435
REAL ESTATE OWNED
Commercial mortgage 1,130,835 540,326 636,475
Residential mortgage 775,000 1,464,123 101,678
---------- ---------- ----------
Total real estate owned 1,905,835 2,004,449 738,153
Real estate in redemption 53,265 485,534 1,491,429
---------- ---------- ----------
Total nonperforming assets $5,230,300 $7,322,970 $7,850,017
========== ========== ==========
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 NINE MONTHS ENDED SEPTEMBER 30, 2003 TO NINE MONTHS ENDED
SEPTEMBER 30, 2002:
NET INTEREST INCOME
Interest income decreased by $4.8 million, along with interest expense
which decreased by $1.3 million, resulting in a decrease in net interest income
of $3.5 million or 17.6% when comparing the nine months ended September 30, 2003
to the nine months ended September 30, 2002. The net interest margin was 4.46%
and 5.03% for the nine months ended September 30, 2003 and 2002, respectively.
Interest income earned on the loan portfolio decreased $2.6 million or 13.5%
when comparing the nine months ended September 30, 2003 to the nine months ended
September 30, 2002. Another large decrease in interest income came from
securities and other investments, with a decrease of $2.2 million when comparing
the nine months ended September 30, 2003 to the nine months ended September 30,
2002. The decrease in interest income was primarily the result of the overall
decrease in interest rates over the last fifteen months and the decline in
average earning asset balances of $19.5 million or 3.9% for the nine months
ended September 30, 2003. Average balances for outstanding loans decreased by
$11.1 million or 3.5% when comparing the nine months ended September 30, 2003 to
the nine months ended September 30, 2002. Average balances for securities
decreased $27.9 million or 17.2%, for the nine months ended September 30, 2003
compared to the nine months ended September 30, 2002. Offsetting some of these
decreases was an increase in the average balance of $19.5 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 $1.3 million or 34.0% when comparing the nine months ended September
30, 2003 to the nine months ended September 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, which equated to a weighted average rate of 4.42
percent and 4.41 percent for the nine months ended September 30, 2003 and the
nine months ended September 30, 2002, respectively. The interest on other
borrowings declined $62,861 or 2.8% when comparing the nine months ended
September 30, 2003 to the nine months ended September 30, 2002.
-13-
(Dollars in Thousands)
The following schedule presents the daily average amount outstanding for
each major category of interest earning assets, nonearning assets, interest
bearing liabilities, and noninterest 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
Nine months ended September 30 2003 2002
----------------------------------------- ----------------------------------------
Tax Average Tax Average
Average Equivalent Yield\ Average Equivalent Yield\
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
INTEREST EARNING ASSETS:
Loans $ 311,351 $ 16,474 7.05 % $ 322,478 $ 19,051 7.88 %
Taxable investment securities 73,149 2,163 3.94 68,173 4,516 5.06
Non-taxable investment securities 11,138 462 5.53 8,314 407 6.36
Interest bearing deposits 33,310 268 1.07 13,847 179 1.71
Other 49,949 1,573 4.20 85,603 1,561 5.98
------------- ------------ ------------- -----------
Total earning assets 478,897 20,940 5.83 498,415 25,714 6.88
NON EARNING ASSETS
Allowance for loan losses (5,385) (4,843)
Cash and due from banks 22,414 21,040
Accrued income and other assets 35,961 32,972
------------- -------------
Total assets $ 531,887 $ 547,584
============= =============
INTEREST BEARING LIABILITIES
Interest-bearing demand deposits 185,437 1,361 0.98 175,131 3,745 2.08
FHLB advances 65,422 2,168 4.42 65,687 2,173 4.41
Other 48,114 1,110 3.08 68,729 57 1.88
------------- ------------ ------------- -----------
Total interest bearing liabilities 298,973 4,639 2.07 309,547 5,975 2.57
------------ -----------
NONINTEREST BEARING LIABILITIES AND
SHAREHOLDERS' EQUITY
Demand deposits 185,680 172,089
Other 2,251 1,524
Preferred stock of subsidiary - 19,500
Shareholders' equity 44,983 44,922
------------- -------------
Total liabilities and shareholders'
equity $ 531,887 $ 547,582
============= =============
Interest rate spread 3.76 4.31
Net interest income (FTE) 16,301 19,739
Less: FTE adjustment 157 139
------------ -----------
Net interest income 16,144 19,600
============ ===========
Contribution to net interest margin from
noninterest bearing sources of funds 0.70 0.72
------- --------
Net interest margin (FTE) 4.46 % 5.03 %
-14-
NON INTEREST INCOME
Total non interest income decreased by $322,136 or 7.6% for the nine months
ended September 30, 2003 when compared to the same period ended 2002. There was
a decrease in deposit account service charges of $89,933 or 3.8% and a reduction
in securities gains of $192,845 to $455,511 or 29.7% when comparing the nine
months ended September 30, 2003 to the same period ended September 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 management of its investment securities portfolio.
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 $170,893 for the nine months ended September 30, 2003
compared to the same period in 2002.
NON INTEREST EXPENSE
Non interest expenses were $17.4 million for the nine months ended
September 30, 2003 compared to $14.9 million for the same period ended September
30, 2002. Increases in severance compensation accounted for $2.8 million of the
$2.5 million increase. Compensation and benefits decreased modestly by $22,034
for the nine months ended September 30, 2003 compared to the same period in
2002. Defaulted loan expenses increased $191,769 for the nine months ended
September 30, 2003 compared to the same period in 2002.
INCOME TAXES
The income tax provision for the first nine months of 2003 totaled
$3,335 compared to $1,900,145 for the same period a year ago. The effective tax
rate was 20.0% for the first nine months of 2003, compared to 30.0% for the nine
months ended September 30, 2002. In addition there was an adjustment to the 2003
tax provision for the difference between taxes accrued in 2002 and the amount of
the final calculation of taxes as shown in the 2002 federal income tax return in
the amount of $72,500.
FINANCIAL CONDITION
Total assets were $528.4 million at September 30, 2003 compared to $542.5
million at December 31, 2002. When comparing average balances for the nine month
periods ending September 30, 2003 and 2002, cash and cash equivalents increased
$20.8 million and represented 10.5% and 6.4%, respectively, of total assets.
However, cash and cash equivalents increased by $23.0 million from December 31,
2002 to September 30, 2003. The majority of these funds are invested on a short
term basis in the Federal Home Loan Bank time deposit account. Late in the third
quarter of 2003, the Bank purchased $29.5 million of high quality single family
whole loans that are located in markets with which the Bank is familiar. The
weighted average yield on these loans is 5.13 percent and the funds used to
purchase these loans were funds previously invested with The Federal Home Loan
Bank which yielded only 0.96 percent during the month of September. It is
anticipated that these loan purchases will serve three very positive and
important goals, (1) improve the net interest margin, (2) diversify the loan
portfolio and (3) continue to improve the overall credit quality of the Bank's
loan portfolio.
INVESTMENTS
Investment balances decreased $37.5 million or 25.0% from December 31, 2002
to September 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 nine months of 2003 have provided limited
opportunities to invest for a term and at a yield that management considered
attractive.
LOANS
Net loan balances increased $2.7 million or 0.8% from December 31, 2002 to
September 30, 2003. Residential loan purchases caused the growth as short-term
deposits held with the Federal Home Loan Bank were used as a funding source.
Franklin continues to aggressively manage its credit risk during the current
sluggish economic period. As a result, total non-performing assets declined to
$5.2 million at September 30, 2003, down from $6.8 million at December 31, 2002.
In addition to the improvement in the non-performing assets classification, the
Bank's delinquent loans, (loans with scheduled payments 30 days or more past
due) to total loans ratio improved from 2.45% as of December 31, 2002 to
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1.37% as of September 30, 2003. The quality of the loan portfolio has been
improved through the reduction in delinquent loans and the addition of the high
quality residential mortgages.
ALLOWANCE FOR LOAN LOSSES
At September 30, 2003, Franklin's allowance for loan losses (ALLL) as a
percentage of loans outstanding was 1.33% compared to 1.52% at September 30,
2002. Franklin increased its provision for the nine months ended September 30,
2003 to $2,276,959 compared to $1,275,000 for the nine months ended September
30, 2002. During the first nine months of 2003, Franklin had net charge-offs of
$3.7 million compared to $1.1 million for the first nine months of 2002. The
majority of the increase in net charge-offs was related to five commercial loan
relationships which were charged-off during the nine months ended September 30,
2003.
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 or purchase 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 nine months of 2003 by $23.0 million substantially as
a result of the decrease in investments.
DEPOSITS AND BORROWED FUNDS
During the nine month period ended September 30, 2003, Franklin experienced
a decrease in total deposits of $12.4 million. Commercial demand deposits were
the principal source of growth in deposits with an increase of $3.0 million,
which was more than offset by the decrease in time deposits of $17.6 million and
a decrease in the money fund accounts of $1.5 million. Thus the majority of the
decrease was within the higher interest rate paying certificate categories.
REGULATORY CAPITAL
The following table compares the Bank's regulatory capital requirements
and ratios at September 30, 2003 and December 31, 2002.
TIER 1 TIER 1 TOTAL
(In thousands) LEVERAGE RISK-BASED RISK-BASED
- ------------------------------------------------------------------------------------------------------------------------------
Regulatory capital balances at September 30, 2003 $ 43,408 $ 43,408 $ 47,875
Required regulatory capital (well capitalized) 26,594 24,864 41,440
-------------------------------------------------------------
Capital in excess of well capitalized $16,814 $18,544 $6,435
=============================================================
Capital ratios at September 30, 2003 8.16% 10.48% 11.55%
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
September 30, 2003 was the result of decreases in risk weighted assets. The Bank
remains well capitalized with a Tier 1 Leverage ratio of 8.16% at September 30,
2003.
The changes in Tier 1 Risk-based and Total Risk-based Ratios are a
reduction of 15 basis points and a decrease of 34 basis points, respectively,
despite an increase in regulatory equity capital of $192,761, but a decrease in
total regulatory capital of $1.3 million when compared to December 31, 2002.
This decrease in total regulatory capital at September 30, 2003 is primarily due
to the reduction in the allowance for loan losses from the December 31, 2002
balance.
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COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2003 TO THREE MONTHS ENDED
SEPTEMBER 30, 2002
The trends and comparisons for the quarters ended September 30, 2003 and
2002 are substantially similar to those of the nine 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 $1.4 million in the third quarter of
2003 compared to the third 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 37% to 50% 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 $1,025,653 in the third quarter of 2003
was $725,653 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 third quarter of 2003 had no gains on the sale
of securities, while the third quarter of 2002 included $327,948 of gains on the
sale of securities.
NON INTEREST EXPENSE
Non interest expense decreased by $799,276 in the third quarter of 2003
compared to the same quarter in 2002. Severance expenses were $66,879 higher in
the third quarter of 2002 than in the third quarter of 2003. Outside service
expenses were down $474,786, compensation and benefits declined by $74,587 and
communication expense declined by $27,004 in the third quarter of 2003 compared
to the third 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 September 30, 2003 and December 31, 2002 12 month gap
model, the increase in the positive gap can be attributed primarily to a
decrease in investment securities along with an increase in time deposits with
the Federal Home Loan Bank, which have a shorter duration. The 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 category into the 1 to 5 year repricing category. 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 purchase of
residential mortgages has reduced the asset sensitivity since the end of the
second quarter by redeploying some of the short term deposits with the FHLB into
loans.
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 rates 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
should 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 or financial
position.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
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 July 29, 2003, the Corporation filed a Form 8-K disclosing in Item
12 thereof and including as an exhibit in Item 7 thereof, a press release
announcing the consolidated results of operations for the second quarter ended
June 30, 2003.
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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.
November 10, 2003 By: /s/ Craig L. Johnson
---------------------------
Craig L. Johnson, President and
Chief Executive Officer
By: /s/ Leonard B. Carleton
---------------------------
Leonard B. Carleton, Chief Financial
Officer
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EXHIBIT INDEX
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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