LOSS EXPERIENCE

Net losses (charge-offs less recoveries) and the percent of such net losses to average net loans (loans less unearned finance charges) and to liquidations (payments, refunds, renewals and charge-offs of customers' loans) are shown in the following table:

Year Ended December 31

2009

2008

2007

2006

2005

 (in thousands, except % data)

DIRECT CASH LOANS

Average Net Loans

$

274,275

$

266,753

$

242,576

$

217,919

$

195,563

Liquidations

$435,146

$432,651

$405,782

$366,275

$336,351

Net Losses

$

24,415

$

21,325

$

17,812

$

16,363

$

16,074

Net Losses as % of Average

   Net Loans

8.90%

7.99%

7.34%

7.51%

8.22%

Net Losses as % of Liquidations

5.61%

4.93%

4.39%

4.47%

4.78%

REAL ESTATE LOANS

Average Net Loans

$

24,042

$

25,451

$

25,015

$

23,557

$

24,403

Liquidations

$

8,543

$

15,324

$

13,436

$

12,579

$

11,625

Net Losses (Recoveries)

$

84

$

(23)

$

114

$

65

$

130

Net Losses (Recoveries)

    as a % of Average Net Loans

.35%

(.09%)

.46%

.28%

.53%

Net Losses (Recoveries)

    as a % of Liquidations

.98%

(.15%)

.85%

.52%

1.12%

SALES FINANCE CONTRACTS

Average Net Loans

$

21,334

$

25,486

$

28,721

$

27,950

$

25,802

Liquidations

$

28,304

$

35,070

$

42,031

$

40,093

$

37,366

Net Losses

$

1,203

$

1,448

$

1,557

$

1,481

$

1,680

Net Losses as % of Average

    Net Loans

5.64%

5.68%

5.42%

5.30%

6.51%

Net Losses as % of  Liquidations

4.25%

4.13%

3.70%

3.69%

4.50%

ALLOWANCE FOR LOAN LOSSES

We determine the allowance for loan losses by reviewing our previous loss experience, reviewing specifically identified loans where collection is believed to be doubtful and evaluating the inherent risks and changes in the composition of our loan portfolio.  Such allowance is, in our opinion, sufficient to provide adequate protection against probable loan losses on the current loan portfolio.  

SEGMENT FINANCIAL INFORMATION

For additional financial information about our segments, see Note 13 “Segment Financial Information” in the Notes to Consolidated Financial Statements.

CREDIT INSURANCE

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

REGULATION AND SUPERVISION

State laws require that each office in which a small loan business is conducted be licensed by the state and that the business be conducted according to the applicable statutes and regulations.  The granting of a license depends on the financial responsibility, character and fitness of the applicant, and, where applicable, the applicant must show evidence of a need through convenience and advantage documentation.  As a condition to obtaining such license, the applicant must consent to state regulation and examination and to the making of periodic reports to the appropriate governing agencies.  Licenses are revocable for cause, and their continuance depends upon an applicant’s continued compliance with applicable laws and in connection with its receipt of a license.  The Company has never had any of its licenses revoked.

We conduct all of our lending operations under the provisions of the Federal Consumer Credit Protection Act (the "Truth-in-Lending Act"), the Fair Credit Reporting Act and the Federal Real Estate Settlement Procedures Act and other federal and state lending laws.  The Truth-in-Lending Act requires us to disclose to our customers the finance charge, the annual percentage rate, the total number and amount of payments and other material information on all loans.

A Federal Trade Commission ruling prevents consumer lenders such as the Company from using certain household goods as collateral on direct cash loans.  We collateralize such loans with non-household goods such as automobiles, boats and other exempt items.

We are also subject to state regulations governing insurance agents in the states in which we sell credit insurance.  State insurance regulations require that insurance agents be licensed and limit the premiums that insurance agents can charge.

Changes in the current regulatory environment, or the interpretation or application of current regulations, could impact our business.  While we believe that we are currently in compliance with all regulatory requirements, no assurance can be made regarding our future compliance or the cost thereof.

SOURCES OF FUNDS

The Company is dependent upon the availability of various sources of funds in order to meet its ongoing financial obligations and to make new loans as a part of its business.  Our various sources of funds as a percent of total liabilities and stockholders’ equity and the number of persons investing in the Company's debt securities was as follows:

As of December 31

2009

2008

2007

2006

2005

Bank Borrowings

 4%

 6%

 4%

7%

3%

Senior Debt

43  

38  

41

43

53

Subordinated Debt

19  

22  

23

19

12

Other Liabilities

4  

4  

5  

4

4

Stockholders’ Equity

  30  

  30  

  27         

  27

  28

    Total

100%

100%

100%  

100%  

100%

Number of Investors

5,406 

5,508 

5,820 

5,868 

6,011 

As of March 29, 2010, all of our common stock was held by five related individuals and none of our common stock was traded in any established public trading market.  The Company does not maintain any equity compensation plans, and did not repurchase any of its equity securities during the most recent fiscal year.  Cash distributions of $51.52 and $21.95 per share were paid in 2009 and 2008, respectively, primarily for the purpose of enabling the Company’s shareholders to pay their income tax obligations, which arise as a result of the Company’s status as an S Corporation.  No other cash dividends were paid during the applicable periods.  For the foreseeable future, the Company expects to pay annual cash distributions equal to an amount sufficient to enable the Company’s shareholders to pay their respective income tax obligations as a result of the Company’s status as an S Corporation.

The average interest rates we pay on borrowings, computed by dividing the interest paid by the average indebtedness outstanding, have been as follows:

Year Ended December 31

2009

2008

2007

2006

2005

Senior Borrowings

4.93%

4.78%

5.81%

4.95%

3.74%

Subordinated Borrowings

  5.89   

6.27   

6.34   

5.18   

3.97

All Borrowings

5.24   

5.33   

5.98   

5.04   

3.78

Certain financial ratios relating to our debt have been as follows:

At December 31

2009

 2008

2007

2006

  2005

Total Liabilities to

Stockholders’ Equity

2.38

2.35

2.66

2.69

2.56

Unsubordinated Debt to

Subordinated Debt plus

Stockholders’ Equity

1.06

  .92

 .99

1.19

1.50

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s Discussion and Analysis provides a narrative of the Company’s financial condition and performance.  The narrative reviews the Company’s results of operations, liquidity and capital resources, critical accounting policies and estimates, and certain other matters. It includes Management’s interpretation of our financial results, the factors affecting these results and the major factors expected to affect our future financial condition, operating results and liquidity. This discussion should be read in conjunction with the Company’s consolidated financial statements and notes thereto contained elsewhere in this Annual Report.

Certain information in this discussion and other statements contained in this Annual Report which are not historical facts are forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve risks and uncertainties.  Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained herein.  Possible factors which could cause our actual future results to differ from any expectations within any forward-looking statements, or otherwise, include, but are not limited to, our ability to manage liquidity and cash flow, the accuracy of Management’s estimates and judgments, adverse economic conditions including the interest rate environment, unforeseen changes in net interest margin, federal and state regulatory changes, unfavorable outcomes of litigation and other factors referenced in the “Risk Factors” section of the Company’s Annual Report and elsewhere herein, or otherwise contained in our filings with the Securities and Exchange Commission from time to time.

General:

The Company is a privately-held corporation that has been engaged in the consumer finance industry since 1941.  We operate branch offices in six southeastern states and had a total of 245 branch locations at December 31, 2009.  The Company and its operations are guided by a strategic plan which includes growth through expansion of our branch office network.  The majority of our revenues are derived from finance charges earned on loans outstanding. Additional revenues are derived from earnings on investment securities, insurance income and other miscellaneous income.    

Financial Condition:

Lingering repercussions from the global economic downturn continued to negatively impact the Company’s performance during 2009.  Nevertheless, we are pleased to report that the Company was steadfast in building its financial strength and ensuring continued liquidity during an otherwise difficult year.  The Company’s cash reserves were $26.3 million at December 31, 2009 compared to $3.2 million at December 31, 2008, representing a 732% increase.  The increase in cash was mainly due to net cash provided from operations and increases in sales of the Company’s senior debt securities.  In addition, the Company’s general liquidity position was further improved due to the redemption at maturity or under call provisions of certain investment securities held by the Company.  Additional liquidity was also obtained through a new credit agreement which was effective September 11, 2009.  (See “Liquidity and Capital Resources” section later in this discussion for additional information about the new credit agreement.) As a result of the increase in the Company’s cash position, our total assets as of December 31, 2009 increased $7.0 million (2%) to $396.4 million as compared to $389.4 million as of December 31, 2008.

The Company had approximately $3.1 million and $2.4 million of cash in restricted accounts at December 31, 2009 and 2008, respectively.  These accounts were held by the Company’s insurance subsidiaries in order to meet the deposit requirements of the State of Georgia and to meet reserve requirements of its reinsurance agreements.

As a consequence of uncertain economic conditions, the Company’s net loan portfolio declined $6.5 million or 2% at December 31, 2009 as compared to December 31, 2008.  Loan originations were $470.1 million during 2009 compared to $499.3 million and $496.4 million during 2008 and 2007, respectively.  A disinclination by consumers to engage in borrowing in the then current economic environment and the adoption of more stringent credit underwriting guidelines implemented by Management were factors believed to be primarily responsible for the decline in loan originations.  In addition, an increase in the Company’s allowance for loan losses also contributed to the decline in the net loan portfolio. The allowance is an offset in the loan portfolio to reserve for losses and is systematically based on the determination of the amount of probable losses inherent in the loan portfolio as of the reporting date.  We continually review charge off experience factors, delinquency reports, historical collection rates, estimates of the value of the underlying collateral, economic trends such as unemployment rates and bankruptcy filings, and other information in order to make the necessary judgments as to probable losses.  As a result of the increase in our net charges offs during 2009 and overall economic conditions, we increased the allowance for loan losses to $26.6 million as of December 31, 2009 compared to $23.0 million at December 31, 2008. Management believes the allowance is adequate to cover any losses inherent in the current portfolio; however, additional negative economic developments could require Management to re-evaluate, and possibly further increase, this allowance in the future.  Any additional allowance could materially negatively impact our results of operations or financial condition in a future period.

The Company originates and services all of its performing consumer loans.  There are no active loans packaged and brokered for sale to third parties.  All loans are made with fixed rates for fixed terms.  No variable rate loan products are offered by the Company.  Because the Company does not offer variable rate loan products, it does not believe it has material exposure to certain issues faced by lenders involved in sub-prime real estate mortgage lending, or who otherwise offer variable rate loans.

Marketable debt securities decreased $8.6 million (10%) at December 31, 2009 as compared to the prior year-end mainly due to the aforementioned redemptions resulting from original maturities or the exercise of call provisions.  The majority of these investments are held by the Company’s insurance subsidiaries.  Management maintains what it believes to be a conservative approach when formulating its investment strategy.  The Company does not participate in hedging programs, interest rate swaps or other activities involving the use of off-balance sheet derivative financial instruments.  The Company’s investment portfolio consists mainly of U.S. Treasury bonds, government agency bonds and various municipal bonds.  Approximately 86% of these investment securities have been designated as “available for sale” with any unrealized gain or loss accounted for in the equity section of the Company’s balance sheet, net of deferred income taxes for those investments held by the insurance subsidiaries.  The remainder of the investment portfolio represents securities that are designated “held to maturity”, as Management has both the ability and intent to hold these securities to maturity, and are carried at amortized cost.

A decline in the net depreciable carrying value of fixed assets was the primary reason for the $1.8 million (11%) decrease in other assets at December 31, 2009 compared to the prior year end.  A reduction in prepaid expenses during 2009 also contributed to the decrease in other assets.  

Senior debt increased $17.2 million (10%) at December 31, 2009 compared to December 31, 2008 mainly due to an increase in sales of the Company’s commercial paper.  Offsetting a portion of the increase was a $6.1 million reduction in outstanding borrowings against the Company’s credit line.  

Subordinated debt decreased $11.7 million, or 14%, at December 31, 2009 compared to December 31, 2008 as a result of redemptions of such securities by investors under the provisions of these securities.  

An increase in the 2009 incentive bonus accrual was a contributing factor in the increase in accounts payable and accrued liabilities at December 31, 2009 compared to the prior year end.  Also contributing was an increase in the accrual for health claims under the Company’s self- insured employee medical program.

Results of Operations:

As previously mentioned, continued impact from the recessionary effects on the economy continued to have an impact on the Company’s operations through 2009.  Lower loan originations during 2009 resulted in a growth in average net receivables (gross receivables less unearned finance charges) of $2.0 million (1%) during 2009 compared to $21.4 million (7%) and $26.9 million (10%) during 2008 and 2007, respectively.  Minimal growth in average net receivables resulted in only a small increase in revenues during 2009.  Total revenues were $139.8 million, $138.6 million and $130.3 million during 2009, 2008 and 2007, respectively.

Net income was $8.4 million, $10.7 million and $12.2 million during 2009, 2008 and 2007, respectively.  The declines in net income during 2009 and 2008 were mainly due to the smaller growth in operating revenues being more than offset by significant increases in the loan loss provision during those years.  Increasing personnel costs during each fiscal year also contributed to the lower net income.

Net Interest Income:

The Company’s primary source of earnings is derived from our net interest income, which represents the difference between income on earning assets and the cost of funds on interest bearing liabilities.  Accordingly, a key measure of our success is our net interest income.  The primary categories of our earning assets are loans and investments.  Bank borrowings and debt securities represent the major portion of our interest bearing liabilities. Factors affecting our net interest margin include the level of average net receivables and the interest income associated therewith, capitalized loan origination costs and our average outstanding debt, as well as the general interest rate environment.  Volatility in interest rates generally has more impact on the income earned on investments and the Company’s borrowing costs than on interest income earned on loans.   Management does not normally change the rates charged on loans originated solely as a result of changes in the interest rate environment.

Net interest income was $85.7 million during 2009, compared to $83.5 million in 2008 and $75.7 million in 2007.  Interest income grew $1.1 million (1%) during 2009 compared to 2008 mainly due to an increase in finance charges earned on loans.  Although loan originations were lower in 2009, average net receivables experienced a small increase.  During 2008 interest income grew $6.8 million (7%) compared to 2007 primarily due to additional earnings on a $21.4 million increase in average net receivables.

Average borrowings outstanding were $253.3 million, $271.4 million and $254.3 million during 2009, 2008 and 2007, respectively.  During the same periods, average borrowing costs were 5.24% and 5.33%, respectively, compared to 5.98% during 2007.  Lower average borrowings and a lower average borrowing rate resulted in a $1.0 million (7%) reduction interest expense during 2009 compared to 2008, which contributed to the increase in the net interest margin.  

Although average borrowings were higher during 2008 compared to 2007, a decline in our average cost of debt due to reductions in interest rates during 2008 resulted in a $1.0 million (6%) decline in interest expense, thereby contributing to the growth in the net margin during 2008 over 2007.

Net Insurance Income:

The Company offers certain optional credit insurance products to loan customers.  Growth in our loan portfolio typically leads to increases in insurance in-force as many loan customers elect to purchase the credit insurance coverage offered by the Company.  Growth in premium income slowed during the year just ended, due the aforementioned suppressed growth in average net receivables, and higher insurance claim payments caused net insurance income to decline $.4 million (2%) as compared to 2008.  Net insurance income increased $.6 million (2%) during 2008 compared to 2007 mainly due to higher premiums, offset partially by higher claim payments.

Other Revenue:

The primary revenue category included in other revenue relates to auto club memberships offered to the Company’s loan customers.  The Company sells the memberships as an agent for a third-party provider.  Lower levels of membership sales during 2009 as compared to 2008 resulted in a $.1 million (1%) decrease in other revenue during the comparable period.  During 2008, sales were higher than 2007, resulting in a $.1 million (2%) increase in other revenue during 2008.

Provision for Loan Losses:

The Company’s provision for loan losses represents the level of net charge-offs and adjustments to the allowance for loan losses to cover credit losses inherent in the outstanding loan portfolio at the balance sheet date.

Provision for loan losses were $29.3 million, $25.7 million and $21.4 million during 2009, 2008 and 2007, respectively.  The increase in the provision during each of the two-years in the period ended December 31, 2009 is attributable to rising credit losses and the higher risk of inherent loan losses due to the adverse economic conditions that are impacting our customers.  Rising unemployment rates, increased bankruptcy filings by customers and more stringent lending standards made it more difficult for certain customers to repay their obligations during each of the two-years in the period ended December 31, 2009.  Net charge offs increased $2.9 million (13%) during 2009 compared to 2008 and $3.3 million (17%) during 2008 compared to 2007.  In addition, the Company increased its reserve for loan losses to cover future losses inherent in the loan portfolio at December 31, 2009 and December 31, 2008.

We believe that the allowance for loan losses is adequate to cover probable losses inherent in our portfolio; however, because the allowance for loan losses is based on estimates, there can be no assurance that the ultimate charge off amount will not exceed such estimates or that our loss assumptions will not increase.

Other Operating Expenses:

Other operating expenses include personnel expense, occupancy expense and all other miscellaneous operating expenses.  Total other operating expenses decreased $.8 million (1%) during 2009 compared to 2008 and $6.2 million (9%) in 2008 compared to 2007.  Effective June 1, 2009, Management implemented certain cost reduction initiatives to attempt to counteract the impact of economic conditions.  This strategy contributed to the reduction in other operating expenses during 2009.  The cost reduction initiatives included the curtailment of the number of new office openings for the remainder of the year and the consolidation of certain branches in areas where we determined we had redundancies.  Another initiative implemented was a 4% reduction in our employee base.  Other expense control initiatives included a freeze on non-essential travel, implementation of energy saving strategies, evaluation of business promotions and ways to further leverage technology.   

Personnel expense constitutes the largest component of our other operating expense category.  During 2009, our personnel expense increased $1.5 million (3%) as compared to the prior year.  Increases in salaries, incentive bonuses, 401-k retirement plan contributions and medical claims associated with the Company’s self insured employee medical program were factors contributing to the increase during the year just ended.  Increases in personnel expense during 2009 were partially offset by the aforementioned reduction in our employee base at mid-year.

Increases in the employee base, merit salary increases, payroll tax expense and higher claims expense associated with the Company’s self-insured employee medical program caused personnel expense to increase $4.0 million (9%) during 2008 compared to 2007.

Occupancy expense increased $.5 million (5%) during 2009 compared to 2008, the majority of which was due a non-recurring charge to buy-out certain operating leases on computer equipment.  Management made a strategic decision to buy-out certain leases during the first quarter of 2009 as most were approaching maturity.  Ownership of the equipment was transferred to the Company as a result of the transactions.  Other factors contributing to the increase in 2009’s occupancy expense were increases in depreciation on fixed assets, increased rent on leases renewed and increased operating costs associated with the full year effect of new branches opened during the prior year.   

Leases for new offices and lease renewals for existing offices were the main contributors to the $.9 million (9%) and $.8 million (9%) increase in occupancy expense during 2008 and 2007, respectively.  Higher utility costs, maintenance costs and depreciation on furniture and equipment also contributed to the increases.

Other operating expenses declined $1.3 million (7%) during 2009 compared to 2008, mainly as a result of the implementation of the aforementioned cost reduction initiatives.  The Company experienced decreases in advertising expenses, legal and audit expenses, management meeting expenses, office supply expenses, securities sales expenses and travel expenses during the current year.  Also contributing was a decrease in equipment lease expenses, as a result of the aforementioned lease buy-outs.

Higher levels of miscellaneous expenses including legal, audit, technology related, employee training and development and travel, were mainly responsible for the $1.3 million (8%) increase in other miscellaneous operating expenses during 2008 compared to the prior year.  

Income Taxes:

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

Effective income tax rates for the years ended December 31, 2009, 2008 and 2007 were 24.2%, 22.5% and 22.5%, respectively.  The higher rate in 2009 was due to a loss in the S Corporation being passed to the shareholders for tax reporting purposes, whereas income earned by the insurance subsidiaries was taxed at the corporate level, which had the effect of increasing the overall consolidated tax rate.  During 2008 and 2007, the S Corporation earned a profit, the tax on which was paid by the shareholders.  Since the tax liability is passed on to the shareholders, upon consolidation, the profit of the S Corporation had the effect of lowering the overall consolidated tax rates for those years.

Volatility of market rates of interest can impact the Company’s investment portfolio and the interest rates paid on its debt securities.  Volatility in interest rates has more impact on the income earned on investments and the Company’s borrowing costs than on interest income earned on loans.  Management does not normally change the rates charged on loans originated solely as a result of changes in the interest rate environment. These exposures are monitored and managed by the Company as an integral part of its overall cash management program.  It is Management’s goal to minimize any adverse effect that movements in interest rates may have on the financial condition and operations of the Company.  The information in the table below summarizes the Company’s risk associated with marketable debt securities and debt obligations as of December 31, 2009.  Rates associated with the marketable debt securities represent weighted averages based on the yield of each individual security.  No adjustment has been made to yield, even though many of the investments are tax-exempt and, as a result, actual yield will be higher than that disclosed.  For debt obligations, the table presents principal cash flows and related weighted average interest rates by contractual maturity dates.  As part of its risk management strategy, the Company does not invest a material amount of its assets in equity securities.  The Company’s subordinated debt securities are sold with various interest adjustment periods, which is the time from sale until the interest rate resets, and which allows the holder to redeem that security prior to the contractual maturity without penalty.  It is expected that actual maturities on a portion of the Company’s subordinated debentures will occur prior to the contractual maturity as a result of interest rate resets.  Management estimates the carrying value of senior and subordinated debt approximates their fair values when compared to instruments of similar type, terms and maturity.  

Loans originated by the Company are excluded from the information below since interest rates charged on loans are based on rates allowable in compliance with federal and state guidelines.  Management does not believe that changes in market interest rates will significantly impact rates charged on loans.  The Company has no exposure to foreign currency risk.

Expected Year of Maturity

2015 &

Fair

2010

2011

2012

2013

2014

Beyond

Total

Value

Assets:

(in millions)

   Marketable Debt Securities

$    9

$13

$ 12

$ 13

  $  6

$ 20

$  73

$  74

   Average Interest Rate

3.7%

3.8%

3.8%

3.5%

3.7%

4.0%

3.8%

Liabilities:

   Senior Debt:

      Senior Demand Notes

$41

—

—

—

—

—

$  41

$  41

      Average Interest Rate

2.2%

—

—

—

—

—

2.2%

      Commercial Paper

$129

—

—

—

—

—

$129

$129

      Average Interest Rate

5.6%

—

—

—

—

—

5.6%

      Notes Payable to Banks

$  —

—

16

—

—

—

$  16

$  16

      Average Interest Rate

—

—

3.8%

—

—

—

3.8%

   Subordinated Debentures

$  18

$  21

$ 18

$ 18

—

—

$  75

$  75

      Average Interest Rate

5.6%

5.8%

5.2%

5.2%

—

—

5.7%

Liquidity and Capital Resources:

Liquidity is the ability of the Company to meet its ongoing financial obligations, either through the collection of receivables or by generating additional funds through liability management. The Company’s liquidity is therefore dependent on the collection of its receivables, the sale of debt securities and the continued availability of funds under the Company’s revolving credit agreement.

In light of continued economic uncertainty, we continue to monitor and review current economic conditions and the related potential implications on us, including with respect to, among other things, changes in loan losses, liquidity, compliance with our debt covenants, and relationships with our customers.

As of December 31, 2009 and December 31, 2008, the Company had $26.3 million and $3.2 million, respectively, invested in cash and short-term investments readily convertible into cash with original maturities of three months or less.  As previously discussed, the Company uses cash reserves to fund its operations, including providing funds for any increase in redemptions of debt securities by investors which may occur.

The Company's investments in marketable securities can be converted into cash, if necessary.  As of December 31, 2009 and 2008, 96% of the Company's cash and cash equivalents and investment securities were maintained in Frandisco Property and Casualty Insurance Company and Frandisco Life Insurance Company, the Company’s insurance subsidiaries.  State insurance regulations limit the use an insurance company can make of its assets.  Ordinary dividend payments to the Company by its wholly owned insurance subsidiaries are subject to annual limitations and are restricted to the greater of 10% of statutory surplus or statutory earnings before recognizing realized investment gains of the individual insurance subsidiaries.  Any dividends above the state limitations are termed “extraordinary dividends” and must be approved in advance by the Georgia Insurance Commissioner.  Prior to 2008, no dividends had been paid by the insurance subsidiaries to the Company since the Company elected in 1996 to be treated as an S Corporation for federal income tax reporting purposes.  Due to the volatility in the economy, Management elected to pay dividends during 2008, which served to strengthen the Company’s liquidity position.  During 2008 the Company received in aggregate $8.9 million in ordinary dividends from its insurance subsidiaries.  In October 2008, the Company filed a request with the Georgia Insurance Commissioner for its insurance subsidiaries to be allowed to pay up to $35.0 million in extraordinary dividends on or before December 31, 2008.  The request was approved and, in December 2008, a total of $20.0 million in extraordinary dividends were paid by the insurance subsidiaries to the Company.

At December 31, 2009, Frandisco Property and Casualty Insurance Company and Frandisco Life Insurance Company had a statutory surplus of $33.0 million and $35.0 million, respectively.  Since ordinary dividends were paid in 2008, the Company’s insurance subsidiaries were not eligible to pay such dividends in 2009.  In light of the current economic climate and the Company’s desire to ensure adequate liquidity, in the first quarter of 2009 the Company filed a request with the Georgia Insurance Department for the insurance subsidiaries to be eligible to pay up to $45.0 million in extraordinary dividends during 2009. Such request was approved in May 2009.  Management elected to not pay any such dividends due to the significant improvement in the Company’s liquidity position.  The maximum aggregate amount of ordinary dividends these subsidiaries can pay to the Company in 2010 without prior approval of the Georgia Insurance Commissioner is approximately $8.5 million.  The Company does not currently believe that any statutory limitations on the payment of cash dividends by the Company’s subsidiaries will materially affect the Company’s liquidity.

Most of the Company's loan portfolio is financed through sales of its various debt securities, which, because of certain redemption features contained therein, have shorter average maturities than the loan portfolio as a whole.  The difference in maturities may adversely affect liquidity if the Company is not able to continue to sell debt securities at interest rates and on terms that are responsive to the demands of the marketplace or maintain sufficient borrowing availability under our credit facility.

The Company’s continued liquidity is therefore dependent on the collection of its receivables and the sale of debt securities that meet the investment requirements of the public.  In addition to its receivables and securities sales, the Company has an external source of funds available under a credit agreement.  Prior to September 11, 2009, the Company had a credit agreement with Wachovia Bank, N.A. (a Wells Fargo Company) and BMO Capital Markets Financing, Inc. The credit agreement provided for unsecured borrowings of up to $50.0 million, subject to certain limitations, and was scheduled to expire on December 15, 2009.

Effective September 11, 2009, the Company entered into a new credit facility with Wells Fargo Preferred Capital, Inc.  In connection with entering into this new agreement, the previous credit agreement was paid off and terminated.  As amended to date, the new credit agreement provides for borrowings of up to $100.0 million, subject to certain limitations, and all borrowings are secured by the finance receivables of the Company.  Availability under the new credit agreement was $83.8 million at December 31, 2009, and the interest rate on outstanding borrowings of $16.2 million was 3.75%.  This compares to available borrowings of $27.7 million at December 31, 2008, at an interest rate of 2.75%.  Management believes the current credit facility should provide sufficient liquidity for the Company.

Available but unborrowed amounts under the credit agreement are subject to a periodic unused line fee of .50%.  The interest rate under the credit agreement is equivalent to the greater of (a) .75% per annum plus 300 basis points or (b) the three month London Interbank Offered Rate (the “LIBOR Rate”) plus 300 basis points.  The LIBOR Rate shall be adjusted on the first day of each calendar month based upon the LIBOR Rate as of the last day of the preceding calendar month.

The credit agreement requires the Company to comply with certain covenants customary for financing transactions of this nature, including, among others, maintaining a minimum interest coverage ratio, a minimum loss reserve ratio, a minimum ratio of earnings to interest, taxes and depreciation and amortization to interest expense, a minimum asset quality ratio, a minimum consolidated tangible net worth ratio, and a maximum debt to tangible net worth ratio, each as defined. The Company must also comply with certain restrictions on its activities consistent with credit facilities of this type, including limitations on: (a) restricted payments; (b) additional debt obligations (other than specified debt obligations); (c) investments (other than specified investments); (d) mergers, acquisitions, or a liquidation or winding up; (e) modifying its organizational documents or changing lines of business; (f) modifying Material Contracts (as defined); (g) certain affiliate transactions; (h) sale-leaseback, synthetic lease, or similar transactions; (i) guaranteeing additional indebtedness (other than specified indebtedness); (k) capital expenditures; or (l) speculative transactions.  The credit agreement also restricts the Company or any of its subsidiaries from creating or allowing certain liens on their assets, entering into agreements that restrict their ability to grant liens (other than specified agreements), or creating or allowing restrictions on any of their ability to make dividends, distributions, inter-company loans or guaranties, or other inter-company payments, or inter-company asset transfers.  At December 31, 2009, the Company was in compliance with all covenants.  The Company has no reason to believe that it will not remain in compliance with these covenants and obligations for the foreseeable future.  The agreement is scheduled to expire on September 11, 2012 and any amounts then outstanding will be due and payable on such date.  

We are not aware of any additional restrictions placed on us, or being considered to be placed on us, related to our ability to access capital, such as borrowings under our credit agreement prior to its maturity.

The increase in the loan loss allowance in 2009 did not directly affect the Company’s liquidity, as the allowance is maintained out of income; however, an increase in the actual loss rate may have a material adverse effect on the Company’s liquidity.  The inability to collect loans could eventually impact the Company’s liquidity in the future.

The Company was subject to the following contractual obligations and commitments at December 31, 2009:

Critical Accounting Policies:

The accounting and reporting policies of 1^st Franklin and its subsidiaries are in accordance with accounting principles generally accepted in the United States and conform to general practices within the financial services industry.  The more critical accounting and reporting policies include the allowance for loan losses, revenue recognition and insurance claims reserves.

Allowance for Loan Losses:

Provision for loan losses are charged to operations in amounts sufficient to maintain the allowance for loan losses at a level considered adequate to cover probable losses inherent in our loan portfolio.  

The allowance for loan losses is established based on the determination of the amount of probable losses inherent in the loan portfolio as of the reporting date.  We review charge off experience factors, delinquency reports, historical collection rates, estimates of the value of the underlying collateral, economic trends such as unemployment rates and bankruptcy filings and other information in order to make the necessary judgments as to probable losses.  Assumptions regarding probable losses are reviewed periodically and may be impacted by our actual loss experience and changes in any of the factors discussed above.

Revenue Recognition:

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

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

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

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

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

Insurance Claims Reserves:

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

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

New Accounting Pronouncements:

See Note 1, “Recent Accounting Pronouncements,” in the accompanying “Notes to Unaudited Consolidated Financial Statements” for a discussion of new accounting standards and the expected impact of accounting standards recently issued but not yet required to be adopted.  For pronouncements already adopted, any material impacts on the Company’s financial statements are discussed in the applicable section(s) of this Management’s Discussion and Analysis of Financial Condition and Results of Operations and Notes to the Company’s Audited Consolidated Financial Statements included elsewhere in this annual report.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To:

The Board of Directors

1^st Franklin Financial Corporation

We have audited the accompanying consolidated statements of financial position of 1^st Franklin Financial Corporation and subsidiaries (the “Company”) as of December 31, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009.  These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.  

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purposes of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of 1^st Franklin Financial Corporation and subsidiaries as of December 31, 2009 and 2008, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America.

/s/ Deloitte & Touche LLP

Atlanta, Georgia

March 30, 2010

1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

DECEMBER 31, 2009 AND 2008

ASSETS

2009   

  2008     

CASH AND CASH EQUIVALENTS (Note 5):

   Cash and Due From Banks

$

3,725,236

$

433,645

   Short-term Investments

22,562,454

2,726,781

26,287,690

3,160,426

RESTRICTED CASH (Note 1)

3,067,695

2,366,779

LOANS (Note 2):

   Direct Cash Loans

327,424,876

324,996,394

   Real Estate Loans

24,336,405

24,175,593

   Sales Finance Contracts

23,071,118

27,586,508

374,832,399

376,758,495

   Less:

Unearned Finance Charges

43,331,239

44,032,487

Unearned Insurance Premiums

25,797,624

24,135,983

Allowance for Loan Losses

26,610,085

23,010,085

279,093,451

285,579,940

MARKETABLE DEBT SECURITIES (Note 3):

   Available for Sale, at fair market value

63,126,997

67,883,686

   Held to Maturity, at amortized cost

10,330,725

14,127,792

73,457,722

82,011,478

OTHER ASSETS:

   Land, Buildings, Equipment and Leasehold Improvements,

      less accumulated depreciation and amortization

         of $15,724,169 and $13,653,028 in 2009

         and 2008, respectively

7,807,112

9,241,725

   Deferred Acquisition Costs

1,459,782

1,360,237

   Due from Non-affiliated Insurance Company

2,000,256

1,753,638

   Miscellaneous

3,251,472

3,948,218

14,518,622

16,303,818

                TOTAL ASSETS

$

396,425,180

$

389,422,441

See Notes to Consolidated Financial Statements

1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

DECEMBER 31, 2009 AND 2008

LIABILITIES AND STOCKHOLDERS' EQUITY

2009

 2008

SENIOR DEBT (Note 6):

   Notes Payable to Banks

$

16,204,309

$

22,267,681

   Senior Demand Notes, including accrued interest

 41,209,099

 41,341,839

   Commercial Paper

129,435,443

106,062,799

186,848,851

169,672,319

ACCOUNTS PAYABLE AND ACCRUED EXPENSES

17,577,438

16,908,641

SUBORDINATED DEBT (Note 7)

74,883,979

86,605,009

        Total Liabilities

279,310,268

273,185,969

COMMITMENTS AND CONTINGENCIES (Note 8)

STOCKHOLDERS' EQUITY:

   Preferred Stock; $100 par value

6,000 shares authorized; no shares outstanding

--

--

   Common Stock:

Voting Shares; $100 par value;

2,000 shares authorized; 1,700 shares

outstanding as of December 31, 2009 and 2008

170,000

170,000

Non-Voting Shares; no par value;

198,000 shares authorized; 168,300 shares

outstanding as of December 31, 2009 and 2008

--

--

   Accumulated Other Comprehensive Income

1,696,845

433,101

   Retained Earnings

115,248,067

115,633,371

               Total Stockholders' Equity

117,114,912

116,236,472

                    TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

$

396,425,180

$

389,422,441

See Notes to Consolidated Financial Statements

1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007

Accumulated

Other

Common Stock

Retained

Comprehensive

Shares

Amount

Earnings

Income

Total

Balance at December 31, 2006

170,000

 $170,000

$ 97,950,753 

$   243,805 

$ 98,364,558 

   Comprehensive Income:

       Net Income for 2007

—

—

12,204,763 

— 

       Net Change in Unrealized Gain

          On Available-For-Sale Securities

—

—

 —  

726,798   

   Total Comprehensive Income

—

—

—  

— 

12,931,561 

   Cash Distributions Paid

          —

            —

   (1,455,593)

               — 

    (1,455,593)

Balance at December 31, 2007

170,000

170,000

108,699,923 

970,603 

109,840,526 

   Comprehensive Income:

       Net Income for 2008

—

—

10,664,776 

— 

       Net Change in Unrealized Gain

          On Available-For-Sale Securities

—

—

— 

(537,502)

   Total Comprehensive Income

—

—

— 

— 

10,127,274 

   Cash Distributions Paid

          —

            —

   (3,731,328)

              — 

   (3,731,328)

Balance at  December 31, 2008

170,000

170,000

115,633,371 

   433,101 

116,236,472 

    Comprehensive Income:

       Net Income for 2009

—

—

8,373,007

— 

       Net Change in Unrealized Gain

          On Available-For-Sale Securities

—

—

— 

1,263,744 

     Total Comprehensive Income

—

—

— 

— 

9,636,751 

     Cash Distributions Paid

          —

            —

    (8,758,311)

              — 

    (8,758,311)

Balance at December 31, 2009

170,000

$170,000

$115,248,067 

$1,696,845 

$117,114,912 

Disclosure of reclassification amount:

2009

2008

2007

Unrealized holding gains (losses) arising during period, net

of applicable income tax (provision) benefits of $(368,964),

        $10,512 and $(205,920) for 2009, 2008 and 2007,

respectively

$   1,267,302 

$    (525,701)

$    727,554 

Less: Reclassification adjustment for net gains  

included in income, net of applicable income taxes of

$1,201, $3,095 and $251 for 2009, 2008 and 2007,

respectively

           3,558 

         11,801 

            756 

Net unrealized gains (losses) on securities, net of applicable

income tax (provision) benefits of $(367,763), $13,607 and

       $(205,039) for 2009, 2008 and 2007, respectively  

$   1,263,744 

$    (537,502)

$    726,798 

See Notes to Consolidated Financial Statements

 1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007

2009      

2008       

2007       

   Net Income

$

8,373,007

$

10,664,776

$

12,204,763 

   Adjustments to reconcile net income to net

       cash provided by operating activities:

Provision for loan losses

29,302,142 

25,725,394 

21,433,742 

Depreciation and amortization

2,577,539 

2,447,007 

2,076,784 

Provision for deferred taxes

15,771 

155,830 

251,823 

Losses due to called redemptions on marketable

securities, loss on sales of equipment and

amortization on securities

314,172 

263,242 

120,291 

Decrease (increase) in Miscellaneous

Assets and other

198,125 

(290,247)

(93,905)

Increase (decrease) in Other Liabilities

285,329 

(1,508,028)

2,278,834 

Net Cash Provided

41,066,085 

37,457,974 

38,272,332 

CASH FLOWS FROM INVESTING ACTIVITIES:

   Loans originated or purchased

(214,933,802)

(236,634,867)

(250,121,741)

   Loan payments

192,118,149 

201,984,749 

201,895,210 

   Increase in restricted cash

(700,916)

(179,757)

(317,439)

   Purchases of securities, available for sale

(2,428,840)

(27,465,879)

(17,692,694)

   Purchases of securities, held to maturity

-- 

(1,202,870)

-- 

   Redemptions of securities, available for sale

8,490,750 

18,813,950 

10,483,100 

   Redemptions of securities, held to maturity

3,790,000 

5,101,000 

3,005,000 

   Purchase of joint venture interest

(27,601)

-- 

-- 

   Capital expenditures

(997,083)

(2,777,574)

(4,383,965)

   Proceeds from sale of equipment

53,331 

25,234 

443,450 

Net Cash Used

(14,636,012)

(42,336,014)

(56,689,079)

CASH FLOWS FROM FINANCING ACTIVITIES:

   Net decrease in Senior Demand Notes

(132,740)

(7,268,898)

(241,074)

   Advances on Credit Line

90,246,309 

103,563,000 

89,345,000 

   Payments on Credit Line

(96,309,681)

(97,980,000)

(97,488,000)

   Commercial Paper issued

396,342,906 

35,766,727 

33,538,927 

   Commercial Paper redeemed

(372,970,262)

(46,781,459)

(24,256,208)

   Subordinated Debt issued

11,623,006 

21,619,938 

36,790,393 

   Subordinated Debt redeemed

(23,344,036)

(26,980,643)

(12,014,336)

   Dividends / Distributions paid

(8,758,311)

(3,731,328)

(1,455,593)

Net Cash (Used) Provided

(3,302,809)

(21,792,663)

24,219,109 

NET INCREASE (DECREASE) IN

     CASH AND CASH EQUIVALENTS

23,127,264 

(26,670,703)

5,802,362   

CASH AND CASH EQUIVALENTS, beginning

3,160,426 

29,831,129 

24,028,767 

CASH AND CASH EQUIVALENTS, ending

$

26,287,690