LOSS EXPERIENCE

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

Year Ended December 31

2014

2013

2012

2011

2010

 (in thousands, except % data)

DIRECT CASH LOANS

Average Net Loans

$

381,367

$

357,552

$

334,084

$

305,152

$

282,750

Liquidations

$669,704

$632,501

$571,504

$520,997

$

465,584

Net Losses

$

27,824

$

24,476

$

21,241

$

21,014

$

22,479

Net Losses as % of Average

   Net Loans

7.30%

6.85%

6.36%

6.89%

7.95%

Net Losses as % of Liquidations

4.15%

3.87%

3.72%

4.03%

4.83%

REAL ESTATE LOANS

Average Net Loans

$

19,765

$

20,031

$

21,192

$

22,253

$

23,351

Liquidations

$

8,513

$

9,254

$

8,792

$

9,854

$

9,798

Net Losses

$

72

$

6

$

63

$

75

$

117

Net Losses as a %

    of Average Net Loans

.36%

.03%

.30%

.34%

.50%

Net Losses as a %

    of Liquidations

.85%

.06%

.72%

.76%

1.19%

SALES FINANCE CONTRACTS

Average Net Loans

$

19,646

$

18,366

$

17,891

$

17,863

$

19,369

Liquidations

$

26,767

$

26,108

$

26,204

$

27,211

$

27,642

Net Losses

$

787

$

471

$

531

$

670

$

811

Net Losses as % of Average

    Net Loans

4.01%

2.56%

2.97%

3.75%

4.19%

Net Losses as % of  Liquidations

2.94%

1.80%

2.03%

2.46%

2.93%

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 in the current loan portfolio.  For additional information about Management’s approach to estimating and evaluating the allowance for loan losses, see Note 2 “Loans” in the Notes to the Consolidated Financial Statements.

SEGMENT FINANCIAL INFORMATION

The Company operates in one reportable business segment.  For additional financial information about our segment and the divisions of our operations, see Note 13 “Segment Financial Information” in the Notes to Consolidated Financial Statements.

CREDIT INSURANCE

We offer optional credit insurance products to our customers when making a loan.  Such products 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 an agent for a non-affiliated insurance company.  Under various agreements, our wholly-owned insurance subsidiaries, Frandisco Life Insurance Company and Frandisco Property and Casualty Insurance Company, reinsure the insurance coverage on our customers written on behalf of this non-affiliated insurance company.

REGULATION AND SUPERVISION

The Company is subject to regulation under numerous state and federal laws and regulations as enforced and interpreted by various state and federal governmental agencies.  Generally, state laws require that each office in which a small loan business such as ours 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.  We are also subject to state regulations governing insurance agents in the states in which we sell credit insurance.  State insurance regulations require, among other things, that insurance agents be licensed and, in some cases, limit the premiums that insurance agents can charge.  We believe we conduct our business in accordance with all applicable state statutes and regulations.  The Company has never had any of its licenses revoked and has never been subject to an enforcement order or regulatory settlement.

We conduct our lending operations under the provisions of various federal laws and implementing regulations.  These laws and regulations are interpreted, implemented, and enforced by the Bureau of Consumer Financial Protection (the "CFPB"). Chief among these federal laws with which the Company must comply are the Federal Consumer Credit Protection Act (the "Truth-in-Lending Act"), the Fair Credit Reporting Act and the Federal Real Estate Settlement Procedures Act.   The Truth-in-Lending Act requires us, among other things, 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. As a result, we generally seek to collateralize such loans with non-household goods such as automobiles, boats and other exempt items.

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.  Significant additional regulation or costs of compliance could materially adversely affect our business and financial condition.

SOURCES OF FUNDS AND COMMON STOCK MATTERS

The Company is dependent upon the availability of funds from various sources 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

2014

2013

2012

2011

2010

Bank Borrowings

 --%

 --%

 --%

 --%

 --%

Senior Debt

55  

55  

53  

53  

49  

Subordinated Debt

6  

7  

8  

10  

14  

Other Liabilities

4  

4  

5  

4  

5  

Stockholders’ Equity

  35  

  34  

  34  

  33  

  32  

    Total

100%    

100%   

100%   

100%   

100%   

Number of Investors

5,405     

5,436   

5,445    

5,406    

5,418    

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

2014

2013

2012

2011

2010

Senior Borrowings

3.31%

3.46%

3.75%

4.08%

4.52%

Subordinated Borrowings

  2.92   

3.14  

3.33   

4.20   

5.33

All Borrowings

3.26   

3.41   

3.69   

4.11   

4.74

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

     As of December 31

2014

 2013

2012

2011

  2010

Total Liabilities to

Stockholders’ Equity

1.91

1.92

1.94

2.03

2.18

Unsubordinated Debt to

Subordinated Debt plus

Stockholders’ Equity

1.46

1.41

1.36

 1.32

 1.19

As of March 27, 2015, all of our voting common stock was closely held by three related individuals and all of our non-voting common stock was held by thirteen shareholders. None of our common stock was listed on any securities exchange or traded on any established public trading market.  The Company does not maintain any equity compensation plans, and did not repurchase any of its equity securities during any period represented.  Cash distributions of $137.50 and $82.46 per share were paid to shareholders in 2014 and 2013, respectively, primarily in amounts to enable the Company’s shareholders to pay their related 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.

Expected Year of Maturity

2020 &

Fair

2015

2016

2017

2018

2019

Beyond

Total

Value

Assets:

(Dollars in millions)

   Marketable Debt Securities

$    8

$   6

$  8

$  10

  $ 6

$ 118

$156

$156

   Average Interest Rate

2.8%

2.6%

2.8%

2.3%

2.6%

3.5%

3.3%

Liabilities:

   Senior Debt:

      Senior Demand Notes

$59

—

—

—

—

—

$  59

$  59

      Average Interest Rate

1.7%

—

—

—

—

—

1.7%

      Commercial Paper

$277

—

—

—

—

—

$277

$277

      Average Interest Rate

3.5%

—

—

—

—

—

3.5%

  Subordinated Debentures

$    9

$   7

$10

$12

—

—

$  38

$  38

      Average Interest Rate

3.0%

2.8%

2.8%

2.7%

—

—

2.9%

Payment due by period

Contractual Obligations

Total

Less

Than

1 Year

1 to 2 Years

3 to 5 Years

More

than 5 Years

(in millions)

   Bank Commitment Fee **

$    1.5

$      .5

$  1.0

$     -

$     -

   Senior Demand Notes *

59.5

59.5

     -

    -

      -

   Commercial Paper *

285.7

285.7

-

-

-

   Subordinated Debt *

41.9

9.5

19.1

13.3

-

Human resource insurance and

support contracts **

.8

.8

-

-

-

   Operating leases (offices)

15.2

5.6

7.4

2.2

     -

   Communication lines contract **

3.4

3.2

.2

 -

-

Software service contract **

    12.7

      3.2

    6.3

    3.2

      -

       Total

$420.7  

$368.0  

$34.0

$18.7

$    -

    *

Includes estimated interest at current rates.

    **

Based on current usage.

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 of America 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:

Provisions 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 estimate 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 of America 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 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 effect on the Company’s results of operations.

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

New Accounting Pronouncements:

See Note 1, “Summary of Significant Accounting Policies - Recent Accounting Pronouncements,” in the accompanying “Notes to 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 consolidated 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 Consolidated Financial Statements included elsewhere in this annual report.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders
1st Franklin Financial Corporation

We have audited the accompanying consolidated statements of financial position of 1st Franklin Financial Corporation and subsidiaries (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2014. 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 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 purpose 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 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 1st Franklin Financial Corporation and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.

/s/ Deloitte & Touche LLP

Atlanta, Georgia

March 30, 2015

1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

DECEMBER 31, 2014 AND 2013

ASSETS

2014   

  2013     

CASH AND CASH EQUIVALENTS (Note 6):

   Cash and Due From Banks

$

1,524,217

$

1,063,339

   Short-term Investments

13,202,325

25,336,500

14,726,542

26,399,839

RESTRICTED CASH (Note 1)

1,073,157

974,452

LOANS (Note 2):

   Direct Cash Loans

471,195,331

445,754,712

   Real Estate Loans

20,271,000

20,329,655

   Sales Finance Contracts

23,906,111

22,269,833

515,372,442

488,354,200

   Less:

Unearned Finance Charges

63,079,794

59,649,718

Unearned Insurance Premiums

35,331,723

34,596,733

Allowance for Loan Losses

28,620,000

24,680,789

388,340,925

369,426,960

MARKETABLE DEBT SECURITIES (Note 3):

   Available for Sale, at fair value

132,847,073

106,061,584

   Held to Maturity, at amortized cost

22,762,252

29,777,456

155,609,325

135,839,040

EQUITY METHOD INVESTMENTS (Note 5)

26,059,579

10,211,635

OTHER ASSETS:

   Land, Buildings, Equipment and Leasehold Improvements,

      less accumulated depreciation and amortization

         of $24,049,665 and $21,657,107 in 2014

         and 2013, respectively

10,205,126

8,913,865

   Deferred Acquisition Costs

2,028,468

1,986,326

   Due from Non-affiliated Insurance Company

2,102,978

2,566,531

   Other Miscellaneous

5,441,945

5,442,413

19,778,517

18,909,135

                TOTAL ASSETS

$

605,588,045

$

561,761,061

See Notes to Consolidated Financial Statements

1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

DECEMBER 31, 2014 AND 2013

LIABILITIES AND STOCKHOLDERS' EQUITY

2014

 2013

SENIOR DEBT (Note 7):

   Note Payable to Banks

$

--

$

--

   Senior Demand Notes, including accrued interest

 58,530,148

 54,055,007

   Commercial Paper

276,656,052

253,960,145

335,186,200

308,015,152

ACCOUNTS PAYABLE AND ACCRUED EXPENSES

24,228,121

21,014,769

SUBORDINATED DEBT (Note 8)

37,726,538

40,378,507

        Total Liabilities

397,140,859

369,408,428

COMMITMENTS AND CONTINGENCIES (Note 9)

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, 2014 and 2013

170,000

170,000

Non-Voting Shares; no par value;

198,000 shares authorized; 168,300 shares

outstanding as of December 31, 2014 and 2013

--

--

   Accumulated Other Comprehensive Income/(Loss)

      3,663,475

(2,472,734)

   Retained Earnings

204,613,711

194,655,367

               Total Stockholders' Equity

208,447,186

192,352,633

                    TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

$

605,588,045

$

561,761,061

See Notes to Consolidated Financial Statements

1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2014, 2013, AND 2012

Accumulated

Other

Common Stock

Retained

Comprehensive

Shares

Amount

Earnings

Income (Loss)

Total

Balance at December 31, 2011

170,000

$170,000

$151,277,894 

$2,136,739 

$153,584,633  

   Comprehensive Income:

       Net Income for 2012

—

—

32,748,715 

— 

       Other Comprehensive Loss

—

—

—  

(38,121)

   Total Comprehensive Income

—

—

—  

— 

32,710,594  

   Cash Distributions Paid

          —

   (9,761,394)

               — 

    (9,761,394) 

Balance at December 31, 2012

170,000

170,000

174,265,215 

2,098,618 

176,533,833  

   Comprehensive Income:

       Net Income for 2013

—

—

34,407,761 

— 

       Other Comprehensive Loss

—

—

— 

(4,571,352)

   Total Comprehensive Income

—

—

— 

— 

29,836,409 

   Cash Distributions Paid

          —

  (14,017,609)

              — 

  (14,017,609)

Balance at December 31, 2013

170,000

170,000

194,655,367

   (2,472,734)

192,352,633

    Comprehensive Income:

       Net Income for 2014

—

—

33,333,746

—

       Other Comprehensive Income

—

—

— 

6,136,209

     Total Comprehensive Income

—

—

— 

—

39,469,955 

     Cash Distributions Paid

          —

           —

  (23,375,402)

                —

   (23,375,402)

Balance at December 31, 2014

170,000

$170,000

$204,613,711 

$3,663,475

$208,447,186

See Notes to Consolidated Financial Statements

 1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012

  2014   

   2013    

   2012    

   Net Income

$

33,333,746 

$

34,407,761 

$

32,748,715 

   Adjustments to reconcile net income to net

       cash provided by operating activities:

Provision for loan losses

32,622,546 

27,623,368 

22,484,582 

Depreciation and amortization

3,156,828 

2,910,855 

2,716,463 

Provision for deferred taxes

41,211 

145,730 

252,359 

Earnings in equity method investment

(847,943)

(211,635)

- 

Losses due to called redemptions on marketable

securities, loss on sales of equipment and

amortization on securities

1,101,092 

1,004,266 

1,126,903 

Decrease (increase) in miscellaneous

assets and other

421,877

(1,561,178)

(433,312)

Increase (decrease) in other liabilities

1,011,240

(333,179)

1,961,216 

Net Cash Provided

70,840,597

63,985,988 

60,856,926 

CASH FLOWS FROM INVESTING ACTIVITIES:

   Loans originated or purchased

(351,600,837)

(334,922,921)

(300,909,120)

   Loan payments

300,064,326 

281,446,113 

252,810,438 

   (Increase) decrease in restricted cash

(98,705)

3,702,378 

891,699 

   Purchases of securities, available for sale

(30,969,513)

(38,947,670)

(28,596,333)

   Purchase of equity fund investment

(15,000,000)

(10,000,000)

 - 

   Sales of securities, available for sale

- 

4,199,916 

265,977 

   Redemptions of securities, available for sale

11,895,000 

12,880,000 

7,528,250 

   Redemptions of securities, held to maturity

6,455,000 

2,975,000 

3,060,000 

   Capital expenditures

(4,487,073)

(2,715,004)

(2,516,138)

   Proceeds from sale of equipment

84,231 

45,662 

64,103 

Net Cash Used

(83,657,571)

(81,336,526)

(67,401,124)

CASH FLOWS FROM FINANCING ACTIVITIES:

   Net increase in Senior Demand Notes

4,475,141   

4,022,163   

3,425,884   

   Advances on credit line

531,475 

531,375 

532,392 

   Payments on credit line

(531,475)

(531,375)

(532,392)

   Commercial paper issued

65,587,144 

61,559,542 

55,411,872 

   Commercial paper redeemed

(42,891,237)

(33,460,285)

(26,745,170)

   Subordinated debt issued

7,210,193 

8,645,970 

8,740,067 

   Subordinated debt redeemed

(9,862,162)

(11,185,439)

(12,692,167)

   Dividends / Distributions paid

(23,375,402)

(14,017,609)

(9,761,394)

Net Cash Provided

1,143,677 

15,564,342 

18,379,092 

NET (DECREASE) INCREASE IN

     CASH AND CASH EQUIVALENTS

(11,673,297)

(1,786,196)

11,834,894 

CASH AND CASH EQUIVALENTS, beginning

26,399,839 

28,186,035 

16,351,141 

CASH AND CASH EQUIVALENTS, ending

$

14,726,542 

$

26,399,839 

$

28,186,035 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

Interest

$

11,881,150 

$

11,537,662 

$

11,333,494 

Income Taxes

4,304,000 

3,857,000 

3,617,900 

Non-cash Exchange of Investment Securities

-  

2,830,022 

811,200 

See Notes to Consolidated Financial Statements