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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003 COMMISSION FILE NO. 0-50078
FRANKLIN BANCORP, INC
(Exact name of bank 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 offices) (Zip Code)
(248) 358-4710
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, no par value
(Title of Class)
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 filing
requirements for the past 90 days.
YES |X| NO ||.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in the definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
YES || NO |X|
As of March 22, 2004 there were issued and outstanding 3,781,024 shares of the
Registrant's Common Stock. The aggregate market value of the voting stock held
by non-affiliates of the Registrant, computed by reference to the price at which
the stock was sold as of June 30, 2003 was $52,176,620.12.
DOCUMENTS INCORPORATED BY REFERENCE: None.
INDEX
PART I
ITEM 1. BUSINESS ..............................................................4
ITEM 2. PROPERTIES............................................................12
ITEM 3. LEGAL PROCEEDINGS.....................................................12
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...................12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.................13
ITEM 6. SELECTED FINANCIAL DATA...............................................13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION......................................................15
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK...........32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...........................32
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE .....................................................32
ITEM 9A. CONTROLS AND PROCEDURES.............................................32
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...................32
ITEM 11. EXECUTIVE COMPENSATION...............................................35
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS ...............................40
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.......................42
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES..............................42
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PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K.......................................................43
SIGNATURES ...................................................................45
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PART I
ITEM 1. BUSINESS
GENERAL
Franklin. Franklin Bancorp, Inc. ("Franklin", the "Company" or the
"Corporation") was incorporated under the Michigan Business Corporation Act on
February 14, 2002. Franklin is a bank holding company registered with, and
subject to, the supervision of the Board of Governors of the Federal Reserve
System under the Bank Holding Company Act of 1956, as amended. Franklin Bank,
National Association ("Franklin Bank" or the "Bank"), a wholly-owned subsidiary
of Franklin, is a national bank, which was incorporated in 1983 as a Michigan
state-chartered savings and loan association and converted its charter to that
of a national bank in 1991. In October 2003, Franklin Bank organized Franklin
Safe Deposit Corporation as its wholly-owned subsidiary, to engage in the safety
deposit box business. Also, in October 2003, Franklin Bank and Franklin Safe
Deposit Corporation formed Franklin Mortgage Services LLC, a Michigan limited
liability company, to act as a mortgage company subsidiary. Franklin Safe
Deposit Corporation is a Michigan corporation which will own and lease
safety-deposit boxes to customers. Franklin Mortgage Services LLC is owned 99%
and 1% by Franklin Bank and Franklin Safe Deposit Corporation, respectively.
Franklin Bank has transferred $146 million of commercial real estate loans to
Franklin Mortgage Services as part of its capital contribution. Franklin
Mortgage Services will be originating first mortgage loans on residential
properties. Franklin became a bank holding company after the close of business
on October 23, 2002 as a result of the reorganization of Franklin Bank involving
an exchange of all the outstanding common stock of Franklin Bank on a
one-for-one basis into common stock of Franklin.
Franklin has corporate power to engage in such activities as permitted to
business corporations under the Michigan Business Corporation Act, subject to
the limitations of the Bank Holding Company Act and regulations of the Federal
Reserve System. In general, the Bank Holding Company Act and regulations
restrict Franklin with respect to its own activities and activities of any
subsidiaries to the business of banking or such other activities, which are
closely related to the business of banking. The principal role of Franklin is to
supervise the activities of Franklin Bank. Franklin derives substantially all of
its income from dividends from Franklin Bank.
Since its conversion to a national banking association charter, Franklin
Bank's business strategy has been focused on low cost deposit gathering and
lending to small and medium-sized businesses, business owners and, to a lesser
extent, individual customers found in Franklin Bank's primary market areas of
Southeast Oakland County and parts of Wayne and Macomb counties, Michigan. While
Franklin Bank offers many standard lending and deposit products, Franklin Bank
promotes its products and services through non-traditional delivery platforms
which emphasize courier deposit pick-up services, lockbox remittance services,
web banking and free ATM services; all of which do not require significant
branch facilities.
Franklin's headquarters are located at 24725 West Twelve Mile Road in
Southfield, Michigan. Franklin Bank maintains its principal office at 24725 West
Twelve Mile Road in Southfield, Michigan "and has" three full service regional
branches located in Southfield, Birmingham and Grosse Pointe Woods, Michigan,
and two Business Center branches in Southfield and Troy, Michigan.
Recent Development. As previously announced, Franklin has entered into a
definitive agreement dated as of November 10, 2003, and as amended on February
3, 2004 (the "merger agreement") to be acquired by First Place Financial
Corporation ("First Place"), a unitary savings and loan holding company. First
Place Bank, a federal savings association and wholly-owned subsidiary of First
Place, is headquartered in Warren, Ohio. Under the agreement, the holding
companies will merge with Franklin merging with and into First Place. After the
holding companies merge, the subsidiaries will merge (the "subsidiary merger"),
with First Place merging with Franklin Bank, and Franklin Bank changing its name
to "First Place Bank" and its main office to Warren, Ohio. In connection with
the merger, on February 9, 2004, Franklin Bank filed an application with the
Office of Thrift Supervision to convert from a national banking association to a
federal savings association. Such conversion is proposed to occur at the same
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time as the merger of the holding companies. First Place and Franklin may agree,
due to business, tax or other considerations, to revise the structure of the
subsidiary merger before the subsidiary merger is completed by amending the
subsidiary merger agreement (e.g., by having Franklin Bank merge with and into
First Place Bank). Completion of the merger depends on satisfying a number of
conditions. There is no certainty as to whether or when the conditions to the
merger will be satisfied, or waived where permissible or that the merger will be
completed.
LENDING ACTIVITIES
Franklin Bank's lending activities focus on originating commercial real
estate loans, other non-real estate commercial loans, residential construction
loans and consumer loans.
Commercial Real Estate Lending. Franklin Bank has historically originated
permanent loans secured by commercial real estate and, to a significantly lesser
extent, land development loans. Essentially all commercial real estate loans
originated by Franklin Bank to date have been secured by real property located
in Michigan.
Franklin Bank's commercial real estate loans generally are for terms of
five to ten years with 25-year amortization periods, generally have
loan-to-value ratios of up to 80% of the appraised value of the secured
property, and are typically secured by full or partial personal guarantees of
the borrowers. At December 31, 2003, approximately 63.2% of Franklin Bank's
commercial real estate loan portfolio had adjustable rates. Of those, 96% are
tied to prime interest rate.
At December 31, 2003, Franklin Bank's largest commercial real estate loan
was a $4.2 million loan secured by a storage facility located in Southfield,
Michigan. Franklin Bank had five other commercial real estate loans in excess of
$2.5 million in accordance with their payment terms.
Commercial real estate lending entails potential risks that are not
inherent in other types of lending. These potential risks include the
concentration of principal in a limited number of loans and borrowers, the
effects of a decline in commercial real estate values on property
collateralizing the loan, and the effects of a decline in general economic
conditions on income producing properties. Furthermore, the repayment of loans
secured by commercial real estate is typically dependent upon the successful
operation of the related real estate project. If the cash flow from the project
is reduced (for example, if leases are not obtained or renewed, or a bankruptcy
court modifies a lease term, or a major tenant is unable to fulfill its lease
obligations), the borrower's ability to repay the loan may be impaired.
Commercial Lending. To a lesser extent, Franklin Bank originates both
secured and unsecured commercial loans to small and medium-sized businesses
located in Southeast Michigan and parts of Wayne and Macomb counties, Michigan.
The loans include term loans, lines of credit, documentary and standby letters
of credit. Loans originated on a secured basis generally have interest rates
tied to the prevailing prime interest rate. Collateral consists of accounts
receivable, inventory, specific equipment and other designated business assets.
All such loans typically are wholly or partially personally guaranteed by the
business owner or related party.
A secured small business line of credit is available to Franklin Bank's
qualified business checking account customers in amounts of up to $50,000. These
loans are structured at higher rates than are charged other types of business
borrowers. Franklin Bank attempts to provide each customer with a 24-hour loan
review and decision process.
Commercial loans involve significant risk and typically are made on the
basis of the borrower's ability to make repayment from the cash flow of the
borrower's business. As a result, the availability of funds for the repayment of
commercial business loans may be substantially dependent on the success of the
business itself. Further, the collateral securing the loans may depreciate over
time, may be difficult to appraise and may fluctuate in value based on the
success of the business.
Residential Construction Lending. Franklin Bank makes construction loans
on single-family residences to individuals who will ultimately be the
owner-occupier of the house. Substantially all of
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Franklin Bank's construction loans have been originated with adjustable rates of
interest and have terms of eighteen months or less.
Franklin Bank's risk of loss on a construction loan is dependent largely
upon the accuracy of the initial estimate of the property's value upon
completion of the project and the estimated cost (including interest) of the
project. If the estimate of construction costs proves to be inaccurate, Franklin
Bank may be required to advance funds beyond the amount originally committed in
order to permit completion of the project. If the estimate of value proves to be
inaccurate, Franklin Bank may be confronted, at or prior to the maturity of the
loan, with a project having a value insufficient to provide appropriate
collateral value.
Consumer Lending. Franklin Bank originates directly and through various
dealers a limited number of consumer loans, which are offered at fixed and
adjustable rates of interest. In late 1999, Franklin Bank entered into an
agreement with DTE Energy (formerly MichCon), a large Michigan utility company,
from which Franklin Bank has significantly increased its consumer home
improvement loan portfolio, however, such agreement terminated on December 31,
2003. Under such agreement, DTE's dealer network would refer customers needing
credit for home improvements to Franklin Bank.
Consumer loans generally entail greater risks than loans secured by real
estate, since many consumer loans are typically unsecured or secured by rapidly
depreciating assets such as automobiles and home improvement collateral.
Accordingly, repossessed collateral for defaulted consumer loans may not provide
an adequate source of repayment of the outstanding loan balance. The relatively
small outstanding balance remaining after repossession of collateral often does
not warrant further substantial collection efforts against the borrowers beyond
obtaining a deficiency judgment. In addition, consumer loan collections are
dependent on the borrower's continuing financial stability, and thus are more
likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Furthermore, the application of various federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the amount
which can be recovered on such loans.
LOANS TO ONE BORROWER
Under federal law, the aggregate amount of loans that Franklin Bank is
permitted to make to any one borrower is generally limited to 15% of total risk
based capital. At December 31, 2003, Franklin Bank's loans-to-one-borrower limit
was approximately $7.2 million at the 15% level. At December 31, 2003, Franklin
Bank has no loans to one borrower in excess of its lending limit.
NONPERFORMING ASSETS AND RISK ELEMENTS
When, in the opinion of management, reasonable doubt exists as to the full
and timely collection of interest or principal on Franklin Bank's outstanding
loans, Franklin Bank will place such loans on non-accrual status. Generally,
consumer loans are charged off no later than when they reach 120 days past due
status, or earlier, if deemed uncollectible. Loans, other than consumer loans,
are generally placed on non-accrual status when management determines that
principal or interest may not be fully collectible, but no later than when the
loan is 90 days past due on principal or interest. Interest on loans is
generally accrued daily based on the principal balance outstanding. However,
when a loan is placed on non-accrual status, the accrued interest income is
discontinued and interest previously accrued but not collected on non-accrual
loans is charged against current income.
ALLOWANCE FOR LOAN LOSSES
The provision for loan losses reflects management's evaluation of the
adequacy of the allowance for loan losses. The allowance for loan losses
represents management's assessment of probable losses inherent in Franklin
Bank's loan portfolio, including all binding commitments to lend. The allowance
provides for probable losses that have been identified with specific borrowing
customers and for probable losses believed to be inherent but that have not been
specifically identified. Franklin Bank allocates the allowance for loan losses
to each loan category based on a defined methodology that has been used for
several years. Internal risk ratings are assigned to each business loan at the
time of approval and are
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subject to subsequent periodic reviews by Franklin Bank management and Franklin
Bank's loan review consultants. Business loans consist of non-real estate
commercial loans, commercial real estate loans and Franklin Bank lines of
credit. A detailed review of the loan portfolio is performed on a quarterly
basis to assess the credit quality of Franklin Bank's commercial loan portfolio.
A specific portion of the allowance is allocated to such loans based upon this
review. The portion of the allowance allocated to the remaining loans is
determined by applying projected loss ratios to each risk rating based on both
qualitative and quantitative factors. The portion of the allowance allocated to
consumer and mortgage loans is determined by applying projected loss ratios to
various segments of the loan portfolio. Projected loss ratios incorporate
factors such as recent charge-off experience, current economic conditions and
trends, geographic dispersion of borrowers, and trends with respect to past due
and non-accrual amounts.
See "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations" below relating to the allowance for loan losses, the
loan portfolio composition, loan commitments, loan maturity schedule and
nonperforming assets.
SOURCE OF FUNDS
Franklin Bank's deposits are its primary source of funds for lending and
for other general business purposes. In addition to deposits, Franklin Bank
derives funds from loan repayments, advances from the FHLB ("FHLB") of
Indianapolis and other borrowings. From time to time, Franklin Bank may derive
funds from repurchase agreements and loan and securities sales. Scheduled loan
repayments are a relatively stable source of funds, while loan prepayments and
interest-bearing deposit inflows and outflows are significantly influenced by
general interest rates and money market conditions. Borrowings may be used to
compensate for reductions in normal sources of funds, such as deposit inflows at
less than projected levels, deposit outflows, or to support expanded activities.
Historically, Franklin Bank has borrowed primarily from the FHLB of Indianapolis
and through repurchase agreements.
The ability of Franklin Bank to attract and maintain deposits, and its
cost of funds, have been, and will continue to be, significantly affected by
general economic and business conditions.
See "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations" below relating to deposits and other sources of
funds.
INVESTMENT ACTIVITIES
Franklin Bank invests in various securities, which are acquired in the
capital markets. These investments may consist of mortgage, government, agency,
municipal and corporate debt securities. See "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations" below relating to
the securities maturity schedule.
COMPETITION
Franklin Bank competes aggressively for its business through a systematic
program of direct calling on both customers and referral sources such as
attorneys, accountants and business people. Franklin Bank's program is enhanced
because of its well-established network of existing relationships, which have
been created over the years in the area's business community and because of the
years of banking experience and community involvement of its senior management
and lending officers. Franklin Bank's programs and services are further enhanced
by its distinctive marketing focus, including its radio advertising campaign,
and by referrals from the growing base of existing business customers.
Generally, Franklin Bank's business strategy focuses on competing in areas
in which it can truly develop niche products and services. Large financial
institutions tend to need very large homogeneous markets in order to support
high levels of automation and systems development. This leaves smaller product
markets and heterogeneous product lines under-served. Large financial
institutions also tend to have rigid structures, which adapt slowly to changing
market environments and, therefore, provide opportunities for smaller
institutions that can react more quickly. Finally, competitive pressures and
other
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regulatory agencies in the past decade have caused a rapid increase in the
merger and acquisition activity among financial institutions. The industry
consolidation has created marketing opportunities for many smaller institutions,
such as Franklin Bank, to service smaller customers in local markets.
SUPERVISION AND REGULATION
Overview - Franklin. Franklin is a Michigan corporation subject to the
Michigan Business Corporation Act. Franklin is a one-bank holding company within
the meaning of the Bank Holding Company Act and is registered as such with, and
subject to, the supervision of the Federal Reserve Board. Franklin is required
to file with the Federal Reserve Board quarterly and annual reports and such
additional information as the Federal Reserve Board may require pursuant to the
Bank Holding Company Act. The Federal Reserve Board regularly conducts
examinations of bank holding companies and their subsidiaries.
As a banking holding company, Franklin is required to obtain the approval
of the Federal Reserve Board:
- before it may acquire all or substantially all of the assets
of any bank, or ownership or control of the voting shares of
any bank if, after giving effect to such acquisition of
shares, Franklin would own or control more than 5% of the
voting shares of such bank; and
- before the merger or consolidation of Franklin and another
bank holding company.
Franklin also is prohibited by the Bank Holding Company Act, except in
certain statutorily prescribed instances, from:
- acquiring direct or indirect ownership or control of more than
5% of the outstanding voting shares of any company that is not
a bank or bank holding company; and
- from engaging, directly or indirectly, in activities other
than those of banking, managing or controlling banks or
furnishing services to its subsidiaries.
However, Franklin may, subject to the prior approval of the Federal
Reserve Board, engage in any, or acquire shares of companies engaged in,
activities that are deemed by the Federal Reserve Board to be so closely related
to banking or managing or controlling banks as to be a proper incident thereto.
Under the Federal Reserve Board's regulations:
- a bank holding company is required to serve as a source of
financial and managerial strength to its subsidiary banks and
may not conduct its operations in an unsafe and unsound
manner; and
- in serving as a source of strength to its subsidiary banks, a
bank holding company should stand ready to use available
resources to provide adequate capital funds to its subsidiary
banks during periods of financial stress or adversity and
should maintain the financial flexibility and capital-raising
capacity to obtain additional resources for assisting its
subsidiary banks.
A bank holding company's failure to meet its obligations to serve as a
source of strength to its subsidiary banks will generally be considered by the
Federal Reserve Board to be an unsafe and unsound banking practice or a
violation of the Federal Reserve Board's regulations or both.
Overview - Franklin Bank. Franklin Bank is a federally chartered national
banking association. Accordingly, Franklin Bank is subject to broad federal
regulation and oversight extending to all it operations by the Office of the
Comptroller of the Currency (the "OCC"). Franklin Bank is a member of the FHLB
of Indianapolis and is subject to certain limited regulation by the FDIC.
Franklin Bank is a member
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of the Savings Association Insurance Fund or SAIF and its deposits are insured
by the FDIC. As a result, the FDIC has certain regulatory authority over
Franklin Bank.
Insurance of Accounts and Regulation by the FDIC. Franklin Bank is
currently a member of the SAIF, which is administered by the FDIC. Deposits are
insured up to applicable limits by the FDIC and such insurance is backed by the
full faith and credit of the United States Government. As insurer, the FDIC
imposes deposit insurance premiums and is authorized to conduct examinations of
and to require reporting by FDIC-insured institutions. It also may prohibit any
FDIC-insurance institution from engaging in any activity the FDIC determines by
regulation or order to pose a serious risk to the FDIC.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, institutions classified as
well-capitalized (i.e. those with a core capital ratio of at least 5%, a ratio
of Tier 1 or core capital to risk weighted assets ("Tier 1 risk-based capital")
of at least 6% and a risk-based capital ratio of at least 10%) and considered
healthy pay the lowest premium while institutions that are less than adequately
capitalized (i.e. those with core or Tier 1 risk-based capital ratios of less
than 4% or a risk-based capital ratio of less than 8%) and considered of
substantial supervisory concern pay the highest premium. Risk classification of
all insured institutions will be made by the FDIC for each semi-annual
assessment period.
Prompt Corrective Action. The OCC is authorized and, under certain
circumstances required, to take certain actions against national banks that fail
to meet their capital requirements. The OCC is generally required to take action
to restrict the activities of an "undercapitalized association" (generally
defined to be one with less than either a 4% core capital ratio, a 4% Tier I
risked-based capital ratio or an 8% risk-based capital ratio). Any such national
bank must submit a capital restoration plan and, until such plan is approved by
the OCC, may not increase its assets, acquire another institution, establish a
branch or engage in any new activities, and generally may not make capital
distributions. The OCC is authorized to impose the additional restrictions that
are applicable to significantly undercapitalized associations.
Any national bank that fails to comply with its capital plan or is
"significantly undercapitalized" (i.e., Tier I risk-based or core capital ratios
of less than 3% or a risk-based capital ratio of less than 6%) must be made
subject to one or more of additional specified actions and operating
restrictions which may cover all aspects of it operations and include a forced
merger or acquisition of the bank. Any national bank that becomes "critically
undercapitalized" (i.e., a tangible capital ratio of 2% or less) is subject to
further mandatory restrictions on its activities in addition to those applicable
to significantly undercapitalized associations. In addition, the OCC must
appoint a receiver (or conservator with the concurrence of the FDIC) for a
national bank, with certain limited exceptions, within 90 days after it becomes
critically undercapitalized. Any undercapitalized association is also subject to
the general enforcement authority of the OCC, including the appointment of a
conservator or a receiver.
The OCC is also generally authorized to reclassify an association into a
lower capital category and impose the restrictions applicable to such category
if the institution is engaged in unsafe or unsound practices or is in an unsafe
or unsound condition.
See the discussion under "Regulatory Capital" in "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations" below.
Limitations on Dividends and Other Capital Distributions. Most of
Franklin's revenues are received by it in the form of dividends paid by Franklin
Bank. Under Michigan law, dividends to shareholders cannot be made if, after
giving them effect, the corporation would not be able to pay its debts as the
debts become due in the usual course of business, or the corporation's total
assets would be less than its total liabilities. As a national bank, Franklin
Bank's ability to pay dividends is governed by the National Bank Act and OCC
regulations. Under such statute and regulations, all dividends by a national
bank must be paid out of current or retained net profits, after deducting
reserves for losses and bad debts. The National Bank Act further restricts the
payment of dividends out of net profits by prohibiting a national bank from
declaring a dividend on its shares of common stock until the surplus fund equals
the amount of capital stock or, if the surplus fund does not equal the amount of
capital stock, until one-tenth of the national bank's net profits for (i) the
preceding four quarters in the case of annual dividends; or (ii) the preceding
two quarters in the case of quarterly or semi-annual dividends, are transferred
to the surplus
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fund. In addition, the prior approval of the OCC is required for the payment of
a dividend if the total of all dividends declared by a national bank in any
calendar year would exceed the total of its net profits for the year combined
with its net profits for the two preceding years, less any required transfers to
surplus or a fund for the retirement of any preferred stock.
The OCC has the authority to prohibit the payment of dividends by a
national bank when it determines such payment to be an unsafe and unsound
banking practice. In addition, Franklin Bank would be prohibited by federal
statute and the OCC's prompt corrective action regulations from making any
capital distribution if, after giving effect to the distribution, it would be
classified as "undercapitalized" under the OCC's regulations.
Community Reinvestment Act. Under the Community Reinvestment Act ("CRA"),
every FDIC-insured institution, including national banks, has a continuing and
affirmative obligation, consistent with safe and sound banking practices, to
help meet the credit needs of its entire community, including low and moderate
income neighborhoods. The CRA does not establish specific lending requirements
or programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the CRA. The CRA
requires the OCC, in connection with the examination of Franklin Bank, to assess
Franklin Bank's record of meeting the credit needs of its community and to take
such record into account in its evaluation of certain applications, such as a
merger or the establishment of a branch, by Franklin Bank. An unsatisfactory
rating may be used as the basis for the denial of an application by the OCC.
Due to the heightened attention being given to the CRA in the past few
years, Franklin Bank may be required to devote additional funds for investment
and lending in its local community. Franklin Bank was examined for CRA
compliance in 2003 and received a satisfactory rating.
Federal Reserve System. As a national bank, Franklin Bank is required to
become a member of the Federal Reserve System and subscribe for stock in the
Federal Reserve Bank ("FRB") of Chicago in an amount equal to 6% of its paid in
capital and surplus (payment for one-half is initially required with the
remainder subject to call by the FRB).
The FRB requires all depository institutions to maintain non-interest
bearing reserves at specified levels against their transaction accounts
(primarily checking, NOW and Super NOW checking accounts).
Federal Home Loan Bank System. Franklin Bank is currently a member of the
FHLB of Indianapolis, which is one of 12 regional FHLB's that administer the
home financing credit function of savings associations. Each FHLB serves as a
reserve or central bank for its member within its assigned region. It is funded
primarily from proceeds derived from the sale of consolidation obligations of
the FHLB System. It makes loans to members (i.e. advances) in accordance with
policies and procedures, established by the board of directors of the FHLB,
which are subject to the oversight of the Federal Housing Finance Board. All
advances from the FHLB are required to be fully secured by sufficient collateral
as determined by the FHLB. In addition, all loan advances are required to
provide funds for residential home financing.
As a member, Franklin Bank is required to purchase and maintain stock in
the FHLB of Indianapolis. At December 31, 2003, Franklin Bank had $5.9 million
in FHLB stock, which was in compliance with this requirement. In past years,
Franklin Bank has received substantial dividends on its FHLB stock although
there can be no assurance such dividends will continue to be paid in the future.
RECENT LEGISLATION
USA Patriot Act. On October 26, 2001, President Bush signed into law, the
Uniting and Strengthening America by Providing Appropriate Tools Required to
Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act"). The USA
Patriot Act is intended to allow the federal government to address terrorist
threats through enhanced domestic security measures, expanded surveillance
powers, increased information sharing and broadened anti-money laundering
requirements. Title III of the USA Patriot Act takes measures intended to
encourage information sharing among bank regulatory agencies and law enforcement
bodies. Certain provisions of Title III impose affirmative obligations on a
broad range
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of financial institutions, including banks, thrifts, brokers, dealers, credit
unions, money transfer agents and parties registered under the Commodity
Exchange Act.
Among its provisions, the USA Patriot Act requires each financial
institution: (i) to establish an anti-money laundering program, (ii) to
establish due diligence policies, procedures and controls with respect to its
private banking accounts and corresponding banking accounts involving foreign
individuals and certain foreign banks and (iii) to avoid establishing,
maintaining, administering, or managing correspondent accounts in the United
States for, or on behalf of, a foreign bank that does not have a physical
presence in any country. In addition, the USA Patriot Act contains a provision
encouraging cooperation among financial institutions, regulatory authorities and
law enforcement authorities with respect to individuals, entities and
organizations engaged in, or reasonably suspected of engaging in, terrorist
acts, or money laundering activities. The federal banking agencies have become
proposing and implementing regulations in interpreting the USA Patriot Act. It
is not anticipated that the USA Patriot Act will have a significant impact on
the financial condition or results of operations of Franklin.
Sarbanes-Oxley Act. On July 30, 2002, President Bush signed into law the
Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") which is intended to
address systemic and structural weaknesses of the capital markets in the United
States that were perceived to have contributed to recent corporate scandals. The
Sarbanes-Oxley Act creates the Public Company Accounting Oversight Board to
oversee the conduct of audits of public companies. Such Board will be funded
from assessments on public companies. In addition, the Sarbanes-Oxley Act
attempts to strengthen the independence of public company auditors and to
increase the responsibility of corporate management. Franklin does not expect
that such compliance will have a material impact on Franklin's financial
condition or results of operations.
EMPLOYEES
At December 31, 2003, the Bank had a total of 163 full-time equivalent
employees, none of whom were employed pursuant to collective bargaining
agreements. The Bank considers its relations with its employees to be
satisfactory.
SELECTED STATISTICAL AND OTHER INFORMATION
Certain statistical and other information referenced below is included in
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations" and in "Notes to Consolidated Financial Statements" below on the
pages referenced.
Page
----
I. Distribution of Assets, Liabilities and Stockholders' Equity;
Interest Rates and Interest Differential
A. Average Balance Sheets ................................................... 19
B. Net Interest Earnings..................................................... 19
C. Net Interest Income Volume/Rate........................................... 18
II. Investment Portfolio
A. Book Value of Investments................................................. 25
B. Due Date of Investments................................................... 25
III. Loan Portfolio
A. Types of Loans............................................................ 24
B. Maturities and Sensitivities of Loans to Changes in Interest Rates........ 25
C. Risk Elements ............................................................ 25
D. Other Interest Bearing Assets............................................. 25
IV. Summary of Loan and Lease Loss Experiences
A. Allowance For Loan Losses................................................. 20
B. Allocation of Allowance For Loan Losses................................... 21
V. Deposit Portfolio
A. Average Deposits.......................................................... 19
B. Maturity Distribution of Time Deposits.................................... 27
VI. Return on Equity and Assets........................................................ 16
VII. Short Term Borrowings.............................................................. 27
11
ITEM 2. PROPERTIES
The Bank leases space for its executive offices located at 24725 West
Twelve Mile Road, Southfield, Michigan 48034. The term of the lease was extended
as of January 1, 2003 and now expires on January 1, 2010. The Bank has an option
to extend the lease for an additional three years.
The Bank also leases its Southfield branch office located at 26336 West
Twelve Mile Road, Southfield, Michigan 48034. This lease expires on March 31,
2008. The Bank has four options to extend the lease for a period of five years
each.
The Bank owns the approximately 2,200 square-foot Grosse Pointe Woods
branch office located at 20247 Mack Avenue. This property had a net book value
of $484,146 at December 31, 2003.
The Bank leases its Birmingham branch office located at 479 Old South
Woodward Avenue. The building's lease expires May 1, 2007, but carries an option
to renew the lease for an additional 20-year term.
The Bank leases its Troy branch located at 755 West Big Beaver Road, Suite
101, Troy, MI 48084. This lease expires on November 1, 2010. The Bank has two
options to extend the lease for a period of five years each.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company is a party to routine legal proceedings
arising out of its general lending activities and other operations. However,
there are no material pending legal proceedings to which the Company or its
subsidiary are a party, or to which any of their property is subject, which, if
determined adversely to the Company or its subsidiary, would individually or in
the aggregate have a material adverse effect on its consolidated financial
position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders of the
Company during the fourth quarter of 2003.
12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Franklin common stock is traded on the Nasdaq National Market under the
symbol "FBCP."
As of March 22, 2004, there were 3,781,024 shares of Franklin common stock
outstanding, which were held by approximately 409 holders of record. Such
numbers do not reflect the number of individuals or institutional investors
holding stock in nominee name through brokerage firms and others.
The following table sets forth during the periods indicated the high and
low sales prices of the Franklin common stock as reported on the Nasdaq National
Market and the dividends declared per share of Franklin common stock for the
periods included.
CALENDAR PERIOD MARKET PRICE Dividends
----------------------- Declared Per
High Low Share
-------- -------- ------------
2003
Quarter ended December 31 $21.55 $18.30 $0.08
Quarter ended September 30 18.69 17.30 0.08
Quarter ended June 30 18.01 16.12 0.08
Quarter ended March 31 18.59 15.75 0.08
2002
Quarter ended December 31 $18.28 $17.58 $0.08
Quarter ended September 30 19.01 17.75 0.08
Quarter ended June 30 19.35 17.65 0.08
Quarter ended March 31 18.35 16.96 0.08
ITEM 6. SELECTED FINANCIAL DATA
The information with respect to selected financial data is included in the table
below entitled "Five Year Summary of Selected Consolidated Financial Data."
13
FIVE YEAR SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA
(Dollar amounts in thousands, except for per share data)
For the Year Ended December 31,
------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Income and Expense Items
Total interest income $ 27,433 $ 33,557 $ 38,809 $ 40,789 $ 36,651
Total interest expense 6,046 7,911 10,537 12,697 10,493
Net interest income 21,387 25,646 28,272 28,093 26,158
Provision for loan losses 2,903 3,810 1,859 3,693 1,226
Non-interest income 5,414 7,027 5,714 4,089 4,154
Non-interest expense 22,525 22,644 20,127 26,715 23,121
Net income before preferred stock dividends 1,078 5,616 8,641 1,918 4,757
Net income applicable to common shares 1,078 3,815 6,840 117 2,956
December 31,
------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Balance Sheet Items
Total assets $ 518,963 $ 542,478 $ 532,559 $ 527,971 $ 516,646
Total average assets 530,530 553,878 527,830 527,247 512,643
Loans 355,124 333,346 325,325 316,124 275,621
Deposits 406,380 429,130 389,358 387,919 400,365
Borrowings 65,000 65,000 79,606 82,326 62,521
Common shareholders' equity 45,737 45,642 42,179 35,288 33,066
Total shareholders' equity 45,737 45,642 42,179 35,288 33,066
Shares outstanding 3,753,667 3,647,593 3,607,542 3,552,550 3,509,537
At or For the Year Ended December 31,
------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Per Share
Book value $ 12.18 $ 12.51 $ 11.69 $ 9.93 $ 9.42
Basic earnings 0.29 1.05 1.92 0.03 0.84
Diluted earnings 0.28 1.01 1.86 0.03 0.83
Cash dividends declared - Common Stock 0.32 0.32 0.28 0.28 0.28
Payout ratio - Common Stock, in percent 109.6% 29.5% 14.6% 842.1% 33.2%
Market price:
End of year $ 21.55 $ 18.25 $ 17.60 $ 11.63 $ 9.56
52 week high 21.55 19.50 17.60 11.63 11.50
52 week low 15.75 16.96 11.03 7.00 7.13
At or For the Year Ended December 31,
------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Asset Quality
Non-performing assets to total assets 0.46% 1.35% 0.68% 0.71% 1.06%
Net charge-offs to average loans 1.22 0.80 0.29 1.12 0.78
Key Ratios
Net interest margin 4.41 5.12% 5.76% 5.62% 5.58%
Net interest spread 3.72 4.15 4.31 3.72 3.94
Operating expenses to average assets 4.25 4.09 3.81 5.07 4.51
Return on average assets 0.20 0.69 1.30 0.02 0.58
Return on average common shareholders' equity 2.39 8.38 17.36 0.35 8.76
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
CRITICAL ACCOUNTING POLICIES
Franklin's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and
follow general practices within the industry in which it operates. Application
of these principles requires management to make estimates, assumptions, and
judgments that affect the amounts reported in the consolidated financial
statements and accompanying notes. These estimates, assumptions, and judgments
are based on information available as of the date of the consolidated financial
statements; accordingly, as this information changes, the consolidated financial
statements could reflect different estimates, assumptions, and judgments.
Certain policies inherently have a greater reliance on the use of estimates,
assumptions, and judgments and as such have a greater possibility of producing
results that cold be materially different than originally reported. Estimates,
assumptions, and judgments are primarily necessary when assets and liabilities
are required to be recorded at fair value, when a decline in the value of an
asset not carried on the financial statements at fair value warrants an
impairment write-down or valuation reserve to be established, or when an asset
or liability needs to be recorded contingent on a future event. Carrying assets
and liabilities at fair value inherently results in more financial statement
volatility. The fair values and the information used to record valuation
adjustments for certain assets and liabilities are based either on quoted market
prices or are provided by third-party sources, when available. When third-party
information is not available, valuation adjustments are estimated in good faith
by management primarily through the use of internal cash flow modeling
techniques. The most significant accounting policies followed by Bancorp are
presented in Note 1 to the consolidated financial statements. These policies,
along with disclosures presented in the other financial statement notes and in
this financial review, provide information on how significant assets and
liabilities are valued in the consolidated financial statements and how those
values are determined. Based on the valuation techniques used and the
sensitivity of financial statements amounts to the methods, assumptions, and
estimates underlying those amounts, management has identified the determination
of the allowance for loan losses and the valuation of repossessed assets to be
the accounting areas that require the most subjective or complex judgments, and
as such could be most subject to revision as new information becomes available.
Any material effects on the consolidated financial statements during the twelve
months at 2003 related to these critical accounting areas are discussed in
management's discussion and analysis of financial condition and results of
operations. In addition, the sensitivities of valuations to adverse changes in
the factors and assumptions used in estimating certain fair values are discussed
in the notes to the consolidated financial statements. The remainder of
management's discussion and analysis should be read in conjunction with the
consolidated financial statements and related notes presented in Part II, Item
8, Financial Statements and Supplementary Data.
15
FINANCIAL SUMMARY
The Corporation reported net income of $1.1 million, or $0.28 per diluted share,
in 2003 compared to $3.8 million, or $1.01 per diluted share, in 2002 and $6.8
million, or $1.86 per diluted share, in 2001. The return on average assets was
0.20 % in 2003, down from 0.69 % in 2002 and 1.30 % in 2001. The return on
average common shareholders' equity was 2.39 % in 2003 compared to 8.38 % in
2002 and 17.36 % in 2001.
FINANCIAL HIGHLIGHTS
(Dollar amounts in thousands; except per share data)
Percent
2003 2002 Change
---- ---- ------
For the year ended December 31,
Net income $ 1,078 $ 3,815 (71.7)%
Net interest income 21,387 25,646 (16.6)
Non-interest income 5,414 7,027 (23.0)
Return on average common shareholders' equity 2.39 8.38 (23.2)
Return on average assets 0.20 0.69 (71.0)
Per share
Diluted earnings $ 0.28 $ 1.01 (72.3)
Cash dividend paid - common 0.32 0.32 --
At December 31,
Assets $ 518,963 $ 542,478 (4.2)
Loans 355,124 333,346 6.5
Deposits 406,380 429,130 (5.3)
Total shareholders' equity 45,737 45,642 0.2
Book value per share $ 12.18 $ 12.51 (2.6)
Market price per share 21.55 18.25 18.1
Total shares outstanding 3,753,667 3,647,593 2.9
SIGNIFICANT EVENTS
On November 10, 2003, the Corporation entered into an agreement as amended on
February 3, 2004, pursuant to which Franklin will be merged with and into First
Place Financial Corp. Franklin shareholders will vote on the merger at a special
meeting on April 5, 2004.
A new management team was formed during 2003.
- On November 10, 2003, Craig L. Johnson was appointed President
and Chief Executive Officer of Franklin and Franklin Bank,
succeeding David L. Shelp who had announced his retirement.
Mr. Johnson joined Franklin Bank on June 16, 2003 as Executive
Vice President and Chief Lending Officer.
- On June 16, 2003, in addition to the appointment of Mr.
Johnson, (see above), Leonard B. Carleton was appointed Chief
Financial Officer and Treasurer of Franklin and Franklin Bank.
- Effective April 14, 2003, Michael A. King was appointed Senior
Vice President of Retail Banking. In addition, on such date,
Ronald J. Carr was promoted from Vice President of Human
Resources to Senior Vice President and Director of Human
Resources.
Market interest rates declined during the first half of 2003 and remained at low
levels during the second half of the year. The cost of variable rate deposits
and the rates offered on new fixed rate deposits were generally lower during the
second half of the year.
In the third and fourth quarters of 2003, the Bank purchased whole loan pools of
first lien residential mortgages totaling $53.3 million.
16
NET INTEREST INCOME
Net interest income is interest earned on loans and investments less interest
paid for deposits and other borrowed funds. That net result, plus the impact of
net non-interest-bearing funds, expressed as a percentage of average
interest-earning assets, is the Bank's net interest margin.
Net interest income and net interest margin are influenced by increases or
decreases in the volume of earning assets or interest paying liabilities, and
the change in the average rate of interest earned on earning assets or paid for
deposits or other borrowed funds.
Net interest income for 2003, 2002 and 2001 was $21.4 million, $25.6 million and
$28.3 million, respectively. This represents a decrease in net interest income
of 16.61% when comparing 2003 to 2002 and a decrease of 9.29% when comparing
2002 to 2001. Net interest margin for those same periods was 4.42%, 5.12% and
5.76%, respectively.
The decrease in net interest income in 2003 as compared to 2002 was principally
caused by a decline in average earning assets of $24.6 million, a greater
decline in the yield on earning assets compared to the reduction in cost of
interest-bearing sources of funds (93 basis points versus 51 basis points,
respectively), and a shift in the mix of earning assets to lower yielding,
short-term investments. Interest earned on loans in 2003 amounted to $22.0
million compared to $25.1 million in 2002 and $28.7 million in 2001. The yield
on loans declined to 6.89% in 2003 from 7.77% in 2002 and 8.87% in 2001.
As management determined that longer term investments were not attractive at the
market rates, funds were invested in interest-bearing deposits with banks until
other opportunities became available. In the third and fourth quarters, whole
mortgage loans were purchased in the amount of $53.3 million. These loans have
yields significantly higher than the interest-bearing deposits and contribute to
improving the quality of the loan portfolio at the same time.
Factors that contributed to the Bank's decrease in net interest income during
the year 2002 include relatively flat average earning balances in the loan
portfolio coupled with a decline in the average rate earned on earning assets.
During the same period the average amount invested in other earning assets, such
as U.S. Treasury and mortgage-backed securities and interest-earning deposits,
increased by $12.3 million with a decrease in the average rate earned on these
investments of 1.37%.
The interest-bearing deposit average balance and the average cost of these
deposits declined in 2003 compared to 2002. As shown in table 2, money market
and NOW checking average balances increased while the other categories of
interest-bearing deposits declined. Interest expense on deposits declined by
$1.9 million in 2003 compared to 2002 and by $2.3 million in 2002 compared to
2001. In December, 2003 the Bank offered a special 20th anniversary CD with a
20-month term and a rate of 2.75%. Approximately $10 million of these CD
accounts were opened.
The FHLB advances have maturities of $10 million in 2004 and $55 million is
2011. The FHLB may elect to convert the advances to floating rates and may do so
if the index exceeds the fixed rate. The cost of the FHLB advances remained
stable because of the fixed rate during the period.
Business and personal checking accounts continue to supply funds without
interest costs. Non-interest bearing sources of funds contributed 0.69 basis
points to the net interest margin in 2003 compared to 0.97 basis points in 2002
and 1.45 basis points in 2001.
17
NET INTEREST INCOME VOLUME/RATE ANALYSIS - TABLE 1
(Dollars in Thousands) 2003/2002 2002/2001
INCREASE/(DECREASE)*IN INCREASE/(DECREASE)*IN
VOLUME RATE/YIELD NET VOLUME RATE/YIELD NET
------ ---------- --- ------ ---------- ---
INTEREST INCOME
LOANS $ (568) $(2,570) $(3,138) $ 48 $(3,566) $(3,518)
INVESTMENT SECURITIES:
U.S. TREASURIES AND MORTGAGE-BACKED
SECURITIES (3,552) (923) (4,475) (240) (1,786) (2,026)
INTEREST BEARING DEPOSITS WITH BANKS 251 (547) (296) 387 (23) 364
OTHER 2,863 (1,078) 1,785 8 (80) (72)
------- ------- ------- ------- ------- -------
TOTAL INTEREST INCOME (1,006) (5,118) (6,124) 203 (5,455) (5,252)
INTEREST EXPENSE
DEPOSITS (437) (1,365) (1,802) 516 (2,802) (2,286)
FHLB ADVANCES (9) 3 (6) 616 (168) 448
OTHER BORROWINGS (57) -- (57) (439) (349) (788)
------- ------- ------- ------- ------- -------
TOTAL INTEREST EXPENSE (503) (1,362) (1,865) 693 (3,319) (2,626)
------- ------- ------- ------- ------- -------
NET INTEREST INCOME (503) (3,756) (4,259) (490) (2,136) (2,626)
======= ======= ======= ======= ======= =======
* THE CHANGE IN INTEREST DUE TO BOTH VOLUME AND RATE HAS BEEN ALLOCATED BETWEEN
THE FACTORS IN PROPORTION TO THE RELATIONSHIP OF THE ABSOLUTE DOLLAR AMOUNTS OF
THE CHANGE IN EACH.
18
NET INTEREST INCOME ANALYSIS - TABLE 2
(Dollars in Thousands) YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------------
2003 2002 2001
------------------------------- ------------------------------- -----------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
--------- --------- ------- --------- --------- ------- --------- --------- ------
Assets
Loans:
Commercial $ 253,896 $ 18,069 7.12% $ 250,424 $ 18,763 7.49% $ 236,086 $ 20,527 8.69%
Residential 44,660 1,999 4.48% 48,178 3,253 6.75% 61,977 5,083 8.20
Consumer 20,826 1,908 9.16% 24,799 3,022 12.19% 22,520 2,747 12.20
Lease Financing 7 34 485.71% 305 109 35.86% 2,581 307 11.94
--------- --------- ------- --------- --------- ------- --------- --------- ------
Total Loans 319,389 22,010 6.89% 323,706 25,147 7.77% 323,164 28,664 8.87%
U.S. Treasuries and
Mortgage-Backed
Securities 68,733 2,476 3.60% 140,568 6,951 4.94% 149,049 9,227 6.19
Tax-Exempt Municipal
Securities (1) 11,202 623 8.43% 8,767 365 6.31% 2,502 115 6.96
Interest-Bearing Deposits
With Banks 33,426 350 1.05% 24,077 646 2.68% 9,715 282 2.90
Other 47,147 2,185 4.63% 7,401 448 6.05% 7,283 520 7.14
--------- --------- ------- --------- --------- ------- --------- --------- ------
Total Earning Assets/Interest
Income 479,897 27,644 5.76% 504,519 33,557 6.69% 491,713 38,809 7.90%
--------- --------- ------- --------- --------- ------- --------- --------- ------
Cash and Due from Banks 21,813 21,564 22,353
All Other Assets 34,041 32,487 18,324
Allowance for Possible
Credit Losses (5,221) (4,692) (4,560)
--------- --------- ------- --------- --------- ------- --------- --------- ------
Total Assets $ 530,530 $ 553,878 $ 527,830
========= ========= ======= ========= ========= ======= ========= ========= ======
Liabilities:
Money Markets 163,985 1,657 1.01% 159,786 2,762 1.73% 150,566 4,335 2.88%
Savings Accounts 151 1 0.57% 281 3 1.00% 276 5 1.73
NOW Checking 21,476 72 0.33% 19,437 131 0.67% 16,667 95 0.57
Certificates 29,997 1,021 3.40% 35,877 1,303 3.63% 25,870 1,303 5.04
Jumbo Certificates 16,146 399 2.47% 27,354 753 2.75% 32,179 1,500 4.66
--------- --------- ------- --------- --------- ------- --------- --------- ------
Total Interest-Bearing
Deposits 231,755 3,150 1.36% 242,735 4,952 2.04% 225,558 7,238 3.21
FHLB Advances 65,316 2,896 4.43% 65,528 2,902 4.43% 51,806 2,454 4.74
Other 3,133 57 1.82% 16,492 845 5.13
--------- --------- ------- --------- --------- ------- --------- --------- ------
Total Interest-Bearing
Liabilities/Expense 297,071 6,046 2.04% 311,396 7,911 2.54% 293,856 10,537 3.59%
--------- --------- ------- --------- --------- ------- --------- --------- ------
Business/Personal Checking 186,258 177,448 172,621
Preferred Stock 0 17,875 19,500
Other Liabilities 2,168 1,605 2,443
Shareholders' Equity 45,033 45,554 39,410
--------- --------- ------- --------- --------- ------- --------- --------- ------
Total Liabilities and
Shareholders' Equity $ 530,530 $ 553,878 $ 527,830
========= ========= ======= ========= ========= ======= ========= ========= ======
Net Interest Income (FTE) $ 21,598 $ 25,646 $ 28,272
--------- --------- ------- --------- --------- ------- --------- --------- ------
Net Interest Spread 3.72% 4.15% 4.31%
--------- --------- ------- --------- --------- ------- --------- --------- ------
Impact of Net Non-Interest
Bearing Source of Funds
And Equity 0.69% 0.97% 1.45%
========= ========= ======= ========= ========= ======= ========= ========= ======
Net Interest Margin 4.41% 5.12% 5.76%
========= ========= ======= ========= ========= ======= ========= ========= ======
(1) Interest rates are calculated on a federal tax equivalent basis.
Interest and principal balances pertaining to non-accrual loans are not included
for this analysis
ALLOWANCE FOR LOAN AND LEASE LOSSES ("ALLL")
The provision for loan and lease losses reflects management's evaluation of the
adequacy of the allowance for loan and lease losses. The allowance for loan and
lease losses represents management's assessment of probable losses inherent in
the Bank's loan portfolio, including all binding commitments to lend. The
allowance provides for probable losses that have been identified with specific
borrowing customers and for probable losses believed to be inherent but that
have not been specifically identified. Internal risk ratings are assigned to
each business loan at the time of approval and are subject to subsequent
periodic reviews by Bank management and the Bank's loan review consultants.
Business loans consist of non-real estate commercial loans, commercial mortgages
and Franklin lines of credit. A detailed review of the loan portfolio is
performed on a quarterly basis to assess the credit quality of the Bank's
commercial loan portfolio. A specific portion of the allowance is allocated to
such loans based upon this review. The portion of the allowance allocated to the
remaining business loans is determined by applying projected loss ratios to each
risk rating based on both qualitative and quantitative factors. The portion of
the allowance allocated to consumer and mortgage loans is determined by applying
projected loss ratios to various segments of the loan portfolio. Projected loss
ratios incorporate factors such as recent charge-off experience, current
economic conditions and trends, geographic dispersion of borrowers, and trends
with respect to past due and non-accrual amounts.
At year-end 2003 the allowance for loan losses was $4.9 million compared to $5.9
million at year-end 2002. In 2003, provisions for loan losses decreased by $0.9
million compared to 2002, which were $1.9 million higher than the provision in
2001. Recoveries were $2.8 million, $1.6 million, and $1.4 million for 2003,
2002, and 2001, respectively. Net charge offs increased by
19
42.2 % in 2003 compared to 2002 and 190 % when comparing year ended 2002 to
2001. During calendar year 2003, management of the Bank continued its aggressive
approach towards reducing troubled assets. The effects of the economic slowdown
resulted in the increase in charge-offs for the Bank's consumer and small
business lines of credit portfolio in 2002. In both 2003 and 2002, the
continuing weak economy resulted in a deterioration of certain Bank loan
relationships and prompted the Bank to take credit actions designed to promptly
charge off troubled loans and increase its loan loss provision. The majority of
the non-performing asset balance at December 31, 2003 consists of ten loans
totaling $2.1 million including four commercial loans, five commercial real
estate loans and one residential property in redemption.
ALLOWANCE FOR LOAN LOSSES - TABLE 3
Year Ended December 31,
-------------------------------------------------------------
2003 2,002 2001 2000
---------- ---------- ---------- ----------
Balance at Beginning of Period $5,926,813 $4,863,948 $3,951,552 $3,584,301
Provision for Losses 2,902,612 3,809,760 1,858,500 3,693,371
Charge-offs
Commercial 1,904,545 2,210,026 1,143,857 2,327,440
Commercial Mortgage 2,687,166 0 0 0
Construction 0 0 0 0
Residential 432,971 268,794 51,815 265,868
Overdraft 74,911 104,424 124,043 142,506
Consumer 1,633,984 1,650,631 847,638 667,646
Lease Financing 0 68,334 175,917 1,055,030
---------- ---------- ---------- ----------
Total Charge-Offs 6,733,577 4,302,209 2,343,270 4,458,490
Recoveries
Commercial 923,859 225,928 303,232 99,587
Commercial Mortgage 537,038 0 0 0
Construction 0 0 0 0
Residential 13,500 0 148 39,980
Overdraft 55,071 35,259 118,548 42,570
Consumer 1,214,172 1,053,712 558,100 114,464
Lease Financing 83,981 240,415 417,138 835,769
---------- ---------- ---------- ----------
Total Recoveries 2,827,621 1,555,314 1,397,166 1,132,370
---------- ---------- ---------- ----------
Net Charge-offs 3,905,956 2,746,895 946,104 3,326,120
---------- ---------- ---------- ----------
Balance at End of Period $4,923,469 $5,926,813 $4,863,948 $3,951,552
========== ========== ========== ==========
Allowance as a Percentage of :
Loans 1.39% 1.78% 1.50% 1.25%
Non-performing assets 205.16 80.93 134.06 106.14
Net Charge-offs 126.05 215.76 514.10 118.80
Net Charge-offs to:
Average Loans Outstanding 1.22 0.85 0.29 1.12
20
ALLOCATION OF ALLOWANCE FOR LOAN AND LEASE LOSSES - TABLE 4
(Dollar amounts in thousands)
December 31,
---------------------------------------------------------------------------------
2003 2002
----------------------------------------- -----------------------------------
Percentage Percentage
Allocated Allocated
Reserve to Percent of Reserve to Percent of
Total Allocated Total Allocated
Loans Reserve to Loans Reserve to
Amount Outstanding Total Reserve Amount Outstanding Total Reserve
------ ----------- ------------- ------ ----------- -------------
Commercial Real Estate Loans $1,009 0.55% 20.50% $2,758 0.83% 46.53%
Commercial Non-Real Estate Loans 2,574 3.19 52.28% 1,599 0.48 26.98
Residential Loans 331 0.47 6.72% 129 0.04 2.18
Consumer Loans 427 2.15 8.67% 747 0.22 12.60
Unallocated 582 0.16 11.83% 694 0.21 11.71
------ ------
Total $4,923 1.39% 100% $5,927 1.78% 100%
December 31,
----------------------------------------------------------------------------------
2001 2000
----------------------------------------- ------------------------------------
Amount Outstanding Total Reserve Amount Outstanding Total Reserve
------ ----------- ------------- ------ ----------- -------------
Commercial Real Estate Loans $1,423 0.44% 29.26% $2,481 0.78% 62.78%
Commercial Non-Real Estate Loans 1,878 0.58 38.61 257 0.08 6.5
Residential Loans 403 0.12 8.28 250 0.08 6.33
Consumer Loans 542 0.17 11.15 278 0.09 7.03
Unallocated 618 0.19 12.7 686 0.22 17.36
------ ------
Total $4,864 1.5% 100% $3,952 1.25% 100%
December 31,
-----------------------------------------
1999
-----------------------------------------
Amount Outstanding Total Reserve
------ ----------- -------------
Commercial Real Estate Loans $2,796 1.02% 78.01%
Commercial Non-Real Estate Loans 29 0.01 0.81
Residential Loans 69 0.02 1.93
Consumer Loans 114 0.01 3.18
Unallocated 576 0.21 16.07
------
Total $3,584 1.27% 100%
21
NON-INTEREST INCOME
Total non-interest income in 2003 amounted to $5.4 million compared to $7.0
million in 2002 and $5.7 million in 2001. Deposit service charges are the
largest recurring component of non-interest income and amounted to $3.1 million
in 2003 down $136 thousand or 4.2 % from 2002. In 2003, non-sufficient funds
("NSF") fees were down by $293 thousand and statement charges were up $186
thousand compared to 2002, in addition miscellaneous fees and returned item
charges were down $27 thousand in 2003. The changes in deposit service charges
in 2002 compared to 2001 were a result of a $175 thousand decrease in NSF fees
and a $165 thousand decrease in statement fees. The gains on sales of other
assets were $270 thousand in 2003 versus a loss of $192 thousand in 2003 for an
increase in non-interest income of $462 thousand when comparing year-to-year
changes.
In 2002 the proceeds from life insurance were $2.3 million, primarily as a
result of the untimely death of an insured officer. In 2003 the increase in the
cash surrender value of life insurance was $515 thousand. This accounts for $1.8
million in the reduction of non-interest income in 2003 compared to 2002.
Net gain on sale of securities was $412 thousand in 2003 compared to $648
thousand in 2002 and $1.1 million in 2002.
NON-INTEREST INCOME ANALYSIS - TABLE 5
(Dollars in Thousands) Year Ended December 31, Percent Change
---------------------------------- --------------------
2003 2002 2001 2003-02 2002-01
------- ------- ------- ------- -------
Deposit Service Charges $ 3,086 $ 3,222 $ 3,595 -4.22% -10.38%
Loan Fees 661 537 325 23.09% 65.23%
Gain on Sale of Securities 412 648 1,144 -36.42% -43.36%
Gain/(Loss) on Sale of Other Assets 270 (192) (59) NM 225.42%
Increase in Cash Value and Proceeds
from Life Insurance 515 2,332 18 -77.92% NM1
Other 470 480 691 -2.08% -30.54%
------- ------- ------- ------- --------
Total Non-Interest Income $ 5,414 $ 7,027 $ 5,714 -22.95% 22.98%
======= ======= ======= ======= ========
22
NON-INTEREST EXPENSE
Total non-interest expenses were $22.3 million in 2003 compared to $22.6 million
in 2002 and $20.1 million in 2001. Included in non-interest expenses were
severance compensation of $3.1 million in 2003, $2.5 million in 2002 and $708
thousand in 2001. Officers with higher value severance packages exercised their
agreements in 2003, including the retirement payment to David Shelp. Merger
related expenses were $304 thousand in 2003, zero in 2002 and $67 thousand in
2001. 2002 expenses included non-recurring expenses relating to a previously
reported investigation conducted by a special committee of independent directors
and the expenses incurred in the creation of the bank holding company of $665
thousand and $181 thousand, respectively.
Compensation, excluding severance compensation, declined for the second year in
a row to $9.4 million in 2003 from $9.6 million in 2002 and $9.8 million in
2001. The full time equivalent staff at December 31, 2003 was 163 compared to
189.5 and 195.5 at December 31, 2002 and 2001, respectively.
The Troy office was opened in January, 2003.
NON-INTEREST EXPENSE ANALYSIS - TABLE 6
(Dollars in Thousands) YEAR ENDED DECEMBER 31, PERCENT CHANGE
--------------------------------- ----------------------
2003 2002 2001 2003-02 2002-01
------- ------- ------- --------- ----------
Salaries $ 7,118 $ 7,460 $ 7,883 -4.6% -5.4%
Employee Benefits 2,257 2,124 1,891 6.3 12.3%
------- ------- ------- ------- -------
Total Compensation Expense 9,375 9,584 9,774 (2.2) -1.9%
Occupancy and Equipment 3,250 3,217 3,332 1.0 -3.5%
Advertising 551 610 799 (9.7) -23.7%
Outside Services 2,651 2,913 2,199 (9.0) 32.5%
Federal Insurance 65 69 186 4.3 -62.9%
Communication Expense 565 594 585 (4.9) 1.5%
Defaulted Loan Expense 791 778 401 11.8 94.0%
Other 1,896 2,389 2,076 (20.6) 15.0%
------- ------- ------- ------- -------
Total Non-Interest Expense Before Merger
and Severance Expenses 19,144 20,154 19,352 (5.8%) 4.1%
Severance Compensation 3,077 2,490 708 23.6% 251.7%
Merger Expenses 304 0 67 -100.0%
------- ------- ------- ------- -------
Total Non-Interest Expense $22,525 $22,644 $20,127 (1.2%) 12.5%
INCOME TAXES
The provision for federal income taxes for 2003, 2002 and 2001 were $296
thousand, $603 thousand and $3.4 million, respectively. The differences reflect
the fluctuations in pre-tax earnings along with the effect of tax-exempt
interest income, non-taxable life insurance gains and low income housing
credits, which reduced the effective tax rate to 21.5 %, 13.65 % and 32.94 % in
2003, 2002 and 2001, respectively.
EARNING ASSETS
At year-end 2003, total earning assets totaled $454.4 million compared to $503.2
million at December 31, 2002. Average earning assets amounted to $479.9 million
in 2003, $504.5 million in 2002 and $491.7 million in 2001.
Loans are the largest component of earning assets with an average balance of
$319.4 million in 2003 compared to average balances of $323.7 million and $323.2
million in 2002 and 2001, respectively. Commercial loans, including commercial
real estate, grew $3.5 million in 2003 compared to 2002 and $14.3 million in
2002 compared to 2001. Both residential and consumer loans had lower average
23
balances in 2003 than in 2002, while consumer loans averaged $2.3 million higher
in 2002 than in 2001. The consumer loans were primarily related to the four-year
lending program in conjunction with DTE Energy that ended at the end of 2003.
Residential loans reduced during 2003 through principal reduction and
refinancing with other lenders. In the third and fourth quarters of 2003, the
Bank acquired whole loan mortgage pools to replenish the portfolio.
Asset or liability sensitivity along with interest rate risk arises in the
normal course of the Bank's business due to differences in the re-pricing and
maturity characteristics of interest rate sensitive assets and liabilities.
Sensitivity of earnings to interest rate changes arises when yields on assets
change differently from the interest costs on liabilities. Asset or liability
sensitivity is determined by the difference between interest-earning assets and
interest-bearing liabilities re-pricing within a specific time period and the
magnitude by which interest rates change on the various types of earning assets
and interest-bearing liabilities. The management of interest rate sensitivity
includes monitoring the maturities and re-pricing opportunities of
interest-earning assets and interest-bearing liabilities.
At year-end 2003, the Bank's investment portfolio had a balance of $91.6 million
compared to $149.8 million at year-end 2002. Compared to the broad array of
investment opportunities generally accepted as suitable bank investments, the
Bank's investment portfolio remained conservative and consisted primarily of
mortgage-backed securities and U.S. government agency securities. At December
31, 2003, the Bank's investment securities portfolio had a weighted average
maturity of 11.2 years and a weighted average yield of 3.12 %.
There were no investments in securities of any one issuer, which exceeded 10% of
stockholders' equity except for holdings of U.S. Government Agency Securities
($59.0 million), CIT Group Inc. Corporate Bonds ($5.0 million), and Goldman
Sachs Group Inc. Corporate bonds ($5.2 million) at December 31, 2003. The
majority of the U.S. Government Agency Securities are pledged to secure
borrowing arrangements for Federal Home Loan Bank borrowings and securities sold
under agreements to repurchase or for other purposes as required or permitted by
law.
LOAN AND LEASE FINANCING PORTFOLIO ANALYSIS - TABLE 7
(Dollars in Thousands)
At December 31,
--------------------------------------------------------------------------------
2003 2002 2001
---------------------- ---------------------- ----------------------
Amount % Amount % Amount %
-------- ------ -------- ------ -------- ------
Commercial $ 74,440 22.7% $ 77,856 23.4% $ 70,613 21.7%
Commercial Mortgage 185,132 52.1 188,121 56.4 169,865 52.2
Residential Mortgage and Home Equity 64,034 19.6 16,753 5 24,627 7.6
Real Estate Construction 10,677 0.0 26,071 7.8 31,858 9.8
Consumer 20,843 5.6 24,512 7.4 27,378 8.4
Lease Financing -- 0.0 33 0.0 984 0.3
-------- ------ -------- ------ -------- ------
Loans $355,124 100% $333,346 100% $325,325 100%
======== ====== ======== ====== ======== ======
The Bank has no foreign loans and there were no concentrations greater than 10%
of total loans that are not disclosed as a separate category.
24
LOAN COMMITMENTS - TABLE 8
(Dollars in Thousands) At December 31,
-------------------------------------
2003 2002 2001
------ ------ ------
Outstanding Loan Commitments 10,278 21,000 21,500
Unused Commercial Line of Credit Commitments 54,740 70,400 53,500
Unused Home Equity Commitments 6,276 4,600 5,200
Undisbursed Construction Loans 7,940 5,900 7,900
LOAN MATURITY ANALYSIS - TABLE 9
(Dollars in Thousands) At December 31,
----------------------------------------------------------------
With One To After
One Year Five Years Five Years Total
----------- ------------ ----------- ------------
Commercial $39,957,729 $ 24,246,011 $10,236,269 $ 74,440,009
Commercial Mortgage 13,099,704 153,271,048 18,760,873 185,131,625
Residential Mortgage and Home Equity 2,362,263 4,871,788 56,801,052 64,035,103
Real Estate Construction 7,133,313 3,543,856 10,677,169
Consumer 1,704,191 19,128,965 7,177 20,840,333
Lease Financing
Lease Financing - Held for Sale
----------- ------------ ----------- ------------
Loans 64,257,200 $205,061,668 $85,805,371 355,124,239
----------- ------------ ----------- ------------
Total Loans Above
=========== ============ =========== ============
Fixed Rates $10,870,303 $131,026,853 $47,006,343 $188,903,499
Floating Rates 53,386,897 74,034,815 38,799,028 166,220,740
----------- ------------ ----------- ------------
Loans $64,257,200 $205,061,668 $85,805,371 $355,124,239
=========== ============ =========== ============
SECURITIES MATURITY ANALYSIS - TABLE 10
(Dollar amounts in thousands)
At December 31, 2003
-------------------------------------------------------------------------------------
Within 1 Year 1 - 5 Years 5 - 10 Years Over 10 Years
----------------- ---------------- ------------------- ----------------
Cost Yield Cost Yield Cost Yield Cost Yield
------- ----- ------- ----- ------- ------- ------- ------
Mortgage-backed securities $ -- $ -- $ 2,561 5.33% $26,315 4.07%
U.S. Government and agency securities 8,526 4.18% 20,040 2.22% 954 6.63%
Tax-exempt municipal securities 2,592 3.44% 762 4.30% 6,594 4.61%
Taxable municipal securities 1,356 1.19%
Corporate bonds 6,496 6.51% 4,999 6.50% 5,165 6.29% 3,000 4.82%
------- ------- ------- -------
Total $15,022 $28,987 $ 9,442 $35,909
At December 31, 2003
-----------------------------------
Maturing
-----------------------------------
Weighted
Average
Amortized Fair Maturity
Cost Value (Years)
--------- ------- --------
Mortgage-backed securities $28,876 $29,250 24.3
U.S. Government and agency securities 29,520 29,750 2.4
Tax-exempt municipal securities 9,949 10,461 9.7
Taxable municipal securities 1,356 1,356 1.4
Corporate bonds 19,659 20,754 6.6
------- -------
Total $89,360 $91,571 11.2
25
OTHER EARNING ASSETS
The Bank's other earning assets are comprised of Federal Home Loan Bank ("FHLB")
stock, Federal Reserve Bank ("FRB") stock, interest-bearing deposits with other
banks and bank owned life insurance. Total other earning assets at year-end
totaled $18.9 million and $29.8 million at December 31, 2003 and 2002.
Interest-bearing deposits with banks averaged $33.4 million in 2003 compared to
$24.1 million in 2002 and $9.7 million in 2001. Liquid funds were temporarily
maintained in these interest-bearing deposits while seeking higher yielding,
high quality alternative investments. Management viewed the available investment
securities as an unattractive alternative during this period of the interest
rate cycle.
As a member of both the FHLB and the FRB, stock ownership is required. At
year-end 2003 and 2002, the Bank's FHLB stock position remained at $5.9 million.
FRB stock held at year-end 2003 was $0.9 million compared to $1.5 million at
December 31, 2002. These investments carried a weighted average yield of 5.26%
during 2003 and 6.05% during 2002.
During December of 2001, the Bank invested $10 million in cash value life
insurance, commonly known as "BOLI". "BOLI" is a tax-free investment vehicle
that provides a stable return which is typically at or above market rates. The
"BOLI" investment is held indefinitely by the Bank. In the event of death of a
member of the insured group, the proceeds from the life insurance claim are
included in the Bank's other income. During 2002, the Bank recognized $2.3
million in proceeds from this product, of which $1.7 million was recognized
during the fourth quarter of 2002 due to the untimely death of the Bank's Senior
Vice President and Chief Credit Officer. The Bank invested $830 thousand in
additional "BOLI" during 2003.
DEPOSITS AND OTHER BORROWED FUNDS
Providing a stable source of low-cost funding, core deposits include
non-interest-bearing business checking deposits, money market savings, personal
checking and savings and retail certificates. Average core deposits were $401.9
million in 2003 compared to $392.3 million in 2002. Average business- and
personal-checking balances were $186.3 million in 2003 compared to $177.4
million in 2002. Average money market savings were $164.0 million in 2003
compared to $159.8 million in 2002 and $150.6 million in 2001. Average retail
certificate of deposits were $30.0 million in 2003 compared to $35.9 million in
2002 and $25.9 million for 2001. The Bank's largest core deposit source
continues to be business and personal checking account balances. The average
balance of those accounts increased during 2003 by $8.8 million.
At December 31, 2003, total deposits were $406.4 million compared to $429.1
million at the end of 2002. Total deposits for any given day can fluctuate
primarily as business checking customer's balances changes as collections and
payments cause their balances to change. There is an indication that business
checking balances tend to be lower around the year end and rise to a higher
level around the middle of each year.
Comparing year end 2002 to 2001, total deposits increased $39.8 million or
10.2%. This significant increase is deposits has not only contributed to funding
loans, but has also allowed the Bank to decrease its other borrowed funds $14.6
million and to redeem the $20.7 million of preferred stock of the Bank's
subsidiary Franklin Finance Corporation which was paying a dividend of 8.70%.
Borrowed funds in the form of advances from the FHLB and repurchase agreements
provided a limited amount of the funding to support loan growth in the year 2002
while providing a source of liquidity which mirrors the estimated duration of
the Bank's deposit portfolio. The average balance in these forms of borrowed
funds was $65.0 million for FHLB advances and $0.3 million for repurchase
agreements in 2003, as compared to $65.3 million for FHLB advances and $3.1
million in repurchase agreements in 2002 and $51.8 million for FHLB advances and
$16.5 million in repurchase agreements, in 2001. In 2004, $10 million of the
FHLB advances mature.
26
SOURCE OF FUNDS - TABLE 11
(Dollars in thousands)
December 31,
----------------------------------------------------------------------------------
2003 2002 2001
---- ---- ----
Business checking $185,159 39.28%% $180,011 36.43% $159,450 34.00%
Money market savings 147,697 31.33% 165,365 33.47 147,231 31.40
Personal checking and savings 25,076 5.32% 25,567 5.17 23,661 5.05
Jumbo certificates 19,736 4.19% 20,967 4.24 33,460 7.13
Retail certificates 28,712 6.09% 37,220 7.53 25,556 5.45
-------- -------- -------- -------- -------- --------
Total deposits 406,380 86.21% 429,130 86.85 389,358 83.03
Borrowings 65,000 13.79% 65000 13.15 79,606 16.97
-------- -------- -------- -------- -------- --------
Total source of funds 471,380 100% $494,130 100% $468,964 100%
MATURITY DISTRIBUTION OF TIME DEPOSITS ANALYSIS - TABLE 12
(In thousands of dollars)
December 31, 2003
-----------------
(less than) $100,000 (greater than) $100,000
-------- --------
Three months or less $ 4,404 $ 5,001
Over three months to six months 6,023 4,462
Over six months to twelve months 15,943 8,905
Over twelve months 2,342 1,368
-------- --------
Total $ 28,712 $ 19,736
======== ========
CONTRACTUAL OBLIGATIONS
The Company has various financial obligations, including contractual obligations
and commercial commitments, which require future cash payments. The following
table presents the aggregated annual maturities of contractual obligations
(based on final maturity dates) at December 31, 2003 (in thousands).
Less than 1-3 3-5 More than
Contractual Obligations Total 1 year years years 5 years
(In thousands of dollars) ----- ------ ----- ----- -------
Deposits without stated maturities $357,932 $ -- $ -- $ -- $357,932
Certificates of deposit 48,448 19,890 24,848 3,447 263
Long-term debt obligations 65,000 10,000 -- -- 55,000
Capital lease obligations -- -- -- -- --
Operating lease obligations 6,614 1,097 2,282 2,065 1,170
Purchase obligations -- -- -- -- --
Other long-term liabilities -- -- -- -- --
-------- ------- ------- ------ --------
Total $477,994 $30,987 $27,130 $5,512 $414,365
27
REGULATORY CAPITAL
The adequacy of the Corporation's capital is reviewed regularly to ensure that
sufficient capital is available to meet current and future funding needs and
comply with regulatory requirements.
Shareholders' equity, excluding the net unrealized gain on securities available
for sale, increased by $1.1 million at year end 2003, or 2.46 %, compared to
December 31, 2002 and represents 8.52 % of total assets. At December 31, 2002,
the similar ratio of shareholders' equity to assets was 7.97%. The increase was
primarily the result of net income of $1.1 million and exercise of common stock
options of $1.2 million, offset by $1.2 million of cash dividends. Dividends
declared per common share remained $0.32 per share in 2003 as in 2002.
Management believes the Corporation has an adequate capital position to meet its
needs in 2004.
The Corporation is subject to risk-based capital adequacy guidelines that
measure capital relative to risk-weighted assets and off-balance sheet financial
instruments. Capital adequacy guidelines issued by the Federal Reserve Board
require bank holding companies to have a minimum total risk-based capital ratio
of 8.00%, with at least half of total capital in the form of Tier 1, or core
capital. The Corporation's total risk-based capital ratio was 13.15% at December
31, 2003. For further information regarding regulatory capital requirements, see
Note 6 to the consolidated financial statements.
The Bank has consistently exceeded the capital levels established by The Office
of the Comptroller of the Currency ("OCC"). During 2003, the Bank's capital
levels remained above the "well capitalized" OCC classification. It is the
Corporation's objective to maintain this highest classification level, which
both ensures compliance with regulatory requirements and allows for greater
potential growth.
The OCC measures regulatory capital three ways: 1) Tier 1 capital to average
assets (the "Tier 1 leverage" ratio), 2) Tier 2 capital to risk weighted assets
and 3) Total capital to risk weighted assets. Minimum accepted ratios for these
three levels are 4.00%, 4.00% and 8.00%, respectively. "Well capitalized"
institutions must meet OCC established minimums of 5.00%, 6.00% and 10.00% for
the three tiers, respectively.
CAPITAL ANALYSIS - TABLE 13
(In thousands)
Tier 1 Tier 1 Total
Leverage Risk-based Risk-based
---------- ---------- ----------
Regulatory capital balances at December 31, 2003 $ 44,279 $ 44,279 $ 49,202
Required regulatory capital (well capitalized) 26,594 25,444 42,090
---------- ---------- ----------
Capital in excess of well capitalized $ 17,685 $ 18,325 $ 7,112
========== ========== ==========
Capital ratios at December 31, 2003 8.32% 10.24% 11.37%
Capital ratios at December 31, 2002 7.55 10.63 11.89
Regulatory capital ratios--"well capitalized" definition 5.00 6.00 10.00
NON-PERFORMING ASSETS
The Bank's policies regarding non-accrual and impaired loans reflect the
importance of early identification of troubled loans. Consumer loans are charged
off no later than 120 days past due, or earlier if deemed uncollectible. Loans
other than consumer loans are generally placed on non-accrual status when
management determines that principal or interest may not be fully collectible,
but generally no later than when the loan is 90 days past due on principal or
interest. Loan amounts in excess of probable future cash collections are charged
off at the time the loan is placed on non-accrual status, to an amount that
represents management's assessment of the ultimate collectibility of the loan.
Interest previously accrued but not collected on non-accrual loans is charged
against current income. Income on such loans is then recognized only to the
extent that cash is received and where the future collection of principal is
probable. When the future collection of principal is not probable, cash received
is applied to the carrying value of the loan.
28
Total non-performing assets at year-end 2003 were $2.4 million compared to $7.3
million and $3.6 million at year-end 2002 and 2001, respectively. The $4.9
million decrease in 2003 reflects sales of other real estate owned and
collection on previously non-performing loans. Non-accrual loans totaled $1.7
million at the end of 2003 compared to $4.8 million at year end 2002, which was
a decrease of $3.1 million; there were no accruing loans past due 90 days at
year-end 2003, 2002 or 2001. Real estate owned or in redemption decreased from
$2.5 million at December 31, 2002 to $0.7 million at December 31, 2003. As a
percentage of total assets, non-performing assets were 0.46 %, 1.35 % and 0.68 %
at year-end 2003, 2002 and 2001, respectively. At December 31, 2003, loans 30 or
more days past due was 0.81 % of total loans outstanding compared to 0.66 % at
December 31, 2002. At December 31, 2001 total non-performing assets were $3.6
million of which $564 thousand was real estate owned or in redemption. At year
end 2001 loans 30 days or more past due were 0.72 percent of total loans.
At December 31, 2003, management was not aware of any potential problem loans
that would have a material effect on loan delinquency or loan charge-offs.
Management continues to actively manage the loan portfolio, seeking to identify
and resolve problem assets at an early stage. Management believes that the Bank
is adequately reserved.
NON-PERFORMING ASSETS - TABLE 14
December 31,
------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Non-accrual loans
Commercial $ 344,963 $ 338,547 $ 284,955 $ 640,936 $ 63,393
Commercial mortgage 1,231,987 3,104,793 2,188,869 1,542,632 807,713
Residential mortgage -- 1,313,654 376,969 216,000 --
Consumer 126,430 75,993 201,745 -- --
Lease financing -- -- 11,360 -- --
---------- ---------- ---------- ---------- ----------
Total non-accrual loans 1,703,380 4,832,987 3,063,898 2,399,568 871,106
Accruing loans past due 90 days or more
Commercial -- -- -- -- 141,029
Commercial mortgage -- -- -- -- --
Residential mortgage -- -- -- 18,867 469,080
Consumer -- -- -- 81,299 257,868
Lease financing -- -- -- 104,617 357,639
---------- ---------- ---------- ---------- ----------
Total -- -- -- 204,783 1,225,616
---------- ---------- ---------- ---------- ----------
Total non-performing loans 1,703,380 4,832,987 3,063,898 2,604,351 2,096,722
Real estate owned
Commercial mortgage 57,250 540,326 77,500 542,182 891,000
Residential mortgage 89,894 1,464,123 486,735 576,384 2,458,516
---------- ---------- ---------- ---------- ----------
Total real estate owned 147,144 2,004,449 564,235 1,118,566 3,349,516
Real estate in redemption 549,345 485,534 -- -- 14,580
---------- ---------- ---------- ---------- ----------
Total non-performing assets $2,399,869 $7,322,970 $3,628,133 $3,722,917 $5,460,818
========== ========== ========== ========== ==========
Total non-accrual loans and real estate owned
as a percentage of:
Total assets 0.36% 1.26% 0.68% 0.71% 1.05%
Loans and real estate owned 0.52% 2.04% 1.11% 1.11% 1.51%
Total non-performing assets as a percentage of:
Total assets 0.46% 1.35% 0.68% 0.71% 1.06%
Loans and real estate owned 0.68% 2.18% 1.11% 1.17% 1.96%
29
INTEREST RATE SENSITIVITY
Interest rate risk arises in the normal course of business due to differences in
the re-pricing and maturity characteristics of assets and liabilities. Since no
single measurement system satisfies all management objectives, a combination of
techniques are used to manage interest rate risk, including simulation analysis,
asset and liability re-pricing schedules and duration of equity. The Asset and
Liability Committee ("ALCO") regularly reviews the results of these interest
rate risk measurements. The ALCO, which is comprised of executive management
from various areas of the Bank, including operations, lending, and deposit
gathering, meets regularly to execute asset and liability management strategies.
The ALCO establishes and monitors guidelines on the sensitivity of earnings to
changes in interest rates. The goal of the ALCO process is to maintain the
Bank's interest rate risk at prudent levels to provide the maximum level of net
interest income and minimal impact on earnings from major interest rate changes.
The ALCO frequently evaluates net interest income under various balance sheet
and interest rate scenarios. The results of these analyses provide the
information needed to assess the proper balance sheet structure.
An unexpected change in economic activity, whether domestically or
internationally, could translate into a materially different interest rate
environment than currently expected as was noted during 2002 and 2003. A process
is maintained where management evaluates "base" net interest income under what
is the current balance sheet structure and interest rate environment. This
"base" net interest income is then evaluated against interest rate scenarios
that are taken up and down 200 basis points from the most likely rate
environment. In addition, adjustments to asset prepayment levels, yield curves
and overall balance sheet mix and growth assumptions are made to be consistent
with each interest rate environment. These assumptions are inherently uncertain
and, as a result, the model cannot precisely predict the impact of higher or
lower interest rates on net interest income. Actual results may differ from
simulated results due to timing, magnitude and frequency of interest rate
changes and changes in market conditions and management strategies, among other
factors.
At December 31, 2003, the measurement of risk exposure to net interest income
during the year 2004 for a 200-basis-point decline in short-term interest rates
indicates the net interest income will decrease 10.75% or $3.0 million and for a
200-basis-point rise indicates an increase of 2.48% or $.69 million.
Additionally the Bank was positively gapped at 3 months by 16.4% of interest
earning assets and at 12 months by 21.99% of interest earning assets. Re-pricing
assets exceeded re-pricing liabilities within all categories other than over 5
years at December 31, 2003. The Bank had a positive gap of 19.37% within 12
months of December 31, 2002. This is an increase in the gap caused by a shift of
investment securities and commercial real estate loans to within 12 months and
other minor balance sheet changes.
30
INTEREST RATE SENSITIVITY ANALYSIS - TABLE 15
(Dollars in thousands)
December 31, 2003
0-3 3-12 1-3 3-5 Over 5
Months Months Years Years Years Total
------ ------ ----- ----- ----- -----
Assets
Interest-bearing deposits $ 744 $ 744
Securities (at cost) 31,140 18,738 22,258 4,603 19,500 96,239
FHLB and FRB stock 6,879 6,879
Loans 80,024 87,642 113,154 44,393 29,911 355,124
-------- ------- ------- ------- -------- --------
Total rate sensitive assets 118,787 106,380 135,412 48,996 49,411 458,986
Liabilities
Savings, NOW and time deposits 10,032 12,392 27,392 5,287 -- 55,103
Money market deposits 23,461 68,361 24,503 20,009 -- 136,334
Borrowings 10,000 -- -- -- 55,000 65,000
-------- ------- ------- ------- -------- --------
Total rate sensitive liabilities 43,493 80,753 51,895 25,296 55,000 256,437
-------- ------- ------- ------- -------- --------
Interest sensitivity gap 75,294 25,627 83,517 23,700 (5,589) 202,549
Cumulative interest sensitivity gap 75,294 100,921 184,438 208,138 202,549
Cumulative interest sensitivity gap to
total rate sensitive assets 16.40% 21.99% 40.18% 45.35% 44.13%
LIQUIDITY
The Bank manages liquidity to insure adequate funds are available to meet the
cash flow needs of depositors, borrowers and the Bank. The Bank's most readily
available sources of liquidity are a highly marketable securities portfolio, the
core deposit base, and the ability to acquire large deposits in the local and
national markets. Also loan repayments, maturities and possible loan sales, FHLB
advances, and repurchase agreements are additional forms of liquidity for the
Bank.
Liquidity is carefully monitored by the ALCO. Prospective funding needs are
anticipated and compared to cash levels and available borrowing capacity. The
Bank manages liquidity according to both a Liquidity Policy and a Liquidity
Crisis Contingency Plan. The Policy and Plan dictate acceptable liquidity
levels, identify all alternative sources for additional liquidity and articulate
certain "triggering events" that would accelerate the acquisition of liquid
reserves. As of December 31, 2003 and 2002, cash and cash equivalents equaled
9.21 % and 5.68 % of total assets, respectively. Net cash flows from operating
activities provided $5.6 million compared to $3.1 million in 2002, while
investing activities provided $34.2 million in 2003 compared to uses of $2.7
million in 2002. The significant fluctuation in cash flows from investing
activities was primarily the result of the reduction in the securities available
for sale portfolio through maturities, paydowns and sales. The $22.8 million
decrease in cash flows from financing activities is primarily the result of a
significant decrease in deposits during 2002 of $39.7 million, offset by the
redemption of preferred stock of $20.7 million and additional borrowing
repayments of $14.6 million. The accumulated effect of the Bank's operating,
investing and financing activities resulted in cash and cash equivalents
increasing approximately $6.3 million during 2002 to $30.8 million at December
31, 2002.
At December 31, 2003, the Bank had liquid assets totaling $139.4 million with
additional borrowing capability of $10.0 million with the FHLB. The Bank's
liquidity is considered adequate by management.
FORWARD-LOOKING STATEMENTS
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
31
intended to identify "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements represent the judgment of management as of the date of this report.
The Corporation disclaims, however, any intent or obligation to update these
forward-looking statements.
Factors which could cause actual results to differ, 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; changes in the national economy and
changes in economic conditions of the Bank's market area and the other risks
detailed from time to time in Franklin's SEC reports.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The information with respect to quantitative and qualitative market risk
is contained under the heading "Interest Rate Sensitivity" under "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operation" on pages 30 and 31.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The auditor's report, consolidated financial statements (including the
quarterly summary of selected consolidated financial data) and notes to
consolidated financial statements are included on pages F-1 through F-27 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(a) The term "disclosure controls and procedures" is defined in rules
13a-15(e) and 15(d)-15(e) of the Securities Exchange Act of 1934 (the "Exchange
Act"). These Rules refer to the controls and 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 Chief
Financial Officer have evaluated the effectiveness of our disclosure controls
and procedures as of the end of the period covered by this 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 Company known to others within the Company which is
required to be included in our periodic reports filed under the Exchange Act.
(b) There has been no change in the Company's internal control over
financial reporting that occurred during the quarter ended December 31, 2003
that materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS. The following table sets forth certain information as of March
22, 2004, with respect to the current directors of Franklin.
32
Current Term
Name Age Position(s) Held Director Since (1) Expires
- ---- --- ---------------- --------------- -------
Walter J. Aspatore 60 Director 2003 2006
Irving R. Beimler 56 Director 2000 2004
Dean A. Friedman 52 Director 1983 2005
Craig L. Johnson 44 President, CEO and Director 2003 2005
Richard J. Lashley 45 Director 2001 2006
John Wm. Palmer 43 Director 2001 2005
David F. Simon 57 Chairman of the Board 1983 2004
- ----------
(1) Includes term as director of Franklin Bank before Franklin became its
holding company.
Walter J. Aspatore: Member of the Audit and Compliance Committee. Mr.
Aspatore is the co-founder and Managing Director of Amherst Partners, LLC, an
investment and merchant banking firm formed in 1994 and specializing in small
and middle market companies. From 1992 to 1994, Mr. Aspatore was the President
and Vice Chairman of Onset Investment Fund, a venture capital fund established
to invest in engineering, manufacturing and technology related businesses. From
1989 to 1992, Mr. Aspatore was the President of Cross & Trecker Corporation, a
multi-national factory automation tool company.
Irving R. Beimler: Member of the Loan, and Nominating and Governance
Committees. Since November 1997, Mr. Beimler has served as Senior Vice President
of Hovde Capital, Inc. and Hovde Capital Advisors, affiliates of Hovde Capital,
L.L.C., general partner of Financial Institutions Partners, II, L.P. (See "Item
12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters.") From January 1996 through November 1997, Mr. Beimler was
a self-employed consultant in Washington, D.C., providing litigation support,
training course development and other consulting services for private companies
and public agencies, including the FDIC. From September 1994 through January
1996, Mr. Beimler served as Executive Vice President and Chief Credit Officer of
the Riggs National Bank in Washington, D.C. From 1974 through 1994, Mr. Beimler
was employed by Fleet Bank and predecessor institutions, serving as Executive
Vice President and Chief Credit Officer of Fleet Bank of New York from 1990
through 1994.
Dean A. Friedman: Secretary of Franklin and Franklin Bank since their
respective inception and member of the Nominating and Governance Committee.
Since 1992, Mr. Friedman has been principally employed as the President and
Chief Executive Officer of Solomon Friedman Advertising, an advertising agency
located in Bloomfield Hills, Michigan.
Craig L. Johnson: Since November 2003, Mr. Johnson has been the President
and CEO of Franklin and of Franklin Bank. Prior to this time, commencing June
2003, Mr. Johnson was the Executive Vice President and Chief Lending Officer of
Franklin Bank. Member of the Loan Committee. From 1991 to October 2002, Mr.
Johnson served in a number of capacities with Republic Bancorp, Inc., most
recently, as Vice Chairman and President of its Commercial Banking Division in
Lansing, Michigan.
Richard J. Lashley: Member of the Audit and Compliance, and Compensation
Committees. Mr. Lashley is an investment manager, primarily as a managing member
and founder of PL Capital, LLC and Goodbody/PL Capital LLC, which firms serve as
the general partners of and/or have discretion over the following: Financial
Edge Fund, LP, Financial Edge/Strategic Fund, LP, Goodbody/PL Capital LP, Dr.
Irving Smokler, and Archimedes Overseas LTD (the "PL Capital Entities"). (See
"Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.") Mr. Lashley is also a director of Central
Bancorp, Inc. of Somerville, Massachusetts. Mr. Lashley is a Certified Public
Accountant (New Jersey - status inactive).
33
John Wm. Palmer: Member of the Audit and Compliance, Compensation,
Strategic Planning and Loan Committees. Mr. Palmer is an investment manager,
primarily as a managing member and founder of PL Capital, LLC and Goodbody/PL
Capital LLC, which firms serve as the general partners of and/or have investment
discretion over the PL Capital Entities. (See "Item 12. Security Ownership of
Certain Beneficial Owners and Management and Related Stockholder Matters.") Mr.
Palmer is also a member of the Board of Directors of Clever Ideas, Inc., a
Chicago based specialty finance company. Mr. Palmer is a Certified Public
Accountant (Illinois and Michigan - status inactive).
David F. Simon: Chairman of the Board of Franklin and Franklin Bank since
their respective inception and a member of the Compensation, Strategic Planning,
Loan, and Nominating and Governance Committees; since January 1, 2001, Mr. Simon
has been engaged in commercial real estate development, acquisition and
consulting primarily through Simon Realty Partners, LLC. Mr. Simon is also a
Managing Director of Wellington Partners LLC providing business advisory and
transactional services to emerging and entrepreneurial businesses. Formerly, Mr.
Simon was an attorney in private practice specializing in securities, real
estate and financial institutions law from 1971 to 1991.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS. The following table sets forth
certain information at March 22, 2004, with respect to the executive officers of
Franklin or Franklin Bank, all of whom serve in the capacities named:
Name Age Position(s) Held Since
- ---- --- ---------------- -----
Leonard B. Carleton 57 Treasurer and Chief Financial 2003
Officer
Ronald J. Carr 46 Senior Vice President - 2001
Director of Human Resources
Michael A. King 49 Senior Vice President - Retail 2003
Banking
Darlene A. Nowak-Baker 38 Senior Vice President - Chief 2004
Lending Officer
Leonard B. Carleton: Mr. Carleton is the Treasurer and Chief Financial
Officer of Franklin and Franklin Bank. From 1978 to 2003, Mr. Carleton served in
a number of capacities with Comerica Bank, most recently, as Senior Vice
President.
Ronald J. Carr: Mr. Carr is the Senior Vice President and Director of
Human Resources of Franklin Bank. Mr. Carr joined Franklin as its Vice President
of Human Resources in 2001. From November 1996 to November 2000, Mr. Carr served
Peoples State Bank in various capacities, including Vice President and Director
of Human Resources and branch manager.
Michael A. King: Mr. King is the Senior Vice-President - Retail Banking.
Prior to joining Franklin, Mr. King was engaged in private consulting since
January 2002. From 1990 to 2001, Mr. King served Michigan National Bank in
various capacities including Global Head of Internet, Director of Alternative
Banking and Retail Zone Manager, overseeing a network of 50 branches.
Darlene Nowak-Baker: Ms. Nowak-Baker is the Senior Vice-President and
Chief Lending Officer. Prior to joining Franklin, Ms. Nowak-Baker served as Vice
President Commercial Loan Officer at Republic Bank for seven years. Prior to
that Ms. Nowak-Baker worked at Comerica Bank.
AUDIT AND COMPLIANCE COMMITTEE
The company has a separately-designated standing audit committee
established by the Board of Directors in accordance with Section 3(a)(58)(A) of
the Securities Exchange Act of 1934 for the purpose of overseeing the accounting
and financial reporting processes of the Company and audits of the financial
statements of the Company. The current members of the Committee are Walter J.
Aspatore, Richard J. Lashley and John Wm. Palmer. Each Committee member is
"independent," as defined in Rule 4200(a)(15) of the National Association of
Securities Dealers' Listing Standards. The Board of Directors
34
determined that Messrs. Lashley and Palmer each met the qualification to be
considered an "audit committee financial expert" as defined under regulations of
the Securities and Exchange Commission.
COMPLIANCE WITH SECTION 16(A) OF SECURITIES EXCHANGE ACT OF 1934
Pursuant to Section 16(a) of the Securities Exchange Act of l934,
Franklin's directors and officers, and persons who own more than ten percent of
Franklin's common stock, are required to file with the Securities and Exchange
Commission (the "SEC") initial reports of ownership and reports of changes in
ownership of common stock and other equity securities of Franklin. Officers,
directors and greater than ten-percent shareholders are required by regulation
to furnish Franklin with copies of all Section 16(a) reports they file. To
Franklin's knowledge, based solely on review of the copies of such reports
furnished to Franklin, all officers, directors and greater than ten percent
beneficial owners complied with all applicable Section 16(a) filing
requirements.
CODE OF ETHICS
Franklin has adopted a code of ethics that applies to, among others, its
principal executive officer, principal financial officer and principal
accounting officer. A copy of Franklin's code of ethics is available at no
charge by contacting:
Deborah Farrah
Franklin Bancorp, Inc
24725 West Twelve Mile Road
Southfield, Michigan 48034
(248) 746-4117
[email protected]
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following Summary Compensation Table sets forth the cash and non-cash
compensation for each of the last three years awarded to or earned by the
current Chief Executive Officer of Franklin, the former Chief Executive Officer
of Franklin and to other executive officers of Franklin who earned total salary
and bonus compensation in excess of $100,000 in 2003.
35
ANNUAL COMPENSATION LONG TERM COMPENSATION AWARDS
RESTRICTED SECURITIES ALL OTHER
NAME AND PRINCIPAL STOCK UNDERLYING COMPENSATION
POSITION YEAR SALARY BONUS (3) AWARD(S) $ OPTIONS/SARS (#) (4)
-------- ---- ------ --------- ---------- ---------------- ---
Craig L. Johnson (1)
President and CEO 2003 $ 83,077 $ 50,000 $ 0 6,500 $ 2,527
David L. Shelp (2)
President and CEO 2003 $ 260,308 $ 0 $ 0 2,000 $1,009,830 (5)
2002 $225,000 $ 0 $ 0 0 $11,367
2001 $215,000 $ 157,219 $ 0 4,500 $12,136
Ronald J. Carr
Senior Vice President 2003 $88,918 $17,500 $ 0 1,125 $ 1,670
2002 $72,569 $13,097 $ 0 735 $ 0
2001 $63,808 $ 0 $ 0 0 $ 0
Michael A. King (6)
Senior Vice President 2003 $93,942 $ 24,000 $ 0 1,125 $ 2,217
(1) Appointed President and CEO on November 10, 2003. Prior to then, since
June 16, 2003, was Executive Vice President and Chief Lending Officer of
Franklin Bank.
(2) Retired as President and CEO on November 10, 2003.
(3) The bonus figures reflect amounts payable for performance in each year
shown; although it may have actually been paid in the year following.
(4) These figures represent Franklin's 401(k) matching contribution,
Franklin's Employee Stock Ownership Plan contribution, and the insurance
premiums paid by Franklin for officers' life and disability insurance coverage.
(5) Also includes $ 998,304 in severance payments paid in 2003.
(6) Appointed Senior Vice President of Retail Banking on, April 14,
2003.
36
OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
POTENTIAL REALIZED VALUE
AT ASSUMED RATES OF
NUMBER OF PERCENT OF STOCK APPRECIATION FOR
SECURITIES TOTAL OPTIONS OPTION TERM
UNDERLYING GRANTED TO EXERCISE OR -----------
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION
NAME GRANTED FISCAL YEAR ($/SH) (1) DATE 5%($)(2) 10%($)(2)
---- ------- ----------- ---------- ---- -------- ---------
Craig L. Johnson 1,500 6% $18.76 6-16-13 $13,530 $38,213
5,000 19% $18.87 6-17-13 $45,365 $128,122
David L. Shelp 2,000 8% $17.93 4-14-13 $17,242 $48,696
Ronald J. Carr 1,125 4% $18.04 4-30-13 $ 9,758 $27,560
Michael A. King 1,125 4% $18.04 4-30-13 $ 9,758 $27,560
(1) Granted at 110% of fair market value on date of grant.
(2) In accordance with the rules of the Securities and Exchange
Commission, these columns show gains that might exist for the respective
options, assuming the market price of Bancorp's common stock appreciates from
the date of grant over a period of ten years at the annualized rates of 5% and
10%, respectively. If the stock price does not increase above the exercise price
at the date of grant, realized value to the named executive officers from these
options will be zero.
AGGREGATE OPTION EXERCISES IN FISCAL YEAR AND
FISCAL YEAR END OPTION VALUES
The following table summarizes the options exercised in the past fiscal
year, as well as the value of the options held by the executive officers named
in the Summary Compensation Table above at December 31, 2003.
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS/SARS
OPTIONS/SARS AT FY-END (#) AT FY-END ($)(1)
SHARES ---------- -------------
ACQUIRED ON VALUE
NAME EXERCISE REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- -------- -------- ------------------------- -------------------------
Craig L. Johnson -0- -0- 6,500/0 $17,585/0
David L. Shelp -0- -0- 43,778/0 $420,269/0
Ronald J. Carr -0- -0- 1,860/0 $6,043.50
Michael A. King -0- -0- 1,125/0 $3,948.75
(1) Value based on market value of Bancorp's common stock on December 31,
2003 minus the exercise price.
37
COMPENSATION OF DIRECTORS
Non-employee Directors are entitled to receive a stated salary for their
services and a reasonable fixed sum, as well as reimbursement of reasonable
expenses, for actual attendance at meetings of the Board and Committees of the
Board. During 2003 the annual retainer amount was $13,000 ($23,000 for the
Chairman of the Board) and the Board fee was $600 per meeting ($1,000 per
meeting for the Chairman of the Board). The fee for all Committee meetings in
2003 was $400 per meeting. Franklin has a 1986 Director's Stock Option Plan and
a 1994 Director's Stock Option Plan. The period of time for granting options
under the 1986 plan has expired. Mr. Friedman is the only current director who
holds options in Franklin's Directors' stock option plans. Directors who are
also employees are excluded from receiving additional compensation for their
service on the Board of Directors and its Committees.
Effective in October 1993, and as amended since then, the Bank entered
into severance agreements with certain of its non-employee Directors to provide
compensation solely in the event of any change in control of Franklin Bank.
Pursuant to these severance agreements, Franklin Bank paid out severance
expenses in 2003 of approximately $892,399 in connection with a director and an
advisory director. Franklin Bank has accrued approximately $426,000 in severance
expense with respect to Mr. Friedman who is entitled to severance payable upon
completion of his service as a Director. There are no severance agreements with
any other Directors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
At a Board meeting held on June 17, 2003, the Board stated that David F.
Simon, a member of the Compensation Committee, is a non-executive Chairman of
the Board of Franklin and of Franklin Bank and is neither an officer or employee
of Franklin or Franklin Bank.
EMPLOYMENT AGREEMENTS/SEVERANCE AGREEMENTS
Franklin Bank and Craig L. Johnson entered into an employment agreement
dated as of June 16, 2003. Pursuant to the agreement, Mr. Johnson was employed
as Franklin Bank's Executive Vice President of Lending. On November 10, 2003,
Mr. Johnson became the President and CEO of Franklin and of Franklin Bank. The
employment agreement, however, has not been modified to reflect such change. The
term of the agreement is for one year, provided, however, that the agreement
shall be automatically extended for successive additional one-year periods,
unless at least 90 days prior to any anniversary date, either Franklin Bank or
Mr. Johnson furnishes the other with written notice that the term shall not be
so extended. Under the agreement, Mr. Johnson is paid a base salary of $160,000
per annum. On or before March 31 following each calendar year (except for
calendar year 2003), Mr. Johnson is eligible to receive an annual performance
bonus based upon Franklin Bank's achieving (i) targeted financial results for
the prior year, taking into consideration the earnings set forth in the annual
budget approved by Franklin Bank's Board of Directors each year; and/or (ii)
such other goals and objectives as mutually determined each year during the term
of agreement between Franklin Bank and Mr. Johnson. The amount of the annual
cash bonus earned and payable for any year shall be up to 40% of Mr. Johnson's
base salary for such year and based on a formula established by the Compensation
Committee for all key executive officers of Franklin Bank. Mr. Johnson is
eligible for a bonus for calendar year 2003 based on mutually agreed upon
performance goals as well as other specific and agreed upon accomplishments,
provided that such bonus shall not exceed $50,000. Pursuant to the employment
agreement, Franklin granted Mr. Johnson an option to purchase 1,500 shares of
Franklin common stock and an option to purchase 5,000 shares of Franklin common
stock pursuant to Franklin's 1994 Stock Option Plan. Pursuant to the agreement,
Franklin Bank agreed to pay Mr. Johnson for his costs of temporary housing for
up to 90 days, not to exceed $2,000 per month. Under the agreement, Mr. Johnson
participates in all of Franklin's benefit plans and, in addition, Franklin has
agreed to pay for country club dues. Under the agreement, Mr. Johnson may be
terminated at any time, with or without cause. In the event that Mr. Johnson is
terminated without cause or there is a material and substantial reduction of his
duties or the relocation of his then current base salary or elimination of
eligibility for annual cash bonus, eligibility for long term incentive
compensation or any existing benefits, then pursuant to a change in control (as
generally defined below), which occurs during the period commencing 180 days
prior to the date of a change in control and ending on the first anniversary of
a change in control, Franklin Bank will pay to Mr. Johnson 1.0 times Mr.
Johnson's base salary and annual cash bonus if the termination occurs during the
first twelve months of his employment, or 1.5 times the average of Mr. Johnson's
previous three years (or fewer years if employment is less than three full
years) of his base salary and annual cash bonus
38
if he is terminated after his first twelve months of employment. During Mr.
Johnson's employment with Franklin Bank and during any period in which Mr.
Johnson receives payment of his base salary, Mr. Johnson may not compete with
Franklin Bank. In addition, during his employment and for a period after
termination of his employment equal to the greater of six months or the period
for which he receives payment of his base salary, Mr. Johnson may not solicit
any customer, employee or agent of Franklin Bank.
Mr. Johnson has executed an amendment to his employment agreement, waiving
his right to receive payments and benefits under his employment agreement and
terminating such agreement upon the consummation of the merger with First Place,
provided that First Place enters into a change in control agreement with Mr.
Johnson, which is substantially identical to severance agreements previously
entered into between First Place and its officers. Without the waiver and
release of a severance payment and upon a qualifying termination following
completion of the merger, Mr. Johnson would be entitled to receive approximately
$150,000 of cash compensation, assuming consummation of the merger at March 22,
2004.
Franklin Bank and Leonard B. Carleton entered into an employment agreement
dated as of June 16, 2003. Pursuant to the agreement, Mr. Carleton is employed
as Franklin's Treasurer and Chief Financial Officer. The term of the agreement
is one year, provided, however, that the agreement shall be automatically
extended for successive additional one-year periods, unless at least 90 days
prior to any anniversary date, either Franklin Bank or Mr. Carleton furnishes
the other with written notice that the term shall not be so extended. Under the
agreement, Mr. Carleton is paid a base salary of $125,000 per annum. On or
before March 31 following each calendar year (except for calendar year 2003),
Mr. Carleton is eligible to receive an annual performance bonus based upon
Franklin Bank's achieving (i) targeted financial results for the prior year,
taking into consideration the earnings set forth in the annual budget approved
by Franklin Bank's board of directors each year; and/or (ii) such other goals
and objectives as mutually determined each year during the term of the agreement
between Franklin Bank and Mr. Carleton. The amount of the annual cash bonus
earned and payable for any year shall be based on a formula established by the
compensation committee for all key executive officers of Franklin Bank. Mr.
Carleton will be eligible for a bonus for calendar year 2003 based on a mutually
agreed upon performance goal, provided that such bonus shall not exceed $25,000.
Pursuant to the employment agreement, Franklin granted Mr. Carleton an option to
purchase 1,125 shares of Franklin common stock and an option to purchase 3,000
shares of Franklin common stock pursuant to Franklin's 1994 stock option plan.
Under the agreement, Mr. Carleton participates in all Franklin's benefit plans.
Under the agreement, Mr. Carleton may be terminated at any time, with or without
cause. In the event that Mr. Carleton is terminated without cause or there is a
material and substantial reduction of his duties or the relocation of Mr.
Carleton from Franklin Bank's current headquarters to a location of at least 50
miles away or Mr. Carleton resigns due to the reduction of his then current base
salary or elimination of eligibility for an annual cash bonus, eligibility for
long term incentive compensation or any existing benefits, then pursuant to a
change in control (as generally defined below), which occurs during the period
commencing 180 days prior to the date of a change in control and ending on the
first anniversary of a change in control, Franklin Bank will pay to Mr. Carleton
1.0 times Mr. Carleton's base salary and annual cash bonus if the termination
occurs during the first twelve months of his employment or 1.5 times the average
of Mr. Carleton's previous three years (or fewer years, if employment is less
than three full years) of his base salary and annual cash bonus if he is
terminated after his first twelve months of employment. During Mr. Carleton's
employment with Franklin Bank and for a period after the termination of Mr.
Carleton's employment equal to the greater of (i) one year; or (ii) a period for
which Mr. Carleton receives payment of his base salary, Mr. Carleton may not
compete with the bank nor solicit any customer, employee or agent of Franklin
Bank. In the event there occurs a qualifying termination following completion of
the merger with First Place, Mr. Carleton will be entitled to a severance
payment of up to approximately $150,000 of cash compensation, assuming
consummation of the merger at March 22, 2004.
On April 14, 2003, Mr. Shelp and Franklin Bank entered into an employment
agreement. The employment agreement terminated upon Mr. Shelp's resignation on
November 10, 2003. Among other things, the employment agreement provided as
follows: Mr. Shelp would serve as the President and Chief Executive Officer and
as a Director of Franklin and of Franklin Bank. Mr. Shelp would be paid a base
salary of $260,000 per annum retroactive to January 1, 2003. Mr. Shelp would be
eligible for the 2003 executive bonus plan pursuant to which his bonus
compensation, to a maximum 90% of his base salary, was to be paid based on
achieving targeted diluted earnings per share goals. Mr. Shelp also was granted
an option with respect to 2,000 shares under the 1994 Key Executive Incentive
Stock Option Plan. Such
39
options vested on the date of Mr. Shelp's termination of employment. With
respect to 2,700 options previously granted to Mr. Shelp, such options became
immediately exercisable on April 14, 2003. After termination of his employment,
Mr. Shelp may provide consulting services to Franklin Bank, upon Franklin Bank's
request and at times mutually agreed to, at the rate of $200 per hour. During
his employment and for a period of 1 year thereafter, Mr. Shelp is prohibited
from soliciting any customer of Franklin Bank or soliciting, for purposes of
employment or association, any employee or agent of Franklin Bank.
As has been disclosed in the previous proxy statements of Franklin Bank,
beginning in 1993, and as amended since then, Franklin Bank has entered into
severance agreements with certain former and current senior officers. The
severance agreements, as amended, generally provide compensation in the event of
a change in control of Franklin Bank (including the merger with First Place) and
either a subsequent termination of the designated officer by Franklin (other
than for cause) or a termination by the officer because of a material change in
the terms of employment occurring within 3 years thereafter. Pursuant to such
severance agreements, Mr. Shelp was paid severance of $998,304 in 2003. There
are only 6 of these previously disclosed severance agreements outstanding. If
the remaining agreements are triggered and payable, they would amount to an
after-tax cost to Franklin of approximately $231,000.
Franklin Bank has entered into change in control agreements with each of
Ronald J. Carr, its Senior Vice President - Director of Human Resources and
Michael A. King, its Senior Vice President - Retail Banking. These agreements
generally provide that upon a change in control (as defined below) and
termination of his employment by Franklin Bank without cause, or his resignation
as a result of his removal from the position with Franklin Bank, or a material
and substantial reduction of his duties in such position or his relocation from
Franklin Bank's current headquarters to a location at least 50 miles away or his
resignation due to the reduction of his then current base salary or elimination
of eligibility for annual cash bonus, eligibility for long-term incentive
compensation or any existing benefits, which occur during the period commencing
180 days prior to the change in control and ending on the first anniversary of a
change in control, then as applicable, Mr. Carr or Mr. King would be entitled to
1.0 times his base salary and annual cash bonus if such termination occurs
during the first twelve months of his employment with Franklin Bank or 1.5 times
the average of his three years (or fewer years if employment is less than three
full years) of the base salary and annual cash bonus paid if such termination
occurs after his first twelve months of employment. A change in control is
generally defined to include acquisition by a person of more than 30% of
Franklin's outstanding voting securities, the purchase of more than 30% of
Franklin's outstanding securities pursuant to a tender or exchange offer, or
upon consummation of a transaction resulting in a merger, where Franklin's
shareholders do not control more than 50% of the merged entities voting
securities, or resulting in the sale of substantially all of the assets of
Franklin or resulting in the liquidation or dissolution of Franklin.
In the event there occurs a qualifying event following completion of the
merger and Mr. Carr is terminated, he would be entitled to a severance payment
of up to approximately $102,500 of cash compensation, assuming consummation of
the merger at March 22, 2004. It is expected that Mr. King will continue with
First Place Bank after the merger as Senior Vice President - Retail Banking of
the Franklin Bank Division and will execute an amendment to his change in
control agreement waiving his right to receive payments under the agreement.
Without the waiver and release of his severance payment and upon a qualifying
event following completion of the merger, Mr. King would be entitled to receive
up to approximately $154,000 of cash compensation, assuming consummation of the
merger at March 22, 2004.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table presents certain information, as of March 22, 2004,
with respect to the common stock owned by each director, each executive officer,
and all executive officers and directors as a group of Franklin, and by each
person (including any "group" as defined in Section 13(d)(3) of the Securities
Exchange Act of 1934, as amended) who is known to Franklin to be the beneficial
owner of more than 5% of the outstanding shares of Franklin's common stock. The
shares and percentages shown below include shares which may be acquired by the
persons listed pursuant to outstanding Franklin stock options beneficially owned
and exercisable within 60 days of March 22, 2004. Except as otherwise indicated
below, each person listed has sole voting and investment power as to the shares
listed:
40
PERCENT OF
OUTSTANDING
COMMON COMMON
STOCK STOCK
NAME AGE (1) (2)
---- --- ---
Walter J. Aspatore 60 500 *
Irving R. Beimler 56 1,000 (3) *
Leonard B. Carleton 57 4,125 *
Ronald Carr 46 1,929 *
Dean A. Friedman 52 53,626 (4) 1.4%
Craig L. Johnson 44 6,600 *
Michael A. King 49 1,125 *
Richard J. Lashley 45 3,000 (1) (5) *
John Wm. Palmer 43 2,000 (1) (5) *
David F. Simon 57 104,509 (6) 2.7%
All Executive Officers and Directors as a group (10 persons) 178,414 4.0%
Hot Creek Investors, L.P. (7) 249,586 (8) 6.6%
Dimensional Fund Advisors, Inc. (7) 193,004 (9) 5.1%
Financial Institution Partners, II L.P. (7) 346,287 (10) 9.2%
PL Capital, LLC and Goodbody/PL Capital LLC (7) 348,000 (11) 9.2%
Philip J. Timyan (7) 261,180 (12) 6.9%
Millenco, L.P. (7) 199,552 (13) 5.3%
- ----------
* less than 1.0% of the outstanding shares
(1) Includes the following shares which may be acquired pursuant to
outstanding stock options: Mr. Carleton: 4,125; Mr. Carr: 1,860; Mr.
Friedman: 18,189; Mr. King: 1,125; Mr. Johnson: 6,500; and Mr. Simon:
67,176. This information also includes common shares which have been
allocated to principal shareholders who are participants in the Franklin
Bank's ESOP approximately as follows: Mr. Carr: 69; and Mr. Simon: 4,309.
Franklin Bank's ESOP holds approximately 70,755 shares. Messrs. Aspatore
and Friedman are members of the ESOP Committee and Messrs. Aspatore and
Friedman are the ESOP Trustees. Generally, participants direct the
Committee how to vote the shares allocated to their account, and to the
extent such shares are not voted or no voting instruction are provided,
the Trustees will vote such shares as instructed by the Committee.
(2) The calculation of each of the percentages shown in this column is based
on the number of shares outstanding at March 22, 2004, plus the number of
shares held by executive officers and directors which may be acquired
pursuant to outstanding options at such date.
(3) Mr. Beimler is the senior vice president of Hovde Capital, Inc. and senior
vice president of Hovde Capital Advisors, which are affiliated with Hovde
Capital, LLC, the general partner of Financial Institutions Partners, II
L.P. See footnote (10) below.
(4) Includes 8,496 shares held by Mr. Friedman as custodian for his children.
(5) With respect to Mr. Lashley, shares include 2,000 shares held by his wife.
Messrs. Lashley and Palmer are investment managers, primarily as managing
members of PL Capital, LLC and Goodbody/PL Capital LLC. See footnote (11)
below.
(6) Includes 5,194 shares held by Mr. Simon as trustee for his children and
7,499 shares held by a group in which Mr. Simon exercises voting control.
In addition, the amount includes 1,951 shares held by an adult son of Mr.
Simon, as to which shares Mr. Simon disclaims beneficial ownership.
(7) Based on information included in Schedule 13D, Schedule 13F and/or
Schedule 13G under the Securities Exchange Act of 1934.
(8) Hot Creek Investors, L.P., Hot Creek Capital, L.L.C., its General Partner,
and David M.W. Harvey, the principal member of the General Partner, are
located in Gardnerville, Nevada.
(9) Dimensional Fund Advisors, Inc. is located in Santa Monica, California.
(10) Financial Institution Partners II, L.P. is located in Washington, D.C.
(11) PL Capital, LLC, Goodbody/PL Capital and the PL Capital Entities are
located in Naperville, Illinois.
(12) Held directly and indirectly, Mr. Timyan's principal business offices are
located in Western Springs, Illinois.
(13) Millenco, L.P., Millenium Management, LLC, its managing partner and Israel
A. Englander, the sole managing member of the managing partner, are
located in New York, New York.
41
EQUITY COMPENSATION PLAN INFORMATION
12-31-03
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE FUTURE ISSUANCE UNDER EQUITY
BE ISSUED UPON EXERCISE EXERCISE PRICE OF COMPENSATION PLANS
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS. WARRANTS AND RIGHTS. REFLECTED IN COLUMN (A))
------------- ------------------- ------------------- ------------------------
(a) (b) (c)
Equity compensation plans 229,965 $11.94 168,992
approved by security holders
The above table provides information about Franklin's equity compensation
plans, which consist solely of four stock option plans. Franklin assumed such
stock option plans in connection with it becoming the holding company for
Franklin Bank. All of Franklin's stock option plans were approved by security
holders. The stock option plans consist of two directors' plans and two employee
plans: the 1986 Directors Stock Option Plan, the 1994 Directors Stock Option
Plan, the 1986 Key Executive Stock Option Plan and the 1994 Key Executive
Incentive Stock Option Plan. The period in which options can be granted under
the two 1986 plans has expired.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For the years ended December 31, 2003, 2002 and 2001, Franklin engaged
Solomon Friedman Advertising, for media placement and radio production fees.
Dean A. Friedman, a director of Franklin, is President, Chief Executive Officer
and a part owner of Solomon Friedman Advertising. The Bank paid $483,877,
$522,483 and $616,027 to Solomon Friedman Advertising for the years ended
December 31, 2003, 2002 and 2001, respectively which includes the costs of media
and production. In August 2002, Franklin adopted a policy prohibiting future
transactions with affiliates, and seeking to end any existing transactions in
accordance with their respective terms. Pursuant to this policy, Franklin was
scheduled to cease doing business with Solomon Friedman Advertising upon
expiration of its written agreement on December 31, 2003. However, Franklin and
Solomon Friedman Advertising have extended the Solomon Friedman Advertising
agreement for the interim period of January 1, 2004 up to the date of the merger
with First Place, and Franklin has waived the application of its policy only
insofar as such extension.
ITEM 14. PRINCIPAL ACCOUNT FEES AND SERVICES
AUDIT AND NON-AUDIT FEES
Aggregate fees for professional services rendered for Franklin by Grant
Thornton LLP as of the years ended December 31, 2003 and 2002 are set forth
below. The aggregate fees included in the Audit category are fees billed for the
fiscal years for the audit of Franklin's annual financial statements and review
of financial statements and statutory and regulatory filings or engagements. The
aggregate fees included in each of the other categories are fees billed in the
fiscal years.
42
2003 2002
---- ----
AUDIT FEES $166,100 $126,570
AUDIT-RELATED FEES 0 0
TAX FEES 47,925 32,364
ALL OTHER FEES 111,660 49,995
TOTAL $325,685 $208,929
Audit Fees for the years ended December 31, 2003 and 2002 were for
professional services rendered for the audits of the consolidated financial
statements of Franklin, quarterly review of the financial statements included in
Franklin's Quarterly Reports on Form 10-Q, or services that are normally
provided by Grant Thornton LLP in connection with statutory and regulatory
filings or engagements for such years.
Audit-Related Fees as of the years ended December 31, 2003 and 2002 were
for assurance and related services by Grant Thornton LLP that are reasonably
related to the performance of the audit or review of Franklin's financial
statements.
Tax Fees as of the years ended December 31, 2003 and 2002 were for
professional services rendered by Grant Thornton LLP for services related to tax
compliance, tax advice and tax planning.
All Other Fees as of the years ended December 31, 2003 and 2002 were for
services rendered for due diligence and severance compensation calculations.
None of the services described above was approved by the Audit Committee
under the de minimus exception provided by Rule 2-01(c)(7)(i)(C) under
Regulation S-X.
POLICY ON AUDIT COMMITTEE PRE-APPROVAL OF AUDIT AND PERMISSIBLE NON-AUDIT
SERVICES OF INDEPENDENT AUDITORS
The Audit Committee pre-approves all audit and non-audit services provided
by the independent auditors prior to the engagement of the independent auditors
with respect to such services.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
The following documents are filed as part of this report:
(A) (1) FINANCIAL STATEMENTS
The consolidated financial statements of Franklin and its subsidiaries
filed with this report are set forth on the Index to Consolidated Financial
Statements of this report.
(A) (2) FINANCIAL STATEMENT SCHEDULES
ALL OTHER FINANCIAL STATEMENT SCHEDULES HAVE BEEN OMITTED AS THE REQUIRED
INFORMATION IS INAPPLICABLE.
(A) (3) EXHIBITS
43
SEQUENTIAL PAGE NUMBER
EXHIBIT WHERE ATTACHED EXHIBITS
NO. DOCUMENT ARE LOCATED IN THE 10-K
2.1 Business Combination Application dated March 14, 2002 filed with the OCC(1)...................
2.2 Consolidation Agreement dated as of April 23, 2002(2).........................................
3.1 Articles of Incorporation(1)..................................................................
3.2 Bylaws(1).....................................................................................
3.3 Amendments to Bylaws(3).......................................................................
4.1 Specimen Stock Certificate(1).................................................................
10.1 Key Executive Stock Option Plan(2)............................................................
10.2 1986 Directors' Stock Option Plan(2)..........................................................
10.3 1994 Directors' Stock Option Plan(2)..........................................................
10.4 Amendment (1998) to 1994 Directors' Stock Option Plan(2)......................................
10.5 Form of Officers Severance Agreement(2).......................................................
10.6 Form of Amendment to Officers Amended and Restated Severance Agreement(2).....................
10.7 Form of Amended and Restated Severance Agreement (Non-Employee Directors)(2)..................
10.8 Form of Amendment to Amended and Restated Severance Agreement (Non-Employee directors)(2).....
10.9 Form of Second Amendment to amended and Restated Severance Agreement
(Non-Employee Directors)(2)...................................................................
10.10 Amended and Restated Severance Agreement of David L. Shelp(2).................................
10.11 Employment Agreement of David. L. Shelp(t)....................................................
10.12 Employment Agreement of Craig L. Johnson(4)...................................................
10.13 Employment Agreement of Leonard B. Carleton(4) ...............................................
10.14 Change in Control Agreement of Ronald J. Carr(4)..............................................
10.15 Change in Control Agreement of Michael A. King(4) ...........................................
10.16 Amended and Restated 1994 Key Executive Incentive Stock Option Plan(4) .......................
10.17 Agreement and Plan of Merger Dated as of November 10, 2003 by and between First Place
Financial Corporation and Franklin Bancorp, Inc.(5)...........................................
10.18 Amendment to Employment Agreement of Craig L. Johnson (t).....................................
21 Subsidiaries of Registrant(t).................................................................
23.1 Consent of Grant Thornton LLP(t)..............................................................
24.1 Powers of Attorney (included on Signature Page) ..............................................
31.1 Certification of Chief Executive Officer(t)...................................................
31.2 Certification of Chief Financial Officer(t)...................................................
32.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(t)....................
(B) REPORTS ON FORM 8-K
On November 12, 2003, registrant filed a Form 8-K, disclosing in Item 5
thereof the proposed merger between First Place Financial Corp. and registrant,
in Item 9 thereof a webcast by First Place Financial Corp. and in Item 12
thereof the results of operations for registrant's 2003 third quarter.
(C) EXHIBITS
See Item 15(a)(3).
(D) FINANCIAL STATEMENT SCHEDULES
None.
- ----------
(1) .Incorporated by reference to Exhibits to form 8-K filed on November 7,
2002, Commission File No. 50078.
(2) Incorporated by reference to Exhibits to form 8-K/A filed on November 15,
2002, Commission file No. 50078.
(3) Incorporated by reference to Exhibit 3.5 to Form 10-K filed on March 31,
2003, Commission File No. 50078.
(4) Incorporated by reference to Exhibits to Form 10-Q filed on August 14,
2003, Commission File No. 50078
(5) Incorporated by reference to Exhibit 99.2 to Form 8-K filed on November
12, 2003, Commission File No. 50078
(t) Filed herewith.
44
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.
March 30, 2004 By: /s/ Craig L. Johnson
-----------------------------------------------
Craig L. Johnson, President and Chief Executive
Officer
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Craig L. Johnson and Leonard B. Carleton, and
each of them, his true and lawful attorneys-in-fact and agents, with full power
of substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities (including his capacity as a director and/or officer of
Franklin Bancorp, Inc.), to sign and file pursuant to the Securities Exchange
Act of 1934, as amended, any and all amendments to this Annual Report on Form
10-K together with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents or any of them, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities
indicated on behalf of Franklin Bancorp, Inc. this 30th day of March 2004.
/s/ Craig L. Johnson /s/ Irving R. Beimler
- --------------------------------------------- -----------------------------------------
Craig L. Johnson, President, CEO and Director Irving R. Beimler, Director
(Principal Executive Officer)
/s/ Leonard B. Carleton /s/ Dean A. Friedman
- --------------------------------------------- -----------------------------------------
Leonard B. Carleton, Chief Financial Dean A. Friedman, Director
Officer and Treasurer (Principal Financial
Officer and Principal Accounting Officer)
/s/ David F. Simon /s/ Richard J. Lashley
- --------------------------------------------- -----------------------------------------
David F. Simon, Chairman of the Board Richard J. Lashley, Director
/s/ Walter J. Aspatore /s/ John W. Palmer
- --------------------------------------------- -----------------------------------------
Walter J. Aspatore, Director John W. Palmer, Director
45
FRANKLIN BANCORP, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants.......................................F-2
Consolidated Statements of Financial Condition at December 31, 2003 and 2002.............F-3
Consolidated Financial Statements of Income for the years ended
December 31, 2003, 2002 and 2001.........................................................F-4
Consolidated Financial Statements of Comprehensive Income for the years ended
December 31, 2003, 2002 and 2001.........................................................F-5
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2003, 2002 and 2001.........................................................F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001.........................................................F-7
Notes to Consolidated Financial Statements...............................................F-8
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Shareholders
Franklin Bancorp, Inc.
We have audited the accompanying consolidated statements of financial condition
of Franklin Bancorp, Inc. and its wholly-owned subsidiary Franklin Bank, N.A. as
of December 31, 2003 and 2002, and the related consolidated statements of
income, comprehensive income, shareholders' equity and cash flows for each of
the three years in the period ended December 31, 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes 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, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Franklin Bancorp,
Inc. and its wholly-owned subsidiary Franklin Bank, N.A. as of December 31, 2003
and 2002, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America.
Southfield, Michigan
January 23, 2004
F-2
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
At December 31,
----------------------------------
2003 2002
---- ----
Assets
Cash and Due From Banks $ 46,995,714 $ 18,171,153
Interest-Earning Deposits 744,479 3,580,028
Time Deposits with Federal Home Loan Bank 103,983 9,050,162
------------- -------------
Cash and Cash Equivalents 47,844,176 30,801,343
Securities Available for Sale 91,570,290 149,836,544
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 355,124,239 333,345,726
Allowance for Loan Losses (4,923,469) (5,926,813)
------------- -------------
Net Loans 350,200,770 327,418,913
Accrued Interest Receivable 2,717,721 3,075,368
Real Estate Owned 147,144 2,004,449
Premises and Equipment, Net 3,075,976 3,026,171
Cash Surrender Value of Life Insurance 11,144,263 9,799,009
Prepaid Expenses and Other Assets 5,383,188 9,106,119
------------- -------------
Total Assets $ 518,962,978 $ 542,478,316
============= =============
Liabilities and Shareholders' Equity
Deposits 406,379,774 429,129,830
Short Term Borrowings 65,000,000 65,000,000
Accrued Interest Payable 214,827 260,275
Other Liabilities 1,631,095 2,446,516
------------- -------------
Total Liablilities 473,225,696 496,836,621
Commitments and Contingencies -- --
Common Stock - No Par Value; Stated Value $1;
Authorized 6,000,000 shares, issued and outstanding
3,753,667 and 3,647,593 at December 31, 2003 and
2002, respectively 3,753,667 3,647,593
Additional Paid-In Capital 28,214,668 27,154,384
Retained Earnings 12,310,373 12,413,704
Accumulated Other Comprehensive Income (Loss) 1,458,574 2,426,014
------------- -------------
Total Shareholders' Equity 45,737,282 45,641,695
------------- -------------
Total Liabilities and Shareholder's Equity $ 518,962,978 $ 542,478,316
============= =============
The accompanying notes are an integral part of these financial statements.
F-3
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31,
------------------------------------------------
2003 2002 2001
---- ---- ----
Interest Income
Interest On Loans $22,009,688 $ 25,147,191 $ 28,664,587
Interest on Securities 3,081,173 5,856,111 7,373,257
Other Interest and Dividends 2,341,892 2,553,531 2,771,627
----------- ------------ ------------
Total Interest Income 27,432,753 33,556,833 38,809,471
Interest Expense
Interest on Deposits 3,149,406 4,951,123 7,237,936
Interest on Other Borrowings 2,896,187 2,959,471 3,299,197
----------- ------------ ------------
Total Interest Expense 6,045,593 7,910,594 10,537,133
Net Interest Income 21,387,160 25,646,239 28,272,338
Provision for Loan Losses 2,902,612 3,809,760 1,858,500
----------- ------------ ------------
Net Interest Income After Provision for Loan Losses 18,484,548 21,836,479 26,413,838
Non-Interest Income
Deposit Account Service Charges 3,085,870 3,222,270 3,594,836
Loan Fees 660,767 536,999 325,032
Net Gain on Sale of Securities 412,000 648,357 1,143,587
Net Gain on Sale of Other Assets 270,239 (191,897) (58,843)
Increase in Cash Value or and Proceeds from Life
Insurance 515,254 2,331,772 18,357
Other 470,287 479,574 690,705
----------- ------------ ------------
Total Non-Interest Income 5,414,417 7,027,075 5,713,674
Non-Interest Expense
Compensation and Benefits 9,375,052 9,584,065 9,773,879
Severance Compensation 3,077,030 2,489,519 708,047
Occupancy and Equipment 3,250,226 3,217,045 3,332,432
Advertising 550,778 609,690 798,619
Federal Insurance Premiums 65,366 69,237 186,318
Defaulted Loan Expense 790,793 778,223 400,720
Communication Expense 565,166 594,277 585,340
Outside Services 2,651,310 2,913,156 2,199,226
Merger Expense 303,509 -- 67,192
Other 1,895,595 2,388,858 2,074,904
----------- ------------ ------------
Total Non-Interest Expense 22,524,825 22,644,070 20,126,677
----------- ------------ ------------
Income Before Provision for Federal Income Taxes 1,374,140 6,219,484 12,000,835
Provision for Federal Income Taxes 296,067 603,137 3,360,066
----------- ------------ ------------
Net Income Before Preferred Stock Dividends 1,078,073 5,616,347 8,640,769
Preferred Stock Dividends of Subsidiary -- 1,800,900 1,800,900
----------- ------------ ------------
Net Income $ 1,078,073 $ 3,815,447 $ 6,839,869
=========== ============ ============
Income Per Common Share
Basic $ 0.29 $ 1.05 $ 1.92
Diluted 0.28 1.01 1.86
The accompanying notes are an integral part of these financial statements.
F-4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Year Ended December 31,
2003 2002 2001
----------- ---------- ----------
Net Income $ 1,078,073 $3,815,447 $6,839,869
Other comprehensive income net of tax:
Unrealized gains on securities:
Unrealized gains/(loss) arising during period (695,670) 1,844,135 1,369,433
Less reclassification adjustment for gains included 271,770 427,916 754,767
----------- ---------- ----------
in net income
Other comprehensive income (967,440) 1,416,219 614,666
----------- ---------- ----------
Comprehensive Income $ 110,633 $5,231,666 $7,454,535
=========== ========== ==========
The accompanying notes are an integral part of these financial statements.
F-5
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For year ended December 31, 2003
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDER'S
STOCK CAPITAL EARNINGS INCOME/(LOSS) EQUITY
----------- ------------ ------------ ------------- -------------
Balance at January 1, 2001 $ 3,552,550 $ 27,459,376 $ 3,881,411 $ 395,129 $ 35,288,466
Net income 6,839,869 6,839,869
Exercise of options 54,992 379,870 434,862
Less: cash dividends declared (998,404) (998,404)
Other comprehensive income 614,666 614,666
----------- ------------ ------------ ----------- ------------
Balance at December 31, 2001 3,607,542 27,839,246 9,722,876 1,009,795 42,179,459
Net income 3,815,447 3,815,447
Exercise of options 40,051 439,757 479,808
Tax benefit on non-qualified stock options 74,983 74,983
Initial issuance costs of Franklin Finance
preferred stock (1,199,602) (1,199,602)
Less: cash dividends declared (1,124,619) (1,124,619)
Other comprehensive 1,416,219 1,416,219
----------- ------------ ------------ ----------- ------------
Balance at December 31, 2002 3,647,593 27,154,384 12,413,704 2,426,014 45,641,695
Net income 1,078,073 1,078,073
Exercise of options 106,074 1,060,284 1,166,358
Less: cash dividends declared (1,181,404) (1,181,404)
Other comprehensive income (967,440) (967,440)
----------- ------------ ------------ ----------- ------------
Balance at Dec. 31, 2003 $ 3,753,667 $ 28,214,668 $ 12,310,373 $ 1,458,574 $ 45,737,282
=========== ============ ============ =========== ============
The accompanying notes are an integral part of these financial statements.
F-6
CONSOLIDATED STATEMENTS OF CASH FLOWS
TWELVE MONTHS ENDED DECEMBER 31,
--------------------------------
2003 2002 2001
---- ---- ----
Cash flows from operating activities
Net income $ 1,078,073 $ 3,815,447 $ 6,839,869
Adjustments to reconcile net income to cash provided by
operating activities:
Provision for loan losses 2,902,612 3,809,760 1,858,500
Depreciation and amortization 1,210,181 1,157,721 1,342,882
Realized gain on sale of securities, net and other assets (682,239) (456,460) (1,084,744)
Gain on redemption of life insurance -- (1,720,147) --
Increase in cash surrender value of life insurance (515,254) (611,625) (18,357)
Net deferral of loan origination costs/fees 36,293 46,217 (386,250)
Decrease in accrued interest receivable 357,647 197,719 855,019
Amortization and accretion on securities (370,458) 950,189 (1,190,768)
Decrease/(increase) in prepaid expenses and other assets 2,377,677 (4,929,101) (884,401)
Increase/(decrease) in accrued interest payable, deferred taxes
and other liabilities (815,422) 791,759 (1,022,494)
------------ ------------ -------------
Total adjustments 4,501,037 (763,968) (530,613)
------------ ------------ -------------
Net cash provided by operating activities 5,579,110 3,051,479 6,309,256
Cash flows from investment activities
(Purchase) of securities available for sale (34,944,375) (49,668,362) (149,287,216)
Proceeds from sales of securities available for sale 32,738,159 26,970,258 111,620,470
Proceeds from maturities and paydowns of securities available for sale 59,047,968 33,528,612 46,112,188
Net decrease/(increase) in loans (22,781,857) (13,510,972) (10,247,400)
(Purchase) sale of Federal Reserve Bank/Federal Home Loan
Bank stock 530,950 (22,400) (210,550)
Proceeds from/(Purchase of) cash value life insurance (830,000) 2,551,120 (10,000,000)
Proceeds from the sale of real estate owned 1,536,451 579,487 982,223
Capital expenditures (1,068,470) (1,030,930) (622,525)
------------ ------------ -------------
Net cash provided by/(used in) investment activities 34,228,825 (603,187) (11,652,810)
Cash flows from financing activities
Net (decrease)/increase in deposits (22,750,056) 39,771,581 1,439,664
Decrease in short term borrowings and subordinated capital notes -- (14,605,696) (2,720,405)
Exercise of common stock options 1,166,358 554,791 434,862
Redemption of preferred stock -- (20,700,000) --
Cash dividends paid on common stock (1,181,404) (1,124,619) (998,404)
------------ ------------ -------------
Net cash (used in)/provided by financing activities (22,765,102) 3,896,057 (1,844,283)
------------ ------------ -------------
Net increase in cash and cash equivalents 17,042,834 6,344,349 (7,187,837)
Beginning cash and cash equivalents 30,801,342 24,456,994 31,644,831
------------ ------------ -------------
Ending cash and cash equivalents $ 47,844,176 $ 30,801,343 24,456,994
============ ============ =============
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest $ 6,171,214 $ 7,930,130 $ 10,559,583
Federal income taxes -- 2,475,000 3,280,000
Non-cash investing and financing activities:
Transfer from loans to real estate owned (net) 2,473,971 2,697,132 486,735
The accompanying notes are an integral part of these financial statements.
F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Effective at the close of business on October 23, 2002, Franklin Bank, N.A. (the
"Bank") was reorganized and Franklin Bancorp, Inc. ("Bancorp" or the
"Corporation") was formed. All of the outstanding common shares of the Bank were
exchanged on a one for one basis for the common shares of Bancorp to create a
one bank holding company. As control did not change, this transaction was
accounted for at historical cost, therefore there was not a significant effect
on the comparability of the financial statements presented. Franklin Bank, N.A.
is a nationally chartered commercial bank, and a member of the Federal Reserve
Bank ("FRB") System and the Federal Home Loan Bank ("FHLB") System. As a member
of these systems, the Bank maintains a required investment in capital stock of
the FRB of Chicago and the FHLB of Indianapolis.
Deposits are insured by the Savings Association Insurance Fund ("SAIF") within
certain limitations, as administered by the Federal Deposit Insurance
Corporation ("FDIC"). The Bank operates four branches along with its main office
branch in the communities of Southfield, Birmingham, Grosse Pointe Woods, and
Troy, Michigan. The Bank is engaged in the business of commercial and retail
banking. The majority of the Bank's income is derived from commercial and to a
lesser extent retail business lending activities and investments.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements consist of the accounts of Bancorp and its
wholly-owned subsidiary Franklin Bank, N.A. and its wholly owned subsidiaries,
Franklin Mortgage Services LLC and Franklin Safe Deposit Company. Significant
inter-company balances and transactions have been eliminated.
PREFERRED STOCK OF SUBSIDIARY
Franklin Finance Corporation ("the Company"), formerly a wholly owned subsidiary
of Franklin Bank, N.A. issued 2,070,000 shares of 8.70% Non-cumulative
Exchangeable Preferred Stock, Series A ("Series A Preferred Shares"), with a
liquidation preference of $10 per share. The Company was a real estate
investment trust established for the purpose of acquiring, holding and managing
real estate mortgage assets. Dividends on Series A Preferred Shares were
non-cumulative and were payable quarterly in arrears. The Series A Preferred
Shares were treated as regulatory Capital for the Bank. On December 22, 2002,
the Series A Preferred Shares were redeemed for cash at a redemption price of
$10 per share, plus accrued and unpaid dividends, thereon. The Board of
Directors of the Company approved this dissolution and liquidation of the
Company effective as of December 31, 2002.
SECURITIES
The Bank classifies securities into held to maturity, available for sale and
trading categories. Held to maturity securities are those which management has
the positive intent and the Bank has the ability to hold to maturity, and are
reported at amortized cost. Available for sale securities are those which the
Bank may decide to sell if needed for liquidity, asset/liability management or
other reasons. Available for sale securities are reported at fair value, with
unrealized gains or losses included as a separate component of other
comprehensive income or loss. Trading securities are bought principally for sale
in the near term, and are reported at fair value with unrealized gains or losses
included in earnings. There were no securities classified as trading or held to
maturity at December 31, 2003 or 2002.
Realized gains or losses are determined based on the amortized cost of the
specific security sold. Interest and dividend income is adjusted by amortization
of purchase premium or discount and are included in income.
F-8
LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans, for which management has the intent and the Bank has the ability to hold
for the foreseeable future, until maturity or payoff, are reported at their
outstanding, unpaid principal balances, reduced by any charge-offs or specific
valuation accounts and net of any deferred fees or costs on originated loans,
unamortized premiums or discounts on purchased loans. Loans held for sale are
reported at the lower of cost or fair value.
On an ongoing basis, the Bank's loan portfolio is reviewed and analyzed as to
credit risk, performance, collateral value and quality. The allowance for loan
losses is maintained at a level believed to be adequate by management to provide
for probable loan losses inherent in the loan portfolio. Management's judgment
as to the adequacy of the allowance, including the allocated and unallocated
elements, is a result of ongoing review of larger individual loans, the overall
risk characteristics of the smaller homogeneous loans, the level of
non-performing assets, historical net charge-offs and the impact of prevailing
economic conditions. Loans are charged-off to the extent they are deemed to be
uncollectible.
A loan is considered impaired and placed on non-accrual status when, based on
current information and events, it is probable that the Bank will be unable to
collect all principal and interest amounts due according to the contractual
terms of the loan agreement typically when the loan becomes 90 days past due.
Smaller balance homogeneous loans are collectively evaluated for impairment.
Impaired loans, or portions thereof, are charged off when deemed uncollectible.
The carrying value of impaired loans is 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
representing interest income are reported as such and recognized as income when
received. Increases or decreases in carrying value due to changes in estimates
of future payments or the passage of time are reported as reductions or
increases in the provision for loan losses.
Discounts and premiums on purchased residential real estate loans are amortized
to income using the interest method over the remaining period to contractual
maturity, adjusted for anticipated prepayments. Discounts and premiums on
purchased consumer loans are recognized over the expected lives of the loans
using methods that approximate the interest method.
Loan origination fees and certain direct origination costs are capitalized and
recognized as an adjustment of the yield of the related loan. Fees received for
originating loans for other institutions are recognized as income when the
services are performed.
CONCENTRATIONS
The Bank has no foreign loans and there were no concentrations greater than 10%
of total loans that are not disclosed as a separate category.
REAL ESTATE OWNED
Real estate properties acquired through, or in lieu of, loan foreclosure are
initially recorded at fair value less estimated costs to sell at the date of
foreclosure, establishing a new cost basis. After foreclosure, valuations are
periodically performed by management, and the real estate is carried at the
lower of the new cost basis or the new fair value. Revenue and expenses from
operations are included in defaulted loan expense, and additions to the
valuation allowance are included in other expense.
PREMISES AND EQUIPMENT
Premises and equipment, including leasehold improvements, are carried at cost
less accumulated depreciation and amortization. Depreciation and amortization
are computed on a straight-line basis over the estimated lives of the assets.
The service lives are 30 years for building, three to seven years for furniture
and equipment and the lesser of the lease terms or useful life (three to ten
years) for leasehold improvements.
F-9
CASH SURRENDER VALUE OF LIFE INSURANCE
During 2003 and 2001, the Bank purchased life insurance policies on key members
of management. In the event of death of one of these individuals, the Bank would
receive a specified cash payment equal to the face value of the policy. Such
policies are recorded at their cash surrender value. Increases in cash surrender
value are reported as income.
STATEMENT OF CASH FLOWS
For the purpose of presentation in the consolidated statements of cash flows,
cash and cash equivalents are defined as those amounts included in the
consolidated statements of financial condition caption "Cash and cash
equivalents." These items have original maturities of ninety days or less.
STOCK OPTIONS
At December 31, 2003 and 2002, the Corporation has two stock-based, employee
compensation plans and two stocked based director compensation plans, which are
described more fully in Note 9. 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 cost is reflected in net income, as all options granted under those
plans has an exercise price greater than or equal to the market value of the
underlying common stock on the date of grant. The following table illustrates
the effect on net income (loss) and earning (loss) per share if the Corporation
had applied the fair value recognition provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation, as amended by FASB Statement No. 148,
to stock-based employee compensation.
Year Ended December 31,
2003 2002 2001
---- ---- ----
Net income, as reported $ 1,078,073 $ 3,815,447 $ 6,839,869
Deduct: total stock-based employee compensation
expense determined under fair value based method for
all awards, net of tax 133,186 20,608 116,936
------------- ------------- -------------
Pro forma net income $ 944,887 $ 3,794,839 $ 6,722,933
Earnings per share:
Basic - as reported $ 0.29 $ 1.05 $ 1.92
Basic - pro forma 0.26 1.04 1.83
Diluted - as reported 0.28 1.01 1.86
Diluted - pro forma 0.25 1.01 1.83
INCOME PER COMMON SHARE
Basic income per share excludes dilution and is computed by dividing income
available to common shareholders by the weighted average common shares
outstanding for the period. Diluted income per share reflects the potential
dilution that could occur if options or other contracts to issue common stock
were exercised and converted into common stock or resulted in the issuance of
common stock that then shared income of the entity.
COMPREHENSIVE INCOME
Comprehensive income is the sum of net income plus the change in net unrealized
gains, net of deferred taxes, on investment securities available for sale.
F-10
INCOME TAXES
The Corporation records income tax expense based on the amount of taxes due on
its return plus changes in deferred taxes, computed based on the expected future
tax consequences of temporary differences between the carrying amounts and tax
bases of assets and liabilities, using enacted tax rates. Valuation allowances
are established when necessary to reduce deferred tax assets to the amount
expected to be realized.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Estimates that are more susceptible to change in the near term include the
allowance for loan loss, the fair value of securities available for sale, and
valuation of repossessed assets.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the FASB issued Interpretation No. 45 (FIN 45),"Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others", which addresses the disclosure to be made
by a guarantor in its interim and annual financial statements about its
obligations under guarantees. FIN 45 requires the guarantor to recognize a
liability for the non-contingent component of the guarantee, this is the
obligation to stand ready to perform in the event that specified triggering
events or conditions occur. The initial measurement of this liability is the
fair value of the guarantee at inception. The recognition of the liability is
required even if it is not probable that payments will be required under the
guarantee or if the guarantee was issued with a premium payment or as part of a
transaction with multiple events. The initial recognition and measurement
provisions are effective for all guarantees within the scope of FIN 45 issued or
modified after December 31, 2002. The impact of adoption is not expected to have
a significant impact on the Corporation's financial reporting.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation
of Variable Interest Entities," which addresses consolidation by business
enterprises of variable interest entities that possess certain characteristics
as defined within the interpretation. However, in December 2003, the FASB issued
Interpretation No. 46(R) ("FIN 46(R)"), which revises FIN 46 and is intended to
clarify some of the provisions of FIN 46 and to exempt certain entities from its
requirements. FIN 46(R) requires the deconsolidation of trust preferred security
subsidiaries. FIN 46(R) grants the companies the option to adopt its provisions
as of the end of the first period ending after December 31, 2003 or elect to
defer until the first period ending after March 15, 2004. As of December 31,
2003, the Company has decided to defer the application of FIN 46(R) until March
15, 2004. Management believes the adoption of FIN 46(R) in the first quarter of
2004 will not have a material impact on the financial statements.
On April 30, 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" (SFAS 149) which is effective for
hedging relationships entered into or modified after June 30, 2003. SFAS 149
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities under SFAS 133. The adoption of this rule
did not have a material impact on the Corporation's results of operations or
financial condition.
2. LOANS
December 31,
---------------------------------
2003 2002
---- ----
Loans held for investment
Real estate
Single family mortgage $ 62,090,659 $ 11,256,265
Home equity 4,565,146 5,449,350
Commercial mortgage 181,440,549 188,394,330
Construction 21,782,420 38,888,679
Consumer 19,831,239 24,512,016
Commercial 72,122,884 76,918,188
Lease financing 0 34,184
------------- -------------
Total loans held for investment 361,832,897 345,453,012
Less
Undistributed construction funds 7,494,420 12,777,497
Unamortized discounts on purchased loans -- 150,624
Unamortized discounts on lease financing -- 1,220
Unamortized net loan fees (785,762) (822,055)
------------- -------------
Loans held for investment 355,124,239 333,345,726
Allowance for loan losses 4,923,469 5,926,813
------------- -------------
Net loans $ 350,200,770 $ 327,418,913
F-11
2. LOANS (CONTINUED)
ALLOWANCE FOR LOAN LOSSES
Year Ended December 31,
2003 2002 2001
---------- ---------- ----------
Balance at Beginning of Period $5,926,813 $4,863,948 $3,951,552
Provision for Losses 2,902,612 3,809,760 1,858,500
Charge-offs
Commercial 1,904,545 2,210,026 1,143,857
Commercial Mortgage 2,687,166 0 0
Construction 0 0 0
Residential 432,971 268,794 51,815
Overdraft 74,911 104,424 124,043
Consumer 1,633,984 1,650,631 847,638
Lease Financing 0 68,334 175,917
---------- ---------- ----------
Total Charge-Offs 6,733,577 4,302,209 2,343,270
Recoveries
Commercial 923,859 225,928 303,232
Commercial Mortgage 537,038 0 0
Construction 0 0 0
Residential 13,500 0 148
Overdraft 55,071 35,259 118,548
Consumer 1,214,172 1,053,712 558,100
Lease Financing 83,982 240,415 417,138
---------- ---------- ----------
Total Recoveries 2,827,621 1,555,314 1,397,166
---------- ---------- ----------
Net Charge-offs 3,905,956 2,746,895 946,104
---------- ---------- ----------
Balance at End of Period $4,923,469 $5,926,813 $4,863,948
========== ========== ==========
At December 31, 2003, 2002 and 2001, the balance of impaired loans was $ 1.7
million, $4.8 million and $3.1 million, respectively. Of this amount, $669
thousand, $1.4 million and $595 thousand in impaired loans required no allowance
for loan loss allocation at December 31, 2003, 2002 and 2001, respectively. At
December 31, 2003, 2002 and 2001 the remaining impaired loans of $1.0 million,
$3.4 million and $2.5 million had $0.4 million, $2.0 million and $298 thousand
of the allowance for loan losses allocated to them, respectively, although the
entire allowance remains available for charge-offs of any loan.
The average balance of impaired loans for 2003, 2002 and 2001 was $4.4 million,
$1.5 million and $2.0 million, respectively. Contractual interest income due and
recognized on impaired loans during 2003 was $194 thousand and $121 thousand,
respectively with $285,000 due and $10,800 recognized in 2002, and $341,000 due
and $0 recognized on impaired loans in 2001. Non-accrual loans at December 31,
2003, 2002 and 2001 amounted to $1.7 million, $4.8 million and $3.1 million
respectively, and are included in impaired loans.
At December 31, 2001, the Bank serviced whole loans and participations sold to
others totaling approximately $1 million; the Bank was not servicing loans for
others at December 31, 2003 or 2002.
A large percentage of the Bank's portfolio of loans is comprised of loans
collateralized by commercial or residential real estate, substantially all of
which were located in southeastern Michigan.
Management believes the allowance for loan losses at December 31, 2003, 2002 and
2001 is adequate. However, changing economic conditions in the Bank's lending
area or future events impacting specific outstanding loans may result in
adjustments to the allowance.
F-12
3. DEBT AND EQUITY SECURITIES
Securities Available for Sale
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses(1) Value
---- ----- --------- -----
December 31, 2003
Mortgage-backed securities $ 28,875,884 $ 432,330 $ (57,891) $ 29,250,323
U.S. Government and agency securities 29,520,552 298,406 (69,375) 29,749,583
Tax-exempt municipal securities 9,948,524 512,327 10,460,851
Taxable municipal securities 1,356,000 1,356,000
Corporate bonds 19,659,369 1,094,164 -- 20,753,533
------------ ------------ ------------ ------------
Total $ 89,360,329 $ 2,337,227 $ (127,266) $ 91,570,290
December 31, 2002
Mortgage-backed securities $ 66,165,358 $ 1,812,586 $ 67,977,944
U.S. Government and agency securities 29,104,210 602,966 29,707,176
Tax-exempt municipal securities 8,757,475 243,702 9,001,177
Taxable municipal securities 1,000,000 1,000,000
Corporate bonds 41,133,723 1,089,039 (72,515) 42,150,247
------------ ------------ ------------ ------------
Total $146,160,766 $ 3,748,293 $ (72,515) $149,836,544
(1) Investments with unrealized losses have been in an unrealized loss position
for less than 12 months. The Bank believes the losses are temporary based on
fluxuations in market interest rates.
F-13
3. DEBT AND EQUITY SECURITIES (CONTINUED)
Gross realized gains, losses and proceeds on sale of securities available for
sale were:
Year ended December 31,
-------------------------------------------------
2003 2002 2001
---- ---- ----
Gross realized gains on U.S. Government and agency
securities $ -- $ 341,182 $ 291,877
Gross realized gains on mortgage-backed securities 455,511 307,175 468,325
Gross realized gains/(losses) on corporate bonds (43,737) -- 438,438
Gross realized losses on SBA pool -- -- (55,053)
-------------
Gross proceeds from the sale of available for sale securities 32,249,491 26,970,258 111,620,470
The scheduled maturities of available for sale securities at December 31, 2003
were as follows:
Amortized Fair
Cost Value
---- -----
Securities due within one year
U.S. Government and agency securities $ 8,526,280 $ 8,665,469
Corporate bonds 6,495,756 6,596,967
----------- -----------
Tax-exempt municipals 15,022,036 15,262,436
Securities due after one through five years
Mortgage-backed securities 20,040,060 19,990,990
Corporate bonds 4,998,834 5,418,730
Taxable municipals 1,356,000 1,356,000
Tax-exempt municipals 2,591,945 2,710,426
----------- -----------
28,986,839 29,476,146
Securities due after five through ten years
Mortgage-backed securities 2,560,997 2,666,296
U.S. Government and agency securities 954,212 1,093,125
Corporate bonds 5,164,779 5,710,120
Tax-exempt municipals 762,585 811,548
----------- -----------
9,442,573 10,281,089
Securities due after ten years
Mortgage-backed securities 26,314,887 26,584,026
Corporate bonds 3,000,000 3,027,716
Tax-exempt municipals 6,593,994 6,938,877
----------- -----------
35,908,881 36,550,619
----------- -----------
Total $89,360,329 $91,570,290
F-14
4. DEPOSITS
December 31,
------------------------------
2003 2002
---- ----
Business checking $177,665,712 $180,011,082
Personal checking 7,645,666 5,396,446
------------ ------------
Total non-interest bearing deposits 185,311,378 185,407,528
Statement savings 130,704 272,427
Variable rate accounts
Money funds 93,124,079 111,118,189
Money markets 54,561,371 54,247,085
Negotiable order of withdrawal accounts 24,804,963 19,897,678
Fixed rate certificates of deposit 48,447,279 58,186,923
------------ ------------
Total $406,379,774 $429,129,830
============ ============
Time deposits issued in denominations of $100,000 or more at December 31, 2003
and 2002 totaled $19.7 million and $21.0 million, respectively.
Fixed rate certificates of deposit at December 31, 2003 mature as follows:
2004 $ 19,890,058
2005 21,082,285
2006 3,765,471
2007 3,183,497
2008 263,101
Thereafter 262,866
------------
Total $ 48,447,279
Interest expense on deposits is summarized as follows:
Years Ended December 31,
------------------------------------------
2003 2002 2001
---- ---- ----
Statement savings $ 1,139 $ 2,808 $ 4,773
Variable rate accounts:
Money funds 1,104,307 1,276,799 1,713,112
Money markets 554,087 1,484,947 2,621,801
Negotiable order of withdrawal accounts 72,284 130,826 95,467
Fixed rate certificates 1,417,588 2,055,743 2,802,783
---------- ---------- ----------
Total $3,149,406 $4,951,123 $7,237,936
========== ========== ==========
F-15
5. BORROWINGS
The Bank utilizes borrowings from the FHLB as well as securities sold under
agreements to repurchase (repurchase agreements) to meet its borrowing needs. At
December 31, 2003, the Bank had available additional borrowing capacity of up to
$10 million, which would be collateralized by investment securities available
for sale and performing first mortgage loans. At December 31, 2003, 2002 and
2001, investment securities and performing first mortgage loans of approximately
$115.7 million and $101.4 million, respectively, were pledged to secure
borrowings.
Contract Outstanding
Interest December 31,
Description Maturity Rate 2003 2002
- ----------- -------- ----- ---- ----
FHLB Advance February 23, 2004 5.50 $ 10,000,000 $ 10,000,000
FHLB Advance January 10, 2011 4.78 20,000,000 20,000,000
FHLB Advance January 11, 2011 4.15 10,000,000 10,000,000
FHLB Advance September 6, 2011 4.82 10,000,000 10,000,000
FHLB Advance September 12, 2011 2.99 15,000,000 15,000,000
------------ ------------
$ 65,000,000 $ 65,000,000
============ ============
Advances with contract maturity dates in 2011 are subject to conversion to
floating rates at the option of the FHLB re-pricing provisions prior to the
stated maturity date.
The following table sets forth the maximum month-end balance, average daily
balance, and weighted average rate of the FHLB advances and line of credit for
the periods indicated:
Year Ended December 31,
---------------------------------------------
2003 2002 2001
---- ---- ----
Maximum balance $65,000,000 $82,181,269 $79,605,696
Average balance 65,000,000 65,528,135 51,805,602
Weighted average interest rate 4.39 4.43 4.74
The following table sets forth the maximum month-end balance, average daily
balance, and weighted average interest rate of the repurchase agreements for the
periods indicated:
Year Ended December 31,
---------------------------------------------
2003 2002 2001
---- ---- ----
Maximum balance $ -- $20,451,000 $46,993,075
Average balance -- 3,133,395 16,491,525
Weighted average interest rate -- 1.82 5.13
In December 2003, the Bank paid a dividend of $8 million to the holding company,
and the holding company used these funds to purchase a subordinated, capital
note from the Bank in the same amount. The note bears interest at 5.25 % and
matures in seven years. The note and investment are eliminated in consolidation
of the financial statements.
F-16
6. REGULATORY MATTERS
The Bank is required by law to maintain average cash balances or balances with
the Federal Reserve Bank based on a percentage of deposits. At December 31, 2003
and 2002, these reserves totaled $3.9 million and $3.4 million, respectively.
The Corporation (on a consolidated basis) and the Bank are subject to various
regulatory capital requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory and
possibly additional discretionary actions by regulators that, if undertaken,
could have a direct material effect on the Corporation's and the Bank's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Corporation and the Bank must meet
specific capital guidelines that involve quantitative measures of their assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The capital amounts and classifications are also subject
to qualitative judgments by the regulators about components, risk weightings,
and other factors. Prompt corrective action provisions are not applicable to
Bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy
require the Corporation and the Bank to maintain minimum amounts and ratios (set
forth in the following table) of total and Tier I capital (as defined in the
regulations) to risk weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). As of December 31, 2003 the Corporation
and the Bank met all capital adequacy requirements to which they are subject.
As of December 31, 2003, the most recent notification from the Office of the
Comptroller of the Currency categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized an institution must maintain minimum total risk-based, Tier I
risk-based, and Tier I leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the Bank's category. The Corporation's actual capital amounts and ratios
as of December 31, 2003 and 2002 are presented in the following table.
Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Provisions
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- -----
As of December 31, 2003
Total capital (to risk weighted assets) $49,202 11.37% $26,594 8.00% $43,257 10.00%
Tier 1 capital (to risk weighted assets) 44,279 10.24 17,303 4.00 25,954 6.00
Tier 1 capital (to risk fourth quarter average
assets) 44,279 8.32 21,060 4.00 31,590 5.00
As of December 31, 2002
Total capital (to risk weighted assets) 48,304 11.89 32,510 8.00% 40,637 10.00%
Tier 1 capital (to risk weighted assets) 43,214 10.63 18,255 4.00 24,382 6.00
Tier 1 capital (to risk fourth quarter average
assets) 43,214 7.55 22,896 4.00 28,620 5.00
The Bank is also subject to limitations under the Federal Reserve Act on the
amount of loans or advances that can be extended to the Corporation and
dividends that can be paid to the Corporation. Loans or advances are limited to
10 percent of the Bank's capital stock and surplus on a secured basis.
Generally, approval is needed if total dividends declared in any calendar year
exceed the retained "net profit" (as defined in the Federal Reserve Act) of that
year plus the retained "net profit" of the preceding two years. In addition,
dividends paid by the Bank to the Corporation would be prohibited if the effect
thereof would cause the Bank's capital to be reduced below applicable minimum
capital requirements. The amount of retained "net profit" is approximately $0 at
January 1, 2004 as the Bank paid the $8 million dividend in December 2003.
F-17
7. PREMISES AND EQUIPMENT
December 31,
-------------------------------
2003 2002
---- ----
Land and land improvements $ 200,000 $ 200,000
Building 583,337 583,337
Furniture, fixtures and equipment 12,557,809 11,832,452
Leasehold improvements 2,835,554 2,494,572
------------ ------------
Total 16,176,700 15,110,361
Less accumulated depreciation and amortization (13,100,724) (12,084,190)
------------ ------------
Premises and equipment, net $ 3,075,976 $ 3,026,171
============ ============
F-18
8. FEDERAL INCOME TAXES
The following is a summary of the provision for federal income taxes:
Year Ended December 31,
---------------------------------------------
2003 2002 2001
---- ---- ----
Current expense $(226,778) $ 1,003,270 $ 3,549,584
Deferred expense/(benefit) 522,845 (400,133) (189,518)
--------- ----------- -----------
Total $ 296,067 $ 603,137 $ 3,360,066
========= =========== ===========
A reconciliation of the statutory rate to the effective rate is shown below:
Year Ended December 31,
---------------------------------------------
2003 2002 2001
---- ---- ----
Provision computed at statutory rate $ 467,208 $ 2,114,625 $ 4,080,284
Tax exempt interest (122,225) (99,272) (100,114)
Bank owned life insurance (175,186) (778,680) --
Affordable housing credit -- (125,740) (125,740)
Other, net 126,271 104,510 117,942
--------- ----------- -----------
Total $ 296,067 $ 1,215,443 $ 3,972,372
========= =========== ===========
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and deferred liabilities are presented below:
December 31,
--------------------------
2003 2002
---- ----
Deferred tax assets:
Allowance for loan losses $1,673,979 $2,015,117
Non-accrual loan interest 52,042 96,794
Gain on sale of real estate owned -- 149,080
Premises and equipment 31,364 288,353
Low income housing credit 125,740 --
Other 74,897 15,528
---------- ----------
Total deferred tax assets 1,958,023 2,564,872
Deferred tax liabilities:
Unrealized gain on securities 751,386 1,249,765
Affordable housing 62,233 42,710
Net deferred loan fees 267,117 310,926
Other 132,793 145,375
---------- ----------
Total deferred tax liabilities 1,213,529 1,748,776
---------- ----------
Net deferred tax assets $ 744,493 $ 816,096
========== ==========
The above amounts are included in prepaid expenses and other assets and other
liabilities on the consolidated statements of financial condition.
F-19
9. STOCK OPTIONS AND EMPLOYEE STOCK OWNERSHIP PLAN
In 1986 and 1994, shareholders approved the adoption of two separate stock
option plans for certain key executives and two separate stock option plans for
non-employee directors of the Bank, (collectively, "the Plans"). As part of the
consummation of the reorganization discussed in Note 1, the Bank's stock option
plans were assumed by the Corporation. In 1996, shareholders approved an
amendment to Key Executive Plan. In 1998, the shareholders approved a
modification to both of these plans. In 2003, the shareholders approved another
modification of the key executives plan.
The Key Executive Plans authorize the grant of 364,400 common shares, while the
Directors' Plan provides for the grant of up to 115,000 common shares. Grants
made under the Plans are subject to certain anti-dilution provisions. If an
option expires or terminates for any reason without having been fully exercised,
unexercised portions of the options are available for further grant under the
Plans.
Committees selected by the Board of Directors administer the Plans. Subject to
the eligibility and other limitations of the Directors' Plan, the Committees are
authorized to make grants under the Plans and otherwise administer the Plans.
The Committees may determine the term of each option the date on which each
option shall be granted and the other relevant provisions of each option
agreement.
The Financial Accounting Standards Board issued Statement No. 123, "Accounting
for Stock Based Compensation" ("SFAS No. 123") for transactions entered into
during 1996 and thereafter. The Statement, which was amended by SFAS No. 148,
establishes a fair value method of accounting for employee stock options and
similar equity instruments such as warrants, and encourages all companies to
adopt that method of accounting for all of their employee stock compensation
plans. However, the Statements allow companies to continue measuring
compensation cost for such plans using accounting guidance in place prior to
SFAS Nos. 123 and 148. Companies that elect to remain with the former method of
accounting must make pro-forma disclosures of net income and earnings per share
as if the fair value method provided for in SFAS No. 123 had been adopted.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes options-pricing model with the following weighted-average
assumptions used for grants in 2003: dividend yield of 3%; expected volatility
of 5.1%; risk-free interest rates of approximately 4.0%; and expected lives of
10 years. The result being a fair value per option of $4.17. There were no
options granted in 2002 and therefore no valuation was performed.
The following table summarizes stock options by plan at December 31, 2003. All
information presented in this footnote with respect to stock options has been
adjusted for the effects of all stock dividends.
Exercise Price Per Share
-----------------------------------------------------------------
Number of Number of
Shares Weighted Shares
Outstanding Range Average Exercisable
----------- ----- ------- -----------
Key Executives' 1994 Plan 199,776 $8.14-$18.87 $ 11.88 199,776
Directors' 1986 Plan 4,514 $2.93-$8.78 $ 6.53 4,514
Directors' 1994 Plan 25,675 $6.99-$16.63 $ 13.37 25,675
--------- -------
Balance at December 31, 2003 229,965 $2.93-$18.87 $ 11.94 229,965
F-20
9. STOCK OPTIONS AND EMPLOYEE STOCK OWNERSHIP PLAN (CONTINUED)
The following is a summary of stock option activity for each of the three years
in the period ended December 31, 2003.
Weighted
Average
Exercise Price per Number of
Price Share Options
----- ----- -------
Outstanding January 1, 2001 $10.15 $2.20-$16.63 373,476
Addition of options - Key Executives' 1994 Plan 15.42 $9.69-$18.70 82,352
Addition of options - Directors' 1994 Plan 16.63 $16.63 16,000
Exercised in 2001 7.93 $2.20-$13.89 (54,992)
Outstanding December 31, 2001 11.74 $2.20-$18.70 416,836
Exercised in 2002 11.98 $2.20-$13.89 (40,050)
Retired in 2002 12.52 $6.99-$18.70 (16,136)
Outstanding December 31, 2002 11.68 $2.20-$18.70 360,650
Additions of options - Key Executives' 1994 Plan 18.31 $17.93-$18.87 30,295
Exercised in 2003 11.00 $2.20-$18.70 (106,074)
Retired in 2003 11.00 $2.93-$18.70 (54,906)
Outstanding December 31, 2003 11.89 $2.93-$18.87 229,965
The Corporation also has an Employee Stock Ownership Plan ("ESOP"). Cash
contributions to the ESOP may be invested in either common or preferred stock of
the Corporation, purchased in the open market. For the years ended December 31,
2003, 2002, and 2001, cash contributions of $84,000, $95,295, and $107,195,
respectively, were made to the ESOP. The Corporation is not committed to
predetermined ESOP contributions. The Board of Directors, as recommended by the
ESOP Committee, must approve any further contributions to the ESOP.
The Corporation sponsors a defined contribution savings plan qualified under
Section 401(k) of the Internal Revenue Code. Substantially all full-time
employees are covered under the Plan. The Corporation began contributing to the
Plan in 2001, an amount equal to 25 % of employee's gross earnings up to 8% of
the employee's compensation. The cost of the Plan amounted to $76,617, $71,102
and $20,658 in 2003, 2002 and 2001, respectively.
F-21
10. TRANSACTIONS WITH RELATED PARTIES
The Bank has engaged an advertising agency in which a Director has a partial
ownership interest. The Bank paid $483,877, $522,483, and $616,027, to this
company for the years ended December 31, 2003, 2002, and 2001, respectively.
Loan activity to officers of the Bank and their associates is summarized as
follows:
Year Ended December 31,
---------------------------------
2003 2002 2001
---- ---- ----
Balance, beginning of year $ -- $ 6,888 $82,347
Additions -- 34,542 15,300
Less: Principal payments and loans sold -- 41,340 90,759
Balance, end of year $ -- $ -- $ 6,888
There were no loans to officers of the Bank and their associates during 2003.
As of December 31, 2003, 2002 and 2001, there were no loans outstanding to
Directors of the Corporation, the Bank or their associates.
11. FAIR VALUE OF FINANCIAL INVESTMENTS
The following disclosure of the fair value of financial instruments is made in
accordance with the requirements of Statement of Financial Accounting Standards
No. 107, "Disclosures about Fair Value of Financial Instruments". The
Corporation using available market information and appropriate valuation methods
has determined the fair value amounts. However, considerable judgment is
necessarily required to interpret market data to develop the estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Corporation could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the fair value amounts.
Fair values were determined using the following assumptions:
(Dollars is thousands)
December 31,
--------------------------------------------------
2003 2002
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
ASSETS
Cash and cash equivalents $ 47,844 $ 47,844 $ 30,801 $ 30,801
Securities available for sale 91,570 91,570 149,837 149,837
Loans 355,124 358,831 327,419 336,410
Accrued interest receivable 2,718 2,718 3,075 3,075
FHLB and FRB stock 6,879 6,879 7,410 7,410
LIABILITIES
Deposits without stated maturities 357,932 357,932 370,943 370,943
Time deposits 48,448 49,212 58,187 59,291
Borrowings 65,000 72,655 65,000 65,217
Accrued interest payable 215 215 260 260
F-22
CASH AND CASH EQUIVALENTS
For cash and cash equivalents, the carrying amount is a reasonable estimate of
fair value.
SECURITIES AVAILABLE FOR SALE
For securities available for sale, fair values are based on quoted market prices
or dealer quotes.
LOANS
For certain homogeneous categories of loans, such as some residential mortgages,
consumer loans, commercial real estate loans, etc., fair value is estimated by
discounting the future cash flows over the life to maturity using the current
rates at which similar loans would be made to borrowers with similar credit
ratings. For those loans tied to a prime rate index, fair values approximate
carrying values. Both the carrying value and fair value of loans receivable are
shown net of the allowance for loan losses.
ACCRUED INTEREST RECEIVABLE AND PAYABLE
The carrying values of accrued interest receivable and payable approximate their
fair values.
FHLB STOCK AND FRB STOCK
The carrying values of the FHLB and FRB stock approximate fair value.
DEMAND DEPOSITS AND TIME DEPOSITS
The fair values of demand deposits, savings accounts and certain money market
deposits are the amount payable on demand at the reporting date. The fair value
of fixed-maturity certificates of deposit is estimated using the current rates
for deposits of similar remaining maturities.
BORROWINGS
The fair value of borrowings is estimated using the current rates for borrowings
of similar remaining maturities.
12. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF CREDIT RISK
At December 31, 2003, 2002 and 2001 the Bank had outstanding loan commitments
for loans that have either not been accepted by the borrower or not closed of
approximately $10.3 million, $21.0 million, and $21.5 million, respectively.
These include commitments for commercial business loans, residential mortgages
and home equity loans.
Under loan agreements for transactions which had closed, the Bank had
commitments to fund commercial lines of credit, of approximately $70.4 million,
$53.5 million and $52.9 million at December 31, 2003, 2002 and 2001,
respectively. The Bank had commitments to fund construction loans of
approximately $5.9 million, $7.9 million and $12.8 million at December 31, 2003,
2002 and 2001, respectively. The Bank had commitments to fund home equity loans
of approximately $4.6 million, $5.2 million and $6.7 million at December 31,
2003, 2002 and 2001, respectively. As certain commitments to make loans and fund
lines of credit expire without being used, the amount does not necessarily
represent future cash commitments.
F-23
The Bank leases four of its offices from unaffiliated entities for its
headquarters in Southfield and three branch offices in Birmingham, Southfield,
and Troy. Minimum rents under all non-cancelable leases are summarized as
follows:
Year Ended
December 31,
------------
2004 $ 1,097,003
2005 1,126,156
2006 1,155,430
2007 1,069,475
2008 995,507
Thereafter 1,170,083
-----------
$ 6,613,654
Rental expense for the years ended December 31, 2003, 2002, and 2001 totaled
$1,152,977, $1,000,584, and $957,839, respectively.
As of December 31, 2003, a contingent liability exists of approximately $0.3
million through April 2004 relating to remaining officer severance arrangements.
The Bank is a defendant in lawsuits arising in the normal course of business. In
the opinion of management the results of these lawsuits will not have a
significant adverse effect on the Bank's consolidated financial statements.
COMMITMENTS
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. The commitments for equity lines of credit may expire
without being drawn upon. Therefore, the total commitment amounts do not
necessarily represent future cash requirements. The amount of collateral
obtained, if it is deemed necessary by the Company, is based on management's
credit evaluation of the customer.
Unfunded commitments under commercial lines-of-credit, revolving credit lines
and overdraft protection agreements are commitments for possible future
extensions of credit to existing customers. These lines-of-credit are
uncollateralized and usually do not contain a specified maturity date and may
not be drawn upon to the total extent to which the Company is committed.
Commercial and standby letters-of-credit are conditional commitments issued by
the Company to guarantee the performance of a customer to a third party. Those
letters-of-credit are primarily issued to support public and private borrowing
arrangements. Essentially all letters of credit issued have expiration dates
within one year. The credit risk involved in issuing letters-of-credit is
essentially the same as that involved in extending loan facilities to customers.
The Company generally holds collateral supporting those commitments if deemed
necessary.
13. COMPUTATION OF PRIMARY AND FULLY DILUTED INCOME PER SHARE
The following table sets forth the computation of basic and diluted income 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:
F-24
Year Ended
December 31,
2003 2002 2001
---------- ---------- ----------
Numerator
Net Income $1,078,073 $3,815,447 $6,839,869
Numerator for basic and diluted earnings per share
Income available for common shareholders $1,078,073 $3,815,447 $6,839,869
Denominator
Denominator for basic earnings per share -
Weighted average share outstanding 3,700,353 3,632,268 3,569,608
Employee stock options 83,823 138,227 109,111
Denominator for diluted earnings per share -
Adjusted weighted average share outstanding 3,784,176 3,770,495 3,678,719
Basic earnings per share $ 0.29 $ 1.05 $ 1.92
Diluted earnings per share $ 0.28 $ 1.01 $ 1.86
14. RECENT DEVELOPMENT
As previously announced, Franklin has entered into a definitive agreement dated
as of November 10, 2003, and as amended on February 3, 2004 (the "merger
agreement") to be acquired by First Place Financial Corporation ("First Place"),
a unitary savings and loan holding company. First Place Bank, a federal savings
association and wholly-owned subsidiary of First Place, is headquartered in
Warren, Ohio. Under the agreement, the holding companies will merge with
Franklin merging with and into First Place. After the holding companies merge,
the subsidiaries will merge (the "subsidiary merger"), with First Place merging
with Franklin Bank, and Franklin Bank changing its name to "First Place Bank"
and its main office to Warren, Ohio. In connection with the merger, on February
9, 2004, Franklin Bank filed an application with the Office of Thrift
Supervision to convert from a national banking association to a federal savings
association. Such conversion is proposed to occur at the same time as the merger
of the holding companies. First Place and Franklin may agree, due to business,
tax or other considerations, to revise the structure of the subsidiary merger
before the subsidiary merger is completed by amending the subsidiary merger
agreement (e.g., by having Franklin Bank merge with and into First Place Bank).
Completion of the merger depends on satisfying a number of conditions. There is
no certainty as to whether or when the conditions to the merger will be
satisfied, or waived where permissible or that the merger will be completed.
F-25
15. PARENT COMPANY ONLY FINANCIAL INFORMATION
During the year ended December 31, 2002, Franklin Bancorp was formed. Following
is condensed financial information as of and for the year ended December 31,
2003 and 2002.
December 31,
-------------------------------
2003 2002
---- ----
Condensed Balance Sheet
Cash $ 638,082 $ 962
Receivable from subsidiary 115,504 181,629
Investment in subsidiary 44,983,696 45,459,104
------------ ------------
Total assets $ 45,737,282 $ 45,641,695
============ ============
Shareholders' Equity $ 45,737,282 $ 45,641,695
============ ============
Year Ended December 31,
-------------------------------
2003 2002
---- ----
Condensed Statement of Income
Dividend from subsidiary $ 8,791,828 $ 472,723
Income on subordinated note 1,167 --
Operating expenses 313,568 180,855
------------ ------------
8,479,427 291,868
Income tax benefit 106,613 61,491
Undistributed earnings of subsidiary (7,507,967) 3,462,088
------------ ------------
Net income $ 1,078,073 $ 3,815,447
============ ============
Condensed Statement of Cash Flows
Operating activities
Net income $ 1,078,073 $ 3,815,447
Adjustments to reconcile net income to
cash provided by operating activities
Undistributed earnings of subsidiary 7,507,968 (3,462,088)
(Increase)/decrease in due from affiliates 66,125 (181,629)
------------ ------------
Cash provided by operations 8,652,166 171,730
Financing activities
Cash dividend paid on common stock (1,181,404) (290,906)
Exercise of common stock options 1,166,358 120,138
Purchase of subordinated note (8,000,000) --
------------ ------------
Cash used in financing activities (8,015,046) (170,768)
------------ ------------
Increase/(Decrease) in cash 637,120 962
Beginning cash balance 962 0
------------ ------------
Ending cash balance $ 638,082 $ 962
============ ============
F-26
16. QUARTERLY SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA
(Dollar amounts in thousands, except per share data)
2003
-------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest income $ 7,290 $ 7,030 $ 6,462 $ 6,651
Interest expense 1,683 1,508 1,448 1,407
Net interest income 5,607 5,522 5,014 5,244
Provision for loan losses 626 626 1,026 625
Net interest income after provision for loan losses 4,981 4,896 3,988 4,619
Non-interest income 1,540 1,302 1,154 1,418
Non-interest expense 7,632 5,160 4,690 5,042
Income/(loss) before provision for federal income taxes (1,111) 1,038 452 995
Provision/(benefit) for federal income taxes (333) 311 25 293
Net income/(loss) $ (778) $ 727 $ 427 $ 702
Income per common share:
Net income/(loss) per common share
Basic $ (0.21) $ 0.20 $ 0.12 $ 0.19
Diluted (0.21) 0.19 0.11 0.18
Average common shares outstanding
Basic 3,666,688 3,685,136 3,709,083 3,718,870
Diluted 3,754,431 3,762,263 3,794,077 3,802,693
2002
-------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest income $ 8,627 $ 8,525 $ 8,425 $ 7,980
Interest expense 1,989 2,003 1,984 1,935
Net interest income 6,638 6,522 6,441 6,045
Provision for loan losses 475 500 300 2,535
Net interest income after provision for loan losses 6,163 6,022 6,141 3,510
Non-interest income 1,195 1,528 1,523 2,781
Non-interest expense 4,573 4,827 5,490 7,754
Income before provision for federal income taxes 2,785 2,723 2,174 (1,463)
Provision for federal income taxes 721 676 503 (1,297)
Net income before preferred stock dividends 2,064 2,047 1,671 (166)
Preferred stock dividends of subsidiary 450 450 450 450
Net income $ 1,614 $ 1,597 $ 1,221 $ (616)
Income per common share:
Net income per common share
Basic $ 0.45 $ 0.44 $ 0.34 $ (0.18)
Diluted 0.43 0.42 0.32 (0.16)
Average common shares outstanding
Basic 3,620,125 3,631,768 3,635,331 3,641,879
Diluted 3,755,540 3,779,187 3,774,348 3,772,285
F-27
EXHIBITS INDEX
EXHIBIT PAGE NO.
- ------- --------
10.11 Employment Agreement of David L. Shelp.................. 46
10.18 Amendment to Employment Agreement of Craig L. Johnson... 50
21 Subsidiaries of Registrant.............................. 50
23.1 Consent of Grant Thornton LLP........................... 51
24.1 Power of Attorney ...................................... Included on signature page
31.1 Certification of Chief Executive Officer ............... 52
31.2 Certification of Chief Financial Officer................ 53
32.1 Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002............................ 54