<PAGE> 1
As filed with the Securities and Exchange Commission on December 3, 1997
Registration No. 333-37463
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
-------------------------
AMENDMENT NO. ONE TO THE
FORM S-11
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
-------------------------
FRANKLIN FINANCE CORPORATION
(Exact name of registrant as specified in its charter)
MICHIGAN 38-3372606
(State or other jurisdiction (Primary Standard (I.R.S. Employer
of incorporation or Industrial Classification Identification No.)
organization) Code Number)
24725 WEST TWELVE MILE ROAD, SOUTHFIELD, MICHIGAN 48034 (248) 358-4710
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)
-------------------------
READ P. DUNN
PRESIDENT
FRANKLIN FINANCE CORPORATION
24725 WEST TWELVE MILE ROAD
SOUTHFIELD, MICHIGAN 48034
(248) 358-4710
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
-------------------------
PLEASE SEND COPIES OF ALL COMMUNICATIONS TO:
James S. Fleischer, P.C. Donald J. Kunz
Michael S. Sadow, Esquire HONIGMAN MILLER SCHWARTZ AND COHN
SILVER, FREEDMAN & TAFF, L.L.P. 2290 First National Building
(A limited liability partnership including Detroit, Michigan 48226
professional corporations) (313) 256-7800
1100 New York Avenue, N.W.
Seventh Floor, East Tower
Washington, DC 20005-3934
(202) 414-6100
-------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are being offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933 check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
====================================================================================================================================
TITLE OF EACH AMOUNT PROPOSED MAXIMUM PROPOSED MAXIMUM
CLASS OF SECURITIES TO BE OFFERING PRICE AGGREGATE OFFERING AMOUNT OF
TO BE REGISTERED REGISTERED(1) PER SHARE(1) PRICE(1) REGISTRATION FEE
====================================================================================================================================
<S> <C> <C> <C> <C>
[ ]% Noncumulative Exchangeable 2,070,000 shares $10.00 $20,700,000 $6,272.73
Preferred Stock, Series A, par value
$10.00 per share
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</TABLE>
(1)Estimated solely for the purpose of calculating the registration fee.
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
<PAGE> 2
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor
may offers to buy be accepted prior to the time the registration statement
becomes effective. This prospectus shall not constitute an offer to sell or
the solicitation of an offer to buy nor shall there be any sale of these
securities in any State in which such offer, solicitation or sale would be
unlawful prior to registration or qualification under the securities laws
of any such State.
SUBJECT TO COMPLETION, DATED DECEMBER 3, 1997
1,800,000 SHARES
FRANKLIN FINANCE CORPORATION
[ ]% NONCUMULATIVE PREFERRED STOCK, SERIES A
(LIQUIDATION PREFERENCE $10.00 PER SHARE)
EXCHANGEABLE INTO PREFERRED STOCK OF FRANKLIN BANK, N.A.
------------------
Franklin Finance Corporation (the "Company") is hereby offering 1,800,000
shares of its [ ]% Noncumulative Exchangeable Preferred Stock, Series A, par
value $10.00 per share (the "Series A Preferred Shares"). The Company has been
formed for the purpose of acquiring, holding and managing real estate mortgage
assets that are intended to generate sufficient income to permit the declaration
of dividends on the Series A Preferred Shares at the stated rate and to meet the
operating expenses of the Company. Dividends on the Series A Preferred Shares
are payable at the rate of [ ]% per annum of the liquidation preference (an
amount equal to $[ ] per annum per share), if, when and as declared by the
Board of Directors of the Company. Dividends are not cumulative and, if
declared, are payable quarterly in arrears on the last day of March, June,
September and December in each year, commencing December 31, 1997. If no
dividend is declared on the Series A Preferred Shares by the Company for a
quarterly dividend period, holders of the Series A Preferred Shares will have no
right to receive a dividend for that period, and the Company will have no
obligation to pay a dividend for that period, whether or not dividends are
declared and paid for any future period. Dividends in each dividend period will
accrue from the first day of the period, whether or not declared or paid in the
prior period. ------------------
SEE "RISK FACTORS" COMMENCING ON PAGE 13 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE SERIES A PREFERRED
SHARES. AMONG THE RISKS WHICH PROSPECTIVE INVESTORS SHOULD CONSIDER ARE THE
FOLLOWING:
- THE COMPANY AND THE BANK HAVE COMMON OFFICERS AND DIRECTORS
WHICH PRESENTS AND MAY CONTINUE TO PRESENT CONFLICTS OF
INTEREST IN THE COMPANY'S DEALINGS WITH THE BANK, INCLUDING
THAT THE OWNER OF THE BANK'S COMMON STOCK MAY HAVE INVESTMENT
GOALS AND STRATEGIES THAT DIFFER FROM THOSE OF THE HOLDERS OF
THE SERIES A PREFERRED SHARES;
- THE COMPANY'S OPERATIONS ARE TOTALLY DEPENDENT ON FRANKLIN
BANK, N.A., A NATIONAL BANK (THE "BANK");
- A DECLINE IN INTEREST RATES MAY ADVERSELY EFFECT THE COMPANY'S
CASH FLOW AND THEREFORE THE COMPANY'S ABILITY TO PAY
DIVIDENDS;
- SERIES A PREFERRED SHARES AUTOMATICALLY WILL BE EXCHANGED FOR
SERIES A PREFERRED SHARES OF THE BANK UPON THE OCCURRENCE OF
AN EXCHANGE EVENT (AS DEFINED BELOW);
- THE COMPANY'S ABILITY TO PAY DIVIDENDS IS SUBJECT TO
RESTRICTION BY FINANCIAL INSTITUTION REGULATORY AUTHORITIES;
- DIVIDENDS ARE NOT CUMULATIVE; ACCORDINGLY, IF NO DIVIDEND IS
DECLARED ON THE SERIES A PREFERRED SHARES BY THE COMPANY FOR A
DIVIDEND PERIOD, HOLDERS OF SUCH SHARES WILL HAVE NO RIGHT TO
RECEIVE A DIVIDEND FOR THAT PERIOD; AND
- THE PROPERTIES SECURING THE COMPANY'S INITIAL MORTGAGE LOAN
PORTFOLIO ARE GEOGRAPHICALLY CONCENTRATED IN MICHIGAN.
----------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------
THE SERIES A PREFERRED SHARES ARE NOT DEPOSIT ACCOUNTS OR OTHER DEBT OBLIGATIONS
OF THE BANK AND ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR
ANY OTHER GOVERNMENTAL AGENCY OR OTHERWISE INSURED.
<TABLE>
<CAPTION>
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INITIAL PUBLIC UNDERWRITING PROCEEDS TO
OFFERING PRICE COMMISSION(1) COMPANY(2)
<S> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------------------
Per Share................................ $10.00 $ $
- -----------------------------------------------------------------------------------------------------------------------------
Total(3)................................. $18,000,000 $ $
=============================================================================================================================
</TABLE>
(1) The Company and the Bank have agreed to indemnify the several Underwriters
against certain liabilities, including liabilities under the Securities Act
of 1933.
(2) Before deducting expenses payable by the Company estimated at $342,500.
(3) The Company has granted the several Underwriters an option for 30 days to
purchase up to an additional 270,000 Series A Preferred Shares at the
initial public offering price per Series A Preferred Share, less
underwriting commissions, solely to cover over-allotments, if any. If such
option is exercised in full, the total initial public offering price,
underwriting commission and proceeds to the Company will be $20,700,000,
$[ ] and $[ ], respectively.
------------------
The Series A Preferred Shares are offered severally by the Underwriters, as
specified herein, subject to receipt and acceptance by them and subject to their
right to reject any order in whole or in part. It is expected that the Series A
Preferred Shares will be ready for delivery through the facilities of The
Depository Trust Company in New York, New York, on or about [ ],
1997 against payment therefor in immediately available funds.
------------------
(RONEY & CO. LOGO) PRINCIPAL FINANCIAL SECURITIES, INC.
THE DATE OF THIS PROSPECTUS IS , 1997.
<PAGE> 3
The Series A Preferred Shares are not redeemable prior to [ ],
2002 (except upon the occurrence of a Tax Event as described herein). On and
after [ ], 2002, the Series A Preferred Shares may be redeemed for cash
at the option of the Company, in whole or in part, at a redemption price of
$10.00 per share, plus the accrued and unpaid dividends for the most recent
quarter, if any, thereon, subject to the receipt of prior approval from the
Office of the Comptroller of the Currency or any successor regulatory agency.
The Series A Preferred Shares will not be subject to any sinking fund or
mandatory redemption and will not be convertible into any other securities of
the Company.
Each Series A Preferred Share will be exchanged automatically (the
"Automatic Exchange") for one newly issued Series A preferred share of the Bank
(the "Bank Preferred Shares") only in the event the appropriate regulatory
agency directs in writing (a "Directive") an exchange of the Series A Preferred
Shares for Bank Preferred Shares because (i) the Bank becomes "undercapitalized"
under prompt corrective action regulations, (ii) the Bank is placed into
conservatorship or receivership or (iii) the appropriate federal regulatory
agency, in its sole discretion and even if the Bank is not "undercapitalized,"
anticipates the Bank becoming "undercapitalized" in the near term (the "Exchange
Event"). CONSEQUENTLY, AN INVESTMENT IN SERIES A PREFERRED SHARES COULD BE
REPLACED BY AN INVESTMENT IN BANK PREFERRED SHARES AT A TIME WHEN THE BANK'S
FINANCIAL CONDITION IS DETERIORATING OR WHEN THE BANK HAS BEEN PLACED INTO
CONSERVATORSHIP OR RECEIVERSHIP. POTENTIAL INVESTORS IN THE SERIES A PREFERRED
SHARES, THEREFORE, SHOULD CAREFULLY CONSIDER THE DESCRIPTION OF THE BANK SET
FORTH ELSEWHERE IN THIS PROSPECTUS. SEE THE BANK PROSPECTUS ATTACHED HERETO AT
ANNEX I. In the event of the Automatic Exchange, the Bank Preferred Shares would
constitute a new series of preferred shares of the Bank, would have the same
dividend rights, liquidation preference, redemption options and other attributes
as the Series A Preferred Shares, except that the Bank Preferred Shares would
not be listed on the Nasdaq National Market or any other quotation system, and
would rank pari passu in terms of cash dividend payments and liquidation
preference with any outstanding shares of preferred stock of the Bank. Holders
of Series A Preferred Shares cannot exchange their Series A Preferred Shares for
Bank Preferred Shares voluntarily, and, absent the occurrence of the Automatic
Exchange, holders of Series A Preferred Shares will have no dividend, voting,
liquidation preference or other rights with respect to the Bank or any security
of the Bank. See "Description of Series A Preferred Shares -- Automatic
Exchange".
The Company expects that all of its mortgage assets will be acquired from
the Bank, or its affiliates. All of the shares of the Company's common stock,
par value $300.00 per share (the "Common Stock"), are owned by the Bank. The
Bank currently intends that, so long as any Series A Preferred Shares are
outstanding, it will maintain direct or indirect ownership of at least a
majority of the outstanding shares of Common Stock of the Company.
A PURCHASE OF SERIES A PREFERRED SHARES IS A PURCHASE OF SECURITIES ISSUED
BY THE COMPANY. NO OBLIGATION OF THE COMPANY IS GUARANTEED BY THE BANK.
The Company expects to qualify as a real estate investment trust (a "REIT")
for federal income tax purposes, commencing with the taxable year ending
December 31, 1997. No person or persons acting as a group is permitted to
beneficially own more than 9.9% of any series of preferred stock of the Company,
including the Series A Preferred Shares, with limited exceptions.
Prior to the offering, there has been no market for the Series A Preferred
Shares. The Company has applied for listing of the Series A Preferred Shares on
the Nasdaq National Market, subject to official notice of issuance, under the
symbol FSVBP. The Bank intends to register the Bank Preferred Shares with the
OCC promptly following the issuance of such shares, but does not intend to apply
for listing of the Bank Preferred Shares on any national securities exchange or
for quotation of the Bank Preferred Shares through the Nasdaq System.
Consequently, there can be no assurance as to the liquidity of the trading
markets for the Bank Preferred Shares, if issued, or that an active public
market for the Bank Preferred Shares would develop or be maintained.
IN CONNECTION WITH THE OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE SERIES A
PREFERRED SHARES OFFERED HEREBY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE
PREVAIL IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ
NATIONAL MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.
THIS PROSPECTUS CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITH RESPECT TO
THE FINANCIAL CONDITION, RESULTS OF OPERATIONS AND BUSINESS OF THE BANK. THESE
FORWARD-LOOKING STATEMENTS INVOLVE CERTAIN RISKS AND UNCERTAINTIES. FACTORS THAT
MAY CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY SUCH
FORWARD-LOOKING STATEMENTS INCLUDE, AMONG OTHERS, THE FOLLOWING POSSIBILITIES:
(1) COMPETITIVE PRESSURE IN THE BANKING INDUSTRY INCREASES SIGNIFICANTLY; (2)
CHANGES IN THE INTEREST RATE ENVIRONMENT REDUCE MARGINS; (3) GENERAL ECONOMIC
CONDITIONS ARE LESS FAVORABLE THAN EXPECTED, RESULTING IN, AMONG OTHER THINGS, A
DETERIORATION IN CREDIT QUALITY; (4) THE IMPACT OF REGULATORY CHANGES IS OTHER
THAN EXPECTED; (5) CHANGES IN BUSINESS CONDITIONS AND INFLATION; AND (6) CHANGES
IN THE SECURITIES MARKETS.
<PAGE> 4
TABLE OF CONTENTS
<TABLE>
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Page
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<S> <C>
PROSPECTUS SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
The Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
The Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Possible Conflicts of Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
The Offering . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
THE FORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
The Formation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Benefits to the Bank and its Affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
TAX STATUS OF THE COMPANY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
RISK FACTORS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Conflicts of Interest in Business of the Company May Result in Decisions of the Company
That Do Not Fully Reflect the Interests of the Stockholders of the Company . . . . . . . . . . . . . . . 11
Benefits to Insiders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Common Officers and Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Purchasing and Servicing of Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
No Third Party Valuation of the Mortgage Loans; No Arm's-Length Negotiations
with Affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Risks Related to Investments in Mortgage Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Geographic Concentration of the Company's Mortgage Assets in Michigan May
Make the Company's Performance Subject to Economic Conditions in Michigan . . . . . . . . . . . 13
Legal Restrictions on Servicing and Collection Procedures for Mortgage Assets May
Limit the Company's Collection of Principal and Interest and Adversely Affect the
Company's Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Commercial Mortgage Loans Involve a Greater Risk of Loss than Residential
Mortgage Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Lack of Credit Enhancement or Special Hazard Insurance Could Increase Risk of Loss
on Mortgage Loans Held by the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Economic and Business Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
A Decline in Interest Rates May Adversely Affect the Company's Ability
to Pay Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Changes in Real Estate Market Conditions May Adversely Affect the Company's
Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Properties with Environmental Problems May Increase Costs and Create Liabilities
for the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Ability to Increase Leverage May Adversely Affect the Company's Interest Income . . . . . . . . . 15
Delays in Foreclosing or Liquidating Defaulted Mortgage Loans Could Affect the
Value of the Underlying Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Tax, Legal and Regulatory Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Adverse Consequences of Failure to Qualify or Maintain REIT Status May
Result in the Company Being Subject to Taxation as a Regular Corporation . . . . . . . . . . . . 16
Series A Preferred Shares May Be Redeemed by the Company Upon the
Occurrence of a Tax Event . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Automatic Exchange May Cause a Taxable Event to Holders of Series A
Preferred Shares. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Investment in the Series A Preferred Shares of the Company by Certain Plans
May Give Rise to a Prohibited Transaction Under ERISA and the Code . . . . . . . . . . . . . . . 18
Board of Directors May Change or Revise Certain Policies and Strategies
Without Stockholder Consent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
</TABLE>
i
<PAGE> 5
<TABLE>
<S> <C>
A Decline in the Bank's Capital Position or the Receivership of the Bank May
Cause the Series A Preferred Shares to be Automatically Exchanged into
Bank Preferred Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Regulatory Authorities May Impose Restrictions on Dividends and Operations
of the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Regulatory Authorities May Impose Dividend Restrictions on Bank Preferred
Shares Received Upon an Automatic Exchange . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Other Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Uncertainty as to the Company's Ability to Implement Successfully its Operating
Policies and Strategies Resulting from its Lack of Operating History . . . . . . . . . . . . . . 20
The Company's Success May Depend on the Services of the Bank . . . . . . . . . . . . . . . . . . . 20
Dividends Not Declared by the Board During any Quarter Would Not Be Paid
in a Subsequent Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
No Prior Market for Series A Preferred Shares . . . . . . . . . . . . . . . . . . . . . . . . . . 21
In the Event the Series A Preferred Shares are Exchanged for Bank Preferred
Shares, the Bank Preferred Shares Will Not Be Listed On the Nasdaq System
or Any Exchange . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
THE COMPANY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
USE OF PROCEEDS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
CAPITALIZATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
BUSINESS AND STRATEGY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Liquidity and Capital Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
General Description of Mortgage Assets; Investment Policy . . . . . . . . . . . . . . . . . . . . . . . . 31
Acquisition of Initial Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
Management Policies and Programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Description of Initial Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
Servicing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
Employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
MANAGEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
Directors and Executive Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
Independent Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
Audit Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
Credit Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
Compensation of Directors and Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
Limitations on Liability of Directors and Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
The Advisor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
CERTAIN TRANSACTIONS CONSTITUTING THE FORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
The Formation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
Benefits to the Bank and its Affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
DESCRIPTION OF SERIES A PREFERRED SHARES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
Automatic Exchange . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
Voting Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Redemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
Rights Upon Liquidation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
Independent Director Approval . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
Restrictions on Ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
DESCRIPTION OF CAPITAL STOCK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
Common Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
Preferred Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
</TABLE>
ii
<PAGE> 6
<TABLE>
<S> <C>
Restrictions on Ownership and Transfer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
FEDERAL INCOME TAX CONSIDERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Taxation of the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Failure to Qualify . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
Tax Treatment of Automatic Exchange . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
Taxation of United States Stockholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
Taxation of Foreign Stockholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
Information Reporting Requirements and Backup Withholding Tax . . . . . . . . . . . . . . . . . . . . . . 77
Other Tax Consequences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
ERISA CONSIDERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
Plan Asset Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
Effect of Plan Asset Status . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
Prohibited Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
Unrelated Business Taxable Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
CERTAIN INFORMATION REGARDING THE BANK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
UNDERWRITING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82
EXPERTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
RATINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
CERTAIN LEGAL MATTERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
ADDITIONAL INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
GLOSSARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85
INDEX TO FINANCIAL STATEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-1
</TABLE>
iii
<PAGE> 7
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the detailed
information appearing elsewhere in this Prospectus. See "Glossary" commencing
at page [____] for the definitions of certain terms used in this Prospectus.
The offering of 1,800,000 shares of [____]% Noncumulative Exchangeable
Preferred Stock, Series A, par value $10.00 per share (the "Series A Preferred
Shares"), is referred to herein as the "Offering". Unless otherwise indicated,
all information in this Prospectus assumes that the over-allotment option
described in "Underwriting" is not exercised.
THE COMPANY
Franklin Finance Corporation is a newly-formed Michigan corporation
incorporated on September 25, 1997 and created for the purpose of acquiring,
holding and managing real estate mortgage assets ("Mortgage Assets"). The
Company has been formed by Franklin Bank, N.A., a national bank, to provide the
Bank with a means of raising capital which will count toward the OCC required
levels of capital for bank regulatory purposes. The Series A Preferred Shares
will be treated as capital for regulatory purposes for the Bank, up to
regulatory limits. The issuance of the Series A Preferred Shares by the
Company is a more cost-effective means of raising capital for the Bank than if
the Bank were to issue preferred stock itself, because of the Company's ability
to deduct for income tax purposes the dividends payable on the Series A
Preferred Shares as a result of its qualification as a REIT. See "Certain
Transactions Constituting the Formation--Benefits to the Bank and Its
Affiliates" herein and "Capitalization" and "Regulation" contained in the Bank
Prospectus attached hereto as Annex I.
The Company will elect to be subject to tax as a REIT under the
Internal Revenue Code of 1986, as amended (the "Code"), and will generally not
be subject to federal income tax to the extent that it distributes its earnings
to its stockholders and maintains its qualification as a REIT. In order to be
treated as a REIT, the Company is required to distribute dividends (other than
capital gain dividends) to its stockholders in an amount equal to at least 95%
of the Company's "REIT Taxable Income". See "Federal Income Tax
Considerations" for a discussion of the requirements to qualify as a REIT. All
of the shares of the Company's common stock, par value $300.00 per share (the
"Common Stock"), are owned by the Bank. The Bank currently intends that, so
long as any Series A Preferred Shares are outstanding, it will maintain direct
or indirect ownership of at least a majority of the outstanding shares of
Common Stock of the Company. For information regarding restrictions on
ownership of the Series A Preferred Shares, see "Description of Capital
Stock--Restrictions on Ownership and Transfer".
The Company has five directors of whom two are independent directors.
An "Independent Director" is a director who, prior to and subsequent to his
appointment, is not and will not be a director, officer or employee of the Bank
or any affiliate of the Bank or any person or persons that, in the aggregate,
own more than one percent of the common stock of the Bank and is not an officer
or employee of the Company.
1
<PAGE> 8
The Company currently expects to pay an aggregate amount of dividends
with respect to its outstanding shares of capital stock equal to
approximately 100% of the Company's "REIT Taxable Income" (which excludes
capital gains). Dividends will be declared at the discretion of the Board of
Directors after considering the Company's distributable funds, financial
requirements, tax considerations and other factors. Although there can be no
assurances, because (i) the Mortgage Assets are interest bearing, (ii) the
Series A Preferred Shares represent only approximately 50% of the Company's
capitalization and (iii) the Company does not anticipate incurring any
indebtedness, the Company currently expects that both its cash available for
distribution and its "REIT Taxable Income" will be in excess of amounts needed
to pay dividends on the Series A Preferred Shares. See "Risk Factors -- A
Decline in Interest Rates May Adversely Affect the Company's Ability to Pay
Dividends".
A PURCHASE OF SERIES A PREFERRED SHARES IS A PURCHASE OF SECURITIES
ISSUED BY THE COMPANY. NO OBLIGATION OF THE COMPANY IS GUARANTEED BY THE
BANK.
The principal executive offices of the Company are located at 24725
West Twelve Mile Road, Southfield, Michigan 48034, telephone number (248)
358-4710.
RISK FACTORS
The purchase of the Series A Preferred Shares offered hereby is
subject to certain risks. See "Risk Factors" commencing on page 13. Among such
risks are the following:
o The Company and the Bank have common officers and directors,
which presents and may continue to present conflicts of
interest in the Company's dealings with the Bank, that may
result in the Company making decisions which do not fully
reflect the interests of the Company's stockholders.
Conflicts of interest may arise with respect to
transactions, including without limitation, the Company's
acquisition of the Initial Portfolio; future acquisitions of
Mortgage Loans from the Bank or its affiliates; servicing of
Mortgage Loans; future dispositions of Mortgage Loans to the
Bank or any of its non-bank subsidiaries; and the modification
of the Advisory Agreement or the Servicing Agreements. Any
resolution of a conflict may adversely effect the Company's
results of operations.
o The Company will be dependent in virtually every phase of
its operations on the diligence and skill of the officers and
employees of the Bank and its affiliates. The Company will
contract with the Bank to advise the Board of Directors,
direct the day-to-day operations of the Company, and to
service the Mortgage Loans. Thus the Company's success will
depend on the skill and experience of the Bank's employees.
o Certain directors and officers of the Company will have
demands on their time other than those of the Company.
2
<PAGE> 9
o The Company, with no operating history, faces uncertainty as
to its ability to successfully implement its operating
policies and strategies.
o The rate at which dividends are to be paid is fixed and a
majority of the Mortgage Loans that constitute the Initial
Portfolio are adjustable rate Mortgage Loans, therefore, a
significant decline in interest rates may adversely affect the
Company's ability to pay dividends on the Series A Preferred
Shares. In such an interest rate environment, the Company may
experience an increase in prepayments on its Mortgage Loans
and may find it more difficult to purchase additional Mortgage
Loans bearing rates sufficient to support payment of the
dividends on the Series A Preferred Shares.
o As a subsidiary of the Bank, the Company is subject to the
risk that banking authorities will restrict the ability of the
Company to transfer assets, to make distributions to
stockholders, including dividends to the holders of Series A
Preferred Shares, or to redeem shares of Preferred Stock.
Under certain circumstances, certain of these restrictions
could result in the Company's failure to qualify as a REIT,
which could result in the inability of the Company to pay
dividends on the Series A Preferred Shares.
o The Company may be taxed as a regular corporation if it fails
to qualify as a REIT. If the Company fails to maintain its
status as a REIT for federal income tax purposes, it will be
subject to corporate income tax and will not be permitted to
deduct, for income tax purposes, dividends on the Series A
Preferred Shares or the Common Stock and may not generate
sufficient after-tax income to support payment of dividends on
the Series A Preferred Shares.
o A decline in the performance or capital levels of the Bank or
the placement of the Bank into conservatorship or receivership
could lead to the exchange of the Series A Preferred Shares
for Bank Preferred Shares, which would represent an investment
in the Bank and not in the Company, which is subject to
certain risks that are distinct from the risks associated with
an investment in the Company.
o In the event of receivership of the Bank, the claims of the
Bank's depositors and of its secured, senior, general and
subordinated creditors will be entitled to a priority of
payment over the claims of holders of equity securities such
as the Bank Preferred Shares.
o An Automatic Exchange will be a taxable event to the holders
of the Series A Preferred Shares.
o The Board of Directors may amend or revise (in certain
circumstances subject to the approval of a majority of the
Independent Directors) the policies of the Company set forth
herein, including the Company's policy regarding incurring
indebtedness. To the extent the Company were to change its
policy with respect
3
<PAGE> 10
to the incurrence of indebtedness, the Company would be
subject to risks associated with leverage, including, without
limitation, changes in interest rates, prepayment risk and
risks of various hedging strategies which may adversely affect
the Company's ability to pay dividends on the Series A
Preferred Shares.
o The geographic concentration in Michigan of the collateral
underlying the Mortgage Loans could adversely affect the value
of the Series A Preferred Shares and the Mortgage Loans held
by the Company.
o Casualty losses, borrower default and state law enforceability
issues, as well as other events and circumstances, may result
in losses on the Company's investments.
o Dividends are not cumulative. Consequently, if the Board of
Directors does not authorize and declare a dividend on the
Series A Preferred Shares for any quarterly period, including
if prevented by federal regulators from paying such dividend,
the holders of Series A Preferred Shares would not be entitled
to receive dividends whether or not funds are or subsequently
become available.
THE BANK
The Bank is a national bank with its deposits insured by the FDIC to
the maximum extent permitted by law. At September 30, 1997, the Bank had
total assets of $480.0 million and stockholders' equity of $32.8 million.
Its common stock trades on the Nasdaq National Market under the symbol "FSVB".
At September 30, 1997, the Bank conducted business from three regional
banking offices which generally offer traditional banking services and one
business center office exclusively catering to small and medium sized business
customers in Michigan. For the year ended December 31, 1996 and the nine
months ended September 30, 1997, the Bank had net income of $905,600 ($2.5
million excluding the one time SAIF recapitalization assessment) and $3.1
million, respectively; and a return on average assets of .19%, (.83% excluding
the SAIF assessment) and 89%, respectively. For more information concerning
the Bank, see the Bank Prospectus attached hereto as Annex I.
Each Series A Preferred Share will be exchanged automatically for
one newly issued Series A preferred share of the Bank (a "Bank Preferred
Share") only if the appropriate regulatory agency directs in writing an
exchange of the Series A Preferred Shares for Bank Preferred Shares because (i)
the Bank becomes "undercapitalized" under prompt corrective action regulations,
(ii) the Bank is placed into conservatorship or receivership or (iii) the
appropriate regulatory agency, in its sole discretion and even if the Bank is
not "undercapitalized," anticipates the Bank becoming "undercapitalized" in the
near term (the "Exchange Event"). CONSEQUENTLY, AN INVESTMENT IN SERIES A
PREFERRED SHARES COULD BE REPLACED BY AN INVESTMENT IN BANK PREFERRED SHARES AT
A TIME WHEN THE BANK'S FINANCIAL CONDITION IS DETERIORATING OR THE BANK HAS
BEEN PLACED INTO CONSERVATORSHIP OR RECEIVERSHIP. POTENTIAL INVESTORS IN THE
SERIES A PREFERRED SHARES, THEREFORE, SHOULD CAREFULLY CONSIDER
4
<PAGE> 11
THE DESCRIPTION OF THE BANK SET FORTH IN THE BANK PROSPECTUS ATTACHED HERETO AT
ANNEX I. See also "Description of Series A Preferred Shares--Automatic
Exchange". The Bank will be considered to be "undercapitalized" under the
prompt corrective action regulations established pursuant to the FDICIA, if it
has (i) a core capital (or leverage) ratio of less than 4.0%, (ii) a Tier 1
risk-based capital ratio of less than 4.0%, or (iii) a total risk-based capital
ratio of less than 8.0%. Tier 1 or core capital consists of common
shareholders' equity, noncumulative perpetual preferred stock, and minority
interests in consolidated subsidiaries, less certain intangible assets and
investments in certain subsidiaries. Total capital consists of core capital
plus supplementary capital (which includes cumulative perpetual preferred
stock, qualifying subordinated debt, and a limited amount of the allowances for
loan and lease losses) to the extent such supplementary capital does not exceed
100% of core capital, less certain equity investments. For purposes of the
prompt corrective action regulations, the Bank's capital category is determined
as of the most recent date (i) certain quarterly financial reports are required
to be filed with the regulators; (ii) a final report of examination has been
delivered to the Bank; or (iii) the Bank is notified in writing by the OCC of
its capital category or a change in such category. At September 30, 1997 and
December 31, 1996 and 1995, the Bank's core capital (or leverage) ratio was
6.54%, 5.99% and 6.58%, its Tier 1 risk-based capital ratio was 8.01%, 7.27%
and 7.85%, and its total risk-based capital ratio was 10.77%, 10.04% and
10.59%, respectively. After giving effect to the Offering, the September 30,
1997 ratios would have been 9.06%, 12.33% and 15.09%, respectively.
The Bank Preferred Shares will only be issued upon the occurrence of
the Automatic Exchange. The Bank Preferred Shares will not be registered with
the Commission but are being registered with the OCC. A copy of the prospectus
filed with the OCC relating to the Bank Preferred Shares is affixed to this
Prospectus (the "Bank Prospectus") at Annex I. The principal executive offices
of the Bank are located at 24725 West Twelve Mile Road, Southfield, Michigan
48034, and its telephone number at such address is (248) 358-4710.
POSSIBLE CONFLICTS OF INTEREST
The Company and the Bank have common officers and directors which
presents and may continue to present conflicts of interest in the Company's
dealings with the Bank. The Bank may have interests which are not identical to
those of the Company. Consequently, conflicts of interest may continue to arise
with respect to transactions, including without limitation, the Company's
acquisition of the Initial Portfolio; future acquisitions of Mortgage Loans
from the Bank or its affiliates; servicing of Mortgage Loans, particularly with
respect to Mortgage Loans that become Classified or placed on Nonaccrual Status
or which have been, more than once during the preceding twelve months, more
than 30 days past due in the payment of principal and interest; future
dispositions of Mortgage Loans to the Bank or any of its non-bank subsidiaries;
and the modification of the Advisory Agreement or the Servicing Agreements.
It is the intention of the Company and the Bank that any agreements
and transactions between the Company, on the one hand, and the Bank or their
affiliates, on the other hand, are fair to all parties and consistent with
market terms, including the prices paid and received for Mortgage Loans,
including those in the Initial Portfolio, on their acquisition or disposition
by the
5
<PAGE> 12
Company or in connection with the servicing of such Mortgage Loans. The
requirement in the Certificate of Designation establishing the Series A
Preferred Shares that certain actions of the Company be approved by a majority
of the Independent Directors is also intended to ensure fair dealings between
the Company, the Bank and their respective affiliates. However, there can be no
assurance that such agreements or transactions will be on terms as favorable to
the Company as those that could have been obtained from unaffiliated third
parties. Furthermore, although such actions will be approved by the
Independent Directors, daily operations between the Company and the Bank, in
its capacity as Advisor and Servicer to the Company, will not be required to be
approved by a majority of the Independent Directors. Instead, the Bank, acting
in its capacities as Advisor and Servicer, will conduct the day-to-day
operations of the Company in accordance with the guidelines established in the
Advisory Agreement and the Servicing Agreement which have been approved by a
majority of the Independent Directors. See "Risk Factors--Conflicts of
Interest in the Business of the Company May Result in Decisions of the Company
That Do Not Fully Reflect the Interests of the Stockholders of the Company" and
"Business and Strategy --Management Policies and Programs--Conflict of Interest
Policies".
THE OFFERING
For a more complete description of the terms of the Series A Preferred
Shares specified in the following summary, see "Description of Series A
Preferred Shares".
Issuer . . . . . . . . . . . . . . Franklin Finance Corporation, a
newly-formed Michigan corporation
created for the purpose of acquiring,
holding and managing Mortgage
Assets.
Securities Offered . . . . . . . . 1,800,000 Series A Preferred Shares.
The Company has granted the
Underwriters an option for 30 days to
purchase up to an additional
270,000 Series A Preferred Shares at
the initial public offering price
solely to cover over-allotments, if any.
Ranking . . . . . . . . . . . . . . With respect to the payment of
dividends and amounts upon
liquidation, the Series A Preferred
Shares will rank senior to the
Company's Common Stock. Additional
shares of preferred stock of the
Company (the "Preferred Stock")
ranking senior to the Series A
Preferred Shares may not be issued
without the approval of holders of at
least two-thirds of the Series A
Preferred Shares. Additional shares
of Preferred Stock ranking on a
parity with the Series A Preferred
Shares may not be issued without the
approval of a majority of the
Independent Directors. See "Description
of Series A Preferred
Shares--Independent Director Approval".
6
<PAGE> 13
Use of Proceeds . . . . . . . . . . The net proceeds to the Company from
the Offering, together with proceeds
received in connection with the sale
of shares of Common Stock to the
Bank, will be used to purchase the
Company's initial portfolio of Mortgage
Assets and to pay the expenses of the
Offering and the formation of the
Company (currently estimated by the
Company to be approximately
[$________] in the aggregate). See
"Use of Proceeds".
Dividends . . . . . . . . . . . . . Dividends on the Series A Preferred
Shares are payable at the rate of [ ]%
per annum of the liquidation preference
(an amount equal to $[ ] per annum per
share), if, when and as declared by
the Board of Directors of the
Company. If declared, dividends are
payable quarterly in arrears on the
last day of March, June, September and
December in each year, commencing
December 31, 1997. Dividends accrue
in each quarterly period from the first
day of such period, whether or not
dividends are paid with respect to
the preceding period. Dividends on the
Series A Preferred Shares are not
cumulative and, accordingly, if no
dividend is declared on the Series
A Preferred Shares by the Company for
a quarterly dividend period, holders
of the Series A Preferred Shares will
have no right to receive a dividend
for that period, and the Company will
have no obligation to pay a dividend
for that period, whether or not
dividends are declared and paid for any
future period with respect to either the
Series A Preferred Shares or the Common
Stock. If no dividend is paid on the
Series A Preferred Shares for a
quarterly dividend period, the payment
of dividends on the Common Stock (100%
of which is owned by the Bank) will be
prohibited for that period and at least
the following three quarterly
dividend periods. See "Description of
Series A Preferred Shares--Dividends".
Liquidation Preference . . . . . . The liquidation preference for each
Series A Preferred Share is $10.00,
plus an amount equal to the quarterly
accrued and unpaid dividends, if any,
thereon. See "Description of Series A
Preferred Shares -- Rights Upon
Liquidation".
7
<PAGE> 14
Redemption . . . . . . . . . . . . The Series A Preferred Shares are
not redeemable prior to
[ ], 2002 (except
upon the occurrence of a Tax Event as
defined in "Description of Series A
Preferred Shares--Redemption"). On and
after [ ], 2002, the Series A
Preferred Shares may be redeemed for
cash at the option of the Company,
in whole or in part, at any time and
from time to time, at a redemption price
of $10.00 per share, plus the accrued
and unpaid dividends for the most recent
quarter, if any, thereon. Upon the
occurrence of a Tax Event, the Company
will have the right at any time to
redeem the Series A Preferred Shares in
whole (but not in part) at a
redemption price of $10.00 per share,
plus the accrued and unpaid dividends
for the most recent quarter, if any,
thereon. The Series A Preferred Shares
will not be subject to any sinking fund
or mandatory redemption and will not be
convertible into any other securities of
the Company. See "Description of Series
A Preferred Shares--Redemption".
Automatic Exchange . . . . . . . . Each Series A Preferred Share will be
exchanged automatically for one Bank
Preferred Share upon the occurrence of
the Automatic Exchange. See
"Description of Series A Preferred
Shares--Automatic Exchange".
Voting Rights . . . . . . . . . . . Except as described herein with respect
to certain voting rights in the
Company, holders of Series A Preferred
Shares will not have any voting rights.
In any matter on which the Series A
Preferred Shares may vote (as expressly
provided herein or as may be required by
law), each Series A Preferred Share
will be entitled to one vote. See
"Description of Series A Preferred
Shares--Voting Rights".
Ownership Limits . . . . . . . . . Ownership of more than 9.9% of any
outstanding series of Preferred Stock,
including the Series A Preferred
Shares offered hereby, is restricted in
order to preserve the Company's status
as a REIT for federal income tax
purposes. See "Description of
Capital Stock--Restrictions on Ownership
and Transfer".
Trading . . . . . . . . . . . . . . The Company has applied for listing of
the Series A Preferred Shares on the
Nasdaq National Market, subject to
official notice of issuance, under the
symbol "FSVBP".
Ratings . . . . . . . . . . . . . . It is not expected that the Series A
Preferred Shares will be rated
by any independent rating agency.
8
<PAGE> 15
THE FORMATION
THE FORMATION
Prior to or simultaneously with the completion of the Offering, the
Company, the Bank and its affiliates will engage in the transactions described
under "Certain Transactions Constituting the Formation--The Formation". These
transactions are designed to (i) facilitate the Offering, (ii) transfer the
ownership of the Initial Portfolio (defined below) to the Company and (iii)
enable the Company to qualify as a REIT for federal income tax purposes
commencing with its taxable year ending December 31, 1997.
The following chart outlines the relationship between the Company, the
Bank and its affiliates following completion of the Offering.
-------------------------------
FRANKLIN BANK, N.A.
(THE BANK)
-------------------------------
| |
| 100% | Advisory Public
| Common Stock | Agreement Preferred
| | Stockholders
| | /
| | / 100%
| | Servicing / Series A
-------------------------------- | Agreements / Preferred Shares
| | | /
--------------------------- -------------------------------
FRANKLIN HOME LEADING FRANKLIN FINANCE CORPORATION
GROUP, INC. (THE COMPANY)
--------------------------- -------------------------------
As a newly-formed entity, the Company has no prior operating history.
As of the date hereof, the Company has $1,000 in assets, $1,000 in
stockholder's equity and no indebtedness. Immediately after the issuance by
the Company of the Series A Preferred Shares to the public and the Common Stock
to the Bank and the purchase by the Company of the Initial Portfolio, the
Company (assuming that (i) the Underwriters' over-allotment option is not
exercised and (ii) there are $1,100,000 in aggregate offering and
organizational expenses) will have $36 million in Mortgage Assets, $18 million
of stated capital attributable to the Series A Preferred Shares, $5.7 million
of stated capital attributable to the Common Stock and $12.3 million of
additional paid-in capital. See "Capitalization".
Through its subsidiary, Franklin Home Lending Group, Inc., the Bank
makes home equity loans and construction loans to builders and developers for
the construction of one- to four-family residences in the Bank's lending market
area. See the Bank Prospectus attached hereto at Annex I.
9
<PAGE> 16
BENEFITS TO THE BANK AND ITS AFFILIATES
The Bank is required by the OCC to maintain certain levels of capital
for bank regulatory purposes. The Bank has informed the Company that the Series
A Preferred Shares will be treated as capital of the Bank for regulatory
purposes. The Bank has indicated to the Company that such treatment, together
with the Company's ability to deduct, for income tax purposes, the dividends
payable on the Series A Preferred Shares as a result of the Company's
qualification as a REIT, will provide the Bank with a more cost-effective means
of obtaining capital for regulatory purposes than if the Bank were to issue
preferred stock itself.
The Bank will realize certain other benefits from the Offering and the
other transactions constituting the formation of the Company, including (i) the
receipt by the Bank of the net proceeds from the sale of $18 million of the
Series A Preferred Shares in connection with the sale to the Company of the
Initial Portfolio, (ii) an annual advisory fee equal to $125,000 under the
Advisory Agreement and (iii) an annual servicing fee of approximately $135,000.
It is also expected that the Bank will receive annual dividends totaling
approximately $_______ in respect of the Common Stock held by the Bank. For
information detailing the assumptions used in calculating the foregoing fees,
see "Certain Transactions Constituting the Formation--Benefits to the Bank and
Its Affiliates".
TAX STATUS OF THE COMPANY
The Company will elect to be taxed as a REIT under Sections 856
through 860 of the Code, commencing with its taxable year ending December 31,
1997. As a REIT, the Company generally will not be subject to federal income
tax on net income and capital gains that it distributes to the holders of its
Common Stock and Preferred Stock, including the Series A Preferred Shares.
In the opinion of the Company's special tax counsel, Seyburn, Kahn,
Ginn, Bess, Deitch and Serlin, P.C. ("Seyburn Kahn"), commencing with the
Company's taxable year ending December 31, 1997, the Company will be organized
in conformity with the requirements for qualification as a REIT, and its
proposed method of operation will enable it to meet the requirements for
qualification and taxation as a REIT under the Code. A REIT is subject to a
number of organizational and operational requirements, including a requirement
that it currently distribute to stockholders at least 95% of its "REIT Taxable
Income". Notwithstanding qualification for taxation as a REIT, the Company may
be subject to federal, state and/or local tax. See "Risk Factors--Tax, Legal
and Regulatory Risks" and "Federal Income Tax Considerations".
RISK FACTORS
Prospective investors should carefully consider the following
information in conjunction with the other information contained in this
Prospectus before purchasing Series A Preferred Shares in the Offering. For a
description of certain risk factors relating to the Bank and the Bank
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Preferred Stock, prospective investors should carefully review and consider the
information contained in the section entitled "Risk Factors" in the attached
Bank Prospectus. This Prospectus contains certain forward-looking statements
and information relating to the Company and the Bank that are based on the
beliefs of management as well as assumptions made by and information currently
available to management. In addition, the words "anticipate," "believe,"
"estimate," "expect," "intend" and similar expressions, as they relate to the
Company, the Bank or the Company's or the Bank's management, are intended to
identify forward-looking statements. Such statements reflect the current views
of the Company or the Bank with respect to future events and are subject to
certain risks, uncertainties and assumptions, including the risk factors
described in this Prospectus. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect,
actual results may vary materially from those described herein as anticipated,
believed, estimated, expected or intended. The Company and the Bank do not
intend to update these forward-looking statements.
CONFLICTS OF INTEREST IN THE BUSINESS OF THE COMPANY MAY RESULT
IN DECISIONS OF THE COMPANY THAT DO NOT FULLY REFLECT THE INTERESTS OF
THE STOCKHOLDERS OF THE COMPANY
BENEFITS TO INSIDERS. The Company is subject to various potential
conflicts of interest arising from its relationship with the Bank.
First, the Bank is the sole holder of the Common Stock of the Company. As the
holder of all of the outstanding voting stock of the Company, the Bank will
have the right to elect all directors of the Company, including the Independent
Directors, and to receive any dividends paid on the Common Stock. For the
first 12 months following completion of the Offering, dividends paid on the
Common Stock are anticipated to be approximately $___________. See "Certain
Transactions Constituting the Formation - Benefits to the Bank and its
Affiliates".
Second, the Bank, in its role as Advisor to the Company under the
Advisory Agreement, will render management services to the Company
for an advisory fee, and in its role as Sevicer to the Company under the
Servicing Agreement, will service the Mortgage Assets for a servicing fee,
which fees benefit the Bank. The Bank, as Advisor, will be entitled to receive
an annual advisory fee equal to $125,000 with respect to the advisory and
management services provided by it to the Company. The Bank, as Servicer, will
receive an annual servicing fee with respect to each Mortgage Loan serviced for
the Company equal to the outstanding principal balance of such Mortgage Loans
multiplied by a fee of .375%. For the first 12 months following completion of
the Offering, servicing fees paid to the Bank as Servicer are anticipated to be
approximately $_____________. See "Certain Transactions Constituting the
Formation - Benefits to the Bank and its Affiliates".
COMMON OFFICER AND DIRECTORS. All of the officers and directors of
the Company, other than the Independent Directors, are officers or
directors of the Bank, and will continue to serve in those capacities in the
future. As such, they are expected to provide services not only to the Company
but also to the Bank and its other affiliate, Franklin Home Lending Group, Inc.
Although the Company expects that such officers and directors will devote
adequate time to the Company's operations, if the operations of the Bank or its
affiliate need immediate attention, there can be no assurance that the
Company's officers and directors will have adequate time for the Company.
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PURCHASING AND SERVICING OF ASSETS. The Company is subject to
conflicts of interest with the Bank as the Company intends to acquire the
Initial Portfolio from the Bank; make future acquisitions of Mortgage Loans
from the Bank or its affiliates; service Mortgage Loans, particularly with
respect to Mortgage Loans that become Classified or placed on Nonaccrual Status
or which have been, more than once during the preceding twelve months, more
than 30 days past due in the payment of principal and interest; and make future
dispositions of Mortgage Loans to the Bank or any of its non-bank subsidiaries.
For example, conflicts of interest may arise between the Bank and the
Company with respect to the Commercial Mortgage Loans included in
the Initial Portfolio. The Company's interest will be limited to its interest
in the Commercial Mortgage Loan, but the Bank may have other interests as a
result of the Bank's overall relationship with the mortgagor in the course of
its commercial lending business. In addition, certain of the Commercial
Mortgage Loans are cross-collateralized with other credit facilities with the
Bank. As a result of the Bank having a relationship with the mortgagor of a
Commercial Mortgage Loan, including as lender with respect to other outstanding
loans to such mortgagor, the Bank, in its role as Advisor and Servicer, may
have different interests with respect to such Commercial Mortgage Loan in the
event that such Commercial Mortgage Loan becomes Classified or placed on
Nonaccrual Status or is otherwise past due in the payment of principal and
interest. As a result of such conflict, the Company may hold a Commercial
Mortgage Loan for a shorter or longer period of time than would otherwise be
the case if the Bank were not the Servicer of the Commercial Mortgage Loan or
the Advisor to the Company.
It is the intention of the Company and the Bank that any agreements
and transactions between the Company, on the one hand, and the Bank, on the
other hand, will be fair to all parties and consistent with market terms,
including the prices paid and received for Mortgage Assets, including
the Mortgage Loans in the Initial Portfolio, on their acquisition or
disposition by the Company or in connection with the servicing of such Mortgage
Assets. The requirement in the Certificate of Designation establishing the
Series A Preferred Shares that certain actions of the Company be approved by a
majority of the Independent Directors is also intended to ensure fair dealings
between the Company, the Bank and their respective affiliates. However, there
can be no assurance that such agreements or transactions will be on terms as
favorable to the Company as those that could have been obtained from
unaffiliated third parties. Any resolution of a conflict may adversely effect
the Company's results of operations. See "Business and Strategy--Management
Policies and Programs--Conflict of Interest Policies".
NO THIRD PARTY VALUATION OF THE MORTGAGE LOANS; NO ARM'S-LENGTH
NEGOTIATIONS WITH AFFILIATES. The Company and the Bank expect that the
fair value of the Initial Portfolio will approximately equal the amount
(approximately $36 million) that the Company will pay for the Initial
Portfolio. However, no third party valuations of the Mortgage Loans
constituting the Initial Portfolio will be obtained for purposes of the
Offering, and there can be no assurance that the fair value of the Initial
Portfolio will not differ from the purchase price payable by the Company.
In addition, it is not anticipated that third party valuations will be
obtained in connection with future acquisitions and dispositions of Mortgage
Assets even in circumstances where an
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<PAGE> 19
affiliate of the Company is selling the Mortgage Assets to, or purchasing the
Mortgage Assets from, the Company. Accordingly, although the Company and the
Bank intend that future acquisitions or dispositions of Mortgage Assets will be
on a fair value basis, there can be no assurance that the consideration to be
paid (or received) by the Company to (or from) the Bank or any of their
respective affiliates in connection with future acquisitions or dispositions of
Mortgage Assets will not differ from the fair value of such Mortgage Assets.
RISKS RELATED TO INVESTMENTS IN MORTGAGE ASSETS
GEOGRAPHIC CONCENTRATION OF THE COMPANY'S MORTGAGE ASSETS IN MICHIGAN
MAY MAKE THE COMPANY'S PERFORMANCE SUBJECT TO ECONOMIC CONDITIONS
IN MICHIGAN. Geographically, the Company's Mortgage Loans will be generally
concentrated in the State of Michigan. Geographic concentration of loans may
present risks in addition to those present with respect to Mortgage Loans
generally. Substantially all of the properties underlying the Company's
Residential and Commercial Mortgage Loans included in the Initial Portfolio are
located in Michigan. Mortgage Loans secured by properties located in Michigan
may be subject to a greater risk of default than other comparable Mortgage
Loans in the event of adverse economic, political or business developments or
natural hazards that may affect Michigan and the ability of property owners in
Michigan to make payments of principal and interest on the underlying
mortgages. The Company complies with general hazard insurance policy
requirements of Fannie Mae ("FNMA") or the Federal Home Loan Mortgage
Corporation ("FHLMC") or the Bank's underwriting guidelines.
LEGAL RESTRICTIONS ON SERVICING AND COLLECTION PROCEDURES FOR MORTGAGE
ASSETS MAY LIMIT THE COMPANY'S COLLECTION OF PRINCIPAL AND INTEREST AND
ADVERSELY AFFECT THE COMPANY'S RESULTS OF OPERATIONS. Applicable state laws
may regulate interest rates and other charges and require certain disclosures
to borrowers. In addition, most states have other laws, public policy and
general principles of equity relating to the protection of consumers, unfair
and deceptive practices and practices which may apply to the servicing and
collection of the Mortgage Loans. Depending on the provisions of the
applicable law and the specific facts and circumstances involved, violations of
these laws, policies and principles may limit the ability of the Company to
collect all or part of the principal of or interest on the Mortgage Loans, may
entitle the borrower to a refund of amounts previously paid and, in addition,
could subject the Company to damages and administrative sanctions. Management
of the Company believes the laws of the State of Michigan with regard to
Mortgage Loans do not impose any uniquely unfavorable burdens or conditions.
COMMERCIAL MORTGAGE LOANS INVOLVE A GREATER RISK OF LOSS THAN
RESIDENTIAL MORTGAGE LOANS. The Company anticipates that approximately 40%
(measured by aggregate outstanding principal amount) of its portfolio of
Mortgage Assets on an ongoing basis will consist of Commercial Mortgage Loans.
Commercial Mortgage Loans have certain distinct risk characteristics. The
Company's current policy is not to acquire any Commercial Mortgage Loan if such
Commercial Mortgage Loan would constitute more than 5% of the total book value
of the Mortgage Assets of the Company at the time of its acquisition.
Commercial Mortgage Loans generally lack standardized terms, which may
complicate their structure. Commercial real estate
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<PAGE> 20
properties themselves tend to be unique and are more difficult to value than
residential real estate properties. Commercial Mortgage Loans also tend to
have shorter maturities than Residential Mortgage Loans and may not be fully
amortizing, meaning that they may have a significant principal balance or
"balloon" payment due on maturity. In addition, commercial real estate
properties are generally subject to relatively greater environmental risks than
non-commercial properties and to the corresponding burdens and costs of
compliance with environmental laws and regulations. Also, there may be costs
and delays involved in enforcing rights of a property owner against tenants in
default under the terms of leases with respect to commercial properties. For
example, tenants may seek the protection of the bankruptcy laws, which could
result in termination of lease contracts.
LACK OF CREDIT ENHANCEMENT OR SPECIAL HAZARD INSURANCE COULD INCREASE
RISK OF LOSS ON MORTGAGE LOANS HELD BY THE COMPANY. The Company generally does
not intend to obtain credit enhancements such as mortgagor bankruptcy insurance
or to obtain special hazard insurance for its Mortgage Loans, other than
standard hazard insurance, which will in each case only relate to individual
Mortgage Loans. Accordingly, during the time it holds Mortgage Loans for which
third party insurance is not obtained, the Company will be subject to risks of
borrower defaults and bankruptcies and special hazard losses that are not
covered by standard hazard insurance (such as those occurring from floods
unless flood insurance has been obtained on an individual basis). In addition,
in the event of a default on any Mortgage Loan held by the Company resulting
from declining property values or worsening economic conditions, among other
factors, the Company would bear the risk of loss of principal to the extent of
any deficiency between (i) the value of the related mortgaged property, plus
any payments from an insurer (or guarantor in the case of Commercial Mortgage
Loans) and (ii) the amount owing on the Mortgage Loan. The Initial Portfolio
has a loan to value ratio of approximately 65%.
ECONOMIC AND BUSINESS RISK
A DECLINE IN INTEREST RATES MAY ADVERSELY AFFECT THE COMPANY'S ABILITY
TO PAY DIVIDENDS. The Company's income will consist primarily
of interest payments on the Mortgage Assets held by it. The Company
anticipates that approximately 56% of its Commercial Mortgage Loans and
approximately 49% of its Residential Mortgage Loans will bear interest at
adjustable rates. If there is a decline in interest rates (as measured by the
indices upon which the interest rates of the Mortgage Loans are based), then as
the adjustable rate loans adjust downward the Company will experience a
decrease in income available to be distributed to its stockholders. In such an
interest rate environment, the Company may also experience an increase in
prepayments on its Mortgage Loans (generally fixed rate loans) and may find it
more difficult to purchase additional Mortgage Loans bearing rates sufficient
to support payment of the dividends on the Series A Preferred Shares. Because
the rate at which dividends are required to be paid on the Series A Preferred
Shares is fixed, there can be no assurance that a declining interest rate
environment would not adversely affect the Company's ability to pay dividends
on the Series A Preferred Shares.
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<PAGE> 21
CHANGES IN REAL ESTATE MARKET CONDITIONS MAY ADVERSELY AFFECT THE
COMPANY'S RESULTS OF OPERATIONS. The results of the Company's
operations will be affected by various factors, many of which are beyond the
control of the Company, such as: (i) local and other economic conditions
affecting real estate value; (ii) the ability of a property to attract and
retain tenants, which may in turn be affected by local conditions such as an
oversupply of space or a reduction in demand for rental space in the
area, the attractiveness of properties to tenants, competition from other
available space and the ability of the owner to pay leasing commissions,
provide adequate maintenance and insurance, pay tenant improvement costs and
make other tenant concessions; and (iii) interest rate levels and the
availability of credit to refinance such loans at or prior to maturity. The
results of the Company's operations depend on, among other things, the level of
interest income generated by the Company's Mortgage Assets, the market value of
such Mortgage Assets and the supply of and demand for such Mortgage Assets.
Further, no assurance can be given that the values of the properties securing
the Mortgage Loans included in the Company's Initial Portfolio have remained or
will remain at the levels existing on the dates of origination of such Mortgage
Loans.
PROPERTIES WITH ENVIRONMENTAL PROBLEMS MAY INCREASE COSTS AND CREATE
LIABILITIES FOR THE COMPANY. In the event that the Company is
forced to foreclose on a defaulted Mortgage Loan to recover its investment in
such Mortgage Loan, the Company may be subject to environmental liabilities in
connection with the underlying real property which could exceed the value of
the real property. Although the Company intends to exercise due diligence to
discover potential environmental liabilities prior to the acquisition of any
property through foreclosure, hazardous substances or wastes, contaminants,
pollutants or sources thereof (as defined by state and federal laws and
regulations) may be discovered on properties during the Company's ownership or
after a sale thereof to a third party. If such hazardous substances are
discovered on a property which the Company has acquired in foreclosure or
otherwise, the Company may be required to remove those substances and clean up
the property. There can be no assurance that in such a case the Company would
not incur full recourse liability for the entire cost of any removal and
clean-up, that the cost of such removal and clean-up would not exceed the value
of the property or that the Company could recoup any of such costs from any
third party. The Company may also be liable to tenants and other users of
neighboring properties. In addition, the Company may find it difficult or
impossible to sell the property prior to or following any such clean-up.
ABILITY TO INCREASE LEVERAGE MAY ADVERSELY AFFECT THE COMPANY'S
INTEREST INCOME. Although the Company does not currently intend to
incur any indebtedness in connection with the acquisition and holding of
Mortgage Assets, the Company may do so at any time (although indebtedness in
excess of 20% of the aggregate amount of net proceeds received in connection
with the issuance of Preferred Stock and Common Stock may not be incurred
without the approval of a majority of the Independent Directors of the
Company). To the extent the Company were to change its policy with respect to
the incurrence of indebtedness, the Company would be subject to risks
associated with leverage, including, without limitation, changes in interest
rates,
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prepayment risk and risks of various hedging strategies which may adversely
affect the Company's ability to pay dividends on the Series A Preferred Shares.
DELAYS IN FORECLOSING OR LIQUIDATING DEFAULTED MORTGAGE LOANS COULD
AFFECT THE VALUE OF UNDERLYING PROPERTY. Even assuming that the
mortgaged properties underlying the Mortgage Loans held by the Company provide
adequate security for such Mortgage Loans, substantial delays could be
encountered in connection with the liquidation of defaulted Mortgage Loans,
with corresponding delays in the receipt of related proceeds by the Company. An
action to foreclose on a mortgaged property securing a Mortgage Loan is
regulated by state statutes and rules and is subject to many of the delays and
expenses of other lawsuits if defenses or counterclaims are interposed,
sometimes requiring several years to complete. Furthermore, in some states an
action to obtain a deficiency judgment is not permitted following a nonjudicial
sale of a mortgaged property. In the event of a default by a mortgagor, these
restrictions, among other things, may impede the ability of the Company to
foreclose on or sell the mortgaged property or to obtain proceeds sufficient to
repay all amounts due on the related Mortgage Loan. In addition, the Servicer
will be entitled to deduct from collections received all expenses reasonably
incurred in attempting to recover amounts due and not yet repaid on liquidated
Mortgage Loans, including legal fees and costs of legal action, real estate
taxes and maintenance and preservation expenses, thereby reducing amounts
available to the Company.
TAX, LEGAL AND REGULATORY RISKS
ADVERSE CONSEQUENCES OF FAILURE TO QUALIFY OR MAINTAIN REIT STATUS MAY
RESULT IN THE COMPANY BEING SUBJECT TO TAXATION AS A REGULAR
CORPORATION. The Company intends to operate so as to qualify as a REIT under
the Code. Although the Company believes that it will be owned and organized and
will operate in such a manner, and Seyburn Kahn will render certain opinions,
described under "Federal Income Tax Considerations" below, regarding the
Company's qualification as a REIT, no assurance can be given that the Company
will be able to operate in such a manner so as to qualify as a REIT or to
remain so qualified. Qualification as a REIT involves the application of highly
technical and complex Code provisions for which there are only limited judicial
or administrative interpretations. The determination of various factual matters
and circumstances, not entirely within the Company's control and not addressed
by the opinion of Seyburn Kahn, may affect the Company's ability to qualify as
a REIT. Although the Company is not aware of any proposal in Congress to amend
the tax laws in a manner that would materially and adversely affect the
Company's ability to operate as a REIT, no assurance can be given that new
legislation or new regulations, administrative interpretations or court
decisions will not significantly change the tax laws in the future with respect
to qualification as a REIT or the federal income tax consequences of such
qualification.
The Company is relying on the opinion of Seyburn Kahn, special tax
counsel to the Company, regarding various issues affecting the Company's
ability to qualify, and retain qualification, as a REIT. Such opinion is not
binding on the Internal Revenue Service ("IRS").
If in any taxable year the Company fails to qualify as a REIT, the
Company would not be allowed a deduction for distributions to stockholders in
computing its taxable income and would
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be subject to federal income tax (including any applicable alternative minimum
tax) on its taxable income at regular corporate rates. As a result, the amount
available for distribution to the Company's stockholders would be reduced for
the year or years involved which could result in the inability of the Company
to pay dividends on the Series A Preferred Shares. In addition, unless entitled
to relief under certain statutory provisions, the Company would also be
disqualified from treatment as a REIT for the four taxable years following the
year during which qualification was lost. A failure of the Company to qualify
as a REIT would not by itself give the Company the right to redeem the Series A
Preferred Shares. See "Description of Series A Preferred Shares--Redemption".
Notwithstanding that the Company currently intends to operate in a
manner designed to qualify as a REIT, future economic, market, legal, tax or
other considerations may cause the Company to determine that it is in the best
interests of the Company and the holders of its Common Stock and Preferred
Stock to revoke the REIT election. As long as any Series A Preferred Shares are
outstanding, any such determination by the Company may not be made without the
approval of a majority of the Independent Directors. The tax law prohibits the
Company from electing treatment as a REIT for the four taxable years following
the year of such revocation. See "Federal Income Tax Considerations".
SERIES A PREFERRED SHARES MAY BE REDEEMED BY THE COMPANY UPON
OCCURRENCE OF A TAX EVENT. At any time following the occurrence of a Tax
Event, even if such Tax Event occurs prior to [ ], 2002, the Company
will have the right to redeem the Series A Preferred Shares in whole but not in
part. See "Description of Series A Preferred Shares--Redemption". Upon the
occurrence of a Tax Event, should the Company not redeem the Series A Preferred
Shares, the Company's ability to pay dividends on the Series A Preferred Shares
may be adversely affected.
A "Tax Event" means the receipt by the Company of an opinion of a law
or accounting firm experienced in such matters to the effect that, as a
result of (i) any amendment to, clarification of, or change (including any
announced prospective change) in the laws or treaties (or any regulations
thereunder) of the United States or any political subdivision or taxing
authority thereof or therein affecting taxation, (ii) any judicial decision,
official administrative pronouncement, published or private ruling, regulatory
procedure, notice or announcement (including any notice or announcement of
intent to adopt such procedures or regulations) ("Administrative Action") or
(iii) any amendment to, clarification of, or change in the official position or
the interpretation of such Administrative Action or any interpretation or
pronouncement that provides for a position with respect to such Administrative
Action that differs from the theretofore generally accepted position, in each
case, by any legislative body, court, governmental authority or regulatory
body, irrespective of the manner in which such amendment, clarification or
change is made known, which amendment, clarification, or change is effective or
such pronouncement or decision is announced on or after the date of issuance of
the Series A Preferred Shares, there is more than an insubstantial risk that
(a) dividends paid or to be paid by the Company with respect to the capital
stock of the Company are not, or will not be, fully deductible by the Company
for United States federal income tax purposes or (b) the Company is,
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or will be, subject to more than a de minimis amount of other taxes, duties or
other governmental charges.
AUTOMATIC EXCHANGE MAY CAUSE A TAXABLE EVENT TO HOLDERS OF SERIES A
PREFERRED SHARES. Upon the occurrence of the Exchange Event and a Directive,
the outstanding Series A Preferred Shares will be automatically exchanged on a
one-for-one basis into Bank Preferred Shares. See "Description of Series A
Preferred Shares--Automatic Exchange". Assuming, as is anticipated to be the
case, that the Bank Preferred Shares will be nonvoting, the Automatic Exchange
will be taxable, and each holder of Series A Preferred Shares will have a gain
or loss, as the case may be, measured by the difference between the basis of
such holder in the Series A Preferred Shares and the fair market value of the
Bank Preferred Shares received in the Automatic Exchange. Assuming that such
holder's Series A Preferred Shares were held for more than one year prior to
the Automatic Exchange and held as capital assets, any gain or loss will be
long-term capital gain or loss. See "Federal Income Tax Considerations--Tax
Treatment of Automatic Exchange".
INVESTMENT IN THE SERIES A PREFERRED SHARES OF THE COMPANY BY CERTAIN
PLANS MAY GIVE RISE TO A PROHIBITED TRANSACTION UNDER ERISA AND THE CODE. The
Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and
section 4975 of the Code prohibit certain transactions that involve (i) certain
pension, profit- sharing or other employee benefit plans subject to Title I of
ERISA (each a "Plan") and (ii) the assets of a Plan. A "party in interest" or
"disqualified person" with respect to a Plan will be subject to (x) an initial
15% excise tax on the amount involved in any prohibited transaction involving
the assets of the Plan for each year or part thereof during which the
transaction is not corrected and (y) an excise tax equal to 100% of the amount
involved if any prohibited transaction is not corrected. Consequently, the
fiduciary of a Plan contemplating an investment in the Series A Preferred
Shares should consider whether the Company, any other person associated with
the issuance of the Series A Preferred Shares, or any affiliate of the
foregoing is or might become a "party in interest" or "disqualified person"
with respect to the Plan. In such a case, the acquisition or holding of Series
A. Preferred Shares by or on behalf of the Plan could be considered to give
rise to a prohibited transaction under ERISA and the Code. See "ERISA
Considerations"
BOARD OF DIRECTORS MAY CHANGE OR REVISE CERTAIN POLICIES AND
STRATEGIES WITHOUT STOCKHOLDER CONSENT. The Board of Directors has
established the investment policies and operating policies and strategies of
the Company, certain of which are described in this Prospectus. These policies
may be amended or revised from time to time at the discretion of the Board of
Directors (in certain circumstances subject to the approval of a majority of
the Independent Directors) without a vote of the Company's stockholders,
including holders of the Series A Preferred Shares. The ultimate effect of any
change in the policies and strategies set forth in this Prospectus on a holder
of Series A Preferred Shares may be positive or negative. See "Business and
Strategy--Management Policies and Programs".
A DECLINE IN THE BANK'S CAPITAL POSITION OR THE RECEIVERSHIP OF THE
BANK MAY CAUSE THE SERIES A PREFERRED SHARES TO BE AUTOMATICALLY EXCHANGED INTO
BANK PREFERRED SHARES. The purchase of Series A Preferred Shares involves a
high degree of risk with respect to the
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<PAGE> 25
performance and capital levels of the Bank. A decline in the performance and
capital levels of the Bank or the placement of the Bank into conservatorship or
receivership could result in the exchange of the Series A Preferred Shares for
Bank Preferred Shares, which would be an investment in the Bank and not in the
Company. As a result, holders of Series A Preferred Shares would become
preferred stockholders of the Bank at a time when the Bank's financial
condition was deteriorating or when the Bank had been placed into
conservatorship or receivership. An investment in the Bank is subject to
certain risks that are distinct from the risks associated with an investment in
the Company. For example, an investment in the Bank would involve risks
relating to the capital levels of, and other regulatory requirements applicable
to, the Bank and the performance of the Bank's loan portfolio. An investment
in the Bank is also subject to the general risks inherent in equity investments
in depository institutions. In the event of a liquidation of the Bank, the
claims of depositors and secured, senior, general and subordinated creditors of
the Bank would be entitled to a priority of payment over the claims of holders
of equity interests such as the Bank Preferred Shares. As a result, if the
Bank were to be placed into receivership after the Automatic Exchange or if the
Automatic Exchange were to occur after receivership of the Bank, the holders of
the Bank Preferred Shares likely would receive, if anything, substantially less
than the holders of the Series A Preferred Shares would have received had the
Series A Preferred Shares not been exchanged for Bank Preferred Shares.
Furthermore, there can be no assurance that the Bank would be in a financial
position, after the occurrence of the Automatic Exchange, to make any dividend
payments on the Bank Preferred Shares. Potential investors in the Series A
Preferred Shares should carefully consider the risks with respect to an
investment in the Bank set forth in the Bank Prospectus attached hereto as
Annex I. See also "Description of Series A Preferred Shares--Automatic
Exchange".
REGULATORY AUTHORITIES MAY IMPOSE RESTRICTIONS ON DIVIDENDS AND
OPERATIONS OF THE COMPANY. Because the Company is a subsidiary of the Bank,
regulatory authorities will have the right to examine the Company and its
activities. Under certain circumstances, including any determination that the
Bank's relationship to the Company results in an unsafe and unsound banking
practice, such regulatory authorities will have the authority to restrict the
ability of the Company to transfer assets, to make distributions to its
stockholders (including dividends to the holders of Series A Preferred Shares,
as described below), or to redeem shares of Preferred Stock, or even to require
the Bank to sever its relationship with or divest its ownership of the Company.
Such actions could potentially result in the Company's failure to qualify as a
REIT. See "Federal Income Tax Considerations--Failure to Qualify".
Payment of dividends on the Series A Preferred Shares could also be
subject to regulatory limitations if the Bank becomes "undercapitalized" for
purposes of the OCC prompt corrective action regulations, which is currently
defined as having a total risk-based capital ratio of less than 8.0%, a Tier 1
risk-based capital ratio of less than 4.0% or a core capital (or leverage)
ratio of less than 4.0%. At September 30, 1997, the Bank's total risk-based
capital ratio was 10.77%, its Tier 1 risk-based capital ratio was 8.01% and
its core capital (or leverage) ratio was 6.54%. Such ratios, adjusted to
give effect to the sale of Series A Preferred Shares in the Offering, would
have been 15.09%, 12.33% and 9.06%, respectively.
19
<PAGE> 26
The Company currently expects that its net income will be in excess of
amounts needed to pay dividends on the Series A Preferred
Shares. See "Business and Strategy--Dividends".
REGULATORY AUTHORITIES MAY IMPOSE DIVIDEND RESTRICTIONS ON BANK
PREFERRED SHARES RECEIVED UPON AN AUTOMATIC EXCHANGE. If the Automatic
Exchange occurs, the Bank would likely be prohibited from paying dividends on
the Bank Preferred Shares. In all circumstances following the Automatic
Exchange, the Bank's ability to pay dividends would be subject to various
restrictions under OCC regulations. See "Federal Income Tax Considerations--Tax
Treatment of Automatic Exchange".
The 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 cash 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 Bank's net
profits for the preceding half year in the case of quarterly or semi-annual
dividends, or the preceding two half-year periods in the case of annual
dividends, are transferred to the surplus 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, the 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, the Bank would be
classified as "undercapitalized" under the OCC's regulations.
Furthermore, in the event the Bank is placed into conservatorship or
receivership (whether before or after the Automatic Exchange), the Bank would
likely be unable to pay dividends on the Bank Preferred Shares. In addition,
in the event of a liquidation of the Bank, the claims of the Bank's depositors
and of its secured, senior, general and subordinated creditors would be
entitled to a priority of payment over the dividend and other claims of holders
of equity interests such as the Bank Preferred Shares issued pursuant to the
Automatic Exchange.
OTHER RISKS
UNCERTAINTY AS TO THE COMPANY'S ABILITY TO IMPLEMENT SUCCESSFULLY ITS
OPERATING POLICIES AND STRATEGIES RESULTING FROM ITS LACK OF OPERATING HISTORY.
The Company was organized on September 1997. The Company has no operating
history and has not implemented its operating policies and strategies. The
Company will be dependent upon the experience and expertise of the Bank in
advising the Company and administering its day-to-day operations.
20
<PAGE> 27
THE COMPANY'S SUCCESS MAY DEPEND ON THE SERVICES OF THE BANK. The
Company is a newly organized corporation with no operating history
and no revenues to date. The Company will contract with the Bank, as the
Advisor to the Company, to advise the Board of Directors and direct the
day-to-day business affairs of the Company. Thus, the Company's success may
depend on the services of the Advisor and its officers and employees. The
Company will be dependent for the selection, structuring and monitoring of its
Mortgage Assets on the diligence and skill of its officers (all of whom are
also officers of the Bank or its affiliates) and the officers and employees of
the Bank, as Advisor. See "Management". In addition, the Company will be
dependent upon the expertise of the Bank, as Servicer, for the servicing of its
Mortgage Loans. To the extent officers and employees of the Bank and its
affiliates do not exercise an appropriate level of diligence and skill, the
Company's results of operations may be adversely affected. The Advisor may
subcontract all or a portion of its obligations under the Advisory Agreement,
and the Servicer may subcontract all or a portion of its obligations under the
Servicing Agreements, to one or more affiliates, and under certain conditions
to non-affiliates, involved in the business of managing or servicing, as the
case may be, Mortgage Assets. In the event the Advisor or the Servicer
subcontracts its obligations in such a manner, the Company will be dependent
upon the subcontractor to provide any such services. See "Management--The
Advisor" and "Business and Strategy--Servicing".
DIVIDEND NOT DECLARED BY THE BOARD DURING ANY QUARTER WOULD NOT BE
PAID IN A SUBSEQUENT QUARTER. In order to qualify as Tier 1 capital, dividends
on the Series A Preferred Shares are not cumulative. Consequently, if the
Board of Directors does not declare a dividend on the Series A Preferred Shares
for any quarterly period, the holders of the Series A Preferred Shares would
not be entitled to recover such dividend whether or not funds are or
subsequently became available. The Board of Directors may determine, in its
business judgment, that it would be in the best interests of the Company to pay
less than the full amount of the stated dividends on the Series A Preferred
Shares or no dividends for any quarter notwithstanding that funds are
available. Factors that would generally be considered by the Board of
Directors in making this determination are the Company's financial condition
and capital needs, the impact of legislation and regulations as then in effect
or as may be proposed, economic conditions, and such other factors as the Board
may deem relevant. To remain qualified as a REIT, the Company must distribute
annually at least 95% of its "REIT Taxable Income" (not including capital
gains) to stockholders. See "--Tax Risks," below and "Federal Income Tax
Considerations--Taxation of the Company--Organizational Requirements".
NO PRIOR MARKET FOR SERIES A PREFERRED SHARES. Prior to the
Offering, there has been no public market for the Series A Preferred Shares and
there can be no assurance that an active trading market will develop or be
sustained or that the Series A Preferred Shares may be resold at or above the
initial public offering price.
IN THE EVENT THE SERIES A PREFERRED SHARES ARE EXCHANGED FOR BANK
PREFERRED SHARES, THE BANK PREFERRED SHARES WILL NOT BE LISTED ON THE
NASDAQ SYSTEM OR ANY EXCHANGE. Although the Series A Preferred Shares will be
listed on the Nasdaq National Market, the Bank does not intend to apply for
listing of the Bank Preferred Shares, for which the Series A Preferred Shares
will be exchanged automatically on a one-for-one basis upon the occurrence
21
<PAGE> 28
of the Automatic Exchange, on any national securities exchange or for quotation
of the Bank Preferred Shares through the Nasdaq System. Consequently, there
can be no assurance as to the liquidity of the trading markets for the Bank
Preferred Shares, if issued, or that an active public market for the Bank
Preferred Shares would develop or be maintained. Therefore, the value of the
Bank Preferred Shares will not be readily determinable. The Automatic Exchange
will be a taxable exchange with respect to which each holder of the Series A
Preferred Shares will have a gain or loss, as the case may be, measured by the
difference between the basis of such holder in the Series A Preferred Shares
and the fair market value of the Bank Preferred Shares received in the
Automatic Exchange. Each individual holder will be required to determine the
fair market value of the Bank Preferred Shares received to determine the tax
effect of the Automatic Exchange. Any such determination may be subject to
challenge by the IRS.
THE COMPANY
The Company is a newly-formed Michigan corporation incorporated on
September 25, 1997 and created for the purpose of acquiring, holding and
managing Mortgage Assets that will generate net income for distribution to
stockholders. The Company has been formed by the Bank to provide the Bank with
a means of raising capital for bank regulatory purposes. The Company is not a
financial institution or insurance company for purposes of Section 856(a) of
the Code. The Series A Preferred Shares will be treated as capital for the
Bank for regulatory purposes. The issuance of the Series A Preferred Shares by
the Company is a more cost-effective means of raising capital for the Bank than
if the Bank were to issue preferred stock itself, because of the Company's
ability to deduct for income tax purposes the dividends payable on the Series A
Preferred Shares as a result of the Company's qualification as a REIT.
The Company anticipates that approximately 60% of its portfolio of
Mortgage Assets will represent interests in Residential Mortgage Loans and
mortgage securities and that approximately 40% of its portfolio of Mortgage
Assets will represent interests in Commercial Mortgage Loans (in each case
measured by aggregate outstanding principal amounts).
The Company expects that all of the Mortgage Assets in the Initial
Portfolio will be acquired as whole loans from the Bank. The Bank will
administer the day-to-day operations of the Company in its role as Advisor
under the Advisory Agreement. The Company will elect to be subject to tax as a
REIT under the Code, and will generally not be subject to federal income tax to
the extent that it distributes its earnings to its stockholders and maintains
its qualification as a REIT.
All of the Common Stock of the Company is owned by the Bank. The Bank
conducts its business through a network of three regional banking offices and
one business center office serving exclusively small and medium sized business
customers in Michigan. As of September 30, 1997, the Bank had total assets
of $480.0 million and stockholders' equity of $32.8 million. For more
information concerning the Bank, see the Bank Prospectus attached hereto at
Annex I.
22
<PAGE> 29
The Series A Preferred Shares will be exchanged automatically on a
one-for-one basis for Bank Preferred Shares upon the occurrence of the
Automatic Exchange. CONSEQUENTLY, AN INVESTMENT IN SERIES A PREFERRED SHARES
COULD BE REPLACED BY AN INVESTMENT IN BANK PREFERRED SHARES AT A TIME WHEN THE
BANK'S FINANCIAL CONDITION IS DETERIORATING OR WHEN THE BANK HAS BEEN PLACED
INTO CONSERVATORSHIP OR RECEIVERSHIP. POTENTIAL INVESTORS IN THE SERIES A
PREFERRED SHARES, THEREFORE, SHOULD CAREFULLY CONSIDER THE DESCRIPTION OF THE
BANK SET FORTH IN THE BANK PROSPECTUS ATTACHED HERETO AS ANNEX I. NO OBLIGATION
OF THE COMPANY IS GUARANTEED BY THE BANK. See also "Description of Series A
Preferred Shares--Automatic Exchange".
For a further description of the operations of the Company, see
"Business and Strategy," "Management," "Risk Factors" and "Federal Income Tax
Considerations".
USE OF PROCEEDS
The proceeds to the Company from the sale of the Series A Preferred
Shares offered hereby are expected to be $18 million (assuming the
Underwriters' over-allotment option is not exercised). Simultaneously with the
consummation of the Offering, the Bank will purchase shares of Common Stock for
a price equal to $18 million. The Company will use the aggregate proceeds of
$36 million received in connection with both the Offering and the sale of
shares of Common Stock to the Bank to purchase the Initial Portfolio from the
Bank. See "Business and Strategy".
If the Underwriters exercise their option to purchase additional
Series A Preferred Shares to cover over-allotments in the Offering, the Bank
will purchase additional shares of Common Stock for a price equal to the
aggregate initial public offering price of such additional Series A Preferred
Shares. The Company will use the additional proceeds from any such additional
sales of Series A Preferred Shares and shares of Common Stock to purchase
additional Mortgage Loans of the types described in "Business and
Strategy--Description of Initial Portfolio". The Company expects that it will
purchase any such additional Commercial and Residential Mortgage Loans within
six months from the exercise by the Underwriters of their over-allotment
option. Pending such purchase, the Company will invest such additional
proceeds in mortgage-backed securities or short-term money market investments.
Simultaneously with the consummation of the Offering, the Bank will
also purchase additional shares of Common Stock for a price equal to the
aggregate amount of underwriting commissions and expenses incurred by the
Company in connection with the Offering and all expenses incurred by the
Company in connection with its formation and the offering of the Series A
Preferred Shares (currently estimated by the Company to be approximately
$1,100,000 in the aggregate) in order to provide the Company with funds
sufficient to pay such expenses. Simultaneously with the consummation of any
sale of additional Series A Preferred Shares in connection with the exercise by
the Underwriters of their over-allotment option, the Bank will also purchase
additional shares of Common Stock for a price equal to the aggregate amount of
23
<PAGE> 30
underwriting commissions and expenses incurred by the Company in connection
with the exercise of such overallotment option in order to provide the Company
with funds sufficient to pay such expenses.
The following table illustrates the use of proceeds by the Company
from the sale of the Series A Preferred Shares offered hereby (assuming the
Underwriters' over-allotment option is not exercised) and the sale of shares of
Common Stock to the Bank described above.
<TABLE>
<S> <C>
Gross proceeds from the Offering of
Series A Preferred Shares . . . . . . . . . . . . . . . . . . . $18,000,000
Gross proceeds from the issuance of
shares of Common Stock to the Bank . . . . . . . . . . . . . . . 19,100,000
Public Offering Expenses:
Underwriting commissions . . . . . . . . . . . . . . . . . . . [757,500]
Other expenses of the formation
and the Offering . . . . . . . . . . . . . . . . . . . . . . . 342,500(1)
-----------
Net proceeds to be applied to the
purchase of Mortgage Assets from
the Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . $36,000,000
===========
</TABLE>
--------------
(1) Assumes that expenses incurred by the Company
in connection with its formation and the
Offering of the Series A Preferred Shares,
other than underwriting commissions, are
$342,500. If such expenses are in excess of
$342,500, the Bank will purchase additional
shares of Common Stock for a purchase price
equal to such excess.
Neither the Bank nor any of its affiliates will receive any
transaction fees upon completion of the Offering, including any advance payment
in respect of servicing or advisory fees.
24
<PAGE> 31
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
October 3, 1997 (the date of the most recent audited financial statement of the
Company) and as adjusted to reflect (i) the consummation of the Offering
(assuming the Underwriters' over-allotment option is not exercised) and (ii)
the transactions described in "Certain Transactions Constituting The
Formation--The Formation" and the use of the net proceeds therefrom as
described under "Use of Proceeds".
<TABLE>
<CAPTION>
October 3, 1997
---------------------------------------
As
Actual Adjusted
------------------ ------------------
(In Thousands)
<S> <C> <C>
DEBT
Total long-term debt . . . . . . . . . . . . . . . . . $ --- $ ---
------- -------
STOCKHOLDERS' EQUITY
Preferred Stock, par value $10.00; 2,500,000
authorized, none issued and outstanding, actual;
and 2,500,000 shares authorized, 1,800,000
shares issued and outstanding, as adjusted . . . . . . . --- 18,000
Common Stock, par value $1.00 per share(1);
1,000 shares authorized, 1,000 shares issued and
outstanding, actual; and 60,000 shares authorized,
19,100 shares issued and outstanding, as adjusted . . . 1 5,730
Additional paid-in capital . . . . . . . . . . . . . . . --- 12,270
------- -------
Total stockholders' equity . . . . . . . . . . . . . . $ 1 $36,000
------- -------
TOTAL CAPITALIZATION . . . . . . . . . . . . . . . . . . . $ 1 $36,000
======= =======
</TABLE>
- --------------------------
(1) The Company was formed with an initial capitalization of $1,000. Prior to
consummation of the Offering, the charter of the Company will be amended to
increase the authorized capital of the Company and to increase the par
value of the Common Stock to $300.00 per share. Since the par value per
share of the Preferred Stock equals the issue price of a Series A Preferred
Share, the full $18.0 million raised in the Offering will represent
Preferred Stock capital. The par value of the Common Stock will equal 30%
of its purchase price of $1,000 per share and, accordingly, the Bank will
be acquiring 19,100 shares of Common Stock upon the consummation of the
Offering for an aggregate purchase price of $19,100,000 (such number of
shares of Common Stock includes Common Stock acquired by the Bank in order
to provide sufficient funds to pay aggregate offering and organization
expenses, currently estimated by the Company to be approximately
$1,100,000). As a result of these issuances of Common Stock, the Common
Stock capital amount, upon consummation of the Offering, will equal
$5,730,000. The additional paid-in capital of $12,270,000 represents the
excess of the purchase price for the Common Stock over the par value of
such shares after deducting the aggregate amount of offering and
organization expenses.
25
<PAGE> 32
BUSINESS AND STRATEGY
GENERAL
The Company's principal business objective is to acquire, hold and
manage Mortgage Assets that will generate net income for distribution to
stockholders. The Company expects that all of its initial Mortgage Assets will
be acquired from the Bank as whole loans ("Mortgage Loans") secured by first
mortgages or deeds of trust on single-family (one- to four-unit) residential
real estate properties ("Residential Mortgage Loans") or by commercial real
estate properties ("Commercial Mortgage Loans"). The Company may also from time
to time acquire investment grade mortgage securities that qualify as real
estate assets under Section 856(c)(6)(B) of the Code. Mortgage loans
underlying the mortgage securities will be secured by single-family
residential, multifamily or commercial real estate properties located in the
United States. The Company does not expect to be in the business of selling or
trading Mortgage Assets. The Company will acquire the Initial Portfolio of
Mortgage Loans from the Bank for an aggregate purchase price of approximately
$36 million. See "Certain Transactions Constituting the Formation".
In order to preserve its status as a REIT under the Code,
substantially all of the assets of the Company will consist of Mortgage Loans
and other qualified REIT real estate assets of the type set forth in Section
856(c)(6)(B) of the Code. See "Federal Income Tax Considerations".
Simultaneously with the consummation of the Offering, the Bank will
purchase shares of Common Stock for a price equal to $18 million.
The Company will use the aggregate proceeds of $36 million received in
connection with both the Offering and such sale of shares of Common Stock to
the Bank to purchase a portfolio of Mortgage Loans (the "Initial Portfolio")
from the Bank. If the Underwriters exercise their option to purchase additional
Series A Preferred Shares to cover over-allotments, the Bank will purchase
additional shares of Common Stock for a price equal to the aggregate public
offering price of the additional Series A Preferred Shares purchased pursuant
to the Underwriters' over-allotment option, and the Company will use the
additional proceeds from any such additional sales of Series A Preferred Shares
and shares of Common Stock to purchase additional Mortgage Loans of the types
described in "--Description of Initial Portfolio". Simultaneously with the
consummation of the Offering (or upon the exercise by the Underwriters of their
over-allotment option), the Bank will also purchase additional shares of Common
Stock for a price equal to the aggregate amount of underwriting commissions and
expenses incurred by the Company in connection with the Offering (including
without limitation any underwriting commissions associated with the exercise by
the Underwriters of their over-allotment option) and all expenses incurred by
the Company in connection with its formation in order to provide the Company
with funds sufficient to pay such expenses. See "Use of Proceeds".
On September 30, 1997, the pool of Mortgage Loans from which the
Initial Portfolio will be selected had an aggregate outstanding principal
balance of approximately $43.1 million. Approximately 60% (measured by
aggregate outstanding principal balance) of such pool consists of Residential
Mortgage
26
<PAGE> 33
Loans. See "--Description of Initial Portfolio-- Residential Mortgage Loans".
The remainder of such pool consists of Mortgage Loans secured by Commercial
Mortgage Loans. See "--Description of Initial Portfolio-- Commercial Mortgage
Loans". The Bank will enter into servicing agreements with respect to the
Residential Mortgage Loans and the Commercial Mortgage Loans (the "Servicing
Agreements") pursuant to which it will service the Mortgage Loans included in
the Initial Portfolio and will be entitled to receive fees in connection with
the servicing of such Mortgage Loans. The Bank in its role as servicer under
the Servicing Agreements is hereinafter referred to as the "Servicer". The
Company will not receive income from servicing loans. See "--Servicing".
The Company and the Bank believe, based on Bank management's
experience in evaluating mortgage loans, that the fair value of the Initial
Portfolio will approximately equal the amount (approximately $36 million) that
the Company will pay for the Initial Portfolio. However, no third party
valuations of the Mortgage Loans constituting the Initial Portfolio have been
or will be obtained for purposes of the Offering. See "Risk Factors--Conflicts
of Interest in the Business of the Company May Result in Decisions of the
Company That Do Not Fully Reflect the Interests of the Stockholders of the
Company--No Third Party Valuation of the Mortgage Loans; No Arm's-Length
Negotiations with Affiliates".
The Company will enter into an advisory agreement with the Bank (the
"Advisory Agreement") pursuant to which the Bank will administer the
day-to-day operations of the Company. The Bank in its role as advisor under the
terms of the Advisory Agreement is hereinafter referred to as the "Advisor".
The Advisor will be responsible for (i) monitoring the credit quality of
Mortgage Assets held by the Company, (ii) advising the Company with respect to
the acquisition, management, financing and disposition of the Company's
Mortgage Assets and (iii) holding documents relating to the Mortgage Assets as
custodian on behalf of the Company. The Advisor may from time to time
subcontract all or a portion of its obligations under the Advisory Agreement to
one or more of its affiliates involved in the business of managing Mortgage
Assets. The Advisor may, with the approval of a majority of the Board of
Directors, as well as a majority of the Independent Directors, subcontract all
or a portion of its obligations under the Advisory Agreement to unrelated third
parties. The Advisor will not, in connection with the subcontracting of any of
its obligations under the Advisory Agreement, be discharged or relieved in any
respect from its obligations under the Advisory Agreement. The Advisor and its
personnel have substantial experience in mortgage finance and in the
administration of Mortgage Assets.
The Advisory Agreement has an initial term of five years, and will be
renewed automatically for additional five-year periods unless notice of
nonrenewal is delivered to the Advisor by the Company. The Advisory Agreement
may be terminated by the Company at any time upon 90 days' prior notice. As
long as any Series A Preferred Shares remain outstanding, any decision by the
Company either not to renew the Advisory Agreement or to terminate the Advisory
Agreement must be approved by a majority of the Board of Directors, as well as
by a majority of the Independent Directors. The Advisor will be entitled to
receive an annual advisory fee equal to $125,000. See "Management--The
Advisor".
See "Certain Transactions Constituting the Formation--Benefits to the
Bank and Its Affiliates" for information regarding the aggregate amounts
payable to the Bank and its affiliates
27
<PAGE> 34
in connection with the Offering and the transactions to be entered into in
connection with the Offering.
The Company's Board of Directors is composed of five members, two of
whom will be Independent Directors. Certain actions by the Company
require the prior approval of a majority of Independent Directors. See
"Description of Series A Preferred Shares--Independent Director Approval". So
long as there are only two Independent Directors, any action that requires the
approval of a majority of the Independent Directors must be approved by both
Independent Directors. Pursuant to the Certificate of Designation establishing
the Series A Preferred Shares, the Independent Directors are required to take
into account the interests of the holders of both the Series A Preferred Shares
and the Common Stock in assessing the benefit to the Company of any proposed
action requiring their approval. The Company currently has four officers. The
Company has no other employees and does not anticipate that it will require
additional employees. See "Management".
The Company may from time to time purchase additional Mortgage Assets
or interests in Mortgage Assets out of proceeds received in connection with the
repayment or disposition of Mortgage Assets or the issuance of additional
shares of Common Stock or Preferred Stock. Additional shares of Preferred
Stock ranking senior to the Series A Preferred Shares may not be issued by the
Company without the approval of holders of at least two-thirds of the
outstanding Series A Preferred Shares. Additional shares of Preferred Stock
ranking on a parity with the Series A Preferred Shares may not be issued by the
Company without the approval of a majority of the Independent Directors. See
"Description of Series A Preferred Shares--Voting Rights" and "--Independent
Director Approval". The Company does not currently intend to issue any
additional shares of Preferred Stock unless it simultaneously issues additional
shares of Common Stock to the Bank, and the aggregate proceeds to be received
from such issuance of Common Stock approximately equals the sum of the
aggregate offering price of such additional Preferred Stock and the Company's
expenses (including any underwriting commissions or placement fees) incurred in
connection with the issuance of such additional shares of Preferred Stock. It
is currently anticipated that the Company will issue additional shares of
Preferred Stock if such issuance would provide the Bank with the most
cost-effective means of raising capital for bank regulatory purposes at the
time. See "Certain Transactions Constituting the Formation--Benefits to the
Bank and Its Affiliates".
The Company currently anticipates that all of the Mortgage Loans that
it may acquire in the future will be purchased from the Bank and affiliates of
the Bank. No arrangements or procedures are currently in place regarding the
acquisition by the Company of Mortgage Loans from unaffiliated third parties.
The Company expects that any additional Mortgage Loans acquired by the Company
will be whole loans or mortgage securities, will represent first lien
positions, will be acquired on a basis consistent with secondary market
standards and will have been originated or purchased by the Bank, and
underwritten in conformity with standards generally applied by the Bank or
affiliates of the Bank at the time such Mortgage Loans were originated or
purchased. The Company currently intends to maintain approximately 60% of its
portfolio of Mortgage Assets in Residential Mortgage Loans and mortgage
securities, and approximately 40% of its portfolio in Commercial Mortgage
Loans. Initially, the Company will not hold a significant
28
<PAGE> 35
amount of mortgage securities, although there is no limit on the amount that
may be purchased. The Company does not contemplate ownership of property other
than Mortgage Assets. The Company's current policy is not to acquire any
Commercial Mortgage Loan if such Commercial Mortgage Loan would constitute more
than 5% of the total book value of the Mortgage Assets of the Company at the
time of its acquisition. The Company's current policy prohibits the acquisition
of any Mortgage Loan or any interest in a Mortgage Loan (other than an interest
resulting from the acquisition of mortgage securities), which Mortgage Loan (i)
is delinquent in the payment of principal or interest; (ii) is or was at any
time during the preceding 12 months (a) Classified, (b) in Nonaccrual Status,
or (c) renegotiated due to financial deterioration of the borrower; or (iii)
has been, more than once during the preceding 12 months, more than 30 days past
due in the payment of principal or interest. Loans that are in Nonaccrual
Status are generally loans that are past due 90 days or more in principal or
interest and Classified loans are troubled loans which are deemed substandard
or doubtful and where the full collectibility of principal and interest on such
loan is doubtful. Mortgage Loans acquired by the Company in the future will be
whole loans originated or purchased by the Bank or an affiliate of the Bank.
DIVIDENDS
The Company currently expects to pay an aggregate amount of dividends
with respect to its outstanding shares of capital stock equal to approximately
100% of the Company's "REIT Taxable Income" (excluding capital gains). In order
to remain qualified as a REIT, the Company must distribute annually at least
95% of its "REIT Taxable Income" (excluding capital gains) to stockholders. The
Company anticipates that none of the dividends on the Series A Preferred Shares
and none or no material portion of the dividends on the Common Stock will
constitute non-taxable returns of capital.
The Company's income will consist primarily of interest payments on
the Mortgage Assets held by it. The Company anticipates that a majority of its
Mortgage Assets will bear interest at adjustable rates. If there is a decline
in interest rates (as measured by the indices upon which the interest rates of
the Mortgage Assets are based), then the Company will experience a decrease in
income available to be distributed to its stockholders. In addition, in such an
interest rate environment the Company may experience an increase in prepayments
on its Residential Mortgage Loans and may find it more difficult to purchase
additional Mortgage Assets bearing rates sufficient to support payment of the
dividends on the Series A Preferred Shares. Because the rate at which dividends
are required to be paid on the Series A Preferred Shares is fixed, there can be
no assurance that a declining interest rate environment would not adversely
affect the Company's ability to pay dividends on the Series A Preferred Shares.
Dividends will be declared at the discretion of the Board of Directors
after considering the Company's distributable funds, financial requirements,
tax considerations and other factors. Although there can be no assurances,
because (i) the Mortgage Assets are interest bearing, (ii) the Series A
Preferred Shares represent only approximately 50% of the Company's
capitalization and (iii) the Company does not anticipate incurring any
indebtedness, the Company currently expects that both its cash available for
distribution and its "REIT Taxable Income" will be in excess of amounts needed
to pay dividends on the Series A Preferred Shares. Accordingly, the Company
29
<PAGE> 36
expects that it will, after paying the quarterly dividends on the Series A
Preferred Shares, pay dividends to holders of its Common Stock. Assuming (i)
the Mortgage Loans included in the Initial Portfolio are held for the 12-month
period following completion of the Offering, (ii) principal repayments are
reinvested in additional Mortgage Assets with characteristics similar to those
of the Mortgage Loans included in the Initial Portfolio and (iii) interest
rates remain constant during such 12-month period, the Company anticipates that
the Initial Portfolio will generate interest income of approximately $2.8
million, after payment of servicing and advisory fees, during such 12-month
period. Since the aggregate annual dividend payment on the Series A Preferred
Shares is $[____] million, based on the foregoing, the Company anticipates that
$[____] million would be available for payment of dividends on the Common Stock
held by the Bank.
There are several limitations which restrict the Company's ability to
pay dividends on the Common Stock (none of which should adversely affect either
the ability of the Company to pay dividends in respect of the Series A
Preferred Shares or the ability of the Company to maintain its status as a
REIT). First, under the Company's current dividend policy, the Company may not
make any distribution in respect of the Common Stock with respect to any year
to the extent that, after taking into account such proposed distribution, total
cash or property distributions on the Company's outstanding shares of Preferred
Stock and Common Stock with respect to that year would exceed 105% of the
Company's "REIT Taxable Income" (excluding capital gains) for that year plus
net capital gains of the Company for that year. This policy regarding the
limitations on payment of dividends in respect of Common Stock may not be
modified without the approval of a majority of the Independent Directors.
Second, if the Company fails to declare and pay full dividends on the Series A
Preferred Shares in any dividend period, the Company may not make any dividends
or other distributions with respect to the Common Stock until such time as
dividends on all outstanding Series A Preferred Shares have been (i) declared
and paid for three consecutive dividend periods and (ii) declared and paid or
declared and a sum sufficient for the payment thereof has been set apart for
payment for the fourth consecutive dividend period. See, "Description of
Series A Preferred Shares--Dividends". Third, Michigan law provides that no
dividends (as well as other distributions) may be paid on the capital stock of
the Company if, after giving it effect, the Company would not be able to pay
its debts as they become due in the usual course of business, or the Company's
total assets would be less than the sum of its total liabilities plus the
amount that would be needed, if the Company were to be dissolved at the time of
the distribution, to satisfy the preferential rights upon dissolution of
shareholders whose preferential rights are superior to those receiving the
distribution.
The OCC prompt corrective action regulations prohibit banks from
making "capital distributions" (defined to include a transaction that the OCC
determines, by order or regulation, to be "in substance a distribution of
capital") unless the institution is at least "adequately capitalized" after the
distribution. There can be no assurances that the OCC would not seek to
restrict the Company's payment of dividends on the Series A Preferred Shares
under this provision if the Bank were to fail to maintain the status of at
least "adequately capitalized". Currently, an institution is considered
"adequately capitalized" if it has a total risk-based capital ratio of at least
8.0%, a Tier 1 risk-based capital ratio of at least 4.0% and a core capital (or
leverage) ratio of at least 4.0%. At September 30, 1997, the Bank's total
risk-based capital ratio was 10.77%, Tier 1 risk-based capital ratio was
8.01% and core capital (or leverage) ratio was 6.54%. Such
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ratios, adjusted to give effect to the sale of Series A Preferred Shares in the
Offering, would be 15.09%, 12.33% and 9.06%, respectively. In addition,
the Exchange Event may take place under circumstances in which the Bank will
not be considered "adequately capitalized" for purposes of the OCC prompt
corrective action regulations. Thus, at the time of the Automatic Exchange,
the Bank would likely be prohibited from paying dividends on the Bank Preferred
Shares. Further, the Bank's ability to pay dividends on the Bank Preferred
Shares following the Automatic Exchange also would be subject to OCC
regulations and resolution of the Bank's board of directors. In the event that
the Bank did pay dividends on the Bank Preferred Shares, such dividends would
be paid out of the Bank's current or retained net profits.
Under certain circumstances, including any determination that the
Bank's relationship to the Company results in an unsafe and unsound banking
practice, regulatory authorities will have the authority to issue an order
which restricts the ability of the Company to make dividend payments to its
stockholders.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal liquidity need will be to fund the acquisition
of additional Mortgage Assets as Mortgage Assets held by the Company are
repaid. The acquisition of such additional Mortgage Assets will be funded with
the proceeds of principal repayments on its portfolio of Mortgage Assets. The
Company does not anticipate that it will have any other material capital
expenditures. The Company believes that cash generated from the payment of
interest and principal on its Mortgage Assets portfolio will provide sufficient
funds to meet both operating requirements and payment of dividends by the
Company in accordance with the REIT Requirements for the foreseeable future.
GENERAL DESCRIPTION OF MORTGAGE ASSETS; INVESTMENT POLICY
Residential Mortgage Loans. The Company may from time to time acquire
both conforming and nonconforming Residential Mortgage Loans consistent with
its primary investment objective to acquire assets primarily for income.
Conforming Residential Mortgage Loans comply with the requirements for
inclusion in a loan guarantee program sponsored by either the FHLMC or FNMA.
Under current regulations, the maximum principal balance allowed on conforming
mortgage loans ranges from $214,600 for one-unit residential loans to
$442,450 for four-unit residential loans. Nonconforming Residential Mortgage
Loans are mortgage loans that do not qualify in one or more respects for
purchase by FHLMC or FNMA under their standard programs. Typically,
nonconforming mortgage loans do not meet agency guarantee criteria because
their principal balance or loan-to-value ratios exceed agency limits. Sometimes
the mortgage loans or the borrower does not meet other agency credit
underwriting standards or other requirements. The Company expects that all of
the Residential Mortgage Loans it purchases in the Initial Portfolio will be
nonconforming, since the Bank typically does not originate conforming
Residential Mortgage Loans. The Residential Mortgage Loans included in the
Initial Portfolio are generally nonconforming mortgage loans because either the
principal balances or loan-to-value ratios of such loans are in excess of
agency limits or because the documentation used by the Bank to underwrite such
loans differs from the agency standards. While the loans generated by the
Bank are typically non-conforming, all of the Residential Mortgage Loans
included in the Initial Portfolio were originated consistent with the
underwriting policies of the Bank at the time such Mortgage Loans were
originated. Although the Company's policy is
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to hold Mortgage Loans to maturity, a substantial portion of the Company's
Nonconforming Residential Mortgage Loans are expected to meet the requirements
for sale to investors in the secondary mortgage market.
Each Residential Mortgage Loan will be evidenced by a promissory note
secured by a mortgage or deed of trust or other similar security instrument
creating a first lien on single-family (one- to four-unit) residential
properties. Residential real estate properties underlying Residential Mortgage
Loans consist of individual dwelling units, individual condominium units, two-
to four-family dwelling units, planned unit developments and townhouses.
The Company currently expects that approximately 49% of the
Residential Mortgage Loans to be acquired by it will be adjustable rate
Mortgage Loans and that approximately 51% of the Residential Mortgage Loans
will be fixed rate Mortgage Loans.
Commercial Mortgage Loans. The Company may from time to time acquire
Commercial Mortgage Loans secured by apartment buildings, light industrial and
warehouse properties, office buildings and retail strip centers. The Company
expects that substantially all of the Commercial Mortgage Loans it acquires
will be secured by real estate located in Michigan. Unlike Residential
Mortgage Loans, Commercial Mortgage Loans generally lack standardized terms.
Although Commercial Mortgage Loans are generally nonrecourse to the borrower,
the Company anticipates that substantially all of the Commercial Mortgage Loans
that it will acquire will either be recourse to the borrower or supported by a
guarantee of an affiliate of the borrower. However, there is no requirement
that Commercial Mortgage Loans acquired by the Company have third party
guarantees. Commercial Mortgage Loans may also not be fully amortizing,
meaning that they may have a significant principal balance or "balloon" payment
due on maturity. Moreover, commercial properties, particularly industrial and
warehouse properties, are generally subject to relatively greater environmental
risks than non-commercial properties, generally giving rise to increased costs
of compliance with environmental laws and regulations. See "Risk Factors--Risks
Related to Investments in Mortgage Assets" and "Economic and Business
Risks--Properties with Environmental Problems May Increase Costs and Create
Liabilities for the Company".
The credit quality of a Commercial Mortgage Loan may depend on, among
other factors, the existence and structure of underlying leases, the physical
condition of the property (including whether any maintenance has been
deferred), the creditworthiness of tenants, the historical and anticipated
level of vacancies and rents on the property and on other comparable properties
located in the same region, potential or existing environmental risks, the
availability of credit to refinance the Commercial Mortgage Loan at or prior to
maturity and the local and regional economic climate in general. Foreclosures
of defaulted Commercial Mortgage Loans are generally subject to a number of
complicating factors, including environmental considerations, which are
generally not present in foreclosures of Residential Mortgage Loans. The
Company will sell any foreclosed Mortgage Assets. See "Risk Factors--Risks
Related to Mortgage Assets--Commercial Mortgage Loans involve greater risk of
loss than Residential Mortgage Loans" and "Economic and Business
Risks--Properties with Environmental Problems May Increase Costs and Create
Liabilities for the Company".
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Mortgage Securities. The Company may from time to time acquire
investment grade mortgage securities representing interests in or obligations
backed by pools of Mortgage Assets. The Mortgage Assets underlying the mortgage
securities will be secured by single-family residential, multifamily or
commercial real estate properties located throughout the United States. There
is no limit on the amount of mortgage securities that may be purchased. The
Company does not intend to acquire any interest-only, principal-only or other
similar mortgage securities generally considered to be of a high risk nature.
The Company will not be precluded from investing in mortgage securities where
the Bank or one of its affiliates is the sponsor or issuer.
ACQUISITION OF INITIAL PORTFOLIO
Simultaneously with the consummation of the Offering, the Company will
acquire the Initial Portfolio pursuant to the terms of two mortgage purchase
agreements with the Bank: the Residential Mortgage Loan Purchase and Warranties
Agreement (the "Residential Mortgage Purchase Agreement") and the Commercial
Mortgage Loan Purchase and Warranties Agreement (the "Commercial Mortgage
Purchase Agreement", and, together with the Residential Mortgage Purchase
Agreement, the "Mortgage Purchase Agreements"), each to be entered into
simultaneously with the consummation of the Offering. The Residential Mortgage
Loans in the Initial Portfolio will be sold to the Company pursuant to the
Residential Mortgage Purchase Agreement. The Commercial Mortgage Loans in the
Initial Portfolio will be sold to the Company pursuant to the Commercial
Mortgage Purchase Agreement. Each Mortgage Loan will be identified in a
schedule appearing as an exhibit to its respective mortgage purchase agreement
(each, a "Mortgage Loan Schedule"). Each Mortgage Loan Schedule will specify,
among other things, with respect to each Mortgage Loan: the interest rate or
interest rate formula applicable to each Mortgage Loan, the original principal
amount and the unpaid principal balance as of the purchase date, the monthly
payment, maturity date, mortgagor, type of mortgaged property, location of the
mortgaged property and current interest rate.
In addition, the Bank will deliver or cause to be delivered to the
Company the mortgage note with respect to each Mortgage Loan (together with all
amendments and modifications thereto) endorsed in blank, the original or
certified copy of the mortgage (together with all amendments and modifications
thereto) with evidence of recording indicated thereon, if available, and an
original or certified copy of an assignment of the mortgage in recordable form.
Such documents will initially be held by the Bank, as Advisor, acting as
custodian for the Company. Although the Company will have the right to record
the assignments of mortgage at any time, it does not currently anticipate doing
so. The Company believes that maintaining record title of the Mortgage Loans
in the name of the Servicer will facilitate the servicing of the Mortgage
Loans. Once the assignments of mortgage are recorded, the Company's lien on the
mortgaged properties will date back to the date of the original mortgages and
rank ahead of any intervening mortgages granted by the borrowers. However, if
the Bank, in violation of the Advisory Agreement and the Servicing Agreements,
sells any of the Company's Mortgage Loans to a third party who records its
assignment of mortgage before the Company records its assignment of mortgage
with respect to such Mortgage Loan, the Company may lose its ownership interest
in such Mortgage Loan. See "--Servicing" and "--Description of Initial
Portfolio--General".
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The Bank will make certain customary representations and warranties
with respect to the Mortgage Loans in the Initial Portfolio for the benefit of
the Company, including, among other things: (i) the information provided with
respect to the Mortgage Loans is correct in all material respects; (ii) each
Mortgage Loan is subject to a valid first lien subject only to the lien for
current real property taxes and assessments not yet due and payable, generally
acceptable covenants, conditions, restrictions, rights of way, easements and
other matters of public record present at the time of origination and other
common matters; (iii) the validity of the mortgage documents; (iv) all required
payments have been made; and (v) each Mortgage Loan complies with applicable
federal and state laws, including, without limitation, usury, truth-in-lending,
real estate settlement procedures, consumer credit protection, fair housing,
equal credit opportunity and disclosure laws. See also "Description of Initial
Portfolio". The Bank will be obligated to repurchase any Mortgage Loan sold by
it to the Company as to which there is a material breach of any such
representation or warranty, unless the Bank elects to substitute a qualified
Mortgage Loan for such Mortgage Loan. The Bank will also indemnify the Company
for damages or costs resulting from any such breach. The repurchase price for
any such Mortgage Loan will be its outstanding principal amount plus accrued
and unpaid interest on the date of repurchase plus any premium paid by the
Company. In addition, under the terms of the Mortgage Purchase Agreements, the
Company will acquire, in addition to the Mortgage Loans included in the Initial
Portfolio, (i) all amounts, including payments of principal and interest (other
than payments of principal and interest due on or before [_____________], 1997
with respect to the Residential Mortgage Loans and [_______________], 1997 with
respect to the Commercial Mortgage Loans) held in one or more accounts
maintained for the benefit of or in the name of the Company pursuant to the
Servicing Agreements and (ii) all insurance policies relating to the Mortgage
Properties and the proceeds thereof. See "--Servicing".
MANAGEMENT POLICIES AND PROGRAMS
In administering the Company's Mortgage Assets, the Advisor has a high
degree of autonomy. The Board of Directors, however, has adopted certain
policies to guide administration of the Company and the Advisor with respect to
the acquisition and disposition of assets, use of capital and leverage, credit
risk management and certain other activities. These policies, which are
discussed below, may be amended or revised from time to time at the discretion
of the Board of Directors (in certain circumstances subject to the approval of
a majority of the Independent Directors) without a vote of the Company's
stockholders, including holders of the Series A Preferred Shares. See also
"--Dividends".
Asset Acquisition and Disposition Policies. Subsequent to the
acquisition of the Initial Portfolio, the Company anticipates that it will from
time to time purchase additional Mortgage Loans from the Bank, although
Mortgage Loans may be acquired from unaffiliated third parties, out of proceeds
received in connection with the repayment or disposition of Mortgage Loans or
the issuance of additional shares of Common Stock and Preferred Stock.
Mortgage Loans acquired by the Company in the future will be whole loans
originated or purchased by the Bank or an affiliate of the Bank. The Company
anticipates that additional Mortgage Loans purchased from the Bank or its
affiliates will be purchased on terms that are substantially identical to those
that could be obtained by the Company if such additional Mortgage Loans were
purchased from
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third parties unaffiliated with the Company. No arrangements or procedures are
currently in place regarding the purchase of additional Mortgage Loans from
unaffiliated third parties. The Company currently anticipates that additional
Mortgage Loans acquired by the Company will be of the types described in
"--Description of Initial Portfolio", although if the Bank or its affiliates
develop additional Mortgage Loan products, the Company may purchase such
additional types of Mortgage Loans. In addition, the Company may from time to
time acquire mortgage securities representing interests in or obligations
backed by pools of Mortgage Loans that will be secured by single-family
residential, multifamily or commercial real estate properties located
throughout the United States. The Company currently anticipates that it will
not acquire the right to service any Mortgage Loan it acquires in the future
and that the Bank or an affiliate of the Bank will act as servicer of any such
additional Mortgage Loans. The Company anticipates that any servicing
arrangement that it enters into in the future with the Bank will contain fees
and other terms that would be substantially equivalent to those that would be
contained in servicing arrangements entered into with third parties
unaffiliated with the Company.
The Company currently intends to maintain approximately 60% of its
portfolio of Mortgage Assets in Residential Mortgage Loans or mortgage
securities and approximately 40% of the Company's portfolio of Mortgage Assets
in Commercial Mortgage Loans (in each case measured by aggregate outstanding
principal balances). The Company's current policy is not to acquire any
Commercial Mortgage Loan that constitutes more than 5% of the total book value
of the Mortgage Assets of the Company at the time of its acquisition. In
addition, the Company's current policy prohibits the acquisition of any
Mortgage Loan or any interest in a Mortgage Loan (other than an interest
resulting from the acquisition of mortgage securities), which Mortgage Loan (i)
is delinquent in the payment of principal or interest at the time of proposed
acquisition; (ii) is or was at any time during the preceding 12 months (a)
Classified, (b) in Nonaccrual Status, or (c) renegotiated due to financial
deterioration of the borrower; or (iii) has been, more than once during the
preceding 12 months, more than 30 days past due in the payment of principal or
interest.
The Company may choose, at any time subsequent to its acquisition of
any Mortgage Loan, to require the Servicer of the Mortgage Loan to dispose of
any Mortgage Loan, for any reason, including as a result of such mortgage loan
becoming Classified or being placed in Nonaccrual Status or having been, more
than once during the preceding 12 months, more than 30 days past due in the
payment of principal or interest. The Bank has indicated to the Company that it
will purchase, at the then fair value, any Mortgage Loan of the Company that
the Company chooses to dispose of for the foregoing reasons.
Capital and Leverage Policies. To the extent that the Board of
Directors determines that additional funding is required, the Company may raise
such funds through additional equity offerings, debt financing or retention of
cash flow (after consideration of provisions of the Code requiring the
distribution by a REIT of at least 95% of its "REIT Taxable Income" and taking
into account taxes that would be imposed on undistributed taxable income), or a
combination of these methods.
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The Company will have no debt outstanding following consummation of
the Offering, and the Company does not currently intend to incur any
indebtedness. However, the organizational documents of the Company do not
contain any limitation on the amount or percentage of debt, funded or
otherwise, the Company might incur. Notwithstanding the foregoing, the Company
may not, without the approval of a majority of the Independent Directors, incur
debt for borrowed money other than debt not in excess of 20% of the aggregate
amount of net proceeds received in connection with the issuance of all
outstanding Preferred Stock and Common Stock of the Company. Any such debt
incurred may include intercompany advances made by the Bank to the Company.
The Company may also issue additional series of Preferred Stock.
However, the Company may not issue additional shares of Preferred Stock senior
to the Series A Preferred Shares without the consent of holders of at least
two-thirds of the outstanding shares of Preferred Stock at that time, voting as
a single class, including the Series A Preferred Shares, and the Company may
not issue additional shares of Preferred Stock on a parity with the Series A
Preferred Shares without the approval of a majority of the Company's
Independent Directors. The Company does not currently intend to issue any
additional series of Preferred Stock unless it simultaneously issues additional
Common Stock to the Bank and the proceeds to be received from the issuance of
the Common Stock are approximately equal to the aggregate offering price of
such additional Preferred Stock plus the Company's expenses (including
underwriting commissions or placement fees) in connection with the issuance of
such additional shares of Preferred Stock. It is currently anticipated that the
Company will issue additional shares of Preferred Stock if such issuance would
provide the Bank with the most cost-effective means of raising capital for bank
regulatory purposes at the time. See "Certain Transactions Constituting the
Formation--Benefits to the Bank and Its Affiliates".
Credit Risk Management Policies. The Company expects that each
Mortgage Loan acquired from the Bank in the future will be a whole loan, will
represent a first lien position and will be originated by the Bank or such
affiliate in the ordinary course of its real estate lending activities based on
the underwriting standards generally applied (at the time of origination) for
its own account by the Bank or the affiliate of the Bank which originated the
Mortgage Loan. See "--Description of Initial Portfolio--Underwriting
Standards". The Company also expects that all Mortgage Loans held by the
Company will be serviced pursuant to the Servicing Agreements, which require
servicing in conformity with servicing guidelines promulgated by the Company
or, in the case of Residential Mortgage Loans, with FHLMC guidelines and
procedures. The Company may also choose, at any time subsequent to its
acquisition of any Mortgage Loan, to require the Servicer of such Mortgage
Loans to dispose of any Mortgage Loan for any reason, including as a result of
such Mortgage Loan becoming Classified or being placed in Nonaccrual Status, or
having been, more than once during the preceding 12 months, more than 30 days
past due in the payment of principal and interest.
Conflict of Interest Policies. Because of the nature of the Company's
relationship with the Bank, conflicts of interest exist and may continue to
arise with respect to certain transactions, including, without limitation, the
Company's acquisition of Mortgage Loans from, or disposition of Mortgage Loans
to, the Bank, foreclosure on defaulted Commercial Mortgage Loans and the
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modification of the Advisory Agreement or either of the Servicing Agreements.
It is the Company's policy that the terms of any financial dealings with the
Bank and its affiliates will be consistent with those available from third
parties in the mortgage lending industry. In addition, neither the Advisory
Agreement nor either of the Servicing Agreements may be modified or terminated
without the approval of a majority of the Independent Directors.
Conflicts of interest between the Company and the Bank may also arise
in connection with making decisions that bear upon the credit arrangements that
the Bank or one of its affiliates may have with a mortgagor under a Mortgage
Loan. Conflicts could also arise in connection with actions taken by the Bank
as a controlling person in the Company. It is the intention of the Company and
the Bank that any agreements and transactions between the Company, on the one
hand, and the Bank or its affiliates, on the other hand, including without
limitation the Mortgage Purchase Agreements and Servicing Agreements, are fair
to all parties and are consistent with market terms for such types of
transactions. The Servicing Agreements provide that (i) foreclosures and
dispositions of the Mortgage Loans are to be performed with a view to
maximizing the recovery by the Company as owner of the Mortgage Loans and (ii)
the Servicer shall service the Mortgage Loans solely with a view toward the
interests of the Company, and without regard to the interests of the Bank or
its affiliates. The requirement in the Certificate of Designation establishing
the Series A Preferred Shares that certain actions of the Company be approved
by a majority of the Independent Directors is also intended to ensure fair
dealings between the Company and the Bank and their respective affiliates.
However, there can be no assurance that any such agreement or transaction will
be on terms as favorable to the Company as would have been obtained from
unaffiliated third parties.
There are no provisions in the Company's Articles of Incorporation
limiting any officer, director, security holder or affiliate of the Company
from having any direct or indirect pecuniary interest in any Mortgage Asset to
be acquired or disposed of by the Company or in any transaction in which the
Company has an interest or from engaging in acquiring, holding and managing
Mortgage Assets. As described herein, it is expected that the Bank and its
affiliates will have direct interests in transactions with the Company
(including without limitation the sale of Mortgage Assets to the Company);
however, it is not currently anticipated that any of the officers or directors
of the Company will have any interests in such Mortgage Assets.
Other Policies. The Company intends to operate in a manner that will
not subject it to regulation under the Investment Company Act of 1940. The
Company does not intend to (i) invest in the securities of other issuers for
the purpose of exercising control over such issuers, (ii) underwrite securities
of other issuers, (iii) actively trade in loans or other investments, (iv)
offer securities in exchange for property or (v) make loans to third parties,
including, without limitation, officers, directors or other affiliates of the
Company. The Company may, under certain circumstances, purchase the Series A
Preferred Shares and other shares of its capital stock in the open market or
otherwise, provided, however, that the Company will not redeem or repurchase
any shares of its Common Stock for so long as any Series A Preferred Shares are
outstanding without the approval of a majority of the Independent Directors.
The Company has no present intention of causing the Company to repurchase any
shares of its capital stock, and any such action
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would be taken only in conformity with applicable federal and state laws and
regulations and the requirements for qualifying as a REIT.
The Company intends to publish and distribute to stockholders, in
accordance with Exchange Act rules, annual reports containing financial
statements prepared in accordance with generally accepted accounting principles
and certified by the Company's independent public accountants. The Certificate
of Designation establishing the Series A Preferred Shares provides that the
Company shall maintain its status as a reporting company under the Exchange Act
for so long as any of the Series A Preferred Shares are outstanding.
The Company currently intends to make investments and operate its
business at all times in such a manner as to be consistent with the
requirements of the Code to qualify as a REIT. However, future economic,
market, legal, tax or other considerations may cause the Board of Directors,
subject to approval by a majority of Independent Directors, to determine that
it is in the best interests of the Company and its stockholders to revoke its
REIT status.
DESCRIPTION OF INITIAL PORTFOLIO
Information with respect to the Residential Mortgage Loans and the
Commercial Mortgage Loans in the Initial Portfolio is presented as of
September 30, 1997. The composition of the Initial Portfolio actually
purchased by the Company contemporaneously with the consummation of the
Offering will differ from the Initial Portfolio as described in this Prospectus
only to the extent it is discovered prior to the consummation of the Offering
that a Mortgage Loan included in the Initial Portfolio described herein (i) is
delinquent in the payment of principal or interest; (ii) is or was at any time
during the preceding 12 months (a) Classified, (b) in Nonaccrual Status, or (c)
renegotiated due to financial deterioration of the borrower; or (iii) has been,
more than once during the preceding 12 months, more than 30 days past due in
the payment of principal or interest. In such event a Mortgage Loan similar in
aggregate outstanding principal balance and product type will be substituted
for such non-purchased Mortgage Loan.
References herein to percentages of Mortgage Loans included in the
Initial Portfolio refer in each case to the percentage of the aggregate
outstanding principal balance of the Mortgage Loans in the Initial Portfolio as
of September 30, 1997, based on the outstanding principal balances of such
Mortgage Loans as of such date, after giving effect to scheduled monthly
payments due on or prior to such date, whether or not received.
The detailed information set forth in this Prospectus with respect to
the Mortgage Loans applies only to the Initial Portfolio and the Company's
portfolio of Mortgage Assets in the future may or may not have the
characteristics described below.
General. The Initial Portfolio contains 291 Residential Mortgage
Loans, representing approximately 60% of the unpaid principal balance of the
Mortgage Loans contained in the Initial Portfolio, and 19 Commercial Mortgage
Loans, representing approximately 40% of the unpaid principal balance of the
Mortgage Loans contained in the Initial Portfolio. On September 30,
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1997, the Mortgage Loans included in the Initial Portfolio had an aggregate
outstanding principal balance of $35.8 million.
Except for the $1.7 million of purchased Residential Mortgage Loans
discussed below, all of the Residential Mortgage Loans included in the Initial
Portfolio were originated by the Bank in the ordinary course of its real estate
lending activities. All of the Residential Mortgage Loans included in the
Initial Portfolio were originated consistent with the underwriting policies of
the Bank or secondary market standards at the time at which such Mortgage Loans
were originated. See "Business--Residential Mortgage Lending" in the Bank
Prospectus attached hereto at Annex I.
The Initial Portfolio contains 29 Residential Mortgage Loans
aggregating $1.7 million in outstanding principal balance as of September 30,
1997 which are insured by the Federal Housing Administration ("FHA"). These
loans were purchased by the Bank from a local mortgage banker who continues
to service the loans. While these loans have loan-to-value ratios in excess of
the Bank's general underwriting guidelines for conventional residential loans,
each such loan is fully insured by the FHA.
Each Commercial Mortgage Loan included in the Initial Portfolio was
originated by the Bank in the ordinary course of its commercial real estate
lending activities.
Excluding the FHA insured loans, all of the Residential Mortgage Loans
included in the Initial Portfolio were originated between 1983 and 1997, and
have original terms to stated maturity from 3-30 years. As of September
30, 1997, the average outstanding principal balance of a Residential Mortgage
Loan was $73,701. The weighted average number of months since origination of
the Residential Mortgage Loans included in the Initial Portfolio (calculated as
of September 30, 1997) was approximately 72.9 months. The weighted average
Loan-to-Value Ratio (defined below) of the Residential Mortgage Loans included
in the Initial Portfolio is 76.9%; however, 30.9% of the Residential
Mortgage Loans have Loan-to-Value Ratios of greater than 80%. "Loan-to-Value
Ratio" means the ratio (expressed as a percentage) of the original principal
amount of such Mortgage Loan to the lesser of (i) the appraised value at
origination of the underlying mortgaged property and (ii) if the Mortgage Loan
was made to finance the acquisition of property, the purchase price of the
mortgaged property.
All of the Commercial Mortgage Loans included in the Initial Portfolio
were originated between 1983 and 1997, and have original terms to stated
maturity of between three and 30 years. Substantially all Mortgage Loans
included in the Initial Portfolio have mortgage notes which contain
"due-on-sale" provisions.
None of the Mortgage Loans included in the Initial Portfolio (i) is
delinquent in the payment of principal or interest as of September 30, 1997;
(ii) is or was at any time during the preceding 12 months (a) Classified, (b)
in Nonaccrual Status, or (c) renegotiated due to financial deterioration of the
borrower; or (iii) was, more than once during the preceding 12 months, more
than 30 days past due in the payment of principal or interest. If, prior to the
acquisition of the Initial Portfolio, any Mortgage Loan included in the
description of the Initial Portfolio herein falls
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within any of the foregoing categories, the Company will not purchase such
Mortgage Loan but will instead purchase a Mortgage Loan similar in aggregate
outstanding principal balance and product type which does not fall into any of
these categories.
Residential Mortgage Loans. The following types of Residential
Mortgage Loan products, each of which is more fully described below, will be
included in the Initial Portfolio: One-Year ARM, and 5, 10, 15, 20, 25 and
30-year fixed rate Residential Mortgage Loans. All of these loans are secured
by one- to four-family residential properties.
The following table sets forth certain information with respect to
each type of Residential Mortgage Loan included in the Initial Portfolio:
TYPE OF RESIDENTIAL MORTGAGE LOAN PRODUCT
<TABLE>
<CAPTION>
Percentage of
Initial Residential
Aggregate Portfolio by
Number of Principal Aggregate Weighted Average
Type Mortgage Loans Balance Principal Balance Remaining Term
--------------------------- -------------- --------------------------------------- ----------------
(In Thousands)
<S> <C> <C> <C> <C>
Fixed Rate . . . . . . . . 159 $10,959,530 51.10% 125.76
One-Year ARM . . . . . . . 132 10,487,465 48.90 229.02
------ ----------- -----
Total . . . . . . . . . . . 291 $21,446,995 100.00% 176.26
====== =========== ======
</TABLE>
Of the Residential Mortgage Loans included in the Initial Portfolio,
approximately 51.1% bear interest at fixed rates. The interest rates of the
fixed rate Residential Mortgage Loans included in the Initial Portfolio range
from 6.00% per annum to 10.49% per annum. The weighted average interest rate of
the fixed rate Residential Mortgage Loans included in the Initial Portfolio is
approximately 8.26% per annum. The following tables contain certain
additional data with respect to the interest rates of the fixed rate
Residential Mortgage Loans included in the Initial Portfolio:
40
<PAGE> 47
INTEREST RATE OF FIXED RATE RESIDENTIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
Percentage of
Initial Residential
Number of Aggregate Portfolio by
Mortgage Principal Aggregate
Principal Interest Rate Balance Loans Balance Principal Balance
---------------------------------------- -------------- ----------------- -----------------
(In Thousands)
<S> <C> <C> <C>
6.00%-6.49% . . . . . . . . . . . . . . 62 $1,946,696 9.08%
6.50%-6.99% . . . . . . . . . . . . . . --- --- ---
7.00%-7.49% . . . . . . . . . . . . . . 3 339,276 1.58
7.50%-7.99% . . . . . . . . . . . . . . 6 910,959 4.25
8.00%-8.49% . . . . . . . . . . . . . . 4 324,541 1.51
8.50%-8.99% . . . . . . . . . . . . . . 30 2,864,824 13.36
9.00%-9.49% . . . . . . . . . . . . . . 22 2,395,717 11.17
9.50%-9.99% . . . . . . . . . . . . . . 18 1,498,298 6.99
10.00%-10.49% . . . . . . . . . . . . . 14 679,219 3.16
----- -------------- ------
Total . . . . . . . . . . . . . . . 159 $10,959,530 51.10%
====== =========== =====
</TABLE>
ORIGINAL TERM OF FIXED RATE RESIDENTIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
Percentage of
Aggregate Initial Residential
Original Term Number of Principal Portfolio by Aggregate
(in months) Mortgage Loans Balance Principal Balance
------------------------ -------------- ----------------- -------------------------
(In Thousands)
<S> <C> <C> <C>
0 -- 61 . . . . . . 46 $5,461,486 25.47%
61 -- 121 . . . . . . 10 514,814 2.40
121 -- 181 . . . . . . 64 1,992,168 9.29
181 -- 241 . . . . . . 1 181,089 0.84
241 -- 301 . . . . . . 0 --- 0.00
301 -- 361 . . . . . . 38 2,809,973 13.10
----- ----------- ------
Total . . . . 159 $10,959,530 51.10%
===== =========== ======
</TABLE>
Of the Residential Mortgage Loans included in the Initial Portfolio,
approximately 48.9% bear interest at adjustable rates. The interest rates on
the "adjustable rate mortgages" or "ARMs" contained in the Initial Portfolio are
all tied to the one-year Treasury Index (defined below) ("One-Year ARM"), and
adjust periodically. ARMs are typically subject to limitations on lifetime
interest rates as well as periodic interest rate adjustments. The current
interest rates of the Residential Mortgage Loans included in the Initial
Portfolio that are ARMs ranged from 7.00% per annum to 9.13% per annum as of
September 30, 1997. As of September 30, 1997, the weighted average current
interest rate of the Residential Mortgage Loans included in the Initial
Portfolio that are ARMs was approximately 8.14% per annum. The following
table contains certain additional data as of September 30, 1997 with respect
to the interest rates of the Residential Mortgage Loans included in the Initial
Portfolio that are ARMs:
41
<PAGE> 48
CURRENT INTEREST RATE OF ADJUSTABLE RATE
RESIDENTIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
Percentage of
Number of Aggregate Initial Residential
Mortgage Principal Portfolio by Aggregate
Current Interest Rate Balance Loans Balance Principal Balance
---------------------------------------- -------------- ----------------- -----------------------
(In Thousands)
<S> <C> <C> <C>
7.00% - 7.49% . . . . . . . . . . . . . 22 $ 1,558,910 7.27%
7.50% - 7.99% . . . . . . . . . . . . . 33 2,286,781 10.66
8.00% - 8.49% . . . . . . . . . . . . . 32 2,416,418 11.27
8.50% - 8.99% . . . . . . . . . . . . . 38 3,678,584 17.15
9.00% - 9.49% . . . . . . . . . . . . . 7 546,772 2.55
----- ----------- ------
Total . . . . . . . . . . . . . . . 132 $10,478,487 48.90%
====== =========== ======
</TABLE>
"Gross Margin", with respect to a Residential Mortgage Loan that is an
ARM, means the applicable fixed percentage which, when added to the applicable
index, results in the current interest rate paid by the borrower of such
Residential Mortgage Loan (without taking into account any interest rate caps
or minimum interest rates). Gross Margin is inapplicable to fixed rate
Residential Mortgage Loans. As of September 30, 1997, the weighted average
Gross Margin of the Residential Mortgage Loans included in the Initial
Portfolio that are ARMs was approximately 2.46%.
The following table sets forth certain additional data as of
September 30, 1997 with respect to the Gross Margins of the Residential
Mortgage Loans included in the Initial Portfolio that are ARMs:
GROSS MARGIN ON RESIDENTIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
Percentage of
Initial Residential
Number of Aggregate Portfolio by
Mortgage Principal Aggregate
Gross Margin Balance Loans Balance Principal Balance
---------------------------------------- -------------- ------------------ -------------------
(In Thousands)
<S> <C> <C> <C>
1.50% - 1.99% . . . . . . . . . . . . . 24 $ 1,807,156 8.43%
2.00% - 2.49% . . . . . . . . . . . . . 35 2,269,183 10.58
2.50% - 2.99% . . . . . . . . . . . . . 48 3,806,063 17.74
3.00% - 3.49% . . . . . . . . . . . . . 25 2,605,063 12.15
------ -------------- ------
Total . . . . . . . . . . . . . . . 132 $ 10,487,465 48.90%
====== ============== ======
</TABLE>
The interest rate of each ARM loan included in the Initial Portfolio
adjusts at the times (each, a "Rate Adjustment Date") and in the manner
described below subject to lifetime interest rate caps, to minimum interest
rates and to maximum annual interest rate increases or decreases, each as
specified in the mortgage note relating to the ARM. Information set forth below
regarding interest rate caps and minimum interest rates applies to the Initial
Portfolio only. Mortgage Loans
42
<PAGE> 49
purchased by the Company after consummation of the Offering may be subject to
different interest rate caps and minimum interest rates.
Each ARM bears interest at its initial interest rate until its first
Rate Adjustment Date. Effective with each Rate Adjustment Date, the monthly
principal and interest payment on most of the adjustable rate Mortgage Loans
included in the Initial Portfolio will be adjusted to an amount that will fully
amortize the then-outstanding principal balance of such Residential Mortgage
Loan over its remaining term to stated maturity and that will be sufficient to
pay interest at the adjusted interest rate. Most of the Mortgage Loans
included in the Initial Portfolio allow the mortgagor to prepay at any time
some or all of the outstanding principal balance of the Mortgage Loan without
fee or penalty.
One-Year ARM. The interest rate with respect to each One-Year ARM is
fixed at an initial rate for the first twelve monthly payments and adjusts
annually thereafter on the date specified in the related mortgage note to a
rate equal to the then-current Treasury Index (defined below) plus the Gross
Margin set forth in such mortgage note, subject to a maximum annual interest
rate increase or decrease of 2.00%, a lifetime interest rate cap equal to the
initial interest rate with respect to such Residential Mortgage Loan plus 6%
and to a minimum interest rate no less than the Gross Margin. The sum of the
Treasury Index and the Gross Margin is rounded upwards to the nearest 0.125%.
The "Treasury Index" with respect to each One-Year ARM is the weekly average
yield on U.S. Treasury securities adjusted to a constant maturity of one year
as published by the Federal Reserve Board in Statistical Release H.15 (519) or
any similar publication or, if not so published, as reported by any Federal
Reserve Bank or by any U.S. Government department or agency and made available
to the Advisor. Should the Treasury Index not be published or become otherwise
unavailable, the Advisor will select a comparable alternative index over which
it has no control and which is readily available.
Fixed Rate Loans. The fixed rate Residential Mortgage Loans which are
included in the Initial Portfolio or may be purchased by the Company will
generally have original terms to stated maturity of up to 30 years. The
majority of the Bank's fixed rate residential mortgage loans by dollar amount
have terms of five years or less with amortization periods of up to 30 years.
Commercial Mortgage Loans. The Commercial Mortgage Loans included in
the Initial Portfolio will consist of retail strip centers,
multi-family residential rental properties, warehouse, industrial and office
center properties located in Michigan. The borrowers of the Commercial
Mortgage Loans included in the Initial Portfolio are primarily customers of the
Bank to which the Bank has extended such Commercial Mortgage Loans in the
ordinary course of its commercial real estate lending activities.
Substantially all of the Commercial Mortgage Loans included in the Initial
Portfolio are either recourse to the borrower or guaranteed as to the payment
of principal and interest by an affiliate of the borrower. The outstanding
principal balances of the Commercial Mortgage Loans included in the Initial
Portfolio ranged from $118,059 to $1.55 million as of September 30, 1997.
The following table sets forth certain information with respect to
each type of commercial property underlying each Commercial Mortgage Loan
included in the Initial Portfolio:
43
<PAGE> 50
TYPE OF COMMERCIAL MORTGAGE LOAN
<TABLE>
<CAPTION>
Percentage
of Initial Weighted Weighted Weighted
Commercial Average Average Average
Portfolio by Original Current Expected
Aggregate Aggregate Loan-to Loan-to Months
Principal Principal Value Value Remaining
Type of Mortgaged Property Balance Balance Ratio(1) Ratio(2) to Maturity
-------------------------- ------------- ------------ ------- ------ -----------
(In Thousands)
<S> <C> <C> <C> <C> <C>
36+ unit apartments . . . . . . . $ 1,043,535 7.3% 44% 43% 34.45
5-36 unit apartments . . . . . . 2,513,572 17.5 75 67 21.58
Industrial . . . . . . . . . . . 1,252,198 8.7 52 52 55.00
Office . . . . . . . . . . . . . 550,000 3.8 77 71 47.00
Retail strip center . . . . . . . 7,594,502 53.0 72 68 58.61
Warehouse . . . . . . . . . . . . 1,384,862 9.7 56 55 53.00
----------- ------
Total . . . . . . . . . . . . $14,338,669 100.0% 68% 64% 49.06
- --------------- ============= =====
</TABLE>
(1) Represents the ratio of the outstanding principal amount of each
Commercial Mortgage Loan at the time of loan origination or
modification, if any, to the value of the property securing such
Commercial Mortgage Loan at the time of loan origination or
modification, if any.
(2) Represents the ratio of the outstanding principal amount of the Commercial
Mortgage Loan at September 30, 1997 to the value of the property securing
such Commercial Mortgage Loan at the time of loan origination or
modification, if any.
Of the Commercial Mortgage Loans included in the Initial Portfolio,
none are fully amortizing and all will have significant principal balances or
"balloon" payments due upon maturity.
Of the Commercial Mortgage Loans included in the Initial Portfolio,
approximately 43.8% bear interest at fixed rates. The interest rates of the
fixed rate Commercial Mortgage Loans included in the Initial Portfolio range
from 8.50% per annum to 9.75% per annum. The following table contains certain
additional data with respect to the interest rates of the fixed rate Commercial
Mortgage Loans included in the Initial Portfolio (including those variable rate
Commercial Mortgage Loans that have been converted, pursuant to their terms, to
fixed rates):
INTEREST RATE OF FIXED RATE COMMERCIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
Percentage of Initial
Number of Commercial Portfolio
Mortgage Aggregate Principal By Aggregate
Loans Balance Principal Balance
---------- -------------------- ------------------------
(In Thousands)
<S> <C> <C> <C>
8.50% - 8.99% . . . . . . . . . . . . 2 2,637,061 18.4%
9.00% - 9.49% . . . . . . . . . . . . 3 2,334,998 16.3
9.50% - 9.99% . . . . . . . . . . . . 2 1,305,032 9.1
--- ------------ -----
Total . . . . . . . . . . . . . . 7 $6,277,091 43.8%
===== ========== ====
</TABLE>
44
<PAGE> 51
Of the Commercial Mortgage Loans included in the Initial Portfolio,
56.2% bear interest at variable rates which are typically tied to an index
(such as the Bank's Prime Rate or the U.S. Treasury Index adjusted for a
constant maturity of either one year or three years) and are adjustable
periodically. The current interest rates borne by the variable rate Commercial
Mortgage Loans included in the Initial Portfolio ranged from 7.00% per annum to
10.00% per annum as of September 30, 1997. The following table contains
certain additional data as of September 30, 1997 with respect to the interest
rates of the variable rate Commercial Mortgage Loans included in the Initial
Portfolio:
CURRENT INTEREST RATE OF VARIABLE RATE
COMMERCIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
Percentage of Initial
Number of Commercial Portfolio By
Mortgage Aggregate Principal Aggregate
Loans Balance Principal Balance
----------- -------------------- ------------------------
--
(In Thousands)
<S> <C> <C> <C>
7.00% - 7.49% . . . . . . . . . . . 1 $ 979,020 6.8%
7.50% - 7.99% . . . . . . . . . . . --- ---
---
8.00% - 8.49% . . . . . . . . . . . 1 703,486 4.9
8.50% - 8.99% . . . . . . . . . . . 3 1,859,398 13.0
9.00% - 9.49% . . . . . . . . . . . 2 2,490,805 17.4
9.50% - 9.99% . . . . . . . . . . . 4 1,885,064 13.1
10.00% - 10.49% . . . . . . . . . . . 1 143,805 1.0
--- ------------ -----
Total . . . . . . . . . . . . . . 12 $8,061,578 56.2%
==== ========== ====
</TABLE>
Underwriting Standards. The Bank has represented to the Company that
all of the Residential Mortgage Loans included in the Initial Portfolio were
originated generally in accordance with the underwriting policy customarily
employed by the Bank (or secondary market standards) at the time at which the
Residential Mortgage Loan in the Initial Portfolio was originated. The Bank has
represented to the Company that all of the Commercial Mortgage Loans included
in the Initial Portfolio were originated generally consistent with the
underwriting policies customarily employed by the Bank at the time at which the
Commercial Mortgage Loans in the Initial Portfolio were originated.
Residential Mortgage Loans. The underwriting standards applied at
origination of the Residential Mortgage Loans were intended to evaluate the
borrower's credit standing and repayment ability, and the value and adequacy of
the underlying mortgaged property as collateral. Initially, each prospective
borrower was required to provide a current balance sheet describing assets and
liabilities and a statement of income and expenses, as well as, to the extent
required by applicable state law, an authorization to apply for a credit report
which summarized the borrower's credit history with merchants and lenders and
any record of bankruptcy.
For any prospective borrower, an employment verification was obtained
from the borrower's employer wherein the employer reported the length of
employment with the employer, the employee's current salary, and whether it was
expected that the borrower would continue such
45
<PAGE> 52
employment in the future, or the borrower submitted such other evidence of
employment (such as pay stubs) satisfactory to the Bank. For a self-employed
prospective borrower, the borrower was generally required to submit copies of
personal and business federal income tax returns for the previous two years.
For certain prospective borrowers, the borrower authorized verification of all
deposits at financial institutions at which the borrower had demand or savings
accounts.
Once the credit report and the employment and deposit verifications
were received by the underwriting officer considering the loan application, a
determination was made as to whether the prospective borrower had sufficient
monthly income available (i) to meet the borrower's monthly obligations on the
proposed Residential Mortgage Loan (determined on the basis of the monthly
payments due in the year of origination) and other expenses related to the home
(such as property taxes and hazard insurance) and (ii) to meet other financial
obligations and monthly living expenses. In all instances, the Bank's
underwriting policies (including those applied in originating the Mortgage
Loans in the Initial Portfolio) may be varied in cases deemed appropriate by
its underwriting officers.
In determining the adequacy of the property as collateral, an
independent appraisal was made of each property considered for financing. Each
appraiser was selected in accordance with predetermined guidelines established
for appraisers. The appraiser was required to inspect the property and verify
that it was in good condition and that construction, if new, had been
completed. If the appraiser reported any exceptions to the verification, the
Bank (or its predecessor) or its agent determined that such property had been
substantially completed to its satisfaction. The appraisal was based on the
appraiser's judgment of value giving appropriate weight to both the market
value of comparable properties and the cost of replacing the property and other
factors as appropriate. The Bank's or its predecessors' underwriting standards
also required a search of the public records relating to a mortgaged property
for liens and judgments against such mortgaged property, as well as customary
title insurance.
Commercial Mortgage Loans. The loan underwriting procedures and
guidelines utilized by the Bank in connection with the origination of the
Commercial Mortgage Loans included in the Initial Portfolio were intended to
assess the value of the related mortgaged property, the ability of such
mortgaged property to be used by the borrower or its agents and the financial
condition of the borrower, including its ability to service the Commercial
Mortgage Loan. The underwriting guidelines included an internal system for
rating the quality of the mortgaged property.
The underwriting guidelines took into account such factors as
suitability of the mortgaged property for the proposed use; the availability,
rental rates and relative value of comparable properties in the relevant market
area and the anticipated growth or decline in both the immediate and broader
geographic areas in which the mortgaged property is located; the current or
projected occupancy or leasing ratios, if relevant; the condition and age of
the mortgaged property; the management ability of the borrower, including its
business experience and financial soundness; and such other economic,
demographic or other factors as in the judgment of the Bank might affect the
value of the mortgaged property and the ability of the borrower to service the
Commercial Mortgage Loan. For each proposal for a Commercial Mortgage Loan the
commercial lending credit group of the Bank analyzed the proposed transaction
focusing on economic assumptions and
46
<PAGE> 53
the feasibility of the loan, identified and evaluated potential risks, and made
a recommendation to approve or disapprove the loan. The proposed transaction
was then presented to the appropriate senior officer or committee of the Bank
for approval.
Once a loan proposal was approved by the appropriate senior officer or
committee, a loan commitment was issued by the Bank to the proposed borrower,
subject to, among other things, receipt of acceptable environmental (including
Phase I) and appraisal reports and, if deemed appropriate, engineering reports.
The Bank contracted with approved firms to prepare these reports for the
account of the Bank. Any environmental exceptions were approved by the
appropriate senior officer or committee of the Bank before the loan was funded.
Geographic Distribution. Substantially all of the residential real
estate properties underlying the Company's Residential Mortgage Loans included
in the Initial Portfolio are located in Michigan. Consequently, these
Residential Mortgage Loans may be subject to a greater risk of default than
other comparable Residential Mortgage Loans in the event of adverse economic,
political or business developments and natural hazards in Michigan that may
affect the ability of residential property owners in Michigan to make payments
of principal and interest on the underlying mortgages. Standard hazard
insurance required to be maintained with respect to Residential Mortgage Loans
held by the Company may not protect the Company against losses occurring from
tornados and other natural disasters. Consequently, in the event of a natural
disaster, the Company's ability to pay dividends on the Series A Preferred
Shares could be adversely affected as the Company will not maintain special
hazard insurance to protect against such losses.
All of the commercial mortgaged properties underlying its Commercial
Mortgage Loans will be located in Michigan. Consequently, these Commercial
Mortgage Loans may be subject to a greater risk of default than other
comparable Commercial Mortgage Loans in the event of adverse economic,
political or business developments in Michigan that may affect the ability of
businesses in that area to make payments of principal and interest on the
underlying mortgages.
Loan-to-Value Ratios; Insurance. Eighteen of the non-government
insured Residential Mortgage Loans have Loan-to-Value Ratios of greater than
80%. Nine of these loans are insured under primary mortgage guaranty
insurance policies. The remainder do not carry such insurance due to
waivers of this requirement by the Bank consistent with the Bank's underwriting
policies and have a weighted average loan-to-value ratio of approximately
94.8%. "Loan-to-Value Ratio" means the ratio (expressed as a percentage) of
the original principal amount of such Mortgage Loan to the lesser of (i) the
appraised value at origination of the underlying mortgaged property and (ii) if
the Mortgage Loan was made to finance the acquisition of property, the purchase
price of the mortgaged property. At the time of origination of the Residential
Mortgage Loans, each of the primary mortgage insurance policy insurers was
approved by FNMA or FHLMC.
A standard hazard insurance policy is required to be maintained by the
mortgagor with respect to each Residential Mortgage Loan in an amount equal to
the maximum insurable value of the improvements securing such Residential
Mortgage Loan or the principal balance of such
47
<PAGE> 54
Residential Mortgage Loan, whichever is less. If the residential real estate
property underlying a Residential Mortgage Loan is located in a flood zone,
such Residential Mortgage Loan may also be covered by a flood insurance policy
as required by law. No mortgagor bankruptcy insurance will be maintained by the
Company with respect to the Residential Mortgage Loans in the Initial
Portfolio. The Company will not maintain any special hazard insurance policy
with respect to any Residential Mortgage Loan which could mitigate damages
caused by any natural disaster. In addition, the standard hazard insurance
required to be maintained with respect to Residential Mortgage Loans does not
protect the Company against losses occurring from natural disasters. In the
event of any such natural disaster, the Company's ability to pay dividends on
the Series A Preferred Shares could be adversely affected.
A standard hazard insurance policy is also required to be maintained
by the mortgagor with respect to each of the Commercial Mortgage Loans included
in the Initial Portfolio. If the commercial real estate property securing a
Commercial Mortgage Loan is located in a flood zone, such Commercial Mortgage
Loan may be covered by a flood insurance policy as required by law. However, as
with the Residential Mortgage Loans in the Initial Portfolio, no special hazard
insurance or mortgagor bankruptcy insurance will be maintained by the Company
with respect to the Commercial Mortgage Loans in the Initial Portfolio.
SERVICING
The Mortgage Loans included in the Initial Portfolio will be sold to
the Company by the Bank on a servicing retained basis. The Bank will service
the Mortgage Loans included in the Initial Portfolio pursuant to the terms of
the Servicing Agreements. The Bank in its role as servicer under the terms of
the Servicing Agreements is herein referred to as the "Servicer". The Servicer
will receive an annual servicing fee with respect to each Mortgage Loan
serviced for the Company which shall equal the outstanding principal balance of
such Mortgage Loans multiplied by a fee of .375%.
Each Servicing Agreement requires the Servicer to service the
Company's Mortgage Loans in a manner generally consistent with servicing
guidelines promulgated by the Company and, in the case of Residential Mortgage
Loans, with FHLMC guidelines and procedures. The Servicing Agreements require
the Servicer to service the Mortgage Loans solely with a view toward the
interests of the Company, and without regard to the interests of the Bank or
its affiliates. The Servicer will collect and remit principal and interest
payments, administer mortgage escrow accounts, submit and pursue insurance
claims and initiate and supervise foreclosure proceedings on the Mortgage Loans
it services. The Servicer will also provide accounting and reporting services
required by the Company for such Mortgage Loans. Each Servicing Agreement
requires the Servicer to follow such collection procedures as are customary in
the industry, including contacting delinquent borrowers and supervising
foreclosures and property dispositions in the event of unremedied defaults in
accordance with servicing guidelines promulgated by the Company. The Servicer
may, in its discretion, arrange with a defaulting borrower a schedule for the
liquidation of delinquencies, provided that, in the case of Residential
Mortgage Loans, no primary mortgage guarantee insurance coverage is adversely
affected. The Servicer may also be directed by the Company, at any time during
the servicing process, to dispose of any Mortgage
48
<PAGE> 55
Loan which becomes Classified, placed in Nonaccrual Status or which has been,
more than once during the preceding 12 months, more than 30 days past due in
the payment of principal and interest.
The Servicer may from time to time subcontract all or a portion of its
servicing obligations under the Servicing Agreements to one or more of its
affiliates or, subject to approval of a majority of the Independent Directors,
may subcontract all or a portion of its obligations under the Servicing
Agreements to an unrelated third party. The Servicer will not, in connection
with subcontracting any of its obligations under the Servicing Agreements, be
discharged or relieved in any respect from its obligation to the Company to
perform its obligations under the Servicing Agreements.
Each Servicing Agreement requires the Servicer to pay all expenses
related to the performance of its duties under such Servicing Agreement. In
addition, the Servicer will be required to make advances of principal and
interest and, with respect to the Residential Mortgage Loans and certain
Commercial Mortgage Loans, taxes and required insurance premiums that are due
from mortgagors, unless (with respect to advances of principal and interest) it
determines that such advances are nonrecoverable. If such advances are made,
the Servicer generally will be reimbursed prior to the Company out of proceeds
related to such Mortgage Loan. The Servicer also will be entitled to
reimbursement by the Company for expenses incurred by it in connection with the
liquidation of defaulted Mortgage Loans serviced by it and in connection with
the restoration of mortgaged property. If claims are not made or paid under
applicable insurance policies or if coverage thereunder has ceased, the Company
will suffer a loss to the extent that the proceeds from liquidation of the
mortgaged property, after reimbursement of the Servicer's expenses in the sale,
are less than the outstanding principal balance of the related Mortgage Loan.
The Servicer will be responsible to the Company for any loss suffered as a
result of its failure to make and pursue timely claims or as a result of
actions taken or omissions made by it which cause the policies to be canceled
by the insurer.
In connection with any foreclosure proceedings that the Servicer may
institute, the Servicer may exercise any power of sale contained in any
mortgage or deed of trust, obtain a deed in lieu of foreclosure or otherwise
acquire title to a mortgaged property underlying a Mortgage Loan by operation
of law or otherwise in accordance with the terms of the relevant Servicing
Agreement. The Servicer will not be permitted under the terms of the Commercial
Mortgage Loan Servicing Agreement to acquire title to any commercial real
estate property underlying a Commercial Mortgage Loan or take any action that
would cause the Company to be an "owner" or an "operator" within the meaning of
certain federal environmental laws, unless it has also previously determined,
subject to the approval of the Advisor, based on a report prepared by an
independent person who regularly conducts environmental assessments, that (i)
the mortgaged property is in compliance with applicable environmental laws or
that it would be in the best interests of the Company to take such actions as
are necessary to cause the mortgaged property to comply therewith and (ii)
there are no circumstances or conditions present at the mortgaged property
relating to the use, management or disposal of any hazardous substances,
hazardous materials, hazardous wastes or petroleum-based materials for which
investigation, testing, monitoring, containment, clean-up or remediation could
be required under any federal, state or local law or
49
<PAGE> 56
regulation, or, if any such materials are present for which such
action could be required, that it would be in the best interest of the Company
to take such actions with respect to the mortgaged property.
The Company may terminate either Servicing Agreement upon the
happening of one or more events specified in the Servicing Agreement. Such
events relate generally to the Servicer's proper and timely performance of its
duties and obligations under the Servicing Agreement. In addition, the Company
may also terminate either Servicing Agreement without cause upon 30 days'
notice and payment of a termination fee that is competitive with that which is
generally payable in the industry.
The termination fee will be equal to 2% of the aggregate outstanding
principal amount of the loans then serviced under the applicable Servicing
Agreement. As long as any Series A Preferred Shares remain outstanding, the
Company may not terminate, or elect not to renew, either Servicing Agreement
without the approval of a majority of the Independent Directors. As is
customary in the mortgage loan servicing industry, the Servicer will be
entitled to retain any late payment charges and penalties collected in
connection with the Mortgage Loans serviced by it. In addition, the Servicer
will receive any benefit derived from interest earned on collected principal
and interest payments between the date of collection and the date of remittance
to the Company and from interest earned on tax and insurance impound funds with
respect to Mortgage Loans serviced by it. Each Servicing Agreement requires the
Servicer to remit to the Company no later than the 18th day of each month all
principal and interest due from borrowers of Mortgage Loans serviced by it
(unless deemed nonrecoverable by the Servicer) from the last remittance date.
When any mortgaged property underlying a Mortgage Loan is conveyed by
a mortgagor, the Servicer generally will enforce any "due-on-sale" clause
contained in the Mortgage Loan, to the extent permitted under applicable law
and governmental regulations. The terms of a particular Mortgage Loan or
applicable law, however, may provide that the exercise of the "due-on-sale"
clause is prohibited under certain circumstances related to the security
underlying the Mortgage Loan and the buyer's ability to fulfill the obligations
under the related mortgage note. Upon any assumption of a Mortgage Loan by a
transferee, a fee equal to a specified percentage of the outstanding principal
balance of the Mortgage Loan is typically required, which sum will be retained
by the Servicer as additional servicing compensation.
As a result of the relationship between the Servicer and the Company,
certain conflicts of interest exist. See "Risk Factors--Conflicts of
Interest in business of the Company may result in decisions of the Company that
do not fully reflect the interests of the stockholders of the Company".
EMPLOYEES
The Company has four officers, each of whom is described further below
under "Management". The Company does not anticipate that it will require any
additional employees because it has retained the Advisor to perform certain
functions pursuant to the Advisory Agreement described below under
"Management--The Advisor". It is currently anticipated that
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<PAGE> 57
all of the officers of the Company will also be officers or employees of the
Bank or their affiliates. The Company will maintain corporate records and
audited financial statements that are separate from those of the Bank or any of
its affiliates. None of the officers, employees or directors of the Company
will have any direct or indirect pecuniary interest in any Mortgage Asset to be
acquired or disposed of by the Company or in any transaction in which the
Company has an interest or will engage in acquiring, holding and managing
Mortgage Assets.
COMPETITION
The Company does not anticipate that it will engage in the business of
originating Mortgage Loans. It does anticipate that it will purchase Mortgage
Loans in addition to those in the Initial Portfolio and that all of these
Mortgage Loans will be purchased from the Bank or affiliates of the Bank.
LEGAL PROCEEDINGS
The Company is not the subject of any material litigation. None of the
Company, the Advisor, the Bank or any of its affiliates is currently involved
in nor, to the Company's knowledge, currently threatened with any material
litigation with respect to the Mortgage Loans to be included in the Initial
Portfolio, other than routine litigation arising in the ordinary course of
business, most of which is expected to be covered by liability insurance.
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The Company's Board of Directors is composed of five members, two of
whom are Independent Directors. These directors will serve until their
successors are duly elected and qualified. There is no current intention to
alter the number of directors comprising the Board of Directors. Pursuant to
the Certificate of Designation establishing the Series A Preferred Shares, the
Independent Directors are required to take into account the interests of the
holders of both the Series A Preferred Shares and the Common Stock in assessing
the benefit to the Company of any proposed action requiring their consent. In
considering the interests of the holders of the Series A Preferred Shares, the
Independent Directors shall owe the same duties which the Independent Directors
owe to holders of Common Stock. The Company currently has four officers. The
Company has no other employees and does not anticipate that it will require
additional employees. See "Business and Strategy--Employees". For compensation
information relating to certain of the Company's directors and executive
officers, see "Management - Compensation of Executive Officers" and " -
Employment Agreements" in the Bank Prospectus attached hereto as Annex I.
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<PAGE> 58
The persons who are directors and executive officers of the Company
are as follows:
<TABLE>
<CAPTION>
Name Position and Offices Held
---------------------------------- ---------------------------------------------------------
<S> <C>
Robert M. Walker Director
Lloyd A. Schwartz Director
Read P. Dunn President and Chief Executive Officer
Edward J. Shehab Director and Senior Vice President
David L. Shelp Director, Treasurer and Chief Financial Officer
David F. Simon Director and Secretary
</TABLE>
The following is a summary of the experience of the executive officers
and directors of the Company:
Robert M. Walker, age 54, has served since 1992 as Senior Associate at
James V. McTevia & Associates, a Detroit area firm specializing in financial
and management consulting services. Mr. Walker is a certified public accountant
and certified fraud examiner. He has over 28 years of experience in public
accounting, financial and management consulting, and the financial services
industry.
Lloyd A. Schwartz, age 69, is a certified public accountant and has
served as the Deputy Receiver/Rehabilator of two Michigan-based insurance
companies since 1993. Mr. Schwartz has also served as a Technical Reviewer for
the Michigan Association of Certified Public Accountants peer review program
since 1990. Prior to 1990, Mr. Schwartz was a partner with the accounting firm
of Coopers & Lybrand, L.L.P.
Read P. Dunn, age 51, is President and Chief Executive Officer of the
Bank and has held these positions since its inception in 1983. Mr. Dunn is a
member of the Bank's Loan, Securities, CRA Compliance and Marketing Committees.
He is a certified public accountant and was the former President and senior
officer at another financial institution for over 14 years.
David L. Shelp, age 51, has been the Treasurer of the Bank since its
inception in 1983. Mr. Shelp was an Assistant Treasurer of another financial
institution in Lansing, Michigan from 1975 to 1981 and its Controller from 1981
to 1983.
Edward J. Shehab, age 37, joined the Bank in 1985 as a financial
analyst. Prior to that time, Mr. Shehab was an assistant secondary trader at
another financial institution. Since 1991, Mr. Shehab has been Vice President
of Finance at the Bank.
David F. Simon, age 50, is Chairman of the Board of the Bank and has
held this position since its inception in 1983. Mr. Simon is a member of the
Bank's Loan, Securities, CRA Compliance and Marketing Committees. He formerly
was an attorney in private practice specializing in securities and financial
institutions law from 1971 to 1991. Mr. Simon is the son-in-law of Edgar M.
Fenton, a Director of the Bank.
INDEPENDENT DIRECTORS
The Company's Certificate of Designation establishing the Series A
Preferred Shares requires that, so long as any Series A Preferred Shares are
outstanding, certain actions by the Company be approved by a majority of the
Independent Directors of the Company. See "Description of Series A Preferred
Shares--Independent Director Approval". Robert M. Walker and Schwartz
are the Company's initial Independent Directors. For so long as there are only
two Independent Directors, any action that requires the approval of a majority
of Independent Directors must be approved by both Independent Directors.
If at any time the Company fails to declare and pay a quarterly
dividend payment on the Series A Preferred Shares, the number of directors then
constituting the Board of Directors of the
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Company will be increased by two at the Company's next annual meeting and the
holders of Series A Preferred Shares, voting together with the holders of any
other outstanding series of Preferred Stock as a single class, will be entitled
to elect two additional directors to serve on the Company's Board of Directors.
Any member of the Board of Directors elected by holders of the Company's
Preferred Stock will be deemed to be an Independent Director for purposes of
the actions requiring the approval of a majority of the Independent Directors.
See "Description of Series A Preferred Shares--Voting Rights".
AUDIT COMMITTEE
Upon consummation of the Offering, the Company will establish an audit
committee which will review the engagement and independence of its auditors.
The audit committee will also review the adequacy of the Company's internal
accounting controls. The audit committee will initially be comprised of Messrs.
Walker and Schwartz.
CREDIT COMMITTEE
Upon consummation of the Offering, the Company will establish a credit
committee which will review and approve the acquisition of any additional
Mortgage Loans by the Company, will review the status of all Mortgage Loans
which have become Classified or have been placed in Nonaccrual Status, and will
review the terms and conditions upon which any such Loans are modified or
disposed of by the Company. The credit committee will initially be comprised of
Messrs. Simon, Shehab and Shelp.
COMPENSATION OF DIRECTORS AND OFFICERS
The Company intends to pay the Independent Directors of the Company
fees for their services as directors. The Independent Directors will receive a
fee of $500 for attendance (in person or by telephone) at each meeting of the
Board of Directors or Committee of the Board. However, multiple fees shall not
be paid for two or more meetings attended on the same day. The Company will
not pay any compensation to its officers or employees or to directors who are
not Independent Directors.
LIMITATIONS ON LIABILITY OF DIRECTORS AND OFFICERS
The Company's Articles of Incorporation eliminate, to the fullest
extent permitted by the Michigan law, the personal liability of a director to
the Company or its stockholders for monetary damages for breach of such
director's fiduciary duty. The Company's Articles of Incorporation empower the
Company to indemnify, to the fullest extent permitted by Michigan law, any
director or officer of the Company. The Company's Articles of Incorporation
also empower the Company to purchase and maintain insurance to protect any
director or officer against any liability asserted against him or her, or
incurred by him or her, arising out of his or her status as such.
The by-laws of the Company (the "By-laws") require indemnification of
the Company's directors and officers and specify that the right to
indemnification is a contract right, setting forth
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<PAGE> 60
certain procedural and evidentiary standards applicable to the enforcement of a
claim under the By-laws. The By-laws also entitle any director or officer to be
reimbursed for the expenses of defending any claim against him or her arising
out of his or her status as such. The By-laws of the Company also provide that
the Company may enter into contracts with any director or officer in
furtherance of the indemnification provisions contained in the By-laws and
allow the Company to create a trust fund to ensure payment of amounts
indemnified.
THE ADVISOR
In connection with the consummation of the Offering and the formation
of the Company as described herein, the Company will enter into the Advisory
Agreement with the Bank to administer the day-to-day operations of the Company.
The Bank in its role as Advisor under the terms of the Advisory Agreement is
herein referred to as the Advisor. The Advisor will be responsible for (i)
monitoring the credit quality of the Mortgage Assets held by the Company, (ii)
advising the Company with respect to the acquisition, management, financing and
disposition of the Company's Mortgage Assets and (iii) maintaining custody of
the documents related to the Company's Mortgage Loans. The Advisor may, from
time to time, subcontract all or a portion of its obligations under the
Advisory Agreement to one or more of its affiliates involved in the business of
managing Mortgage Assets or, with the approval of a majority of the Board of
Directors as well as a majority of the Independent Directors, subcontract all
or a portion of its obligations under the Advisory Agreement to unrelated third
parties. The Advisor will not, in connection with the subcontracting of any of
its obligations under the Advisory Agreement, be discharged or relieved in any
respect from its obligations under the Advisory Agreement.
At September 30, 1997, the Advisor held approximately $48.8
million of residential mortgage loans and approximately $106.3 million of
commercial mortgage loans. In 1996, the Advisor stopped originating
residential mortgage loans except as an accommodation to its business
customers. In its commercial mortgage loan business, the Advisor typically
services the commercial mortgage loans in its portfolio which it has
originated.
The Advisory Agreement has an initial term of five years, and will be
renewed automatically for additional five-year periods unless notice of
nonrenewal is delivered to the Advisor by the Company. The Advisory Agreement
may be terminated by the Company at any time upon 90 days' prior notice. As
long as any Series A Preferred Shares remain outstanding, any decision by the
Company either not to renew the Advisory Agreement or to terminate the Advisory
Agreement must be approved by a majority of the Board of Directors, as well as
by a majority of the Independent Directors. The Advisor will be entitled to
receive an annual advisory fee equal to $125,000 with respect to the advisory
and management services provided by it to the Company.
As a result of the relationship between the Bank and the Company,
certain conflicts of interest may arise. See "Risk Factors--Conflicts of
Interest in Business of the Company May Result in Decisions of the
Company That Do Not Fully Reflect The Interests of the Stockholders of the
Company".
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The principal executive offices of the Advisor are located at 24725
West Twelve Mile Road, Southfield, Michigan 48034, telephone number (248)
358-4710.
CERTAIN TRANSACTIONS CONSTITUTING THE FORMATION
THE FORMATION
Prior to or simultaneously with the completion of the Offering, the
Company, the Bank and its affiliates will engage in the transactions described
below which are designed (i) to facilitate the Offering, (ii) to transfer the
ownership of the Initial Portfolio to the Company and (iii) to enable the
Company to qualify as a REIT for federal income tax purposes commencing with
its taxable year ending December 31, 1997.
The transactions constituting the formation of the Company will
include the following:
- The Articles of Incorporation of the Company will be amended
to provide for 2,500,000 authorized shares of Preferred Stock
and 60,000 authorized shares of Common Stock, and the Company
will file a Certificate of Designation with the State of
Michigan establishing the terms of the Series A Preferred
Shares.
- The Company will sell to the public 1,800,000 Series A
Preferred Shares in the Offering (assuming the Underwriters'
over-allotment option is not exercised).
- The Bank will acquire 18,000 shares of Common Stock for a
purchase price equal to $18 million. In addition, the Bank
will acquire additional shares of Common Stock for a purchase
price equal to the aggregate amount of underwriting
commissions and expenses of the Offering and the formation of
the Company.
- The Bank will sell the Initial Portfolio to the Company for an
aggregate purchase price equal to approximately $36 million
pursuant to the terms of the Residential Mortgage Purchase
Agreement and the Commercial Mortgage Purchase Agreement.
- The Company will enter into the Advisory Agreement with the
Bank pursuant to which the Bank, as Advisor, will manage the
Mortgage Assets held by the Company and administer the
day-to-day operations of the Company. See "Management--The
Advisor".
- The Company will enter into the Servicing Agreements with the
Bank pursuant to which the Bank, as Servicer, will service the
Mortgage Loans included in the Initial Portfolio. See
"Business and Strategy--Servicing".
The Bank currently owns, and following the completion of the Offering
intends to continue to own, all of the issued and outstanding shares of Common
Stock of the Company. The Bank currently intends that, so long as any Series A
Preferred Shares are outstanding, it will maintain
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<PAGE> 62
direct or indirect ownership of at least a majority of the outstanding shares
of Common Stock of the Company.
A PURCHASE OF SERIES A PREFERRED SHARES IS A PURCHASE OF SECURITIES
ISSUED BY THE COMPANY. NO OBLIGATION OF THE COMPANY IS GUARANTEED BY THE
BANK.
In addition to its ownership of 100% of the Common Stock of the
Company, the Bank will also have responsibility for the day-to-day management
and custody of the Company's assets, in its capacity as Advisor under the
Advisory Agreement, and will have responsibility for servicing the Mortgage
Loans as Servicer under the Servicing Agreements. See "Management--The Advisor"
and "Risk Factors--Conflicts of Interest in Business of the Company May
Result in Decisions of the Company That Do Not Fully Reflect the Interests of
the Stockholders of the Company".
The Company and the Bank intend that the fair value of the Initial
Portfolio will approximately equal the amount (approximately $36 million) that
the Company will pay for the Initial Portfolio. However, no third party
valuations of the Mortgage Loans constituting the Initial Portfolio have been
or will be obtained for purposes of the Offering, and there can be no assurance
that the fair value of the Initial Portfolio will not differ from the purchase
price to be paid by the Company. See "Risk Factors--Conflicts of Interest in
Business of the Company May Result in Decisions of the Company That Do Not
Fully Reflect the Interests of the Stockholders of the Company--No Third Party
Valuation of the Mortgage Loans; No Arm's-Length Negotiations with
Affiliates".
BENEFITS TO THE BANK AND ITS AFFILIATES
The Bank and its affiliates expect to realize the following benefits
in connection with the Offering and the formation of the Company:
o The Bank is required by the OCC to maintain certain levels of
capital for regulatory purposes. The Bank has informed the
Company that the Series A Preferred Shares will be treated as
capital of the Bank for regulatory purposes. The Bank would
not be permitted to treat any securities issued by a trust
established by the Bank to securitize its mortgage assets as
capital for regulatory purposes.
o As a result of the Company's qualification as a REIT, the
dividends payable on the Series A Preferred Shares will be
deductible for income tax purposes and will provide the Bank
with a more cost-effective means of obtaining regulatory
capital than if the Bank were to issue preferred stock itself.
o The Bank will receive approximately $36 million at the
consummation of the Offering (assuming no exercise by the
Underwriters of their over-allotment option) in connection
with the sale of the Initial Portfolio to the Company
(approximately
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<PAGE> 63
$18 million of which represents new funds after giving effect
to the Bank's expense of purchasing the Company's Common
Stock).
o The Bank will be entitled to receive annual advisory and
servicing fees and annual dividends in respect of the Common
Stock. For the first 12 months following completion of the
Offering, these annual fees and dividends are anticipated to
be as follows:
<TABLE>
<S> <C>
Advisory Fee . . . . . . . . . . . . . . . . . $125,000
Servicing Fee(1) . . . . . . . . . . . . . . . $135,000
Common Stock Dividend(2) . . . . . . . . . . . [ ]
-------
$[ ]
=======
</TABLE>
---------------
(1) Assumes that for the first 12 months following
completion of the Offering, the Company holds
Residential Mortgage Loans and Commercial Mortgage
Loans with the same outstanding principal balances as
those Mortgage Loans included in the Initial
Portfolio. See "Business and Strategy--Servicing" for
a description of the basis upon which the servicing
fees will be calculated.
(2) The amount of dividends to be paid in respect of the
Common Stock is expected to be equal to the excess of
the Company's "REIT Taxable Income" (excluding capital
gains) over the amount of dividends paid in respect of
Preferred Stock. The aggregate annual dividend amount
of the Series A Preferred Shares is $[____] million.
Assuming that (i) the Mortgage Loans included in the
Initial Portfolio are held for the 12-month period
following completion of the Offering, (ii) principal
repayments are reinvested in additional Mortgage Loans
with characteristics similar to those of the Mortgage
Loans included in the Initial Portfolio and (iii)
interest rates remain constant during such 12-month
period, the Company anticipates that the Initial
Portfolio will generate "REIT Taxable Income"
(excluding capital gains) of approximately $2.8
million, after payment of servicing and advisory fees,
during such 12-month period.
o The Bank will also be entitled to retain any late payment
charges and penalties collected in connection with the
Mortgage Loans serviced by it. In addition, the Bank, as
Servicer, will receive any benefit derived from interest
earned on collected principal and interest payments between
the date of collection and the date of remittance to the
Company and from interest earned on tax and insurance escrow
funds with respect to Mortgage Loans serviced by it.
DESCRIPTION OF SERIES A PREFERRED SHARES
The following summary sets forth the material terms and provisions of
the Series A Preferred Shares, and is qualified in its entirety by reference to
the terms and provisions of the Certificate of Designation establishing the
Series A Preferred Shares and the Company's Articles of Incorporation, the
forms of which have been filed with the Securities and Exchange Commission (the
"Commission") as exhibits to the registration statement of which this
Prospectus forms a part. See "Description of Capital Stock" below.
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GENERAL
The Series A Preferred Shares form a series of the Preferred Stock of
the Company, which Preferred Stock may be issued from time to time in one or
more series with such rights, preferences and limitations as are determined by
the Company's Board of Directors or, if then constituted, a duly authorized
committee thereof. The Board of Directors has authorized the Company to issue
the Series A Preferred Shares.
When issued, the Series A Preferred Shares will be validly issued,
fully paid and nonassessable. The holders of the Series A Preferred Shares will
have no preemptive rights with respect to any shares of the capital stock of
the Company or any other securities of the Company convertible into or carrying
rights or options to purchase any such shares. The Series A Preferred Shares
will not be convertible into shares of Common Stock or any other class or
series of capital stock of the Company and will not be subject to any sinking
fund or other obligation of the Company for its repurchase or retirement.
The transfer agent, registrar and dividend disbursement agent for the
Preferred Stock will be Boston EquiServe Limited Partnership. The registrar
for shares of Preferred Stock will send notices to shareholders of any meetings
at which holders of the Preferred Stock have the right to elect directors of
the Company or to vote on any other matter.
DIVIDENDS
Holders of Series A Preferred Shares will be entitled to receive, when
and as declared by the Board of Directors of the Company out of assets of the
Company legally available therefor, cash dividends at the rate of [____]% per
annum of the initial liquidation preference (equivalent to $[_____] per share
per annum). If declared, dividends on the Series A Preferred Shares will be
payable quarterly on March 31, June 30, September 30 and December 31 of each
year, at such annual rate, commencing on December 31, 1997. Dividends in each
quarterly period will accrue from the first day of such period, whether or not
declared or paid for the prior quarterly period. Each declared dividend will
be payable to holders of record as they appear on the stock register of the
Company on such record dates, not exceeding 45 days preceding the payment dates
thereof, as shall be fixed by the Board of Directors of the Company or a duly
authorized committee thereof. Dividends payable on the Series A Preferred
Shares for any period greater or less than a full dividend period shall be
computed on the basis of twelve 30-day months, a 360-day year and the actual
number of days elapsed in the period. Dividends payable on the Series A
Preferred Shares for each full dividend period shall be computed by dividing
the rate per annum by four.
The right of holders of Series A Preferred Shares to receive dividends
is noncumulative. Accordingly, if the Board of Directors fails to declare a
dividend on the Series A Preferred Shares for a quarterly dividend period, then
holders of the Series A Preferred Shares will have no right to receive a
dividend for that period, and the Company will have no obligation to pay a
dividend for that period, whether or not dividends are declared and paid for
any future period with respect to either the Series A Preferred Shares or the
Common Stock. If the Company fails to pay or declare and set aside for payment
a quarterly dividend on the Series A Preferred Shares, holders
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<PAGE> 65
of the Preferred Stock of the Company, including the Series A Preferred Shares,
will be entitled to elect two directors. See "--Voting Rights".
If full dividends on the Series A Preferred Shares for any dividend
period shall not have been declared and paid, or declared and a sum sufficient
for the payment thereof shall not have been set apart for such payments, no
dividends shall be declared or paid or set aside for payment and no other
distribution shall be declared or made or set aside for payment upon the Common
Stock or any other capital stock of the Company ranking junior to or on a
parity with the Series A Preferred Shares as to dividends or amounts upon
liquidation, nor shall any Common Stock or any other capital stock of the
Company ranking junior to or on a parity with the Series A Preferred Shares as
to dividends or amounts upon liquidation be redeemed, purchased or otherwise
acquired for any consideration (or any monies to be paid to or made available
for a sinking fund for the redemption of any such stock) by the Company (except
by conversion into or exchange for other capital stock of the Company ranking
junior to the Series A Preferred Shares as to dividends and amounts upon
liquidation), until such time as dividends on all outstanding Series A
Preferred Shares have been (i) declared and paid for three consecutive dividend
periods and (ii) declared and paid or declared and a sum sufficient for the
payment thereof has been set apart for payment for the fourth consecutive
dividend period.
When dividends are not paid in full (or a sum sufficient for such full
payment is not set apart) upon the Series A Preferred Shares and the shares of
any other series of capital stock ranking on a parity as to dividends with the
Series A Preferred Shares, all dividends declared upon the Series A Preferred
Shares and any other series of capital stock ranking on a parity as to
dividends with the Series A Preferred Shares shall be declared pro rata so that
the amount of dividends declared per share on the Series A Preferred Shares and
such other series of capital stock shall in all cases bear to each other the
same ratio that full dividends, for the then-current dividend period, per share
on the Series A Preferred Shares (which shall not include any accumulation in
respect of unpaid dividends for prior dividend periods) and full dividends,
including required or permitted accumulations, if any, on such other series of
capital stock bear to each other.
For a discussion of the tax treatment of distributions to
stockholders, see "Federal Income Tax Considerations--Taxation of United States
Stockholders" and "--Taxation of Foreign Stockholders" and for a discussion of
certain potential regulatory limitations on the Company's ability to pay
dividends, see "Risk Factors--Tax, Legal and Regulatory Risks--Regulatory
Authorities May Impose Restrictions on Dividends and Operations of the
Company".
AUTOMATIC EXCHANGE
Each Series A Preferred Share will be exchanged automatically for one
newly issued Bank Preferred Share if the appropriate regulatory agency directs
in writing an exchange of the Series A Preferred Shares for Bank Preferred
Shares because (i) the Bank becomes "undercapitalized" under prompt corrective
action regulations established pursuant to FDICIA, (ii) the Bank is placed into
conservatorship or receivership or (iii) the appropriate regulatory agency, in
its sole discretion and even if the Bank is not "undercapitalized," anticipates
the Bank becoming "undercapitalized"
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in the near term (i.e., the Exchange Event). Upon the Automatic Exchange, each
holder of Series A Preferred Shares shall be unconditionally obligated to
surrender to the Bank the certificates representing each Series A Preferred
Share of such holder, and the Bank shall be unconditionally obligated to issue
to such holder in exchange for each such Series A Preferred Share a certificate
representing one Bank Preferred Share. Any Series A Preferred Shares purchased
or redeemed by the Company prior to the Time of Exchange (as defined below)
shall not be deemed outstanding and shall not be subject to the Automatic
Exchange.
The Automatic Exchange shall occur as of 8:00 a.m. Eastern Time on the
date for such exchange set forth in the Directive, or, if such date is not set
forth in the Directive, as of 8:00 a.m. on the earliest possible date such
exchange could occur consistent with the Directive (the "Time of Exchange"), as
evidenced by the issuance by the Bank of a press release prior to such time.
As of the Time of Exchange, all of the Series A Preferred Shares will be deemed
cancelled without any further action by the Company, all rights of the holders
of Series A Preferred Shares as stockholders of the Company will cease, and
such persons shall thereupon and thereafter be deemed to be and shall be for
all purposes the holders of Bank Preferred Shares within 30 days of such event,
and the Bank will deliver to each such holder certificates for Bank Preferred
Shares upon surrender of certificates for Series A Preferred Shares. Until
such replacement stock certificates are delivered (or in the event such
replacement certificates are not delivered), certificates previously
representing Series A Preferred Shares shall be deemed for all purposes to
represent Bank Preferred Shares. All corporate action necessary for the Bank
to issue the Bank Preferred Shares will be completed upon completion of the
Offering. Accordingly, once the Directive is issued, no action will be
required to be taken by holders of Series A Preferred Shares, by the Bank or by
the Company in order to effect the Automatic Exchange as of the Time of
Exchange.
Absent the occurrence of the Exchange Event, no shares of Bank
Preferred Shares will be issued. Upon the occurrence of the Exchange Event,
the Bank Preferred Shares to be issued as part of the Automatic Exchange would
constitute a newly issued series of preferred stock of the Bank and would
constitute 100% of the issued and outstanding shares of Bank Preferred Shares.
Holders of Bank Preferred Shares would have the same dividend rights,
liquidation preference, redemption options and other attributes as to the Bank
as holders of Series A Preferred Shares have as to the Company, except that the
Bank Preferred Shares would not be listed on the Nasdaq System. Any accrued
and unpaid dividends for the most recent quarter on the Series A Preferred
Shares as of the Time of Exchange would be deemed to be accrued and unpaid
dividends for the most recent quarter on the Bank Preferred Shares. The Bank
Preferred Shares would rank pari passu in terms of dividend payment and
liquidation preference with any outstanding shares of preferred stock of the
Bank. The Bank intends to register the Bank Preferred Shares with the OCC
pursuant to a Bank Prospectus, a copy of which is affixed to this Prospectus as
Annex I and incorporated herein by reference. The Bank Preferred Shares will
not be registered with the Commission and will be offered pursuant to an
exemption from registration under Section 3(a)(5) of the Securities Act of
1933, as amended (the "Securities Act"). The Bank does not intend to apply for
listing of the Bank Preferred Shares on any national securities exchange or for
quotation of the Bank Preferred Shares through the Nasdaq System. Absent the
occurrence of the Exchange Event, however, the Bank will not issue any Bank
Preferred Shares, although the Bank will be
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<PAGE> 67
able to issue preferred stock in series. There can be no assurance as to the
liquidity of the trading markets for the Bank Preferred Shares, if issued, or
that an active public market for the Bank Preferred Shares would develop or be
maintained.
Holders of Series A Preferred Shares cannot exchange their Series A
Preferred Shares for Bank Preferred Shares voluntarily. In addition, absent
the occurrence of the Automatic Exchange, holders of Series A Preferred Shares
will have no dividend, voting, liquidation preference or other rights with
respect to any security of the Bank; such rights as are conferred by the Series
A Preferred Shares exist solely as to the Company.
VOTING RIGHTS
Except as expressly required by applicable law, or except as indicated
below, the holders of the Series A Preferred Shares will not be entitled to
vote. In the event the holders of Series A Preferred Shares are entitled to
vote as indicated below, each Series A Preferred Share will be entitled to one
vote on matters on which holders of the Series A Preferred Shares are entitled
to vote.
If at the time of any annual meeting of the Company's stockholders for
the election of directors the Company has failed to pay or declare and set
aside for payment a quarterly dividend during any of the four preceding
quarterly dividend periods on any series of Preferred Stock of the Company,
including the Series A Preferred Shares, the number of directors then
constituting the Board of Directors of the Company will be increased by two,
and the holders of the Series A Preferred Shares, voting together with the
holders of all other series of Preferred Stock as a single class, will be
entitled to elect such two additional directors to serve on the Company's Board
of Directors at each such annual meeting. Each director elected by the holders
of shares of the Preferred Stock shall continue to serve as such director until
the later of (i) the full term for which he or she shall have been elected or
(ii) the payment of four quarterly dividends on the Preferred Stock, including
the Series A Preferred Shares.
The affirmative vote or consent of the holders of at least two-thirds
of the outstanding shares of each series of Preferred Stock of the Company,
including the Series A Preferred Shares, voting as a single class without
regard to series, will be required (a) to create any class or series of stock
which shall have preference as to dividends or distribution of assets over any
outstanding series of Preferred Stock of the Company other than a series which
shall not have any right to object to such creation or (b) to alter or change
the provisions of the Company's Articles of Incorporation (including the
Certificate of Designation establishing the Series A Preferred Shares) so as to
adversely affect the voting powers, preferences or special rights of the
holders of a series of Preferred Stock of the Company; provided that if such
amendment shall not adversely affect all series of Preferred Stock of the
Company, such amendment need only be approved by at least two-thirds of the
holders of shares of all series of Preferred Stock adversely affected thereby.
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REDEMPTION
The Series A Preferred Shares will not be redeemable prior to
[___________] 2002 (except upon the occurrence of a Tax Event). On or after
such date, the Series A Preferred Shares will be redeemable at the option of
the Company, in whole or in part, at any time or from time to time on not less
than 30 nor more than 60 days' notice by mail, at a redemption price of $10.00
per share, plus the accrued and unpaid dividends for the most recent quarter to
the date of redemption, if any, thereon. Any such redemption may only be
effected with the prior approval of the OCC (unless at such time such approvals
are not required). Unless full dividends on the Series A Preferred Shares have
been or contemporaneously are declared and paid or declared and a sum
sufficient for the payment thereof has been set apart for payment for the then
current dividend period, no Series A Preferred Shares shall be redeemed unless
all outstanding Series A Preferred Shares are redeemed and the Company shall
not purchase or otherwise acquire any Series A Preferred Shares; provided,
however, that the Company may purchase or acquire Series A Preferred Shares
pursuant to a purchase or exchange offer made on the same terms to holders of
all outstanding Series A Preferred Shares.
The Company will also have the right at any time, upon the occurrence
of a Tax Event and with the prior written approval of the OCC, to redeem the
Series A Preferred Shares, in whole (but not in part) at a redemption price of
$10.00 per share, plus the accrued and unpaid dividends for the most recent
quarter to the date of redemption, if any, thereon.
RIGHTS UPON LIQUIDATION
In the event of any voluntary or involuntary liquidation, dissolution
or winding up of the Company, the holders of the Series A Preferred Shares at
the time outstanding will be entitled to receive out of assets of the Company
available for distribution to stockholders, before any distribution of assets
is made to holders of Common Stock or any other class of stock ranking junior
to the Series A Preferred Shares upon liquidation, liquidating distributions in
the amount of $10.00 per share, plus the accrued and unpaid dividends for the
most recent quarter thereon, if any, to the date of liquidation.
After payment of the full amount of the liquidating distributions to
which they are entitled, the holders of Series A Preferred Shares will have no
right or claim to any of the remaining assets of the Company. In the event
that, upon any such voluntary or involuntary liquidation, dissolution or
winding up, the available assets of the Company are insufficient to pay the
amount of the liquidation distributions on all outstanding Series A Preferred
Shares and the corresponding amounts payable on all shares of other classes or
series of capital stock of the Company ranking on a parity with the Series A
Preferred Shares in the distribution of assets upon any liquidation,
dissolution or winding up of the affairs of the Company, then the holders of
the Series A Preferred Shares and such other classes or series of capital stock
shall share ratably in any such distribution of assets in proportion to the
full liquidating distributions to which they would otherwise be respectively
entitled.
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For such purposes, the consolidation or merger of the Company with or
into any other entity, the consolidation or merger of any other entity with or
into the Company or the sale of all or substantially all of the property or
business of the Company shall not be deemed to constitute a liquidation,
dissolution or winding up of the Company.
INDEPENDENT DIRECTOR APPROVAL
The Certificate of Designation establishing the Series A Preferred
Shares requires that, so long as any Series A Preferred Shares are outstanding,
certain actions by the Company be approved by a majority of the Independent
Directors. For so long as there are only two Independent Directors, any action
that requires the approval of a majority of Independent Directors must be
approved by both Independent Directors. [___________] and [____________] are
the Company's initial Independent Directors. See "Management--Independent
Directors". In addition, any members of the Board of Directors of the Company
elected by holders of Preferred Stock, including the Series A Preferred Shares,
will be deemed to be Independent Directors for purposes of approving actions
requiring the approval of a majority of the Independent Directors.
The actions which may not be taken without the approval of a majority
of the Independent Directors include (i) the issuance of additional Preferred
Stock ranking on a parity with the Series A Preferred Shares, (ii) the
incurrence of debt for borrowed money in excess of 20% of the aggregate amount
of net proceeds received in connection with the issuance of Preferred Stock and
Common Stock, (iii) the modification of the general distribution policy or the
declaration of any distribution in respect of Common Stock for any year if,
after taking into account any such proposed distribution, total distributions
on the Series A Preferred Shares and the Common Stock would exceed an amount
equal to the sum of 105% of the Company's "REIT Taxable Income" (excluding
capital gains) for such year plus net capital gains of the Company for that
year, (iv) the acquisition of real estate assets other than Mortgage Loans or
Mortgage-Backed Securities that (A) qualify as real estate assets under Section
856(c)(6)(B) of the Code, (B) are rated investment grade or better by at least
one nationally recognized independent rating organization, (C) are not
interest-only, principal-only or high-risk securities and (D) represent
interests in or obligations backed by pools of mortgage loans, (v) the
redemption of any shares of Common Stock, (vi) the termination or modification
of, or the election not to renew, the Advisory Agreement or any Servicing
Agreement or the subcontracting of any duties under the Advisory Agreement or
the Servicing Agreements to third parties unaffiliated with the Bank, (vii) any
dissolution, liquidation or termination of the Company prior to [___________],
2002, (viii) any material amendment to or modification of either of the
Mortgage Purchase Agreements, including, without limitation, any amendment to
the representations, warranties and covenants contained in such agreements made
in connection with the acquisition of additional Mortgage Loans and (ix) the
determination to revoke the Company's REIT status or the amendment of any of
the ownership limitations contained in the Articles of Incorporation. The
Certificate of Designation requires that, in assessing the benefits to the
Company of any proposed action requiring their consent, the Independent
Directors take into account the interests of holders of both the Common Stock
and the Preferred Stock, including, without limitation, holders of the Series
A Preferred Shares. In considering the interests of the holders of Preferred
Stock, including without limitation the holders
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of the Series A Preferred Shares, the Independent Directors shall owe the same
duties which the Independent Directors owe to the holders of Common Stock.
RESTRICTIONS ON OWNERSHIP
For information regarding restrictions on ownership of the Series A
Preferred Shares, see "Description of Capital Stock--Restrictions on Ownership
and Transfer".
DESCRIPTION OF CAPITAL STOCK
The following summary of the material terms and provisions of the
capital stock of the Company does not purport to be complete and is subject in
all respects to the applicable provisions of the Michigan law and the Articles
of Incorporation of the Company.
COMMON STOCK
General. The Company is authorized to issue up to 60,000 shares of
Common Stock. Upon consummation of the Offering and the transactions described
in "Certain Transactions Constituting the Formation", the Company will have
outstanding 19,100 shares of Common Stock, all of which will be held by the
Bank.
Dividends. Holders of Common Stock are entitled to receive dividends
when, as and if declared by the Board of Directors out of funds legally
available therefor, provided that, so long as any shares of Preferred Stock are
outstanding, no dividends or other distributions (including redemptions and
purchases) may be made with respect to the Common Stock unless full dividends
on the shares of all series of Preferred Stock, including accumulations in the
case of noncumulative Preferred Stock, have been paid for the prior four
quarters. In order to remain qualified as a REIT, the Company must distribute
annually at least 95% of its annual "REIT Taxable Income" (not including
capital gains) to stockholders.
Voting Rights. Subject to the rights, if any, of the holders of any
class or series of Preferred Stock, all voting rights are vested in the Common
Stock. The holders of Common Stock are entitled to one vote per share. All of
the issued and outstanding shares of Common Stock are currently, and upon
consummation of the Offering will be, held by the Bank.
Rights Upon Liquidation. In the event of the liquidation, dissolution
or winding up of the Company, whether voluntary or involuntary, after there
have been paid or set aside for the holders of all series of Preferred Stock
the full preferential amounts to which such holders are entitled, the holders
of Common Stock will be entitled to share equally and ratably in any assets
remaining after the payment of all debts and liabilities.
PREFERRED STOCK
Subject to limitations prescribed by Michigan law and the Company's
Articles of Incorporation, the Board of Directors or, if then constituted, a
duly authorized committee thereof
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is authorized to issue, from the authorized but unissued shares of capital
stock of the Company, Preferred Stock in such classes or series as the Board of
Directors may determine and to establish, from time to time, the number of
shares of Preferred Stock to be included in any such class or series and to fix
the designation and any preferences, conversion and other rights, voting
powers, restrictions, limitations as to dividends, qualifications and terms and
conditions of redemption of the shares of any such class or series, and such
other subjects or matters as may be fixed by resolution of the Board of
Directors.
Preferred Stock, upon issuance against full payment of the purchase
price therefor, will be fully paid and nonassessable. The specific terms of a
particular class or series of Preferred Stock will be described in the
Certificate of Designation relating to that class or series.
A Certificate of Designation relating to each class or series of
Preferred Stock will set forth the preferences and other terms of such class or
series, including, without limitation, the following: (1) the title and stated
value of such class or series; (2) the number of shares of such class or series
offered and the liquidation preference per share of such class or series; (3)
the dividend rate(s), period(s), and/or payment date(s) or method(s) of
calculation thereof applicable to such class or series; (4) whether such class
or series of Preferred Stock is noncumulative or not and, if noncumulative, the
date from which dividends on such class or series shall accumulate; (5) the
provision for a sinking fund, if any, for such class or series; (6) the
provision for redemption, if applicable, of such class or series; (7) any
limitations on direct or beneficial ownership and restrictions on transfer, in
each case as may be appropriate to preserve the status of the Company as a
REIT; (8) any voting rights of such class or series; (9) the relative ranking
and preferences of such class or series as to dividend rights and rights upon
liquidation, dissolution or winding up of the affairs of the Company; (10) any
limitations on issuance of any class or series of Preferred Stock ranking
senior to or on a parity with such class or series of Preferred Stock as to
dividend rights and rights upon liquidation, dissolution or winding up of the
affairs of the Company; and (11) any other specific terms, preferences, rights,
limitations or restrictions of such class or series.
RESTRICTIONS ON OWNERSHIP AND TRANSFER
The Company's Articles of Incorporation contain certain restrictions
on the number of shares of Common Stock and Preferred Stock that individual
stockholders may own. For the Company to qualify as a REIT under the Code, no
more than 50% in number or value of its outstanding shares of capital stock may
be owned, directly or indirectly, by five or fewer individuals (as defined in
the Code to include certain entities) during the last half of a taxable year
(other than the first year) or during a proportionate part of a shorter taxable
year (the "Five or Fewer Test"). The capital stock of the Company must also be
beneficially owned by 100 or more persons during at least 335 days of a taxable
year or during a proportionate part of a shorter taxable year (the "One Hundred
Persons Test"). The ownership by the Bank of 100% of the shares of Common Stock
of the REIT will not adversely affect the Company's REIT qualification because
each stockholder of the Bank counts as a separate beneficial owner for purposes
of the Five or Fewer Test and the capital stock of the Bank is widely held.
Further, the Articles of Incorporation of the Company contain restrictions on
the acquisition of Preferred Stock intended to ensure compliance with the One
Hundred Persons Test. Such provisions include a restriction that if any
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transfer of shares of capital stock of the Company would cause the Company to
be beneficially owned by fewer than 100 persons, such transfer shall be null
and void and the intended transferee will acquire no rights to the stock.
Subject to certain exceptions specified in the Company's Articles of
Incorporation, no holder of Preferred Stock is permitted to own (including
shares deemed to be owned by virtue of the attribution provisions of the Code)
more than 9.9% (the "Ownership Limit") of any issued and outstanding class or
series of Preferred Stock. The Board of Directors may (but in no event will be
required to), upon receipt of a ruling from the IRS or an opinion of counsel
satisfactory to it, waive the Ownership Limit with respect to a holder if such
holder's ownership will not then or in the future jeopardize the Company's
status as a REIT.
The Articles of Incorporation provide that shares of any class or
series of Preferred Stock owned, or deemed to be owned, by or transferred to a
stockholder in excess of the Ownership Limit (the "Excess Shares") will
automatically be transferred, by operation of law, to a trustee as a trustee of
a trust for the exclusive benefit of a charity to be named by the Company as of
the day prior to the day the prohibited transfer took place. Any distributions
paid prior to the discovery of the prohibited transfer are to be repaid by the
original transferee to the Company and by the Company to the trustee; any vote
of the shares while the shares were held by the original transferee prior to
the Company's discovery thereof shall be void ab initio and the original
transferee shall be deemed to have given its proxy to the trustee. Any unpaid
distributions with respect to the original transferee will be rescinded as void
ab initio. In liquidation, the original transferee stockholder's ratable share
of the Company's assets would be limited to the price paid by the original
transferee for the Excess Shares or, if no value was given, the price per share
equal to the closing market price on the date of the purported transfer. The
trustee of the trust shall promptly sell the shares to any person whose
ownership is not prohibited, whereupon the interest of the trust shall
terminate. Proceeds of the sale shall be paid to the original transferee up to
its purchase price (or, if the original transferee did not purchase the shares,
the value on its date of acquisition) and any remaining proceeds shall be paid
to a charity to be named by the Company.
The constructive ownership rules of the Code are complex and may cause
Preferred Stock owned, directly or indirectly, by a group of related
individuals and/or entities to be deemed to be constructively owned by one
individual or entity. As a result, the acquisition of less than 9.9% of a class
or series of issued and outstanding Preferred Stock (or the acquisition of an
interest in an entity that owns shares of such series of Preferred Stock) by an
individual or entity could cause that individual or entity (or another
individual or entity) to own constructively in excess of 9.9% of such class or
series of Preferred Stock, and thus subject such stock to the Ownership Limit.
Direct or constructive ownership in excess of the Ownership Limit would cause
ownership of the shares in excess of the limit to be transferred to the
trustee.
All certificates representing shares of Preferred Stock will bear a
legend referring to the restrictions described above.
The Ownership Limit provisions will not be automatically removed even
if the REIT Provisions (as defined herein) are changed so as to eliminate any
ownership concentration
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limitation or if the ownership concentration limitation is increased. The
Articles of Incorporation may not be amended to alter, change, repeal or amend
any of the Ownership Limit provisions without the prior approval of a majority
of the Independent Directors.
The Articles of Incorporation require that any person who beneficially
owns 1% (or such lower percentage as may be required by the Code or the
Treasury Regulations) of the outstanding shares of any class or series of
Preferred Stock of the Company must provide certain information to the Company
within 30 days of June 30 and December 31 of each year. In addition, each
stockholder shall upon demand be required to disclose to the Company in writing
such information as the Company may request in order to determine the effect,
if any, of such stockholder's actual and constructive ownership on the
Company's status as a REIT and to ensure compliance with the Ownership Limit.
FEDERAL INCOME TAX CONSIDERATIONS
The following summary of material federal income tax considerations
regarding the Offering is based upon current law, is for general information
only and is not tax advice. The information set forth below, to the extent that
it constitutes summaries of tax matters or tax conclusions, has been reviewed
by Seyburn Kahn, and it is their opinion that such information is accurate in
all material respects. The discussion below is based on existing federal income
tax law, which is subject to change, with possible retroactive effect. The
discussion below does not address all aspects of taxation that may be relevant
in the particular circumstances of each stockholder or to certain types of
stockholders (including insurance companies, tax-exempt entities, financial
institutions or broker-dealers, foreign corporations and persons who are not
citizens or residents of the United States, except to the extent discussed)
subject to special treatment under the federal income tax laws.
EACH PROSPECTIVE INVESTOR IS URGED TO SEEK INDIVIDUAL ADVICE
CONCERNING THE EFFECT ON HIM OR HER OF THE PURCHASE, OWNERSHIP AND SALE OF THE
SERIES A PREFERRED SHARES UNDER FEDERAL, STATE, LOCAL AND FOREIGN TAX LAWS,
INCLUDING THE EFFECT OF POSSIBLE CHANGES IN TAX LAW.
TAXATION OF THE COMPANY
General. The Company will elect to be taxed as a REIT under Sections
856 through 860 of the Code and the applicable Treasury Regulations (the "REIT
Requirements" or the "REIT Provisions"), which are the requirements for
qualifying as a REIT, commencing with its taxable year ending December 31,
1997. The Company believes that, commencing with its taxable year ending
December 31, 1997, it will be owned and organized and will operate in such a
manner as to qualify for taxation as a REIT under the Code, and the Company
intends to continue to operate in such a manner, but no assurance can be given
that it will operate in a manner so as to qualify or remain qualified.
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The REIT Requirements are technical and complex. The following
discussion sets forth only the material aspects of those requirements. This
summary is qualified in its entirety by the applicable Code provisions, rules
and regulations promulgated thereunder, and administrative and judicial
interpretations thereof.
In the opinion of Seyburn Kahn, commencing with the Company's taxable
year ending December 31, 1997, the Company will be organized in conformity with
the requirements for qualification and taxation as a REIT under the Code. This
opinion is based on the assumption that the Company will be organized and
operated in the manner described herein. See "The Company", "Business and
Strategy" and "Certain Transactions Constituting Formation". This opinion is
conditioned upon the accuracy of certain factual representations made by the
Company regarding its organization and operations, as well as the nature of the
business and Mortgage Assets. The representations made by the Company upon
which Seyburn Kahn relies are as follows:
1. The REIT has been duly organized as a corporation under the laws
of the state of Michigan on or after August 6, 1997 and before
December 31, 1997.
2. By the end of 1997, the REIT will be operating as real estate
investment trust as defined in Sections 856 to 859 of the Code,
and will be operating in accordance with the following parameters:
a. The Company will be managed by one or more directors;
b. Ownership of the common and preferred stock of the Company
will be evidenced by transferable shares of certificates;
c. The Company will not be operated as a bank or insurance
company;
d. The preferred shares will be owned by more than 100 persons;
e. In the last half of the year, there will not be 5 or fewer
persons who own more than half of the value of the Company;
f. The Company will validly elect to be taxed as a REIT;
g. The Company will adopt a calendar year end;
h. At least 75% of the value of the total assets of the Company
will consist of real estate assets (including mortgage
assets), cash, cash items (including receivables) and
government securities;
i. Not more than 25% of the total value of the Company assets
will be represented by securities (other than those provided
in paragraph h. above);
(1) not more than 5% of the value of the trust will
consist of securities of any one issuer (other than
securities included in the 75% test described in
paragraph h. above);
(2) not more than 10% of the outstanding voting
securities of any one issuer will be held by the
trust (other than securities included in the 75% test
described in paragraph h. above);
j. At least 75% of the gross income of the Company will be
derived from rents from real property, interest or
mortgages, gain from the sale or disposition of real
property, dividends from other real estate investment
trusts, abatements and refunds of taxes on real property,
income and gain from foreclosure property, commitment fees
for loans, and qualified temporary investment income; and
k. At least 95% of the Company's gross income will be derived
from sources described in paragraph j above, dividends,
interest and capital gains on the sale or disposition of
stocks and securities.
3. The Company will not securitize its mortgage assets or otherwise
participate in a "trade or business" of selling mortgage assets.
4. The Company will hold title to the mortgage assets in its own
name.
5. The Company will distribute an aggregate amount of dividends with
respect to the Company's outstanding shares of capital stock
equal to (i) 95% of the Company's real estate investment trust
taxable income excluding capital gains, (ii) 95% of the excess
income, minus (iii) any excess noncash income.
The opinion of Seyburn Kahn is based on the proposed method of
operations of the Company; qualification and taxation as a REIT depends upon
the Company's ability to meet, through actual annual operating results, the
requirements imposed under the Code, as discussed below. The actual annual
operating results will not be reviewed by Seyburn Kahn. No assurance can be
given that the actual results of the company's operation for any one taxable
year will satisfy such requirements. See"-- Failure to Qualify".
If the Company qualifies for taxation as a REIT, it generally will not
be subject to federal corporate income taxes on that portion of its ordinary
income or capital gain that is currently distributed to stockholders. Such
treatment substantially eliminates the federal "double taxation" on earnings
(at the corporate and the stockholder levels) that generally results from
investment in a corporation.
Despite the REIT election, the Company may be subject to federal
income and excise tax as follows:
First, the Company will be taxed at regular corporate rates on any
undistributed "REIT Taxable Income", including undistributed net
capital gains. For tax years beginning after August 5, 1997, the
Company may elect to pay tax on all or a portion of its undistributed
capital gains, but treat such capital gains as having been distributed
to its shareholders. If so elected by the Company, the shareholders
would be taxed on the deemed received capital gains but credited with
a pro rated share of the tax paid by the Company and the amount of
deemed paid tax would generally be creditable on the shareholders'
federal return.
Second, under certain circumstances, the Company may be subject to the
"alternative minimum tax" on certain of its items of tax preferences,
if any.
Third, if the Company has (i) net income from the sale or other
disposition of "foreclosure property" that is held primarily for sale
to customers in the ordinary course of business or (ii) other
nonqualifying net income from foreclosure property, it will be subject
to tax at the highest corporate rate on such income.
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Fourth, if the Company has net income from prohibited transactions
(which are, in general, certain sales or other dispositions of
property held primarily for sale to customers in the ordinary course
of business, other than sales of foreclosure property, involuntary
conversions and sales that qualify for a statutory safe harbor), such
income will be subject to a 100% tax.
Fifth, if the Company should fail to satisfy the 75% gross income test
or the 95% gross income test (as discussed below), but has nonetheless
maintained its qualifications as a REIT because certain other
requirements have been met, it will be subject to a 100% tax on the
net income attributable to the greater of the amount by which the
Company fails the 75% or 95% test, multiplied by a fraction intended
to reflect the Company's profitability.
Sixth, if the Company should fail to distribute, or fail to be treated
as having distributed, with respect to each calendar year at least the
sum of (i) 85% of its REIT ordinary income for such year, (ii) 95% of
its REIT capital gain net income for such year, and (iii) any
undistributed taxable income from prior periods, the Company would be
subject to a 4% excise tax on the excess of such required distribution
over the amounts actually distributed.
The Company does not now intend to acquire any appreciated assets from
a corporation generally subject to full corporate-level tax in a transaction in
which any gain on the transfer is not fully recognized. However, in the event
of such an acquisition, the Company could, under certain circumstances, be
subject to tax upon disposition of such assets.
Organizational Requirements. The Code defines a REIT as a
corporation, trust, or association (i) that is managed by one or more trustees
or directors; (ii) the beneficial ownership of which is evidenced by
transferable shares, or by transferable certificates of beneficial interest;
(iii) that would be taxable as a domestic corporation, but for the REIT
Requirements; (iv) that is neither a financial institution nor an insurance
company subject to certain provisions of the Code; (v) the beneficial ownership
of which is held by 100 or more persons; (vi) not more than 50% in value of the
outstanding stock of which is owned, directly or indirectly, by five or fewer
individuals (as defined in the Code to include private foundations and certain
pension trusts and other entities) at any time during the last half of each
taxable year; (vii) that is not a bank, an insurance company or certain other
specified types of financial institutions; and (viii) that meets certain other
tests, described below, regarding the nature of its income and assets. The Code
provides that conditions (i) through (iv), inclusive, must be met during the
entire taxable year and that condition (v) must be met during at least 335 days
of a taxable year of 12 months, or during a proportionate part of a taxable
year of less than 12 months. Conditions (v) and (vi) will not apply until after
the first taxable year for which an election is made to be taxed as a REIT. For
purposes of condition (vi), certain tax-exempt entities are generally treated
as individuals, and the beneficiaries of a pension trust that qualifies under
Section 401(a) of the Code and that holds shares of a REIT will be treated as
holding shares of the REIT in proportion to their actuarial interests in the
pension trust. See "--Taxation of United States Stockholders--Treatment of
Tax-Exempt Stockholders".
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Seyburn Kahn is of the opinion that, for purposes of condition (v)
above, beneficial owners of both common and preferred shares of a corporation
are counted toward the 100 holder requirement. The Company expects that the
Series A Preferred Shares will be held by not less than 100 beneficial owners
at all times such shares are outstanding. Such ownership of the Series A
Preferred Shares would allow the Company to meet condition (v) above. Seyburn
Kahn is of the opinion that, in determining whether condition (vi) above is
met, shareholders of a corporation are treated as owning their proportionate
share of any stock held by that corporation. The Company expects that the stock
of the Company and of the Bank will at no time be held directly or indirectly
by five or fewer shareholders who are individuals, private foundations, pension
trusts or other relevant entities that in the aggregate own more than 50
percent by value of the stock of the Company or the Bank, respectively. Stock
ownership of the Company and the Bank in accordance with the Company's
expectation will satisfy condition (vi) with respect to the Company. In
addition, the Company's Articles of Incorporation include certain restrictions
regarding transfer of its shares, which restrictions are intended to assist the
Company in continuing to satisfy the share ownership requirements described in
conditions (v) and (vi) above. Such transfer and ownership restrictions are
described under "Description of Capital Stock--Restrictions on Ownership and
Transfer".
In addition, a corporation may not elect to become a REIT unless its
taxable year is the calendar year. The Company satisfies this requirement.
In the case of a REIT that is a partner in a partnership, Treasury
Regulations provide that the REIT will be deemed to own its proportionate share
of the assets of the partnership and will be deemed to be entitled to the
income of the partnership attributable to such share. In addition, the
character of the assets and gross income of the partnership will retain the
same character in the hands of the REIT for purposes of the REIT Requirements,
including satisfying the gross income tests and the assets test.
Income Tests. In order to maintain qualification as a REIT, the
Company must annually satisfy two gross income requirements. First, at least
75% of the Company's gross income (excluding gross income from prohibited
transactions) for each taxable year must be derived directly or indirectly from
investments relating to real property or mortgages on real property (as
interest on obligations secured by mortgages on real property, certain "rents
from real property" or as gain on the sale or exchange of such property and
certain fees with respect to agreements to make or acquire mortgage loans),
from certain types of temporary investments or certain other types of gross
income. Second, at least 95% of the Company's gross income (excluding gross
income from prohibited transactions) for each taxable year must be derived from
such real property investments as aforesaid and from dividends, interest, and
gain from the sale or other disposition of stock or securities and certain
other types of gross income (or from any combination of the foregoing).
For interest to qualify as "interest on obligations secured by
mortgages on real property or on interests in real property," the obligation
must be secured by real property having a fair market value at the time of
acquisition at least equal to the principal amount of the loan. The term
"interest" includes only an amount that constitutes compensation for the use or
forbearance of
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money. For example, a fee received or accrued by a lender which is in fact a
charge for services performed for a borrower rather than a charge for the use
of borrowed money is not includible as interest; amounts earned as
consideration for entering into agreements to make loans secured by real
property, although not interest, are otherwise treated as within the 75% and
95% classes of gross income so long as the determination of those amounts does
not depend on the income or profits of any person. By statute, the term
interest does not include any amount based on income or profits except that the
Code provides that (i) interest "based on a fixed percentage or percentages of
receipts or sales" is not excluded and (ii) when the REIT makes a loan that
provides for interest based on the borrower's receipts or sales and the
borrower leases under one or more leases based on income or profits, only a
portion of the contingent interest paid by the borrower will be disqualified as
interest.
Rents received or deemed to be received by the Company will qualify as
"rents from real property" in satisfying the gross income requirements for a
REIT described above only if certain statutory conditions are met that limit
rental income essentially to rentals on investment-type properties. In the
event that a REIT acquires by foreclosure property that generates income that
does not qualify as "rents from real property," such income may be treated as
qualifying for two years following foreclosure (which period may be extended by
the IRS) so long as (i) all leases entered into after foreclosure generate only
qualifying rent, (ii) only limited construction takes place and (iii) within 90
days of foreclosure, any trade or business in which the property is used is
conducted by an independent contractor from which the REIT derives no income.
In the event the special foreclosure property rule applies to qualify otherwise
unqualified income, the net income that qualifies only under the special rule
for foreclosure property may be subject to tax, as described above.
Relief Provisions. If the Company fails to satisfy one or both of the
75% or 95% gross income tests for any taxable year, it may nevertheless qualify
as a REIT for such year if it is entitled to relief under certain provisions of
the Code. These relief provisions will be generally available if the Company's
failure to meet such tests was due to reasonable cause and not due to willful
neglect, the Company attaches a schedule of the sources of its income to its
return, and any incorrect information on the schedule was not due to fraud with
intent to evade tax. It is not possible, however, to state whether in all
circumstances the Company would be entitled to the benefit of these relief
provisions. As discussed above in "--Taxation of the Company--General," even if
these relief provisions apply, a tax would be imposed with respect to the
excess net income.
Asset Tests. At the close of each quarter of its taxable year, the
Company must satisfy three tests relating to the nature of its assets. First,
at least 75% of the value of the Company's total assets must be represented by
real estate assets (including stock or debt instruments held for not more than
one year that were purchased with the proceeds of a stock offering or long-term
(at least five years) debt offering of the Company), cash, cash items, and
government securities. Second, not more than 25% of the Company's total assets
may be represented by securities other than those in the 75% asset class.
Third, of the investments included in the 25% asset class, the value of any one
issuer's securities owned by the Company may not exceed 5% of the value of the
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Company's total assets and the Company may not own more than 10% of any one
issuer's outstanding voting securities.
After initially meeting the asset tests at the close of any quarter,
the Company will not lose its status as a REIT if it fails to satisfy the asset
tests at the end of a later quarter solely by reason of changes in asset
values. If the failure to satisfy the asset tests results from an acquisition
of securities or other property during a quarter, the failure can be cured by
disposition of sufficient nonqualifying assets within 30 days after the close
of that quarter. The Company intends to maintain adequate records of the value
of its assets to ensure compliance with the asset tests, and to take such
action within 30 days after the close of any quarter as may be required to cure
any noncompliance but no assurance can be given that such asset tests will be
met. Failure to maintain these records could result in substantial IRS
penalties.
Annual Distribution Requirements. In order to be treated as a REIT,
the Company is required to distribute dividends (other than capital gain
dividends) to its stockholders in an amount at least equal to (A) the sum of
(i) 95% of the Company's "REIT Taxable Income" (computed without regard to the
dividends paid deduction and the Company's net capital gain) plus (ii) 95% of
the net income, if any, from foreclosure property in excess of the special tax
on income from foreclosure property, minus (B) the sum of certain items of
noncash income. Such distributions must be paid in the taxable year to which
they relate or in the following taxable year if declared before the Company
timely files its tax return for such year and if paid on or before the first
regular dividend payment after such declaration. To the extent that the Company
does not distribute (or is not treated as having distributed) all of its net
capital gain or distributes (or is treated as having distributed) at least 95%,
but less than 100% of its "REIT Taxable Income," as adjusted, it will be
subject to tax thereon at regular ordinary and capital gains corporate tax
rates. The Code permits a stockholder to elect to be treated for tax purposes
as having (i) received a distribution in the amount specified in the election
and (ii) contributed the amount thereof to the capital of the Company. In the
event the Company fails to distribute 100% of its income and capital gains, the
Bank may elect to be so treated. Furthermore, if the Company should fail to
distribute during each calendar year at least the sum of (i) 85% of its REIT
ordinary income for such year, (ii) 95% of its REIT capital gain net income for
such year, and (iii) any undistributed taxable income from prior periods, the
Company would be subject to a 4% excise tax on the excess of such required
distribution over the amounts actually distributed. The Company intends to make
timely distributions sufficient to satisfy the annual distribution requirement.
For tax years beginning after August 5, 1997, the Company may elect to pay tax
on all or a portion of its undistributed capital gains, but treat such capital
gains as having been distributed to its shareholders. If so elected by the
Company, the shareholders would be taxed on the deemed received capital gains
but credited with a pro rated share of the tax paid by the Company and the
amount of deemed paid tax would generally be creditable on the shareholders'
federal return.
"REIT Taxable Income" is the taxable income of a REIT, which generally
is computed in the same fashion as the taxable income of any corporation,
except that (i) certain deductions are not available, such as the deduction for
dividends received, (ii) it may deduct dividends paid (or deemed paid) during
the taxable year, (iii) net capital gains and losses are excluded, and (iv)
certain other adjustments are made.
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It is possible that, from time to time, the Company may not have
sufficient cash or other liquid assets to meet the 95% distribution requirement
due to timing differences between (i) the actual receipt of income and actual
payment of deductible expenses and (ii) the inclusion of such income and
deduction of such expenses in calculating the taxable income of the Company. In
the event that such an insufficiency or such timing differences occur, in order
to meet the 95% distribution requirement the Company may find it necessary to
arrange for borrowings or to pay dividends in the form of taxable stock
dividends if it is practicable to do so.
Under certain circumstances, the Company may be able to rectify a
failure to meet the distribution requirement for a year by paying "deficiency
dividends" to stockholders in a later year, which may be included in the
Company's deduction for dividends paid for the earlier year. Thus, the Company
may be able to avoid being taxed on amounts distributed as deficiency
dividends; however, the Company will be required to pay interest based upon the
amount of any deduction taken for deficiency dividends.
FAILURE TO QUALIFY
If the Company fails to qualify for taxation as a REIT in any taxable
year, and the relief provisions described above do not apply, the Company will
be subject to tax (including any applicable alternative minimum tax) on its
taxable income at regular corporate rates. Distributions to stockholders in
any year in which the Company fails to qualify will not be deductible by the
Company nor will they be required to be made. In such event, to the extent of
current and accumulated earnings and profits, all distributions to stockholders
will be taxable as ordinary income, and subject to certain limitations of the
Code, corporate distributees may be eligible for the dividends-received
deduction. Unless entitled to relief under specific statutory provisions, the
Company will also be disqualified from taxation as a REIT for the four taxable
years following the year during which qualification was lost, and will not be
permitted to requalify unless it distributes any earnings and profits
attributable to the period when it failed to qualify. In addition, it would be
subject to tax on any built-in gains on property held during the period during
which it did not qualify if it sold such property within 10 years of
requalification. It is not possible to state whether in all circumstances the
Company would be entitled to such statutory relief.
TAX TREATMENT OF AUTOMATIC EXCHANGE
Upon the occurrence of the Automatic Exchange, the outstanding Series
A Preferred Shares will be automatically exchanged on a one-for-one basis for
Bank Preferred Shares. See "Description of Series A Preferred
Shares--Automatic Exchange". The Automatic Exchange will be a taxable exchange
with respect to which each holder of the Series A Preferred Shares will have a
gain or loss, as the case may be, measured by the difference between the basis
of such holder in the Series A Preferred Shares and the fair market value of
the Bank Preferred Shares received in the Automatic Exchange. Because the Bank
Preferred Shares will not be listed on the Nasdaq System or on any exchange,
each individual holder will be required to determine the fair market value of
Bank Preferred Shares received to determine the tax effect of the Automatic
Exchange. Assuming that such holder's Series A Preferred Shares were held as
capital assets for more than one year prior to the Automatic Exchange, any gain
or loss will be long-term capital gain or loss.
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The 1997 Taxpayer Relief Act may also provide certain taxpayers (generally
non-corporate taxpayers) even more favorable long-term capital gain treatment
if the holding period exceeds 18 months.
TAXATION OF UNITED STATES STOCKHOLDERS
As used herein, the term "United States Stockholder" means a holder of
Series A Preferred Shares that is for United States federal income tax purposes
(i) a citizen or resident of the United States, (ii) a corporation,
partnership, or other entity created or organized in or under the laws of the
United States or of any political subdivision thereof, or (iii) an estate or
trust the income of which is subject to United States federal income taxation
regardless of its source.
Distributions Generally. As long as the Company qualifies as a REIT,
distributions to a United States Stockholder up to the amount of the Company's
current or accumulated earnings and profits (and not designated as capital
gains dividends) will be taken into account as ordinary income and will not be
eligible for the dividends-received deduction for corporations. Distributions
that are designated by the Company as capital gain dividends will be treated as
long-term capital gain (to the extent they do not exceed the Company's actual
net capital gain) for the taxable year without regard to the period for which
the stockholder has held its stock. However, corporate stockholders may be
required to treat up to 20% of certain capital gains dividends as ordinary
income, pursuant to Section 291(d) of the Code. A distribution in excess of
current or accumulated earnings and profits will first be treated as a tax-free
return of capital, reducing the tax basis in the United States Stockholder's
Series A Preferred Shares, and a distribution in excess of the United States
Stockholder's tax basis in its Series A Preferred Shares will be taxable gain
realized from the sale of such shares. Dividends declared by the Company in
October, November or December of any year payable to a stockholder of record on
a specified date in any such month shall be treated as both paid by the Company
and received by the stockholder on December 31 of such year, provided that the
dividend is actually paid by the Company during January of the following
calendar year. Stockholders may not claim the benefit of any tax losses of the
Company on their own income tax returns. For tax years beginning after August
5, 1997, the Company may elect to pay tax on all or a portion of its
undistributed capital gains, but treat such capital gains as having been
distributed to its shareholders. If so elected by the Company, the
shareholders would be taxed on the deemed received capital gains but credited
with a pro rated share of the tax paid by the Company and the amount of deemed
paid tax would generally be creditable on the shareholders' federal return.
The Company will be treated as having sufficient earnings and profits
to treat as a dividend any distribution by the Company up to the amount
required to be distributed in order to avoid imposition of the 4% excise tax
discussed under "--Taxation of the Company--General" and "--Taxation of the
Company--Annual Distribution Requirements" above. As a result, stockholders may
be required to treat as taxable dividends certain distributions that would
otherwise result in tax-free returns of capital. Moreover, any "deficiency
dividend" will be treated as a "dividend" (an ordinary dividend or a capital
gain dividend, as the case may be), regardless of the Company's earnings and
profits.
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Losses incurred on the sale or exchange of Series A Preferred Shares
held for less than six months will be deemed a long-term capital loss to the
extent of any capital gain dividends received by the selling stockholder with
respect to such stock.
Treatment of Tax-Exempt Stockholders. Distributions from the Company
to a tax-exempt employee's pension trust or other domestic tax-exempt
stockholder will generally not constitute "unrelated business taxable income"
unless the stockholder has borrowed to acquire or carry its shares of the
Company. A tax-exempt employee's pension trust that holds more than 10% of the
shares of the capital stock of the Company may under certain circumstances be
required to treat a certain percentage of dividends as unrelated business
taxable income if the Company is "predominantly held" by qualified trusts. For
these purposes, a qualified trust is any trust defined under Section 401(a) of
the Code and exempt from tax under Section 501(a) of the Code.
TAXATION OF FOREIGN STOCKHOLDERS
The rules governing United States income taxation of non-resident
alien individuals, foreign corporations, foreign partnerships, and foreign
trusts and estates holding Series A Preferred Shares (collectively, "Foreign
Stockholders") are complex, and no attempt will be made herein to provide more
than a summary of such rules. A Foreign Stockholder should consult with its own
tax advisor to determine the effect of federal, state, and local and country of
tax residence income tax laws on an investment in the Company, including any
reporting requirements.
In general, a Foreign Stockholder will be subject to regular United
States income tax to the same extent as a United States Stockholder with
respect to income or gain derived from its investment in the Company if under
all facts and circumstances such income or gain is "effectively connected" with
such stockholder's conduct of a trade or business in the United States. See
"--Taxation of United States Stockholders". A corporate Foreign Stockholder
that receives income that is effectively connected with a United States trade
or business may also be subject to the branch profits tax under Section 884 of
the Code, which is payable in addition to the regular United States corporate
income tax. The following discussion will apply to a Foreign Stockholder whose
income or gain derived from investment in the Company is not so effectively
connected in light of the facts and circumstances.
The Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA")
significantly affects the federal income tax treatment of the sale or exchange
of shares in REITs held by a Foreign Stockholder. Under FIRPTA, gain or loss
realized on the sale or exchange of a "United States real property interest"
("USRPI") by a foreign taxpayer is treated by statute as effectively connected
with a U.S. trade or business as a matter of law, without regard to the
particular facts and circumstances. Shares of a corporation generally are
treated as a USRPI only if the fair market value of USRPIs owned by the
corporation equals or exceeds 50% of the fair market value of its total assets.
If at no time within the five years preceding the sale or exchange of shares in
the Company the shares constituted a USRPI, gain or loss on the sale or
exchange will not be treated as effectively connected with a U.S. trade or
business by reason of FIRPTA. While ownership of real property within the U.S.
(including ownership of interests in certain entities) is always a USRPI, a
loan secured by a mortgage on U.S. real property constitutes a USRPI only if
the
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amounts payable by the borrower are contingent on the income or receipts of the
borrower or the property or otherwise based on the property. Because such
contingent interest is not likely to be present in the residential mortgage
loans to be owned by the Company that are expected to represent approximately
80% of the assets of the Company (although such interest is fairly common in
commercial loans) the Company believes it is unlikely that its shares will be
USRPIs or that it will derive significant gain from the sale or exchange of
USRPIs, although whether its shares are a USRPI or it derives income from
USRPIs will depend upon the facts as they ultimately develop. A distribution of
cash to a Foreign Stockholder that is not attributable to gain from sales or
exchanges by the Company of USRPIs and not designated by the Company as a
capital gain dividend is not subject to FIRPTA but generally will be subject to
the withholding of United States federal income tax at a rate of 30%, unless
(i) a lower treaty rate applies or (ii) the Foreign Stockholder files an IRS
Form 4224 with the withholding agent certifying that the investment to which
the distribution relates is effectively connected to a United States trade or
business of such Foreign Stockholder. A Foreign Stockholder who receives a
distribution that has been subject to such withholding tax may file a claim for
refund to the extent the withholding has been imposed on a portion of such
distributions representing amounts in excess of current and accumulated
earnings and profits. Under FIRPTA, distributions of proceeds attributable to
gain from the Company's sale or exchange of a USRPI are subject to income tax
at the normal capital gains rates applicable to United States stockholders
(subject to applicable alternative minimum tax and a special alternative
minimum tax in the case of a nonresident alien individual). Also, these
distributions may be subject to a 30% branch profits tax in the hands of a
corporate Foreign Stockholder not entitled to a treaty exemption or reduced
rate of tax. Treasury Regulations require the withholding of 35% of any
distribution that could be designated by the Company as a capital gain
dividend. This amount is creditable against the Foreign Stockholder's tax
liability. It should be noted that the 35% withholding tax rate on capital gain
dividends is higher than the 28% (greater than one year holding period) or 20%
(greater than 18 month holding period) maximum rate on capital gains of
individuals. Capital gain dividends not attributable to gain on the sale or
exchange of USRPIs are not subject to United States taxation if there is no
requirement of withholding.
If the shares of the Company do constitute a USRPI (or did so
constitute within the previous five years), gain or loss on the sale or
exchange of the shares will be treated as effectively connected with the
conduct of a U.S. trade or business unless one or more special rules apply to
preclude U.S. taxation.
If the Company is a "domestically-controlled REIT," a sale of Series A
Preferred Shares by a Foreign Stockholder generally will not be subject to
United States taxation. A domestically controlled REIT is a REIT in which, at
all times during a specified testing period, less than 50% in value of its
shares is held directly or indirectly, under Code attribution rules, by Foreign
Stockholders. Because the Series A Preferred Shares will be publicly traded, no
assurance can be given that the Company will constitute a
domestically-controlled REIT or that it will be possible to ascertain whether
or not it is domestically-controlled.
If the Company is not a domestically-controlled REIT, a sale of Series
A Preferred Shares would be subject to tax under FIRPTA as a sale of a USRPI
and gain or loss would be effectively
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connected with a United States trade or business if either (i) the Series A
Preferred Shares were not "regularly traded" (as defined by applicable Treasury
Regulations) on an established securities market (e.g., the Nasdaq System, on
which the Series A Preferred Shares will be listed) during the quarter in which
the Series A Preferred Shares were sold or (ii) even if the Series A Preferred
Shares were "regularly traded", the selling stockholder held, directly or
indirectly, more than 5% of the Series A Preferred Shares during the five-year
period ending on the date of disposition. The applicable Treasury Regulations
that define "regularly traded" for this purpose may be interpreted to provide
that a security will not be "regularly traded" for any calendar quarter during
which 100 or fewer persons (treating related persons as one person) in the
aggregate own 50% or more of such security or the quarterly trading volume is
less than 7.5% of the average number of the issued and outstanding shares of
such security (2.5% if there are 2,500 or more stockholders of record). In the
event that the Series A Preferred Shares were not "regularly traded" and the
Company did not at that time constitute a domestically-controlled REIT, a
Foreign Stockholder (without regard to its ownership percentage of Series A
Preferred Shares) must treat as effectively connected with a United States
trade or business any gain or loss on any sale or other disposition of Series A
Preferred Shares that occurs within a calendar quarter during which the Series
A Preferred Shares were not "regularly traded" and the shares were a USRPI.
If the gain on the sale of the Company's Series A Preferred Shares
were subject to taxation under FIRPTA, the Foreign Stockholder would be subject
to the same treatment as a United States Stockholder with respect to such gain
(subject to applicable alternative minimum tax and a special alternative
minimum tax in the case of a nonresident alien individual). Notwithstanding the
foregoing, capital gain from sale of shares of a REIT not subject to FIRPTA
will nonetheless be taxable to a Foreign Stockholder who is an individual
(under rules generally applicable to United States Stockholders) if such person
is in the United States for 183 days or more during the taxable year of
disposition and certain other conditions apply. In any event, a purchaser of
Series A Preferred Shares from a Foreign Stockholder will not be required under
FIRPTA to withhold on the purchase price if the purchased Series A Preferred
Shares are "regularly traded" on an established securities market or if the
Company is a domestically-controlled REIT. Otherwise, under FIRPTA the
purchaser of Series A Preferred Shares may be required to withhold 10% of the
purchase price and remit such amount to the IRS.
Shares of the Company owned by a nonresident alien decedent are
subject to United States federal estate tax (which is imposed at rates up to
55%) unless an estate tax treaty binding upon the United States provides
otherwise.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING TAX
The Company will report to its stockholders and the IRS the amount of
dividends paid or deemed paid during each calendar year, and the amount of tax
withheld, if any.
United States Stockholders. Under certain circumstances, a United
States Stockholder of Series A Preferred Shares may be subject to backup
withholding at a rate of 31% on payments made with respect to, or cash proceeds
of a sale or exchange of, Series A Preferred Shares. Backup withholding will
apply only if the holder (i) fails to furnish the person required to withhold
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with its Taxpayer Identification Number ("TIN") which, for an individual, would
be his or her Social Security Number, (ii) furnishes an incorrect TIN, (iii) is
notified by the IRS that it has failed properly to report payments of interest
and dividends, or (iv) under certain circumstances, fails to certify, under
penalty of perjury, that it has furnished a correct TIN and has not been
notified by the IRS that it is subject to backup withholding for failure to
report interest and dividend payments. Backup withholding will not apply with
respect to payments made to certain exempt recipients, such as corporations and
tax-exempt organizations. A United States Stockholder should consult with a tax
advisor regarding qualification for exemption from backup withholding and the
procedure for obtaining such an exemption. Backup withholding is not an
additional tax. Rather, the amount of any backup withholding with respect to a
payment to a United States Stockholder will be allowed as a credit against such
United States Stockholder's United States federal income tax liability and may
entitle such United States Stockholder to a refund, provided that the required
information is furnished to the IRS.
Foreign Stockholders. Additional issues may arise pertaining to
information reporting and backup withholding with respect to Foreign
Stockholders, and a Foreign Stockholder should consult with a tax advisor with
respect to any such information reporting and backup withholding requirements.
Backup withholding with respect to a Foreign Stockholder is not an additional
tax. Rather, the amount of any backup withholding with respect to a payment to
a Foreign Stockholder will be allowed as a credit against any United States
federal income tax liability of such Foreign Stockholder. If withholding
results in an overpayment of taxes, a refund may be obtained provided that the
required information is furnished to the IRS.
OTHER TAX CONSEQUENCES
The Company and its stockholders may be subject to state or local
taxation in various state or local jurisdictions, including those in which it
or they transact business or reside. The state and local tax treatment of the
Company and its stockholders may not conform to the federal income tax
consequences discussed above. Consequently, prospective stockholders should
consult their own tax advisors regarding the effect of state and local tax laws
on an investment in the Company.
ERISA CONSIDERATIONS
GENERAL
In evaluating the purchase of Series A Preferred Shares, a fiduciary
of a qualified profit-sharing, pension or stock bonus plan, including a plan
for self-employed individuals and their employees or any other employee benefit
plan subject to the Employee Retirement Income Security Act of 1974, as amended
("ERISA"), a collective investment fund or separate account in which such plans
invest and any other investor using assets that are treated as the assets of an
employee benefit plan subject to ERISA (each, a "Plan" and collectively,
"Plans") should consider (a) whether the ownership of Series A Preferred Shares
is in accordance with the documents and instruments governing such Plan; (b)
whether the ownership of Series A Preferred Shares is solely in the interest of
Plan participants and beneficiaries and otherwise consistent with the
fiduciary's responsibilities and in compliance with the requirements of Part 4
of Title I of ERISA, including,
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in particular, the diversification, prudence and liquidity requirements of
Section 404 of ERISA and the prohibited transaction provisions of Section 406
of ERISA and Section 4975 of the Code; (c) whether the Company's assets are
treated as assets of the Plan; and (d) the need to value the assets of the Plan
annually. In addition, the fiduciary of an individual retirement arrangement
under Section 408 of the Code (an "IRA") considering the purchase of Series A
Preferred Shares should consider whether the ownership of Series A Preferred
Shares would result in a non-exempt prohibited transaction under Section 4975
of the Code.
The fiduciary investment considerations summarized below provide a
general discussion that does not include all of the fiduciary investment
considerations relevant to Plans and, where indicated, IRAs. This summary is
based on the current provisions of ERISA and the Code and regulations and
rulings thereunder, and may be changed (perhaps adversely and with retroactive
effect) by future legislative, administrative or judicial actions. PLANS AND
IRAS THAT ARE PROSPECTIVE PURCHASERS OF SERIES A PREFERRED SHARES SHOULD
CONSULT WITH AND RELY UPON THEIR OWN ADVISORS IN EVALUATING THESE MATTERS IN
LIGHT OF THEIR OWN PARTICULAR CIRCUMSTANCES.
PLAN ASSET REGULATION
Under Department of Labor regulations governing what constitutes the
assets of a Plan or IRA ("Plan Assets") for purposes of ERISA and the related
prohibited transaction provisions of the Code (the "Plan Asset Regulation", 29
C.F.R. Sec.2510.3-101), when a Plan or IRA makes an equity investment in
another entity, the underlying assets of the entity will not be considered Plan
Assets if the equity interest is a "publicly-offered security".
For purposes of the Plan Asset Regulation, a "publicly-offered
security" is a security that is (a) "freely transferable", (b) part of a class
of securities that is "widely held," and (c) sold to the Plan or IRA as part of
an offering of securities to the public pursuant to an effective registration
statement under the Securities Act and part of a class of securities that is
registered under the Exchange Act within 120 days (or such later time as may be
allowed by the Commission) after the end of the fiscal year of the issuer
during which the offering of such securities to the public occurred. The Series
A Preferred Shares will be registered under the Securities Act of 1933, as
amended (the "Securities Act"), and the Exchange Act within the time periods
specified in the Plan Asset Regulation.
The Plan Asset Regulation provides that a security is "widely held"
only if it is a part of the class of securities that is owned by 100 or more
investors independent of the issuer and of one another. A security will not
fail to be "widely held" because the number of independent investors falls
below 100 subsequent to the initial offering as a result of events beyond the
control of the issuer. The Company expects the Series A Preferred Shares to be
"widely held" upon the completion of the Offering.
The Plan Asset Regulation provides that whether a security is "freely
transferable" is a factual question to be determined on the basis of all the
relevant facts and circumstances. The Plan Asset Regulation further provides
that when a security is part of an offering in which the minimum
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investment is $10,000 or less, as is the case with the Offering, certain
restrictions ordinarily will not, alone or in combination, affect the finding
that such securities are "freely transferable". The Company believes that any
restrictions imposed on the transfer of the Series A Preferred Shares are
limited to the restrictions on transfer generally permitted under the Plan
Asset Regulation and are not likely to result in the failure of the Series A
Preferred Shares to be "freely transferable".
A Plan should not acquire or hold the Series A Preferred Shares if the
Company's underlying assets will be treated as the assets of such Plan.
However, the Company believes that under the Plan Asset Regulation the Series A
Preferred Shares should be treated as "publicly-offered securities" and,
accordingly, the underlying assets of the Company should not be considered to
be assets of any Plan or IRA investing in the Series A Preferred Shares.
EFFECT OF PLAN ASSET STATUS
ERISA generally requires that the assets of a Plan be held in trust
and that the trustee, or an investment manager (within the meaning of Section
3(38) of ERISA), have exclusive authority and discretion to manage and control
the assets of the Plan. As discussed above, the assets of the Company under
current law do not appear likely to be assets of the Plans receiving Series A
Preferred Shares as a result of the Offering. However, if the assets of the
Company were deemed to be assets of the Plans under ERISA, certain directors
and officers of the Company might be deemed fiduciaries with respect to the
Plans that invest in the Company and the prudence and other fiduciary standards
set forth in ERISA would apply to them and to all investments.
If the assets of the Company were deemed to be Plan Assets,
transactions between the Company and parties in interest or disqualified
persons with respect to the investing Plan or IRA could be prohibited
transactions unless a statutory or administrative exemption is available. In
addition, investment authority would also have been improperly delegated to
such fiduciaries, and, under certain circumstances, Plan fiduciaries who make
the decision to invest in the Series A Preferred Shares could be liable as
co-fiduciaries for actions taken by the Company that do not conform to the
ERISA standards for investments under Part 4 of Title I of ERISA.
PROHIBITED TRANSACTIONS
Section 406 of ERISA provides that Plan fiduciaries are prohibited
from causing the Plan to engage in certain types of transactions. Section
406(a) prohibits a fiduciary from knowingly causing a Plan to engage directly
or indirectly in, among other things: (a) a sale or exchange, or leasing, of
property with a party in interest; (b) a loan or other extension of credit with
a party in interest; (c) a transaction involving the furnishing of goods,
services or facilities with a party in interest; or (d) a transaction involving
the transfer of Plan assets to, or use of Plan assets by or for the benefit of,
a party in interest. Additionally, Section 406 prohibits a Plan fiduciary from
dealing with Plan assets in its own interest or for its own account, from
acting in any capacity in any transaction involving the Plan on behalf of a
party (or representing a party) whose interests are adverse to the interests of
the Plan, and from receiving any consideration for its own account from any
party dealing with the Plan in connection with a transaction involving Plan
assets. Similar
80
<PAGE> 87
provisions in Section 4975 of the Code apply to transactions between
disqualified persons and Plans and IRAs and result in the imposition of excise
taxes on such disqualified persons.
If a prohibited transaction has occurred, Plan fiduciaries involved in
the transaction could be required to (a) undo the transaction, (b) restore to
the Plan any profit realized on the transaction and (c) make good to the Plan
any loss suffered by it as a result of the transaction. In addition, parties in
interest or disqualified persons would be required to pay excise taxes or
penalties.
If the investment constituted a prohibited transaction under Section
408(e)(2) of the Code by reason of the Company engaging in a prohibited
transaction with the individual who established an IRA or his beneficiary, the
IRA would lose its tax-exempt status. The other penalties for prohibited
transactions would not apply.
Thus, the acquisition of the Series A Preferred Shares by a Plan could
result in a prohibited transaction if an Underwriter, the Company, the Bank, or
any of their affiliates is a party in interest or disqualified person with
respect to the Plan. Any such prohibited transaction could be treated as exempt
under ERISA and the Code if the Series A Preferred Shares were acquired
pursuant to and in accordance with one or more "class exemptions" issued by the
Department of Labor, such as Prohibited Transaction Class Exemption ("PTCE")
75-1 (an exemption for certain transactions involving employee benefit plans
and broker-dealers (such as the Underwriters), reporting dealers, and banks),
PTCE 84-14 (an exemption for certain transactions determined by an independent
qualified professional asset manager), PTCE 90-1 (an exemption for certain
transactions involving insurance company pooled separate accounts), PTCE 91-38
(an exemption for certain transactions involving bank collective investment
funds), PTCE 95-60 (an exemption for certain transactions involving an
insurance company's general account) and PTCE 96-23 (an exemption for certain
transactions determined by a qualifying in-house asset manager).
A Plan should not acquire the Series A Preferred Shares pursuant to
the Offering if such acquisition will constitute a non-exempt prohibited
transaction.
UNRELATED BUSINESS TAXABLE INCOME
Plan fiduciaries should also consider the consequences of holding more
than 10% of the Series A Preferred Shares if the Company is "predominantly
held" by qualified trusts. See "Federal Income Tax Considerations--Taxation of
United States Stockholders--Treatment of Tax-Exempt Stockholders".
CERTAIN INFORMATION REGARDING THE BANK
As an integral part of this Prospectus, a copy of the Bank Prospectus
filed with the OCC relating to the Bank Preferred Shares to be issued upon the
Exchange Event is attached hereto as Annex I and is incorporated by reference
herein. All material information relating to the Bank, including information
relating to the Bank's financial position, can be found therein. There has
been no material change in the Bank's affairs since the conclusion of the
fiscal year ended December 31, 1996 which has not otherwise been disclosed by
the Bank.
81
<PAGE> 88
UNDERWRITING
Subject to the terms and conditions of the underwriting agreement
dated [_____________], 1997 (the "Underwriting Agreement") among the Company,
the Bank and the underwriters named below (the "Underwriters"), the Company has
agreed that the Company will sell to each of the Underwriters, and each of such
Underwriters for which Roney & Co., L.L.C. and Principal Financial Securities,
Inc. are acting as representatives (the "Representatives") have severally
agreed to purchase from the Company, the respective number of Series A
Preferred Shares set forth opposite its name below:
<TABLE>
<CAPTION>
Number of Shares
of Series A
Underwriter Preferred Shares
----------------------------------------------------------------------------------- -----------------------
<S> <C>
Roney & Co., L.L.C. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Principal Financial Securities, Inc. . . . . . . . . . . . . . . . . . . . . . .
---------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800,000
=========
</TABLE>
Under the terms and conditions of the Underwriting Agreement, the
Underwriters are committed to take and pay for all the Series A Preferred
Shares offered hereby, if any are taken.
The Underwriters propose to offer the Series A Preferred Shares in
part directly to the public at the initial public offering price set forth on
the cover page of this Prospectus, and in part to certain securities dealers at
such price less a concession of $[____] per share. The Underwriters may allow,
and such dealers may reallow, a concession not in excess of $[____] per share
to certain brokers and dealers. After the Series A Preferred Shares are
released for sale to the public, the offering price and other selling terms may
from time to time be varied by the Representatives.
The Company has granted the Underwriters an option exercisable for 30
days after the date of this Prospectus to purchase up to an aggregate of
270,000 additional Series A Preferred Shares solely to cover over-allotments,
if any. If the Underwriters exercise their over-allotment option, the
Underwriters have severally agreed, subject to certain conditions, to purchase
approximately the same percentage thereof that the number of Series A Preferred
Shares to be purchased by each of them, as shown in the foregoing table, bears
to the 1,800,000 Series A Preferred Shares offered hereby.
The Company has agreed that, during the period beginning from the date
of this Prospectus and continuing to and including the date 90 days after the
date of this Prospectus, it will not offer, sell, contract to sell or otherwise
dispose of any securities of the Company which are substantially similar to the
Series A Preferred Shares or which are convertible or exchangeable into
securities which are substantially similar to the Series A Preferred Shares
without the prior written consent of the Representatives, except for the Series
A Preferred Shares offered in connection with the Offering.
82
<PAGE> 89
The Representatives of the Underwriters have informed the Company that
they do not expect sales to accounts over which the Underwriters exercise
discretionary authority to exceed five percent of the total number of Series A
Preferred Shares offered by them.
Prior to the Offering, there has been no public market for the Series
A Preferred Shares.
The Company has filed an application to list the Series A Preferred
Shares, subject to official notice of issuance, on the Nasdaq National Market
(the "Exchange"). In order to meet one of the requirements for listing the
Series A Preferred Shares on the Exchange, the Underwriters have undertaken to
sell the Series A Preferred Shares to a minimum of 400 beneficial holders. The
Representatives have advised the Company that they intend to make a market in
the Series A Preferred Shares prior to commencement of trading on the Exchange,
but are not obligated to do so and may discontinue any such market making at
any time without notice.
The Company and the Bank have agreed to indemnify the several
Underwriters against certain liabilities, including liabilities under the
Securities Act.
Certain of the Underwriters or their affiliates have provided from
time to time, and expect to provide in the future, investment or commercial
banking services to affiliates of the Company, for which such Underwriters or
their affiliates have received or will receive customary fees and commissions.
EXPERTS
The balance sheet of Franklin Finance Corporation as of October 3,
1997 included in this Prospectus has been so included in reliance on the report
of Grant Thornton LLP, independent certified public accountants, given on the
authority of said firm as experts in auditing and accounting.
RATINGS
It is not expected that the Series A Preferred Shares will be rated by
any independent securities rating service.
CERTAIN LEGAL MATTERS
The validity of the Series A Preferred Shares offered hereby will be
passed upon for the Company by Silver, Freedman & Taff, L.L.P., Washington,
D.C. Certain tax matters described under "Federal Income Tax Considerations"
will be passed upon for the Company by Seyburn, Kahn, Ginn, Bess, Deitch and
Serlin, P.C., Southfield, Michigan. The validity of the Series A Preferred
Shares will be passed upon for the Underwriters by Honigman Miller Schwartz and
Cohn, Detroit, Michigan.
83
<PAGE> 90
ADDITIONAL INFORMATION
The Company has filed with the Commission a registration statement (of
which this Prospectus is a part) on Form S-11 (the "Registration Statement")
under the Securities Act, with respect to the Series A Preferred Shares offered
hereby. This Prospectus does not contain all the information set forth in the
Registration Statement, certain portions of which have been omitted as
permitted by the rules and regulations of the Commission. Statements contained
in this Prospectus as to the content of any contract or other document are not
necessarily complete, and in each instance reference is made to the copy of
such contract or other document filed as an exhibit to the Registration
Statement, each such statement being qualified in all respects by such
reference. For further information regarding the Company and the Series A
Preferred Shares offered hereby, reference is made to the Registration
Statement and the exhibits thereto.
The Registration Statement and the exhibits forming a part thereof
filed by the Company with the Commission can be inspected at and copies can be
obtained from the Commission, Room 1024, Judiciary Plaza, 450 Fifth Street,
N.W., Washington, D.C. 20549, or at the following regional offices of the
Commission: 7 World Trade Center, 13th Floor, Suite 1300, New York, New York
10048 and Northwestern Atrium Center, 500 West Madison Street, 14th Floor,
Suite 1400, Chicago, Illinois 60661. Copies of such materials can be obtained
from the Public Reference Section of the Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549, at prescribed rates. Such material may also be accessed
electronically by means of the Commission's home page on the Internet at
"http://www.sec.gov".
The Certificate of Designation establishing the rights, preferences
and limitations of the Series A Preferred Shares provides that the Company
shall maintain its status as a reporting company under the Exchange Act for so
long as any of the Series A Preferred Shares are outstanding.
84
<PAGE> 91
GLOSSARY
"Advisor" means the Bank in its role as advisor under the Advisory
Agreement.
"Advisory Agreement" means the agreement between the Bank and the
Company pursuant to which the Bank will (i) administer the day-to-day
operations of the Company, (ii) monitor the credit quality of the Mortgage
Assets held by the Company, (iii) advise the Company with respect to the
acquisition, management, financing and disposition of the Company's Mortgage
Assets and (iv) maintain custody of the documents related to the Company's
Mortgage Loans.
"ARM" or "adjustable rate mortgage" means a Mortgage Loan that
features adjustments of the underlying interest rate at predetermined times
based on an agreed margin to an established index. An ARM is usually subject to
periodic interest rate and/or payment caps and a lifetime interest rate cap.
"Articles of Incorporation" means the Amended and Restated Articles of
Incorporation of the Company.
"Automatic Exchange" means the automatic exchange on a share-for-share
basis of Series A Preferred Shares for Bank Preferred Shares upon the
occurrence of the Exchange Event.
"Bank" means Franklin Bank, N.A., a national bank organized under the
laws of the United States, and the parent of the Company.
"Bank Preferred Shares" means the newly issued series of preferred
stock of the Bank for which the Series A Preferred Shares will be exchanged
automatically upon the occurrence of the Exchange Event.
"Bank Prospectus" means the registration statement pursuant to which
the Bank Preferred Shares are being registered with the OCC.
"Board of Directors" means the board of directors of the Company.
"By-laws" means the by-laws of the Company.
"Classified" means a loan which, for financial institution regulatory
purposes, is designated as "substandard", "doubtful" or "loss". For such
purposes, a substandard asset is one that is deemed inadequately protected by
the current sound worth and paying capacity of the obligor or of the collateral
pledged, if any, because the asset has a well-defined weakness or weaknesses
that jeopardize the liquidation of the debt. An asset classified as doubtful
has all the weaknesses inherent in one classified substandard, with the added
characteristic that the weaknesses make collection or liquidation in full, on
the basis of currently existing facts, conditions and values, highly
questionable and improbable. Assets classified as loss are considered
uncollectible.
85
<PAGE> 92
"Code" means the Internal Revenue Code of 1986, as amended.
"Commercial Mortgage Loan" means a whole loan secured by a first
mortgage or deed of trust on a commercial real estate property.
"Commercial Mortgage Purchase Agreement" means the Commercial Mortgage
Loan Purchase and Warranties Agreement between the Company and the Bank.
"Commission" means the United States Securities and Exchange
Commission.
"Common Stock" means the common stock, par value $300.00 per share, of
the Company.
"Company" means Franklin Finance Corporation, a Michigan corporation.
"Directive" means the writing issued by the appropriate regulatory
agency directing the Automatic Exchange.
"DOL" means the United States Department of Labor.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended.
"Excess Shares" means the shares of any class or series of Preferred
Stock owned, or deemed to be owned, by or transferred to a stockholder in
excess of the Ownership Limit.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Exchange Event" means the appropriate regulatory agency directs in
writing an exchange of the Series A Preferred Shares for Bank Preferred Shares
because (i) the Bank becomes "undercapitalized" under prompt corrective action
regulations established pursuant to FDICIA, (ii) the Bank is placed into
conservatorship or receivership or (iii) the appropriate regulatory agency, in
its sole discretion and even if the Bank is not "undercapitalized," anticipates
the Bank becoming "undercapitalized" in the near term.
"FDIC" means the Federal Deposit Insurance Corporation.
"FDICIA" means the Federal Deposit Insurance Corporation Improvement
Act of 1991, as amended.
"FHLB" means the Federal Home Loan Bank.
"FHLMC" means the Federal Home Loan Mortgage Corporation.
"FIRPTA" means the Foreign Investment in Real Property Tax Act of
1980, as amended.
86
<PAGE> 93
"Five or Fewer Test" means the Code requirement that not more than 50%
in value of the Company's outstanding stock may be owned, directly or
indirectly, by five or fewer individuals (as defined in the Code).
"FNMA" means Fannie Mae.
"FNMA Required Net Yield" means (i) with respect to any Mortgage Loan
with an original term of 20, 25 or 30 years, FNMA's required net yield for
30-year fixed rate mortgages (covered by 60-day mandatory commitments) that was
in effect 45 days prior to the effective date of any conversion of such
Mortgage Loan and (ii) with respect to any Mortgage Loan with an original term
of 15 years, FNMA's required net yield for 15-year fixed rate mortgages
(covered by 60-day mandatory commitments) that was in effect 45 days prior to
the effective date of any conversion of such Mortgage Loan.
"Foreign Stockholders" means holders of Series A Preferred Shares that
are for United States federal income tax purposes (i) non-resident alien
individuals, (ii) foreign corporations and foreign partnerships or (iii)
foreign trusts and estates.
"Gross Margin" means, with respect to a Residential Mortgage Loan that
is an ARM, the applicable fixed percentage which, when added to the applicable
index, calculates to the current interest rate paid by the borrower of the
adjustable rate Mortgage Loan (without taking into account any interest rate
caps or minimum interest rates). Gross Margin is inapplicable to fixed rate
loans.
"Independent Directors" means the members of the Board of Directors
who, prior to and subsequent to their appointment, are not and will not be
directors, officers or employees of the Bank or any affiliate of the Bank or
any person or persons that, in the aggregate, own more than one percent of the
common stock of the Bank and are not officers or employees of the Company.
"Initial Portfolio" means the initial portfolio of Mortgage Loans
purchased by the Company from the Bank.
"IRA" means an individual retirement arrangement under Section 408 of
the Code.
"IRS" means the United States Internal Revenue Service.
"LIBOR" means the London Inter-Bank Offered Rate.
"Lifetime interest rate cap" means, with respect to Mortgage Loans
that are ARMs, the maximum interest rate that may accrue during any period over
the term of such Mortgage Loan as stated in the governing instruments
evidencing such Mortgage Loan.
"Loan-to-Value Ratio" means, with respect to any Mortgage Loan, the
ratio (expressed as a percentage) of the original principal amount of such
Mortgage Loan to the lesser of (i) the appraised value at origination of the
mortgaged property underlying such Mortgage Loan and (ii)
87
<PAGE> 94
if the Mortgage Loan was made to finance the acquisition of property, the
purchase price of the mortgaged property.
"Mortgage Assets" means real estate mortgage assets, including
mortgage securities.
"Mortgage Loans" means whole loans secured by single-family (one- to
four-unit) residential real estate properties or by commercial real estate
properties.
"Nonaccrual Status" means a loan on which, in the opinion of
management, principal or interest is not likely to be paid in accordance with
the terms of the loan agreement or on which the principal or interest is past
due 90 days or more and collateral, if any, is insufficient to cover principal
and interest.
"OCC" means the Office of the Comptroller of the Currency, Department
of the Treasury.
"Offering" means the offering of Series A Preferred Shares pursuant to
the Prospectus.
"One Hundred Persons Test" means the Code requirement that the capital
stock of the Company be owned by 100 or more persons during at least 335 days
of a taxable year or during a proportionate part of a shorter taxable year.
"One-Year ARM" means an ARM that adjusts annually beginning in the
month in which the 12th monthly payment is due.
"Ownership Limit" means the provision in the Company's Articles of
Incorporation limiting any person from owning (including shares deemed to be
owned by the attribution provisions of the Code) more than 9.9% of any issued
and outstanding class or series of Preferred Stock.
"Periodic interest rate cap" means, with respect to ARMs, the maximum
change in the coupon rate permissible under the terms of the loan at each
coupon adjustment date. Periodic interest rate caps limit both the speed by
which the coupon rate can adjust upwards in a rising interest rate environment
and the speed by which the coupon rate can adjust downwards in a falling rate
environment.
"Plan" means a pension, profit-sharing, retirement or other employee
benefit plan.
"Plan Asset Regulation" means the DOL regulations determining the
assets of a Plan for purposes of ERISA and the related prohibited transaction
excise tax provisions of the Code.
"Preferred Stock" means preferred stock, par value $10.00 per share,
of the Company.
"Prime Rate" for any date means the lowest prime rate as published in
the "Money Rates" table of The Wall Street Journal for that date.
88
<PAGE> 95
"Prospectus" means this prospectus, as the same may be amended.
"Rate Adjustment Date" means, with respect to any ARM, a date on which
the interest rate on such ARM adjusts.
"Registration Statement" means the registration statement filed by the
Company with the Commission on Form S-11 with respect to the Series A Preferred
Shares.
"REIT" means a real estate investment trust as defined pursuant to the
REIT Provisions, or any successor provisions thereof.
"REIT Provisions" and "REIT Requirements" means Sections 856 through
860 of the Code and the applicable Treasury Regulations.
"REIT Taxable Income" shall have the meaning set forth in "Federal
Income Tax Considerations--Taxation of the Company--Annual Distribution
Requirements".
"Residential Mortgage Loan" means a whole loan secured by a first
mortgage or deed of trust on a single family (one-to four-unit) residential
real estate property.
"Residential Mortgage Purchase Agreement" means the Residential
Mortgage Loan Purchase and Warranties Agreement between the Company and the
Bank.
"Securities Act" means the Securities Act of 1933, as amended.
"Series A Preferred Shares" means the shares of Preferred Stock of the
Company offered hereby.
"Servicer" means the Bank in its role as servicer of the Mortgage
Loans under the Servicing Agreements.
"Servicing Agreements" means the servicing agreements entered into by
the Bank with respect to the Residential Mortgage Loans and the Commercial
Mortgage Loans.
"Tax Event" means the receipt by the Company of an opinion of a
nationally recognized law or accounting firm experienced in such matters to the
effect that, as a result of (i) any amendment to, clarification of, or change
(including any announced prospective change) in the laws or treaties (or any
regulations thereunder) of the United States or any political subdivision or
taxing authority thereof or therein affecting taxation, (ii) any judicial
decision, official administrative pronouncement, ruling, regulatory procedure,
notice or announcement (including any notice or announcement of intent to adopt
such procedures or regulations) ("Administrative Action") or (iii) any
amendment to, clarification of, or change in the official position or the
interpretation of such Administrative Action or judicial decision or any
interpretation or pronouncement that provides for a position with respect to
such Administrative Action or judicial decision that differs from the
theretofore generally accepted position, in each case, by any
89
<PAGE> 96
legislative body, court, governmental authority or regulatory body,
irrespective of the manner in which such amendment, clarification or change is
made known, which amendment, clarification, or change is effective or such
pronouncement or decision is announced on or after the date of issuance of the
Series A Preferred Shares, there is more than an insubstantial risk that (a)
dividends payable by the Company with respect to the capital stock of the
Company are not, or will not be, fully deductible for United States federal
income tax purposes or (b) the Company is, or will be, subject to more than a
de minimis amount of other taxes, duties or other governmental charges.
"TIN" means Taxpayer Identification Number.
"Treasury Index" means the weekly average yield on U.S. Treasury
securities adjusted to a constant maturity of one year as published by the
Federal Reserve Board in Statistical Release H.15 (519) or any similar
publication or, if not so published, as reported by any Federal Reserve Bank or
by any U.S. Government department or agency.
"Treasury Regulations" means the income tax regulations promulgated
under the Code.
"Underwriters" means those underwriters to which the Company will sell
the Series A Preferred Shares pursuant to the terms of the Underwriting
Agreement.
"Underwriting Agreement" means the underwriting agreement by and among
the Company, the Bank and the Underwriters.
"United States Stockholders" means holders of Series A Preferred
Shares that are for United States federal income tax purposes (i) citizens or
residents of the United States, (ii) corporations, partnerships, or other
entities created or organized in or under the laws of the United States or of
any political subdivisions thereof, or (iii) an estate or trust the income of
which is subject to United States federal income taxation regardless of its
source.
"USRPI" means United States real property interest.
90
<PAGE> 97
INDEX TO FINANCIAL STATEMENT
Report of Independent Certified Public Accountants . . . . . . . . . . . . F-2
Balance Sheet of Franklin Finance Corporation as of October 3, 1997 . . . . F-3
Note to Financial Statement . . . . . . . . . . . . . . . . . . . . . . . . F-4
F-1
<PAGE> 98
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors of
Franklin Finance Corporation:
We have audited the accompanying balance sheet of Franklin Finance Corporation
(the "Company") as of October 3, 1997. This financial statement is the
responsibility of the Company's management. Our responsibility is to express
an opinion on this financial statement based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statement is free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statement. 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 our audit provides a reasonable basis for
our opinion.
In our opinion, the balance sheet referred to above presents fairly, in all
material respects, the financial position of Franklin Finance Corporation as of
October 3, 1997, in conformity with generally accepted accounting principles.
/s/ Grant Thornton LLP
- ------------------------
Grant Thornton LLP
Southfield, Michigan
October 6, 1997.
F-2
<PAGE> 99
FRANKLIN FINANCE CORPORATION
BALANCE SHEET
October 3, 1997
<TABLE>
<S> <C>
ASSETS
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,000
======
STOCKHOLDER'S EQUITY
Common Stock, par value $1.00 per share, 1,000 shares
authorized; 1,000 shares issued and outstanding . . . . . . . . . . . . . . . $1,000
======
</TABLE>
The Note to the Financial Statement is an integral part of this Statement.
F-3
<PAGE> 100
FRANKLIN FINANCE CORPORATION
NOTE TO FINANCIAL STATEMENT
1. ORGANIZATION
Franklin Finance Corporation (the "Company"), a wholly-owned
subsidiary of Franklin Bank, N.A. (the "Bank"), was incorporated on September
25, 1997 in the State of Michigan.
The Company intends to invest in mortgage-related assets financed by
common and preferred stock offerings and expects to generate income for
distribution to its future preferred and common stockholders primarily from the
net interest income derived from its investments in mortgage-related assets.
The Company intends to purchase these mortgage-related assets from the Bank at
their estimated fair values. These assets will be recorded in the Company's
financial statements at the Bank's historical cost basis which will approximate
their estimated fair values. The Company intends to operate in a manner that
permits it to elect, and it intends to elect, to be subject to tax as a real
estate investment trust for federal income tax purposes. The Company has not
had any operations as of October 3, 1997.
The Company intends to sell preferred stock in an underwritten public
offering. The cost of this public offering will be paid by the Company out of
proceeds from a sale of common stock to the Bank. If the public offering is not
consummated, the Bank will pay any offering costs.
F-4
<PAGE> 101
BANK PROSPECTUS ANNEX I
1,800,000 Shares
FRANKLIN BANK, N.A.
[____%] Noncumulative Preferred Stock, Series A
(Liquidation preference $10.00 per share)
The [__%] Noncumulative Preferred Stock, Series A, par value $10.00 per
share (the "Series A Preferred Shares"), of Franklin Bank, N.A. ("Franklin" or
the "Bank") will be issued only upon the automatic exchange of the [____%]
Noncumulative Exchangeable Preferred Stock, Series A (the "Preferred Capital
Shares") of Franklin Finance Corporation, a wholly owned subsidiary of the Bank,
upon the occurrence of certain events. See "Prospectus Summary -- Franklin Bank,
N.A. -- REIT Preferred Offering." Dividends on the Series A Preferred Shares
will be payable at the same rate as the Preferred Capital Shares if, when and as
declared by the Board of Directors of the Bank. For a description of the terms
of the Series A Preferred Shares, see "Description of the Series A Preferred
Shares" herein.
The Series A Preferred Shares rank, in priority of payment of dividends
and rights upon the voluntary or involuntary dissolution, liquidation or winding
up of the Bank, junior to all claims of the Bank's creditors, including the
claims of the Bank's depositors. The Series A Preferred Shares rank superior and
prior to the issued and outstanding common stock of the Bank with respect to
dividend rights and rights upon voluntary or involuntary dissolution,
liquidation or winding up of the Bank, and to all other classes and series of
equity securities of the Bank hereafter issued, other than any class or series
expressly designated as being on parity with or senior to the Series A Preferred
Shares. The common stock of the Bank is the only class of equity securities
currently outstanding.
The Preferred Capital Shares have been registered with the Securities
and Exchange Commission (the "SEC") and an application for listing on the Nasdaq
National Market (the "NMS") has been filed to list the Preferred Capital Shares
under the symbol "FSVBP". In the event the Preferred Capital Shares are
exchanged into Series A Preferred Shares, the Bank does not intend to apply for
listing of the Series A Preferred Shares on any national securities exchange or
for quotation through the Nasdaq System.
AN INVESTMENT IN THE SERIES A PREFERRED SHARES INVOLVES A HIGH DEGREE
OF RISK. INVESTORS SHOULD CAREFULLY CONSIDER THE RISK FACTORS AND OTHER
CONSIDERATIONS RELATING TO THE BANK AND THE SERIES A PREFERRED SHARES. SEE "RISK
FACTORS AND OTHER CONSIDERATIONS."
-----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE OFFICE OF THE
COMPTROLLER OF THE CURRENCY, THE SECURITIES AND EXCHANGE COMMISSION OR
ANY OTHER FEDERAL AGENCY, OR BY ANY STATE SECURITIES COMMISSION, NOR
HAS SUCH OFFICE , COMMISSION, OTHER AGENCY OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
THE SECURITIES OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS OR SAVINGS DEPOSITS
AND ARE NOT INSURED OR GUARANTEED BY THE FEDERAL DEPOSIT INSURANCE
CORPORATION OR ANY OTHER GOVERNMENT AGENCY. THESE SECURITIES
ARE BEING OFFERED PURSUANT TO A PROSPECTUS FILED WITH THE
OFFICE OF THE COMPTROLLER OF THE CURRENCY.
The date of this Prospectus is [_________, 1997].
<PAGE> 102
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information...................................................... BP-2
Information with Respect to the Registrant................................. BP-3
Prospectus Summary......................................................... BP-4
Recent Developments....................................................... BP-10
Risk Factors and Other Considerations..................................... BP-10
Franklin Finance Corporation.............................................. BP-14
Use of Proceeds........................................................... BP-14
Capitalization............................................................ BP-15
Management's Discussion and Analysis
of Financial Condition and Results of Operations................. BP-16
Business ................................................................. BP-33
Regulation................................................................ BP-44
Management................................................................ BP-50
Description of the Series A Preferred Shares.............................. BP-57
Exchange ................................................................. BP-62
Experts ................................................................. BP-62
Legal Matters............................................................. BP-62
Index to Financial Statements............................................... F-1
</TABLE>
AVAILABLE INFORMATION
The Bank is subject to the information reporting requirements of the
Securities Exchange Act of 1934, as amended ("Exchange Act"). In accordance
therewith, the Bank files reports and other information with the Office of the
Comptroller of the Currency ("OCC"). Such reports and other information may be
inspected without charge and copied at prescribed rates at the public reference
facilities maintained by the OCC at 250 E Street, S.W., Washington, D.C. 20219.
The Bank has filed with the OCC a Registration Statement on Form S-11
(including any amendments thereto, the "Form S-11") with respect to the
securities covered by this Prospectus. This Prospectus does not contain all of
the information set forth in the Form S-11, certain items of which are contained
in exhibits to the Form S-11 as permitted by the rules and regulations of the
OCC. For further information with respect to the Bank and the securities offered
hereby, reference is made to the Form S-11, including the exhibits filed as a
part thereof. Statements contained in this Prospectus as to the contents of any
contract or other document referred to are not necessarily complete, and in each
instance reference is made to the copy of such contract or other document filed
as an exhibit to the Form S-11, each such statement being qualified in all
respects by such reference. The Form S-11 and the exhibits thereto may be
inspected without charge and copied at prescribed rates at the public reference
facilities maintained by the OCC at 250 E Street S.W., Washington, D.C. 20219.
BP-2
<PAGE> 103
INFORMATION WITH RESPECT TO THE REGISTRANT
As an integral part of this Prospectus, the Bank has attached complete
copies of its audited financial statements for the fiscal year ended December
31, 1996 and its unaudited financial statements for the nine months ended
September 30, 1997. All material financial information as of these periods
relating to the Bank can be found in these documents. There has been no material
change in the Bank's financial affairs since the conclusion of these periods,
which has not otherwise been disclosed by the Bank in this Prospectus.
THIS PROSPECTUS CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITH
RESPECT TO THE FINANCIAL CONDITION, RESULTS OF OPERATIONS AND BUSINESS OF THE
BANK. THESE FORWARD-LOOKING STATEMENTS INVOLVE CERTAIN RISKS AND UNCERTAINTIES.
FACTORS THAT MAY CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
CONTEMPLATED BY SUCH FORWARD-LOOKING STATEMENTS INCLUDE, AMONG OTHERS, THE
FOLLOWING POSSIBILITIES: (1) COMPETITIVE PRESSURE IN THE BANKING INDUSTRY
INCREASES SIGNIFICANTLY; (2) CHANGES IN THE INTEREST RATE ENVIRONMENT REDUCE
MARGINS; (3) GENERAL ECONOMIC CONDITIONS ARE LESS FAVORABLE THAN EXPECTED,
RESULTING IN, AMONG OTHER THINGS, A DETERIORATION IN CREDIT QUALITY; (4) THE
IMPACT OF REGULATORY CHANGES IS OTHER THAN EXPECTED; (5) CHANGES IN BUSINESS
CONDITIONS AND INFLATION; AND (6) CHANGES IN THE SECURITIES MARKETS.
BP-3
<PAGE> 104
PROSPECTUS SUMMARY
This Prospectus Summary, including the Selected Consolidated Financial
and Other Data, does not purport to be complete and is qualified in its entirety
by the more detailed information and financial statements and notes thereto
appearing elsewhere in this Prospectus. Capitalized terms used in this summary
and not defined herein have the meanings ascribed to such terms elsewhere in
this Prospectus.
FRANKLIN BANK, N.A.
GENERAL
Franklin Bank, N.A. ("Franklin" or the "Bank") is a national bank
headquartered in Southfield, Michigan. The Bank conducts its business through a
network of three regional banking offices which generally offer traditional
banking services and one business center office catering exclusively to small
and medium sized business customers. The Bank was founded in 1983 as a savings
institution and converted to a national bank in 1991.
Franklin's primary business strategy consists principally of attracting
deposits from small and medium sized businesses and making business loans, real
estate loans, indirect lease loans and, to a lesser extent, consumer loans. The
Bank emphasizes products and services principally to businesses whose needs it
believes are not adequately serviced by the larger financial institutions that
dominate the Bank's local market. The Bank's deposits are fully insured by the
Savings Association Insurance Fund ("SAIF") which is administered by the Federal
Deposit Insurance Corporation ("FDIC") up to the maximum permitted by law of
$100,000 per insured depositor. The Bank is subject to comprehensive regulation,
examination and supervision by the OCC and by the FDIC. At September 30, 1997
and December 31, 1996, the Bank was in compliance with its regulatory capital
requirements and was considered a well capitalized institution. Assets totaled
$480.0 million at September 30, 1997. The Bank's common stock trades on the
Nasdaq National Market under the symbol "FSVB." See "Business."
The executive office of the Bank is located at 24725 West Twelve Mile
Road, Southfield, Michigan 48034, telephone (248) 358-4710.
REIT PREFERRED OFFERING
A registration statement has been filed with the SEC for the public
issuance of $18.0 million of Preferred Capital Shares by Franklin Finance
Corporation, a new real estate investment trust ("REIT") subsidiary of the Bank
(the "REIT Subsidiary"). See "Franklin Finance Corporation." The Preferred
Capital Shares, which would be automatically exchanged for Series A Preferred
Shares upon the occurrence of certain trigger events (specifically, if the
appropriate regulatory agency directs in writing an exchange of the Preferred
Capital Shares for Series A Preferred Shares because (i) the Bank becomes
"undercapitalized" under prompt corrective action regulations established
pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991,
as amended ("FDICIA"), (ii) the Bank is placed into conservatorship or
receivership, or (iii) the appropriate
BP-4
<PAGE> 105
regulatory agency, in its sole discretion, anticipates the Bank becoming
"undercapitalized" in the near term), are designed to qualify as core capital of
the Bank, subject to the regulatory capital requirements and/or limitations
applicable to the Bank. The automatic exchange feature was designed to ensure
that the Preferred Capital Shares provide the same level of capital support to
the Bank on a consolidated basis as other forms of core capital by making the
capital represented by the Preferred Capital Shares directly available to
creditors of the Bank in certain circumstances. Proceeds from the issuance of
the Preferred Capital Shares, together with capital contributions from the Bank
to the REIT Subsidiary, will be used by the REIT Subsidiary to purchase certain
REIT-qualified assets from the Bank's mortgage loan portfolio. Because the REIT
Subsidiary will elect to qualify as a REIT for federal income tax purposes,
dividends payable on the REIT Preferred Capital Shares will be deductible by the
REIT Subsidiary for income tax purposes. The treatment of the REIT Preferred
Capital Shares as core capital of the Bank and the REIT Subsidiary's ability to
deduct, for income tax purposes, the dividends payable on the REIT Preferred
Capital Shares will provide the Bank with a more cost-effective means of
obtaining regulatory capital than if the Bank were to issue preferred stock
itself. See "Regulation - Regulatory Capital Requirements."
The mortgage loans expected to be transferred to the REIT Subsidiary by
the Bank have been selected from the Bank's existing portfolio of fixed and
adjustable-rate mortgage loans. The Bank will determine the fair market values
of the selected mortgage loans based on current market conditions.
THE OFFERING
Securities Offered..................... 1,800,000 Series A Preferred Shares.
Exchange............................... The Series A Preferred Shares are to be
issued, if ever, in connection with an
exchange of the Preferred Capital Shares
of Franklin Finance Corporation, a
wholly owned subsidiary of the Bank. See
"Exchange."
Ranking................................ The Series A Preferred Shares rank
senior to the Bank's common stock, par
value $1.00 per share (the "Common
Stock") and junior to all claims of the
Bank's creditors, including the claims
of the Bank's depositors. Additional
shares of preferred stock ranking senior
to the Series A Preferred Shares may not
be issued without the approval of
holders of at least 2/3 of the Series A
Preferred Shares.
Dividends.............................. Dividends on the Series A Preferred
Shares are payable at the rate of [___]%
per annum of the initial liquidation
preference (an amount equal to $[____]
per annum per share), if, when, and as
declared by the Board of Directors of
the
BP-5
<PAGE> 106
Bank. If declared, dividends are payable
quarterly in arrears on the last day of
March, June, September and December in
each year, or, if such day is not a
business day, on the next business day.
Dividends on the Series A Preferred
Shares are not cumulative and,
accordingly, if no dividend is declared
on the Series A Preferred Shares by the
Bank for a quarterly dividend period,
holders of the Series A Preferred Shares
will have no right to receive a dividend
for that period, and the Bank will have
no obligation to pay a dividend for that
period, whether or not dividends are
declared and paid for any future period.
Upon the exchange of Preferred Capital
Shares for Series A Preferred Shares,
any accrued and unpaid dividends for the
most recent quarter of the Preferred
Capital Shares at the time of the
exchange will be deemed to be accrued
and unpaid dividends on the Series A
Preferred Shares. See "Description of
the Series A Preferred Shares --
Dividends." The Bank's ability to pay
cash dividends is subject to regulatory
and other restrictions described herein.
Liquidation Preference................. The liquidation preference for each
Series A Preferred Share is $10.00, plus
an amount equal to the accrued and
unpaid dividends for the most recent
quarter, if any, thereon for the then-
current dividend period to the date
fixed for liquidation. See "Description
of the Series A Preferred Shares --
Rights Upon Liquidation."
Redemption............................. The Bank may not redeem the Series A
Preferred Shares before [_________],
2002. After such date, the Series A
Preferred Shares may be redeemed for
cash at the option of the Bank, in whole
or in part, at any time and from time to
time, at the redemption price of $10.00
per share, plus the accrued and unpaid
dividends for the most recent quarter
thereon, to the date fixed for
redemption, if any, thereon. Redemption
of the Series A Preferred Shares
BP-6
<PAGE> 107
will be subject to compliance with
applicable regulatory and other
restrictions. See "Description of the
Series A Preferred Shares --
Redemption."
Voting Rights.......................... Holders of Series A Preferred Shares
will not have any voting rights, except
as expressly provided herein. On any
matter on which holders of the Series A
Preferred Shares may vote, each Series A
Preferred Share will be entitled to one
vote. See "Description of the Series A
Preferred Shares -- Voting Rights."
Use of Proceeds....................... The Series A Preferred Shares will only
be issued in connection with an exchange
for the Preferred Capital Shares. The
proceeds from the sale of the Preferred
Capital Shares were used by Franklin
Finance Corporation to purchase a
portfolio of mortgage assets and to pay
expenses associated with the formation
and offering of the Preferred Capital
Shares. The conversion of Preferred
Capital Shares into Series A Preferred
Shares will produce no proceeds to the
Bank. See "Use of Proceeds."
Absence of a Public Market............ There is currently no public market for
the Series A Preferred Shares as such
shares have not been issued and such
shares will not be listed on any
securities exchange or for quotation
through the Nasdaq System.
RISK FACTORS
See "Risk Factors and Other Considerations" for a discussion of the
risk factors and other considerations relating to the Bank and the Series A
Preferred Shares.
BP-7
<PAGE> 108
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The selected consolidated financial and other data of the Bank herein
as of and for the nine months ended September 30, 1997 and as of and for the
years ended December 31, 1996, 1995, 1994, 1993 and 1992 have been derived from
the Consolidated Financial Statements of the Bank and the unaudited
consolidated financial statements of the Bank. In the opinion of management all
adjustments (which consist of normal recurring accruals) necessary for a fair
presentation of the results of operations for such periods have been included.
The results of operations for the nine months ended September 30, 1997 are not
necessarily indicative of the results that may be expected for the entire year.
<TABLE>
<CAPTION>
At or for the
Nine Months
Ended At or for the Year Ended December 31,
September 30, ------------------------------------------------------------------------
1997 1996 1995 1994 1993 1992
------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
<S> <C> <C> <C> <C> <C> <C>
INCOME AND BALANCE SHEET ITEMS
Total interest income ................... $ 30,533 $ 39,707 $ 36,656 $ 29,397 $ 28,275 $ 31,441
Total interest expense .................. 12,232 18,113 18,291 14,031 15,271 20,894
Net interest income ..................... 18,301 21,595 18,365 15,366 13,004 10,547
Provision for loan losses ............... 2,600 2,410 1,051 220 180 290
Non-interest income ..................... 3,066 3,721 3,337 3,111 2,612 1,702
Non-interest expense .................... 14,397 21,609 15,856 14,882 12,171 9,733
Income before accounting change and
extraordinary items(1) ............... 3,122 906 3,356 2,396 2,155 1,447
Net income .............................. 3,122 906(2) 3,356 2,396 2,334 873
Net income applicable to common shares... 3,122 906(2) 3,356 1,999 1,516 45
Total assets ............................ 479,982 495,793 487,137 426,810 389,460 391,029
Total average assets .................... 489,796 478,559 434,536 400,178 387,485 400,889
Total loans ............................. 416,654 419,861 374,285 315,957 319,060 335,739
Deposits ................................ 424,075 401,890 399,866 353,315 332,680 340,910
Borrowings .............................. 19,710 61,088 52,750 39,048 27,790 24,100
Common shareholders' equity(3) .......... 32,827 30,336 30,931 25,935 15,897 14,193
Total shareholders' equity .............. 32,827 30,336 30,931 25,935 24,977 23,393
Shares outstanding(4) ................... 3,320,045 3,315,545 3,307,082 3,300,743 1,678,796 1,596,621
PER SHARE
Book value(4) ........................... $ 9.89 $ 9.15 $ 9.35 $ 7.86 $ 9.47 $ 8.89
Primary earnings(4) ..................... 0.91 0.27(2) 1.00 0.80 0.85 0.03
Fully diluted earnings(4) ............... 0.90 0.27(2) 0.99 0.74 0.72 0.03
Cash dividends declared - Common(4)(5)... .18 0.24 0.17 0.23 0.18 ---
Cash dividends paid - Common(4) ......... .18 0.24 0.23 0.23 0.18 ---
Dividend payout ratio - Common(4)(5) .... 19.2% 83.3%(2) 16.1% 27.0% 20.4% ---
Market price:
End of period ......................... $ 16.375 $ 11.75 $ 13.00 $ 8.25 $ 8.75 $ 8.00
52 week high .......................... 16.75 12.50 13.00 9.75 10.50 9.50
52 week low ........................... 10.00 9.25 7.25 7.00 7.75 6.38
</TABLE>
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<PAGE> 109
<TABLE>
<CAPTION>
At or for the
Nine Months
Ended At or for the Year Ended December 31,
September 30, -------------------------------------------------------------------
1997 1996 1995 1994 1993 1992
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSET QUALITY
Nonaccrual loans and real estate owned........ .72% 0.74% 1.96% 0.67% 1.28% 1.91%
Nonperforming assets to total assets.......... 2.19 3.08 2.42 1.78 2.35 2.09
Net charge-offs to average loans.............. 1.04 0.58 0.49 0.19 0.18 0.07
KEY RATIOS
Net interest margin........................... 5.40% 4.89% 4.48% 4.11% 3.49% 2.72%
Net interest spread........................... 4.07 3.75 3.45 3.40 2.97 2.33
Operating expenses to average assets.......... 3.92 4.52 3.65 3.72 3.14 2.43
Return on average assets...................... .89 0.19(2) 0.77 0.60 0.60 0.22
Return on average common shareholders'
equity...................................... 13.14 2.93(2) 11.96 11.98 15.51 6.66
</TABLE>
(1) The accounting change of $178,377 for 1993 resulted from the implementation
of SFAS No. 109 - "Accounting for Income Taxes." The extraordinary item of
$574,069 after tax in 1992 was due to debt refinancing.
(2) Net income included the one time special FDIC assessment for an after tax
expense of $1.6 million. Absent this one time assessment, net income for
1996 would have been $2.5 million, or $0.74 per share; and the return on
average assets and the return on average common shareholders' equity would
have been .52% and 8.26%, respectively.
(3) Preferred stock remaining at December 31, 1993 was entirely
converted/redeemed in 1994. The conversion of the preferred stock into
common stock was the primary cause for the increase in the common
shareholders' equity in 1994.
(4) Adjusted for the 5% common stock dividends declared December 17, 1996, and
paid January 24, 1997, declared December 19, 1995 and paid January 16,
1996, declared December 15, 1994 and paid January 17, 1995 and declared
December 16, 1993 and paid February 1, 1994 and the 7% common stock
dividend declared January 27, 1992 and paid February 24, 1992.
(5) Cash dividends have been paid on the common shares for 19 consecutive
quarters beginning with the first quarter of 1993 through the third
quarter of 1997. However, unlike prior years, the fourth quarter 1995
dividend was declared in January 1996 and causes the cash dividends
declared and the dividend pay out ratios to vary in year to year
comparisons.
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<PAGE> 110
RECENT DEVELOPMENTS
On December 1, 1997, the Bank entered into a letter of intent to sell
to ICON Funding Corporation of Harrison, New York ("ICON"), up to $42.0 million
of equipment lease loans, with servicing released. The sale of these loans
will represent the sale of approximately 35% of the Bank's lease financing
portfolio at September 30, 1997.
The Bank expects the transaction to close by December 31, 1997 and to
generate a gain to the Bank on the sale of the loans of approximately $750,000,
assuming the full $42.0 million of loans are purchased by ICON at the agreed
upon pricing. The transaction is subject to the execution of a definitive
purchase agreement, which will contain customary representations and
warranties, and satisfactory completion of ICON's customary due diligence work
on the loans.
The Bank has also determined to charge-off an additional $350,000
during the fourth quarter of 1997. The charge-off relates to a group of
related loans which at September 30, 1997 had a balance of approximately
$750,000 and was classified by the Bank as non-accruing. See "Business --
Non-Performing Assets and Risk Elements".
RISK FACTORS AND OTHER CONSIDERATIONS
An investment in the Series A Preferred Shares involves a high degree
of risk. Investors should carefully consider the following risk factors and
other considerations relating to the Bank and the Series A Preferred Shares.
THE AUTOMATIC EXCHANGE
The Series A Preferred Shares will be issued in an automatic exchange
for the Preferred Capital Shares, only if (i) the Bank becomes
"undercapitalized" under prompt corrective action regulations, (ii) the Bank is
placed into conservatorship or receivership or (iii) the appropriate federal
regulatory agency, in its sole discretion, anticipates the Bank becoming
"undercapitalized" in the near term. As a result, holders of Preferred Capital
Shares would become holders of Series A Preferred Shares of the Bank at a time
when the Bank's financial condition was deteriorating or when the Bank had been
placed into conservatorship or receivership. In the event of receivership of the
Bank, the claims of depositors and secured, senior, general and subordinated
creditors of the Bank would be entitled to a priority of payment over the claims
of holders of equity interests such as the Series A Preferred Shares. As a
result of such subordination, either if the Bank were to be placed into
receivership after the automatic exchange or if the automatic exchange were to
occur after receivership of the Bank, the holders of the Series A Preferred
Shares likely would receive, if anything, substantially less than the holders of
the Series A Preferred Shares would have received had the Preferred Capital
Shares not been exchanged for Series A Preferred Shares.
BANK PREFERRED SHARES WILL NOT BE LISTED ON THE NASDAQ SYSTEM
Although the Preferred Capital Shares will be listed on the Nasdaq
System, the Bank does not intend to apply for listing of the Series A Preferred
Shares, for which the Preferred Capital Shares will be exchanged automatically
on a one-for-one basis upon the occurrence of an Exchange Event as defined
hereafter under "Exchange", on any national securities exchange or for quotation
of the Series A Preferred Shares through the Nasdaq System. Consequently, there
can be no assurance as to the liquidity of the trading markets for the Series A
Preferred Shares, if issued, or that an active public market for the Series A
Preferred Shares would develop or be maintained.
DIVIDEND AND OTHER REGULATORY RESTRICTIONS ON OPERATIONS OF THE BANK
Federal regulatory authorities have the right to examine the Bank and
its activities. Under certain circumstances, including any determination that
the Bank's activities constitute an unsafe and unsound banking practice, such
regulatory authorities will have the authority to restrict the ability of the
Bank to transfer assets, to make distributions to its stockholders (including
dividends to the holders of Series A Preferred Shares, as described below), or
to redeem shares of preferred stock. Furthermore, in the event the Bank is
placed into conservatorship or receivership, the Bank would be unable to pay
dividends on the Series A Preferred Shares. In addition, in the event of a
liquidation of the Bank, the claims of the Bank's depositors and of its secured,
senior, general and subordinated creditors would be entitled to a priority of
payment over the dividend and other claims
BP-10
<PAGE> 111
of holders of equity interests such as the Series A Preferred Shares issued
pursuant to the Automatic Exchange.
The 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 cash 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 Bank's net profits for
the preceding half year in the case of quarterly or semi-annual dividends, or
the preceding two half-year periods in the case of annual dividends, are
transferred to the surplus 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, the 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, the Bank would be
classified as "undercapitalized" under the OCC's regulations.
Payment of dividends on the Series A Preferred Shares could also be
subject to regulatory limitations if the Bank became "undercapitalized" for
purposes of the OCC prompt corrective action regulations, which is currently
defined as having a total risk-based capital ratio of less than 8.0%, a Tier 1
risk-based capital ratio of less than 4.0% or a core capital (or leverage) ratio
of less than 4.0%. At September 30, 1997, the Bank was in compliance with all of
its regulatory capital requirements. As of that date, the Bank's total
risk-based capital ratio was 10.77%, its Tier 1 risk-based capital ratio was
8.01% and its core capital (or leverage) ratio was 6.54%. Such ratios, adjusted
to give effect to the sale of Preferred Capital Shares in the Offering, would be
15.09%, 12.33% and 9.06%, respectively.
DIVIDENDS NOT CUMULATIVE
Dividends on the Series A Preferred Shares are not cumulative.
Consequently, if the Board of Directors does not declare a dividend on the
Series A Preferred Shares for any quarterly period, the holders of the Series A
Preferred Shares would not be entitled to recover such dividend whether or not
funds are or subsequently become available. The Board of Directors may
determine, in its business judgment, that it would be in the best interests of
the Bank to pay less than the full amount of the stated dividends on the Series
A Preferred Shares or no dividends for any quarter notwithstanding that funds
are available. Factors that would be considered by the Board of Directors in
making this determination are the Bank's financial condition and capital needs,
the impact of legislation and regulations as then in effect or as may be
proposed, economic conditions, and such other factors as the Board may deem
relevant.
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<PAGE> 112
The Series A Preferred Shares will be issued upon an exchange of the
Preferred Capital Shares. Each Preferred Capital Share will be exchanged
automatically for one Series A Preferred Share if the appropriate regulatory
agency directs in writing an exchange of the Preferred Capital Shares for Series
A Preferred Shares because (i) the Bank becomes "undercapitalized" under prompt
corrective action regulations established pursuant to FDICIA, (ii) the Bank is
placed into conservatorship or receivership or (iii) the appropriate regulatory
agency, in its sole discretion, anticipates the Bank's becoming
"undercapitalized" in the near term. The OCC's prompt corrective action
regulations prohibit "capital distributions" (including dividends) unless an
institution is at least "adequately capitalized." Thus, at the time of the
exchange, by regulation, the Bank may not be permitted to pay dividends on the
Series A Preferred Shares. In addition, the Bank's ability to pay dividends on
the Series A Preferred Shares even if the Bank were "adequately capitalized"
following the exchange would be subject to various restrictions under OCC
regulations.
RISKS ASSOCIATED WITH LOANS GENERALLY
An investment in the Series A Preferred Shares may be affected by,
among other things, a decline in real estate values or a downturn in the
economic or business environment in the State of Michigan. In the event assets
held by the Bank become nonperforming, the Bank may not have sufficient income
or capital to pay dividends on the Series A Preferred Shares. Factors that could
affect the value of the assets held by the Bank include the following:
Geographic Concentration. Substantially all of the loans originated by
the Bank are secured by property located in the State of Michigan, or are made
to individuals or businesses doing business in the State of Michigan. These
loans may be subject to a greater risk of default than other comparable loans in
the event of adverse economic, political or business developments or natural
hazards that may affect this region and the ability of the borrowers in this
region to make payments of principal and interest on the underlying loans.
Commercial Real Estate Lending. The Bank's portfolio of mortgage assets
contains commercial real estate loans. Commercial real estate loans have certain
distinct risk characteristics. These loans generally lack standardized terms,
which may complicate their structure. Commercial real estate properties
themselves tend to be unique and are more difficult to value than residential
real estate properties. Commercial real estate loans also tend to have shorter
maturities than residential mortgage loans and may not be fully amortizing,
meaning that they may have a significant principal balance or "balloon" payment
due on maturity. In addition, commercial real estate properties, particularly
industrial and warehouse properties, are generally subject to relatively greater
environmental risks than non-commercial properties and to the corresponding
burdens and costs of compliance with environmental laws and regulations. See
"--Environmental Considerations." Also, there may be costs and delays involved
in enforcing rights of a property owner against tenants in default under the
terms of leases with respect to commercial properties. For example, tenants may
seek the protection of the bankruptcy laws, which could result in termination of
lease contracts. See "Business--Commercial Real Estate Lending."
Lease Financing and Commercial Lending. The Bank is engaged in both
commercial equipment lease financing, sometimes referred to as lease
discounting, and commercial business
BP-12
<PAGE> 113
lending. See "Business -- Lease Financing" and "-- Commercial Lending." These
types of loans typically involve a higher degree of risk than other types of
lending as they 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 lease financing loans and commercial
business loans may be substantially dependent on the success of the business
itself (which, in turn, is likely to be dependent upon the general economic
environment). The Bank's commercial business loans are usually, but not always,
secured by business assets and personal guarantees, whereas the lease loans are
generally secured by the collateral financed and guaranteed by the lessor and/or
related third parties. However, 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.
ENVIRONMENTAL CONSIDERATIONS
In the event that the Bank is forced to foreclose on a defaulted
mortgage loan to recover its investment in such mortgage loan, the Bank may be
subject to environmental liabilities in connection with the underlying real
property which could exceed the value of the real property. Although the Bank
intends to exercise due diligence to discover potential environmental
liabilities prior to the acquisition of any property through foreclosure,
hazardous substances or wastes, contaminants, pollutants or sources thereof (as
defined by state and federal laws and regulations) may be discovered on
properties during the Bank's ownership or after a sale thereof to a third party.
If such hazardous substances are discovered on a property which the Bank has
acquired in foreclosure or otherwise, the Bank may be required to remove those
substances and clean up the property. There can be no assurances that in such a
case the Bank would not incur full recourse liability for the entire costs of
any removal and clean-up, that the cost of such removal and clean-up would not
exceed the value of the property or that the Bank could recoup any of such costs
from any third party. The Bank may also be liable to tenants and other users of
neighboring properties. In addition, the Bank may find it difficult or
impossible to sell the property prior to or following any such clean-up.
RISK OF FUTURE REVISIONS IN POLICIES AND STRATEGIES BY BOARD OF DIRECTORS
The Board of Directors has established the investment policies and
operating policies and strategies of the Bank, certain of which are described in
the Prospectus. These policies may be amended or revised from time to time at
the discretion of the Board of Directors (in certain circumstances subject to
the approval of a majority of the Independent Directors) without a vote of the
Bank's stockholders, including holders of the Series A Preferred Shares. The
ultimate effect of any change in the policies and strategies set forth in the
Prospectus on a holder of Series A Preferred Shares may be positive or negative.
NO MARKET FOR SERIES A PREFERRED SHARES
Prior to the Exchange Event, there has been no market for the Series A
Preferred Shares as no such shares will have been issued, and there can be no
assurance that an active trading market will develop or be sustained or at what
price the Series A Preferred Shares may be resold.
BP-13
<PAGE> 114
FRANKLIN FINANCE CORPORATION
In 1997, the Bank established Franklin Finance Corporation for the
purpose of acquiring, holding and managing real estate mortgage assets. All of
Franklin Finance Corporation's common stock is owned by the Bank. It is expected
that substantially all of its mortgage assets will be acquired from the Bank.
Franklin Finance Corporation will enter into a subservicing agreement with the
Bank pursuant to which the Bank will service mortgage assets. Franklin Finance
Corporation will be the issuer of the Preferred Capital Shares which, under
certain circumstances, would be exchanged for the Series A Preferred Shares.
USE OF PROCEEDS
The Series A Preferred Shares are to be issued, if ever, in connection
with an exchange of the Preferred Capital Shares, which shares were sold
pursuant to an effective registration statement filed with the SEC. The proceeds
from the sale of the Preferred Capital Shares were used by Franklin Finance
Corporation to purchase a portfolio of mortgage assets. The exchange of
Preferred Capital Shares into Series A Preferred Shares will produce no proceeds
to the Bank.
BP-14
<PAGE> 115
CAPITALIZATION
The following table sets forth the actual capital of the Bank at
September 30, 1997 and as adjusted as of such date to give effect to (i) the
issuance of the Preferred Capital Shares by Franklin Finance Corporation
(assuming the Underwriters' over-allotment option is not exercised) and (ii) an
exchange of the Preferred Capital Shares into Series A Preferred Shares of the
Bank. This table should be read in conjunction with the Consolidated Financial
Statements of the Bank and the notes thereto included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997
---------------------------------------
AS AS
ACTUAL ADJUSTED(1) ADJUSTED(2)
------ ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
LIABILITIES:
Deposits........................................................... $424,075 $424,075 $424,075
Repurchase agreements.............................................. 12,235 12,235 12,235
Subordinated capital notes......................................... 7,475 7,475 7,475
Other.............................................................. 3,370 3,370 3,370
-------- -------- --------
Total liabilities........................................... 447,155 447,155 447,155
Minority interest in capital stock of consolidated subsidiary......... --- 18,000(3) ---
SHAREHOLDER'S EQUITY:
[ ]% Noncumulative Preferred Stock, Series A, $10.00 par value,
3,000,000 shares authorized; issued and outstanding,
1,800,000 as adjusted........................................... --- --- 18,000
Common stock, $1.00 par value, 6,000,000 shares authorized,
3,319,625 shares issued and outstanding........................ 3,320 3,320 3,320
Capital contributed in excess of par............................... 24,190 24,190 24,190
Retained earnings.................................................. 5,165 5,165 5,165
Net unrealized holding gains....................................... 152 152 152
-------- -------- --------
Total shareholder's equity............................... 32,827 32,827 50,827
-------- -------- --------
Total liabilities and shareholder's equity.......... $479,982 $497,982 $497,982
======== ======== ========
REGULATORY CAPITAL RATIO
Core (or leverage)................................................. 6.54% 9.06%(3) 10.07%
Tier 1 risk-based capital.......................................... 8.01% 12.33% 12.33%
Total risk-based................................................... 10.77% 15.09% 15.09%
</TABLE>
(1) Adjusted to give effect to the issuance of the Preferred Capital Shares by
Franklin Finance Corporation.
(2) Adjusted to give effect to the exchange of the Preferred Capital Shares
into Series A Preferred Shares of the Bank.
(3) All of the preferred stock of Franklin Finance Corporation, while
outstanding, is eligible as permanent regulatory capital of the Bank and,
as such, is includable in the core capital accounts of the Bank at up to a
maximum of 25% of the Bank's total core (or leverage) capital.
BP-15
<PAGE> 116
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NET INTEREST INCOME
Net interest income, the difference between what is earned on loans and
investments and what is paid for liabilities, primarily deposits, continued its
positive trend. For 1996, 1995 and 1994, net interest income totaled $21.6
million, $18.4 million and $15.4 million, respectively. After the provision for
loan losses, net interest income was $19.2 million, $17.3 million and $15.1
million for the same years' comparison, holding relatively steady as a
percentage of net revenue at 84%, 84% and 83% for 1996, 1995 and 1994.
Expressed as a percentage of average earning assets, net interest margin
improved 9.2%, reaching 4.89% for 1996 compared to 4.48% for 1995 and 4.11% for
1994.
This improvement in 1996 was primarily a function of asset volume rather
than yield. Strong loan growth was especially evident in lease financing, the
highest yielding portfolio. Total interest income for 1996 was $39.7 million,
compared to $36.7 million in 1995 and $29.4 million in 1994.
Analysis of liability volume and price reveals interest expense due to
volume increasing, although the overall cost of funds rates decreased by a
greater amount. The growth in money market balances was the source of the
liability volume increase despite a partial offset by decreased FHLB advances
and other borrowings. As a result, interest expense in 1996 was $18.1 million,
down slightly compared to $18.3 million in 1995, following a surge from $14.0
million in 1994. According to the most recent Uniform Bank Performance Report,
the gap between interest expense of peers and Franklin narrowed from 175 basis
points to 44 basis points in four years. However, interest expense is still too
high and represents a tangible opportunity for future, continued improvement.
Net interest income is, for traditional banks, the most important component
of earnings. Future plans should hinge upon the continued preservation and
improvement of this primary revenue driver. Reducing the overall cost of funds
remains a focus and will be primarily accomplished, short term, through
certificate repricing.
BP-16
<PAGE> 117
The following tables set forth information regarding the components of, and
changes in, the Bank's net interest income.
<TABLE>
<CAPTION>
1996/1995 1995/1994
-------------------------------------- ---------------------------------
Increase/(Decrease)(1) in Increase/(Decrease)(1) in
Volume Rate/Yield Net Volume Rate/Yield Net
------------- ---------- --------- --------- ------------ --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Loans................................................ $4,809 $(406) $ 4,403 $2,241 $3,686 $5,927
Investment securities:
U.S. treasuries and mortgage-backed securities..... (1,103) (158) (1,261) 1,028 170 1,198
Interest bearing deposits with banks............... (81) (96) (177) (98) 75 (23)
Other.............................................. 67 20 87 96 61 157
------ ----- ------- ------ ------ ------
Total interest income................................ 3,692 (640) 3,052 3,267 3,992 7,259
------ ----- ------- ------ ------ ------
INTEREST EXPENSE
Deposits............................................. 1,223 (904) 319 1,018 2,356 3,374
FHLB advances........................................ (312) (53) (365) (44) 66 22
Subordinated notes................................... --- --- --- (1) (1) (2)
Other borrowings..................................... (112) (20) (132) 857 9 866
------ ----- ------- ------ ------ ------
Total interest expense............................... 799 (977) (178) 1,830 2,430 4,260
------ ----- ------- ------ ------ ------
NET INTEREST INCOME.................................. $2,893 $ 337 $ 3,230 $1,437 $1,562 $2,999
====== ===== ======= ====== ====== ======
</TABLE>
- ---------------------
(1) 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.
BP-17
<PAGE> 118
<TABLE>
<CAPTION>
Year Ended December 31,(1)
------------------------------------------------------------------------
1996 1995
--------------------------------- ---------------------------------
Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------- -------- ---------- ------- -------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Loans:
Commercial real estate................................ $146,060 $13,897 9.51% $163,220 $15,475 9.48%
Lease Financing....................................... 68,200 6,800 9.97 38,166 3,902 10.22
Commercial............................................ 71,527 6,787 9.49 46,590 4,805 10.31
Residential mortgage.................................. 48,435 4,320 8.92 44,659 3,926 8.79
Residential construction.............................. 22,533 2,076 9.21 19,313 1,941 10.05
Consumer.............................................. 15,211 1,613 10.60 9,588 1,040 10.85
-------- -------- -------- --------
Total loans............................................. 371,966 35,493 9.54 321,536 31,089 9.67
U.S. treasuries and mortgage-backed securities.......... 47,559 2,977 6.26 65,086 4,238 6.51
Interest-bearing deposits with banks.................... 14,133 670 4.74 15,721 847 5.39
Other................................................... 8,398 568 6.76 7,404 482 6.51
-------- -------- -------- --------
Total earning assets/interest income.................... 442,056 39,708 8.98 409,747 36,656 8.95
-------- -------- -------- --------
Cash and due from banks................................. 23,232 16,367
All other assets........................................ 16,194 11,297
Allowance for possible credit losses.................... (2,923) (2,875)
-------- -------- --
Total assets............................................ $478,559 $434,536
======== ========
LIABILITIES
Money markets........................................... $129,833 $ 5,531 4.26% $107,042 $ 4,695 4.39%
Savings accounts........................................ 362 9 2.49 402 10 2.49
NOW checking............................................ 5,690 49 0.86 5,431 49 0.90
Certificates............................................ 81,963 4,942 6.03 93,919 5,516 5.87
Jumbo certificates...................................... 98,331 5,631 5.73 89,944 5,573 6.20
-------- -------- -------- --------
Total interest-bearing deposits......................... 316,179 16,162 5.11 296,738 15,843 5.34
-------- -------- -------- --------
FHLB advances........................................... 6,512 381 5.85 11,806 746 6.32
Subordinated notes...................................... 7,475 693 9.27 7,475 693 9.27
Other................................................... 16,129 877 5.44 16,690 1,009 6.05
-------- -------- -------- --------
Total interest-bearing liabilities/expense.............. 346,295 18,113 5.23 332,709 18,291 5.50
-------- -------- -------- --------
Business/personal checking.............................. 97,021 69,594
Other liabilities....................................... 4,380 4,173
Shareholders' equity.................................... 30,863 28,060
-------- --------
Total liabilities and shareholders' equity.............. $478,559 $434,536
======== ========
Net interest income..................................... $21,595 $18,365
======= =======
Net interest spread..................................... 3.75% 3.45%
==== ====
Net interest margin..................................... 4.89% 4.48%
==== ====
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31,(1)
---------------------------------------
1994
---------------------------------------
Average
Balance Interest Yield/Rate
-------- -------- ----------
(Dollars in Thousands)
<S> <C> <C> <C>
ASSETS
Loans:
Commercial real estate.................................. $180,243 $15,382 8.53%
Lease Financing......................................... 23,022 2,236 9.71
Commercial.............................................. 30,758 2,808 9.13
Residential mortgage.................................... 40,423 2,582 6.39
Residential construction................................ 14,465 1,386 9.58
Consumer................................................ 7,573 768 10.14
-------- --------
Total loans............................................... 296,484 25,162 8.49
U.S. treasuries and mortgage-backed securities............ 49,181 3,040 6.18
Interest-bearing deposits with banks...................... 22,397 870 3.88
Other..................................................... 5,847 325 5.56
-------- --------
Total earning assets/interest income...................... 373,909 29,397 7.86
-------- --------
Cash and due from banks................................... 10,887
All other assets.......................................... 19,103
Allowance for possible credit losses...................... (3,721)
--------
Total assets.............................................. $400,178
========
LIABILITIES
Money markets............................................. $108,491 $ 3,582 3.30%
Savings accounts.......................................... 516 13 2.52
NOW checking.............................................. 6,804 52 0.76
Certificates.............................................. 120,584 6,180 5.13
Jumbo certificates........................................ 52,125 2,642 5.07
-------- --------
Total interest-bearing deposits........................... 288,520 12,469 4.32
-------- --------
FHLB advances............................................. 16,145 724 4.48
Subordinated notes........................................ 7,489 695 9.28
Other..................................................... 2,710 143 5.28
-------- --------
Total interest-bearing liabilities/expense................ 314,864 14,031 4.46
-------- --------
Business/personal checking................................ 46,051
Other liabilities......................................... 13,960
Shareholders' equity...................................... 25,303
--------
Total liabilities and shareholders' equity................ $400,178
========
Net interest income....................................... $15,366
=======
Net interest spread....................................... 3.40%
====
Net interest margin....................................... 4.11%
====
</TABLE>
- ------------------
(1) Interest and principal balances pertaining to nonaccrual loans are not
included for this analysis.
BP-18
<PAGE> 119
NONINTEREST INCOME
Fueled by deposit service fees and other charges primarily incidental
to business relationships, noninterest income grew 11.5% in 1996 compared to
1995, to $3.7 million compared to $3.3 million, respectively. Noninterest income
in 1994 was $3.1 million. Excluding gains on sales of securities and loans, the
improvement of "core" noninterest income (sustainable, recurring income derived
from operations) from 1995 to 1996 was 18.8% compared to 11.4% from 1994 to
1995.
Loan processing and servicing fees were $795,831 for 1996, $905,728 for
1995 and $805,171 for 1994. Commercial prepayment penalties accounted for the
majority of the increase in 1995 compared to 1994. In 1996, loans that paid off
prematurely were nearer to maturity, consequently the penalty fees were less
than in 1995. Fees from loan servicing continue to decrease as the portfolio,
$5.0 million at year end 1996, diminishes.
Following a year of adjusting to a new third party provider and
subsequent lower sales volume in 1995, investment product income improved 31.7%
in 1996, contrasted to an 81.4% decrease from 1994 to 1995. While the total
volume here is not yet significant, the trend is welcome and expected to
continue.
Notwithstanding steady improvement in noninterest income growth, its
ratio to average assets remains less than peer. New business relationships,
which generate deposit fees, are being added monthly. The investment product
program is undergoing further refinement and sales have increased. In 1997, fee
income will be more rigorously collected from every opportunity. These positive
dynamics point to anticipated continued noninterest income improvement.
The following table sets forth information regarding the Bank's
noninterest income.
<TABLE>
<CAPTION>
Year Ended Percent Change
------------------------------- --------------------
1996 1995 1994 1995-96 1994-95
---- ---- ---- ------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Deposit service charges.................... $2,200 $1,639 $1,327 34.2% 23.5%
Loan processing and servicing fees......... 796 906 805 (12.1) 12.5
Security and loan gains.................... 415 553 612 (25.0) (9.6)
Investment product income.................. 54 41 221 31.7 (81.4)
Other...................................... 256 198 146 29.3 35.6
------ ------ ------
Total non-interest income.................. $3,721 $3,337 $3,111 11.5% 7.3%
====== ====== ======
</TABLE>
NONINTEREST EXPENSE
Noninterest expense increased in every area except taxes and
supervisory fees, and totaled $21.6 million in 1996 compared to $15.9 million
and $14.9 million in 1995 and 1994, respectively.
The greatest area of increase in percentage terms was beyond control:
the one time assessment to recapitalize the thrift insurance fund. This action,
taken in the third quarter, brought
BP-19
<PAGE> 120
federal insurance premiums to $3.1 million in 1996, up 242.5% over 1995. Future
federal insurance costs, however, will be reduced by an anticipated amount in
excess of $600,000 annually.
Staff was added during 1996, particularly to meet the challenges of
advanced technology and to bring customers higher levels of service and
sophistication. More staff and standard merit increases for existing staff drove
total compensation up 19.1% in 1996 compared to 1995. Total compensation was
$8.7 million, $7.3 million and $6.9 million in 1996, 1995 and 1994,
respectively. Additional staff requires more space and equipment. In addition to
new purchases, existing personal computers were substantially upgraded in 1996
to accommodate higher level software applications. Thus, occupancy and equipment
costs rose 37.2% from 1995 to 1996 compared to 22.3% from 1994 to 1995.
The 58.3% advertising increase in 1996 compared to 1995 was a
conscious, strategic decision considered an investment from which future,
continued value could be derived. Sustained disruption in local banking services
brought on by competitors' mergers and consolidations has provided an opportune
competitive environment for several years. Aggressive, effective advertising was
accelerated to gain further small business market share.
Advertising expenses are, however, budgeted for significant reduction
in 1997 from 1996 levels. Cross selling to the existing customer base will
supplement advertising and lower the acquisition costs of new and expanded
business.
Professional fees, up 55.9% in 1996 compared to 1995 after a 39.5%
reduction in 1995 compared to 1994, were largely the result of outside legal
services, accounting and other consulting fees. Several special projects and
audits were commissioned during 1996 to ensure compliance and enhance
procedures.
Supplies and printing and communication expenses were up 25.4% and
30.5% in 1996 compared to 1995. Every vendor supplying these services will
experience more pressure in 1997 to discount prices and competitively bid for
the Bank's business.
There is plentiful opportunity and admitted need for improvement in
noninterest expense. The two largest areas unrelated to compensation, namely
federal insurance premiums and advertising, are slated for significant
reductions in 1997. Assertive bargaining with vendors, prudent control of
further staff increases and heightened accountability for cost control across
all departments will also advance this initiative.
BP-20
<PAGE> 121
The following table sets forth information regarding the Bank's
noninterest expense.
<TABLE>
<CAPTION>
Year Ended Percent Change
------------------------------- --------------------
1996 1995 1994 1995-96 1994-95
------ ------- ------- ------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Salaries......................................... $ 6,843 $ 5,923 $ 5,570 15.5% 6.3%
Employee benefits................................ 1,897 1,417 1,322 33.8 7.2
------- ------- -------
Total compensation expense................... 8,740 7,340 6,892 19.1 6.5
Occupancy and equipment.......................... 2,530 1,844 1,508 37.2 22.3
Advertising...................................... 1,050 663 866 58.3 (23.4)
Professional fees................................ 265 170 281 55.9 (39.5)
Federal insurance................................ 3,116 910 795 242.5 14.5
Taxes and supervisory fees....................... 340 390 388 (12.8) 0.5
Supplies and printing............................ 563 449 322 25.4 39.4
Communication expense............................ 591 453 431 30.5 5.1
Defaulted loan expense........................... 579 528 941 9.7 (43.9)
Other............................................ 3,835 3,109 2,458 23.4 26.5
------- ------- -------
Total non-interest expense................... $21,609 $15,856 $14,882 36.3% 6.5%
======= ======= =======
</TABLE>
INCOME TAXES
Provisions for federal income tax for 1996, 1995 and 1994 were
$390,749, $1.4 million and $978,750, respectively. The year to year differences
reflected fluctuations in pre-tax earnings. Effective tax rates, computed by
dividing the income tax provision by income before taxes, for 1996, 1995 and
1994 were 30.1%, 30.0% and 29.0%, respectively.
EARNING ASSETS
Total loans increased 12.2% and totaled $419.9 million at year end 1996
compared to $374.3 million at year end 1995. With the exception of commercial
real estate, all other loan categories grew by varying degrees, lease financing
and commercial non-real estate the most dominant. Lease financing added $35.2
million and was, at year end 1996, the second largest portfolio segment at
23.2%. Equipment leases are purchased indirectly, primarily in pools, from local
dealers and the demand for this financing is brisk. Commercial term loans and
lines of credit increased 18.1% and represented 19.7% of the total loan
portfolio at year end 1996. Smallest in both absolute dollars and percentage of
portfolio, consumer loans nevertheless grew by 50.4% and totaled $18.7 million
at year end 1996 compared to $12.4 million the previous year. For the most part,
these are purchased pools of installment debt.
Commercial mortgages were at their lowest level in five years at year
end 1996, in both absolute dollars and as a percentage of the total portfolio.
Residential mortgages also declined as a percentage of the total portfolio,
albeit to a lesser degree. Residential and commercial construction during 1996
held relatively steady compared to 1995, with a $33.6 million portfolio at year
end, up 8.4% from $31.0 million at year end 1995.
BP-21
<PAGE> 122
In 1997 the Bank intends to continue its emphasis on lease financing,
and, to a lesser degree, indirect consumer installment loans and residential
construction. Commercial mortgages, one of the most profitable portfolios based
on recent product analysis, including historical charge-off experience, may
again become a more active investment area.
Late in 1996, the ceiling of the highly automated small business line
of credit was raised from $30,000 to $150,000. Still under review for credit
quality, operating costs and efficiency, this product, when fully launched,
should greatly appeal to the small business market and reduce commercial lending
operating costs. In early 1997, an international department, opened under the
auspices of a seasoned professional, began to service customers. Letters of
credit and other forms of import/export financing will be in the portfolio mix
for the first time in 1997. Both the expanded small business line of credit and
new international department support efforts to attract new business
relationships and contribute to future commercial loan growth.
Investment securities, consisting of U.S. Government and agency issues,
mortgage-backed securities and municipal bonds, totaled $49.3 million at year
end 1996 compared to $52.4 million at year end 1995. For both years, all
investment securities were classified available for sale.
BP-22
<PAGE> 123
The following tables set forth information regarding the Bank's loan
portfolio.
<TABLE>
<CAPTION>
At December 31,
---------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
----------------- ---------------- ---------------- ----------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial real estate...... $139,499 33.2% $152,868 40.8% $167,283 53.0% $191,753 60.1% $212,687 63.3%
Lease financing............. 97,518 23.2 62,270 16.6 32,491 10.3 20,065 6.3 9,809 2.9
Commercial.................. 82,480 19.7 69,859 18.7 39,296 12.4 27,266 8.6 11,782 3.5
Residential mortgage........ 48,031 11.4 45,833 12.3 42,598 13.5 60,384 18.9 86,691 25.9
Residential construction.... 33,645 8.0 31,034 8.3 25,991 8.2 13,167 4.1 9,487 2.8
Consumer.................... 18,688 4.5 12,422 3.3 8,299 2.6 6,426 2.0 5,284 1.6
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans................. $419,861 100.0% $374,286 100.0% $315,958 100.0% $319,061 100.0% $335,740 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
</TABLE>
BP-23
<PAGE> 124
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------
1996 1995 1994
---- ---- ----
(In Thousands)
<S> <C> <C> <C>
Outstanding loan commitments......................... $ 3,300 $ 6,100 $ 7,500
Unused commercial line of credit commitments......... 40,700 36,000 15,200
Unused home equity commitments....................... 12,200 13,600 15,800
Undisbursed residential construction loans........... 9,400 12,100 6,500
</TABLE>
<TABLE>
<CAPTION>
At December 31, 1996
-------------------------------------------------
Within One to After
One Year Five Years Five Years Total
-------- ---------- ---------- --------
(In Thousands)
<S> <C> <C> <C> <C>
Commercial real estate.............. $39,211 $ 74,233 $26,055 $139,499
Lease financing..................... 2,790 94,192 536 97,518
Commercial.......................... 11,924 29,549 41,007 82,480
Residential mortgage................ 1,401 22,986 23,645 48,032
Residential construction............ 21,361 3,328 118 24,807(1)
Consumer............................ 1,658 11,447 5,583 18,688
------- -------- ------- --------
Total disbursed loans............... $78,345 $235,735 $96,944 $411,024
------- -------- ------- --------
TOTAL LOANS ABOVE
Fixed rates......................... $18,550 $163,416 $32,560 $214,526
Floating rates...................... 59,795 72,319 64,384 196,498
------- -------- ------- --------
Total disbursed loans............... $78,345 $235,735 $96,944 $411,024
======= ======== ======= ========
</TABLE>
- ----------------
(1) Does not include $8,838 of residential construction loans which were
not disbursed at December 31, 1996.
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
Consistent with expectations for higher provisions reported here last
year, the provision for loan losses was $2.4 million in 1996 compared to $1.1
million and $220,000 in 1995 and 1994, respectively. Charge-offs against the
reserve in 1996, 1995 and 1994, net of recoveries , were $2.1 million, $1.6
million and $562,078, respectively.
At year end 1996, the allowance as a percentage of total loans was
0.76%, compared to 0.78% at year end 1995 and 1.09% at year end 1994. Net
charge-offs to average loans outstanding were 0.58%, 0.49% and 0.19% for the
years ended 1996, 1995 and 1994, respectively.
Commercial (non real estate) and lease financing experienced the
greatest losses. Commercial charge-offs in 1996 were $953,199 and lease
financing charge-offs were $876,513. In 1995, commercial and lease financing
charge-offs were $217,471 and $1,125,961, respectively. The lease financing
portfolio did, however, have the greatest amount of recoveries in 1996 of any
portfolio with $162,353 compared to $20,025 in 1995.
Losses on transaction accounts, primarily business checking, were up
significantly and totaled $423,620 in 1996 compared to $181,071 and $73,537 in
1995 and 1994, respectively.
BP-24
<PAGE> 125
Real estate charge-offs in 1996, 1995 and 1994, both commercial and
residential, were the lowest of any portfolios.
The lease financing and commercial portfolios have grown rapidly in
recent years as the real estate concentration, both commercial and residential,
has diminished. Liquidation value on non-real estate collateral is less secure,
hence the contrast between historical low charge-off experience. Similarly,
during the same period, business deposit relationships have been the fastest
growing deposit category, bringing with them increased transactional losses.
Measures to control future loan losses include stronger underwriting
standards, a new automated collection system, suspension and probation of lease
dealers whose paper exhibits unacceptable levels of delinquency and loss,
greater scrutiny of new deposit customers and ongoing analysis of where, how and
by whom losses are being perpetrated.
The following table sets forth information regarding the Bank's
allowance for loan losses.
<TABLE>
<CAPTION>
For the Year Ended December 31,
------------------------------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period............... $2,930 $3,453 $3,795 $4,199 $4,142
Provision for losses......................... 2,410 1,051 220 180 290
CHARGE-OFFS
Commercial real estate..................... 42 172 --- --- 183
Lease financing............................ 877 1,126 438 273 ---
Commercial................................. 953 218 119 45 ---
Residential mortgage....................... 9 --- --- 126 15
Consumer................................... 553 243 223 228 39
------ ------ ------ ------ --------
Total charge-offs............................ 2,434 1,759 780 672 237
RECOVERIES
Commercial real estate..................... 9 17 143 --- ---
Lease financing............................ 163 20 2 85 ---
Commercial................................. 60 37 45 --- ---
Residential mortgage....................... --- 1 1 1 ---
Consumer................................... 62 110 27 2 4
------ ------ ------ ------ --------
Total recoveries............................. 294 185 218 88 4
------ ------ ------ ------ --------
Net charge-offs.............................. 2,140 1,574 562 584 233
------ ------ ------ ------ --------
Balance at end of period..................... $3,200 $2,930 $3,453 $3,795 $4,199
====== ====== ====== ====== ========
Allowance as a percentage of:
Total loans................................ 0.76% 0.78% 1.09% 1.19% 1.25%
Nonperforming assets....................... 86.89 30.67 121.03 76.10 56.29
Net charge-offs............................ 149.53 186.15 614.41 649.83 1,802.15
Net charge-offs to:
Average loans outstanding.................. 0.58 0.49 0.19 0.18 0.07
</TABLE>
BP-25
<PAGE> 126
DEPOSITS AND BORROWED FUNDS
Total deposits rose only slightly from year end 1995 to year end 1996,
from $399.9 million to $401.9 million. However, meaningful shifts took place
within the individual deposit categories.
Business checking deposits climbed 18.1% to $107.0 million at year end
1996 from $90.6 million at year end 1995. These relationships remain attractive
due to their positive effect on both net interest margin and fee income. At
26.6% of the deposit portfolio, this segment is now the second largest deposit
classification. Personal checking and savings, though smallest in absolute
dollars, grew 19.7% in 1996 and these accounts contribute to the benefit of
lower interest cost and fees as well.
Behind checking accounts, variable rate money market accounts are the
next most valuable deposit category and balances here grew 16.1%, climbing from
$120.8 million at year end 1995 to $140.2 million at year end 1996.
While business relationships have been and remain the primary focus in
recent years, more effective cross selling to this same group is producing
additional money market balances.
Higher cost certificates of deposit, jumbo and retail, declined. Less
aggressive pricing for these costly deposits resulted in a 22.7% reduction in
the jumbo certificate portfolio and a 17.3% reduction in retail certificates
from year end 1995 to 1996. A conscious decision to materially reduce the level
of municipal deposits was reached in 1996; competition for these deposits proved
too costly. In addition, contrary to original expectations, lower cost checking
accounts and money market savings from the municipal money managers were not
forthcoming.
Certificate account balances should continue to decline in 1997. A
large pool (approximately $8.0 million) of long term (10 year) 10.0%
certificates mature and it is likely the majority of these depositors will seek
investments with yields superior to today's certificate rates.
Ideally, and to the extent possible without taxing liquidity, replacing
certificates with lower cost demand deposits and money market balances would
vastly help bring the cost of funds in line with peer.
Short term borrowings are FHLB advances and repurchase agreements used
to supplement liquidity to meet loan demand. At December 31, 1996, of the total
$53.6 million in this category, $43.6 million matured in January 1997. The
remaining $10.0 million matures in May 1997. At year end 1995, total short term
borrowings were $45.3 million. Advances are collateralized by FHLB stock, first
mortgage loans under a specific lien arrangement and designated portfolio
securities. Repurchase agreements are collateralized by U.S. Government treasury
and agency securities.
BP-26
<PAGE> 127
The following tables set forth information regarding the Bank's
deposits.
<TABLE>
<CAPTION>
At December 31,
--------------------------------------------------------------
1996 1995 1994
------------------ ------------------- -------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Business checking................... $106,977 23.5% $ 90,641 20.4% $ 59,818 15.5%
Money market savings................ 140,209 30.8 120,794 27.1 104,127 27.1
Personal checking and savings....... 12,021 2.6 10,044 2.3 8,226 2.1
Jumbo certificates.................. 68,786 15.1 89,034 20.0 87,471 22.8
Retail certificates................. 73,897 16.2 89,353 20.1 93,673 24.3
-------- ----- -------- ----- -------- -----
Total deposits...................... 401,890 88.2 399,866 89.9 353,315 91.8
-------- ----- -------- ----- -------- -----
Short-term borrowings............... 53,613 11.8 45,275 10.1 31,568 8.2
-------- ----- -------- ----- -------- -----
Total sources of funds.............. $455,503 100.0% $445,141 100.0% $384,883 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
<TABLE>
<CAPTION>
At December 31, 1996
-------------------------------------------
Less than $100,000 Greater than $100,000
------------------ ---------------------
(Dollars in Thousands)
<S> <C> <C>
Three months or less............................ $14,957 $41,877
Over three months to six months................. 15,170 19,134
Over six months to twelve months................ 17,839 13,080
Over twelve months.............................. 17,368 3,258
-------- -------
Total........................................... $65,334 $77,349
======= =======
</TABLE>
LIQUIDITY
Liquidity refers to readily available funds to meet the needs of
borrowers and depositors. Levels of liquidity are closely monitored in
conjunction with loan funding requirements and deposit outflows. Adequate
liquidity protects institutions from raising funds under duress at excessive
expense and provides a necessary cushion for occasional unpredictable
aberrations in demand. While adequate liquidity is imperative, excessive
liquidity in lower yielding cash investments or other easily marketable assets
reduces potential interest income. Thus, an appropriate balance must be
maintained to protect the institution and at the same time, prudently maximize
income opportunities.
Sources of liquidity from both assets and liabilities include deposits
at the FRB, securities available for sale, loan repayments and maturities, time
deposits at the FHLB, core deposits, FHLB advances, repurchase agreements and
subordinated capital notes.
Liquid assets at year end 1996 were $82.0 million compared to $120.7
million at year end 1995. Liability sources of liquidity were $455.5 million at
year end 1996 compared to $445.1 million at year end 1995.
BP-27
<PAGE> 128
The following table sets forth information regarding the Bank's
investment securities, all of which are classified by the Bank as available for
sale.
<TABLE>
<CAPTION>
At December 31, 1996
-------------------------------------------------------------------------------
Maturing
Within 1 Year 1-5 Years 5-10 Years + 10 Years
------------------ ----------------- ------------------- ----------------
Cost Yield Cost Yield Cost Yield Cost Yield
-------- -------- ------- -------- -------- ------- -------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities.................... $ 381 7.43% $10,964 6.68% $ --- ---% $ --- ---%
U.S. government and agency securities......... 1,332 6.65 33,721 6.01 --- --- --- ---
Municipal securities.......................... --- --- --- --- 1,969 7.44 $ 676 7.43
------ ------- ------ ----
Total......................................... $1,713 6.82% $44,685 6.17% $1,969 7.44% $ 676 7.43%
====== ======= ====== ====
</TABLE>
<TABLE>
<CAPTION>
At December 31, 1996
------------------------------------------
Weighted
Amortized Fair Average
Cost Value Maturity (Years)
----------- --------- ----------------
<S> <C> <C> <C>
Mortgage-backed securities....................... $11,345 $11,405 2.32
U.S. government and agency securities............ 35,053 35,214 2.20
Municipal securities............................. 2,645 2,724 8.10
------- -------
Total............................................ $49,043 $49,343 2.54
======= =======
</TABLE>
BP-28
<PAGE> 129
CAPITAL
Shareholders' equity at year end 1996 was $30.3 million compared to
$30.9 million at year end 1995. An unrealized loss on securities available for
sale compared to an unrealized gain (net of tax), and cash and common stock
dividends insufficiently offset by net income in 1996 compared to 1995, were the
reasons for the slight decrease in shareholders' equity from 1995 to 1996.
Capital levels mandated by federal banking agencies are presented under
Regulatory Accepted Accounting Principles ("RAAP"). For determination of capital
adequacy, the accounting treatment of loan interest accruals, unrealized gains
and losses on securities, and other issues, are not identical under Generally
Accepted Accounting Principles ("GAAP") and RAAP. Under RAAP, shareholders'
equity was $29.5 million.
The Office of the Comptroller of the Currency ("OCC") measures three
separate levels of capital under RAAP: Total capital to risk weighted assets,
Tier 1 capital to risk weighted assets and Tier 1 capital to average assets. The
minimum accepted ratios for these three capital levels are 8.00%, 4.00% and
4.00%, respectively. Institutions with capital levels equal to 10.00%, 6.00% and
5.00%, respectively, for each of these measurements, are classified as "well
capitalized", the highest of five designations, by the OCC. At December 31,
1996, all three OCC capital levels for the "well capitalized" classification
were again exceeded.
Cash dividends at $0.24 for 1996 were consistent with recent years and
once again, a 5% common stock dividend was also awarded investors. Due to lower
net income resulting from the one time assessment to recapitalize the FDIC
insurance fund, the dividend payout ratio of 83.3% for 1996 is abnormally high.
Barring unforeseen occurrences, cash dividend payout ratios should return to the
range of 20.0% - 25.0% in 1997. Tangentially, a well-received dividend
reinvestment plan was installed in late 1996 allowing shareholders to cost
effectively increase their equity position. See Note 7 of Notes to Consolidated
Financial Statements herein.
The following table sets forth information regarding the Bank's
regulatory capital. See Note 7 of Notes to Consolidated Financial Statements
herein.
<TABLE>
<CAPTION>
At December 31,
-------------------------------
1996 1995 1994
---- ---- ----
(In Thousands)
TIER 1
<S> <C> <C> <C>
Common equity........................................ $29,480 $30,931 $25,935
Unrealized (gain)/loss on securities available
for sale, net of tax................................ (198) (976) 1,188
------- ------- -------
Adjusted common equity............................... 29,282 29,955 27,123
Less: Disallowed intangibles......................... (76) (87) (100)
------- ------- -------
Total tier 1 capital................................. 29,206 29,868 27,023
------- ------- -------
TIER 2
Qualifying subordinated capital notes................ 7,475 7,475 7,480
Eligible allowance for losses........................ 3,650 2,930 3,453
------- ------- -------
Total tier 2 capital................................. 11,125 10,405 10,933
------- ------- -------
Total risk-based capital............................. $40,331 $40,273 $37,956
======= ======= =======
</TABLE>
BP-29
<PAGE> 130
OTHER EARNING ASSETS
Short-term investments and interest-earning deposits held with the FHLB
of Indianapolis comprise the majority of other earning assets. Membership in the
FHLB has been maintained subsequent to the commercial bank conversion in
September 1991 and this membership has served both investment and borrowing
needs. Interest earning FHLB time deposits at year end 1996 were $3.6 million
compared to $37.3 million at year end 1995. Average yields on these deposits
were 4.74% and 5.39%, respectively.
Investing in FHLB stock is a membership requirement and at December 31,
1996, this investment totaled $5.2 million compared to $4.5 million at year end
1995. Due to also being a member of the FRB, $772,450 and $716,250 in FRB stock
was held at year end 1996 and 1995, respectively. The blended dividend yields on
the FHLB and FRB stock investments were 7.58% and 7.54% for 1996 and 1995,
respectively. Total dividends and interest received on these earning assets in
1996 were $1.1 million, compared to $1.0 million in 1995 and $1.1 million in
1994.
INTEREST RATE SENSITIVITY
As the predominant source of revenue, net interest income merits
protection and enhancement through active asset and liability management.
Interest rate risk is generally determined by the comparative levels of assets
and liabilities subject to repricing during the same time periods. Pre-payment
assumptions, competitive pressures, historical patterns and economic forecasts
should be viewed in tandem with any point in time analysis, thus adding to the
challenge of properly aligning both portfolios to not only protect, but maximize
future net interest income opportunities.
The current internal policy states that the difference between
repricing assets and liabilities within a cumulative twelve month time period
must be no greater than 10% of total assets. At December 31, 1996, this
difference, or "gap" was 8.8% in favor of liabilities; there was a cumulative
amount of $41.6 million more deposits and other borrowings maturing and
repricing within twelve months, than there were loans, securities and other
assets. The majority of both repricing liabilities and assets were within 0-3
months of December 31, 1996.
Loans which mature and renew in the first half of 1997 should do so at
rates consistent or slightly higher than previous terms. Conversely, a large
pool of long term (10 year), relatively high interest rate (10.0%) deposits
mature within the first six months of 1997. Those of this pool which renew will
reprice considerably lower than 10.0%. Net interest income should thus improve
further as loan yields maintain and deposit costs drop.
Beyond the benefit of this current portfolio dynamic, the majority of
both the asset and liability portfolios are either adjustable, tied to a widely
accepted market index, or relatively short term (five years or less). Thus,
significant pools are available for repricing to current market conditions on an
ongoing basis.
BP-30
<PAGE> 131
The Federal Financial Institutions Examination Council ("FFIEC")
revised the Uniform Financial Institutions Rating System ("UFIRS") to include a
sixth component specifically addressing sensitivity to market risk. Effective
January 1, 1997, federal bank examiners will review a bank's exposure to foreign
exchange risk, trading risk and interest rate risk as part of their evaluation.
Interest rate risk management will be the primary issue in the evaluation of
most banks' sensitivity to market risk, since foreign exchange and trading risk
exposure is generally inconsequential for the majority of institutions.
Examiners are expected to concentrate on the risk management process rather than
the actual level of interest rate risk. Specifically, an institution's grade on
this component will be based upon how well it can identify, measure, monitor and
control its interest rate risk.
The following table sets forth information regarding the Bank's
interest rate sensitivity.
<TABLE>
<CAPTION>
At December 31, 1996
----------------------------------------------------------------------------------
0-3 3-6 6-12 1-5 Over 5
Months Months Months Years Years Total
--------- -------- -------- ------- --------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-bearing deposits $ 3,718 $ --- $ --- $ --- $ --- $ 3,718
Securities --- --- 1,712 44,902 2,429 49,043
Federal Home Loan Bank and
Federal Reserve Bank stock 5,926 --- --- --- --- 5,926
Loans 192,928 23,466 16,897 69,317 10,898 313,506
Lease financing 9,904 9,153 16,836 61,430 195 97,518
--------- -------- ------- ------- --------- --------
Total rate sensitive assets (RSA's) 212,476 32,619 35,445 175,649 13,522 469,711
--------- -------- ------- ------- --------- --------
LIABILITIES
Savings and time deposits 64,240 33,210 30,837 19,946 113,448 261,681
Money market deposits 140,209 --- --- --- --- 140,209
Short-term borrowings 53,613 --- --- --- --- 53,613
Long-term borrowings --- --- --- --- 7,475 7,475
--------- -------- ------- ------- --------- --------
Total rate sensitive liabilities (RSL's) 258,062 33,210 30,837 19,946 120,923 462,978
--------- -------- ------- ------- --------- --------
Interest sensitivity GAP (RSA's-RSL's) (45,586) (591) 4,608 155,703 (107,401) 6,733
--------- -------- ------- ------- --------- --------
Cumulative interest sensitivity GAP (45,586) (46,177) (41,569) 114,134 6,733 ---
--------- -------- ------- ------- --------- --------
Cumulative sensitivity GAP to
total rate sensitive assets (9.7)% (9.8)% (8.8)% 24.3% 1.4%
</TABLE>
NONACCRUAL LOANS AND REAL ESTATE OWNED
Nonaccrual loans and real estate owned decreased by 61.5% from year
end 1995 to year end 1996, falling from $9.6 million to $3.7 million. The
single largest nonaccrual loan present at year end 1995, a $2.35 million
apartment project, was sold. Charge-offs to the allowance for loan losses were
aggressive, particularly in the commercial non-real estate and lease financing
portfolios. A portion of one large commercial credit ($900,000) was transferred
from nonaccrual in 1995 to real estate owned in 1996 as was a significant
residential property ($440,000).
BP-31
<PAGE> 132
The following table sets forth information regarding the Bank's
nonaccrual loans and real estate owned.
<TABLE>
<CAPTION>
At December 31,
--------------------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
NONACCRUAL LOANS
Commercial real estate ........................ $ 309 $4,394 $ 266 $ 337 $1,073
Lease financing ............................... -- 360 879 155 2
Commercial .................................... 1,894 3,744 358 69 --
Residential mortgage .......................... -- 715 635 813 294
Consumer ...................................... -- 135 25 97 163
------ ------ ------ ------ ------
Total ......................................... 2,203 9,348 2,163 1,471 1,532
Restructured loans ............................ -- -- -- 1,407 2,814
------ ------ ------ ------ ------
Total nonaccrual loans ........................ 2,203 9,348 2,163 2,878 4,346
------ ------ ------ ------ ------
IN-SUBSTANCE FORECLOSURE
Commercial real estate ........................ -- -- -- -- 1,597
REAL ESTATE OWNED
Commercial real estate ........................ 929 -- 554 1,762 1,003
Residential mortgage .......................... 443 -- -- 123 508
------ ------ ------ ------ ------
Total in-substance foreclosure and real
estate owned ................................. 1,372 -- 554 1,885 3,108
Other repossessed assets ...................... 108 206 136 224 6
------ ------ ------ ------ ------
Total nonaccrual loans and real estate owned... $3,683 $9,554 $2,853 $4,987 $7,460
====== ====== ====== ====== ======
Total nonaccrual loans and real estate
owned as a percentage of:
Total assets ................................ 0.74% 1.96% 0.67% 1.28% 1.91%
Loans and real estate owned ................. 0.93 2.70 0.94 1.60 2.21
</TABLE>
BP-32
<PAGE> 133
BUSINESS
Franklin is a national bank headquartered in Southfield, Michigan. The
Bank conducts its business through a network of three regional banking offices
which generally offer traditional banking services and one business center
office catering exclusively to small and medium sized business customers. The
Bank was founded in 1983 as a savings institution and converted to a national
bank in 1991.
The Bank's deposit gathering and lending activities reflect the Bank's
business strategy of primarily serving the substantial number of small to
medium-sized businesses and affluent individual customers in its primary market
areas, Oakland County and the Grosse Pointe communities in Michigan. These areas
are, generally, among the more affluent areas of the Detroit metropolitan area.
The Bank attracts its target group of small to medium-sized businesses
and affluent individual customers through the promotion of select products and
services, including commercial checking accounts, business lines of credit, term
loans and equipment lease financing. The Bank competes aggressively for this
business through a systematic program of direct calling on both customers and
referral sources such as attorneys, accountants and business people. The 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 of its senior
personnel.
The Bank's strategy is designed to reduce its overall cost of funds,
improve net interest margins, minimize risk, diversify its loan portfolio,
increase fee income and minimize branch related costs. Management believes that
its business strategy has been enhanced by recent bank mergers and acquisitions
in its market area which have reduced the level of competition. Further,
management believes that the resulting larger institutions are no longer as
focused on serving small to medium-sized businesses and that the Bank is
uniquely situated to serve these customers.
BP-33
<PAGE> 134
LENDING ACTIVITIES
Loan Portfolio Composition. The following table sets forth information
concerning the composition of the Bank's loan portfolio in dollar amounts and
percentages, by type of loan. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Earning Assets" for five year
historical information.
<TABLE>
<CAPTION>
At At December 31,
September 30, ----------------------------------------------------------------
1997 1996 1995 1994
-------------------- ----------------------------------------------------------------
Amount Percent Amount Percent Amount Percent Amount Percent
--------- -------- ---------- ------- --------- ------- --------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial real estate ................... $ 106,320 25.5% $ 139,499 33.2% $ 152,868 40.8% $ 167,283 53.0%
Lease financing .......................... 128,357 30.8 97,518 23.2 62,270 16.6 32,491 10.3
Commercial ............................... 80,512 19.3 82,480 19.7 69,859 18.7 39,296 12.4
Residential mortgage ..................... 48,794 11.7 48,031 11.4 45,832 12.3 42,597 13.5
Residential construction ................. 32,991 7.9 33,645 8.0 31,034 8.3 25,991 8.2
Consumer ................................. 19,680 4.8 18,688 4.5 12,422 3.3 8,299 2.6
--------- ----- --------- ----- --------- ----- --------- -----
Total loans .............................. 416,654 100.0% 419,861 100.0% 374,285 100.0% 315,957 100.0%
===== ===== ===== =====
Less
Undisbursed funds ...................... 8,697 8,837 10,598 6,737
Amounts due on underlying mortgages
on commercial real estate loans ...... --- 364 479 653
Unamortized discounts on purchased
loans ................................. 204 156 140 251
Unamortized discounts on lease
financing ............................. 17,637 14,338 9,196 4,544
Unamortized net loan expense ........... 34 28 11 (99)
--------- --------- --------- ----------
Loans Receivable.......................... 390,046 396,138 353,861 303,871
Allowance for loan losses ................ 2,754 3,200 2,930 3,453
--------- --------- --------- ----------
Net loans ................................ $ 387,292 $ 392,938 $ 350,931 $ 300,418
========= ========= ========= =========
</TABLE>
BP-34
<PAGE> 135
Commercial Real Estate Lending. The 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 the Bank to date have been secured by real property located in
Michigan. See "Risk Factors--Risks Associated with Lending Generally."
The 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 security property, and are
typically secured by full or partial personal guarantees of the borrowers. At
September 30, 1997, approximately 45.1% of the Bank's commercial real estate
loan portfolio had adjustable rates. Of these 54.5% are tied to prime and adjust
daily and 45.5% are tied to a treasury index and adjust semi-annually.
At September 30, 1997, the Bank's largest commercial real estate loan
was a $4.2 million loan secured by a multi-family project located in Ingham
County, Michigan. The Bank had only three other commercial real estate loans in
excess of $2.5 million at such date. At September 30, 1997, all of these loans
were performing in accordance with their payment terms.
The following table shows the composition of the Bank's commercial real
estate loans at September 30, 1997. See "Non-Performing Assets and Risk
Elements."
<TABLE>
<CAPTION>
Loans Percentage Amount
Outstanding of Total Non-Performing
----------- ---------- --------------
(Dollars in thousands)
<S> <C> <C> <C>
Multifamily residential .............. $ 26,437 24.9% $ --
Retail (shopping center) ............. 23,846 22.4 841
Neighborhood office .................. 20,675 19.5 ---
Light industrial ..................... 16,811 15.8 952
Mobile home parks and nursing homes .. 3,229 3.0 --
Other ................................ 15,322 14.4 ---
-------- ----- --------
Total commercial real estate loans ... $106,320 100.0% $ 1,793
======== ===== ========
</TABLE>
Commercial real estate lending entails potential risks which 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. See also
"Risk Factors -- Risks Associated with Loans Generally."
Lease Financing. The Bank regularly purchases small-ticket lease loans
from over a dozen equipment lease dealers. Purchases occur on a loan by loan
basis or through the purchase of pools of lease loans. The leases are originated
by the various lease dealers to small businesses, municipalities and other
entities usually located in Southeastern Michigan and, to a lesser extent,
outside the state of Michigan. By dollar volume, 85% of the lease loans are
located in Michigan.
BP-35
<PAGE> 136
As of September 30, 1997, the portfolio had grown to $128.4 million. The Bank
does not originate any lease loans on a direct basis.
Typically, the Bank's lease loans are for shorter durations (usually
less than 60 months) and higher yields than other commercial loans. The lease
loans are generally secured by the collateral financed and guaranteed by the
lessee and/or related third parties. The equipment securing the Bank's lease
financing includes such items as computer equipment, telephone systems, medical
equipment, transportation equipment, office equipment and machine tools. The
average size indirect lease loan is $25,000.
The lease financing done by the Bank is not to be confused with direct
leasing. Under a direct lease, the leasing company acts as lessor and actually
owns the equipment, leases it to a third party and takes back the equipment at
the end of the lease and assumes the accompanying residual risk. Under the
Bank's lease loans, the Bank will not be the lessor, but rather the Bank will be
a funding source to the leasing company ("Lessor"). The Bank will make a loan to
the Lessor based on the discounted value of the lease payment stream and will
take an assignment of the lease payments which will then be made directly to the
Bank. The Lessor continues to own the equipment and assumes the residual risk,
which means that the Bank is not dependent on the residual value of the
equipment at the end of the lease loan term to realize its expected rate of
return. The Bank simply discounts a stream of payments and services the loan.
Lease loans typically involve a higher degree of risk than other types
of commercial loans and are made based primarily on the perceived ability of the
business to repay the loan from operations, rather than on the value of the
collateral. See also "Risk Factors--Risks Associated with Lending Generally."
Commercial Lending. The Bank's commercial lending activities encompass
loans with a variety of purposes and security, including loans to finance
accounts receivable, inventory and equipment. At September 30, 1997, the Bank
had 50 standby letters of credit outstanding, in an aggregate amount of $4.2
million. Generally, the Bank's commercial business lending has been
limited to borrowers headquartered, or doing business, in the Bank's market
area.
The Bank originates both secured and unsecured commercial loans to
small and medium-sized businesses located in Southeastern Michigan. The loans
include term loans, lines of credit, documentary and standby letters of credit
and a proprietary unsecured product known as "Express Cash" lines of credit. The
Bank does not purchase any commercial loans.
The term loans, lines of credit and letters of credit are generally
originated on a secured basis with 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
parties.
The "Express Cash" line of credit is available to the Bank's qualified
business checking account customers in amounts up to $150,000. These loans are
unsecured to borrowers at higher rates than are charged other types of business
borrowers. Each customer is guaranteed a 24 hour loan review process.
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<PAGE> 137
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. See also "Risk Factors--Risks Associated with Lending
Generally."
Residential Mortgage Lending. In May 1996, the Bank ceased soliciting
residential mortgage loan originations; however, from time to time the Bank will
make such loans to existing customers. Franklin's existing residential mortgage
loan portfolio, by dollar value, consists of approximately 50% fixed rate
mortgage loans and 50% adjustable rate mortgage ("ARM") loans. The Bank's ARM
loans generally amortize over 30 years with rate adjustments every year during
the term of the loan. The Bank's fixed-rate loans were originated with a term of
up to 30 years. The majority of the Bank's fixed-rate residential loans by
dollar amount have terms of five years or less with amortization periods of up
to 30 years. Loan to value ratios on residential mortgage loans originated by
the Bank typically did not exceed 80%, unless mortgage insurance was obtained.
Residential Construction Lending. Through its subsidiary, Franklin Home
Lending Group, Inc., the Bank makes construction loans to builders and
developers for the construction of one- to four-family residences in the Bank's
lending market area. To a lesser extent, the Bank also makes construction loans
on single-family residences to individuals who will ultimately be the
owner-occupier of the house. Substantially all of the Bank's construction loans
have been originated with adjustable rates of interest and have terms of
eighteen months or less. Construction loans generally have a maximum
loan-to-value ratio of 80%. The Bank obtains personal guarantees for all of its
construction loans.
The 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 cost proves to be inaccurate, the 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, the Bank may be confronted, at or prior to the maturity of the loan,
with a project having a value which is insufficient to assure full repayment.
When loan payments become due, borrowers may experience cash flow from the
property which is not adequate to service total debt. In such cases, the Bank
may be required to modify the terms of the loan. See "--Loan Delinquencies."
Consumer Lending. The Bank originates a limited amount of consumer
loans. Consumer loans originated by the Bank are offered at fixed and adjustable
rates of interest.
Consumer loans generally entail greater risk than do mortgage loans,
since many consumer loans are typically unsecured or secured by rapidly
depreciating assets such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not warrant
further substantial collection efforts against the borrower 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
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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 the Bank is
permitted to make to any one borrower is generally limited to 15% of unimpaired
capital and surplus, plus an additional 10% for consumer installment loans. At
September 30, 1997, the Bank's loans to one borrower limit was approximately
$6.3 million at the 15% level and $10.6 million including additional consumer
installment loans. See "Regulation". At September 30, 1997, the Bank had no
loans to one borrower in excess of its lending limit. The Bank's four largest
loans to one borrower or a group of related borrowers at September 30, 1997
totaled $4.6 million, $4.4 million, $4.2 million and $4.0 million, and the Bank
had only two other loan concentrations in excess of $3.0 million at such date.
At September 30, 1997, all of the foregoing loans were performing in accordance
with their terms.
LOAN DELINQUENCIES
The following table sets forth information concerning delinquent loans
at September 30, 1997. The amounts presented represent the total remaining
principal balances of the related loans (before reserves for losses), rather
than the actual payment amounts which are overdue.
<TABLE>
<CAPTION>
Loans Delinquent for:
-----------------------------------------------------------------
30-59 Days 60-89 Days 90 Days and Over Total
----------------- ----------------- ----------------- -----------------
Number Amount Number Amount Number Amount Number Amount
------ ------ ------ ------ ------ ------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial real estate ..... 3 $ 574 4 $ 787 3 $ 1,793 10 $ 3,154
Lease financing ............ 121 1,824 54 843 36 655 211 3,322
Commercial ................. 34 2,612 12 529 14 2,587 60 5,728
Residential mortgage ....... 9 341 3 7 7 1,145 19 1,493
Residential construction ... 6 1,659 -- -- 3 319 9 1,978
Consumer ................... 143 472 52 156 7 15 202 643
------- ------- ------- ------- ------- ------- ------- -------
Total ................... 316 $ 7,482 125 $ 2,322 70 $ 6,514 511 $16,318
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
NONPERFORMING ASSETS AND RISK ELEMENTS
Nonaccrual loans are loans where, in the opinion of management,
reasonable doubt exists as to the full, timely collection of interest or
principal. Generally loans are placed on nonaccrual status when either principal
or interest is 90 days or more past due. The Bank generally places these loans
on a nonaccrual status unless some payments on the loan are being made,
management believes the loan will be brought current in the near term and such
loans are well secured and in the process of collection. Interest on loans is
generally accrued daily based on the principal balance outstanding. However,
when a loan is placed on nonaccrual status, the accrual of interest income is
discontinued and uncollected accrued interest is charged against current income.
For the nine months ended September 30, 1997 and the year ended
December 31, 1996, the Bank would have recorded interest income of $262,000 and
$297,000, respectively, if nonaccrual and
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restructured loans had performed in accordance with their original terms. The
Bank recognized $9,000 and $108,000, respectively, of interest income on these
loans in the 1997 and 1996 periods.
The following table sets forth the amounts and categories of risk
elements in the Bank's loan portfolio:
<TABLE>
<CAPTION>
At December 31,
At September ----------------------------------------------------
30,
1997 1996 1995 1994 1993 1992
------- ------- ------- ------- ------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
ACCRUING LOANS PAST DUE 90
DAYS OR MORE
Commercial real estate ........... $ 1,793 $ 6,387 $ 1,182 $ 3,398 $ 3,616 $ --
Lease financing .................. 655 1,240 120 250 146 --
Commercial ....................... 2,587 2,685 742 838 26 --
Residential mortgage ............. 1,464 929 141 194 233 667
Consumer ......................... 15 354 73 57 156 47
------- ------- ------- ------- ------- -------
Total ............................ 6,514 11,595 2,258 4,737 4,177 714
------- ------- ------- ------- ------- -------
NONACCRUAL LOANS
Commercial real estate ........... -- 309 4,394 266 337 1,073
Lease financing .................. -- -- 360 879 155 2
Commercial ....................... 834 1,894 3,744 358 69 --
Residential mortgage ............. -- -- 715 635 813 294
Consumer ......................... -- -- 135 25 97 163
------- ------- ------- ------- ------- -------
Total ............................ 834 2,203 9,348 2,163 1,471 1,532
Restructured loans ............... -- -- -- -- 1,407 2,814
------- ------- ------- ------- ------- -------
Total nonperforming loans ........ 7,348 13,798 11,606 6,900 7,055 5,060
------- ------- ------- ------- ------- -------
IN-SUBSTANCE FORECLOSURE
Commercial mortgage .............. -- -- -- -- -- 1,597
REAL ESTATE OWNED
Commercial real estate ........... 2,463 929 -- 554 1,762 1,003
Residential mortgage ............. 136 443 -- -- 123 508
------- ------- ------- ------- ------- -------
Total in-substance foreclosure
and real estate owned ........... 2,599 1,372 -- 554 1,885 3,108
Other repossessed assets ......... 487 108 206 136 224 6
------- ------- ------- ------- ------- -------
Total nonperforming assets ....... $10,434 $15,278 $11,812 $ 7,590 $ 9,164 $ 8,174
======= ======= ======= ======= ======= =======
Total nonperforming assets as
a percentage of:
Total assets ................... 2.19% 3.08% 2.42% 1.78% 2.35% 2.09%
Loans and real estate owned .... 2.67 3.63 3.16 2.40 2.86 2.41
Total nonaccrual loans and real
estate owned as a percentage of:
Total assets ................... 0.72% 0.74% 1.96% 0.67% 1.28% 1.91%
Loans and real estate owned .... 1.82 0.93 2.70 0.94 1.60 2.21
</TABLE>
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<PAGE> 140
Included in accruing loans delinquent 90 days or more are the following
loans: one commercial real estate loan totaling $626,000 which was paid in full
during October 1997; two commercial loans totaling $1.6 million; and one
residential mortgage loan totaling $950,000.
The two commercial loans had an outstanding balance as of September
30, 1997 of $1.3 million and $300,000. The $1.3 million commercial loan has
been restructured and is currently performing in accordance with its repayment
terms. With respect to the commercial loan totaling $300,000, the borrower
has filed for protection from creditors under the federal bankruptcy statutes.
The Bank has commenced foreclosure proceedings on the residential
mortgage loan totaling $950,000. A 1993 appraisal valued the property securing
this loan at approximately $1.2 million and the borrower has received and
accepted an offer to purchase the property for approximately $1.5 million.
There are subordinated liens totaling in excess of $600,000 secured by this
residence which are held by other financial institutions. The borrower has
filed for protection from creditors under federal bankruptcy statutes.
OTHER REAL ESTATE OWNED
Other real estate owned totaled $2.6 million at September 30, 1997
compared to $1.4 million at December 31, 1996. At September 30, 1997, other real
estate owned consisted of seven loans secured by six properties (one
industrial property, two restaurants, one apartment complex, one retail store
and one residential property).
At foreclosure, real estate is recorded at estimated fair value less
disposal costs. Any difference between estimated fair value and the loan balance
is charged to the allowance for loan losses.
OTHER LOANS OF CONCERN
At September 30, 1997, in addition to nonperforming assets, the Bank
had 35 loans categorized as other loans of concern aggregating $9.0 million,
which are classified by management as "substandard" for regulatory
classification purposes. These are loans which are currently performing but
which demonstrate a specific weakness or weaknesses which, if not corrected,
could cause failure of the borrower and default. These loans are closely
monitored by management.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established at levels considered
appropriate based on management's judgment of potential losses in the loan
portfolio. The loan portfolio is reviewed at least quarterly for changes in
performance, collateral value and overall quality. Allocated allowances are
established for problem loans with expected losses, and in addition, allowances
are established for unidentified potential losses. Regulatory agencies, as an
integral part of their examination process, periodically review the Bank's
allowance for loan losses. Such agencies may require the
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<PAGE> 141
Bank to recognize additions to the allowance based upon their judgment of the
information available to them at the time of their examination. A $2.6 million
provision for potential loan losses was made in the first nine months of 1997,
compared to $2.41 million in fiscal 1996 and $1.05 million in fiscal 1995.
Management's judgment in determining the level of the allowance for loan losses
is influenced by several factors during the quarterly reviews. These factors
include, but are not limited to, past loan performance and loss experience,
current economic and market conditions, collateral location and market values,
and delinquency statistics and ratios. In addition, management considers the
level of nonperforming assets and classified assets, the level of lending
activity and the overall size of the loan portfolio. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Should actual circumstances and losses differ substantially from management's
assumptions or estimates, such allowance for loan losses may not be sufficient
to absorb all future losses, and net loans could be significantly and adversely
affected.
The following table sets forth an analysis of the Bank's allowance for
loan losses:
<TABLE>
<CAPTION>
For the Nine
Months Ended
September 30, For the Year Ended December 31,
------------- -------------------------------------------------
1997 1996 1995 1994 1993 1992
---- ---- ---- ---- ---- ----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance at beginning of period .. $3,200 $2,930 $3,453 $3,795 $4,199 $4,142
Provision for losses ............ 2,600 2,410 1,051 220 180 290
CHARGE-OFFS:
Commercial real estate ........ -- 42 172 -- -- 183
Lease financing ............... 1,565 877 1,126 438 273 --
Commercial .................... 1,479 953 218 119 45 --
Residential mortgage .......... --- 9 -- -- 126 15
Consumer ...................... 655 553 243 223 228 39
------ ------ ------ ------ ------ ------
Total charge-offs ............... 3,699 2,434 1,759 780 672 237
RECOVERIES:
Commercial real estate ........ -- 9 17 143 -- --
Lease financing ............... 383 163 20 2 85 --
Commercial .................... 101 60 37 45 -- --
Residential mortgage .......... 1 -- 1 1 1 --
Consumer ...................... 168 62 110 27 2 4
------ ------ ------ ------ ------ ------
Total recoveries ................ 653 294 185 218 88 4
------ ------ ------ ------ ------ ------
Net charge-offs ................. 3,046 2,140 1,574 562 584 233
------ ------ ------ ------ ------ ------
Balance at end of period ........ $2,754 $3,200 $2,930 $3,453 $3,795 $4,199
====== ====== ====== ====== ====== ======
ALLOWANCE AS A PERCENTAGE OF:
Total loans ................... 0.66% 0.76% 0.78% 1.09% 1.19% 1.25%
Nonperforming loans ........... 26.25 20.95 24.81 45.49 41.41 51.37
Net charge-offs ............... 67.81 149.53 186.15 614.41 649.83 1,802.15
Net charge-offs to average loans
outstanding ................... 1.04 0.58 0.49 0.19 0.18 0.07
</TABLE>
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<PAGE> 142
The following table summarizes the allocation of the allowance for loan
losses by major categories at the dates indicated:
<TABLE>
<CAPTION>
At December 31,
At September 30, ------------------------------------------------------------------
1997 1996 1995 1994
------------------ -------------------------------------------------------------------
Percent of Percent of Percent of Percent of
Loans to Loans to Loans to Loans to
Amount Total Amount Total Amount Total Amount Total
------ ----- ------ ----- ------ ----- ------ -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial real estate .... $ 100 0.09% $ 180 0.12% $ 454 0.29% $ 784 0.46%
Lease financing ........... 946 0.87 1,177 1.42 1,308 2.60 1,539 4.53
Commercial ................ 1,594 2.00 1,622 2.09 910 1.63 611 1.72
Residential mortgage ...... 3 -- 50 0.07 78 0.12 118 0.23
Residential construction .. -- -- -- -- -- -- -- --
Consumer ................. 111 0.60 171 0.91 180 1.21 401 5.65
------ ---- ------ ------ ------
Total ................. $2,754 0.72% $3,200 0.81% $2,930 0.85% $3,453 1.15%
====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------
1993 1992
-----------------------------------------------
Percent of Percent of
Loans to Loans to
Amount Total Amount Total
------ ----- ------ -----
<S> <C> <C> <C> <C>
Commercial real estate .... $3,435 1.79% $3,973 1.85%
Lease financing ........... 225 1.40 148 1.51
Commercial ................ 48 0.18 32 0.30
Residential mortgage ...... 47 0.07 20 0.02
Residential construction .. -- -- -- --
Consumer .................. 40 0.67 26 0.41
------ ------
Total ................. $3,795 1.22% $4,199 1.26%
====== ======
</TABLE>
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<PAGE> 143
INVESTMENT ACTIVITIES
The Bank has invested in various securities which are acquired in the
capital markets. These investments consist of mortgage, government, agency,
municipal, and corporate debt securities.
The following table presents information concerning the type and fair
value of the Bank's investment securities at the dates indicated.
<TABLE>
<CAPTION>
At At December 31,
September 30, ----------------------------------
1997 1996 1995 1994
---- ---- ---- ------
(In Thousands)
<S> <C> <C> <C> <C>
U.S. treasury and agency obligations .. $21,275 $35,214 $33,971 $44,314
Municipal securities .................. 2,741 2,724 3,158 2,703
Mortgage securities ................... 6,053 11,405 15,280 19,110
------- ------- ------- -------
Total ............................ $30,069 $49,343 $52,409 $66,127
======= ======= ======= =======
</TABLE>
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Earning Assets," "--Liquidity" and Note 3 of Notes to
Consolidated Financial Statements for additional information regarding the
Bank's investment securities.
SOURCE OF FUNDS
Deposits are the primary source of the Bank's funds for use in lending
and for other general business purposes. In addition to deposits, the Bank
derives funds from loan repayments, advances from the FHLB of Indianapolis and
other borrowings, and at times has derived funds from reverse 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 or deposit outflows, or to support expanded activities.
Historically, the Bank has borrowed primarily from the FHLB of Indianapolis and
through institutional reverse repurchase agreements. For additional information
on the Bank's deposits and borrowings, see Notes 4 and 6 of Notes to
Consolidated Financial Statements for the year ended December 31, 1996 and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Since 1992 the Bank has emphasized its no interest business checking
and money market savings accounts in order to reduce its cost of funds and
provide a more stable, long-term source of deposits than would be available from
certificate of deposits. The ability of the 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.
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<PAGE> 144
COMPETITION
Franklin 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. The 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 personnel.
The 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, the Bank believes
that it should attempt to compete in areas in which it can truly develop niche
products and services so as to avoid direct face-to-face competition with larger
financial institutions.
Direct competition for deposits comes from other commercial banks,
credit unions and savings institutions. Additional significant competition for
deposits comes from money market mutual funds and corporate and government
securities. The primary factors in competing for loans are interest rates and
the range of services offered. Competition for origination of real estate loans
and business loans normally comes from other commercial banks and insurance
companies.
EMPLOYEES
At September 30, 1997, the Bank had 213 employees, including 23 part-time
employees. Management considers its relations with its employees to be
satisfactory. The Bank's employees are not represented by any collective
bargaining group.
The Bank currently maintains a comprehensive employee benefit program
providing, among other benefits, a 401(k) plan and an Employee Stock Ownership
Program, hospitalization and major medical insurance, paid sick leave, long-term
disability insurance and life insurance.
REGULATION
GENERAL
The Bank is a national bank, the deposits of which are federally
insured and backed by the full faith and credit of the United States Government.
Accordingly, the Bank is subject to broad federal regulation and oversight
extending to all its operations by the OCC and the FDIC. The Bank is also a
member of the FHLB of Indianapolis. The deposits of the Bank are insured by the
SAIF, which is administered by the FDIC.
Certain of these regulatory requirements and restrictions are discussed
below or elsewhere in this document.
FEDERAL REGULATION OF NATIONAL BANKS
The OCC has extensive authority over the operations of national banks.
As part of this authority, the Bank is required to file periodic reports with
the OCC and is subject to periodic
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<PAGE> 145
examinations by the OCC. All national banks are subject to a semi-annual
assessment, based upon the bank's total assets, to fund the operations of the
OCC.
The OCC also has extensive enforcement authority over all national
banks, including the Bank. This enforcement authority includes, among other
things, the ability to assess civil money penalties, to issue cease-and-desist
or removal orders and to initiate injunctive actions. In general, these
enforcement actions may be initiated for violations of laws and regulations and
unsafe or unsound practices. Other actions or inactions may provide the basis
for enforcement action, including misleading or untimely reports filed with the
OCC. Except under certain circumstances, public disclosure of final enforcement
actions by the OCC is required.
The OCC, as well as the other federal banking agencies, has adopted
guidelines establishing safety and soundness standards on such matters as loan
underwriting and documentation, internal controls and audit systems, interest
rate risk exposure and compensation and other employee benefits. Any institution
which fails to comply with these standards must submit a compliance plan. A
failure to submit a plan or to comply with an approved plan will subject the
institution to further enforcement action. The OCC and the other federal banking
agencies have also proposed additional guidelines on asset quality and earnings
standards. No assurance can be given as to whether or in what form the proposed
regulations will be adopted.
INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC
As insurer, the FDIC is authorized to impose deposit insurance premiums
and to conduct examinations of and require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious risk
to the FDIC. The FDIC also has the authority to initiate enforcement actions
against national banks, after giving the OCC an opportunity to take such action,
and may terminate deposit insurance if it determines that the institution has
engaged in unsafe or unsound practices or is in an unsafe or unsound condition.
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., 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., 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 semi-annually.
In order to equalize the deposit insurance premium schedules for BIF
and SAIF insured institutions, the FDIC imposed a one-time special assessment on
all SAIF-assessable deposits pursuant to federal legislation passed on September
30, 1996. The Bank's special assessment, which was $1.6 million net of income
tax, was paid in November 1996. Effective January 1, 1997, the
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<PAGE> 146
premium schedule for BIF and SAIF insured institutions ranged from 0 to 27 basis
points. However, SAIF-insured institutions such as the Bank are required to pay
a Financing Corporation (FICO) assessment, in order to fund the interest on
bonds issued to resolve thrift failures in the 1980s, equal to 6.48 basis points
for each $100 in domestic deposits, while BIF-insured institutions pay an
assessment equal to 1.52 basis points for each $100 in domestic deposits. The
assessment is expected to be reduced to 2.43 basis points no later than January
1, 2000, when BIF insured institutions fully participate in the assessment.
These assessments, which may be revised based upon the level of BIF and SAIF
deposits, will continue until the bonds mature in the year 2017.
National Banks. The Bank is subject to the capital regulations of the
OCC. The OCC's regulations establish two capital standards for national banks: a
leverage requirement and a risk-based capital requirement. In addition, the OCC
may, on a case-by-case basis, establish individual minimum capital requirements
for a national bank that vary from the requirements which would otherwise apply
under OCC regulations. A national bank that fails to satisfy the capital
requirements established under the OCC's regulations will be subject to such
administrative action or sanctions as the OCC deems appropriate.
The leverage ratio adopted by the OCC requires a minimum ratio of "Tier
1 capital" to adjusted total assets of 3% for national banks rated composite 1
under the CAMEL rating system for banks. National banks not rated composite 1
under the CAMEL rating system for banks are required to maintain a minimum ratio
of Tier 1 capital to adjusted total assets of 4% to 5%, depending upon the level
and nature of risks of their operations. For purposes of the OCC's leverage
requirement, Tier 1 capital generally consists of common stockholders' equity
and retained income and certain non-cumulative perpetual preferred stock and
related income, except that no intangibles and certain purchased mortgage
servicing rights and purchased credit card relationships may be included in
capital.
The risk-based capital requirements established by the OCC's
regulations require national banks to maintain "total capital" equal to at least
8% of total risk-weighted assets. For purposes of the risk-based capital
requirement, "total capital" means Tier 1 capital (as described above) plus
"Tier 2 capital," provided that the amount of Tier 2 capital may not exceed the
amount of Tier 1 capital, less certain assets. The components of Tier 2 capital
include certain permanent and maturing capital instruments that do not qualify
as core capital and general valuation loan and lease loss allowances up to a
maximum of 1.25% of risk-weighted assets.
The OCC has revised its risk-based capital requirements to permit the
OCC to require higher levels of capital for an institution in light of its
interest rate risk. In addition, the OCC has proposed that a bank's interest
rate risk exposure would be quantified using either the measurement system set
forth in the proposal or the institution's internal model for measuring such
exposure, if such model is determined to be adequate by the institution's
examiner. Small institutions that are highly capitalized and have minimal
interest rate risk, would be exempt from the rule unless otherwise determined by
the OCC. Management of the Bank does not believe the OCC's proposed interest
rate risk component regulations would have any material impact on the Bank's
capital, if adopted as proposed.
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<PAGE> 147
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 1
risked-based capital ratio or an 8% risk-based capital ratio). Any such
association 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 banking association that fails to comply with its capital
plan or is "significantly undercapitalized" (i.e., Tier 1 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 its operations and include
a forced merger or acquisition of the bank. An association 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 an
association, 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.
The imposition by the OCC of any of these measures on the Bank may have
a substantial adverse effect on the Bank's operations and profitability and the
value of its common stock.
LIMITATIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS
The 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 cash 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 Bank's net profits for
the preceding half year in the case of quarterly or semi-annual dividends, or
the preceding two half-year periods in the case of annual dividends, are
transferred to the surplus 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.
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<PAGE> 148
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, the 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, the Bank would be
classified as "undercapitalized" under the OCC's regulations. See "-- Prompt
Corrective Action."
COMMUNITY REINVESTMENT ACT
Under the Community Reinvestment Act ("CRA"), every FDIC insured
institution 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 the
Bank, to assess the institution'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 the Bank. An
unsatisfactory rating may be used as the basis for the denial of an application
by the OCC.
The federal banking agencies, including the OCC, have recently revised
the CRA regulations and the methodology for determining an institution's
compliance with the CRA. Due to the heightened attention being given to the CRA
in the past few years, the Bank may be required to devote additional funds for
investment and lending in its local community. The Bank was examined for CRA
compliance in March 1997 and received a rating of satisfactory.
FEDERAL RESERVE SYSTEM
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). At September 30,
1997, the Bank had $825,150 of FRB stock, which was in compliance with these
reserve requirements.
National banks are authorized to borrow from the Federal Reserve Bank
"discount window," but FRB regulations require associations to exhaust other
reasonable alternative sources of funds, including FHLB borrowings, before
borrowing from the Federal Reserve Bank.
The Bank is a member of the Federal Reserve System.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the FHLB of Indianapolis, which is one of 12
regional FHLBs that administer the home financing credit function of savings
associations and member banks. Each FHLB serves as a reserve or central bank for
its members within its assigned region. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System. It makes
loans to members (i.e., advances) in accordance with policies and procedures,
established by
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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 long-term advances are required to provide funds for residential home
financing.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Indianapolis. At September 30, 1997, the Bank had $5.87 million in FHLB
stock, which was in compliance with this requirement. In past years, the Bank
has received dividends on its FHLB stock. Over the past five calendar years such
dividends have averaged 8.22% and were 7.83% for calendar year 1996.
Under federal law the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to low- and
moderately priced housing programs through direct loans or interest subsidies on
advances targeted for community investment and low- and moderate-income housing
projects. These contributions have affected adversely the level of FHLB
dividends paid and could continue to do so in the future. These contributions
could also have an adverse effect on the value of FHLB stock in the future. A
reduction in value of The Bank's FHLB stock may result in a corresponding
reduction in the Bank's capital.
FEDERAL AND STATE TAXATION
Federal Taxation. In addition to the regular income tax, the Bank is
generally subject to a minimum tax. An alternative minimum tax is imposed at a
minimum tax rate of 20% on alternative minimum taxable income, which is the sum
of a bank's regular taxable income (with certain adjustments) and tax preference
items, less any available exemption. The alternative minimum tax is imposed to
the extent it exceeds the bank's regular income tax and net operating losses can
offset no more than 90% of alternative minimum taxable income. For taxable years
beginning after 1986 and before 1996, the Bank was also subject to an
environmental tax equal to 0.12% of the excess of alternative minimum taxable
income for the taxable year (determined without regard to net operating losses
and the deduction for the environmental tax) over $2 million.
The Bank files federal income tax returns on a fiscal year basis using
the accrual method of accounting. The Bank's federal income tax returns for the
last three years are open to possible audit by the IRS. No returns are being
audited by the IRS at the current time. In the opinion of management, any
examination of open returns would not result in a deficiency which could have a
material adverse effect on the financial condition of the Bank.
Michigan Taxation. The State of Michigan imposes a tax on intangible
personal property in the amount of $.20 per $1,000 of deposits of a bank less
deposits owed to the federal or Michigan state governments, their agencies or
certain other financial institutions. The Michigan intangibles tax is being
phased out over four years until the tax is fully repealed effective January 1,
1998. The State of Michigan also imposes a "Single Business Tax." The Single
Business Tax is a value-added type of tax for the privilege of doing business in
the State of Michigan. The major components of the Single Business Tax are
federal taxable income, compensation and depreciation as increased by net
operating loss carryforwards, if any, utilized in arriving at federal taxable
income, and decreased
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by the cost of acquisition of tangible assets during the year. The tax rate is
2.30% of the Michigan adjusted tax base.
PROPERTIES
Offices. The following table sets forth information with respect to the
Bank's offices as of September 30, 1997.
<TABLE>
<CAPTION>
Owned
or
Office Locations Leased Lease Expiration Date
- ---------------- ------ ---------------------
<S> <C> <C>
EXECUTIVE OFFICE AND BUSINESS
CENTER OFFICE:
24725 West Twelve Mile Road
Southfield, Michigan.................... Leased January 2003;
One 5 year option
REGIONAL OFFICES:
26336 West Twelve Mile Road
Southfield, Michigan.................... Leased March 31, 2008;
Four 5 year options
20247 Mack Avenue
Grosse Pointe Woods, Michigan.......... Owned --
479 South Woodward Avenue
Birmingham, Michigan.................... Leased May 2007;
One 20 year option
</TABLE>
The Bank believes its current facilities are adequate to meet its
needs.
LEGAL PROCEEDINGS
From time to time the Bank is a party to routine legal proceedings
arising out of its general lending activities and other operations. There are no
material pending legal proceedings to which the Bank or its subsidiary is a
party, or to which any of their property is subject, which, if determined
adversely to the Bank or its subsidiary, would individually or in the aggregate
have a material adverse effect on the Bank's consolidated financial position.
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<PAGE> 151
MANAGEMENT
DIRECTORS
All of the members of the Bank's Board of Directors are elected
annually. The Bank has appointed one Advisory Director, Mr. Joseph A. Pick, a
retired Bank director, to serve until the 1998 annual meeting of shareholders.
Advisory directors participate in all meetings of the Board of Directors but
have no voting privileges.
INFORMATION REGARDING DIRECTORS
The table below sets forth certain information, at December 31, 1996,
regarding the composition of the Bank's Board of Directors, including terms of
office.
<TABLE>
<CAPTION>
Director of
Bank
Name Age Positions Held in the Bank Since
- ------------------------------- --- ------------------------------------------------ -----------
<S> <C> <C> <C>
Read P. Dunn 51 Director, President and Chief Executive Officer 1984
David F. Simon 50 Chairman of the Board 1983
Edgar M. Fenton 75 Director 1983
Dean A. Friedman 46 Director and Secretary 1983
Herbert N. Glass 49 Director 1983
William E. Murcko 50 Director 1983
George M. Nyman 50 Director 1983
James R. Wechsler 47 Director 1983
</TABLE>
The business experience of each of the directors during the last five
years is as follows:
Read P. Dunn. Mr. Dunn is President and Chief Executive Officer of
Franklin and has held these positions since its inception. Mr. Dunn is a member
of Franklin's Loan, Securities, CRA Compliance and Marketing Committees. He is a
certified public accountant and was the former President and senior officer at
another financial institution, where he was employed for 14 years.
David F. Simon. Mr. Simon is Chairman of the Board of Franklin and has
held this position since its inception. Mr. Simon is a member of Franklin's
Loan, Securities, CRA Compliance and Marketing Committees. He formerly was an
attorney in private practice specializing in securities and financial
institutions law from 1971 to 1991. Mr. Simon is the son-in-law of Edgar M.
Fenton, a Director of Franklin.
Edgar M. Fenton. Mr. Fenton is a member of the Loan and CRA Compliance
Committees of Franklin. He is Chairman of the Board and Chief Executive Officer
of Cadroy Management Company and the Fenton Company, each located in Southfield,
Michigan (real estate development, investment and management), affiliated with
both companies since 1952. Mr. Fenton served four
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terms as President of the Apartment Association of Michigan (1985-1989). Mr.
Fenton is the father-in-law of David F. Simon, Chairman of the Board of
Franklin.
Herbert N. Glass. Mr. Glass is a member of the ESOP, Securities, Audit,
Compensation and Marketing Committees of Franklin. Since 1976 Mr. Glass has
served as President of The Glass Freedman Company, a registered investment
advisor, located in Bingham Farms, Michigan (pension, life insurance and
investment consulting, actuarial and administrative services provided to
corporations and retirement programs). Mr. Glass is a Certified Pension
Consultant, a Certified Financial Planner, a Chartered Life Underwriter, a
Chartered Financial Consultant and a Licensed Insurance Counselor.
William E. Murcko. Mr. Murcko is a member of the Audit, ESOP, CRA
Compliance, Compensation and Marketing Committees of Franklin. Since 1990 Mr.
Murcko has served as President and Chief Operating Officer of Communication
Associates, Inc., an advertising agency located in Birmingham, Michigan.
George M. Nyman. Mr. Nyman is a member of the Audit and Loan Committees
of Franklin. Since 1975 Mr. Nyman has served as President of Professional
Property Management Co. of Michigan, Inc., located in Troy, Michigan (real
estate management firm) and as a Vice President of the Apartment Association of
Michigan since 1990.
James R. Wechsler. Mr. Wechsler is a member of the Audit, ESOP and Loan
Committees of Franklin. He is currently President of Wechsler Financial Group,
Inc. of Farmington Hills, Michigan, a financial management, investment and
consulting firm, a position he has held since 1989. In addition, since January
1992 he has served as Chairman of Advance Mortgage Corporation, a mortgage
lender located in Farmington Hills, Michigan. He is also a licensed real estate
broker in the State of Michigan.
EXECUTIVE OFFICERS
The following information as to the business experience during the past
five years is supplied with respect to executive officers of the Bank who do not
serve on the Bank's Board of Directors at December 31, 1996. Executive officers
are elected annually to serve until their successors are elected or until they
resign or are removed by the Board of Directors. There are no arrangements or
understandings between the persons named and any other person pursuant to which
such officers were elected.
Rebecca Christian, age 43, is Senior Vice President, Marketing, a
position she has held since 1991. Ms. Christian is a member of Franklin's
Securities, ESOP and Marketing Committees.
David L. Shelp, age 50, has been the Treasurer of Franklin since its
inception in 1983. Mr. Shelp was an Assistant Treasurer of another financial
institution in Lansing, Michigan, from 1975 to 1981 and its Controller from 1981
to 1983.
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<PAGE> 153
Edward J. Shehab, age 37, joined Franklin in 1985 as a financial
analyst. Prior to that time, Mr. Shehab was an assistant secondary trader at
another financial institution. Since 1991, Mr. Shehab has been Vice President of
Finance.
MEETINGS AND COMMITTEES OF THE BOARD
The Board of Directors has established the following Committees: (a)
Audit; (b) Loan; (c) Securities; (d) CRA Compliance; (e) Marketing; (f)
Compensation and (g) ESOP.
The Audit Committee, which meets quarterly, is responsible for, among
other things, establishing standards for financial reporting, establishing
standards for internal systems control, reviewing all audit reports and
interfacing with the independent auditors.
The Loan Committee, which meets as necessary, is responsible for, among
other things, reviewing and acting upon loan applications, reviewing loan
quality reports, and reviewing troubled loan restructurings or sales.
The Securities Committee, which meets quarterly, is responsible for
oversight of Franklin's sale of investment and insurance products.
The CRA Compliance Committee, which meets quarterly, is responsible for
development of Franklin's CRA plans and monitoring progress and policies in
connection therewith.
The Marketing Committee, which meets as necessary, is responsible for
developing new products and monitoring Franklin's advertising and overall
marketing activities.
The Compensation Committee meets as necessary and is responsible for
reviewing the Bank's compensation philosophy, retirement planning, determining
compensation for the Bank's top senior management and reviewing stock option
plans.
The ESOP Committee meets semi-annually and is responsible for
overseeing Franklin's Employee Stock Ownership Plan and administering the Plan
functions.
The Board of Directors, acting as a Nominating Committee, selects the
management nominees to the Board. No nominations for Directors, except those by
the nominating committee, shall be voted upon at an annual meeting unless other
nominations by shareholders are made in writing and submitted to the President
of Franklin at 24725 West Twelve Mile Road, Southfield, Michigan 48034 not less
than 14 days or more than 50 days before the applicable annual meeting to which
the nomination relates. Nominations by shareholders should include: (1) the name
and address of each proposed nominee; (2) the principal occupation of each
proposed nominee; (3) the name and residence address of the notifying
shareholder; and (4) the number of shares of capital stock of the Bank owned by
the notifying shareholder.
The Audit Committee was established in July 1991; the ESOP Committee in
September 1991; and the Loan and Marketing Committees in December 1991; the
Securities Committee in May
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<PAGE> 154
1993; the CRA Compliance Committee in May 1993; and the Compensation Committee
in December 1993.
During the year ended December 31, 1996, there were 13 meetings of the
Board of Directors, six meetings of the Audit Committee, two meetings of the
Securities Committee; four meetings of the CRA Compliance Committee; one meeting
of the ESOP Committee, 38 meetings of the Loan Committee, four meetings of the
Compensation Committee and three meetings of the Marketing Committee. All of the
Directors attended in excess of 75% of the aggregate of the total number of
meetings of the Board of Directors and the total number of meetings held by all
Committees of the Board on which they served.
COMPENSATION OF DIRECTORS
Under Franklin's Bylaws, Directors are entitled to receive a stated
salary for their services and a reasonable fixed sum, as well as reasonable
expenses, for actual attendance at meetings of the Board and Committees of the
Board. During 1996, the annual retainer amount was $12,000 and the Board and
Committee fees were $1,000 and $600 per meeting, respectively. In order to
retain qualified individuals who are willing to serve as Directors and in order
to promote a close identity of interests between Directors and shareholders, the
non-employee directors participate in director stock option plans. Non-employee
Directors also receive certain health care benefits under a Bank-sponsored
health care plan. Directors who are also employees of the Bank are excluded from
receiving additional compensation for their service on the Board of Directors
and its Committees.
Franklin has also entered into severance agreements with its
non-employee directors to provide compensation solely in the event of any change
in control of Franklin and subsequent failure to nominate, re-elect or
termination of the designated director within three years thereafter. Under the
agreements, as amended, each such terminated director would receive compensation
equal to $15,000 per year of service as a director of Franklin for each full
year, in addition to the continuation for three years of any benefit plans. In
addition, a Director may elect to surrender his rights in any outstanding stock
options (whether or not currently exercisable) and receive a cash payment in an
amount generally equal to the difference between the option price of the shares
and the greater of (i) the price paid for the control shares, (ii) the tender
offer price paid for the shares leading to control or (iii) the mean between the
low and high selling price of the shares of common stock on the date of
termination. Also, Franklin will maintain all benefit plans in which the
Director was entitled to participate for three years. All severance agreements
provide for the creation of a separate trust in the event of a change in control
or potential change of control as determined by the Board. The aggregate amounts
due the directors will be funded into the trust and paid as appropriate. All
unexpended funds will revert to Franklin.
COMPENSATION OF EXECUTIVE OFFICERS
The following table sets forth information concerning the compensation
paid or granted to the Bank's Chief Executive Officer and to each of the three
other most highly compensated executive officers of the Bank whose total salary
and bonus compensation was in excess of $100,000 in 1996.
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<PAGE> 155
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long Term
Compensation Awards
-------------------
Annual Compensation Securities
---------------------------------- Restricted Underlying
Other Annual Stock Options/ All Other
Name and Principal Salary Bonus Compensation Award(s) SARs Compensation
Position Year ($) ($) ($) ($) (#)(1) ($)
- ------------------------ ---- -------- -------- ------------ ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Read P. Dunn 1996 $275,000 $ 35,543 $--- $--- -- $ 5,697(2)
President and Chief 1995 250,620 54,410 -- -- 12,127 9,051
Executive Officer 1994 250,620 93,982 -- -- 27,562 6,155
David F. Simon 1996 $250,000 $ 32,312 $--- $--- -- $ 4,962(2)
Chairman of the Board 1995 205,800 44,679 -- -- 5,512 8,496
1994 205,800 77,175 -- -- 27,562 5,820
David L. Shelp 1996 $104,147 $ 9,100 $--- $--- -- $ 3,622(2)
Treasurer 1995 97,600 14,865 -- -- 2,756 6,626
1994 97,600 24,302 -- -- 7,717 4,219
Rebecca Christian 1996 $ 95,514 $ 7,611 $--- $--- -- $ 3,113(2)
Senior Vice President 1995 86,400 15,064 -- -- 2,756 5,780
1994 86,400 23,051 -- -- 7,717 3,568
</TABLE>
- ------------------------
(1) As adjusted for 5% stock dividends declared in December 1994 and
January 1996 and 1997.
(2) Represents $3,652, $3,652, $3,021, and $2,793 contributed by Franklin
in 1996 to its ESOP, plus $2,045, $1,310, $601, and $320 paid by
Franklin as premiums with respect to term life insurance for Messrs.
Dunn, Simon, Shelp and Ms. Christian, respectively.
The following table sets forth certain information concerning the
number of options exercised in the past fiscal year, as well as the value of the
options held, by the executive officers named in the Summary Compensation Table
above at December 31, 1996. To date, the Bank has not awarded any stock
appreciation rights.
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR END OPTION VALUES
<TABLE>
<CAPTION>
Number of Securities Value of
Underlying Unexercised
Unexercised In-the-money
Options at Options at
Shares FY-End(#) FY-End($)(2)
Acquired On Value ----------------------------------------------------------------
Name Exercise(#) Realized($)(1) Exercisable Unexercisable Exercisable Unexercisable
- ----------------- ----------- -------------- ----------- ------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
Dunn............. --- --- 32,540 16,069 $97,688 $48,272
Simon............ --- --- 24,618 14,884 78,476 37,076
Shelp............ --- --- 8,850 5,559 37,410 16,656
Christian........ 2,483 $19,540 5,587 5,268 14,363 15,465
</TABLE>
- --------------------------------
(1) Value based on market value of the Bank's common stock on exercise minus the
exercise price.
(2) Value based on market value of the Bank's common stock on December 31, 1996
minus the exercise price.
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<PAGE> 156
EMPLOYMENT AGREEMENTS
Franklin has entered into employment agreements with Read P. Dunn,
President and Chief Executive Officer, and David F. Simon, Chairman. Except, in
the event of a change in control, both employment agreements are automatically
renewed for successive one-year terms each year unless either party gives notice
sixty days before the expiration of any one-year period. In 1996, both
agreements provided for a base salary, an annual bonus and various benefits;
such as term life insurance, a long term disability policy and club dues.
Generally, termination of either Mr. Dunn's or Mr. Simon's employment, other
than for cause, death or disability would not prejudice their right to
compensation or other benefits for the remainder of the term of their respective
agreements. Both employment agreements contain non-compete and confidentiality
provisions.
Franklin has entered into severance agreements with certain senior
officers (presently consisting of 15 persons). The severance agreements provide
compensation solely in the event of a defined change in control of Franklin and
subsequent termination of the designated officer within three years thereafter.
Franklin's primary purpose in entering into the severance agreements
with the senior officers selected is to provide an inducement for such officers
to remain employed by Franklin during the transition period involving a change
in control. With continuation of these officer's employment reasonably assured,
Franklin and its shareholders should be more assured that these officers will
act, with respect to a possible change in control, for the sole benefit of
Franklin and the shareholders, and without undue concern for their own financial
security.
Generally, under the agreements, as amended, the President/Chief
Executive Officer and Chairman are each entitled to receive severance
compensation equal to 2.99 times gross compensation, as defined. The Senior Vice
Presidents and Treasurer are each entitled to receive severance compensation
equal to 1.5 times gross compensation, as defined. The Vice Presidents are
entitled to receive severance compensation equal to six months gross
compensation, as defined. In addition, an officer may elect to surrender his
rights in any outstanding stock options (whether or not currently exercisable)
and receive a cash payment in an amount generally equal to the difference
between the option price of the shares and the greater of (i) the price paid for
the control shares, (ii) the tender offer price paid for the shares leading to
control or (iii) the mean between the low and high selling price of the shares
of common stock on the date of termination. Also, Franklin will maintain all
benefit plans in which an officer was entitled to participate for three years.
All severance agreements provide for the creation of a separate trust
in the event of a change in control or potential change in control as defined by
the Board of Directors. The aggregate amounts due all covered senior officers
will be funded into the trust and paid as appropriate. All unexpended funds will
revert to Franklin.
CERTAIN TRANSACTIONS
During the year ended December 31, 1996, Franklin engaged Communication
Associates, Inc. to provide advertising and printing services for Franklin.
William E. Murcko, a Director, is
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<PAGE> 157
President, Chief Operating Officer and a minority shareholder of Communication
Associates, Inc. For the year ended December 31, 1996, Franklin paid
Communication Associates, Inc. for such services $207,319. Of this amount,
$60,000 was paid as media placement and radio production fees to Solomon
Friedman Advertising, an advertising agency part owned by another director, Dean
A. Friedman, which provides creative services to Communications Associates on
behalf of the Bank. An additional $141,911 was paid directly to Solomon Friedman
Advertising in 1996 for creative services. Management believes that the terms
and conditions of the engagement are fair and comparable to those which could
have been obtained from an independent party.
DESCRIPTION OF THE SERIES A PREFERRED SHARES
The following summary sets forth the material terms and provisions of
the Series A Preferred Shares, and is qualified in its entirety by reference to
the terms and provisions of the Certificate of Designation establishing the
Series A Preferred Shares and the Bank's Articles of Association, as amended,
the forms of which have been filed with the OCC as exhibits to the registration
statement of which this Prospectus forms a part.
GENERAL
The Series A Preferred Shares form an initial series of preferred stock
of the Bank, which preferred stock may be issued from time to time in one or
more series with such rights, preferences and limitations as are determined by
the Bank's Board of Directors or, if then constituted, a duly authorized
committee thereof. The Board of Directors has authorized the Bank to issue the
Series A Preferred Shares.
When issued, the Series A Preferred Shares will be validly issued,
fully paid and nonassessable. The holders of the Series A Preferred Shares will
have no preemptive rights with respect to any shares of the capital stock of the
Bank or any other securities of the Bank convertible into or carrying rights or
options to purchase any such shares. The Series A Preferred Shares will not be
convertible into shares of Common Stock or any other class or series of capital
stock of the Bank and will not be subject to any sinking fund or other
obligation of the Bank for their repurchase or retirement.
The transfer agent, registrar and dividend disbursement agent for the
Series A Preferred Shares will be Boston Equiserve Limited Partnership. The
registrar for the Series A Preferred Shares will send notices to shareholders of
any meetings at which holders of such shares have the right to elect directors
of the Bank or to vote on any other matter.
DIVIDENDS
Holders of Series A Preferred Shares shall be entitled to receive, if,
when, and, as declared by the Board of Directors of the Bank out of assets of
the Bank legally available therefor, cash dividends at the rate of [__]% per
annum of the initial liquidation preference (equivalent to $[______] per share
per annum). If declared, dividends on the Series A Preferred Shares shall be
payable quarterly in arrears on the last day of March, June, September, and
December of each year,
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<PAGE> 158
or, if such day is not a business day, on the next business day, at such annual
rate. Dividends in each quarterly period will accrue from the first day of such
period. Each declared dividend shall be payable to holders of record as they
appear at the close of business on the stock register of the Bank on such record
dates, not exceeding 45 days preceding the payment dates thereof, as shall be
fixed by the Board of Directors of the Bank or a duly authorized committee
thereof. Upon the exchange of Preferred Capital Shares for Series A Preferred
Shares, any accrued and unpaid dividends for the most recent quarter of the
Preferred Capital Shares at the time of the conversion will be deemed to be
accrued and unpaid dividends for the most recent quarter on the Series A
Preferred Shares.
The right of holders of Series A Preferred Shares to receive dividends
is noncumulative. Accordingly, if the Board of Directors fails to declare a
dividend on the Series A Preferred Shares for a quarterly dividend period, then
holders of the Series A Preferred Shares will have no right to receive a
dividend for that period, and the Bank will have no obligation to pay a dividend
for that period, whether or not dividends are declared and paid for any future
period with respect to either the preferred stock or the Common Stock. If the
Bank fails to declare and pay or declare and set aside for payment a quarterly
dividend on the Series A Preferred Shares, holders of the preferred stock of the
Bank, including the Series A Preferred Shares, will be entitled to elect two
directors. See " --Voting Rights."
If full dividends on the Series A Preferred Shares for any dividend
period shall not have been declared and paid, or declared and a sum sufficient
for the payment thereof shall not have been set apart for such payments, no
dividends shall be declared and paid or set aside for payment and no other
distribution shall be declared or made or set aside for payment upon the Common
Stock or any other capital stock of the Bank ranking junior to or on a parity
with the Series A Preferred Shares as to dividends or amounts upon liquidation,
nor shall any Common Stock or any other capital stock of the Bank ranking junior
to or on a parity with the Series A Preferred Shares as to dividends or amounts
upon liquidation be redeemed, purchased or otherwise acquired for any
consideration (or any monies to be paid to or made available for a sinking fund
for the redemption of any such stock) by the Bank, except by conversion into, or
exchange for, other capital stock of the Bank ranking junior to the Series A
Preferred Shares as to dividends and amounts upon liquidation), until such time
as dividends on all outstanding Series A Preferred Shares have been (i) declared
and paid or declared and a sum sufficient for the payment thereof has been set
apart for payment for three consecutive dividend periods and (ii) declared and
paid or declared and a sum sufficient for the payment thereof has been set apart
for payment for the fourth consecutive dividend period.
If any Series A Preferred Shares are outstanding, no full dividends
shall be declared and paid or set apart for payment and no other distribution
shall be declared and made or set aside for payment on any series of capital
stock of the Bank ranking, as to dividends, on a parity with or junior to the
Series A Preferred Shares for any dividend period unless full dividends have
been or contemporaneously are declared and paid, or declared and a sum
sufficient for the payment thereof is set apart for such payments on the Series
A Preferred Shares, for the then-current dividend period. When dividends are not
paid in full (or a sum sufficient for such full payment is not set apart) upon
the Series A Preferred Shares and the shares of any other series of capital
stock ranking on a parity as to dividends with the Series A Preferred Shares,
all dividends declared upon Series A Preferred Shares and any other series of
capital stock ranking on a parity as to dividends with the Series A
BP-58
<PAGE> 159
Preferred Shares shall be declared pro rata so that the amount of dividends
declared per share on the Series A Preferred Shares and such other series of
capital stock shall in all cases bear to each other the same ratio that full
dividends, for the then-current dividend period, per share on the Series A
Preferred Shares, which shall not include any accumulation in respect of unpaid
dividends for prior dividend periods, and full dividends, including required or
permitted accumulations, if any, on such other series of capital stock bear to
each other.
REDEMPTION
The Series A Preferred Shares will not be redeemable prior to
[_______], 2002. On or after such date, the Series A Preferred Shares will be
redeemable at the option of the Bank, in whole or in part, at any time or from
time to time on not less than 30 nor more than 60 days' notice by mail, at a
redemption price of $10.00 per share, plus the accrued and unpaid dividends for
the most recent quarter to the date of redemption, if any, thereon.
Any such redemption must comply with the prompt corrective action
regulations of the OCC, which may prohibit a redemption or require the OCC's
prior approval of a redemption. Unless full dividends on the Series A Preferred
Shares have been, or contemporaneously are, declared and paid or declared and a
sum sufficient for the payment thereof has been set apart for payment for the
then current dividend period, no Series A Preferred Shares shall be redeemed
unless all outstanding Series A Preferred Shares are redeemed and the Bank shall
not purchase or otherwise acquire any Series A Preferred Shares; provided,
however, that the Bank may purchase or acquire Series A Preferred Shares
pursuant to a purchase or exchange offer made on the same terms to holders of
all outstanding Series A Preferred Shares.
VOTING RIGHTS
Except as expressly required by applicable law, or except as indicated
below, the holders of the Series A Preferred Shares will not be entitled to
vote. In the event the holders of Series A Preferred Shares are entitled to vote
as indicated below, each Series A Preferred Share will be entitled to one vote
on matters on which holders of the Series A Preferred Shares are entitled to
vote.
If at the time of any annual meeting of the Bank's stockholders, the
Bank has declared and failed to pay or declared and failed to set aside for
payment a quarterly dividend during any of the four preceding quarterly dividend
periods on any series of preferred stock of the Bank, including the Series A
Preferred Shares, the number of directors then constituting the Board of
Directors of the Bank will be increased by two (if not already increased by two
due to a default in preference dividends), and the holders of the Series A
Preferred Shares, voting together as a single class with the holders of all
other series of preferred stock as a single class will be entitled to elect such
two additional directors to serve on the Bank's Board of Directors at each such
annual meeting. Each director elected by the holders of shares of the preferred
stock shall continue to serve as such director until the later of (i) the
expiration of the term of such director or (ii) the payment of four consecutive
quarterly dividends on the Series A Preferred Shares.
BP-59
<PAGE> 160
The affirmative vote or consent of the holders of at least 66-2/3% of
the outstanding shares of each series of preferred stock of the Bank, including
the Series A Preferred Shares, voting as a single class without regard to
series, will be required (a) to create any class or series of stock which shall
have preference as to dividends or distribution of assets over any outstanding
series of preferred stock of the Bank other than a series which shall not have
any right to object to such creation or (b) to alter or change the provisions of
the Bank's Articles of Association (including the Certificate of Designation
establishing the Series A Preferred Shares) so as to adversely affect the voting
powers, preferences or special rights of the holders of a series of preferred
stock of the Bank; provided that if such amendment shall not adversely affect
all series of preferred stock of the Bank, such amendment need only be approved
by at least 66-2/3% of the holders of shares of all series of preferred stock
adversely affected thereby.
RIGHTS UPON LIQUIDATION
In the event of any voluntary or involuntary liquidation, dissolution
or winding up of the Bank, the holders of the Series A Preferred Shares at the
time outstanding will be entitled to receive or have funds set aside for such
payments out of assets of the Bank available for distribution to stockholders,
before any payment or distribution of assets is made to holders of Common Stock
or any other class of stock ranking junior to the Series A Preferred Shares upon
liquidation, liquidating distributions in the amount of $10.00 per share, plus
the accrued and unpaid dividends for the most recent quarter thereon, if any, to
the date of liquidation.
After receipt of payment of the full amount of the liquidating
distributions to which they are entitled, the holders of Series A Preferred
Shares will have no right or claim to any of the remaining assets of the Bank.
In the event that, upon any such voluntary or involuntary liquidation,
dissolution or winding up, the available assets of the Bank are insufficient to
pay the amount of the liquidation distributions on all outstanding Series A
Preferred Shares and the corresponding amounts payable on all shares of other
classes or series of capital stock of the Bank ranking on a parity with the
Series A Preferred Shares in the distribution of assets upon any liquidation,
dissolution or winding up of the affairs of the Bank, then the holders of the
Series A Preferred Shares and such other classes or series of capital stock
shall share ratably in any such distribution of assets in proportion to the full
liquidating distributions to which they would otherwise be respectively
entitled.
For such purposes, the consolidation or merger of the Bank with or into
any other entity or the sale, lease or conveyance of all or substantially all of
the property or business of the Bank, shall not be deemed to constitute
liquidation, dissolution or winding up of the Bank.
APPROVAL OF INDEPENDENT DIRECTORS
The Bank's Certificate of Designation establishing the Series A
Preferred Shares requires that, so long as any Series A Preferred Shares are
outstanding, certain actions by the Bank be approved by a majority of the
Independent Directors of the Bank. At any time that there are only two
Independent Directors, any action that requires the approval of a majority of
Independent Directors must be approved by both Independent Directors.
"Independent Director" means any director of the Bank who (i) is not a current
director, officer or employee of the Bank, of Franklin Finance
BP-60
<PAGE> 161
Corporation or of any affiliate of the Bank; and (ii) is not a person or persons
that, in the aggregate, own more than one percent of the Common Stock of the
Bank. In addition, any members of the Board of Directors of the Bank elected by
holders of preferred stock, including the Series A Preferred Shares, will be
deemed to be independent directors for purposes of approving actions requiring
the approval of a majority of the Independent Directors. The actions which
require the prior approval of a majority of the Independent Directors include:
(i) the issuance of a series of preferred stock on a
parity with the Series A Preferred Shares; and
(ii) the redemption of any shares of Common Stock.
In assessing the benefits to the Bank of any proposed action requiring their
consent, the Independent Directors shall take into account the interests of
holders of both the Common Stock and the preferred stock, including, without
limitation, the holders of the Series A Preferred Shares. In considering the
interests of the holders of the preferred stock, including without limitation
holders of the Series A Preferred Shares, the Independent Directors shall owe
the same duties which the Independent Directors owe to holders of Common Stock.
CERTAIN DEFINITIONS
"BIF" means the Bank Insurance Fund or any successor thereto.
"FDIC" means the Federal Deposit Insurance Corporation or any successor
thereto.
"FHLB" means any of the regional Federal Home Loan Banks.
"FRB" means the Federal Reserve Board or any successor thereto.
"OCC" means the Office of the Comptroller of the Currency or any
successor thereto.
"Person" means any individual, corporation, limited liability company,
partnership, joint venture, association, joint-stock company, trust,
unincorporated organization or government or any agency or political
subdivisions thereof.
"Regulatory Capital Requirements" means the minimum amount of capital
required to meet each of the industry-wide regulatory capital requirements
applicable to the Bank pursuant to 12 U.S.C. Section 1464(t) and 12 C.F.R.
Section 567 (and any amendment to either thereof) or any successor law or
regulation, or such higher amount of capital as the Bank, individually, is
required to maintain in order to meet any individual minimum capital standard
applicable to the Bank pursuant to 12 U.S.C. Section 1464(s) and 12 C.F.R.
Section 567.3 (and any amendment to either such Section) or any successor law or
regulation.
"SAIF" means the Savings Association Insurance Fund or any successor
thereto.
BP-61
<PAGE> 162
"Series A Preferred Shares" means the 1,800,000 Shares of the [___]%
Noncumulative Series A Preferred Shares of the Bank.
EXCHANGE
The Series A Preferred Shares are to be issued, if ever, in connection
with an exchange of the Preferred Capital Shares. The Preferred Capital Shares
are subject to an automatic exchange in whole and not in part, on a
share-for-share basis, into Series A Preferred Shares if the appropriate
regulatory agency directs in writing an exchange of the Preferred Capital Shares
for Series A Preferred Shares because (i) the Bank becomes "undercapitalized"
under prompt corrective action regulations established pursuant to FDICIA, (ii)
the Bank is placed into conservatorship or receivership or (iii) the appropriate
regulatory agency, in its sole discretion, anticipates the Bank's becoming
"undercapitalized" in the near term (an "Exchange Event"). The Bank has
registered with the OCC a total of 2,070,000 Series A Preferred Shares to cover
an Exchange Event, if necessary, of the 1,800,000 Preferred Capital Shares
offered by Franklin Finance Corporation and the 270,000 share over-allotment
option granted to the underwriters of the Preferred Capital Shares.
EXPERTS
The Consolidated Financial Statements of the Bank and subsidiary as of
December 31, 1996 and for the year ended December 31, 1996, have been audited by
Grant Thornton LLP, independent certified public accountants, as indicated in
their report with respect thereto and are included herein in reliance upon the
authority of said firm as experts in auditing and accounting. The Consolidated
Financial Statements of the Bank and subsidiary as of December 31, 1995, and for
each of the two years in the period ended December 31, 1995, have been audited
by Crowe, Chizek and Company LLP, independent certified public accountants, as
indicated in their report with respect thereto and are included herein in
reliance upon the authority of said firm as experts in auditing and accounting.
LEGAL MATTERS
The legality of the securities offered by this Prospectus has been
passed upon for the Bank by Silver, Freedman & Taff, L.L.P., Washington, D.C., a
partnership including professional corporations, and for the underwriters by
Honigman Miller Schwartz and Cohn, Detroit, Michigan.
BP-62
<PAGE> 163
FRANKLIN BANK, N.A.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Reports of Independent Certified Public Accountants....................................................... F-2
Consolidated Financial Statements for the Years Ended December 31, 1996, 1995 and 1994:
Consolidated Statements of Condition at December 31, 1996 and 1995........................................ F-4
Consolidated Statements of Income for the Years Ended
December 31, 1996, 1995 and 1994......................................................................... F-5
Consolidated Statements of Shareholder's Equity for the
Years Ended December 31, 1996, 1995 and 1994............................................................ F-6
Consolidated Statements of Cash Flows for the
Years Ended December 31, 1996, 1995 and 1994............................................................ F-7
Notes to Consolidated Financial Statements................................................................ F-8
Consolidated Financial Statements for the Quarterly Period Ended September 30, 1997:
Consolidated Statements of Condition at September 30, 1997................................................ F-28
Consolidated Statement of Operations for the Nine Months Ended
September 30, 1997 and 1996.............................................................................. F-29
Consolidated Statements of Cash Flows for the Nine
Months Ended September 30, 1997 and 1996................................................................. F-30
Notes to Consolidated Financial Statements................................................................ F-31
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................................................ F-35
</TABLE>
F-1
<PAGE> 164
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Shareholders
Franklin Bank, N.A.
We have audited the accompanying consolidated statements of financial condition
of Franklin Bank, N.A. as of December 31, 1996, and the related consolidated
statements of income, shareholders' equity, and cash flows for the year then
ended. These financial statements are the responsibility of the Bank's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
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 audit provides a reasonable basis for our opinion.
In our opinion, the 1996 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Franklin Bank,
N.A. as of December 31, 1996, and the consolidated results of its operations and
its consolidated cash flows for the year then ended in conformity with generally
accepted accounting principles.
Southfield, Michigan
January 31, 1997
F-2
<PAGE> 165
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Franklin Bank, N.A.
Southfield, Michigan
We have audited the accompanying consolidated statements of financial condition
of Franklin Bank, N.A. as of December 31, 1995, and the related consolidated
statements of income, shareholders' equity and cash flows for each of the two
years in the period ended December 31, 1995. These financial statements are the
responsibility of the Bank's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 Bank, N.A.
at December 31, 1995, and the results of its operations and its cash flows for
reach of the two years in the period ended December 31, 1995, in conformity with
generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Bank
changed its method of accounting for impaired loans in 1995 to conform to new
accounting guidance.
/s/ Crow, Chizek and Company LLP
--------------------------------
Crowe, Chizek and Company LLP
Grand Rapids, Michigan
March 22, 1996
F-3
<PAGE> 166
FRANKLIN BANK, N.A.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
At December 31,
--------------
1996 1995
---- ----
<S> <C> <C>
ASSETS
Cash and due from banks ............................................... $ 28,921,009 $ 30,885,733
Interest-earning deposits ............................................. 113,276 106,976
Time deposits with Federal Home Loan Bank ............................. 3,604,559 37,299,960
------------- -------------
Cash and cash equivalents ............................................. 32,638,844 68,292,669
Securities available for sale(3) ...................................... 49,343,125 52,408,622
Federal Home Loan Bank stock, at cost ................................. 5,153,200 4,486,100
Federal Reserve Bank stock, at cost ................................... 772,450 716,250
Loans ................................................................. 396,137,334 353,861,434
Allowance for loan losses ............................................. (3,199,549) (2,930,392)
------------- -------------
Net loans(2)(6)(12) ................................................... 392,937,785 350,931,042
Accrued interest receivable ........................................... 4,008,474 3,329,053
Real estate owned ..................................................... 1,371,569 --
Premises and equipment, net(8) ........................................ 5,129,246 4,487,427
Prepaid expenses and other assets(10) ................................. 4,438,155 2,485,787
------------- -------------
Total assets .......................................................... $ 495,792,848 $ 487,136,950
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits(4) ........................................................... $ 401,889,982 $ 399,866,440
Advances from Federal Home Loan Bank(6) ............................... 24,000,000 35,000,000
Repurchase agreements(6) .............................................. 29,612,500 10,275,000
Subordinated capital notes(9) ......................................... 7,475,000 7,475,000
Advance payments by borrowers for taxes and insurance ................. 172,502 278,339
Accrued interest payable .............................................. 689,523 851,048
Other liabilities ..................................................... 1,617,824 2,459,706
------------- -------------
Total liabilities ..................................................... 465,457,331 456,205,533
Commitments and contingencies(14) ..................................... -- --
Shareholders' Equity:(7)(9)(11)
Common stock - par value $1.00; authorized 6,000,000 shares, issued and
outstanding 3,315,545 and 3,307,082 shares at
December 31,1996 and 1995, respectively ............................. 3,315,545 3,307,082
Additional paid-in capital ............................................ 24,179,756 22,420,752
Unrealized gain on securities available for sale, net of tax
of $101,976 in 1996 and $502,708 in 1995 ............................ 197,956 975,846
Retained earnings ..................................................... 2,642,260 4,227,737
------------- -------------
Total shareholders' equity ............................................ 30,335,517 30,931,417
------------- -------------
Total liabilities and shareholders' equity ............................ $ 495,792,848 $ 487,136,950
============= =============
</TABLE>
See Notes to Consolidated Financial Statements.
F-4
<PAGE> 167
FRANKLIN BANK, N.A.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
INTEREST INCOME
Interest on loans ............................................ $35,492,621 $31,089,479 $25,162,754
Interest on securities ....................................... 3,111,971 4,392,861 3,124,457
Other interest and dividends ................................. 1,102,820 1,173,917 1,109,735
----------- ----------- -----------
Total interest income ........................................ 39,707,412 36,656,257 29,396,946
----------- ----------- -----------
INTEREST EXPENSE
Interest on deposits(5) ...................................... 16,161,791 15,843,347 12,469,196
Interest on other borrowings(6) .............................. 1,950,984 2,447,461 1,561,398
----------- ----------- -----------
Total interest expense ....................................... 18,112,775 18,290,808 14,030,594
----------- ----------- -----------
Net interest income .......................................... 21,594,637 18,365,449 15,366,352
Provision for loan losses(2) ................................. 2,409,614 1,051,191 220,000
----------- ----------- -----------
Net interest income after provision for loan losses .......... 19,185,023 17,314,258 15,146,352
OTHER INCOME
Deposit account service charges .............................. 2,199,882 1,638,823 1,326,954
Loan fees .................................................... 795,831 905,728 805,171
Net gain on sales of securities(3) ........................... 414,632 553,378 19,804
Net gain on sale of loans .................................... -- -- 592,048
Other ........................................................ 310,379 238,875 366,562
----------- ----------- -----------
Total other income ........................................... 3,720,724 3,336,804 3,110,539
----------- ----------- -----------
OTHER EXPENSES
Compensation and benefits .................................... 8,739,951 7,339,647 6,891,819
Occupancy and equipment ...................................... 2,530,034 1,844,198 1,507,985
Advertising .................................................. 1,049,785 662,735 865,855
Federal insurance premiums ................................... 3,116,341 909,713 795,253
Defaulted loan expense ....................................... 579,487 527,576 941,045
Communication expense ........................................ 591,034 452,525 431,042
Outside services ............................................. 1,936,540 1,544,960 1,218,102
Other ........................................................ 3,066,177 2,575,080 2,230,790
----------- ----------- -----------
Total other expenses ......................................... 21,609,349 15,856,434 14,881,891
----------- ----------- -----------
Income before provision for federal income taxes ............. 1,296,398 4,794,628 3,375,000
Provision for federal income taxes(10) ....................... 390,749 1,438,389 978,750
----------- ----------- -----------
Net income ................................................... $ 905,649 $ 3,356,239 $ 2,396,250
=========== =========== ===========
Preferred stock dividend ..................................... -- --- 396,830
----------- ----------- -----------
Net income applicable to common stock after
preferred stock dividend ................................... $ 905,649 $ 3,356,239 $ 1,999,420
=========== =========== ===========
INCOME PER COMMON SHARE
Preliminary ................................................ $ 0.27 $ 1.00 $ 0.80
Fully diluted .............................................. $ 0.27 $ 0.99 $ 0.74
</TABLE>
See Notes to Consolidated Financial Statements.
F-5
<PAGE> 168
FRANKLIN BANK, N.A.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Unrealized
Preferred Common Additional Gain/(Loss) Retained
Stock Stock Paid-in Capital on Securities Earnings
----- ----- --------------- ------------- --------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1994 ................................. $ 9,080,000 $1,450,208 $11,257,301 $ 65,481 $ 3,124,416
Net income ................................................. -- -- -- -- 2,396,250
Cash dividends:
Preferred ($0.90 per share) .............................. -- -- -- -- (396,830)
Common ($0.23 per share) ................................. -- -- -- -- (571,383)
Common stock dividend ...................................... -- 142,279 1,031,522 -- (1,176,281)
Common stock dividend on preferred stock converted to
common stock ............................................. -- 11,509 92,048 -- (103,557)
Conversion of preferred stock into common .................. (8,427,687) 1,135,859 7,291,828 -- --
Redemption and payment of fractional shares on conversion
of preferred stock into common ........................... (652,313) -- -- -- (24,278)
Exercise of options ........................................ -- 44,522 252,595 -- --
Exercise of warrants ....................................... -- 209,494 955,243 -- --
Change in unrealized gain (loss) on securities available for
sale, net of tax ......................................... -- -- -- (1,253,447) --
----------- ---------- ----------- ----------- -----------
Balance at December 31, 1994 ............................... -- 2,993,871 20,880,537 (1,187,966) 3,248,337
Net income ................................................. -- -- -- -- 3,356,239
Cash dividends on common stock ($0.17 per share) ........... -- -- -- -- (539,284)
Common stock dividend ...................................... -- 149,641 1,683,461 -- (1,837,555)
Exercise of options ........................................ -- 6,090 14,234 -- --
Change in unrealized gain (loss) on securities available for
sale, net of tax ......................................... -- -- -- 2,163,812 --
----------- ---------- ----------- ----------- -----------
Balance at December 31, 1995 ............................... -- 3,149,602 22,578,232 975,846 4,227,737
Net income ................................................. -- -- -- -- 905,649
Cash dividends on common stock ($0.24 per share) ........... -- -- -- -- (754,274)
Common stock dividends ..................................... -- 157,643 1,576,430 -- (1,736,852)
Exercise of options ........................................ -- 8,300 25,094 -- --
Change in unrealized gain (loss) on securities available
for sale, net of tax ..................................... -- -- -- (777,890) --
----------- ---------- ----------- ----------- -----------
Balance at December 31, 1996 ............................... $ -- $3,315,545 $24,179,756 $ 197,956 $ 2,642,260
=========== ========== =========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
Total
Shareholders'
Equity
------
<S> <C>
Balance at January 1, 1994 ................................. $ 24,977,406
Net income ................................................. 2,396,250
Cash dividends:
Preferred ($0.90 per share) .............................. (396,830)
Common ($0.23 per share) ................................. (571,383)
Common stock dividend ...................................... (2,480)
Common stock dividend on preferred stock converted to
common stock ............................................. --
Conversion of preferred stock into common .................. --
Redemption and payment of fractional shares on conversion
of preferred stock into common ........................... (676,591)
Exercise of options ........................................ 297,117
Exercise of warrants ....................................... 1,164,737
Change in unrealized gain (loss) on securities available for
sale, net of tax ......................................... (1,253,447)
------------
Balance at December 31, 1994 ............................... 25,934,779
Net income ................................................. 3,356,239
Cash dividends on common stock ($0.17 per share) ........... (539,284)
Common stock dividend ...................................... (4,453)
Exercise of options ........................................ 20,324
Change in unrealized gain (loss) on securities available for
sale, net of tax ......................................... 2,163,812
------------
Balance at December 31, 1995 ............................... 30,931,417
Net income ................................................. 905,649
Cash dividends on common stock ($0.24 per share) ........... (754,274)
Common stock dividends ..................................... (2,779)
Exercise of options ........................................ 33,394
Change in unrealized gain (loss) on securities available
for sale, net of tax ..................................... (777,890)
------------
Balance at December 31, 1996 ............................... $ 30,335,517
============
</TABLE>
See Notes to Consolidated Financial Statements.
F-6
<PAGE> 169
FRANKLIN BANK, N.A.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net Income ............................................................................ $ 905,649 $ 3,356,239 $ 2,396,250
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Provision for loan losses ......................................................... 2,409,614 1,051,191 220,000
Depreciation and amortization ..................................................... 1,140,948 702,963 587,653
Gain on sale of assets ............................................................ (560,315) (553,378) (611,852)
Net deferral of loan origination fees ............................................. 18,309 109,379 385,294
(Accretion) amortization on securities ............................................ 368,388 -- --
(Increase) in accrued interest receivable ......................................... (679,421) (191,580) (610,839)
(Increase)/decrease prepaid expenses and other assets ............................. (1,558,625) 737,389 (478,471)
Increase/(decrease) accrued interest payable, deferred taxes and other liabilities (1,006,186) (5,626,216) 4,576,837
------------ ------------ ------------
Total adjustments ..................................................................... 132,712 (3,770,252) 4,068,622
------------ ------------ ------------
Net cash provided by (used in) operating activities ................................... 1,038,361 (414,013) 6,464,872
INVESTING ACTIVITIES
Purchases of securities held to maturity .............................................. -- -- (41,501,702)
Proceeds from maturities and paydowns of securities held to maturity .................. -- -- 973,222
Purchases of securities available for sale ............................................ (26,393,344) (4,552,926) (22,314,465)
Proceeds from sales of securities available for sale .................................. 25,908,461 19,569,371 13,953,125
Proceeds from maturities and paydowns of securities available for sale ................ 2,418,003 4,003,278 6,743,113
Proceeds from the sale of loans ....................................................... -- -- 16,030,306
Net (increase) in loans ............................................................... (45,954,459) (51,673,101) (10,793,746)
Proceeds from the sale of real estate owned ........................................... 293,906 553,588 4,311,011
Capital expenditures .................................................................. (1,775,778) (1,077,659) (837,842)
Purchase of Federal Home Loan Bank stock .............................................. (667,100) (962,500) (60,100)
Purchase of Federal Reserve Bank stock ................................................ (56,200) (59,150) (24,050)
------------ ------------ ------------
Net cash used in investing activities ................................................. (46,226,511) (34,199,099) (33,521,128)
FINANCING ACTIVITIES
Net increase in deposits .............................................................. 2,023,542 46,551,830 20,634,413
Increase/(decrease) in FHLB advances .................................................. (11,000,000) 20,000,000 (5,300,000)
Proceeds from repayment of repurchase agreements ...................................... 19,337,500 (6,292,500) 16,567,500
Prepayments of subordinated capital notes ............................................. -- (5,000) (10,000)
Net (decrease) in advance payments for taxes and insurance ............................ (105,837) (243,116) (222,485)
Redemption and payment of fractional shares on preferred stock conversion ............. -- -- (676,591)
Cash dividends on common stock ........................................................ (754,274) (712,861) (480,805)
Exercise of common stock options and warrants ......................................... 33,394 20,324 1,461,854
Payment of preferred stock dividends .............................................. -- -- (396,830)
----------- ----------- ------------
Net cash from financing activities ................................................ 9,534,325 59,318,677 31,577,056
------------ ----------- ------------
Net increase/(decrease) in cash and cash equivalents .............................. (35,653,825) 24,705,565 4,520,800
------------ ----------- ------------
Beginning cash and cash equivalents ............................................... 68,292,669 43,587,104 39,066,304
------------ ----------- ------------
Ending cash and cash equivalents .................................................. $ 32,638,844 $68,292,669 $ 43,587,104
============ =========== ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest ........................................................................ $ 18,273,852 $18,137,953 $ 13,944,430
Federal income taxes ............................................................ 969,057 1,562,291 650,000
Non-cash investing and financing activities:
Transfer of securities from held to maturity to available for sale(3) ........... -- 43,451,341 --
Transfer from loans to real estate owned (net) .................................. 1,519,792 -- 2,979,675
Transfer of loans from held for sale to held to maturity ........................ -- -- 3,497,022
</TABLE>
See Notes to Consolidated Financial Statements.
F-7
<PAGE> 170
FRANKLIN BANK, N.A.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION - Franklin Bank, N.A. ("the Bank") 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 three branches along with its main
office branch in the communities of Southfield, Birmingham, and Grosse Pointe
Woods, 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 Franklin Bank, N.A. and its wholly owned subsidiary.
Significant intercompany balances and transactions have been eliminated.
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, fair value of certain financial instruments and the
determination and carrying value of impaired loans.
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
equity, net of income taxes. 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, 1996 or 1995.
F-8
<PAGE> 171
FRANKLIN BANK, N.A.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Realized gains or losses are determined based on the amortized cost of
the specific security sold. Interest and dividend income adjusted by
amortization of purchase premium or discount, are included in earnings.
LOANS - 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.
The allowance for loan losses is maintained at a level believed
adequate by Management to absorb potential losses in the loan portfolio.
Management's determination of the adequacy of the allowance is based on an
evaluation of the portfolio, past loan loss experience, current economic
conditions, volume, amount and composition of the loan portfolio, and other
factors. The allowance is increased by provisions for loan losses charged to
income and reduced by net charge-offs.
The Bank adopted Financial Accounting Standards Board Statement of
Financial Accounting Standards "SFAS" No. 114, "Accounting by Creditors for
Impairment of a Loan" (as amended by "SFAS" No. 118) on January 1, 1995. Under
this standard, the carrying value of loans considered impaired is reduced to the
present value of expected future cash flows or, as a practical expedient, to the
fair value of the collateral by allocating a portion of the allowance for loan
losses to such loans. If these allocations cause the allowance for loan losses
to require increase, such increase is reported in the provision for loan losses.
There was no increase in the allowance for loan losses resulting from the
adoption of "SFAS" No. 114 at January 1, 1995.
A loan is considered impaired 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.
Smaller balance homogeneous loans are collectively evaluated for impairment.
Impaired loans, or portions thereof, are charged off when deemed uncollectible.
Interest on impaired loans is accrued and recognized as income based
upon the principal amount outstanding. 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 other cash payments are reported as reductions in carrying value. 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.
F-9
<PAGE> 172
FRANKLIN BANK, N.A.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.)
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.
REAL ESTATE OWNED - Real estate properties acquired through, or in
lieu of, loan foreclosure are initially recorded at the lesser of original
recorded investment or fair value minus 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 (1) new cost basis or (2) fair value minus estimated costs to sell.
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.
STATEMENTS 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.
DIVIDENDS - The payment of dividends on the Bank's common shares (if
any) is limited by applicable law and regulations promulgated by the Office of
the Comptroller of the Currency ("OCC"). The indenture relating to the Bank's
subordinated capital notes also contains certain limitations on the payment of
dividends in the event of default.
INCOME TAXES - The Bank 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.
STOCK DIVIDENDS - The Bank accounts for stock dividends by capitalizing
retained earnings in an amount equal to the fair value of the additional shares
issued. All per share amounts are retroactively adjusted for stock dividends.
F-10
<PAGE> 173
FRANKLIN BANK, N.A.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.)
RECLASSIFICATIONS - Certain reclassifications have been made in the
consolidated financial statements to conform to the 1996 presentation.
ISSUED BUT NOT YET ADOPTED ACCOUNTING STANDARDS - The Financial
Accounting Standards Board has issued Statement of Financial Accounting
Standards "SFAS" No. 125, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities", as amended by "SFAS" No. 127. The
Statement provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities based on
consistent application of a financial-components approach that focuses on
control. The Statement is effective for transfers and servicing of financial
assets and extinguishments of liabilities occurring after December 31, 1996,
except for certain transactions such as repurchase agreements and securities
lending, which are effective after December 31, 1997. This pronouncement is to
be applied prospectively. Management does not expect the Statement to have a
significant impact on the consolidated financial condition or results of
operations of the Bank.
2. LOANS
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
<S> <C> <C>
Real Estate
Single family mortgage ......................................................... $ 39,323,446 $ 38,317,145
Home equity .................................................................... 8,689,435 7,489,674
Commercial mortgage ............................................................ 139,499,287 152,868,239
Construction ................................................................... 33,644,580 31,034,492
Lease financing .................................................................. 97,518,144 62,270,137
Commercial ....................................................................... 82,479,849 69,859,366
Land contracts ................................................................... 18,623 24,412
Consumer ......................................................................... 18,687,898 12,421,817
------------ ------------
Total loans ...................................................................... 419,861,262 374,285,282
Less
Undisbursed funds .............................................................. 8,837,330 10,597,770
Amounts due on underlying mortgages on commercial real
estate loans ................................................................ 363,591 479,423
Unamortized discounts on purchased loans ....................................... 156,172 139,746
Unamortized discounts on lease financing ....................................... 14,337,932 9,196,317
Unamortized net loan expenses .................................................. 28,903 10,592
------------ ------------
Loans ............................................................................ 396,137,334 353,861,434
Allowance for loan losses ........................................................ 3,199,549 2,930,392
------------ ------------
Net loans ........................................................................ $392,937,785 $350,931,042
============ ============
</TABLE>
F-11
<PAGE> 174
FRANKLIN BANK, N.A.
2. LOANS (CONT.)
ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Balance at beginning of period .......................... $2,930,392 $3,452,583 $3,794,661
Provision for loan losses ............................... 2,409,614 1,051,191 220,000
CHARGE-OFFS
Commercial .............................................. 953,199 217,471 118,997
Commercial mortgage ..................................... 42,075 172,078 --
Residential ............................................. 9,293 -- --
Consumer ................................................ 552,937 243,362 222,648
Lease financing ......................................... 876,513 1,125,961 438,329
---------- ---------- ----------
Total charge-offs ....................................... 2,434,017 1,758,872 779,974
---------- ---------- ----------
RECOVERIES
Commercial .............................................. 59,895 37,095 44,699
Commercial mortgage ..................................... 9,105 16,900 143,300
Residential ............................................. -- 1,000 700
Consumer ................................................ 62,207 110,470 26,870
Lease financing ......................................... 162,353 20,025 2,327
---------- ---------- ----------
Total recoveries ........................................ 293,560 185,490 217,896
---------- ---------- ----------
Net charge-offs ......................................... 2,140,457 1,573,382 562,078
---------- ---------- ----------
Balance at end of period ................................ $3,199,549 $2,930,392 $3,452,583
========== ========== ==========
</TABLE>
At December 31, 1996 and 1995, the balance of impaired loans was
$6,818,048 and $9,347,870, respectively. Of this amount, $1,789,767 and
$7,929,182 in impaired loans required no allowance for loan loss allocation for
the years ended December 31, 1996 and 1995, respectively. At December 31, 1996
and 1995 the remaining impaired loans of $5,028,281 and $1,418,688 had
$1,104,372 and $400,320 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 1996 and 1995 was $7,224,030
and $5,085,528, respectively. Interest income recognized on impaired loans
during 1996 and 1995 was $190,315 and $97,289, respectively. All of the interest
income was recognized on a cash basis.
Non-accrual loans at December 31, 1996 and 1995, which amounted to
$2,203,598 and $9,347,870, respectively, are loans which were on non-accrual
status prior to the adoption of "SFAS" No. 114, "Accounting by Creditors for
Impairment of a Loan."
At December 31, 1996 and 1995, the Bank serviced whole loans and
participations sold amounting to approximately $7,899,253 and $12,575,000,
respectively.
F-12
<PAGE> 175
FRANKLIN BANK, N.A.
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.
3. DEBT AND EQUITY SECURITIES
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
---- ----- ------ ----------
<S> <C> <C> <C> <C>
SECURITIES AVAILABLE FOR SALE
December 31, 1996:
Mortgage-backed securities ............................ $11,344,468 $ 82,242 $21,452 $11,405,258
U.S. government and agency securities ................. 35,052,990 169,271 7,948 35,214,313
Municipal securities .................................. 2,645,737 79,507 1,690 2,723,554
----------- ---------- ------- -----------
Total ................................................... $49,043,195 $ 331,020 $31,090 $49,343,125
=========== ========== ======= ===========
December 31, 1995:
Mortgage-backed securities ............................ $15,228,752 $ 80,095 $29,369 $15,279,478
U.S. government and agency securities ................. 32,642,392 1,328,923 -- 33,971,315
Municipal securities .................................. 3,058,926 99,583 680 3,157,829
----------- ---------- ------- -----------
Total ................................................... $50,930,070 $1,508,601 $30,049 $52,408,622
=========== ========== ======= ===========
</TABLE>
Gross realized gains, losses and proceeds on sales of securities available for
sale were:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Gross realized gains on U.S. government and agency
securities.......................................................... $ 401,029 $ 620,042 $ 75,995
Gross realized gains on mortgage-backed securities.................... 10,525 --- ---
Gross realized gains on municipal securities.......................... 3,075 --- ---
Gross realized losses on U.S. government and agency
securities.......................................................... --- 66,664 56,191
Gross proceeds from the sale of available for sale
securities.......................................................... 25,908,461 19,569,371 13,953,125
</TABLE>
The scheduled maturities of available for sale securities at December 31, 1996
were as follows:
<TABLE>
<CAPTION>
Amortized
Cost Fair Value
---- ----------
<S> <C> <C>
Mortgage-backed securities ..................................................... $11,344,468 $11,405,258
U.S. government and agency securities due after one
through five years ........................................................... 35,052,990 35,214,313
Municipal bonds due after five through ten years ............................... 1,969,455 2,041,390
Municipal bonds due after 10 through 15 years .................................. 676,282 682,164
----------- -----------
Total .......................................................................... $49,043,195 $49,343,125
=========== ===========
</TABLE>
Pledged securities carried at fair value at December 31, 1996 equaled
$46,619,570.
F-13
<PAGE> 176
FRANKLIN BANK, N.A.
3. DEBT AND EQUITY SECURITIES (CONT.)
In accordance with the FASB Special Report, A Guide to Implementation of
Statement No. 115 on Accounting for Certain Investments in Debt and Equity
Securities, securities held to maturity with an amortized cost of $41,772,215
and a fair value of $43,451,341, were transferred to the available for sale
classification on December 12, 1995. The transfer increased shareholders' equity
by $1,108,223 , which is net of the related deferred tax asset of $570,903. The
classification was made to provide greater flexibility in managing liquidity and
interest rate risk.
4. DEPOSITS
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
<S> <C> <C>
Business checking ........................................................ $106,976,511 $ 90,640,821
Personal checking ........................................................ 5,800,735 3,670,555
Statement savings ........................................................ 344,106 403,012
Variable-rate accounts:
Money funds ............................................................ 94,824,064 79,700,272
Money market ........................................................... 45,385,107 41,094,111
Negotiable order of withdrawal accounts .................................. 5,876,495 5,970,920
Fixed rate certificates .................................................. 142,682,964 178,386,749
------------ ------------
Total .................................................................... $401,889,982 $399,866,440
============ ============
</TABLE>
Time deposits issued in denominations of $100,000 or more at December
31, 1996 and 1995 were $77,348,778 and $97,558,493, respectively.
Certificate accounts at December 31, 1996 mature as follows:
<TABLE>
<S> <C>
1997.................................................................. $122,057,420
1998.................................................................. 10,906,559
1999.................................................................. 3,369,541
2000.................................................................. 2,931,546
2001.................................................................. 2,747,948
2002 and thereafter................................................... 669,950
------------
Total................................................................. $142,682,964
============
</TABLE>
F-14
<PAGE> 177
FRANKLIN BANK, N.A.
5. INTEREST EXPENSE ON DEPOSITS
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Statement savings................................. $ 9,027 $ 10,034 $ 12,846
Variable-rate accounts:
Money funds..................................... 3,954,804 3,252,376 2,390,371
Money markets................................... 1,576,301 1,442,733 1,191,175
Negotiable order of withdrawal accounts........... 49,561 48,615 51,639
Fixed-rate certificates........................... 10,572,098 11,089,589 8,823,165
------------ ------------ ------------
Total............................................. $ 16,161,791 $ 15,843,347 $ 12,469,196
============ ============ ===========
</TABLE>
6. OTHER BORROWED FUNDS
At December 31, 1996, FHLB advances incurred interest and were
repayable as follows:
<TABLE>
<CAPTION>
Date of Maturity Interest Rate Amount
- ---------------- ------------- ------
<S> <C> <C>
May 14, 1997.................................................. 5.62% $10,000,000
January 21, 1997.............................................. 5.62 7,000,000
January 30, 1997.............................................. 5.62 7,000,000
---- -----------
Total......................................................... 5.62% $24,000,000
==== ===========
</TABLE>
At December 31, 1996, repurchase agreements incurred interest and were repayable
as follows:
<TABLE>
<CAPTION>
Date of Maturity Interest Rate Amount
- ---------------- ------------- ------
<S> <C> <C>
January 7, 1997............................................... 5.90% $ 5,187,500
January 7, 1997............................................... 5.90 7,385,000
January 7, 1997............................................... 5.90 8,690,000
January 7, 1997............................................... 5.92 4,220,000
January 7, 1997............................................... 5.90 4,130,000
---- -----------
Total......................................................... 5.90% $29,612,500
==== ===========
</TABLE>
At December 31, 1995, FHLB advances incurred interest and were
repayable as follows:
<TABLE>
<CAPTION>
Date of Maturity Interest Rate Amount
- ---------------- ------------- ------
<S> <C> <C>
January 20, 1996 ................................................... 5.96% $30,000,000
January 28, 1996 ................................................... 5.79 5,000,000
---- -----------
Total .............................................................. 5.94% $35,000,000
==== ===========
</TABLE>
F-15
<PAGE> 178
FRANKLIN BANK, N.A.
6. OTHER BORROWED FUNDS (CONT.)
At December 31, 1995, repurchase agreements incurred interest and were
repayable as follows:
<TABLE>
<S> <C> <C>
Date of Maturity Interest Rate Amount
January 4, 1996 .................................................... 5.81% $ 5,175,000
January 4, 1996 .................................................... 5.94 5,100,000
---- -----------
Total .............................................................. 5.88% $10,275,000
==== ===========
</TABLE>
FHLB advances are collateralized by the Bank's first mortgage loans
under a specific lien arrangement and by the designated securities. The maximum
borrowings allowed under this arrangement are approximately $46 million at
December 31, 1996. At December 31, 1996, first mortgage loans pledged as
collateral totaled approximately $39 million and securities pledged totaled
approximately $15 million. At December 31, 1996 there was approximately $29
million of pledged securities as collateral for the outstanding repurchase
agreements. These securities were held in safekeeping by the originators of the
repurchase agreements.
The following table sets forth the maximum month-end balance, average
daily balance and weighted average interest rate of FHLB advances for the
periods indicated:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Maximum balance ......................................... $36,000,000 $35,000,000 $31,600,000
Average balance ......................................... 6,512,372 11,805,869 16,145,000
Weighted average interest rate .......................... 5.84% 6.32% 4.48%
</TABLE>
The following table sets forth the maximum month-end balance, average
daily balance and weighted average interest rate of repurchase agreements for
the periods indicated:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Maximum balance................................ $29,612,500 $24,760,000 $16,567,500
Average balance................................ 16,129,323 16,689,536 2,710,323
Weighted average interest rate................. 5.44% 6.04% 5.28%
</TABLE>
F-16
<PAGE> 179
FRANKLIN BANK, N.A.
7. REGULATORY MATTERS
The Bank is 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 Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classifications are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set forth in
the table below) 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). Management believes, as of December 31, 1996, that the Bank
meets its capital adequacy requirements to which it is subject.
As of December 31, 1996, 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 the Bank 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.
<TABLE>
<CAPTION>
Well Capitalized
For Capital Under Prompt
Actual Adequacy Purposes Corrective Provisions
------ ----------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1996:
Total capital (to risk weighted assets) ............ $40,330,549 10.04% $32,147,360 8.00% $40,184,200 10.00%
Tier 1 capital (to risk weighted assets) ........... 29,206,000 7.27 16,073,680 4.00 24,110,520 6.00
Tier 1 capital (to average assets) ................. 29,206,000 5.99 19,514,000 4.00 24,392,500 5.00
As of December 31, 1995:
Total capital (to risk weighted assets) ............ 40,272,771 10.59 30,421,280 8.00 38,026,600 10.00
Tier 1 capital (to risk weighted assets) ........... 29,867,379 7.85 15,210,640 4.00 22,815,960 6.00
Tier 1 capital (to average assets) ................. 29,867,379 6.58 18,150,459 4.00 22,688,050 5.00
</TABLE>
F-17
<PAGE> 180
FRANKLIN BANK, N.A.
8. PREMISES AND EQUIPMENT
<TABLE>
<CAPTION>
At December 31,
---------------
1996 1995
---- ----
<S> <C> <C>
Land and land improvements ................................................. $ 200,000 $ 200,000
Building ................................................................... 583,337 583,337
Furniture, fixtures and equipment .......................................... 5,374,302 4,063,372
Leasehold improvements ..................................................... 1,962,706 1,795,090
----------- -----------
Total ...................................................................... 8,120,345 6,641,799
Less accumulated depreciated and amortization .............................. (2,991,099) (2,154,372)
----------- -----------
Premises and equipment, net ................................................ $ 5,129,246 $ 4,487,427
=========== ===========
</TABLE>
9. SUBORDINATED NOTES AND WARRANTS
At December 31, 1996 and 1995, the Bank has outstanding $7,475,000 of
8.50% subordinated capital notes due January 15, 2003 (the "Notes").
The Notes, including principal and interest payments thereon, are
subordinated at all times to the prior payment of senior indebtedness due and
owing, including deposit accounts. The Notes may be redeemed at the Bank's
option on or after January 15, 1996, subject to certain conditions. The Notes
are considered regulatory capital for purposes of determining risk-based
capital.
10. FEDERAL INCOME TAXES
The following is a summary of the provision for federal income taxes.
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Current ..................................... $342,567 $1,396,641 $ 1,031,973
Deferred .................................... 48,182 41,748 (53,223)
-------- ---------- -----------
Total ....................................... $390,749 $1,438,389 $ 978,750
======== ========== ===========
</TABLE>
A reconciliation of the statutory rate to the effective rate is shown
below:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Provision computed at statutory rate ...................... $ 440,775 $ 1,630,174 $ 1,147,500
Tax exempt interest ....................................... (103,366) (104,345) (77,402)
Other, net ................................................ 53,340 (87,440) (91,348)
--------- ----------- -----------
Total ..................................................... $ 390,749 $ 1,438,389 $ 978,750
========= =========== ===========
</TABLE>
F-18
<PAGE> 181
10. FEDERAL INCOME TAXES (CONT.)
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and deferred tax liabilities are presented
below:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995
---- ----
<S> <C> <C>
DEFERRED TAX ASSETS
Allowance for loan losses.......................... $303,934 $ 212,420
Nonaccrual loan interest........................... 97,960 199,989
Net deferred loan fees............................. 9,827 3,602
Other.............................................. 23,257 36,131
---------- ----------
Total deferred tax assets............................ 434,978 452,142
DEFERRED TAX LIABILITIES
Premises and equipment............................. 218,873 197,922
Unrealized gain on securities...................... 101,976 502,708
Other.............................................. 33,726 23,659
---------- ----------
Total deferred tax liabilities....................... 354,575 724,289
---------- ----------
Net deferred tax assets/(liabilities)................ $ 80,403 $ (272,147)
========== ==========
</TABLE>
11. STOCK OPTIONS AND EMPLOYEE STOCK OWNERSHIP PLAN
In 1994, shareholders approved the adoption of two separate stock
option plans for certain key executives and non-employee directors of the Bank.
Under the Key Executive Plan, up to 140,000 common shares may be
granted and up to 50,000 common shares under the Director's Plan. 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.
The Plans are administered by Committees selected by the Board of
Directors. 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 (not
to exceed 10 years from the date of grant), the date on which each option shall
be granted and the other relevant provisions of each option agreement.
F-19
<PAGE> 182
FRANKLIN BANK, N.A.
11. STOCK OPTIONS AND EMPLOYEE STOCK OWNERSHIP PLAN (CONT.)
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 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
Statement allows companies to continue measuring compensation cost for such
plans using accounting guidance in place prior to SFAS No. 123. 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. Additionally pro-forma
disclosures for awards granted in 1995 are to be presented for comparative
purposes.
The Bank has not adopted the fair value accounting provisions of SFAS
No. 123 and will continue to apply its current method of accounting.
Accordingly, SFAS No. 123 has no impact on the Bank's consolidated financial
position or results of operation.
The Bank accounts for the stock option plans under APB Opinion No. 25,
"Accounting for Stock Issued to Employees." No compensation costs have been
recognized for the plans. Had compensation cost for the plans been determined
based on the fair value of the options at the grant dates consistent with the
method of SFAS No. 123, the Bank's net income and income per share would have
been as follows for the years ended December 31:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Net income
As reported ........................................................ $ 905,649 $ 3,356,239
Pro forma .......................................................... 948,526 3,142,341
Primary income per share
As reported ........................................................ $ 0.27 $ 1.00
Pro forma .......................................................... 0.28 0.94
Fully diluted income per share
As reported ........................................................ $ 0.27 $ 0.99
Pro forma .......................................................... 0.28 0.93
</TABLE>
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 1996 and 1995, respectively:
dividend yield of 1.94 percent for each year; expected volatility of 37.57 and
39.52 percent; risk-free interest rates of 6.56 and 5.90 percent; and expected
lives of 10 years.
The Bank also has options outstanding under previous plans. The
weighted-average remaining contractual life of shares outstanding at December
31, 1996 is 7.2 years.
F-20
<PAGE> 183
FRANKLIN BANK, N.A.
11. STOCK OPTIONS AND EMPLOYEE STOCK OWNERSHIP PLAN (CONT.)
The following table summarizes outstanding stock options by plan at
December 31, 1996. All information presented in this footnote with respect to
stock options has been adjusted for the effects of all stock dividends.
<TABLE>
<CAPTION>
Exercise Price Per Share
------------------------
Number of Weighted
Shares Range Average
------ ----- -------
<S> <C> <C> <C>
Key executives' 1986 plan....................... 27,410 $ 2.03-9.22 $3.39
Director's 1986 plan............................ 39,003 3.08-9.22 7.15
Key executives' 1994 plan....................... 151,019 8.55-11.74 9.43
Directors' 1994 plan............................ 22,587 7.34-7.71 7.52
-------- ------------- ------
Balance at December 31, 1996.................... 240,019 $2.30-11.74 $8.19
======= =========== =====
</TABLE>
The following is a summary of stock option activity for each of the
three years in the period ended December 31, 1996.
<TABLE>
<CAPTION>
Weighted
Average Price Per Number of
Exercise Price Share Options
-------------- ----- -------
<S> <C> <C> <C>
Outstanding - January 1, 1994.................... $ 5.33 $ 2.03-9.22 136,590
New plans........................................ 8.44 7.34-8.55 127,331
Exercised in 1994................................ 5.78 2.30-5.96 (51,550)
Expired/cancelled in 1994........................ 5.96 5.96 (2,261)
------ ------------ --------
Outstanding - December 31, 1994.................. 7.46 2.30-9.22 210,110
Additions of options 1994 executives' plan....... 11.74 11.74 44,100
Addition of options 1994 directors' plan......... 7.71 7.71 11,018
Exercised in 1995................................ 3.02 2.30-3.08 (6,715)
------ ------------ --------
Outstanding - December 31, 1995.................. 8.13 2.30-11.74 258,513
Exercised in 1996................................ 3.83 2.30-9.22 (8,715)
Cancelled in 1996................................ 7.81 2.30-11.74 (9,779)
------ ------------ --------
Outstanding - December 31, 1996.................. $ 8.19 $ 2.30-11.74 240,019
====== ============ ========
</TABLE>
The weighted average fair value of options granted in 1995 was $10.93.
Of the 240,019 options outstanding at December 31, 1996, options for
169,285 shares were exercisable, at a weighted average exercise price of $7.86.
The Bank also has an Employee Stock Ownership Plan ("ESOP").
Contributions to the ESOP may be invested in either common or preferred stock of
the Bank, purchased in the open market. For the years ended December 31, 1996,
1995 and 1994, contributions of $122,200, $200,200 and $150,500, respectively,
were made to the ESOP. The Bank is not committed to predetermined ESOP
contributions. Any future contributions to the ESOP, as recommended by the ESOP
Committee, must be approved by the Board of Directors.
F-21
<PAGE> 184
FRANKLIN BANK, N.A.
12. TRANSACTIONS WITH RELATED PARTIES
The Bank has engaged two advertising agencies each partially-owned
separately by two members of the Board of Directors. The Bank paid $349,230,
$145,072 and $204,212 for the years ended December 31, 1996, 1995 and 1994,
respectively.
Loan activity to officers and their associates is summarized as
follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Balance, beginning of year ....................................... $619,104 $691,413 $684,006
Additions - new loans ............................................ 48,692 68,993 178,698
Less - principal payments and loans sold ......................... 443,714 141,302 171,291
-------- -------- --------
Balance, end of year ............................................. $224,082 $619,104 $691,413
======== ======== ========
</TABLE>
As of December 31, 1996, and 1995 there were no loans outstanding to
Directors of the Bank or their associates. Also effective March 1, 1995 all
employee checking accounts moved to other banks and no new loans were made to
any employee after this date with the exception of draws on existing home equity
lines of credit.
F-22
<PAGE> 185
FRANKLIN BANK, N.A.
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosures 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
fair value amounts have been determined by the Bank using available market
information and appropriate valuation methodologies. 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 Bank 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.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
------------------------ -------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
-------- ---------- -------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents ... $ 32,639 $ 32,639 $ 68,293 $ 68,293
Securities available for sale 49,343 49,343 52,409 52,409
Net loans ................... 392,938 391,972 350,931 352,161
Accrued interest receivable . 4,008 4,008 3,329 3,329
FHLB and FRB stock .......... 5,926 5,926 5,202 5,202
Excess servicing ............ 40 40 47 47
LIABILITIES
Demand deposits ............. 259,207 259,207 221,480 221,480
Time deposits ............... 142,683 143,453 178,387 179,522
Short term debt ............. 53,613 53,613 45,275 45,275
Long term debt .............. 7,475 8,434 7,475 7,802
Accrued interest payable .... 690 690 851 851
</TABLE>
Fair values were determined using the following assumptions:
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.
NET 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.
F-23
<PAGE> 186
FRANKLIN BANK, N.A.
13. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONT.)
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.
LONG-TERM DEBT - Rates currently available to the Bank for debt with
similar terms and remaining maturities are used to estimate fair value. For that
debt which has repriced within the last six months, its fair market value would
approximate its carrying value.
SHORT-TERM DEBT - The carrying value of the short-term debt
approximates its fair value.
14. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF CREDIT RISK
At December 31, 1996, 1995 and 1994, the Bank had outstanding loan
commitments for loans that have either not been accepted by the borrower or not
closed of approximately $3.3 million, $6.1 million and $7.5 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, construction and home equity
loans of approximately $40.7 million, $36.0 million and $15.2 million at
December 31, 1996, 1995 and 1994, respectively. The Bank had commitments to fund
construction loans of approximately $9.4 million, $12.1 million and $6.5 million
at December 31, 1996, 1995 and 1994, respectively. The Bank had commitments to
fund home equity loans of approximately $12.2 million, $13.6 million and $15.8
million at December 31, 1996, 1995 and 1994, 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-24
<PAGE> 187
FRANKLIN BANK, N.A.
14. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF CREDIT RISK
(CONT.)
The Bank leases three of its offices from nonaffiliated entities for
its headquarters in Southfield and two branch offices in Birmingham and
Southfield. Minimum rents under all non-cancelable leases are summarized as
follows:
<TABLE>
<CAPTION>
At
December 31, 1996
-----------------
<S> <C>
1997...................................................... $ 790,081
1998...................................................... 782,328
1999...................................................... 753,828
2000...................................................... 753,828
2001...................................................... 753,828
Thereafter................................................ 4,542,408
----------
Total..................................................... $8,376,301
==========
</TABLE>
Rental expense for the years ended December 31, 1996, 1995 and 1994 was
$751,699, $698,784 and $567,789, respectively.
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.
The Bank had non-interest bearing deposits of $25.4 million with
Detroit Branch of Chicago Federal Reserve Bank at December 31, 1996.
F-25
<PAGE> 188
FRANKLIN BANK, N.A.
15. COMPUTATION OF PRIMARY AND FULLY DILUTED INCOME PER SHARE
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------------
1996 1995 1994
---------- ---------- -----------
<S> <C> <C> <C>
PRIMARY INCOME PER SHARE
Net income ............................................... $ 905,649 $3,356,239 $ 2,396,250
Preferred stock dividends ................................ -- -- (396,830)
---------- ---------- -----------
Net income applicable to common stock after preferred
stock dividend ......................................... $ 905,649 $3,356,239 $ 1,999,420
---------- ---------- -----------
Weighted average shares outstanding:
Common stock ........................................... 3,308,945 3,302,316 2,398,747
Common stock equivalents: from assumed exercise of
Stock options and warrants ........................... 76,281 54,276 87,849
---------- ---------- -----------
Average shares outstanding, primary ...................... 3,385,226 3,356,592 2,486,596
---------- ---------- -----------
Primary income per share ................................. $ 0.27 $ 1.00 $ 0.80
========== ========== ===========
FULLY DILUTED INCOME PER SHARE
Net income ............................................... $ 905,649 $3,356,239 $ 2,396,250
---------- ---------- -----------
Weighted average shares outstanding:
Common stock ........................................... 3,308,945 3,302,316 2,398,747
Series A $0.90 noncumulative convertible preferred stock
assumed conversion (at rate of $6.66 per share) ...... -- -- 737,037
---------- ---------- -----------
Common stock equivalents: from assumed exercise of
stock options and warrants ........................... 79,993 92,519 87,849
---------- ---------- -----------
Average shares outstanding, fully diluted ................ 3,388,938 3,394,835 3,223,633
---------- ---------- -----------
Fully diluted income per share ........................... $ 0.27 $ 0.99 $ 0.74
========== ========== ===========
</TABLE>
Primary income per share is computed by dividing net income, after
deducting dividends declared on the Series A $0.90 noncumulative convertible
preferred stock, by the weighted average number of common shares and common
stock equivalents which would arise from considering exercisable dilutive stock
options and warrants. Fully diluted income per share is computed by dividing net
income by the common shares and common stock equivalents above and assumes the
conversion of the Series A $0.90 noncumulative convertible preferred stock, if
dilutive.
All per share amounts presented in the Consolidated Statements of
Income and the weighted average share amounts have been adjusted for the 5%
common stock dividends declared in December 1996, 1995 and 1994. During 1994,
1,264,974 common shares were issued upon conversion of $8,427,687 of the Series
A $0.90 noncumulative convertible preferred stock, and 230,967 common shares
were issued upon exercise of warrants which were issued with subordinated
capital notes on August 2, 1990. The exercise option period of the warrants
expired on September 15, 1994. Had the conversion of the preferred stock and the
exercise of the common stock purchase warrants occurred on January 1, 1994
primary income per share for 1994 would have been $0.74.
F-26
<PAGE> 189
FRANKLIN BANK, N.A.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTERLY PERIOD ENDED
SEPTEMBER 30, 1997
F-27
<PAGE> 190
FRANKLIN BANK, N.A. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
AT AT
SEPTEMBER 30, 1997 DECEMBER 31, 1996
------------------ -----------------
(unaudited)
<S> <C> <C>
ASSETS
Cash and due from banks $ 38,139,632 $ 28,921,009
Interest earning deposits 132,843 113,276
Time deposits with Federal Home Loan Bank 1,092,277 3,604,559
------------- -------------
Cash and cash equivalents 39,364,752 32,638,844
Securities available for sale 30,068,727 49,343,125
Federal Home Loan Bank stock, at cost 5,868,900 5,153,200
Federal Reserve Bank stock, at cost 825,150 772,450
------------- -------------
Loans Receivable 390,045,736 396,137,334
Allowance for loan losses (2,754,165) (3,199,549)
------------- -------------
Net loans 387,291,571 392,937,785
Accrued interest receivable 3,368,137 4,008,474
Real estate owned 2,599,326 1,371,569
Premises and equipment, net 4,781,147 5,129,246
Prepaid expenses and other assets 5,814,148 4,438,155
------------- -------------
Total assets $ 479,981,858 $ 495,792,848
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ 424,074,629 $ 401,889,982
Advances from Federal Home Loan Bank 24,000,000
Repurchase agreements 12,235,000 29,612,500
Subordinated capital notes 7,475,000 7,475,000
Advance payments by borrowers for taxes and insurance 304,996 172,502
Accrued interest payable 569,159 689,523
Other liabilities 2,495,823 1,617,824
------------- -------------
Total liabilities 447,154,607 465,457,331
Shareholders' equity
Common stock - Par value $1.00; authorized 6,000,000 shares; issued
and outstanding 3,320,045 shares at September 30, 1997 and
3,315,545 shares at December 31, 1996 3,320,045 3,315,545
Additional paid-in capital 24,189,860 24,179,756
Unrealized gain on securities available for sale, net of tax 152,337 197,956
Retained earnings 5,165,009 2,642,260
------------- -------------
Total shareholders' equity 32,827,251 30,335,517
------------- -------------
Total liabilities and shareholders' equity $ 479,981,858 $ 495,792,848
============= =============
</TABLE>
See Notes to Consolidated Financial Statements
F-28
<PAGE> 191
FRANKLIN BANK, N.A. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
------------- ------------ ------------- -------------
<S> <C> <C> <C> <C>
INTEREST INCOME
Interest on loans $27,622,049 $26,174,380 $9,187,419 $ 9,015,357
Interest on securities 2,065,757 2,340,341 612,231 770,032
Other interest and dividends 845,251 883,906 315,651 244,537
------------- ----------- ------------- -----------
Total interest income 30,533,057 29,398,627 10,115,301 10,029,926
INTEREST EXPENSE
Interest on deposits 10,192,921 12,409,223 3,387,082 4,091,200
Interest on Federal Home Loan
Bank advances and other
borrowings 2,039,165 1,236,447 440,362 477,860
------------- ----------- ------------- -----------
Total interest expense 12,232,086 13,645,670 3,827,444 4,569,060
------------- ----------- ------------- -----------
Net interest income 18,300,971 15,752,957 6,287,847 5,460,866
Provision for loan losses 2,600,000 1,175,000 900,000 425,000
------------- ----------- ------------- -----------
Net interest income after
provision for loan losses 15,700,971 14,577,957 5,387,847 5,035,866
------------- ----------- ------------- -----------
OTHER INCOME
Deposit account service charges 2,012,449 1,634,485 746,154 606,908
Loan fees 565,530 795,682 183,998 255,080
Net gain on sale of securities
and loans 215,198 414,632 64,885 111,740
Investment products 54,100 39,133 21,905 9,247
Other 218,481 192,685 70,330 55,915
------------- ----------- ------------- -----------
Total other income 3,065,758 3,076,617 1,087,272 1,038,890
------------- ----------- ------------- -----------
OTHER EXPENSES
Compensation and benefits 7,101,705 6,402,269 2,382,525 2,054,627
Occupancy and equipment 2,136,654 1,807,708 762,048 633,471
Advertising 446,718 884,514 148,511 154,146
Federal insurance premiums 277,791 3,085,933 92,407 2,603,047
Defaulted loan expense 583,552 249,815 306,623 126,818
Communication expense 502,763 425,889 171,182 148,831
Outside service expenses 1,318,404 1,321,199 431,268 486,747
Other 2,029,300 2,221,557 689,595 792,835
------------- ----------- ------------- -----------
Total other expenses 14,396,887 16,398,884 4,984,159 7,000,522
------------- ----------- ------------- -----------
Income before provision for
federal income taxes 4,369,842 1,255,690 1,490,959 (925,766)
Provision for federal income taxes 1,247,726 352,066 428,637 (343,468)
------------- ----------- ------------- -----------
Net income $ 3,122,116 $ 903,624 $1,062,322 $ (582,298)*
============= =========== ============= ===========
EARNINGS PER SHARE
Shares outstanding
Primary 3,419,488 3,378,307 3,446,175 3,366,698
Fully diluted 3,457,478 3,378,307 3,461,543 3,366,698
Net income
Primary $ 0.91 $ 0.27* $ 0.31 ($0.17)*
Fully diluted $ 0.90 $ 0.27* $ 0.31 ($0.17)*
</TABLE>
* After the effect of a one-time charge to earnings of $1.6 million ($0.48
per share), after tax, for the SAIF special assessment.
See Notes to Consolidated Financial Statements
F-29
<PAGE> 192
FRANKLIN BANK, N.A. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FLOWS (unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
1997 1996
-------------------- --------------------
<S> <C> <C>
OPERATION ACTIVITIES
Net income $ 3,122,116 $ 903,624
Adjustments to reconcile net income to cash provided by operating activities:
Provision for loan losses 2,600,000 1,175,000
Depreciation and amortization 1,036,267 793,116
Gain on sale of assets (220,011) (414,632)
Net deferral of loan origination fees 5,720 31,169
(Increase)/decrease in accrued interest receivable 640,337 (437,063)
Amortization on securities 333,213
Increase/(decrease) in prepaid expenses and other assets (1,361,860) (1,967,171)
Increase in accrued interest payable, deferred taxes and other liabilities 757,635 1,908,569
------------ -------------
Total adjustments 3,791,301 1,088,988
------------ -------------
Net cash from operating activities 6,913,417 1,992,612
INVESTING ACTIVITIES
Purchase of securities available for sale (18,652,083) (26,404,875)
Proceeds from sales of securities available for sale 36,604,449 23,914,566
Proceeds from maturities and paydowns of securities available for sale 1,127,454 12,494
Net (increase)/decrease in loans 1,817,328 (34,474,821)
Proceeds from the sale of real estate owned 7,667 757,486
Capital expenditures (678,802) (1,235,125)
Purchase of Federal Home Loan Bank stock (715,700) (667,100)
Purchase of Federal Reserve Bank stock (52,700) (55,650)
------------- -------------
Net cash from investing activities 19,457,613 (38,153,025)
FINANCING ACTIVITIES
Net increase in deposits 22,184,647 15,878,521
Decrease in FHLB advances (24,000,000) (10,000,000)
Increase (decrease) in repurchase agreements (17,377,500) 14,717,500
Net increase in advance payments for taxes and insurance 132,494 354,042
Exercise of common stock options 14,604 19,851
Cash dividends on common stock (599,367) (567,086)
------------ -------------
Net cash from financing activities (19,645,122) 20,402,828
Net increase in cash and cash equivalents 6,725,908 (15,757,585)
Beginning cash and cash equivalents 32,638,844 68,292,669
------------ -------------
Ending cash and cash equivalents $ 39,364,752 $ 52,535,084
============ =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ 8,525,698 $ 9,182,199
Federal income taxes 740,586 963,983
Non-cash investing and financing activities
Transfer from loans to real estate owned 1,797,158 916,930
</TABLE>
See Notes to Consolidated Financial Statements
F-30
<PAGE> 193
FRANKLIN BANK, N.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation and Significant Accounting Policies:
The accompanying consolidated financial statements of Franklin Bank N.A. and
its subsidiary ("Franklin" or the "Bank") have been prepared in accordance with
the instructions for Form 10-Q. Accordingly, they do not include all
information and footnotes necessary for a fair presentation of consolidated
financial condition, results of operations and cash flows in conformity with
generally accepted accounting principles. The statements do, however, include
all adjustments (consisting of normal recurring accruals) which management
considers necessary for a fair presentation of the interim periods.
This 10-Q is written with the presumption that the users of the interim
financial statements have read or have access to the Bank's Annual Report on
Form 10-K, which contains the latest audited financial statements and notes
thereto, together with Management's Discussion and Analysis of Financial
Condition and Results of Operations as of December 31, 1996 and for the year
then ended. Therefore, only material changes in financial condition and results
of operations are discussed in the remainder of Part I.
The results of operations for the three and nine month periods ended
September 30, 1997 are not necessarily indicative of the results to be expected
for the year ended December 31, 1997.
The Consolidated Statement of Financial Condition as of December 31, 1996 has
been derived from the audited Consolidated Statement of Financial Condition as
of that date.
The carrying values of impaired loans are periodically adjusted to reflect
cash payments, revised estimates of future cash flows and increases in the
present value of expected cash flows due to the passage of time. Cash payments
representing interest income are reported as such. Other cash payments are
reported as reductions in carrying value, while increases or decreases due to
changes in estimates of future payments and due to the passage of time are
reported as bad debt expense, if reductions, or otherwise as reductions in bad
debt expense.
F-31
<PAGE> 194
FRANKLIN BANK, N.A. AND SUBSIDIARY
2. Earnings Per Share:
<TABLE>
<CAPTION>
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
--------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
PRIMARY EARNINGS PER SHARE (1)
Net income $3,122,116 $ 903,624 $ 1,062,333 $ (582,298)
Average common shares outstanding:
Common stock 3,318,119 3,307,724 3,320,045 3,307,999
Common stock equivalents:
Assumed exercise of stock options 101,369 70,583 126,130 58,699
---------- ----------- ---------- -----------
Primary common stock and equivalents 3,419,488 3,378,307 3,446,175 3,366,698
---------- ----------- ----------- -----------
Primary earnings per share $ 0.91 $ 0.27 $ 0.31 $ (0.17)
========== =========== =========== ===========
FULLY DILUTED EARNINGS PER SHARE (1)
Net income $3,122,116 $ 903,624 $1,062,333 $ (582,298)
Average common share outstanding:
Common stock 3,318,119 3,307,724 3,320,045 3,307,999
Common stock equivalents:
Assumed exercise of stock options 139,359 70,583 141,498 58,699
---------- ----------- ---------- -----------
Fully diluted common stock and equivalents 3,457,478 3,378,307 3,461,543 3,366,698
---------- ----------- ----------- -----------
Fully diluted earnings per share $ 0.90 $ 0.27 $ 0.31 $ (0.17)
========== =========== =========== ===========
</TABLE>
(1) Adjusted for the 5% common stock dividend declared on December 19, 1996
and paid on January 16, 1997.
3. Loans, Nonperforming Assets and Allowance for Loan Losses:
Loans at September 30, 1997 and December 31, 1996 consisted of the
following:
<TABLE>
<CAPTION>
AT AT
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
<S> <C> <C>
Commercial real estate $106,320,120 $139,499,287
Lease financing 128,356,980 97,518,144
Commercial 80,512,403 82,479,849
Residential mortgage 48,793,324 48,031,504
Residential construction 32,991,004 33,644,580
Consumer 19,680,491 18,687,898
------------ ------------
Total loans 416,654,322 419,861,262
Less
Undisbursed funds 8,695,694 8,837,330
Amounts due on underlying mortgages on
commercial real estate loans 363,591
Unamortized discounts on purchased loans 204,484 156,172
Unamortized discounts on lease financing 17,673,785 14,337,932
Unamortized net loan expenses 34,623 28,903
------------ ------------
Loans receivable 390,045,736 396,137,334
Allowance for loan losses 2,754,165 3,199,549
------------ ------------
Net loans $387,291,571 $392,937,785
============ ============
</TABLE>
F-32
<PAGE> 195
FRANKLIN BANK, N.A. AND SUBSIDIARY
3. Loans, Non-performing Assets and Allowance for Loan Losses (continued):
<TABLE>
<CAPTION>
At At
September 30, December 31,
1997 1996
--------------------- --------------------
<S> <C> <C>
ACCRUING LOANS PAST DUE 90 DAYS OR MORE
Commercial real estate $ 1,793,482 $ 6,386,841
Lease financing 655,190 1,239,622
Commercial 2,644,196 2,685,522
Residential mortgage 1,463,276 929,413
Consumer 15,384 353,876
------------ -----------
Total 6,571,528 11,595,274
----------- -----------
NONACCRUAL LOANS
Commercial real estate --- 309,246
Commercial 834,555 1,894,352
----------- -----------
Total nonaccrual loans 834,555 2,203,598
----------- -----------
Total nonperforming loans 7,406,083 13,798,872
REAL ESTATE OWNED
Commercial real estate 2,462,905 929,063
Residential mortgage 136,421 442,506
----------- -----------
Total real estate owned 2,599,326 1,371,569
Other repossessed assets 486,927 107,743
----------- -----------
Total nonperforming assets $10,492,336 $15,278,184
=========== ===========
Total nonperforming assets as a percentage of:
Total assets 2.19% 3.08%
Total loans and real estate owned 2.50% 3.63%
Total nonaccrual loans and real estate as a percentage of:
Total assets 0.72% 0.74%
Total loans and real estate owned 0.82% 0.93%
</TABLE>
F-33
<PAGE> 196
FRANKLIN BANK, N.A. AND SUBSIDIARY
3. Loans, Non-performing Assets and Allowance for Loan Losses (continued):
The following table summarizes changes in the allowance for loan losses
arising from loans charged off, recoveries of loans previously charged off and
additions to the allowance which have been charged to expense:
<TABLE>
<CAPTION>
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1997 SEPTEMBER 30, 1996
------------------ ------------------
<S> <C> <C>
Balance at beginning of period $3,199,549 $2,930,392
Provision for possible losses 2,600,000 1,175,000
CHARGE-OFFS
Commercial real estate 20,426
Lease financing 1,564,552 533,422
Commercial 1,479,428 661,885
Consumer 654,975 369,578
---------- ----------
Total charge-offs 3,698,955 1,585,311
RECOVERIES
Commercial real estate 7,724
Lease financing 382,878 134,089
Commercial 101,296 14,051
Residential mortgage 1,127
Consumer 168,270 45,900
---------- ----------
Total recoveries 653,571 201,764
---------- ----------
Net charge-offs 3,045,384 1,383,547
---------- ----------
Balance at end of period $2,754,165 $2,721,845
========== ==========
Allowance as a percentage of:
Total loans 0.66% 0.70%
Nonperforming loans 26.25 27.62
Net charge-offs (annualized) 67.83 147.55
Net charge-offs to average loans outstanding (annualized) 1.05 0.50
</TABLE>
Information regarding impaired loans is as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1997 SEPTEMBER 30, 1996
------------------ ------------------
<S> <C> <C>
Average investment in impaired loans $6,101,028 $7,295,941
Interest income recognized on impaired loans on cash basis 122,897 140,442
</TABLE>
<TABLE>
<CAPTION>
At At
September 30, 1997 September 30, 1996
------------------ ------------------
<S> <C> <C>
Balance of impaired loans $5,331,702 $5,523,914
Less portion of which no allowance for loan losses is allocated 349,882
Portion of impaired loan balance for which an allowance
for credit losses is allocated 4,981,820 5,523,914
Portion of allowance for loan losses to the impaired loan
balance 779,872 481,312
</TABLE>
F-34
<PAGE> 197
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
Except for the historical information contained herein, the matters discussed
in this Report may be deemed to be forward-looking statements that involve risk
and uncertainties. Words or phrases "will likely result", "are expected to",
"will continue", "is anticipated", "estimate", "project", or similar
expressions are intended to identify "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Factors which
could cause actual results to differ include, but are not limited to,
fluctuations in interest rates, changes in economic conditions in the Bank's
market area, changes in policies by regulatory agencies, the acceptance of new
products, the impact of competitive products and pricing, and the other risks
detailed from time to time in the Bank's SEC reports, including the report on
Form 10-K for the year ended December 31, 1996. These forward-looking
statements represent the Bank's judgement as of the date of this report. The
Bank disclaims, however, any intent or obligation to update these
forward-looking statements.
Total assets were $480.0 million at September 30, 1997 compared to $495.8
million at December 31, 1996. At September 30, 1997 and December 31, 1996, cash
and cash equivalents plus interest earning securities represented 14.5% and
16.5%, respectively, of total assets. Loan receivable balances decreased $6.1
million or 1.5% from December 31, 1996 to September 30, 1997. This decrease in
loans receivable was due primarily to commercial loan sales of $21.1 million
during the quarter ended March 31, 1997.
At September 30, 1997 and December 31, 1996 the Bank had outstanding loan
commitments for loans that have not been accepted by the borrower or closed of
approximately $5.3 million, and $3.3 million, respectively. These include
commitments for commercial business loans, residential mortgages and home
equity loans. Approximately $.7 million of the commitments at September 30,
1997 were for fixed rate loans with maturities of approximately 39 months and a
weighted average rate of 10.87%, with the remainder being adjustable rate
loans.
Under loan agreements for transactions which had closed, the Bank had
commitments to fund commercial lines of credit, construction and home equity
loans of approximately $64.7 million and $40.7 million at September 30, 1997
and December 31, 1996 respectively. The Bank had commitments to fund
construction loans of approximately $9.8 million and $9.4 million at September
30, 1997 and December 31, 1996 respectively. The Bank had commitments to fund
home equity loans of approximately $10.7 million and $12.2 million at September
30, 1997 and December 31, 1996 respectively. As certain commitments to make
loans and fund full lines of credit expire without being used, the amount does
not necessarily represent future cash commitments
The level of non-performing assets decreased from $15.3 million at December
31, 1996 to $10.5 million at September 30, 1997. This was a decrease of 31.3%.
During the period ended September 30, 1997, Franklin's allowance for loan and
lease losses (ALLL) decreased to 0.66% of total loans from 0.70% at September
30, 1996. Franklin increased its provision for the nine months ended September
30, 1997 to $2.6 million compared to $1.2 million
F-35
<PAGE> 198
for the nine months ended September 30, 1996. Management periodically reviews
the adequacy of the ALLL and presently considers Franklin's ALLL adequate under
the circumstances.
LIQUIDITY
Franklin competes aggressively for business, consumer and municipal
deposits in southeastern Michigan and also offers a limited number of
non-affiliated non-deposit investment products. Historically, Franklin's
principal sources of funds for its lending and investment activities have
consisted of deposits, principal repayment on loans, Federal Home Loan Bank
advances and repurchase agreements. Principal uses of funds for Franklin
include the origination of loans and the repayment of maturing deposit accounts
and other borrowings.
During the nine month period ended September 30, 1997, Franklin had an
increase in deposits of $22.2 million with a decrease in other borrowed funds
of $41.4 million which resulted in a $19.2 million decrease in deposits and
other borrowings, including interest credited. During this same time period,
there was a decrease of $6.1 million in loans and a decrease of $12.5 million
in cash and securities. However, business checking balances increased by $19.2
million from $107.0 million at December 31, 1996 to $126.2 million at September
30, 1997. This increase in the core deposit base, with a large decrease in the
non-core deposits base, contributed to the Bank's margin improvement during the
nine months ended September 30, 1997.
REGULATORY CAPITAL
The following table compares the Bank's regulatory capital
requirements at September 30, 1997 and December 31, 1996.
<TABLE>
<CAPTION>
TIER 1 TIER 1 RISK- TOTAL RISK-
(IN THOUSANDS) LEVERAGE BASED BASED
RATIO RATIO RATIO
---------------- --------------- ----------------
<S> <C> <C> <C>
Regulatory capital balances at September 30, 1997 $31,391 $31,391 $42,216
Required regulatory capital (well capitalized) 24,004 23,526 39,210
------- -------- --------
Capital in excess of well capitalized $ 7,387 $ 7,865 $ 3,006
======= ======== ========
Capital ratios at September 30, 1997 6.54% 8.01% 10.77%
Capital ratios at December 31, 1996 5.99 7.27 10.04
Regulatory capital ratios --"well capitalized" definition 5.00 6.00 10.00
</TABLE>
F-36
<PAGE> 199
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 1997 TO NINE MONTHS ENDED
SEPTEMBER 30, 1996
Interest income increased by $1.1 million, while interest expense
decreased by $1.4 million, thus increasing net interest margin by $2.5 million
for the nine months ended September 30, 1997 compared to September 30, 1996.
Interest income increases were in part due to an increase in average
outstanding loans in period to period comparisons. The decrease in interest
expense was due to a decrease in the average outstanding balance of interest
bearing liabilities as well as a drop in the weighted average rate being paid
on the liabilities. For the nine months ended September 30, 1997 compared to
the nine months ended September 30, 1996, there was an increase of $15.2
million in the average balance of interest earning assets, and a decrease of
$15.2 million in average balances of interest bearing liabilities. The weighted
average yield on earning assets increased to 9.01% for the nine months ended
September 30, 1997 from 8.97% for the nine months ended September 30, 1996.
The weighted average rate paid on interest bearing liabilities decreased from
5.27% for the nine months ended September 30, 1996 to 4.94% for the nine months
ended September 30, 1997. This decrease in the average rate was the result of
lower rates being paid on retail certificates of deposits and money market
accounts. The weighted average rate paid on the retail certificate of deposit
and money market accounts for the period ended September 30, 1997 was 4.5%
compared to 5.0% for the period ended September 30, 1996.
The net interest margin was 5.40% and 4.81%, respectively, for the
nine months ended September 30, 1997 and 1996. Management's continuing focus
on increasing non-interest bearing business account balances and growth in the
lease financing and non-real estate commercial loan areas are the principal
reasons for the improved net interest margin in 1997. For the nine months ended
September 30, 1997 compared to the nine months ended September 30, 1996, there
was an increase of $12.4 million and $30.3 million in the average balance of
Money Market Demand Accounts and business and personal checking accounts
respectively. Another contributing factor toward an improved margin was the
decrease in Money Market Demand Account rates from 4.31% to 3.92% for the nine
month periods ended September 30, 1996 and September 30, 1997, respectively.
Franklin currently has approximately $135.6 million in loan balances
outstanding which reprice during the three month period ending December 31,
1997, and approximately $38.7 million in loans which reprice during the period
beginning December 31, 1997 and ending September 30, 1998. The Bank also has
$11.0 million in other securities which will mature during the twelve month
period ending September 30, 1998. Also, $120.5 million of the certificate of
deposit accounts and all of the $142.9 million money market accounts
outstanding at September 30, 1997 would be subject to repricing in an interest
rate move, thus helping to offset any loss in the interest margin due to
declining yields on assets which reprice with a change in the prime rate or the
one year Treasury bill rate.
On the lending side, Franklin's activity was primarily in business
loans. The average balances of non-real estate indirect lease financing loans
increased by $34.3 million during the nine months ended September 30, 1997 to
an average balance of $98.4 million. For the nine months ended September 30,
1997 these loans yielded a weighted average rate of 9.47%. The average
outstanding balances of non-real estate commercial loan product; such as small
business loans, lines of credit,
F-37
<PAGE> 200
loans secured by equipment, accounts receivables and inventory, increased by
$10.3 million during the nine months ended September 30, 1997 to an average
balance of $80.6 million. These loans were yielding a weighted average rate of
8.9% for the nine months ended September 30, 1997.
Total other income for the nine months ended September 30, 1997 and
1996 was $3.1 million. Total other income in 1997 consisted primarily of
deposit service fees and loan origination fees. Deposit service fees increased
$378,000 in correlation with the increase in the number of business checking
accounts. Loan fees decreased by $230,000 primarily due to a decrease in late
charges assessed. Revenues received in connection with the sale of investment
products by a third-party vendor (such as mutual funds and annuities) increased
by $15,000. In an effort to take advantage of securities price movements, the
Bank sold $36.6 million of securities held in its available for sale portfolio
in the first nine months of 1997. This sale resulted in a net gain being
recognized of $215,000 for the nine months ended September 30, 1997. For the
same period ended September 30, 1996, net gain on the sales of securities and
loans totaled $415,000.
The $2.0 million net decrease in operating expenses during the nine
months ended September 30, 1997 compared to the prior period primarily resulted
from a decrease in FDIC assessment of $2.8 million, a decrease in advertising
of $438,000 and a decrease in communication, outside services, and other
expenses of $118,000 offset by an increase in compensation and benefits of
$699,000, an increase in occupancy and equipment of $329,000 and an increase in
defaulted loan expenses of $334,000. The decrease in the FDIC assessment for
the nine months ended September 30, 1997, primarily reflects the $2.3 million
special assessment for the period ended September 30, 1996, and reduced ongoing
FDIC insurance premiums thereafter. The increase in compensation, benefits and
payroll taxes of $699,000 was attributed to (i) an average salary increase for
existing employees of 3.5%; (ii) an increase in the average number of full
time equivalent staffing of 30 employees, when comparing the nine months ended
September 30, 1997 to September 30, 1996; (iii) the costs associated with
acquiring new employees to fill vacated and newly created positions; and the
costs to employ temporary employees which rose by $209,000 in period to period
comparisons. The increase in occupancy and equipment expenses was due to
increases in rent of $54,000 due to additional space being occupied in the main
office and expanded records storage space. Also, office building and furniture
and fixtures depreciation expense increased by $239,000 due to purchases of
additional computer hardware and software applications. During the last
quarter of 1996 and through the first nine months of 1997, the Bank embarked on
an aggressive program of upgrading its personal computer environment and
Windows-based system at the Bank. This process also included upgrading the
local area network. These expenditures in computer hardware and software
programs assist the Bank in continuing to process additional interest free
checking accounts, which help to improve both the margin and fee income
components of the Bank's total income. The overall decrease in other operating
expenses of $192,000 was attributable to decreases in dues/subscriptions of
$25,000, employee training costs of $44,000, supplies and printing cost
decreases of $45,000 and other operating expenses of $70,000.
In period to period comparisons, total defaulted loan expense
increased by $334,000 for the period ended September 30, 1997 compared to the
same period ended September 30, 1996. There were $145,000 in gains on the sale
of the Bank's other real estate owned ("ORE0") property during the nine months
ended September 30, 1996 and $74,000 in rental income. By comparison, there
was no rental income and only $5,000 in gains on sale of OREO properties booked
during the nine
F-38
<PAGE> 201
months ended September 30, 1997. Management continues to focus on controlling
defaulted loan expense, but does not anticipate further gains on the sale of
OREO properties or material rental income for the remainder of 1997.
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 1997 TO THREE MONTHS ENDED
SEPTEMBER 30, 1996
Interest income increased by $85,000, while interest expense decreased
by $742,000, increasing net interest income by $827,000 for the three months
ended September 30, 1997, compared to the same period in 1996. Interest income
increases were due to an increase in average outstanding balances of assets
such as lease financing and non-real estate commercial loans. The decrease in
interest expense was the result of lower rates being paid on Money Market
Demand Accounts from 4.26% at September 30, 1996 to 3.92% at September 30,
1997. The net interest margin was 5.64% and 4.84%, respectively, for the
quarters ended September 30, 1997 and 1996. See "Comparison of nine months
ended September 30, 1997 to nine months ended September 30, 1996" for further
discussion of the increase in net interest income and interest margin.
Total other income for the quarter ended September 30, 1997 was $1.1
million, compared to $1.0 million for the quarter ended September 30, 1996.
There was an increase in deposit service fees of $139,000 or 22.9% for the
quarter ended September 30, 1997 compared to the same period ended September
30, 1996. This increase in deposit service fees was primarily due to the
increase in the number of business checking accounts. See "Comparison of nine
months ended September 30, 1997 to nine months ended September 30, 1996" for
further discussion of the increase in other income.
The net decrease of $2.0 million in operating expenses during the
quarter ended September 30, 1997 was primarily the result of a decrease in FDIC
insurance of $2.5 million, a decrease in other expense of $103,000, offset by
an increase in compensation and benefits of $328,000, an increase in occupancy
and equipment costs of $129,000, and an increase in defaulted loan expenses of
$180,000 compared to the quarter ended September 30, 1996. See "Comparison of
nine months ended September 30, 1997 to nine months ended September 30, 1996"
for further discussion of the increases in operating expenses.
F-39
<PAGE> 202
=========================================================
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY SUCH
SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THIS DATE.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Table of Contents....................... i
Prospectus Summary...................... 1
The Formation........................... 9
Tax Status of the Company............... 10
Risk Factors............................ 10
The Company............................. 22
Use of Proceeds......................... 23
Capitalization.......................... 25
Business and Strategy................... 26
Management.............................. 51
Certain Transactions Constituting the
Formation............................. 55
Description of Series A Preferred
Shares................................ 57
Description of Capital Stock............ 64
Federal Income Tax Considerations....... 67
ERISA Considerations.................... 78
Certain Information Regarding the
Bank.................................. 81
Underwriting............................ 82
Experts................................. 83
Ratings................................. 83
Certain Legal Matters................... 83
Additional Information.................. 84
Glossary................................ 85
Index to Financial Statement............ F-1
</TABLE>
------------------
THROUGH AND INCLUDING , 199 (THE 25TH DAY AFTER THE COMMENCEMENT OF
THE OFFERING), ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES,
WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A
PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
=========================================================
=========================================================
1,800,000 SHARES
FRANKLIN FINANCE
CORPORATION
% NONCUMULATIVE
PREFERRED STOCK, SERIES A
--------------------
PROSPECTUS
--------------------
(RONEY & CO LOGO)
PRINCIPAL FINANCIAL
SECURITIES, INC.
DECEMBER , 1997
=========================================================
<PAGE> 203
PART II. INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 30. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 31. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
<TABLE>
<CAPTION>
<S> <C>
Registration Fee.............................................. $ 6,273
Printing and Out of Pocket Expenses........................... 110,000
Legal Fees and Expenses (includes issuer's
counsel counsel and tax counsel).............................. 175,000
Accounting Fees and Expenses.................................. 40,000
Blue Sky Fees and Expenses.................................... 5,000
Other 6,227
---------
Total............................................... $342,500
========
</TABLE>
ITEM 32. SALES TO SPECIAL PARTIES.
See response to Item 33 below.
ITEM 33. RECENT SALES OF UNREGISTERED SECURITIES
In connection with the formation of Franklin Finance Corporation (the
"Company" or the "Registrant"), the Company issued 1000 shares of Common Stock,
par value $1.00 per share, to Franklin Bank, N.A. (the "Bank"). Prior to the
consummation of the Offering, the Company will amend its Articles of
Incorporation to change the par value of its Common Stock to $300.00 per share.
Simultaneously with the consummation of the Offering, the Company will issue an
aggregate of 19,045 shares of Common Stock to the Bank. The description of
these transactions in the Prospectus under the heading "Certain Transactions
Constituting The Formation" is incorporated herein by reference. These shares of
Common Stock will be issued in reliance upon the exemption from registration
under Section 4(2) of the Securities Act of 1933 (the "Securities Act").
ITEM 34. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Michigan Business Corporation Act, as amended ("MBCA"), provides
that a Michigan corporation, such as the Registrant, may indemnify a director,
officer, employee or agent of the corporation (an "Indemnitee") against the
Indemnitee's expenses and judgments, fines and amounts paid in settlement
actually and reasonably incurred in connection with any threatened, pending or
completed action, suit or proceeding (other than an action by or in the right of
the corporation) involving the Indemnitee by reason of the fact that the
Indemnitee is or was a director, officer,
II-1
<PAGE> 204
employee or agent of the corporation, if the Indemnitee acted in good faith and
in a manner the Indemnitee reasonably believed to be in or not opposed to the
best interest of the corporation and, with respect to any criminal action or
proceeding, had no reasonable cause to believe his or her conduct was unlawful.
The MBCA also provides that in derivative actions, a corporation may indemnify a
director, officer, employee or agent of the corporation against expenses
actually and reasonably incurred by the Indemnitee to the extent that the
Indemnitee is successful on the merits or otherwise in any such action, suit or
proceeding or in the defense of any claim, issue or matter therein. Under the
MBCA, no indemnification shall be made with respect to any claim, issue or
matter as to which an Indemnitee shall have been adjudged to be liable to the
corporation unless and only to the extent that the court shall determine upon
application that, despite the adjudication of liability but in view of all of
the circumstances of the case, the Indemnitee is fairly and reasonably entitled
to indemnity for such expenses which the court shall deem proper. The MBCA also
generally permits the advancement of reasonable expenses and empowers the
corporation to purchase and maintain directors' and officers' insurance.
Section 209 of the MBCA provides that the articles of incorporation of
a corporation may contain a provision eliminating or limiting the personal
liability of a director to the corporation or its stockholders for monetary
damages for breach of fiduciary duty as a director, provided that such provision
shall not eliminate or limit the liability of a director (i) for any breach of
the director's duty of loyalty to the corporation or its stockholders, (ii) for
acts or omissions not in good faith or which involve intentional misconduct or
knowing violation of law, (iii) under Section 551(1) (relating to liability for
unauthorized acquisitions or redemptions of, or dividends on, capital stock and
loans to a director, officer, or employee the corporation or of a subsidiary of
the corporation) of the MBCA, (iv) for any transaction from which the director
derived an improper personal benefit or (v) for an act or omission occurring
prior to the date such a provision becomes effective.
The Amended and Restated Articles of Incorporation of the Registrant
provides that, to the fullest extent that the MBCA as from time to time in
effect permits the limitation or elimination of the liability of directors, no
director of the Registrant shall be personally liable to the Registrant or its
stockholders for monetary damages for breach of fiduciary duty as a director.
The Amended and Restated Articles of Incorporation empowers the
Registrant to indemnify any director, officer, employee or agent of the
Registrant or any other person who is serving at the Registrant's request in any
such capacity with another corporation, partnership, joint venture, trust or
other enterprise (including, without limitation, an employee benefit plan) to
the fullest extent permitted under the MBCA as from time to time in effect, and
any such indemnification may continue as to any person who has ceased to be a
director, officer, employee or agent and may inure to the benefit of the heirs,
executors and administrators of such a person.
The Amended and Restated Articles of Incorporation also empowers the
Registrant by action of its Board of Directors, notwithstanding any interest of
the directors in the action, to purchase and maintain insurance in such amounts
as the Board of Directors deems appropriate to protect any director, officer,
employee or agent of the Registrant or any other person who is serving at the
Registrant's request in any such capacity with another corporation, partnership,
joint venture, trust or other enterprise (including, without limitation, an
employee benefit plan) against any liability asserted against such individual or
incurred by such individual in any such capacity arising out of
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such individual's status as such (including, without limitation, expenses,
judgments, fines (including any excise taxes assessed on a person with respect
to any employee benefit plan) and amounts paid in settlement) to the fullest
extent permitted under the MBCA as from time to time in effect, whether or not
the Registrant would have the power or be required to indemnify any such
individual under the terms of any agreement or by-law or the MBCA.
In addition, the Registrant's By-laws require indemnification to the
fullest extent permitted under applicable law, as from time to time in effect.
The By-laws provide a clear and unconditional right to indemnification for
expenses (including attorneys' fees), judgments, fines and amounts paid in
settlement actually and reasonably incurred by any person in connection with any
threatened, pending or completed investigation, claim, action, suit or
proceeding, whether civil, administrative or investigative (including, to the
extent permitted by law, any derivative action) by reason of the fact that such
person is or was serving as a director, officer, employee or agent of the
Registrant or, at the request of the Registrant, of another corporation,
partnership, joint venture, trust or other enterprise (including, without
limitation, an employee benefit plan). The By-laws specify that the right to
indemnification so provided is a contract right, set forth certain procedural
and evidentiary standards applicable to the enforcement of a claim under the
By-laws, entitle the persons to be indemnified to be reimbursed for the expenses
of prosecuting any such claim against the Registrant and entitle them to have
all expenses incurred in advance of the final disposition of a proceeding paid
by the Registrant. Such provisions, however, are intended to be in furtherance
and not in limitation of the general right to indemnification provided in the
By-laws, which right of indemnification and of advancement of expenses is not
exclusive.
The Registrant's By-laws also provide that the Registrant may enter
into contracts with any director, officer, employee or agent of the Registrant
in furtherance of the indemnification provisions in the By-laws, as well as
create a trust fund, grant a security interest or use other means (including,
without limitation, a letter of credit) to ensure payment of amounts
indemnified.
ITEM 35. TREATMENT OF PROCEEDS FROM STOCK BEING REGISTERED.
Not applicable.
ITEM 36. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements
See F-1 of the Prospectus for an index to financial statements included
as part of the Prospectus.
(b) Exhibits
See Index to Exhibits.
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ITEM 37. UNDERTAKINGS.
The undersigned Registrant hereby undertakes to provide to the
Underwriters, at the closing specified in the Underwriting Agreement,
certificates in such denominations and registered in such names as required by
the Underwriters to permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the Registrant pursuant to the provisions described under Item 34 above, or
otherwise, the Registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Securities Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a director, officer,
or controlling person of the Registrant in the successful defense of any action,
suit or proceeding), is asserted by such director, officer, or controlling
person in connection with the securities being registered, the Registrant will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(i) For the purpose of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus filed
as part of this registration statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the Registrant pursuant to
Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be
deemed to be part of this registration statement as of the time it was
declared effective.
(ii) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating
to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering
thereof.
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<PAGE> 207
SIGNATURES
Pursuant to the requirements of the Securities Act, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-11 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in Southfield, Michigan, on the 2nd day of December, 1997.
FRANKLIN FINANCE CORPORATION
By: /s/ Read P. Dunn
-------------------------------------------
Read P. Dunn, President and Chief Executive
Officer (Authorized Officer)
Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed by the following persons in the capacities and on the
dates indicated.
/s/David F. Simon Dated: December 2, 1997
- --------------------------------------------------
David F. Simon
Director and Secretary
/s/David L. Shelp Dated: December 2, 1997
- --------------------------------------------------
David L. Shelp
Director, Treasurer and Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/Edward J. Shehab Dated: December 2, 1997
- --------------------------------------------------
Edward J. Shehab
Director and Senior Vice President
/s/Read P. Dunn Dated: December 2, 1997
- --------------------------------------------------
Read P. Dunn
President and Chief Executive Officer
(Principal Executive Officer)
- -------------------------------------------------- Dated:
- -------------------------------------------------- Dated:
<PAGE> 208
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- ----------------------------------------------------------------------------------
<S> <C>
1 Form of Underwriting Agreement between the Company, the Bank and the
Underwriters*
3(a)(i) Articles of Incorporation of the Company*
3(a)(ii) Form of Certificate of Designation establishing the Series A Preferred Shares*
3(a)(iii) Form of Restated Articles of Incorporation*
3(b) Bylaws of the Company*
4.1 Specimen of certificate representing Noncumulative, Exchangeable Preferred
Stock, Series A, of the Company*
4.2 Specimen of certificate representing Noncumulative Preferred Stock, Series A, of
the Bank*
5.1 Form of Opinion of Silver, Freedman & Taff, L.L.P., special
counsel to the Company, relating to Noncumulative, Exchangeable
Preferred Stock, Series A*
5.2 Form of Opinion of Silver, Freedman & Taff, L.L.P., special counsel to the Bank,
relating to Noncumulative Preferred Stock, Series A*
8 Opinion of Tax Adviser to the Company relating to certain tax matters*
10.1 Form of Residential Mortgage Loan Purchase and Warranties Agreement between
the Company and the Bank*
10.2 Form of Commercial Mortgage Loan Purchase and Warranties Agreement between
the Company and the Bank*
10.3 Form of Residential Mortgage Loan Servicing Agreement between the Company
and the Bank*
10.4 Form of Commercial Mortgage Loan Servicing Agreement between the Company
and the Bank*
10.5 Form of Advisory Agreement between the Company and the Bank*
23.1 Consent of Grant Thornton LLP
23.2 Consent of Crowe, Chizek and Company LLP
23.3 Consent of Tax Advisor (included in Exhibit 8)*
23.4 Consent of Silver, Freedman & Taff, L.L.P.*
23.5 Consent of Honigman Miller Schwartz and Cohn*
24 Powers of Attorney*
</TABLE>
*Previously filed.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated October 6, 1997, accompanying the
balance sheet of Franklin Finance Corporation contained in the Registration
Statement on Form S-11 and Prospectus. We consent to the use of the
aforementioned report in the Registration Statement and Prospectus, and to the
use of our name as it appears under the caption "Experts".
We have also issued our report dated January 31, 1997, accompanying the
consolidated financial statements of Franklin Bank, N.A. contained in Annex I
of Prospectus constituting part of the Registration Statement on Form S-11. We
consent to the use of the aforementioned report in the Registration Statement
and Annex I of the Prospectus, and to the use of our name as it appears under
the caption "Experts".
/S/ GRANT THORNTON LLP
Southfield, Michigan
December 2, 1997
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the inclusion in Annex I of the Prospectus
constituting part of this Registration Statement on Form S-11 of our report
dated March 22, 1996 relating to the financial statements of Franklin Bank,
N.A., which appears in Annex I of such Prospectus. We also consent to the
reference to us under the heading "Experts" in Annex I of such Prospectus.
/s/ Crowe, Chizek and Company LLP
Crowe, Chizek and Company LLP
Grand Rapids, Michigan
December 2, 1997
