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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number: 000-50518

Franklin Bank Corp.

Registrant’s telephone number, including area code:

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.01 Par Value,

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     þ

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes o          No þ

     As of March 10, 2004, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $365.9 million.

     As of March 10, 2004, there were 21,225,263 shares of the registrant’s common stock, $.01 par value, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the Proxy Statement for the 2004 Annual Meeting of Shareholders of Franklin Bank Corp. to be held on May 5, 2004 are incorporated by reference in this Form 10-K in response to Part III, Items 10, 11, 12, 13 and 14.

FRANKLIN BANK CORP.

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PART I

      In this report, Franklin Bank Corp. (including its subsidiaries) is sometimes referred to as the “company”, “we”, “our”, or “us”, and Franklin Bank, S.S.B. is sometimes referred to as “Franklin Bank” or the “bank”.

      We are a Texas-based savings and loan holding company with approximately $2.3 billion in assets, $1.3 billion in deposits and $245.4 million in stockholders’ equity as of December 31, 2003. Through our wholly-owned subsidiary, Franklin Bank, S.S.B., a Texas state savings bank, we originate single family residential mortgage loans, provide community banking products and services, originate residential construction loans and provide mortgage banker finance products and services. As of December 31, 2003, in addition to our corporate offices in Houston, Texas, where we provide many of our banking services, we had thirteen full service banking branches in Texas, two regional residential construction lending offices in Florida and Arizona, 34 retail mortgage offices in 16 states throughout the United States, and a regional wholesale origination office in California.

      On December 23, 2003 we completed an initial public offering of our common stock and received net proceeds of approximately $140.2 million. On December 30, 2003, we acquired Jacksonville Bancorp., Inc., or Jacksonville, a Texas-based savings and loan holding company with approximately $467.6 million in assets and $399.8 million in deposits at the date of acquisition. On February 29, 2004, we acquired Lost Pines Bancshares, Inc., or Lost Pines, a Texas-based bank holding company with approximately $40.3 million in assets and $36.5 million in deposits at the date of acquisition.

Our Strategy

      Our principal growth and operating strategy is to:

	•	increase the scope and profitability of our product lines by expanding our markets and utilizing the expertise of our key management;
	•	expand our community banking business by acquiring small- to medium-sized financial institutions in growing Texas markets outside of metropolitan areas and by establishing new banking branches to complement our existing banking branch network; and
	•	continue to build our franchise by providing superior service through qualified and relationship-oriented employees who are committed to the communities in which we offer our products.

Acquisitions

      Since our formation in August 2001, we have completed the following acquisitions:

      We continue to seek opportunities to expand our community banking business by acquiring small- to medium-sized financial institutions in growing Texas markets outside of metropolitan areas. We believe that acquisitions such as these complement our asset strategy and provide an excellent source of deposits, a key component of our growth. When we acquire a financial institution we integrate its lending and deposit platforms with ours as soon as practical. We operate the acquired entity either as a new geographic division or

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History

      In August 2001, our founders organized Franklin Bank Corp. as a new Delaware holding company, formerly known as BK2 Inc., for the purpose of acquiring all of the outstanding capital stock of Franklin Bank, which was then engaged in traditional community banking activities in the greater Austin, Texas market. We completed this acquisition on April 9, 2002.

      At the time of the acquisition, Franklin Bank had approximately $62.3 million in assets, $58.5 million in deposits and $3.1 million in stockholders’ equity, and operated two banking branches in Austin, Texas, with a community banking focus. We acquired the bank with the intent of implementing a business strategy to expand the bank’s branches, grow and diversify its lending activities and increase its overall profitability.

      In April 2003, we acquired Highland Lakes Bancshares Corporation, or Highland, located in Kingsland, Texas. At the time of the acquisition, Highland had approximately $83.6 million in assets and $72.9 million in deposits. The acquisition of Highland complemented our existing banking branches and expanded our presence in our target market.

      In December 2003, we acquired Jacksonville, which had $467.6 million in assets and $399.8 million in deposits at the time of acquisition. The acquisition of Jacksonville added nine banking branches in and around the Tyler/ Jacksonville, Texas area.

      On February 29, 2004, we acquired Lost Pines, which had approximately $40.3 million in assets and $36.5 million in deposits at the date of acquisition. The acquisition of Lost Pines expands our presence in the outlying areas of the Austin, Texas market.

Business Activities

      Our banking services are concentrated in mortgage banking, community banking, residential construction lending and mortgage banker finance product lines.

      We originate, acquire and sell residential mortgage loans. We focus on originating single family mortgages, for sale into the secondary market, that conform in credit characteristics to secondary marketing standards and criteria set by government sponsored enterprises, and on acquiring loans for our portfolio, targeting high quality borrowers with high credit ratings. We believe that mortgage loans to high quality borrowers with high credit ratings can provide us with better returns on a portfolio basis than loans in the “conforming” mortgage loan market because of our comprehensive credit evaluation and risk-based pricing. Our product types include FHA/ VA insured mortgages, “alternate A” or expanded criteria mortgages, FNMA/ FHLMC conventional mortgages and jumbo mortgage loans to high credit quality borrowers. We currently originate mortgage loans through two channels, retail and wholesale, and acquire mortgage loans through our correspondents. The earnings that we derive from our origination channels are based on the interest spread on our mortgage loans held for sale and the gain from the subsequent sale of these loans into the secondary market. We intend to expand our mortgage banking business by increasing the loans originated through our retail and wholesale channels through the addition of loan officers and locations. For the year ended December 31, 2003, approximately 80% of our interest income came from mortgage banking activities, including approximately 71% from our portfolio loans and approximately 9% from our origination activities.

      Retail Mortgage Origination. We currently originate mortgage loans directly to borrowers through our community banking locations and through our retail mortgage offices located in 16 states throughout the United States. Since the inception of this product niche in January 2003, we have expanded the number of our offices from three to 34 at the end of December 2003. Through these offices, as of December 31, 2003, we had originated $188.6 million in mortgage loans since January 1, 2003, $51.5 million of which was in the fourth quarter of 2003.

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      We believe that our retail mortgage office structure provides us with a low fixed cost method of originating mortgage loans. This structure is set up so that each mortgage loan manager is compensated based solely on the mortgage office’s profitability. For each loan originated, the mortgage office receives a credit, which is similar to a fee paid to a mortgage loan broker, and is charged an administration fee to cover our processing costs for that loan. All direct expenses of the mortgage office are charged to that office and the mortgage office manager’s compensation is the net income generated by that mortgage office. This allows us to compete at the point of sale to the consumer while minimizing the fixed costs found in a traditional retail mortgage origination network. We monitor the profitability of each mortgage office and expect to minimize our exposure by closing those mortgage offices that do not meet their profitability goals. Most of our retail mortgage office leases are short term, and we utilize third party providers for our closing and post closing functions, which gives us the flexibility to scale our mortgage origination business to the volumes that we are originating at any given time.

      Through these offices, we interact with our borrowers with the assistance of loan officers who facilitate the efficient processing and closing of the loans. In addition, we intend to reach new and existing retail loan customers through direct-to-the-customer tools, such as the Internet, direct mail and advertising in selected print media. Furthermore, our mortgage loan officers obtain business by developing and nurturing a referral network of realtors, real estate attorneys, builders and accountants.

      Wholesale Mortgage Origination. Wholesale mortgage origination refers to the origination of mortgage loans with the assistance of mortgage companies or mortgage brokers. The loans are originated and closed in either our name or, under certain circumstances, the assisting entity’s name with immediate assignment to us. We currently originate wholesale residential mortgage loans in Texas and California, and may expand on a nationwide basis. We believe the wholesale origination of loans represents an efficient way for us to originate loans. During the year ended December 31, 2003, we originated $103.2 million in mortgage loans through our wholesale office in California and our corporate office in Houston, Texas.

      In the wholesale origination process, the mortgage company or mortgage broker identifies applicants, gathers required information and documents, and acts as our liaison with the borrower during the lending process. We provide updated pricing for our mortgage loan products to these entities on a daily basis. Once a completed mortgage application is presented to us, our staff underwrites it according to our standard credit criteria.

      Prior to starting a relationship with a wholesale originator, we conduct due diligence on the entity. Our due diligence includes reviewing their financial condition, running credit and fraud checks on their principals, checking business references and verifying with the applicable regulators that a broker is in good standing. Once approved, we require that the entity sign an agreement that governs the mechanics of doing business with us and that sets forth the representations and warranties the broker makes regarding each loan submitted to us.

      Correspondent Acquisitions. We acquire mortgage loans through correspondent relationships we have with financial institutions, mortgage companies and mortgage brokers. These entities originate, fund and bundle mortgages with the intent to sell them to us. When acquiring loans on a correspondent basis, we commit to purchase the loan prior to the closing of the mortgage based upon predetermined and agreed upon criteria. As of December 31, 2003, we had purchased approximately $1.4 billion of single family mortgage loans since January 1, 2003, and intend in the future to continue to purchase recently originated loans from larger financial institutions, mortgage companies and investment banks on an opportunistic basis. These purchases allow us to obtain residential mortgage loans for our portfolio without the cost of originating them ourselves.

      Loan Disposition. We currently sell a majority of the mortgage loans we originate into the secondary market under normal customary terms, and may in the future sell some loans through securitizations. We typically sell fixed-rate loans into the secondary market, but may also from time to time sell adjustable-rate loans. The majority of our sales are made under mandatory delivery agreements with major financial institutions, including the Federal National Mortgage Association, or FNMA, for whom we are an approved seller/servicer, the Federal Home Loan Mortgage Corporation, or FHLMC, and Countrywide Home Loans

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      Our community banking operations offer a wide variety of small business and consumer banking products, including consumer checking, money market accounts, certificates of deposit, auto loans, home improvement loans, small business loans, small commercial real estate loans and mortgage loans. Currently, our branch network consists of 13 branches, four located in the Austin, Texas area and nine located in Tyler, Texas and the surrounding area. All of our branch locations are full service branches and offer a full range of deposits and loans.

      We intend to aggressively grow our community banking activities through the establishment of new banking branches, acquisitions, direct mail and online banking. Our community banking strategy is focused on expanding our presence by acquiring and establishing new banking branches in growing Texas markets outside the state’s principal metropolitan areas. A key part of our strategy is to hire experienced local bankers in those markets with extensive ties in the community. We employ competitive pricing policies, advertising and customer service to attract and retain deposits and to provide superior service in the markets we serve. In this regard, we attempt to price our deposits at competitive rates. As a result, we have experienced a steady growth in deposits. As of December 31, 2003, total deposits from our community banking products totaled $565.4 million, including $399.8 million acquired from Jacksonville on December 30, 2003. Interest expense relating to those deposits represented approximately 12% of our total interest expense for the year ended December 31, 2003. Interest income on our community banking products was approximately 5% of our total interest income for the same period.

      On April 30, 2003, we closed our acquisition of Highland, located in Kingsland, Texas. At the time of the acquisition, Highland had approximately $83.6 million in assets and $72.9 million in deposits. Highland’s wholly-owned subsidiary, Highland Lakes Bank, or Highland Bank, was a Texas state bank that operated one branch in Kingsland, Texas. This acquisition complemented our existing banking branches and expanded our presence in our target market.

      On December 30, 2003 we acquired Jacksonville, a Texas-based savings and loan holding company with approximately $467.6 million in assets and $399.8 million in deposits as of the date of the acquisition. Jacksonville’s wholly-owned subsidiary, Jacksonville Savings Bank, S.S.B., or Jacksonville Bank, was a Texas state savings bank that operated nine community banking branches in and around Tyler, Texas. Jacksonville provides community banking products, originates single family residential mortgage loans and, to a lesser extent, multi-family and commercial real estate, construction, land, business and consumer loans. As a result of this acquisition, we added nine community banking branches and increased our deposits by approximately $399.8 million. The Jacksonville acquisition provides us with a community-based banking presence in a growing region of the Texas market. In addition, Jacksonville’s products complement our niche products. We expect to be able to build upon the base that Jacksonville provides us.

      On February 29, 2004, we acquired Lost Pines, a Texas-based bank holding company with approximately $40.3 million in assets and $36.5 million in deposits at the date of acquisition. Lost Pines’ wholly-owned subsidiary, Lost Pines National Bank, was a national bank that operated two community banking branches outside of Austin, Texas. Lost Pines provides community banking products and originates commercial real estate and commercial loans. The Lost Pines acquisition complements our existing community banking branches and expands our presence in the outlying areas of the Austin, Texas market.

      We will continue to seek opportunities to acquire financial institutions that are consistent with our strategy of growing our community banking.

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      The focus of our residential construction lending business is financing the construction of multiple single-family detached dwellings in established subdivisions. We have expanded our geographical scope from Texas to include Arizona, Florida, Georgia, Nevada and Washington, and currently provide residential construction loans from our corporate offices in Houston, Texas, and our regional offices in Phoenix, Arizona and Orlando, Florida. We intend to extend our single-family construction operations in other desirable markets in order to further diversify our portfolio geographically.

      The builders we target for financing are medium size builders that construct at least 50 homes each year. In order to be approved for a construction loan, we require that builders satisfy specific qualification requirements, including reputation in the community, speculative inventory levels, geographic area concentration and other factors. As of December 31, 2003, we had $291.7 million in residential construction loans committed, of which $161.8 million were outstanding. For the year ended December 31, 2003, we derived approximately 8% of our total interest income from residential construction lending products.

      Residential construction lending generally entails a higher degree of risk than traditional mortgage lending, including the risk of a general downturn in the builder’s local economy, interest rate increases and misrepresentation by the builders of the completion status of the home against which loan funds have been drawn.

      We utilize certain lending practices to reduce these risks, including pricing all residential construction loans based on a risk adjusted return on capital and underwriting them based on debt/net worth, cash flow coverage, loan to value and loan to cost ratios, interest reserve coverage, experience of management, inventory turnover by subdivision and guarantees. We monitor the ongoing financial condition of the builder and the status of construction by regular review of periodic builder reports and financials and site inspection of the actual construction. We approve draws only after third party on-site inspections and review of subdivision performance and borrowers’ inventory. We believe these requirements significantly reduce the potential for misdirected advances to other areas of the builder’s business.

      Mortgage banker finance is a new product that we began to offer in July 2003. We provide small- and medium-sized mortgage companies with credit facilities, including secured warehouse lines of credit, repurchase agreements, and working capital credit lines. We also offer these companies a complete line of fee-based cash management products tailored to their business, including balance reporting, online banking, cash management and custody services. In addition to providing interest income, we expect the mortgage banker finance business to give us an excellent source of deposits generated by our cash management products.

      These loans are subject to the risk that the collateral may be fraudulently or improperly documented. Additionally, mortgage banking companies are generally more thinly capitalized than other commercial borrowers.

      To reduce these risks we have assembled a team of experienced mortgage banker finance professionals to manage this business. To date, we have established the necessary procedures, controls, and systems to operate this business, including taking control of the mortgage collateral and employing field auditors to examine our mortgage banking clients. As of December 31, 2003, we had $20.0 million in warehouse lines committed of which $3.7 million was outstanding.

      Our target customers are existing mortgage banking companies that have an excellent track record in the mortgage business. We approve potential mortgage banker finance customers and determine advance rates for loans based on a number of factors, including credit performance, experience, perceived interest rate risk, liquidity risk, and risks associated with the particular mortgage loans originated by the mortgage banking firm.

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      In the past we have engaged to a limited extent in multi-family lending. Currently, we believe that, due to the affordability of single family homes, multi-family lending does not meet our risk profile and we do not intend to pursue opportunities in this product line. However, we may in the future make multi-family loans, including small multi-family mortgages and small multi-family housing construction loans if the market for these types of loans improves.

      If we begin to offer this product again, we intend to originate multi-family loans primarily to fund existing projects and new construction, and would expect to offer long-term financing for established, operating multi-family properties and short-term financing for construction, acquisition, and rehabilitation.

Underwriting and Risk Management

      We originate and purchase loans in accordance with the underwriting criteria described below. Generally, our underwriting guidelines are designed to help us evaluate a borrower’s credit history and capacity to repay the loan, the value of the property, if any, that will secure the loan, and the adequacy of such property as collateral for the loan.

      Currently, we underwrite every loan we originate or purchase, other than certain purchased single family loans that contain homogeneous characteristics. This means we thoroughly review the borrower’s credit history, financial documents and appraisal for accuracy and completeness. Our underwriting standards are applied in accordance with applicable federal and state laws and regulations.

      For originated residential mortgage loans, we use standardized secondary market underwriting and credit criteria in order to ensure the quality of the asset. In addition, we review credit scores derived from the application of one or more nationally recognized credit scoring models. We also require a qualified appraisal of the mortgaged property, conforming to FNMA and FHLMC standards. Each appraisal includes a market data analysis based on recent sales of comparable homes in the area and a replacement cost analysis based on the current cost of building a similar home. The appraisal may not be more than 180 days old on the day the loan is originated.

      For purchased single family residential mortgage loan packages, we classify the loan package into “A” quality and “Alt-A” quality. As of December 31, 2003, the majority of our purchased loan packages were “A” quality. For the loan package to be classified as “A” quality it must meet the following criteria: for owner occupied loans, first mortgage loans, one or two unit dwellings; no loans that exceed an 80% loan-to-value ratio; loans greater than $650,000 must have a 65% loan-to-value ratio or less; and cash out refinance loans cannot exceed a 75% loan-to-value ratio. In addition, no more that 10% of the loan package may have the following characteristics on a combined basis: a loan-to-value ratio greater than 90%, negative amortization, be a condominium, be located in a depressed residential market or be from the same zip code.

      We underwrite loan packages that meet the “A” criteria using stratified statistical sampling. Loans that fall into the “Alt-A” classification must be underwritten using the standards for “A” loans or reviewed for mitigating factors from data supplied and warranted by the seller. Our management credit committee is presented with and approves the level of underwriting on each loan package.

      For residential construction, commercial real estate loans and commercial loans, we focus on a borrower’s ability to make principal and interest payments and the value of the collateral securing the underlying loans. We use debt/net worth, cash flow coverage, experience of management and guarantees. Independent appraisers generally perform on-site inspections and valuations of the collateral for commercial real estate loans.

      We underwrite our consumer loans for vehicles and other consumer durables using credit scoring, collateral value and relationships. We utilize the same underwriting standards for home improvement and lot loans as we do for our residential mortgages.

      A management credit committee appointed by the bank’s board of directors sets our underwriting guidelines and credit policies. The bank’s management credit committee consists of the bank’s Chief

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      All loans, except for single family loans and consumer loans, must be recommended by the loan officer and the relevant managing director and be approved by the management credit committee. The chief credit officer or any two members of the management credit committee may nevertheless disapprove a loan that satisfied the underwriting standards.

      Residential construction, commercial real estate and mortgage banker finance loans less than $500,000 and business loans less than $250,000 can be approved by the individual loan officer, the product managing director plus either the bank’s Chief Executive Officer or the Chief Executive Officer’s designee. All loans that are approved outside of the management credit committee must be ratified at the next regularly scheduled meeting. Loans greater than $5 million, except for residential construction loans and consumer loans where the limit is $7.5 million and $500,000, respectively, must be approved by the bank’s board of directors’ credit committee.

      The bank’s board credit committee is comprised of Lewis S. Ranieri, Alan E. Master, John B. Selman, William B. Rhodes, Anthony J. Nocella and Robert E. Rhoades.

      In addition to applying standard criteria and a centralized approval process to ensure loans are thoroughly underwritten, we also tie our loan production managers’ compensation to profitability by compensating them for overall profitability and not just the volume of the loans they originate. We hold back a portion of their compensation until the end of the year, netting the payout to the performance of their profit center. We believe this will result in our originated loans being of a higher quality than if the managers’ compensation were tied solely to loan volume.

      Finally, in order to monitor our overall credit exposure, we have established a bank risk management committee that is appointed by the bank’s board of directors to provide an oversight function for the credit review and risk management process. The bank’s risk management committee is comprised of the bank’s Chief Executive Officer, the Chief Financial Officer, the Managing Director — Mortgage Banking, the Managing Director — Credit and Administration, the Managing Director — Commercial Lending, the Managing Director — Austin Banking and a Senior Vice President — Finance. This committee is charged with the review of asset classifications, review of individual portfolio risks (including loan type concentrations, loan size, geographic concentrations, and demographic and economic conditions), approval of changes to our credit policies and approval of the methodology and level of the allowance for loan losses. This committee monitors delinquencies, specific loan performance and negative or adverse economic trends. The committee also monitors our geographic limitation policy that limits the amount of assets that can be in any one state to 25% of total assets, except for California, which is limited to 35%, and Texas, which is unlimited. This policy is designed to limit the exposure that we have to any one region.

Competition

      We face substantial competition for loans and deposits as well as other sources of funding in our markets. We compete in all of our lending lines of business with thrifts, commercial banks, credit unions, mortgage companies and specialty finance companies, many of which operate nationwide lending networks. In each case we must compete on the basis of service quality, product offerings and rates.

      We also compete for funding. We compete at our thirteen banking branch locations for deposits from local customers. We also must compete nationwide for deposits to fund our lending activities. We compete for deposits with thrifts, commercial banks and credit unions and our deposit products must compete with the investment products offered by a broad variety of financial institutions including thrifts, commercial banks, credit unions, brokerage firms, investment banks, insurance companies and other financial services companies, many of which are substantially larger and have more resources than us.

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      Economic factors, along with legislative and technological changes, will have an ongoing impact on the competitive environment within the financial services industry. As an active participant in the financial markets, we strive to anticipate and adapt to dynamic and competitive conditions, but there can be no assurances as to their impact on our future business. In order to compete with other competitors in our markets, we attempt to use to the fullest extent possible the flexibility which our independent status permits, including an emphasis on personalized service, local promotional activity and community involvement.

Regulation and Supervision

      The company and BK2 Holdings, Inc., its intermediate subsidiary, are registered savings and loan holding companies and are subject to Office of Thrift Supervision, or OTS, and the Texas Savings and Loan Department, or TSLD, regulation, examination, supervision and reporting requirements.

      The bank is a Texas-chartered, federally-insured state savings bank and is subject to the regulation, examination and reporting requirements of the TSLD. The Federal Deposit Insurance Corporation, or FDIC, also has regulatory and examination authority respecting the bank. The bank’s deposits are insured by the FDIC through the Bank Insurance Fund, or BIF. As a subsidiary of a savings and loan holding company, the bank is also subject to certain federal and state restrictions in its dealings with the company and affiliates thereof.

      The bank is a member of the Federal Home Loan Bank, or FHLB, of Dallas, which is one of 12 regional FHLBs that administer programs in support of the home financing credit function of savings institutions and commercial banks. Each FHLB serves as a source of liquidity for its members within its assigned region. It makes loans (i.e., advances) to members in accordance with policies and procedures established by its Board of Directors. On September 2, 2003, the FHLB of Dallas implemented its new capital stock structure. Under this structure, the bank is required to maintain 0.20% of its assets at each December 31 in FHLB of Dallas capital stock, which is a member’s minimum required investment, plus 4.25% of its advances outstanding. At December 31, 2003, the bank held $32.4 million in FHLB of Dallas capital stock, compared to its requirement of $31.0 million.

      The supervision and regulation of savings and loan holding companies and their subsidiaries is intended primarily for the protection of depositors, the deposit insurance funds of the FDIC and the banking system as a whole, and not for the protection of the shareholders or creditors of savings and loan holding companies. The banking agencies have broad enforcement power over savings and loan holding companies and banks, including the power to restrict operations and impose substantial fines and other penalties for violations of laws and regulations.

      Below is a brief description of certain laws and regulations which relate to the regulation of the company and the bank. The description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.

      Overview. The company has elected to treat the bank as a “savings association” for purposes of Section 10 of the Home Owners’ Loan Act, or HOLA. As a result, the company is a registered savings and loan holding company and subject to the regulation, examination, supervision and reporting requirements of the OTS and TSLD. The company must file a quarterly report with the OTS that describes its financial condition.

      For the company to continue to be regulated as a savings and loan holding company, the bank must continue to be a “qualified thrift lender.” Otherwise, the company could be required to register as a bank holding company and become subject to regulation by the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended. Regulation as a bank holding company could be adverse to the company’s business plans and impose additional and possibly more burdensome regulatory requirements on the company. See “— The Bank — Qualified Thrift Lender Test.”

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      Scope of Permissible Activities. As a savings and loan holding company, the company is permitted to engage in activities considered to be “financial in nature,” incidental to such financial activity or complementary to a financial activity. Activities that are considered to be financial in nature include lending activities, insurance underwriting, insurance agency activity, investment advisory services, securities underwriting, merchant banking activities and activities authorized by the Board of Governors of the Federal Reserve System as permissible for bank holding companies under the Bank Holding Company Act (subject, in the case of bank holding company activities, to OTS approval). The company is also permitted to engage in additional activities listed in HOLA or OTS regulations, the most significant of which relate to real estate ownership, development and management activities.

      If the OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings institution (i.e., a savings association or savings bank), the OTS may impose such restrictions as it deems necessary to address such risk, including limiting:

	•	payment of dividends by the savings institution;
	•	transactions between the savings institution and its affiliates; and
	•	any activities of the savings institution that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings institution.

      Restrictions on Acquisitions. Except under limited circumstances, savings and loan holding companies are prohibited from acquiring, without prior approval of the OTS:

	•	control of any other savings institution or savings and loan holding company or all or substantially all the assets thereof; or
	•	more than 5% of the voting shares of a savings institution or holding company of a savings institution which is not a subsidiary.

      In evaluating an application by a holding company to acquire a saving association, the OTS must consider the financial and managerial resources and future prospects of the holding company and savings association involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors. Acquisitions which result in a savings and loan holding company controlling savings associations in more than one state are generally prohibited, except in supervisory transactions involving failing savings associations or based on specific state authorization of such acquisitions. Except with the prior approval of the OTS, no director or officer of a savings and loan holding company or person owning or controlling by proxy or otherwise more than 25% of such company’s voting stock may acquire control of any savings institution, other than a subsidiary savings institution, or of any other savings and loan holding company.

      Change of Control. Federal law requires, with few exceptions, OTS approval (or, in some cases, notice and effective clearance) prior to any acquisition of control of the company. Among other criteria, under OTS regulations, “control” is conclusively presumed to exist if a person or company acquires, directly or indirectly, more than 25% of any class of voting stock of the savings association or holding company. Control is also presumed to exist, subject to rebuttal, if an acquiror acquires more than 10% of any class of voting stock (or more than 25% of any class of stock) and is subject to any of several “control factors,” including, among other matters, the relative ownership position of a person, the existence of control agreements and board composition.

      Change in Management. If a savings and loan holding company is in a “troubled condition,” as defined in the OTS regulations, it is required to give 30 days’ prior written notice to the OTS before adding or replacing a director, employing any person as a senior executive officer or changing the responsibility of any senior executive officer so that such person would assume a different senior executive position. The OTS then has the opportunity to disapprove any such appointment.

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      Limitations on Dividends. The company is a legal entity separate and distinct from the bank. The company’s principal source of revenue consists of dividends from the bank. The payment of dividends by the bank is subject to various regulatory requirements, including a minimum of 30 days’ advance notice to the OTS of any proposed dividend to the company.

      Other limitations may apply depending on the size of the proposed dividend and the condition of the bank. See “— The Bank — Restrictions on Capital Distributions.”

      Texas Regulations. Under the Texas Savings Bank Act, or TSBA, each registered holding company, such as the company, is required to file reports with the TSLD as required by the Texas Savings and Loan Commissioner, or the Commissioner, and is subject to such examination as the Commissioner may prescribe.

      The bank is required to file reports with the TSLD and the FDIC concerning its activities and financial condition, in addition to obtaining regulatory approvals prior to entering into certain transactions, such as any merger or acquisition with another institution. The regulatory system to which the bank is subject is intended primarily for the protection of the deposit insurance fund and depositors, not stockholders. The regulatory structure also provides the TSLD and the FDIC with substantial discretion in connection with their supervisory and enforcement functions. The TSLD and the FDIC conduct periodic examinations of the bank in order to assess its compliance with federal and state regulatory requirements. As a result of such examinations, the TSLD and the FDIC may require various corrective actions.

      Virtually every aspect of the bank’s business is subject to numerous federal and/or state regulatory requirements and restrictions with respect to such matters as the nature and amounts of loans and investments that may be made, the issuance of securities, the amount of cash reserves that must be established against deposits, the establishment of branches, mergers, non-banking activities and other operations. Numerous laws and regulations also set forth special restrictions and procedural requirements with respect to the extension of credit, credit practices, the disclosure of credit terms and discrimination in credit transactions.

      Regulatory Capital Requirements. Federally insured, state-chartered banks are required to maintain minimum levels of regulatory capital. These standards generally are as stringent as the comparable capital requirements imposed on national banks. The FDIC also is authorized to impose capital requirements in excess of these standards on individual banks on a case-by-case basis.

      Under current FDIC regulations, the bank is required to comply with three separate minimum capital adequacy requirements: a “Tier 1 capital ratio” and two “risk-based” capital requirements. “Tier 1 capital” generally includes common stockholders’ equity (including retained earnings), qualifying noncumulative perpetual preferred stock and any related surplus, and minority interests in the equity accounts of fully consolidated subsidiaries, minus intangible assets, other than properly valued mortgage servicing assets, nonmortgage servicing assets and purchased credit card relationships up to certain specified limits and minus net deferred tax assets in excess of certain specified limits.

      Leverage Capital Ratio. FDIC regulations establish a minimum 3.0% ratio of Tier 1 capital to total assets, as defined, for the most highly-rated, state-chartered, FDIC-supervised banks and a minimum 4.0% ratio of Tier 1 capital to total assets, as defined, for all other state-chartered, FDIC-supervised banks. Under FDIC regulations, highly-rated banks are those that the FDIC determines are not anticipating or experiencing significant growth and have well diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity and good earnings. As of December 31, 2003, the minimum leverage capital ratio for capital adequacy purposes for the bank was 4.0% and its actual leverage capital ratio was 11.91%.

      Risk-Based Capital Requirements. The risk-based capital requirements contained in FDIC regulations generally require the bank to maintain a minimum ratio of Tier 1 capital to risk-weighted assets of at least 4.0% and a ratio of total capital to risk-weighted assets of at least 8.0%.

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      For purposes of the risk-based capital requirements, “total capital” means Tier 1 capital plus supplementary (or Tier 2) capital, so long as the amount of supplementary (or Tier 2) capital that is used to satisfy the requirement does not exceed the amount of Tier 1 capital. Supplementary (or Tier 2) capital includes, among other things, cumulative perpetual preferred stock, non-cumulative perpetual preferred stock where the dividend is reset periodically, long-term preferred stock (original maturity of at least 20 years), mandatory convertible subordinated debt, perpetual subordinated debt and mandatory redeemable preferred stock. Intermediate-term preferred stock and other subordinated debt is includable in Tier 2 capital up to 50% of Tier 1 capital. The allowance for loan and lease losses up to a maximum of 1.25% of risk-weighted assets is included in Tier 2 capital, as are certain unrealized gains in equity securities and unrealized gains or losses in other assets. To determine the amount of capital required, assets and certain off-balance sheet items are assigned to various categories, with each category having a different “risk weighting.” As of December 31, 2003, the bank’s Tier 1 capital to risk-weighted assets ratio was 16.27% and its total risk-based capital to risk weighted assets ratio was 16.70%.

      Corrective Measures for Capital Deficiencies. The Prompt Corrective Action regulations, which were promulgated to implement certain provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991, or FDICIA, also effectively impose capital requirements on state-chartered banks, by subjecting banks with less capital to increasingly stringent supervisory actions. For purposes of the Prompt Corrective Action regulations, a bank is “undercapitalized” if it has a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 4%, or a leverage capital ratio of less than 4% (or less than 3% if the bank has received a composite rating of 1 in its most recent examination report and is not experiencing significant growth). A bank is “adequately capitalized” if it has a total risk-based capital ratio of 8% or higher, a Tier 1 risk-based capital ratio of 4% or higher, a leverage ratio of 4% or higher (3% or higher if the bank received a composite rating of 1 in its most recent examination report and is not experiencing significant growth), and does not meet the definition of a “well capitalized” bank. A bank is “well capitalized” if it has a total risk-based capital ratio of 10% or higher, a Tier 1 risk-based capital ratio of 6% or higher, a leverage capital ratio of 5% or higher, and is not subject to any written requirement to meet and maintain any higher capital level(s).

      Under the regulation, “well capitalized” institutions are not subject to any brokered deposit limitations, while “adequately capitalized” institutions are able to accept, renew or roll over brokered deposits only (i) with a waiver from the FDIC, and (ii) subject to the limitation that they do not pay an effective yield on any such deposit which exceeds by more that 75 basis points (a) the effective yield paid on deposits accepted in its normal market area, or (b) the national rate paid on deposits of comparable maturity for deposits accepted outside the institution’s normal market area. “Undercapitalized” institutions will not be permitted to accept brokered deposits and are subject to certain limitations on interest rates that may be paid in connection with any deposit solicitation.

      Under the provisions of FDICIA and the Prompt Corrective Action regulations, an “undercapitalized” bank is subject to a limit on the interest it may pay on deposits. Also, an undercapitalized bank cannot make any capital distribution, including paying a dividend (with some exceptions), or pay any management fee (other than compensation to an individual in his or her capacity as an officer or employee of the bank). Such a bank also must submit a capital restoration plan to the FDIC for approval, restrict total asset growth and obtain regulatory approval prior to making any acquisition, opening any new branch office or engaging in any new line of business. An undercapitalized bank may also be subject to other, discretionary, regulatory actions. Additional mandatory and discretionary regulatory actions apply to “significantly undercapitalized” and “critically undercapitalized” banks. Failure of a bank to maintain the required capital could result in such bank being transferred to new owners in a supervisory transaction or being declared insolvent and closed.

      FDIC Insurance Premiums. The deposits of the bank are insured to the maximum extent permitted by the BIF. As the insurer, the FDIC is authorized to conduct examinations of, and to 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 threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings institutions.

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      The FDIC has implemented a risk-based assessment system under which FDIC-insured depository institutions pay annual premiums at rates based on their risk classification. A bank’s risk classification is based on its capital levels and the level of supervisory concern the bank poses to the regulators. Institutions assigned to higher risk classifications (that is, institutions that pose a greater risk of loss to their respective deposit insurance funds) pay assessments at higher rates than institutions that pose a lower risk. A decrease in the bank’s capital ratios or the occurrence of events that have an adverse effect on the bank’s asset quality, management, earnings or liquidity could result in a substantial increase in deposit insurance premiums paid by the bank, which would adversely affect the bank’s earnings. In addition, the FDIC can impose special assessments in certain instances. The range of assessments in the risk-based system is a function of the reserve ratio in the BIF. The current range of BIF assessments is between 0% and 0.27% of deposits because the BIF reserve ratio was greater than 1.25% when the ratios were set. In 2002, the BIF reserve ratio fell below 1.25%, creating the possibility that the FDIC would raise assessment rates, but in 2003 the ratio was slightly above 1.25%. If the ratio were to fall below that level again, the FDIC would consider whether to levy higher assessments. Congress has also recently considered proposals that would increase assessments on certain types of rapidly growing institutions.

      Federal law aimed at recapitalizing the Savings Association Insurance Fund requires, among other things, that banks insured under the BIF pay a portion of the interest due on bonds that were issued to replace funds paid out for the failure of insured thrifts by the Federal Savings and Loan Insurance Corporation in 1987. With respect to the assessment of the bond obligations, the BIF rate was 0.0152%% of deposits for the fourth quarter of 2003 and is adjusted quarterly to reflect changes in the assessment bases of the respective funds based on quarterly Call Report submissions.

      Safety and Soundness Standards. The FDIC and the other federal bank regulatory agencies have established guidelines for safety and soundness, addressing operational and managerial standards, as well as compensation matters for insured financial institutions. Institutions failing to meet these standards are required to submit compliance plans to their appropriate federal regulators. The FDIC and the other agencies have also established guidelines regarding asset quality and earnings standards for insured institutions. The bank believes that it is in compliance with these guidelines and standards.

      Activities and Investments of Insured State-Chartered Banks. The activities and equity investments of FDIC-insured, state-chartered banks are presumptively limited by federal law to those that are permissible for national banks. An insured state bank generally may not acquire or retain any equity investment of a type, or in an amount, that is not permissible for a national bank. The FDIC has authority, however, to allow a state-chartered non-member bank to engage in activities or make investments not permissible for national banks. An insured state bank is permitted to, among other things:

	•	acquire or retain a majority interest in a subsidiary;
	•	invest as a limited partner in a partnership, the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank’s assets;
	•	acquire up to 10% of the voting stock of a company that solely provides or reinsures directors’ and officers’ liability insurance; and
	•	acquire or retain the voting shares of a depository institution if certain requirements are met.

      Qualified Thrift Lender Test. The bank is required to meet a qualified thrift lender test under both federal and state law. This test requires a savings bank to have at least 65% of its portfolio assets, as defined by regulation, in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings bank may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code of 1986, as amended. Under either test, such assets primarily consist of residential housing related loans and investments. As of December 31, 2003, the bank met the test.

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      Under federal law, any savings association (including a state savings bank that is treated as a savings association under Section 10 of HOLA) that fails to meet the qualified thrift lender test must convert to a bank charter, other than a savings bank charter, unless it requalifies as a qualified thrift lender and thereafter remains a qualified thrift lender. However, any savings bank which the OTS has deemed to be a savings association upon application by such bank, such as the bank, is precluded from requalifying for five years. Because of the five-year ban on requalification, a state savings bank that fails the OTS test must divest all investments and cease all activities not permissible for a national bank within three years. Within one year after the failure, the holding company of a state savings bank must register with the Federal Reserve Board as a bank holding company and become subject to all restrictions on bank holding companies administered by the Federal Reserve Board. New investments and activities are immediately limited to those permissible for both a savings association and a national bank. The savings bank is also limited to national bank branching rights in its home state. In addition, the savings bank is immediately ineligible to receive any new FHLB borrowings and is subject to national bank limits on payment of dividends.

      Restrictions on Acquisitions. There are restrictions under federal and Texas law regarding the acquisition of control of the bank. Federal and Texas laws generally provide that no company, directly or indirectly or acting in concert with one or more persons, or through one or more subsidiaries, or through one or more transactions, may acquire control of a savings bank at any time without prior approval of the appropriate regulatory agencies. The concept of acting in concert is very broad under these laws. In addition, federal and state laws require that, prior to obtaining control of a savings bank, a person, other than a company, must give prior notice and have received no objection to such acquisition of control and/or make an application to the appropriate regulatory agencies and receive approval to effect the acquisition.

      Potential Enforcement Actions. Insured depository institutions and their institution-affiliated parties may be subject to potential enforcement actions by the FDIC and the TSLD for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. The OTS may also bring enforcement actions based on its supervision of the company as a savings and loan holding company or on its regulation of capital distributions by the bank. Enforcement actions may include the appointment of a conservator or receiver, the issuance of a cease-and-desist order that can be judicially enforced, the termination of insurance of deposits (in the case of the bank), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the imposition of restrictions and sanctions under the prompt corrective action provisions of the FDICIA. Management of the bank knows of no pending or threatened enforcement actions against the bank.

      Liquidity. The bank is required to maintain a balance of “liquid assets” (cash, balances in a Federal Reserve Bank, and other readily marketable investments, including unencumbered federal government sponsored enterprises) equal to 10% of average daily deposits for the most recently completed calendar quarter. As of December 31, 2003, the bank was in compliance with this requirement.

      Restrictions on Capital Distributions. The bank is required to provide to the OTS not less than 30 days’ advance notice of the proposed declaration by its board of directors of any dividend on its capital stock. The OTS may object to the payment of the dividend on safety and soundness grounds. In addition, the bank would be subject to a more stringent OTS review if a proposed distribution would cause the bank to become under-capitalized or would exceed current net income plus retained net income for the previous two years or if the OTS did not regard the bank as well capitalized or well managed. The bank is currently not subject to this more stringent review.

      Texas law permits the bank to pay dividends out of current or retained income in cash or additional stock so long as the savings bank meets its capital requirements.

      The FDIC prohibits an insured depository institution from paying dividends on its capital stock or interest on its capital notes or debentures (if such interest is required to be paid only out of net profits) or distributing any of its capital assets while it remains in default in the payment of any assessment due the FDIC. The bank is not in default in any assessment payment to the FDIC.

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      Federal Reserve System. The Federal Reserve Board requires all depository institutions to maintain reserves against their transaction accounts (primarily checking accounts) and non-personal time deposits. As of December 31, 2003, the bank was in compliance with such requirements.

      The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy applicable liquidity requirements. Because required reserves must be maintained in the form of vault cash or a non-interest-bearing account at a Federal Reserve Bank, the effect of this reserve requirement is to reduce a bank’s earning assets. The amount of funds necessary to satisfy this requirement has not had a material effect on the bank’s operations.

      Restrictions on Transactions with Affiliates and Insiders. Transactions between the bank and its nonbanking affiliates, including the company, are subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W. In general, Section 23A imposes limits on the amount of such transactions, and also requires certain levels of collateral for loans to affiliated parties. It also limits the amount of advances to third parties which are collateralized by any securities or obligations or the securities or obligations of any of the company’s nonbanking subsidiaries.

      Affiliate transactions are also subject to Section 23B of the Federal Reserve Act which generally requires that certain transactions between the bank and its affiliates be on terms substantially the same, or at least as favorable to the bank, as those prevailing at the time for comparable transactions with or involving other nonaffiliated persons.

      The restrictions on loans to directors, executive officers, principal shareholders and their related interests (collectively referred to herein as “insiders”) contained in the Federal Reserve Act and Federal Reserve Regulation O apply to all insured institutions and their subsidiaries and holding companies. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions.

      The USA PATRIOT Act of 2001. The USA PATRIOT Act requires financial institutions to prohibit correspondent accounts with foreign shell banks, establish an anti-money laundering program that includes employee training and an independent audit, follow minimum standards for identifying customers and maintaining records of the identification information and make regular comparisons of customers against agency lists of suspected terrorists, their organizations and money launderers.

      Privacy Regulation. The company and its subsidiaries are subject to numerous privacy-related laws and their implementing regulations, including but not limited to Title V of the Gramm-Leach-Bliley Act, the Fair Credit Reporting Act, the Electronic Fund Transfer Act, the Right to Financial Privacy Act, the Children’s Online Privacy Protection Act, and other federal and state privacy and consumer protection laws. Those laws and the regulations promulgated under their authority can limit, under certain circumstances, the extent to which financial institutions may disclose nonpublic personal information that is specific to a particular individual to affiliated companies and nonaffiliated third parties. Moreover, the bank is required to establish and maintain a comprehensive Information Security Program in accordance with the Interagency Guidelines Establishing Standards for Safeguarding Customer Information. The program must be designed to:

	•	insure the security and confidentiality of customer information;
	•	protect against any anticipated threats or hazards to the security or integrity of such information; and
	•	protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.

      In addition, the Federal Trade Commission has recently implemented a nationwide “do not call” registry that allows consumers to prevent unsolicited telemarketing calls. Millions of households already have placed their telephone numbers on this registry.

      Texas Savings Bank Law. As a Texas-chartered savings bank, the bank is subject to regulation and supervision by the TSLD under the TSBA. The TSBA contains provisions governing the incorporation and

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      The bank is required under the TSBA to comply with certain capital requirements established by the TSLD. The TSBA also restricts the amount the bank can lend to one borrower to that permitted to national banks, which is generally not more than 15% of the bank’s unimpaired capital and unimpaired surplus and, if such loans are fully secured by readily marketable collateral, an additional 10% of unimpaired capital and unimpaired surplus. The TSLD generally examines the bank once every year and the current practice is for the TSLD to conduct a joint examination with the FDIC. The TSLD monitors the extraordinary activities of the bank by requiring that the bank seek the TSLD’s approval for certain transactions, such as the establishment of additional offices, a reorganization, merger or purchase and assumption transaction, changes of control, or the issuance of capital obligations. The TSLD may intervene in the affairs of a savings bank if the savings bank, or its director, officer or agent has engaged in an unsafe and unsound practice, violated the savings bank’s articles of incorporation, violated a statute or regulation, filed materially false or misleading information, committed a criminal act or a breach of fiduciary duty, or if the savings bank is, or is in imminent danger of becoming, insolvent.

Consumer Protection Regulations

      The bank is subject to many federal consumer protection statutes and regulations including, but not limited to, the following:

      The Truth-in-Lending Act. The Truth-in-Lending Act, or TILA, is designed to ensure that credit terms are disclosed in a way that permits consumers to compare credit terms more readily and knowledgeably. As a result of the TILA, all creditors must use the same credit terminology and expressions of rates, the annual percentage rate, the finance charge, the amount financed, the total of payments, and the payment schedule.

      The Fair Housing Act. The Fair Housing Act regulates many practices, including making it unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap, or familial status.

      The Fair Credit Reporting Act. The Fair Credit Reporting Act, or FCRA, includes extensive rules governing credit reporting agencies and entities that collect information from consumers in connection with extensions of credit.

      The Fair and Accurate Credit Transactions Act of 2003. The Fair and Accurate Credit Transactions Act of 2003, or FACT, was enacted into law on December 4, 2003. FACT makes permanent the preemption of state laws contained in FCRA that was set to expire on January 1, 2004. On December 16, 2003, the Federal Reserve Board and the Federal Trade Commission issued an interim final rule establishing December 31, 2003 as the effective date for provisions of FACT that determine the relationship between the FCRA and state laws. In addition to preemption, FACT also imposes new requirements, including new restrictions on information sharing with affiliates for the purpose of making marketing solicitations, new consumer protection measures in the area of identity theft, a new requirement to provide a notice of action taken when a consumer is offered credit that is materially less favorable than the most favorable terms available to a substantial proportion of a lender’s customers. FACT also gives consumers the right to see their credit score and to receive a free annual copy of their credit report. On February 5, 2004, the Federal Trade Commission and the Federal Reserve Board announced the approval of final rules that establish March 31, 2004 as the effective date for the provisions of FACT that do not require significant changes to business operations and December 31, 2004 as the effective date for other provisions of FACT that may require significant changes to business procedures.

      The Equal Credit Opportunity Act. The Equal Credit Opportunity Act prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national

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      The Real Estate Settlement Procedures Act. The Real Estate Settlement Procedures Act, or RESPA, requires lenders to provide borrowers with disclosures regarding the nature and cost of real estate settlements. The RESPA is applicable to all federally related mortgage loans. A “federally related mortgage loan” includes any loan secured by a first or subordinate lien on residential real property designed for occupancy by one-to-four families, including a refinancing of an existing loan secured by the same property, if:

	•	the loan is made by any lender, the deposits of which are federally insured, or any lender that is regulated by a federal agency;
	•	the loan is insured, guaranteed or supplemented by a federal agency;
	•	the loan is intended to be sold to the FNMA, the GNMA, or the FHLMC; or
	•	the loan is made by any creditor who makes or invests in residential real estate loans aggregating more than $1 million per year.

      In 2002, the Department of Housing and Urban Development, or HUD, undertook to substantially revise the rules implementing the RESPA, which specifies disclosures and procedures for mortgage lenders to provide their customers. The HUD proposal would modify the disclosures provided to mortgage customers. In response to criticism of the HUD’s initial proposals, the agency in 2003 determined not to adopt final rules and now is reconsidering them. It is uncertain whether new rules will be proposed and whether any revised RESPA rules adopted will be favorable or adverse to us.

      The Home Mortgage Disclosure Act. The Home Mortgage Disclosure Act is intended to provide public information that can be used to help determine whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located and to assist in identifying possible discriminatory lending patterns.

      The Community Reinvestment Act. The Community Reinvestment Act, or CRA, is intended to encourage insured depository institutions, while operating safely and soundly, to help meet the credit needs of their communities. The CRA specifically directs the federal regulatory agencies, in examining insured depository institutions, to assess the institution’s record of helping to meet the credit needs of their entire community, including low- and moderate-income neighborhoods, consistent with safe and sound banking practices. The CRA further requires the agencies to take a financial institution’s record of meeting its community credit needs into account when evaluating applications for, among other things, domestic branches, consummating mergers or acquisitions, or holding company formations. To evaluate large retail institutions, the agencies apply three tests — the lending, investment, and service tests — to determine an overall CRA rating for the financial institution. We expect that the bank will be considered a large institution for CRA rating purposes by the end of 2004. The ratings range from a high of “outstanding” to a low of “substantial noncompliance.” A bank receiving a “satisfactory” or better rating is deemed in compliance with the CRA.

      The bank’s last public evaluation dated January 7, 2002, issued by its primary federal regulator, the FDIC, rated the bank “satisfactory.”

      The Bank Secrecy Act and Money Laundering Laws. The Bank Secrecy Act, or BSA, requires every financial institution within the United States to file a Currency Transaction Report with the Internal Revenue Service, or IRS, for each transaction in currency of more than $10,000 not exempted by the Treasury Department.

      The Money Laundering Prosecution Improvements Act requires financial institutions, typically banks, to verify and record the identity of the purchaser upon the issuance or sale of bank checks or drafts, cashier’s checks, traveler’s checks, or money orders involving $3,000 or more in cash. Institutions must also verify and record the identity of the originator and beneficiary of certain funds transfers.

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      Electronic Fund Transfer Act. The Electronic Fund Transfer Act, or EFTA, provides a basic framework establishing the rights, liabilities, and responsibilities of participants in “electronic fund transfer systems,” defined to include automated teller machine transfers, telephone bill-payment services, point-of-sale terminal transfers, and preauthorized transfers from or to a consumer’s account (for example, direct deposit of social security payments). Its primary objective is to protect the rights of individuals using these systems. The EFTA limits a consumer’s liability for certain unauthorized electronic fund transfers and requires certain error resolution procedures.

      The Expedited Funds Availability Act. The Expedited Funds Availability Act seeks to insure prompt availability of funds deposited into a customer’s account and to expedite the return of checks.

      The Truth-in-Savings Act. The Truth-in-Savings Act, or TISA, is principally a disclosure law, the purpose of which is to encourage comparative shopping for deposit products. The common denominator used by the TISA to facilitate comparison shopping of interest payable on deposit accounts is the annual percentage yield.

      The bank attempts in good faith to assure compliance with the requirements of the consumer protection statutes to which it is subject, as well as the regulations that implement the statutory provisions. The requirements are complex, however, and even inadvertent non-compliance could result in civil and, in some cases, criminal liability.

      Legislative and Regulatory Proposals. Proposals to change the laws and regulations governing the capital, operations and taxation of, and federal insurance premiums paid by, savings banks and other financial institutions and companies that control such institutions are frequently raised in Congress, state legislatures and before the FDIC and other bank regulatory authorities. The likelihood of any major changes in the future and the impact such changes might have on us or the bank are impossible to determine. Similarly, proposals to change the accounting treatment applicable to savings banks and other depository institutions are frequently raised by the SEC, the FDIC, the IRS and other appropriate authorities, including, among others, proposals relating to fair market value accounting for certain classes of assets and liabilities. The likelihood and impact of any additional future accounting rule changes and the impact such changes might have on us or the bank are impossible to determine at this time.

Employees

      As of December 31, 2003, all of our 399 employees were employed by the bank. We have entered into an arrangement with Administaff Companies II, L.P., to provide personnel management services to us. This service is provided through a co-employment relationship between us and Administaff, under which all of our employees are employed by both us and Administaff, and we have outsourced the entirety of our human resources function to Administaff.

Risk Factors

      Our business is subject to certain risks. See “Cautionary Note Regarding Forward-Looking Information” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in this report for a discussion of certain of these risks.

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Executive Officers of the Registrant

      The names, ages as of December 31, 2003, recent business experience and positions or offices held by each of the executive officers of Franklin Bank Corp are as follows:

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