UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

Commission file number:  000-50518

Franklin Bank Corp.

Registrant’s telephone number, including area code:
(713) 339-8900

Securities registered pursuant to Section 12(b) of the Act:
None

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

Common Stock, $.01 Par Value,
(Title of each class)

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 [X] No [  ]

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

     As of May 14, 2004, there were 21,225,263 shares of the registrant’s common stock, $.01 par value, outstanding.

FRANKLIN BANK CORP.
INDEX TO FORM 10-Q

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

FRANKLIN BANK CORP.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)

See notes to interim consolidated financial statements.

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FRANKLIN BANK CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)

See notes to interim consolidated financial statements.

2

FRANKLIN BANK CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)

See notes to interim consolidated financial statements.

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FRANKLIN BANK CORP.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
(unaudited)

1. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying Consolidated Financial Statements are unaudited and include the accounts of Franklin Bank Corp. (the “company”), a subsidiary of the company, and Franklin Bank (the “bank”) and have been prepared in accordance with accounting principles generally accepted in the United States of America. The information included in these interim financial statements reflects all adjustments that are, in the opinion of management, necessary for a fair presentation of all periods presented. Such adjustments are of a normal recurring nature unless otherwise disclosed in the Form 10-Q. Operating results for the three months ended March 31, 2004 are not necessarily indicative of the results that may be expected for the entire year or any interim period. The interim financial information should be read in conjunction with Franklin Bank Corp’s 2003 Annual Report on Form 10-K. Certain prior period amounts have been reclassified to conform to the current period presentation and had no effect on net income or stockholders’ equity.

Stock—Based Compensation

     The company measures its employee stock-based compensation using the intrinsic value based method of accounting under the provisions of AICPA Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, no compensation cost has been recognized for the company’s stock options. Pro-forma information regarding net income is required under SFAS No. 123, “Accounting for Stock-Based Compensation” and has been determined as if the company accounted for its employee stock-option plans under the fair value method of SFAS No. 123. The fair value of options at the date of grant was estimated using a Black-Scholes option-pricing model, which requires use of highly subjective assumptions. Also, employee stock options have characteristics that are significantly different from those of traded options, including vesting provisions and trading limitations that impact their liquidity. Because employee stock options have differing characteristics, and changes in the subjective input assumptions can materially affect the fair- value estimate, the Black-Scholes valuation model does not necessarily provide a reliable measure of the fair value of the employee stock options. The following table shows the pro forma amounts attributable to stock-based employee compensation cost for the periods presented (dollars in thousands except per share data):

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     Basic and diluted earnings per share were computed as follows (dollars in thousands, except per share data):

     Options to purchase 298,748 shares of common stock at an exercise price of $10.00 were excluded from the computation of diluted EPS for the three months ended March 31, 2003, because the options’ exercise prices were greater than the fair market value of the common stock.

3. Goodwill and Intangible Assets

     The changes in the carrying amount of goodwill for the year ended December 31, 2003 and the three months ended March 31, 2004 are as follows (in thousands):

     Intangible assets other than goodwill include core deposit premiums paid and mortgage servicing rights. The changes in other intangible assets are as follows (in thousands):

     During the first quarter of 2003 certain estimates regarding goodwill related to the acquisition of Franklin Bank were finalized and the core deposit intangible study based on the actual deposit accounts acquired was finalized. The study valued the core deposit intangible at $204,000 as compared to the estimated valuation of $1.6 million at acquisition, which was based on the asset and liability tables for the first quarter of 2002 as published by the Office of Thrift Supervision. As a result, $237,000 of amortization recorded in 2002 was reversed in 2003.

     At March 31, 2004 and December 31, 2003, the fair value of servicing rights retained from single family loan sales totaled $1.2 million and $1.1 million related to $128.9 million and $117.8 million, respectively, of principal serviced for others. The bank did not securitize any financial assets during the three months ended March 31, 2004 or the year ended December 31, 2003.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Note Regarding Forward Looking Information

     A number of the presentations and disclosures in this report, including any statements preceded by, followed by or which include the words “may,” “could,” “should,” “will,” “would,” “hope,” “might,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “assume” or similar expressions constitute forward-looking statements. These forward-looking statements, implicitly and explicitly, include information concerning possible or assumed future results of operations, trends, financial results and business plans, including those relating to:

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earnings growth;

•

revenue growth;

•

future acquisitions;

•

origination volume in our mortgage business;

•

non-interest income levels, including fees from product sales;

•

credit performance on loans made or acquired by us;

•

tangible capital generation;

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margins on sales or securitizations of loans;

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cost and mix of deposits;

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market share;

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expense levels;

•

results from new business initiatives in our community banking business; and

•

other business operations and strategies.

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     Forward-looking statements involve inherent risks and uncertainties that are subject to change based on various important factors, some of which are beyond our control. We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. Such factors include, but are not limited to:

	•		risks and uncertainties related to acquisitions and divestitures, including related integration and restructuring activities, and changes in our mix of product offerings;
	•		prevailing economic conditions;

•

changes in interest rates, loan demand, real estate values, and competition, which can materially affect origination levels and gains on sale results in our mortgage business, as well as other aspects of our financial performance;

•

the level of defaults, losses and prepayments on loans made by us, whether held in portfolio, sold in the whole loan secondary markets or securitized, which can materially affect charge-off levels, require credit loss reserve levels and our periodic valuation of our retained interests from securitizations we may engage in;

•

changes in accounting principles, policies and guidelines;

•

adverse changes or conditions in capital or financial markets, which can adversely affect our ability to sell or securitize loan originations on a timely basis or at prices which are acceptable to us, as well as other aspects of our financial performance;

•

actions by rating agencies and the effects of these actions on our businesses, operations and funding requirements;

•

changes in applicable laws, rules, regulations or practices with respect to tax and legal issues, whether of general applicability or specific to us and our subsidiaries; and

•

other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services.

     In addition, we regularly explore opportunities for acquisitions of and hold discussions with financial institutions and related businesses, and also regularly explore opportunities for acquisitions of liabilities and assets of financial institutions and other financial services providers. We routinely analyze our lines of business and from time to time may increase, decrease or terminate one or more activities.

     If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, the forward-looking information and statements contained in this report. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. The forward-looking statements are made as of the date of this report, and we do not intend, and assume no obligation, to update the forward-looking statements or to update the reasons why actual results could differ from those projected in the forward-looking statements. All forward-looking statements contained in this report are expressly qualified by these cautionary statements.

Critical Accounting Policies

     Certain of the company’s accounting policies, by their nature, involve a significant amount of subjective and complex judgment by our management. These policies relate to our allowance for credit losses, rate lock commitments and goodwill and other intangible assets. We believe that our estimates, judgments and assumptions are reasonable given the circumstances at the time of the estimate. However, actual results could differ significantly from these estimates and assumptions which could have a material impact on our

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financial condition and results of operations. These policies are described in further detail in the Company’s 2003 Annual Report of Form 10-K under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies”.

Significant Transactions

     On February 29, 2004, we acquired Lost Pines for approximately $7.0 million in cash, including $168,000 in direct acquisition costs. Lost Pines was a Texas-based bank holding company with approximately $39.9 million in assets and $36.2 million in deposits at the date of the acquisition.

     On December 30, 2003, we acquired Jacksonville for approximately $69.4 million in cash, including $1.6 million in direct acquisition costs. Jacksonville was a Texas-based savings and loan holding company with approximately $467.6 million in assets and $399.8 million in deposits at the time of the acquisition.

     In December 2003, the company sold 10,508,016 shares of common stock at an initial offering price of $14.50 per share. Underwriting discounts and other issuance costs totaling $12.1 million are included as a reduction to paid-in capital on our consolidated statement of stockholders’ equity. Of the proceeds, approximately $67.7 million was used to acquire Jacksonville, approximately $52.3 million was contributed to the capital of the bank for general corporate purposes and approximately $6.9 million was used to fund the acquisition of Lost Pines.

     On April 30, 2003, we completed our acquisition of Highland. Total consideration for Highland was $18.6 million, including $15.0 million in cash, $2.7 million in shares of our common stock, valued at $10.00 per share, and $1.0 million in direct acquisition costs. At the time of the acquisition, Highland’s total assets were approximately $83.6 million and deposits were approximately $72.9 million. The acquisition of Highland complemented our existing community banking branches and expanded our presence in our target Texas market.

Results of Operations

     The company derives a majority of its income from interest earned on its loan portfolio. Funding for these assets was sourced from the cash raised in the private stock offering completed in November 2002 and from community banking deposits, brokered deposits and borrowings from the Federal Home Loan Bank. The funds raised in the company’s initial public offering in December 2003 were utilized to acquire Jacksonville and Lost Pines and for general corporate purposes. The company’s mortgage banking activities, which generate gains on sales of single family loans and securities and loan fees, also contribute to our net income.

     Net income was $4.3 million, or $0.20 per diluted share, for the three months ended March 31, 2004, compared to $533,000, or $0.05 per share, for the three months ended March 31, 2003. The results from operations for the three months ended March 31, 2004 include activity for Lost Pines beginning March 1, 2004.

     Net interest income. Net interest income increased $11.4 million to $14.2 million for the three months ended March 31, 2004, compared to $2.8 million for the same period in 2003. The increase was due to a $1.7 billion increase in average interest-earning assets, resulting primarily from purchases and originations of single family loans and an increase in residential construction loans. Additionally, we recognized the effect of the Jacksonville acquisition for the full quarter, which added approximately $458.2 million of average interest-earning assets during the three months ended March 31, 2004. The net yield increased 57 basis points, from 1.92% for the three months ended March 31, 2003 to 2.49% for the three months ended March 31, 2004. This increase was primarily due to the acquisition of Jacksonville, which had an approximate 19 basis point positive impact on our net yield, an increase in commercial and consumer loans, and slower prepayments on our single family mortgage portfolio, resulting in a reduction in premium amortization.

     The table below illustrates the company’s average balances and related income, expense, and weighted average yields and rates for the three months ended March 31, 2004 and 2003. Balances for both periods

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