Exhibit 13

1^st FRANKLIN FINANCIAL CORPORATION

ANNUAL REPORT

DECEMBER 31, 2011

TABLE OF CONTENTS

The Company

  1

Chairman's Letter

  2

Selected Consolidated Financial Information

  3

Business

  4

Management's Discussion and Analysis of Financial Condition and

     Results of Operations

12

Report of Independent Registered Public Accounting Firm

20

Consolidated Financial Statements

21

Directors and Executive Officers

43

Corporate Information

43

Ben F. Cheek, Jr.  Office of the Year

45

THE COMPANY

1^st Franklin Financial Corporation, a Georgia corporation, has been engaged in the consumer finance business since 1941, particularly in making direct cash loans and real estate loans.  As of December 31, 2011 the business was operated through 106 branch offices in Georgia, 39 in Alabama, 39 in South Carolina, 32 in Mississippi, 27 in Louisiana and 15 in Tennessee.  Also on that date, the Company had 1,074 employees.

As of December 31, 2011, the resources of the Company were invested principally in loans, which comprised 68% of the Company's assets.  The majority of the Company's revenues are derived from finance charges earned on loans and other outstanding receivables.  Our remaining revenues are derived from earnings on investment securities, insurance income and other miscellaneous income.

To our Investors, Bankers, Co-Workers, Customers and Friends:

1^st Franklin Financial celebrated its 70^th year in business during 2011 and I am pleased to report that it was another banner year for our company.  As you review the information following this letter, you will find that we enjoyed record financial results and that the overall strength of our balance sheet and capital structure places us on a solid foundation for future growth and expansion.  Our assets at the end of 2011 stood at $464.9 million which was an increase of 10% over 2010 and our retained earnings which were added to the capital base grew by 15%.  Each of these figures is important as we set our plans and goals for the years ahead.

The year 2011 was certainly a year with many highlights and rewarding accomplishments and I would like to mention and reflect on just a few that seem particularly significant.

·

Funds provided by our investors in our Investment Center grew by $20.8 million which funded all of our lending activity for the year.

·

Six (6) new branch offices were opened, Bastrop, Thibodaux and LaPlace in Louisiana, Hartsville in South Carolina, Philadelphia in Mississippi and Dublin in Georgia.

·

We continued to leverage technology by replacing a substantial number of the workstations and printer/scanner/ copiers in the branches.

·

We began working to re-design and update our “1ffc.com” website which will launch in 2012.

·

We began exploring new marketing initiatives through email marketing and messages.

·

A “Live check” product was offered to our loan customers and it was enthusiastically received.

·

More on-line services such as on-line statements, applications and payment options were offered to both our loan customers and investors.

·

And, a continuing effort by our Management Team in cooperation with our two national trade associations was made in order to educate members of Congress and federal regulators about our industry.

Naturally, we are proud of these accomplishments and we look forward to building on these and others as we move further into 2012.

“Positive people – positive results” was our theme for 2011 and I feel that the year’s results reflect the positive commitment to excellence that was made by all of the “Friendly Franklin Folks.”  1^st Class customer service is the goal that we strive for each day and that is a continuing goal as we look forward to a challenging and exciting future.

As always, my thanks go out to each of you, our investors, our bankers, our co-workers and other friends.  We treasure your confidence and support and look forward to 2012 and beyond as we follow our new theme “A legacy of service and uncompromising integrity.”

Very sincerely yours,                        

/s/ Ben F. Cheek, III

Ben F. Cheek, III                             

   Chairman of the Board and CEO            

SELECTED CONSOLIDATED FINANCIAL INFORMATION

Set forth below is selected consolidated financial information of the Company. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the more detailed consolidated financial statements and notes thereto included herein.

Year Ended December 31

2011

2010

2009

 2008

 2007

Selected Income Statement Data:

(In 000's, except ratio data)

Revenues:

Interest and Finance Charges

$

111,730

$

103,150

$

99,337

$

98,212

$

91,415

Insurance

39,440

36,521

35,375

35,191

33,799

Other

6,724

5,790

5,134

5,207

5,083

Net Interest Income

100,089

90,711

85,655

83,484

75,669

Interest Expense

11,641

12,439

13,682

14,728

15,746

Provision for Loan Losses

19,009

20,907

29,302

25,725

21,434

Income Before Income Taxes

32,229

23,423

11,050

13,761

15,754

Net Income

29,123

20,683

8,373

10,665

12,205

Ratio of Earnings to

  Fixed Charges

3.42

2.67

1.72

1.86

1.92

As of December 31

2011

2010

 2009

 2008

 2007

Selected Balance Sheet Data:

(In 000's, except ratio data)

Net Loans

$

317,959

$

294,974

$

279,093

$

285,580

$

276,655

Total Assets

464,885

422,064

396,425

389,422

402,454

Senior Debt

243,801

208,492

186,849

169,672

182,373

Subordinated Debt

46,870

59,780

74,884

86,605

91,966

Stockholders’ Equity

153,585

132,710

117,115

116,236

109,841

Ratio of Total Liabilities

  to Stockholders’ Equity

2.03

2.18

2.38

2.35

2.66

References in this Annual Report to “1^st Franklin”, the “Company”, “we”, “our” and “us” refer to 1^st Franklin Financial Corporation and its subsidiaries.

1^st Franklin is engaged in the consumer finance business, particularly in making consumer loans to individuals in relatively small amounts for relatively short periods of time, and in making first and second mortgage loans on real estate in larger amounts and for longer periods of time.  We also purchase sales finance contracts from various retail dealers.  At December 31, 2011, direct cash loans comprised 90%, real estate loans comprised 5% and sales finance contracts comprised 5% of our outstanding loans, respectively.

In connection with our business, we also offer optional credit insurance coverage to our customers when making a loan.  Such coverage may include credit life insurance, credit accident and health insurance, and/or credit property insurance.  Customers may request credit life insurance coverage to help assure any outstanding loan balance is repaid if the customer dies before the loan is repaid or they may request accident and health insurance coverage to help continue loan payments if the customer becomes sick or disabled for an extended period of time.  Customers may also choose property insurance coverage to protect the value of loan collateral against damage, theft or destruction.  We write these various insurance products as an agent for a non-affiliated insurance company.  Under various agreements, our wholly-owned insurance subsidiaries, Frandisco Life Insurance Company and Frandisco Property and Casualty Insurance Company, reinsure the insurance coverage on our customers written on behalf of this non-affiliated insurance company.

Earned finance charges generally account for the majority of our revenues.  The following table shows the sources of our earned finance charges in each of the past five years:

Year Ended December 31

 2011

    2010

    2009

    2008

    2007

(in thousands)

Direct Cash Loans

$101,683

$  92,915

$88,648

$85,392

$77,472

Real Estate Loans

3,539

3,631

3,676

3,857

3,878

Sales Finance Contracts

     3,637

     3,929

   4,171

   5,186

   5,814

   Total Finance Charges

$108,859

$100,475

$96,495

$94,435

$87,164

Our business consists mainly of making loans to salaried people and other wage earners who depend primarily on their earnings to meet their repayment obligations.  We make direct cash loans primarily to people who need money for some non-recurring or unforeseen expense, including for debt consolidation or to purchase household goods such as furniture and appliances.  These loans are generally repayable in 6 to 60 monthly installments and generally do not exceed $10,000 principal amount.  The loans are generally secured by personal property (other than certain household goods), motor vehicles and/or real estate. We believe that the interest and fees we charge on these loans are in compliance with applicable federal and state laws.

First and second mortgage loans on real estate are made to homeowners who typically use funds to improve their property or who wish to restructure their financial obligations.  We generally make such loans in amounts from $3,000 to $50,000 and with maturities of 35 to 180 months. We believe that the interest and fees we charge on these loans are in compliance with applicable federal and state laws.

Our decision making on loan originations is based on perceived (i) ability to pay, (ii) creditworthiness, (iii) stability, (iv) willingness to pay and (v) collateral security.  The Company does not utilize credit score modeling or risk based pricing in its loan decision making.  Prior to the making of a loan, we complete what the Company considers to be a relevant credit investigation on a potential customer.  Such investigation primarily focuses on a evaluation of a potential borrower’s income, existing total indebtedness, length and stability of employment, trade or other references, debt payment history (including related collections), existing credit and any other relationships such potential borrower may have with the Company.  The Company considers and evaluates a potential borrower’s debt-to-disposable income ratio after giving effect to the potential loan and may, in certain instances and depending upon the overall results of the credit evaluation process, require additional internal review and supervisory approvals prior to approving a proposed loan.  

Sales finance contracts are those contracts which are purchased from retail dealers.  These contracts have maturities that generally range from 3 to 60 months and generally do not individually exceed $10,000 in principal amount. We believe that the interest rates we charge on these contracts are in compliance with applicable federal and state laws.

1^st Franklin competes with several national and regional finance companies, as well as a variety of local finance companies, in the communities we serve.  Competition is based primarily on interest rates and terms offered and on customer service, as well as, to some extent, reputation.  We believe that our emphasis on customer service helps us compete effectively in the markets we serve.

Because of our reliance on the continued income stream of most of our loan customers, our ability to continue the profitable operation of our business depends to a large extent on the continued employment of these people and their ability to meet their obligations as they become due. Therefore, a continuation of the current uncertain economic conditions, a further increase in unemployment, or continued increases in the number of personal bankruptcies within our typical customer base, may have a material adverse effect on our collection ratios and profitability.

The average annual yield on loans we make (the percentage of finance charges earned to average net outstanding balance) has been as follows:

DESCRIPTION OF LOANS

Year Ended December 31

2011

2010

2009

2008

2007

DIRECT CASH LOANS:

Number of Loans  Made to

New Borrowers

41,821

35,474

29,786

30,871

33,354

Number of Loans Made to

Former Borrowers

33,240

30,370

26,666

28,945

31,050

Number of Loans Made to

Present Borrowers

159,177

141,688

132,195

133,902

132,251

Total Number of Loans Made

234,238

207,532

188,647

193,718

196,655

Total Volume of Loans

Made (in 000’s)

$550,120

$485,604

$437,575

$453,968

$441,462

Average Size of Loan Made

$2,349

$2,340

$2,320

$2,343

$2,245

Number of Loans Outstanding

171,984

160,352

152,602

151,515

148,178

Total Loans Outstanding (in 000’s)

$376,568

$347,445

$327,425

$324,996

$303,679

Percent of Total Loans Outstanding

90%

89%

87%

87%

84%

Average Balance on

Outstanding Loans

$2,190

$2,167

$2,146

$2,145

$2,049

REAL ESTATE LOANS:

Total Number of Loans Made

520

525

668

790

893

Total Volume of Loans Made (in 000’s)

$  9,010

$  8,429

$  8,703

$14,448

$14,924

Average Size of Loan Made

$17,327

$16,055

$13,029

$18,288

$16,713

Number of Loans Outstanding

1,776

1,905

2,015

2,032

2,007

Total Loans Outstanding (in 000’s)

$22,123

$22,967

$24,336

$24,176

$25,052

Percent of Total Loans Outstanding

5%

6%

7%

6%

7%

Average Balance on

Outstanding Loans

$12,457

$12,056

$12,078

$11,897

$12,482

SALES FINANCE CONTRACTS:

Number of Contracts Purchased

13,939

14,947

13,212

15,407

20,548

Total Volume of Contracts

Purchased (in 000’s)

$25,281

$26,266

$23,789

$30,909

$40,054

Average Size of Contract

Purchased

$1,814

$1,757

$1,801

$2,006

$1,949

Number of Contracts Outstanding

13,096

14,343

14,340

16,041

19,528

Total Contracts

Outstanding (in 000’s)

$19,765

$21,695

$23,071

$27,586

$31,747

Percent of Total Loans Outstanding

5%

5%

6%

7%

9%

Average Balance on

Outstanding Contracts

$1,509

$1,513

$1,609

$1,720

$1,626

LOANS ORIGINATED, ACQUIRED, LIQUIDATED AND OUTSTANDING

Year Ended December 31

2011

2010

2009

2008

2007

LOANS ACQUIRED

Direct Cash Loans

$

550,078

$

483,989

$

437,323

$

453,968

$

441,462

Real Estate Loans

9,010

8,429

8,703

14,448

14,924

Sales Finance Contracts

23,705

24,555

21,372

30,232

38,997

Net Bulk Purchases

1,618

3,326

2,669

677

1,057

Total Loans Acquired

$

584,411 

$

520,299 

$

470,067 

$

499,325 

$

496,440 

LOANS LIQUIDATED *

Direct Cash Loans

$

520,997

$

465,584

$

435,146

$

432,651

$

405,782

Real Estate Loans

9,854

9,798

8,543

15,324

13,436

Sales Finance Contracts

27,211

27,642

28,304

35,070

42,031

Total Loans Liquidated

$

558,062

$

503,024

$

471,993

$

483,045

$

461,249

LOANS OUTSTANDING

Direct Cash Loans

$376,568

$347,445

$

327,425

$

324,996

$

303,679

Real Estate Loans

22,123

22,967

24,336

24,176

25,052

Sales Finance Contracts

19,765

21,695

23,071

27,586

31,747

Total Loans Outstanding

$418,456

$392,107

$

374,832

$

376,758

$

360,478

UNEARNED FINANCE CHARGES

Direct Cash Loans

$

46,297

$

42,724

$

40,002

$

39,933

$

35,850

Real Estate Loans

317

284

208

41

118

Sales Finance Contracts

2,593

2,803

3,121

4,058

4,753

Total Unearned

Finance Charges

$

49,207

$

45,811

$

43,331

$

44,032

$

40,721

DELINQUENCIES

We classify delinquent accounts at the end of each month according to the number of installments past due at that time, based on the then-existing terms of the contract.  Accounts are classified in delinquency categories based on the number of days past due.  When three installments are past due, we classify the account as being 60-89 days past due; when four or more installments are past due, we classify the account as being 90 days or more past due.  Once an account becomes greater than 149 days past due, our charge off policy governs when the account must be charged off.  For more information on our charge off policy, see Note 2 of the accompanying audited consolidated financial statements.

In connection with any bankruptcy court initiated repayment plan, the Company effectively resets the delinquency rating of each account to coincide with the court initiated repayment plan.  Effectively, the account’s delinquency rating is changed thereafter under normal grading parameters.  The following table shows the number of loans in bankruptcy in which the delinquency rating was reset to coincide with a court initiated repayment plan.

2011

2010

2009

2008

2007

  Number of Bankrupt Delinquency Resets

1,601

2,022

2,224

1,936

1,882

Beginning January 1, 2010, the Company also began tracking the dollar amount of loans in bankruptcy in which the delinquency rating was reset.  During 2011 and 2010, the Company reset the delinquency rating to coincide with court initiated repayment plans on bankrupt accounts with principal balances totaling $5.3 million and $5.9 million, respectively.  This represented approximately 1.37% and 1.64% of the average principal loan portfolio outstanding during 2011 and 2010, respectively.

The following table shows the amount of certain classifications of delinquencies and the ratio of such delinquencies to related outstanding loans:

As of December 31

2011

2010

2009

2008

2007

(in thousands, except % data)

DIRECT CASH LOANS:

60-89 Days Past Due

$

5,712

$

5,766

$

6,382

$

7,247

$

6,589

Percentage of Principal Outstanding

1.53%

1.67%

1.97%

2.25%

2.19%

90 Days or More Past Due

$

11,911

$

12,596

$

15,158

$

16,407

$

13,100

Percentage of Principal Outstanding

3.19%

3.66%

4.67%

5.10%

4.36%

REAL ESTATE LOANS:

60-89 Days Past Due

$

115

$

271

$

278

$

282

$

179

Percentage of Principal Outstanding

.53%

1.20%

1.16%

1.19%

.73%

90 Days or More Past Due

$

656

$

561

$

585

$

480

$

452

Percentage of Principal Outstanding

3.01%

2.48%

2.44%

2.02%

1.84%

SALES FINANCE CONTRACTS:

60-89 Days Past Due

$

204

$

266

$

346

$

518

$

468

Percentage of Principal Outstanding

1.04%

1.22%

1.50%

1.90%

1.48%

90 Days or More Past Due

$

492

$

644

$

739

$

1,080

$

1,089

Percentage of Principal Outstanding

2.49%

2.97%

3.21%

3.96%

3.45%

LOSS EXPERIENCE

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

Year Ended December 31

2011

2010

2009

2008

2007

 (in thousands, except % data)

DIRECT CASH LOANS

Average Net Loans

$

305,152

$

282,750

$

274,275

$

266,753

$

242,576

Liquidations

$520,997

$465,584

$435,146

$432,651

$

405,782

Net Losses

$

21,014

$

22,479

$

24,415

$

21,325

$

17,812

Net Losses as % of Average

   Net Loans

6.89%

7.95%

8.90%

7.99%

7.34%

Net Losses as % of Liquidations

4.03%

4.83%

5.61%

4.93%

4.39%

REAL ESTATE LOANS

Average Net Loans

$

22,253

$

23,351

$

24,042

$

25,451

$

25,015

Liquidations

$

9,854

$

9,798

$

8,543

$

15,324

$

13,436

Net Losses (Recoveries)

$

75

$

117

$

84

$

(23)

$

114

Net Losses (Recoveries)

    as a % of Average Net Loans

.34%

.50%

.35%

(.09%)

.46%

Net Losses (Recoveries)

    as a % of Liquidations

.76%

1.19%

.98%

(.15%)

.85%

SALES FINANCE CONTRACTS

Average Net Loans

$

17,863

$

19,369

$

21,334

$

25,486

$

28,721

Liquidations

$

27,211

$

27,642

$

28,304

$

35,070

$

42,031

Net Losses

$

670

$

811

$

1,203

$

1,448

$

1,557

Net Losses as % of Average

    Net Loans

3.75%

4.19%

5.64%

5.68%

5.42%

Net Losses as % of  Liquidations

2.46%

2.93%

4.25%

4.13%

3.70%

ALLOWANCE FOR LOAN LOSSES

We determine the allowance for loan losses by reviewing our previous loss experience, reviewing specifically identified loans where collection is believed to be doubtful and evaluating the inherent risks and changes in the composition of our loan portfolio.  Such allowance is, in our opinion, sufficient to provide adequate protection against probable loan losses in the current loan portfolio.  For additional information about Management’s approach to estimating and evaluating the allowance for loan losses, see Note 2 “Loans” in the Notes to the Consolidated Financial Statements.

SEGMENT FINANCIAL INFORMATION

For additional financial information about our segments, see Note 13 “Segment Financial Information” in the Notes to Consolidated Financial Statements.

CREDIT INSURANCE

We offer optional credit insurance coverage to our customers when making a loan.  Such coverage may include credit life insurance, credit accident and health insurance and/or credit property insurance.  Customers may request credit life insurance coverage to help assure any outstanding loan balance is repaid if the customer dies before the loan is repaid or they may request credit accident and health insurance coverage to help continue loan payments if the customer becomes sick or disabled for an extended period of time.  Customers may also choose property insurance coverage to protect the value of loan collateral against damage, theft or destruction.  We write these various insurance products as an agent for a non-affiliated insurance company.  Under various agreements, our wholly-owned insurance subsidiaries, Frandisco Life Insurance Company and Frandisco Property and Casualty Insurance Company, reinsure the insurance coverage on our customers written on behalf of this non-affiliated insurance company.

REGULATION AND SUPERVISION

In some jurisdictions, we are deemed to operate as a “small loan business.”  Generally, state laws require that each office in which a small loan business is conducted be licensed by the state and that the business be conducted according to the applicable statutes and regulations.  The granting of a license depends on the financial responsibility, character and fitness of the applicant, and, where applicable, the applicant must show evidence of a need through convenience and advantage documentation.  As a condition to obtaining such license, the applicant must consent to state regulation and examination and to the making of periodic reports to the appropriate governing agencies.  Licenses are revocable for cause, and their continuance depends upon an applicant’s continued compliance with applicable laws and in connection with its receipt of a license.  We believe we conduct our business in accordance with all applicable statutes and regulations.  The Company has never had any of its licenses revoked.

We conduct all of our lending operations under the provisions of the Federal Consumer Credit Protection Act (the "Truth-in-Lending Act"), the Fair Credit Reporting Act and the Federal Real Estate Settlement Procedures Act and other federal and state lending laws.  The Truth-in-Lending Act requires us, among other things, to disclose to our customers the finance charge, the annual percentage rate, the total number and amount of payments and other material information on all loans.

A Federal Trade Commission ruling prevents consumer lenders such as the Company from using certain household goods as collateral on direct cash loans.  As a result, we seek to collateralize such loans with non-household goods such as automobiles, boats and other exempt items.

We are also subject to state regulations governing insurance agents in the states in which we sell credit insurance.  State insurance regulations require, among other things, that insurance agents be licensed and limit the premiums that insurance agents can charge.

Changes in the current regulatory environment, or the interpretation or application of current regulations, could impact our business.  While we believe that we are currently in compliance with all regulatory requirements, no assurance can be made regarding our future compliance or the cost thereof.

SOURCES OF FUNDS AND COMMON STOCK MATTERS

The Company is dependent upon the availability of funds from various sources in order to meet its ongoing financial obligations and to make new loans as a part of its business.  Our various sources of funds as a percent of total liabilities and stockholders’ equity and the number of persons investing in the Company's debt securities was as follows:

As of December 31

2011

2010

2009

2008

2007

Bank Borrowings

 --%

 --%

 4%

 6%

4%

Senior Debt

53  

49  

43  

38

41

Subordinated Debt

10  

14  

19  

22

23

Other Liabilities

4  

5  

4  

4  

5

Stockholders’ Equity

  33  

  32  

  30  

  30         

  27

    Total

100%

100%

100%

100%  

100%  

Number of Investors

5,406

5,418 

5,406 

5,508 

5,820 

The average interest rates we pay on borrowings, computed by dividing the interest paid by the average indebtedness outstanding, have been as follows:

Year Ended December 31

2011

2010

2009

2008

2007

Senior Borrowings

4.08%

4.52%

4.93%

4.78%

5.81%

Subordinated Borrowings

  4.20   

5.33   

5.89   

6.27   

6.34

All Borrowings

4.11   

4.74   

5.24   

5.33   

5.98

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

As of December 31

2011

 2010

2009

2008

  2007

Total Liabilities to

Stockholders’ Equity

2.03

2.18

2.38

2.66

2.18

Unsubordinated Debt to

Subordinated Debt plus

Stockholders’ Equity

1.32

1.19

 1.06

 .99

1.19

As of March 29, 2012, all of our common stock was closely held by five related individuals and none of our common stock was listed on any securities exchange or traded on any established public trading market.  The Company does not maintain any equity compensation plans, and did not repurchase any of its equity securities during the most recent fiscal year.  Cash distributions of $51.97 and $29.07 per share were paid in 2011 and 2010, respectively, primarily in amounts to enable the Company’s shareholders to pay their related income tax obligations which arise as a result of the Company’s status as an S Corporation.  No other cash dividends were paid during the applicable periods.  For the foreseeable future, the Company expects to pay annual cash distributions equal to an amount sufficient to enable the Company’s shareholders to pay their respective income tax obligations as a result of the Company’s status as an S Corporation.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s Discussion and Analysis provides a narrative of the Company’s financial condition and performance.  The narrative reviews the Company’s results of operations, liquidity and capital resources, critical accounting policies and estimates, and certain other matters. It includes Management’s interpretation of our financial results, the factors affecting these results and the significant factors that we currently believe may materially affect our future financial condition, operating results and liquidity. This discussion should be read in conjunction with the Company’s consolidated financial statements and notes thereto contained elsewhere in this Annual Report.

Our significant accounting policies are disclosed in Note 1 to the consolidated financial statements.  Certain information in this discussion and other statements contained in this Annual Report which are not historical facts are forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve risks and uncertainties.  Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained herein.  Possible factors which could cause our actual future results to differ from any expectations within any forward-looking statements, or otherwise, include, but are not limited to, our ability to manage liquidity and cash flow, the accuracy of Management’s estimates and judgments, adverse economic conditions including the interest rate environment, unforeseen changes in net interest margin, federal and state regulatory changes, unfavorable outcomes of litigation and other factors referenced in the “Risk Factors” section of the Company’s Annual Report and elsewhere herein, or otherwise contained in our filings with the Securities and Exchange Commission from time to time.

General:

The Company is a privately-held corporation that has been engaged in the consumer finance industry since 1941.  Our operations focus primarily on making installment loans to individuals in relatively small amounts for short periods of time.  Other lending-related activities include the purchase of sales finance contracts from various dealers and the making of first and second mortgage real estate loans.  All our loans are at fixed rates, and contain fixed terms and fixed payments.  We operate branch offices in six southeastern states and had a total of 258 branch locations at December 31, 2011.  The Company and its operations are guided by a strategic plan which includes planned growth through expansion of our branch office network.  The Company expanded its operations with the opening of six new branch offices during the year just ended.  The majority of our revenues are derived from finance charges earned on loans outstanding. Additional revenues are derived from earnings on investment securities, insurance income and other miscellaneous income.    

Financial Condition:

The Company’s consolidated statement of financial position at December 31, 2011 reflects an increase of $42.8 million (10%) in total assets to $464.9 million compared to $422.1 million at December 31, 2010.  Our growth was primarily driven by increases in our loan and investment portfolios.

Loan originations were $584.1 million during 2011 compared to $520.3 million during 2010 representing an increase of $65.7 million or 13%.  As a result of the increase in loan originations, we ended 2011 with a net loan portfolio, net of the allowance for loan losses, of $318.0 million compared to $295.0 million at December 31, 2010.  In addition to the increase in loan originations, a $2.7 million reduction in our allowance for loan losses also contributed to the increase in our net loan portfolio during 2011.  Our allowance for loan losses reflects Management’s estimate of the level of allowance adequate to cover probable losses inherent in our loan portfolio as of the date of the consolidated statement of financial position.  To evaluate the overall adequacy of our allowance for loan losses, we consider the level of loan receivables, historical loss trends, loan delinquency trends, bankruptcy trends and overall economic conditions.  As a result of an overall improvement in the credit quality of the Company’s loan portfolio, Management lowered the allowance for loan losses at December 31, 2011 compared to December 31, 2010.  Management believes the allowance for loan losses, although lowered in 2011, continued to be adequate to cover probable losses; however, changes in trends or deterioration in economic conditions could result in a change in the allowance.  Any increase could have a material adverse impact on our results of operation or financial condition in the future.

An increase in investing activity by the Company’s insurance subsidiaries resulted in a $29.5 million increase (38%) increase in our investment portfolio at December 31, 2011 compared to the prior year end.  The increase in investing activity was due to Management’s effort to transfer surplus funds generated from our insurance subsidiaries during the current year and funds previously held in short-term investments into higher yielding instruments.  Short-term investments declined $19.8 million (73%) as a result of the transfer of funds into our investment securities portfolio.  Management maintains what it believes to be a conservative approach when formulating its investment strategy.  The Company does not participate in hedging programs, interest rate swaps or other activities involving the use of off-balance sheet derivative financial instruments.  The Company’s investment portfolio consists mainly of U.S. Treasury bonds, government agency bonds and various municipal bonds.  Approximately 66% of these investment securities have been designated as “available for sale” with any unrealized gain or loss accounted for in the equity section of the Company’s consolidated statement of financial position, net of deferred income taxes for those investments held by the insurance subsidiaries.  The remainder of the investment portfolio represents securities that are designated “held to maturity”, as Management has both the ability and intent to hold these securities to maturity, and are carried at amortized cost.

Cash and cash equivalents decreased $14.4 million (47%) at December 31, 2011 compared to December 31, 2010.  Funding associated with the increase in our loan portfolio and the aforementioned transfer of surplus funds into investment securities were the primary factors causing the decline.

Other assets increased $2.9 million (20%) at December 31, 2011 compared to the prior year end mainly due to an increase in fixed assets.  The Company purchased approximately 1,100 new computer workstations and over 300 new printers to replace aging equipment in its branch operations.  The new equipment will be depreciated over a four year period.

Senior debt outstanding at December 31, 2011 amounted to $243.8 million compared to $208.5 million at December 31, 2010, representing a $35.3 million (17%) increase.  The increase was mainly due to an increase in sales of certain of the Company’s short-term investment securities.  Offsetting a portion of the increase was a $.9 million reduction in outstanding borrowings against the Company’s credit line.

The Company’s subordinated debt decreased $12.9 million, or 22%, at December 31, 2011 compared to the prior year end as a result of redemptions of such securities by investors under the provisions of these securities.  Due to the low interest rate environment, many of the Company’s investors are opting for the Company’s shorter term senior debt.

As a result of the aforementioned decline in subordinated debt, accrued interest payable thereon was lower at the end 2011.  Accounts payable and accrued expenses decreased $.5 million (2%) at December 31, 2011 compared to the prior year end mainly due to the lower accrued interest.

Results of Operations:

The year ended December 31, 2011 marked the Company’s seventieth year in existence and results of operations were the most successful in its history.  Total revenues reached a record $157.9 million during 2011 compared to $145.5 million during 2010.  Net income earned was $29.1 million and $20.7 million during the same comparable periods, respectively.  The 2011 increase in revenue and net income was mainly due to higher finance charge earnings and insurance earnings.  Lower borrowing costs and credit losses during the current year also contributed to the increase in net income.

Net Interest Income:

A principal component impacting the Company’s operating performance is its net interest income.  It represents the difference between income on earning assets (loans and investments) and the cost of funds on interest bearing liabilities.  The primary categories of our earning assets are loans and investments.  Bank borrowings and debt securities represent a majority of our interest bearing liabilities. Factors affecting our net interest margin include the level of average net receivables and the interest income associated therewith, capitalized loan origination costs and our average outstanding debt, as well as the general interest rate environment.  Volatility in interest rates generally has more impact on the income earned on investments and the Company’s borrowing costs than on interest income earned on loans.   Management does not normally change the rates charged on loans originated solely as a result of changes in the interest rate environment.

Our net interest income increased to $100.1 million during 2011 compared to $90.7 million during 2010 and $85.7 million during 2009.  Higher levels of average net receivables outstanding during 2011 and 2010 resulted in increases in interest income.  Interest income grew $8.6 million (8%) during 2011 compared to 2010, and $3.8 million (4%) during 2010 compared to 2009.

Historical low interest rates have also had a favorable impact on our net interest income.  Although average borrowings were $284.8 million during 2011 compared to $257.8 during 2010 and $253.3 during 2009, interest expense declined.  During 2011, our weighted average borrowing rates declined to 4.09% compared to 4.74% during the prior year.  As a result of the lower rates, interest expense decreased $.8 million during 2011 compared to 2010 and $1.2 million during 2010 compared to 2009.

Net Insurance Income:

The aforementioned increase in average net receivables during the two year period ended December 31, 2011 also led to increases in our net insurance income.  The Company offers certain optional credit insurance products to loan customers.  Growth in our loan portfolio typically leads to increases in insurance in-force as many loan customers elect to purchase the credit insurance coverage offered by the Company.  Net insurance income increased $2.4 million and $1.2 million during 2011 and 2010, respectively.  A reduction in insurance claims expense also contributed to the increase during 2010.

Other Revenue:

The Company, as an agent for a third party, offers auto club memberships to loan customers during the closing of a loan.  The primary revenue category included in other revenue relates to commissions earned by the Company on sales of the auto club memberships.  Higher sales during 2011 and 2010 resulted in the other revenue increasing $.9 million and $.7 million, respectively.

Provision for Loan Losses:

The Company’s provision for loan losses represents net charge offs and adjustments to the allowance for loan losses to cover credit losses inherent in the outstanding loan portfolio at the balance sheet date.  Determining the proper allowance for loan losses is a critical accounting estimate which involves Management’s judgment with respect to certain relevant factors, such as historical and expected loss trends, unemployment rates in various locales, current and expected net charge offs, delinquency levels, bankruptcy trends and overall general economic conditions.  See Note 2, “Loans”, in the accompanying “Notes to Consolidated Financial Statements” for additional discussion regarding the allowance for loan losses.

Our provision for loan losses declined $1.9 million (9%) and $8.4 million (29%) during 2011 and 2010, respectively.  Lower levels of net charge offs and a reduction in our allowance for loan losses during the two respective years led to the decline in our loss provision.  Net charge offs during 2011 were $21.8 million compared to $23.4 million during 2010 and $25.7 million during 2009.  Management reduced the allowance for loan losses during 2011 and 2010 by $2.7 million and $2.5 million, respectively.  The decision to lower the allowance for loan losses was based on favorable trends in the various relevant factors described previously in this report.

We believe that the allowance for loan losses is adequate to cover probable losses inherent in our portfolio; however, because the allowance for loan losses is based on estimates, there can be no assurance that the ultimate charge off amount will not exceed such estimates or that our loss assumptions will not increase.

Operating Expenses:

Operating expenses are comprised of personnel expense, occupancy expense and miscellaneous expenses.  Higher salaries and higher claims expense associated with the Company’s self insured employee medical program contributed to the $3.8 million (7%) increase in personnel expense during 2011 compared to 2010.  Salary increases and higher payroll taxes led to the $3.2 million increase in personnel expense during 2010 compared to 2009.  The successful operating results during 2011 and 2010 resulted in higher levels of accrued incentive awards each year, which also contributed to the increase in personnel expense during the periods.

Higher depreciation expense on equipment due to the aforementioned new computer equipment and printers purchased during the year was one factor causing the $.7 million increase in occupancy expense during 2011 compared to 2010.  Increases in maintenance expenses, telephone expense, utilities expense and rent expense also contributed to the rise in occupancy expenses during the year just ended.  Occupancy expense decreased $.4 million (4%) during 2010 compared to 2009 mainly due to a non-recurring charge incurred during 2009 to buy-out certain operating leases on computer equipment.  Other factors contributing the lower occupancy expense during 2010 were reductions in cost of maintenance agreements on equipment and lower depreciation expense on furniture and fixtures.

Other operating expenses increased $1.3 million (7%) and $.2 million (1%) during 2011 and 2010, respectively.  During 2011, increases in advertising expense, charitable contributions, computer expense, postage, securities sales expense, supplies and training expense were the primary categories causing the increase in other operating expenses.  During 2010, increases in postage, expenses associated with collateral held, management meeting expenses, training expenses and travel expenses were the primary categories resulting in higher other operating expenses.

Income Taxes:

The Company has elected to be treated as an S Corporation for income tax reporting purposes.  Taxable income or loss of an S Corporation is treated as income of, and is reportable in the individual tax returns of the shareholders of the Company.  However, income taxes continue to be reported for the Company’s insurance subsidiaries, as they are not allowed to be treated as S Corporations, and for the Company’s state income tax purposes in Louisiana, which does not recognize S Corporation status.  Deferred income tax assets and liabilities are recognized and provisions for current and deferred income taxes continue to be recorded by the Company’s subsidiaries.  The deferred income tax assets and liabilities are due to certain temporary differences between reported income and expenses for financial statement and income tax purposes.  

Effective income tax rates for the years ended December 31, 2011, 2010 and 2009 were 9.6%, 11.7% and 24.2%, respectively.  During 2011 and 2010, the S Corporation earned a profit, which was reported as taxable income of the shareholders.  Since this tax liability is passed on to the shareholders, upon consolidation, the profit of the S Corporation had the effect of lowering the overall consolidated effective tax rates for those years.  The higher rate in 2009 was due to a loss at the S Corporation level being passed to the shareholders for tax reporting purposes, whereas income earned by the insurance subsidiaries was taxed at the corporate level, which had the effect of increasing the overall consolidated effective tax rate.  

Quantitative and Qualitative Disclosures About Market Risk:

Volatility in market rates of interest can impact the Company’s investment portfolio and the interest rates paid on its debt securities.  Volatility in interest rates has more impact on the income earned on investments and the Company’s borrowing costs than on interest income earned on loans, as  Management does not normally change the rates charged on loans originated solely as a result of changes in the interest rate environment. These exposures are monitored and managed by the Company as an integral part of its overall cash management program.  It is Management’s goal to minimize any adverse effect that movements in interest rates may have on the financial condition and operations of the Company.  The information in the table below summarizes the Company’s risk associated with marketable debt securities and debt obligations as of December 31, 2011.  Rates associated with the marketable debt securities represent weighted averages based on the yield to maturity of each individual security.  No adjustment has been made to yield, even though many of the investments are tax-exempt and, as a result, actual yield will be higher than that disclosed.  For debt obligations, the table presents principal cash flows and related weighted average interest rates by contractual maturity dates.  As part of its risk management strategy, the Company does not invest a material amount of its assets in equity securities.  The Company’s subordinated debt securities are sold with various interest adjustment periods, which is the time from sale until the interest rate adjusts, and which allows the holder to redeem that security prior to the contractual maturity without penalty.  It is expected that actual maturities on a portion of the Company’s subordinated debentures will occur prior to the contractual maturity as a result of interest rate adjustments.  Management estimates the carrying value of senior and subordinated debt approximates their fair values when compared to instruments of similar type, terms and maturity.  

Loans originated by the Company are excluded from the information below since interest rates charged on loans are based on rates allowable in compliance with any applicable regulatory guidelines.  Management does not believe that changes in market interest rates will significantly impact rates charged on loans.  The Company has no exposure to foreign currency risk.

Expected Year of Maturity

2017 &

Fair

2012

2013

2014

2015

2016

Beyond

Total

Value

Assets:

(in millions)

   Marketable Debt Securities

$    9

$  13

$ 13

$ 10

  $  10

$ 52

$107

$107

   Average Interest Rate

3.5%

3.4%

2.6%

3.2%

3.3%

2.5%

3.4%

Liabilities:

   Senior Debt:

      Senior Demand Notes

$47

—

—

—

—

—

$  47

$  47

      Average Interest Rate

2.1%

—

—

—

—

—

2.1%

      Commercial Paper

$197

—

—

—

—

—

$197

$197

      Average Interest Rate

4.0%

—

—

—

—

—

4.0%

  Subordinated Debentures

$    9

$  10

$ 12

$ 16

—

—

$  47

$  47

      Average Interest Rate

3.4%

3.7%

3.3%

3.1%

—

—

3.5%

Liquidity and Capital Resources:

Liquidity is the ability of the Company to meet its ongoing financial obligations, either through the collection of receivables or by generating additional funds through liability management. The Company’s liquidity is therefore dependent on the collection of its receivables, the sale of debt securities and the continued availability of funds under the Company’s revolving credit agreement.

In light of continued economic uncertainty, we continue to monitor and review current economic conditions and the related potential implications on us, including with respect to, among other things, changes in loan losses, liquidity, compliance with our debt covenants, and relationships with our customers.

As of December 31, 2011 and December 31, 2010, the Company had $16.4 million and $30.7 million, respectively, invested in cash and short-term investments readily convertible into cash with original maturities of three months or less.  As previously discussed, the Company uses cash reserves to fund its operations, including providing funds for any increase in redemptions of debt securities by investors which may occur.

The Company's investments in marketable securities can be converted into cash, if necessary.  As of December 31, 2011 and 2010, respectively, 92% and 96% of the Company's cash and cash equivalents and investment securities were maintained in Frandisco Property and Casualty Insurance Company and Frandisco Life Insurance Company, the Company’s insurance subsidiaries.  Georgia state insurance regulations limit the use an insurance company can make of its assets.  Ordinary dividend payments to the Company by its wholly owned insurance subsidiaries are subject to annual limitations and are restricted to the greater of 10% of statutory surplus or statutory earnings before recognizing realized investment gains of the individual insurance subsidiaries.  Any dividends above these state limitations are termed “extraordinary dividends” and must be approved in advance by the Georgia Insurance Commissioner.  The maximum aggregate amount of dividends these subsidiaries could pay to the Company during 2011, without prior approval of the Georgia Insurance Commissioner, was approximately $8.2 million.  In May 2011, the Company filed a request with the Georgia Insurance Department for the insurance subsidiaries to be eligible to pay up to $45.0 million in additional extraordinary dividends during 2011.  Management requested the approval to ensure the availability of additional liquidity for the Company due to the continuing uncertainties in the economy.  In July 2011, the request was approved.  The Company elected not to pay any dividends from the insurance subsidiaries during 2011.

At December 31, 2011, Frandisco Property and Casualty Insurance Company and Frandisco Life Insurance Company had a statutory surplus of $46.2 million and $46.7 million, respectively.  The maximum aggregate amount of ordinary dividends these subsidiaries can pay to the Company in 2012 without prior approval of the Georgia Insurance Commissioner is approximately $9.3 million.  The Company does not currently believe that any statutory limitations on the payment of cash dividends by the Company’s subsidiaries will materially affect the Company’s liquidity.

Most of the Company's loan portfolio is financed through sales of its various debt securities, which, because of certain redemption features contained therein, have shorter average maturities than the loan portfolio as a whole.  The difference in maturities may adversely affect liquidity if the Company is not able to continue to sell debt securities at interest rates and on terms that are responsive to the demands of the marketplace or maintain sufficient borrowing availability under our credit facility.

The Company’s continued liquidity is therefore also dependent on the collection of its receivables and the sale of debt securities that meet the investment requirements of the public.  In addition to its receivables and securities sales, the Company has an external source of funds available under a credit facility with Wells Fargo Preferred Capital, Inc.  This credit agreement provides for borrowings of up to $100.0 million, subject to certain limitations, and all borrowings are secured by the finance receivables of the Company.  There were no borrowings outstanding against the credit line at December 31, 2011; however if there had been, the interest rate would have been 3.75%.  This compares to outstanding borrowings of $.9 million at December 31, 2010, at an interest rate of 3.75%.  Management believes the current credit facility, when considered with funds expected to be available from operations, should provide sufficient liquidity for the Company.

Available but unborrowed amounts under the credit agreement are subject to a periodic unused line fee of .50%.  The interest rate under the credit agreement is equivalent to the greater of (a) .75% per annum plus 300 basis points or (b) the three month London Interbank Offered Rate (the “LIBOR Rate”) plus 300 basis points.  The LIBOR Rate is adjusted on the first day of each calendar month based upon the LIBOR Rate as of the last day of the preceding calendar month.

The credit agreement requires the Company to comply with certain covenants customary for financing transactions of this nature, including, among others, maintaining a minimum interest coverage ratio, a minimum loss reserve ratio, a minimum ratio of earnings to interest, taxes and depreciation and amortization to interest expense, a minimum asset quality ratio, a minimum consolidated tangible net worth ratio, and a maximum debt to tangible net worth ratio, each as defined. The Company must also comply with certain restrictions on its activities consistent with credit facilities of this type, including limitations on: (a) restricted payments; (b) additional debt obligations (other than specified debt obligations); (c) investments (other than specified investments); (d) mergers, acquisitions, or a liquidation or winding up; (e) modifying its organizational documents or changing lines of business; (f) modifying Material Contracts (as defined); (g) certain affiliate transactions; (h) sale-leaseback, synthetic lease, or similar transactions; (i) guaranteeing additional indebtedness (other than specified indebtedness); (j) capital expenditures; or (k) speculative transactions.  The credit agreement also restricts the Company or any of its subsidiaries from creating or allowing certain liens on their assets, entering into agreements that restrict their ability to grant liens (other than specified agreements), or creating or allowing restrictions on any of their ability to make dividends, distributions, inter-company loans or guaranties, or other inter-company payments, or inter-company asset transfers.  At December 31, 2011, the Company was in compliance with all covenants.  The Company has no reason to believe that it will not remain in compliance with these covenants and obligations for the foreseeable future.  The agreement is scheduled to expire on September 11, 2014 and any amounts then outstanding will be due and payable on such date.  

We are not aware of any additional restrictions placed on us, or being considered to be placed on us, related to our ability to access capital, such as borrowings under our credit agreement prior to its maturity.

Any decrease in the Company’s allowance for loan losses would not directly affect the Company’s liquidity, as the allowance is maintained out of income; however, an increase in the actual loss rate may have a material adverse effect on the Company’s liquidity.  The inability to collect loans could eventually impact the Company’s liquidity in the future.

The Company was subject to the following contractual obligations and commitments at December 31, 2011:

Critical Accounting Policies:

The accounting and reporting policies of 1^st Franklin and its subsidiaries are in accordance with accounting principles generally accepted in the United States and conform to general practices within the financial services industry.  The more critical accounting and reporting policies include the allowance for loan losses, revenue recognition and insurance claims reserves.

Allowance for Loan Losses:

Provision for loan losses are charged to operations in amounts sufficient to maintain the allowance for loan losses at a level considered adequate to cover probable losses inherent in our loan portfolio.  

The allowance for loan losses is established based on the estimate of the amount of probable losses inherent in the loan portfolio as of the reporting date.  We review charge off experience factors, delinquency reports, historical collection rates, estimates of the value of the underlying collateral, economic trends such as unemployment rates and bankruptcy filings and other information in order to make the necessary judgments as to probable losses.  Assumptions regarding probable losses are reviewed periodically and may be impacted by our actual loss experience and changes in any of the factors discussed above.

Revenue Recognition:

Accounting principles generally accepted in the United States require that an interest yield method be used to calculate the income recognized on accounts which have precomputed charges.  An interest yield method is used by the Company on each individual account with precomputed charges to calculate income for those on-going accounts; however, state regulations often allow interest refunds to be made according to the “Rule of 78’s” method for payoffs and renewals.  Since the majority of the Company's accounts which have precomputed charges are paid off or renewed prior to maturity, the result is that most of the those accounts effectively yield on a Rule of 78’s basis.

Precomputed finance charges are included in the gross amount of certain direct cash loans, sales finance contracts and certain real estate loans.  These precomputed charges are deferred and recognized as income on an accrual basis using the effective interest method.  Some other cash loans and real estate loans, which do not have precomputed charges, have income recognized on a simple interest accrual basis.  Income is not accrued on a loan that is more than 60 days past due.

Loan fees and origination costs are deferred and recognized as an adjustment to the loan yield over the contractual life of the related loan.  

The property and casualty credit insurance policies written by the Company, as agent for a non-affiliated insurance company, are reinsured by the Company’s property and casualty insurance subsidiary.  The premiums are deferred and earned over the period of insurance coverage using the pro-rata method or the effective yield method, depending on whether the amount of insurance coverage generally remains level or declines.

The credit life and accident and health policies written by the Company, as agent for a non-affiliated insurance company, are also reinsured by the Company’s life insurance subsidiary.  The premiums are deferred and earned using the pro-rata method for level-term life policies and the effective yield method for decreasing-term life policies.  Premiums on accident and health policies are earned based on an average of the pro-rata method and the effective yield method.

Insurance Claims Reserves:

Included in unearned insurance premiums and commissions on the consolidated statements of financial position are reserves for incurred but unpaid credit insurance claims for policies written by the Company and reinsured by the Company’s wholly-owned insurance subsidiaries.  These reserves are established based on accepted actuarial methods.  In the event that the Company’s actual reported losses for any given period are materially in excess of the previously estimated amounts, such losses could have a material adverse effect on the Company’s results of operations.

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

New Accounting Pronouncements:

See Note 1, “Recent Accounting Pronouncements,” in the accompanying “Notes to
Audited Consolidated Financial Statements” for a discussion of new accounting standards and the expected impact of accounting standards recently issued but not yet required to be adopted.  For pronouncements already adopted, any material impacts on the Company’s consolidated financial statements are discussed in the applicable section(s) of this Management’s Discussion and Analysis of Financial Condition and Results of Operations and Notes to the Company’s Audited Consolidated Financial Statements included elsewhere in this annual report.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To:

The Board of Directors and Shareholders

1^st Franklin Financial Corporation

We have audited the accompanying consolidated statements of financial position of 1st Franklin Financial Corporation and subsidiaries (the "Company") as of December 31, 2011 and 2010, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2011. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.  

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of 1st Franklin Financial Corporation and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.

/s/ Deloitte & Touche LLP

Atlanta, Georgia

March 29, 2012

1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

DECEMBER 31, 2011 AND 2010

ASSETS

2011   

  2010     

CASH AND CASH EQUIVALENTS (Note 5):

   Cash and Due From Banks

$

9,130,030

$

3,635,920

   Short-term Investments

7,221,111

27,065,494

16,351,141

30,701,414

RESTRICTED CASH (Note 1)

5,568,529

3,778,734

LOANS (Note 2):

   Direct Cash Loans

376,568,048

347,445,192

   Real Estate Loans

22,123,077

22,967,279

   Sales Finance Contracts

19,764,821

21,694,633

418,455,946

392,107,104

   Less:

Unearned Finance Charges

49,206,783

45,811,133

Unearned Insurance Premiums

29,929,658

27,211,693

Allowance for Loan Losses

21,360,085

24,110,085

317,959,420

294,974,193

MARKETABLE DEBT SECURITIES (Note 3):

   Available for Sale, at fair value

70,882,334

66,310,922

   Held to Maturity, at amortized cost

36,780,206

11,890,954

107,662,540

78,201,876

OTHER ASSETS:

   Land, Buildings, Equipment and Leasehold Improvements,

      less accumulated depreciation and amortization

         of $17,608,651 and $17,364,987 in 2011

         and 2010, respectively

9,342,174

6,687,456

   Deferred Acquisition Costs

1,718,297

1,563,629

   Due from Non-affiliated Insurance Company

2,246,092

1,903,137

   Miscellaneous

4,036,392

4,253,457

17,342,955

14,407,679

                TOTAL ASSETS

$

464,884,585

$

422,063,896

See Notes to Consolidated Financial Statements

1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

DECEMBER 31, 2011 AND 2010

LIABILITIES AND STOCKHOLDERS' EQUITY

2011

 2010

SENIOR DEBT (Note 6):

   Note Payable to Banks

$

--

$

900,000

   Senior Demand Notes, including accrued interest

 46,606,960

 40,392,404

   Commercial Paper

197,194,186

167,199,875

243,801,146

208,492,279

ACCOUNTS PAYABLE AND ACCRUED EXPENSES

20,628,730

21,081,545

SUBORDINATED DEBT (Note 7)

46,870,076

59,779,620

        Total Liabilities

311,299,952

289,353,444

COMMITMENTS AND CONTINGENCIES (Note 8)

STOCKHOLDERS' EQUITY:

   Preferred Stock; $100 par value

6,000 shares authorized; no shares outstanding

--

--

   Common Stock:

Voting Shares; $100 par value;

2,000 shares authorized; 1,700 shares

outstanding as of December 31, 2011 and 2010

170,000

170,000

Non-Voting Shares; no par value;

198,000 shares authorized; 168,300 shares

outstanding as of December 31, 2011 and 2010

--

--

   Accumulated Other Comprehensive Income

2,136,739

1,550,273

   Retained Earnings

151,277,894

130,990,179

               Total Stockholders' Equity

153,584,633

132,710,452

                    TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

$

464,884,585

$

422,063,896

See Notes to Consolidated Financial Statements

1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009

Accumulated

Other

Common Stock

Retained

Comprehensive

Shares

Amount

Earnings

Income

Total

Balance at December 31, 2008

170,000

 $170,000

$115,633,371 

$  433,101 

$116,236,472 

   Comprehensive Income:

       Net Income for 2009

—

—

8,373,007 

— 

       Net Change in Unrealized Gain

          On Available-For-Sale Securities

—

—

 —  

1,263,744   

   Total Comprehensive Income

—

—

—  

— 

9,636,751 

   Cash Distributions Paid

          —

            —

   (8,758,311)

               — 

    (8,758,311)

Balance at December 31, 2009

170,000

170,000

115,248,067 

1,696,845 

117,114,912 

   Comprehensive Income:

       Net Income for 2010

—

—

20,683,437 

— 

       Net Change in Unrealized Gain

          On Available-For-Sale Securities

—

—

— 

(146,572)

   Total Comprehensive Income

—

—

— 

— 

20,536,865 

   Cash Distributions Paid

          —

            —

   (4,941,325)

              — 

   (4,941,325)

Balance at  December 31, 2010

170,000

170,000

130,990,179 

   1,550,273 

132,710,452 

    Comprehensive Income:

       Net Income for 2011

—

—

29,123,118 

— 

       Net Change in Unrealized Gain

          On Available-For-Sale Securities

—

—

— 

586,466 

     Total Comprehensive Income

—

—

— 

— 

29,709,584 

     Cash Distributions Paid

          —

            —

    (8,835,403)

              — 

    (8,835,403)

Balance at December 31, 2011

170,000

$170,000

$151,277,894 

$2,136,739 

$153,584,633 

Disclosure of reclassification amount:

2011

2010

2009

Unrealized holding gains (losses) arising during period, net

of applicable income tax benefits (provision) of $(260,943)            $55,313 and $(368,964) for 2011, 2010 and 2009,

respectively

$     597,641 

$   (142,840)

$    1,267,302  

Less: Reclassification adjustment for net gains  

included in income, net of applicable income taxes of

$1,869, $1,381 and $1,201 for 2011, 2010 and 2009,

respectively

         11,175 

           3,732 

           3,558 

Net unrealized gains (losses)on securities, net of applicable

income tax benefits (provision) of $(259,074), $56,694

and $(367,763) for 2011, 2010 and 2009, respectively

$     586,466 

$   (146,572)

$   1,263,744 

See Notes to Consolidated Financial Statements

 1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009

2011

2010

2009

   Net Income

$

29,123,118

$

20,683,437

$

8,373,007

   Adjustments to reconcile net income to net

       cash provided by operating activities:

Provision for loan losses

19,008,749 

20,907,373 

29,302,142 

Depreciation and amortization

2,586,017 

2,465,829 

2,577,539 

Provision for deferred taxes

24,348 

272,131 

15,771 

Losses due to called redemptions on marketable

securities, loss on sales of equipment and

amortization on securities

564,126 

379,558 

314,172 

(Increase) decrease in miscellaneous

assets and other

(280,623)

(1,008,646)

198,125 

(Decrease) increase in other liabilities

(736,171)

3,288,604 

285,329 

Net Cash Provided

50,289,564 

46,988,286 

41,066,085 

CASH FLOWS FROM INVESTING ACTIVITIES:

   Loans originated or purchased

(268,764,514)

(241,803,898)

(214,933,802)

   Loan payments

226,770,538 

205,015,783 

192,118,149 

   Increase in restricted cash

(1,789,795)

(711,039)

(700,916)

   Purchases of securities, available for sale

(17,503,960)

(9,969,266)

(2,428,840)

   Purchases of securities, held to maturity

(28,785,585)

(4,659,094)

-- 

   Sales of securities, available for sale

2,267,712 

-- 

-- 

   Sales of securities, held to maturity

817,615 

-- 

-- 

   Redemptions of securities, available for sale

11,100,000 

6,189,950 

8,490,750 

   Redemptions of securities, held to maturity

2,695,000 

3,065,000 

3,790,000 

   Purchase of joint venture interest

-- 

-- 

(27,601)

   Capital expenditures

(5,565,398)

(1,430,092)

(997,083)

   Proceeds from sale of equipment

554,630 

130,350 

53,331 

Net Cash Used

(78,203,757)

(44,172,306)

(14,636,012)

CASH FLOWS FROM FINANCING ACTIVITIES:

   Net increase (decrease) in Senior Demand Notes

6,214,556   

(816,695)

(132,740)

   Advances on credit line

4,308,977 

11,240,082 

90,246,309 

   Payments on credit line

(5,208,977)

(26,544,391)

(96,309,681)

   Commercial Paper issued

51,932,342 

53,169,908 

396,342,906 

   Commercial Paper redeemed

(21,938,031)

(15,405,476)

(372,970,262)

   Subordinated Debt issued

10,518,270 

12,182,268 

11,623,006 

   Subordinated Debt redeemed

(23,427,814)

(27,286,627)

(23,344,036)

   Dividends / Distributions paid

(8,835,403)

(4,941,325)

(8,758,311)

Net Cash Provided (Used)

13,563,920 

1,597,744 

(3,302,809)

NET (DECREASE) INCREASE IN

     CASH AND CASH EQUIVALENTS

(14,350,273)

4,413,724 

23,127,264 

CASH AND CASH EQUIVALENTS, beginning

30,701,414 

26,287,690 

3,160,426 

CASH AND CASH EQUIVALENTS, ending

$

16,351,141 

$

30,701,414 

$

26,287,690 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

Interest

$

11,710,584 

$

12,519,354 

$

13,607,180 

Income Taxes

3,082,000 

2,488,000 

2,663,225 

Assets Assumed (Note 12)

-- 

-- 

289,746 

See Notes to Consolidated Financial Statements

1^st FRANKLIN FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009

1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business:

1^st Franklin Financial Corporation (the "Company") is a consumer finance company which originates and services direct cash loans, real estate loans and sales finance contracts through 258 branch offices located throughout the southeastern United States.  In addition to this business, the Company writes credit insurance when requested by its loan customers as an agent for a non-affiliated insurance company specializing in such insurance.  Two of the Company's wholly owned subsidiaries, Frandisco Life Insurance Company and Frandisco Property and Casualty Insurance Company, reinsure the credit life, the credit accident and health and the credit property insurance so written.

Basis of Consolidation:

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries.  Inter-company accounts and transactions have been eliminated.

Fair Values of Financial Instruments:

The following methods and assumptions are used by the Company in estimating fair values for financial instruments:

Cash and Cash Equivalents.  Cash includes cash on hand and with banks.  Cash equivalents are short-term highly liquid investments with original maturities of three months or less.  The carrying value of cash and cash equivalents approximates fair value due to the relatively short period of time between the origination of the instruments and their expected realization.

Loans.  The fair value of the Company's direct cash loans and sales finance contracts approximate the carrying value since the estimated life, assuming prepayments, is short-term in nature.  The fair value of the Company's real estate loans approximate the carrying value since the interest rate charged by the Company approximates market rates.

Marketable Debt Securities.  The fair value of marketable debt securities is based on quoted market prices.  If a quoted market price is not available, fair value is estimated using market prices for similar securities.  See Note 3 for the fair value of marketable debt securities and Note 4 for information related to how these securities are valued.

Senior Debt.  The carrying value of the Company's senior debt securities approximate fair value due to the relatively short period of time between the origination of the instruments and their expected payment.

Subordinated Debt.  The carrying value of the Company's subordinated debt approximates fair value due to the re-pricing frequency of the securities.

Use of Estimates:

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could vary from these estimates.

Income Recognition:

Accounting principles generally accepted in the United States of America require that an interest yield method be used to calculate the income recognized on accounts which have precomputed charges.  An interest yield method is used by the Company on each individual account with precomputed charges to calculate income for those on-going accounts, however, state regulations often allow interest refunds to be made according to the “Rule of 78's” method for payoffs and renewals.  Since the majority of the Company's accounts with precomputed charges are paid off or renewed prior to maturity, the result is that most of the accounts with precomputed charges effectively yield on a Rule of 78's basis.

Precomputed finance charges are included in the gross amount of certain direct cash loans, sales finance contracts and certain real estate loans.  These precomputed charges are deferred and recognized as income on an accrual basis using the effective interest method.  Some other cash loans and real estate loans, which do not have precomputed charges, have income recognized on a simple interest accrual basis.  Any loan which becomes 60 days or more past due, based on original contractual term, is placed in a non-accrual status.  When a loan is placed in non-accrual status, income accruals are discontinued.  Accrued income prior to the date an account becomes 60 days or more past due is not reversed.  Income on loans in non-accrual status is earned only if payments are received.  A loan in nonaccrual status is restored to accrual status when it becomes less than 60 days past due.

Loan fees and origination costs are deferred and recognized as an adjustment to the loan yield over the contractual life of the related loan.  

The property and casualty credit insurance policies written by the Company, as agent for an unrelated insurance company, are reinsured by the Company’s property and casualty insurance subsidiary.  The premiums are deferred and earned over the period of insurance coverage using the pro-rata method or the effective yield method, depending on whether the amount of insurance coverage generally remains level or declines.

The credit life and accident and health policies written by the Company, as agent for an unrelated insurance company, are reinsured by the Company’s life insurance subsidiary.  The premiums are deferred and earned using the pro-rata method for level-term life policies and the effective yield method for decreasing-term life policies.  Premiums on accident and health policies are earned based on an average of the pro-rata method and the effective yield method.