LOSS EXPERIENCE

Net losses (charge-offs less recoveries) and the percent such net losses represent of average net loans (loans less unearned finance charges) and 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

2015

2014

2013

2012

2011

 (in thousands, except % data)

DIRECT CASH LOANS

Average Net Loans

$ 404,057

$ 381,367

$ 357,552

$ 334,084

$ 305,152

Liquidations

$ 695,608

$ 669,704

$ 632,501

$ 571,504

$ 520,997

Net Losses

$  31,119

$  27,824

$  24,476

$  21,241

$  21,014

Net Losses as % of Average

   Net Loans

7.70%

7.30%

6.85%

6.36%

6.89%

Net Losses as % of Liquidations

4.47%

4.15%

3.87%

3.72%

4.03%

REAL ESTATE LOANS

Average Net Loans

$ 21,194

$ 19,765

$ 20,031

$ 21,192

$ 22,253

Liquidations

$   7,941

$   8,513

$  9,254

$   8,792

$   9,854

Net Losses

$       11

$       72

$        6

$       63

$       75

Net Losses as a %

    of Average Net Loans

.05%

.36%

.03%

.30%

.34%

Net Losses as a %

    of Liquidations

.14%

.85%

.06%

.72%

.76%

SALES FINANCE CONTRACTS

Average Net Loans

$ 22,908

$ 19,646

$ 18,366

$ 17,891

$ 17,863

Liquidations

$ 29,151

$ 26,767

$ 26,108

$ 26,204

$ 27,211

Net Losses

$     877

$     787

$      471

$      531

$     670

Net Losses as % of Average

    Net Loans

3.83%

4.01%

2.56%

2.97%

3.75%

Net Losses as % of  Liquidations

3.01%

2.94%

1.80%

2.03%

2.46%

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

The Company operates in one reportable business segment.  For additional financial information about our segment and the divisions of our operations, see Note 13 “Segment Financial Information” in the Notes to Consolidated Financial Statements.

CREDIT INSURANCE

We offer optional credit insurance products to our customers when making a loan.  Such products 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

The Company is subject to regulation under numerous state and federal laws and regulations as enforced and interpreted by various state and federal governmental agencies.  Generally, state laws require that each office in which a small loan business such as ours 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 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, in some cases, limit the premiums that insurance agents can charge.  We believe we conduct our business in accordance with all applicable state statutes and regulations.  The Company has never had any of its licenses revoked and has never been subject to an enforcement order or regulatory settlement.

We conduct our lending operations under the provisions of various federal laws and implementing regulations.  These laws and regulations are interpreted, implemented, and enforced by the Bureau of Consumer Financial Protection (the "CFPB"). Chief among these federal laws with which the Company must comply are the Federal Consumer Credit Protection Act (the "Truth-in-Lending Act"), the Fair Credit Reporting Act and the Federal Real Estate Settlement Procedures Act.   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 generally seek to collateralize such loans with non-household goods such as automobiles, boats and other exempt items.

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.  Significant additional regulation or costs of compliance could materially adversely affect our business and financial condition.

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

2015

2014

2013

2012

2011

Bank Borrowings

 -%

 -%

 -%

 -%

 -%

Senior Debt

   58  

   55  

   55  

   53  

   53  

Subordinated Debt

   5  

   6  

   7  

   8  

   10  

Other Liabilities

   4  

   4  

   4  

   5  

   4  

Stockholders’ Equity

    33  

    35  

    34  

    34  

    33  

    Total

100%

100%

100%

100%

100%

Number of Investors

   5,415

   5,405

   5,436

   5,445

   5,406

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

2015

2014

2013

2012

2011

Senior Borrowings

3.32%

3.31%

3.46%

3.75%

4.08%

Subordinated Borrowings

  2.82   

2.92  

3.14   

3.33   

4.20

All Borrowings

3.27   

3.26   

3.41   

3.69   

4.11

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

As of December 31

2015

 2014

2013

2012

  2011

Total Liabilities to

Stockholders’ Equity

2.00

1.91

1.92

1.94

2.03

Unsubordinated Debt to

Subordinated Debt plus

Stockholders’ Equity

1.59

1.46

1.41

 1.36

 1.32

As of March 28, 2016, all of our voting common stock was closely held by three related individuals and all of our non-voting common stock was held by thirteen shareholders. 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 any period represented.  Cash distributions of $60.60 and $137.50 per share were paid to shareholders in 2015 and 2014, 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 "Summary of Significant Accounting Policies" in the Notes to 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, changes in our ability to manage liquidity and cash flow, the accuracy of Management’s estimates and judgments, adverse developments in economic conditions including the interest rate environment, unforeseen changes in our 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 285 branch locations at December 31, 2015.  The Company and its operations are guided by a strategic plan which includes planned growth through strategic expansion of our branch office network.  The Company expanded its operations with the opening of seven 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 total assets increased $68.8 million (11%) to $674.4 million as of December 31, 2015 compared to $605.6 million at December 31, 2014.  Increases in our cash, investment and loan portfolios were the primary areas of growth in the asset section of our balance sheet.   

Our cash and short-term investments increased $36.7 million (249%) at December 31, 2015 compared to December 31, 2014.  Surplus funds generated from increased sales of our debt securities during 2015 and funds generated from operations led to the growth in our cash and holdings of short-term investments.

The Company maintains an amount of funds in restricted accounts at its insurance subsidiaries in order to comply with certain requirements imposed on insurance companies by the State of Georgia and to meet the reserve requirements of its reinsurance agreements.  Restricted cash also includes escrow deposits held by the Company on behalf of certain mortgage real estate customers.  At December 31, 2015, restricted cash was approximately $9.3 million compared to $1.1 million at December 31, 2014.

The Company has two investment portfolios on the Statements of Financial Position.  One is titled "Marketable Debt Securities" which consists primarily of invested surplus funds generated by the Company's insurance subsidiaries.  This investment portfolio increased $5.3 million (3%) at December 31, 2015 compared to December 31, 2014 as a result of the aforementioned increase in surplus funds generated from sales of the our debt securities and funds generated from operations.  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.  This investment portfolio consists mainly of U.S. Treasury bonds, government agency bonds and various municipal bonds.  Approximately 89% of these investment securities have been designated as “available for sale” at December 31, 2015 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 this 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.

A second investment portfolio, captioned "Equity Method Investments", consists of invested surplus funds generated from operations and financing activities of the Parent Company.  Management originally invested $10.0 million of these funds on November 1, 2013 in Meritage Capital, Centennial Absolute Return Fund, L.P. in an attempt to increase yield.  An additional $15.0 million was invested on April 1, 2014.  Total value of the fund was $25.0 million at December 31, 2015 compared to $26.1 million at December 31, 2014.  The decline in the value of the fund during 2015 was due to the volitility in the bond and equity markets.  The Company uses the equity method of accounting to account for this investment.  

Our net loan portfolio grew $18.0 million (5%) to $406.4 million at December 31, 2015 compared to $388.3 million at December 31, 2014. The increase in the net loan portfolio was the result of higher loan originations during the year just ended.  Loan originations were $764.4 million during 2015 compared to $732.0 million during the prior year.  A $4.9 million increase in the Company's allowance for loan losses (which is included in the net loan portfolio) offset a portion of the increase in the portfolio.  Our allowance for loan losses reflects Management's estimate of the level of allowance adequate to cover probable losses inherent in the loan portfolio as of the date of the 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.  Management increased the allowance for loan losses at December 31, 2015 compared to December 31, 2014 mainly due to a higher level of charge offs during 2015 and the higher level of loans outstanding.  Management believes the allowance for loan losses is adequate to cover probable losses; however, changes in trends or deterioration in economic conditions could result in a change in the allowance or an increase in actual losses.  Any increase could have a material adverse impact on our results of operation or financial condition in the future.  

Increases in deferred acquisition costs and accounts receivable related to our credit insurance business were the primary factors causing the $1.6 million (8%) increase in miscellaneous other assets at December 31, 2015 compared to the prior year end.

A substantial portion of the Company's funding is generated from sales of the Company's various debt securities.  Aggregate senior and subordinated debt of the Company increased $51.6 million (14%) to $424.5 million at December 31, 2015 compared to $372.9 million at December 31, 2014.  Higher sales of the Company's senior demand notes and commercial paper resulted in the increase.

Other liabilities increased $1.2 million (5%) at December 31, 2015 compared to the prior year end mainly due to increases in accounts payable, accrued deferred compensation expenses and accrued employee health insurance claims.

Results of Operations:

Total revenues were $208.4 million, $199.7 million and $186.0 million during 2015, 2014 and 2013, respectively.  Growth in earning assets (loans and investments) during the period just ended led to higher finance charge earnings, insurance earnings and investment income, which led to higher revenues during the comparable periods.  Higher expenses during 2015 and 2014 offset the increases in revenues during the same respective periods resulting in declines in net income.  Net income for each of the three years ended December 31, 2015 was $25.9 million, $33.3 million and $34.4 million, respectively.

Net Interest Income:

Net interest income is a principal component of the Company’s operating performance and resulting net income.  It represents the difference between income on earning assets and the cost of funds on interest bearing liabilities.  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.

Net interest income was $139.6 million during 2015, compared to $132.6 million in 2014 and $121.1 million during 2013.  The higher margins during 2015 and 2014 were due to higher levels of average net receivables outstanding and the associated finance charge income thereon.  Average net receivables were $440.3 million during 2015 compared to $413.3 million during 2014 and $388.0 million during 2013.  Interest income grew $8.0 million (6%) during 2015 compared to 2014, and $12.0 million (9%) during 2014 compared to 2013 as a result of the higher average net receivables outstanding.      

Interest expense was $13.0 million, $12.0 million and $11.5 million during 2015, 2014 and 2013, respectively, mainly due to increases in average borrowings outstanding.  Average borrowings were $395.5 million during 2015 compared to $363.9 during 2014 and $335.8 during 2013.  Although average borrowings increased, the continued low interest rate environment has enabled the Company to minimize increases in interest expense.  Our weighted average borrowing rate was 3.28% during the two year period just ended and 3.42% during 2013.

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 (insurance revenues less claims and expenses) increased $2.8 million (7%), $1.7 million (5%) and $1.8 million (5%) during the three years ended December 31, 2015, respectively.

Other Revenue:

Other revenue earned was $3.3 million during 2015 compared to $7.2 million during 2014 and $7.7 million during 2013.  The primary revenue category included in other revenue relates to commissions earned by the Company on sales of the auto club memberships.  The Company, as an agent for a third party, offers auto club memberships to loan customers during the closing of a loan.  During fourth quarter of 2014, the Company elected to begin offering customers an enhanced auto club product with expanded coverage.  Commission rates earned by the Company on the enhanced product are lower than those earned on the original product offered.  The lower commission rates were one of the primary causes of the $3.8 million (54%) decline in other revenue during 2015 compared to 2014.  During 2014, other revenue decreased $.5 million (9%) compared to 2013 mainly due to lower commissions earned on sales of auto club memberships.

Another factor contributing to the decrease in other revenue during 2015 compared to 2014 was a $1.0 million loss in income on the equity method investment held by the Company.  As previously mentioned, the Company has a $25.0 million equity fund investment.  Volatility in the bond and equity markets resulted in a loss on this investment during 2015.  During 2014, the investment earned $1.0 million.

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.

Higher net charge offs and additions to the allowance for loan losses resulted in increases in the provision for loan losses during 2015 and 2014.  Net charge offs during 2015, 2014 and 2013 were $32.0 million, $28.7 million and $25.0 million, respectively.  During 2015 and 2014, the Company increased the allowance for loan losses by $4.9 million and $3.9 million, respectively.  As a result of the foregoing, our provision for loan losses increased $4.3 million (13%) and $5.0 million (18%) during 2015 and 2014, respectively.

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 increased approximately $8.1 million (8%) during 2015 compared to 2014, and approximately $8.5 million (9%) during 2014 compared to 2013.  Operating expenses include personnel expense, occupancy expense and miscellaneous other expenses.    

Personnel expense increased $4.4 million (7%) during 2015 as compared to 2014 and $4.4 million (7%) during 2014 compared to 2013.  The increases in each of the two year periods just ended were primarily due to increases in the employee base, merit salary increases, higher contributions to the Company's 401(k) plan, higher claims expense associated with the Company’s self insured employee medical program and higher payroll taxes.  An increase in the accrual for incentive bonuses during 2014 also contributed to the increase in personnel expense during that year compared to 2013.

Occupancy expense increased $.5 million (4%) during 2015 compared to 2014 and $.8 million (7%) during 2014 compared to 2013.  Higher maintenance expense, utilities expense, telephone expense, depreciation expense and increased rent expense were the primary factors responsible for the increase in occupancy expense.

Other operating expenses increased $3.1 million (12%) and $3.3 million (14%) during 2015 and 2014, respectively.  During 2015, increased marketing efforts resulted in increases in advertising expense and postage, both of which were significant factors in the increase in other operating expenses compared to 2014.  Increases in charitable contributions, computation errors, computer expenses, consultant fees and travel expenses were other categories contributing to the increase in other operating expenses during 2015.  During 2014, increases in advertising expense, charitable contributions, loss on sale of assets, insurance expenses, computer expense, postage, travel expenses and taxes and licenses were the primary categories causing the increase in other operating expenses compared to 2013.

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, 2015, 2014 and 2013 were 16.9%, 11.2% and 10.4%, respectively.  During each of the three years ended December 31, 2015, 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 the profit of the S Corporation had the effect of lowering the Company's overall consolidated effective tax rates for those years.  The increase in rates during the last two years is due to decreases in the ratio of taxable income for the Parent Company compared to the insurance subsidiaries. The Company's life insurance subsisidiary no longer qualified for the small life insurance company tax deduction, which also contributed to the increase in rates.

Quantitative and Qualitative Disclosures About Market Risk:

Volatility in market interest rates 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, 2015.  Rates associated with the marketable debt securities represent weighted averages based on the tax effected 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.  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 table 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

2021 &

Fair

2016

2017

2018

2019

2020

Beyond

Total

Value

Assets:

(Dollars in millions)

   Marketable Debt Securities

$    5

$   7

$  8

$  6

  $ 3

$ 132

$161

$161

   Average Interest Rate

2.2%

2.6%

2.3%

2.8%

3.1%

3.4%

3.2%

Liabilities:

   Senior Debt:

      Senior Demand Notes

$71

—

—

—

—

—

$  71

$  71

      Average Interest Rate

1.7%

—

—

—

—

—

1.7%

      Commercial Paper

$317

—

—

—

—

—

$317

$317

      Average Interest Rate

3.5%

—

—

—

—

—

3.5%

  Subordinated Debentures

$    6

$   8

$9

$13

—

—

$  36

$  36

      Average Interest Rate

2.9%

2.8%

2.8%

2.8%

—

—

2.8%

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, 2015 and December 31, 2014, the Company had $51.4 million and $14.7 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, 2015 and 2014, 79% and 80%, respectively, 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 have paid to the Company during 2015, without prior approval of the Georgia Insurance Commissioner, was approximately $11.8 million.  The Company elected not to pay any dividends from the insurance subsidiaries during 2015.    

At December 31, 2015, Frandisco Property and Casualty Insurance Company and Frandisco Life Insurance Company had a statutory surplus of $70.5 million and $67.3 million, respectively.  The maximum aggregate amount of dividends these subsidiaries can pay to the Company in 2016 without prior approval of the Georgia Insurance Commissioner is approximately $12.5 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.

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 revolving credit facility with Wells Fargo Bank, NA.  This credit agreement provides for borrowings or reborrowings 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, 2015 or 2014.  The credit agreement has a commitment terminaton date  of September 11, 2018.  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 certain contracts; (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, 2015, 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.  

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 any adjustment to the allowance has no impact on cash; 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, 2015:

Payment due by period

Contractual Obligations

Total

Less

Than

1 Year

1 to 2 Years

3 to 5 Years

More

than 5 Years

(in millions)

   Bank Commitment Fee **

$    1.4

$      .5

$  .9

$     -

$     -

   Senior Demand Notes *

72.2

72.2

     -

    -

      -

   Commercial Paper *

327.8

327.8

-

-

-

   Subordinated Debt *

40.0

7.2

18.5

14.3

-

Human resource insurance and

support contracts **

.8

.8

-

-

-

   Marketing Database

.3

.1

.1

.1

   Operating leases (offices)

15.9

5.7

7.7

2.5

     -

   Communication lines contract **

1.4

.6

.6

.2

-

Software service contract **

      9.4

      3.1

    6.3

        -

      -

       Total

$469.2  

$418.0  

$34.1

$17.1

$    -

    * Includes estimated interest at current rates.

    ** Based on current usage.

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 of America 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:

Provisions 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 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 which have precomputed charges are paid off or renewed prior to maturity, the result is that most of the 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, “Summary of Significant Accounting Policies - Recent Accounting Pronouncements,” in the accompanying “Notes to 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 Consolidated Financial Statements included elsewhere in this annual report.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders
1st 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, 2015 and 2014, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015. 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, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.

/s/ Deloitte & Touche LLP

Atlanta, Georgia

March 30, 2016

1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

DECEMBER 31, 2015 AND 2014

ASSETS

2015   

  2014     

CASH AND CASH EQUIVALENTS (Note 6):

   Cash and Due From Banks

$      5,531,687

$     1,524,217

   Short-term Investments

45,917,730

13,202,325

51,449,417

14,726,542

RESTRICTED CASH (Note 1)

9,335,466

1,073,157

LOANS (Note 2):

   Direct Cash Loans

494,836,733

471,195,331

   Real Estate Loans

22,128,090

20,271,000

   Sales Finance Contracts

30,071,077

23,906,111

   547,035,900

   515,372,442

   Less:

Unearned Finance Charges

65,699,425

63,079,794

Unearned Insurance Premiums

41,446,393

35,331,723

Allowance for Loan Losses

33,500,000

28,620,000

406,390,082

388,340,925

MARKETABLE DEBT SECURITIES (Note 3):

   Available for Sale, at fair value

143,862,165

132,847,073

   Held to Maturity, at amortized cost

17,058,181

22,762,252

160,920,346

155,609,325

EQUITY METHOD INVESTMENTS (Note 5)

24,989,505

26,059,579

OTHER ASSETS:

   Land, Buildings, Equipment and Leasehold Improvements,

      less accumulated depreciation and amortization

         of $26,780,217 and $24,049,665 in 2015

         and 2014, respectively

9,918,857

10,205,126

   Deferred Acquisition Costs

2,483,781

2,028,468

   Due from Non-affiliated Insurance Company

2,886,086

2,102,978

   Other Miscellaneous

6,040,269

5,441,945

21,328,993

19,778,517

                TOTAL ASSETS

$  674,413,809

$  605,588,045

See Notes to Consolidated Financial Statements

1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

DECEMBER 31, 2015 AND 2014

LIABILITIES AND STOCKHOLDERS' EQUITY

2015

 2014

SENIOR DEBT (Note 7):

   Senior Demand Notes, including accrued interest

$   71,001,087

$    58,530,148

   Commercial Paper

317,488,208

276,656,052

388,489,295

335,186,200

ACCOUNTS PAYABLE AND ACCRUED EXPENSES

25,430,137

24,228,121

SUBORDINATED DEBT (Note 8)

36,004,009

37,726,538

        Total Liabilities

449,923,441

397,140,859

COMMITMENTS AND CONTINGENCIES (Note 9)

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, 2015 and 2014

170,000

170,000

    Non-Voting Shares; no par value;

         198,000 shares authorized; 168,300 shares

          outstanding as of December 31, 2015 and 2014

--

--

   Accumulated Other Comprehensive Income

      4,142,986

      3,663,475

   Retained Earnings

220,177,382

204,613,711

               Total Stockholders' Equity

224,490,368

208,447,186

                    TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

$ 674,413,809  

$ 605,588,045  

See Notes to Consolidated Financial Statements

1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2015, 2014, AND 2013

Accumulated

Other

Common Stock

Retained

Comprehensive

Shares

Amount

Earnings

Income (Loss)

Total

Balance at December 31, 2012

170,000

$170,000

$174,265,215 

$2,098,618 

$176,533,833  

   Comprehensive Income:

       Net Income for 2013

—

—

34,407,761 

— 

       Other Comprehensive Loss

—

—

— 

(4,571,352)

   Total Comprehensive Income

—

—

— 

— 

29,836,409 

   Cash Distributions Paid

          —

  (14,017,609)

               — 

   (14,017,609) 

Balance at December 31, 2013

170,000

170,000

194,655,367

   (2,472,734)

192,352,633

   Comprehensive Income:

       Net Income for 2014

—

—

33,333,746

—

       Other Comprehensive Loss

—

—

— 

6,136,209

   Total Comprehensive Income

—

—

— 

—

39,469,955 

   Cash Distributions Paid

          —

  (23,375,402)

                —

   (23,375,402)

Balance at December 31, 2014

170,000

170,000

204,613,711

   3,663,475

208,447,186

    Comprehensive Income:

       Net Income for 2015

—

—

25,865,673

—

       Other Comprehensive Income

—

—

— 

479,511

     Total Comprehensive Income

—

—

— 

—

26,345,184 

     Cash Distributions Paid

          —

           —

  (10,302,002)

                —

   (10,302,002)

Balance at December 31, 2015

170,000

$170,000

$220,177,382

$  4,142,986

$224,490,368

See Notes to Consolidated Financial Statements

 1^st FRANKLIN FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2015, 2014 AND 2013

2015      

2014       

2013       

   Net Income

$ 25,865,673 

$ 33,333,746 

$ 34,407,761 

   Adjustments to reconcile net income to net

       cash provided by operating activities:

     Provision for loan losses

36,887,285 

32,622,546 

27,623,368 

     Depreciation and amortization

3,318,710 

3,156,828 

2,910,855 

     Provision for deferred taxes

1,037,993 

41,211 

145,730 

Loss (Earnings) in equity method investment

1,070,074 

(847,943)

(211,635)

     Losses due to called redemptions on marketable

        securities, loss on sales of equipment and

        amortization on securities

768,903 

1,101,092 

1,004,266 

     (Increase) decrease in miscellaneous

assets and other

(1,836,742)

421,877

(1,561,178)

     (Decrease) Increase in other liabilities

(149,424)

1,011,240

(333,179)

           Net Cash Provided

66,962,472 

70,840,597

63,985,988 

CASH FLOWS FROM INVESTING ACTIVITIES:

   Loans originated or purchased

(387,639,565)

(351,600,837)

(334,922,921)

   Loan payments

332,703,123 

300,064,326 

281,446,113 

   (Increase) decrease in restricted cash

(8,262,309)

(98,705)

3,702,378 

   Purchases of securities, available for sale

(20,649,356)

(30,969,513)

(38,947,670)

   Purchase of equity fund investment

- 

(15,000,000)

(10,000,000)

   Sales of securities, available for sale

797,246 

- 

4,199,916 

   Redemptions of securities, available for sale

9,200,000 

11,895,000 

12,880,000 

   Redemptions of securities, held to maturity

5,340,000 

6,455,000 

2,975,000 

   Capital expenditures

(3,045,037)

(4,487,073)

(2,715,004)

   Proceeds from sale of equipment

37,737 

84,231 

45,662 

           Net Cash Used

(71,518,161)

(83,657,571)

(81,336,526)

CASH FLOWS FROM FINANCING ACTIVITIES:

   Net increase in Senior Demand Notes

12,470,939   

4,475,141   

4,022,163   

   Advances on credit line

531,641 

531,475 

531,375 

   Payments on credit line

(531,641)

(531,475)

(531,375)

   Commercial paper issued

67,964,535 

65,587,144 

61,559,542 

   Commercial paper redeemed

(27,132,379)

(42,891,237)

(33,460,285)

   Subordinated debt issued

8,164,215 

7,210,193 

8,645,970 

   Subordinated debt redeemed

(9,886,744)

(9,862,162)

(11,185,439)

   Dividends / Distributions paid

(10,302,002)

(23,375,402)

(14,017,609)

           Net Cash Provided

41,278,564 

1,143,677 

15,564,342 

NET INCREASE (DECREASE) IN

     CASH AND CASH EQUIVALENTS

36,722,875 

(11,673,297)

(1,786,196)

CASH AND CASH EQUIVALENTS, beginning

14,726,542 

26,399,839 

28,186,035 

CASH AND CASH EQUIVALENTS, ending

$  51,449,417 

$  14,726,542 

$  26,399,839 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

Interest

$   12,874,565 

$  11,881,150 

$   11,537,662 

Income Taxes

 3,768,000 

4,304,000 

 3,857,000 

Non-cash Exchange of Investment Securities

533,859 

-  

2,830,022 

See Notes to Consolidated Financial Statements