SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934


For Quarterly Period Ended		Commission File Number:
September 30, 2003		0-24133

FRANKLIN FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)


Tennessee		62-1376024

(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

230 Public Square, Franklin, Tennessee		37064

(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code (615)790-2265

Not applicable

(Former name, former address and formal fiscal year, if changed since last report)

Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934)

Yes x No o

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:


Common Stock, No Par Value		8,382,621

Class	Outstanding at November 6, 2003

TABLE OF CONTENTS


PART I. — FINANCIAL INFORMATION
	Item I. Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Unaudited Consolidated Financial Statements
	ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 4 — CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
EXHIBIT INDEX
EX-31.1 SECTION 302 CERTIFICATION OF THE CEO
EX-31.2 SECTION 302 CERTIFICATION OF THE CFO
EX-32 SECTION 906 CERTIFICATIONS OF THE CEO & CFO

PART I. — FINANCIAL INFORMATION

Item I. Financial Statements

FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

(Unaudited)


					(In thousands)
					September 30,			December 31,
					2003			2002

Assets
Cash and cash equivalents					$	21,668		$	28,061
Federal funds sold						—			18,922
Investment securities available-for-sale, at fair value						65,320			68,325
Mortgage-backed securities available-for-sale, at fair value						222,843			189,647
Investment securities held-to-maturity, fair value $3,871 at September 30, 2003 and $8,137 at December 31, 2002						3,807			8,043
Mortgage-backed securities held-to-maturity, fair value $116 at September 30, 2003 and $198 at December 31, 2002						109			185
Federal Home Loan and Federal Reserve Bank stock, restricted						4,377			4,113
Loans held for sale						5,370			19,432
Loans						536,351			538,263
Allowance for loan losses						(5,478	)		(5,761	)

				Loans, net		530,873			532,502

Premises and equipment, net						8,967			9,691
Accrued interest receivable						3,933			3,713
Mortgage servicing rights						4,999			3,749
Repossessed and foreclosed assets, net						3,833			1,555
Other assets						3,492			3,295

					$	879,591		$	891,233

Liabilities and Stockholders’ Equity
Liabilities:
	Deposits:
			Noninterest-bearing		$	78,285		$	78,507
			Interest-bearing			666,368			679,865

				Total deposits		744,653			758,372
			Repurchase agreements			200			200
			Long-term debt and other borrowings			78,040			76,382
			Accrued interest payable			1,146			1,478
			Other liabilities			721			6,253

				Total liabilities		824,760			842,685

Stockholders’ equity:
	Common stock, No par value. Authorized 500,000,000 shares; issued 8,360,462 and 7,968,022 at September 30, 2003 and December 31, 2002, respectively					15,839			12,659
	Accumulated other comprehensive (loss) gain, net of tax					(75	)		2,807
	Unearned compensation related to outstanding restricted stock awards					(96	)		(147	)
	Retained earnings					39,163			33,229

		Total stockholders’ equity				54,831			48,548

					$	879,591		$	891,233

See Notes to Unaudited Consolidated Financial Statements

FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income
(Unaudited and in thousands except for per share data)


			Three Months Ended				Nine Months Ended
			September 30,				September 30,

			2003		2002		2003		2002

Interest income:
	Interest and fees on loans		$	8,398	$	9,028	$	25,600	$	26,161
	Taxable securities			2,388		3,429		8,060		10,991
	Tax-exempt securities			527		263		1,178		744
	Federal funds sold			4		29		81		50

		Total interest income		11,317		12,749		34,919		37,946

Interest expense:
	Certificates of deposit over $100,000			1,120		1,320		3,638		4,280
	Other deposits			1,483		2,020		4,826		5,855
	Federal Home Loan Bank advances			847		856		2,519		2,549
	Other borrowed funds			217		268		673		870

		Total interest expense		3,667		4,464		11,656		13,554

		Net interest income		7,650		8,285		23,263		24,392
Provision for loan losses				470		760		1,875		2,210

		Net interest income after provision for loan losses		7,180		7,525		21,388		22,182
Other income:
	Service charges on deposit accounts			777		749		2,134		2,137
	Mortgage banking activities			2,273		1,144		3,814		2,780
	Other service charges, commissions and fees			12		129		343		467
	Commissions on sale of annuities and brokerage activity			30		113		78		374
	Gain on sale of mortgage loans			213		675		1,202		801
	Gain on sale of investment securities			339		428		1,348		591

		Total other income		3,644		3,238		8,919		7,150

Other expenses:
	Salaries and employee benefits			2,962		3,042		9,129		8,854
	Occupancy expense			553		531		1,596		1,579
	Mortgage banking			681		388		1,730		1,076
	Furniture and equipment			257		330		864		1,018
	Communications and supplies			178		159		470		473
	Advertising and marketing			83		102		292		307
	FDIC and regulatory assessments			77		69		231		202
	Repossessed and foreclosed assets, net			134		2		2,769		805
	Merger expenses			—		360		19		360
	Other			664		681		1,899		1,759

		Total other expenses		5,589		5,664		18,999		16,433

		Income before income taxes		5,235		5,099		11,308		12,899
Income taxes				1,830		1,833		3,932		4,517

		Net income	$	3,405	$	3,266	$	7,376	$	8,382

Net income per share – basic			$	0.41	$	0.41	$	0.89	$	1.06

Net income per share — diluted			$	0.37	$	0.37	$	0.82	$	0.95

Dividends declared per share			$	0.05775		0.055		0.17325		0.1650
Weighted average shares outstanding:
Basic				8,358		7,908		8,278		7,891
Diluted				9,130		8,844		9,014		8,785

See Notes to Unaudited Consolidated Financial Statements

FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders’ Equity
(Unaudited and in thousands)


															Accumulated			Unamortized
			Common Stock												Other			Cost of
									Comprehensive			Retained			Comprehensive			Restricted
			Shares			Amount			Income (Loss)			Earnings			Income (Loss)			Stock Awards			Total

BALANCE – JANUARY 1, 2003				7,968		$	12,659					$	33,229		$	2,807		$	(147	)	$	48,548
Comprehensive Income:
	Net Income									7,376			7,376									7,376
	Other comprehensive loss, net of tax:
		Unrealized holding losses on securities (net of tax of $2,281)								(3,718	)
		Less: Reclassification adjustment for gains included in net income (net of $512 tax)								836

	Other comprehensive loss									(2,882	)					(2,882	)					(2,882	)

Comprehensive income									$	4,494

Exercise of stock options and issuance of common stock				394			2,516															2,516
Amortization of restricted stock																			51			51
Tax benefit of stock options exercised							679															679
Cancellation of restricted stock				(2	)		(15	)														(15	)
Cash dividend declared: $0.17325 per share													(1,442	)								(1,442	)

BALANCE – SEPTEMBER 30, 2003				8,360		$	15,839					$	39,163		$	(75	)	$	(96	)	$	54,831

See Notes to Unaudited Consolidated Financial Statements

FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)


				(In thousands)
				Nine Months Ended
				September 30,

				2003			2002
Cash flows from operating activities:
Net income				$	7,376		$	8,382
	Adjustments to reconcile net income to net cash provided by operating activities:
		Depreciation, amortization and accretion			3,650			55
		Provision for loan losses			1,875			2,210
		Loans originated for sale			(205,763	)		(126,653	)
		Proceeds from sale of loans			224,483			129,187
		Gain on sale of investment securities			(1,348	)		(591	)
		Gain on sale of loans			(1,224	)		(822	)
		Loss on foreclosed and repossessed assets			2,769			805
		(Gain) Loss on sale of premises and equipment			(3	)		98
		Increase in accrued interest receivable			(220	)		(133	)
		Decrease in accrued interest payable			(332	)		(338	)
		Decrease in other liabilities			(3,814	)		(132	)
		Increase in other assets			(8,429	)		(3,795	)
		Tax benefit of stock options exercised			679			—

			Net cash provided by operating activities		19,699			8,273

Cash flows from investing activities:
		Increase (decrease) in federal funds sold			18,922			(1,636	)
		Proceeds from sale of securities available-for-sale			50,817			65,523
		Proceeds from maturities of securities available-for-sale			147,424			42,016
		Proceeds from maturities of securities held-to-maturity			4,362			3,809
		Purchases of securities available-for-sale			(233,357	)		(89,287	)
		Purchase of securities held-to-maturity			—			(4,114	)
		Purchase of Federal Home Loan and Federal Reserve stock			(264	)		(122	)
		Net increase in loans			(3,680	)		(96,559	)
		Proceeds from sale of foreclosed and repossessed assets			771			4,466
		Purchases of premises and equipment, net			(159	)		(430	)

			Net cash used in investing activities		(15,164	)		(76,334	)

Cash flows from financing activities:
		Net proceeds from issuance of common stock			2,553			317
		Dividends paid			(1,420	)		(1,300	)
		(Decrease) increase in deposits			(13,719	)		64,779
		Decrease in repurchase agreements			—			(3,000	)
		Increase in other borrowings			1,658			10,717

			Net cash (used in) provided by financing activities		(10,928	)		71,513

			Net (decrease) increase in cash and cash equivalents		(6,393	)		3,452
Cash and cash equivalents at beginning of period					28,061			23,665

Cash and cash equivalents at end of period				$	21,668		$	27,117

Cash payments for interest				$	11,988		$	13,892
Cash payments for income taxes				$	3,951		$	4,668

See Notes to Unaudited Consolidated Financial Statements

FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements

NOTE A — BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements of Franklin Financial Corporation and Subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine-month periods ended September 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

NOTE B – SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies of the Company are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. During the nine months ended September 30, 2003, there were no significant changes to those accounting policies.

Stock-based Compensation

At September 30, 2003, the Company has three stock-based employee compensation plans, which are described more fully in Note 14 to the Consolidated Financial Statements included in the Company’s 2002 Annual Report on Form 10-K. The Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations. The Company calculates compensation expense on its restricted stock plan as the difference between the market price of the underlying stock on the date of the grant and the purchase price, if any, and recognizes such amount on a straight-line basis over the restriction period in which the restricted stock is earned by the recipient. No stock-based employee compensation cost is reflected in net income for the Company’s two stock option plans, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provision of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, as amended, to stock-based employee compensation. No options were granted during the three and nine months ended September 30, 2003 and during the three months ended September 30, 2002.


		(In thousands)

		Nine months ended

		September 30		September 30
		2003		2002

Net earnings available to stockholders:
	As reported	$	7,376	$	8,382
	Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		—		(1,508	)

Pro forma		$	7,376	$	6,874


		September 30		September 30
		2003		2002
Basic earnings per share:
	As reported	$	0.89	$	1.06
	Pro forma	$	0.89		0.87
Diluted earnings per share available to stockholders:
	As reported	$	0.82	$	0.95
	Pro forma	$	0.82		0.78

In calculating the pro forma disclosures, the fair value of the options granted is estimated as of the date granted using the Black-Scholes option pricing model with the following weighted average assumptions:


	2003		2002

Dividend yield		—		1.7	%
Expected volatility		—		32	%
Risk-free interest rate range		—		3.35 - 3.73	%
Expected life		—	7-10 years

The weighted-average fair value of options, calculated using the Black-Scholes option pricing model, granted during the nine months ended September 30, 2002 was $5.36 per share.

NOTE C — DIVIDENDS

In July 2003, the Company’s Board of Directors declared a $.05775 per share cash dividend payable on October 1, 2003.

NOTE D – SEGMENTS

The Company’s reportable segments are determined based on management’s internal reporting approach, which is by operating subsidiaries. The reportable segments of the Company are comprised of the Franklin National Bank (“Bank”) segment, excluding its subsidiaries, and the Mortgage Banking segment, Franklin Financial Mortgage.

The Bank segment provides a variety of banking services to individuals and businesses through its branches in Brentwood, Franklin, Fairview, Nashville and Spring Hill, Tennessee. Its primary deposit products are demand

deposits, savings deposits, and certificates of deposit, and its primary lending products are commercial business, construction, real estate mortgage and consumer loans. The Bank segment primarily earns interest income from loans and investments in securities. It earns other income primarily from deposit and loan fees.

The Mortgage Banking segment originates, purchases and sells residential mortgage loans. It sells loan originations into the secondary market, but retains much of the applicable servicing. As a result of the retained servicing, the Mortgage Banking segment capitalizes mortgage servicing rights and amortizes these rights over the estimated lives of the associated loans. Its primary sources of revenue are fees and servicing income, but it also reports interest income earned on warehouse balances waiting for funding. The segment originates retail mortgage loans in the Nashville, Tennessee metropolitan areas. It also purchases wholesale mortgage loans through correspondent relationships with other banks.

The “All Other” segment consists of the Company’s insurance and securities subsidiaries and the bank holding company operations which do not meet the quantitative threshold for separate disclosure. The revenue earned by the insurance and securities subsidiaries is reported in other income in the consolidated financial statements and the revenue earned by the bank holding company consists of intercompany transactions that are eliminated in consolidation.

No transactions with a single customer contributed 10% or more of the Company’s total revenue. The accounting policies for each segment are the same as those used by the Company. The segments include overhead allocations and intercompany transactions that were recorded at estimated market prices. All intercompany transactions have been eliminated to determine the consolidated balances. The results of the two reportable segments of the Company are included in the following table.

Three Months Ended September 30, 2003


					Mortgage
(In thousands)			Bank		Banking		All Other			Eliminations			Consolidated

Total interest income			$	11,103	$	248	$	695		$	(729	)	$	11,317
Total interest expense				3,497		35		419			(284	)		3,667

Net interest income				7,606		213		276			(445	)		7,650
Provision for loan losses				470		—		—			—			470

Net interest income after provision				7,136		213		276			(445	)		7,180

Total other income				1,172		2,411		3,481			(3,420	)		3,644
Total other expense				3,942		1,447		522			(322	)		5,589

Income before taxes				4,366		1,177		3,235			(3,543	)		5,235
Provision for income taxes				1,545		400		(115	)		—			1,830

Net income (loss)			$	2,821	$	777	$	3,350		$	(3,543	)	$	3,405

Other significant items
	Total assets		$	853,440	$	23,876	$	92,637		$	(90,362	)	$	879,591
	Depreciation, amortization and accretion			972		458		33			—			1,463
Revenues from external customers
	Total interest income		$	11,069	$	248	$	—		$	—		$	11,317
	Total other income			1,172		2,411		61			—			3,644

		Total income	$	12,241	$	2,659	$	61		$	—		$	14,961

Revenues from affiliates
	Total interest income		$	34	$	—	$	695		$	(729	)	$	—
	Total other income			—		—		3,420			(3,420	)		—

		Total income	$	34	$	—	$	4,115		$	(4,149	)	$	—

Three Months Ended September 30, 2002


						Mortgage
(In thousands)			Bank			Banking		All Other			Eliminations			Consolidated

Total interest income			$	12,550		$	242	$	677		$	(720	)	$	12,749
Total interest expense				4,252			39		501			(328	)		4,464

Net interest income				8,298			203		176			(392	)		8,285
Provision for loan losses				760			—		—			—			760

Net interest income after provision				7,538			203		176			(392	)		7,525

Total other income				1,245			1,823		3,387			(3,217	)		3,238
Total other expense				3,986			1,104		896			(322	)		5,664

Income before taxes				4,797			922		2,667			(3,287	)		5,099
Provision for income taxes				1,742			312		(221	)		—			1,833

Net income (loss)			$	3,055		$	610	$	2,888		$	(3,287	)	$	3,266

Other significant items
	Total assets		$	795,038		$	23,947	$	86,768		$	(84,615	)	$	821,138
	Depreciation, amortization and accretion			(120	)		231		33			—			144
Revenues from external customers
	Total interest income		$	12,507		$	242	$	—		$	—		$	12,749
	Total other income			1,245			1,823		170			—			3,238

		Total income	$	13,752		$	2,065	$	170		$	—		$	15,987

Revenues from affiliates
	Total interest income		$	43		$	—	$	677		$	(720	)	$	—
	Total other income			—			—		3,217			(3,217	)		—

		Total income	$	43		$	—	$	3,894		$	(3,937	)	$	—

Nine Months Ended September 30, 2003


					Mortgage
(In thousands)			Bank		Banking		All Other			Eliminations			Consolidated

Total interest income			$	34,304	$	722	$	2,052		$	(2,159	)	$	34,919
Total interest expense				11,115		107		1,305			(871	)		11,656

Net interest income				23,189		615		747			(1,288	)		23,263
Provision for loan losses				1,875		—		—			—			1,875

Net interest income after provision				21,314		615		747			(1,288	)		21,388

Total other income				3,739		4,934		7,713			(7,467	)		8,919
Total other expense				14,196		4,238		1,530			(965	)		18,999

Income before taxes				10,857		1,311		6,930			(7,790	)		11,308
Provision for income taxes				3,780		473		(321	)		—			3,932

Net income (loss)			$	7,077	$	838	$	7,251		$	(7,790	)	$	7,376

Other significant items
	Total assets		$	853,440	$	23,876	$	92,637		$	(90,362	)	$	879,591
	Depreciation, amortization and accretion			2,316		1,237		97			—			3,650
Revenues from external customers
	Total interest income		$	34,197	$	722	$	—		$	—		$	34,919
	Total other income			3,739		4,934		246			—			8,919

		Total income	$	37,936	$	5,656	$	246		$	—		$	43,838

Revenues from affiliates
	Total interest income		$	107	$	—	$	2,052		$	(2,159	)	$	—
	Total other income			—		—		7,467			(7,467	)		—

		Total income	$	107	$	—	$	9,519		$	(9,626	)	$	—

Nine Months Ended September 30, 2002


						Mortgage
(In thousands)			Bank			Banking		All Other			Eliminations			Consolidated

Total interest income			$	37,402		$	670	$	2,031		$	(2,157	)	$	37,946
Total interest expense				12,923			119		1,498			(986	)		13,554

Net interest income				24,479			551		533			(1,171	)		24,392
Provision for loan losses				2,210			—		—			—			2,210

Net interest income after provision				22,269			551		533			(1,171	)		22,182

Total other income				2,953			3,585		9,342			(8,730	)		7,150
Total other expense				12,404			3,029		1,967			(967	)		16,433

Income before taxes				12,818			1,107		7,908			(8,934	)		12,899
Provision for income taxes				4,525			379		(387	)		—			4,517

Net income (loss)			$	8,293		$	728	$	8,295		$	(8,934	)	$	8,382

Other significant items
	Total assets		$	795,038		$	23,947	$	86,768		$	(84,615	)	$	821,138
	Depreciation, amortization and accretion			(636	)		590		101			—			55
Revenues from external customers
	Total interest income		$	37,276		$	670	$	—		$	—		$	37,946
	Total other income			2,953			3,585		612			—			7,150

		Total income	$	40,229		$	4,255	$	612		$	—		$	45,096

Revenues from affiliates
	Total interest income		$	126		$	—	$	2,031		$	(2,157	)	$	—
	Total other income			—			—		8,730			(8,730	)		—

		Total income	$	126		$	—	$	10,761		$	(10,887	)	$	—

NOTE E – LOANS

In addition to the disclosures included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 related to loans and allowance for loan losses, the following represents information regarding non-accrual loans and loans past due 90 days or more still accruing interest.


	September 30,		September 30,		December 31,
	2003		2002		2002

			(in thousands)
Loans accounted for on a non-accrual basis	$	1,662	$	5,204	$	5,218
Accruing loans which are contractually past due 90 days or more as to principal and interest payments		1,270		173		2,459

NOTE F – MORTGAGE BANKING

The Company’s mortgage banking subsidiary has net worth requirements with the U.S. Department of Housing and Urban Development and Federal Home Loan Mortgage Corporation of $250,000. The Company exceeds this requirement as of September 30, 2003 and December 31, 2002.

Changes in the balance of mortgage servicing rights, net, were as follows:


		(In thousands) Nine Months Ended September 30,

		2003			2002

Balance — beginning of period		$	3,749		$	2,254
	Additions		2,213			1,446
	Amortization		(1,213	)		(552	)
	Impairment adjustment		250			—

Balance — end of period		$	4,999		$	3,148

Accumulated amortization of mortgage servicing rights was approximately $3,438,000 and $2,224,000 at September 30, 2003 and December 31, 2002, respectively.

At September 30, 2003, the weighted-average amortization period of the Company’s mortgage servicing rights was 4.2 years. Projected amortization expense for the gross carrying value of mortgage servicing rights at September 30, 2003 is estimated to be as follows (in thousands):


Remainder of 2003	$	614
2004		1,828
2005		1,276
2006		591
2007		267
2008		183
After 2008		295

Gross carrying value of mortgage servicing rights	$	5,053

NOTE G – DEFINITIVE AFFILIATION AGREEMENT

On July 23, 2002, the Company signed a definitive affiliation agreement, as amended on September 9, 2002 and December 10, 2002, which provides for the acquisition of the Company by Fifth Third Bancorp (“Fifth Third”) through a merger of the Company with and into a wholly-owned subsidiary of Fifth Third. The Board of Directors of the Company approved the definitive affiliation agreement and the transactions contemplated thereby.

On March 27, 2003, the Company entered into an additional amendment to the affiliation agreement to extend its termination date to June 30, 2004. As consideration for this amendment, Fifth Third agreed to amend the exchange ratio to provide shareholders of the Company shares of Fifth Third common stock valued at a fixed price of $31.00 per share of the Company, plus any increase in the book value per share (excluding certain items as defined in the amendment) of the Company’s common stock from March 31, 2003 through the most

recent quarter end prior to the closing. Further, in the event that Fifth Third is not granted regulatory approval for the merger on or before May 31, 2004, the Company will have the right to terminate the agreement and to receive a termination fee of $27 million from Fifth Third.

NOTE H – CONTINGENCIES AND GUARANTEES

Contingencies

The Company is involved in various legal proceedings in the normal course of business. On August 24, 2000, Jerrold S. Pressman filed a complaint in the U.S. District Court for the Middle District of Tennessee, against Franklin National Bank and Gordon E. Inman, Chairman of the Board of the Company and the Bank, alleging breach of contract, tortious interference with contract, fraud, and civil conspiracy in connection with the denial of a loan to a potential borrower involved in a real estate transaction. The Bank and Mr. Inman filed their answers in this matter on September 18, 2000, and a motion for Summary Judgment on October 10, 2000. The Court denied the Bank’s motion for Summary Judgment on February 15, 2001. On July 27, 2001, the Bank and Mr. Inman filed a second motion for Summary Judgment. The Court granted in part and denied in part the Bank and Mr. Inman’s motion for Summary Judgment on October 5, 2001. The case was set for trial to begin on March 5, 2002; however, on February 22, 2002, the Court, on its own Motion, continued the trial until September 10, 2002. Mr. Pressman’s amended complaint seeks compensatory damages in an amount not to exceed $20 million and punitive damages in an amount not to exceed $40 million from each defendant. On September 3, 2002, the Court granted Mr. Pressman’s motion to Continue Trial and set February 25, 2003, to begin the trial. A bench trial on the merits of the case was held between February 25 and March 7, 2003. On April 30, 2003, the United States District Judge issued an Order in which a judgment was entered for the Defendants Franklin National Bank and Mr. Inman on all of Mr. Pressman’s claims. On May 2, 2003, Mr. Pressman filed a Notice of Appeal to the United States Court of Appeals for the Sixth Circuit. A Proof Brief of Appellee Franklin National Bank will be timely filed with the Court. No provision has been made in the accompanying consolidated financial statements for the ultimate resolution of this matter.

There are also other legal actions in which the Company is a defendant. Management under the advice of legal counsel believes the Company also has meritorious defenses against these claims and intends to defend such actions vigorously. No provision has been made in the consolidated financial statements for the ultimate resolution of these matters.

Guarantees

In the ordinary course of business, the Company sells mortgage loans without recourse that may have to be subsequently repurchased due to defects that occurred during the origination of the loan. The defects are categorized as documentation errors, underwriting errors, early payment defaults and fraud. When a loan sold to an investor without recourse fails to perform, the investor will typically review the loan to determine whether defects in the origination process occurred. If a defect is identified, the Company may be required to either repurchase the loan or indemnify the investor for losses sustained. If there are no defects, the Company has no commitment to repurchase the loan. The requirement to repurchase the loan or indemnify the investor is generally limited to 90 days from the date the related mortgage loan is sold to the investor. As of September 30, 2003, these guarantees totaled $60.8 million. No reserve has been established at September 30, 2003 to cover the potential exposure related to these guarantees as the Company does not believe the ultimate loss related to this exposure is material to the consolidated financial statements.

The Company maintains insurance for general liability, director and officer liability and property. Certain policies are subject to deductibles. In addition to the insurance coverage provided, the Company will indemnify certain officers and directors for actions taken on behalf of the Company.

ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The Bank represents virtually all of the assets of the Company. The Bank, located in Franklin, Tennessee, opened in December of 1989 and continues to experience growth. The Bank has nine full service branches. In August 1996, the Bank opened an insurance subsidiary, Franklin Financial Insurance. In October 1997, the Bank opened a financial services subsidiary, Franklin Financial Securities. The financial services subsidiary offers financial planning and securities brokerage services through Legg Mason Financial Partners. In December 1997, the Bank began operating its mortgage division as a separate subsidiary, Franklin Financial Mortgage. In September 2003, the mortgage subsidiary closed its retail mortgage origination office in Chattanooga, Tennessee. Franklin Financial Mortgage originates, sells and services wholesale and retail mortgage loans. In September 2000, the Company formed Franklin Capital Trust I, a Delaware business trust and wholly owned subsidiary of the Company, for the purpose of issuing Trust Preferred Securities to the public. In December 2000, the Company received approval from the Federal Reserve Bank to convert from a bank holding company to a financial holding company to allow the Company additional avenues for growth opportunities. In May 2001, the Company’s stock began trading on the NASDAQ National Market under the symbol “FNFN”.

Recent Developments

On July 23, 2002, the Company entered into a definitive affiliation agreement (the “Agreement”) which provides for the acquisition of the Company by Fifth Third Bancorp, an Ohio corporation (“Fifth Third”) through the merger of the Company with and into a wholly owned subsidiary of Fifth Third. The original Agreement provided that each shareholder of the Company would receive, on a tax-free basis, between 0.3832 and 0.4039 shares of common stock of Fifth Third for each share of Company common stock owned, with the exact ratio to be determined based on the average closing price of the common stock of Fifth Third for the ten consecutive trading days ending on the fifth trading day preceding the closing of the merger.

On September 9, 2002 and December 10, 2002, the parties amended the Agreement to extend the deadlines for certain regulatory and other filings by Fifth Third and to extend the termination date for the Agreement to April 1, 2003. The reasons for the delay related to an investigation by various banking regulators and a moratorium imposed by the banking regulators prohibiting acquisitions by Fifth Third, including the pending acquisition of the Company. On March 27, 2003, Fifth Third announced that it entered into a written agreement with the Federal Reserve Bank of Cleveland and the Ohio Department of Commerce, Division of Financial Institutions arising out of the previously discussed regulatory review of Fifth Third. The written agreement outlines a series of steps to address and strengthen Fifth Third’s risk management processes and internal controls. These steps include independent third party reviews and the submission of written plans in a number of areas. These areas include Fifth Third’s management, corporate governance, internal audit, account reconciliation procedures and policies, information technology, and strategic planning.

On March 27, 2003, the Company entered into Amendment No. 3 to the Agreement to extend the termination date of the Agreement to June 30, 2004. In this amendment, Fifth Third agreed to amend the exchange ratio in the merger to provide that the Company’s shareholders would receive Fifth Third common stock valued at a fixed price of $31.00 per share of Franklin common stock. In addition, the Company’s shareholders would receive the benefit of any increase in the book value per share (excluding certain items as defined in the amendment) of the Company’s common stock from March 31, 2003 through the most recent quarter end prior

to closing. In the event that the Board of Governors of the Federal Reserve System has not granted regulatory approval for the merger on or before May 31, 2004, the Company has the right to terminate the Agreement and to receive a termination fee of $27 million from Fifth Third.

The closing of the transaction is subject to the approval of the Company’s shareholders and normal regulatory approvals. The terms of the Agreement and the amendments thereto are more fully described in the Company’s Current Reports on Form 8-K as filed with the Securities and Exchange Commission on July 25, 2002 (which report also contains a copy of the Affiliation Agreement), September 10, 2002, December 18, 2002 and March 27, 2003. The above description of the Agreement and the amendments thereto is qualified in its entirety by reference to the Agreement and the amendments, which are attached as exhibits to the Company’s Current Reports on Form 8-K.

Critical Accounting Policies

Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, we have identified three policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our consolidated financial statements. These policies relate to the methodology for the determination of our allowance for loan and lease losses, the valuation of our repossessed and foreclosed assets and the valuation of our mortgage servicing rights.

The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. A loan is considered impaired when management has determined it is possible that all amounts due according to the contractual terms of the loan agreement will not be collected. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries.

Repossessed and foreclosed assets are acquired through, or in lieu of, loan foreclosure and are held for sale and initially recorded at fair value at the date of foreclosure, thereby establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by independent appraisers and/or management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Gains and losses from the sale of these assets are included in other income or other expense as appropriate. Any expenses to maintain such assets and changes in the valuation allowance, if any, are included in other expenses.

Servicing assets on loans sold are measured by allocating the previous carrying amount between the assets sold and the retained interests based on their relative fair values at the date of transfer. Our mortgage servicing rights are related to in-house originations serviced for others. The initial amount recorded as mortgage servicing rights is essentially the difference between the amount that can be realized when loans are sold, with servicing released, as compared to loans sold, with servicing retained. Mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing revenues. Impairment of mortgage servicing rights is assessed based on the fair value of those rights.

These policies and the judgments, estimates and assumptions are described in greater detail in subsequent sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 1 to the Consolidated Financial Statements included in the Company’s 2002 Annual Report on Form 10-K. We believe that the judgments, estimates and assumptions used in the preparation of our consolidated financial statements are appropriate given the factual circumstances at the time. However, given the sensitivity

of our consolidated financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition.

Financial Condition

Total assets decreased $11.6 million, or 1.3%, since December 31, 2002, to a total of $879.6 million at September 30, 2003. The decline in assets is primarily attributable to a decrease in loans held for sale of $14.1 million, or 72.4%, a decrease in cash and cash equivalents of $6.4 million, or 22.8%, and a decrease in federal funds sold of $18.9 million, or 100%. These were offset by an increase in total investment securities of $25.9 million, or 9.7%.

The Bank’s loan demand has slowed slightly as demonstrated by the decrease in net loans of $1.6 million, or 0.3%, since December 31, 2002. The allowance for loan losses reflects a decrease of $283,000, or 4.9%, since December 31, 2002, to $5.5 million, or approximately 1.01% of total loans, at September 30, 2003. The decrease is primarily reflective of the overall decrease in total loans. Management believes that the level of the allowance for loan losses is adequate at September 30, 2003. Management reviews in detail the level of the allowance for loan losses on a quarterly basis. The allowance is below the Bank’s peer group average as a percentage of loans, however the Bank’s past due loans, at 0.82% of total loans at September 30, 2003, have historically been below peer group average. At September 30, 2003, the Bank had non-accrual loans of $1.7 million compared to non-accrual loans of $5.2 million at December 31, 2002. The Bank had one large relationship of $3.8 million that was placed on non-accrual during the third quarter of 2002. Of this amount, approximately $819,000 was charged off to the allowance for loan losses in the third quarter of 2003. Assets were repossessed that collateralized remaining debt and were reclassified from loans to repossessed and foreclosed assets on the consolidated balance sheet in the second quarter of 2003. Subsequent to the repossession date, during the second quarter of 2003, the Bank established a valuation allowance on these assets in the amount of $2.4 million. The valuation allowance represents a write down in the value of the assets based on information obtained by management from an independent third party. Management is in the process of selling the repossessed assets and the valuation allowance has been adjusted appropriately, as of September 30, 2003, to approximately $2.0 million. Management believes it has adequately valued these assets as of September 30, 2003. At September 30, 2003, the Bank had loans that were specifically classified as impaired of approximately $16.1 million compared to $19.2 million at December 31, 2002. The allowance for loan losses related to impaired loans was $643,000 at September 30, 2003 compared to $698,000 at December 31, 2002. The average carrying value of impaired loans was approximately $17.0 million for the nine-month period ended September 30, 2003. Interest income of approximately $225,000 was recognized on these impaired loans during the nine-month period ended September 30, 2003.

At September 30, 2003 the fair value of securities classified as available-for-sale was less than the cost of the securities by $124,000. At December 31, 2002 the fair value of securities classified as available-for-sale exceeded the cost of the securities by $4.5 million. As a result, an unrealized loss net of taxes of $75,000 and an unrealized gain net of taxes of $2.8 million at September 30, 2003 and December 31, 2002, respectively, is included in “Accumulated Other Comprehensive Income” in the stockholders’ equity section of the balance sheet. The change from an unrealized gain at December 31, 2002 to an unrealized loss at September 30, 2003 is primarily due to the change in economic market conditions during the nine-months ended September 30, 2003.

Securities available-for-sale increased $30.2 million, or 11.7%, during the nine months ended September 30, 2003. The increase was due to excess funds being invested in the investment portfolio due to slower loan growth during the first nine months of 2003 and proceeds from securities called within the held-to-maturity portfolio being reinvested as available-for-sale securities. Securities held-to-maturity decreased $4.3 million, or 52.4%, due to zero coupon agency securities being called during the first and second quarters of 2003. Net premises and equipment decreased by $724,000, or 7.5%, since December 31, 2002 primarily due to depreciation expense offset slightly by purchases of equipment. Accrued interest receivable increased $220,000,

or 5.9%, since December 31, 2002. This increase is due to the increase of $25.9 million in investment securities since December 31, 2002, offset by significantly lower interest rates. Repossessed and foreclosed assets increased $2.3 million, or 146.5%, since December 31, 2002. The increase is due to the $2.2 million balance, as of September 30, 2003, of assets repossessed from one large borrowing relationship as described above, less the $2.0 million valuation allowance related to these assets. In addition, additional real estate foreclosures occurred in the third quarter 2003 totaling approximately $2.3 million. These foreclosures were partially offset by sales of foreclosed assets in the third quarter of $351,000.

Total deposits decreased $13.7 million, or 1.8%, since December 31, 2002. The decrease is primarily attributable to the $13.5 million decrease in interest-bearing deposits. Brokered certificates of deposits have decreased $35.0 million since December 31, 2002. The Company has been able to let these certificates mature and has been able to partially replace them with increases in the core, retail and public funds deposits. Accrued interest payable decreased $332,000, or 22.5%, since December 31, 2002. The decrease is due to the overall decrease in interest-bearing deposits and a significant decrease in interest rates during 2003. Long-term debt and other borrowings increased $1.7 million, or 2.2%, since December 31, 2002 due to temporary federal funds purchased of $3.1 million, offset partially by the Company’s $1.5 million repayment of a note to a correspondent bank. Other liabilities decreased $5.5 million, or 88.5%, since December 2002. The decrease is due to federal and state tax payments made during 2003 that exceeded income tax expense recorded for the nine months ended September 30, 2003. The decrease is also attributable to the settlement of a purchased investment security in the first quarter of 2003. In addition, deferred taxes related to unrealized holding gains on securities held as available-for-sale decreased by $1.8 million from December 31, 2002. Stockholders’ equity increased $6.3 million, or 12.9%, from December 31, 2002 to September 30, 2003. The increase is primarily attributable to $7.4 million in net income offset by a decrease of $2.9 million in accumulated other comprehensive income, and by $1.4 million in dividends declared. Stockholders equity also increased due to a $3.2 million increase in common stock resulting from the exercise of stock options. Unearned compensation of $96,000 was also recorded due to the issuance of restricted stock. The restricted stock was issued as part of the Company’s Key Employee Restricted Stock Plan and vests over a period of four years. The unearned compensation is being amortized on a straight-line basis over the four-year vesting period of the restricted stock.

Liquidity and Capital Resources

Management continuously monitors the Bank’s liquidity, and strives to maintain an asset/liability mix that provides the highest possible net interest margin without taking undue risk with regard to asset quality or liquidity. Liquidity management involves meeting the funds flow requirements of customers who may withdraw funds on deposit or have need to obtain funds to meet their credit needs. Banks in general must maintain adequate cash balances to meet daily cash flow requirements as well as satisfy the reserves required by applicable regulations. The cash balances held are one source of liquidity. Other sources of liquidity are provided by the investment portfolio, federal funds purchased, Federal Home Loan Bank advances, sales of loan participations, loan payments, brokered and public funds deposits and the Company’s ability to borrow funds, as well as issue new capital.

Management believes that liquidity is at an adequate level with cash and due from banks of $21.7 million at September 30, 2003. Loans and securities scheduled to mature within one year exceed $269 million at September 30, 2003, which should provide further liquidity. In addition, approximately $288.2 million of securities are classified as available-for-sale and could be sold to help meet liquidity needs should they arise. The Company has a line of credit of $5.0 million with a lending institution and the Bank is approved to borrow up to $10.0 million in funds from the Federal Home Loan Bank through overnight advances and $72.5 million in federal funds lines to assist with capital and liquidity needs. The Company had $900,000 in borrowings against its line of credit and the Bank had $3.1 million in federal funds purchased at September 30, 2003. In February and August, 1998 the Bank entered into long term convertible Federal Home Loan Bank advances

with a ten year maturity and a one year call option totaling $6.0 million. During the fourth quarter of 1999, these advances converted to variable rate advances, which reprice quarterly based on 90-day LIBOR. As part of its leverage program, during the third quarter of 2000 the Bank entered into three long-term convertible Federal Home Loan Bank advances. One advance of $25.0 million has a ten year maturity with a three year call option. The other two advances totaling $27.0 million have a five year maturity with a one year call option. After the three and one year call options, these advances may be converted by the Federal Home Loan Bank from a fixed to a variable rate. The Bank has the right to repay the advances on the date of conversion to a variable rate without penalty. The Bank has $200,000 outstanding in repurchase agreements to further develop its relationship with customers. The Bank has approximately $65.1 million in brokered deposits at September 30, 2003. The majority of these brokered deposits are $100,000 or less, but they are generally considered to be more volatile than the Bank’s core deposit base.

Approximately $55.7 million in loan commitments are expected to be funded within the next six months. Approximately $10.5 million of these commitments are in the mortgage banking segment. Furthermore, the Bank has approximately $99.9 million of other loan commitments, primarily unused lines and letters of credit, which may or may not be funded. Commitments may be funded by core or brokered deposits, cash flow from the securities portfolio or other funding sources which the Bank maintains. The mortgage banking segment has $8.0 million in commitments to sell loans at September 30, 2003.

Management monitors the Company’s asset and liability positions in order to maintain a balance between rate- sensitive assets and rate-sensitive liabilities and at the same time maintain sufficient liquid assets to meet expected liquidity needs. Management believes that the Company’s liquidity is adequate at September 30, 2003 and that liquidity will remain adequate over future periods. Other than as set forth above, there are no known trends, commitments, events or uncertainties that will result in or are reasonably likely to result in the Company’s liquidity increasing or decreasing in any material way. The Company is not aware of any current recommendations by the regulatory authorities, which if they were to be implemented, would have a material adverse effect on the Company’s liquidity, capital resources or results of operations.

Net cash flow provided by operating activities was $19.7 million for the first nine months of 2003. The proceeds from the sale of loans exceeded loans originated for sale by $18.7 million for the nine months ended September 30, 2003. The majority of this change in cash flow is due to less loan originations as compared to the sale of loans in the mortgage banking segment during the nine months ended September 30, 2003. The increase in cash flow is also due to net income for the nine months ended September 30, 2003 of $7.4 million. These increases are partially offset by an increase in other assets of $8.4 million and a decrease in other liabilities of $3.8 million for the nine months ended September 30, 2003.

Net cash used in investing activities was $15.2 million for the nine months ended September 30, 2003, which was largely due to the banking segment. The cash used in investing activities was primarily due to an increase in the net investment portfolio of $30.8 million for the nine months ended September 30, 2003. In addition, the change in net loans reflect an increase of $3.7 million for the first nine months of 2003. These uses of cash for investing activities was partially offset by a decrease in federal funds sold of $18.9 million.

Net cash used in financing activities was $10.9 million for the first nine months of 2003. The decrease in cash flow is primarily due to a decrease in deposits of $13.7 million in the first nine months of 2003 partially offset by an increase in common stock from the exercise of stock options of $2.6 million.

Equity capital exceeded regulatory requirements at September 30, 2003, at 8.1% of average assets. The Company’s and the Bank’s minimum capital requirements and compliance with the same are shown in the following table.


	Leverage Capital						Tier 1 Capital						Total Risk-Based Capital

	Regulatory						Regulatory						Regulatory
	Minimum			Actual			Minimum			Actual			Minimum			Actual

Company		3.0	%		8.1	%		4.0	%		11.7	%		8.0	%		12.6	%
Bank		3.0	%		7.3	%		4.0	%		10.8	%		8.0	%		12.0	%

Results of Operations

The Company had net income of $3.4 million in the third quarter of 2003 and $7.4 million for the first nine months of 2003 compared to net income of $3.3 million and $8.4 million for the same periods in 2002. Net income for the third quarter of 2003 increased $139,000, or 4.3% compared to the third quarter of 2002. Net income for the nine months ended September 30, 2003 decreased $1.0 million, or 12.0% compared to the nine months ended September 30, 2002.

Total interest income decreased $1.4 million, or 11.2%, in the three months ended September 30, 2003 and $3.0 million, or 8.0%, for the nine months ended September 30, 2003 compared to the same periods in 2002. Total interest expense decreased $797,000, or 17.9%, for the three months ended September 30, 2003 and $1.9 million, or 14.0% for the nine months ended September 30, 2003 compared to the same periods in 2002. The decrease in total interest income is primarily attributable to significantly lower interest rates offset partially by an increase in average earning assets of $97.9 million, or 13.3%, for the first nine months of 2003 compared to 2002. The decrease in total interest income is primarily due to the banking segment. The decrease in total interest expense is primarily due to the significant decrease in interest rates offset by an increase in average interest-bearing liabilities of $65.4 million, or 11.0%, for the nine months ended September 30, 2003 as compared to the same period in 2002. The banking segment continues to experience strong deposit rate competition. The Company had a net interest margin of 3.66% for the third quarter of 2003 and 3.72% for the nine months ended September 30, 2003 compared to 4.34% and 4.42%, respectively, for the same periods in 2002. The decrease in net interest margin is due to significant decreases in short-term interest rates. Loans are repricing faster than deposits that have previously repriced at lower interest rates. As short-term interest rates decrease, a significant portion of the Bank’s loan portfolio reprices immediately. The Bank currently has a relatively short-term certificate of deposit portfolio which has supported the net interest margin in the declining rate environment, but with the extended low rate environment, loan repricings are occurring at a faster rate than repricing of deposits. In addition, the Bank is receiving a large amount of cash flow in the investment portfolio due to mortgage-backed securities prepaying much faster as interest rates decline. This cash flow is being reinvested into securities at lower yields, causing a decline in the net interest margin.

The provision for loan losses was $470,000 and $760,000 for the three months ended September 30, 2003 and 2002, respectively. The year-to-date provision is $1.9 million for the nine months ended September 30, 2003 as compared to $2.2 million for the same period in 2002. The Bank’s asset quality remains strong. Net charge-offs were $2.2 million, or 0.40% of average loans outstanding at September 30, 2003 compared to net charge-offs of $1.1 million, or 0.22%, of average loans outstanding at September 30, 2002. Approximately $819,000 of the provision for loan losses for the first nine months of 2003, related to a single loan relationship of the Bank which was fully reserved for and subsequently charged off in the third quarter 2003. For the first nine months of 2002, the provision for loan losses included approximately $905,000 from a problem loan relationship that was subsequently charged off in 2002.

Total other income was $3.6 million in the third quarter of 2003, an increase of $406,000, or 12.5% from $3.2 million for the same period in 2002. The increase was largely attributable to an increase of $1.1 million, or 98.7%, in mortgage banking activities offset partially by a decrease of $462,000 in the gain on the sale of mortgage loans. For the third quarter of 2003 a $1.2 million recovery of a previously recorded impairment of mortgage servicing rights is included in mortgage banking activities income. Total other income of $8.9 million for the nine months ended September 30, 2003 increased $1.8 million, or 24.7%, from $7.1 million from the

same period in 2002. The increase is primarily due to increases of $1.0 million, or 37.2%, in mortgage banking activities, a $401,000, or 50.0% increase in the gain on the sale of mortgage loans and an increase in the gain on sale of investment securities of $757,000, or 128.1%. Mortgage servicing rights income contributed $2.2 million and $1.4 million for the nine months ended September 30, 2003 and 2002, respectively, to the total income for the mortgage banking segment.

Total other expenses had a slight decrease of $75,000, or 1.3%, during the third quarter of 2003 as compared to the same period in 2002. Total other expenses increased $2.6 million, or 15.6%, for the nine months ended September 30, 2003 as compared to the same period in 2002. Mortgage banking expenses increased by $293,000 or 75.5%, for the third quarter of 2003 compared to third quarter of 2002. Increases in mortgage correspondent pricing and mortgage servicing rights amortization contributed to the increase in mortgage banking expenses. Mortgage banking expenses increased by $654,000, or 60.8%, for the nine months ended September 30, 2003 as compared to the same period in 2002. The increase is primarily attributable to a combined increase of $836,000 in mortgage correspondent pricing and mortgage servicing rights amortization. Repossessed and foreclosed assets expense increased $132,000 for the third quarter of 2003 as compared to the third quarter of 2002. For the nine months ended September 30, 2003, repossessed and foreclosed assets expense increased $2.0 million compared to the same period in 2002. In the second quarter of 2003, a $2.4 valuation allowance was recorded on several pieces of repossessed assets related to a single customer relationship and a $40,000 valuation allowance on a piece of foreclosed property was recorded. In the third quarter of 2003 an additional valuation allowance of $72,000 was recorded on pieces of repossessed assets. Salaries and employee benefits decreased $80,000, or 2.6% for the third quarter of 2003 compared to third quarter of 2002. For the nine months ended September 30, 2003, salaries and employee benefits increased $275,000, or 3.1%. The increase is attributable to increases in mortgage commission expense of $388,000 due to the increase in mortgage loan originations and accrued officer incentives of $283,000 for the nine months ended September 30, 2003. In the first half of 2002, officer incentives were paid in Company stock options and therefore, not recorded as compensation expense. Due to certain restrictions in the Company’s affiliation Agreement with Fifth Third Bancorp, officer incentives are no longer paid in options but rather are paid in cash, and are therefore expensed in the Company’s consolidated statements of income. These increases are partially offset by a $446,000 decrease in Bank salaries due to the reduction of overall personnel.

Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and requires that the amount recorded as a liability be capitalized by increasing the carrying amount of the related long-lived asset. Subsequent to initial measurement, the liability is accreted to the ultimate amount anticipated to be paid, and is also adjusted for revisions to the timing or amount of estimated cash flows. The capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss. SFAS No. 143 was required to be adopted for fiscal years beginning after June 15, 2002, with earlier application encouraged. The adoption of SFAS No. 143 on January 1, 2003 did not have a material impact on the Company’s consolidated financial position or results of operations.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which is effective for exit or disposal activities initiated after December 31, 2002. SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002 and did not

have a material impact on the Company’s consolidated financial position or results of operations as of and for the quarter and nine months ended September 30, 2003.

In November 2002, the FASB issued Interpretation (“FIN”) No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34. This interpretation requires that upon issuance of a guarantee, the entity must recognize a liability for the fair value of the obligation it assumes under that obligation. This interpretation is intended to improve the comparability of financial reporting by requiring identical accounting for guarantees issued with separately identified consideration and guarantees issued without separately identified consideration. The initial recognition and measurement provisions of FIN No. 45 are to be applied prospectively to guarantees issued or modified after December 31, 2002. The interpretation’s disclosure requirements were effective for the Company as of December 31, 2002. Significant guarantees that have been entered into by the Company at September 30, 2003 and December 31, 2002 are disclosed in Note H to the consolidated financial statements included in this report.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of FASB Statement No. 123. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS No. 148 is effective for annual and interim periods beginning after December 15, 2002. As the Company has elected not to change to the fair value based method of accounting for stock-based employee compensation, the adoption of SFAS No. 148 did not have an impact on the Company’s consolidated financial position or results of operations.

In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities. FIN No. 46 addresses consolidation by business enterprises of variable interest entities that have certain characteristics. This Interpretation applies immediately to variable interest entities created in January 31, 2003 and to variable interest entities in which an enterprise obtains an interest after that date. Under certain circumstances, the effective date of FIN No. 46 has been delayed to the first year or interim period ending after December 15, 2003. The adoption of the provisions of FIN No. 46 related to variable interest entities created in January 31, 2003, or after that date, did not have an impact on the Company’s consolidated financial position or results of operations. The Company is in the process of evaluating the impact that the adoption of the provision of FIN No. 46 related to variable interest entities created before February 1, 2003 would have on the company’s trust preferred securities currently reported with long-term debt and other borrowings on its consolidated statement of financial position.

In April 2003, the FASB issued SFAS No. 149, Amendment to Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS No. 149 is applied prospectively and is effective for contracts entered into or modified after June 30, 2003, except for SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003 and certain provisions relating to forward purchases and sales on securities that do not yet exist. The adoption on April 1, 2003 of the components of SFAS No. 149 which address SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003 did not have a material impact on the Company’s consolidated interim financial position and results of operations. The adoption of the remaining components of SFAS No. 149 is not anticipated to have a material impact on the Company’s consolidated financial position or results of operations.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatory redeemable financial instruments of nonpublic entities. The adoption of SFAS No. 150 did not have an impact on the Company’s consolidated financial position or results of operations.

Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995

Certain statements in this Form 10-Q contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, which statements generally can be identified by the use of forward-looking terminology, such as “may,” “will,” “expect,” “estimate,” “anticipate,” believe,” “target,” “plan,” “project,” or “continue” or the negatives thereof or other variations thereon or similar terminology, and are made on the basis of management’s plans and current analyses of the Company, its business and the industry as a whole. These forward looking statements are subject to risks and uncertainties, including, but not limited to, economic conditions, competition, interest rate sensitivity and exposure to regulatory and legislative changes. The above factors, in some cases, have affected, and in the future could affect, the Company’s financial performance and could cause actual results for fiscal 2003 and beyond to differ materially from those expressed or implied in such forward-looking statements. The Company does not undertake to publicly update or revise its forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company’s financial performance is subject to risk from interest rate fluctuations. This interest rate risk arises due to differences between the amount of interest-earning assets and the amount of interest-bearing liabilities subject to repricing over a specified period and the amount of change in individual interest rates. The liquidity and maturity structure of the Company’s assets and liabilities are important to the maintenance of acceptable net interest income levels. An increasing interest rate environment can negatively impacts earnings as the Company’s rate sensitive liabilities, have in the past, generally repriced faster than its rate sensitive assets. Conversely, in a decreasing interest rate environment, earnings can be positively impacted. This potential asset/liability mismatch in pricing is referred to as “gap” and is measured as rate sensitive assets divided by rate sensitive liabilities for a defined time period. A gap of 1.0 means that assets and liabilities are perfectly matched as to repricing within a specific time period and interest rate movements will not affect net interest margin, assuming all other factors hold constant. Management has specified gap guidelines for a one-year time horizon between 0.7 and 1.3. At September 30, 2003, the Company had a gap ratio of approximately 1.0 for the one-year period ending September 30, 2004.

A 200 basis point decrease in the general level of interest rates spread evenly during the next twelve months is estimated to cause a increase in net interest income of $706,000 as compared to net interest income if interest rates were unchanged during the next twelve months. In comparison, a 200 basis point increase in the general level of interest rates spread evenly during the next twelve months is estimated to cause a decrease in net interest income of $706,000, as compared to net interest income if rates were unchanged during the next twelve months.

As discussed above, this level of variation is within the Company’s acceptable limits. This simulation analysis assumed that savings and checking interest rates had a low correlation to changes in market rates of interest and that certain asset prepayments changed as refinancing incentives evolved. Further, in the event of a change in

such magnitude in interest rates, the Company’s asset and liability management committee would likely take actions to further mitigate its exposure to the change. However, given the uncertainty of specific conditions and corresponding actions, which would be required, the analysis assumed no change in the Company’s asset/liability composition.

ITEM 4 — CONTROLS AND PROCEDURES

Management has developed and implemented a policy and procedures for reviewing disclosure controls and procedures and internal control over financial reporting on a quarterly basis. As of September 30, 2003, management, including the Company’s principal executive and financial officers, evaluated the effectiveness of the design and operation of disclosure controls and procedures, and, based on their evaluation, our principal executive and financial officers have concluded that these controls and procedures are operating effectively. There were no significant changes in the Company’s internal control over financial reporting during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Disclosure controls and procedures are the Company’s controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files under the Exchange Act is accumulated and communicated to management, including the principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Except as set forth above, there are no material pending legal proceedings to which the Company or the Bank is a party or of which any of their properties are subject; nor are there material proceedings known to the Company to be contemplated by any governmental authority; nor are there material proceedings known to the Company, pending or contemplated, in which any director, officer, or affiliate or any principal security holder of the Company, or any associate of any of the foregoing is a party or has an interest adverse to the Company or the Bank.

Item 6. Exhibits and Reports on Form 8-K

(a)

Exhibits.


Exhibit No.		Description of Exhibit

31.1		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

	(b)		Reports on Form 8-K.

			On July 28, 2003, the Company furnished a Form 8-K to the Commission in connection with the Company’s press release announcing the Company’s results for the three and six months ended June 30, 2003 and its financial condition as of June 30, 2003.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		FRANKLIN FINANCIAL CORPORATION

Dated: November 14, 2003	By:	/s/ Gordon E. Inman

		Gordon E. Inman, President and Chief Executive Officer (Principal Executive Officer)

Dated: November 14, 2003	By:	/s/ Kelly S. Swartz

		Kelly S. Swartz, Vice President and Chief Financial Officer (Principal Financial Officer)

EXHIBIT INDEX


Exhibit No.		Description of Exhibit

31.1		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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FRANKLIN FINANCIAL CORP /TN/ 10-Q