Since Franklin Bank Corp. was established in 2002, its organizers have made clear that their plan was to build the company through acquisitions and sell it for top dollar, much as they did with another Houston company, Bank United Corp.
But Franklin's fortunes have taken a turn for the worse in recent quarters, and if the $5.9 billion-asset company is sold any time soon, it would almost certainly be at a fire sale price.
The latest dose of bad news came Monday night when Franklin disclosed that a 10-week internal investigation had uncovered significant accounting errors related to its residential mortgage portfolio and that it is facing a Securities and Exchange Commission probe into its real estate lending practices.
Though a sale is possible, analysts say, a more likely scenario is that Franklin would raise capital to stay afloat — hardly ideal for shareholders, since it would significantly dilute their holdings' value. Brian Klock, a vice president at KBW Inc.'s Keefe Bruyette & Woods Inc., said he believes the company needs to raise as much as $255 million in capital — $175 million of common equity and $80 million in subordinated debt.
Possibly the only good news for shareholders is that Lewis S. Ranieri, the holding company's chairman, is to take over as interim chief executive officer.
Mr. Ranieri, who co-founded Franklin but has not been actively involved in managing it, is an industry icon. He is widely credited with creating the market for mortgage-backed securities in the 1980s and later was instrumental in building Bank United into an $18 billion-asset company before selling it to Washington Mutual Inc. in 2001 for $1.5 billion.
"It's an important gesture from the board to have Lew back running the day-to-day operations," said Mr. Klock. "The reality is, I think the company is going to need to raise some common equity and having Lew involved will give investors more confidence."
Mr. Ranieri succeeds Anthony Nocella, also a Bank United alumnus and a Franklin founder. Mr. Nocella is to remain a director, as well as chairman of the thrift subsidiary. He will assist the executive committee at Franklin until his retirement by Dec. 31, the company's press release stated.
The shake-up comes after the internal audit committee investigation found problems with Franklin's accounting for single-family mortgage loan modification programs that were developed to reduce delinquencies. It said the company did not charge off certain uncollectible single-family second liens and did not properly record certain mark-to-market writedowns on loans transferred from "held for sale" to "held for investment."
Franklin has delayed filing its 2007 annual report and its first-quarter results, but the company gave some insight early this month on what to expect when it amended call reports filed with the Federal Deposit Insurance Corp. The reports showed a $35.2 million first-quarter loss at its Franklin Bank unit and a $74.5 million fourth-quarter loss.
Franklin's shares have plummeted amid concern that its concentration of mortgage and residential construction loans was too high and its tangible-capital levels too low. In October, when the stock was trading around $9.50 a share, Mr. Nocella said Franklin was considering a range of options, including selling the company in pieces or taking itself private.
Dan Bass, the managing director in the Houston office of Carson Medlin Co., said Franklin has been in talks with private-equity firms about a buyout. "Private equity could go in there and take it private and work through the construction piece," he said.
But with its share price now hovering around $1, KBW's Mr. Klock said he does not think a sale would be in the shareholders' best interest, especially since $25 million was raised last summer through a friends-and-family offering at more than $16 per share. "It's a low probability that they would sell," he said. "With that big of an investment from insiders, it doesn't make sense to sell for two bucks."
Mr. Klock estimated that the company's tangible book value has fallen from $4.88 a share at the end of December to about $3.62 now. Additional cumulative losses in the loan portfolio could reduce that value to $1.14.
"Nonperforming loans from construction and single-family mortgage will continue to increase for the whole industry but especially for Franklin, which has a high concentration of construction and single-family mortgages in markets like California, Florida, Arizona, Michigan, and Georgia," he said.
