Franklin Bank Corp. in Houston is at a crossroads.
In the second quarter the $5.5 billion-asset savings bank holding company accomplished two major goals it had set when it went public in 2003: reducing the single-family mortgages on its books to 50% of its overall portfolio and reaching $2 billion in core deposits.
But those moves did little for the stock price, which is down 55% for the year amid concern that Franklin’s concentration of mortgage and residential construction loans is too high and its tangible-capital levels are too low, according to analysts who follow the company.
Now Franklin is trying to figure out what to do next.
Anthony Nocella, its president and chief executive, said its options include selling all or parts of itself — perhaps sooner than it had intended — going private, and continuing with business as usual in hopes that the stock rebounds.
"We think we have a fiduciary duty to our shareholders, and that responsibility is to explore strategic alternatives," Mr. Nocella said in an interview last week. "By the end of 2008 we should know where we are going. Everything is on the table as a strategic alternative."
Mr. Nocella, chairman Lewis R. Ranieri, and a group investors acquired Franklin in 2002, about a year after they had sold the $18 billion-asset Bank United Corp. in Houston to Washington Mutual Inc.
As part of that deal, the group retained much of Bank United’s mortgage origination and construction lending offices in seven states. After buying Franklin, which at the time was based in Austin and had just $50 million of assets, the group folded those operations into the bank.
Franklin has since made nine acquisitions in Texas and moved its headquarters to Houston.
As it has built up its branch network and commercial banking assets in Texas, Franklin has considered selling mortgages originated in its offices outside Texas, largely to make itself more attractive to potential buyers down the road.
Selling Franklin has always been part of management’s game plan, though Mr. Nocella gave the impression in May that a sale was a ways off.
"We’re still building our franchise," he told American Banker, shortly after Franklin bought the $516 million-asset First National Bank of Bryan.
Franklin intended to sell the out-of-state mortgage portfolio to a real estate investment trust, but Mr. Nocella said last week that most potential buyers had recently lost their appetite for mortgage assets. Still, through amortization and natural runoff the company has removed $800 million of mortgages from its balance sheet since the end of 2006, while continuing to boost its core deposits.
But investors have not been impressed. The stock was trading at $9.35 late Monday and is down nearly 30% since July 24, when Franklin cut earnings guidance by 6 to 7 cents for the third quarter.
Mr. Nocella has speculated that the stock has plummeted because investors have confused his company with First Franklin, a subprime lender owned by Merrill Lynch & Co. Inc.
(In a presentation to investors last week, Mr. Nocella made reference to an American Banker front-page story that he said mischaracterized his company as a top subprime lender. A search of the newspaper’s archive turned up no such story, and when he was asked about it Mr. Nocella said he had been mistaken.)
Brian Klock, an analyst with KBW Inc.’s Keefe, Bruyette & Woods Inc., cited other reasons for the stock slide. Chief among them was Franklin’s exposure to construction loans throughout the country and its relatively low level of loan-loss reserves.
If the single-family mortgages were removed from the balance sheet, Franklin would have a loan-loss reserve ratio of 62 basis points for the rest of the portfolio; most other Texas banks have a ratio is in the range of 1.10% to 1.20%, Mr. Klock said.
"What I think investors are looking for is a conservative and prudent risk manager," he said. "Now is the time to build more reserves, rather than to have a lower level of reserves."
Another reason investors could be unloading Franklin’s stock now is its level of tangible common equity on the balance sheet. Mr. Klock, who downgraded Franklin on Friday, from "perform" to "underperform," said he would like to see its tangible common equity go from 2.2% to 5% because of its low loan-loss reserves.
Mr. Klock said he does not see one clear-cut choice for Franklin to maximize shareholder value.
Finding a buyer could be a challenge, he said, because roughly $1.1 billion, or 30%, of its loan portfolio is made up of lines of credit to builders. About $700 million of loans are on properties outside of Texas.
"No bank is going to want to step up and buy a bank with all that construction, so if Franklin wants to sell, they might have to sell off the construction and maybe the mortgages outside of Texas," Mr. Klock said. "If you can’t find a buyer to buy the whole franchise as is, then you have to sell the pieces. And if you can’t find someone to buy the pieces at the price you want, then you have to find someone to take it private."
If a private company bought Franklin, it could wait out the credit cycle, and management could maintain control of day-to-day operations and possibly still sell off pieces to raise capital to continue expanding in Texas, Mr. Klock said. The private firm could then one day take the company public again or sell Franklin when the markets improve.
"The issue with private investors is they aren’t going to want to overpay for a franchise," he said.
Mr. Nocella said the company is not at the point where it must sell, and it does not have to "take the first offer through the door," but he said he is exploring all options.
He pointed out that Franklin’s construction loans are not with major builders but with smaller ones that its lenders have had relationships with since the Bank United days.
Still, its ratio of noncurrent loans to loans was at 1.51% at June 30, 42 basis points higher than that of other savings banks with assets of at least $5 billion, according to Federal Deposit Insurance Corp. data.
To maintain healthy earnings while the construction market slows, Franklin is looking to new avenues to replace those lost profits, Mr. Nocella said. One option is to start warehousing mortgages for small mortgage originators in Houston, where several large warehousing operations have recently been shuttered.
Jon Arfstrom, a managing director with Royal Bank of Canada’s RBC Capital Markets, said that if Franklin meets quarterly expectations and shows that its credit quality is improving, then the stock price could rebound. "I really think they have done the right thing in terms of providing guidance to the Street on both asset quality and earnings estimates," Mr. Arfstrom said. "They will have to prove it and deliver on those numbers."
Until Franklin decides what its next move will be, it must continue to focus on "good, solid core earnings and clean asset quality," Mr. Arfstrom said.
"In terms of building franchise value, I think they have done that," he said. "The last piece of the puzzle is can they get fair market value in public markets or an exit in a sale."
