Comprehensive case Franklin Bank Corp was founded in 2001 with the purpose of providing community banking services outside the major metropolitan areas of Texas. From its Houston headquarters, Franklin Bank managed approximately 40 community banks in Texas and commercial lending and mortgage origination offices in many Western states. Franklin Bank Corp was headed by Lewis Ranieri, who has been credited with inventing structured mortgage securities, which are derivative securities based on mortgages or other loans. Despite managements' credentials and previously glowing recommendations by financial analysts, Franklin's stock price plummeted over the past year from over $20 per share to under $1, and the company has been threatened with delisting by NASDAQ. Behind the fall is the bursting of the real estate bubble, beginning in 2007, and the consequent increases in loan defaults, foreclosures and distress sales of properties.

In recent years, more than 80% of Franklin Bank's total assets have been ’loans held for investment,’ which are mostly home mortgages. The causes of the burst bubble are legion, but many observers cite low savings rates by individuals, lax lending practices by banks, lax government oversight of those practices, initially low interest rates, excessive debt carried by individuals and unrealistic expectations about uninterrupted growth in property market values.

Franklin Bank Corp's auditors discovered accounting irregularities related to the recognition of the allowance for loan losses and write offs of uncollectible loans. Whether these were willful attempts to mislead investors and prop up the bank's faltering stock price or rather were the results of mismanagement is not known at this time, but is the subject of an SEC investigation.

For purposes of this case, assume that Franklin Bank underestimated its allowance by not recognising the bursting of the real estate bubble and its exposure to increased default risk.

Required:

1. Read the article, ’Mortgage-bond guru hit by loan bust,’ Friday May 23, 2008 12:49 pm ET , By Rachel Beck, AP Business Writer ALL BUSINESS: ’No quick end to credit crisis when mortgage-bond inventor gets hit by loan bust.’ NEW YORK (AP).

2. Build a spreadsheet model to estimate Franklin Bank's ’allowance for credit losses.’ Use the excepts from Franklin Bank's 2007 10-Q report, plus other relevant information that you can gather regarding likely ranges of key variables that plausibly affect defaults on the types of loans owned by Franklin Bank. Clearly cite sources of information obtained outside this case. Clearly state all assumptions that underlie your allowance for the loan loss model. Also clearly describe limitations to your model that presumably could be relieved with more detailed, inside information. For this case, ignore other sources of business risk to Franklin Bank, such as losses on securities held for trading.
3. Evaluate the sensitivity of your model to individually significant sources of variation in your allowance for credit losses model.
4. Create and evaluate multiple scenarios, including at least the best case, worst case and most likely case scenarios.
5. Use Monte Carlo analysis to estimate business risk, as reflected in this case in the allowance for credit losses.