Houston-based Franklin Bank Corp. — notable because its chairman happens to be Lewis Ranieri, one of the pioneers of the early mortgage-backed securities market — said late Monday that an independent audit found numerous accounting errors at the bank tied to loan modifications and foreclosures. In particular, the audit found that Franklin did not properly account for certain single family mortgage loan modification programs developed and implemented as part of an effort to reduce delinquencies and mitigate foreclosure losses — a finding that, on the surface, looks similar to a January audit at Downey Financial (DSL) that changed how the firm accounted for “troubled debt restructurings.” Other accounting errors included a failure to charge off second liens, a lack of recording of foreclosure and REO activity in its single-family mortgage portfolio, and improper mark-to-market activity on loans transferred into the bank’s investment portfolio. All are large errors that are likely to at least force the Houston bank to take significant losses when it restates its financial results. “Franklin’s Board of Directors fully accepts the findings of the independent review,” said Lewis Ranieri, Chairman of the Board of Franklin Bank Corp. “Completion of the investigation is an important milestone for all shareholders as we take the necessary steps to implement the recommendations of the Audit Committee.” SEC investigation In addition to investigations by the Federal Deposit Insurance Corp. and the Texas Department of Savings and Mortgage Lending, the company said that the Securities and Exchange Commission had also opened up a new “informal inquiry” into the accounting errors at the firm. The challenges clearly weren’t what investors, or Ranieri, had envisioned when Franklin first burst onto the scene six years ago. Investors were giddy at the prospects of investing in a bank run by the so-called “godfather of the secondary mortgage market.” Ranieri now serves as temporary CEO, in addition to his chairman duties, as the company said that Anthony J. Nocella, Franklin’s most recent CEO, accelerate his personal plans to retire last month. “The SEC’s inquiry is ongoing, and there can be no assurance that there will not be additional issues or matters arising from that inquiry,” the company’s press statement said. Bloomberg covered the bank’s exposure to credit risk:

Franklin said in January it had ample liquidity with more than $1 billion in available funds. By the end of March, Franklin reported $356 million of loans for which it wasn’t receiving interest, up 56 percent from three months earlier. The bank’s allowance for losses was just $63 million. “It would appear that they are under-reserved,” said Brian Klock, an analyst at KBW Inc. in an e-mail yesterday.