Franklin Financial Services Corporation — Q2 2021 Form 10-Q Summary
Business context and reporting period
Franklin Financial Services Corporation is a Pennsylvania bank holding company whose principal subsidiary, Farmers and Merchants Trust Company of Chambersburg, operates a commercial bank primarily serving south-central Pennsylvania. This unaudited Form 10-Q covers the three and six months ended June 30, 2021, with comparisons to the corresponding 2020 periods and December 31, 2020 balance-sheet data.
Financial performance and condition
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Net income | $5.3 million | $3.1 million | $10.1 million | $4.8 million |
| Diluted EPS | $1.19 | $0.71 | $2.28 | $1.10 |
| Net interest income | $10.8 million | $10.3 million | $21.7 million | $20.6 million |
| Provision/(recovery) for loan losses | $(1.1) million recovery | $2.0 million provision | $(1.9) million recovery | $5.0 million provision |
| Noninterest income | $4.5 million | $3.4 million | $8.7 million | $7.3 million |
| Noninterest expense | $10.1 million | $9.6 million | $20.3 million | $19.2 million |
| Net interest margin | 2.82% | 3.26% | 2.92% | 3.39% |
At June 30, 2021, total assets were $1.678 billion, up from $1.535 billion at year-end 2020. Loans were $999.0 million before the allowance and $984.0 million net. Deposits were $1.491 billion, up 10.1% from year-end. Cash and cash equivalents were $98.1 million, while available-for-sale securities were $512.2 million at fair value.
The allowance for loan losses was $15.1 million, or 1.51% of gross loans, compared with 1.66% at December 31, 2020. Nonperforming loans were $8.8 million, or 0.88% of gross loans, and nonperforming assets were $8.8 million, or 0.53% of total assets. Net charge-offs for the first half were a recovery of $166 thousand.
Six-month operating cash flow was $12.1 million, compared with $2.6 million in the prior-year period. Investing activities used $105.8 million, primarily for purchases of investment securities, while financing activities provided $134.7 million, principally from deposit growth. Cash and cash equivalents increased $41.0 million during the first half.
The Corporation had $20.0 million of subordinated notes outstanding, recorded at $19.6 million net of issuance costs. The notes qualify as Tier 2 capital and have fixed rates of 5.00% and 5.25% until their respective conversion dates. The Bank remained well capitalized, with a 15.02% CET1 ratio, 16.28% total risk-based capital ratio, and 8.46% Tier 1 leverage ratio at June 30, 2021.
Material changes versus comparable periods
- Six-month net income more than doubled to $10.1 million from $4.8 million, driven mainly by the loan-loss recovery and higher noninterest income.
- Net interest income increased 5.3% for the first half, but the net interest margin declined to 2.92% from 3.39% as asset yields fell despite materially lower deposit costs.
- Noninterest income increased $1.4 million year over year, led by higher investment and trust fees, mortgage-loan sale gains, debit-card income, and debt-security gains. The prior year included an $812 thousand bank-owned life insurance gain that did not recur.
- Noninterest expense increased $1.1 million, including higher salaries and benefits, FDIC insurance, data processing, and pension costs.
- The investment portfolio grew $115.3 million from year-end, while net loans declined $8.9 million. Commercial real estate loans declined $8.6 million and commercial loans declined $8.1 million, partly reflecting PPP forgiveness and repayments.
- Deposits increased $136.6 million, principally in noninterest-bearing checking, interest-bearing checking, and money-management accounts; time deposits declined $6.3 million.
- Accumulated other comprehensive income declined $2.3 million as the net unrealized gain on debt securities decreased, while shareholders’ equity increased $6.0 million to $151.2 million.
Guidance, outlook, risks, contingencies, and unusual items
Management provided no formal earnings or financial guidance. Management stated that declining COVID-19 cases, increased vaccinations, and easing restrictions suggested an economic recovery, but emphasized that the extent and timing remained uncertain. Key forward-looking risks include COVID-19 developments, economic conditions, interest rates, funding costs, monetary policy, regulation, inflation, technology, and competition.
- PPP loans totaled $53.6 million and were 100% SBA-guaranteed, subject to SBA forgiveness and guarantee processes. Deferred PPP fees were $1.9 million and may be recognized more rapidly when loans are forgiven.
- Loans totaling $13.3 million remained modified or deferred at June 30, 2021, primarily involving hotels, rental real estate, and food service. Management expected these loans to return to principal-and-interest payments in the third quarter, but warned that credit quality could deteriorate if borrowers fail to perform.
- Commercial real estate exposure includes $76.1 million of hotel and motel loans. The bank identified hotel loans as the greatest risk concentration among modified loans.
- The bank had $390.2 million of unfunded loan commitments and $23.1 million of standby letters of credit. A $1.5 million reserve remained for a commercial borrower-related standby-letter-of-credit exposure after a $636 thousand reversal in the second quarter.
- Available liquidity was reported at $485.9 million, including Federal Home Loan Bank capacity, Federal Reserve discount-window capacity, correspondent-bank lines, and the PPP Liquidity Facility. The PPPLF was scheduled to expire July 31, 2021; management did not expect a material liquidity impact.
- CECL adoption was deferred to January 1, 2023. Management expects a one-time cumulative-effect adjustment to the allowance and is continuing implementation and model testing.
- On July 23, 2021, after the reporting date, the Bank completed a headquarters property transaction and expected to recognize an approximately $1.8 million pretax gain on sale.
- The Board declared a third-quarter 2021 dividend of $0.32 per share, payable August 25, 2021. Under its repurchase plan, the Corporation repurchased 23,155 shares during the second quarter at an average price of $30.48.
Most important facts for investors to verify
- Whether modified hotel and commercial real estate loans return to scheduled principal-and-interest payments without increased nonaccruals or charge-offs.
- The sustainability of the $1.9 million first-half loan-loss recovery and the adequacy of the reduced 1.51% allowance ratio.
- Future net interest margin pressure from low market rates, the expanded securities portfolio, and changing deposit balances.
- The credit, duration, and unrealized-loss exposure of the $512.2 million available-for-sale securities portfolio.
- The timing and earnings effect of PPP forgiveness and recognition of the remaining $1.9 million of deferred fees.
- The effect of CECL adoption in 2023 on retained earnings, allowance levels, provisions, and regulatory capital.
- The expected timing and final pretax gain from the July 2021 headquarters transaction.