Franklin Financial Services Corporation — 2019 Q2 Form 10-Q Summary
Business context and reporting period
Franklin Financial Services Corporation is a Pennsylvania bank holding company for Farmers and Merchants Trust Company of Chambersburg, serving south-central Pennsylvania. The filing covers the three and six months ended June 30, 2019. Financial statements are unaudited and presented in accordance with condensed U.S. GAAP. The company had 4.34 million common shares outstanding as of July 31, 2019.
Financial performance and condition
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net income | $4.0 million, versus $(5.2) million in 2018 | $7.2 million, versus $(1.7) million in 2018 |
| Diluted EPS | $0.90, versus $(1.18) | $1.63, versus $(0.38) |
| Net interest income | $10.6 million, versus $10.1 million | $20.9 million, versus $19.8 million |
| Provision for loan losses | $0, versus $9.1 million | $399 thousand, versus $9.3 million |
| Noninterest income | $3.7 million, versus $3.2 million | $6.9 million, versus $6.4 million |
| Noninterest expense | $9.6 million, versus $11.2 million | $19.0 million, versus $19.8 million |
- Total assets were $1.252 billion at June 30, 2019, up $42.6 million, or 3.5%, from December 31, 2018.
- Gross loans were $982.5 million, up $9.1 million, or 0.9%; net loans were $969.9 million. Commercial real estate loans increased $17.7 million, while commercial and industrial loans declined $9.2 million.
- Deposits increased $30.4 million, or 2.8%, to $1.113 billion, led by a $24.4 million increase in time deposits and a $25.7 million increase in interest-bearing checking deposits.
- Cash and cash equivalents increased to $82.4 million from $53.0 million at year-end. Management reported no short-term borrowings at June 30.
- Six-month operating cash flow was $8.5 million, compared with cash used of $2.2 million in the prior-year period. Investing activities used $5.9 million, while financing activities provided $26.8 million.
- The net interest margin was 3.80% for the first six months, compared with 3.75% in 2018. The efficiency ratio improved to 67.34% from 73.96%.
- Return on average assets was 1.18% and return on average equity was 12.02% for the first six months, compared with negative results in the 2018 period.
- Shareholders’ equity was $123.9 million, up from $118.4 million. Book value per share was $28.21 and tangible book value per share was $26.21.
- The quarterly cash dividend increased to $0.30 per share from $0.27. The company repurchased 54,153 shares during the first half under its 2018 repurchase plan.
Material changes versus the prior comparable period
- Results benefited substantially from the absence of the 2018 loan participation charge-off and related provisions. In the second quarter of 2018, the company recorded an $8.7 million charge-off, a $9.1 million loan-loss provision, and a $2.4 million provision for credit losses on off-balance-sheet exposures.
- Net interest income increased as loan volume and yields rose, although deposit costs increased. The six-month cost of funds increased to 0.65% from 0.34%.
- Noninterest income increased primarily from higher investment and trust services fees, debit-card and other service fees, and $253 thousand of year-to-date gains on debt securities.
- Noninterest expense declined despite higher salaries, advertising, data-processing, legal and professional costs, and other expenses, primarily because the prior-year off-balance-sheet credit-loss provision did not recur.
- Asset quality weakened from year-end: nonaccrual loans increased to $5.3 million from $2.3 million, total nonperforming loans increased to $5.7 million from $2.7 million, and nonperforming assets increased to $8.4 million from $5.3 million. The allowance coverage ratio remained 1.28% of gross loans.
- The company adopted lease accounting on January 1, 2019, recognizing a $6.2 million right-of-use asset and lease liability without a material effect on earnings or retained equity.
Guidance, outlook, management commentary, risks and unusual items
- No formal earnings or revenue guidance is provided. Management expects commercial lending, particularly in-market lending, to remain the primary source of future loan growth.
- Management stated that liquidity is adequate and that anticipated funding needs can be met. Available sources included approximately $371.9 million of unused Federal Home Loan Bank borrowing capacity, $17.1 million of Federal Reserve Discount Window capacity and a $6.0 million unsecured correspondent-bank line.
- The Bank was “well capitalized” under Basel III. At June 30, the corporation’s total risk-based capital ratio was 15.19%, Tier 1 leverage ratio was 9.63%, and CET1 ratio was 13.93%; the Bank’s corresponding ratios were 15.02%, 9.52% and 13.77%.
- The company was implementing the expected credit loss standard, ASU 2016-13. Management expected earlier recognition and possibly a larger allowance, but had not yet determined the financial statement impact. The CECL model began running in test mode during the second quarter.
- Off-balance-sheet commitments included $326.7 million of commitments to extend credit and $27.4 million of standby letters of credit. A $2.4 million allowance related to standby letters of credit issued for a commercial borrower that declared bankruptcy remained recorded.
- Management identified no material pending legal proceedings, but stated that future litigation outcomes cannot be reliably estimated. A previously accrued $10.0 million settlement payment was made in May 2018.
- Risks include interest-rate and funding-cost changes, economic and credit conditions, commercial real estate concentration, regulatory and tax changes, competition, technology, liquidity access and the impact of CECL adoption. The July 31, 2019 Federal Funds rate cut was expected to reduce prime lending rates.
- The allowance for securities-related credit losses was not increased. Unrealized losses on available-for-sale securities declined to $481 thousand from $1.5 million at year-end and were considered temporary.
Most important facts for investors to verify
- Whether the improvement in earnings is sustainable after excluding the unusually large 2018 credit-loss and charge-off items.
- Trends in nonaccrual loans, commercial real estate exposure, impaired loans and the adequacy of the $12.6 million allowance.
- The eventual balance-sheet and earnings impact of CECL adoption.
- Deposit pricing and funding costs following the increase in time deposits and the Federal Reserve rate cut.
- Performance of commercial real estate and land-development lending, including the $86.1 million of purchased commercial loan participations and related unfunded exposure.
- Liquidity availability under stressed conditions, particularly reliance on Federal Home Loan Bank funding and the treatment of off-balance-sheet commitments.
- The company’s ability to maintain dividends and share repurchases while preserving its well-capitalized status.