Franklin Financial Services Corporation — Form 10-Q Summary
Business context and reporting period
Franklin Financial Services Corporation is the holding company for Farmers and Merchants Trust Company of Chambersburg, a commercial bank serving south-central Pennsylvania, and other subsidiaries. This unaudited Form 10-Q covers the three and nine months ended September 30, 2015, compared primarily with the corresponding 2014 periods and December 31, 2014 balance-sheet amounts.
Key financial metrics
| Metric | Three months ended Sept. 30, 2015 | Nine months ended Sept. 30, 2015 |
|---|---|---|
| Total interest income | $8.7 million | $25.8 million |
| Net interest income | $8.2 million | $24.0 million |
| Provision for loan losses | $0.4 million | $1.0 million |
| Noninterest income | $2.7 million | $9.5 million |
| Noninterest expense | $7.6 million | $22.8 million |
| Net income | $2.6 million | $7.9 million |
| Diluted earnings per share | $0.61 | $1.87 |
| Net interest margin | 3.57% tax-equivalent | 3.59% tax-equivalent |
| Cash dividends declared per share | $0.19 | $0.55 |
At September 30, 2015, total assets were $1.036 billion, net loans were $760.8 million, deposits were $917.4 million, total liabilities were $926.2 million, and shareholders’ equity was $110.1 million. Cash and cash equivalents were $40.9 million. Short-term borrowings were $3.5 million, with no long-term debt or repurchase agreements outstanding.
For the first nine months, operating activities provided $10.0 million of cash, investing activities used $47.0 million, and financing activities provided $29.3 million. Cash and cash equivalents declined $7.7 million from year-end 2014. The allowance for loan losses was $9.9 million, or 1.28% of gross loans.
Both the Corporation and the Bank were reported as well capitalized under Basel III. At September 30, 2015, the Corporation’s common equity Tier 1, total risk-based capital, and Tier 1 leverage ratios were 14.44%, 15.69%, and 10.33%, respectively; the Bank’s corresponding ratios were 14.40%, 15.66%, and 10.17%.
Material changes versus prior comparable periods
- Nine-month net income increased 21.1% to $7.9 million from $6.6 million in 2014; diluted EPS increased to $1.87 from $1.56.
- Net interest income increased $0.3 million year over year, primarily from asset growth and lower funding costs. Interest expense declined $0.6 million, while the tax-equivalent net interest margin increased to 3.59% from 3.56%.
- Noninterest income increased $1.5 million, or 18.6%, to $9.5 million. Investment and trust fees, deposit service charges, loan service charges, and other income contributed to the increase.
- Noninterest expense decreased $0.3 million, or 1.3%, to $22.8 million. Lower FDIC insurance, legal, advertising, occupancy, and intangible-amortization costs more than offset higher data-processing and bank-shares-tax expenses.
- The loan-loss provision increased to $1.0 million from $0.5 million, primarily because of loan growth. Net charge-offs decreased to $0.3 million from $1.2 million.
- Gross loans increased 6.1% from year-end to $770.7 million, led by commercial loans, which increased 16.0%, and commercial real estate loans, which increased 3.4%. Total deposits increased 4.1% to $917.4 million, driven by checking and savings balances.
- Nonperforming loans declined to $6.2 million, or 0.80% of gross loans, from $12.6 million, or 1.74%, at year-end. Nonperforming assets declined to $13.0 million, or 1.25% of assets, despite other real estate owned increasing to $6.8 million from $3.7 million.
- Shareholders’ equity increased $6.6 million. Retained earnings grew from net income after $2.3 million of declared dividends, and the dividend reinvestment plan added $0.9 million of capital.
Guidance, outlook, risks, contingencies and unusual items
- The filing provides no formal earnings or financial guidance. Management stated that current-period results are not necessarily indicative of full-year results.
- Management cited continued opportunities for commercial lending in its Pennsylvania market and stated that it believes the local economy is well suited for growth. It also expects the consumer loan portfolio to continue running down.
- Management believes liquidity is adequate to meet anticipated demands. Available sources included approximately $35 million under an FHLB line, $16 million of unsecured correspondent-bank lines, approximately $246.6 million of excess FHLB borrowing capacity, and approximately $26 million of Federal Reserve discount-window capacity.
- Unused loan commitments totaled $275.5 million and standby letters of credit totaled $26.7 million at September 30, 2015. Management stated that the collateral and guarantees supporting standby letters of credit should cover potential payments; the recorded liability was not material.
- Reported nine-month earnings benefited from unusual items, including a $728 thousand gain on conversion of equity securities related to the Integrity Bancshares acquisition and approximately $171 thousand from liquidation of an offshore insurance investment. Management estimated that, excluding these items, nine-month net income would have been approximately $7.3 million, still about 12% above the prior year.
- A $250 thousand deferred-tax valuation-allowance reversal reduced the third-quarter effective tax rate to 10.6%; without the reversal, management estimated the rate would have been 19.3%. The nine-month effective tax rate was 18.3%.
- Other real estate owned generated a $218 thousand net loss year to date, including a $250 thousand write-down in the third quarter. Management identified additional potential losses if current trends continue in private-label mortgage-backed securities.
- The investment portfolio contained $45.6 million of temporarily impaired securities with $0.9 million of unrealized losses. Trust-preferred securities had $0.5 million of unrealized losses, while private-label mortgage-backed securities had cumulative other-than-temporary impairment charges of $555 thousand. The Bank is participating in a class-action lawsuit involving a private-label mortgage-backed securities servicer.
- The pension plan’s expected 2015 expense was approximately $387 thousand, compared with $276 thousand in 2014. Adoption of new mortality tables could reduce funded status by an estimated $1.6 million and increase 2015 expense by approximately $272 thousand, although no adoption date had been determined.
- Management disclosed no material pending legal proceedings, no material changes in risk factors, and effective disclosure controls as of September 30, 2015.
Most important facts for investors to verify
- Reconcile reported loan growth, credit-quality improvement, the increased allowance ratio, and the rise in other real estate owned.
- Separate recurring earnings from the $728 thousand conversion gain, approximately $171 thousand insurance-investment gain, tax valuation-allowance reversal, and other unusual items.
- Monitor commercial real estate and commercial-loan concentration, purchased participations of approximately $139.0 million, and the $29.7 million watch-list balance.
- Assess potential future write-downs on trust-preferred and private-label mortgage-backed securities, including the related litigation.
- Verify liquidity capacity, deposit stability, unfunded commitments, and the effect of pledged securities and collateral availability on borrowing capacity.
- Review pension assumptions and the potential effect of new mortality tables on funded status, expense, and future contributions.
- Confirm the filing’s subsequent dividend disclosure, which contains an apparent date inconsistency regarding the stated payment date.