Franklin Financial Services Corporation — 2013 Q1 Form 10-Q
Reporting period: Three months ended March 31, 2013. Franklin Financial Services Corporation operates primarily through Farmers and Merchants Trust Company of Chambersburg, a community bank serving south-central Pennsylvania. The filing is unaudited and should be read with the 2012 Form 10-K.
Financial performance and condition
| Metric | Q1 2013 | Comparable period or date | Change |
|---|---|---|---|
| Total revenue, interest and noninterest income | $11.5 million | $12.5 million in Q1 2012 | Down approximately 8.2% |
| Net interest income | $7.9 million | $8.0 million in Q1 2012 | Down $124 thousand |
| Net interest margin | 3.45% | 3.57% | Down 12 basis points |
| Provision for loan losses | $803 thousand | $1.95 million in Q1 2012 | Down $1.15 million |
| Noninterest income | $2.4 million | $2.6 million in Q1 2012 | Down 7.0% |
| Noninterest expense | $7.6 million | $7.0 million in Q1 2012 | Up 8.2% |
| Net income | $1.55 million | $1.37 million in Q1 2012 | Up 13.3% |
| Diluted EPS | $0.38 | $0.34 in Q1 2012 | Up $0.04 |
| Cash dividend declared per share | $0.17 | $0.27 in Q1 2012 | Lower |
- Assets and capital: Total assets were $1.054 billion at March 31, 2013, up $26.8 million from year-end 2012. Shareholders’ equity was $92.9 million, up $1.3 million. Book value per share was $22.55 and tangible book value per share was $20.12.
- Loans and credit quality: Gross loans were $746.2 million, down 1.0% from December 31, 2012; net loans were $735.2 million. The allowance for loan losses increased to $10.9 million, or 1.47% of loans, from 1.38% at year-end.
- Credit performance: Net charge-offs were $239 thousand, compared with $2.2 million in Q1 2012. Nonperforming assets declined to $40.1 million from $42.1 million at year-end, while nonperforming loans were 4.64% of gross loans. Watch-list loans declined to $88.9 million from $104.3 million.
- Deposits and funding: Total deposits increased 3.2% to $902.2 million, primarily from money-management, interest-checking and savings accounts. Securities sold under repurchase agreements were $39.4 million, and long-term debt was $12.4 million.
- Liquidity: Cash and cash equivalents were $111.8 million, up $34.0 million from year-end. Management reported approximately $35 million available under an FHLB line, $16 million of unsecured correspondent-bank lines and approximately $53 million of Federal Reserve Discount Window borrowing capacity.
- Cash flow: Operating activities provided $4.2 million, investing activities provided $5.4 million and financing activities provided $24.4 million. Cash and cash equivalents increased $34.0 million during the quarter.
- Capital: The Corporation reported an 8.40% Tier 1 leverage ratio, a 13.06% Tier 1 risk-based capital ratio and an 8.81% common equity ratio. Management stated that the Corporation and Bank were well capitalized under applicable regulatory standards.
- Efficiency and returns: Return on average assets was 0.60%, return on average equity was 6.85% and the efficiency ratio was 71.30%, compared with 64.15% in Q1 2012.
Material changes versus Q1 2012 and year-end 2012
- Net income improved despite lower revenue because the provision for loan losses fell substantially, reflecting much lower charge-offs than in Q1 2012.
- Interest income declined $849 thousand as loan and investment yields fell. Interest expense declined $725 thousand, primarily because average funding costs fell from 0.98% to 0.61% and long-term debt balances were lower.
- Noninterest income declined $179 thousand. Mortgage banking activities moved to a $22 thousand loss from $47 thousand of income, and the prior-year period included a $38 thousand gain on other real estate owned and a nonrecurring insurance recovery.
- Noninterest expense increased $572 thousand, mainly from higher salaries and benefits, health insurance costs, branch occupancy costs and debit-card processing expenses. Pension expense declined due to the plan’s fully funded status following a $6.0 million additional contribution in December 2012.
- Loan balances decreased, although residential first-lien mortgages increased. Management expected its selective mortgage-retention program to continue, while commercial and consumer loan balances continued to decline.
- Investment securities increased to $134.8 million. The portfolio had a $2.7 million net unrealized gain, while the securities portfolio included $33.5 million of temporarily impaired securities with $1.5 million of unrealized losses. Management recorded no other-than-temporary impairment charge.
Outlook, commentary, risks and unusual items
- Management expects the low interest-rate environment to continue beyond 2013, which may further pressure net interest margin as asset yields decline faster than funding costs.
- Management expects investment portfolio yields to decline as higher-yielding securities mature or pay down and reinvestment yields remain low.
- Management expects 2013 pension expense of approximately $560 thousand, compared with $1.1 million in 2012, and does not expect additional pension contributions in 2013.
- The Bank remained on FHLB “full collateral delivery status,” limiting borrowing capacity to collateral physically delivered. Management expects this status to continue and noted that a disruption to FHLB lending could materially affect funding.
- Unfunded loan commitments and standby letters of credit totaled $211.6 million. Standby letters of credit were $21.4 million; management stated that collateral and guarantees were expected to cover potential payments.
- The private-label mortgage-backed securities portfolio had $490 thousand of cumulative impairment charges. Management stated that no additional impairment was required at quarter-end but warned that further write-downs could occur if loss trends continue. The Bank is participating in a class-action lawsuit involving a PLMBS servicer.
- Credit risk remains concentrated in commercial real estate, including land development, hotels and motels, farmland, office buildings and shopping centers. Significant nonaccrual credits include development, construction and agricultural exposures, and one new $2.7 million nonaccrual loan was added during the quarter.
- Other real estate owned increased to $5.4 million across eleven properties. Residential properties totaling $410 thousand were in foreclosure at quarter-end.
- The filing states that no material legal proceedings were pending and that there were no material changes to previously reported risk factors or market-risk exposure.
Investor verification checklist
- Verify the sustainability of earnings growth after adjusting for the sharp year-over-year reduction in loan-loss provision expense.
- Monitor net interest margin, asset yields, deposit repricing and the effect of continued low interest rates.
- Track nonperforming loans, watch-list loans, impaired loans, TDRs, OREO and commercial real estate concentrations.
- Assess whether the $10.9 million allowance for loan losses remains adequate as collateral values and workout outcomes develop.
- Review the valuation and credit performance of trust-preferred and private-label mortgage-backed securities, including potential additional impairment charges.
- Confirm ongoing access to FHLB, Federal Reserve and correspondent-bank liquidity, particularly while the Bank remains subject to full collateral delivery status.
- Evaluate the reduced quarterly dividend of $0.17 per share and the company’s capital-allocation priorities.