Franklin Financial Services Corporation — 2013 Q2 Form 10-Q
Reporting period: Quarterly and year-to-date periods ended June 30, 2013; comparisons are primarily with June 30, 2012 and December 31, 2012. The company is a Pennsylvania-based bank holding company whose principal subsidiary is Farmers and Merchants Trust Company of Chambersburg. Financial statements are unaudited and amounts are in thousands except per-share data.
Business Context and Financial Position
- Total assets were $1.033 billion, up $5.3 million from year-end 2012.
- Gross loans were $729.2 million, down 3.2% from December 31, 2012; net loans were $717.7 million, down 3.4%.
- Investment securities available for sale were $150.0 million, up $16.7 million, primarily reflecting purchases of U.S. Agency mortgage-backed securities.
- Total deposits were $881.8 million, up $7.4 million. Interest-bearing checking and savings increased $55.2 million, while time deposits declined $43.2 million.
- Shareholders’ equity was $92.8 million, compared with $91.6 million at year-end 2012.
Financial Results and Key Metrics
| Metric | Three months ended June 30, 2013 | Three months ended June 30, 2012 | Six months ended June 30, 2013 | Six months ended June 30, 2012 |
|---|---|---|---|---|
| Total interest income | $8,876 | $10,002 | $17,978 | $19,952 |
| Net interest income | $7,580 | $8,191 | $15,440 | $16,175 |
| Provision for loan losses | $803 | $825 | $1,605 | $2,775 |
| Noninterest income | $2,401 | $2,493 | $4,785 | $5,056 |
| Noninterest expense | $7,625 | $7,597 | $15,208 | $14,606 |
| Net income | $1,355 | $1,906 | $2,906 | $3,275 |
| Diluted EPS | $0.33 | $0.47 | $0.70 | $0.81 |
- Second-quarter net income decreased 28.9%; first-half net income decreased 11.3%.
- Tax-equivalent net interest income declined to $8.0 million in the second quarter from $8.6 million, and to $16.2 million for the first half from $16.9 million.
- Net interest margin was 3.26% for the second quarter and 3.35% for the first half, versus 3.51% and 3.54%, respectively, in the prior-year periods.
- The first-half efficiency ratio increased to 72.29% from 66.49%. Return on average assets declined to 0.56% from 0.64%, and return on average equity declined to 6.34% from 7.49%.
- Net cash provided by operating activities was $7.6 million. Investing activities provided $5.6 million, and financing activities provided $3.1 million. Cash and cash equivalents increased to $94.1 million from $77.8 million at year-end 2012.
- Long-term debt was $12.4 million and repurchase agreements were $38.9 million at June 30, 2013.
Material Changes Versus Comparable Periods
- Lower loan balances and reduced yields on loans and securities pressured interest income and net interest margin. Average loans declined $33.2 million in the second quarter and $20.3 million for the first half.
- Lower funding costs partially offset reduced asset yields. Average interest-bearing liability costs declined to 0.62% in the second quarter from 0.86% and to 0.61% for the first half from 0.92%.
- Noninterest income declined 3.7% in the second quarter and 5.4% year to date, mainly because of lower loan and deposit service charges, increased OREO losses, and a $50 thousand other-than-temporary impairment charge on three equity securities.
- Noninterest expense increased 0.4% in the second quarter and 4.1% year to date, reflecting higher occupancy, legal and professional, salaries and benefits, and other OREO-related costs.
- The provision for loan losses declined materially year to date, from $2.8 million to $1.6 million, and net charge-offs declined from $2.9 million to $546 thousand.
- Accumulated other comprehensive loss increased to $4.8 million from $4.1 million, primarily because of lower unrealized securities gains following the second-quarter decline in bond prices.
Credit Quality, Capital, Outlook, and Risks
- Nonperforming loans were $31.1 million, down from $37.0 million at year-end; nonperforming assets were $36.3 million, down from $42.1 million. Nonperforming loans represented 4.26% of gross loans, while the allowance for loan losses was $11.4 million, or 1.57% of loans.
- Watch-list loans declined to $88.7 million from $104.3 million. Management stated that all TDR loans were complying with modified terms, but workout periods may be lengthy and additional loans could become delinquent.
- Other real estate owned totaled $5.3 million. The company recorded a $135 thousand writedown on two properties during the first half and had $1.3 million of residential properties in foreclosure.
- Management expects the investment portfolio yield to continue declining as higher-yielding securities mature or pay down and reinvestment yields remain low. Management also expects the low interest-rate environment to continue pressuring net interest margin.
- The company 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 Board declared a regular quarterly dividend of $0.17 per share for the third quarter of 2013. The first-half dividend payout ratio was 48.1%.
- The company reported that it was well capitalized. At June 30, 2013, the consolidated total risk-based capital ratio was 13.49%, Tier 1 risk-based capital ratio was 12.23%, and Tier 1 leverage ratio was 8.41%.
- Liquidity included approximately $35 million available under an FHLB line, $16 million of unsecured correspondent-bank lines, and approximately $36 million of Federal Reserve Discount Window borrowing capacity. The FHLB had placed the Bank on full collateral delivery status, reducing borrowing capacity relative to prior arrangements.
- Unused commitments and standby letters of credit totaled $232.6 million and $20.6 million, respectively. Management believes collateral and guarantees support the standby letters of credit and that liquidity is sufficient for anticipated needs.
- Key risks include prolonged low interest rates, declining asset yields, commercial real estate and agricultural credit exposure, collateral values, potential additional securities or OREO write-downs, dependence on FHLB funding, economic conditions, regulatory changes, and competition.
Important Facts for Investors to Verify
- Whether declining commercial loan balances and persistent low rates continue to reduce net interest margin and earnings.
- The performance of the $88.7 million watch list, $31.1 million of nonperforming loans, TDR portfolio, and significant nonaccrual credits.
- Whether the $11.4 million allowance for loan losses remains adequate relative to commercial real estate, agricultural, and collateral-dependent exposures.
- Potential additional losses on the $56.7 million of temporarily impaired securities, including $4.9 million of trust-preferred securities and private-label mortgage-backed securities.
- The effect of FHLB collateral delivery restrictions and the availability of alternative funding sources.
- Future deposit mix changes, particularly the replacement of repurchase agreements and brokered time deposits with more liquid deposit products.
- Implementation of new regulatory capital rules beginning in 2015 and the company’s planned election to exclude unrealized securities gains and losses from regulatory capital.
- The filing states that no material legal proceedings or material changes in risk factors were present; investors should nevertheless review the full annual-report risk disclosures and subsequent filings.