Business Context and Reporting Period
Franklin Financial Services Corporation is a Pennsylvania bank holding company operating primarily through Farmers and Merchants Trust Company of Chambersburg. The unaudited Form 10-Q covers the three months ended March 31, 2023, with comparisons to March 31, 2022 and December 31, 2022.
Key Financial Metrics
| Metric | Q1 2023 | Comparable period | Change |
|---|---|---|---|
| Total assets | $1.711 billion | $1.767 billion at March 31, 2022 | Down 3.2% |
| Net loans | $1.063 billion | $985.9 million at March 31, 2022 | Up 7.9% |
| Deposits | $1.502 billion | $1.596 billion at March 31, 2022 | Down 5.9% |
| Net interest income | $12.837 million | $10.808 million | Up 18.8% |
| Net interest margin | 3.41% | 2.66% | Up 75 basis points |
| Net income | $3.292 million | $3.012 million | Up 9.3% |
| Diluted EPS | $0.75 | $0.67 | Up 11.9% |
| Operating cash flow | $7.717 million | $4.446 million | Up $3.271 million |
Interest income increased to $16.583 million from $11.534 million, while interest expense increased to $3.746 million from $726 thousand as deposit and borrowing costs rose. Average earning-asset yield increased to 4.38% from 2.83%, while the cost of interest-bearing deposits increased to 1.14% from 0.15%.
Noninterest income declined 17.0% to $3.225 million, primarily because of a $602 thousand loss on debt-security sales and lower mortgage-sale gains. Noninterest expense increased 6.7% to $12.019 million, driven mainly by salaries and benefits and higher occupancy costs. The efficiency ratio was 72.02% versus 75.50% in Q1 2022.
Return on average assets was 0.80%, return on average equity was 11.33%, and return on average tangible equity was 12.11%. The effective tax rate was 6.3%, including a $280 thousand tax credit; management stated that the rate would have been 14.3% without that credit.
Balance Sheet, Liquidity, Debt and Capital
- Gross loans increased $26.4 million, or 2.5%, from year-end 2022 to $1.077 billion. Commercial real estate totaled $575.5 million and commercial loans totaled $247.0 million.
- Deposits declined $49.3 million, or 3.2%, from year-end 2022. Interest-bearing checking and money-management balances fell $60.5 million in aggregate, partly offset by a $16.2 million increase in time deposits, including $8.6 million of brokered CDs.
- Cash and cash equivalents increased to $86.6 million from $64.9 million at year-end. Management estimated that approximately 92% of deposits were FDIC-insured or collateralized.
- The Bank had $50.0 million outstanding under the Federal Reserve Bank Term Funding Program at 4.38%, due March 22, 2024, secured by $72.0 million of debt securities.
- Available liquidity was reported at $541.1 million, including Federal Home Loan Bank capacity of $403.7 million, Federal Reserve Discount Window capacity of $59.5 million, remaining BTFP capacity of $21.9 million and correspondent-bank capacity of $56.0 million.
- Subordinated notes had a carrying value of $19.6 million and a principal amount of $20.0 million, with maturities in 2030 and 2035.
- The Bank remained well capitalized. At March 31, 2023, its CET1 ratio was 14.74%, total risk-based capital ratio was 15.99%, and Tier 1 leverage ratio was 9.92%.
Material Changes Versus Prior Period
- Net interest income benefited from higher market rates and loan growth, despite lower average earning assets and deposits.
- The available-for-sale securities portfolio declined to $457.8 million from $486.8 million at year-end. Approximately $33 million of securities were sold in a portfolio restructuring, producing a $602 thousand realized loss.
- Accumulated other comprehensive loss improved by $7.3 million to $44.0 million, principally because of improved fair values of debt securities. The portfolio still had $52.4 million of gross unrealized losses.
- The company adopted the CECL model on January 1, 2023. Adoption reduced the loan allowance by $536 thousand, increased the allowance for unfunded commitments by $412 thousand, increased retained earnings by $98 thousand and created a $26 thousand deferred tax liability.
- The loan allowance was $14.1 million, or 1.31% of gross loans, compared with 1.35% at year-end 2022. The allowance for unfunded commitments increased to $1.9 million from $1.5 million.
- Shareholders’ equity increased $9.4 million from year-end to $123.6 million. The company paid a $0.32 per-share dividend and repurchased 8,752 shares during the quarter.
Outlook, Risks, Contingencies and Unusual Items
The filing provides no formal earnings or financial guidance. Management stated that the primary market area remains suitable for growth and that the company believes it can meet anticipated liquidity demands. Management also stated that the Bank’s liquidity position is supported by multiple borrowing sources and unencumbered securities.
- Management identified risks from inflation, interest-rate changes, funding costs, monetary policy, competition, regulation, technology and continuing instability in the banking sector.
- Recent bank failures and industry concerns could cause deposit volatility, higher liquidity needs, securities or loan deterioration, increased FDIC insurance premiums or special assessments, and greater interest-rate volatility.
- The securities portfolio’s unrealized losses were attributed by management to interest-rate changes rather than credit impairment. Management stated it does not intend, and does not believe it will be required, to sell the securities before recovery or maturity.
- Commercial real estate represented approximately 53% of gross loans. Key exposures included apartments, hotels and motels, office buildings, shopping centers and development land.
- Nonaccrual loans were $120 thousand, loans 90 days or more past due and still accruing were $106 thousand, and the watch list totaled $9.2 million.
- Off-balance-sheet commitments to extend credit totaled $400.3 million, and standby letters of credit totaled $27.8 million. The filing states that many commitments may expire without being drawn.
- No material litigation was reported, although management noted that potential losses in other matters could not be estimated. No material changes in market-risk exposure or internal controls were reported.
Important Facts for Investors to Verify
- Confirm the sustainability of the 3.41% net interest margin as deposit costs continue rising and deposits declined during the quarter.
- Assess liquidity and funding reliance, including the $50.0 million BTFP borrowing, deposit trends, uninsured or uncollateralized deposits, and availability of contingent funding.
- Review unrealized securities losses, duration, collateralization and the potential effect of forced sales on accumulated other comprehensive income and capital.
- Evaluate commercial real estate concentrations, especially hotels, offices and construction loans, as economic conditions and property values change.
- Reconcile the filing’s credit-loss discussion: the statements report total provision expense of $529 thousand, while one MD&A passage refers to $592 thousand despite listing $467 thousand for loans and $62 thousand for unfunded commitments.
- Separate recurring earnings from unusual items, including the $602 thousand securities-sale loss and the $280 thousand tax credit.
- Verify the continuation of the $0.32 quarterly dividend and the pace and pricing of the authorized 150,000-share repurchase plan.