Franklin Financial Services Corporation — Q1 2022 Form 10-Q Summary
Business context and reporting period
Franklin Financial Services Corporation is a Pennsylvania-based bank holding company whose principal subsidiary, Farmers and Merchants Trust Company of Chambersburg, provides commercial banking, lending, deposit, investment, and trust services primarily in south-central Pennsylvania and Washington County, Maryland. This report covers the three months ended March 31, 2022. The financial statements are unaudited.
Key financial metrics
| Metric | Q1 2022 | Comparable period or prior date |
|---|---|---|
| Net income | $3.0 million | $4.8 million in Q1 2021 |
| Diluted earnings per share | $0.67 | $1.09 in Q1 2021 |
| Net interest income | $10.8 million | $10.8 million in Q1 2021 |
| Net interest margin | 2.66% | 3.03% in Q1 2021; 2.79% in Q4 2021 |
| Noninterest income | $3.9 million | $4.2 million in Q1 2021 |
| Noninterest expense | $11.3 million | $10.2 million in Q1 2021 |
| Efficiency ratio | 75.50% | 66.06% in Q1 2021 |
| Total assets | $1.767 billion | $1.774 billion at December 31, 2021 |
| Gross loans | $1.001 billion | $998.8 million at December 31, 2021 |
| Deposits | $1.596 billion | $1.584 billion at December 31, 2021 |
| Cash and cash equivalents | $173.7 million | $175.1 million at December 31, 2021 |
| Shareholders’ equity | $137.1 million | $157.1 million at December 31, 2021 |
Return on average assets was 0.69%, return on average equity was 7.96%, and return on average tangible equity was 8.47%, all year-to-date annualized. Book value per share was $30.77 and tangible book value per share was $28.75 at March 31, 2022.
There was no provision for loan losses in Q1 2022, compared with an $800 thousand provision reversal in Q1 2021. The allowance for loan losses was $15.1 million, or 1.50% of gross loans. Nonaccrual loans totaled $7.4 million, or 0.74% of gross loans.
Operating cash flow was $4.4 million. Investing activities used $16.8 million, primarily reflecting purchases of investment securities and capital expenditures, while financing activities provided $10.9 million, primarily from deposit growth. Cash and cash equivalents decreased $1.4 million during the quarter.
The Corporation had $20.0 million of subordinated notes outstanding, recorded at $19.6 million net of issuance costs. The notes carry fixed rates of 5.00% and 5.25% during their initial fixed-rate periods and qualify as Tier 2 capital. The Bank remained well capitalized, with a 16.30% total risk-based capital ratio and an 8.65% Tier 1 leverage ratio.
Material changes versus comparable periods
- Net income declined 37.7% year over year, and diluted EPS declined from $1.09 to $0.67.
- Net interest income was essentially flat, but the net interest margin fell to 2.66% from 3.03%, driven by lower earning-asset yields. Average earning assets increased 12.2%, while average loans declined 1.3% and average deposits increased 13.8%.
- PPP-related loan balances declined to $2.9 million from $7.8 million at year-end 2021; all deferred PPP fees had been recognized by March 31, 2022.
- Noninterest income declined 8.1% year over year, primarily because gains on loan sales fell $528 thousand. Investment and trust services fees increased $192 thousand, and deposit service charges increased $155 thousand.
- Noninterest expense increased 10.8% year over year, led by higher salaries and benefits, marketing, and data-processing costs. Management attributed some data-processing growth to implementation of a customer relationship management platform.
- Shareholders’ equity declined $19.9 million from year-end, primarily because accumulated other comprehensive loss increased by $21.9 million as rising market interest rates reduced the fair value of available-for-sale securities.
- The available-for-sale securities portfolio had a $23.6 million net unrealized loss at quarter-end, compared with a $4.1 million net unrealized gain at year-end 2021. Management considered the losses temporary and recorded no other-than-temporary impairment charge.
Guidance, outlook, risks, contingencies, and unusual items
The filing does not provide formal earnings or revenue guidance. Management stated that the local market economy remained diverse and favorable for growth, but cautioned that results may be affected by economic conditions, inflation, interest rates, Federal Reserve policy, funding costs, regulation, taxation, technology, competition, and continuing effects of the COVID-19 pandemic.
Interest-rate risk is significant: rising rates contributed to lower securities fair values and a substantial decline in accumulated other comprehensive income, while the yield on earning assets declined year over year. The investment portfolio had $24.6 million of gross unrealized losses across 464 securities; management expects collection of principal and interest and does not currently intend or expect to be forced to sell the securities before recovery or maturity.
Credit exposures include commercial real estate, hotels and motels, construction lending, commercial loan participations, and loans concentrated in the primary market area. The watch list totaled $38.5 million, including $7.4 million of nonaccrual loans. The Corporation had 17 troubled debt restructurings totaling $5.4 million, including $611 thousand not performing under modified terms.
Off-balance-sheet commitments included $376.8 million of commitments to extend credit and $26.5 million of standby letters of credit. A $1.5 million reserve remained for letters of credit associated with a commercial borrower bankruptcy. Available liquidity totaled $451.8 million through Federal Home Loan Bank, Federal Reserve discount-window, and correspondent-bank facilities, with no amounts outstanding under those sources.
The Corporation is preparing for adoption of the current expected credit loss standard on January 1, 2023. Management expects a one-time cumulative-effect adjustment to the allowance and retained earnings, but has not determined the amount. The Corporation is testing a third-party CECL model during 2022.
The Board declared a $0.32 per-share dividend for the second quarter of 2022. No shares were repurchased under the authorized 150,000-share repurchase plan during the first quarter. Management reported effective disclosure controls and no material changes to internal control over financial reporting. No material litigation or material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether the lower net interest margin persists as interest rates and deposit costs change.
- The timing and magnitude of the CECL adoption adjustment effective January 1, 2023.
- The duration and credit performance of the $24.6 million unrealized-loss position in the securities portfolio.
- Credit quality trends in commercial real estate, hotel and motel, construction, and purchased-participation loan portfolios.
- The adequacy of the $15.1 million loan-loss allowance and the $1.5 million reserve for standby-letter-of-credit exposure.
- Whether deposit growth and available borrowing capacity remain sufficient to support loan growth and stressed liquidity needs.
- The effect of higher operating expenses and the 75.50% efficiency ratio on future profitability.