Franklin Financial Services Corporation: FY2021 Form 10-K Summary
Business context and reporting period
Franklin Financial Services Corporation is a Pennsylvania bank holding company conducting substantially all business through Farmers and Merchants Trust Company of Chambersburg, a community bank serving south-central Pennsylvania. The bank provides commercial, retail, mortgage, consumer, trust and investment services through its Pennsylvania banking offices. This filing covers the fiscal year ended December 31, 2021; the request identifies the period as 2021 Q4, but the filing is an annual Form 10-K.
Key financial metrics
| Metric | 2021 | 2020 | Change |
|---|---|---|---|
| Total assets | $1.774 billion | $1.535 billion | 15.6% increase |
| Loans, net | $983.7 million | $992.9 million | 0.9% decrease |
| Deposits | $1.584 billion | $1.355 billion | 17.0% increase |
| Shareholders’ equity | $157.1 million | $145.2 million | 8.2% increase |
| Net interest income | $44.7 million | $42.0 million | 6.5% increase |
| Net income | $19.6 million | $12.8 million | 53.3% increase |
| Diluted earnings per share | $4.42 | $2.93 | 50.9% increase |
| Return on average assets | 1.17% | 0.91% | Improved |
| Return on average equity | 13.20% | 9.56% | Improved |
| Net interest margin | 2.88% | 3.21% | 33 basis-point decrease |
| Efficiency ratio | 66.12% | 67.32% | Improved |
Net interest income benefited from greater earning-asset balances and lower funding costs, despite lower asset yields. Average earning assets increased 18.8%, while the cost of interest-bearing liabilities declined to 0.24% from 0.39%. Noninterest income rose 29.2% to $19.5 million, including a $1.8 million gain on the sale of the headquarters building, higher trust and investment fees, mortgage-sale gains and debit-card income.
The provision for loan losses was a $2.1 million reversal in 2021 versus a $4.6 million provision in 2020. Gross loan charge-offs were $330 thousand and recoveries were $707 thousand, producing net recoveries of $377 thousand. The allowance for loan losses was $15.1 million at year-end, or approximately 1.51% of gross loans as reported in management’s overview.
Cash and cash equivalents increased to $175.1 million from $57.1 million. Operating activities provided $26.3 million of cash, investing activities used $133.9 million, and financing activities provided $225.6 million. The bank reported no short-term borrowings at year-end and had $448.0 million of stated available liquidity through the Federal Home Loan Bank, the Federal Reserve Discount Window and correspondent-bank lines.
Debt consisted principally of $20.0 million of unsecured subordinated notes, recorded net of issuance costs at $19.6 million. The notes mature in 2030 and 2035, carry fixed rates of 5.00% and 5.25% for their initial periods, and subsequently convert to SOFR-based rates.
Material changes versus the prior comparable period
- Net income increased $6.8 million, primarily reflecting the loan-loss provision reversal, higher net interest income and stronger noninterest income.
- Total assets increased $238.8 million, driven by deposit growth, a $132.9 million increase in the investment portfolio and a $124.6 million increase in short-term interest-bearing deposits at other banks.
- Deposits increased $229.8 million, with the largest growth in interest-bearing checking and money management accounts. Time deposits declined modestly.
- Loans declined $10.9 million, primarily because $44.5 million of PPP loans were forgiven or otherwise reduced; year-end PPP loans were $7.8 million versus $52.3 million in 2020.
- Nonperforming loans to gross loans improved to 0.74% from 0.87%, and nonperforming assets to total assets improved to 0.42% from 0.57%. Watch-list loans declined to $36.6 million from $66.1 million.
- Noninterest expense increased 9.9% to $43.2 million, led by higher salaries and benefits, data-processing expense, FDIC insurance and pension settlement costs.
- Regular cash dividends increased to $1.25 per share from $1.20. The payout ratio declined to 28.2% from 40.8%. The company repurchased $1.2 million of common stock during 2021 and authorized a new 150,000-share repurchase plan.
- Accumulated other comprehensive income declined by $3.7 million, primarily because of lower fair values of available-for-sale investment securities.
Outlook, commentary, risks and unusual items
Management described the local economy as recovering from the most severe effects of the COVID-19 shutdowns, with lower unemployment and continued growth opportunities in the bank’s primary market. Management expected higher interest rates to benefit the bank over the long term but stated that anticipated 2022 rate increases were not expected to have a material effect on results.
All COVID-related modified loans had returned to contractual payment schedules by December 31, 2021. Remaining PPP exposure was limited and fully SBA-guaranteed, subject to risks involving SBA forgiveness, documentation, compliance and potential litigation.
Key risks include the concentration of lending in south-central Pennsylvania; significant exposure to commercial and real estate loans; potential collateral-value declines; changes in interest rates and deposit pricing; competition; reliance on Federal Home Loan Bank funding for contingency liquidity; cybersecurity and operational disruptions; market sensitivity of trust and investment fees; the transition from LIBOR; climate-related risks; and the uncertain effects of COVID-19 and its variants.
The company had $375.6 million of unused loan commitments and $23.3 million of standby letters of credit. A $1.5 million reserve remained for a previously identified letter-of-credit exposure. Management did not expect existing litigation to have a material adverse effect on financial position, but stated that potential losses from certain matters could not be estimated.
The allowance for loan losses and goodwill impairment were identified as critical accounting areas. Goodwill of $9.0 million was not impaired. The company was preparing for CECL adoption effective January 1, 2023 and expected a one-time adjustment to the allowance and retained earnings, although the ultimate impact had not yet been determined.
The bank and corporation exceeded applicable regulatory capital requirements and were considered well capitalized. At December 31, 2021, bank ratios included CET1 of 15.28%, total risk-based capital of 16.54% and Tier 1 leverage of 8.57%.
Important facts for investors to verify
- Reconcile the reported allowance-for-loan-loss balances and ratios across the MD&A, financial statements and loan-quality tables, as the extracted filing text contains apparent table-label inconsistencies.
- Assess sensitivity to commercial real estate, hotel, construction and geographically concentrated lending, including the $5.6 million nonaccrual hotel loan with a $698 thousand specific reserve.
- Review the expected CECL impact, implementation status and resulting allowance and capital effects beginning in 2023.
- Monitor deposit retention, money-management pricing and the maturity of approximately $55.7 million of time deposits scheduled to mature within one year.
- Evaluate interest-rate sensitivity, including the disclosed projected net-interest-income increase under rising-rate scenarios and the risk of deposit-cost increases.
- Review liquidity dependence on the Federal Home Loan Bank and the availability and collateral requirements of the stated $448.0 million liquidity sources.
- Consider the recurring versus nonrecurring composition of 2021 earnings, particularly the $1.8 million headquarters-sale gain, the $2.1 million loan-loss reversal and pension settlement expense.
- Confirm the company’s transition plans for LIBOR-linked contracts and the terms of subordinated notes that convert to SOFR-based rates.