Franklin Financial Services Corporation — Q1 2020 Form 10-Q Summary
Business Context and Reporting Period
Franklin Financial Services Corporation is a Pennsylvania bank holding company whose principal subsidiary, Farmers and Merchants Trust Company of Chambersburg, serves south-central Pennsylvania. This unaudited Form 10-Q covers the three months ended March 31, 2020, with comparisons to the three months ended March 31, 2019 and December 31, 2019 balance-sheet data. Results reflect the initial effects of the COVID-19 pandemic.
Key Financial Metrics
| Metric | Q1 2020 | Comparable / Prior Period |
|---|---|---|
| Total assets | $1.262 billion | $1.269 billion at Dec. 31, 2019; $1.213 billion at Mar. 31, 2019 |
| Loans, gross | $936.4 million | $934.6 million at Dec. 31, 2019 |
| Deposits | $1.117 billion | $1.125 billion at Dec. 31, 2019; $1.076 billion at Mar. 31, 2019 |
| Net interest income | $10.3 million | $10.3 million in Q1 2019 |
| Net interest margin | 3.53% | 3.86% in Q1 2019 |
| Provision for loan losses | $3.0 million | $399 thousand in Q1 2019 |
| Noninterest income | $3.9 million | $3.2 million in Q1 2019 |
| Noninterest expense | $9.5 million | $9.4 million in Q1 2019 |
| Net income | $1.7 million | $3.2 million in Q1 2019 |
| Diluted EPS | $0.39 | $0.73 in Q1 2019 |
| Return on average assets | 0.54% | 1.08% in Q1 2019 |
| Return on average equity | 5.31% | 10.90% in Q1 2019 |
Cash and cash equivalents were $53.4 million at March 31, 2020, down $30.5 million from year-end, primarily because cash was deployed into investment securities. Operating cash flow was $2.5 million, compared with $4.2 million in Q1 2019. Investing activities used $23.1 million and financing activities used $9.9 million.
The allowance for loan losses increased to $14.7 million, or 1.57% of gross loans, from $12.0 million, or 1.28%, at year-end. Net charge-offs were $236 thousand. Nonperforming loans were $3.7 million, or 0.40% of gross loans, compared with 0.42% at year-end.
The company had no borrowings outstanding at March 31, 2020. Available liquidity totaled $419.6 million, consisting of unused Federal Home Loan Bank capacity of $377.6 million, Federal Reserve Discount Window capacity of $21.0 million, and correspondent-bank capacity of $21.0 million.
The Bank remained well capitalized. Corporation total risk-based capital was 15.99%, Common Equity Tier 1 capital was 14.73%, and the Tier 1 leverage ratio was 9.85%. Shareholders’ equity was $129.0 million, compared with $127.5 million at year-end.
Material Changes Versus Prior Comparable Period
- Net income declined 46.9%, primarily because the loan-loss provision increased by $2.6 million in response to pandemic-related risk factors.
- Net interest income was broadly stable, but the net interest margin declined 33 basis points to 3.53% as earning-asset yields fell. Lower deposit costs partly offset the pressure.
- Average loans declined to $934.5 million from $978.5 million, while average investment securities increased to $196.2 million from $133.5 million.
- Noninterest income increased $724 thousand, principally from an $812 thousand gain on a bank-owned life insurance policy. Equity securities produced a $127 thousand loss versus a $3 thousand gain in Q1 2019.
- Gross loans increased $1.8 million from year-end, with residential real estate and construction growth offsetting a $4.0 million decline in commercial loans.
- Available-for-sale securities increased to $208.0 million from $187.4 million at year-end, and accumulated other comprehensive loss improved by $1.6 million due largely to unrealized securities gains.
- Deposits decreased $8.0 million from year-end. Noninterest-bearing checking increased $6.3 million, while interest-bearing checking, savings, and time deposits declined.
- The company repurchased 36,401 shares for $1.2 million before suspending repurchase activity on March 19, 2020.
Outlook, Management Commentary, Risks, and Unusual Items
- Management identified COVID-19 as the principal near-term risk. Business closures, unemployment, reduced economic activity, loan deferrals, and weaker collateral values could increase credit losses, impair goodwill, reduce securities values, and pressure earnings, capital, or liquidity.
- As of March 31, the Bank had granted approximately $30 million of loan deferrals or modifications. As of April 30, the reported amount had increased to approximately $154 million, or 16% of gross loans, with management expecting additional modifications in the second quarter.
- As of April 30, the Bank had funded 512 Paycheck Protection Program loans totaling $50.1 million. Management expected approximately $2.0 million of PPP processing fees to be recognized during the second and third quarters of 2020.
- The Bank was participating in the PPP Liquidity Facility, which carries a stated fixed rate of 0.35% and permits PPP loans to serve as collateral. The Bank expected the facility to support PPP funding without using normal liquidity sources.
- Management stated that the balance sheet, capital position, and available liquidity should meet anticipated pandemic-related demands, but the duration and economic effects of the pandemic remained uncertain.
- The company expects 2020 pension expense of approximately $680 thousand, compared with $421 thousand in 2019, primarily because of higher recognized actuarial losses.
- The allowance for loan losses increased by $3.0 million, including a $2.6 million increase in the qualitative component after economic-condition and risk-level factors moved from moderate to very high.
- The company expects CECL adoption on January 1, 2023. It stated that adoption may result in earlier recognition and potentially a larger credit-loss allowance; implementation work and model testing were underway.
- The Board declared a regular quarterly dividend of $0.30 per share for the second quarter of 2020, payable May 27, 2020.
- Management reported no material pending governmental proceedings and believes existing litigation will not have a material adverse effect on financial position, while noting that potential future litigation losses cannot be estimated clearly.
Most Important Facts for Investors to Verify
- Whether the substantial increase in loan deferrals after March 31 converts into delinquencies, nonaccrual loans, restructurings, or additional provisions.
- Whether the $14.7 million allowance adequately covers credit deterioration in accommodation and food services, retail, construction, real estate, and other higher-risk exposures.
- The timing, amount, and collectability of the expected $2.0 million of PPP processing fees and the treatment of PPP loans and PPPLF borrowings in future capital and liquidity reporting.
- Whether the 3.53% net interest margin stabilizes or declines further as loan yields, deposit pricing, and interest rates change.
- Potential additional securities impairments or other comprehensive income volatility, particularly in asset-backed, trust-preferred, and mortgage-backed securities.
- The effect of continued pandemic-related weakness on goodwill, pension expense, capital ratios, dividend capacity, and share repurchases.
- The filing text reports approximately $30 million of deferrals at March 31 and approximately $154 million at April 30; investors should reconcile the timing, definitions, and portfolio composition of these amounts.