Franklin Financial Services Corporation — 2019 Q1 Form 10-Q
Business context and reporting period
Franklin Financial Services Corporation is the parent of Farmers and Merchants Trust Company of Chambersburg, a commercial bank serving south-central Pennsylvania, and Franklin Future Fund Inc. The unaudited filing covers the three months ended March 31, 2019, with comparative results for the three months ended March 31, 2018 and balance-sheet comparisons to December 31, 2018. The company’s common stock trades on Nasdaq under FRAF.
Key financial metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total interest income | $12.0 million | $10.5 million | +$1.5 million |
| Net interest income | $10.3 million | $9.7 million | +6.6% |
| Provision for loan losses | $399 thousand | $200 thousand | +$199 thousand |
| Noninterest income | $3.2 million | $3.1 million | +$17 thousand |
| Noninterest expense | $9.4 million | $8.6 million | +8.8% |
| Net income | $3.2 million | $3.5 million | -7.6% |
| Diluted earnings per share | $0.73 | $0.80 | -$0.07 |
| Net interest margin | 3.86% | 3.72% | +14 basis points |
| Efficiency ratio | 67.93% | 65.68% | Higher |
Average interest-earning assets increased to $1.127 billion from $1.097 billion, while the yield on those assets increased to 4.45% from 4.02%. Interest expense rose to $1.7 million from $0.8 million, primarily because deposit costs increased. The effective tax rate was 12.1%, compared with 12.3%.
At March 31, 2019, total assets were $1.213 billion, loans were $980.5 million gross and $967.8 million net, deposits were $1.076 billion, and shareholders’ equity was $121.5 million. Cash and cash equivalents were $47.0 million. The filing reports no short-term borrowings at quarter-end. Total risk-based capital was 14.95% for the bank and 15.04% for the corporation; the bank remained well capitalized.
Net cash provided by operating activities was $4.2 million. Investing activities used $2.8 million, primarily from a $7.2 million increase in loans, while financing activities used $7.4 million, including $1.2 million of dividends and $0.6 million for treasury-stock repurchases. Cash and cash equivalents declined $5.9 million during the quarter.
Material changes versus comparable periods
- Net interest income increased $636 thousand as loan growth and higher asset yields more than offset increased funding costs.
- Gross loans increased $7.1 million, or 0.7%, from year-end 2018. Commercial real estate loans increased $10.0 million, particularly in hotels and motels and land development, while commercial and industrial loans declined $4.8 million.
- Deposits declined $6.1 million, primarily in checking and money-management accounts, while time deposits increased $27.5 million. The bank acquired $10.0 million of short-term wholesale brokered CDs.
- Credit quality weakened: nonaccrual loans rose to $5.6 million from $2.3 million, nonperforming loans rose to $5.8 million from $2.7 million, and nonperforming assets rose to $8.5 million from $5.3 million. Management attributed the increase primarily to a $3.5 million commercial real estate credit moving to nonaccrual status.
- The allowance for loan losses increased to $12.7 million from $12.4 million, or 1.29% of gross loans versus 1.28%. Net charge-offs were $133 thousand, compared with $3 thousand in Q1 2018.
- Noninterest expense increased $764 thousand, led by a $456 thousand increase in salaries and benefits, as well as higher data-processing, legal and professional, and other expenses.
- The available-for-sale securities portfolio declined to $127.9 million from $131.5 million at year-end. Its net unrealized position improved to a $290 thousand gain from a $1.1 million loss.
Guidance, outlook, risks, contingencies, and unusual items
- No formal earnings or financial guidance was provided. Management expects commercial lending to remain the primary area of future loan growth through in-market lending.
- Management stated that liquidity is sufficient to meet anticipated demands. At quarter-end, the bank reported approximately $367.8 million of available FHLB borrowing capacity, $17.5 million of Federal Reserve Discount Window capacity, and approximately $65.4 million of unencumbered securities available for liquidity or collateral.
- Management expects 2019 pension expense of approximately $420 thousand, compared with $500 thousand in 2018.
- The company adopted the new lease standard on January 1, 2019, recognizing a $6.2 million right-of-use asset and lease liability without a material effect on earnings or retained earnings.
- The company is implementing the current expected credit loss standard, scheduled for adoption on January 1, 2020. Management expects earlier and potentially larger credit-loss recognition but had not yet determined the financial impact; a third-party vendor was selected and model testing was expected to begin in Q2 2019.
- Off-balance-sheet commitments to extend credit totaled $288.0 million, and standby letters of credit totaled $25.3 million. A $2.4 million allowance related to letters of credit issued for a commercial borrower that filed for bankruptcy remained in place.
- The bank held $2.7 million of other real estate owned, including a property carried at $2.6 million that management expected to sell in 2019 without a loss.
- The company declared a $0.30-per-share regular dividend for Q2 2019, compared with $0.27 paid for Q1. It repurchased 14,553 shares for $538 thousand under its authorized repurchase plan.
- Management reported no material pending legal proceedings or material changes to previously disclosed risk factors. The company had previously accrued and paid a $10 million settlement related to the Kalan litigation.
- Forward-looking results remain subject to economic conditions, interest rates, funding costs, monetary policy, regulation, taxation, technology, and competition.
Important facts for investors to verify
- Whether the increase in nonaccrual and nonperforming commercial real estate loans persists or leads to higher provisions and charge-offs.
- The adequacy of the $12.7 million allowance for loan losses and the eventual impact of CECL adoption in 2020.
- Deposit trends, including reliance on higher-cost time deposits and the $10.0 million brokered-CD balance.
- Commercial real estate concentration, including $74.5 million in hotels and motels and $48.3 million in land development loans.
- Liquidity availability and the continued accessibility of FHLB, Federal Reserve, brokered-deposit, and securities-based funding sources.
- Whether loan growth can offset rising deposit costs and higher operating expenses while maintaining the reported 3.86% net interest margin.
- The terms and remaining authorization under the stock repurchase plan, as well as the sustainability of the increased $0.30 quarterly dividend.