Franklin Financial Services Corporation — 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, operates a commercial bank serving south-central Pennsylvania. The unaudited filing covers the three months ended March 31, 2018, compared with the three months ended March 31, 2017 and December 31, 2017 balance-sheet data.
Key financial metrics
| Metric | Q1 2018 | Comparable period or prior year-end |
|---|---|---|
| Total assets | $1.169 billion | $1.180 billion at Dec. 31, 2017; $1.131 billion at Mar. 31, 2017 |
| Net loans | $930.7 million | $931.9 million at Dec. 31, 2017; $892.3 million at Mar. 31, 2017 |
| Deposits | $1.034 billion | $1.047 billion at Dec. 31, 2017; $1.007 billion at Mar. 31, 2017 |
| Net interest income | $9.7 million | $9.0 million in Q1 2017 |
| Net interest margin | 3.72% | 3.69% in Q1 2017 |
| Noninterest income | $3.1 million | $2.9 million in Q1 2017 |
| Noninterest expense | $8.6 million | $8.0 million in Q1 2017 |
| Provision for loan losses | $200 thousand | $120 thousand in Q1 2017 |
| Net income | $3.5 million | $3.0 million in Q1 2017 |
| Basic and diluted EPS | $0.80 | $0.70 in Q1 2017 |
| Effective tax rate | 12.3% | 20.8% in Q1 2017 |
| Cash and cash equivalents | $42.1 million | $58.6 million at Dec. 31, 2017 |
Net income increased approximately 16% year over year. Return on average assets was 1.21%, return on average equity was 12.17%, and the efficiency ratio was 65.68%. The allowance for loan losses was $12.0 million, or 1.27% of gross loans. Net charge-offs were $3 thousand, compared with net recoveries of $83 thousand in Q1 2017.
Material changes versus comparable periods
- Net interest income increased $728 thousand, supported by loan growth and higher loan yields. Average loans increased to $936.0 million from $890.6 million, while the tax-equivalent net interest margin increased to 3.72% from 3.69%.
- Noninterest income increased $223 thousand, primarily from higher investment and trust services fees and loan service charges. Assets under management were $837.4 million, compared with $786.8 million at March 31, 2017.
- Noninterest expense increased $691 thousand, mainly from salaries and benefits, advertising, and data-processing costs related to new software.
- The lower federal corporate tax rate following the Tax Cuts and Jobs Act reduced tax expense and the effective tax rate.
- Total loans were essentially flat from year-end. Commercial real estate loans increased $5.4 million, while commercial loans declined $3.8 million and residential real estate loans declined $4.3 million.
- Deposits declined $12.7 million, primarily because of lower time deposits and noninterest-bearing deposits. The company had no short-term borrowings at quarter-end.
- Cash and cash equivalents declined $16.5 million during the quarter. Operating activities provided $3.5 million, while investing and financing activities used $6.6 million and $13.4 million, respectively.
- Accumulated other comprehensive loss increased to $7.0 million from $6.0 million, largely because of higher unrealized losses on available-for-sale debt securities as interest rates rose.
Guidance, outlook, risks, contingencies, and unusual items
- The filing provides no formal earnings or revenue guidance. Management expects commercial lending to remain the primary area of future loan growth, with reduced reliance on purchased loan participations.
- Management stated that liquidity was sufficient to meet anticipated demands. At March 31, 2018, the Bank reported $332 million of available FHLB borrowing capacity and approximately $19 million of Federal Reserve Discount Window borrowing capacity.
- The Bank was well capitalized under Basel III. The Bank’s CET1 ratio was 14.16%, total risk-based capital ratio was 15.41%, and Tier 1 leverage ratio was 9.86%.
- Credit quality remained generally stable. Nonperforming loans were $2.7 million, nonperforming assets were $5.3 million, and watch-list loans increased to $13.3 million from $12.8 million at year-end.
- Other real estate owned totaled $2.6 million, including a property carried at approximately $2.5 million that was under contract for sale. The due-diligence period had been extended to May 2018, and the outcome remained uncertain.
- On April 11, 2018, the Bank entered into agreements to settle the Kalan class-action litigation for $10 million, subject to court approval. The settlement was accrued as an expense in 2017, so the filing does not indicate a new Q1 2018 income-statement charge.
- The company adopted accounting standards covering revenue recognition, equity securities, cash-flow presentation, and pension-cost presentation. Management reported no material effect from these adoptions.
- The expected-credit-loss standard, CECL, is scheduled for 2020 adoption. Management expects it could result in earlier and potentially larger credit-loss provisions and was developing its implementation methodology.
- Forward-looking results remain exposed to economic conditions, interest-rate changes, funding costs, monetary policy, regulation, taxation, technology, competition, and litigation outcomes.
Important facts for investors to verify
- Confirm court approval and final funding of the $10 million Kalan settlement and assess any effect on capital or future cash flows.
- Monitor deposit trends, available liquidity, and reliance on FHLB or other wholesale funding following the $16.5 million quarterly decline in cash.
- Evaluate concentrations in commercial real estate, hotels and motels, construction lending, and purchased loan participations.
- Track watch-list, nonaccrual, TDR, and nonperforming loans, including the two significant nonaccrual credits identified by management.
- Assess whether the allowance for loan losses remains adequate as the portfolio mix changes and CECL implementation advances.
- Review the impact of rising rates on deposit costs, the net interest margin, and the $1.7 million of unrealized losses in the available-for-sale securities portfolio.
- Verify the status and proceeds of the planned OREO sale and the timing of the $0.27-per-share second-quarter 2018 dividend.