Franklin Financial Services Corporation — Q2 2014 Form 10-Q Summary
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 filing covers the three and six months ended June 30, 2014; financial statements are unaudited. The company reported 4,193,398 common shares outstanding as of July 31, 2014.
Key financial metrics
| Metric | Three months ended June 30, 2014 | Three months ended June 30, 2013 | Six months ended June 30, 2014 | Six months ended June 30, 2013 |
|---|---|---|---|---|
| Net interest income | $7.9 million | $7.6 million | $15.7 million | $15.4 million |
| Provision for loan losses | $266 thousand | $803 thousand | $464 thousand | $1.6 million |
| Noninterest income | $2.9 million | $2.4 million | $5.2 million | $4.8 million |
| Noninterest expense | $7.6 million | $7.6 million | $15.3 million | $15.2 million |
| Net income | $2.3 million | $1.4 million | $4.1 million | $2.9 million |
| Diluted EPS | $0.55 | $0.33 | $0.99 | $0.70 |
| Cash dividend per share declared | $0.17 | $0.17 | $0.34 | $0.34 |
At June 30, 2014, total assets were $1.02 billion, up $38.0 million from December 31, 2013. Net loans were $723.2 million, up 1.3%, and total deposits were $900.7 million, up 6.5%. Shareholders’ equity was $100.0 million, compared with $95.4 million at year-end 2013. Cash and cash equivalents were $54.8 million, compared with $40.7 million at year-end.
The six-month net interest margin was 3.56%, compared with 3.35% in the prior-year period. Management reported a 0.82% annualized return on average assets, an 8.60% annualized return on average equity, and a 70.63% efficiency ratio. The reported allowance for loan losses was $9.5 million, or 1.30% of gross loans.
Six-month operating cash flow was $6.4 million, compared with $7.6 million in 2013. Investing activities used $24.3 million, principally reflecting purchases of investment securities and loan growth. Financing activities provided $32.0 million, mainly from deposit growth. Cash increased by $14.0 million during the period.
Long-term debt was $12.0 million at June 30, 2014, while repurchase-agreement borrowings declined to $2.3 million from $23.8 million at year-end. The company reported approximately $35 million available on an FHLB line, $16 million of unsecured correspondent-bank lines, approximately $39 million of Federal Reserve Discount Window borrowing capacity, and $226.9 million of excess borrowing capacity.
Material changes versus prior comparable periods
- Six-month net income increased 42.6%, driven primarily by lower loan-loss provisions, lower funding costs, and higher noninterest income.
- Six-month interest income declined $643 thousand, but interest expense declined $891 thousand, increasing net interest income by $248 thousand.
- Noninterest income increased $458 thousand, including higher securities gains, deposit service charges, other service fees, and debit-card income. Securities gains were $221 thousand versus $29 thousand in 2013, partly reflecting liquidation of most of the equity portfolio.
- Noninterest expense increased $96 thousand year over year. Salaries, occupancy, and data-processing costs increased, while advertising, FDIC insurance, and Pennsylvania bank-shares tax declined.
- Average interest-bearing liabilities declined and their average cost fell to 0.42% from 0.61% for the first six months. Management attributed part of the decrease to the maturity or calling of $46.9 million of brokered deposits in 2013.
- Commercial loans increased $12.9 million from year-end, while commercial real estate loans declined $6.9 million. Total loans increased $9.3 million.
- Nonperforming loans declined to $21.0 million from $25.2 million at year-end, and nonperforming assets declined to $25.2 million from $30.0 million. Nonperforming loans were 2.87% of gross loans, compared with 3.49% at year-end.
- Net charge-offs increased to $647 thousand for the first six months from $546 thousand in 2013, while the allowance declined $183 thousand from year-end.
Guidance, outlook, risks, contingencies, and unusual items
The filing does not provide formal earnings or revenue guidance. Management expects home-equity lending and consumer lending to remain subdued until economic conditions improve, while pursuing commercial lending opportunities and selected loan participations. The company purchased $11.6 million of loan participations during the first half and held $133.9 million of purchased participations at June 30, 2014.
Management expected 2014 pension expense of approximately $275 thousand, compared with $560 thousand in 2013. On July 24, 2014, the board declared a $0.17 per-share dividend for the third quarter, payable August 27, 2014.
The investment portfolio totaled $175.4 million at fair value. Unrealized losses were $1.9 million across 99 temporarily impaired securities, improved from $3.5 million at year-end. Management recorded no new other-than-temporary impairment charges but noted that additional write-downs on private-label mortgage-backed securities remain possible. The portfolio included $5.3 million of trust-preferred securities with $625 thousand of unrealized losses and $1.9 million of cumulative credit-related impairment charges on private-label mortgage-backed securities. The Bank is participating in a class-action lawsuit involving alleged defective warranties and representations by a private-label mortgage-backed securities servicer.
Credit risk remains concentrated in commercial real estate and commercial lending. Watch-list loans totaled $65.1 million, including $46.6 million rated substandard. Seven significant nonaccrual loans represented 84% of total nonaccrual balances. Management noted that workout periods may be lengthy and that additional loans could become nonperforming. Other real estate owned totaled $4.1 million, and $788 thousand of residential properties were in foreclosure.
Unused commitments and standby letters of credit totaled $252.5 million. Standby letters of credit were $22.5 million, and management believed collateral and guarantees would cover potential payments. The filing states that no pending legal proceedings were material to shareholders’ equity or financial condition.
Primary forward-looking risks include economic conditions, interest rates, funding costs, monetary policy, regulation and taxation, technology, competition, credit quality, collateral values, liquidity, and market values of investment securities. Management stated that liquidity was adequate and that there were no material changes in market-risk exposure during the period.
Important facts for investors to verify
- Reconcile the reported regulatory capital ratios, as the filing presents slightly different total risk-based capital figures in separate sections.
- Monitor commercial real estate concentrations, watch-list loans, nonaccrual loans, TDRs, OREO, charge-offs, and the adequacy of the $9.5 million allowance.
- Assess potential future losses on trust-preferred and private-label mortgage-backed securities, including the $515 thousand of cumulative credit-related OTTI charges and ongoing litigation.
- Evaluate sustainability of earnings growth given the substantial reduction in loan-loss provisions and the contribution from securities gains.
- Track deposit composition, the transition from repurchase agreements to deposit sweeps, pledged collateral, and available borrowing capacity.
- Review the effect of future interest-rate changes on the net interest margin, funding costs, securities valuations, and derivative positions.