Business Context and Reporting Period
Company: Franklin Financial Services Corp (and subsidiaries, primarily Farmers and Merchants Trust Company of Chambersburg)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2010
Business Overview: A Pennsylvania-based commercial bank holding company operating in Franklin, Cumberland, Fulton, and Huntingdon Counties. The company provides commercial and consumer banking services, including lending, deposit taking, and trust services.
Key Financial Metrics
| Metric | Q1 2010 | Q1 2009 | Dec 31, 2009 |
|---|---|---|---|
| Net Income | $1,974,000 | $2,101,000 | - |
| Earnings Per Share (Diluted) | $0.51 | $0.55 | - |
| Total Assets | $974,267,000 | - | $979,373,000 |
| Net Loans | $740,723,000 | - | $730,626,000 |
| Total Deposits | $726,680,000 | - | $738,365,000 |
| Shareholders' Equity | $80,623,000 | - | $78,766,000 |
| Net Interest Income | $7,545,000 | $7,219,000 | - |
| Noninterest Income | $2,395,000 | $2,287,000 | - |
| Noninterest Expense | $6,660,000 | $6,150,000 | - |
| Provision for Loan Losses | $625,000 | $593,000 | - |
| Net Cash Provided by Operating Activities | $3,021,000 | $4,307,000 | - |
Key Ratios (Annualized):
- Return on Average Equity (ROE): 10.00% (vs. 11.42% in 2009)
- Return on Average Assets (ROA): 0.82% (vs. 0.94% in 2009)
- Net Interest Margin: 3.46% (vs. 3.61% in 2009)
- Efficiency Ratio: 65.17% (vs. 62.93% in 2009)
- Allowance for Loan Losses to Total Loans: 1.25%
Material Changes vs. Prior Period
- Profitability: Net income decreased 6% year-over-year to $1.97 million, driven by a 9.1% increase in salaries and benefits and a 57.4% increase in legal fees, partially offset by higher net interest income.
- Net Interest Income: Increased $326,000 (4.5%) to $7.55 million due to a $67.6 million increase in average loan balances. However, the Net Interest Margin compressed to 3.46% as asset yields fell 40 basis points while liability costs only fell 28 basis points.
- Asset Composition: Total assets decreased $5.1 million from year-end 2009. Net loans grew $10.1 million, but this was offset by a $10.6 million decrease in investment securities and a $4.8 million decrease in cash equivalents.
- Deposits: Total deposits declined $11.7 million. While non-interest bearing and savings accounts grew, time deposits fell $36.0 million, primarily due to the non-renewal of approximately $23 million in short-term brokered CDs.
- Loan Quality: Nonperforming loans increased $957,000 to $19.2 million (2.56% of total loans), driven by residential real estate loans moving to nonaccrual status. Net charge-offs were $213,000.
Guidance, Outlook, Risks, and Unusual Items
- Outlook: Management expects the net interest margin to remain under pressure due to an extended period of low market interest rates. Loan growth is expected to continue, particularly in commercial lending, while consumer loans may decline further due to the exit of the indirect lending portfolio.
- Unusual Items:
- OTTI Losses: Recognized $255,000 in other-than-temporary impairment (OTTI) losses on two Alt-A mortgage-backed securities.
- Legal Expenses: Legal and professional fees increased significantly due to ongoing lawsuits related to the 2008 acquisition of Community Financial, Inc.
- Severance: Salaries and benefits included an accrual for a severance payment.
- Risks:
- Interest Rate Risk: Low Fed funds rates continue to compress margins as liability rates cannot be reduced further.
- Investment Portfolio: Significant unrealized losses exist in the portfolio ($3.9 million), particularly in corporate trust-preferred securities and Alt-A mortgage-backed securities. Management continues to monitor these for potential future write-downs.
- FHLB Exposure: The Federal Home Loan Bank (FHLB) has suspended dividends and stock repurchases. While the Bank has $95 million in available credit, a capital call or cessation of lending by FHLB would negatively impact liquidity.
Investor Verification Checklist
- Investment Portfolio Quality: Verify the status of the $3.9 million in unrealized losses, specifically the 10 corporate trust-preferred securities and 7 Alt-A mortgage-backed securities, to assess the risk of future OTTI charges.
- Loan Migration: Monitor the trend of residential real estate loans moving to nonaccrual status, which drove the increase in nonperforming assets.
- Deposit Stability: Assess the impact of the $23 million run-off in brokered CDs and the ability to replace this funding with core deposits.
- Legal Contingencies: Review the status of the lawsuits stemming from the Community Financial, Inc. acquisition that drove the spike in legal fees.
- Capital Adequacy: Confirm that regulatory capital ratios (Total Risk-Based Capital at 11.08%) remain well above the "Well Capitalized" threshold despite the economic environment.