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)
Reporting Period: Quarter and nine months ended September 30, 2010
Business Overview: A Pennsylvania-based commercial bank holding company operating in Franklin, Fulton, Cumberland, and Huntingdon Counties. The company provides traditional banking services including commercial, residential, and consumer lending, as well as trust and investment services.
Key Financial Metrics (Nine Months Ended Sept 30, 2010)
| Metric | 2010 (YTD) | 2009 (YTD) |
|---|---|---|
| Net Income | $5.9 million | $4.8 million |
| Earnings Per Share (Diluted) | $1.53 | $1.26 |
| Total Assets | $967.6 million | $979.4 million (Year-end 2009) |
| Net Loans | $748.2 million | $730.6 million (Year-end 2009) |
| Total Deposits | $726.8 million | $738.4 million (Year-end 2009) |
| Net Interest Income | $23.1 million | $21.8 million |
| Noninterest Income | $6.7 million | $6.6 million |
| Noninterest Expense | $19.8 million | $19.6 million |
| Provision for Loan Losses | $1.9 million | $2.7 million |
| Return on Average Assets (ROA) | 0.79% | 0.66% |
| Return on Average Equity (ROE) | 9.56% | 8.34% |
| Net Interest Margin | 3.47% | 3.44% |
| Efficiency Ratio | 64.16% | 65.50% |
Material Changes vs. Prior Period
- Profitability: Net income increased 23.1% year-over-year, driven by a lower provision for loan losses ($788k decrease) and improved net interest income, despite higher salary and benefit expenses.
- Asset Growth: Net loans grew by $17.6 million (2.4%) since year-end 2009, primarily due to increases in commercial real estate and commercial/industrial loans. This growth was partially offset by a decrease in investment securities ($18.1 million).
- Deposit Trends: Total deposits decreased $11.6 million. While non-interest bearing and savings/checking deposits grew significantly, time deposits fell $68.8 million due to the non-replacement of maturing brokered CDs ($25 million in Q1 and $15 million in scheduled maturities).
- Asset Quality: Nonperforming loans increased slightly to $19.2 million (2.53% of total loans) from $18.3 million at year-end 2009. Net charge-offs were $1.2 million, consistent with the prior year.
- Investment Portfolio: The portfolio saw $573,000 in Other-Than-Temporary Impairment (OTTI) charges, primarily related to equity securities and private label mortgage-backed securities.
Outlook, Risks, and Management Commentary
- Interest Rate Environment: Management notes that the Federal Reserve's low interest rate policy continues to pressure net interest margins. Significant margin improvement is unlikely in 2010 or 2011 if rates remain low.
- Regulatory Impact: The Dodd-Frank Act is expected to increase compliance costs. Specific concerns include new overdraft fee regulations (opt-in requirements) which may reduce fee income, and changes to FDIC assessment bases.
- Loan Portfolio Strategy: The bank is exiting its indirect consumer lending portfolio, which is expected to run down. Commercial lending remains strong, though the bank anticipates fewer loan participations available for purchase in late 2010 compared to 2009.
- Capital Management: The company maintains a dividend payout ratio of 52.9% (down from 64.4% in 2009) to preserve capital. No share repurchases were made in the first nine months of 2010.
- Specific Risk - First Chester Investment: The bank holds a significant investment in First Chester County Corporation (approx. $2.1 million cost basis). Due to a pending merger with Tower Bancorp, the bank expects to record a loss in Q4 2010. The loss amount is variable based on delinquency rates and stock prices, estimated between $123,000 and $1.1 million pre-tax.
- Liquidity: The bank maintains strong liquidity with $131 million available on FHLB lines and $26 million in unsecured correspondent lines. However, reliance on FHLB funding carries risk given the FHLB's own capital strain.
Investor Verification Checklist
- OTTI Charges: Verify the specific composition of the $573k OTTI charge and the remaining unrealized losses ($4.3 million) in the investment portfolio, particularly in trust preferred and Alt-A mortgage-backed securities.
- First Chester Merger Loss: Monitor Q4 2010 results for the final determination of the loss on the First Chester/Tower Bancorp merger transaction.
- Deposit Stability: Assess the sustainability of deposit growth given the significant runoff of brokered CDs and the shift to lower-cost money market accounts.
- Nonperforming Loans: Track the $11.8 million in significant nonaccrual loans, specifically the $3.4 million exposure to a modular home construction borrower in bankruptcy.
- Overdraft Fee Impact: Evaluate the long-term impact of the July 2010 opt-in regulations on deposit service charge revenue.