Business Context and Reporting Period
Company: Franklin Financial Services Corp (Parent of Farmers and Merchants Trust Company of Chambersburg)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and nine months ended September 30, 2008
Business Overview: A commercial bank holding company operating primarily in Franklin, Cumberland, Fulton, and Huntingdon Counties, Pennsylvania. The company reported strong core banking performance despite significant turbulence in the broader financial markets during the third quarter of 2008.
Key Financial Metrics
| Metric (in thousands) | 9 Months Ended Sep 30, 2008 | 9 Months Ended Sep 30, 2007 | Change |
|---|---|---|---|
| Net Income | $7,594 | $6,680 | +13.7% |
| Diluted EPS | $1.98 | $1.73 | +14.5% |
| Total Assets | $884,585 | $820,371 | +7.8% |
| Net Loans | $647,513 | $564,256 | +14.8% |
| Total Deposits | $605,828 | $606,277 | -0.1% |
| Net Interest Income | $22,586 | $18,540 | +21.8% |
| Noninterest Income | $6,157 | $7,789 | -20.9% |
| Noninterest Expense | $17,490 | $16,923 | +3.4% |
| Provision for Loan Losses | $778 | $790 | -1.5% |
| Cash Flow from Operations | $8,232 | $5,853 | +40.6% |
Key Ratios (Annualized, 9 Months 2008):
- Net Interest Margin: 4.04% (vs. 3.51% in 2007)
- Return on Average Equity (ROE): 12.62%
- Return on Average Assets (ROA): 1.18%
- Nonperforming Loans to Total Loans: 0.68%
- Allowance for Loan Losses to Total Loans: 1.18%
Material Changes vs. Prior Period
- Net Interest Income Expansion: Net interest income increased $4.1 million year-over-year. This was driven by a significant decrease in the cost of interest-bearing liabilities (from 3.80% to 2.39%) which outpaced the decline in asset yields. The net interest margin improved to 4.04%.
- Loan Portfolio Growth: Net loans grew by $83.3 million since year-end 2007, primarily due to a $86.9 million increase in commercial loans via purchased participations. This growth was partially offset by a run-off in the residential mortgage portfolio.
- Investment Portfolio Impairments: Noninterest income declined due to $631,000 in impairment writedowns on eight bank stocks and a $707,000 loss on the sale of a Washington Mutual corporate bond. Total unrealized losses on available-for-sale securities increased to $4.7 million.
- Expense Management: Noninterest expenses rose $567,000, primarily due to increased salaries and benefits ($552k) and advertising ($285k) for new customer incentives and a new office. However, pension expense decreased significantly due to plan changes.
- Asset Quality Improvement: The nonperforming loan ratio decreased from 1.01% to 0.68%, largely due to payoffs of loans purchased from Equipment Finance LLC (EFI). Net charge-offs increased 37% to $433,000.
Outlook, Risks, and Management Commentary
- Acquisition Activity: On July 26, 2008, the company announced an agreement to merge with Community Financial, Inc. (Community Trust Company), pending regulatory approval. Completion is expected in 2008.
- Equity Investment Risk: The company holds an equity method investment in American Home Bank, N.A., which is being acquired by First Chester County Corporation. Management is reviewing the impact of this transaction.
- Market Environment: Management notes the severe strain on financial markets in Q3 2008 (Lehman Brothers, Washington Mutual failures). While the local economy remains stable with low unemployment, housing sales have slowed.
- Regulatory Changes: The company anticipates a significant increase in FDIC insurance premiums in 2009 due to new recapitalization plans. The company expects to retain the temporary unlimited deposit insurance coverage for non-interest bearing deposits.
- Liquidity: The company maintains strong liquidity with $12.5 million in unpledged securities and over $100 million in available FHLB lines of credit. Management expects to meet all anticipated liquidity demands.
- Future Margins: While margins have improved, management expects net interest margin to tighten as assets continue to reprice downward in a lower rate environment.
Investor Verification Checklist
- Acquisition Status: Verify the regulatory approval status and expected closing date of the merger with Community Financial, Inc.
- Investment Portfolio Valuation: Monitor the $4.7 million in unrealized losses on debt securities and the potential for further writedowns on the equity portfolio of bank stocks.
- FDIC Premium Impact: Assess the projected increase in FDIC insurance premiums for 2009 and its impact on future noninterest expenses.
- Loan Quality Trends: Track the net charge-off ratio, which rose 37% year-over-year, to ensure the allowance for loan losses remains adequate as the economy evolves.
- Interest Rate Sensitivity: Evaluate the impact of the Federal Reserve's rate cuts (Fed funds rate at 1.50% as of Oct 2008) on the company's net interest margin, given the expectation of margin compression.