Franklin Financial Services Corporation: Q3 2021 Form 10-Q Summary
Business Context and Reporting Period
Franklin Financial Services Corporation is the holding company for Farmers and Merchants Trust Company of Chambersburg, a commercial bank serving south-central Pennsylvania, and Franklin Future Fund Inc. This unaudited Form 10-Q covers the three and nine months ended September 30, 2021, with comparisons to the 2020 periods and December 31, 2020.
Financial Position and Key Metrics
| Metric | Q3 2021 / September 30, 2021 | Comparable Period or Prior Year-End |
|---|---|---|
| Net income | $5.9 million; diluted EPS $1.31 | Q3 2020: $3.5 million; $0.79 |
| Nine-month net income | $16.0 million; diluted EPS $3.60 | Nine months 2020: $8.2 million; $1.89 |
| Total assets | $1.732 billion | December 31, 2020: $1.535 billion |
| Net interest income | Q3: $11.6 million; nine months: $33.3 million | Q3 2020: $10.4 million; nine months 2020: $31.0 million |
| Net interest margin | Q3: 2.89%; nine months: 2.91% | Q3 2020: 3.02%; nine months 2020: 3.25% |
| Noninterest income | Q3: $6.2 million; nine months: $14.9 million | Q3 2020: $3.6 million; nine months 2020: $10.9 million |
| Noninterest expense | Q3: $11.0 million; nine months: $31.3 million | Q3 2020: $9.6 million; nine months 2020: $28.8 million |
| Cash and cash equivalents | $98.9 million | December 31, 2020: $57.1 million |
| Net loans | $1.003 billion | December 31, 2020: $992.9 million |
| Total deposits | $1.544 billion | December 31, 2020: $1.355 billion |
| Shareholders’ equity | $152.8 million; book value $34.49 per share | December 31, 2020: $145.2 million; $33.07 per share |
| Allowance for loan losses | $15.4 million, or 1.51% of gross loans | December 31, 2020: $16.8 million, or 1.66% |
Nine-month operating cash flow was $23.9 million, compared with $2.4 million in the prior-year period. Investing activities used $168.7 million, primarily reflecting purchases of available-for-sale securities and capital expenditures. Financing activities provided $186.6 million, principally from deposit growth. Cash increased $41.7 million during the nine months.
The Corporation had $20.0 million of unsecured subordinated notes, recorded at $19.6 million net of issuance costs. The notes mature in 2030 and 2035 and qualify as Tier 2 capital. The Bank reported a 14.97% CET1 ratio, 16.23% total risk-based capital ratio, and 8.57% Tier 1 leverage ratio, and was considered well capitalized.
Material Changes Versus Comparable Periods
- Q3 net income increased 69% year over year, while nine-month net income increased 94%. Results included a $1.8 million gain on the sale of the Bank’s headquarters building.
- Net interest income increased despite lower margins, supported by higher average earning assets, a larger securities portfolio, lower deposit costs, and PPP-related interest and fees. PPP interest and fees were $1.2 million in Q3 and $2.8 million year to date.
- The nine-month loan-loss provision was a $1.9 million recovery, compared with a $5.4 million provision in 2020. Management attributed the reversal to improved economic and credit-risk factors and a lower historical charge-off rate.
- Noninterest income increased primarily due to the headquarters sale, higher investment and trust fees, increased mortgage-sale gains, and higher debit-card income.
- Noninterest expense increased 8.5% year to date, led by salaries and benefits, data processing, FDIC insurance, and nonservice pension costs.
- Deposits increased $189.7 million, or 14.0%, from year-end 2020. Loan growth was modest at 0.8% gross and 1.0% net, while PPP loans declined $30.5 million to $21.7 million as loans were forgiven.
- Accumulated other comprehensive income declined $5.4 million, reflecting lower fair values of the available-for-sale securities portfolio. The portfolio had $3.5 million of gross unrealized losses at September 30, 2021, which management considered temporary.
- Nonperforming loans were $8.6 million, or 0.85% of gross loans, compared with $8.7 million, or 0.87%, at year-end 2020. The watch list declined to $58.5 million from $66.1 million.
Outlook, Risks, Contingencies, and Unusual Items
Management stated that no loans remained on COVID-19 modified payment schedules at September 30, 2021. The Bank’s primary credit exposures include commercial real estate, hotels and motels, construction, commercial lending, loan participations, and the local south-central Pennsylvania economy. Management also identified interest-rate changes, funding costs, monetary policy, inflation, regulation, technology, competition, and continuing COVID-19 effects as risks to future results.
The Bank had $413.3 million of unused commitments and standby letters of credit at September 30, 2021. A $1.5 million reserve remained for a commercial borrower-related standby letter-of-credit exposure after a $636 thousand reserve reversal in the second quarter. Litigation is conducted in the ordinary course; management did not expect pending matters to have a material adverse effect, but stated that potential losses for certain matters could not be estimated.
The Corporation expects to adopt the current expected credit loss standard, ASU 2016-13, on January 1, 2023. It expects a one-time cumulative-effect adjustment to the allowance and retained earnings, but the ultimate impact remains under evaluation. The CECL model was being tested during 2021.
Liquidity sources totaled $433.8 million at September 30, 2021, including $351.4 million of FHLB capacity, $26.4 million of Federal Reserve Discount Window capacity, and $56.0 million of correspondent-bank capacity. Management stated that it believed anticipated liquidity demands could be met.
The Board declared a $0.32 per share dividend for the fourth quarter of 2021, payable November 24, 2021. Under the repurchase plan authorizing up to 150,000 shares, 35,718 shares had been repurchased through September 30, 2021.
Important Facts for Investors to Verify
- Assess the sustainability of earnings excluding the $1.8 million headquarters-sale gain and the $1.9 million year-to-date loan-loss recovery.
- Monitor margin compression, including the decline in net interest margin to 2.91% from 3.25% year to date.
- Review commercial real estate, hotel, construction, participation, and local-market credit concentrations, including the $8.6 million of nonaccrual loans.
- Evaluate the effect of rising unrealized securities losses on accumulated other comprehensive income, capital, and future liquidity.
- Track deposit stability and reliance on reciprocal deposits, which represented 16.0% of total liabilities at September 30, 2021.
- Determine the eventual balance-sheet and earnings impact of CECL adoption in 2023.
- Review the $413.3 million of unfunded commitments and standby letters of credit, including the remaining $1.5 million reserve.
- Confirm future dividend and share-repurchase activity against earnings, capital ratios, and liquidity requirements.