Franklin Financial Services Corporation — Q2 2020 Form 10-Q Summary
Business context and reporting period
Franklin Financial Services Corporation is a Pennsylvania-based bank holding company whose primary subsidiary is Farmers and Merchants Trust Company of Chambersburg. The filing covers the three and six months ended June 30, 2020. Results reflect the initial economic effects of the COVID-19 pandemic, including loan deferrals, increased credit-loss provisioning, lower interest rates, and participation in the Paycheck Protection Program (PPP).
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net income | $3.1 million | $4.0 million | $4.8 million | $7.2 million |
| Diluted EPS | $0.71 | $0.90 | $1.10 | $1.63 |
| Net interest income | $10.3 million | $10.6 million | $20.6 million | $20.9 million |
| Net interest margin | 3.26% | 3.74% | 3.39% | 3.80% |
| Provision for loan losses | $2.0 million | $0 | $5.0 million | $0.4 million |
| Noninterest income | $3.4 million | $3.7 million | $7.3 million | $6.9 million |
| Noninterest expense | $9.6 million | $9.6 million | $19.2 million | $19.0 million |
| Income tax benefit/(expense) | $0.9 million benefit | $0.7 million expense | $1.0 million benefit | $1.1 million expense |
- Total assets were $1.423 billion at June 30, 2020, up from $1.269 billion at December 31, 2019.
- Gross loans were $1.012 billion, up 8.3% from year-end 2019; net loans were $995.6 million.
- Deposits were $1.273 billion, up 13.1% from year-end 2019, primarily in checking and savings accounts.
- The allowance for loan losses increased to $16.6 million, or 1.64% of gross loans, from $12.0 million, or 1.28%, at year-end 2019.
- Cash and cash equivalents were $58.6 million, compared with $83.8 million at December 31, 2019.
- Shareholders’ equity was $134.8 million, compared with $127.5 million at year-end 2019. Book value per share was $30.98.
- Six-month operating cash flow was $2.6 million, compared with $8.5 million in the prior-year period. Investing activities used $172.9 million, principally for securities purchases and loan growth, while financing activities provided $145.1 million.
- The Corporation had no borrowings outstanding at June 30, 2020. Available liquidity sources totaled approximately $476.7 million, including Federal Home Loan Bank, Federal Reserve, correspondent-bank, and PPPLF capacity.
Material changes versus prior comparable periods
- Second-quarter net income declined 23% and six-month net income declined 34%, primarily because of higher loan-loss provisions and lower net interest margins.
- Net interest margin declined as asset yields fell with market rates. Lower deposit costs partially offset the decline in interest income.
- Noninterest income decreased in the second quarter because of lower deposit-related fees and the absence of prior-year securities gains, but increased for the six-month period due mainly to an $812,000 gain on a bank-owned life insurance policy and higher mortgage-related fees.
- Commercial loans increased $66.4 million from year-end 2019, primarily from PPP lending. PPP loans totaled $62.5 million at June 30, 2020.
- The Bank granted approximately $196.5 million of COVID-related loan deferrals or modifications, representing approximately 19% of gross loans. Management noted that future delinquencies and nonaccrual loans could rise as these loans exit deferral periods.
- The commercial real estate portfolio included approximately $70 million of hotel loans, all rated no better than Pass-watch at quarter-end. Approximately $57 million was moved to that rating during the quarter.
- The CARES Act produced a $1.1 million tax benefit from carrying back a prior net operating loss, materially reducing reported income tax expense.
- The stock repurchase program was suspended on March 19, 2020; no shares were repurchased in the second quarter.
Guidance, outlook, risks and unusual items
- No formal earnings or financial guidance was provided. Management expects pandemic-related economic effects to continue through the remainder of 2020 and believes the current balance sheet, capital position, and liquidity resources can meet anticipated demands.
- Management reported nonperforming loans of $4.2 million, or 0.41% of gross loans, and described overall asset quality as stable at June 30, 2020.
- COVID-19 remains the principal risk, with potential effects on borrower repayment capacity, credit losses, allowance requirements, securities valuations, liquidity, operations, and regulatory capital.
- Loan concentrations and pandemic-sensitive exposures include real estate and rental/leasing, accommodation and food services, construction, retail, and hotel properties. Loans classified as medium or high pandemic risk totaled approximately $494.5 million, or about 49% of gross loans.
- The Bank remained well capitalized. The Corporation’s total risk-based capital ratio was 15.93% and Tier 1 leverage ratio was 9.22%; the Bank’s corresponding ratios were 15.64% and 9.05%.
- The Bank had $320.9 million of unfunded commitments to extend credit and $22.1 million of standby letters of credit. A $2.1 million reserve remained for letters of credit associated with a bankrupt commercial borrower.
- On August 4, 2020, after quarter-end, the Corporation issued $20 million of subordinated notes: $15 million due in 2030 and $5 million due in 2035. The notes carry initial fixed rates of 5.00% and 5.25%, respectively, and are intended to qualify as regulatory capital.
- Management stated that disclosure controls were effective as of June 30, 2020 and that no material changes occurred in internal control over financial reporting.
Important facts for investors to verify
- Performance of the approximately $196 million of modified or deferred loans as payment deferrals expire.
- Future credit losses, allowance adequacy, and the effect of COVID-19 on hotel, commercial real estate, and other higher-risk borrowers.
- Whether PPP loan forgiveness accelerates recognition of the approximately $2.1 million of remaining PPP processing fees.
- Sustainability of deposits that management identifies as potentially short-term, including approximately $36 million of remaining PPP proceeds.
- Liquidity capacity and any future use of PPPLF, Federal Home Loan Bank advances, or the $20 million subordinated debt proceeds.
- Impact of the planned adoption of the current expected credit loss standard in 2023; the filing does not provide a clear quantified implementation impact.
- Potential future securities impairment or other comprehensive income volatility if economic and market conditions deteriorate.