Franklin Financial Services Corporation — FY2023 Form 10-K Summary
Business context and reporting period
Franklin Financial Services Corporation is a Pennsylvania bank holding company conducting substantially all business through Farmers and Merchants Trust Company of Chambersburg, a community bank operating 22 offices in south-central Pennsylvania and Washington County, Maryland. The filing covers the fiscal year ended December 31, 2023; it is an annual report rather than a quarterly filing.
The Bank provides commercial, residential mortgage, construction, consumer, deposit, trust and wealth-management services. Total assets were approximately $1.84 billion at year-end.
Financial performance and condition
| Metric | 2023 | 2022 | Change |
|---|---|---|---|
| Total assets | $1.836 billion | $1.700 billion | 8.0% |
| Net interest income | $53.6 million | $51.6 million | 4.0% |
| Net income | $13.6 million | $14.9 million | (9.0%) |
| Diluted EPS | $3.10 | $3.36 | (7.7%) |
| Net interest margin, fully tax equivalent | 3.31% | 3.11% | 20 basis points |
| Noninterest income | $14.9 million | $15.3 million | (2.6%) |
| Noninterest expense | $50.0 million | $48.7 million | 2.7% |
| Return on average assets | 0.78% | 0.83% | Down |
| Return on average equity | 11.39% | 11.64% | Down |
| Efficiency ratio | 70.75% | 71.21% | Improved |
Interest income increased 36.0% to $76.8 million as earning-asset yields rose, but interest expense increased 375.5% to $23.1 million as deposit and wholesale funding costs repriced higher. The net interest spread narrowed to 2.95% from 3.04%.
Provision for credit losses was $2.7 million, including $2.6 million on loans and $135 thousand on unfunded commitments, versus $650 thousand of loan-loss provision in 2022. Net loan charge-offs were $176 thousand. The allowance for loan losses was $16.1 million, or 1.28% of gross loans, compared with 1.35% at the prior year-end.
Net loans increased 19.7% to $1.241 billion, led by a $139.5 million increase in commercial real estate loans. Gross commercial-purpose loans represented 82% of the portfolio, while approximately 80% of loans were secured by real estate. Nonaccrual loans were $147 thousand and nonperforming loans were 0.01% of gross loans at year-end.
Deposits declined 0.9% to $1.538 billion. Money-management deposits were $572.1 million, or approximately 37% of deposits, and time deposits increased 130.8% to $132.4 million. Estimated uninsured deposits were $299.9 million, or 19.5% of total deposits.
Year-end borrowings totaled $130.0 million: $90.0 million from the Federal Reserve Bank Term Funding Program and $40.0 million from the Federal Home Loan Bank. The Corporation also had approximately $20.0 million of subordinated notes. Available liquidity capacity was reported at $557.4 million, including $444.2 million of unused FHLB capacity, $55.5 million at the Federal Reserve Discount Window, $1.7 million remaining under BTFP capacity and $56.0 million of correspondent-bank lines.
Operating cash flow was $26.6 million, compared with $25.2 million in 2022. Investing cash flow was negative $178.3 million, primarily because of $205.9 million of net loan growth. Financing cash flow was positive $109.9 million, primarily from new borrowings. Cash and cash equivalents declined to $23.1 million from $64.9 million.
Shareholders’ equity increased 15.7% to $132.1 million, helped by a $10.3 million improvement in accumulated other comprehensive income as securities values recovered. Book value per share was $30.23 and tangible book value per share was $28.17. The regular cash dividend remained $1.28 per share.
Material changes versus the prior comparable period
- Net income declined $1.3 million despite higher net interest income, primarily because of sharply higher funding costs, increased credit-loss provision, higher operating expenses and securities-sale losses.
- Net interest margin expanded to 3.31%, but the cost of interest-bearing liabilities rose to 1.75% from 0.36%; the cost of deposits rose to 1.23% from 0.23%.
- The loan portfolio grew 19.6% on a gross basis, with commercial real estate growth the principal driver.
- The Bank adopted CECL on January 1, 2023, reducing the loan allowance by $536 thousand, increasing the unfunded-commitment allowance by $412 thousand and increasing retained earnings by $98 thousand, net of tax.
- Noninterest income included a $1.1 million realized loss on debt-security sales related to portfolio restructuring. Management sold lower-yielding securities and reinvested at higher yields.
- Noninterest expense rose $1.3 million, including higher salaries and benefits, occupancy costs and a $495 thousand lease-termination expense.
- Wealth-management fees increased 5.0% to $7.5 million; assets under management increased to $1.095 billion from $904.3 million.
- In December 2023, the Board approved a new one-year plan to repurchase up to 150,000 shares. No shares were purchased during the fourth quarter.
Guidance, outlook, commentary and risks
The filing does not provide formal earnings or revenue guidance. Management stated that the local market remains suited for growth and that the Corporation benefits over the long term from higher interest rates, while noting that the economic outlook and Federal Reserve policy remain uncertain.
Subsequent to year-end, the Bank borrowed $200 million from the FHLB for three years at 4.32% to restructure borrowings and fund expected loan growth. Two BTFP borrowings totaling $40 million were refinanced into a facility maturing in January 2025.
- Interest-rate and funding risk: modeled one-year net interest income declined 7.5% under a gradual 300-basis-point rate increase and declined 2.1% under a gradual 300-basis-point decrease.
- Credit concentration: commercial and real estate lending is concentrated in the local market; commercial real estate includes substantial office, hotel, apartment and retail exposure. Watch-list loans increased to $17.2 million from $11.6 million.
- Liquidity concentration: FHLB funding is the largest component of contingency liquidity. Reduced access to FHLB or other wholesale sources could materially affect liquidity.
- Investment portfolio: available-for-sale securities had a $49.6 million gross unrealized loss at year-end, although management concluded the losses were not credit-related and did not expect forced sales.
- Operational and cybersecurity risk: management reported that cyber incidents had not materially affected the Corporation through year-end, but acknowledged that threats and third-party vendor risks continue to increase.
- Regulatory and legal risk: the Bank was well capitalized, with a 13.63% total risk-based capital ratio and 9.44% Tier 1 leverage ratio. Litigation is considered ordinary-course and not expected to materially affect financial position, but potential losses for certain matters could not be estimated.
- Unfunded commitments: commitments to extend credit totaled $444.1 million and standby letters of credit totaled $19.9 million; the related reserve was approximately $2.0 million.
Important facts for investors to verify
- Reconcile future net interest income with deposit repricing, the $130 million year-end borrowings and the subsequent $200 million FHLB term loan.
- Monitor commercial real estate concentrations, especially office, hotel, apartment and development-land exposure, as well as the $17.2 million watch list.
- Assess whether the 1.28% allowance-to-loans ratio remains adequate under changing economic forecasts and CECL assumptions.
- Review liquidity coverage, uninsured deposits of $299.9 million and reliance on FHLB, Federal Reserve and correspondent-bank capacity.
- Evaluate the effect of unrealized securities losses, portfolio restructuring and potential future interest-rate movements on capital and earnings.
- Confirm the sustainability of wealth-management and debit-card fee income, which are material components of noninterest revenue.
- Verify the timing and terms of the subsequent borrowings and the status of the 150,000-share repurchase authorization.