Franklin Financial Services Corporation — Q1 2014 Form 10-Q Summary
Business context and reporting period
Franklin Financial Services Corporation is a Pennsylvania-based bank holding company whose principal subsidiary, Farmers and Merchants Trust Company of Chambersburg, operates a commercial bank in south-central Pennsylvania. The filing covers the three months ended March 31, 2014; financial statements are unaudited and presented in thousands of dollars except per-share data.
Financial results and key metrics
| Metric | Q1 2014 | Q1 2013 or period-end comparison |
|---|---|---|
| Total assets | $1.026 billion | Up $41.9 million from December 31, 2013 |
| Net loans | $716.3 million | Up 0.4% from December 31, 2013 |
| Total deposits | $892.9 million | Up 5.6% from December 31, 2013 |
| Net interest income | $7.744 million | $7.860 million |
| Net interest margin | 3.57% | 3.45% |
| Noninterest income | $2.380 million | $2.384 million |
| Noninterest expense | $7.688 million | $7.582 million |
| Net income | $1.826 million | $1.551 million |
| Diluted EPS | $0.44 | $0.38 |
| Cash dividend | $0.17 per share | $0.17 per share |
| Return on average assets | 0.74% | 0.60% |
| Return on average equity | 7.72% | 6.85% |
| Efficiency ratio | 72.64% | 71.30% |
Interest income declined $528 thousand year over year, while interest expense declined $412 thousand. The resulting $116 thousand decrease in net interest income was more than offset by a $605 thousand reduction in the provision for loan losses. The effective tax rate increased to 18.4% from 16.6%.
Operating cash flow was $3.639 million. Investing activities used $3.698 million, principally reflecting net loan growth and securities purchases. Financing activities provided $38.695 million, primarily from deposit growth. Cash and cash equivalents increased to $79.381 million from $40.745 million at year-end 2013.
Shareholders’ equity was $97.673 million, compared with $95.388 million at December 31, 2013. Total long-term debt was $12.401 million and repurchase agreements were $15.905 million. Regulatory capital remained strong: total risk-based capital was 14.53%, Tier 1 risk-based capital was 13.25%, and Tier 1 leverage was 9.26% for the Corporation.
Material changes versus comparable periods
- Net income increased 17.7% and diluted EPS increased 15.8%, primarily because of the lower loan-loss provision.
- Net interest margin improved by 12 basis points despite lower average interest-earning assets and a 4.0% decline in average loans.
- Average interest-bearing liabilities declined $47.4 million, and their average cost fell to 0.43% from 0.61%, reflecting lower deposit and repurchase-agreement costs.
- Noninterest income was essentially flat. Investment and trust services fees increased 7.1%, while loan service charges declined 33.2% as mortgage production and related activity weakened.
- Noninterest expense increased 1.4%, driven principally by higher occupancy costs and compensation-related items.
- Deposits increased $47.2 million, led by money management and interest-bearing checking accounts; time deposits declined $3.6 million.
- Commercial loans increased $8.7 million, while commercial real estate loans declined $6.9 million and consumer loans declined $764 thousand.
- Nonperforming loans declined to $24.632 million from $25.247 million, and nonperforming assets declined to $28.939 million from $29.955 million at year-end. Nonperforming assets were 2.82% of total assets versus 3.04%.
Outlook, commentary, risks, and unusual items
- Management stated that the first-quarter results are not necessarily indicative of full-year results and provided no formal earnings guidance.
- Management expects home-equity lending and consumer borrowing to remain subdued until the broader economy improves. Commercial lending opportunities remain a focus, including selected purchased loan participations.
- The allowance for loan losses increased slightly to $9.745 million, or 1.34% of gross loans, after $198 thousand of provision expense and $155 thousand of net charge-offs. Management considered the allowance adequate, but its calculation depends on collateral values, economic conditions, historical loss rates, and other subjective assumptions.
- The watch list totaled $65.5 million, including $55.2 million of substandard loans. Nonaccrual loans were $24.337 million. Management noted that lengthy workouts could keep nonperforming loans elevated, although potential problem loans declined to $40.9 million from $51.0 million.
- Other real estate owned declined to $4.307 million, but the company recorded a $120 thousand writedown and a $122 thousand net loss on OREO during the quarter.
- Investment securities totaled $161.626 million and had $2.396 million of unrealized losses, which management deemed temporary. Trust preferred securities had an $833 thousand unrealized loss, and private-label mortgage-backed securities had $515 thousand of cumulative credit-related impairment charges. Management warned that additional write-downs could occur if loss trends continue.
- The company is participating in a class-action lawsuit against a private-label mortgage-backed securities servicer involving alleged defective warranties and representations. Management did not expect pending legal proceedings to be material to equity or financial condition.
- Liquidity was supported by approximately $35 million of available FHLB capacity, $16 million of unsecured correspondent-bank lines, approximately $45 million of Federal Reserve discount-window borrowing capacity, and $233.2 million of excess borrowing capacity. Management stated that anticipated liquidity demands could be met, but noted risks associated with potential FHLB funding constraints.
- The bank had $233.2 million of unused commitments and $20.4 million of standby letters of credit. Management stated that collateral and guarantees were expected to cover potential standby-letter-of-credit payments.
- The FOMC continued tapering bond purchases while maintaining historically low short-term rates. Management noted that market participants expected possible rate increases in 2015; changes in rates, funding costs, regulation, competition, and economic conditions could materially affect results.
- The company adopted ASU 2013-11 regarding presentation of unrecognized tax benefits. Management did not expect ASU 2014-04, effective after December 15, 2014, to have a material effect.
Important facts for investors to verify
- Whether commercial real estate concentrations, watch-list loans, nonaccrual loans, TDRs, and collateral-dependent credits improve or deteriorate in subsequent quarters.
- Whether the lower loan-loss provision is sustainable or reflects a temporary reduction in credit costs.
- Future performance and valuation of the trust preferred and private-label mortgage-backed securities portfolios, including any additional impairment charges.
- Deposit retention and funding costs as customers migrate from repurchase agreements to deposit sweep products.
- Availability of FHLB, Federal Reserve, and correspondent-bank funding under stressed liquidity conditions.
- Progress and potential exposure associated with the private-label mortgage-backed securities servicer litigation.
- The effect of interest-rate changes on the net interest margin, deposit pricing, loan demand, securities values, and derivative positions.