Franklin Financial Services Corporation: Q1 2016 Form 10-Q Summary
Business context and reporting period
Franklin Financial Services Corporation is a Pennsylvania bank holding company whose principal subsidiary, Farmers and Merchants Trust Company of Chambersburg, serves south-central Pennsylvania. The filing covers the three months ended March 31, 2016. Financial statements are unaudited and presented in accordance with U.S. GAAP; amounts are in thousands except per-share data.
Financial performance and condition
| Metric | Q1 2016 | Comparable / prior period |
|---|---|---|
| Total assets | $1,069,936 | $1,035,295 at Dec. 31, 2015; $1,019,337 at Mar. 31, 2015 |
| Interest income | $9,098 | $8,526 in Q1 2015 |
| Net interest income | $8,553 | $7,885 in Q1 2015 |
| Provision for loan losses | $300 | $325 in Q1 2015 |
| Noninterest income | $2,953 | $3,652 in Q1 2015 |
| Noninterest expense | $7,795 | $7,489 in Q1 2015 |
| Net income | $2,726 | $2,884 in Q1 2015 |
| Diluted EPS | $0.64 | $0.68 in Q1 2015 |
| Cash dividend declared per share | $0.19 | $0.17 in Q1 2015 |
| Net interest margin | 3.70% | 3.66% in Q1 2015 |
| Return on average assets | 1.04% | 1.17% in Q1 2015 |
| Return on average equity | 9.75% | 11.21% in Q1 2015 |
Net loans increased 2.6% from year-end 2015 to $792.2 million, led by an $18.9 million increase in commercial real estate loans. Total deposits increased 3.5% to $951.0 million, primarily through growth in commercial checking, money management and savings accounts. The allowance for loan losses increased to $10.3 million, or 1.29% of gross loans.
Cash and cash equivalents were $59.1 million, up from $39.2 million at year-end. Net cash provided by operating activities was $2.4 million, while investing activities used $14.3 million, primarily because net loans increased by $20.4 million. Financing activities provided $32.0 million, principally from deposit growth. The Corporation reported no borrowings at March 31, 2016.
Shareholders’ equity increased to $114.3 million from $111.4 million at year-end. Book value per share was $26.65 and tangible book value per share was $24.54. The Bank’s March 31, 2016 regulatory capital ratios were 14.65% CET1, 14.65% Tier 1 risk-based capital, 15.91% total risk-based capital and 10.39% Tier 1 leverage; management stated that the Bank was well capitalized under Basel III.
Material changes versus prior comparable periods
- Net income declined 5.5% year over year, primarily because Q1 2015 included approximately $899 thousand of nonrecurring noninterest income, including a $728 thousand gain on conversion of an investment security and a $171 thousand gain related to an offshore insurance investment.
- Net interest income increased $668 thousand, supported by higher average loans and lower deposit funding costs. Average loans increased $75.5 million, while the average cost of interest-bearing deposits declined from 0.35% to 0.28%.
- Noninterest income decreased $699 thousand. Investment and trust service fees declined modestly, while loan service charges, deposit fees and debit-card income increased.
- Noninterest expense increased $306 thousand, primarily from higher salaries and benefits, incentive compensation, advertising, Pennsylvania bank shares tax, data processing and foreclosed real estate expense. Core deposit intangible amortization declined to zero because the intangible was fully amortized in 2015.
- Nonperforming loans increased to $10.4 million from $5.7 million at year-end, and nonperforming assets increased to $16.7 million from $12.2 million. A $5.4 million commercial real estate hotel credit moved to nonaccrual at quarter-end.
- Watch-list loans increased to $31.6 million from $27.9 million, including a $5.4 million hotel loan downgraded from special mention to substandard. Management reported no loans rated doubtful or loss.
- Accumulated other comprehensive loss improved by $702 thousand, primarily from higher unrealized gains on securities.
Outlook, commentary, risks and unusual items
- No formal earnings or revenue guidance was provided. Management stated that quarterly results are not necessarily indicative of full-year results.
- Management believes liquidity is adequate to meet anticipated demands. At quarter-end, the Bank reported approximately $117 million available on its FHLB line, $6 million of unsecured correspondent-bank lines, $260.9 million of excess FHLB borrowing capacity and approximately $22 million of Federal Reserve Discount Window borrowing capacity.
- Unused loan commitments and standby letters of credit totaled approximately $294.8 million and $29.1 million, respectively. Management stated that these commitments generally do not present significant liquidity risk, but their credit exposure is similar to loan facilities.
- The investment portfolio included $4.96 million of trust preferred securities with $1.00 million of unrealized losses and $1.28 million of private-label mortgage-backed securities. Management deemed most unrealized losses temporary, but recorded a $20 thousand OTTI charge in Q1 2016 and noted that additional write-downs are possible if loss trends continue.
- Other real estate owned totaled $6.3 million across six properties. One property was sold at an $8 thousand loss and another received a $46 thousand write-down. An agreement of sale for a significant property was executed in early May 2016, but management stated that the outcome remained uncertain.
- Management identified economic conditions, interest rates, funding costs, monetary policy, regulation, taxation, technology and competition as material forward-looking risks.
- The Board declared a $0.21 per-share regular dividend for Q2 2016. It also authorized quarterly repurchases of up to $350 thousand through March 31, 2017; 15,521 shares were repurchased for approximately $350 thousand in late April 2016.
- Management stated that disclosure controls and procedures were effective as of March 31, 2016, with no material changes to internal control over financial reporting. No material litigation or material changes to risk factors were reported.
Important facts for investors to verify
- Whether the increase in commercial real estate and watch-list loans leads to additional nonaccrual loans, charge-offs or allowance provisions.
- The status and collateral value of the $5.4 million hotel credit transferred to nonaccrual and the other significant impaired or TDR credits.
- Performance and valuation of the trust preferred and private-label mortgage-backed securities, including potential future OTTI charges.
- Whether loan growth can continue without materially increasing funding costs, credit risk or liquidity pressure.
- The effect of the April 2016 share repurchase and the higher dividend on capital ratios and retained earnings.
- The final outcome and proceeds of the pending OREO sale and whether additional property write-downs are required.
- Future adoption effects of the new revenue, financial instruments and lease accounting standards; the filing states that the lease impact was still under evaluation.