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FRAF > SEC Filings for FRAF > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for FRANKLIN FINANCIAL SERVICES CORP /PA/ | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for FRANKLIN FINANCIAL SERVICES CORP /PA/


9-Nov-2012

Quarterly Report

Management's Discussion and Analysis of Results of Operations and Financial Condition

For the Three and Nine Month Periods Ended September 30, 2012 and 2011

Forward Looking Statements

Certain statements appearing herein which are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements refer to a future period or periods, reflecting management's current views as to likely future developments, and use words such as "may," "will," "expect," "believe," "estimate," "anticipate," or similar terms. Because forward-looking statements involve certain risks, uncertainties and other factors over which the Corporation has no direct control, actual results could differ materially from those contemplated in such statements. These factors include (but are not limited to) the following: general economic conditions, changes in interest rates, changes in the Corporation's cost of funds, changes in government monetary policy, changes in government regulation and taxation of financial institutions, changes in the rate of inflation, changes in technology, the intensification of competition within the Corporation's market area, and other similar factors.

Critical Accounting Policies

Management has identified critical accounting policies for the Corporation to include Allowance for Loan Losses, Mortgage Servicing Rights, Financial Derivatives, Temporary Investment Impairment and Stock-based Compensation. There were no changes to the critical accounting policies disclosed in the 2011 Annual Report on Form 10-K in regards to application or related judgments and estimates used. Please refer to Item 7 of the Corporation's 2011 Annual Report on Form 10-K for a more detailed disclosure of the critical accounting policies.

Results of Operations

Year-to-Date Summary

At September 30, 2012, total assets were $1.057 billion, an increase of $67.0 million from December 31, 2011. Net loans decreased to $742.5 million and total deposits increased to $857.8 million. The Corporation reported net income for the first nine months of 2012 of $5.0 million. This is a 7.6% increase versus net income of $4.7 million for the same period in 2011. Total revenue (interest income and noninterest income) decreased $1.6 million year-over-year. Interest income decreased $1.5 million, but was offset by a decrease of $1.6 million in interest expense, resulting in a $116 thousand increase in net interest income. Noninterest income decreased 1.3% due to a decrease in deposit fees. Noninterest expense increased 2.4% due to increases in salary and benefits expense. The provision for loan losses was $3.6 million for the period, $1.8 million less than in 2011. Diluted earnings per share increased to $1.24 in 2012 from $1.18 in 2011.

Key performance ratios as of, or for the nine months ended September 30, 2012 and 2011 are listed below:

                                                            September 30
                                                         2012          2011

        Performance measurements
        Return on average assets*                           0.65 %        0.63 %
        Return on average equity*                           7.56 %        7.39 %
        Return on average tangible assets (1)*              0.68 %        0.66 %
        Return on average tangible equity (1)*              8.91 %        8.84 %
        Efficiency ratio (2)                               67.09 %       65.97 %
        Net interest margin*                                3.51 %        3.67 %
        Current dividend yield*                             4.73 %        7.06 %

        Shareholders' Value (per common share)
        Diluted earnings per share                     $    1.24     $    1.18
        Regular cash dividends paid                    $    0.61     $    0.81
        Book value                                     $   22.41     $   21.63
        Tangible book value (3)                        $   19.90     $   19.46
        Market value                                   $   14.37     $   15.30
        Market value/book value ratio                      64.12 %       70.74 %
        Price/earnings multiple*                            8.71          9.75

        Safety and Soundness
        Leverage ratio (Tier 1)                             8.20 %        8.07 %
        Total risk-based capital ratio                     12.66 %       11.76 %
        Equity ratio                                        8.67 %        8.67 %
        Tangible equity ratio (4)                           7.78 %        7.70 %
        Nonperforming loans/gross loans                     4.78 %        3.41 %
        Nonperforming assets/total assets                   3.99 %        2.96 %
        Allowance for loan losses as a % of loans           1.34 %        1.20 %
        Net charge-offs/average loans*                      0.56 %        0.88 %

        Trust assets under management (market value)   $ 511,059     $ 485,800

* Annualized

(1) Excludes goodwill, intangibles and intangible amortization expense, net of tax

(2)Noninterest expense / tax equivalent net interest income plus noninterest income less net securities gains

(3) Total shareholders' equity less goodwill and intangibles / shares outsanding

(4)Total shareholders' equity less goodwill and intangibles / total assets less goodwill and intangibles

GAAP versus Non-GAAP Presentations. The Corporation supplements its traditional GAAP measurements with Non-GAAP measurements. The Non-GAAP measurements include Return on Average Tangible Assets and Return on Average Tangible Equity. As a result of merger transactions, intangible assets (primarily goodwill and core deposit intangibles) were created. The Non-GAAP disclosures are intended to eliminate the effects of the intangible assets and allow for better comparisons to periods when such assets did not exist. The following table shows the adjustments made between the GAAP and NON-GAAP measurements:

         GAAP Measurement                             Calculation
Return on Average Assets                Net Income / Average Assets
Return on Average Equity                Net Income / Average Equity
      Non- GAAP Measurement                           Calculation
Return on Average Tangible Assets       Net Income plus Intangible Amortization
                                        / Average Assets less Average Intangible
                                        Assets
Return on Average Tangible Equity       Net Income plus Intangible Amortization
                                        / Average Equity less Average Intangible
                                        Assets
Efficiency Ratio                        Noninterest Expense / Tax Equivalent Net
                                        Interest Income plus Noninterest Income
                                        (excluding Security Gains/Losses and
                                        Other Than Temporary Impairment)

Comparison of the three months ended September 30, 2012 to the three months ended September 30, 2011:

Net Interest Income

The most important source of the Corporation's earnings is net interest income, which is defined as the difference between income on interest-earning assets and the expense of interest-bearing liabilities supporting those assets. Principal categories of interest-earning assets are loans and securities, while deposits, securities sold under agreements to repurchase (Repos), short-term borrowings and long-term debt are the principal categories of interest-bearing liabilities. Demand deposits enhance net interest income because they are noninterest-bearing deposits. For the purpose of this discussion, balance sheet items refer to the average balance for the period and net interest income is adjusted to a fully taxable-equivalent basis. This tax-equivalent adjustment facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Corporation's 34% Federal statutory rate.

Tax equivalent interest income for the third quarter of 2012 decreased $620 thousand quarter-over-quarter. Average interest-earning assets increased $49.5 million from 2011, but the yield on these assets decreased by 48 basis points to 4.10%. The average balance of investment securities increased $4.4 million while average loans decreased $9.8 million quarter-over-quarter. Average loan yield decreased 22 basis points to 4.74.

Interest expense was $1.7 million for the third quarter, a decrease of $595 thousand from the 2011 total of $2.3 million. Average interest-bearing liabilities increased $44.4 million to $841.1 million for 2012 from an average balance of $796.7 million in 2011. The average cost of these liabilities decreased from 1.14% in 2011 to .80% in 2012. Average interest-bearing deposits increased $66.9 million, due to increases in interest checking and savings accounts ($16.8 million), and money management deposits ($62.5 million). The cost of interest-bearing deposits decreased from 1.00% to .67%. Securities sold under agreements to repurchase (Repos) decreased $12.0 million on average over the prior year quarter while the average rate decreased from .25% in 2011 to .15% in 2012. The average balance of long-term debt decreased by $10.6 million due to scheduled amortization and maturities, as well as a prepayment of $8.0 million on two Federal Home Loan Bank of Pittsburgh (FHLB) advances that occurred in the third quarter of 2012.

The changes in the balance sheet and interest rates resulted in a slight decrease in tax equivalent net interest income of $25 thousand to $8.5 million in 2012. The Bank's net interest margin decreased from 3.61% in 2011 to 3.42% in 2012. The decrease in the net interest margin is the result of a decrease in the rate on interest-earning assets of 48 basis points, while the yield on interest-bearing liabilities only decreased 34 basis points. Net interest income decreased $80 thousand during the quarter, with $81 thousand of the decrease from rate, offset by an increase of $1 thousand due to volume.

With interest rates forecast to remain at current levels until 2015, the Bank does not expect any increase in the asset yield for several years. As a result, it is likely that the cost of interest-bearing deposits will continue to be reduced in an effort to maintain the net interest margin.

The following table shows a comparative analysis of average balances, asset yields and funding costs for the three months ended September 30, 2012 and 2011. These components drive changes in net interest income.

                                                        For the Three Months Ended September 30
                                                 2012                                            2011
                               Average        Income or        Average          Average        Income or        Average
(Dollars in thousands)         balance         expense        yield/rate        balance         expense        yield/rate

Interest-earning assets:
Interest-bearing
obligations of other banks
and federal funds sold       $    82,008     $        56             0.27 %   $    27,159     $        17             0.25 %
Investment securities:
Taxable                          101,011             466             1.83 %       101,111             620             2.43 %
Nontaxable                        40,576             559             5.47 %        36,096             521             5.73 %
Loans                            761,235           9,104             4.74 %       770,995           9,647             4.96 %
Total interest-earning
assets                           984,830          10,185             4.10 %       935,361          10,805             4.58 %
Other assets                      73,137                                           71,622
Total assets                 $ 1,057,967                                      $ 1,006,983

Interest-bearing
liabilities:
Deposits:
Interest-bearing checking    $   123,866              21             0.07 %   $   110,904              27             0.10 %
Money Management                 376,522             621             0.65 %       314,062             839             1.06 %
Savings                           56,117              16             0.11 %        52,269              19             0.14 %
Time                             194,391             604             1.23 %       206,736             840             1.61 %
Total interest-bearing
deposits                         750,896           1,262             0.67 %       683,971           1,725             1.00 %

Securities sold under
agreements to repurchase          51,681              20             0.15 %        63,642              40             0.25 %
Long- term debt                   38,501             410             4.22 %        49,052             522             4.22 %
Total interest-bearing
liabilities                      841,078           1,692             0.80 %       796,665           2,287             1.14 %
Noninterest-bearing
deposits                         112,718                                          113,149
Other liabilities                 13,705                                           10,701
Shareholders' equity              90,466                                           86,468
Total liabilities and
shareholders' equity         $ 1,057,967                                      $ 1,006,983
Tax equivalent net
interest income/Net
interest margin                                    8,493             3.42 %                         8,518             3.61 %
Tax equivalent adjustment                           (457 )                                           (402 )
Net interest income                          $     8,036                                      $     8,116

All amounts have been adjusted to a tax-equivalent basis using a tax rate of 34%. Investments include the average unrealized gains or losses. Loan balances include nonaccruing loans and are gross of the allowance for loan losses.

Provision for Loan Losses

For the third quarter of 2012, the provision expense was $825 thousand versus $2.8 million in 2011. For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.

Noninterest Income

For the third quarter of 2012, noninterest income decreased from the same period in 2011. Investment and trust service fees were unchanged, while loan service charges increased $131 thousand due to the volume of mortgage refinancing. Mortgage banking fees increased $26 thousand, as the 2012 impairment charge was $24 thousand less than the prior year's impairment charge. Deposit service charges decreased $39 thousand due to lower retail overdraft fees and less retail checking service charge fees. Other service charges and fees increased $45 thousand primarily due to an increase in ATM fees, while debit card income increased $30 thousand due to increased volume. Other income was negative for the quarter, due to a loss of $217 thousand on the sale of an OREO property. Securities gains of $23 thousand were recorded during 2012 from bonds called prior to maturity, compared to $138 thousand from sales of equity securities in the same period in 2011. An other-than-temporary impairment charge of $50 thousand on two bonds was recorded in 2012, compared to none in 2011.

The following table presents a comparison of noninterest income for the three months ended September 30, 2012 and 2011:

                                              For the Three Months Ended
(Dollars in thousands)                               September 30                         Change
                                               2012                2011            Amount           %
Noninterest Income
Investment and trust services fees         $         957       $         953     $        4           0.4
Loan service charges                                 328                 197            131          66.5
Mortgage banking activities                          (27 )               (53 )           26          49.1
Deposit service charges and fees                     479                 518            (39 )        (7.5 )
Other service charges and fees                       209                 164             45          27.4
Debit card income                                    288                 258             30          11.6
Increase in cash surrender value of life
insurance                                            159                 168             (9 )        (5.4 )
Other                                               (157 )                70           (227 )      (324.3 )
OTTI losses on securities                           (162 )                 -           (162 )         N/A
Less: Loss recognized in other
comprehensive income (before taxes)                 (112 )                 -           (112 )         N/A
Net OTTI losses recognized in earnings               (50 )                 -            (50 )         N/A
Securities gains (losses), net                        23                 138           (115 )       (83.3 )
Total noninterest income                   $       2,209       $       2,413     $     (204 )        (8.5 )

Noninterest Expense

Noninterest expense for the third quarter of 2012 was $7.4 million compared to $7.0 million in 2011. The increase in salaries and benefits was primarily due to annual salary adjustments ($152 thousand) and pension expense ($92 thousand), but these increases were partially offset by a $23 thousand decrease in health insurance expense, due to lower claims expense during the quarter from the Bank's participation in a self-insured health insurance plan. Occupancy expense remained flat quarter-over-quarter, while advertising expense decreased $41 thousand, due to less usage of TV, radio and print advertising. Legal and professional expenses decreased $35 thousand as expenses for consulting and legal matters are less in 2012 compared to prior year. Data processing fees increased $43 thousand due to higher cost for software expenses. Other expenses decreased $18 thousand due to nonrecurring expenses in relation to the core system upgrade that were paid in the third quarter of 2011.

The following table presents a comparison of noninterest expense for the three months ended September 30, 2012 and 2011:

(Dollars in thousands)               For the Three Months Ended
                                            September 30                       Change
                                      2012                2011           Amount         %
Noninterest Expense
Salaries and benefits             $       4,141       $       3,796     $    345         9.1
Net occupancy expense                       499                 495            4         0.8
Furniture and equipment expense             226                 194           32        16.5
Advertising                                 315                 356          (41 )     (11.5 )
Legal and professional fees                 252                 287          (35 )     (12.2 )
Data processing                             382                 339           43        12.7
Pennsylvania bank shares tax                187                 173           14         8.1
Intangible amortization                     109                 112           (3 )      (2.7 )
FDIC insurance                              274                 256           18         7.0
Other                                       970                 988          (18 )      (1.8 )
Total noninterest expense         $       7,355       $       6,996     $    359         5.1

Income Taxes

For the third quarter of 2012 the Corporation recorded a Federal income tax expense of $318 thousand compared to a tax benefit of $301 thousand for the same quarter in 2011. The tax benefit in 2011 was due to a lower level of pre-tax income, due primarily to a higher provision for loan loss expense resulting in a higher proportion of tax free income to pre-tax income and less tax expense.

Comparison of the nine months ended September 30, 2012 to the nine months ended September 30, 2011:

Net Interest Income

Tax equivalent interest income for the first nine months of 2012 decreased by $1.4 million compared to 2011. Average interest-earning assets increased $48.0 million from 2011, but the yield on these assets decreased by 44 basis points. The average balance of investment securities increased $1.2 million from 2011. Average loans decreased $1.8 million year over year and the yield decreased 20 basis points to 4.85%.

Interest expense was $5.5 million for the first nine months of 2012, a decrease of $1.6 million from $7.1 million in 2011. Average interest-bearing liabilities increased $42.6 million to $829.7 million for 2012 from an average balance of $787.2 million in 2011. The average cost of these liabilities decreased from 1.21% in 2011 to 0.88% in 2012. Average interest-bearing deposits increased $65.5 million, due to increases in interest checking and savings accounts ($14.1 million) and money management deposits ($58.2 million), but these increases were partially offset by decreases in time deposits ($6.7 million). The cost of interest-bearing deposits decreased from 1.03% to .73%. Securities sold under agreements to repurchase have decreased $8.5 million on average over the prior year and the average rate has decreased to .15% from .25% a year earlier. The average balance of long-term debt decreased by $14.2 million due to scheduled amortization and maturities, as well as a prepayment of $8.0 million on two Federal Home Loan Bank of Pittsburgh (FHLB) advances that occurred in the third quarter of 2012.

The changes in the balance sheet and interest rates resulted in an increase in tax equivalent net interest income of $217 thousand to $25.5 million in 2012 compared to $25.2 million in 2011. The Bank's net interest margin decreased to 3.51% in 2012 from 3.67% in 2011. The decrease in the net interest margin is the result of a decrease in the rate on interest-earning assets of 44 basis points, while the yield on interest-bearing liabilities only decreased 33 basis points. Net interest income increased $116 thousand during the year, with a $289 thousand increase from volume, which was offset by $173 thousand decrease from rates.

With interest rates forecast to remain at current levels until 2015, the Bank does not expect any increase in the asset yield for several years. As a result, it is likely that the cost of interest-bearing deposits will continue to be reduced in an effort to maintain the net interest margin.

The following table shows a comparative analysis of average balances, asset yields and funding costs for the nine months ended September 30, 2012 and 2011. These components drive changes in net interest income.

                                                        For the Nine Months Ended September 30
                                                 2012                                            2011
                               Average        Income or        Average         Average        Income or        Average
(Dollars in thousands)         Balance         expense        yield/rate       balance         expense        yield/rate

Interest-earning assets:
Interest-bearing
obligations of other
banks and federal funds
sold                         $    71,409     $       148             0.28 %   $   22,843     $        43             0.25 %
Investment securities:
Taxable                           93,750           1,385             1.97 %       97,560           1,888             2.59 %
Nontaxable                        39,557           1,636             5.51 %       34,518           1,514             5.86 %
Loans                            762,907          27,763             4.85 %      764,697          28,905             5.05 %
Total interest-earning
assets                           967,623          30,932             4.26 %      919,618          32,350             4.70 %
Other assets                      72,906                                          70,942
Total assets                 $ 1,040,529                                      $  990,560

Interest-bearing
liabilities:
Deposits:
Interest-bearing checking    $   120,125              65             0.07 %   $  109,873              78             0.09 %
Money Management                 362,705           1,875             0.69 %      304,546           2,478             1.09 %
Savings                           54,899              47             0.11 %       51,063              50             0.13 %
Time                             196,121           2,033             1.38 %      202,835           2,547             1.68 %
Total interest-bearing
deposits                         733,850           4,020             0.73 %      668,317           5,153             1.03 %

Securities sold under
agreements to repurchase          51,990              59             0.15 %       60,507             113             0.25 %
Short- term borrowings                 -               -                -            238               1             0.73 %
Long- term debt                   43,901           1,390             4.22 %       58,114           1,837             4.23 %
Total interest-bearing
liabilities                      829,741           5,469             0.88 %      787,176           7,104             1.21 %
Noninterest-bearing
deposits                         108,802                                         105,477
Other liabilities                 13,161                                          12,758
Shareholders' equity              88,825                                          85,149
Total liabilities and
shareholders' equity         $ 1,040,529                                      $  990,560
Tax equivalent net
interest income/Net
interest margin                                   25,463             3.51 %                       25,246             3.67 %
Tax equivalent adjustment                         (1,252 )                                        (1,151 )
Net interest income                          $    24,211                                     $    24,095

All amounts have been adjusted to a tax-equivalent basis using a tax rate of 34%. Investments include the average unrealized gains or losses. Loan balances include nonaccruing loans and are gross of the allowance for loan losses.

Provision for Loan Losses

For the first nine months of 2012, the provision expense was $3.6 million versus $5.4 million in 2011. For more information concerning loan quality and the allowance for loan losses, refer to the Loan discussion in the Financial Condition section.

Noninterest Income

For the first nine months of 2012, noninterest income decreased slightly to $7.3 million compared to $7.4 million in the same period in 2011. Investment and trust service fees increased $41 thousand due to higher income from estate fees. Loan service charges decreased $40 thousand, as 2011 contained a large prepayment penalty on a commercial loan. This loan was match funded with an FHLB advance and the fee to prepay the FHLB advance is recorded in other expense for 2011. Mortgage banking fees increased year-over-year as 2012 had a net reversal of previously recorded impairment charges of $87 thousand compared to a net impairment charge of $69 thousand in 2011. Deposit service charges decreased $220 thousand in 2012 due to a decrease in retail overdraft fees and retail checking service charges. The reduction in overdraft fees and checking service charges is the result of changes the Bank made in response to regulatory guidance on best practices. Other service charges and fees increased primarily due to ATM fees, while debit card income was up $106 thousand due to increased volume. Other income decreased $191 thousand mainly due to a loss of $217 thousand on the sale of an OREO property. Other-than-temporary impairment charges of $50 thousand were taken in 2012 compared to $55 thousand on two bonds in 2011. The Corporation also had realized gains of $44 thousand in 2012 from . . .

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