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FRAF > SEC Filings for FRAF > Form 10-Q on 5-Aug-2013All Recent SEC Filings

Show all filings for FRANKLIN FINANCIAL SERVICES CORP /PA/

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


5-Aug-2013

Quarterly Report

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

For the Three and Six Months Ended June 30, 2013 and 2012

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 2012 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 2012 Annual Report on Form 10-K for a more detailed disclosure of the critical accounting policies.

Results of Operations

Year-to-Date Summary

At June 30, 2013, total assets were $1.033 billion, an increase of $5.3 million from December 31, 2012. Net loans decreased to $717.7 million and total deposits increased to $881.8 million. The Corporation reported net income for the first six months of 2013 of $2.9 million. This is an 11.3% decrease versus net income of $3.3 million for the same period in 2012. Total revenue (interest income and noninterest income) decreased $2.2 million year-over-year. Interest income decreased $2.0 million, while interest expense decreased by $1.2 million, resulting in a $735 thousand decrease in net interest income. The provision for loan losses was $1.6 million for the period, $1.2 million less than in 2012. Noninterest income decreased 5.4% mainly from decreases in loan and deposit service charges compared to prior year. Noninterest expense increased 4.1% due to increases in salary and benefits expense and net occupancy expense. Diluted earnings per share decreased to $.70 in 2013 from $.81 in 2012.

Key performance ratios as of, or for the six months ended June 30, 2013 and 2012 are listed below:

                                                    June 30,
                                               2013          2012

Performance measurements
Return on average assets*                         0.56 %        0.64 %
Return on average equity*                         6.34 %        7.49 %
Return on average tangible assets (1)*            0.59 %        0.67 %
Return on average tangible equity (1)*            7.38 %        8.82 %
Efficiency ratio (2)                             72.29 %       66.49 %
Net interest margin*                              3.35 %        3.54 %
Current dividend yield*                           4.25 %        5.18 %
Dividend payout ratio                            48.14 %       54.35 %

Shareholders' Value (per common share)
Diluted earnings per share                   $    0.70     $    0.81
Basic earnings per share                          0.71          0.81
Regular cash dividends paid                       0.34          0.44
Book value                                       22.44         22.00
Tangible book value (3)                          20.04         19.52
Market value                                     16.00         13.12
Market value/book value ratio                    71.30 %       59.64 %
Price/earnings multiple*                         11.43          8.10

Safety and Soundness
Leverage ratio (Tier 1)                           8.41 %        8.10 %
Risk-based capital ratio (Tier 1)                13.06 %       12.19 %
Common equity ratio                               8.98 %        8.51 %
Tangible common equity ratio (4)                  8.10 %        7.60 %
Nonperforming loans/gross loans                   4.26 %        3.83 %
Nonperforming assets/total assets                 3.52 %        3.10 %
Allowance for loan losses as a % of loans         1.57 %        1.25 %
Net charge-offs/average loans*                    0.15 %        0.75 %

Trust assets under management (fair value)   $ 557,776     $ 503,537

* 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 outstanding

(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, Return on Average Tangible Equity, Tangible Book Value and Tangible Common Equity ratio. As a result of merger transactions, intangible assets (primarily goodwill, core deposit intangibles and customer list) 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. However, not all companies use the same calculation methods for the same non-GAAP measurements and therefore may not be comparable. 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
Book Value                 Total Shareholders' Equity / Shares Outstanding
Common Equity Ratio        Total Shareholders' Equity / Total Assets




      Non- GAAP Measurement                            Calculation

Return on Average Tangible Assets   Net Income plus Intangible Amortization (net of
                                    tax) / Average Assets less Average Intangible
                                    Assets
Return on Average Tangible Equity   Net Income plus Intangible Amortization (net of
                                    tax) / Average Equity less Average Intangible
                                    Assets
Tangible Book Value                 Total Shareholders' Equity less Intangible Assets
                                    / Shares outstanding
Tangible Common Equity Ratio        Total Shareholders' Equity less Intangible Assets
                                    / Total Assets less Intangible Assets

Comparison of the three months ended June 30, 2013 to the three months ended June 30, 2012:

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 year 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 net interest income for the second quarter of 2013 decreased $588 thousand quarter over quarter. Average interest-earning assets increased $3.3 million from 2012, but the yield on these assets decreased by 46 basis points. The average balance of investment securities increased $14.7 million while average gross loans decreased $33.2 million (4.3%) quarter over quarter. Average mortgage loans increased $20.0 million, but the increase was more than offset by a decrease in the average balance of commercial loans and consumer loans. Average commercial loans decreased $41.5 million, as commercial loans continue to run-off. Average consumer loans, including home equity loans, decreased $11.8 million, as consumers continue to borrow less.

Interest expense was $1.3 million for the second quarter, a decrease of $515 thousand from the 2012 total of $1.8 million. Average interest-bearing liabilities decreased $3.5 million to $837.7 million for 2013 from an average balance of $841.2 million in 2012. The average cost of these liabilities decreased from .86% in 2012 to .62% in 2013. Average interest-bearing deposits increased $48.9 million, due to increases in interest checking and savings accounts ($55.3 million), and money management deposits ($34.4 million). The cost of interest-bearing deposits decreased from .70% to .59%. Securities sold under agreements to repurchase (Repos) decreased $18.4 million on average over the prior year quarter while the average rate remained the same in both periods at .15%. The average balance of long-term debt decreased by $34.0 million, primarily due to $33.1 million of prepayments on seven Federal Home Loan Bank of Pittsburgh (FHLB) advances in 2012.

The changes in the balance sheet and interest rates resulted in a decrease in tax equivalent net interest income to $8.0 million in 2013 from $8.6 million in 2012. The Bank's net interest margin decreased from 3.51% in 2012 to 3.26% in 2013. The decrease in the net interest margin is the result of a decrease in the rate on interest-earning assets of 46 basis points, while the yield on interest-bearing liabilities only decreased 24 basis points. Tax equivalized net interest income decreased $588 thousand during the quarter, due to a $732 thousand decrease from lower rates, which was partially offset by a $144 thousand increase from volume.

The following table presents average balances, tax-equivalent (T/E) interest income, and yields earned or rates paid on the assets or liabilities. All nontaxable interest income has been adjusted to a tax-equivalent basis using a tax rate of 34%.

                                                                      For the Three Months Ended June 30,
                                                             2013                                             2012

                                           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             $   101,799     $        73             0.29 %   $    80,054     $        55             0.28 %
Investment securities:
Taxable                                      103,062             387             1.51 %        92,097             469             2.04 %
Nontaxable                                    43,027             561             5.23 %        39,250             539             5.51 %
Loans:
Commercial, industrial and
agricultural                                 588,246           6,408             4.37 %       629,700           7,247             4.62 %
Residential mortgage                          77,231             818             4.25 %        57,207             819             5.74 %
Home equity loans and lines                   59,513             869             5.86 %        68,457           1,042             6.11 %
Consumer                                       9,592             161             6.73 %        12,437             209             6.74 %
Loans                                        734,582           8,256             4.51 %       767,801           9,317             4.87 %

Total interest-earning assets                982,470           9,277             3.79 %       979,202          10,380             4.25 %
Other assets                                  73,223                                           74,134
Total assets                             $ 1,055,693                                      $ 1,053,336

Interest-bearing liabilities:
Deposits:
Interest-bearing checking                $   171,308              36             0.08 %   $   121,435              22             0.07 %
Money Management                             404,394             501             0.50 %       370,020             621             0.67 %
Savings                                       60,783              14             0.09 %        55,321              16             0.12 %
Time                                         155,525             611             1.58 %       196,364             645             1.32 %
Total interest-bearing deposits              792,010           1,162             0.59 %       743,140           1,304             0.70 %

Securities sold under agreements to
repurchase                                    33,260              12             0.15 %        51,622              19             0.15 %
Long- term debt                               12,407             122             3.94 %        46,434             488             4.22 %
Total interest-bearing liabilities           837,677           1,296             0.62 %       841,196           1,811             0.86 %
Noninterest-bearing deposits                 116,700                                          110,169
Other liabilities                              8,262                                           13,441
Shareholders' equity                          93,054                                           88,530
Total liabilities and shareholders'
equity                                   $ 1,055,693                                      $ 1,053,336
T/E net interest income/Net interest
margin                                                         7,981             3.26 %                         8,569             3.51 %
Tax equivalent adjustment                                       (401 )                                           (378 )
Net interest income                                      $     7,580                                      $     8,191

Provision for Loan Losses

For the second quarter of 2013, the Bank recorded net charge-offs of $308 thousand compared to $705 thousand in 2012. The charge-offs were more than offset by the second quarter provision expense of $803 thousand and as a result, the allowance for loan losses (ALL) increased $495 thousand from the end of the first quarter. For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.

Noninterest Income

For the second quarter of 2013, noninterest income decreased $92 thousand from the same period in 2012. Investment and trust service fees increased due to higher recurring asset management fees. Loan service charges decreased compared to 2012, primarily from lower secondary mortgage market fees, as the Bank is now retaining a higher volume of its mortgage production. Mortgage banking fees increased, as 2013 had a reversal of prior impairment charges ($48 thousand) compared to an impairment charge ($16 thousand) in the prior year. Deposit service charges decreased due to lower retail overdraft fees. Other service charges and fees increased primarily due to increases in ATM fees and debit card income also increased. Losses on other real estate owned increased in 2013 due to a writedown on two properties of $135 thousand. Other income increased due to an increase in title insurance income in 2013. The Corporation had OTTI losses on three equity securities in 2013 compared to none in 2012. Securities gains were recorded during both periods.

The following table presents a comparison of noninterest income for the three months ended June 30, 2013 and 2012:

                                           For the Three Months Ended
                                                     June 30                            Change
(Dollars in thousands)                      2013                2012            Amount            %
Noninterest Income
Investment and trust services fees      $       1,130       $       1,059     $        71            6.7
Loan service charges                              192                 269             (77 )        (28.6 )
Mortgage banking activities                        40                 (27 )            67          248.1
Deposit service charges and fees                  452                 479             (27 )         (5.6 )
Other service charges and fees                    233                 213              20            9.4
Debit card income                                 316                 295              21            7.1
Increase in cash surrender value of
life insurance                                    153                 167             (14 )         (8.4 )
Other real estate owned (losses)
gains, net                                       (141 )               (10 )          (131 )     (1,310.0 )
Other                                              47                  27              20           74.1
OTTI losses recognized in earnings                (50 )                 -             (50 )       (100.0 )
Securities gains (losses), net                     29                  21               8           38.1
Total noninterest income                $       2,401       $       2,493     $       (92 )         (3.7 )

Noninterest Expense

Noninterest expense for the second quarter of 2013 increased $28 thousand compared to the same period in 2012. The decrease in salaries and benefits was primarily due to a decrease in pension expense ($128 thousand) as a result of the additional cash contribution to the pension plan at the end of 2012. Occupancy and equipment expense increased due to a new branch in Mechanicsburg that opened in the fourth quarter of 2012 and an updated facility in Newville. Advertising decreased due to lower production costs in the second quarter of 2013 compared to 2012. Legal and professional fees increased due to consulting expenses, while data processing fees and shares tax expense remained relatively flat year over year. ATM/debit card processing increased from start-up costs incurred by the Bank to begin printing debit cards in house, and other expenses increased due to higher carrying costs of other real estate owned properties.

The following table presents a comparison of noninterest expense for the three months ended June 30, 2013 and 2012:

                                     For the Three Months Ended
(Dollars in thousands)                         June 30                        Change
Noninterest Expense                   2013                2012          Amount         %
Salaries and benefits             $       4,018       $       4,157     $  (139 )      (3.3 )
Net occupancy expense                       568                 493          75        15.2
Furniture and equipment expense             244                 218          26        11.9
Advertising                                 317                 396         (79 )     (19.9 )
Legal and professional fees                 359                 260          99        38.1
Data processing                             451                 440          11         2.5
Pennsylvania bank shares tax                204                 187          17         9.1
Intangible amortization                     106                 109          (3 )      (2.8 )
FDIC insurance                              270                 267           3         1.1
ATM/debit card processing                   165                 155          10         6.5
Other                                       923                 915           8         0.9
Total noninterest expense         $       7,625       $       7,597     $    28         0.4

Provision for Income Taxes

For the second quarter of 2013 the Corporation recorded a Federal income tax expense of $198 thousand compared to $356 thousand for the same quarter in 2012. Tax expense was lower in 2013, due to a higher proportion of tax free income to pre-tax income, which therefore resulted in lower tax expense. As a result, the effective tax rate decreased year over year to 12.7% for the second quarter of 2013 compared to 15.7% for 2012. All taxable income for the Corporation is taxed at a rate of 34%.

Comparison of the six months ended June 30, 2013 to the six months ended June 30, 2012:

Net Interest Income

Tax equivalent net interest income for the first half of 2013 decreased $703 thousand. Average interest-earning assets increased $18.2 million from 2012, but the yield on these assets decreased by 46 basis points. The average balance of investment securities increased $12.2 million while average loans decreased $20.3 million (2.7%) year over year. Average mortgage loans increased $19.0 million, but the increase was offset by a decrease in the average balance of commercial loans and consumer loans. Average commercial loans decreased $27.5 million, as commercial loans continue to run-off. Average consumer loans, including home equity loans, decreased $11.9 million, as consumers continue to borrow less.

Interest expense was $2.5 million for the first half of 2013, a decrease of $1.3 million from the 2012 total of $3.8 million. Average interest-bearing liabilities increased $10.2 million to $834.2 million for 2013 from an average balance of $824.0 million in 2012. The average cost of these liabilities decreased from .92% in 2012 to .61% in 2013. Average interest-bearing deposits increased $56.2 million, due to increases in interest checking and savings accounts ($45.8 million), and money management deposits ($40.5 million). The cost of interest-bearing deposits decreased from .76% to .58% driven down primarily by an 18 basis point reduction in the cost of money management accounts. Securities sold under agreements to repurchase (Repos) decreased $11.8 million on average over the prior year while the average rate remained constant at .15% in both years. The average balance of long-term debt decreased by $34.2 million, primarily due to $33.1 million of prepayments on seven Federal Home Loan Bank of Pittsburgh (FHLB) advances in 2012.

The changes in the balance sheet and interest rates resulted in a decrease in tax equivalent net interest income of $703 thousand to $16.2 million in 2013 compared to $16.9 million in 2012. The Bank's net interest margin decreased from 3.54% in 2012 to 3.35% in 2013. The decrease in the net interest margin is the result of a decrease in the rate on interest-earning assets of 46 basis points, while the yield on interest-bearing liabilities only decreased 31 basis points. Tax equivalized net interest income decreased $703 thousand during the year, due to a $1.1 million decrease from lower rates, which was partially offset by a $420 thousand increase from volume.

The following table presents average balances, tax-equivalent (T/E) interest income, and yields earned or rates paid on the assets or liabilities. All nontaxable interest income has been adjusted to a tax-equivalent basis using a tax rate of 34%.

                                                                 For the Six Months Ended June 30,
                                                       2013                                             2012
                                     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       $    92,396     $       131             0.29 %   $    66,051     $        91             0.28 %
Investment securities:
Taxable                                 99,223             757             1.54 %        90,079             919             2.05 %
Nontaxable                              42,084           1,114             5.34 %        39,042           1,078             5.54 %
Loans:
Commercial, industrial and
agricultural                           597,370          12,990             4.39 %       624,866          14,539             4.67 %
Residential mortgage                    75,335           1,672             4.48 %        56,317           1,533             5.46 %
Home equity loans and lines             60,357           1,768             5.91 %        69,723           2,119             6.10 %
Consumer                                10,346             336             6.55 %        12,846             432             6.74 %
Loans                                  743,408          16,766             4.55 %       763,752          18,623             4.89 %

Total interest-earning assets          977,111          18,768             3.87 %       958,924          20,711             4.33 %
Other assets                            73,207                                           72,790
Total assets                       $ 1,050,318                                      $ 1,031,714

Interest-bearing liabilities:
Deposits:
Interest-bearing checking          $   158,861              61             0.08 %   $   118,234              44             0.07 %
Money Management                       396,236           1,049             0.53 %       355,721           1,253             0.71 %
Savings                                 59,471              30             0.10 %        54,284              31             0.11 %
Time                                   166,915           1,125             1.36 %       196,997           1,431             1.46 %
Total interest-bearing deposits        781,483           2,265             0.58 %       725,236           2,759             0.76 %

Securities sold under agreements
to repurchase                           40,351              30             0.15 %        52,147              39             0.15 %
Long- term debt                         12,414             243             3.95 %        46,630             980             4.21 %
Total interest-bearing
liabilities                            834,248           2,538             0.61 %       824,013           3,778             0.92 %
Noninterest-bearing deposits           115,672                                          106,822
Other liabilities                        7,945                                           12,886
Shareholders' equity                    92,453                                           87,993
Total liabilities and
shareholders' equity               $ 1,050,318                                      $ 1,031,714
T/E net interest income/Net
interest margin                                         16,230             3.35 %                        16,933             3.54 %
Tax equivalent adjustment                                 (790 )                                           (758 )
Net interest income                                $    15,440                                      $    16,175

Provision for Loan Losses

For 2013, the Bank recorded net charge-offs of $546 thousand compared to $2.9 million in 2012. The charge-offs were more than offset by the year-to-date provision expense of $1.6 million and as a result, the allowance for loan losses (ALL) increased $1.1 million over year-end 2012. For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.

Noninterest Income

. . .

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