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FRAF > SEC Filings for FRAF > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for FRANKLIN FINANCIAL SERVICES CORP /PA/

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


12-Nov-2013

Quarterly Report

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

For the Three and Nine Months Ended September 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 September 30, 2013, total assets were $1.003 billion, a decrease of $24.1 million from December 31, 2012. Net loans decreased to $708.8 million and total deposits decreased to $865.8 million. The Corporation reported net income for the first nine months of 2013 of $5.1 million. This is an 1.4% increase versus net income of $5.0 million for the same period in 2012. Total revenue (interest income and noninterest income) decreased $2.7 million year-over-year. Interest income decreased $2.7 million, while interest expense decreased by $2.0 million, resulting in a $775 thousand decrease in net interest income. The provision for loan losses was $2.0 million for the period, $1.6 million less than in 2012. Noninterest income increased .3% mainly from increases in investment and trust services income compared to prior year. Noninterest expense increased 2.9% due to increases in salary and benefits expense and net occupancy expense. Diluted earnings per share decreased to $1.23 in 2013 from $1.24 in 2012.

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

                                                  September 30,
                                               2013          2012
Performance measurements
Return on average assets*                         0.66 %        0.65 %
Return on average equity*                         7.37 %        7.56 %
Return on average tangible assets (1)*            0.69 %        0.68 %
Return on average tangible equity (1)*            8.58 %        8.91 %
Efficiency ratio (2)                             70.70 %       67.09 %
Net interest margin*                              3.40 %        3.51 %
Current dividend yield*                           4.26 %        4.73 %
Dividend payout ratio                            41.31 %       49.27 %

Shareholders' Value (per common share)
Diluted earnings per share                   $    1.23     $    1.24
Basic earnings per share                          1.23          1.24
Regular cash dividends paid                       0.51          0.61
Book value                                       22.51         22.41
Tangible book value (3)                          20.14         19.90
Market value                                     15.95         14.37
Market value/book value ratio                    70.86 %       64.12 %
Price/earnings multiple*                          9.73          8.71

Safety and Soundness
Leverage ratio (Tier 1)                           8.90 %        8.20 %
Risk-based capital ratio (Tier 1)                13.92 %       12.66 %
Common equity ratio                               9.31 %        8.67 %
Tangible common equity ratio (4)                  8.41 %        7.78 %
Nonperforming loans/gross loans                   4.00 %        4.78 %
Nonperforming assets/total assets                 3.35 %        3.99 %
Allowance for loan losses as a % of loans         1.58 %        1.34 %
Net charge-offs/average loans*                    0.17 %        0.56 %

Trust assets under management (fair value)   $ 560,940     $ 511,059

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

Comparison of the three months ended September 30, 2013 to the three months ended September 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 third quarter of 2013 decreased $108 thousand quarter over quarter. Average interest-earning assets decreased $37.1 million from 2012 and the yield on these assets decreased by 19 basis points. The average balance of investment securities increased $20.2 million while average gross loans decreased $35.6 million (4.7%) quarter over quarter. Average mortgage loans increased $17.5 million while average commercial loans decreased $44.4 million, as commercial loans continue to run-off. Average consumer loans, including home equity loans, decreased $8.7 million, as consumers continue to borrow less.

Interest expense was $945 thousand for the third quarter, a decrease of $747 thousand from the 2012 total of $1.7 million. Average interest-bearing liabilities decreased $40.0 million to $801.0 million for 2013 from an average balance of $841.2 million in 2012. The average cost of these liabilities decreased from .80% in 2012 to .47% in 2013. Average interest-bearing deposits increased $12.0 million, due to increases in interest checking and savings accounts ($68.7 million), and money management deposits ($6.1 million). The cost of interest-bearing deposits decreased from .67% to .42%. Securities sold under agreements to repurchase (Repos) decreased $26.0 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 $26.1 million, primarily due to prepayments on 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 $8.4 million in 2013 from $8.5 million in 2012. The Bank's net interest margin increased from 3.42% in 2012 to 3.51% in 2013. The increase in the net interest margin is the result of a decrease in the rate on interest-earning assets of only 19 basis points, while the yield on interest-bearing liabilities decreased by 33 basis points. Tax equivalized net interest income decreased $108 thousand during the quarter, due to a $233 thousand decrease from lower rates, which was partially offset by a $125 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 September 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             $    60,244     $        49             0.32 %   $    82,008     $        56             0.27 %
Investment securities:
Taxable                                      118,863             495             1.65 %       101,011             466             1.83 %
Nontaxable                                    42,909             557             5.19 %        40,576             559             5.47 %
Loans:
Commercial, industrial and
agricultural                                 577,760           6,399             4.31 %       622,199           7,145             4.50 %
Residential mortgage                          79,827             840             4.17 %        62,296             761             4.85 %
Home equity loans and lines                   58,617             839             5.68 %        64,843             991             6.06 %
Consumer                                       9,465             151             6.33 %        11,897             207             6.90 %
Loans                                        725,669           8,229             4.45 %       761,235           9,104             4.74 %

Total interest-earning assets                947,685           9,330             3.91 %       984,830          10,185             4.10 %
Other assets                                  71,030                                           73,137
Total assets                             $ 1,018,715                                      $ 1,057,967

Interest-bearing liabilities:
Deposits:
Interest-bearing checking                $   187,111              48             0.10 %   $   123,866              21             0.07 %
Money Management                             382,620             422             0.44 %       376,522             621             0.65 %
Savings                                       61,584              12             0.07 %        56,117              16             0.11 %
Time                                         131,623             329             0.99 %       194,391             604             1.23 %
Total interest-bearing deposits              762,938             811             0.42 %       750,896           1,262             0.67 %

Securities sold under agreements to
repurchase                                    25,702              10             0.15 %        51,681              20             0.15 %
Long- term debt                               12,405             124             3.99 %        38,501             410             4.22 %
Total interest-bearing liabilities           801,045             945             0.47 %       841,078           1,692             0.80 %
Noninterest-bearing deposits                 118,077                                          112,718
Other liabilities                              7,365                                           13,705
Shareholders' equity                          92,228                                           90,466
Total liabilities and shareholders'
equity                                   $ 1,018,715                                      $ 1,057,967
T/E net interest income/Net interest
margin                                                         8,385             3.51 %                         8,493             3.42 %
Tax equivalent adjustment                                       (389 )                                           (457 )
Net interest income                                      $     7,996                                      $     8,036

Provision for Loan Losses

For the third quarter of 2013, the Bank recorded net charge-offs of $412 thousand compared to $339 thousand in 2012. The net charge-offs exceeded the third quarter provision expense of $350 thousand and as a result, the allowance for loan losses (ALL) decreased $62 thousand during the third quarter. 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 2013, noninterest income increased $295 thousand from the same period in 2012. Investment and trust service fees increased due to higher asset management fees and nonrecurring estate fees, while commissions on the sale of insurance and investment products lagged behind 2012. 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 ($17 thousand) compared to an impairment charge ($13 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 and debit card fees. Losses on other real estate owned decreased in 2013 due to lower writedowns on OREO properties. Other income increased due to the recovery of a judgement in 2013. The Bank had OTTI losses on two bonds in 2013 and in 2012. Securities gains were recorded in 2012, compared to none in 2013.

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

                                           For the Three Months Ended
                                                  September 30                          Change
(Dollars in thousands)                      2013                2012            Amount            %
Noninterest Income
Investment and trust services fees      $       1,140       $         957     $       183           19.1
Loan service charges                              232                 328             (96 )        (29.3 )
Mortgage banking activities                        18                 (27 )            45          166.7
Deposit service charges and fees                  472                 479              (7 )         (1.5 )
Other service charges and fees                    232                 209              23           11.0
Debit card income                                 315                 288              27            9.4
Increase in cash surrender value of
life insurance                                    150                 159              (9 )         (5.7 )
Other real estate owned (losses)
gains, net                                       (119 )              (197 )            78           39.6
Other                                              89                  40              49          122.5
OTTI losses recognized in earnings                (25 )               (50 )            25           50.0
Securities gains (losses), net                      -                  23             (23 )          N/A
Total noninterest income                $       2,504       $       2,209     $       295           13.4

Noninterest Expense

Noninterest expense for the third quarter of 2013 increased $27 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, PA that opened in the fourth quarter of 2012 and an updated facility in Newville, PA. Advertising increased due to higher production costs in the third quarter of 2013 compared to 2012. Legal and professional fees were relatively flat quarter over quarter, while data processing fees increased as the Bank added online initiatives for customer efficiency and protection, including mobile banking, mobile express deposit, online account opening and enhanced authentication for online banking logons. ATM/debit card processing increased from start-up costs incurred by the Bank to begin printing debit cards in-house. Other expenses were down, as the third quarter of 2013 had lower expenses for loan collection activities and carrying costs for other real estate owned compared to same period in 2012.

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

                                     For the Three Months Ended
(Dollars in thousands)                      September 30                      Change
Noninterest Expense                   2013                2012          Amount         %
Salaries and benefits             $       3,977       $       4,141     $  (164 )      (4.0 )
Net occupancy expense                       566                 499          67        13.4
Furniture and equipment expense             239                 226          13         5.8
Advertising                                 386                 315          71        22.5
Legal and professional fees                 233                 252         (19 )      (7.5 )
Data processing                             472                 382          90        23.6
Pennsylvania bank shares tax                204                 187          17         9.1
Intangible amortization                     106                 109          (3 )      (2.8 )
FDIC insurance                              245                 274         (29 )     (10.6 )
ATM/debit card processing                   174                 162          12         7.4
Other                                       780                 808         (28 )      (3.5 )
Total noninterest expense         $       7,382       $       7,355     $    27         0.4

Provision for Income Taxes

For the third quarter of 2013 the Corporation recorded a Federal income tax expense of $583 thousand compared to $318 thousand for the same quarter in 2012. Tax expense was higher in 2013, due to more pre-tax income and a lower ratio of tax-free to taxable income in 2013 as compared to 2012. As a result, the effective tax rate increased quarter over quarter to 21.1% for the third quarter of 2013 compared to 15.4% for 2012. All taxable income for the Corporation is taxed at a rate of 34%.

Comparison of the nine months ended September 30, 2013 to the nine months ended September 30, 2012:

Net Interest Income

Tax equivalent net interest income for the first nine months of 2013 decreased $846 thousand. Average interest-earning assets decreased $428 thousand from 2012 and the yield on these assets decreased by 38 basis points. The average balance of investment securities increased $14.9 million while average loans decreased $25.5 million (3.3%) year over year. Average mortgage loans increased $18.5 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 $33.2 million, as commercial loans continue to run-off. Average consumer loans, including home equity loans, decreased $10.8 million, as consumers continue to borrow less.

Interest expense was $3.5 million for the first nine months of 2013, a decrease of $2.0 million from the 2012 total of $5.5 million. Average interest-bearing liabilities decreased $6.7 million to $823.1 million for 2013 from an average balance of $829.7 million in 2012. The average cost of these liabilities decreased from .88% in 2012 to .57% in 2013. Average interest-bearing deposits increased $41.4 million, due to increases in interest checking and savings accounts ($53.5 million), and money management deposits ($28.9 million). The cost of interest-bearing deposits decreased from .73% to .53%. Securities sold under agreements to repurchase (Repos) decreased $16.6 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 $31.5 million, primarily due to prepayments on 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 $846 thousand to $24.6 million in 2013 compared to $25.5 million in 2012. The Bank's net interest margin decreased from 3.51% in 2012 to 3.40% in 2013. The decrease in the net interest margin is the result of a decrease in the rate on interest-earning assets of 38 basis points, while the yield on interest-bearing liabilities only decreased 31 basis points. Tax equivalized net interest income decreased $846 thousand during the year, due to a $1.5 million decrease from lower rates, which was partially offset by a $612 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 Nine Months Ended September 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             $    81,561     $       180             0.29 %   $    71,409     $       148             0.28 %
Investment securities:
Taxable                                      105,842           1,253             1.58 %        93,750           1,385             1.97 %
Nontaxable                                    42,362           1,671             5.26 %        39,557           1,636             5.51 %
Loans:
Commercial, industrial and
agricultural                                 590,762          19,390             4.31 %       623,971          21,721             4.58 %
Residential mortgage                          76,849           2,511             4.37 %        58,325           2,295             5.24 %
Home equity loans and lines                   59,771           2,607             5.83 %        68,084           3,109             6.08 %
Consumer                                      10,048             488             6.49 %        12,527             638             6.78 %
Loans                                        737,430          24,996             4.48 %       762,907          27,763             4.85 %

Total interest-earning assets                967,195          28,100             3.88 %       967,623          30,932             4.26 %
Other assets                                  72,473                                           72,906
Total assets                             $ 1,039,668                                      $ 1,040,529

Interest-bearing liabilities:
Deposits:
Interest-bearing checking                $   168,381             110             0.09 %   $   120,125              65             0.07 %
Money Management                             391,649           1,470             0.50 %       362,705           1,875             0.69 %
Savings                                       60,183              42             0.09 %        54,899              47             0.11 %
Time                                         155,022           1,454             1.25 %       196,121           2,033             1.38 %
Total interest-bearing deposits              775,235           3,076             0.53 %       733,850           4,020             0.73 %

Securities sold under agreements to
repurchase                                    35,414              40             0.15 %        51,990              59             0.15 %
Long- term debt                               12,411             367             3.95 %        43,901           1,390             4.22 %
Total interest-bearing liabilities           823,060           3,483             0.57 %       829,741           5,469             0.88 %
Noninterest-bearing deposits                 116,483                                          108,802
Other liabilities                              7,750                                           13,161
Shareholders' equity                          92,375                                           88,825
Total liabilities and shareholders'
equity                                   $ 1,039,668                                      $ 1,040,529
T/E net interest income/Net interest
margin                                                        24,617             3.40 %                        25,463             3.51 %
Tax equivalent adjustment                                     (1,181 )                                         (1,252 )
Net interest income                                      $    23,436                                      $    24,211

All nontaxable interest income has been adjusted to a tax-equivalent basis, using a tax rate of 34%.

Provision for Loan Losses

For 2013, the Bank recorded net charge-offs of $958 thousand compared to $3.2 million in 2012. The charge-offs were more than offset by the year-to-date provision expense of $2.0 million and as a result, the allowance for loan losses (ALL) increased $997 thousand over year-end 2012. For more information refer to . . .

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