Franklin Financial Services (FRAF) - 2019 Q2 - Quarterly Report

Part I - FINANCIAL INFORMATION This section details the unaudited consolidated financial statements, management's analysis, market risk, and internal controls Item 1 Financial Statements This section presents unaudited consolidated financial statements, showing asset growth, a shift to net income, and improved cash flows Consolidated Balance Sheets This section provides a snapshot of the company's financial position, detailing assets, liabilities, and equity at specific dates | Metric | June 30, 2019 (in thousands) | December 31, 2018 (in thousands) | | :-------------------------- | :----------------------------- | :------------------------------- | | Total assets | $1,252,141 | $1,209,587 | | Total liabilities | $1,128,227 | $1,091,191 | | Total shareholders' equity | $123,914 | $118,396 | | Net Loans | $969,904 | $960,960 | | Total deposits | $1,113,049 | $1,082,629 | Consolidated Statements of Income This section details the company's financial performance over specific periods, showing a significant turnaround to net income Net Income (Loss) and EPS (Three Months Ended June 30) | Metric | 2019 (in thousands) | 2018 (in thousands) | Change | | :----------------------- | :------------------ | :------------------ | :----- | | Net Income (Loss) | $3,984 | $(5,181) | +$9,165 | | Basic EPS | $0.91 | $(1.18) | +$2.09 | | Diluted EPS | $0.90 | $(1.18) | +$2.08 | Net Income (Loss) and EPS (Six Months Ended June 30) | Metric | 2019 (in thousands) | 2018 (in thousands) | Change | | :----------------------- | :------------------ | :------------------ | :----- | | Net Income (Loss) | $7,221 | $(1,679) | +$8,900 | | Basic EPS | $1.64 | $(0.38) | +$2.02 | | Diluted EPS | $1.63 | $(0.38) | +$2.01 | - Provision for loan losses significantly decreased: $0 for Q2 2019 vs. $9,129 thousand for Q2 2018, and $399 thousand for YTD 2019 vs. $9,329 thousand for YTD 2018[12] Consolidated Statements of Comprehensive Income This section presents comprehensive income, including net income and other comprehensive income components, for the reported periods Total Comprehensive Income (Loss) (Three Months Ended June 30) | Metric | 2019 (in thousands) | 2018 (in thousands) | Change | | :--------------------------- | :------------------ | :------------------ | :----- | | Total Comprehensive Income (Loss) | $4,767 | $(5,453) | +$10,220 | Total Comprehensive Income (Loss) (Six Months Ended June 30) | Metric | 2019 (in thousands) | 2018 (in thousands) | Change | | :--------------------------- | :------------------ | :------------------ | :----- | | Total Comprehensive Income (Loss) | $9,103 | $(2,732) | +$11,835 | - Net unrealized gains on debt securities for the six months ended June 30, 2019, were $2,381 thousand, a significant improvement from a loss of $(1,387) thousand in 2018[15] Consolidated Statements of Changes in Shareholders' Equity This section details the changes in shareholders' equity, reflecting net income, dividends, and stock repurchases Shareholders' Equity Changes (Six Months Ended June 30, 2019) | Metric | Amount (in thousands) | | :------------------------------------ | :-------------------- | | Balance at January 1, 2019 | $118,396 | | Net income | $7,221 | | Other comprehensive income | $1,882 | | Cash dividends declared | $(2,509) | | Acquisition of treasury stock | $(2,027) | | Balance at June 30, 2019 | $123,914 | Consolidated Statements of Cash Flows This section summarizes cash inflows and outflows from operating, investing, and financing activities over the period Cash Flow Summary (Six Months Ended June 30) | Metric | 2019 (in thousands) | 2018 (in thousands) | Change | | :------------------------------------ | :------------------ | :------------------ | :----- | | Net cash provided (used) by operating activities | $8,509 | $(2,244) | +$10,753 | | Net cash used in investing activities | $(5,854) | $(36,113) | +$30,259 | | Net cash provided by financing activities | $26,835 | $9,224 | +$17,611 | | Increase (decrease) in cash and cash equivalents | $29,490 | $(29,133) | +$58,623 | | Cash and cash equivalents at end of period | $82,447 | $29,470 | +$52,977 | Notes to Consolidated Financial Statements This section provides detailed explanations of accounting policies, significant transactions, and financial instrument details - The Corporation adopted ASU 2016-02, 'Leases (Topic 842),' on January 1, 2019, recognizing a $6.2 million lease liability and a right-of-use asset without a material effect on consolidated results of operations[27][52] - ASU 2016-13, 'Financial Instruments - Credit Losses (Topic 326)' (CECL model), is effective January 1, 2020 (delayed for smaller reporting companies to January 2023) and is expected to result in earlier recognition and potentially a larger allowance for loan losses[28] Key Investment and Loan Metrics | Metric | June 30, 2019 (in thousands) | December 31, 2018 (in thousands) | | :------------------------------------ | :----------------------------- | :------------------------------- | | AFS securities fair value | $129,422 | $131,472 | | Net gains on sales of debt securities (YTD) | $253 | $52 | | Total loans outstanding | $982,457 | $973,375 | | Allowance for Loan Losses (ALL) | $12,553 | $12,415 | | Impaired loans | $14,359 | $11,926 | | Nonaccrual loans | $5,312 | $2,300 | - The Bank was 'well capitalized' under Basel III requirements at June 30, 2019, with a Common Equity Tier 1 Risk-based Capital Ratio of 13.77% and a Total Risk-based Capital Ratio of 15.02%[76][78] - Total commercial commitments to extend credit increased to $270,082 thousand at June 30, 2019, from $216,913 thousand at December 31, 2018[90] Item 2 Management's Discussion and Analysis of Results of Operations and Financial Condition This section analyzes the Corporation's improved financial performance, driven by increased net interest income and reduced loan loss provisions Summary of Operations This section provides an overview of the Corporation's financial results, highlighting net income and key performance ratios - Reported net income of $4.0 million for the second quarter and $7.2 million year-to-date, a significant improvement from prior year losses[102] - Diluted earnings per share increased to $0.90 for Q2 2019 (from -$1.18 in Q2 2018) and $1.63 year-to-date (from -$0.38 in YTD 2018)[103] - Total assets were $1.252 billion at June 30, 2019, an increase of $42.6 million from year-end 2018[103] Key Performance Ratios (Year-to-Date Annualized June 30) | Metric | 2019 | 2018 | | :-------------------------------- | :----- | :----- | | Return on average assets | 1.18% | -0.29% | | Return on average equity | 12.02% | -2.89% | | Efficiency ratio | 67.34% | 73.96% | | Net interest margin | 3.80% | 3.75% | | Nonperforming loans/gross loans | 0.59% | 0.59% | | Allowance for loan losses as a % of loans | 1.28% | 1.29% | Net Interest Income This section analyzes changes in net interest income, driven by fluctuations in asset and liability volumes and rates - Tax equivalent net interest income increased by $449 thousand to $10.9 million in Q2 2019 (from $10.5 million in Q2 2018), driven by volume ($346 thousand) and rate changes ($103 thousand)[111][113] - For the first half of 2019, tax equivalent net interest income increased $1.1 million to $21.6 million (from $20.5 million in H1 2018), with volume contributing $676 thousand and rates $427 thousand[121][123] Net Interest Margin and Cost of Funds | Metric | Q2 2019 | Q2 2018 | YTD 2019 | YTD 2018 | | :---------------- | :------ | :------ | :------- | :------- | | Net Interest Margin | 3.74% | 3.78% | 3.80% | 3.75% | | Cost of Funds | 0.66% | 0.37% | 0.65% | 0.34% | Provision for Loan Losses This section details the provision for loan losses, reflecting changes in loan portfolio quality and growth - No provision for loan loss expense was recorded for Q2 2019 due to slower loan growth, compared to $9.1 million in Q2 2018, which included an $8.7 million charge-off from a loan participation[114] - Year-to-date provision for loan loss expense was $399 thousand in 2019, significantly down from $9.3 million in 2018[124] Noninterest Income This section analyzes noninterest income sources, including investment and trust fees, and debt securities gains Noninterest Income (Three Months Ended June 30) | Metric | 2019 (in thousands) | 2018 (in thousands) | Change Amount | Change % | | :------------------------------------ | :------------------ | :------------------ | :------------ | :------- | | Total noninterest income | $3,696 | $3,221 | $475 | 14.7 | | Investment and trust services fees | $1,647 | $1,464 | $183 | 12.5 | | Debt securities gains, net | $229 | $52 | $177 | 340.4 | | Debit card income | $464 | $417 | $47 | 11.3 | Noninterest Income (Six Months Ended June 30) | Metric | 2019 (in thousands) | 2018 (in thousands) | Change Amount | Change % | | :------------------------------------ | :------------------ | :------------------ | :------------ | :------- | | Total noninterest income | $6,862 | $6,369 | $493 | 7.7 | | Investment and trust services fees | $3,099 | $2,861 | $238 | 8.3 | | Debt securities gains, net | $253 | $52 | $201 | 386.5 | | Debit card income | $866 | $802 | $64 | 8.0 | Noninterest Expense This section details noninterest expenses, including salaries, benefits, and other operating costs Noninterest Expense (Three Months Ended June 30) | Metric | 2019 (in thousands) | 2018 (in thousands) | Change Amount | Change % | | :------------------------------------ | :------------------ | :------------------ | :------------ | :------- | | Total noninterest expense | $9,606 | $11,188 | $(1,582) | (14.1) | | Provision for credit losses on off-balance sheet exposures | $0 | $2,361 | $(2,361) | (100.0) | | Salaries and benefits | $5,355 | $5,096 | $259 | 5.1 | | Advertising | $481 | $341 | $140 | 41.1 | | Data processing | $738 | $604 | $134 | 22.2 | Noninterest Expense (Six Months Ended June 30) | Metric | 2019 (in thousands) | 2018 (in thousands) | Change Amount | Change % | | :------------------------------------ | :------------------ | :------------------ | :------------ | :------- | | Total noninterest expense | $19,017 | $19,837 | $(820) | (4.1) | | Provision for credit losses on off-balance sheet exposures | $0 | $2,361 | $(2,361) | (100.0) | | Salaries and employee benefits | $10,797 | $10,082 | $715 | 7.1 | | Legal and professional | $901 | $771 | $130 | 16.9 | Provision for Income Taxes This section outlines the income tax expense or benefit, reflecting pre-tax income and effective tax rates - Federal income tax expense for Q2 2019 was $669 thousand, compared to a tax benefit of $(1,816) thousand in Q2 2018, due to a pre-tax loss in 2018[119] - For the first half of 2019, federal income tax expense was $1.1 million, compared to a tax benefit of $(1.3) million in H1 2018. The effective tax rate for YTD 2019 was 13.4%[133] Financial Condition This section reviews the Corporation's financial position, including cash, investments, loans, deposits, and capital adequacy - Cash and cash equivalents increased by $29.4 million to $82.4 million at June 30, 2019, from $53.0 million at year-end 2018[135] - The AFS securities portfolio had a net unrealized gain of $1.3 million at June 30, 2019, compared to a net unrealized loss of $1.1 million at prior year-end[137] Loans Outstanding by Class | Loan Class | June 30, 2019 (in thousands) | December 31, 2018 (in thousands) | Change Amount | Change % | | :------------------------------------ | :----------------------------- | :------------------------------- | :------------ | :------- | | Total residential real estate 1-4 family | $191,903 | $196,120 | $(4,217) | (2.2) | | Total residential real estate - construction | $14,088 | $10,225 | $3,863 | 37.8 | | Commercial real estate | $505,653 | $487,980 | $17,673 | 3.6 | | Commercial | $264,862 | $274,054 | $(9,192) | (3.4) | | Consumer | $5,951 | $4,996 | $955 | 19.1 | | Total loans | $982,457 | $973,375 | $9,082 | 0.9 | Nonperforming Assets | Metric | June 30, 2019 (in thousands) | December 31, 2018 (in thousands) | | :------------------------------------ | :----------------------------- | :------------------------------- | | Total nonaccrual loans | $5,312 | $2,300 | | Total loans past due 90 days or more and still accruing | $360 | $357 | | Total nonperforming loans | $5,672 | $2,657 | | Other real estate owned | $2,684 | $2,684 | | Total nonperforming assets | $8,356 | $5,341 | | Nonperforming loans to total gross loans | 0.58% | 0.27% | | Allowance for loan losses to nonperforming loans | 221.32% | 467.26% | - Total deposits increased $30.4 million (2.8%) to $1.113 billion, driven by a $24.4 million (39.7%) increase in time deposits[176][178] - Shareholders' equity increased $5.5 million to $123.9 million, with a dividend payout ratio of 34.75% for the first six months of 2019[180] - The Bank was 'well capitalized' under Basel III requirements at June 30, 2019, with a Total Risk-based Capital Ratio of 15.02% (minimum 10.00%)[184][185] - The Bank maintains strong liquidity, with $371.9 million available borrowing capacity from FHLB and $17.1 million from the Federal Reserve Discount Window[193][194] Item 3 Quantitative and Qualitative Disclosures about Market Risk There were no material changes in the Corporation's exposure to market risk during the six months ended June 30, 2019 - No material changes in the Corporation's exposure to market risk during the six months ended June 30, 2019[197] Item 4 Controls and Procedures The Corporation's management, including the Chief Executive Officer and Chief Financial Officer, concluded that its disclosure controls and procedures were effective as of June 30, 2019. No material changes in internal control over financial reporting occurred during the quarter - The Corporation's disclosure controls and procedures were effective as of June 30, 2019[198] - No material changes in internal control over financial reporting occurred during the quarterly period ended June 30, 2019[198] Part II - OTHER INFORMATION This section covers legal proceedings, risk factors, equity sales, defaults, and other miscellaneous disclosures Item 1 Legal Proceedings Management believes there are no material legal proceedings pending or threatened against the Corporation. A previously disclosed class action lawsuit was settled in July 2018, with a $10.0 million payment made by F&M Trust in May 2018, which had been accrued in 2017 - No material legal proceedings are pending or known to be threatened against the Corporation[203] - The Kalan et al. v. Farmers and Merchants Trust Company of Chambersburg, et al. class action lawsuit settlement was granted final approval on July 31, 2018, with a $10.0 million payment made in May 2018[204] Item 1A Risk Factors There were no material changes in the Corporation's risk factors during the six months ended June 30, 2019 - No material changes in the Corporation's risk factors during the six months ended June 30, 2019[205] Item 2 Unregistered Sales of Equity Securities and Use of Proceeds During Q2 2019, the Corporation repurchased 39,600 shares of common stock for $1,467 thousand under the 2018 Repurchase Plan, which authorized up to 100,000 shares and was completed in Q3 2019 Shares Repurchased (Q2 2019) | Period | Number of Shares Purchased | Weighted Average Price Paid per Share | Dollar Amount of Shares Purchased (in thousands) | | :------- | :------------------------- | :------------------------------------ | :----------------------------------------------- | | April 2019 | 21,940 | $36.83 | $808 | | May 2019 | 300 | $38.08 | $11 | | June 2019 | 17,360 | $37.32 | $648 | | Total | 39,600 | $37.05 | $1,467 | - The 2018 Repurchase Plan, authorizing up to 100,000 shares, was completed in the third quarter of 2019[207] Item 3 Defaults Upon Senior Securities The Company reported no defaults upon senior securities - No defaults upon senior securities[208] Item 4 Mine Safety Disclosures This item is not applicable to the Corporation - Not Applicable[209] Item 5 Other Information No other information was reported in this section - No other information was reported[210] Item 6 Exhibits This section lists the exhibits filed with the Form 10-Q, including corporate governance documents, the 2019 Omnibus Stock Incentive Plan, and various certifications - Exhibits include Articles of Incorporation, Bylaws, 2019 Omnibus Stock Incentive Plan, Rule 13a – 14(a)/15d-14(a) Certifications, Section 1350 Certifications, and the Interactive Data File (XBRL)[210] SIGNATURES The report was duly signed on August 2, 2019, by Timothy G. Henry, Chief Executive Officer and President, and Mark R. Hollar, Treasurer and Chief Financial Officer - The report was signed by Timothy G. Henry (CEO and President) and Mark R. Hollar (Treasurer and CFO) on August 2, 2019[214]