Franklin Financial Services (FRAF) - 2020 Q2 - Quarterly Report

Part I - FINANCIAL INFORMATION Item 1. Financial Statements The unaudited consolidated financial statements for the period ended June 30, 2020, show a significant increase in total assets to $1.42 billion, driven by loan growth (including $62.5 million in PPP loans) and a larger investment portfolio, while net income for the first six months of 2020 decreased to $4.8 million from $7.2 million in the prior year, primarily due to a $5.0 million provision for loan losses related to the COVID-19 pandemic's economic impact, with shareholders' equity increasing to $134.8 million Consolidated Balance Sheets As of June 30, 2020, total assets grew to $1.423 billion from $1.269 billion at year-end 2019, driven by a $77.6 million increase in gross loans to $1.012 billion and a $98.8 million increase in debt securities available for sale, funded by a $148.0 million increase in total deposits, which reached $1.273 billion, with shareholders' equity rising to $134.8 million Consolidated Balance Sheet Highlights (in thousands) | Account | June 30, 2020 | December 31, 2019 | Change | | :--- | :--- | :--- | :--- | | Total Assets | $1,423,111 | $1,269,157 | +$153,954 | | Net Loans | $995,583 | $922,609 | +$72,974 | | Debt securities available for sale | $286,217 | $187,433 | +$98,784 | | Total cash and cash equivalents | $58,599 | $83,828 | -$25,229 | | Total Liabilities | $1,288,271 | $1,141,629 | +$146,642 | | Total deposits | $1,273,353 | $1,125,392 | +$147,961 | | Total Shareholders' Equity | $134,840 | $127,528 | +$7,312 | Consolidated Statements of Income For the six months ended June 30, 2020, net income was $4.8 million ($1.10 per diluted share), down from $7.2 million ($1.63 per diluted share) in the same period of 2019, primarily driven by a significant increase in the provision for loan losses to $5.0 million, compared to $399 thousand in the prior year, while net interest income remained relatively stable at $20.6 million Six Months Ended June 30 (in thousands, except per share data) | Metric | 2020 | 2019 | | :--- | :--- | :--- | | Net Interest Income | $20,585 | $20,890 | | Provision for loan losses | $4,975 | $399 | | Noninterest Income | $7,301 | $6,862 | | Noninterest Expense | $19,173 | $19,017 | | Net Income | $4,786 | $7,221 | | Diluted EPS | $1.10 | $1.63 | - The provision for loan losses for the six months ended June 30, 2020, increased dramatically to $4.975 million from just $399 thousand in the prior-year period, reflecting the anticipated economic impact of the COVID-19 pandemic[11] Consolidated Statements of Cash Flows For the six months ended June 30, 2020, net cash used in investing activities was $172.9 million, primarily due to the purchase of investment securities, largely funded by net cash provided by financing activities of $145.1 million, driven by a significant increase in deposits, with net cash from operating activities at $2.6 million, resulting in an overall decrease in cash and cash equivalents of $25.2 million during the period Six Months Ended June 30 (in thousands) | Cash Flow Activity | 2020 | 2019 | | :--- | :--- | :--- | | Net cash provided by operating activities | $2,572 | $8,509 | | Net cash used in investing activities | ($172,941) | ($5,854) | | Net cash provided by financing activities | $145,140 | $26,835 | | Net (Decrease) Increase in Cash | ($25,229) | $29,490 | Notes to Consolidated Financial Statements Key disclosures include the delayed adoption of the CECL accounting standard to January 1, 2023, a loan portfolio growth to $1.012 billion (including $62.5 million in PPP loans), a significant increase in the allowance for loan losses to $16.6 million (1.64% of gross loans) due to the pandemic, approximately $196 million in granted loan deferrals, all capital ratios remaining above "well-capitalized" minimums, and a significant subsequent event of issuing $20 million in subordinated debt in August 2020 - The adoption of ASU 2016-13 (CECL) has been delayed and is now effective for the Corporation on January 1, 2023, with the company working with a third-party vendor and expecting to run the model in test mode in 2020[26] - As of June 30, 2020, the Bank has granted approximately $196 million in loan deferrals or modifications, representing about 19% of gross loans, in response to the COVID-19 pandemic[54] - On August 4, 2020, the Corporation completed a subordinated debt offering, selling $15.0 million in 10-year notes and $5.0 million in 15-year notes, structured to qualify as Tier 2 capital[105][106] Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition Management attributes the year-over-year decline in net income primarily to a $5.0 million provision for loan losses taken in H1 2020 due to the economic uncertainty from the COVID-19 pandemic, which increased the allowance for loan loss ratio to 1.64%, while the company actively participated in the Paycheck Protection Program (PPP), funding $62.8 million in loans, contributing to a $77.6 million growth in the total loan portfolio and a $148.0 million increase in deposits, with management believing the Corporation's asset quality is stable and its capital position, with a total risk-based capital ratio of 15.93%, is strong enough to meet the challenges Results of Operations Net income for Q2 2020 was $3.1 million, down from $4.0 million in Q2 2019, and for the first six months, net income was $4.7 million, down from $7.2 million, primarily driven by a $5.0 million year-to-date provision for loan losses due to the COVID-19 pandemic's economic impact, with net interest income seeing a slight decline as the net interest margin compressed to 3.39% from 3.80% year-over-year despite growth in earning assets, while noninterest income increased year-to-date due to a gain on a bank-owned life insurance policy, and noninterest expense remained relatively flat Key Performance Metrics (YTD) | Metric | June 30, 2020 | June 30, 2019 | | :--- | :--- | :--- | | Net Income (in millions) | $4.8 | $7.2 | | Diluted EPS | $1.10 | $1.63 | | Net Interest Margin | 3.39% | 3.80% | | Provision for Loan Loss (in millions) | $5.0 | $0.4 | | Return on average assets | 0.73% | 1.18% | | Return on average equity | 7.37% | 12.02% | - The Corporation recorded an income tax benefit of $1.1 million in Q2 2020 due to the CARES Act, which allows for the carryback of a 2018 Net Operating Loss (NOL) to a period with a higher statutory tax rate (34% vs. 21%)[115][128] Financial Condition As of June 30, 2020, the Corporation's financial condition remained strong despite economic headwinds, with total assets growing to $1.423 billion, the loan portfolio increasing by $77.6 million since year-end largely due to $62.5 million in PPP loans, the allowance for loan losses significantly bolstered to 1.64% of gross loans, deposits surging by $148.0 million enhancing liquidity, shareholders' equity growing to $134.8 million, and all regulatory capital ratios exceeding "well-capitalized" thresholds - The loan portfolio grew by $77.6 million (8.3%) since year-end 2019, primarily driven by $62.5 million in Paycheck Protection Program (PPP) loans[115][158] - Total deposits increased by $148.0 million (13.1%) since year-end 2019, with a significant portion of the growth in noninterest-bearing and low-cost checking accounts, and approximately $36.0 million of the increase attributed to remaining PPP loan proceeds[191][192] - The Corporation suspended its stock repurchase plan on March 19, 2020, having repurchased 36,401 shares in the first quarter of 2020 before the suspension[199][228] Loan Quality and Allowance for Loan Losses Overall loan quality remained stable, with the nonperforming loans to gross loans ratio at 0.41%, but in response to the pandemic, the Bank increased its Allowance for Loan Losses (ALL) by $4.6 million since year-end to $16.6 million, or 1.64% of gross loans, driven by a significant increase in the qualitative component of the ALL calculation reflecting heightened economic risk, and also implemented widespread loan modifications, granting deferrals on approximately $196 million (19% of gross loans), with the largest exposures in the Real Estate, and Accommodation and Food Services sectors Loan Quality Ratios | Metric | June 30, 2020 | Dec 31, 2019 | | :--- | :--- | :--- | | Nonperforming loans / gross loans | 0.41% | 0.42% | | Allowance for loan losses / gross loans | 1.64% | 1.28% | | Allowance for loan losses / nonperforming loans | 397.86% | 306.43% | - The Bank granted loan deferrals totaling $196.5 million, with the largest concentrations in Real Estate and Rental/Leasing ($72.4 million) and Accommodation and Food Services ($70.8 million)[174][176] - The increase in the Allowance for Loan Losses was primarily due to changes in the qualitative analysis, including increasing the risk factor for economic conditions to "very high" and assigning a higher risk score to the portfolio of modified loans[185] Liquidity The Corporation maintains a strong liquidity position, with total available liquidity of $476.7 million at June 30, 2020, primarily from borrowing capacity from the FHLB ($372.2 million) and the Federal Reserve, and to support liquidity during the pandemic, the Bank is participating in the Paycheck Protection Program Liquidity Facility (PPPLF), which provides low-cost funding for the $62.5 million in PPP loans it originated, preserving its traditional liquidity sources Available Liquidity Sources (in thousands) | Source | Available Capacity | | :--- | :--- | | Federal Home Loan Bank | $372,200 | | Federal Reserve Bank Discount Window | $21,000 | | Correspondent Banks | $21,000 | | Paycheck Protection Program Liquidity Facility | $62,513 | | Total | $476,713 | - The Bank is utilizing the Paycheck Protection Program Liquidity Facility (PPPLF) to fund its PPP loans, which allows it to preserve its normal liquidity sources like the FHLB[212] Item 3. Quantitative and Qualitative Disclosures about Market Risk The Corporation reported no material changes in its exposure to market risk during the six months ended June 30, 2020 - There were no material changes in the Corporation's exposure to market risk during the six months ended June 30, 2020[215] Item 4. Controls and Procedures Management, including the CEO and CFO, evaluated the company's disclosure controls and procedures and concluded they were effective as of June 30, 2020, with no material changes to internal control over financial reporting during the quarter - Based on an evaluation as of June 30, 2020, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation's disclosure controls and procedures are effective[216] - No changes in internal control over financial reporting occurred during the quarter ended June 30, 2020, that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting[216] Part II - OTHER INFORMATION Item 1. Legal Proceedings The Corporation is involved in litigation incidental to its business but does not anticipate that the ultimate liability from these proceedings will have a material adverse effect on its financial position, and no material proceedings by governmental authorities are pending or threatened - In management's opinion, the ultimate aggregate liability from all current litigation is not expected to have a material adverse effect on the Corporation's financial position[222] Item 1A. Risk Factors A significant new risk factor has been identified related to the COVID-19 pandemic, which has negatively impacted global, national, and local economies, leading to potential adverse effects on the company's revenue, credit losses, and loan portfolio quality, with the extent of the impact highly uncertain and dependent on future developments, including the duration of the pandemic and government responses - The COVID-19 pandemic is identified as a significant risk factor that could materially and adversely impact the business, including increased credit losses, reduced demand for products and services, and potential impairments on securities[225] - The ultimate impact of the pandemic on business operations and financial condition is highly uncertain and depends on future developments, such as the scope and duration of the pandemic and related government actions[225][226] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds The Corporation's 2019 stock repurchase plan, authorized for up to 150,000 shares, was suspended on March 19, 2020, and no shares were repurchased during the second quarter of 2020 - The Corporation suspended its stock repurchase plan on March 19, 2020, and made no share purchases during the second quarter of 2020[228] Item 3. Defaults Upon Senior Securities None - None[229] Item 4. Mine Safety Disclosures Not Applicable - Not Applicable[229] Item 5. Other Information None - None[230] Item 6. Exhibits This section lists the exhibits filed with the report, including Articles of Incorporation, Bylaws, CEO/CFO certifications (Rule 13a-14(a) and Section 1350), and Interactive Data Files (XBRL) - Exhibits filed include CEO and CFO certifications pursuant to Sarbanes-Oxley Act rules and Interactive Data Files (XBRL)[230]