Franklin Financial Services (FRAF) - 2020 Q3 - Quarterly Report

Part I - Financial Information Item 1. Financial Statements The report presents unaudited consolidated financial statements for the nine months ended September 30, 2020 Consolidated Balance Sheets Total assets grew to $1.51 billion, driven by increases in securities, loans, and deposits Consolidated Balance Sheet Highlights (in thousands) | Account | Sep 30, 2020 | Dec 31, 2019 | | :--- | :--- | :--- | | Total Assets | $1,511,213 | $1,269,157 | | Total cash and cash equivalents | $71,160 | $83,828 | | Debt securities available for sale | $346,473 | $187,433 | | Net Loans | $1,005,807 | $922,609 | | Total Liabilities | $1,371,639 | $1,141,629 | | Total deposits | $1,336,749 | $1,125,392 | | Subordinate notes | $19,547 | $— | | Total Shareholders' Equity | $139,574 | $127,528 | Consolidated Statements of Income Net income declined to $8.2 million for the nine-month period due to a higher provision for loan losses Income Statement Summary (in thousands, except per share data) | Metric | Nine Months Ended Sep 30, 2020 | Nine Months Ended Sep 30, 2019 | | :--- | :--- | :--- | | Net Interest Income | $30,968 | $31,725 | | Provision for loan losses | $5,350 | $237 | | Noninterest Income | $10,903 | $10,342 | | Noninterest Expense | $28,821 | $28,010 | | Net Income | $8,248 | $11,720 | | Diluted Earnings Per Share | $1.89 | $2.66 | Consolidated Statements of Cash Flows Cash and cash equivalents decreased by $12.7 million, as financing activities funded investment purchases Cash Flow Summary for Nine Months Ended Sep 30 (in thousands) | Activity | 2020 | 2019 | | :--- | :--- | :--- | | Net cash provided by operating activities | $2,375 | $14,566 | | Net cash (used in) provided by investing activities | ($242,245) | $12,000 | | Net cash provided by financing activities | $227,202 | $70,611 | | (Decrease) increase in cash and cash equivalents | ($12,668) | $97,177 | Notes to Consolidated Financial Statements Disclosures cover CECL adoption, COVID-19 loan modifications, new debt, and regulatory capital ratios - The Corporation is preparing for the adoption of the new CECL standard, effective January 1, 2023, which is expected to result in earlier recognition of loan loss allowances[25] - As of September 30, 2020, the Bank has granted approximately $83 million in loan deferrals (about 8% of gross loans) in response to the COVID-19 pandemic under the CARES Act[53] - In Q3 2020, the Corporation issued $20 million of unsecured subordinated debt notes, structured to qualify as Tier 2 Capital[79] Regulatory Capital Ratios (Bank) as of Sep 30, 2020 | Ratio | Actual | Well-Capitalized Minimum | | :--- | :--- | :--- | | Common Equity Tier 1 | 13.99% | 6.50% | | Tier 1 Risk-based Capital | 13.99% | 8.00% | | Total Risk-based Capital | 15.25% | 10.00% | | Tier 1 Leverage | 8.61% | 5.00% | Management's Discussion and Analysis (MD&A) Management analyzes financial results, focusing on the pandemic's impact on loan loss provisions and balance sheet changes Results of Operations Net income fell to $8.2 million due to a $5.4 million provision for loan losses related to the COVID-19 pandemic Year-to-Date Performance Summary (in thousands) | Metric | YTD Sep 30, 2020 | YTD Sep 30, 2019 | | :--- | :--- | :--- | | Net Income | $8,248 | $11,720 | | Net Interest Income | $30,968 | $31,725 | | Provision for Loan Losses | $5,350 | $237 | | Noninterest Income | $10,903 | $10,342 | | Noninterest Expense | $28,821 | $28,010 | - The year-to-date provision for loan loss expense increased to $5.4 million due to qualitative factor increases related to the economic effects of the COVID-19 pandemic[112] - A tax benefit of $1.1 million was recorded in Q2 2020 due to a CARES Act provision allowing the carryback of a 2018 Net Operating Loss (NOL)[115][142] Financial Condition Total assets grew to $1.51 billion, funded by a surge in deposits and new subordinated debt - Net loans increased by $83.2 million (9%) in 2020, largely due to $63.4 million in Paycheck Protection Program (PPP) loans[117] - Deposits increased by $211.4 million since year-end 2019, attributed to government stimulus payments and lower consumer spending during the pandemic[119] - In Q3 2020, the Corporation issued $20.0 million of subordinated notes to enhance regulatory capital and for general corporate purposes[120][197] Loan Portfolio and Quality Loan quality deteriorated with nonperforming loans rising to 0.93%, driven by downgrades in the hotel portfolio Loan Portfolio Composition (in thousands) | Loan Class | Sep 30, 2020 | Dec 31, 2019 | | :--- | :--- | :--- | | Residential real estate 1-4 family | $200,372 | $190,543 | | Residential real estate - construction | $14,214 | $13,323 | | Commercial real estate | $505,498 | $494,262 | | Commercial (incl. PPP) | $296,331 | $230,007 | | Consumer | $6,543 | $6,440 | | Total Gross Loans | $1,022,958 | $934,575 | Credit Quality Metrics | Metric | Sep 30, 2020 | Dec 31, 2019 | | :--- | :--- | :--- | | Nonperforming loans to total gross loans | 0.93% | 0.42% | | Nonperforming assets to total assets | 0.63% | 0.31% | | Allowance for loan losses to nonperforming loans | 180.31% | 306.43% | - The 'watch list' of loans increased to $48.1 million from $11.6 million at year-end 2019, primarily due to downgrades of hotel loans impacted by the pandemic[163] - As of Sep 30, 2020, the Bank had $82.5 million in active loan deferrals under the CARES Act, with the hotel sector comprising the largest portion at $60.8 million[175][177] Allowance for Loan Losses (ALL) The ALL increased to $17.2 million (1.68% of loans) due to higher qualitative risk factors for the pandemic - The year-to-date increase in the ALL was primarily driven by the qualitative analysis component of the calculation methodology[184][185][186] - Due to the pandemic, the qualitative risk factor for 'economic conditions' was increased to 'very high', and modified loans received a separate, higher risk assessment[186] Allowance for Loan Losses (ALL) Summary | Metric | Sep 30, 2020 | Dec 31, 2019 | | :--- | :--- | :--- | | ALL Balance (in thousands) | $17,151 | $11,966 | | ALL as a % of gross loans | 1.68% | 1.28% | | ALL as a % of gross loans (ex-PPP) | 1.79% | N/A | Liquidity and Capital Resources The Corporation maintains strong liquidity with $497.1 million in available funding and well-capitalized ratios Available Liquidity at Sep 30, 2020 (in thousands) | Liquidity Source | Available | | :--- | :--- | | Federal Home Loan Bank | $387,935 | | Federal Reserve Bank Discount Window | $24,786 | | Correspondent Banks | $21,000 | | Paycheck Protection Program Liquidity Facility | $63,395 | | Total | $497,116 | - The Corporation's stock repurchase plan was suspended on March 19, 2020, and no shares were purchased during the third quarter[200][233] Quantitative and Qualitative Disclosures about Market Risk No material changes in market risk exposure were reported for the first nine months of 2020 - There were no material changes in the Corporation's market risk exposure during the first nine months of 2020[218] Controls and Procedures Management concluded that disclosure controls and procedures were effective as of September 30, 2020 - The CEO and CFO concluded that as of September 30, 2020, the Corporation's disclosure controls and procedures are effective[219] - No changes were made during the quarter that materially affected internal control over financial reporting[219] Part II - Other Information Legal Proceedings Current litigation is not expected to have a material adverse effect on the Corporation's financial position - 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[226] Risk Factors Key risks include the uncertain impact of the COVID-19 pandemic and potential liabilities from PPP lending - The COVID-19 pandemic could materially and adversely impact the business through increased credit losses, reduced revenue, and operational disruptions[229] - Participation in the PPP exposes the Corporation to litigation risk from applicants regarding its loan processing procedures[231] - There is a credit risk that the SBA may deny its guarantee on PPP loans if it finds deficiencies in origination, underwriting, or servicing[232] Unregistered Sales of Equity Securities and Use of Proceeds The stock repurchase plan was suspended in March 2020, with no shares repurchased in the third quarter - The stock repurchase plan was suspended on March 19, 2020, and no share purchases were made during the third quarter of 2020[233] Other Items and Exhibits The report confirms no defaults on senior securities and lists all filed exhibits, including certifications - The report confirms no defaults on senior securities and lists filed exhibits, including CEO/CFO certifications and XBRL data files[234][236]