FORM 10-Q

 

(Mark One)

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to

Commission file number 0-12126

 

FRANKLIN FINANCIAL SERVICES CORPORATION

(Exact name of registrant as specified in its charter)

 

PENNSYLVANIA		25-1440803
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
20 SOUTH MAIN STREET (P.O. BOX 6010), CHAMBERSBURG,PA 17201-0819
(Address of principal executive offices)
717/264-6116
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý    No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes o No   ý

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

There were 3,370,400 outstanding shares of the Registrant’s common stock as of October 31, 2004.

 

 

INDEX

 

PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
		Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003
		Consolidated Statements of Income for the Three and Nine Months ended September 30, 2004 and 2003
		Consolidated Statements of Changes in Shareholders’ Equity for the Nine Months ended September 30, 2003 and September 30, 2004
		Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2003
		Notes to Consolidated Financial Statements
Item 2 - Management’s Discussion and Analysis of
		Financial Condition and Results of Operations
Item 3 – Quantitative and Qualitative Disclosures about Market Risk
Item 4 – Controls and Procedures
PART II - OTHER INFORMATION
SIGNATURE PAGE
EXHIBITS

 

 

Consolidated Balance Sheets

(Amounts in thousands, except per share data)

 

		September 30 2004			December 31 2003
Assets
Cash and due from banks		$	11,225		$	15,360
Interest bearing deposits in other banks and fed funds sold		5,656			256
Total cash and cash equivalents		16,881			15,616
Investment securities available for sale		160,394			153,381
Restricted stock		4,348			4,753
Loans held for sale		13,122			12,113
Loans		345,525			333,946
Allowance for loan losses		(4,673		)	(3,750		)
Net Loans		340,852			330,196
Premises and equipment, net		9,721			9,564
Bank owned life insurance		10,674			10,319
Other assets		16,384			13,760
Total Assets		$	572,376		$	549,702
Liabilities
Deposits
Demand (non-interest bearing)		$	68,575		$	59,547
Savings and Interest checking		214,116			201,715
Time		117,646			111,169
Total Deposits		400,337			372,431
Securities sold under agreements to repurchase		46,696			38,311
Short term borrowings		12,450			25,200
Long term debt		53,326			56,467
Other liabilities		5,411			5,435
Total Liabilities		518,220			497,844
Shareholders’ equity
Common stock $1 par value per share, 15,000 shares authorized with 3,806 and 3,045 shares issued and 3,370 and 2,692 shares outstanding at September 30, 2004 and December 31, 2003, respectively.		3,806			3,045
Capital stock without par value, 5,000 shares authorized with no shares issued or outstanding		—			—
Additional paid in capital		19,859			19,819
Retained earnings		35,116			34,251
Accumulated other comprehensive income		2,309			1,767
Treasury stock, 436 shares and 353 shares at cost at September 30, 2004 and December 31, 2003, respectively		(6,934		)	(7,024		)
Total shareholders’ equity		54,156			51,858
Total Liabilities and Shareholders’ Equity		$	572,376		$	549,702

 

The accompanying notes are an integral part of these financial statements

 

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Consolidated Statements of Income

(Amounts in thousands, except per share data)

 

		For the Three Months Ended September 30						For the Nine Months Ended September 30
		2004			2003			2004			2003
Interest Income
Loans		$	4,876		$	4,928		$	14,393		$	14,998
Interest and dividends on investments:
Taxable interest		838			736			2,406			2,410
Tax exempt interest		441			393			1,237			1,179
Dividend income		48			47			152			153
Federal funds sold		48			21			67			22
Deposits and obligations of other banks		1			7			5			31
Total interest income		6,252			6,132			18,260			18,793
Interest Expense
Deposits		1,295			1,234			3,661			4,086
Securities sold under agreements to repurchase		132			89			280			271
Short term borrowings		58			—			160			14
Long term debt		773			857			2,326			2,562
Total interest expense		2,258			2,180			6,427			6,933
Net interest income		3,994			3,952			11,833			11,860
Provision for loan losses		160			241			640			1,166
Net interest income after provision for loan losses		3,834			3,711			11,193			10,694
Noninterest Income
Investment and trust services fees		673			603			1,970			1,851
Service charges and fees		815			713			2,336			2,139
Mortgage banking activities		116			290			556			837
Increase in cash surrender value of life insurance		105			125			355			404
Other		87			5			(171		)	336
Securities gains, net		80			14			204			277
Total noninterest income		1,876			1,750			5,250			5,844
Noninterest Expense
Salaries and benefits		2,078			1,818			6,228			5,548
Net occupancy expense		285			245			849			740
Furniture and equipment expense		178			164			548			499
Advertising		192			211			634			600
Legal & professional fees		169			171			437			417
Data processing		265			272			842			846
Pennsylvania bank shares tax		117			111			350			333
Other		699			710			2,016			1,954
Total noninterest expense		3,983			3,702			11,904			10,937
Income before Federal income taxes		1,727			1,759			4,539			5,601
Federal income tax expense		310			329			730			1,092
Net income		$	1,417		$	1,430		$	3,809		$	4,509
Per share data*
Basic earnings per share		$	0.42		$	0.42		$	1.13		$	1.34
Diluted earnings per share		$	0.42		$	0.42		$	1.13		$	1.34
Regular cash dividends paid		$	0.23		$	0.21		$	0.65		$	0.61

 

The accompanying notes are an integral part of these financial statements.

 

* Per share amounts for both periods are adjusted to reflect a 25% stock dividend declared by the Board of Directors on April 8, 2004

and distributed on June 28, 2004 to shareholders of record on June 14, 2004.

 

3

 

Consolidated Statements of Changes in Shareholders’ Equity

for the nine months ended  September 30, 2004 and 2003

 

(Dollars in thousands, except per share data)		Common Stock			Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income			Treasury Stock			Total
Balance at December 31, 2002		$	3,045		$	19,762		$	31,148		$	525		($7,252		)	$	47,228
Comprehensive income:
Net income		—			—			4,509			—			—			4,509
Unrealized gain on securities, net of reclassification adjustments and tax		—			—			—			337			—			337
Unrealized gain on hedging actvities, net of reclassification adjustments and tax		—			—			—			183			—			183
Total Comprehensive income																	5,029
Cash dividends declared, $.61 per share		—			—			(2,038		)	—			—			(2,038		)
Common stock issued under stock option plans		—			34			—			—			161			195
Balance at September 30, 2003		$	3,045		$	19,796		$	33,619		$	1,045		$	(7,091	)	$	50,414
Balance at December 31, 2003		$	3,045		$	19,819		$	34,251		$	1,767		($7,024		)	$	51,858
Comprehensive income:
Net income		—			—			3,809			—			—			3,809
Unrealized gain on securities, net of reclassification adjustments and tax		—			—			—			196			—			196
Unrealized gain on hedging actvities, net of reclassification adjustments and tax		—			—			—			346			—			346
Total Comprehensive income																	4,351
Cash dividends declared, $.65 per share		—			—			(2,174		)	—			—			(2,174		)
25% stock dividend		761			—			(761		)	—			—			—
Cash paid in lieu of fractional shares		—			—			(9		)	—			—			(9		)
Common stock issued under stock option plans		—			40			—			—			90			130
Balance at September 30, 2004		$	3,806		$	19,859		$	35,116		$	2,309		$	(6,934	)	$	54,156

 

The accompanying notes are an integral part of these financial statements.

 

4

 

Consolidated Statements of Cash Flows

 

		For the Nine Months Ended September 30
(Amounts in thousands)		2004			2003
Cash flows from operating activities
Net income		$	3,809		$	4,509
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		836			768
Net amortization of investment securities		469			667
Amortization and net write-down of mortgage servicing rights		128			184
Provision for loan losses		640			1,166
Securities gains, net		(204		)	(277		)
Loans originated for sale		(157,349		)	(38,724		)
Proceeds from sale of loans		156,837			42,650
Gain on sales of loans		(497		)	(874		)
Gain on sale of premises and equipment		—			(299		)
Increase in cash surrender value of life insurance		(355		)	(404		)
Increase in interest receivable and other assets		(362		)	(549		)
Increase in interest payable and other liabilities		370			36
Other, net		103			(44		)
Net cash provided by operating activities		4,425			8,809
Cash flows from investing activities
Proceeds from sales of investment securities available for sale		564			1,282
Proceeds from maturities of investment securities available for sale		28,535			37,644
Purchase of investment securities available for sale		(38,825		)	(28,881		)
Net decrease (increase) in restricted stock		405			(54		)
Net increase in loans		(11,332		)	(16,793		)
Proceeds from sale of premises and equipment		—			625
Capital expenditures		(854		)	(549		)
Net cash used in investing activities		(21,507		)	(6,726		)
Cash flows from financing activities
Net increase in demand deposits, NOW accounts and savings accounts		21,429			4,392
Net increase in certificates of deposit		6,477			9,464
Net decrease in short term borrowings		(4,365		)	(699		)
Long term debt advances		—			2,519
Long term debt payments		(3,141		)	(869		)
Dividends paid		(2,174		)	(2,038		)
Cash paid in lieu of fractional shares from stock split		(9		)	—
Common stock issued under stock option plans		130			195
Net cash provided by financing activities		18,347			12,964
Increase in cash and cash equivalents		1,265			15,047
Cash and cash equivalents as of January 1		15,616			14,572
Cash and cash equivalents as of September 30		$	16,881		$	29,619

 

The accompanying notes are an integral part of these statements.

 

5

 

FRANKLIN FINANCIAL SERVICES CORPORATION and SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1 - Basis of Presentation

 

The consolidated financial statements include the accounts of Franklin Financial Services Corporation (the Corporation), and its wholly-owned subsidiaries, Farmers and Merchants Trust Company of Chambersburg (the Bank) and Franklin Financial Properties Corp.  Farmers and Merchants Trust Company of Chambersburg is a commercial bank that has one wholly-owned subsidiary, Franklin Realty Services Corporation.  Franklin Realty Services Corporation is an inactive real-estate brokerage company.  Franklin Financial Properties Corp. holds real estate assets that are leased by the Bank. All significant intercompany transactions and account balances have been eliminated.

 

In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations, and cash flows at September 30, 2004, and for all periods presented have been made.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted.  It is suggested that these condensed consolidated financial statements be read in conjunction with the audited financial statements and notes thereto included in the Corporation’s 2003 Annual Report on Form 10-K.  The results of operations for the period ended September 30, 2004, are not necessarily indicative of the operating results for the full year.

 

For purposes of reporting cash flows, cash and cash equivalents include Cash and due from banks, Interest-bearing deposits in other banks and Federal funds sold.  Generally, Federal funds are purchased and sold for one-day periods.

 

Earnings per share is computed based on the weighted average number of shares outstanding during each period, adjusted for a 5 for 4 stock split issued in the form of a 25% stock dividend.  The Board of Directors approved the stock split on April 8, 2004 to be distributed on June 28, 2004, to shareholders of record on June 14, 2004. A reconciliation of the weighted average shares outstanding used to calculate basic earnings per share and diluted earnings per share follows:

 

		For the quarter ended September 30
(Amounts in thousands)		2004		2003
Weighted average shares outstanding (basic)		3,368		3,354
Impact of common stock equivalents, primarily stock options		7		10
Weighted average shares outstanding (diluted)		3,375		3,364

 

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		For the nine months ended September 30
(Amounts in thousands)		2004		2003
Weighted average shares outstanding (basic)		3,366		3,353
Impact of common stock equivalents, primarily stock options		9		7
Weighted average shares outstanding (diluted)		3,375		3,360

 

 

7

 

Note 2. Capital Adequacy

 

Quantitative measures established by regulation to ensure capital adequacy require financial institutions to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets and of Tier I capital to average assets. The Capital ratios of the Corporation and its bank subsidiary are as follows:

 

		As of September 30, 2004 (unaudited)
		Actual					Minimum Capital Required					Capital Required To Be Considered Well Capitalized
(Amounts in thousands)		Amount			Ratio		Amount			Ratio		Amount			Ratio
Total Capital (to Risk Weighted Assets)
Corporation		$	56,236		14.27	%	$	31,527		8.00	%	N/A
Bank		46,600			12.11	%	30,786			8.00	%	$	38,483		10.00	%
Tier 1 Capital (to Risk Weighted Assets)
Corporation		$	51,260		13.01	%	$	15,764		4.00	%	N/A
Bank		41,849			10.30	%	15,393			4.00	%	$	23,090		6.00	%
Tier 1 Capital (to Average Assets)
Corporation		$	51,260		8.95	%	$	22,919		4.00	%	N/A
Bank		41,849			7.42	%	22,575			4.00	%	$	28,218		5.00	%

 

8

 

Note 3 – Comprehensive Income

 

The components of other comprehensive income (loss) are as follows:

 

		Three months ended September 30						Nine months ended September 30
(Amounts in thousands)		2004			2003			2004			2003
Investment Securities:
Unrealized holding gains (loss) arising during the period		$	1,962		$	(1,357	)	$	501		$	788
Reclassification adjustments for gains included in net income		(80		)	(14		)	(204		)	(277		)
Cash-flow Hedges:
Unrealized holding (loss) gain arising during the period		(167		)	52			(30		)	(329		)
Reclassification adjustments for losses included in net income		147			210			554			606
Other comprehensive income(loss)		1,862			(1,109		)	821			788
Tax effect		(633		)	377			(279		)	$	(268	)
Other comprehensive income (loss),net of tax		$	1,229		$	(732	)	$	542		$	520

 

Note 4             Guarantees

 

The Corporation does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit.  Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party.  Generally, all letters of credit, when issued have expiration dates within one year.  The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers.  The Bank, generally, holds collateral and/or personal guarantees supporting these commitments.  The Bank had $6.0 million standby letters of credit of as of September 30, 2004 and $1.7 million as of December 31, 2003.   Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding guarantees.

 

9

 

Note 5             Stock Based Compensation

 

The Corporation has elected to follow the disclosure requirements of FASB Statement No. 123, “Accounting for Stock-Based Compensation.”  Accordingly, no compensation expense for the plans has been recognized in the financial statements of the Corporation.  Had compensation cost for the plans been recognized in accordance with Statement No. 123, the Corporation’s net income and per share amounts would have been reduced to the following pro-forma amounts.

 

				Three Months Ended September 30
(Amounts in thousands, except per share)				2004			2003
Net Income:		As reported		$	1,417		$	1,430
		Compensation not expensed, net of tax		(16		)	(17		)
		Proforma		$	1,401		$	1,413
Basic earnings per share:		As reported		$	.42		$	0.42
		Proforma		.42			0.42
Diluted earnings per share:		As reported		$	.42		$	0.42
		Proforma		.42			0.42

 

				Nine Months Ended September 30
(Amounts in thousands, except per share)				2004			2003
Net Income:		As reported		$	3,809		$	4,509
		Compensation not expensed, net of tax		(63		)	(62		)
		Proforma		$	3,746		$	4,447
Basic earnings per share:		As reported		$	1.13		$	1.34
		Proforma		1.11			1.33
Diluted earnings per share:		As reported		$	1.13		$	1.34
		Proforma		1.11			1.32

 

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Note 6 – Pensions

 

The components of pension expense for the periods presented are as follows:

 

		Three months ended September 30						Nine months ended September 30
(Amounts in thousands)		2004			2003			2004			2003
Components of net periodic Benefit cost:
Service cost		$	96		$	81		$	288		$	243
Interest cost		170			158			510			474
Expected return on plan assets		(219		)	(213		)	(657		)	(639		)
Amortization of prior service cost		6			6			19			18
Net periodic benefit cost		$	53		$	32		$	160		$	96

 

In the third quarter of 2004, the Bank contributed $293,075 to its Pension Plan.  This contribution was in accordance with the Bank's funding policy to contribute annually the amount required to meet the minimum funding requirements of the Employee Retirement Income Security Act of 1974.

 

Note 7 – Recent  Accounting Pronouncements

 

In March 2004, the Emerging Issues Task Force (EITF) reached consensus on Issue 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.”  EITF No. 03-01 includes new guidance for evaluating and recording impairment losses on debt and equity investments, as well as new disclosure requirements for investments that are deemed to be temporarily impaired.  The accounting guidance of EITF No. 03-01 is effective for fiscal years beginning after June 15, 2004, while the disclosure requirements are effective for fiscal years ending after June 15, 2004.  The Corporation does not believe that the adoption will have a material effect on its financial position or results of operations.

 

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Management’s Discussion and Analysis of
Results of Operations and Financial Condition
For the Three and Nine-Month Periods
Ended September 30, 2004 and 2003

 

Part 1, Item 2

 

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 and Stock-based Compensation. There were no new critical accounting policies adopted during the interim period nor were there any changes to the critical accounting policies disclosed in the 2003 Annual Report on Form 10-K in regards to application or related judgements and estimates used.  Please refer to Item 7 on pages 9,10,11 and 12 of the Corporation’s 2003 Annual Report on Form 10-K for a more detailed disclosure of the critical accounting policies.

 

Results of Operations

 

Summary

 

The Corporation reported earnings for the quarter ended September 30, 2004 of $1,417,000.  This represents a slight decrease of only .09% from the reported earnings of $1,430,000 for the same period in 2003. Basic earnings per share and diluted earnings per share were $.42 for both the third quarter of 2004 and 2003.  Net interest income increased $42,000, noninterest income increased $126,000 and noninterest expense increased $281,000 quarter versus quarter.

 

Net income for the first nine months of 2004 was $3,809,000, a decrease of 15.5%, versus net income of $4,509,000 for the first nine months of 2003.  Basic earnings per share and diluted earnings per share were $1.13 and $1.34 for the first nine months of 2004 and 2003, respectively.  Net interest income remained flat compared to 2003. However, the provision for loan losses decreased by $526,000 from 2003 to 2004.  Noninterest income decreased $594,000 from the prior year due primarily to a decline in

 

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mortgage banking revenue and a loss from the Corporation’s investment in a joint venture mortgage banking company.  Noninterest expense increased approximately $1 million from the prior year driven primarily by increases in salary and benefit costs.

 

Other key performance ratios as of, or for the nine months ended September 30 are listed below:

 

		2004		2003
Return on average equity (ROE)		9.46	%	12.11	%
Return on average assets (ROA)		.89	%	1.11	%
Nonperforming assets / total assets		.35	%	1.22	%
Allowance for loan loss as% of loans		1.35	%	1.32	%
Net (recovery) charge-offs / average loans		(.07	) %	.42	%

 

A more detailed discussion of the operating results for the third quarter and nine months ended September 30, 2004, follows:

 

Net Interest Income

Comparison of the three months ending September 30, 2004 to the three months ending September 30, 2003:

Net interest income for both the third quarter of 2004 and 2003 was $4.0 million. Interest income increased $120,000 to $6.3 million in 2004 from $6.1 million in 2003. Increases in interest income on investments ($151,000) and Federal funds & interest bearing deposits ($21,000) were partially offset by a decrease of $52,000 in interest on loans.  Overall, the increase in interest income was the result of growth in earning assets that more than offset a slight decrease in the yield on earning assets from year to year.

 

Interest expense increased $78,000 to $2.3 million for the third quarter of 2004 from $2.2 million in 2003.  Interest expense on deposits increased $61,000 and interest expense on short-term borrowings increased $58,000.  The increase in deposit expense was fueled by growth in nearly all interest-bearing deposit accounts during 2004.  Interest expense on short-term borrowings was driven up by both an increase in interest rates and balances. The payoff of several borrowings from the Federal Home Loan Bank of Pittsburgh (FHLB) was responsible for lower interest expense on long term debt.

 

The net interest margin for the third quarter of 2004 was 3.23% compared to 3.37% in 2003. The interest spread also decreased to 2.93% in 2004 from 3.08% in 2003.

 

Comparison of the nine months ending September 30, 2004 to the nine months ending September 30, 2003:

Net interest income for the first nine months of 2004 was $11.8 million compared with $11.9 million for the same period in 2003.    Interest income fell $533,000 (2.8%) to $18.3 million in 2004 from $18.8 million in 2003.  Slight increases in interest income in the investment portfolio and Federal funds could not offset a $605,000 decrease in interest income in the loan portfolio.  While the average loan portfolio showed growth of 7.5% from 2003, the yield on the loan portfolio fell from 6.17% in 2003 to 5.53% in 2004 and more than offset the benefits of the increased volume.

 

Total interest expense fell during the period.  Interest expense was $6.4 million in 2004 versus $6.9 million in 2003.  Even though interest bearing deposit balances grew during the period, the rate paid on these accounts in 2004 was lower than the rate paid in 2003. Interest expense on short term borrowings increased $146,000 from 2003 to 2004.  This is the result of an increase in the average balance of short term borrowings during 2004.  These borrowing fluctuate with the bank’s liquidity needs.  Interest expense on long term debt decreased $236,000 from 2003 to 2004.  Several loans from the FHLB were paid off during 2004 and as a result the bank recorded less interest expense than in 2003.  Overall, the balance of interest bearing liability accounts rose 3.8% during 2004, but the cost of these funds fell from 2.19% to 1.96%, resulting in reduced interest expense.

 

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