FRANKLIN FINANCIAL SERVICES CORPORATION
1996 ANNUAL REPORT
President's Message
Dear Shareholder,
1996 was a year of renewal and positioning for the future at Franklin
Financial. While your company recorded earnings of $4,127,000, this
represented a modest decline from 1995 earnings of $4,179,000. 1996 earnings
performance was impacted by expenses related to technology investments, an
increased provision for loan losses, and our market expansion into Cumberland
County during the fourth quarter.
As shareholders, you received an 8.3% increase in dividends during the
year as per share dividends increased from $.72 in 1995 to $.78 in 1996. The
book value of a single share of Franklin Financial stock increased from
$18.02 to $18.70 and market value improved as well, from $27.25 to $32.13.
These values were adjusted to reflect the 3 for 2 stock split in the form of
a 50% stock dividend distributed on December 29, 1995.
Part of your management's continuing efforts to enhance long-term
shareholder value includes our stock repurchase program to effectively manage
our capital position. During the year, we purchased 88,604 shares at a cost
of $2,682,500. Many analysts believe that repurchase programs should be viewed
as a strategic acquisition, resulting in increased earnings per share and
return on equity, as well as potentially higher stock prices to the continuing
shareholders. The impact of this strategy is reflected in the increase in
earnings per share from $2.17 in 1995 to $2.20 in 1996.
Assets at the end of 1996 reached a record $336,120,000, an increase of
7.2% over assets of $313,473,000 on December 31, 1995. The 5% year-to-year
growth in our loan portfolio reflects an acceleration in the fourth quarter
which is quite promising after three consecutive relatively flat years, giving
us added optimism to our projection of more asset growth with emerging
development and penetration into the Cumberland County market.
Preparing for future growth and service delivery, we made a number of
investments in technology, including installing a digital image processing
system, streamlining loan operations and introducing a debit card, which
benefit our company through the reduction of processing expenses and increases
in noninterest income. We are carefully monitoring the payback on these
investments, to ensure that they are within anticipated time frames.
Our market expansion into Cumberland County impacted earnings by
increasing salary and benefits, facilities, marketing and other expenses.
Unlike most branch acquisitions, the transaction to purchase the former PNCBank
offices did not include customer deposits and loans. We simply bought the
facilities and retail customer lists, thereby absorbing overhead
expense without an immediate corresponding revenue stream. The new deposit and
loan activity generated at these offices through the end of the first quarter
of 1997 is very encouraging. We expect that our investment in these new
markets will provide us with the potential for a significant increase in assets
and additional income generation capability, and will enhance long-term value
to our shareholders in the years ahead. In addition to the new offices in
Boiling Springs, Newville, and Shippensburg, we opened a new office at the Penn
Hall campus in Chambersburg which has already far exceeded our first-year
projections.
Net interest income after the provision for loan losses slipped 2.6% to
$13,105,000, largely as a result of an increased provision for possible loan
losses. The trend of rising consumer bankruptcies that began in the fourth
quarter of 1995 continues to loom as a negative factor. Management acted
prudently to increase the loan loss provision expense and intends to closely
monitor the credit quality of our loan portfolio to ensure that we remain
adequately reserved.
Noninterest income showed an 11.0% increase over 1995 results. As our
investment and trust service business continues to expand and develop, trust
assets under management grew to $262,840,000 by year end, a 17.3% increase from
a year earlier. Other contributors to noninterest income included security
sales, the sale of real estate and other assets related to our former real
estate brokerage subsidiary, and sales of mortgages into the secondary market.
Meanwhile, other noninterest expenses increased by only 1.2% to $11,372,000 and
were positively impacted by the reduction in FDIC insurance premiums.
Clearly we have a number of strategic initiatives before us that we must
implement in order to be successful in our mission. Among these are the need
to be attentive to increased non-bank competition and the challenge of
maintaining our net interest margin and growing our net interest income. We
will also continue to be challenged to maintain loan quality. As a community
bank, I also feel that we must capitalize on the competitive opportunities
presented by increasingly affordable technology as well as by the continuing
consolidation trend in the banking industry.
Before I conclude this letter, I want to express my appreciation to Bob
Zullinger and the other members of the board of directors for giving me the
opportunity to serve as your president and chief executive officer as well as
for their continued support and guidance. My personal pledge remains to work
effectively and diligently to uphold the values that have guided our company
for the past nine decades and to achieve our mission.
At Franklin Financial and F&M Trust, our commitment continues to be to
quality service: providing excellent customer service to produce quality
earnings. It is our belief that the delivery of quality service by our
employees to customers and our communities is the cornerstone for quality
earnings to you our shareholders. This is how we will prosper as an
independent, locally owned community bank. Our core values --- proactivity,
honesty and integrity, teamwork, and a concern for the individual --- will
serve as our road map to achieve our mission and guide us as we act as a good
corporate citizen within our communities.
Our continued success ultimately is linked to successfully serving our
constituencies --- our shareholders, our customers, our employees, and our
communities. The long-term value of our company has been placed in our
stewardship, and we intend to work toward this benefit.
Sincerely,
William E. Snell, Jr.
President and Chief Executive Officer
1996 - A Year of Growth and Expansion
F&M Trust Company celebrated its 90th anniversary in 1996. Throughout
the nine decades that the bank has endured, developed and prospered as an
independent community bank, the economic, cultural, and business climates have
changed, progressed and reoccured over the years. The success of F&M Trust is
attributable to many individuals but is truly the result of core values and
commitments to quality service, performance, and the ability to change.
While it is often said that things change, people make change
possible --- they are leaders, pioneers, change agents. One of the most
significant change agents in the company's history, Robert G. Zullinger,
retired from the banking profession in June of 1996 following 46 years of
service to F&M Trust. Bob held just about every position there was at the bank
as he climbed the corporate ladder. His resume' includes teller, bookkeeper,
manager of the installment loan department, trust officer, loan officer, vice
president, and eventually president and chief executive officer. His
day-to-day energy and insight have been missed but his experience and depth of
knowledge continues to benefit the bank through his contributions as an advisor
to the company and as vice chairman of the Board of Directors.
In keeping with change and progress, F&M Trust moved forward with
strategic initiatives focused upon technology, training and growth that are
designed to promote the bank's mission of exceptional quality service and
enhanced long-term shareholder value as an independent community bank.
Reengineering operations systems was a major part of F&M Trust's
technology investment with a primary focus on improvements to quality service
and cost reduction. Early in the year the bank purchased and installed a
digital image processing system. The system creates digitized images of checks
and deposit items that can be processed less expensively and more quickly
than paper documents. The images of the documents are captured and stored on
optical disks. Optical disk platters archive images for easy retrieval and
research.
The system benefits the bank through increased productivity by reducing
the storage space needed for processed documents, lowering postage expense,
improving the efficiency of statement printing and distribution, and enhancing
signature verification and research. Customers receive a clear, easy-to-read
and easy-to-file statement which includes images of their checks and improved
responsiveness to requests for cancelled check information and research. The
system also allows F&M Trust to provide additional services to better meet the
needs of individuals and businesses.
By the end of the year, nearly 99.5% of bank customers were receiving
only imaged statements. The image processing system has improved productivity
and efficiency in document processing, and is meeting management's projected
return on investment.
Loan operations were streamlined through enhancements made to the loan
system through a conversion to the BancSource(TM) system. The improvements
have effectively channeled paper flow while creating greater customer service
opportunities.
In July, the Freedom Card, a MasterMoney(TM) debit card, was introduced.
The Freedom Card looks like a credit card but it works more like an ATM card
and a check. Customers can pay for goods and services at MasterCard locations
and the amount of their purchases is deducted directly from their checking
account. The card also works like an ATM card so customers can get cash, make
deposits, transfer funds between accounts, and more through automated teller
machines on the MAC(R) or CIRRUS(R) networks. The Freedom Card reduces
processing expense since there are fewer checks to process and provides
additional noninterest income for the bank.
Since the technology represented by these processing systems and the
Freedom Card is only a delivery vehicle, it must be driven by people. Training
people to effectively utilize new technology is often of greater importance
than the technology itself. All employees now have faster access to
information through a wide area network of personal computers. F&M Trust
employees made a considerable commitment to increasing their knowledge and
application of these enhancements to improve productivity and efficiency.
Employees also are exposed to developmental opportunities through an
association with the Covey Leadership Center which promotes their effectiveness
as individuals as well as bank employees. Through various other training and
educational offerings, they have exhibited a commitment to improve their
technical and customer relations skills.
Many bank employees assisted in the training of new employees
hired to staff the new offices in Boiling Springs, Newville, and
Shippensburg. These three offices, located in buildings previously operated
as PNCBank branches, grew F&M Trust's service area which now extends from
Waynesboro to the Carlisle area. In addition to these new offices, the bank
opened a new office at the Penn Hall campus of Menno Haven retirement community
earlier in the year, bringing the number of community offices to a dozen.
Expansion wasn't limited to banking offices. As legislation removed some
of the barriers between banking and insurance powers, F&M Trust was expanding
its investment and trust services into the retail banking environment with the
Personal Investment Center. The Personal Investment Center is located in the
Memorial Square Office lobby and offers financial planning, investment
management and retirement planning services. The center is staffed by
Certified Financial Planner Kevin Shoemaker who offers investment planning that
may include alternative non-bank financial products like annuities and mutual
funds as well as discount brokerage services to better meet the needs of a
wider base of customers.
The investment and trust services department continued to develop
additional clients and focused new efforts towards businesses in a joint effort
with the commercial services department to provide employee benefit and 401(k)
plans. The commercial services department proactively attracted new business
customers for bill paying, investment, and lending services. Participating
with other lending institutions provided commercial services with the
opportunity to generate additional loans and grow revenues.
Serving families and individuals through mortgage lending and retail
services continued to be a significant portion of the bank's business. F&M
Trust further established itself as the market leader in mortgages in 1996, as
the volume of closed mortgages increased 40.3%. During the year, two new
mortgage products were introduced: the "5/1" and "10/1" mortgages. Both of
these products are hybrid adjustable rate mortgages that offer a fixed rate,
either for the first five years or for the first ten years. F&M Trust also
remained very active in first-time home buyer lending through Pennsylvania
Housing Finance Agency (PHFA) financing and offers Federal Home Administration
(FHA) and Veterans Administration (VA) financing.
Retail services, including deposit services and lending, remained
integral to business largely due to the delivery of quality service by our
staff. Service excellence is critical for a community bank to differentiate
itself from its competition. By knowing customers, listening to their needs,
responding in a timely and professional manner with the most appropriate
services that meet their needs, and exceeding their expectations, bank
employees provide the high level of customer service that is necessary.
Part of the quality equation also includes F&M Trust's commitment to the
community, and the bank and its employees shine in this arena. For years the
bank has been looked upon as the community leader for involvement and support,
and that continues today. Giving back to the community through donations and
financial support is only a small part of what you'll find at F&M Trust. You'll
also find a commitment to get involved, have an impact, and make a difference
in the lives of others, whether it be to preserve history, conserve the
environment, help the less fortunate help themselves, or act as role models for
youth.
Even as much as the bank expanded and grew in the past year, don't expect
a slow down in 1997. Additional strategic initiatives are underway to
introduce a telephone banking service called the Freedom Access Center enabling
customers to get account information and conduct banking business over the
telephone, 24 hours a day, 7 days a week. In order to serve customers more
effectively, a Marketing Customer Information File (MCIF) system will be
installed. This will enable bank employees to look at a customer's overall
relationship of accounts and services and make recommendations to better meet
customer needs. Several new deposit products are also being examined that would
offer customers benefits for relationship banking.
Product enhancements will be supported by improvements in service
delivery through additional customer service training, leadership training,
lending training and operations systems enhancements in 1997. All in all,
management expects that 1997 will be another year of growth, expansion, and
solidifying the company's position to improve service delivery and provide for
additional long-term shareholder value.
CONSOLIDATED FINANCIAL HIGHLIGHTS
Twelve Months Ended
December 31
% increase
(amounts in thousands, except per share) 1996 1995 (decrease)
Performance
Net income $4,127 $4,179 (1)
Return on assets 1.29% 1.34%
Return on equity 11.83% 12.50%
Shareholders' Value (per share)
Net income $2.20 $2.17 1
Dividends 0.78 0.72 8
Book value 18.70 18.02 4
Market value 32.13 27.25
Market value/book value ratio 171.82% 151.22%
Price/earnings multiple 14.60x 12.56x
Dividend yield 2.43% 2.64%
Safety and Soundness
Shareholders' equity/asset ratio 10.03% 10.77%
Nonperforming assets/total assets 0.54% 0.65%
Allowance for loan loss as a % of loans 1.36% 1.47%
Net charge-offs/average loans 0.32% 0.27%
Allowance for loan loss/nonaccrual loans 357.48% 468.11%
Allowance for loan loss/nonperforming loans 176.88% 175.08%
Risk-based capital (Tier 1) 14.75% 16.41%
Balance Sheet Highlights
Total assets $336,120 $313,473 7
Investment Securities 89,792 77,342 16
Loans, net 221,166 210,067 5
Deposits 268,202 257,211 4
Shareholders' equity 35,341 34,956 1
Trust assets under management (market value) 262,840 224,163 17
SUMMARY OF SELECTED FINANCIAL DATA
1996 1995 1994 1993 1992
(amounts in thousands, except per share)
Summary of operations
Interest income $24,799 $24,971 $22,028 $21,559 $23,245
Interest expense 11,087 11,210 9,720 10,120 11,901
Net interest income 13,712 13,761 12,308 11,439 11,344
Provision for possible loan losses 607 302 48 701 1,281
Net interest income after provision
for possible loan losses 13,105 13,459 12,260 10,738 10,063
Other income 3,773 3,400 3,604 5,048 4,117
Other expenses 11,372 11,229 11,104 11,817 10,857
Income before income taxes and
cumulative effect of
accounting change 5,506 5,630 4,760 3,969 3,323
Income tax 1,379 1,451 1,000 897 617
Income before cumulative effect
of accounting change 4,127 4,179 3,760 3,072 2,706
Cumulative effect of
accounting change -- -- -- 250 -
Net income $4,127 $4,179 $3,760 $3,322 $2,706
Per common share*
Net income before cumulative effect
of accounting change $2.20 $2.17 $1.92 $1.59 $1.41
Cumulative effect of
accounting change -- -- -- 0.12 -
Net income $2.20 $2.17 $1.92 $1.71 $1.41
Cash dividends $0.78 $0.72 $0.65 $0.61 $0.55
Balance sheet data
End of year
Total assets $336,120 $313,473 $310,554 $314,557 $307,252
Deposits 268,202 257,211 256,697 262,707 266,836
Loans, net 221,166 210,067 219,311 210,663 210,870
Shareholders' equity 35,341 34,956 32,873 30,618 27,653
Performance yardsticks (unaudited)
Return on average assets 1.29% 1.34% 1.21% 1.07% 0.92%
Return on average equity 11.83% 12.50% 11.82% 11.49% 10.16%
Dividend payout ratio 36.42% 33.98% 32.55% 32.54% 34.35%
Average equity to average asset ratio 10.87% 10.69% 10.26% 9.33% 9.02%
Trust assets under management (unaudited)
Personal trusts (market value) $261,803 $223,230 $182,872 $182,184 $157,537
Corporate trusts (market value) 1,037 933 1,611 1,747 1,508
$262,840 $224,163 $184,483 $183,931 $159,045
* Per share information has been adjusted retroactively to reflect all stock splits and dividends.
Market and Dividend Information
The Corporation's common stock is not actively traded in the over-the-counter market. The Corpoation
stock is listed under the symbol "FRAF" on the O.T.C. Electronic Bulletin Board, an automated quotation
service, made available through, and governed by, the NASDAQ system. Current price information is
available from account executives at most brokerage firms as well as the registered market makers of
Franklin Financial Services Corporation common stock. (See a listing of market makers on page 55 of
this report.) There were 1,717 shareholders of record as of December 31, 1996. The range of high and
low bid prices, as reported by local sources, are shown below for the years 1996 and 1995. Also shown
are the quarterly cash dividends paid for the same years.
Per share Per share
1996 High Low Cash div. 1995 High* Low* Cash div.
1st quarter . . . $28.75 $26.25 $0.19 1st quarter . . . $22.83 $22.17 $0.17
2nd quarter . . . 30.00 28.75 0.19 2nd quarter . . . 22.83 22.17 0.17
3rd quarter . . . 31.25 30.00 0.20 3rd quarter . . . 23.83 22.83 0.19
4th quarter . . . 31.25 31.25 0.20 4th quarter . . . 26.25 23.83 0.19
$0.78 $0.72
*Bid prices have been adjusted retroactively to reflect all stock splits and dividends. Cash dividend
per share have been adjusted to reflect the 3 for 2 stock split issued in the form of a 50% stock dividend
distributed on December 29, 1995.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors, Franklin Financial Services
Corporation:
We have audited the accompanying consolidated balance sheets of FRANKLIN
FINANCIAL SERVICES CORPORATION (a Pennsylvania corporation) and subsidiaries as
of December 31, 1996 and 1995, and the related consolidated statements of
income, changes in shareholders' equity, and cash flows for each of the three
years in the period ended December 31, 1996. These financial statements are the
responsibility of the Corporation's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of FRANKLIN FINANCIAL SERVICES
CORPORATION and subsidiaries as of December 31, 1996 and 1995, and the results
of their operations and cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles.
Arthur Andersen LLP
Lancaster, PA
January 28, 1997
Consolidated Balance Sheets
(Amounts in thousands, except per share data) December 31
1996 1995
Assets
Cash and due from banks (Note 3) $10,265 $8,244
Interest-bearing deposits in other banks 256 6,660
Investment securities held to maturity (market value of $36,199 and $35,563 at
December 31, 1996 and 1995, respectively) (Notes 1 and 4) 36,290 35,317
Investment securities available for sale (Notes 1 and 4) 53,502 42,025
Loans, net (Notes 1 and 5) 221,166 210,067
Premises and equipment, net (Notes 1 and 7) 6,698 5,645
Other assets 7,943 5,515
Total assets $336,120 $313,473
Liabilities
Deposits (Note 8)
Demand (noninterest-bearing) $34,847 $31,609
Savings and interest checking 104,763 99,049
Time 128,592 126,553
Total Deposits 268,202 257,211
Securities sold under agreements to repurchase(Note 9) 15,122 13,611
Other borrowings (Note 9) 14,891 5,650
Other liabilities 2,564 2,045
Total liabilities 300,779 278,517
Commitments and contingencies (Notes 13 and 15)
Shareholders' equity (Notes 2, 12 and 14)
Common stock, $1 par value per share, 5,000 shares authorized with 2,030
shares issued and 1,890 and 1,940 outstanding at December 31, 1996
and 1995, respectively 2,030 2,030
Capital stock without par value, 5,000 shares authorized with no shares
issued and outstanding - -
Additional paid-in capital 19,745 19,431
Retained earnings 17,590 14,966
Net unrealized gain on securities 613 677
Treasury stock (3,830) (2,053)
Unearned compensation (Note 11) (807) (95)
Total shareholders' equity 35,341 34,956
Total liabilities and shareholders' equity $336,120 $313,473
The accompanying notes are an integral part of these statements.
Consolidated Statements of Income
(Amounts in thousands, except per share data) Years ended December 31
1996 1995 1994
Interest income (Note 1)
Interest on loans $19,903 $20,280 $17,723
Interest on deposits and other obligations of other banks 210 683 45
Interest on Federal funds sold - 9 3
Interest on investments:
U.S. Government obligations 311 283 322
Obligations of U.S. Government agencies and corporations 2,542 1,893 1,638
Obligations of states and political subdivisions 999 1,096 1,295
Other securities 695 585 876
Dividend income 139 142 126
Total interest income 24,799 24,971 22,028
Interest expense
Interest on deposits (Note 8) 9,848 10,119 8,824
Interest on securities sold under agreements to repurchase 762 639 212
Other borrowings 477 452 684
Total interest expense 11,087 11,210 9,720
Net interest income 13,712 13,761 12,308
Provision for possible loan losses (Notes 1 and 6) 607 302 48
Net interest income after provision for possible loan losses 13,105 13,459 12,260
Noninterest income
Trust commissions 1,175 1,166 1,038
Service charges, commissions and fees 1,861 1,930 1,948
Other 571 294 399
Securities gains 166 10 219
Total noninterest income 3,773 3,400 3,604
Noninterest expense
Salaries and employee benefits 6,406 6,100 5,774
Net occupancy expense 524 517 505
Furniture and equipment expense 751 762 750
FDIC insurance 163 323 580
Other 3,528 3,527 3,495
Total noninterest expense 11,372 11,229 11,104
Income before Federal income taxes 5,506 5,630 4,760
Federal income tax expense (Note 10) 1,379 1,451 1,000
Net income $4,127 $4,179 $3,760
Earnings per share (Note 1)*
Net income per share $2.20 $2.17 $1.92
* Net income per share computations for 1994 have been adjusted to reflect a 3 for 2 stock split issued
in the form of a 50% stock dividend distributed on December 29, 1995.
The accompanying notes are an integral part of these statements.
Consolidated Statements of Changes in Shareholders' Equity
For years ended December 31, 1996, 1995 and 1994:
Additional Net Unrealized
Common Paid-in Retained Gain(Loss)on Treasury Unearned
(Amounts in thousands, except Stock Capital Earnings Securities Stock Compensation Total
per share data)
Balance at December 31, 1993 $1,231 $15,493 $14,358 $302 ($154) ($612) $30,618
Year ended December 31, 1994
Net income - -- 3,760 - - - 3,760
Cash dividends, $.65 per share (1,224) - - - (1,224)
10% stock dividend 122 3,888 (4,010) - - - -
Common stock issued under
stock option plans (Note 12) - 70 - - 147 - 217
Net unrealized gain on
securities (Note 1 and
Note 4) - - - (655) - - (655)
Acquisition of 842 shares of
treasury stock at cost - - - - (29) - (29)
Amortization of unearned
compensation (Note 11) - - - - - 186 186
Balance at December 31, 1994 1,353 19,451 12,884 (353) (36) (426) 32,873
Year ended December 31, 1995
Net income - - 4,179 - - - 4,179
Cash dividend, $.72 per share - - (1,420) - - - (1,420)
50% stock dividend 677 - (677) - - - -
Common stock issued under
stock option plans (Note 12) - (20) - - 218 - 198
Change in net unrealized loss
on securities (Note 1 and
Note 4) - - - 1,030 - - 1,030
Acquisition of 64,741 shares of
treasury stock at cost - - - - (2,235) - (2,235)
Amortization of unearned
compensation (Note 11) - - - - - 331 331
Balance at December 31, 1995 2,030 19,431 14,966 677 (2,053) (95) 34,956
Year ended December 31, 1996
Net income - - 4,127 - - - 4,127
Cash dividends, $.78 per share - - (1,503) - - - (1,503)
Common stock issued under
stock option plans (Note 12) - (33) - - 233 - 200
Change in net unrealized gain
on securities (Note 1 and
Note 4) - - - (64) - - (64)
Restricted stock issued under
long-term incentive
compensation plan
(28,926 shares, net of forfeitures) - 177 - - 672 (849) -
Acquisition of 88,604 shares of
treasury stock at cost - - - - (2,682) - (2,682)
Tax benefit of restricted
stock transaction - 170 - - - - 170
Amortization of unearned
compensation (Note 11) - - - - - 137 137
Balance at December 31, 1996 $2,030 $19,745 $17,590 $613 ($3,830) ($807) $35,341
Cash dividends in 1994 have been adjusted to reflect a 3 for 2 stock split issued
in the form of a 50% stock dividend distributed on December 29, 1995.
The accompanying notes are an integral part of these statements.
Consolidated Statements of Cash Flows
Years ended December 31
1996 1995 1994
(Amounts in thousands)
Cash flows from operating activities
Net income $4,127 $4,179 $3,760
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation 741 627 620
Premium amortization on investment securities 107 74 264
Discount accretion on investment securities (129) (173) (151)
Provision for possible loan losses 607 302 48
Securities gains, net (166) (10) (219)
Proceeds from sale of mortgage loans 15,225 15,076 7,680
Principal gains on sales of mortgage loans (71) (61) (47)
Gain on sale of premises and equipment (196) (25) (116)
Loan charge-offs, net of recoveries (688) (586) (221)
Increase in interest receivable (138) (214) (165)
Increase in interest payable 117 169 155
(Decrease) Increase in unearned discount (361) (591) 686
(Increase)Decrease in prepaid and other assets (432) (615) 88
Increase(Decrease) in accrued expenses and other liabilities 436 (893) 189
Other , net 305 366 180
Net cash provided by operating activities 19,484 17,625 12,751
Cash flows from investing activities
Proceeds from sales of investment securities
available for sale 334 - 757
Proceeds from maturities of investment securities
held to maturity 11,026 18,172 21,850
Proceeds from maturities of investment securities
available for sale 12,641 6,633 4,793
Purchase of investment securities held to maturity (11,999) (9,250) (13,438)
Purchase of investment securities available for sale (24,360) (18,651) (967)
Net change in loans (25,811) (4,896) (16,824)
Acquisition of branch offices and customer lists (2,667) - -
Capital expenditures (1,120) (1,313) (421)
Proceeds from sales of premises and equipment 331 158 216
Net cash used in investing activities (41,625) (9,147) (4,034)
Cash flows from financing activities
Net increase (decrease) in demand deposits, NOW accounts
and savings accounts 8,952 (4,642) (8,278)
Net increase in certificates of deposit 2,039 5,156 2,268
Dividends (1,503) (1,420) (1,224)
Common stock issued under stock option plans 200 198 217
Purchase of treasury shares (2,682) (2,235) (29)
Cash inflows (outflows) from other borrowings 10,752 698 (437)
Net cash provided by (used in) financing activities 17,758 (2,245) (7,483)
(Decrease) Increase in cash and cash equivalents (4,383) 6,233 1,234
Cash and cash equivalents as of January 1 14,904 8,671 7,437
Cash and cash equivalents as of December 31 $10,521 $14,904 $8,671
Supplemental Disclosures of Cash Flow Information
Cash paid during the year for: 1996 1995 1994
Interest paid on deposits and other borrowed funds $10,970 $11,041 $9,565
Income tax paid 1,335 1,425 995
The accompanying notes are an integral part of these statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. Summary of Significant Accounting Policies
The accounting policies of Franklin Financial Services Corporation and its
subsidiary conform to generally accepted accounting principles and to general
industry practices. A summary of the more significant accounting policies which
have been consistently applied in the preparation of the accompanying
consolidated financial statements follows:
Principles of Consolidation - The consolidated financial statements include
the accounts of Franklin Financial Services Corporation (the Corporation) and
its wholly-owned subsidiary, Farmers and Merchants Trust Company, a commercial
bank (the Bank). Effective May 1, 1995, The Mont Alto State Bank, also a
commercial bank and a subsidiary of the Corporation, was merged into Farmers
and Merchants Trust Company. In addition, on December 29, 1995, Franklin
Founders Life Insurance Company, a credit life reinsurance company and a
subsidiary of the Corporation was dissolved. All significant intercompany
transactions and account balances have been eliminated.
Nature of Operations - The Corporation conducts all of its business through
its subsidiary bank, Farmers and Merchants Trust Company. The Bank serves its
customer base through twelve full-service offices located in Franklin and
Cumberland Counties in Pennsylvania.
The Bank is a community-oriented commercial bank that emphasizes quality
customer service and convenience. As part of its strategy, the Bank has sought
to develop a variety of products and services that meet the needs of its
retail, commercial and trust customers.
Use of Estimates in the Preparation of Financial Statements - The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Statement of Cash Flows - 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.
Investment Securities - Except as noted below, debt securities are acquired
with the intent to hold to maturity and are stated at cost, adjusted for
amortization of premiums and accretion of discounts which are recognized as
adjustments of interest income. Certain specific debt securities and all
marketable equity securities have been classified as "available for sale" to
serve as a potential source of liquidity. Available for sale securities are
stated at estimated market value with the related unrealized holding gains and
losses reported as a separate component of shareholders' equity, net of tax,
until realized. Realized securities gains and losses are computed using the
specific identification method.
Interest and dividends on investment securities are recognized as income
when earned. Gains or losses on the disposition of investment securities are
based on the net proceeds and the adjusted carrying amount of the specific
securities sold. In the opinion of management, the Corporation has the ability
and intent to hold investment securities carried at amortized cost to maturity.
In December 1995, the Corporation reclassified investment securities with
a book value of $15,706,000 and a market value of $15,745,000 from held to
maturity to available for sale. This reclassification was allowable under
Financial Accounting Standards Board(FASB) guidance which permitted
institutions to make a one-time reassessment of the appropriateness of
investment security classifications. As a result of this reclassification,
the unrealized gain on securities recorded as a component of shareholders'
equity increased approximately $26,000, net of tax.
Loans - Interest on all loans is accrued over the term of the loans based
on the amount of principal outstanding. Unearned interest on installment loans
is recognized on a basis which approximates the interest method.
Accrual of interest income is generally discontinued when a loan becomes
90 days past due as to principal or interest and management considers the
collection of principal or interest to be doubtful. When interest accruals are
discontinued, interest credited to income in the current year is reversed and
interest accrued in any prior year is charged to the allowance for loan losses.
Allowance for Possible Loan Losses - For financial reporting purposes, the
provision for possible loan losses charged to current operating income is based
on estimates, and ultimate losses may vary from the current estimates. These
estimates are reviewed periodically and, as adjustments become necessary, they
are reported in earnings in the period in which they become known. The adequacy
of the level of the reserve is determined by a continuing review of the
composition of the loan portfolio, overall portfolio quality, specific problem
loans, prior loan loss experience and current and prospective economic
conditions that may affect a borrower's ability to pay.
On January 1, 1995, the Corporation adopted Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a
Loan" (Statement No. 114) as amended by Statement of Financial Accounting
Standards No. 118, "Accounting by Creditors for Impairment of a Loan - Income
Recognition and Disclosures" (Statement No. 118). Statement No. 114 requires
that impaired loans be measured based on the present value of expected future
cash flows discounted at the loan's effective interest rate, or at the loan's
observable market price or fair value of the collateral if the loan is
collateral dependent, except for loans considered to be homogeneous pools and
leases for which this statement does not apply. Management considers most
consumer loans as homogeneous pools. A loan is considered to be impaired when,
based on current information and events, it is probable that the Corporation
will be unable to collect all amounts due according to the contractual terms of
the loan agreement. Prior to the adoption of Statement No. 114, the allowance
for loan losses related to impaired loans was based on undiscounted cash flows
or the fair value of the collateral for collateral dependent loans. Adoption of
Statement No. 114 did not significantly affect the Corporation's financial
statements.
Premises and Equipment - Premises and equipment are stated at cost less
accumulated depreciation. Depreciation is computed using the
straight-line method. When assets are retired or sold, the asset cost and
related accumulated depreciation are eliminated from the respective accounts,
and any resultant gain or loss is included in net income.
The cost of maintenance and repairs is charged to operating expense as
incurred, and the cost of major additions and improvements is capitalized.
Federal Income Taxes - The Corporation and its subsidiary file a
consolidated Federal income tax return. The Corporation accounts for income
taxes in accordance with Statement No. 109, "Accounting for Income Taxes."
Deferred tax assets or liabilities are computed based on the difference between
the financial statement and income tax bases of assets and liabilities using the
applicable enacted marginal tax rate. Deferred income tax expenses or benefits
are based on the changes in the deferred tax asset or liability from period to
period.
Earnings per share - Earnings per share is computed based on the weighted
average number of shares outstanding during each year, adjusted retroactively
for stock splits and dividends. Adjustments resulted from a 3 for 2 stock split
issued in the form of a 50% stock dividend distributed on December 29, 1995
to shareholders of record on December 8, 1995, and a 10% stock dividend
distributed on December 30, 1994 to shareholders of record on December 9, 1994.
Stock options and restricted stock are not reflected in the computation as there
is no material dilutive effect.
Reclassifications - Certain prior period amounts have been reclassified to
conform with the current year presentation.
Recent Accounting Pronouncements:
Accounting for Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities - In June 1996, the FASB issued Statement No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities."
This Statement provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishment of liabilities. Those standards
are based on consistent application of a financial-components approach that
focuses on control. Under that approach, after a transfer of financial assets,
an entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished. This Statement
provides consistent standards for distinguishing transfers of financial assets
that are sales from transfers that are secured borrowings. Statement No. 127
was also issued in 1996 and amended Statement No. 125 by deferring for one year
the effective date for certain provisions of Statement No. 125. Statement
No. 125, as amended, was adopted prospectively on January 1, 1997, and Statement
No. 127 will be adopted on January 1, 1998. No material financial statement
impact is anticipated.
NOTE 2. Regulatory Matters
Certain restrictions exist under Federal law regarding the ability of the
Bank to transfer funds to the Corporation in the form of cash dividends, loans,
or advances. The dividend limitation generally restricts dividend payments to
the Bank's retained net income in the current and preceding two calendar years.
Accordingly, under this limitation, as of December 31, 1996 approximately
$4,653,000 of the undistributed earnings of the Bank would be available for
distribution to the Corporation as dividends without prior regulatory approval.
The Bank also is limited as to the amount it may loan the Corporation, unless
such loans are collateralized by specific obligations.
The Corporation's subsidiary Bank is subject to various regulatory capital
requirements administered by federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Corporation's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities, and certain off-balance-sheet items
as calculated under regulatory accounting practices. The Bank's capital amounts
and classification are also subject to qualitative judgements by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 1996, that the
Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 1996, the most recent notification from Federal Deposit
Insurance Corporation categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based,
Tier I leverage ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed the
institution's category.
The table that follows presents the total risk-based, Tier I risk-based and
Tier I leverage requirements for the Corporation and the Bank. Actual capital
amounts and ratios are also presented.
As of December 31, 1996
To be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provision
(Amounts in thousands) Amount Ratio Amount Ratio Amount Ratio
Total Capital (to Risk Weighted Assets)
Corporation $35,354 16.00% $17,676 8.00% $22,095 10.00%
Bank 32,479 14.80% 17,554 8.00% 21,943 10.00%
Tier I Capital (to Risk Weighted Assets)
Corporation $32,588 14.75% $8,838 4.00% $13,257 6.00%
Bank 29,732 13.55% 8,777 4.00% 13,166 6.00%
Tier I Capital (to Average Assets)
Corporation $32,588 10.03% $13,003 4.00% $16,253 5.00%
Bank 29,732 9.23% 12,878 4.00% 16,098 5.00%
As of December 31, 1995
To be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provision
Amount Ratio Amount Ratio Amount Ratio
Total Capital (to Risk Weighted Assets)
Corporation $36,489 17.66% $16,528 8.00% $20,661 10.00%
Bank 32,569 15.96% 16,330 8.00% 20,412 10.00%
Tier I Capital (to Risk Weighted Assets)
Corporation $33,895 16.41% $8,264 4.00% $12,396 6.00%
Bank 30,005 14.70% 8,165 4.00% 12,247 6.00%
Tier I Capital (to Average Assets)
Corporation $33,895 10.77% $12,587 4.00% $15,733 5.00%
Bank 30,005 9.60% 12,504 4.00% 15,630 5.00%
Management believes that under the current and proposed regulations the Corporation and its Bank subsidiary
will continue to meet the minimum capital requirements in the forseeable future. However, events beyond
the control of the Corporation, such as increased interest rates or a downturn in the economy in areas
where the Bank subsidiary has a concentration of its loans, could adversely affect future earnings and,
consequently, the ability of the Corporation and its Bank subsidiary to meet future capital requirements.
NOTE 3. Restricted Cash Balances
Aggregate cash reserves of $2,624,000 and $1,874,000 were maintained to
satisfy Federal regulatory requirements at December 31, 1996 and 1995,
respectively. As compensation for check clearing and other services,
compensating balances are required to be maintained with correspondent banks.
At December 31, 1996 and 1995, these balances were approximately
$900,000 and $600,000, respectively.
NOTE 4. Investment Securities
Included as Other in the Held to Maturity classification in the following schedules are common stock of
the Federal Home Loan Bank of Pittsburgh and Atlantic Central Bankers Bank which in the aggregagate total
$ 1,223,000 and $1,139,000 at December 31, 1996 and 1995, respectively. Common stock of the
Federal Home Loan Bank and Atlantic Central Bankers Bank represent ownership in institutions which
are wholly owned by other financial institutions.
The amortized cost and estimated market values of investment securities as of December 31,
1996 and 1995 are as follows:
Gross Gross Estimated
Amortized unrealized unrealized market
(Amounts in thousands) cost gains losses value
1996 Held to Maturity
U.S. Treasury securities and obligations of U.S.
Government agencies and corporations $1,051 $7 $ - $1,058
Obligations of state and political subdivision 19,496 142 102 19,536
Corporate debt securities 3,688 4 15 3,677
Mortgage-backed securities 10,832 41 168 10,705
35,067 194 285 34,976
Other 1,223 -- -- 1,223
$36,290 $194 $285 $36,199
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1996 Available for Sale
Equity securities $1,380 $1,110 $ - $2,490
U.S. Treasury securities and obligations of U.S.
Government agencies and corporations 27,054 89 88 27,055
Obligations of state and political subdivision 1,934 8 12 1,930
Corporate debt securities 5,046 14 2 5,058
Mortgage-backed securities 17,159 17 207 16,969
$52,573 $1,238 $309 $53,502
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1995 Held to Maturity
U.S. Treasury securities and obligations of U.S.
Government agencies and corporations $849 $ - $ - $849
Obligations of state and political subdivision 16,225 276 17 16,484
Corporate debt securities 6,795 21 26 6,790
Mortgage-backed securities 10,309 97 105 10,301
34,178 394 148 34,424
Other 1,139 -- -- 1,139
$35,317 $394 $148 $35,563
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1995 Available for Sale
Equity securities $1,330 $826 $ - $2,156
U.S. Treasury securities and obligations of U.S.
Government agencies and corporations 25,717 212 6 25,923
Obligations of state and political subdivision 2,417 14 11 2,420
Corporate debt securities 1,025 11 -- 1,036
Mortgage-backed securities 10,511 28 49 10,490
$41,000 $1,091 $66 $42,025
At December 31, 1996 and 1995, investment securities pledged to secure public funds, trust balances
and other deposits and obligations totaled $54,864,000 and $41,547,000, respectively. Proceeds from the sale
of available for sale securities totaled approximately $334,000 for the year ended December 31,1996.
The net gains realized from these sales were $166,000. There were no sales in 1995. However, net
gains of $10,000 were realized in 1995 which were the result of calls on two municipal securities
The amortized cost and estimated market value of debt securities at December 31, 1996, by contractual
maturity follows. Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or prepayment penalties.
Estimated
Amortized market
cost value
Held to Maturity
Due in one year or less $2,690 $2,706
Due after one year through five years 14,711 14,738
Due after five years through ten years 5,191 5,141
Due after ten years 1,643 1,686
$24,235 $24,271
Mortgage-backed securities 10,832 10,705
$35,067 $34,976
Estimated
Amortized market
cost value
Available for Sale
Due in one year or less $7,613 $7,629
Due after one year through five years 19,937 19,945
Due after five years through ten years 6,484 6,469
$34,034 $34,043
Mortgage-backed securities 17,159 16,969
$51,193 $51,012
The amortized cost and estimated market value of mortgage backed securities by issuer as of December 31, 1996
and 1995 are as follows:
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1996 Held to Maturity
Federal Home Loan Mortgage Corporation $4,028 $12 $41 $3,999
Federal National Mortgage Association 3,094 4 53 3,045
Government National Mortgage Association 530 13 -- 543
Other Private 3,180 12 74 3,118
$10,832 $41 $168 $10,705
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1996 Available for Sale
Federal Home Loan Mortgage Corporation $10,995 $ - $161 $10,834
Federal National Mortgage Association 5,556 5 46 5,515
Government National Mortgage Association 608 12 -- 620
$17,159 $17 $207 $16,969
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1995 Held to Maturity
Federal Home Loan Mortgage Corporation $4,771 $60 $21 $4,810
Federal National Mortgage Association 3,786 10 37 3,759
Government National Mortgage Association 622 27 -- 649
Other Private 1,130 -- 47 1,083
$10,309 $97 $105 $10,301
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1995 Available for Sale
Federal Home Loan Mortgage Corporation $6,175 $ $43 $6,132
Federal National Mortgage Association 3,601 6 6 3,601
Government National Mortgage Association 735 22 -- 757
$10,511 $28 $49 $10,490
NOTE 5. Loans
A summary of loans outstanding at the end of the reporting periods follows:
December 31
(Amounts in thousands) 1996 1995
Real estate (primarily first mortgage residential loans) $79,478 $83,800
Real estate - Construction 3,727 5,233
Commercial, industrial and agricultural 91,244 74,678
Consumer (including home equity lines of credit) 49,936 50,017
224,385 213,728
Less: Unearned discount (159) (520)
Allowance for possible loan losses (3,060) (3,141)
Net Loans $221,166 $210,067
Loans to directors and executive officers and to their related interests and affiliated
enterprises amounted to approximately $1,416,000 and $1,116,000 at December 31, 1996 and
1995, respectively. Such loans are made in the ordinary course of business at the Bank's
normal credit terms and do not present more than a normal risk of collection. During 1996,
$712,000 of new loans were made and repayments totaled $412,000.
NOTE 6. Allowance for Possible Loan Losses
December 31
(Amounts in thousands) 1996 1995 1994
Balance at beginning of year $3,141 $3,425 $3,598
Charge-offs
Commercial, industrial and agricultural (183) (89) (51)
Consumer (582) (511) (230)
Real estate (12) (76) (38)
Total charge-offs (777) (676) (319)
Recoveries:
Commercial, industrial and agricultural 25 46 60
Consumer 64 43 19
Real estate -- 1 19
Total recoveries 89 90 98
Net charge-offs (688) (586) (221)
Provision for possible loan losses 607 302 48
Balance at end of year $3,060 $3,141 $3,425
Nonaccrual loans at December 31, 1996 and 1995 were approximately $856,000 and $671,000,
respectively. The gross interest that would have been recorded if these loans had been
current in accordance with their original terms and the amounts actually recorded in
income were as follows:
(Amounts in thousands) 1996 1995
Gross interest due under terms $120 $129
Amount included in income (46) (26)
Interest income not recognized $74 $103
At December 31, 1996 and 1995, the Corporation recorded no restructured loans.
At December 31, 1996 and 1995, the recorded investment in loans that were considered
to be impaired, as defined by Statement No. 114, totaled $789,300 and $495,000, respectively.
Impaired loans have an allowance for credit losses of $14,000 and $123,500 as of December 31,
1996 and 1995, respectively. The Corporation does not recognize interest income on its impaired
loans. Cash receipts on impaired loans are credited to the earliest amount owed by the
borrower. The average recorded investment in impaired loans during the years ended December 31,
1996 and 1995, was $594,200 and $857,400 respectively.
NOTE 7. Premises and Equipment
Premises and equipment consist of:
Estimated December 31
(Amounts in thousands) useful life 1996 1995
Land $1,088 $ 841
Buildings 18-40 years 7,479 6,846
Furniture, fixtures and equipment 3-13 years 4,987 4,215
Total cost 13,554 11,902
Less: Accumulated Depreciation (6,856) (6,257)
$6,698 $5,645
NOTE 8. Deposits
Deposits are summarized as follows:
December 31
(Amounts in thousands) 1996 1995
Demand $34,847 $31,609
Savings:
Interest-bearing checking 34,473 31,090
Money market accounts 25,288 22,694
Passbook and statement savings 45,002 45,265
104,763 99,049
Time:
Deposits of $100,000 and over 30,345 19,450
Other time deposits 98,247 107,103
128,592 126,553
Total deposits $268,202 $257,211
The interest expense on time deposits with denominations of $100,000 or more for the years
ended December 31, 1996, 1995 and 1994 was $1,179,000, $1,185,000 and $825,000, respectively.
NOTE 9. Securities Sold Under Agreements to Repurchase and Other Borrowings
The Corporation enters into sales of securities under agreements to repurchase.
Securities sold under agreements to repurchase averaged $16,144,000 and
$12,465,000 during 1996 and 1995, respectively, and the maximum amounts
outstanding at any month end during 1996 and 1995, were $19,955,000
and $16,212,000, respectively. The weighted average interest rate on these
repurchase agreements was 4.72% and 5.12% for 1996 and 1995, respectively.
At December 31, 1996, securities sold under agreements to repurchase totaled
$15,122,000 with interest rates ranging from 4.43% to 4.68%. The securities
that serve as collateral for securities sold under agreements to repurchase
represent primarily U.S. Government and U.S. Agency securities with a book and
market value of $20,366,636 and $20,258,184 respectively, at December 31, 1996.
The securities sold under agreements to repurchase are overnight borrowings.
A summary of other borrowings at the end of the reporting period follows:
December 31
(Amounts in thousands) 1996 1995
Open Repo Plus (a) $7,050 $ -
Term loans (b) 7,841 5,650
Total other borrowings $14,891 $5,650
(a) Open Repo Plus is a revolving term commitment with the Federal Home Loan Bank of Pittsburgh
(FHLB) used on an overnight basis. The term of these commitments may not exceed 364 days
and the outstanding balance reprices daily at market rates. The total amount available under the
commitment in place on December 31, 1996 was $20,000,000 and the rate on the outstanding
balance was 6.75%.
(b) Term loans with the FHLB bear interest at fixed rates ranging from 5.70% to 7.27% (weighted
average rate of 6.53%) with various maturities beginning September 30, 1997 to September 30, 2002
All borrowings from the FHLB are collateralized by FHLB stock, mortgage-backed securities
and first mortgage loans.
The scheduled maturities of the term borrowings are as follows:
1997 $746
1998 687
1999 5,634
2000 592
2001 29
2002 and beyond 153
$7,841
NOTE 10. Federal Income Taxes
The temporary differences which give rise to significant portions of deferred
tax assets and liabilities under Statement No.109 are as follows:
(amounts in thousands)
Deferred Taxes December 31
Temporary Difference 1996 1995
Allowance for possible loan losses $1,034 $1,068
Deferred compensation 182 180
Pensions 53 22
Restricted stock 91 164
Depreciation (91) (243)
Net unrealized gain on securities (316) (349)
Deferred loan fees and costs,net 387 534
Other, net (36) 123
Valuation allowance - (118)
Deferred taxes, net $1,304 $1,381
In determining the level of valuation reserves required, the Corporation has determined based upon
its historical level of earnings, its interest margin, gap position and future taxable income that it is
more likely than not that the net deferred tax assets will be realized over a period approximating
5 years. Accordingly, the valuation allowance was reduced in 1996.
The components of the provision for Federal income taxes attributable to income from operations were
as follows:
Years ended December 31
(Amounts in thousands) 1996 1995 1994
Currently payable $1,302 $1,488 $1,108
Deferred tax expense (benefit) 77 (37) (108)
Income tax provision $1,379 $1,451 $1,000
For the years ended December 31, 1996, 1995 and 1994, the income tax provisions are different from
the tax expense which would be computed by applying the Federal statutory rate to pretax operating
earnings. A reconciliation between the tax provision at the statutory rate and the tax provision at the
effective tax rate is as follows:
Years ended December 31
(Amounts in thousands) 1996 1995 1994
Tax provision at statutory rate $1,872 $1,914 $1,618
Income on tax-exempt loans and securities (418) (461) (530)
Nondeductible interest expense relating to
carrying tax-exempt obligations 61 65 60
Dividends received exclusion (15) (16) (30)
Valuation allowance adjustment (118) (101) (100)
Other, net (3) 50 (18)
Income tax expense $1,379 $1,451 $1,000
The tax provision in each year is applicable to:
Years ended December 31
(Amounts in thousands) 1996 1995 1994
Operations $1,323 $1,448 $926
Securities gains (losses) 56 3 74
Income tax provision $1,379 $1,451 $1,000
NOTE 11. Employee Benefit Plans
The Bank has a noncontributory retirement plan covering all employees of
F& M Trust who meet certain age and service requirements. Benefits are based
on years of service and the employee's compensation during the highest five
consecutive years out of the last ten years of employment. The Banks' funding
policy is to contribute annually the amount required to meet the minimum
funding requirements of the Employee Retirement Income Security Act of 1974.
Contributions are intended to provide not only for benefits attributed to
service to date but also for those expected to be earned in the future.
The following table sets forth the plan's funded status at December 31,
1996 based on a September 30, 1996 actuarial valuation together with
comparative 1995 and 1994 amounts:
NOTE 11. Employee Benefit Plans
(Amounts in thousands) 1996 1995 1994
Actuarial present value of benefit obligations:
Accumulated benefit obligation, including vested benefits
of $5,089, $4,566 and $3,845 in 1996, 1995 and 1994,
respectively $5,182 $4,635 $3,886
Projected benefit obligation for service rendered to date 7,261 6,550 5,208
Plan assets at fair value* 7,817 7,023 5,720
Plan assets greater than projected benefit obligation 556 473 512
Unrecognized net (gain) (612) (502) (512)
Unrecognized net asset at October 1, 1988 being recognized
over 12 years (155) (194) (233)
Unrecognized prior service cost 119 130 -
Accrued pension cost included in other liabilities ($92) ($93) ($233)
Net pension cost included the following components:
Service cost - benefits earned during the period $296 $236 $219
Interest cost on projected benefit obligation 450 408 356
Actual return on plan assets (1,180) (1,220) (511)
Net amortization and deferral 603 718 115
Net periodic pension cost $169 $142 $179
*Plan assets are primarily invested in equities, general assets of insurance companies and insurance contracts.
The assumed weighted-average discount rate and rate of increase in future
compensation levels used in determining the actuarial present value of the
projected benefit obligations were 7.00% and 5.75% in 1996. These rates were
7.25% and 6.00% and 7.75% and 5.75% in 1995 and 1994, respectively. The
expected long-term rate of return on assets was 8.00% in 1996, 1995 and 1994.
The Corporation maintains a 401(k) plan covering all employees who have
completed one year of service. Employee contributions to the plan are matched
on a graduated basis with a minimum match of 100% up to 3% of the participant's
total compensation and a maximum match of 87.5% up to 4% of the participant's
total compensation. The Corporation's match is subject to approval annually
by the Board of Directors. Under this plan, not more than 15.00% of each
participant's total compensation may be contributed in any given plan year.
The Corporation's contribution in 1996, 1995 and 1994, as approved by the Board
of Directors, was $132,500, $125,000 and $107,000, respectively.
Under the terms of the Corporation's Long-Term Incentive Plan of 1990
("the Plan"), the Compensation Committee of the Board of Directors (the
Committee) is authorized to award up to 176,550 shares of presently authorized
but unissued or reacquired common stock to certain employees of the Corporation
and its subsidiary. Awards may be granted in the form of Options, Stock
Appreciation Rights, Restricted Stock, Performance Units and Performance
Shares.
Pursuant to the Plan, in 1991 the Corporation implemented a program known
as the Senior Management Incentive Program (the Program) and as of December 31,
1996 has awarded 75,725 restricted shares of $1.00 par value per share common
stock of the Corporation to certain employees at no cost to the employee
participants. These shares are issued subject to specific transfer
restrictions, including the passage of time, ranging from one to ten years; and
shall fully vest upon the expiration of ten years from the date of the
agreements, or earlier, dependent upon the Corporation meeting certain income
requirements established by the Board of Directors.
The Committee has also awarded 15,489 restricted shares of the $1.00 par
value per share common stock of the Corporation to certain employees at no cost
to the employee participant. These shares also are issued subject to certain
transfer restrictions and will automatically vest upon the expiration of ten
years from the Agreement date (except for one senior officer whose shares
vested in a shorter period).
Unearned compensation, representing the fair market value of the shares
at the date of issuance, will be expensed over the vesting period. The cost
associated with the plan was approximately $137,000 in 1996, $297,000 in 1995
and $274,000 in 1994. The total of restricted shares vested was 1,035, 25,325
and 12,682 in 1996, 1995 and 1994, respectively.
In addition to the restricted shares issued to the employee participants
of the Program, the employees could elect to receive a portion of their award
in cash. The payment of cash each year is dependent upon the Corporation
meeting certain income requirements established by the Board of Directors.
There was no incentive compensation expense under this feature of the plan in
1996. For the years ended December 31, 1995 and 1994, related incentive
compensation expense was $37,000 and $31,000, respectively.
NOTE 12. Stock Option Plans
In 1994, the Board of Directors of the Corporation approved and adopted the Employee Stock Purchase
Plan of 1994. Under the Plan 132,000 shares of stock can be purchased by participating employees over a
10-year period. The number of shares which can be purchased by each participant is limited, as defined,
and the option price is to be set by the Board of Directors. However, the option price cannot be less than
lessor of 90% of the fair market value of the shares on the date the option to purchase shares is granted,
or 90% of the fair market value of the shares on the exercise date. These options must be exercised one
year from the date of grant. Any shares related to unexercised options are available for future grant.
The following table summarizes the stock option activity (stock options have been adjusted to reflect a
stock dividends):
Number of shares
1996 1995
Outstanding, beginning of year 15,308 11,222
Granted at:
$28.86 per share 13,048 -
21.79 per share _ 15,926
Exercised at:
$28.86 per share (453) -
21.79 per share (8,492) (618)
29.76 per share _ (5,555)
Terminated at:
$21.79 per share (6,816) -
29.76 per share _ (5,667)
Outstanding, end of year 12,595 15,308
Exercisable 12,595 15,308
Available for grant 104,278 110,510
During 1996, the Corporation adopted Statement No. 123, "Accounting for Stock-Based Compensation."
As provided for in the statement, the Corporation elected to continue the intrinsic value method of
expense recognition. Had compensation cost for the Employee Stock Purchase Plan been determined
in accordance with Statement No. 123, the Corporation's net income and net income per share amounts
would not have been materially different from 1996 and 1995 results as reported.
NOTE 13. Deferred Compensation Agreement
The Corporation has entered into deferred compensation
agreements with several officers and directors which provide for
the payment of benefits over a ten-year period, beginning at age
65. At inception, the present value of the obligations under
these deferred compensation agreements amounted to approximately
$600,000, which is being accrued over the estimated remaining
service period of these officers and directors. These
obligations are partially funded through life insurance covering
these individuals.
NOTE 14. Shareholders' Equity
In March 1996, the Board of Directors authorized the repurchase of up to
50,000 shares of the Corporation's common stock through March 1997.
Subsequently in July 1996, the Board of Directors modified the stock repurchase
program from 50,000 shares to 100,000 shares and extended the repurchase period
from March 1997 to July 10, 1997.
In January 1995, the Board of Directors authorized the repurchase of up to
50,000 shares of the Corporation's outstanding common stock through January
1996. In addition, the repurchase of a separate block of 25,000 outstanding
shares was also authorized by the Board of Directors.
Under these programs, the Corporation repurchased 88,604 shares for $2.7
million and 64,741 shares for $2.2 million during 1996 and 1995, respectively.
The Corporation will use the treasury shares acquired for general corporate
purposes including stock dividends and stock splits, employee benefit and
executive compensation plans and the dividend reinvestment plan.
Subsequent to year-end 1996, the Board of Directors authorized the repurchase
of up to 100,000 shares of the Corporation's common stock through March 1998.
On October 5, 1995, the Board of Directors approved a 3 for 2 stock split
issued in the form of a 50% stock dividend, which was distributed on December
29, 1995 to shareholders of record on December 8, 1995. The result was a
transfer from retained earnings to common stock of approximately $677,000.
A cash amount of approximately $8,200 was paid in lieu of issuing fractional
shares arising from the stock dividend.
Note 15. Commitments and Contingencies
In the normal course of business, the Bank is party to financial instruments which are not
reflected in the accompanying financial statements and are commonly referred to as off-balance-sheet
instruments. These financial instruments are entered into primarily to meet the financing
needs of the Bank's customers and include commitments to extend credit and standby letters of
credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk not
recognized in the statement of financial position.
The Corporation's exposure to credit loss in the event of nonperformance by other parties
to the financial instruments for commitments to extend credit and standby letters of credit is
represented by the contract or notional amount of those instruments. The Bank uses the same
credit policies in making commitments and conditional obligations as they do for on-balance-sheet
instruments.
Unless noted otherwise, the Bank does not require collateral or other security to support
financial instruments with credit risk.
Contract or
(Amounts in thousands) notional amount
Financial instruments whose contract amounts represent credit risk:
Commercial commitments to extend credit $26,576
Consumer commitments to extend credit (secured) 12,595
Consumer commitments to extend credit (unsecured) 11,049
Standby letters of credit 905
Commitments to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses with the exception of home equity lines and personal
lines of credit and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Bank upon extension of
credit, is based on management's credit evaluation of the counterparty. Collateral for most
commercial commitments varies but may include accounts receivable, inventory, property, plant,
and equipment and income-producing commercial properties. Collateral for secured consumer
commitments consists of liens on residential real estate.
Standby letters of credit are instruments issued by the Bank which guarantee the
beneficiary payment by the Bank in the event of default by the Bank's customer in the
nonperformance of an obligation or service. Most standby letters of credit are extended for one-year periods.
The credit risk involved in issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers. The Bank holds collateral supporting those
commitments for which collateral is deemed necessary primarily in the form of certificates of
deposit and liens on real estate.
Most of the Bank's business activity is with customers located within Franklin County,
Pennsylvania and surrounding counties and does not involve any significant concentrations of
credit to any one entity or industry.
The Bank has entered into various noncancellable operating leases. Total rental expense
on these leases was $316,000, $378,000 and $155,000 in the years 1996, 1995 and 1994,
respectively. Future minimum payments under these leases are as follows:
1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . $295,000
1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285,000
1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 280,000
2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,400
2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,500
In the normal course of business, the Corporation has commitments, lawsuits, contingent
liabilities and claims. However, the Corporation does not expect that the outcome of these
matters will have a materially adverse effect on its consolidated financial position or results of
operations.
Note 16. Disclosures About Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is practicable to
estimate that value:
Cash, Federal funds sold and Interest-bearing deposits:
For these short-term instruments, the carrying amount is a reasonable
estimate of fair value.
Investment securities and Investments available for sale:
For debt and marketable equity securities held for investment purposes
and available for sale, respectively, fair values are based on quoted market
prices or dealer quotes. If a quoted market price is not available, fair value
is estimated using quoted market prices for similar securities.
Loans, net of allowance for possible loan losses:
The fair value of loans is estimated for each major type of loan (e.g.
real estate, commercial, industrial and agricultural and consumer) by
discounting the future cash flows associated with such loans. The model
considers scheduled principal maturities, repricing characteristics, prepayment
assumptions and interest cash flows. The discount rates used are estimated
based upon consideration of a number of factors including the treasury yield
curve, credit quality factors, expense and service charge factors.
Deposit liabilities and Other borrowings:
The fair market value of demand deposits, savings accounts, and money
market deposits is the amount payable on demand at the reporting date. This
fair value does not include the benefit that results from the low cost of
funding provided by these deposits compared to the cost of borrowing funds in
the market. The fair value of fixed-maturity certificates of deposit and
long-term debt are estimated by discounting the future cash flows using rates
approximating those currently offered for certificates of deposit and
borrowings with similar remaining maturities. The other borrowings consist of
borrowings on a line of credit with the FHLB at a variable interest rate and
securities sold under agreements to repurchase for which the carrying value
approximates a reasonable estimate of the fair value.
Unrecognized Financial Instruments:
At December 31, 1996, the Corporation had outstanding commitments to
extend credit of $50,220,000 and commitments under standby letters of credit
of $905,000. Such commitments include fixed and variable rate commercial and
consumer commitments. The value of the commitment is a reasonable estimate of
the fair value as the fees and rates charged are approximately consistent with
the amounts which would be charged to enter into similar arrangements at
year-end.
The estimated fair value of the Corporation's financial instruments at December 31 are as follows:
1996 1995
Carrying Fair Carrying Fair
(Amounts in thousands) Amount Value Amount Value
Financial assets:
Cash and short-term investments $10,521 $10,521 $14,904 $14,904
Investment securities held to maturity 36,290 36,199 35,317 35,563
Investment securities available for sale 53,502 53,502 42,025 42,025
Net loans 221,166 224,888 210,067 214,107
Total Financial Assets $321,479 $325,110 $302,313 $306,599
Financial liabilities:
Deposits $268,202 $268,478 $257,211 $257,495
Short-term borrowings 22,172 22,172 13,611 13,611
Long-term debt 7,841 7,897 5,650 5,716
Total Financial Liabilities $298,215 $298,547 $276,472 $276,822
The above values do not necessarily reflect the premium or discount that could result from offering for sale
at one time the Corporation's entire holdings of a particular instrument. In addition, these values, derived from
the methods and asumptions described above, do not consider the potential income taxes or other expenses that
would be incurred on an actual sale of an asset or settlement of a liability.
NOTE 17. Parent Company (Franklin Financial Services Corporation) Financial Information
Balance Sheets
December 31
(Amounts in thousands) 1996 1995
Assets:
Investment securities $1,761 $2,323
Equity investment in subsidiaries 32,410 31,261
Premises 1,238 1,216
Other assets 262 473
Total assets $35,671 $35,273
Liabilities:
Accrued expenses $87 $5
Deferred tax liability 243 312
Total liabilities 330 317
Shareholders' equity:
Common stock 2,030 2,030
Additional paid-in capital 19,745 19,431
Retained earnings 17,590 14,966
Net unrealized gain on securities 613 677
Treasury stock ( 141 and 90 shares, at cost,
at December 31, 1996 and 1995 respectively) (3,830) (2,053)
Unearned compensation (807) (95)
Total shareholders' equity 35,341 34,956
Total liabilities and shareholders' equity $35,671 $35,273
Statements of Income
Years ended
December 31
(Amounts in thousands) 1996 1995 1994
Income:
Dividends from Bank $2,631 $3,325 $1,429
Interest and dividend income 42 48 32
Gain on sale of securities 105 - 135
Other income 37 18 -
Gain on sale of premises 90 - 117
2,905 3,391 1,713
Operating expenses 292 321 263
Income before equity in undistributed income
of subsidiary 2,613 3,070 1,450
Equity in undistributed income of subsidiary 1,514 1,109 2,310
Net income $4,127 $4,179 $3,760
Statements of Cash Flows
Years ended
December 31
(Amounts in thousands) 1996 1995 1994
Cash flows from operating activities
Consolidated net income $4,127 $4,179 $3,760
Less: Equity in undistributed income of subsidary (1,514) (1,109) (2,310)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 29 36 35
Discount accretion on investment securities (1) (3) -
Premium amortization - - 4
Gain on sale of premises (90) - (116)
Securities gains, net (105) - (135)
Decrease in other assets 179 587 149
Increase (Decrease) in other liabilities 13 (45) 12
Other, net 409 559 259
Net cash provided by operating activities 3,047 4,204 1,658
Cash flows from investing activities
Proceeds from sales of investment securities 232 - 290
Proceeds from maturities of investment securities 850 534 100
Purchase of investment securities (218) (987) (967)
Net change in loans 32 58 (150)
Proceeds from sale of premises 225 - 200
Capital expenditures (183) (352) (23)
Net cash provided by (used in) investing activities 938 (747) (550)
Cash flows from financing activities
Dividends (1,503) (1,420) (1,224)
Proceeds from sales of common stock 200 198 145
Purchase of treasury shares (2,682) (2,235) (29)
Net cash used in financing activities (3,985) (3,457) (1,108)
Increase in cash and cash equivalents $ - $ - $ -
Cash and cash equivalents as of January 1 - - -
Cash and cash equivalents as of December 31 $ - $ - $ -
NOTE 18. Quarterly Results of Operation (Unaudited)
The following is a summary of the quarterly results of consolidated operations of Franklin Financial
for the years ended December 31, 1996 and 1995:
(Amounts in thousands) Three months ended
1996 March 31 June 30 September 30 December 31
Interest income $6,116 $6,032 $6,398 $6,253
Interest expense 2,784 2,725 2,774 2,804
Net interest income 3,332 3,307 3,624 3,449
Provision for loan losses 94 131 96 286
Other noninterest income 834 1,026 877 870
Securities gains(losses) 78 - (1) 89
Noninterest expense 2,725 2,736 2,997 2,914
Income before income taxes 1,425 1,466 1,407 1,208
Income taxes 375 330 345 329
Net Income $1,050 $1,136 $1,062 $879
Per share $0.55 $0.57 $0.60 $0.47
1995
Interest income $6,009 $6,175 $6,555 $6,232
Interest expense 2,627 2,749 2,952 2,882
Net interest income 3,382 3,426 3,603 3,350
Provision for loan losses 39 83 90 90
Other noninterest income 910 892 751 837
Securities gains - - - 10
Noninterest expense 2,801 2,830 2,942 2,656
Income before income taxes 1,452 1,405 1,322 1,451
Income taxes 365 349 296 441
Net Income $1,087 $1,056 $1,026 $1,010
Per share* $0.56 $0.55 $0.54 $0.53
*Based on weighted-average shares outstanding during the period reported adjusted retroactively to reflect
a 3 for 2 stock split issued in the form of a 50% stock dividend and distributed on December 29, 1995 to
shareholders of record on December 8, 1995. Consequently, the sum of quarterly earnings per share may not
equal the annual per share amount.
Management's Discussion and Analysis
The following discussion and analysis is intended to assist the reader in
reviewing the financial information presented and should be read in
conjunction with theconsolidated financial statements and other financial data
presented elsewhere herein.All changes discussed below have been brought about
by general economic conditions unless otherwise noted.
Results of Operations: Summary
Franklin Financial Services Corporation recorded net income of $4.1
million for the year ended December 31, 1996, a decrease of $52,000, or 1.2%,
compared to recorded net income of $4.2 million a year earlier. Per share
earnings were $2.20 for 1996, up 1.4% over $2.17 for 1995. Net income and per
share earnings recorded for 1994 were $3.8 million and $1.92, respectively.
The Corporation's return on average assets and return on average equity were
1.29% and 11.83%, respectively, for 1996 compared to 1.34% and 12.50%,
respectively, for 1995. For 1994, the return on average assets and return on
average equity were 1.21% and 11.82%, respectively.
During 1996 average earning assets grew moderately by $3.8 million, or
1.3%, to $302.7 million. The Corporation's net interest margin on a
tax-equivalent basis moved to 4.7% at December 31, 1996, from 4.8% one year
earlier. Net interest income on a full-tax equivalent basis equaled $14.2
million in 1996 compared to $14.4 million and $13.0 million in 1995 and 1994,
respectively.
The Corporation's measures of asset quality remain strong. The percentage
of nonperforming assets, comprised of nonaccrual loans, restructured
loans, loans past due 90 days or more and other real estate owned, represented
.54% of total assets at December 31, 1996, compared to .65% one year earlier.
The ratio of allowance for possible loan losses to total loans was 1.36% at
December 31, 1996, compared to 1.47% at December 31, 1995. Nonperforming loans
were covered 1.8 times by the allowance at December 31, 1996 and 1995. Net
charge-offs to average loans increased to .32% for 1996 from .27% for 1995
requiring an increase in the provision for loan loss to $607,000 in 1996 from
$302,000 in 1995. Loan charge-offs for 1996 were related primarily to the
consumer loan portfolio.
Noninterest income, excluding securities gains, increased $217,000, or
6.4% to $3.6 million for 1996 compared to $3.4 million for 1995 and 1994.
Securities gains from the sale of available for sale securities for the years
ended December 31, 1996, 1995 and 1994 totaled $166,000, $10,000 and $219,000,
respectively.
Noninterest expense increased $143,000, or 1.3%, to $11.4 million for
1996 compared to $11.2 million and $11.1 million for 1995 and 1994. An
increase of $306,000 in salaries and employee benefits partially offset by a
reduction of $160,000 for FDIC insurance expense accounted for the increase in
noninterest expense.
Total assets at December 31, 1996 were $336.1 million compared to $313.5
million at December 31, 1995. Total loans, net of discount, grew to $224.2
million at year-end 1996 from $213.2 million at year-end 1995. Total deposits
reached $268.2 million at December 31, 1996 compared to $257.2 million at
December 31, 1995. In order to support asset growth, which exceeded deposit
growth, the Corporation increased other borrowings with the Federal Home Loan
Bank of Pittsburgh to $14.9 million at December 31, 1996 compared to $5.6
million at December 31, 1995.
The Corporation's capital position remains strong with total capital of
$35.3 million at December 31, 1996 compared to $35.0 million one year earlier.
At December 31, 1996, the Corporation's average Tier I leverage ratio and Tier
I and Tier II risk-based capital ratios were 10.02%, 14.75% and 16.00%,
respectively, compared to 10.77%, 16.41% and 17.66%, respectively, at December
31, 1995.
Cash dividends paid to shareholders as approved by the Board of Directors
amounted to $.78 for 1996, an 8.3% increase, compared to $.72 for 1995. On
December 29, 1995, a 3 for 2 stock split issued in the form of a 50% stock
dividend was distributed to shareholders of record on December 8, 1995.
A more detailed discussion of the areas having the greatest impact on the
reported results for 1996 follows.
TABLE 1. Net Interest Income (unaudited)
Net interest income, defined as interest income less interest expense, is as shown in the following table:
(Amounts in thousands) 1996 % Change 1995 % Change 1994
Interest income $24,799 (0.69)% $24,971 13.36% $22,028
Interest expense 11,087 (1.10)% 11,210 15.33% 9,720
Net interest income $13,712 (0.36)% $13,761 11.81% $12,308
Tax equivalent adjustment 514 599 689
Net interest income/ $14,226 (0.93)% $14,360 10.49% $12,997
full taxable equivalent
Net Interest Income
Net interest income is a major component of the Corporation's
operating income and represents the difference in dollars between rates
earned on interest-earning assets and rates paid on interest-bearing
liabilities. Net interest income is impacted by changes in interest rates
and changes in volumes of interest-earning assets and interest-bearing
liabilities. For the following discussion net interest income is adjusted
to a tax-equivalent basis. This adjustment facilitates performance
comparisons between taxable and tax-exempt assets by increasing the tax-exempt
income by an amount equivalent to the Federal income taxes which
would have been paid if this income were taxable at the Corporation's 34%
Federal statutory rate. Table 1 presents net interest income on a full tax
equivalent basis for each of the years in the three year period ended
December 31, 1996. Table 2 presents average balances, tax equivalent
interest income and expense and average rates earned and paid on the
Corporation's interest earning assets and interest-bearing liabilities.
Table 3 analyzes the changes attributable to the volume and rate components
of net interest income.
Short term interest rates declined slightly early in 1996 and remained
relatively stable for the remainder of the year. The average prime rate in
1996 was 8.27% and the average Federal funds rate was 5.31% versus 8.83% and
5.85%, respectively in 1995. Long term rates rose steadily during the first
half of the year, then drifted generally downward during the second half.
Overall, interest rates were lower and the yield curve was steeper in 1996
than in 1995.
Net interest income declined slightly in 1996 slipping $134,000 to
$14.2 million at year-end 1996, from $14.4 million in 1995. As Tables 2 and
3 reflect, a moderate growth in volume and a 20 basis point decrease in the
yield on interest-earning assets versus a 12 basis point decrease in the
rates paid on interest-bearing liabilities adversely impacted net interest
income. Consequently, the net interest margin which reflects the interest
rate spread plus the contribution of assets funded by interest free sources
decreased to 4.7% for the year ended December 31, 1996, from 4.8% for the
year ended December 31, 1995.
Average interest-earning assets grew $3.8 million to $302.7 million
during 1996 from $298.9 million for 1995 and represented 94.3% and 95.5%,
respectively, of total assets for the related years. Average loans
comprised 72.0% of average interest-earning assets and, accordingly,
contributed 79.2% of the total interest income in 1996. Despite the
moderate growth in average interest-earning assets during the year, interest
income decreased $257,000, or 1.0%, to $25.3 million for 1996 from $25.6
million in 1995. The decrease reflects lower market interest rates during
the year and increased competitive pressures which produced a decline in the
yield on average loans of 19 basis points to 9.19% for 1996 versus 9.38% for
1995. The yield on investment securities for 1996 decreased 14 basis points
to 6.29% from 6.43% in 1995 due to reinvesting matured securities at lower
rates when compared to the rates of the matured securities. The cost of
interest-bearing deposits decreased 11 basis points to 4.36% for 1996 from
4.47% for 1995 due to lower market rates. Federal funds purchased and
securities sold under agreements to repurchase realized a reduction of 48
basis points to 4.65% for 1996 from 5.13%, driven primarily by a lower
Federal funds rate.
Average interest rates rose in 1995 compared to 1994. The average
prime rate in 1995 was 8.83% and the average Federal Funds rate was 5.85%
versus 7.14% and 4.23%, respectively in 1994. Net interest income on a
tax-equivalent basis grew $1.4 million, or 10.5%, to $14.4 million 1995 from
$13.0 million in 1994. Average earning assets grew moderately by $2.5
million to $298.9 million for 1995 over 1994, and realized an
increase in the yield earned of 89 basis points to 8.56%. Average
interest-bearing liabilities decreased $1.7 million to $245.8 million for 1995
compared to 1994 but showed an increase in the rates paid on those liabilities
of 63 basis points to 4.56% for 1995 versus 3.93% for 1994.
Table 2. Analysis of Net Interest Income (unaudited)
1996
Average Income or Average
(Amounts in thousands) balance expense yield/rate
Interest-earning assets:
Interest-bearing deposits in other banks $4,122 $210 5.09%
Federal funds sold - - -
Investment securities
Taxable 60,317 3,640 6.03%
Nontaxable 20,181 1,426 7.07%
Loans, net of unearned discount 218,033 20,037 9.19%
Total interest-earning assets 302,653 25,313 8.36%
Noninterest-earning assets 18,164
Total assets $320,817
Interest-bearing liabilities:
Deposits:
Interest-bearing checking $32,006 $697 2.18%
Money market deposit accounts 23,633 841 3.56%
Savings 45,835 1,300 2.84%
Time 124,411 7,010 5.63%
Total interest-bearing deposits 225,885 9,848 4.36%
Federal funds purchased and securities sold under
agreements to repurchase 16,376 762 4.65%
Other borrowings 7,280 477 6.55%
Total interest-bearing liabilities 249,541 11,087 4.44%
Noninterest-bearing liabilities 36,398
Shareholders' equity 34,878
Total liabilities and shareholders' equity $320,817
Net interest income/Net interest margin 14,226 4.70%
Tax equivalent adjustment (514)
Net interest income 13,712
All amounts have been adjusted to a tax-equivalent basis using a tax rate of 34%
Table 2. Analysis of Net Interest Income (unaudited)
1995
Average Income or Average
(Amounts in thousands) balance expense yield/rate
Interest-earning assets:
Interest-bearing deposits in other banks $11,694 $683 5.84%
Federal funds sold 155 9 5.81%
Investment securities
Taxable 47,935 2,867 5.98%
Nontaxable 21,145 1,577 7.46%
Loans, net of unearned discount 217,932 20,434 9.38%
Total interest-earning assets 298,861 25,570 8.56%
Noninterest-earning assets 13,938
Total assets $312,799
Interest-bearing liabilities:
Deposits:
Interest-bearing checking $27,734 $564 2.03%
Money market deposit accounts 26,663 1,022 3.83%
Savings 46,183 1,345 2.91%
Time 125,780 7,188 5.71%
Total interest-bearing deposits 226,360 10,119 4.47%
Federal funds purchased and securities sold under
agreements to repurchase 12,454 639 5.13%
Other borrowings 7,032 452 6.43%
Total interest-bearing liabilities 245,846 11,210 4.56%
Noninterest-bearing liabilities 33,523
Shareholders' equity 33,430
Total liabilities and shareholders' equity $312,799
Net interest income/Net interest margin 14,360 4.80%
Tax equivalent adjustment (599)
Net interest income 13,761
All amounts have been adjusted to a tax-equivalent basis using a tax rate of 34%
Table 2. Analysis of Net Interest Income (unaudited)
1994
Average Income or Average
(Amounts in thousands) balance expense yield/rate
Interest-earning assets:
Interest-bearing deposits in other banks $1,026 $45 4.39%
Federal funds sold 69 3 4.35%
Investment securities
Taxable 54,851 2,947 5.37%
Nontaxable 23,636 1,841 7.79%
Loans, net of unearned discount 216,688 17,881 8.25%
Total interest-earning assets 296,270 22,717 7.67%
Noninterest-earning assets 13,571
Total assets $309,841
Interest-bearing liabilities:
Deposits:
Interest-bearing checking $28,115 $526 1.87%
Money market deposit accounts 33,416 1,041 3.12%
Savings 51,821 1,364 2.63%
Time 115,550 5,893 5.10%
Total interest-bearing deposits 228,902 8,824 3.85%
Federal funds purchased and securities sold under
agreements to repurchase 5,177 212 4.10%
Other borrowings 13,493 684 5.07%
Total interest-bearing liabilities 247,572 9,720 3.93%
Noninterest-bearing liabilities 30,468
Shareholders' equity 31,801
Total liabilities and shareholders' equity $309,841
Net interest income/Net interest margin 12,997 4.39%
Tax equivalent adjustment (689)
Net interest income 12,308
All amounts have been adjusted to a tax-equivalent basis using a tax rate of 34%
Years ended December 31
1996 1995 1994
Rate Analysis:
Yield on total earning assets 8.36% 8.56% 7.67%
Cost of funds supporting earning assets 3.66% 3.76% 3.28%
Net rate on earning assets 4.70% 4.80% 4.39%
TABLE 3. Rate-Volume Analysis of Net Interest Income (unaudited)
Table 3 attributes increases and decreases in components of net interest income either to changes in
average volume or to changes in average rates for interest-earning assets and interest-bearing liabilities.
Numerous and simultaneous balance and rate changes occur during the year. The amount of change
that is not due solely to volume or rate is allocated proportionally to both.
1996 Compared to 1995 1995 Compared to 1994
Increase (Decrease) due to: Increase (Decrease) due to:
(Amounts in thousands) Volume Rate Net Volume Rate Net
Interest earned on:
Interest-bearing deposits
in other banks ($395) ($78) ($473) $468 $170 $638
Federal funds sold (9) 0 (9) 4 2 6
Investment securities
Taxable 747 26 773 (372) 292 (80)
Nontaxable (70) (81) (151) (194) (70) (264)
Loans 9 (406) (397) 103 2,450 2,553
Total net change in
interest income 282 (539) (257) 9 2,844 2,853
Interest expense on:
Interest-bearing checking 91 42 133 (7) 45 38
Money market deposit
accounts (111) (70) (181) (210) 191 (19)
Savings (10) (35) (45) (148) 129 (19)
Time (78) (100) (178) 522 773 1,295
Federal funds purchased
and securities sold
under agreements to
repurchase 174 (51) 123 299 128 427
Other borrowings 16 9 25 (328) 96 (232)
Total net change
in interest expense 82 (205) (123) 128 1,362 1,490
Increase (Decrease) in net
interest income $200 ($334) ($134) ($119) $1,482 $1,363
Nonaccruing loans are included in the loan balances used to calculate the above rate volume analysis.
The interest associated with these nonaccruing loans is not shown in the loan income numbers. All nontaxable
interest income has been adjusted to a tax-equivalent basis, using a tax rate of 34%.
Provision for Possible Loan Losses
The provision for loan losses charged against earnings was $607,000 in
1996 compared to $302,000 in 1995, an increase of 101.1%. The increase was
mainly due to an increase in consumer loan delinquencies and subsequent
charge-offs. Net charge-offs exceeded provision expense by $81,000 in 1996.
The provision for loan losses in 1994 was $48,000. The provision for loan
losses is determined based upon the adequacy of the allowance for possible
loan losses and upon an analysis of the loan portfolio, current economic
conditions and other relevant factors. For more information, refer to the
loan quality discussion and Table 10.
Noninterest Income and Expense
Total noninterest income for 1996 increased $373,000, or 11.0%, to
$3.8 million compared to a decrease of $204,000 to $3.4 million in 1995.
Excluding securities gains, total noninterest income increased $217,000, or
6.4%, to $3.6 million for the year ended December 31, 1996, compared to
virtually no increase in 1995 versus 1994.
Trust fiduciary activities produced commissions of $1.2 million in
1996 compared to $1.2 million and $1.0 million in 1995 and 1994,
respectively. An increase in personal trust activities offset by a decrease
in estate settlement activities resulted in flat trust commissions in 1996
versus 1995. Service charges, commissions and fees decreased $69,000 to
$1.8 million in 1996 from $1.9 million in 1995 compared with a decrease of
$18,000 for 1995 versus 1994. Increased deferred loan fees related to
mortgage lending activities is primarily responsible for the decrease.
Other noninterest income increased $277,000, or 94.2%, to $571,000 in 1996
compared to 1995 due primarily to nonrecurring items. In 1996 the
Corporation recognized gains of $196,000 related to the sale of the former
real estate brokerage subsidiary and $58,000 related to the sale of
foreclosed property. The increase in other noninterest income in 1996
compares to a decrease in 1995 versus 1994 of $105,000 due largely to a gain
of $116,000 on real estate sold in 1994.
Gains on the sale of available for sale investment securities,
primarily equity securities, resulted in an increase in securities gains of
$156,000 to $166,000 for the year ended December 31, 1996 compared to
$10,000 for the same period a year earlier. Management reviews the
performance and quality of equity securities within the investment portfolio
on a regular basis to determine appropriate investment positions and
possible deterioration within the portfolio. During 1996 management
concluded that some equity investment positions should be reduced and
accordingly, sold those equity securities producing the increased gains.
Securities gains decreased $209,000 in 1995 versus 1994 to $10,000 from
$219,000.
Total noninterest expense increased $143,000, or 1.3%, to $11.4
million for the year ended December 31, 1996 from $11.2 million at December
31, 1995. Salaries and employee benefits increased $306,000, or 5.0%, to
$6.4 million for 1996 compared to $6.1 million for 1995. Salaries expense
increased $359,000, or 8.0%, to $4.8 million while benefits expense
decreased 3.2% to $1.6 million primarily due to a decrease in costs associated
with the long term incentive plan. Full time equivalent employees increased
to 195 at December 31, 1996 compared to 177 at December 31, 1995 due primarily
to staffing at three community offices acquired from PNCBank in the
fourth quarter of 1996. Salaries expense related to the three acquired
branches totaled approximately $69,000. The remainder of the salaries
expense increase was due primarily to general merit increases. Federal
Deposit Insurance Corporation (FDIC) deposit insurance expense decreased
$160,000, or 49.5%, to $163,000 for 1996 from $323,000 for 1995. The FDIC
insurance fund is comprised of two funds - the Bank Insurance Fund (BIF) and
the Savings Association Insurance Fund (SAIF). In the second quarter of
1995 BIF reached its fully funded level of 1.25% of total insured
deposits, as legislated by Congress in 1989. Consequently, the FDIC reduced
the assessments for 1996 to zero. Most of the Corporation's deposits are
insured under BIF. The Corporation has SAIF insured
deposits related to the acquisition of the Waynesboro office in 1992. SAIF
deposits equaled approximately $20.0 million at December 31, 1996. The SAIF
continued to assess its members quarterly through the third
quarter of 1996. In September 1996, SAIF financial institutions were
assessed a one-time charge to bring the SAIF to its fully funded level
of 1.25% of total deposits. The Corporation was assessed $123,000 for this
one-time charge. Total SAIF expense for 1996 amounted to
$163,000.
The FDIC Board of Directors voted to retain the existing BIF
assessment schedule of 0 to 27 basis points (annual rates) for the first
semiannual period of 1997 continuing the zero percent rate. In addition,
under the Deposit Insurance Funds Act of 1996 (DIFA) all BIF and SAIF
financial institutions will be required to pay premiums to the Financing
Corporation (FICO). For the Corporation, BIF deposits will be assessed an
annual FICO rate of 1.296 basis points and SAIF deposits will be assessed an
annual rate of 6.48 basis points. Management expects that its FDIC
insurance expenses will be significantly reduced in 1997.
Total noninterest expense increased $125,000, or 1.1%, to $11.2
million in 1995 from $11.1 million in 1994. Increased costs in salaries and
benefits offset by decreased costs related to FDIC deposit insurance
accounted for most of the change. In 1995 the FDIC refunded to BIF members
the portion of their assessment for the second and third quarters of
1995 which represented overpayment once the BIF had achieved fully
funded status. Accordingly, the Corporation received a refund of $132,000
in 1995.
Provision for Income Taxes
Federal income tax expense amounted to $1.4 million in 1996, compared
to $1.5 million and $1.0 million in 1995 and 1994, respectively. The
Corporation's effective tax rates for the years ended December 31, 1996,
1995 and 1994 were 25.0%, 25.8% and 21.0%, respectively. The effective tax
rate in 1996 versus 1995 was virtually unchanged. The increase in the
effective tax rate for 1995 versus 1994 was primarily due to lower tax-free
income relative to pretax income. For a more comprehensive analysis of
Federal income tax expense refer to Note 10 of the accompanying financial
statements.
Table 4. Investment Securities at Amortized Cost
(unaudited)
The following tables present amortized costs of investment securities by type at December 31 for the
past three years:
Amortized cost
(Amounts in thousands) 1996 1995 1994
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government
agencies and corporations $1,051 $849 $17,466
Obligations of state and political subdivisions 19,496 16,225 18,909
Corporate debt securities 3,688 6,795 11,147
Mortgage-backed securities 10,832 10,309 9,810
35,067 34,178 57,332
Other 1,223 1,139 1,162
$36,290 $35,317 $58,494
Amortized cost
1996 1995 1994
Available for Sale
Equity Securities $1,380 $1,330 $1,213
U.S. Treasury securities and obligations of U.S. Government
agencies and corporations 27,054 25,717 -
Obligations of state and political subdivisions 1,934 2,417 2,400
Corporate debt securities 5,046 1,025 -
Mortgage-backed securities 17,159 10,511 11,004
$52,573 $41,000 $14,617
The Other Held to Maturity classification in the above schedule represents common stock of the Federal
Home Loan Bank of Pittsburgh and Atlantic Central Bankers Bank which in the aggregate total $1,223,000,
$1,139,000 and $1,162,000 at December 31, 1996, 1995 and 1994 respectively. Common stock of the
Federal Home Loan Bank and Atlantic Central Bankers Bank represents ownership in institutions which are wholly
owned by other financial institutions.
TABLE 5. Time Certificates of Deposit of $100,000 or More (unaudited)
The maturity of outstanding certificates of deposit of $100,000 or more at December 31, 1996
is as follows:
(Amounts in thousands) Amount
Maturity distribution:
Within three months $14,576
Over three through six months 3,409
Over six through twelve months 8,740
Over twelve months 3,620
Total $30,345
Financial Condition
The Corporation's financial condition is evaluated in terms of its
sources and uses of funds. Liabilities represent sources of funds while
assets reflect the uses of those funds. At December 31, 1996, total assets
reached $336.1 million, an increase of $22.6 million, or 7.2%, as compared
to December 31, 1995.
Investment securities increased $12.5 million, or 16.2%, during 1996
to $89.8 million at December 31, 1996, compared to a $4.8 million increase
in 1995. The growth in investment securities in 1996 occurred primarily in
mortgage-backed securities and municipal obligations and equaled $7.0
million and $2.8 million, respectively. U.S. Government securities and
corporate debt securities increased $1.3 million and $914,000, respectively.
As disclosed in Note 4 of the financial statements, the Corporation's
mortgage-backed securities portfolio consists primarily of mortgage-backed
securities issued by various agencies of the Federal government which carry
either an explicit or implied Federal guarantee. Of the mortgage-backed
securities issued by private issuers, the majority were rated triple A by a
nationally recognized rating agency. None was rated lower than double A.
Accordingly, the credit risk associated with the Corporation's mortgage-backed
securities is low. The interest rate risk accompanying the mortgage-backed
securities held by the Corporation is considered to be moderate. The current
portfolio has an estimated duration of 2.96 years, suggesting that the market
value of the mortgage-backed portfolio would rise (or fall) approximately 3.0%
given a 100 basis point decrease (or increase) in market interest rates.
However, proportionately greater price volatility would be expected with a
larger change in market interest rates. The relatively short duration of the
mortgage-backed portfolio indicates that the Corporation's exposure to
prepayment of these assets in a lower rate environment is moderate. With
the exception of one $163,000 mortgage-backed security, all collateralized
mortgage obligations (CMOs) pass the Federal Financial Institutions
Examination Council's high-risk stress test.
The Corporation held $1.4 million and $1.3 million in available for
sale equity securities (amortized cost basis) at December 31, 1996 and 1995,
respectively. All equity securities are investments in common stocks of
other financial institutions.
At December 31, 1996, the net unrealized gain, net of tax, on
available for sale securities was $613,000 compared to $677,000, a year
earlier.
Total loans, net of unearned discount, grew to $224.2 million at
December 31, 1996, an increase of $11.0 million, or 5.2% over the reported
$213.2 million at December 31, 1995. Total loans, net of unearned discount,
represented 66.7% of total year-end assets compared to 68.0% for 1995. As
Table 7 reflects, at December 31, 1996, consumer loan volume, including
first mortgage residential loans and real estate construction loans
decreased a total of $5.9 million, or 4.2%, to $133.1 million while
commercial, industrial and agricultural loans increased $16.6 million, or
22.2%, to $91.2 million. The Corporation originated and sold approximately
$15.2 million in mortgage loans to the secondary market, primarily to
Federal National Mortgage Association (FNMA) in 1996 compared to $15.0
million originated and sold primarily to Countrywide Funding Corporation in
1995. Consumer loan demand, except for mortgages, continued to be weak
during 1996 reflecting increased bank and nonbank competition in the local
market. Conversely, commercial loan demand rebounded in 1996 and showed
renewed optimism in the local business community.
The ratio of nonperforming assets (primarily loans) to total assets
improved to .54% at December 31, 1996 from .65% at December 31, 1995.
Included in nonperforming assets was other real estate owned (OREO) totaling
$99,000 and $258,000 at December 31, 1996 and 1995, respectively. OREO
represents foreclosed real estate. The ratio of allowance for possible loan
loss to total loans was 1.36% at December 31, 1996, and provided coverage
for nonaccrual and nonperforming loans 3.6 times and 1.8 times,
respectively. The ratio of allowance for possible loan loss to total loans
at December 31, 1995, was 1.47%. For a more indepth analysis of the loan
portfolio refer to the loan quality discussion which appears below.
Funding for asset growth came primarily from deposit growth and other
borrowings. Total deposits grew $11.0 million, or 4.3%, to $268.2 million
at December 31, 1996 from $257.2 million at December 31, 1995. Moderate
increases were reported in all deposit components - noninterest-bearing
demand, savings and interest checking, and time. Savings and interest
checking recorded the largest increase at $5.7 million.
The deposit dollar market share is decreasing for the banking industry
and the Corporation is not immune to this trend. In its market area the
Corporation competes with as many as twelve banks and five credit unions, in
addition to other financial service intermediaries such as brokerage houses
and insurance companies. As an alternative funding source, the Corporation
looks to its borrowing ability with the Federal Home Loan Bank of Pittsburgh
(FHLB). Other borrowings with FHLB increased $9.2 million, or 163.6%, to
$14.9 million at December 31, 1996 from $5.7 million a year earlier. The
increase in other borrowings included an increase in overnight borrowings of
$7.0 million and an increase in term borrowings of $2.2 million. Securities
sold under agreements to repurchase (Repos) increased $1.5 million to $15.1
million at December 31, 1996, from $13.6 million a year earlier. Repos are
also a funding source for the Corporation and represent customer cash
management accounts.
In the fourth quarter of 1996 the Corporation purchased four branch
offices from PNCBank. Three of these offices are located in adjoining
Cumberland County and have been converted to F&M Trust community offices . The
fourth office is located in Franklin County and will not be used by
F&M Trust as a community office. Included in the purchase price of $2.7 million
was real estate, personal property and customer lists. Unlike most branch
acquisitions, there were no loans acquired and no deposits assumed in the
transaction. Management recognizes that the additional expense associated
with the operation of these three new community offices will adversely
impact earnings in the short-term, but believes that the long-term
effect of the acquisition will have a positive impact on earnings.
TABLE 6. Short-Term Borrowings (unaudited)
Federal funds purchased, FHLB borrowings, and Securities Sold Under Agreements to Repurchase:
(Amounts in thousands) 1996 1995 1994
Ending balance $22,172 $13,611 $12,062
Average balance 18,639 12,990 11,948
Maximum month-end balance 26,724 16,212 16,695
Weighted-average interest rate on average balances 4.84% 5.14% 4.11%
Loan Quality
The Corporation's loan portfolio, net of unearned discounts and the
allowance for possible loan losses, equaled $221.2 million on December 31,
1996, or 5.3% greater than on December 31, 1995 (see Table 7). As a result
of the Corporation's continued strategy of selling certain types of
residential mortgages to secondary market investors, the real estate
portfolio showed a 6.5% decrease to $83.2 million at December 31, 1996,
compared to $89.0 million at December 31, 1995. Significant growth occurred
in the commercial, industrial and agricultural loan portfolio, increasing
22.1% to $91.2 million at December 31, 1996 from $74.7 million at December
31, 1995. The increase in commercial, industrial and agricultural loans was
largely attributable to the relatively healthy local economy and the
Corporation's more competitive loan pricing structure. Consumer loans
showed a modest decline to $49.9 million at December 31, 1996, compared to
$50.0 million at December 31, 1995. The decrease in consumer loans resulted
primarily from reductions in direct installment and indirect auto loans.
Strong growth within the consumer loan portfolio occurred in closed-end home
equity loans, which recorded an increase of 21.5% at December 31, 1996 to
$10.4 million. As a percentage of total loans, the real estate portfolio
represented 37.1% at December 31, 1996, down from 41.7% at December 31,
1995. Growth in the commercial portfolio caused that segment to rise to
40.7% of total loans at December 31, 1996 compared to 35.0% one year
earlier. The consumer loan portfolio equaled 22.3% of total loans at
December 31, 1996 versus 23.4% at December 31, 1995.
The Corporation's net charge-offs in 1996 totaled $688,000 (0.32% of
average loans), a 17.4% increase from the $586,000 (0.27% of average loans)
in net charge-offs recorded in 1995. At 0.32%, the Corporation's ratio of
net charge-offs to average loans was the highest since a ratio of 0.35% in
1992. As Table 10 shows, 75.3% of 1996 net charge-offs occurred within the
consumer loan portfolio, which increased 10.7% to $518,000 in 1996 from
$468,000 in 1995. Commercial net charge-offs grew $115,000, or 267.4% to
$158,000 in 1996 compared to $43,000 in 1995.
Table 9 shows that the Corporation's nonperforming assets totaled $1.8
million at December 31, 1996, a 10.9% decrease from the $2.1 million in
nonperforming assets at December 31, 1995. Nonaccrual loans increased
27.6% at December 31, 1996 to $856,000, compared to $671,000 one year
earlier. The increase in nonaccrual loans was related primarily to one
commercial account, which represented $494,000 in outstanding loans, or
approximately 57.7% of total nonaccrual loans at December 31, 1996. Aside
from that one account, the Corporation was successful in reducing nonaccrual
loans through partial and full payments. Offsetting the increase in
nonaccrual loans were decreases in loans past due 90 days or more and still
accruing interest and other real estate owned (OREO). Loans past due 90 days
or more decreased $249,000 to $874,000 at December 31, 1996, down 22.2% from
$1.1 million at December 31, 1995. The reduction in loans past due 90 days or
more was concentrated in the consumer and commercial portfolios. As
reported last year, the Corporation's management has and will continue to
focus on loan quality control efforts to ensure that all lending activities
are adequately and uniformly supported by quality assurance structures and
processes. The final component of nonperforming assets, other real estate
owned, decreased to $99,000 at December 31, 1996 from $258,000 a year
earlier, and includes only one residential property. Subsequent to December
31, 1996, the property in OREO has become subject to an agreement of sale.
For the second consecutive year, the Corporation recorded no restructured
loans. Potential problem loans at December 31, 1996 have been determined to
be immaterial.
The allowance for possible loan losses was $3.1 million at December
31, 1996 and 1995 and represented 1.36% and 1.47%, respectively, of loans,
net of unearned discounts. On December 31, 1996 the ratio of the allowance
for possible loan losses to nonperforming loans was 176.9%. This indicator
of allowance adequacy has remained steady, providing coverage of 175.1% and
152.7% for the years ended December 31, 1995 and 1994, respectively. While
the allowance has gradually decreased from prior years, the Corporation has
recorded significant reductions in nonperforming loans during that period
and management has determined that allowance to be adequate.
The loan loss reserve analysis utilized by management to establish the
allowance considers financial condition, repayment capacity, payment
performance, collateral values and support from guarantors for specifically
allocated commercial loans; and, for the remainder of the loan portfolio
historical losses, delinquency rates, and general economic conditions
(refer to Tables 8 and 10 for allocation of the reserve and
loan loss activity as of December 31, 1996). Management continuously
monitors the adequacy of the allowance for possible loan losses and
maintains it within a range which complies with loan portfolio
requirements. Management's assessment of loan loss reserve
adequacy is reviewed quarterly by the Loan Policy and Audit Committees of
the Board of Directors.
The maintenance of loan quality, because of its contributions to the
Corporation's financial performance, remains a priority of management. In
1996, the corporation established an internal loan review function, which
will help provide early recognition of deteriorating commercial credit
situations, periodic review of the Corporation's loan portfolio, an
independent assessment of the overall credit process and an assessment of
the adequacy of the allowance for possible loan losses. In early 1997,
management will be focusing its loan quality control efforts on consumer
lending, which is the subject of growth plans and which, as mentioned
earlier, experienced increased delinquencies and losses in 1996. Rising
personal bankruptcies are also a concern in the consumer portfolio.
Non-business bankruptcy filings grew 28% in Pennsylvania over the past two
years; the Middle District of Pennsylvania reported a 40% increase in
bankruptcy filings over the past year, ranking fifth out of the 94 Federal
court districts. More importantly is the fact that more people are filing
for bankruptcy with little warning, as evident in loan loss rates growing at
a faster pace than delinquency rates. Accordingly, employee training in
consumer lending, as well as in credit recovery, remains a priority of the
Corporation.
In 1995, President Clinton approved the BRAC recommendations that
included the realignment of Letterkenny Army Depot in the Chambersburg
(Franklin County) area. Letterkenny Army Depot is one of the area's largest
employers; however, job reductions will occur gradually through the year
2001. The Franklin County Reuse Committee has been formed by the Franklin
County Commissioners to investigate and recruit private industry to replace
lost government jobs. Through the Franklin County Reuse Committee's
efforts, the government has approved the transfer of 1,900 acres of real
estate to the community. As a result of these efforts, the Reuse Committe
expects that jobs will begin to be created within the next 18 months.
The Franklin County Reuse Committee has designated the
area as an industrial site, making it one of the largest in Pennsylvania.
With the positive direction the reuse of Letterkenny Army Depot is taking,
management of the Corporation does not anticipate any material negative
impact from the realignment of the Depot regarding deposit growth, loan
demand or loan losses.
TABLE 7. Loan Portfolio (unaudited)
The following table presents an analysis of the Banks' loan portfolio for each of the past five years:
December 31
(Amounts in thousands) 1996 1995 1994 1993 1992
Real estate (primarily first mortgage
residential loans) $79,478 $83,800 $92,481 $95,918 $101,583
Real estate - construction 3,727 5,233 4,207 4,232 4,607
Commercial, industrial and agricultural 91,244 74,678 75,783 72,537 69,071
Consumer (including home equity lines
of credit) 49,936 50,017 51,376 41,969 39,517
Total loans 224,385 213,728 223,847 214,656 214,778
Less: Unearned discount (159) (520) (1,111) (425) (475)
Allowance for possible loan losses (3,060) (3,141) (3,425) (3,598) (3,433)
Net loans $221,166 $210,067 $219,311 $210,633 $210,870
TABLE 8. Allocation of the Allowance for Possible Loan Losse
The following table shows allocation of the allowance for possible loan losses by major loan category and the
percentage of the loans in each category to total loans at year-end:
(Amounts in thousands) December 31
1996 1995 1994 1993 1992
$ % $ % $ % $ % $ %
Real estate $220 37% $583 42% $989 43% - 47% - 50%
Commercial
industrial and
agricultural 1,326 41% 1,136 35% 1,520 34% 2,519 34% 2,403 32%
Consumer 1,514 22% 1,422 23% 916 23% 1,079 19% 1,030 18%
$3,060 100% $3,141 100% $3,425 100% $3,598 100% $3,433 100%
TABLE 9. Nonperforming Assets (unaudited)
The following table presents an analysis of nonperforming assets for each of the past five years.
December 31
(Amounts in thousands) 1996 1995 1994 1993 1992
Nonaccrual loans $856 $671 $1,047 $1,877 $2,574
Loans past due 90 days or more
(not included above) 874 1,123 601 1,193 994
Restructured loans - - 595 872 1,086
Total nonperforming loans 1,730 1,794 2,243 3,942 4,654
Other real estate 99 258 - 267 342
Total non performing assets $1,829 $2,052 $2,243 $4,209 $4,996
The Corporation has no foreign loans. The Bank's policy is to classify loans as nonaccrual when
the payment of principal or interest has not been made for a period of 90 days and management
considers the collection of principal and interest doubtful. Any interest accrued prior to the date of
nonaccrual classification is reversed. Subsequent payments are applied as a reduction of
principal until the loan is returned to accruing status.
Restructured loans occur when a borrower has experienced financial hardship and the loan
repayment terms are adjusted to be more favorable to the borrower than those with which new loans
would be granted.
TABLE 10. Allowance for Possible Loan Losses
The following table presents an analysis of the allowance for possible loan losses for each of
past five years.
December 31
(Amounts in thousands) 1996 1995 1994 1993 1992
Balance at beginning of year $3,141 $3,425 $3,598 $3,433 $2,682
Charge-offs:
Commercial,industrial and agriculturial (183) (89) (51) (447) (685)
Consumer (582) (511) (230) (219) (213)
Real estate (12) (76) (38) (34) (7)
Total charge-offs (777) (676) (319) (700) (905)
Recoveries:
Commercial, industrial and agriculturial 25 46 60 104 166
Consumer 64 43 19 60 34
Real estate - 1 19 - -
Total recoveries 89 90 98 164 200
Net charge-offs (688) (586) (221) (536) (705)
Provision for possible loan losses 607 302 48 701 1,281
Waynesboro acquisition - - - - 175
Balance at end of year $3,060 $3,141 $3,425 $3,598 $3,433
Ratios:
Net loans charged off as a percentage
of average loans 0.32% 0.27% 0.10% 0.26% 0.35%
Allowance as a percentage of net
loans (at December 31) 1.36% 1.47% 1.54% 1.68% 1.60%
Liquidity and Interest Rate Sensitivity
The Corporation must meet the financial needs of the communities which
it serves, while providing a satisfactory return on the shareholders'
investment. In order to accomplish this, Franklin Financial Services
Corporation must maintain sufficient liquidity in order to respond quickly
to the changing level of funds required for both loan and deposit activity.
The goal of liquidity management is to meet the ongoing cash flow
requirements of depositors who want to withdraw funds and of borrowers who
request loan disbursements. Historically, Franklin Financial Services
Corporation has satisfied its liquidity needs from the scheduled repayment
of loans and securities, maturing investment securities, deposit growth, its
ability to borrow through existing lines of credit and its earnings.
Investments classified as available for sale provide an additional source of
readily available liquidity.
Growth in deposits generally provides the major portion of funds
required to meet increased loan demand. Total deposits grew by $11.0
million between December 31, 1995 and 1996. In addition, the Corporation
increased other borrowings by $9.2 million. These funding sources, together
with an increase of $1.5 million in funds from securities sold under
agreement to repurchase, were sufficient to meet the increase in loan demand
and increased investments in securities. Table 6 presents specific
information concerning short-term borrowings.
Changes in interest rates can have a significant impact on the
Corporation's net income. The objective of interest rate risk management is
to identify and manage the sensitivity of net income to changing interest
rates so as to produce consistent earnings that are not contingent upon
favorable trends in interest rates. The Corporation uses several tools to
measure interest rate risk. Income simulation modeling, the primary
measurement tool, is used to project net income in different interest rate
environments, and considers not only the impact of changing interest rates
but also other sources of variability including loan and securities
prepayments, loan spreads and customer preferences. The Corporation's
simulation modeling also measures the sensitivity of the economic value of
all assets and liabilities under different interest rate scenarios. The
Corporation establishes tolerance ranges for these measures of interest rate
sensitivity and manages within the ranges.
An interest rate sensitivity or gap analysis is used to supplement
simulation modeling. Gap analysis classifies assets and liabilities into
maturity and repricing time intervals. The interest rate gap, the
difference between interest-sensitive assets and liabilities,
provides management with an indication of how net interest income will be
impacted by changing rates scenarios.
Table 11 presents an interest rate sensitivity analysis of the
Corporation at December 31, 1996. The positive gap in the under one-year
time intervals suggests that the Corporation's near-term earnings would
increase in a higher interest rate environment. However, the simulation
modeling indicates that prospective earnings for a one-year time period are
well insulated and would fluctuate by less than five percent in response to
a 200 basis point increase or decrease in market interest rates.
Table 11. Interest Rate Sensitivity Analysis (Unaudited)
Interest Rate Sensitivity Gaps
(Amounts in Thousands) 1-90 91-181 182-365 1-5 Beyond
Days Days Days Years 5 Years Total
Interest-earning assets:
Interest -bearing deposits in other banks $256 $ - $ - $ - $ - $256
Federal funds sold - - - - - -
Investment securities 8,454 3,108 7,205 41,805 29,220 89,792
Loans, net of unearned income 80,767 11,983 23,009 44,099 64,527 224,385
Total interest-earning assets $89,477 $15,091 $30,214 $85,904 $93,747 $314,433
Interest-bearing liabilities:
Interest-bearing checking $ - $ - $ - $ 27,584 6,889 34,473
Money market deposit accounts 2,519 3,761 7,623 11,385 - 25,288
Savings - - - 36,001 9,001 45,002
Time 29,398 19,144 38,932 40,920 198 128,592
Federal funds purchased and securities sold
under agreement to repurchase 15,122 - - - - 15,122
Other borrowings 7,050 - 745 6,943 153 14,891
Total interest-bearing liabilities $54,089 $22,905 $47,300 $122,833 $16,241 $263,368
Interest rate gap $35,388 ($7,814) ($17,086) ($36,929) $77,506 $51,065
Cumulative interest rate gap $35,388 $27,574 $10,488 ($26,441) $51,065 $ 51,065
Note 1: The maturity/repricing distribution of investment securities is based on the maturity date for nonamortizing,
noncallable securities; probable exercise/non-exercise of call option for callable securities; and estimated amortization
based on industry experience for amortizing securities.
Note 2: Distribution of loans is based on contractual repayment terms except for residential mortgages where the scheduled
maturities are accelerated based on estimated prepayments of approximately 15 percent per year (constant prepayment rate).
Note 3: Interest-bearing checking, MMDA and savings accounts are non-maturity deposits which are distributed in accordance
with guidelines provided by the FDIC.
Table 12. Maturity Distribution of Investment Portfolio (unaudited)
The following presents an analysis of investments in debt securities at December 31, 1996 by maturity, and the weighted average
yield for maturity presented. Securities with "put options" have been classified in the earliest period in which the options can
be exercised. The yields in this table are presented on a tax-equivalent basis.
After one year After five years After ten
One year or less through five years through ten years years Total
Amortized Amortized Amortized Amortized Amortized
(Amounts in thousands) Cost Yield Cost Yield Cost Yield Cost Yield Cost Yield
Held to Maturity
U.S. Treasury securities
& obligations of
U.S. Government agencies
& corporations $ --- --- $1,051 6.38% $ --- --- $ --- --- $1,051 6.38%
Obligations of state &
political subdivisions 1,916 7.60% 11,392 6.86% 4,545 6.84% 1,643 8.35% 19,496 7.05%
Corporate debt securities 470 5.63% 2,572 5.97% 646 5.81% --- --- 3,688 5.90%
Mortgage-backed securities 542 6.43% 974 6.39% 2,124 6.34% 7,192 6.66% 10,832 6.56%
$2,928 7.07% $15,989 6.66% $7,315 6.60% $8,835 6.97% $35,067 6.76%
Market Market Market Market Market
Value Yield Value Yield Value Yield Value Yield Value Yield
Available for Sale
U.S. Treasury securities
& obligations of
U.S. Goverment agencies
& corporations $6,614 6.03% $14,486 6.17% $5,955 7.07% $ --- --- $27,055 6.33%
Obligations of state &
political subdivisions 1,930 6.66% --- --- --- --- --- --- 1,930 6.66%
Corporate debt securities 1,015 6.11% 3,530 6.61% 513 6.97% --- --- 5,058 6.55%
Mortgage-backed securities --- --- 4,180 6.24% 8,757 6.56% 4,032 5.95% 16,969 6.34%
$9,559 6.17% $22,195 6.25% $15,226 6.77% $4,032 5.95% $51,012 6.37%
TABLE 13. Maturities and Interest Rate Terms of Selected Loans (unaudited)
Stated maturities (or earlier call dates) of selected loans as of December 31, 1996 are summarized in the
table below. Residential mortgages and consumer loans are excluded from the presentation.
After
one year
Within but within After
(Amounts in thousands) one year five year five years Total
Loans:
Real estate - construction $3,727 - - $3,727
Commercial, industrial and agricultural 17,553 31,823 41,868 $91,244
$21,280 $31,823 $41,868 $94,971
The following table shows for the above loans the amounts which have predetermined interest rates
and the amounts which have variable interest rates at December 31, 1996:
After
one year
but within After
five year five years Total
Loans with predetermined rates $14,372 $20,528 $34,900
Loans with variable rates 17,451 21,340 $38,791
$31,823 $41,868 $73,691
TABLE 14. Capital Ratios
December 31
1996 1995 1994
(unaudited)
Risk-based ratios
Tier 1 14.75% 16.41% 15.36%
Tier 2 16.00% 17.66% 16.62%
Leverage Ratio 10.03% 10.77% 10.99%
Capital and Dividends
Total shareholders' equity equaled $35.3 million at December 31, 1996,
representing an increase of $385,000, or 1.1% over $34.9 million at December
31, 1995. In 1996, earnings retained amounted to $2.6 million but was
more than offset by the repurchase of outstanding common stock totaling $2.7
million. One year earlier, earnings retained amounted to $2.1 million and the
repurchase of outstanding common stock totaled $2.2 million. The change in net
unrealized gains in available for sale investment securities, net of deferred
taxes for 1996 versus 1995 resulted in a decrease to shareholders' equity of
$64,000 compared to an increase of $1.0 million for 1995 versus 1994.
In March 1996, the Board of Directors authorized the repurchase of up
to 50,000 shares of the Corporation's outstanding common stock through March
1997. Subsequently, in July 1996, the Board of Directors modified the stock
repurchase program from 50,000 shares to 100,000 shares and extended the
repurchase period from March 1997 to July 1997. Treasury stock acquired is
used for general corporate purposes including stock dividends and stock splits,
employee benefit and executive compensation plans and the dividend reinvestment
plan. As a result of stock repurchase programs the Corporation repurchased
88,604 shares at a cost of $2.7 million and 64,741 shares at a cost of
$2.2 million in 1996 and 1995, respectively. Subsequent to year-end 1996 ,
the Board of Directors authorized the repurchase of up to 100,000 shares of
the Corporation's common stock through March 1998.
A strong capital position is important to the Corporation and provides
a solid foundation for the anticipated future growth of the Corporation. A
strong capital position also instills confidence in the Corporation by
depositors, regulators and investors, and is considered essential by
management. Common measures of adequate capitalization for banking institutions
are ratios of capital to assets. These ratios indicate the proportion of
permanently committed funds to the total asset base. Guidelines issued by
federal and state regulatory authorities require both banks and bank holding
companies to meet minimum leverage capital ratios and risk-based capital
ratios.
The Leverage ratio compares Tier I Capital to total balance sheet
assets while the risk-based ratio compares Tier I and Tier II capital to
risk-weighted assets and off-balance-sheet activity in order to make capital
levels more sensitive to the risk profiles of individual banks.
Current regulatory capital guidelines call for a minimum Tier I
leverage ratio of 4.0% and minimum Tier I and Tier II risk-based capital
ratios of 4.0% and 8.0%, respectively. Well capitalized banking
institutions are determined to have leverage capital ratios greater than or
equal to 5.0% and Tier I and Tier II risk-based capital ratios greater than
or equal to 6.0% and 10.0%, respectively.
Tier I capital is composed of common stock, additional paid-in-capital
and retained earnings reduced by goodwill, other intangible assets and the
effect of unrealized losses on available for sale equity securities.
Tier II capital is composed of Tier I capital plus the allowance for
loan losses. Table 14 presents the consolidated capital ratios for the
Corporation at December 31, 1996, 1995 and 1994. At year-end, the
Corporation and its banking subsidiary exceeded all regulatory capital
requirements. For additional information on capital adequacy refer to
Note 2 of the financial statements.
The Corporation paid cash dividends of $.78 per common share to its
shareholders in 1996, an increase of 8.3% over the $.72 per common share
paid in 1995. In 1994 the cash dividends paid equaled $.65 per common
share. The ratio of cash dividends paid to net income for 1996 was 36.4%
compared to 34.0% and 32.6%, respectively, for 1995 and 1994.
In 1995 the Board of Directors approved a 3 for 2 stock split issued
in the form of a 50% stock dividend distributed on December 29, 1995, to
shareholders of record on December 8, 1995.
Book value per common share was $18.70 at December 31, 1996, versus
$18.02 at December 31, 1995. Market value per common share was $32.13 at
December 31, 1996 versus $27.25 at December 31, 1995. Market value
disclosed in the financial highlights reflects the mean between the bid and
ask prices for the last business day of the year. As of year-end 1996, the
Corporation's common stock was trading at 171.8% of its December 31 book
value compared to 151.2% at year-end 1995; the price earnings multiple was
14.6 times at December 31, 1996 compared to 12.5 times at December 31, 1995.
Shareholders' Information
Dividend Reinvestment Plan
Franklin Financial Services Corporation offers a dividend reinvestment program
whereby shareholders with stock registered in their own names may reinvest their
dividends in additional shares of the Corporation. Information concerning this
optional program ia available by contacting the Corporate Secretary at
20 South Main Street, P.O. Box T, Chammbersburg, PA 17201-0819,
telephone 717/264-6116.
Dividend Direct Deposit Program
Franklin Financial Services Corporation offers a dividend direct deposit
program whereby shareholders with registered stock in their own names may
choose to have their dividends directly deposited into the bank account of
their choice on the dividend payment date. Information concerning this
optional program ia available by contacting the Corporate Secretary at
20 South Main Street, P.O. Box T, Chammbersburg, PA 17201-0819,
telephone 717/264-6116.
Annual Meeting
The Annual Shareholders' Meeting will be held on Tuesday, April 29, 1997 at
The Lighthouse Restuarant, 4301 Philadelphia Avenue, Chambersburg. The
business meeting will begin at 10:30 a.m. and will be followed by a
luncheon served at 12:00 noon.
Stock Information
The following brokers are registered market makers of Franklin Financial
Services Corporation's common stock:
Ferris Baker Watts Hopper Soliday & Co., Inc.
17 East Washington Street 1703 Oregon Pike
Hagerstown, MD 21740 Lancaster, PA 17601
800/344-4413 800/646-8647
F.J. Morrissey & Co., Inc. Ryan, Beck & Co.
1700 Market Street, Suite 1420 3 Parkway
Philadelphia, PA 19103-3913 Philadelphia, PA 19102
215/563-3296 800/223-8969
Registrar and Transfer Agent
The registrar and transfer agent for Franklin Financial Services Corporation
is Fulton Bank, P.O. Box 4887, Lancaster, PA 17604.