FRANKLIN FINANCIAL SERVICES CORPORATION
1998 ANNUAL REPORT
Table of Contents
Page
Consolidated Financial Highlights
Summary of Selected Financial Data
A Message to the Shareholders
Report of Independent Public Accountants
Financial Statements
Notes to Consolidated Financial Statements
Management's Discussion & Analysis
Capital and Dividends
Forward-Looking Statements
Impact of Inflation
Shareholders' Information
Franklin Financial Services Corporation (the Corporation) is a
holding company with headquarters in Chambersburg, Pennsylvania.
The Corporation's direct subsidiary is Farmers and Merchants Trust
Company (the Bank).
F&M Trust is a full-service bank offering commercial, retail and
trust services with various community offices located in Franklin
and Cumberland Counties.
CONSOLIDATED FINANCIAL HIGHLIGHTS
% increase
(amounts in thousands, except per share) 1998 1997 (decrease)
------------------------------ -----------
Performance
Net income $4,805 $4,363 10
Return on assets 1.29% 1.26%
Return on equity 12.58% 12.03%
------------------------------ -----------
Shareholders' Value (per share)*
Basic earnings per share $1.76 $1.59 11
Regular cash dividends paid 0.62 0.56 11
Special cash dividends paid 0.66 -
Regular cash dividends declared 0.47 0.71 -34
Special cash dividends declared - 0.66
Book value 14.24 12.99 10
Market value (mean of bid and ask) 29.88 34.16 -13
Market value/book value ratio 209.83% 262.97%
Price/earnings multiple 16.98x 21.49x
Yield on cash dividends paid 4.28% 1.64%
------------------------------ -----------
Safety and Soundness
Leverage ratio (Tier 1) 9.16% 9.22%
Nonperforming assets/total assets 0.51% 0.54%
Allowance for loan loss as a % of loans 1.35% 1.35%
Net charge-offs/average loans 0.32% 0.29%
Risk-based capital (Tier 1) 12.73% 13.53%
------------------------------
Balance Sheet Highlights
Total assets $425,001 $353,865 20
Investment Securities 127,118 87,098 46
Loans, net 258,488 241,244 7
Deposits 326,579 274,555 19
Shareholders' equity 39,901 36,305 10
Trust assets under management (market value) 401,063 350,866 14
======== ======== ========
* Per share information has been adjusted to reflect a 3 for 2 stock split issued in the
form of a 50% stock dividend declared on November 13, 1997, and distributed on February 3, 199
on January 13, 1998.
SUMMARY OF SELECTED FINANCIAL DATA
1998 1997 1996 1995 1994
(amounts in thousands, except per share) -------------------------------------------------------
Summary of operations
Interest income $27,529 $26,308 $24,799 $24,971 $22,028
Interest expense 13,151 12,225 11,087 11,210 9,720
-------------------------------------------------------
Net interest income 14,378 14,083 13,712 13,761 12,308
Provision for possible loan losses 1,061 936 607 302 48
Net interest income after provision -------------------------------------------------------
for possible loan losses 13,317 13,147 13,105 13,459 12,260
Noninterest income 5,030 4,306 3,683 3,351 3,569
Noninterest expense 12,038 11,700 11,282 11,180 11,069
-------------------------------------------------------
Income before income taxes 6,309 5,753 5,506 5,630 4,760
Income tax 1,504 1,390 1,379 1,451 1,000
-------------------------------------------------------
Net income $4,805 $4,363 $4,127 $4,179 $3,760
======== ======== ======== ======== ========
Per common share*
Basic earnings per share $1.76 $1.59 $1.46 $1.45 $1.28
Cash dividends declared $0.47 $1.37 $0.52 $0.48 $0.43
======== ======== ======== ======== ========
Balance sheet data
End of year
Total assets $425,001 $353,865 $336,120 $313,473 $310,554
Deposits 326,579 274,555 268,202 257,211 256,697
Loans, net 258,488 241,244 221,166 210,067 219,311
Shareholders' equity 39,901 36,305 35,341 34,956 32,873
Performance yardsticks (unaudited)
Return on average assets 1.29% 1.26% 1.29% 1.34% 1.21%
Return on average equity 12.58% 12.03% 11.83% 12.50% 11.82%
Dividend payout ratio 74.90% 36.01% 36.42% 33.98% 32.55%
Average equity to average asset ratio 10.24% 10.49% 10.87% 10.69% 10.26%
Trust assets under management (unaudited)
Personal trusts (market value) $399,959 $349,647 $261,803 $223,230 $182,872
Corporate trusts (market value) 1,105 1,219 1,037 933 1,611
-------------------------------------------------------
$401,064 $350,866 $262,840 $224,163 $184,483
======== ======== ======== ======== ========
* Per share information has been adjusted retroactively to reflect all stock splits and dividends.
A Message to the Shareholders
Dear Shareholder:
Earnings at Franklin Financial in 1998 reached $4,805,000,
representing a 10.1% improvement over 1997 earnings of $4,363,000
and a new record for your company. Basic earnings per share for
1998 were $1.76 compared to $1.59 in 1997, representing a 10.7%
increase.
As shareholders, you received a 10.7% increase in regular
cash dividends paid per share during the year as regular per share
dividends increased from $.56 in 1997 to $.62 in 1998. Adding to
that was the special $1 cash dividend which was paid to
shareholders in January 1998, bringing total cash dividends paid
to $1.28 per share when adjusted to reflect the 50% stock dividend
distributed on February 3, 1998.
The solid growth in core earnings recorded by Franklin
Financial in 1998 was not reflected in the market value of our
stock. After outperforming the S&P 500 for six of seven years
since 1991, the historically high price/earnings multiples awarded
to bank stocks eroded during the second half of 1998. Subsequent
to reaching a 1998 high of $39.00 on May 15, the market value of
Franklin Financial stock flattened out for several months before
declining to $29.875 at year end. Although disappointing to
investors, our price/earnings multiple and market value/book value
ratios at year end 1998 appear to be in line with the market's
valuation of other community banks in our peer group.
Assets reached a record $425,001,000, growing by 20.1%.
Contributing to the increase in assets was a 7.1% growth in loans,
reflecting a favorable economic environment and strong business
development efforts. The low interest rate environment
contributed to above average refinancing activity and strong
mortgage origination volume. The continued expansion into the
Cumberland County market and further development of new business
in Franklin County is attributable to our philosophy and
commitment as an independent community bank. We are able to offer
greater responsiveness and flexibility at a time of rapid
consolidation within the financial services industry which creates
value for our customers and positions us as a strong competitor in
the future.
While the low interest rate environment benefitted borrowers,
banks experienced increased pressure to retain or grow deposit
dollars. The banking industry as a whole is faced with more and
more customers turning to uninsured non-deposit investment
alternatives such as mutual funds, stocks, bonds, and annuities to
earn a higher return on their investment while assuming additional
risk. Banks are no longer just competing with other banks and
credit unions for deposits, but now face intense competition from
non-banks including mutual fund companies, investment firms, and
insurance companies. However, our position as an independent
community bank enabled us to attract and retain deposit dollars,
resulting in deposit growth of 18.9% to $326,579,000 at December
31, 1998.
Balances in our Money Management Account, which was
introduced in mid-1997 and pays a market rate of interest,
exceeded $40 million by the end of 1998 including significant new
dollars. And we successfully attracted new funds in certificates
of deposit through the Freedom Account CD promotion in the fall of
the year. As our deposit growth exceeded loan growth in 1998,
these funds were employed in our investment portfolio.
We continue to be confronted by the trend of rising consumer
bankruptcies that began in the fourth quarter of 1995. We have
acted prudently to increase the loan loss provision expense
accordingly to $1,061,000, a 13.4% increase above the provision
for loan loss in 1997, in order to maintain the allowance for loan
losses at a level equal to the 1.35% of loans outstanding. We
continue to focus upon several strategic initiatives to combat
this trend including consumer loan training, loan policy
revisions, and an enhanced loan review function. As we have
stated previously, there appears to be no quick-fix solution to
this disturbing nationwide trend and it is our intention to
closely monitor the credit quality of our loan portfolio to ensure
that we remain adequately reserved by maintaining an acceptable
level in the allowance for loan losses.
The increased provision for loan loss negatively affected net
interest income after provision, which remained relatively
constant in absolute dollars at $13,317,000. Net interest income,
as reported, reflects the effect of increased holdings of tax-free
investment securities. While the tax-free investments generate
lower net interest income, they also reduce income tax expense and
tend to contribute to higher net income.
As we continue to evolve from a bank into a diversified
financial services provider, nontraditional bank services are
making a more significant contribution to our performance. A
major thrust of our efforts in this area during 1998 occurred in
the Waynesboro market, where we first placed a full-time trust
officer in the Waynesboro Office, and followed that in December
with the opening of our second Personal Investment Center. We
have been very pleased with the results the Personal Investment
Center, which integrates financial planning and investment
services into the retail environment of the community office, has
achieved. We are planning to expand this concept to the
Cumberland County market in 1999, with a location in our
Shippensburg Office. In addition, we will broaden the products
and services offered through The Personal Investment Center by
adding health and life insurance products during the first half of
1999
The market value of trust assets under management grew by
14.3% and surpassed the $400 million mark, reaching $401,064,000
at year end 1998. Fee income generated by the Investment and
Trust Services Department was $1,847,000, an increase of 29.1%
over the previous year. We attribute this growth to both the
volume of business generated as well as the increased market
valuation. The additional fee income brought in by The Personal
Investment Center and the Investment and Trust Services
Department, which indicates the direction and focus the banking
industry is taking, was also augmented by noninterest income from
debit card usage, cash management services for business customers
and the sale of mortgages into the secondary market.
During 1998, we effectively controlled our noninterest
expense which increased only 2.9% to $12,038,000. This increase
includes nonrecurring expense related to the sale of real estate
and the demolition of buildings in downtown Chambersburg for the
expansion of our Memorial Square Office and headquarters. As we
communicated to you in prior letters and reports, we purchased the
former JJ Newberry building with plans to replace the current
structure on that site with an extension of the current Memorial
Square building. The construction of the new facility is part of
our downtown revitalization plans which are expected to run
through next year.
Many of the technology improvements and upgrades made in 1998
have enhanced our ability to handle future growth and service
delivery, as well as effectively deal with the Year 2000 issue,
more commonly referred to as the Y2K problem. Our preparation to
ensure that all our systems and vendors that support our systems
are Y2K compliant began almost two years ago with the development
of our Strategic Technology Plan. Many of our systems have
already passed Y2K readiness testing or will soon be tested for
Year 2000 compliance, and we have just completed another routine
Y2K examination by the Federal Deposit Insurance Corporation
(FDIC). We are confident that we can effectively serve our
customers on January 1, 2000 and beyond.
Before concluding this letter, I would like to express my
gratitude to John Hull for his years of service to Franklin
Financial and F&M Trust Company. John retired from the Board
following the annual Shareholders Meeting in April of 1998 after
26 years of service and commitment to our company. His vast
experience, knowledge, and contributions to our discussions along
with commitment to uphold the values that have guided our company
for more than 90 years will be missed.
As John retired, we were pleased to have added two new
directors to our board: Stephen E. Patterson and Donald A. Fry.
Both gentlemen have already made significant contributions to our
board deliberations and have provided us with much needed
representation from the Waynesboro and Shippensburg markets,
respectively.
The financial services industry continues to change at a
tremendous pace affected by competitive, regulatory, demographic,
cultural, economic, and technological influences. What does the
future of community banking hold? The Kiplinger Washington Letter
(January 22, 1999) reports, Small community banks are holding
their own amid all the mergers and acquisitions among the large
regional and money-center institutions. Their strength is
personal service to business and individuals . . . getting to know
customers' needs and going out of their way to meet them. Banks
won't end up like airlines, with a handful of bigs running the
show. Despite recent mergers, there are still 9000 separate banks
in the U.S.
We agree that community banking is not doomed and believe
that our institution can continue to make a difference in the
quality of life of our neighbors and in our communities. It is
very important for communities to have a local, independent
community bank where customers can find financial solutions
delivered by people they know and trust. Community banks,
however, cannot continue to operate according to the status quo,
but must evolve from the traditional banking mode to one of full-
service financial service providers. Our commitment to our
communities and our customers is to remain independent through
this evolution while we enhance long-term value to our
shareholders.
As stated in our mission statement and core values statement,
it is our belief that the delivery of quality service by our
employees to customers and communities are the cornerstone for
quality earnings to you, our shareholders. Our future success is
ultimately linked to our past success, that being to effectively
serve our four core constituencies --- our shareholders, our
customers, our employees, and our communities. As the case has
been for over 93 years, we are guided by our core values ---
proactivity, honesty and integrity, accountability, and a concern
for the individual --- as we focus upon achieving our mission as a
good corporate citizen within our communities.
Sincerely,
William E. Snell, Jr.
President and Chief Executive Officer
Market and Dividend Information
The Corporation's common stock is not actively traded in the
over-the-counter market. The Corporation+s stock is listed under
the symbol "FRAF" on the O.T.C. Electronic Bulletin Board, an
automated quotation service. 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
60 of this report).
There were 1,930 shareholders of record as of December 31,
1998. The range of high and low bid prices, as reported by local
sources, is shown below for the years 1998 and 1997. Also shown
are the regular quarterly cash dividends paid for the same years.
Per Share
1998 High Low Cash div.
1st quarter ..... $36.00 $32.83 $0.15
2nd quarter ..... 37.75 36.00 0.15
3rd quarter ..... 37.00 30.00 0.16
4th quarter ..... 30.00 29.00 0.16
-----
0.62
======
Per Share*
1997 High Low Cash div.
1st quarter ..... $22.00 $20.83 $0.133
2nd quarter ..... 22.00 22.00 0.133
3rd quarter ..... 24.67 22.00 0.147
4th quarter ..... 32.83 24.67 0.147
-------
0.56
=======
*Per share information has been adjusted to reflect a 3 for 2
stock split issued in the form of a 50% stock dividend distributed
on February 3, 1998.
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 subsidiary as of December 31, 1998 and 1997, 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, 1998. 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 consolidated
financial position of FRANKLIN FINANCIAL SERVICES CORPORATION and
subsidiary as of December 31, 1998 and 1997, and the consolidated
results of their operations and cash flows for each of the three
years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles.
/s/ Arther Andersen L.L.P.
Lancaster, PA
January 29, 1999
Consolidated Balance Sheets
(Amounts in thousands) December 31
-----------------------------
1998 1997
-----------------------------
Assets
Cash and due from banks (Note 3) $12,895 $10,863
Interest-bearing deposits in other banks 11,514 249
Investment securities held to maturity (market value of $28,030 at
December 31, 1997) (Notes 1 and 4) - 27,779
Investment securities available for sale (Notes 1 and 4) 127,118 59,319
Loans, net (Notes 1 and 5) 258,488 241,244
Premises and equipment, net (Notes 1 and 7) 5,889 5,907
Other assets 9,097 8,504
-----------------------------
Total assets $425,001 $353,865
========== ==========
Liabilities
Deposits (Note 8)
Demand (noninterest-bearing) $42,224 $37,591
Savings and interest checking 141,477 113,138
Time 142,878 123,826
-----------------------------
Total Deposits 326,579 274,555
Securities sold under agreements to repurchase(Note 9) 24,414 16,075
Other borrowings (Note 9) 30,744 21,434
Other liabilities 3,363 5,496
-----------------------------
Total liabilities 385,100 317,560
-----------------------------
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 3,045
shares issued and 2,802 and 2,795 outstanding at
December 31, 1998 and 1997, respectively 3,045 3,045
Capital stock without par value, 5,000 shares authorized with no shares
issued and outstanding - -
Additional paid-in capital 19,793 19,761
Retained earnings 20,562 17,087
Accumulated other comprehensive income 1,783 1,935
Treasury stock (4,620) (4,760)
Unearned compensation (Note 11) (662) (763)
-----------------------------
Total shareholders' equity 39,901 36,305
-----------------------------
Total liabilities and shareholders' equity $425,001 $353,865
========== ==========
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
---------------------------------
1998 1997 1996
---------------------------------
Interest income (Note 1)
Interest on loans $22,022 $21,088 $19,903
Interest on deposits and other obligations of other banks 359 28 210
Interest on investments:
U.S. Government obligations 235 293 311
Obligations of U.S. Government agencies and corporatio 2,191 2,632 2,542
Obligations of states and political subdivisions 1,613 1,407 999
Other securities 946 704 695
Dividend income 163 156 139
---------------------------------
Total interest income 27,529 26,308 24,799
---------------------------------
Interest expense
Interest on deposits (Note 8) 11,205 10,057 9,848
Interest on securities sold under agreements to repurchase 1,053 750 762
Other borrowings 893 1,418 477
---------------------------------
Total interest expense 13,151 12,225 11,087
---------------------------------
Net interest income 14,378 14,083 13,712
---------------------------------
Provision for possible loan losses (Notes 1 and 6) 1,061 936 607
---------------------------------
Net interest income after provision for possible loan losse 13,317 13,147 13,105
---------------------------------
Noninterest income
Trust fees 1,847 1,431 1,175
Service charges, commissions and fees 2,241 2,023 1,939
Other 317 65 403
Securities gains 625 787 166
---------------------------------
Total noninterest income 5,030 4,306 3,683
---------------------------------
Noninterest expense
Salaries and employee benefits 6,053 6,434 6,276
Net occupancy expense 623 624 524
Furniture and equipment expense 783 776 751
Other 4,579 3,866 3,731
---------------------------------
Total noninterest expense 12,038 11,700 11,282
---------------------------------
Income before Federal income taxes 6,309 5,753 5,506
Federal income tax expense (Note 10) 1,504 1,390 1,379
---------------------------------
Net income $4,805 $4,363 $4,127
======= ======= =======
Earnings per share (Note 1)*
Basic earnings per share $1.76 $1.59 $1.46
Weighted average shares outstanding (000's) 2,731 2,738 2,818
Diluted earnings per share $1.74 $1.58 $1.45
Weighted average shares outstanding (000's) 2,769 2,767 2,838
*Earnings per share for all periods have been adjusted to reflect a 3 for 2 stock split issued in
dividend distributed on February 3, 1998.
The accompanying notes are an integral part of these statements.
Consolidated Statements of Changes in Shareholders' Equity
For years ended December 31, 1998, 1997 and 1996:
Accumulated
Additional Other
Common Paid-in Retained ComprehensiveTreasury Unearned
(Amounts in thousands, except per share d Stock Capital Earnings Income Stock Compensatio Total
----------------------------------------------------------------------
Balance at December 31, 1995 $2,030 $19,431 $14,966 $677 ($2,053) ($95) $34,956
Year ended December 31, 1996
Comprehensive income:
Net income - - 4,127 - - - 4,127
Unrealized gains on securities, net of - - - (64) - - (64)
---------
Total Comprehensive income 4,063
Cash dividends declared, $.52 per share - - (1,503) - - - (1,503)
Common stock issued under
stock option plans (Note 12) - (33) - - 233 - 200
Restricted stock issued under
long-term incentive compensation plan
(28,926 shares net of forfeitures) - 177 - - 672 (849)
Acquisition of 132,906 shares of
treasury stock at cost (2,682) (2,682)
Tax benefit of restricted stock transact - 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
======= ======= ======= ========== ======= ========= =======
Year ended December 31, 1997
Comprehensive income:
Net income - - 4,363 - - - 4,363
Unrealized gains on securities, net of ta - - - 1,322 - - 1,322
---------
Total Comprehensive income 5,685
Cash dividends declared, $1.37 per share - - (3,851) - - - (3,851)
50% stock split 1,015 - (1,015) - - - -
Common stock issued under
stock option plans (Note 12) - 27 - - 294 - 321
Restricted stock issued under long-term
incentive compensation plan
(2,174 shares net of forfeitures) - (11) - - 60 (73) (24)
Acquisition of 56,974 shares of
treasury stock at cost (1,284) (1,284)
Amortization of unearned
compensation (Note 11) - - - - - 117 117
----------------------------------------------------------------------
Balance at December 31, 1997 $3,045 $19,761 $17,087 $1,935 ($4,760) ($763) $36,305
======= ======= ======= ========== ======= ========= =======
Year ended December 31, 1998
Comprehensive income:
Net income - - 4,805 - - - 4,805
Unrealized holding gains arising
during current period, net of tax - - - 302 - - 302
Reclassification adjustment for realized
gains included in net income, net of ta - - - (454) - - (454)
---------
Total Comprehensive income 4,653
Cash dividends declared, $.47 per share - - (1,316) - - - (1,316)
Cash in lieu of fractional shares
on 50% stock split - - (14) - - - (14)
Common stock issued under
stock option plans (Note 12) - 32 - - 140 - 172
Amortization of unearned
compensation (Note 11) - - - - - 101 101
----------------------------------------------------------------------
Balance at December 31, 1998 $3,045 $19,793 $20,562 $1,783 ($4,620) ($662) $39,901
======= ======= ======= ========== ======= ========= =======
Cash dividends per share in all periods have been adjusted to reflect a 3 for 2 stock split issued
in the form of a 50% stock dividend and distributed on February 3,1998.
The accompanying notes are an integral part of these statements.
Consolidated Statements of Cash Flow
Years ended December 31
---------------------------------
1998 1997 1996
---------------------------------
(Amounts in thousands)
Cash flows from operating activities
Net income $4,805 $4,363 $4,127
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation 761 775 741
Premium amortization on investment securities 121 116 107
Discount accretion on investment securities (275) (156) (129)
Provision for possible loan losses 1,061 936 607
Securities gains, net (625) (787) (166)
Proceeds from sale of mortgage loans 26,048 11,947 15,225
Principal loss (gain) on sales of mortgage loans 35 (62) (71)
Loss (gain) on sale of premises and equipment 294 37 (196)
Loan charge-offs, net of recoveries (816) (692) (688)
Decrease (increase) in interest receivable 4 (154) (138)
Increase in interest payable 401 108 117
Decrease in unearned discount (33) (116) (361)
Increase in prepaid and other assets (689) (240) (432)
(Decrease) increase in accrued expenses and other liabilities (77) (236) 436
Other , net 50 333 305
---------------------------------
Net cash provided by operating activities 31,065 16,172 19,484
---------------------------------
Cash flows from investing activities
Proceeds from sales of investment securities available for sale 945 4,364 334
Proceeds from maturities of investment securities held to matur 5,579 10,088 11,026
Proceeds from maturities of investment securities available for 26,085 9,515 12,641
Purchase of investment securities held to maturity - (1,577) (11,999)
Purchase of investment securities available for sale (72,081) (16,905) (24,360)
Net change in loans (43,504) (32,091) (25,811)
Acquisition of branch office and customer list - - (2,667)
Capital expenditures (1,246) (433) (1,120)
Proceeds from sales of premises and equipment 208 143 331
---------------------------------
Net cash used in investing activities (84,014) (26,896) (41,625)
---------------------------------
Cash flows from financing activities
Net increase in demand deposits, NOW accounts
and savings accounts 32,972 11,119 8,952
Net increase (decrease) in certificates of deposit 19,052 (4,766) 2,039
Dividends paid (3,599) (1,571) (1,503)
Common stock issued under stock option plans 172 321 200
Purchase of treasury shares - (1,284) (2,682)
Cash inflows from other borrowings 17,649 7,496 10,752
---------------------------------
Net cash provided by financing activities 66,246 11,315 17,758
---------------------------------
Increase (decrease) in cash and cash equivalents 13,297 591 (4,383)
Cash and cash equivalents as of January 1 11,112 10,521 14,904
---------------------------------
Cash and cash equivalents as of December 31 $24,409 $11,112 $10,521
======= ======= =======
Supplemental Disclosures of Cash Flow Information
Cash paid during the year for: 1998 1997 1996
---------------------------------
Interest paid on deposits and other borrowed funds $12,748 $12,117 $10,970
Income tax paid 1,845 1,200 1,335
The accompanying notes are an integral part of these statements
NOTE 1. Summary of Significant Accounting Policies
The accounting policies of Franklin Financial Services
Corporation and its subsidiaries 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).
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
community 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 both its retail and commercial
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 - For 1997 and 1996 and through October
1, 1998, except as noted below, debt securities were 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. On October 1, 1998, the Corporation adopted
Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities." As permitted
under Statement No. 133, the Corporation transferred investment
securities classified as "held to maturity" with a book value of
$22,961,000 to the "available for sale" classification. The
transfer resulted in an increase to Shareholders' equity of
approximately $985,000, net of tax.
Available for sale securities are stated at estimated market
value, adjusted for amortization of premiums and accretion of
discounts which are recognized as adjustments of interest income.
The related unrealized holding gains and losses are 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.
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 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.
Premises and Equipment - Premises and equipment are stated at
cost less accumulated depreciation and amortization. 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 declared on November 13, 1997, and
distributed on February 3, 1998, to shareholders of record on
January 13, 1998.
The Corporation adopted Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" (Statement 128), on
December 31, 1997. Statement 128 requires dual presentation of
basic and diluted earnings per share on the face of the income
statement for all entities with complex capital structures. The
Corporation+s basic earnings per share is calculated as net income
divided by the weighted average number of shares outstanding. For
diluted earnings per share, net income is divided by the weighted
average number of shares outstanding plus the incremental number
of shares added as a result of converting common stock
equivalents, calculated using the treasury stock method. The
Corporation's common stock equivalents consist of outstanding
restricted stock and stock options.
A reconciliation of the weighted average shares outstanding
used to calculate basic earnings per share and diluted earnings
per share follows:
(In thousands) 1998 1997 1996
______ ______ ______
Weighted average shares
outstanding (basic) 2,731 2,738 2,818
Impact of common stock
equivalents 38 29 20
______ ______ ______
Weighted average shares
outstanding (diluted) 2,769 2,767 2,838
====== ======= ========
Reclassifications - Certain prior period amounts have been
reclassified to conform with the current year presentation.
Recent Accounting Pronouncements:
Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use - In March 1998, the American Institute
of Certified Public Accountants issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." This Statement of Position (SOP)
provides guidance on accounting for the costs of computer software
developed or obtained for internal use. The guidance includes
characteristics of computer software identified as internal-use
software, appropriate recognition of related costs as current
expense or capitalized costs and the types of costs that should be
capitalized. This SOP is effective for fiscal years beginning
after December 15, 1998. The adoption of this statement is not
expected to have a material effect on the Corporation+s financial
position or results of operations.
Accounting for Derivative Instruments and Hedging Activities -
In June 1998, the FASB issued Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This Statement
establishes accounting and reporting standards requiring that
every derivative instrument (including certain derivative
instruments embedded in other contracts and for hedging
activities) be recorded in the balance sheet as either an asset or
liability measured at its fair value. The Statement requires that
changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met.
Special accounting for qualifying hedges allows a derivative+s
gains and losses to offset related results on the hedged item in
the income statement, and requires that a company formally
document, designate, and assess the effectiveness of transactions
that receive hedge accounting treatment. Statement No. 133 is
effective for fiscal years beginning after June 15, 1999. Early
adoption is permitted as of any fiscal quarter after its issuance.
The Corporation adopted Statement No. 133 on October 1, 1998, with
no material financial statement impact. As provided for under FAS
No. 133, the Corporation transferred its Held to Maturity
investment securities portfolio to the Available for Sale category
(refer to Note 4).
Disclosure about Segments of an Enterprise and Related
Information - In June, 1997 the FASB issued Statement No. 131,
"Disclosures about Segments of an Enterprise and Related
Information" (Statement 131). Statement 131 became effective in
1998 and requires that public business enterprises report
financials and descriptive information about its reportable
operating segments. Based on the guidance provided by Statement
131, the Corporation does not have any operating segments which
require such additional information. The Corporation owns one
banking subsidiary which provides deposit and lending products and
services and operates in the same geographical area. The
descriptive information related to competition, concentration of
credit risks and other operating factors is applicable to the
Corporation.
Reporting Comprehensive Income - In June 1997, the FASB
issued Statement No. 130, "Reporting Comprehensive Income."
Comprehensive income is defined as the change in equity of a
business enterprise during a period from transactions and other
events and circumstances from nonowner sources. Comprehensive
income includes net income plus all other components of
comprehensive income. The only changes in equity that are excluded
from comprehensive income are those resulting from investments by
owners and distributions to owners. The Corporation adopted
Statement No. 130 on January 1, 1998. Comprehensive income is
reflected in the Consolidated Statements of Equity and includes
net income and unrealized gains on securities.
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 was adopted on January 1,
1998. There was no material financial statement impact from the
adoption of Statement No. 125 in 1997 or from the adoption of
Statement No. 127 in 1998.
NOTE 2. Regulatory Matters
The Bank 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 1 capital
(as defined in the regulations) to risk-weighted assets (as
defined), and of Tier 1 capital (as defined) to average assets (as
defined). Management believes, as of December 31, 1998, that the
Bank meets all capital adequacy requirements to which it is
subject.
As of December 31, 1998, 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 1 risk-based, Tier 1
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 1
risk-based and Tier 1 leverage requirements for the Corporation
and the Bank. Actual capital amounts and ratios are also
presented.
As of December 31, 1998
------------------------------------------------------
To be well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------------------------------------------------
(Amounts in thousands) Amount Ratio Amount Ratio Amount Ratio
-------------------------------------------------------
Total Capital (to Risk Weighted Assets)
Corporation $40,048 13.97% $22,940 8.00% $28,674 10.00%
Bank 35,708 12.58% 22,706 8.00% 28,383 10.00%
Tier 1 Capital (to Risk Weighted Assets)
Corporation $36,500 12.73% $11,470 4.00% $17,205 6.00%
Bank 32,160 11.33% 11,353 4.00% 17,030 6.00%
Tier 1 Capital (to Average Assets)
Corporation $36,500 9.16% $15,935 4.00% $19,919 5.00%
Bank 32,160 8.13% 15,826 4.00% 19,782 5.00%
As of December 31, 1997
--------------------------------------------------------
To be well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------------------------------------------
(Amounts in thousands) Amount Ratio Amount Ratio Amount Ratio
-------------------------------------------------------
Total Capital (to Risk Weighted Assets)
Corporation $35,394 14.80% $19,133 8.00% $23,916 10.00%
Bank 31,261 13.24% 18,889 8.00% 23,611 10.00%
Tier 1 Capital (to Risk Weighted Assets)
Corporation $32,401 13.53% $9,579 4.00% $14,368 6.00%
Bank 28,305 11.99% 9,445 4.00% 14,167 6.00%
Tier 1 Capital (to Average Assets)
Corporation $32,401 9.22% $14,049 4.00% $17,562 5.00%
Bank 28,305 8.18% 13,841 4.00% 17,301 5.00%
Management believes that under the current and propsoed regualtions
the Corporation and its Bank subsidiary will continue to meet the
mininum capital requirements in the foreseeable 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
The Corporation's subsidiary bank is required to maintain
reserves in the form of cash and balances with the Federal Reserve
Bank, against its deposit liabilities. At December 31, 1998 and
1997, required reserves held at the Federal Reserve Bank, for the
bank subsidiary, were approximately $3,225,000 and $2,879,000. In
addition, as compensation for check clearing and other services, a
compensatory balance maintained at the Federal Reserve Bank at
December 31, 1998 and 1997 equaled approximately $900,000.
NOTE 4. Investment Securities
On October 1, 1998, the Corporation adopted Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities." As provided for under Statement No. 133,
Corporation transferred investment securities classified as "held to maturity" with a book value of $22,961,000
the "available for sale" classification. The transfer resulted in an increase to Shareholders' equity of
$985,000, net of tax.
The amortized cost and estimated market values of investment securities as of December 31, 1998 an
1997 are as follows:
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
--------------------------------------------------------
1998 Available for Sale
Equity securities $3,404 $1,270 $ - $4,674
U.S. Treasury securities and obligations of U.S.
Government agencies and corporations 13,992 251 - 14,243
Obligations of state and political subdivision 48,490 1,341 379 49,452
Corporate debt securities 32,959 201 107 33,053
Mortgage-backed securities 25,572 166 42 25,696
--------------------------------------------------------
$124,417 $3,229 $528 $127,118
======== ======== ======== ========
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1997 Held to Maturity --------------------------------------------------------
U.S. Treasury securities and obligations of U.S.
Government agencies and corporations $1,030 $9 $ - $1,039
Obligations of state and political subdivision 15,025 227 8 15,244
Corporate debt securities 2,343 12 7 2,348
Mortgage-backed securities 7,989 66 48 8,007
--------------------------------------------------------
26,387 314 63 26,638
--------------------------------------------------------
Other* 1,392 -- -- 1,392
--------------------------------------------------------
$27,779 $314 $63 $28,030
======== ======== ======== ========
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1997 Available for Sale --------------------------------------------------------
Equity securities $1,588 $2,050 $ - $3,638
U.S. Treasury securities and obligations of U.S.
Government agencies and corporations 20,967 172 3 21,136
Obligations of state and political subdivision 14,926 674 - 15,600
Corporate debt securities 4,029 51 - 4,080
Mortgage-backed securities 14,877 42 54 14,865
--------------------------------------------------------
$56,387 $2,989 $57 $59,319
======== ======== ======== ========
*Included as Other in the Held to Maturity classification in the above schedules are common stock o
Federal Home Loan Bank of Pittsburgh and Atlantic Central Bankers Bank which in the aggregate total
$1,392,000 at December 31, 1997. 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.
At December 31, 1998 and 1997, investment securities pledged to secure public funds, trust balances
and other deposits and obligations totaled $59,350,000 and $50,078,000, respectively. Proceeds from the
of available for sale securities for the years ended December 31, 1998 and 1997, totaled approximately $9
and $4,364,000, respectively. The net gains realized from these sales were $625,000 and $787,000, respectively.
for the same periods.
The amortized cost and estimated market value of debt securities at December 31, 1998, by contractu
maturity, are shown below. 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
Available for Sale -------------------------
Due in one year or less $26,320 $26,261
Due after one year through five years 19,755 20,171
Due after five years through ten years 8,225 8,375
Due after ten years 41,141 41,941
------------------------
$95,441 $96,748
Mortgage-backed securities 25,572 25,696
-----------------------
$121,013 $122,444
======== ========
The amortized cost and estimated market value of mortgage backed securities by issuer as of December
1998 and 1997 are as follows:
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1998 Available for Sale --------------------------------------------------------
Federal Home Loan Mortgage Corporation $12,762 $77 $18 $12,821
Federal National Mortgage Association 7,959 47 2 8,004
Government National Mortgage Association 1,290 13 10 1,293
Other Private 3,561 29 12 3,578
--------------------------------------------------------
$25,572 $166 $42 $25,696
======== ======== ======== ========
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1997 Held to Maturity --------------------------------------------------------
Federal Home Loan Mortgage Corporation $2,662 $19 $7 $2,674
Federal National Mortgage Association 2,182 6 30 2,158
Government National Mortgage Association 430 11 -- 441
Other Private 2,715 30 11 2,734
--------------------------------------------------------
$7,989 $66 $48 $8,007
--------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1997 Available for Sale --------------------------------------------------------
Federal Home Loan Mortgage Corporation $9,843 $19 $46 $9,816
Federal National Mortgage Association 5,034 23 8 5,049
-------------------------------------------------------
$14,877 $42 $54 $14,865
======== ======== ======== ========
NOTE 5. Loans
A summary of loans outstanding at the end of the reporting periods is as follows:
December 31
-----------------------------------
(Amounts in thousands) 1998 1997
--------------------------------
Real estate (primarily first mortgage residential loan $92,293 $82,989
Real estate - Construction 10,501 7,562
Commercial, industrial and agricultural 101,606 98,389
Consumer (including home equity lines of credit) 57,647 55,651
--------------------------------
262,047 244,591
--------------------------------
Less: Unearned discount (10) (43)
Allowance for possible loan losses (3,549) (3,304)
--------------------------------
Net Loans $258,488 $241,244
========= =========
Loans to directors and executive officers and to their related interests and affilia
enterprises amounted to approximately $1,264,000 and $1,154,000 at December 31, 1998 and
1997, 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 199
approximately $450,000 of new loans were made and repayments totaled approximately $340,0
NOTE 6. Allowance for Possible Loan Losses
December 31
(Amounts in thousands) 1998 1997 1996
--------------------------------------
Balance at beginning of year $3,304 $3,060 $3,141
Charge-offs
Commercial, industrial and agricultural (189) (113) (183)
Consumer (688) (637) (582)
Real estate (84) (32) (12)
--------------------------------------
Total charge-offs (961) (782) (777)
Recoveries:
Commercial, industrial and agricultural 63 11 25
Consumer 82 79 64
Real estate -- -- --
--------------------------------------
Total recoveries 145 90 89
--------------------------------------
Net charge-offs (816) (692) (688)
--------------------------------------
Provision for possible loan losses 1,061 936 607
--------------------------------------
Balance at end of year $3,549 $3,304 $3,060
======= ======= =======
At December 31, 1998 and 1997 the Corporation had no restructured loans.
Nonaccrual loans at December 31, 1998 and 1997 were approximately $1,325,000 and $1,148,000,
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) 1998 1997 1996
--------------------------------------
Gross interest due under terms $159 $156 $120
Amount included in income (48) (19) (46)
--------------------------------------
Interest income not recognized $111 $137 $74
======= ======= =======
At December 31, 1998 and 1997, the recorded investment in loans that were considered
to be impaired, as defined by Statement No. 114, totaled $1,041,500 and $1,104,600, respectively.
Impaired loans have an allowance for credit losses of $54,000 and $67,000 as of December 31,
1998 and 1997, 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,
1998 and 1997, was $1,033,375 and $1,060,300, respectively.
NOTE 7. Premises and Equipment
Premises and equipment consist of:
December 31
Estimated ---------------------
(Amounts in thousands) useful life 1998 1997
------- -------
Land $930 $928
Buildings 18-40 years 7,299 7,204
Furniture, fixtures and equipment 3-13 years 5,762 5,166
------- -------
Total cost 13,991 13,298
Less: Accumulated Depreciation (8,102) (7,391)
-------- ---------
$5,889 $5,907
======= =======
<CAPTION
NOTE 8. Deposits
Deposits are summarized as follows:
December 31
---------------------------
(Amounts in thousands) 1998 1997
---------------------------
Demand $42,224 $37,591
Savings:
Interest-bearing checking 46,707 32,770
Money market accounts 56,623 40,836
Passbook and statement savings 38,147 39,532
------------ ------------
141,477 113,138
------------ ------------
Time:
Deposits of $100,000 and over 33,223 17,739
Other time deposits 109,655 106,087
------------ ------------
142,878 123,826
------------ ------------
Total deposits $326,579 $274,555
====== ======
The interest expense on time deposits with denominations of $100,000 or more for the years
ended December 31, 1998, 1997 and 1996 was $1,277,000, $1,144,000, and $1,179,000, 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 und
agreements to repurchase averaged $20,205,000 and $14,685,000 during 1998 and 1997, respectively,
and the maximum amounts outstanding at any month end during 1998 and 1997, were $24,414,000
and $18,538,000, respectively. The weighted average interest rate on these repurchase agreements was
5.21% and 5.11% for 1998 and 1997, respectively. At December 31, 1998, securities sold under
agreements to repurchase totaled $24,414,000 with interest rates ranging from 3.69% to 4.60%. The
securities that serve as collateral for securities sold under agreements to repurchase represent prima
U.S. Government and U.S. Agency securities with a book and market value of $25,641,000 and $26,233,000
respectively, at December 31, 1998. 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) 1998 1997
----------------------
Open Repo Plus (a) $ - $11,150
Term loans (b) 30,744 10,284
---------------------
Total other borrowings $30,744 $21,434
======= =======
(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 t
commitment in place on December 31, 1998 was $35,000,000.
(b) Term loans with the FHLB bear interest at fixed rates ranging from 4.72% to 7.27% (weighted
average rate of 5.57%) with various maturities beginning September 30, 1999 to December 30, 2008
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:
1999 5,635
2000 4,780
2001 1,647
2002 153
2003 -
2004 and beyond 18,529
--------
$30,744
=======
NOTE 10. Federal Income Taxes
The temporary differences which give rise to significant portions of deferred tax assets a
under Statement No.109 are as follows (amounts in thousands):
Deferred Taxes December 31
(Amounts in thousands) ------------------------------
Temporary Difference 1998 1997
----------------------------------------------------------------
Allowance for possible loan losses $1,206 $1,123
Deferred compensation 212 183
Pensions (57) 114
Restricted stock 133 101
Depreciation 81 42
Net unrealized gain on securities (918) (997)
Mortgage servicing rights (132) (70)
Deferred loan fees and costs,net 214 314
Nonaccrual loans 50 -
Property demolition & writedown 288 51
Other, net 56 3
-----------------------
Deferred taxes, net $1,133 $864
======= =======
In determining the level of valuation reserves required, the Corporation has determined based
its historical level of earnings, its interest margin, gap position and future taxable income t
more likely than not that the net deferred tax assets, will be realized over a period of approx
5 years. Accordingly, no valuation allowance was established as of December 31, 1998 and 1997.
The components of the provision for Federal income taxes attributable to income from opera
as follows:
Years ended December 31
---------------------------------------------
(Amounts in thousands) 1998 1997 1996
--------------------------------
Currently payable $1,694 $1,574 $1,302
Deferred tax expense (benefit) (190) (184) 77
--------------------------------
Income tax provision $1,504 $1,390 $1,379
======= ======= =======
For the years ended December 31, 1998, 1997 and 1996, the income tax provisions are differ
the tax expense which would be computed by applying the Federal statutory rate to pretax operat
earnings. A reconciliation between the tax provision at the statutory rate and the tax provisi
effective tax rate is as follows:
Years ended December 31
---------------------------------------------
(Amounts in thousands) 1998 1997 1996
--------------------------------
Tax provision at statutory rate $2,145 $1,956 $1,872
Income on tax-exempt loans and securities (685) (590) (418)
Nondeductible interest expense relating to
carrying tax-exempt obligations 95 81 61
Dividends received exclusion (17) (16) (15)
Valuation allowance adjustment - - (118)
Other, net (34) (41) (3)
--------------------------------
Income tax expense $1,504 $1,390 $1,379
======= ======= =======
The tax provision in each year is applicable to:
Years ended December 31
---------------------------------------------
(Amounts in thousands) 1998 1997 1996
--------------------------------
Operations $1,292 $1,122 $1,323
Securities gains 212 268 56
--------------------------------
Income tax provision $1,504 $1,390 $1,379
======= ======= =======
NOTE 11. Employee Benefit Plans
The Bank has a noncontributory pension plan covering
substantially all employees of F&M Trust who meet certain age and
service requirements. Benefits are based on years of service and
the employee's compensation during the highest five consecutive
years out of the last ten years of employment. The Bank+s funding
policy is to contribute annually the amount required to meet the
minimum funding requirements of the Employee Retirement Income
Security Act of 1974. Contributions are intended to provide not
only for benefits attributed to service to date but also for those
expected to be earned in the future.
In 1998, the Bank adopted Statement of Financial Accounting
Standards No. 132, "Employer's Disclosures about Pensions and
Other Postretirement Benefits" which was effective for fiscal
years beginning after December 15, 1997. Under the Statement,
restatement of disclosures for earlier periods provided for
comparative purposes is required. The Statement does not change
the measurement or recognition of pension and other postretirement
benefit plans. The Statement standardizes the disclosure
requirements for those plans, requires additional information on
changes in the benefit obligation and fair values of plan assets
that will facilitate financial analysis and eliminates certain
disclosures that are no longer as useful as they once were.
The following table sets forth the plan+s funded status at
December 31, 1998, based on a September 30, 1998, actuarial
valuation together with comparative 1997 and 1996 amounts:
<CAPTIO>
(Amounts in thousands) 1998 1997 1996
Change in benefit obligation
Benefit obligation at beginning of year. . . . . . . . .$ 7,611 $ 7,261 $6,549
Service cost. . . . . . . . . . . . . . . . . . . . . . 266 322 296
Interest cost. . . . . . . . . . . . . . . . . . . . . . 531 494 450
Actuarial loss (gain) . . . . . . . . . . . . . . . . . . 380 (142) 522
Benefits paid. . . . . . . . . . . . . . . . . . . . . . . (355) ( 324) (556)
Benefit obligation at end of year. . . . . . . . . . . . 8,433 7,611 7,261
Change in plan assets
Fair value of plan assets at beginning of year* . . . . . 11,223 7,816 7,022
Actual return on plan assets. . . . . . . . . . . . . 673 3,731 1,180
Employer contribution . . . . . . . . . . . . . . . . . 0 0 170
Benefits paid . . . . . . . . . . . . . . . . . . . . (355) (324) ( 556)
Fair value of plan assets at end of year . . . . . . . 11,541 11,223 7,816
Funded status . . . . . . . . . . . . . . . . . . . . . 3,108 3,613 555
Unrecognized transitional asset . . . . . . . . . . . (78) (116) (155)
Unrecognized net actuarial gain . . . . . . . . . . . . .(2,893) (3,873) (612)
Unrecognized prior service cost . . . . . . . . . . . 96 108 119
Prepaid (accrued) benefit cost . . . . . . . . . . . . $ 233 $ ( 268) $ (93)
===== ====== =====
Weighted-average assumptions as of
December 31 1998 1997 1996
Discount rate . . . . . . . . . . . . . . . . . . . . . 6.50% 7.00% 7.00%
Expected return on plan assets . . . . . . . . . . . . 8.00% 8.00% 8.00%
Rate of compensation increase . . . . . . . . . . . . . 5.25% 5.75% 5.75%
1998 1997 1996
Components of net periodic benefit cost
Service cost . . . . . . . . . . . . . . . . . . . . . $ 266 $321 $ 296
Interest cost . . . . . . . . . . . . . . . . . . . . 531 494 450
Expected return on plan assets . . . . . . . . . . . . (971) (612) (549)
Amortization of transitional (asset) obligation . . . . (39) (39) (39)
Amortization of prior service cost . . . . . . . . . . . 11 11 11
Recognized net actuarial gain . . . . . . . . . . . . . (299) 0 0
Net periodic benefit cost . . . . . . . . . . . . . . ..$ (501) $ 175 $ 169
==== ==== ====
*Plan assets are primarily invested in equities, US Government Agencies, corporate bonds and general
assets of insurance companies.
The Bank has a 401(k) plan covering substantially all
employees of F&M Trust who have completed one year and 1000 hours
of service. In 1998, employee contributions to the plan were
matched at 100% up to 3% of each employee+s deferrals plus 50% of
the next 2% of deferrals from participants eligible compensation.
In addition, a 100% discretionary profit sharing contribution of
up to 2% of each employee+s eligible compensation was possible,
provided established net income targets were achieved. Annually,
the Bank+s Board of Directors approves the established net income
targets. Under this plan, not more than 19.00% of each
participant+s total compensation may be contributed in any given
plan year. The related expense for the 401(k) plan and the profit
sharing plan in 1998, 1997 and 1996, as approved by the Board of
Directors, was $266,325, $143,000 and $132,500, 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 264,825
shares of presently authorized but unissued or reacquired common
stock to certain employees of the Corporation and its
subsidiaries. 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 under the Program, as of December 31, 1998, has
awarded 169,152 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. Also, under
the Program the Committee has awarded 18,345 restricted shares of
the $1.00 par value per share common stock of the Corporation to
certain employees at no cost to the participants. 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 charged to income over
the vesting period. The cost associated with the program was
approximately $101,000 in 1998, $117,000 in 1997 and $137,000 in
1996. The total of restricted shares vested was 847 and 1,552 in
1997 and 1996, respectively. No restricted shares vested in 1998.
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 were no cash awards
in 1998, 1997 or 1996.
NOTE 12. Stock Purchase Plan
In 1994, the Board of Directors of the Corporation approved and adopted the Employee Stock Purchase
Plan of 1994 (the Plan). Under the Plan 198,000 shares of stock can be purchased by participating employees over
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 the
lesser 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.
As of December 31, 1998 there are 132,119 shares available for future grant.
The following table summarizes the stock option activity (stock options have been adjusted to reflect all
stock splits):
Option Price Per Share
--------------------------------------------------------
Price Weighted
Stock Options Range Average
----------------------------------------------------------
Balance at December 31, 1995 22,961 $14.53 $14.53
Granted 19,572 19.24 19.24
Exercised (13,417) 14.53 - 19.24 14.77
Canceled (10,224) 14.53 14.53
---------------------
Balance at December 31, 1996 18,892 $19.24 $19.24
Granted 17,700 23.08 23.08
Exercised (15,305) 19.24 - 23.08 20.24
Canceled (7,564) 19.24 19.24
----------------------
Balance at December 31, 1997 13,723 $23.08 $23.08
Granted 17,005 27.68 27.68
Exercised (7,206) 23.08 - 27.68 23.39
Canceled (7,014) 23.08 23.08
----------------------
Balance at December 31, 1998 16,508 $27.68 $27.68
===========
The following table summarizes information concerning options outstanding
at December 31, 1998:
Weighted Weighted
Unexercised Average Average
Stock Remaining Exercise
Exercise Price Options Life (Years) Price
$27.68 16,508 0.75 $27.68
The Corporation has 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. Accordingly, no compensation expense for the Plan has
been recognized in the financial statements of the Corporation. Had
compensation cost for the Plan been recognized in accordance with
Statement No. 123, the Corporation's net income and net income per share
amounts would have been reduced to the following pro-forma amounts:
(Amounts in thousands, except per share) 1998 1997
Net Income: As reported $4,805 $4,363
Proforma 4,780 4,334
Basic earnings per share: As reported $1.76 $1.59
Proforma 1.75 1.58
Diluted earnings per share: As reported $1.74 $1.58
Proforma 1.73 1.57
Weighted average fair value of options granted $3.81 $4.50
The fair value of the options granted has been estimated using the
following assumptions for 1998 and 1997 respectively: risk-free
interest rate of 4.53% and 5.49% , expected volatility of the
Corporation's stock of 14.00% and 20.10%, expected dividend yield
of 2.08% and 3.67%. The expected life of the options in 1998 and
1997 was .76 year and .81 year, respectively.
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
appoximately $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, 1998, the Board of Directors authorized the repurchase of
up to 50,000 shares of the Corporation's common stock for a twelve month
period ending in March 1999. The Corporation uses the repurchased common
stock (Treasury stock) for general corporate purposes including stock
dividends and splits, employee benefit and executive compensation plans, and
the dividend reinvestment plan. There were no shares repurchased under the
plan in 1998. At December 31, 1998 and 1997, respectively, the Corporation
held a total of 242,871 and 250,194 Treasury shares acquired through Board
authorized stock repurchase programs.
On November 13, 1997, the Board of Directors declared a 3 for 2 stock split
issued in the form of a 50% stock dividend to be distributed on February 3,
1998 to the Corporation's shareholders of record at the close of business on
January 13, 1998. The result was a transfer from retained earnings to
common stock of approximately $1,015,000. A cash amount of approximately
$10,500 was paid in lieu of issuing fractional shares arising from the stock
dividend.
Also on November 13, 1997, the Board of Directors declared a special cash
dividend of $.66 per share on the Corporation's common stock, payable January
21, 1998, to the Corporation's shareholders of record as of the close of
business on January 7, 1998 and a regular cash dividend of $.15 per share
payable February 27, 1998 to shareholders of record as of the close of
business on February 12,1998.
In 1996, the Board of Directors authorized the repurchase of up to $150,000
shares of the Corporation's common stock through July 1997. In March 1997, the
Board of Directors extended the repurchase period from July 1997 to March 1998.
Under the program, the Corporation repurchased 50,374 shares and 49,968 shares
during 1997 and 1996, respectively. In addition, the Corporation repurchased
6,600 shares and 82,938 shares in direct Board-authorized repurchases in 1997
and 1996, respectively.
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. The Corporation had the following outstanding commitments to
fund loans as of December 31:
(Amounts in thousands) 1998 1997
_____ _____
Financial instruments whose contract amounts
represent credit risk:
Commercial commitments to extend credit ............ $32,032 $28,681
Consumer commitments to extend credit (secured) .... 15,767 14,716
Consumer commitments to extend credit (unsecured) .. 12,608 11,317
_______ _______
$60,407 $54,714
Standby letters of credit .......................... 2,547 1,053
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 $314,000,
$299,000 and $316,000 in the years 1998, 1997 and 1996,
respectively. Future minimum payments under these leases are as
follows:
1999 ....................... $312,000
2000 ....................... 45,700
2001 ....................... 39,500
2002 ....................... 24,900
2003 and beyond ............ 38,500
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:
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:
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.
Deposits, Securities sold under agreements to repurchase 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, 1998 and 1997, the Corporation had outstanding
commitments to extend credit of $60,407,000 and $54,714,000, respectively,
and commitments under standby letters of credit of $2,547,000 and $1,053,000,
respectively. 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.
Note 16
The estimated fair value of the Corporation's financial instruments at December 31 are as follows:
1998 1997
--------------------------------------------------
Carrying Fair Carrying Fair
(Amounts in thousands) Amount Value Amount Value
----------------------------------------------
Financial assets:
Cash and short-term investments $24,409 $24,409 $11,112 $11,112
Investment securities held to maturity - - 27,779 28,030
Investment securities available for sale 127,118 127,118 59,319 59,319
Net Loans 258,488 267,937 241,244 246,819
----------------------------------------------
Total Financial Assets $410,015 $419,464 $339,454 $345,280
======== ======== ======== ========
Financial liabilities:
Deposits $326,579 $328,684 $274,555 $275,021
Securities sold under agreements to repurchas 24,414 24,414 16,075 16,075
Other borrowings 30,744 31,108 21,434 21,452
----------------------------------------------
Total Financial Liabilities $381,737 $384,206 $312,064 $312,548
======== ======== ======== ========
The above values do not necessarily reflect the premium or discount that could result from offe
at one time the Corporation's entire holdings of a particular instrument. In addition, these values
the methods and asumptions described above, do not consider the potential income taxes or other expe
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) 1998 1997
-----------------------------
Assets:
Due from bank subsidiary $1,386 $3,320
Investment securities 2,735 2,999
Equity investment in subsidiaries 35,454 31,587
Premises 395 881
Other assets 273 340
-----------------------------
Total assets $40,243 $39,127
========= =======
Liabilities:
Deferred tax liability $342 $542
Dividends payable - 2,280
-----------------------------
Total liabilities 342 2,822
Shareholders' equity:
Common stock 3,045 3,045
Additional paid-in capital 19,793 19,761
Retained earnings 20,562 17,087
Net unrealized gain on securities 1,783 1,935
Treasury stock, at cost (4,620) (4,760)
Unearned compensation (662) (763)
-----------------------------
Total shareholders' equity 39,901 36,305
-----------------------------
Total liabilities and shareholders' equity $40,243 $39,127
========= =======
Statements of Income
Years ended
December 31
-----------------------------------------------------------
(Amounts in thousands) 1998 1997 1996
-----------------------------------------
Income:
Dividends from Bank $1,317 $6,020 $2,631
Interest and dividend income 57 44 42
Gain on sale of securities 464 468 105
Other income 1 - 37
Gain on sale of premises 29 - 90
-----------------------------------------
1,868 6,532 2,905
Expenses:
Operating expenses 516 566 292
Loss on sale of premises 170 40 -
-----------------------------------------
Income before equity in undistributed income of subsidiari 1,182 5,926 2,613
Equity in undistributed income of subsidiaries 3,623 (1,563) 1,514
-----------------------------------------
Net income $4,805 $4,363 $4,127
======= ========= =======
Statements of Cash Flows
Years ended
December 31
----------------------------------------------------------
(Amounts in thousands) 1998 1997 1996
-----------------------------------------
Cash flows from operating activities
Consolidated net income $4,805 $4,363 $4,127
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed income of subsidiaries (3,623) 1,563 (1,514)
Depreciation 11 31 29
Discount accretion on investment securities - - (1)
Loss (gain) on sale of premises 141 40 (90)
Securities gains, net (464) (468) (105)
Decrease (increase) in due from bank subsidiary 1,934 (3,142) 92
Decrease (increase) in other assets 66 (256) 119
(Decrease) increase in liabilities - (87) 119
Other, net 234 278 303
-----------------------------------------
Net cash provided by operating activities 3,104 2,322 3,079
-----------------------------------------
Cash flows from investing activities
Proceeds from sales of investment securities 709 644 232
Proceeds from maturities of investment securities - - 850
Purchase of investment securities (580) (534) (218)
Proceeds from sale of premises 208 129 225
Capital expenditures (14) (27) (183)
-----------------------------------------
Net cash provided by investing activities 323 212 906
-----------------------------------------
Cash flows from financing activities
Dividends (3,599) (1,571) (1,503)
Proceeds from sales of common stock 172 321 200
Purchase of treasury shares - (1,284) (2,682)
-----------------------------------------
Net cash used in financing activities (3,427) (2,534) (3,985)
-----------------------------------------
Increase in cash and cash equivalents - - -
Cash and cash equivalents as of January 1 - - -
Cash and cash equivalents as of December 31 $ - $ - $ -
======= ========= =======
Supplemental Disclosures of Cash Flow Information
During 1998 Franklin Financial transfered real estate with a value of $141,000 to its wholly owned subsidiary
NOTE 18. Quarterly Results of Operation (Unaudited)
The following is a summary of the quarterly results of consolidated operations of Franklin Financi
years ended December 31, 1998 and 1997:
(Amounts in thousands) Three months ended
---------------------------------------------------------
1998 March 31 June 30 September 30 December 31
-------------------------------------------------------------------------------------------------------
Interest income $6,729 $6,730 $6,879 $7,191
Interest expense 3,116 3,188 3,333 3,514
---------------------------------------------------------
Net interest income 3,613 3,542 3,546 3,677
Provision for loan losses 365 190 165 341
Other noninterest income 975 1,080 1,050 1,300
Securities gains (losses) 299 196 68 62
Noninterest expense 2,896 3,011 2,905 3,226
---------------------------------------------------------
Income before income taxes 1,626 1,617 1,594 1,472
Income taxes 394 375 416 319
---------------------------------------------------------
Net Income $1,232 $1,242 $1,178 $1,153
======== ========= =========== ===========
Basic earnings per share $0.45 $0.46 $0.43 $0.42
Diluted earnings per share $0.45 $0.45 $0.43 $0.42
======== ========= =========== ===========
1997 March 31 June 30 September 30 December 31
-------------------------------------------------------------------------------------------------------
Interest income $6,383 $6,530 $6,724 $6,671
Interest expense 2,853 2,991 3,173 3,208
---------------------------------------------------------
Net interest income 3,530 3,539 3,551 3,463
Provision for loan losses 193 192 253 298
Other noninterest income 883 871 828 937
Securities gains 111 93 189 394
Noninterest expense 2,795 2,784 2,985 3,136
---------------------------------------------------------
Income before income taxes 1,536 1,527 1,330 1,360
Income taxes 401 344 291 354
---------------------------------------------------------
Net Income $1,135 $1,183 $1,039 $1,006
======== ========= =========== ===========
Basic earnings per share* $0.41 $0.43 $0.38 $0.37
Diluted earnings per share* $0.41 $0.43 $0.38 $0.37
======== ========= =========== ===========
*Based on weighted-average shares outstanding during the period reported adjusted retroactively to refl
of a 50% stock dividend and distributed on February 3, 1998, to shareholders of record on January 13,
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 the consolidated financial statements
and other financial data presented elsewhere herein.
Results of Operations Summary
Franklin Financial Services Corporation again achieved record
net income of $4.80 million for the year ended December 31, 1998,
an increase of 10.1% over the $4.36 million recorded in 1997.
Basic earnings per share for the year ended December 31, 1998,
were $1.76 compared to $1.59 and $1.46 for the years ended
December 31, 1997 and 1996, respectively. Cash dividends declared
in 1998 included three-quarterly dividends and totaled $.47 per
share; cash dividends declared in 1997 included five-quarterly
dividends and totaled $1.37 per share including four regular
quarterly dividends paid in 1997 ($.56 per share), one regular
dividend declared in the fourth quarter of 1997 and paid as a
regular first quarter 1998 cash dividend ($.15 per share) and a
special cash dividend ($.66 per share) declared in the fourth
quarter of 1997 and paid to shareholders on January 20, 1998.
Book value and market value per share at December 31, 1998, were
$14.24 and $29.88, respectively; return on average assets (ROA)
and return on average equity (ROE) for 1998 were 1.29% and 12.58%,
respectively, compared to 1.26% and 12.03%, respectively, one year
earlier. Total assets grew approximately $71.1 million to $425.0
million at December 31, 1998 from $353.9 million at December 31,
1997. Net loans realized good growth, increasing $17.2 million,
or 7.1%, to $258.5 million at year-end 1998 versus year-end 1997.
Deposits recorded strong growth with an increase of $52.0
million, or 18.9%, to $326.6 million at December 31, 1998,
compared to $274.6 million at December 31, 1997. The
Corporation's capital position remains strong at $39.9 million at
December 31, 1998, compared to $36.3 million at December 31, 1997.
The Corporation's Tier 1 leverage ratio was 9.16% at December 31,
1998, compared to 9.22% at December 31, 1997.
A more detailed discussion of the areas having the greatest
impact on the reported results for 1998 follows.
Net Interest Income
The most important source of the Corporation's earnings is
net interest income which is defined as the difference between
income on interest-earning assets and the cost of interest-bearing
liabilities supporting those assets. The principal categories of
interest-earning assets are loans and securities, while deposits
and other borrowings are the principal interest-bearing
liabilities. Net interest income, on a tax-equivalent basis,
increased $401,000, or 2.7% to $15.3 million in 1998 from $14.9
million in 1997. The net interest margin, which reflects the
interest rate spread plus the contribution of assets funded by
noninterest-bearing sources, decreased to 4.38% for the year
ended December 31, 1998, from 4.61% and 4.72% for the years ended
December 31, 1997 and 1996, respectively. The declining trend in
net interest margin is the result of an increasingly competitive
environment for both loans and deposits, which has resulted in
more aggressive pricing for loans and the development of new
market-indexed deposit products, particularly a new money market
account.
For the purpose of this 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 tax-equivalent basis for
each of the years in the three-year period ended December 31,
1998. Table 2 presents average balances, tax-equivalent interest
income and interest 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.
The level of net interest income is affected primarily by
variations in the volume and mix of the Corporation's assets and
liabilities, as well as by changes in the level of interest rates.
Short-term interest rates were stable throughout the first nine
months of 1998 but declined during the final quarter in response
to three separate 25-basis point reductions in the Federal funds
rate. The average prime rate in 1998 was 8.35% and the average
Federal funds rate was 5.36% versus 8.44% and 5.48%, respectively,
in 1997. Intermediate and long term rates drifted lower
throughout the year prompting an exceptionally heavy volume of
mortgage refinancing activity and contributing to lower interest
income. Nevertheless, Tables 2 and 3 reveal that most of the
change in interest income, interest expense and net interest
income can be attributed to an increase in volume rather than
changes in interest rates.
Average interest-earning assets grew $26.5 million or, 8.2%,
to $350.8 million for 1998 from $324.3 million for 1997 and
represented 94.0% and 93.8%, respectively, of total assets for
the related years. Average loans comprised 72.0% of average
interest-earning assets and contributed 78.1% of the total
interest income in 1998. The growth in average interest-earning
assets, when combined with a 25-basis point decrease in the
average yield, resulted in a $1.3 million, or 4.8%, increase in
net interest income to $28.5 million for 1998 from $27.2 million
in 1997. The growth in interest-earning assets was driven
primarily by a $17.3 million increase in net loans, reflecting
the Corporation's business development efforts and a healthy
economic environment. The decrease in the average yield on
interest-earning assets resulted from intensified competitive
pressures for new loans and the prepayments of higher-yielding
mortgage loans producing a 24-basis point decline in the yield on
interest-earning assets to 8.81% for 1998 versus 9.05% for 1997.
The yield on investment securities for 1998 decreased 16-basis
points to 6.43% from 6.59% in 1997 due primarily to the purchase
of new securities at interest rates lower than those of securities
maturing or running off.
Average interest-bearing deposits grew $23.8 million to
$254.9 million in 1998 versus 1997 and resulted in an increase in
interest expense of $1.1 million to $11.2 million for 1998 versus
$10.1 million in 1997. The Corporation continues to experience a
shift from lower cost accounts to higher cost accounts including a
new money market account introduced in 1997; this migration
contributed to the higher interest expense for 1998.
Other borrowings, comprising securities sold under agreements
to repurchase (Repos) and overnight and long-term debt with the
Federal Home Loan Bank of Pittsburgh, decreased $3.6 million
during the year to $34.8 million. The decrease in Repos and other
borrowings was the result of growth in deposits, noninterest-
bearing liabilities and shareholders' equity in 1998 versus 1997.
The average rate paid on Repos and other borrowings decreased six
basis points to 5.58% in 1998 from 5.64% in 1997.
Interest rates were marginally higher in 1997 than in 1996.
The average prime rate in 1997 was 8.44% and the average Federal
funds rate was 5.48% versus 8.27% and 5.31%, respectively, in
1996. Net interest income on a tax-equivalent basis rose $667,000
to $15.0 million in 1997 from $14.3 million in 1996. Average
earning assets grew $21.7 million to $324.3 million for 1997
compared to 1996 with the yield remaining unchanged at 8.38%.
Average interest-bearing liabilities increased $19.9 million to
$269.4 million for 1997 versus 1996 and showed an average increase
in the interest rates paid on those liabilities of 10 basis points
to 4.54% for 1997 versus 4.44% for 1996.
Provision for Possible Loan Losses
The provision for possible loan losses charged against
earnings was $1.061 million in 1998 compared to $936,000 in 1997,
an increase of 13.3%. The higher provision was mainly due to
consumer bankruptcies and subsequent charge-offs and to increase
the size of the allowance in relation to loan growth.
Nonperforming assets increased to $2.17 million at December 31,
1998, from $1.9 million at December 31, 1997. Net charge-offs
increased by $124,000 to $816,000 in 1998 versus $692,000 in 1997.
In 1996, the provision for possible loan losses was $607,000 and
net charge-offs were $688,000. Management performs a quarterly
analysis of the loan portfolio, current economic conditions and
other relevant factors to determine the adequacy of the allowance
for possible loan losses. The result of this quarterly analysis
determines the amount of loan loss provision needed. For more
information, refer to the loan quality discussion and Table 10.
Noninterest Income and Expense
Noninterest income totaled $5.0 million in 1998 and
represented an increase of $724,000, or 16.8%, over the $4.3
million recorded in 1997. Noninterest income recorded in 1997 was
$623,000, or 16.9%, over the $3.7 million recorded in 1996.
Factors contributing to higher, noninterest income were growth in
trust fees related to new trust business and growth in the market
value of trust assets under management, growth in loan fees
related to a higher volume of mortgage loans originated in 1998
versus 1997, and the recognition of a deferred gain, as discussed
below.
Trust fees in 1998 reached another record level of $1.8
million, an increase of $416,000, or 29.1%, over 1997 fees of $1.4
million. The growth in trust assets under management in 1998 was
related primarily to consumer disenchantment with recent mergers
of local banks into megabanks or large regional banks coupled with
an aggressive sales and marketing culture and increased market
value. The Personal Investment Center, still in its infancy, is
also contributing nicely to trust fee income. Trust assets under
management grew 14.3% reaching $401.1 million at December 31,
1998, compared to $350.9 million at December 31, 1997. Trust
assets under management are stated at fair market value. Trust
fee income in 1996 equaled $1.2 million.
Service charges, commissions and fees grew $218,000, or
10.8%, to $2.2 million in 1998 versus $2.0 million in 1997. Loan
origination fees accounted for $180,000 of the increase; deposit
fees and various other service charges accounted for the
remainder. Service charges, commissions and fees totaled $1.9
million in 1996.
Other income was up $252,000 to $317,000 for 1998 compared to
$65,000 in 1997. The remainder of a deferred gain of
approximately $207,000 from the sale of a real estate subsidiary
in 1993 was realized in 1998 and accounted for the large increase
year over year. Other income recorded in 1996 totaled $403,000
and was primarily the result of recording a partial deferred gain
from the above-mentioned sale of a real estate subsidiary
$196,000, gains on foreclosed property $58,000 and $75,000 in
recoveries of prior period loan collection expense.
Gains from the sale of investment securities decreased
$162,000, or 20.1% to $625,000 in 1998 versus 1997. During 1998
and 1997, the gains realized from available for sale equity
securities offset expenses associated with the write-down of bank
owned real estate targeted for demolition, demolition expenses and
increased loan loss provision. In 1996, the Corporation recorded
realized gains of $166,000 from the sale of available for sale
equity securities.
Noninterest expense grew $338,000, or 2.9% to $12.0 million
in 1998 compared to $11.7 million in 1997. The primary
contributor to the increase in noninterest expense was the other
expense category offset partially by a decrease in salaries and
benefits.
Salaries and employee benefits expense decreased $381,000, or
5.9%, to $6.1 million in 1998 compared to $6.4 million in 1997.
Salary expense grew $90,500, or 1.8%, to $5.2 million in 1998 from
$5.1 million in 1997. General merit increases and an increase in
average full-time equivalent employees to 195 in 1998, from 191 in
1997, accounted for the moderate increase. Commissions and
incentive expense increased $162,000, or 122.9%, to $293,000 in
1998 from $131,000 in 1997 due primarily to a strong sales culture
in the retail and trust areas, an accrued officer incentive payout
and a discretionary contribution to the Corporation's Profit
Sharing 401(k) Plan. The officer incentive payout and the
discretionary contribution are tied to the Corporation achieving
performance goals established by the Board of Directors and
totaled approximately $120,000 and $94,000, respectively, in
1998. A decrease in benefits expense driven primarily by a swing
of approximately $676,000 to net periodic pension income of
$501,000 in 1998 from net periodic pension expense of $175,000 in
1997 more than offset the increase in salary, commissions and
incentive expense for 1998. The swing to pension income from
pension expense is related to the over funded status of the
Corporation's pension plan. The plan's exceptional investment
performance over the past several years is largely responsible for
its over-funded status. For more information on the Corporation+s
pension plan refer to Footnote 11 in the accompanying financial
statements.
Other expense increased $713,000, or 18.4%, to $4.6 million
in 1998 from $3.9 million in 1997. The write-down of real estate
held or acquired for a planned expansion and associated
demolition expenses were primarily responsible for the increase in
other expense. Write-down and demolition expense totaled $329,000
and $369,000, respectively, in 1998 compared to $196,000 and
$150,000, respectively, in 1997. Other costs that contributed to
the increase in other expense were amortization of intangibles (up
$189,000), data processing expense (up $53,000), postage (up
$32,000), Pennsylvania Bank Shares Tax (up $19,000), telephone
expense (up $10,000), loan collection expense (up $13,000) and
other various expense (up a net $49,000).
Total noninterest expense in 1996 totaled $11.3 million.
Salaries and benefits accounted for $6.3 million, or 55.6%, of
the total noninterest expense; net occupancy and furniture and
equipment expense accounted for $1.3 million, or 11.3% of the
total and other expense accounted for $3.1 million, or 33.1%, of
total noninterest expense.
Year 2000
The Year 2000 issue arises as a result of the inability of
some computer programs and operating systems to distinguish the
year 1900 from the year 2000. Many computer programs and
operating systems were written using two digits to define the
applicable year, rather than four digits. Consequently, a
computer using time-sensitive software may improperly recognize a
date using "00" as the year 1900 rather than the year 2000. In
some instances, this could result in serious operational
difficulties. In the case of the Corporation, a failure to timely
address internal and third party provider Year 2000 issues could
result in system failures or malfunctions, leading to a variety of
problems such as the inability to compute payment due dates or
interest correctly. Rapid and accurate data processing is
essential to the operation of the Corporation. Similarly, Year
2000 issues also pose a potentially significant credit risk in
that a failure on the part of the Corporation's commercial
borrowers to timely address Year 2000 issues may adversely impact
the financial condition and results of operations of such
borrowers and thus adversely affect the Corporation's commercial
lending activities as a result of an increase in problem loans and
credit losses.
In February 1997, the F&M Trust Senior Management Team
adopted a Strategic Technology Action Plan for addressing the Year
2000 challenge. Senior officers have been charged with
coordinating the organization's Year 2000 efforts to assure
compliance within time frames dictated by sound business practice
and the Federal Financial Institutions Examination Council
(FFIEC). A team has been assembled including all senior officers
to assist in resolving the Year 2000 challenge and meeting all
regulatory requirements. The Year 2000 Strategic Action Plan team
reports its Year 2000 progress to management monthly and to the
Corporation's Board of Directors bimonthly.
There are three primary phases to the Corporation's Year 2000
Plan: I) the assessing/identification phase, II) the renovating
phase and III) the testing/validation phase. Phase I, the
assessing/identification phase, was completed as of December 31,
1997. Phase II, the renovating phase, which involves the design
and implementation of actual codes or system changes, was
completed for all mission critical systems on or before December
31, 1998. Phase III, the testing/validation phase is currently
underway and is expected to be completed on all systems by August
31, 1999.
Equipment and systems that may potentially be impacted by
Year 2000 issues have been identified and their mission critical
status has been determined. The identification process included
information technology and communication systems such as automated
teller machines (ATMs), automated clearing house systems (ACH),
copy machines, facsimile machines, imaging systems, local area
networks, personal computers, telephones and the operating systems
and software for these systems, wide area networks and wire
transfer systems. It also included non-information systems such
as heating and air conditioning, vault controls, alarm systems,
surveillance systems, time clocks and postage meters. Contact has
been made with all outside servicers and major vendors to
ascertain their individual levels of Year 2000 compliance. From
information obtained to date through vendor responses and/or
certifications of Year 2000 compliance, management has determined
that the Corporation should not have a significant adverse impact
from the Year 2000 issue. Monitoring of vendors and outside
servicers will continue through the testing/validation phase until
implementation.
The Corporation is dependent on a service bureau for its
major data processing functions, including its Trust Management
System. Management is monitoring the service bureau's Year 2000
compliance through written status updates and regular contact with
its representatives. This monitoring includes membership and
active participation in a user group made up of client
institutions of the service bureau. An outside auditing firm has
been commissioned to review the service bureau's Year 2000 status
and to provide quarterly reports to the user group. The service
bureau has already implemented some Year 2000 compliant software
and expects the remainder to be running by June 1999. The
Corporation is also dependent on a service bureau for trust
management data processing. The Corporation has hired an outside
technology firm to perform the proxy testing for this system. The
primary trust processing system was Year 2000 compliant as of
September 30, 1998. Several ancillary trust software accounting
programs were year 2000 compliant as of December 31, 1998.
In addition to evaluating the Corporation's Year 2000
readiness, management has established a process to manage the Year
2000 risks posed by its customers. Significant commercial
borrowers (those with aggregate outstanding loans of $250,000 or
more) have been identified and initial contact concerning
borrowers' Year 2000 status was completed as of December 31, 1998
as well as a risk analysis for each borrower contacted. This
process has penetrated approximately 80% of the dollars
outstanding to commercial business borrowers. Ongoing contact will
be maintained with companies that are not yet fully compliant.
The Corporation is required to have a Year 2000 contingency
plan in the event of systems or communications failures at the
beginning of Year 2000. At December 31, 1998, the Corporation's
contingency plan was in the revision stage and was included in the
overall Year 2000 planning. -A target date of March 31, 1999 has
been set as a completion date for the Corporation's Year 2000
contingency plan. Based on information gathered in the
developmental stage of the contingency plan, management believes
that the Corporation will be able to continue to operate in the
Year 2000 even if some systems fail. We expect to have a backup
generator available for use in the event of a power failure and
research is underway for other utility vendors. Also under
consideration in the contingency plan is paper backup of all
customer and general ledger accounts as of December 31, 1999. In
general, the Corporation's Year 2000 contingency plan will follow
the Corporation's established Business Resumption Plan as
developed by various business units within the Corporation and
maintained by the Security Officer. The Business Resumption Plan
contains guidelines for disaster situations that involve the
Corporation's inability to function and outlines individual
responsibilities to resume normal operation in a timely and
efficient manner. The Business Resumption Plan is designed to
provide for customer service and daily operations for a short
period of time. Should the Business Resumption Plan need to
continue for any extended period of time the cost could be
material to the Corporation.
Aggregate costs for Year 2000 compliance are expected to be
immaterial to the Corporation's results of operations at less
than $200,000. Expense incurred through December 31, 1998, and
reflected in noninterest expense totals approximately $19,000.
Due to the uncertainties of all risks and the reliance on
third parties, there can be no assurance about addressing all Year
2000 issues. Therefore, although management is trying to consider
all risks of Year 2000, they cannot guarantee that they have
considered all situations.
Provision for Income Taxes
Federal income tax expense equaled $1.5 million in 1998,
compared to $1.4 million in 1997 and 1996, respectively. The
Corporation's effective tax rate for the years ended December 31,
1998, 1997 and 1996 was 23.8%, 24.2% and 25.0%, respectively. A
gradual increase in tax-free income over the past three years
relative to pretax income was primarily responsible for the
declining effective tax rate over the three-year period. For a
more comprehensive analysis of Federal income tax expense refer to
Note 10 of the accompanying financial statements.
Financial Condition
One method of evaluating the Corporation's condition is in
terms of its sources and uses of funds. Liabilities represent
sources of funds while assets represent uses of funds. At
December 31, 1998, total assets reached $425.0 million, an
increase of $71.1 million, or 20.1%, compared to $353.9 million at
December 31, 1997. Table 2 presents annual average balances of
the Corporation's assets and liabilities over a three-year period
to reflect the growth trends in those assets and liabilities. The
following financial condition discussion will reference the
average balance sheet presented in Table 2 unless otherwise noted.
For 1998, the Corporation held an average of $6.6 million in
interest-bearing deposits in other banks, primarily with the
Federal Home Loan Bank of Pittsburgh (FHLB), compared with an
average balance of $290,000 for 1997. The increase in interest-
bearing deposits in other banks is related to the increase in
deposit liabilities. The deposits at FHLB are overnight funds
and are available for liquidity purposes.
Investment securities averaged $91.5 million for 1998
compared to $88.7 million in 1997, an increase of 3.1%. At
December 31, 1998, as Table 4 reflects, the amortized cost of
investment securities grew $40.3 million, or 47.8%, to $124.4
million from $84.2 million at December 31, 1997. The growth in
investment securities occurred primarily in tax-exempt municipals,
which were part of a $15.0 million investment leverage
transaction, and in corporate debt securities. A total of $15.0
million in long-term callable municipal securities was purchased
in the fourth quarter of 1998 funded by three separate callable
advances totaling $15.0 million. The overall purpose of the
investment leverage transaction was to leverage the Bank's capital
by adding assets and liabilities at a positive interest spread.
The objective of the transaction was to improve the Bank's net
income by exploiting the unused risk-bearing capacity of the
Bank's strong capital position. The average effective cost of the
advances was 5.25% with a spread of 1.34%. The increase in (short-
term) corporate debt securities was largely the result of
offsetting a large short-term municipal deposit. The Corporation
invests in mortgage-backed securities which totaled $25.6 million
at December 31, 1998, up from $22.9 million at December 31, 1997.
As disclosed in Note 4 of the accompanying 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 2.04 years,
suggesting that the market value of the mortgage-backed portfolio
would rise (or fall) approximately 2.0% 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.
On October 1, 1998, the Corporation transferred all of its
Held to Maturity investment securities portfolio to Available for
Sale. The book value of the securities transferred on that date
was approximately $23.0 million. The unrealized gain related to
the investment securities transferred, increased shareholders'
equity $985,000, net of tax. The transfer of investment
securities from Held to Maturity to Available for Sale, without
tainting the entire portfolio, was provided for under Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which the Corporation early
adopted on October 1, 1998. None of the securities transferred
from Held to Maturity were subsequently sold as of December 31,
1998. The Corporation does not have derivative instruments and
does not participate in hedging activities.
Total loans, net of unearned discount, averaged $252.6
million in 1998 versus $253.3 million in 1997. At December 31,
1998, total loans, net of unearned discount and the allowance for
possible loan losses totaled $258.5 million compared to $241.2
million at December 31, 1997. As Table 7 reflects, the growth in
loans occurred primarily in mortgage loans which accounted for
$12.2 million of the increase. Commercial, industrial and
agricultural and consumer loans showed very moderate increases of
$3.2 million and $2.0 million, respectively. As a percentage of
total loans, real estate loans (primarily first mortgage
residential loans) increased to 39.2%, followed by commercial,
industrial and agricultural at 38.8% and consumer (including home
equity lines of credit) at 22.0%. The Corporation does not have a
significant concentration of credit risk in one industry.
The allowance for possible loan losses was $3.5 million at
December 31, 1998, representing 1.35% of loans, net of unearned
discount. At December 31, 1998, the ratio of allowance for
possible loan losses to nonperforming loans was 216.5%. This
indicator of allowance adequacy improved significantly from 192.9%
at December 31, 1997. Although nonperforming loans remained
steady, the Corporation gradually increased the allowance for
possible loan losses in 1998 to support the inherent risk within
the portfolio. Net charge-offs increased $124,000 to $816,000 in
1998 from $692,000 in 1997. At December 31, 1998, management
determined the allowance to be adequate.
As reflected in Table 9, the Corporation's nonperforming
assets increased $269,000, or 14.2%, to $2.2 million at December
31, 1998, from $1.9 million at December 31, 1997. The increase in
nonperforming assets was related entirely to other real estate
owned (OREO)which was up $342,000 to $527,000 at December 31,
1998. The ratio of nonperforming assets to total assets as of
December 31, 1998 and 1997, was .51% and .54%, respectively. A
more detailed discussion on loan quality can be found immediately
following the financial condition discussion.
Funding for asset growth came from deposits, securities sold
under agreements to repurchase, other borrowings and retained
earnings. Deposits averaged $254.9 million in 1998 compared to
$231.0 million in 1997. Securities sold under agreements to
repurchase and other borrowings averaged $20.2 million and $14.6
million, respectively, in 1998 compared to $14.7 million and $23.7
million, respectively, in 1997. Total deposits at December 31,
1998, grew $52.0 million, or 18.9%, to $326.6 million from $274.6
million at December 31, 1997. Most deposit growth occurred in
interest-bearing checking, money market accounts and time deposits
more than $100,000. Recognizing that the banking industry has
been losing deposit-dollar market share, the Corporation's
management has focused on developing new products to attract new
deposits and retain current deposits. In 1998, the Corporation
introduced the Freedom Accounts, which are relationship accounts
designed to meet all of the customer's financial needs through
appropriate F&M Trust services and solutions. These accounts
reward customers for their total financial relationship which
includes consumer loan balances, investment and trust balances,
mutual fund balances, residential mortgage balances and personal
deposit balances. These relationship accounts are aimed at
retaining current customers by creating value and loyalty and
attracting new customers who are looking for the same value and
loyalty. In 1997, the Corporation introduced a new deposit
product named the Money Management Account to compete more
effectively with money market mutual funds and the array of new
bank deposit products that were introduced by local financial
services competitors. Both of these new products have been
successful in attracting and retaining deposits for the
Corporation.
Securities sold under agreements to repurchase (Repos)
averaged $20.2 million in 1998 compared to $14.7 million in 1997.
Repos represent corporate cash management accounts.
Other borrowings averaged $14.6 million in 1998 compared to
$23.7 million in 1997 and represent overnight and long-term
borrowings from FHLB. At December 31, 1998, other borrowings
totaled $20.7 million compared to $21.4 million at December 31,
1997. A large part of the increase in other borrowings year over
year is related to a fourth quarter $15.0 million investment
leverage transaction designed to increase the net interest margin.
Retained earnings contributed approximately $3.7 million to
asset growth in 1998 versus none in 1997 due to the special $.66
cash dividend declared in November 1997. Funding sources will
continue to be a challenge for the Corporation but through a well-
trained sales force, attention to customer service and product
creativity management believes it can meet the challenge.
The local economy is healthy. Unemployment in Franklin County
averaged 3.8% in 1998 and was reported at 3.6% for December 1998.
The unemployment rate may inch up a bit due to the recent
announcements of closings or layoffs from some local businesses,
but is still expected to remain less than 5.0%.
In 1995 the United States Army Base Realignment and Closure
Commission (BRAC) targeted the Letterkenny Army Depot for
realignment. The decision to realign meant that a major employer
and approximately 2,500 jobs would be lost. Through the efforts
of the Franklin County Commissioners, the Letterkenny Industrial
Development Authority (LIDA) was formed. LIDA was formed to
implement the local redevelopment plan of the Franklin County
Reuse Committee for the Letterkenny Army Depot. LIDA has the
responsibility of developing approximately 1,500 acres of the
Letterkenny Army Depot which is to be transferred in phases from
the United States Army to the local community as an industrial
park known as the Cumberland Valley Business Park. Franklin
County is located along the I-81 corridor and has a diverse and
growing economy that has been enhanced as the Cumberland Valley
Business Park takes shape and other business parks develop. To
date LIDA has attracted 11 small businesses to the park
representing service, manufacturing, technology and agriculture
industry sectors. These businesses employ a total of
approximately 300 people. LIDA expects to attract additional
businesses to a 283-acre unimproved area in the business park as a
result of its recent approval as one of twelve Keystone
Opportunity Zones (KOZ) approved by the State of Pennsylvania.
Businesses building in the KOZ would pay no state or local taxes
for up to 12 years. Certain criteria has been established by the
State and LIDA for businesses to qualify for a location in the
KOZ. To compensate for the loss of high paying jobs when the
depot was downsized, KOZ businesses must have average wages at
least three times the Federal minimum wage and an annual payroll
of $1.6 million or more. With the positive direction the reuse
of the Letterkenny Army Depot is taking and the entrance of new
industry into the county, management of the Corporation does not
anticipate any significant negative impact regarding deposit
growth, loan demand or loan losses associated with the 1995 BRAC
decision to realign Letterkenny Army Depot.
In the fourth quarter of 1996 the Corporation purchased four
branch facilities. Three of these facilities are located in
adjoining Cumberland County and were opened as F&M Trust community
offices; the fourth location in Franklin County is being used for
administrative offices. Included in the purchase price of $2.7
million was real estate, personal property and retail customer
lists. Unlike most branch acquisitions, there were no loans
acquired and no deposits assumed in the transaction. Management
recognized that the additional expense associated with the
operation of these three new community offices would adversely
impact earnings in the short- term, but determined that the long-
term effect of the acquisition would result in a positive impact
on earnings. As of December 31, 1998, the expenses associated
with the daily operation and acquisition of these offices were
offset by the revenues generated from the offices. It is expected
that these offices will continue to generate revenues in excess of
their expenses.
Loan Quality
As reflected in Table 9, the Corporation's nonperforming
assets increased in 1998 after remaining relatively stable the
previous two years. Table 9 shows that the Corporation's,
nonperforming assets increased to $2.17 million at December 31,
1998, a 14.2% increase from the $1.90 million in nonperforming
assets reported at December 31, 1997. Growth in nonperforming
assets at December 31, 1998 was related primarily to other real
estate owned, which increased $342,000 to $527,000, up from
$185,000 at December 31, 1997. Other real estate owned consisted
of five properties at December 31, 1998, including three
residential properties and two commercial properties.
Nonperforming loans showed continued improvement at December 31,
1998, decreasing $73,000 to $1.6 million; however, the mix of
nonperforming loans continues to swing toward nonaccrual loans.
Nonaccrual loans increased $177,000 at December 31, 1998, to $1.3
million, representing the third consecutive year of growth.
Nonaccrual loans have trended upward by $654,000 from a $671,000
low reported at December 31, 1995. The increase in nonaccrual
loans was concentrated in the residential mortgage portfolio,
which increased $83,000 at December 31, 1998, to $378,000,
compared to $295,000 at December 31, 1997. Commercial nonaccrual
loans increased $70,000 to $891,000 at December 31, 1998, up from
$821,000 one year earlier. Offsetting the growth in nonaccrual
loans was a decrease in loans past due 90 days or more and still
accruing. Loans past due 90 days or more decreased 44.3% to
$314,000 at December 31, 1998, down $250,000 from $564,000 at
December 31, 1997. Loans past due 90 days or more have gradually
reduced by $809,000 from a $1.1 million high reported at December
31, 1995, providing the overall improvement in nonperforming
loans. For the fourth consecutive year the Corporation reported
no restructured loans.
The Corporation's net charge-offs, shown in Table 10, totaled
$816,000 and represented .32% of average loans in 1998, a 17.9%
increase from the $692,000, and .29% of average loans recorded in
1997. As Table 10 illustrates, 74.3% of 1998 net charge-offs
occurred within the consumer loan portfolio. Consumer net charge-
offs grew $48,000 to $606,000 in 1998 from $558,000 in 1997 and
were concentrated in direct installment loans. Commercial net
charge-offs increased $24,000, or 23.5%, to $126,000 in 1998,
compared to $102,000 in 1997. Real estate net charge-offs more
than doubled to $84,000 in 1998, up from $32,000 one year earlier.
At $3.5 million as of year-end 1998, the allowance for
possible loan losses represented 1.35% of loans, net of unearned
discount, and provided coverage of nonperforming loans at 16.5%.
Management utilizes loan loss reserve analysis to establish the
adequacy of the allowance by considering financial condition,
repayment capacity, payment performance, collateral values and
support from guarantors for specifically allocated credits, while
examining historical losses, delinquency rates and general
economic conditions for the remainder of the loan portfolio (refer
to Tables 8 and 10 for reserve allocation and loan loss activity
for 1998).
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.
Because of its contribution to the Corporation's financial
performance, improving loan quality remains a top priority of
management. In 1998, management continued to focus its loan
quality control efforts on consumer lending, which has experienced
high losses over the past few years. High personal bankruptcies
continue to be a concern in the Corporation's consumer loan
portfolio. According to data from the Administrative Office of
the United States Courts, personal bankruptcy filings reached a
record 1.44 million in 1998. The Middle District of Pennsylvania
recorded a 11.5% increase over 1997, ranking the State as eighth
in the nation for bankruptcy growth. The Corporation's customers
have not been immune to this trend, which has continued into 1999.
As in prior years, management is prepared to maintain the adequacy
of the allowance for possible loan losses. During 1998, strategic
action plans were initiated to address issues surrounding
consumer loan losses and strengthen credit quality. Included in
these strategic action plans are further revisions to the Consumer
Loan Policy to enhance proficiency in underwriting standards,
periodic line of credit reviews, ongoing lender training and
charge-off reviews.
Liquidity
The Corporation must meet the financial services needs of the
customers which it serves, while providing a satisfactory return
on the shareholders' investment. In order to accomplish this, the
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, the Corporation has satisfied its liquidity needs
from earnings, repayment of loans and amortizing securities,
maturing investment securities, deposit growth, and its ability to
borrow through existing lines of credit. Investments classified as
available for sale provide an additional source of readily
available liquidity.
Growth in deposits generally provides a major portion of the
funds required to meet increased loan demand. Total deposits grew
by $52.0 million between December 31, 1997 and 1998. In addition,
the Corporation increased other borrowings by $9.3 million and
securities sold under agreement to repurchase by $8.3 million.
Funding from these sources were sufficient to meet the increase
in loan demand and increased investments in securities. Table 6
presents specific information concerning short-term borrowings.
Market Risk
In the course of its normal business operations the
Corporation is exposed to certain market risks. The Corporation
has no foreign currency exchange rate risk, no commodity price
risk or material equity price risk. However, it is exposed to
interest rate risk. Financial instruments which are sensitive to
changes in market interest rates include fixed and variable-rate
loans, fixed-income securities, interest-bearing deposits and
other borrowings. All interest rate risk arises in connection
with financial instruments entered into for purposes other than
trading.
Changes in interest rates can have an impact on the
Corporation's net interest income and the economic value of
equity. The objective of interest rate risk management is to
identify and manage the sensitivity of net interest income and
economic value of equity to changing interest rates in order to
achieve consistent earnings that are not contingent upon favorable
trends in interest rates.
The Corporation uses several tools to measure and evaluate
interest rate risk. One tool is interest rate sensitivity or gap
analysis. Gap analysis classifies assets and liabilities into
maturity and repricing time intervals. The interest rate gap, the
difference between maturing or repricing assets and liabilities,
provides management with an indication of how net interest income
will be impacted by different interest rate scenarios. Table 11
presents a gap analysis of the Corporation at December 31, 1998.
The negative gap in the under one-year time intervals would
suggest that the Corporation's near-term earnings would decline in
a higher interest rate environment.
Another tool for analyzing interest rate risk is financial
simulation modeling which captures the impact of not only changing
interest rates but also other sources of cash flow variability
including loan and securities prepayments, loan repricing, deposit
pricing and customer preferences. Financial simulation modeling
forecasts both net interest income and the economic value of
equity under a variety of different interest rate environments.
Economic value of equity is defined as the discounted present
value of assets minus the discounted present value of liabilities
and is a surrogate for long-term earnings. The Corporation
regularly measures the effects of an up or down 200-basis point
"rate shock" which is deemed to represent the outside limits of
any reasonably probable movement in market interest rates during a
one-year time frame. The Corporation establishes tolerance ranges
for these measures of interest rate sensitivity and manages within
the ranges. As indicated on Table 12, the financial simulation
analysis revealed that both prospective net interest income over a
one-year time period and the economic value of equity are
adversely affected by higher market interest rates, while
prospective net interest income is favorably affected by lower
interest rates and economic value of equity is unfavorably
affected. Both measures are within the tolerance ranges
established by the Board of Directors.
Computations of the prospective effects of hypothetical
interest rate changes are based on many assumptions, including
relative levels of market interest rates, loan prepayments and
deposit decay. Certain shortcomings are inherent in the
computation of discounted present value and, if key relationships
do not unfold as assumed, actual values may differ from those
presented. Further, the computations do not contemplate certain
actions management could undertake in response to changes in
market interest rates.
Capital and Dividends
Total shareholders' equity equaled $39.9 million at December
31, 1998, representing an increase of $3.6 million, or 9.9%,
versus $36.3 million at December 31, 1997. Higher retained
earnings during the period totaling $3.5 million accounted for
most of the increase. Total shareholders' equity at December 31,
1997, increased $964,000, or 2.7%, versus $35.3 million at
December 31, 1996. Most of the growth in equity year over year
for 1997 versus 1996 was from retained earnings ($503,000) plus
an increase in accumulated comprehensive income offset by the
repurchase of outstanding common stock totaling $1.3 million.
In November 1997 the Board of Directors approved a 3 for 2
stock split issued in the form of a 50% stock dividend distributed
on February 3, 1998, to shareholders of record at the close of
business on January 13, 1998. The 50% Stock Dividend resulted in
a transfer of $1.0 million from retained earnings to common stock.
Cash dividends declared by the Board of Directors in 1998
totaled $.47 per share and resulted in a reduction in
shareholders' equity totaling $1.3 million. Cash dividends
declared by the Board of Directors in 1997 totaled $1.99 per share
($1.37 adjusted for the 50% Stock Dividend) and represented an
increase of 155.1% (163.4% adjusted for the 50% Stock Dividend)
over the $.78 ($.52 adjusted for the 50% Stock Dividend) declared
in 1996. Included in 1997 cash dividends declared are quarterly
dividends paid to shareholders in 1997 totaling $.84 ($.56
adjusted for the 50% Stock Dividend) per share, a special cash
dividend of $1.00 ($.66 adjusted for the 50% Stock Dividend) per
share paid on January 21, 1998, to shareholders of record at the
close of business on January 7, 1998 and a first quarter 1998 cash
dividend of $.15 per share paid on February 27, 1998 to
shareholders of record at the close of business on February 12,
1998. The ratio of cash dividends declared to net income in 1998
was 27.4% compared to 88.2% in 1997.
The Corporation's Board of Directors declared a special cash
dividend of $.40 per share on March 4, 1999. The special cash
dividend is payable on April 15, 1999 to shareholders of record as
of the close of business on March 22, 1999.
On March 5, 1998, the Board of Directors authorized the
repurchase of up to 50,000 shares of the Corporation's outstanding
common stock over a twelve-month period. 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. There were no shares
repurchased under this plan in 1998; however, subsequent to year-
end, the Corporation repurchased 8,975 shares at a cost of
approximately $260,000. At December 31, 1998 and 1997 the
Corporation held a total of 242,871 and 250,194, respectively, in
Treasury shares acquired through Board authorized stock repurchase
programs. Subsequent to year-end, on March 4, 1999, the Board of
Directors approved a new stock repurchase program which authorizes
the repurchase of up to 50,000 shares during a one-year period
beginning on the date of Board approval.
A strong capital position is important to the Corporation and
provides a solid foundation for the future growth of the
Corporation. A strong capital position also instills confidence
in the Bank by depositors, regulators and investors, and is
considered essential by management.
Common measures of adequate capitalization for banking
institutions are capital ratios. 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 1 Capital to total balance
sheet assets while the risk-based ratio compares Tier 1 and Tier 2
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
1 leverage ratio of 4.0% and minimum Tier 1and Tier 2 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 1 and Tier 2 risk-
based capital ratios greater than or equal to 6.0% and 10.0%,
respectively.
Tier 1 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 2 capital is composed of Tier 1 capital plus the
allowance for loan losses. Table 15 presents the capital ratios
for the consolidated Corporation at December 31, 1998, 1997 and
1996. 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
accompanying financial statements.
Book value per common share was $14.24 at December 31, 1998,
versus $12.99 at December 31, 1997 and market value per common
share was $29.88 versus $34.16, respectively. 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 1998, the Corporation's common stock was trading at
209.83% of its December 31 book value compared to 262.97% at year-
end 1997. The price earnings multiple was 17.0 times at December
31, 1998 compared to 21.5 times at December 31, 1997.
Forward-Looking Statements
Certain statements appearing herein which are not historical
in nature are forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Such forward-
looking statements refer to a future period or periods, reflect
management's current views as to likely future developments, and
use the words "may," "will," "expect," "believe," "estimate,"
"anticipate," or similar terms. Because forward-looking
statements involve certain risks, uncertainties and other factors
over which the Corporation has no direct control, actual results
could differ materially from those contemplated in such
statements. These factors include (but are not limited to) the
following: general economic conditions, changes in interest rates,
change in the Corporation's cost of funds, changes in government
monetary policy, changes in government regulation and taxation of
financial institutions, changes in the rate of inflation, changes
in technology, Year 2000 risks, the intensification of competition
within the Corporation's market area, and other similar factors.
Impact of Inflation
The impact of inflation upon financial institutions such as
the Corporation differs from its impact upon other commercial
enterprises. Unlike most other commercial enterprises, virtually
all of the assets and liabilities of the Corporation are monetary
in nature. As a result, interest rates have a more significant
impact on the Corporation's performance than do the effects of
general levels of inflation. Although inflation (and inflationary
expectations) may affect the interest rate environment, it is not
possible to measure with any precision the impact of future
inflation upon the Corporation.
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) 1998 % Change 1997 % Change 1996
-------------------------------------------------------------
Interest income $27,529 4.64% $26,308 6.08% $24,799
Interest expense 13,151 7.57% 12,225 10.26% 11,087
-------------- -------------- ---------
Net interest income $14,378 2.09% $14,083 2.71% $13,712
-------------- -------------- ---------
Tax equivalent adjustment 974 868 572
Net interest income/full taxable equi $15,352 2.68% $14,951 4.67% $14,284
======= ======= =======
Table 2. Analysis of Net Interest Income (unaudited)
1998
---------------------------------
Average Income or Average
(Amounts in thousands) balance expense yield/rate
----------------------------------
Interest-earning assets:
Interest-bearing deposits in other banks $6,634 $359 5.41%
Investment securities
Taxable 60,676 3,641 6.00%
Nontaxable 30,859 2,248 7.28%
Loans, net of unearned discount 252,596 22,255 8.81%
----------------------------------
Total interest-earning assets 350,765 28,503 8.13%
---------------------------------
Noninterest-earning assets 22,266
-----------------
Total assets $373,031
=========
Interest-bearing liabilities:
Deposits:
Interest-bearing checking $37,046 $801 2.16%
Money market deposit accounts 49,933 2,125 4.26%
Savings 38,782 1,080 2.78%
Time 129,094 7,199 5.58%
----------------------------------
Total interest-bearing deposits 254,855 11,205 4.40%
----------------------------------
Securities sold under agreements to repurchase 20,205 1,053 5.21%
Other borrowings 14,638 893 6.10%
----------------------------------
Total interest-bearing liabilities 289,698 13,151 4.54%
----------------------------------
Noninterest-bearing liabilities 45,123
Shareholders' equity 38,210
-----------------
Total liabilities and shareholders' equity $373,031
========
Net interest income/Net interest margin 15,352 4.38%
--------------
Tax equivalent adjustment (974)
--------------
Net interest income 14,378
=======
All amounts have been adjusted to a tax-equivalent basis using a tax rate of 34%
Table 2. Analysis of Net Interest Income (unaudited)
1997
---------------------------------
Average Income or Average
(Amounts in thousands) balance expense yield/rate
----------------------------------
Interest-earning assets:
Interest-bearing deposits in other banks $290 $28 9.66%
Investment securities
Taxable 61,998 3,869 6.24%
Nontaxable 26,744 1,981 7.41%
Loans, net of unearned discount 235,308 21,298 9.05%
----------------------------------
Total interest-earning assets 324,340 27,176 8.38%
---------------------------------
Noninterest-earning assets 21,357
-----------------
Total assets $345,697
========
Interest-bearing liabilities:
Deposits:
Interest-bearing checking $34,222 $730 2.13%
Money market deposit accounts 30,182 1,229 4.07%
Savings 43,488 1,220 2.81%
Time 123,121 6,878 5.59%
----------------------------------
Total interest-bearing deposits 231,013 10,057 4.35%
----------------------------------
Securities sold under agreements to repurchase 14,685 750 5.11%
Other borrowings 23,738 1,418 5.97%
----------------------------------
Total interest-bearing liabilities 269,436 12,225 4.54%
----------------------------------
Noninterest-bearing liabilities 39,989
Shareholders' equity 36,272
--------------
Total liabilities and shareholders' equity $345,697
========
Net interest income/Net interest margin 14,951 4.61%
-----------------------
Tax equivalent adjustment (868)
--------------
Net interest income 14,083
=======
All amounts have been adjusted to a tax-equivalent basis using a tax rate of 34%
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%
Investment securities
Taxable 60,317 3,640 6.03%
Nontaxable 20,181 1,459 7.23%
Loans, net of unearned discount 218,033 20,062 9.20%
---------------------------------
Total interest-earning assets 302,653 25,371 8.38%
---------------------------------
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%
---------------------------------
Securities sold under 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 14,284 4.72%
----------------------
Tax equivalent adjustment (572)
-------------
Net interest income 13,712
=======
All amounts have been adjusted to a tax-equivalent basis using a tax rate of 34%
Years ended December 31
1998 1997 1996
---------------------------------
Rate Analysis:
Yield on total earning assets 8.13% 8.38% 8.38%
Cost of funds supporting earning assets 3.75% 3.77% 3.66%
---------------------------------
Net rate on earning assets 4.38% 4.61% 4.72%
======== ======= =======
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.
1998 Compared to 1997 1997 Compared to 1996
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 $349 ($18) $331 ($284) $102 ($182)
Investment securities
Taxable (81) (147) (228) 103 126 229
Nontaxable 300 (33) 267 485 37 522
Loans 1,534 (577) 957 1,568 (332) 1,236
------------------------------------ ------------------------------------
Total net change
in interest income 2,102 (775) 1,327 1,872 (67) 1,805
------------------------------------ ------------------------------------
Interest expense on:
Interest-bearing checking 61 10 71 47 (14) 33
Money market deposit
accounts 838 58 896 255 133 388
Savings accounts (131) (9) (140) (66) (14) (80)
Time deposits 333 (12) 321 (72) (60) (132)
Securities sold under
agreements to
repurchase 287 16 303 (83) 71 (12)
Other borrowings (555) 30 (525) 987 (46) 941
------------------------------------ ------------------------------------
Total net change
in interest expense 833 93 926 1,068 70 1,138
------------------------------------ ------------------------------------
Increase (Decrease) in net
interest income $1,269 ($868) $401 $804 ($137) $667
======= ======= ======= ======= ======= =======
Nonaccruing loans are included in the loan balances used to calculate the above rate volume analysis.
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%.
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) 1998 1997 1996
---------------------------------------
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government
agencies and corporations $ - $1,030 $1,051
Obligations of state and political subdivisions - 15,025 19,496
Corporate debt securities - 2,343 3,688
Mortgage-backed securities - 7,989 10,832
---------------------------------------
- 26,387 35,067
Other - 1,392 1,223
---------------------------------------
$ - $27,779 $36,290
======= ======= =======
Amortized cost
1998 1997 1996
---------------------------------------
Available for Sale
Equity Securities $3,404 $1,588 $1,380
U.S. Treasury securities and obligations of U.S. Government
agencies and corporations 13,992 20,967 27,054
Obligations of state and political subdivisions 48,490 14,926 1,934
Corporate debt securities 32,959 4,029 5,046
Mortgage-backed securities 25,572 14,877 17,159
---------------------------------------
$124,417 $56,387 $52,573
======= ======= =======
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 $1,392,000
and $1,223,000 at December 31, 1997 and 1996, 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 and is a requirement for membership.
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, 1998
is as follows:
(Amounts in thousands) Amount
------------
Maturity distribution:
Within three months $18,868
Over three through six months 3,919
Over six through twelve months 5,098
Over twelve months 5,338
------------
Total $33,223
======
TABLE 6. Short-Term Borrowings (unaudited)
(Amounts in thousands) 1998 1997 1996
--------------------------------------
Ending balance $30,744 $21,434 $22,172
Average balance 14,638 23,738 18,639
Maximum month-end balance 30,744 31,701 26,724
Weighted-average interest rate on average balances 6.10% 5.97% 4.84%
TABLE 7. Loan Portfolio (unaudited)
The following table presents an analysis of the Bank's loan portfolio for each of the past five years:
December 31
------------------------------------------------------------------------------
(Amounts in thousands) 1998 1997 1996 1995 1994
-------------- -------------- -------------- -------------- --------------
Real estate (primarily first mortgage
residential loans) $92,293 $82,989 $79,478 $83,800 $92,481
Real estate - construction 10,501 7,562 3,727 5,233 4,207
Commercial, industrial and agricultural 101,606 98,389 91,244 74,678 75,783
Consumer (including home equity lines
of credit) 57,647 55,651 49,936 50,017 51,376
---------------------------------------------------------------------------------
Total loans 262,047 244,591 224,385 213,728 223,847
---------------------------------------------------------------------------------
Less: Unearned discount (10) (43) (159) (520) (1,111)
Allowance for possible loan losses (3,549) (3,304) (3,060) (3,141) (3,425)
---------------------------------------------------------------------------------
Net loans $258,488 $241,244 $221,166 $210,067 $219,311
======== ======== ======== ======== ========
TABLE 8. Allocation of the Allowance for Possible Loan
(unaudited)
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
------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------------------------------------------------------------------------------------
$ % $ % $ % $ % $ %
------------------------------------------------------------------------------------------------
Real estate $239 39% $251 37% $220 37% $583 42% $989 43%
Commercial
industrial and
agricultural 1,779 39% 1,489 40% 1,326 41% 1,136 35% 1,520 34%
Consumer 1,531 22% 1,564 23% 1,514 22% 1,422 23% 916 23%
------------------------------------------------------------------------------------------------
$3,549 100% $3,304 100% $3,060 100% $3,141 100% $3,425 100%
=============== =============== =============== =============== ============
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) 1998 1997 1996 1995 1994
--------------------------------------------------------------
Nonaccrual loans $1,325 $1,148 $856 $671 $1,047
Loans past due 90 days or more
(not included above) 314 564 874 1,123 601
Restructured loans - - - - 595
--------------------------------------------------------------
Total nonperforming loans 1,639 1,712 1,730 1,794 2,243
Other real estate 527 185 99 258 -
--------------------------------------------------------------
Total non performing assets $2,166 $1,897 $1,829 $2,052 $2,243
======= ======= ======= ======= =======
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) 1998 1997 1996 1995 1994
---------------------------------------------------------
Balance at beginning of year $3,304 $3,060 $3,141 $3,425 $3,598
Charge-offs:
Commercial, industrial and agriculture (189) (113) (183) (89) (51)
Consumer (688) (637) (582) (511) (230)
Real estate (84) (32) (12) (76) (38)
---------------------------------------------------------
Total charge-offs (961) (782) (777) (676) (319)
---------------------------------------------------------
Recoveries:
Commercial, industrial and agriculture 63 11 25 46 60
Consumer 82 79 64 43 19
Real estate 1 19
---------------------------------------------------------
Total recoveries 145 90 89 90 98
---------------------------------------------------------
Net charge-offs (816) (692) (688) (586) (221)
---------------------------------------------------------
Provision for possible loan losses 1,061 936 607 302 48
---------------------------------------------------------
Balance at end of year $3,549 $3,304 $3,060 $3,141 $3,425
======= ======= ======= ======= =======
Ratios:
Net loans charged off as a percentage
of average loans 0.32% 0.29% 0.32% 0.27% 0.10%
Allowance as a percentage of net
loans (at December 31) 1.35% 1.35% 1.36% 1.47% 1.54%
Table 11. Interest Rate Sensitivity Analysis
(Unaudited)
------------------------------------------------------------------
Interest Rate Sensitivity Gaps
------------------------------------------------------------------
(Dollars 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 $11,514 $ $ $ $ $11,514
Federal funds sold
Investment securities 33,449 4,618 10,240 36,599 42,212 127,118
Loans, net of unearned income 72,020 14,703 28,625 79,395 63,745 258,488
------------------------------------------------------------------------
Total interest-earning assets $116,983 $19,321 $38,865 $115,994 $105,957 $397,120
======== ======== ======== ======== ======== ========
Interest-bearing liabilities:
Interest-bearing checking $19,095 $350 $699 $5,592 $20,972 $46,707
Money market deposit accounts 55,439 759 425 --- --- 56,623
Savings accounts 20,910 664 425 3,400 12,748 38,147
Time deposits 36,906 18,462 35,698 51,710 102 142,878
Federal funds purchased and securities sold
under agreement to repurchase 24,414 --- --- --- --- 24,414
Other borrowings --- --- 5,635 11,580 13,529 30,744
------------------------------------------------------------------------
Total interest-bearing liabilities $156,764 $20,235 $42,882 $72,282 $47,351 $339,513
======== ======== ======== ======== ======== ========
Interest rate gap ($39,781) ($914) ($4,017) $43,712 $58,606 $57,607
Cumulative interest rate gap ($39,781) ($40,695) ($44,712) ($1,000) $57,606 $115,214
Note 1: The maturity/repricing distribution of investment securities is based on the maturity date for nonamortizing
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 and fixed
rate consumer loans where the scheduled maturities are accelerated based on estimated prepayments of
approximately 25 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 historical decay rates.
TABLE 12 Sensitivity to Change in Market Interest Rates
Interest Rate Scenarios
(Amounts in Thousands) -200 bps -100 bps +100 bps +200 bps
------------- ------------- ------------- -------------
Prospective one-year net interest income:
Change........................... $14,890 $14,818 $14,349 $13,962
Percent change................... 1.7% 1.2% -2.0% -4.6%
Board policy limit............... -7.5% -3.8% -3.8% -7.5%
Economic value of portfolio equity:
Change........................... $46,506 $47,878 $46,397 $43,069
Percent change................... -3.0% -0.2% -3.3% -10.2%
Board policy limit............... 20.0% 10.0% 10.0% 20.0%
Key assumptions:
1. Residential mortgage loans and mortgage-backed securities prepay at rate-sensitive speeds
consistent with observed historical prepayment speeds for pools of residential mortgages.
2. Variable rate loans and variable rate liabilities reprice in accordance with their contractual
Rate changes for adjustable rate mortgages are constrained by their contractual caps and floors.
3. Interest-bearing nonmaturity deposits reprice in response to different interest rate scenarios
consistent with the Corporation's historical rate relationships to market interest rates. Nonmaturity
deposits run off over various future time periods, ranging from one month to twenty years, in
accordance with historical decay rates.
4. Interest rate scenarios assume an immediate, sustained and parallel shift in the term structure
of interest rates.
Table 13. Maturity Distribution of Investment Portfolio
(Unaudited)
The following presents an analysis of investments in securities at December 31, 1998 by maturity, and the weighted average yield
maturity presented. The yields in this table are presented on a tax-equivalent basis and have been calculated using the
amortized costs.
After one year After five yearsAfter ten
One year or lessthrough five yearthrough ten year years Total
----------------------------------------------------------------------------------
Market Market Market Market Market
(Amounts in thousands) Value Yield Value Yield Value Yield Value Yield Value Yield
Available for Sale
U.S. Treasury securities & obligations of
U.S. Government agencies & corporation $6,033 6.08% $4,144 6.68% $4,066 7.27% $ -- --- $14,243 6.59%
Obligations of state & political subdivision --- --- 11,208 6.32% 1,741 7.02% 36,503 7.25% 49,452 7.03%
Corporate debt securities --- --- 24,957 5.75% 2,368 5.80% 5,728 6.20% 33,053 5.83%
Mortgage-backed securities 235 5.10% 9,271 6.17% 6,385 6.30% 9,805 6.60% 25,696 6.36%
Equity securities --- --- --- --- --- --- 4,674 5.34% 4,674 5.34%
------------- ------------- ------------- ------------- --------------
Corporate debt securities $6,268 6.04% $49,580 6.04% $14,560 6.58% $56,710 6.87% $127,118 6.47%
======= ======= ======= ======= =======
TABLE 14. Maturities and Interest Rate Terms of Selected Loans (unaudited)
Stated maturities (or earlier call dates) of selected loans as of December 31, 1998 are summarized in
the table below. Residential mortgages and consumer loans are excluded from the presentation.
After
one year
Within but withi After
(Amounts in thousands) one year five yearfive years Total
------------------------------------------
Loans:
Real estate - construction $10,501 $ - $ - $10,501
Commercial, industrial and agricultural 13,197 33,689 54,720 101,606
------------------------------------------
$23,698 $33,689 $54,720 $112,107
======= ======= ======= =======
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, 1998:
After
one year
but within After
five year five years Total
---------------------------------
Loans with predetermined rates $21,058 $39,034 $60,092
Loans with variable rates 12,631 15,686 28,317
---------------------------------
$33,689 $54,720 $88,409
======= ======= =======
TABLE 15. Capital Ratios
December 31
1998 1997 1996
--------------------------------------
Risk-based ratios
Tier 1 12.73% 13.53% 14.75%
Total capital 13.97% 14.80% 16.00%
Leverage Ratio 9.16% 9.22% 10.03%
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
is available by contacting the Corporate Secretary at 20 South
Main Street, P.O. Box T, Chambersburg, 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 deposited
directly into the bank account of their choice on the dividend
payment date. Information concerning this optional program is
available by contacting the Corporate Secretary at 20 South Main
Street, P.O. Box T, Chambersburg, PA 17201-0819, telephone 717/264-
6116
Annual Meeting
The Annual Shareholders+ Meeting will be held on Tuesday,
April 27, 1999, at The Lighthouse Restaurant, 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 as market makers of
Franklin Financial Services Corporation+s common stock:
Ferris Baker Watts: 17 East Washington Street,
Hagerstown, MD 21740
800/344-4413
Hopper Soliday:
(A division of Tucker Anthony Inc.)
1703 Oregon Pike
Lancaster, PA 17601
800/646-8647
F.J. Morrissey & Co., Inc.:
1700 Market Street, Suite 1420,
Philadelphia, PA 19103-3913
215/563-3296
Ryan, Beck & Co.: 3 Parkway,
Philadelphia, PA 19102
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