<Page>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
OR
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ....... to .......
Commission file number 0-12126
FRANKLIN FINANCIAL SERVICES CORPORATION
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(Exact name of registrant as specified in its charter)
PENNSYLVANIA 25-1440803
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
20 SOUTH MAIN STREET (P.O. BOX 6010), CHAMBERSBURG,PA 17201-0819
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(Address of principal executive officer)
717/264-6116
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if changed since
last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
There were 2,725,852 outstanding shares of the Registrant's common stock as of
August 1, 2001.
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INDEX
<Table>
<Caption>
PAGE
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Balance Sheets as of 3
June 30, 2001 (Unaudited) and
December 31, 2000
Consolidated Statements of Income 4
for the Three and Six Months ended
June 30, 2001 and 2000 (unaudited)
Consolidated Statements of Changes 5
in Shareholders' Equity for the Six Months
ended June 30, 2000 and June 30, 2001 (unaudited)
Consolidated Statements of Cash Flows 6
for the Six Months Ended June 30, 2001
and 2000 (unaudited)
Notes to Consolidated Financial 7
Statements (unaudited)
Item 2 - Management's Discussion and Analysis of 11
Financial Condition and Results of Operations
Item 3 - Quantitative and Qualitative Disclosures about 15
Market Risk
PART II - OTHER INFORMATION 16
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SIGNATURE PAGE 18
</Table>
<Page>
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
<Table>
<Caption>
June 30 December 31
2001 2000
--------------- --------------
(Unaudited)
ASSETS
Cash and due from banks $ 12,922 $ 15,118
Interest bearing deposits in other banks 22,998 2,650
Investment securities available for sale 130,992 125,174
Loans, net 299,196 297,307
Premises and equipment, net 7,976 7,237
Other assets 18,537 18,499
--------- ---------
Total Assets $ 492,621 $ 465,985
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand (non-interest bearing) $ 46,488 $ 47,028
Savings and Interest checking 181,986 178,992
Time 123,937 131,189
--------- ---------
Total Deposits 352,411 357,209
Securities sold under agreements to repurchase 44,525 33,036
Long term debt 47,180 29,477
Other liabilities 3,511 3,062
--------- ---------
Total Liabilities 447,627 422,784
Shareholders' equity:
Common stock $1 par value per share, 15,000 shares authorized
with 3,045 shares issued and 2,725 and 2,758 shares
outstanding at June 30, 2001 and December 31, 2000, respectively 3,045 3,045
Capital stock without par value, 5,000 shares authorized
with no shares issued or outstanding -- --
Additional paid in capital 19,788 19,797
Retained earnings 27,078 25,522
Accumulated other comprehensive income 1,148 343
Treasury stock (6,065) (5,506)
--------- ---------
Total shareholders' equity 44,994 43,201
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Total Liabilities and Shareholders' Equity $ 492,621 $ 465,985
========= =========
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS
<Page>
CONSOLIDATED STATEMENTS OF INCOME
(amounts in thousands, except per share data)
(unaudited)
<Table>
<Caption>
For the Three Months Ended For the Six Months Ended
June 30 June 30
2001 2000 2001 2000
---------------------------- --------------------------
INTEREST INCOME
Interest and fees on loans $ 6,052 $ 6,166 $12,268 $12,081
Interest on deposits in other banks 265 30 389 37
Interest on fed funds sold -- 1 -- 1
Interest and dividends on investments:
Taxable interest 1,218 1,227 2,507 2,492
Tax exempt interest 456 538 956 1,112
Dividends 71 81 145 159
------- ------- ------- -------
Total interest income 8,062 8,043 16,265 15,882
------- ------- ------- -------
INTEREST EXPENSE
Interest on deposits 3,072 3,365 6,532 6,559
Interest on securities sold under agreements to repurchase 438 529 925 894
Interest on short term borrowings -- 23 -- 200
Interest on long term debt 647 411 1,070 821
------- ------- ------- -------
Total interest expense 4,157 4,328 8,527 8,474
------- ------- ------- -------
Net interest income 3,905 3,715 7,738 7,408
Provision for loan losses 315 120 524 393
------- ------- ------- -------
Net interest income after provision for loan losses 3,590 3,595 7,214 7,015
------- ------- ------- -------
NONINTEREST INCOME
Service charges and fees 658 477 1,189 902
Investment and trust services fees 572 542 1,129 1,185
Other 142 62 226 79
Securities gains (losses) (3) 110 -- 217
------- ------- ------- -------
Total noninterest income 1,369 1,191 2,544 2,383
------- ------- ------- -------
NONINTEREST EXPENSE
Salaries and benefits 1,663 1,706 3,307 3,451
Net occupancy expense 186 170 378 350
Furniture and equipment expense 160 143 337 297
Advertising 178 166 301 247
Legal & professional fees 81 119 174 196
Data processing 249 234 484 517
Pennsylvania bank shares tax 101 96 202 192
Other 630 765 1,223 1,287
------- ------- ------- -------
Total noninterest expense 3,248 3,399 6,406 6,537
------- ------- ------- -------
Income before Federal income taxes 1,711 1,387 3,352 2,861
Federal income tax expense 339 234 646 497
------- ------- ------- -------
Net income $ 1,372 $ 1,153 $ 2,706 $ 2,364
======= ======= ======= =======
Basic earnings per share $ 0.51 $ 0.42 $ 1.01 $ 0.87
Weighted average shares outstanding (000's) 2,679 2,716 2,687 2,720
Diluted earnings per share $ 0.50 $ 0.42 $ 0.99 $ 0.86
Weighted average shares outstanding (000's) 2,722 2,759 2,729 2,763
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
<Page>
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the six months ended June 30, 2000 and 2001
(unaudited)
<Table>
<Caption>
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY UNEARNED
(Dollars in thousands, except per share data) STOCK CAPITAL EARNINGS INCOME (LOSS) STOCK COMPENSATION TOTAL
Balance at December 31, 1999 $ 3,045 $ 19,834 $ 22,627 ($ 876) ($ 4,938) ($ 432) $ 39,260
Comprehensive income:
Net income -- -- 2,364 -- -- -- 2,364
Unrealized securities losses arising
during current period, net of tax -- -- -- (439) -- -- (439)
Reclassification adjustment for realized
gains included in net income, net of tax -- -- -- 184 -- -- 184
Unrealized gain on interest rate cap, net of tax -- -- -- 4 -- -- 4
-------- -------- -------- -------- -------- ------- --------
Total Comprehensive income 2,113
Cash dividends declared, $.36 per share -- -- (1,004) -- -- -- (1,004)
Common stock issued under stock option plans -- (11) -- -- 51 -- 40
Forfeiture of restricted stock -- (4) -- -- (20) 24 --
Acquistion of 16,400 shares of Treasury stock -- -- -- -- (275) -- (275)
Amortization of unearned compensation -- -- -- -- -- 55 55
-------- -------- -------- -------- -------- ------- --------
Balance at June 30, 2000 $ 3,045 $ 19,819 $ 23,987 $ (1,127) $ (5,182) $ (353) $ 40,189
======== ======== ======== ======== ======== ======== ========
Balance at December 31, 2000 $ 3,045 $ 19,797 $ 25,522 $ 343 $ (5,506) -- $ 43,201
Comprehensive income:
Net income -- -- 2,706 -- -- -- 2,706
Unrealized securities gains arising
during current period, net of tax -- -- -- 831 -- -- 831
Reclassification adjustment for realized
gains included in net income -- -- -- -- -- -- --
Unrealized loss on off-balance sheet
hedges, net of tax -- -- -- (26) -- -- (26)
-------- -------- -------- -------- -------- ------- --------
Total Comprehensive income 3,511
Cash dividends declared, $.42 per share -- -- (1,150) -- -- -- (1,150)
Common stock issued under stock option plans -- (9) -- -- 44 -- 35
Acquisition of 35,575 shares of treasury stock -- -- -- -- (603) -- (603)
-------- -------- -------- -------- -------- ------- --------
Balance at June 30, 2001 $ 3,045 $ 19,788 $ 27,078 $ 1,148 $ (6,065) $ -- $ 44,994
======== ======== ======== ======== ======== ======== ========
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
<Page>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
(unaudited)
<Table>
<Caption>
For the Six Months Ended
June 30
2001 2000
------------ ------------
Cash flows from operating activities:
Net Income $2,706 $2,364
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 480 462
Net accretion of securities premiums and discounts (28) (4)
Provision for possible loan losses 524 393
Securities gains, net - (217)
Mortgage loans originated for sale (15,528) (3,550)
Proceeds from sale of mortgage loans 15,578 3,574
Gain on sales of mortgage loans (50) (24)
Proceeds from sale of credit card loan portfolio 1,435 0
Gain on sale of credit card loan portfolio (70) -
Gain on sales of other assets (1) -
Increase in cash surrender value of life insurance (194) (26)
Decrease (increase) in interest receivable and other assets 135 (373)
(Decrease) increase in interest payable and other liabilities (23) 107
Other, net 39 (131)
------------ ------------
Net cash provided by operating activities 5,003 2,575
------------ ------------
Cash flows from investing activities:
Proceeds from sales of investment securities available for sale 7,291 4,394
Proceeds from maturities of investment securities available for sale 30,015 10,466
Purchase of investment securities available for sale (41,837) (4,092)
Net increase in loans (3,791) (13,758)
Purchase of bank owned life insurance - (6,000)
Proceeds from sale of other assets 10 -
Capital expenditures (1,216) (1,082)
------------ ------------
Net cash used in investing activities (9,528) (10,072)
------------ ------------
Cash flows from financing activities:
Net change in demand deposits,
NOW accounts and savings accounts 2,454 6,641
Net change in certificates of deposit (7,252) (1,732)
Net change in short term borrowings 11,489 2,580
Long term debt advances 19,378 125
Long term debt payments (1,674) -
Dividends paid (1,150) (1,004)
Common stock issued under stock option plans 35 40
Purchase of treasury shares (603) (275)
------------ ------------
Net cash provided by financing activities 22,677 6,375
------------ ------------
Increase (decrease) in cash and cash equivalents 18,152 (1,122)
Cash and cash equivalents as of January 1 17,768 15,117
------------ ------------
Cash and cash equivalents as of June 30 $35,920 $13,995
============ ============
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
<Page>
FRANKLIN FINANCIAL SERVICES CORPORATION and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Basis of Presentation
The consolidated balance sheets as of June 30, 2001 and December 31,
2000, the consolidated statements of income for the three and six month periods
ended June 30, 2001 and 2000, the consolidated statements of changes in
shareholders' equity for the six months ended June 30, 2000 and June 30, 2001
and the consolidated statements of cash flows for the six month periods ended
June 30, 2001 and 2000 have been prepared by the Corporation, without audit
where indicated. In the opinion of management, all adjustments (which include
only normal recurring adjustments) necessary to present fairly the financial
position, results of operations, and cash flows at June 30, 2001, and for all
periods presented have been made.
The consolidated financial statements include the accounts of Franklin
Financial Services Corporation (the Corporation), and its wholly-owned
subsidiary, Farmers and Merchants Trust Company of Chambersburg (the Bank) and
the Bank's wholly-owned subsidiary, Franklin Realty Services Corporation. All
significant intercompany transactions and account balances have been eliminated.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. It is suggested that these
consolidated financial statements be read in conjunction with the audited
financial statements and notes thereto included in the Corporation's 2000 Annual
Report. The results of operations for the period ended June 30, 2001, are not
necessarily indicative of the operating results for the full year.
For purposes of reporting cash flows, cash and cash equivalents include
cash, cash and due from banks, interest-bearing deposits in other banks and
Federal funds sold. Generally, Federal funds are purchased and sold for one-day
periods.
Earnings per share is computed based on the weighted average number of
shares outstanding during each period, adjusted retroactively for stock splits
and dividends, if any. A reconciliation of the weighted average shares
outstanding used to calculate basic earnings per share and diluted earnings per
share follows:
<Page>
<Table>
<Caption>
For the quarter ended
June 30
-------
2001 2000
------ ------
(Amounts in thousands)
Weighted average shares outstanding (basic) 2,679 2,716
Impact of common stock equivalents,
primarily stock options 43 43
------ ------
Weighted average shares outstanding (diluted) 2,722 2,759
====== ======
<Caption>
For the six months ended
June 30
-------
2001 2000
------ ------
(Amounts in thousands)
Weighted average shares outstanding (basic) 2,687 2,720
Impact of common stock equivalents,
primarily stock options 42 43
------ ------
Weighted average shares outstanding (diluted) 2,729 2,763
====== ======
</Table>
<Page>
Note 2. Capital Adequacy
Quantitative measures established by regulation to ensure capital adequacy
require financial institutions to maintain minimum amounts and ratios of total
and Tier I capital to risk-weighted assets and of Tier I capital to average
assets. The Capital ratios of the Corporation and its bank subsidiary are as
follows:
<Table>
<Caption>
As of June 30, 2001 (unaudited)
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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 $47,215 14.14% $26,713 8.00% N/A
Bank 41,985 12.67% 26,513 8.00% $ 33,141 10.00%
TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS)
Corporation $42,731 12.80% $13,357 4.00% N/A
Bank 37,757 11.39% 13,257 4.00% $ 19,885 6.00%
TIER 1 CAPITAL (TO AVERAGE ASSETS)
Corporation $42,731 8.75% $19,543 4.00% N/A
Bank 37,757 7.77% 19,425 4.00% $ 23,384 5.00%
<Caption>
As of December 31, 2000
-----------------------------------------------------------------------
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 $45,517 13.79% $26,410 8.00% N/A
Bank 41,976 12.85% 26,134 8.00% $32,667 10.00%
TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS)
Corporation $41,650 12.62% $13,205 4.00% N/A
Bank 38,109 11.67% 13,067 4.00% $19,600 6.00%
TIER 1 CAPITAL (TO AVERAGE ASSETS)
Corporation $41,650 8.99% $18,535 4.00% N/A
Bank 38,109 8.27% 18,438 4.00% $23,048 5.00%
</Table>
<Page>
NOTE 3 - Stock Repurchase Program
On March 8, 2001, the Board of Directors authorized the repurchase of
up to 75,000 shares of the Corporation's $1.00 par value common stock. The
repurchases are authorized to be made from time to time during the next 12
months in open market or privately negotiated transactions. The repurchased
shares will be held as treasury shares available for issuance in connection with
future stock dividends and stock splits, employee benefit plans, executive
compensation plans, and for issuance under the Dividend Reinvestment Plan and
other corporate purposes. During the six months ended June 30, 2001, 35,575
shares of the Corporation's common stock were repurchased at a cost of
approximately $603,000.
NOTE 4 - Financial Derivatives
The Corporation uses interest rate swaps and caps, which it has
designated as cash-flow hedges, to manage interest rate risk associated with
variable-rate funding sources. All such derivatives are recognized on the
balance sheet at fair value in other assets or liabilities as appropriate. To
the extent the derivatives are effective and meet the requirements for hedge
accounting, changes in fair value are recognized in other comprehensive income
with income statement reclassification occurring as the hedged item affects
earnings. Conversely, changes in fair value attributable to ineffectiveness or
to derivatives that do not qualify as hedges are recognized as they occur in the
income statement interest expense account associated with the hedged item. Such
changes were minimal during the periods reported on within.
NOTE 5 - Recent Accounting Pronouncements
In July of 2001, the Financial Accounting Standards Board issued
Statement No. 141, "Business Combinations," and Statement NO. 142, "Goodwill and
Other Intangible Assets."
Statement No. 141 requires all business combinations to be accounted
for using the purchase method of accounting as use of the pooling-of-interests
method is prohibited. In addition, this Statement requires that negative
goodwill that exists after the basis of certain acquired assets is reduced to
zero should be recognized as an extraordinary gain. The provisions of this
Statement apply to all business combinations initiated after June 30, 2001.
Statement No. 142 prescribes that goodwill associated with a business
combination and intangible assets with an indefinite useful life should not be
amortized but should be tested for impairment at least annually. The Statement
requires intangibles that are separable from goodwill and that have a
determinable useful life to be amortized over the determinable useful life. The
provisions of this Statement will become effective for the Bank in January of
2002. Upon adoption of this statement, goodwill and other intangible assets
arising from acquisitions completed before July 1, 2001 should be accounted for
in accordance with the provisions of this statement. This transition provision
could require a reclassification of a previously separately recognized
intangible to goodwill and vice versa if the intangibles in question do not meet
the new criteria for classification as a separately recognizable intangible.
Adoption of these statements is not expected to have a material impact
on the Bank's financial condition or results of operations.
<Page>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
FOR THE THREE AND SIX MONTH PERIODS
ENDED JUNE 30, 2001 AND 2000
PART 1, ITEM 2
FORWARD LOOKING STATEMENT
Certain statements appearing herein which are not historical in nature
are forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements refer to a future
period or periods, reflecting management's current views as to likely future
developments, and use words "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, the intensification of competition
within the Corporation's market area, and other similar factors.
RESULTS OF OPERATIONS
The Corporation reported earnings for the second quarter and six months
ended June 30, 2001, totaling $1,372,000 and $2,706,000, respectively,
representing increases of 19.0% and 14.5%, respectively, over the comparable
periods in 2000. Basic earnings per share for the second quarter and six months
ended June 30, 2001 were $.51 and $1.01, respectively compared to $.42 and $.87,
respectively, for the same periods one year earlier. Diluted earnings per share
were $.50 and $.99 for the quarter and six months ended June 30, 2001 compared
to $.42 and $.86, respectively, for the same periods in 2000. Per share earnings
are weighted to reflect the impact of the stock repurchase program. Book value
per share at June 30, 2001 equaled $16.51 versus $14.47 at June 30, 2000.
The Corporation's annualized return on average assets (ROA) and return
on average equity (ROE) for the first six months of 2001 were 1.11% and 12.18%,
respectively, compared to 1.06% and 12.17%, respectively, for the same period in
2000.
<Page>
NET INTEREST INCOME
Net interest income improved to $3.9 million for the second quarter of
2001 versus $3.7 million for the second quarter of 2000, an increase of
$190,000, or 5.1%. Interest income was flat in the second quarter of 2001
compared to the second quarter of 2000 increasing just $19,000 to $8.1 million.
Concurrently, interest expense recorded a decrease of $171,000, or 3.9%, to
$4.16 million for the second quarter of 2001 compared to $4.33 million for the
second quarter of 2000. The steady reduction in market interest rates since the
beginning of the year and continuing through the second quarter of 2001
strengthened the Corporation's net interest income for the period compared to
2000 by reducing interest expense.
Net interest income for the six months ended June 30, 2001 grew
$330,000, or 4.5%, to $7.74 million from $7.41 million for the six months ended
June 30, 2000. Interest income for the period was up $383,000, or 2.41% to
$16.26 million from $15.88 million for the period ended June 30, 2000. Interest
expense grew $53,000, or less than 1.0%, to $8.53 million for the six months
ended June 30, 2001, from $8.47 million for the same period ended June 30, 2000.
A $25.5 million growth in interest-earning assets for the first six months in
2001 yielding 7.57% more than offset the $28.1 million growth in
interest-bearing liabilities yielding 4.40% for the same period. The cumulative
250 basis point reduction in market interest rates since the beginning of the
year favorably impacted the Corporation's net interest income for the six-month
period ended June 30, 2001.
Despite the lower interest rate environment, the Corporation's net
interest margin continues to be squeezed. For the six month period ended June
30, 2001, net interest margin (tax equivalent) was 3.71%, compared to 3.79%, for
the six months ended June 30, 2000. In June 2000, the Corporation purchased $6.0
million of Bank Owned Life Insurance (BOLI). The revenue derived from this
earning asset is recorded as non-interest income. The Corporation's investment
in BOLI generated tax-free revenue of $194,000 for the six months ended June 30,
2001 versus $26,000 for the same period in 2000.
PROVISION FOR LOAN LOSSES
The Corporation expensed $315,000 and $524,000 for loan losses in
the second quarter and six months ended June 30, 2001, respectively, compared
to $120,000 and $393,000 for the same periods in 2000. An increase in
nonperforming loans during the second quarter of 2001, accounted for the higher
provision expense for the second quarter and six months ended June 30, 2001.
NONINTEREST INCOME
Noninterest income, excluding net securities gains and losses, was up
$291,000, or 26.9%, to $1.37 million for the second quarter ended June 30, 2001
from $1.08 million for the second quarter of 2000. Service charges and fees were
$181,000,or 37.9%, higher in the second quarter of 2001 versus 2000. Income
components contributing to the higher service charges and fees were loan fees
related to a significant increase in mortgage loan origination activity, deposit
fees, debit card/point of sale fees and fees derived from the implementation of
a new official check program in the second half of 2000. Other noninterest
income was up $80,000 to $142,000 for the second quarter of 2001 and was
primarily the result of a gain realized from the sale of the Bank's credit card
portfolio and income from BOLI. Net securities gains were down $113,000 to a net
loss of $3,000 for the second quarter.
Noninterest income, excluding net securities gains, for the six months
ended June 30, 2001, was up $378,000, or 17.4%, to $2.54 million from $2.16
million for the same period in 2000. Service charges and fees accounted for more
than 75% of the increase largely due to the same fees as mentioned above. Other
income was up $147,000 to $226,000 for the six months ended June 30, 2001, from
$79,000 for the six months ended June 30, 2000. BOLI income ($194,000) plus the
realized gain from the sale of the Bank's credit card portfolio ($70,000),
reduced by losses on the sale of other real estate owned and other repossessed
assets, were the factors contributing to higher other income for the six months
ended June 30, 2001. A $56,000 decline in Investment and trust services fees to
$1.13 million for the six months ended June 30, 2001 was attributable to lower
market values on trust assets and the loss of a few accounts due to transfer of
wealth to the next generation. The Corporation recorded no net securities gains
in the first six months of 2001 compared to $217,000 for the first six months of
2000.
For the six months ended June 30, 2001, noninterest income, excluding
net securities gains, represented 24.7% of total revenues compared to 23.0% for
the six-month period ended June 30, 2000. Recent opportunities to strengthen the
Corporation's noninterest income include the implementation of an ATM access fee
for noncustomers, the introduction of debit cards, investments in BOLI and a
title insurance company and the formation
<Page>
of a Personal Investment Center that sells mutual funds, annuities and insurance
in addition to the traditional services offered through the Bank's Investment
and Trust Services. In June 2001, the Corporation made an investment in a
start-up banking company that will specialize in mortgage originations. This
investment, which is not significant to the consolidated balance sheet, will
broaden the menu of mortgage products the Bank currently offers to its customers
and has the potential to provide a good source of noninterest income. Management
is committed to seek out new opportunities to strengthen noninterest income and
reduce the Corporation's dependency on net interest income
NONINTEREST EXPENSE
Total noninterest expense decreased $151,000 to $3.25 million for the
second quarter ended June 30, 2001, compared to $3.40 million for the second
quarter ended June 30, 2000. Expense categories recording the largest variances
to the second quarter of 2000 were salaries and benefits, legal and professional
and other expense. Driving the reduction in salaries and benefits expense were
higher deferred costs (credit to expense) associated with an increased volume of
mortgage origination activity without increased staffing, the end of a
restricted stock program that was fully expensed in 2000 and lower education and
training expense. The decreases in these expenses were partially offset by
higher benefit costs related to Pay for Performance, a bonus plan. Lower legal
and professional fees for the quarter were attributable primarily to the timing
of audit expenses and overall lower legal fees. Other expense recorded the
greatest reduction in noninterest expense for the second quarter of 2001 due to
lower loan collection expense and the absence of a nonrecurring charge of
$138,000 in expense related to the sale of nonperforming loans expensed in the
second quarter of 2000.
Total noninterest expense for the six months ended June 30, 2001, was
down $131,000, or 2.0%, to $6.4 million from $6.5 million at June 30, 2000.
Salaries and benefits recorded the largest decrease followed by other expense,
data processing costs and legal and professional fees partially offset by
increases in furniture and equipment expense and advertising. Higher deferred
costs (credit to expense) related to mortgage origination activity and the end
of a restricted stock program that was fully expensed in 2000 contributed to the
reduction in salaries and benefits for the six months. Partially offsetting
these reductions were higher costs associated with pay for performance.
Furniture and equipment expense increased $40,000 or 13.5%, to $337,000 for the
six month period in 2001 compared to the same period in 2000. Higher costs
associated with equipment maintenance and equipment rental were largely
responsible for the increase. Advertising costs for the six month period ended
June 30, 2001 were up $54,000, or 21.8%, to $301,000 and were largely the result
of a new community office in a new market. Other expense was down due to the
same lower expense items discussed for the quarter but was partially offset by
higher processing charges for ATM activity related to the May 2000
implementation of ATM access fees, higher postage expense related to the mailing
of 42,000 privacy notices, higher other real estate expenses and higher
telephone expense. Data processing costs were down due to the timing of
maintenance expenses. Legal and professional fees were down due to the same
items discussed for the quarter.
Federal income tax expense for the second quarter ended and six months
ended June 30, 2001 totaled $339,000 and $646,000, respectively, compared to
$234,000 and $497,000 for the same periods ended June 30, 2000. The
Corporation's effective tax rate for the six months ended June 30, 2001, was
19.3% compared to 17.4% for the six months ended June 30, 2000. The increase in
the effective tax rate was primarily due to a decrease in tax-free income
relative to pretax income. All taxable income for the Corporation is taxed at a
Federal rate of 34%.
FINANCIAL CONDITION
Total assets reached $492.6 million at June 30, 2001 from $465.9
million at December 31, 2000, an increase of 5.71%. Interest-bearing deposits in
other banks grew by $20.4 million to $23.1 million at June 30, 2001, from $2.6
million at December 31, 2000. During the same period, investment securities
available for sale grew $5.7 million, or 4.6%, to $130.9 million while net loans
held steady at $299.2 million. The growth is attributable to leveraged borrowing
more fully described below.
The decrease in total deposits, down $4.8 million, or 1.3%, to $352.4
million at June 30, 2001, from $357.2 million at December 31, 2000, reflects the
continuing challenge in the banking industry to attract and keep deposits.
Increases in securities sold under agreements to repurchase and long-term debt
which, in the aggregate totaled almost $29.0 million at the end of the six-month
period, accounted for the funding to support the growth in assets. Long-term
debt grew $17.7 million, or 60.0%, to $47.2 million at June 30, 2001, from $29.5
million at December 31, 2001. The significant increase in long-term debt is the
result of a strategy implemented earlier in the year to help
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mitigate interest rate risk for the Corporation. The strategy includes
transactions involving interest rate swaps, interest rate caps and term advances
from the Federal Home Loan Bank of Pittsburgh. As of June 30, 2001,
approximately $14.0 million in fixed-rate term advances were taken down with the
proceeds used to fund floating rate securities and overnight investments in
Federal Funds. In addition, a $10.0 million interest rate swap was executed in
May with the Bank paying a fixed rate and receiving a floating rate indexed to
the 3-month U.S. Government Treasury bill. The strategy is designed to protect
the Corporation from rising interest rates.
Total shareholders' equity increased $1.7 million to $44.9 million at
June 30, 2001 from $43.2 million at year-end 2000. During the six-months, an
approximate $800,000 increase in other comprehensive income and an increase in
retained earnings totaling $1.6 million favorably impacted shareholders' equity.
Stock repurchases during the six-month period reduced shareholders' equity
$603,000.
Capital adequacy is currently defined by regulatory agencies through
the use of several minimum required ratios. At June 30, 2001, the Corporation
was well capitalized as defined by the banking regulatory agencies. The
Corporation's leverage ratio, Tier I and Tier II risk-based capital ratios at
June 30, 2001 were 8.75%, 12.80%, and 14.14%, respectively. For more information
on capital ratios refer to Note 2 of the accompanying financial statements.
LOAN QUALITY
Net charge-offs for the second quarter and six-months ended June 30,
2001, totaled $127,000 and $256,000, respectively, compared to $307,000 and
$412,000 for the second quarter and six months, respectively, of 2000. For the
first six months of 2001, 13% of the net charge-offs were related to the real
estate loan portfolio, 32% to the commercial portfolio and 55% to the consumer
portfolio. The annualized ratio of net charge-offs to average loans was .17% at
June 30, 2001 compared to .28% at June 30, 2000.
Nonperforming loans were up $952,400 to $1.90 million at June 30, 2001
from $945,000 at December 31, 2000. However, nonperforming loans at June 30,
2001 were down $665,000 from $2.6 million at June 30, 2000. Included in
nonperforming loans at June 30, 2001, were nonaccrual loans totaling $1.2
million and loans past due 90 days or more totaling $659,000 compared to
$576,000 and $369,000, respectively at December 31, 2000. The Corporation held
other real estate (ORE) equaling $1.1 million at June 30, 2001 compared to $1.4
million at December 31, 2000. Nonperforming assets represented .61% of total
assets at June 30, 2001 compared to .50% at December 31, 2000.
The allowance for loan losses totaled $4.1 million at June 30, 2001,
compared to $3.87 million at December 31, 2000. The allowance represents
1.36% and 1.28%, of total loans at June 30, 2001 and December 31, 2000,
respectively. The allowance provided coverage for nonperforming loans at a
rate of 2.1 times at June 30, 2001.
The local economy continues to be slow. The unemployment rate reported
by the Department of Labor and Industry for Franklin County for June 2001 was
4.7%, an increase from 4.6% reported for May 2001. Franklin County stayed
current with national figures and is just under the state average, keeping its
state ranking of 24th. Pennsylvania's unemployment rate rose from 4.5% in May to
4.8% in June. Despite the national unemployment rate increase in June, the 4.7%
rate reflects that the local and regional economy is surviving the manufacturing
slowdown or recession very well. Franklin County is heavily dependent on the
manufacturing sector of the economy. Recent local announcements of planned
business expansions including the creation of new jobs will help offset the
reduction in jobs due to layoffs and closings.
LIQUIDITY
The Corporation's liquidity ratio (net cash, short-term and marketable
assets divided by net deposits and short-term liabilities) was 31.4% at June 30,
2001. The Corporation has the ability to borrow funds from the Federal Home Loan
Bank of Pittsburgh, if necessary, to enhance its liquidity position. At June 30,
2001, the maximum borrowing capacity for the Corporation with FHLB is
approximately $97.0 million.
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The Corporation is currently involved in the construction of an
addition to its headquarters facility. Approximately $1.5 million of the $3.15
million project has been funded as of June 30, 2001. Completion of this project
is anticipated by year-end 2001.
Management believes that liquidity is adequate to meet the borrowing
and deposit needs of its customers.
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Part I, Item 3
QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
The Corporation is exposed to interest rate risk as part of its
normal operations. For the six-month period ended June 30, 2001, the
Corporation benefited from a cumulative 250 basis point decrease in market
interest rates. In the second quarter of 2001, a strategy was implemented
that is designed to mitigate interest rate risk should interest rates rise in
the future. The strategy includes transactions involving interest rate swaps,
interest rate caps and term advances from the Federal Home Loan Bank of
Pittsburgh. As of June 30, 2001, approximately $14.0 million in fixed rate
term advances were taken down with the proceeds used to fund floating rate
securities and overnight investments in Federal funds. In addition, a $10.0
million interest rate swap was executed in May with the bank paying a fixed
rate and receiving a floating rate indexed to the three-month U.S. Government
Treasury bill. For more information on market rate risk refer to the
Corporation's 2000 10-K.
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PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
None
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
Item 3. DEFAULTS BY THE COMPANY ON ITS SENIOR SECURITIES
None
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 2001 Annual Meeting of Shareholders (the "Meeting") of the
Corporation was held on April 24, 2001. The Meeting was held for the following
purpose:
1. Election of Directors. To elect three Class B directors to hold
office for 3 years from the date of election and until their successors are
elected and qualified.
There was no solicitation in opposition to the nominees of the Board of
Directors for election to the Board. All nominees of the Board of Directors were
elected. The number of votes cast for as well as the number of votes withheld
for each of the nominees for election to the Board of Directors, were as
follows:
<Table>
<Caption>
VOTES
NOMINEE VOTES FOR WITHHELD
- ------- --------- --------
Charles S. Bender II 1,979,431.8106 32,088.2084
Jeryl C. Miller 2,003,028.8106 8,491.2084
Stephen E. Patterson 1,991,429.9485 20,090.0705
</Table>
Item 5. OTHER INFORMATION
None
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(b) Reports on Form 8-K
There were no reports filed on Form 8-K for the period.
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FRANKLIN FINANCIAL SERVICES CORPORATION
and SUBSIDIARY
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Franklin Financial Services Corporation
AUGUST 7, 2001 /s/ WILLIAM E. SNELL, JR.
- ------------------------ -----------------------------------------
William E. Snell Jr.
President and Chief Executive Officer
AUGUST 7, 2001 /s/ ELAINE G. MEYERS
- ------------------------- ------------------------------------------
Elaine G. Meyers
Treasurer and Chief Financial Officer