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 September 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 offices)
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
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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
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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 2,712,230 outstanding shares of the Registrant's common stock as of
November 2, 2001.
INDEX
Page
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PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Balance Sheets
as of September 30, 2001 (unaudited) and
December 31, 2000 3
Consolidated Statements of
Income for the Three and Nine Months ended
September 30, 2001 and 2000 (unaudited) 4
Consolidated Statements of Changes in
Shareholders' Equity for the Nine Months
ended September 30, 2001 and 2000 (unaudited) 5
Consolidated Statements of Cash
Flows for the Nine Months Ended September
30, 2001 and 2000 (unaudited) 6
Notes to Condensed Consolidated Financial
Statements (unaudited) 7
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 11
Item 3 - Qualitative and Quantitative Disclosures About Market Risk 15
PART II - OTHER INFORMATION
SIGNATURE PAGE 17
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
September 30 December 31
2001 2000
------------- ------------
(Unaudited)
ASSETS
Cash and due from banks $ 10,285 $ 15,118
Interest bearing deposits in other banks 5,799 2,650
Investment securities available for sale 142,428 125,174
Loans 313,241 301,174
Allowance for loan losses (4,142) (3,867)
--------- ---------
Net Loans 309,099 297,307
Premises and equipment, net 8,708 7,237
Other assets 22,455 18,499
--------- ---------
Total Assets $ 498,774 $ 465,985
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand (non-interest bearing) $ 44,443 $ 47,028
Savings and Interest checking 189,288 178,992
Time 122,027 131,189
--------- ---------
Total Deposits 355,758 357,209
Securities sold under agreements to repurchase 44,799 33,036
Long term debt 47,116 29,477
Other liabilities 5,410 3,062
--------- ---------
Total Liabilities 453,083 422,784
Shareholders' equity:
Common stock $1 par value per share, 15,000 shares authorized
with 3,045 shares issued and 2,723 and 2,758 shares
outstanding at September 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 19,745 19,797
Retained earnings 27,889 25,522
Accumulated other comprehensive income 1,167 343
Treasury stock (6,155) (5,506)
--------- ---------
Total shareholders' equity 45,691 43,201
--------- ---------
Total Liabilities and Shareholders' Equity $ 498,774 $ 465,985
========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
3
CONSOLIDATED STATEMENTS OF INCOME
(amounts in thousands, except per share data)
(unaudited)
For the Three Months Ended For the Nine Months Ended
September 30 September 30
2001 2000 2001 2000
------- ------ ------- -------
INTEREST INCOME
Interest and fees on loans $5,895 $6,278 $18,164 $18,359
Interest on deposits in other banks 187 58 576 95
Interest on fed funds sold 23 -- 23 1
Interest and dividends on investments:
Taxable interest 1,214 1,273 3,720 3,765
Tax exempt interest 431 522 1,387 1,634
Dividends 61 76 207 235
------ ------ ------- -------
Total interest income 7,811 8,207 24,077 24,089
------ ------ ------- -------
INTEREST EXPENSE
Interest on deposits 2,912 3,552 9,444 10,111
Interest on securities sold under agreements to repurchase 396 630 1,321 1,524
Interest on short term borrowings -- 32 -- 232
Interest on long term debt 679 417 1,748 1,239
------ ------ ------- -------
Total interest expense 3,987 4,631 12,513 13,106
------ ------ ------- -------
Net interest income 3,824 3,576 11,564 10,983
Provision for loan losses 359 180 883 573
------ ------ ------- -------
Net interest income after provision for loan losses 3,465 3,396 10,681 10,410
------ ------ ------- -------
NONINTEREST INCOME
Service charges and fees 639 524 1,828 1,425
Investment and trust services fees 519 591 1,648 1,776
Other 135 96 361 175
Securities gains (losses) 131 21 131 238
------ ------ ------- -------
Total noninterest income 1,424 1,232 3,968 3,614
------ ------ ------- -------
NONINTEREST EXPENSE
Salaries and benefits 1,660 1,619 4,967 5,071
Net occupancy expense 178 181 555 531
Furniture and equipment expense 153 148 491 444
Advertising 124 151 425 398
Legal & professional fees 139 85 313 281
Data processing 213 175 697 693
Pennsylvania bank shares tax 101 96 302 288
Other 633 565 1,860 1,850
------ ------ ------- -------
Total noninterest expense 3,201 3,020 9,610 9,556
------ ------ ------- -------
Income before Federal income taxes 1,688 1,608 5,039 4,468
Federal income tax expense 278 292 923 788
------ ------ ------- -------
Net income $1,410 $1,316 $ 4,116 $ 3,680
====== ====== ======= =======
Basic earnings per share $ 0.53 $ 0.49 $ 1.53 $ 1.36
Weighted average shares outstanding (000's) 2,681 2,709 2,684 2,715
Diluted earnings per share $ 0.51 $ 0.48 $ 1.50 $ 1.33
Weighted average shares outstanding (000's) 2,748 2,754 2,742 2,757
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the nine months ended September 30, 2000 and 2001
(unaudited)
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 -- -- 3,680 -- -- -- 3,680
Unrealized securities losses arising
during current period, net of tax -- -- -- (164) -- -- (164)
Reclassification adjustment for realized
gains included in net income, net of tax -- -- -- 213 -- -- 213
Unrealized gain on off-balance sheet
hedges, net of tax -- -- -- (39) -- -- (39)
--------
Total Comprehensive income 3,690
Cash dividends declared, $.56 per share -- -- (1,558) -- -- -- (1,558)
Common stock issued under stock option plans -- (20) -- -- 94 -- 74
Forfeiture of restricted stock -- (16) -- -- (73) 89 --
Acquisition of 25,900 shares of Treasury stock -- -- -- -- (436) -- (436)
Amortization of unearned compensation -- -- -- -- -- 82 82
------ -------- -------- ------- ------- ----- --------
Balance at September 30, 2000 $3,045 $ 19,798 $ 24,749 $ (866) $(5,353) $(261) $ 41,112
====== ======== ======== ======= ======= ===== ========
Balance at December 31, 2000 $3,045 $ 19,797 $ 25,522 $ 343 $(5,506) -- $ 43,201
Comprehensive income:
Net income -- -- 4,116 -- -- -- 4,116
Unrealized securities gains arising
during current period, net of tax -- -- -- 1,456 -- -- 1,456
Reclassification adjustment for realized
gains, net of tax, included in net income -- -- -- 86 -- -- 86
Unrealized loss on off-balance sheet
hedges, net of tax -- -- -- (718) -- -- (718)
--------
Total Comprehensive income 4,940
Cash dividends declared, $.64 per share -- -- (1,749) -- -- -- (1,749)
Common stock issued under stock option plans -- (52) -- -- 255 -- 203
Acquisition of 48,182 shares of treasury stock -- -- -- -- (904) -- (904)
------ -------- -------- ------- ------- ----- --------
Balance at September 30, 2001 $3,045 $ 19,745 $ 27,889 $ 1,167 $(6,155) $-- $ 45,691
====== ======== ======== ======= ======= ===== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
(unaudited)
For the Nine Months Ended
September 30
2001 2000
-------- --------
Cash flows from operating activities:
Net Income $ 4,116 $ 3,680
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 764 556
Net accretion of securities premiums and discounts (14) (59)
Provision for possible loan losses 883 573
Securities gains, net (131) (238)
Mortgage loans originated for sale (25,845) (6,116)
Proceeds from sale of mortgage loans 25,968 6,159
Gain on sales of mortgage loans (123) (43)
Gain on sales of other assets (71) --
Increase in cash surrender value of life insurance (320) (122)
Decrease (increase) in interest receivable and other assets 462 (1,362)
Increase in interest payable and other liabilities 490 247
Other, net 121 213
-------- --------
Net cash provided by operating activities 6,300 3,488
-------- --------
Cash flows from investing activities:
Proceeds from sales of investment securities available for sale 7,668 6,118
Proceeds from maturities of investment securities available for sale 42,131 13,991
Purchase of investment securities available for sale (64,573) (22,591)
Net increase in loans (14,081) (12,729)
Purchase of equity method investment (1,188) --
Purchase of bank owned life insurance (2,670) (6,000)
Proceeds from sale of other assets 1,438 --
Capital expenditures (2,210) (1,463)
-------- --------
Net cash used in investing activities (33,485) (22,674)
-------- --------
Cash flows from financing activities:
Net change in demand deposits, NOW accounts and savings accounts 7,711 11,505
Net change in certificates of deposit (9,162) 752
Net change in short term borrowings 11,763 6,711
Long term debt advances 19,378 125
Long term debt payments (1,739) (32)
Dividends paid (1,749) (1,560)
Common stock issued under stock option plans 203 74
Purchase of treasury shares (904) (436)
-------- --------
Net cash provided by financing activities 25,501 17,139
-------- --------
Decrease in cash and cash equivalents (1,684) (2,047)
Cash and cash equivalents as of January 1 17,768 15,117
-------- --------
Cash and cash equivalents as of September 30 $ 16,084 $ 13,070
======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
6
FRANKLIN FINANCIAL SERVICES CORPORATION and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Basis of Presentation
The consolidated balance sheets as of September 30, 2001 and December 31,
2000, the consolidated statements of income for the three-month and nine-month
periods ended September 30, 2001 and 2000, the consolidated statements of
changes in shareholders' equity for the nine-month periods ended September 30,
2001 and 2000 and the consolidated statements of cash flows for the nine-month
periods ended September 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 September 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 September 30, 2001, are not
necessarily indicative of the operating results for the full year.
Earnings per share is computed based on the weighted average number of
shares outstanding during each quarter, adjusted retroactively for stock splits
and stock dividends. A reconciliation of the weighted average shares outstanding
used to calculate basic earnings per share and diluted earnings per share
follows:
For the quarter ended
September 30
---------------------
2001 2000
------ ------
(Amounts in thousands)
Weighted average shares outstanding (basic) 2,681 2,709
Impact of common stock equivalents,
primarily stock options 67 45
----- -----
Weighted average shares outstanding (diluted) 2,748 2,754
===== =====
7
For the nine months ended
September 30
-------------------------
2001 2000
----- -----
(Amounts in thousands)
Weighted average shares outstanding (basic) 2,684 2,715
Impact of common stock equivalents,
primarily stock options 58 42
----- -----
Weighted average shares outstanding (diluted) 2,742 2,757
===== =====
NOTE 2 - Capital Adequacy
Quantitative measures established by regulation to ensure capital adequacy
require financial institutions to maintain minimum amounts and ratios of total
and Tier I capital to risk-weighted assets and of Tier I capital to average
assets. The Capital ratios of the Corporation and its bank subsidiary are as
follows:
As of September 30, 2001 (unaudited)
------------------------------------------------------------------------------
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 $48,089 13.45% $28,599 8.00% N/A
Bank 42,414 12.00% 28,233 8.00% $35,291 10.00%
Tier 1 Capital (to Risk Weighted Assets)
- ----------------------------------------
Corporation $43,686 12.22% $14,300 4.00% N/A
Bank 38,113 10.80% 14,116 4.00% $21,175 6.00%
Tier 1 Capital (to Average Assets)
- ----------------------------------
Corporation $43,686 8.72% $20,050 4.00% N/A
Bank 38,113 7.68% 19,843 4.00% $24,803 5.00%
8
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 nine months ended September 30, 2001, 48,182 shares of the
Corporation's common stock were repurchased at a cost of approximately $904,000.
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 June 2001, the Financial Accounting Standards Board issued Statement No.
143, "Accounting for Asset Retirement Obligations," which addresses the
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. This Statement requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is incurred if a
reasonable estimate of fair value can be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived asset.
This Statement will become effective for the Bank on January 1, 2003, but is not
expected to have a significant impact on the financial condition or results of
operations.
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.
9
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. The Corporation has an
intangible asset recorded on its balance sheet that is related to the purchase
of a customer list. Charges against earnings occur based on the determinable
useful life of the intangible asset. At September 30, 2001 and 2000, the
unamortized amount of the intangible asset was $1.0 million and $1.2 million,
respectively.
In August of 2001, the Financial Accounting Standards Board issued
Statement 144, "Accounting for the Impairment of or Disposal of Long-Lived
Assets." This Statement supersedes FASB Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-lived Assets to be Disposed Of,"
and the accounting and reporting provisions for APB Opinion No. 30, "Reporting
the Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions for the disposal of a segment of a business." This Statement also
amends ARB No. 51, "Consolidated Financial Statements." The provisions of this
Statement will be effective for the Bank on January 1, 2002, but are not
expected to have a significant impact on the financial condition or results of
operations.
10
Management's Discussion and Analysis of
Results of Operations and Financial Condition
for the Three and Nine Month Periods
Ended September 30, 2001 and 2000
Part 1, Item 2
FORWARD LOOKING STATEMENTS
Certain statements appearing herein which are not historical in nature are
forward-looking statements within the meaning of 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, changes in the
Corporation's cost of funds, changes in government monetary policy, changes in
government regulation and taxation of financial institutions, changes in the
rate of inflation, changes in technology, the intensification of competition
within the Corporation's market area, and other similar factors.
RESULTS OF OPERATIONS
The Corporation reported earnings for the third quarter and nine months
ended September 30, 2001, totaling $1,410,000 and $4,116,000, respectively,
representing increases of 7.1% and 11.8%, respectively over the same periods in
2000. Basic earnings per share for the third quarter and nine months ended
September 30, 2001 were $.53 and $1.53, respectively, compared to $.49 and
$1.36, respectively, for the same periods one year earlier. Diluted earnings per
share were $.52 and $1.51 for the quarter and nine months ended September 30,
2001 and $.48 and $1.33 for the same periods ended September 30, 2000. Per share
earnings are weighted to reflect the impact of the stock repurchase program.
Book value per share at September 30, 2001 equaled $16.78 versus $14.86 at
September 30, 2000.
The Corporation's annualized return on average assets (ROA) and return on
average equity (ROE) for the first nine months of 2001 were 1.11% and 12.23%,
respectively, compared to 1.09% and 12.48%, respectively, for the same period in
2000.
NET INTEREST INCOME
Net interest income improved to $3.82 million for the third quarter of 2001
versus $3.58 million for the third quarter of 2000, an increase of $248,000, or
6.9%. Interest income was down $396,000, or 4.8% to $7.8 million for the third
quarter of 2001 compared to $8.2 million for the third quarter of 2000. Interest
expense recorded a decrease of $644,000, or 13.9%, to $3.99 million for the
third quarter of 2001 compared to $4.63 million for the third quarter of 2000.
The steady decline in market interest rates beginning in January and continuing
through the third quarter of 2001 strengthened the Corporation's net interest
income. The Federal Reserve reduced interest rates even lower in September which
is expected to have a favorable impact on net interest income for the fourth
quarter. For the third quarter 2001, interest rates on interest-bearing
liabilities fell at a faster pace than interest rates on interest-earning assets
thereby producing a favorable impact on net interest income for the quarter.
Net interest income for the nine months ended September 30, 2001 grew
$581,000, or 5.3%, to $11.56 million from $10.98 million for the nine months
ended September 30, 2000. Interest income and interest expense for the
nine-month period followed the same pattern as the third quarter. Interest
income decreased $12,000 to
11
$24.1 million while interest expense decreased $593,000 to $12.5 million, adding
$581,000 to net interest income in 2001 versus 2000.
Despite the lower interest rate environment and the favorable impact to net
interest income, the Corporation's net interest margin continues to be squeezed.
For the nine-month period ended September 30, 2001, net interest margin (tax
equivalent) was 3.68% compared to 3.75% for the nine months ended September 30,
2000. In June 2000, the Corporation purchased $6.0 million of Bank Owned Life
Insurance (BOLI). An additional purchase totaling $2.6 million was completed in
July 2001. The revenue derived from this earning asset is recorded in
non-interest income. The Corporation's investment in BOLI generated tax-free
revenue of $320,000 for the nine months ended September 30, 2001 versus $122,000
for the same period in 2000.
The Corporation implemented strategies earlier in the year to help mitigate
its interest rate risk. These actions involved long-term debt advances from the
Federal Home Loan Bank of Pittsburgh totaling approximately $14 million and a
$10 million interest rate swap where the Bank pays a fixed interest rate and
receives a floating interest rate indexed to the 3-month U.S. Government
Treasury bill. Another $3.6 million in long-term debt borrowings was used to
fund growth in the commercial loan portfolio. In addition, tax-exempt securities
were reduced by approximately $5.8 million to help offset the tax-exempt income
generated from $8.6 million in Bank Owned Life Insurance. This was done to
manage the Corporation's Federal tax position. All of these actions impact
interest income and interest expense with the expectation that net interest
income will remain stable or improve.
PROVISION FOR LOAN LOSSES
The Corporation charged $359,000 and $883,000 against earnings for loan
losses in the third quarter and nine months ended September 30, 2001,
respectively, compared to $180,000 and $573,000, respectively, for the same
periods in 2000. An increase in nonperforming loans during the third quarter of
2001 accounted for the higher provision expense for the third quarter and nine
months ended September 30, 2001. For more information concerning nonperforming
loans refer to the Loan Quality discussion.
NONINTEREST INCOME
Noninterest income, excluding net securities gains and losses, increased
$82,000, or 6.8%, to $1.29 million for the third quarter ended September 30,
2001 from $1.21 million for the third quarter of 2000. Increases in service
charges and fees, up $115,000 to $639,000 in the third quarter of 2001 versus
2000, were attributable to higher fees related to a significant increase in
mortgage loan origination activity, higher deposit account fees and higher
miscellaneous teller fees. Investment and trust services fees recorded a
decrease of $72,000, or (12.2%), which is primarily related to the downturn in
market values of trust account assets. Other noninterest income was up $39,000,
or 40.6%, to $135,000 for the third quarter of 2001 and was primarily the result
of income from BOLI. Net securities gains, $110,000 higher in the third quarter
of 2001 compared to the third quarter of 2000, equaled $131,000 for the three
months ended September 30, 2001.
Noninterest income, excluding net securities gains, for the nine months
ended September 30, 2001, increased $461,000, or 13.6%, to $3.84 million from
$3.38 million for the third quarter ended September 30, 2000. Service charges
and fees accounted for almost 90% of the increase largely due to the same fees
as mentioned above. Other income was up $186,000 to $361,000 for the nine months
ended September 30, 2001, from $175,000 for the nine months ended September 30,
2000. BOLI income (up $198,000) plus the realized gain from the sale of the
Bank's credit card portfolio ($72,000), reduced by losses on the sale of
foreclosed real estate and other repossessed assets, were the factors
contributing to higher other income for the nine months ended September 30,
2001. A $128,000 decline in Investment and trust services fees to $1.65 million
for the nine months ended September 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 net securities gains totaling
$131,000 for the first nine months of 2001 compared to $238,000 for the first
nine months of 2000.
For the nine months ended September 30, 2001, noninterest income, excluding
net securities gains, represented 24.9% of total revenues compared to 23.5% for
the nine-month period ended September 30, 2000. Recent opportunities to
strengthen the Corporation's noninterest income include the implementation of an
ATM
12
access fee for noncustomers, the introduction of debit cards, investments in
BOLI and a title insurance company and the formation 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 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 increased by $181,000 to $3.20 million for the
third quarter ended September 30, 2001, compared to $3.02 million for the third
quarter ended September 30, 2000. Salaries and benefits recorded a modest
increase of $41,000, or 2.6%, to $1.66 million for the quarter ended September
30, 2001 compared to $1.62 million for the same quarter one year earlier.
Management's ability to control the number of full-time equivalent employees to
195 at September 30, 2001 from 189 at September 30, 2000 contributed to the
small increase in salaries and benefits. Deferred salary and benefit costs
related to loan origination activity were $73,000 higher in the third quarter of
2001 compared to the third quarter of 2000. These higher deferred costs also
contributed to the modest increase in salaries and benefits. Legal and
professional fees were $54,000, or 63.5%, higher in the third quarter of 2001
than the third quarter of 2000. Consulting and legal fees associated with
potential business ventures were primarily responsible for the increase. The
timing of ATM maintenance expenses and a higher volume of general loan and
deposit activity resulted in higher data processing expense (up $38,000) in the
third quarter of 2001 versus 2000. Other expense was up $68,000, or 12.0%, to
$633,000 for the third quarter of 2001 compared to the third quarter of 2000 and
is primarily related to accelerated amortization of an intangible asset
($51,000) and higher charges from the Bank's ATM vendor (up $11,000).
Total noninterest expense for the nine months ended September 30, 2001,
showed a modest increase of $54,000 to $9.61 million from $9.56 million at
September 30, 2000. Salaries and benefits were down $104,000 to $4.97 million
for the nine months ended September 30, 2001, versus $5.07 million for the nine
months ended September 30, 2000. Although salary expense remained flat for the
nine-month period, benefits costs were up. Benefits relating to a corporate
earnings payout, pay for performance program and 401(k) discretionary
contribution were $125,000 higher for the nine month period in 2001 versus 2000
while health and group life insurance costs were $29,000 higher. Offsetting
these increases were higher deferred salary & benefit costs (credit to expense)
related to mortgage loan origination activity volume and the end of a restricted
stock program that was fully expensed in 2000.
Federal income tax expense for the third quarter and nine months ended
September 30, 2001 totaled $278,000 and $923,000, respectively, compared to
$292,000 and $788,000 for the same periods ended September 30, 2000. The
Corporation's effective tax rate for the nine months ended September 30, 2001,
was 18.3% compared to 17.6% for the nine months ended September 30, 2000. All
taxable income for the Corporation is taxed at a rate of 34%.
FINANCIAL CONDITION
Total assets reached $498.8 million at September 30, 2001 from $465.9
million at December 31, 2000, an increase of $32.9 million, or 7%. The growth in
assets for the nine-month period since December 31, 2000 was primarily in
investment securities available for sale (up $17.2 million) and loans (up $12.0
million). The increase in investment securities since year-end was primarily
attributable to purchases of SLMA securities; loan growth was concentrated
entirely in the commercial loan portfolio with the mortgage and consumer loan
portfolios showing modest decreases. Although mortgage loan outstandings were
down for the nine-month period, mortgage loan origination activity was up
significantly. In the first nine months of 2001, mortgage originations totaled
$39.3 million compared to $19.0 million for the same period in 2000, an increase
of 106.4%. Almost all of these loans are sold on the secondary market to FNMA.
13
Total deposits and securities sold under agreements to repurchase (sweep
repos) grew a modest $10.3 million, or 2.6%, to $400.56 million at September 30,
2001 from $390.2 at December 31, 2000. The low interest rate environment during
the nine-month period presented a challenge for retaining certificates of
deposit (CD) as they matured, reflected in a $9.2 million decrease to $122.0
million since year-end. Despite the decrease in CD volume, the Bank has been
successful in retaining and attracting new dollars to its interest-bearing
checking, savings, money market, money management and sweep repo accounts. These
accounts grew $25.8 million in total. Offsetting this growth, in addition to
CDs, were decreases totaling $6.3 million in demand deposits and the Bank's
money market fund for trust customers.
Premises and equipment increased $1.47 million, or 20.3%, to $8.7 million
at September 30, 2001, from $7.24 million at December 31, 2000. The construction
of an addition to the headquarters office is primarily responsible for this
increase. Payment of $2.6 million of the approximate $3.4 million project has
been made to date. Completion of the construction is anticipated to be by
December 31, 2001. Other assets were up $3.9 million, or 21.3%, to $22.45
million at September 30, 2001, from $18.5 million at December 31, 2000. The
purchase of additional BOLI in July 2001 accounted for most of the increase in
other assets.
Long-term debt increased by $17.6 million, or 59.8%, to $47.1 million at
September 30, 2001, from $29.5 million at December 31, 2000. A strategy
implemented earlier in the year to help mitigate interest rate risk for the
Corporation was primarily responsible for this significant increase. The
strategy includes transactions involving interest rate swaps, interest rate caps
and term advances from the Federal Home Loan Bank of Pittsburgh. As of September
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 2001 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. Other
liabilities recorded an increase of $2.3 million, or 76.7%, to $5.4 million at
September 30, 2001, from $3.1 million at December 31, 2000. An increase in the
deferred tax liability related to FAS 115 accounted for approximately $769,000
and an increase of $1.1 million to record the fair value of the interest rate
swap accounted for the remainder of the increase.
Total shareholders' equity increased $2.5 million to $45.7 million at
September 30, 2001 from $43.2 million at year-end 2000. During the nine months,
an approximate $800,000 increase in other comprehensive income and an increase
in retained earnings totaling $2.3 million added to total shareholders' equity.
Unrealized securities gains were partially offset by unrealized losses
associated with the above mentioned interest rate hedging strategies to result
in the net increase to other comprehensive income. Stock repurchases during the
nine-month period reduced shareholders' equity by $904,000.
Capital adequacy is currently defined by regulatory agencies through the
use of several minimum required ratios. At September 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
September 30, 2001 were 8.72%, 12.22%, and 13.45%, respectively. For more
information on capital ratios refer to Note 2 of the accompanying financial
statements.
LOAN QUALITY
Net charge-offs for the third quarter and nine-months ended September 30,
2001, totaled $352,000 and $608,000, respectively, compared to $45,000 and
$457,000 for the third quarter and nine months, respectively, of 2000. For the
first nine months of 2001, 58% of the net charge-offs were related to the
commercial portfolio and 42% to the consumer portfolio. The annualized year to
date ratio of net charge-offs to average loans was .27% at September 30, 2001
compared to .21% at September 30, 2000.
Nonperforming loans were up $2.5 million to $3.45 million at September 30,
2001 from $945,000 at December 31, 2000. Included in nonperforming loans at
September 30, 2001, were nonaccrual loans totaling $2.6 million and loans past
due 90 days or more totaling $823,000 compared to $576,000 and $369,000,
respectively at December 31, 2000. The Corporation held foreclosed real estate
equaling $1.1 million at September 30, 2001 compared to $1.4 million at December
31, 2000. Nonperforming assets represented .92% of total assets at September 30,
2001 compared to .69% at December 31, 2000.
14
Subsequent to September 30, 2001, a commercial borrower with outstanding
loan balances of approximately $1.5 million filed Chapter 11 Bankruptcy. As of
this filing a collateral liquidation analysis is currently underway to quantify
the potential losses, if any, related to this borrower.
The allowance for possible loan losses totaled $4.1 million at September
30, 2001, compared to $3.9 million at December 31, 2000. The allowance
represents 1.31% and 1.28%, of total loans at September 30, 2001 and December
31, 2000, respectively. The allowance provided coverage for nonperforming loans
at a rate of 1.2 times at September 30, 2001.
LOCAL ECONOMY
In the aftermath of terrorist attacks occurring on September 11th, local
economic conditions are slow. The uncertainty brought on as a result of the
tragedy has affected consumers and manufacturers across the country and locally
as well. Franklin County is heavily dependent upon the manufacturing sector for
its employment opportunities. With a slowdown in product orders, manufacturers
are forced to announce layoffs, which has occurred locally. Local consumers are
less anxious to spend their disposable income, thereby affecting the retail
segment of the business community. Although the events of September 11th did not
help the local economy, the slowdown in the local economy began before the
attacks on America occurred. Despite the fact that the country is on the brink
of a recession, the state Department of Labor and Industry announced at the end
of October that Franklin County's unemployment rate dropped to 4.2% in September
from 4.5% in August. During the past quarter, three new warehouse distribution
center projects have been announced which are expected to create approximately
2,000 new jobs. The stable unemployment rate for Franklin County is an indicator
that consumers should be able to make their Bank loan payments. However, there
could be more financial strain on the Bank's commercial customers.
LIQUIDITY
The Corporation's liquidity ratio (net cash, short-term and marketable
assets divided by net deposits and short-term liabilities) was 29.4% at
September 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 September 30, 2001, the funding available to the Corporation from
the FHLB is approximately $93 million. Management believes that liquidity is
adequate to meet the borrowing and deposit needs of its customers.
PART I, ITEM 3
QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Although the Federal funds rate and the National prime rate fell 350 basis
points to a 30-year low between December 31, 2000 and September 30, 2001, the
Corporation's net interest margin remained fairly stable. For the nine-month
period ended September 30, 2001, the tax-equivalized net interest margin was
3.68% compared with 3.67% and 3.75% at December 31, 2000 and September 30, 2001,
respectively. Because of the extent to which rates have declined this year, the
Corporation has become sensitive to future rate declines and expects some added
compression of the net interest margin. An interest rate shock analysis
performed as of September 30, 2001, showed a possible decline in net interest
income of 2.4% or $364,000 in a - 100 basis point rate shock over a one-year
period compared with a decline of 0.9%, or $129,000 at December 31, 2000. Using
a 200 basis point rate shock as of September 30, 2001, the Corporation could see
a possible decline in net interest income of 7.2%, or $1.2 million over a
one-year period compared with a decline of 6.3%, or $874,000 at December 31,
2000. Given the current low interest rate environment, it is highly unlikely
that a 200 basis point drop is realistic. When performing the interest rate
shock analyses, interest rate caps and interest rate swaps are factored in. In
addition, interest rates paid on core deposits are assumed to vary in accordance
with historical relationships. Management of the Corporation is confident that
it is fairly well protected against rising interest rates resulting from the
interest rate hedges that are in place. The net interest income at risk for the
Corporation remains within the guidelines established by the Corporation's
asset/liability policy. The Corporation continues to monitor and manage its
interest rate sensitivity during these unusual times. Please refer to the annual
report to shareholders on Form 10-K filed with the Securities and Exchange
Commission for December 31, 2000, for further discussion on this matter.
15
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
None
Item 5. OTHER INFORMATION
None
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
There were no reports filed on Form 8-K for the period.
16
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
November 9, 2001 /s/ William E. Snell, Jr.
- ---------------- -----------------------------------
William E. Snell, Jr.
President and Chief Executive Officer
November 9, 2001 /s/ Elaine G. Meyers
- ----------------- -------------------------------------
Elaine G. Meyers
Treasurer and Chief Financial Officer
17