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, 1998
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
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 25-1440803
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
20 SOUTH MAIN STREET (P.O. BOX T), CHAMBERSBURG,PA 17201-0819
(Address of principal executive officer)
717/264-6116
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes 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 2,801,930 outstanding shares of the Registrant's common stock as
of November 2, 1998.
INDEX
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Balance Sheets
as of September 30, 1998 (unaudited) and
December 31, 1997
Consolidated Statements of
Income for the Three and Nine Months ended
September 30, 1998 and 1997 (unaudited)
Condensed Consolidated Statements of
Changes in Shareholders' Equity for the
Twelve and Nine Months ended December 31,
1997 and September 30, 1998 (unaudited)
Consolidated Statements of Cash
Flows for the Nine Months Ended September
30, 1998 and 1997 (unaudited)
Notes to Condensed Consolidated Financial
Statements (unaudited)
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
PART II - OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K
SIGNATURE PAGE
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands)
September 30 December 31
1998 1997
------------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Cash and due from banks $11,595 $10,863
Interest bearing deposits in other banks 18,610 249
Investment securities held to maturity (Market value of $ 24,454 and $28,030 at
September 30, 1998 and December 31, 1997 respectively) (Note 3) 22,961 27,779
Investment securities available for sale (Note 3) 68,244 59,319
Loans, net 252,259 241,244
Premises and equipment, net 5,820 5,907
Other assets 9,388 8,504
------------- ------------
Total Assets $388,877 $353,865
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits: (Note 4)
Demand (non-interest bearing) $38,968 $37,591
Savings and Interest checking 128,276 113,138
Time 141,865 123,826
------------- ------------
Total Deposits 309,109 274,555
Securities sold under agreements to repurchase 23,175 16,075
Other borrowings 13,935 21,434
Other liabilities 3,428 5,496
------------- ------------
Total Liabilities 349,647 317,560
Commitments and Contingencies - -
Shareholders' equity:
Common stock $1 par value per share, 5,000 shares authorized
with 3,045 shares issued and 2,799 and 2,795 shares
outstanding at September 30,1998 and December 31,1997,respectively. 3,045 3,045
Capital stock without par value, 5,000 shares authorized
with no shares issued or outstanding - -
Additional paid in capital 19,778 19,761
Retained earnings 19,858 17,087
Net unrealized gain on securities 1,916 1,935
Treasury stock (Note 6) (4,679) (4,760)
Unearned compensation (688) (763)
------------- ------------
Total shareholders' equity 39,230 36,305
------------- ------------
Total Liabilities and Shareholders' Equity $388,877 $353,865
============= ============
The accompanying notes are an integral part of these statements
</TABLE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME
(amounts in thousands, except per share)
(Unaudited)
<S> <C> <C> <C> <C>
For the Three Months Ended For the Nine Months Ended
September 30 September 30
1998 1997 1998 1997
-------------------------- ---------------------------
INTEREST INCOME
Interest on loans $5,459 $5,405 $16,425 $15,707
Interest on deposits in other banks 164 4 227 25
Interest on Federal funds sold 0 0 0 0
Interest and dividends on investments (Note 3) 1,256 1,315 3,686 3,905
------------ ---------- ------------ -----------
Total interest income 6,879 6,724 20,338 19,637
------------ ---------- ------------ -----------
INTEREST EXPENSE
Interest on deposits 2,834 2,567 8,240 7,482
Interest on securities sold under agreements to
repurchase and other borrowings 499 606 1,397 1,535
------------ ---------- ------------ -----------
Total interest expense 3,333 3,173 9,637 9,017
------------ ---------- ------------ -----------
Net interest income 3,546 3,551 10,701 10,620
Provision for possible loan losses 165 253 720 638
------------ ---------- ------------ -----------
Net-interest income after provision
for possible loan losses 3,381 3,298 9,981 9,982
------------ ---------- ------------ -----------
NONINTEREST INCOME
Trust fees 485 354 1,373 1,022
Service charges, commissions and fees 543 465 1,648 1,511
Other 22 9 84 49
Securities gains 68 189 563 393
------------ ---------- ------------ -----------
Total noninterest income 1,118 1,017 3,668 2,975
------------ ---------- ------------ -----------
NONINTEREST EXPENSE
Salaries and benefits 1,530 1,677 4,505 4,814
Net occupancy expense 157 153 465 468
Furniture and equipment expense 177 204 569 583
Other 1,041 951 3,272 2,699
------------ ---------- ------------ -----------
Total noninterest expense 2,905 2,985 8,811 8,564
------------ ---------- ------------ -----------
Income before Federal income taxes 1,594 1,330 4,838 4,393
------------ ---------- ------------ -----------
Federal income tax expense 416 291 1,185 1,036
------------ ---------- ------------ -----------
Net income $1,178 $1,039 $3,653 $3,357
============ ========== ============ ===========
Basic earnings per share $0.43 $0.38 $1.34 $1.22
'Weighted average shares outstanding (000's) 2,730 2,729 2,729 2,743
Diluted earnings per share $0.43 $0.38 $1.32 $1.21
'Weighted average shares outstanding (000's) 2,768 2,765 2,767 2,779
The accompanying notes are an integral part of these statements.
Earnings per share for 1997 have been adjusted to reflect a 3 for 2 stock split issued in the form
of a 50% stock dividend distributed on February 3, 1998.
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C>
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the year ended December 31, 1997 and the Nine Months ended September 30, 1998
(Amounts in thousands, except per share )
Net
Additional Unrealized
Common Paid-in Retained Gain/(Loss) Treasury Unearned
Stock Capital Earnings on Securitie Stock Compensation Total
--------- --------- --------- ---------- --------- ----------- ---------
Balance at December 31, 1996 $2,030 $19,745 $17,590 $613 ($3,830) ($807) $35,341
Net Income - - 4,363 - - - 4,363
- - - - -
Cash dividends paid, $.56 per share - - (1,571) - - - (1,571)
Cash dividends declared, not paid
$ .81 per share - - (2,280) - - - (2,280)
50% stock split 1,015 - (1,015) - - - 0
Common stock issued under stock
option plans - 27 - - 294 - 321
Change in net unrealized gain
on securities - - - 1,322 - - 1,322
Restricted stock issued under long-term
incentive compensation plan - (11) - - 60 (73) (24)
Acquisition of treasury stock at cost - - - - (1,284) - (1,284)
Amortization of unearned compensation - - - - - 117 117
--------- --------- --------- ---------- --------- ----------- ---------
Balance at December 31, 1997 3,045 19,761 17,087 1,935 (4,760) (763) 36,305
--------- --------- --------- ---------- --------- ----------- ---------
Net income - - 3,653 - - - 3,653
Cash dividends declared, $.31 per share - - (868) - - - (868)
Cash in lieu of fractional shares
on 50% stock split - - (14) - - - (14)
Common stock issued under stock
option plans - 17 - - 81 - 98
Change in net unrealized gain
on securities - - - (19) - - (19)
Amortization of unearned compensation - - - - - 75 75
--------- --------- --------- ---------- --------- ----------- ---------
Balance at September 30, 1998 $3,045 $19,778 $19,858 $1,916 ($4,679) ($688) $39,230
(unaudited) ========= ========= ========= ========== ========= =========== =========
The accompanying notes are an integral part of these statements.
</TABLE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in Thousands)
(Unaudited)
For the Nine Months End
September 30
<S> <C> <C>
1998 1997
--------- ----------
Cash flows from operating activities:
Net Income $3,653 $3,357
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 564 583
Premium amortization on investment securities 77 90
Discount accretion on investment securities (101) (117)
Provision for possible loan losses 720 638
Securities gains, net (563) (393)
Principal loss (gain) on sales of mortgage loans 40 (47)
Proceeds from sale of mortgage loans 18,273 8,487
Loss on sale of premises and equipment 294 37
Loan charge-offs, net of recoveries (658) (445)
Increase in interest receivable (103) (390)
Increase in interest payable 385 116
Decrease in unearned discount (29) (99)
Increase in prepaid and other assets (881) (13)
Decrease in accrued expenses and other liabilities (64) (160)
Other, net 52 95
--------- ----------
Net cash provided by operating activities $21,659 $11,739
--------- ----------
Cash flows from investing activities:
Proceeds from sales of investment securities available for sale 851 3,887
Proceeds from maturities of investment securities held to maturity 4,846 7,586
Proceeds from maturities of investment securities
available for sale 11,506 6,974
Purchase of investment securities held to maturity (28) (775)
Purchase of investment securities available for sale (20,748) (16,582)
Net increase in loans (29,323) (24,037)
Capital expenditures (980) (332)
Proceeds from sales of premises and equipment 208 146
--------- ----------
Net cash used in investing activities (33,668) (23,133)
--------- ----------
Cash flows from financing activities:
Net increase in demand deposits,
NOW accounts and savings accounts 16,515 7,746
Net increase (decrease) in certificates of deposit 18,039 (10,944)
Dividends (3,151) (1,161)
Common stock issued under stock option plans 98 260
Purchase of treasury shares 0 (1,207)
Net (decrease) increase in other borrowings (399) 15,796
--------- ----------
Net cash provided by financing activities 31,102 10,490
--------- ----------
Increase in cash and cash equivalents 19,093 (904)
Cash and cash equivalents as of January 1 11,112 10,521
--------- ----------
Cash and cash equivalents as of September 30 $30,205 $9,617
========= ==========
The accompanying notes are an integral part of these statements.
</TABLE>
FRANKLIN FINANCIAL SERVICES CORPORATION and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Basis of Presentation
The consolidated balance sheets as of September 30, 1998 and December 31,
1997, the consolidated statements of income for the three-month and nine-month
periods ended September 30, 1998 and 1997, the condensed consolidated
statements of changes in shareholders' equity as of December 31, 1997 and
September 30, 1998 and the consolidated statements of cash flows for the
nine-month periods ended September 30, 1998 and 1997 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, 1998, 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. 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 condensed
consolidated financial statements be read in conjunction with the audited
financial statements and notes thereto included in the Corporation's 1997
Annual Report. The results of operations for the period ended
September 30, 1998, are not necessarily indicative of the operating results
for the full year.
For purposes of reporting cash flows, cash and cash equivalents include
cash, due from banks, interest-bearing deposits in other banks and federal
funds sold. Generally, Federal funds are purchased and sold for one-day
periods. Supplemental disclosures of cash flows information are as follows:
Cash paid for nine months ended September 30: 1998 1997
Interest paid on deposits and
other borrowed funds . . . . . $9,252,000 $8,930,000
Income taxes paid $1,425,000 $ 775,000
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. Adjustments for 1997 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.
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
1998 1997
---- ----
(Amounts in thousands)
Weighted average shares
outstanding (basic) 2,730 2,729
Impact of common stock equivalents 38 36
----- ----
Weighted average shares
outstanding (diluted) 2,768 2,765
====== ======
For the nine months ended
September 30
1998 1997
---- ----
(Amounts in thousands)
Weighted average shares
outstanding (basic) 2,729 2,743
Impact of common stock equivalents 38 36
----- -----
Weighted average shares
outstanding (diluted) 2,767 2,779
===== =====
<TABLE>
<CAPTION>
Note 2. Capital Adequacy
Quantitative measures established by regulation to ensure capital adequacy require financial
minimum amounts and ratios of total and Tier I capital to risk-weighted assets and of Tier I
The Capital ratios of the Corporation and its bank subsidiary are as follows:
<S> <C> <C> <C> <C> <C> <C>
As of September 30, 1998 (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 $38,706 14.94% $20,725 8.00% $25,906 10.00%
Bank 34,464 13.08% 20,473 8.00% 25,591 10.00%
Tier I Capital (to Risk Weighted Assets)
Corporation $35,466 13.69% $10,362 4.00% $15,543 6.00%
Bank 31,263 12.22% 10,236 4.00% 15,355 6.00%
Tier I Capital (to Average Assets)
Corporation $35,466 9.50% $14,940 4.00% $18,675 5.00%
Bank 31,263 8.45% 14,793 4.00% 18,491 5.00%
</TABLE>
<TABLE>
<CAPTION>
Note 3 - Investment Securities
Amortized cost and estimated market values of investment securities as of September 30, 1998 (unaudited),
and December 31, 1997, were as follows (amounts in thousands):
Held to Maturity
--------------------------------------------
September 30 December 31
1998 1997
--------------------------- ---------------------------
Estimated Estimated
Amortized Market Amortized Market
Cost Value Cost Value
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations
of U.S. Government agencies & corporations $1,015 $1,025 $1,030 $1,039
Obligations of state and political subdivisions 13,185 14,546 15,025 15,244
Corporate debt securities 1,688 1,715 2,343 2,348
Mortgage - backed securities 5,653 5,748 7,989 8,007
--------- --------- --------- ---------
21,541 23,034 26,387 26,638
Other 1,420 1,420 1,392 1,392
--------- --------- --------- ---------
$22,961 $24,454 $27,779 $28,030
========= ========= ========= =========
Available for Sale
--------------------------------------------
September 30 December 31
1998 1997
--------------------------- ---------------------------
Estimated Estimated
Amortized Market Amortized Market
Cost Value Cost Value
--------- --------- --------- ---------
Equity securities $1,879 $2,945 $1,588 $3,638
U.S. Treasury securities and obligations
of U.S. Government agencies & corporations 14,979 15,288 20,967 21,136
Obligations of state and political subdivisions 20,049 21,250 14,926 15,600
Corporate debt securities 7,832 8,008 4,029 4,080
Mortgage - backed securities 20,602 20,753 14,877 14,865
--------- --------- --------- ---------
$65,341 $68,244 $56,387 $59,319
========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
Interest income and dividends received on investment securities for the three and nine months
ended September 30, 1998 and 1997 are as follows (amounts in thousands):
Three Months Nine Months
1998 1997 1998 1997
------------------ ------------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
U.S. Government Obligations $53 $73 $189 $221
Obligations of U.S. Government
Agencies and Corporations 551 631 1,678 2,015
Obligations of States and
Political Subdivisions 400 401 1,156 1,014
Other Securities, primariy
Notes and Debentures 212 152 539 542
Common Stock 40 58 124 113
------------------ ------------------
$1,256 $1,315 $3,686 $3,905
================== ==================
</TABLE>
<TABLE>
<CAPTION>
Note 4 - Deposits
Deposits are summarized as follows (amounts in thousands):
September 30 December 31
1998 1997
------------- -------------
(Unaudited)
<S> <C> <C>
Demand $38,968 $37,591
Savings
Interest-bearing checking 37,392 32,770
Money Market Accounts 52,499 40,836
Passbook and Statement Savings 38,385 39,532
------------- -------------
$128,276 $113,138
============= =============
Time
Deposits of $100,000 and over 34,574 17,739
Other Time Deposits 107,291 106,087
------------- -------------
141,865 123,826
------------- -------------
Total Deposits $309,109 $274,555
============= =============
</TABLE>
NOTE 5 - Comprehensive Income
Effective January 1, 1998, the Corporation adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" which requires
disclosure of all changes in equity that result from transactions and other
economic events of the period other than transactions with owners.
Comprehensive income is defined as the total of net income and all other
nonowner changes in equity. Reclassification of financial statements for
earlier periods that are presented for comparative purposes is required.
For the Corporation, total comprehensive income consists of net income plus
the net change in unrealized gains or losses on available for sale investment
securities. Total comprehensive income for the three and nine months ended
September 30, 1998 and 1997 were $1.2 million and $3.6 million, respectively,
and $1.8 million and $4.8 million,respectively, net of tax.
Note 6 - Treasury Stock
On March 5, 1998, the Board of Directors authorized the repurchase of up
to 50,000 shares of the Corporation's $1.00 par value common stock,
representing approximately 1.79% of such shares then issued and outstanding.
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 third quarter and nine months ended September 30, 1998, there
were no common stock repurchase transactions under the above stock repurchase
plan or under the stock repurchase plan that was authorized in March 1997 and
expired in March 1998.
NOTE 7 - Recent Accounting Pronouncements
On March 4, 1998, the American Institute of Certified Public Accountants
issued Statement of Position, (SOP) 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." This Statement provides
guidelines on accounting for the costs of computer software developed or
obtained for internal use and is effective for financial statements for fiscal
years beginning after December 15, 1998. Adoption of this Statement is not
expected to have a significant impact on the Corporation's financial
condition or results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." The 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 must formally document,
designate, and assess the effectiveness of transactions that receive hedge
accounting treatment.
The Statement is effective for fiscal years beginning after June 15, 1999. A
company may also implement the Statement as of the beginning of any fiscal
quarter after issuance. The Statement cannot be applied retroactively.
Effective October 1, 1998, the Corporation adopted Statement No. 133 which
resulted in no material financial statement impact. As a part of the adoption
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 had an impact
on equity of approximately $985,000, net of tax.
Management's Discussion and Analysis of
Results of Operations and Financial Condition
for the Three and Nine Month Periods
Ended September 30, 1998 and 1997
Part 1, Item 2
Results of Operations
Net income for the third quarter and nine months ended September 30,
1998, was $1.2 million and $ 3.7 million, respectively, compared with $1.0
million and $3.4 million, respectively, for the same periods in 1997. Basic
earnings per share grew 13.1% to $.43 for the third quarter of 1998 from $.38
for the third quarter of 1997. An increase in basic earnings per share of
9.8% to $1.34 from $1.22 was recorded for the first nine months of 1998
compared with the same period one year earlier. Book value per share equaled
$14.01 at September 30, 1998, versus $13.45 at September 30, 1997.
The Corporation's annualized return on average assets (ROA) and return on
average equity (ROE) for the first nine months of 1998 were 1.34% and 12.94%,
respectively, compared to 1.31% and 12.47%, respectively, for the same periods
ended September 30, 1997.
Net interest income for the third quarter and nine months ended September
30, 1998, remained steady at $ 3.5 million and $ 10.7 million, respectively,
when compared to the same periods one year earlier. Total interest income for
the quarter and nine months recorded modest growth of 2.3%, or $155,000 to $
6.9 million and 3.6%, or $701,000, to $20.3 million, respectively, over
interest income for the comparable periods in 1997. More than offsetting the
growth in interest income was an increase in interest expense of 5.0%, or
$160,000, and 6.9%, or $620,000 for the third quarter and nine months,
respectively, ended September 30, 1998, compared to the same periods in 1997.
Average interest-earning assets during the nine months recorded growth of 6.2%
to $342.1 million with a yield of 8.21%, a 17 basis point decrease compared to
the same period in 1997. Average interest-bearing liabilities recorded growth
of 5.1% to $281.6 million with a cost of 4.58%, a 9 basis point increase
compared to the same period in 1997. These factors resulted in a compressed
net interest margin (tax-equivalent basis) of 4.44% at September 30, 1998
compared to 4.64% at September 30, 1997.
The Corporation recorded a provision for possible loan losses of $165,000
and $720,000 for the third quarter and nine months, respectively, versus
$253,000 and $638,000, respectively, for the same periods in 1997. The
allowance for possible loan losses remained at a ratio of 1.3%.
Total noninterest income, excluding securities gains, grew 26.8%, or
$222,000, to $1.0 million and 20.2%, or $523,000, to $3.1 million for the
quarter and nine months, respectively, ended September 30, 1998. Trust fees
were up 37.0%, or $131,000, to $485,000 for the quarter and 34.3%, or
$351,000, to $1.4 million for the nine months ended September 30, 1998. New
trust business coupled with increased market values of trust investments were
the main contributors to the growth in trust fees for the third quarter and
nine months. Service charges, commissions and fees also recorded strong
growth with an increase of 16.8%, or $78,000, to $543,000 for the third
quarter and 9.1%, or $137,000, to $1.6 million for the nine months in 1998
versus the comparable periods in 1997. The increase in service charges,
commissions and fees for the third quarter and nine month periods can be
attributed primarily to loan origination fees associated with a high volume of
mortgage refinancing due to the low interest rate environment. Other income
recorded small increases for the third quarter and nine months related
primarily to recovery of some prior year expense and realized gains from the
sale of bank owned real estate.
The Corporation recorded $68,000 and $563,000 in net securities gains
for the third quarter and nine months, respectively, ended September 30, 1998,
compared to $189,000 and $393,000, respectively, for the same periods in 1997.
Net securities gains recorded were from the available-for-sale equities
portfolio.
Total noninterest expense recorded a decrease of 2.7%, or $80,000, to
$2.9 million for the third quarter ended September 30, 1998, over the third
quarter of 1997 and an increase of 2.9%, or $247,000, to $8.8 million for the
nine months ended September 30, 1998, over the nine months in 1997. Salaries
and benefits expense recorded decreases for the quarter ($147,000) and nine
months ($309,000). Salaries remained steady at $1.3 million for the quarter
and recorded an increase of 2.2%, or $81,000, to $3.8 million for the nine
months ended September 30, 1998. Benefits decreased 45.7%, or $147,000, for
the quarter and 34.9%, or $390,000, for the nine months. The primary
contributor to the decrease in benefits for both periods was a credit to
pension expense of $150,000 for the quarter and $351,000 for the nine months.
The reduction in pension expense is related to the investment performance of
pension plan assets and a change in the benefit formula used to calculate
individual employee benefits. Other noninterest expense grew 9.4%, or
$90,000, to $1.0 million for the third quarter and 21.2%, or $573,000, for the
nine months ended September 30, 1998, compared to the same periods in 1997.
For the nine months, costs totaling $457,000 associated with the acquisition
and demolition of real property for a future project designed to enlarge and
renovate corporate headquarters was primarily responsible for the increase in
other noninterest expense.
Federal income tax expense for the third quarter and nine months ended
September 30, 1998, was $416,000 and $1.2 million, respectively, compared to
$291,000 and $1.0 million, respectively, for the same periods ended September
30, 1997. The effective tax rates for the nine month periods ended September
30, 1998 and 1997 were 24.5% and 23.6%, respectively, versus a statutory rate
of 34.0%. The variance between the effective tax rate and the statutory tax
rate is due primarily to interest income earned on tax-free investments,
tax-free loans and low income housing tax credits.
The Year 2000 Issue
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 Corporation's Senior Management Team adopted a
Strategic Technology Action Plan for addressing the Year 2000 issue. One
senior officer has been charged with the responsibility of assuring Year 2000
compliance within time frames dictated by sound business practice and the
Federal Financial Institutions Examination Council. A team has been assembled
to assist in resolving the Year 2000 issue and meeting all regulatory
requirements. The Year 2000 Strategic Action Plan team reports its Year 2000
progress to Senior Management monthly and to the Corporation's Board of
Directors quarterly. There are three primary phases to the Corporation's Year
2000 Plan, the assessing/identification phase, the renovating phase and 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 code or system changes, is
targeted for December 31, 1998 and Phase III , the testing/validation phase is
expected to be completed 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 ATM modems, 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 noninformation 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 the
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 are expected to be
compliant by December 31, 1998.
In addition to evaluating the Corporation's Year 2000 readiness,
management has also 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; initial contact
concerning the borrowers Year 2000 status will be completed by November 30,
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. At this point, the Corporation has no reason to
doubt the ability of any of these customers to continue to operate effectively
in the Year 2000 or to have a Year 2000 problem that would cause them to
lose significant amounts of money resulting in their inability to make
scheduled loan payments.
The Corporation is required to have a Year 2000 contingency plan in the
event of systems or communication failures at the beginning of the Year 2000.
At September 30, 1998, the Corporation's contingency plan is in the
developmental stage and is 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 developing 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 available a back-up generator for use in the
event of a power failure. Additional research is underway for other utility
vendors. Under consideration in the contingency plan is paper back-up 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 the 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.
Anticipated costs for Year 2000 should be immaterial at under $200,000.
Expense incurred through September 30, 1998, and reflected in noninterest
expense equals approximately $13,000.
Financial Condition
Total assets grew 9.9%, or $35.0 million, to $388.9 million at September
30, 1998, from $353.9 million at December 31, 1997. Total assets at September
30, 1997, were $351.4 million. Interest-bearing deposits in other banks grew
$18.4 million to $18.6 million at September 30, 1998, from $249,000 at
December 31, 1997, representing balances held at the Federal Home Loan Bank of
Pittsburgh (FHLB). Net loans increased 4.6%, or $11.0 million to $252.3
million at September 30, 1998, from $241.2 million at December 31, 1997.
Strong growth in mortgage loans ($8.6 million) was the primary contributor
behind the increase in net loans. In addition consumer loans contributed
approximately $1.4 million and commercial loans $1.0 million to the increase
in net loans. The growth in mortgage loan business occurred despite the sale
of approximately $18.3 million in mortgage loans to the secondary market,
primarily to Federal National Mortgage Association (FNMA). Investment
securities grew 4.7%, or $4.1 million, to $91.2 million at September 30, 1998,
from $87.1 million at December 31, 1997. Proceeds from the sale of
available-for-sale equity securities total $851,000 for the nine months ended
September 30, 1998, and includes $563,000 in realized gains. Net unrealized
gains on available-for-sale securities at September 30, 1998, equaled $1.9
million, net of tax.
Net charge-offs for the third quarter and nine months ended September 30,
1998, totaled $121,000 and $658,000, respectively, versus $100,000 and
$445,000, respectively, for the comparable periods in 1997. For the first
nine months of 1998, the consumer loan portfolio recorded 74.5% of the total
net charge-offs compared to 24.5% recorded for the commercial loan portfolio.
Personal bankruptcies continue to have an adverse impact on the Corporation.
To slow this trend, more stringent loan underwriting guidelines have been
implemented and more comprehensive training of the lending staff has been
completed. The full impact of the new guidelines and training should be
evidenced in the future. The annualized ratio of net charge-offs to average
loans was .35% at September 30, 1998, compared to .29% at December 31, 1997,
and .26% at September 30, 1997.
Nonperforming loans totaled $1.3 million at September 30, 1998, compared
to $1.7 million at December 31, 1997 and $1.9 million at September 30, 1997.
Included in nonperforming loans at September 30, 1998, were $914,000 and
$354,000 in nonaccrual loans and loans past due over 90 days, respectively.
Nonaccrual loans and loans past due over 90 days equaled $1.1 million and
$564,000, respectively, at December 31, 1997. The Corporation recorded other
real estate owned (OREO) totaling $611,000 at September 30, 1998, compared to
$185,000 at year-end 1997. Nonperforming assets represented .50% of total
assets at September 30, 1998 compared to .54% at December 31, 1997.
The allowance for possible loan losses totaled $3.4 million at September
30, 1998 and December 31, 1997, and represented 1.33% and 1.35%, respectively,
of total loans. The allowance at September 30, 1998, provided coverage for
nonperforming loans 2.65 times compared to 1.9 times at December 31, 1997.
Total deposits grew 12.6%, or $34.6 million, to $309.1 million at
September 30, 1998, from $274.6 million at December 31, 1997. Growth in
savings and interest checking, up 13.4%, or $15.1 million, to $128.3 million
at September 30, 1998, and time deposits, up 14.6%, or $18.0 million to $141.9
million at September 30, 1998, accounted for the increase in total deposits.
A new product, the Money Management Account, introduced in spring 1997 has
been instrumental in attracting and retaining savings deposit dollars. The
growth, 14.6%, or $18.0 million, in time deposits is largely due to a large
municipal deposit which is scheduled to mature early in 1999. It is expected
that these dollars will be transferred out of the bank at maturity.
Securities sold under agreements to repurchase grew 44.2%, or $7.1 million to
$23.2 million at September 30, 1998, from $16.1 million at December 31, 1997.
The growth in deposits and securities sold under agreements to repurchase
enabled the Corporation to reduce its overnight borrowings at FHLB to zero.
At September 30, 1998, term borrowings with FHLB totaled $13.9 million. In
the first quarter of 1998, the Corporation paid a special cash dividend and a
regular cash dividend to shareholders which totaled $2.3 million. The payment
of these cash dividends, which were declared in November 1997 and reflected in
the financial statements at year-end 1997, were primarily responsible for the
decrease in other liabilities to $3.4 million at September 30, 1998, from $5.5
million at December 31, 1997.
Unemployment in the Franklin County area remained at approximately 4%.
The local economy is strong and continues to be fairly well diversified.
Liquidity
The Corporation's liquidity position (net cash, short-term and marketable
assets divided by net deposits and short-term liabilities) was 22.4% at
September 30, 1998. The Corporation actively sells mortgage loans to the
secondary market (primarily FNMA) and looks to its borrowing ability with FHLB
to satisfy any liquidity needs. As reported earlier, the Corporation sold
approximately $ 18.3 million in mortgage loans to the secondary market
(primarily FNMA) during the first nine months of 1998 and had advances
outstanding with FHLB totaling $13.9 million. The Corporation's maximum
borrowing capacity with FHLB equals $ 82 million. Management believes that
liquidity is adequate to meet the borrowing and deposit withdrawal needs of
its customers.
Capital Adequacy
Total shareholders' equity increased $2.9 million to $39.2 million at
September 30, 1998, from $36.3 million at December 31, 1997, primarily the
result of earnings retention from the first nine months of 1998. As reported
in the Corporation's 1997 Annual Report, in November 1997 the Board of
Directors approved a 3 for 2 stock split issued in the form of a 50% stock
dividend to shareholders of record at the close of business on January 13,
1998. The common stock certificates from this stock dividend were distributed
to shareholders on February 3, 1998.
In addition to the 50% Stock Dividend, the Board of Directors also
approved a special cash dividend of $1.00 per share ($.66 per share adjusted
for the 50% Stock Dividend) and a $.15 per share first quarter cash dividend
in November 1997. Both of these cash dividends were reflected in the December
31, 1997 financial statements but were paid to shareholders in the first
quarter of 1998. Cash dividends paid to shareholders in the third quarter and
nine months ended September 30, 1998, totaled $448,000 and $3.1 million,
respectively, compared with $409,000 and $1.2 million for the same periods
ended September 30, 1997.
Capital adequacy is currently defined by banking regulatory agencies
through the use of several minimum required ratios. At September 30, 1998,
the Corporation was determined to be 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, 1998, were 9.50%, 13.69 %
and 14.94 %, respectively. For more information refer to Note 2 of the
financial statements.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Reports on Form 8-K
There were no reports filed on Form 8-K for the quarter ended
September 30, 1998.
FRANKLIN FINANCIAL SERVICE 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
Date November 13, 1998 /s/ William E. Snell, Jr.
William E. Snell, Jr.
President and Chief Executive Officer
Date November 13, 1998 /s/ Elaine G. Meyers
Elaine G. Meyers
Treasurer and Chief Financial Officer
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