UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1997
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 incorporation (I.R.S. Employer
or organization) Identification No.)
20 South Main Street, PO Box T, Chambersburg, PA 17201-0819
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (717) 264-6116
Securities registered pursuant to Section 12(b) of the Act:
Names of each exchange
Title of each class on which registered
NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock $1.00 par value per share
(Title of class)
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 periods that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements of the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. X
The aggregate market value of the 2,304,041 shares of the Registrant's common
stock held by nonaffiliates of the Registrant as of February 6, 1998, based on
the average of the bid and asked price for such shares, was $81,793,456.
APPLICABLE ONLY TO REGISTRANTS 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 Section 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 REGISTRANTS)
Indicate by the number of shares outstanding of each of the registrant's
classes of common stock as of the latest practicable date. There were
2,796,082 outstanding shares of the Registrant's common stock as of February
6, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the annual report to stockholders for the year ended
December 31, 1997, are incorporated by reference into Part I and Part II.
(2) Portions of the definitive annual proxy statement to be filed,
pursuant to Reg. 14A within 120 days after December 31, 1997, are incorporated
into Part III.
FRANKLIN FINANCIAL SERVICES CORPORATION
FORM 10-K
INDEX
Part I
Page
Item 1. Business . . . . . . . . . . . . . . . . . . . . .2
Item 2. Properties . . . . . . . . . . . . . . . . . . . 10
Item 3. Legal Proceedings. . . . . . . . . . . . . . . . 10
Item 4. Submission of Matters to a Vote of
Security Holders . . . . . . . . . . . . . . . 10
Part II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters . . . . . . . . . 10
Item 6. Selected Financial Data. . . . . . . . . . . . . 10
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations .11
Item 8. Financial Statements and Supplementary Data. . . 11
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure. . . . .11
Part III
Item 10. Directors and Executive Officers of the
Registrant . . . . . . . . . . . . . . . . . 11
Item 11. Executive Compensation. . . . . . . . . . . . . 11
Item 12. Security Ownership of Certain Beneficial Owners
and Management. . . . . . . . . . . . . . . . . 12
Item 13. Certain Relationships and Related Transactions. 12
Part IV
Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K . . . . . . . . . . . 12
Signatures. . . . . . . . . . . . . . . . . . . . . . . . 15
Index of Exhibits . . . . . . . . . . . . . . . . . . . . 17
Part I
Item 1. Business
General
Franklin Financial Services Corporation (the "Corporation") was
organized as a Pennsylvania business corporation on June 1, 1983 and is a
registered bank holding company under the Bank Holding Company Act of 1956, as
amended (the "BHCA"). On January 16, 1984, pursuant to a plan of
reorganization approved by the shareholders of Farmers and Merchants Trust
Company of Chambersburg ("F&M Trust" or "the Bank") and the appropriate
regulatory agencies, the Corporation acquired all the shares of F&M Trust and
issued its own shares to former F&M Trust shareholders on a share-for-share
basis.
On May 1, 1995, the Mont Alto State Bank, also a commercial bank and a
subsidiary of the Corporation, was merged into Farmers and Merchants Trust
Company. In addition, on December 29, 1995, Franklin Founders Life Insurance
Company, a credit life reinsurance company and a subsidiary of the
Corporation, was liquidated.
The Corporation conducts all of its business through its only direct
subsidiary, F&M Trust, which is wholly-owned. F&M Trust, established in 1906,
is a full-service, Pennsylvania-chartered commercial bank and trust company
which is not a member of the Federal Reserve System. F&M Trust, which operates
12 full service offices in Franklin and Cumberland Counties, Pennsylvania,
engages in general commercial, retail banking and trust services normally
associated with community banks and its deposits are insured (up to applicable
limits) by the Federal Deposit Insurance Corporation (the "FDIC"). A wide
variety of banking services are offered by F&M Trust to businesses,
individuals, and governmental entities. These services include, but are not
necessarily limited to, accepting and maintaining checking, savings, and time
deposit accounts, providing investment and trust services, making loans and
providing safe deposit facilities.
The Corporation's subsidiary is not dependent upon a single customer or
a few customers for a material part of their business. Thus, the loss of any
customer or identifiable group of customers would not materially affect the
business of the Corporation or F&M Trust in an adverse manner. Also, none of
the Corporation's business is seasonal.
The Bank's lending activities consist primarily of commercial,
agricultural and industrial loans, installment and revolving loans to
consumers, residential mortgage loans, and construction loans. Secured and
unsecured commercial and industrial loans, including accounts receivable,
inventory financing and commercial equipment financing, are made to small and
medium-sized businesses, individuals, governmental entities, and non-profit
organizations. F&M Trust also participates in the Pennsylvania Higher
Education Assistance Act student loan program and the Pennsylvania Housing
Finance Agency program.
Installment loans involve both direct loans to consumers and the
purchase of consumer obligations from dealers and others who have sold or
financed the purchase of merchandise, including automobiles and mobile homes,
to their customers on time. The Bank's mortgage loans include long-term loans
to individuals and to businesses secured by mortgages on the borrower's real
property. Construction loans are made to finance the purchase of land and the
construction of buildings thereon, and are secured by short-term mortgages on
real estate. In certain situations, the Bank acquires properties through
foreclosure on delinquent loans. The Bank holds these properties until such
time as they are in a marketable condition and a buyer can be obtained.
F&M Trust's Investment and Trust Services Department offers all of the
personal and corporate trust services normally associated with trust
departments of area banks, including estate planning and administration,
corporate and personal trust fund management, pension, profit sharing and
other employee benefits funds management, custodial services, and trustee
services for publicly issued debentures.
Competition
The Corporation and its subsidiary operate in a competitive environment
that has intensified in the past few years as they have been compelled to
share their market with institutions that are not subject to the regulatory
restrictions on domestic banks and bank holding companies. Profit margins in
the traditional banking business of lending and deposit gathering have
declined as deregulation has allowed nonbanking institutions to offer
alternative services to many of F&M Trust's customers.
The principal market of F&M Trust is in Franklin County and western
Cumberland County, Pennsylvania. Twelve commercial bank competitors of F&M
Trust have offices in this region, in addition to credit unions, savings and
loan associations, mortgage banks, brokerage firms and other competitors. F&M
Trust is the largest locally owned financial institution in Franklin County
and had total assets of approximately $354,000,000 at December 31, 1997.
All of the local commercial bank competitors of the Corporation are
subsidiaries of bank holding companies. The Corporation ranks sixth in size of
the thirteen bank holding companies having offices in its primary market.
Staff
As of December 31, 1997, the Corporation and its subsidiary had 152
full-time employees and 51 part-time employees. Most employees participate in
pension, profit sharing/bonus, and employee stock purchase plans and are
provided with group life, health and major medical insurance. Management
considers employee relations to be excellent.
Supervision and Regulation
Various requirements and restrictions under the laws of the United
States and under Pennsylvania law affect the Corporation and its subsidiaries.
General
The Corporation is registered as a bank holding company subject to
supervision and regulation by the Board of Governors of the Federal Reserve
System (the "Federal Reserve Board") under the BHCA, as amended. As a bank
holding company, the Corporation's activities and those of its banking and
nonbanking subsidiaries are limited to the business of banking and activities
closely related or incidental to banking. Bank holding companies are required
to file periodic reports with and are subject to examination by the Federal
Reserve Board. The Federal Reserve Board has issued regulations under the
BHCA that require a bank holding company to serve as a source of financial and
managerial strength to its subsidiary banks. As a result, the Federal Reserve
Board, pursuant to such regulations may require the Corporation to stand ready
to use its resources to provide adequate capital funds to its banking
subsidiaries during periods of financial stress or adversity.
The BHCA prohibits the Corporation from acquiring direct or indirect
control of more than 5% of the outstanding shares of any class of voting stock
or substantially all of the assets of any bank or merging or consolidating
with another bank holding company without prior approval of the Federal
Reserve Board. Similar restrictions currently apply to acquisition of control
of shares of stock of the Corporation or its banking subsidiaries by other
bank holding companies. Additionally, the BHCA prohibits the Corporation from
engaging in or from acquiring ownership or control of more than 5% of the
outstanding shares of any class of voting stock of any company engaged in a
nonbanking business, unless such business is determined by the Federal Reserve
Board to be so closely related to banking as to be a proper incident thereto.
F&M Trust is not a member of the Federal Reserve System. Accordingly,
its operations are subject to regulation and examination by the FDIC and by
the Pennsylvania Department of Banking ("PDOB"). F&M Trust is subject to
requirements and restrictions under federal and state law, including
requirements to maintain reserves against deposits, restrictions on the types
and amount of loans that may be granted and the interest that may be charged
thereon, and limitations on the types of investments that may be made and the
types of services that may be offered. Various consumer laws and regulations
also affect the operations of the Bank. In addition to the impact of
regulation, commercial banks are affected significantly by the actions of the
Federal Reserve Board as it attempts to control the money supply and credit
availability in order to influence the economy.
Capital Adequacy Guidelines
Bank holding companies are required to comply with the Federal Reserve
Board's risk-based capital guidelines. The required minimum ratio of total
capital to risk-weighted assets (including certain off-balance sheet
activities, such as standby letters of credit) is 8%. At least half of the
total capital is required to be "Tier 1 capital," consisting principally of
common shareholders' equity, less certain intangible assets. The remainder
("Tier 2 capital") may consist of certain preferred stock, a limited amount of
subordinated debt, certain hybrid capital instruments and other debt
securities, and a limited amount of the general loan loss allowance. The
risk-based capital guidelines are required to take adequate account of
interest rate risk, concentration of credit risk, and risks of nontraditional
activities.
In addition to the risk-based capital guidelines, the Federal Reserve
Board requires a bank holding company to maintain a leverage ratio of a
minimum level of Tier 1 capital (as determined under the risk-based capital
guidelines) equal to 3% of average total consolidated assets for those bank
holding companies which have the highest regulatory examination ratings and
are not contemplating or experiencing significant growth or expansion. All
other bank holding companies are required to maintain a ratio of at least 1%
to 2% above the stated minimum. The Bank is subject to almost identical
capital requirements adopted by the FDIC.
The Bank is also subject to PDOB capital guidelines. Although not
adopted in regulation form, the PDOB utilizes capital standards requiring a
minimum of 6% leverage capital and 10% risk-based capital. The components of
leverage and risk-based capital are substantially the same as those defined by
the FDIC.
Prompt Corrective Action Rules
The Federal Deposit Insurance Act (the "FDIA") requires each Federal
banking agency to specify by regulation the levels at which an insured
institution would be considered "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized." The applicable federal bank regulator for a depository
institution can, under certain circumstances, reclassify a "well capitalized"
institution as "adequately capitalized" or require an "adequately capitalized"
or "undercapitalized" institution to comply with supervisory actions as if it
were in the next lower category. Such a reclassification could be made if the
regulatory agency determines that the institution is in an unsafe or unsound
condition (which could include unsatisfactory examination ratings). F&M Trust
meets the criteria to be "well capitalized" within the meaning of applicable
regulations.
Regulatory Restrictions on Dividends
Dividend payments by the Bank to the Corporation are subject to the
Pennsylvania Banking Code of 1965 (the "Banking Code"), the FDIA, and FDIC
regulations. Under the Banking Code, no dividends may be paid except from
"accumulated net earnings" (generally retained earnings). The Federal Reserve
Board and the FDIC have formal and informal policies which provide that
insured banks and bank holding companies should generally pay dividends only
out of current operating earnings, with some exceptions. Under the FDIA, no
dividends may be paid by an insured bank if the bank is in arrears in the
payment of any insurance assessment due to the FDIC. The Prompt Corrective
Action rules also limit the payment of dividends by banks which are not
classified as well capitalized or adequately capitalized.
Under these policies and subject to the restrictions applicable to the
Bank, the Bank could declare, during 1998, without prior regulatory approval,
aggregate dividends of approximately $1.032 million, plus retained net income
to the date of such dividend declaration.
FDIC Insurance Assessments
The FDIC has implemented a risk-related premium schedule for all insured
depository institutions that results in the assessment of premiums based on
capital and supervisory measures. Under the risk-related premium schedule,
the FDIC assigns, on a semiannual basis, each depository institution to one of
three capital groups (well-capitalized, adequately capitalized or
undercapitalized) and further assigns such institution to one of three
subgroups within a capital group. The institution's subgroup assignment is
based upon the FDIC's judgment of the institution's strength in light of
supervisory evaluations, including examination reports, statistical analyses
and other information relevant to measuring the risk posed by the institution.
Only institutions with a total capital to risk-adjusted assets ratio of 10% or
greater, a Tier 1 capital to risk-based assets ratio of 6% or greater, and a
Tier 1 leverage ratio of 5% or greater, are assigned to the well-capitalized
group. As of December 31, 1997, the Bank was well capitalized for purposes of
calculating insurance assessments.
The Bank Insurance Fund ("BIF") is presently fully funded at more than
the minimum amount required by law. Accordingly, the 1998 BIF assessment
rates range from zero for those institutions with the least risk, to $0.27 for
every $100 of insured deposits for institutions deemed to have the highest
risk. The Bank is in the category of institutions that presently pay nothing
for deposit insurance. The FDIC adjusts the rates every six months.
While the Bank presently pays no premiums for deposit insurance, it is
subject to assessments to pay the interest on Financing Corporation ("FICO")
bonds. FICO was created by Congress in 1989 to issue bonds to finance the
resolution of failed thrift institutions. Prior to 1997, only thrift
institutions were subject to assessments to raise funds to pay the FICO bonds.
On September 30, 1996, as part of the Omnibus Budget Act, Congress enacted the
Deposit Insurance Funds Act of 1996, which recapitalized the Savings
Association Insurance Fund ("SAIF") and provided that BIF deposits would be
subject to 1/5 of the assessment to which SAIF deposits are subject for FICO
bond payments through 1999. Beginning in 2000, BIF deposits and SAIF deposits
will be subject to the same assessment for FICO bonds. The FICO assessment
for 1998 for all depository institutions is expected to be $.0126 for each
$100 of BIF deposits and $.063 for each $100 of SAIF deposits. The FDIC sets
the FICO assessment rate every six months.
New Legislation
The Deposit Insurance Funds Act of 1996 was a part of the larger
Economic Growth and Regulatory Paperwork Reduction Act of 1996 ("EGRPRA").
EGRPRA is a lengthy Act that amends many different bank regulatory and
consumer protection statutes. While EGRPRA does not contain any major changes
to banking law (except for the FDIC and FICO assessments discussed above), it
does contain a number of smaller provisions that are beneficial to the banking
industry. In particular, certain routine regulatory application requirements
and procedures have been reduced or eliminated, making it easier and less
expensive for banks to comply with regulatory requirements. While the changes
effected by EGRPRA are welcome, the direct effect on the Corporation and the
Bank are expected to be minimal.
Proposed legislation is introduced in almost every legislative session
that would dramatically affect the regulation of the banking industry.
Whether or not such legislation will ever be enacted and what effect it may
have on the Corporation and the Bank cannot be estimated at this time.
Selected Statistical Information
Certain statistical information is included in the Corporation's 1997
Annual Report and is incorporated herein by reference
Description of Statistical Information Annual
Incorporated by Reference from the Report
1997 Annual Report Page
Net Interest Income 36
Analysis of Net Interest Income 37
Deposits by Major Classification 37
Rate-Volume Analysis of Net Interest Income 38
Investment Securities at Amortized Cost 41
Time Certificates of Deposit of $100,000 or More 41
Short-Term Borrowings 45
Loan Portfolio 45
Allocation of the Allowance for Possible Loan Losses 45
Non-Performing Assets 46
Allowance for Possible Loan Losses 46
Interest Rate Sensitivity 48
Sensitivity to Change in Market Interest Rates 49
Maturity Distribution of Investment Portfolio 49
Maturities and Interest Rate Terms of Loans 50
Item 2. Properties
The Corporation's headquarters is located in the main office of F&M
Trust at 20 South Main street, Chambersburg, Pennsylvania. The Corporation
owns five properties throughout Franklin County which are held for future
expansion and are currently used for banking operations by F&M Trust.
In addition to its main office, F&M Trust owns eleven and leases one
property, all of which are used for banking offices and operations. F&M
Trust also owns three properties which are held for expansion and are
currently leased to others.
Item 3. Legal Proceedings
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The information related to this item is incorporated by reference to the
information appearing under Market and Dividend Information on Page 12 and
Shareholders' Information on Page 59 of the Corporation's 1997 Annual Report
to Shareholders.
Item 6. Selected Financial Data
The information related to this item is incorporated by reference to the
information under Summary of Selected Financial Data on Page 3 of the
Corporation's 1997 Annual Report to Shareholders.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The information related to this item is incorporated by reference to the
information appearing under Management's Discussion and Analysis on Pages 35
through 53 of the Corporation's 1997 Annual Report to Shareholders.
Item 7a. Quantitative and Qualitative Disclosures about Market Risk
The information related to this item is incorporated by reference to the
information appearing under Table 12 of Management's Discussion and Analysis on
Page 49 of the Corporation's 1997 Annual Report to Shareholders.
Item 8. Financial Statements and Supplementary Data
The information related to this item is incorporated by reference to the
information appearing under Financial Statements and Notes to Consolidated
Financial Statements, including the Report of Independent Public Accountants,
on Pages 13 through 30 of the Corporation's 1998 Annual Report to
Shareholders.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Item 10. Directors and Executive Officers of the Registrant
The information related to this item is incorporated by reference to the
material set forth under the captions "Information about Nominees and
Continuing Directors" on Pages 4 through 6, and "Executive Officers" on Page 7
of the Corporation's Proxy Statement for the 1998 Annual Meeting of
Shareholders.
Item 11. Executive Compensation
The information related to this item is incorporated by reference to the
material set forth under the captions "Compensation of Directors" on Page 7
and "Executive Compensation and Related Matters" on Pages 7 through 12 of the
Corporation's Proxy Statement for the 1998 Annual Meeting of Shareholders,
except that information appearing under the captions "Committee Report on
Executive Compensation" and "Stock Performance Graph" on Pages 10 through 13
is not incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information related to this item is incorporated by reference to the
material set forth under the captions "Voting of Shares and Principal Holders
Thereof" on Page 2 and "Information about Nominees and Continuing Directors"
on Pages 4 through 6 of the Corporation's Proxy Statement for the 1998 Annual
Meeting of Shareholders.
Item 13. Certain Relationships and Related Transactions
The information related to this item is incorporated by reference to the
material set forth under the caption "Transactions with Directors and
Executive Officers" on Page 13 of the Corporation's Proxy Statement for the
1998 Annual Meeting of Shareholders.
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) The following documents are filed as part of this report:
(1) The following Consolidated Financial Statements of the
Corporation are incorporated by reference to the 1997 Annual
Report to Shareholders:
Report of Independent Public Accountants;
Consolidated Balance Sheets - December 31, 1997 and 1996;
Consolidated Statement of Income - Years ended December 31,
1997, 1996, and 1995;
Consolidated Statements of Changes in Shareholders' Equity -
Years ended December 31, 1997, 1996, and 1995;
Notes to Consolidated Financial Statements.
(2) All financial statement schedules for which provision is
made in the applicable accounting regulations of the
Securities and Exchange Commission are not required under
the related instructions or are inapplicable and have
therefore been omitted.
(3) The following exhibits are being filed as part of this
report;
3.1 Articles of Incorporation of the Corporation.
Filed as Exhibit 4 to Registration Statement on Form
S-8 (No.33-36509) and incorporated herein by
reference.
3.2 Bylaws of the Corporation.
Filed as Exhibit 4 to Registration Statement on Form
S-8 (No.33-36509) and incorporated herein by
reference.
10.1 Deferred Compensation Agreements with Bank Directors.
Filed as Exhibit 10.1 to the 1995 Form 10-K -- Annual
Report of the Corporation and incorporated herein by
reference.
10.2 Director's Deferred Compensation Plan. Filed as
Exhibit 10.2 to the 1995 Form 10-K -- Annual Report of
the Corporation and incorporated herein by reference.
10.3 Long-Term Incentive Plan of 1990. Filed as Exhibit
10.3 to the 1995 Form 10-K -- Annual Report of the
Corporation and incorporated herein by reference.
10.4 Senior Management Incentive Program, as amended,
October 15, 1992. Filed as Exhibit 10.5 to the 1993
Form 10-K -- Annual report of the Corporation and
incorporated herein by reference.
13 The 1997 Annual Report to Shareholders of the
Corporation.
21 Subsidiaries of the Corporation.
23 Consent of Arthur Andersen LLP
27 Financial Data Schedule
(b) Reports on Form 8-K:
A current report on Form 8-K, dated November 13, 1997 was filed on
November 17,1997 in conjunction with the declaration of a three for
two stock split to be issued in the form of a 50% stock dividend.
(c) The exhibits required to be filed as part of this report are
submitted as a separate section of this report.
(d) Financial Statement Schedules: None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
and 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
By:______________________________________
William E. Snell, Jr.
President and Chief Executive Officer
Date: March 26, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
______________________________ Chairman of the Board March 26, 1998
Jay L. Benedict, Jr. and Director
______________________________ Vice Chairman March 26, 1998
Robert G. Zullinger and Director
______________________________ President and Chief March 26, 1998
William E. Snell, Jr. Executive Officer
and Director
______________________________ Executive Vice March 26, 1998
Charles S. Bender II President and Director
______________________________ Treasurer and Chief March 26, 1998
Elaine G. Meyers Financial Officer
(Principal Financial and
Accounting Officer)
______________________________ Director March 26, 1998
G. Warren Elliott
______________________________ Director March 26,1998
Omer L. Eshleman
______________________________ Director March 26,1998
Dennis W. Good, Jr.
______________________________ Director March 26,1998
H. Huber McCleary
______________________________ Director March 26,1998
Jeryl C. Miller
______________________________ Director March 26,1998
Stephen E. Patterson
______________________________ Director March 26,1998
Charles M. Sioberg
______________________________ Director March 26,1998
Martha B. Walker
Exhibit Index for the Year
Ended December 31, 1997
Item Description
3.1 Articles of Incorporation of the Corporation.
Filed as Exhibit 4 Registration on Form S-8
(No. 33-36509) and incorporated
herein by reference.
3.2 Bylaws of the Corporation.
Filed as Exhibit 4 Registration on Form S-8
(No. 33-36509) and incorporated
herein by reference.
10.1 Deferred Compensation Agreements with Bank Directors.
Filed as Exhibit 10.1 to the 1995 Form 10-K -- Annual Report
of the Corporation and incorporated herein by reference.
10.2 Director's Deferred Compensation Plan.
Filed as Exhibit 10.2 to the 1995 Form 10-K -- Annual Report
of the Corporation and incorporated herein by reference.
10.3 Long-Term Incentive Plan of 1990.
Filed as Exhibit 10.3 to the 1995 Form 10-K -- Annual Report
of the Corporation and incorporated herein by reference.
10.4 Senior Management Incentive Program, as amended,
October 15, 1992. Filed as Exhibit 10.5 to the 1993
Form 10-K -- Annual Report of the Corporation and
incorporated herein by reference.
13 The 1997 Annual Report to Shareholders of the Corporation
21 Subsidiaries of Corporation
23 Consent of Arthur Andersen LLP
27 Financial Data Schedule
FRANKLIN FINANCIAL SERVICES CORPORATION
1997 ANNUAL REPORT
Table of Contents
Consolidated Financia Highlights
Summary of Selected Financial Data
A Message to Shareholders
Report of Independent Public Accountants
Financial Statements
Notes to Consolidated Financial Statements
Managements' Discussion and Analysis
Shareholders' Information
<TABLE>
<CAPTION>
CONSOLIDATED FINANCIAL HIGHLIGHTS
% increase
(amounts in thousands, except per share) 1997 1996 (decrease)
<S> <C> <C> <C>
Performance
Net income $4,363 $4,127 6
Return on assets 1.26% 1.29%
Return on equity 12.03% 11.83%
Shareholders' Value (per share)*
Basic earnings per share $1.59 $1.46 9
Cash dividends paid 0.56 0.52 8
Cash dividends paid (unadjusted) 0.84 0.78 8
Cash dividends declared 1.37 0.52 163
Cash dividends declared (unadjusted) 1.99 0.78 155
Book value 12.99 12.47 4
Market value (mean of bid and ask) 34.16 21.42 59
Market value/book value ratio 262.97% 171.77%
Price/earnings multiple 21.49x 14.57x
Yield on cash dividends paid 1.64% 2.43%
Safety and Soundness
Leverage ratio (Tier 1) 9.22% 10.03%
Nonperforming assets/total assets 0.54% 0.54%
Allowance for loan loss as a % of loans 1.35% 1.36%
Net charge-offs/average loans 0.29% 0.32%
Allowance for loan loss/nonaccrual loans 287.70% 357.48%
Allowance for loan loss/nonperforming loans 192.99% 176.88%
Risk-based capital (Tier 1) 13.53% 14.75%
Balance Sheet Highlights
Total assets $353,865 $336,120 5
Investment Securities 87,098 89,792 -3
Loans, net 241,244 221,166 9
Deposits 274,555 268,202 2
Shareholders' equity 36,305 35,341 3
Trust assets under management (market value) 350,866 262,840 33
* Per share information, except where noted, for 1997 and 1996 has been adjusted to
reflect a 3 for 2 stock split issued in the form of a 50% stock dividend declared
on November 13, 1997, and distributed on February 3, 1998, to shareholders of record
on January 13, 1998. Cash dividends per share declared include the regular quarterly
cash paid to shareholders in 1997 plus the $1.00 per share special dividend and the
regular first quarter 1998 dividend. The latter two were paid in 1998.
</TABLE>
<TABLE>
<CAPTION>
SUMMARY OF SELECTED FINANCIAL DATA
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
(amounts in thousands, except per share)
Summary of operations
Interest income $26,308 $24,799 $24,971 $22,028 $21,559
Interest expense $12,225 11,087 11,210 9,720 10,120
Net interest income 14,083 13,712 13,761 12,308 11,439
Provision for possible loan losses 936 607 302 48 701
Net interest income after provision
for possible loan losses 13,147 13,105 13,459 12,260 10,738
Noninterest income 4,306 3,683 3,351 3,569 5,020
Noninterest expense 11,700 11,282 11,180 11,069 11,789
Income before income taxes and
cumulative effect of
accounting change 5,753 5,506 5,630 4,760 3,969
Income tax 1,390 1,379 1,451 1,000 897
Income before cumulative effect
of accounting change 4,363 4,127 4,179 3,760 3,072
Cumulative effect of
accounting change - - - -- 250
Net income $4,363 $4,127 $4,179 $3,760 $3,322
Per common share*
Basic earnings per share before cumulative
effect of accounting change $1.59 $1.46 $1.45 $1.28 $1.06
Cumulative effect of
accounting change - - - -- 0.09
Basic earnings per share $1.59 $1.46 $1.45 $1.28 $1.15
Cash dividends declared $1.37 $0.52 $0.48 $0.43 $0.41
Balance sheet data
End of year
Total assets $353,865 $336,120 $313,473 $310,554 $314,557
Deposits 274,555 268,202 257,211 256,697 262,707
Loans, net 241,244 221,166 210,067 219,311 210,663
Shareholders' equity 36,305 35,341 34,956 32,873 30,618
Performance yardsticks (unaudited)
Return on average assets 1.26% 1.29% 1.34% 1.21% 1.07%
Return on average equity 12.03% 11.83% 12.50% 11.82% 11.49%
Dividend payout ratio 36.01% 36.42% 33.98% 32.55% 32.54%
Average equity to average asset ratio 10.49% 10.87% 10.69% 10.26% 9.33%
Trust assets under management (unaudited)
Personal trusts (market value) $349,647 $261,803 $223,230 $182,872 $182,184
Corporate trusts (market value) 1,219 1,037 933 1,611 1,747
$350,866 $262,840 $224,163 $184,483 $183,931
* Per share information has been adjusted retroactively to reflect all stock splits and dividends.
</TABLE>
President's Message
Dear Shareholder,
Franklin Financial earned $4,363,000 in 1997, representing a 5.7%
improvement over 1996 earnings of $4,127,000 and a new record for your
company. Our 1997 earnings performance included significant gains on the sale
of investment securities which were offset by an increased provision for loan
losses and other noninterest expenses.
As shareholders, you received a 7.7% increase in dividends paid during
the year as per share dividends increased from $.78 in 1996 to $.84 in 1997.
On November 13, 1997, the board of directors declared a 3 for 2 stock split
issued in the form of a 50% stock dividend plus a special $1 cash dividend
which was paid to shareholders in January 1998. When adjusted to reflect the
50% stock dividend, cash dividends paid per share were $.52 during 1996
compared to $.56 in 1997.
The 50% stock dividend that was declared on November 13, 1997, isn't an
uncommon occurrence for Franklin Financial shareholders. In fact, this is the
sixteenth stock dividend that has been declared since 1961 and, more recently,
the fourth in five years. The 50% stock dividend was made possible by our
strong financial position and reflected our continuing commitment to
generating long-term value for our shareholders. The 50% stock dividend had
the effect of lowering the current price of a single share of Franklin
Financial stock after the "ex" date to a price that, in the $30-40 per share
range, is more affordable thus improving the marketability and availability or
our stock.
Following the announcement of the 50% stock dividend and $1 special cash
dividend, the market price of Franklin Financial stock continued to
appreciate. By December 31, 1997, the market value (mean of bid and ask
price) of a share of Franklin Financial stock reflected a 59.5% increase when
compared to December 31, 1996. The book value of a single share of Franklin
Financial stock improved as well, from $12.47 to $12.99, as adjusted for the
50% stock dividend.
Continuing our stock repurchase program has been a part of your
management's efforts to effectively manage our capital position in order to
enhance long-term shareholder value. In 1997, we purchased 37,983 shares
(56,974 shares as adjusted for the 50% stock dividend) at a cost of
$1,283,551. In addition to the repurchase program, which analysts believe
should be viewed as a strategic acquisition, the board of directors
distributed accumulated capital through the special $1 cash dividend. This $1
dividend reflects the prior performance and strong capital position of your
company, and is a means of distributing previous years' earnings to
shareholders, as well as enhancing long-term shareholder value by leveraging
the company which in the future should generate a higher Return on Equity (a
key measurement of our performance). These initiatives have resulted in
increased earnings per share reflected in the increase in basic earnings per
share from $1.46 in 1996 to $1.59 in 1997 as adjusted for the 50% stock
dividend, and return on equity, as well as potentially higher stock prices to
the current shareholders.
In last year's Annual Report to shareholders, I commented that earnings
in 1996 were impacted by the market expansion of F&M Trust into the Cumberland
County market during the fourth quarter with additional expenses for salaries
and benefits, facilities, marketing and others. I am pleased to report that
our community offices in Boiling Springs, Newville, and Shippensburg have
continued to generate significant growth in both deposits and loans. We
expect that our investment in these new markets will continue to provide us
with the potential for an increase in earning assets and additional income
generation capability.
Asset growth of 5.3% to a record $353,865,000 was fueled by loan growth
of 9.1%, reflecting a favorable economic environment and strong business
development efforts. In addition to the expansion into the Cumberland County
market, we believe that the responsiveness and flexibility that we can deliver
as an independent community bank at a time of rapid consolidation within the
financial services industry creates value in the minds of our customers,
positioning us well for the future.
While interest rates remained low to the benefit of borrowers, it has
placed pressure on us to retain deposit dollars. The banking industry as a
whole is faced with more and more customers turning to uninsured non-deposit
products such as mutual funds, stocks, bonds, and annuities to earn a higher
return on their investment while assuming the possibility of additional risk.
Banks are no longer just competing with other banks and credit unions for
deposits, but now face intense competition from non-banks including mutual
fund companies, investment firms, and insurance companies. During 1997, we
introduced the F&M Trust Money Management Account to attract and retain
deposit dollars that may have eventually been attracted to the non-bank
alternative investments. The Money Management Account pays a market rate of
interest, coupled with the safety of FDIC insurance, and has been widely
accepted, as evidenced by the approximately $25 million growth, including
significant new deposit dollars, registered by this product in just seven
months.
Net interest income after the provision for loan losses remained
relatively constant at $13,147,000, despite an increased provision for
possible loan losses. We continue to be confronted by the trend of rising
consumer bankruptcies that began in the fourth quarter of 1995. During 1997,
management acted prudently to increase the loan loss provision expense
accordingly to $936,000, representing a 54.2% increase above the provision for
loan loss in 1996. We have implemented several strategic initiatives to
combat this trend including consumer loan training, loan policy revisions, and
an enhanced loan review function. However, there appears to be no quick-fix
solution to this disturbing trend. It is our intention to closely monitor the
credit quality of our loan portfolio to ensure that we remain adequately
reserved.
As we continue to evolve into a diversified financial services provider,
nontraditional bank services are making a more significant contribution to our
performance. Last year we introduced The Personal Investment Center at F&M
Trust to integrate financial planning and investment services into the retail
environment of our offices. Based upon the results achieved, an expansion of
The Personal Investment Center concept to additional community office
locations is planned during 1998.
The market value of trust assets under management grew by 33.5% to
$350,866,000 at year end 1997 boosting trust fee income to $1,431,000,
representing a 21.8% increase over the previous year. This growth is
attributable to both the volume of business generated as well as the increased
market valuation. In addition to fee income contributed by The Personal
Investment Center and the Investment and Trust Services Department, which
portend the direction and focus the banking industry is taking, noninterest
income was also augmented by debit card income and the sale of mortgages into
the secondary market.
During 1997, our noninterest expense increased by $418,000 or 3.7% to
$11,700,000, reflecting our efforts to control costs. Included in this
increase was an amount of $386,000 related to the sale of various properties
and an adjustment in the carrying value of other properties held for future
use.
We made several investments in technology in preparation for future
growth and service delivery including the introduction of a voice response
unit accessed via telephone called the Freedom Access Center and the
installation of a Marketing Customer Information File (MCIF) system. We have
continued to make upgrades to our internal software and improvements in our
operations to support the delivery of service to our internal and external
customers.
One of the hottest technology topics in our industry as well as most
others is the "Year 2000 Problem." This issue basically deals with the future
viability of computer software and systems that only use two digits in the
date field. In order to handle the change from 1999 to 2000, one of the
upgrades that must be made to ensure compatibility is a four-digit date field.
In early 1997, we began to prepare for the Year 2000 in our Strategic
Technology Plan with a target date of December 31, 1998 to ensure that all of
our systems and the vendors that support our systems are Year 2000 compliant.
Before concluding this letter, I would like to express my gratitude to
Charles R. Diller for his years of service to Franklin Financial and F&M Trust
Company. Charlie retired from the Board on December 31, 1997 after 25 years
of service and commitment to our company. We will miss his experience,
knowledge, and contributions to our deliberations and his determination to
uphold the values that have guided our company for over 90 years. I extend my
wishes to Charlie and his wife, Sarah, for a pleasant and healthy retirement.
As stated in our mission statement and core values statement, it is our
belief that the delivery of quality service by our employees to customers and
our communities are the cornerstone for quality earnings to you our
shareholders. Our past and future success ultimately is linked to
successfully serving our constituencies --- our shareholders, our customers,
our employees, and our communities. We are guided by our core values ---
proactivity, honesty and integrity, teamwork, and a concern for the individual
- --- as we focus upon achieving our mission as a good corporate citizen within
our communities.
Sincerely,
William E. Snell, Jr.
President and Chief Executive Officer
Market and Dividend Information
The Corporation's common stock is not actively traded in the over-the-
counter market. The Corporatio's stock is listed under the symbol "FRAF"
on the O.T.C. Electronic Bulletin Board, an automated quotation service,
made available through, and governed by, the NASDAQ system. Current price
information is available from account executives at most brokerage firms as
well as the registered market makers of Franklin Financial Services
Corporation common stock. (See a listing of market makers on page 59 of
this report.) There were 1,823 shareholders of record as of December 31, 1997.
The range of high and low bid prices, as reported by local sources, is shown
below for the years 1997 and 1996. Also shown are the quarterly cash dividends
paid for the same years.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C>
Per share*
1997 High Low Cash div. 1996 High Low Cash div.
1st quarter . . . $22.00 $20.83 $0.133 1st quarter . . . $19.17 $17.50 $0.126
2nd quarter . . . 22.00 22.00 0.133 2nd quarter . . . 20.00 19.17 0.126
3rd quarter . . . 24.67 22.17 0.146 3rd quarter . . . 20.83 20.00 0.126
4th quarter . . . 32.83 24.83 0.146 4th quarter . . . 20.83 20.83 0.126
$0.558 $0.518
</TABLE>
* Per share information has been adjusted to reflect a 3 for 2 stock split
issued in the form of a 50% stock dividend distributed on February 3, 1998.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors,
Franklin Financial Services Corporation:
We have audited the accompanying consolidated balance sheets of FRANKLIN
FINANCIAL SERVICES CORPORATION (a Pennsylvania corporation) and subsidiaries
as of December 31, 1997 and 1996, and the related consolidated statements of
income, changes in shareholders' equity, and cash flows for each of the three
years in the period ended December 31, 1997. These financial statements are
the responsibility of the Corporation's management. Our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining,on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of FRANKLIN FINANCIAL
SERVICES CORPORATION and subsidiaries as of December 31, 1997 and 1996, and
the results of their operations and cash flows for each of the three years
in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
Lancaster, PA
January 30, 1998
<TABLE>
<CAPTION>
Consolidated Balance Sheets
(Amounts in thousands) December 31
1997 1996
<S> <C> <C>
Assets
Cash and due from banks (Note 3) $10,863 $10,265
Interest-bearing deposits in other banks 249 256
Investment securities held to maturity (market value of $28,030 and $36,199 at
December 31, 1997 and 1996, respectively) (Notes 1 and 4) 27,779 36,290
Investment securities available for sale (Notes 1 and 4) 59,319 53,502
Loans, net (Notes 1 and 5) 241,244 221,166
Premises and equipment, net (Notes 1 and 7) 5,907 6,698
Other assets 8,504 7,943
Total assets $353,865 $336,120
Liabilities
Deposits (Note 8)
Demand (noninterest-bearing) $37,591 $34,847
Savings and interest checking 113,138 104,763
Time 123,826 128,592
Total Deposits 274,555 268,202
Securities sold under agreements to repurchase(Note 9) 16,075 15,122
Other borrowings (Note 9) 21,434 14,891
Other liabilities 5,496 2,564
Total liabilities 317,560 300,779
Commitments and contingencies (Notes 13 and 15)
Shareholders' equity (Notes 2, 12 and 14)
Common stock, $1 par value per share, 5,000 shares authorized with 3,045
and 2,030 shares issued and 2,795 and 1,890 outstanding at
December 31, 1997 and 1996, respectively 3,045 2,030
Capital stock without par value, 5,000 shares authorized with no shares
issued and outstanding - -
Additional paid-in capital 19,761 19,745
Retained earnings 17,087 17,590
Net unrealized gain on securities 1,935 613
Treasury stock (4,760) (3,830)
Unearned compensation (Note 11) (763) (807)
Total shareholders' equity 36,305 35,341
Total liabilities and shareholders' equity $353,865 $336,120
The accompanying notes are an integral part of these statements.
</TABLE>
<TABLE>
<CAPTION>
Consolidated Statements of Income
(Amounts in thousands, except per share data)
Years ended December 31
1997 1996 1995
<S> <C> <C> <C>
Interest income (Note 1)
Interest on loans $21,088 $19,903 $20,280
Interest on deposits and other obligations of other banks 28 210 683
Interest on Federal funds sold - - 9
Interest on investments:
U.S. Government obligations 293 311 283
Obligations of U.S. Government agencies and corporations 2,632 2,542 1,893
Obligations of states and political subdivisions 1,407 999 1,096
Other securities 704 695 585
Dividend income 156 139 142
Total interest income 26,308 24,799 24,971
Interest expense
Interest on deposits (Note 8) 10,057 9,848 10,119
Interest on securities sold under agreements to repurchase 750 762 639
Other borrowings 1,418 477 452
Total interest expense 12,225 11,087 11,210
Net interest income 14,083 13,712 13,761
Provision for possible loan losses (Notes 1 and 6) 936 607 302
Net interest income after provision for possible loan losses 13,147 13,105 13,459
Noninterest income
Trust fees 1,431 1,175 1,166
Service charges, commissions and fees 2,023 1,939 1,991
Other 65 403 184
Securities gains 787 166 10
Total noninterest income 4,306 3,683 3,351
Noninterest expense
Salaries and employee benefits 6,434 6,276 6,100
Net occupancy expense 624 524 517
Furniture and equipment expense 776 751 762
FDIC insurance 43 163 323
Other 3,823 3,568 3,478
Total noninterest expense 11,700 11,282 11,180
Income before Federal income taxes 5,753 5,506 5,630
Federal income tax expense (Note 10) 1,390 1,379 1,451
Net income $4,363 $4,127 $4,179
Earnings per share (Note 1)*
Basic earnings per share $1.59 $1.46 $1.45
Weighted average shares outstanding (000's) 2,738 2,818 2,882
Diluted earnings per share $1.58 $1.45 $1.43
Weighted average shares outstanding (000's) 2,767 2,838 2,921
*Earnings per share for all periods 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.
The accompanying notes are an integral part of these statements.
</TABLE>
<TABLE>
<CAPTION>
Consolidated Statements of Changes in Shareholders' Equity
For years ended December 31, 1997, 1996 and 1995:
<S> <C> <C> <C> <C> <C> <C> <C>
Additional Net Unrealized
Common Paid-in Retained Gain (Loss) Treasury Unearned
(Amounts in thousands, except per share) Stock Capital Earnings Securities Stock Compensation Total
Balance at December 31, 1994 $1,353 $19,451 $12,884 ($353) ($36) ($426) $32,873
Year ended December 31, 1995
Net income - - 4,179 - - - 4,179
Cash dividends paid, $.48 per share - (1,420) - - - (1,420)
50% stock split 677 - (677) - - -
Common stock issued under
stock option plans (Note 12) - (20) - - 218 - 198
Change in net unrealized loss
on securities (Note 1 and Note 4) - - - 1,030 - - 1,030
Acquisition of 97,111 shares of
treasury stock at cost - - - - (2,235) - (2,235)
Amortization of unearned
compensation (Note 11) - - - - - 331 331
Balance at December 31, 1995 2,030 19,431 14,966 677 (2,053) (95) 34,956
Year ended December 31, 1996
Net income - - 4,127 - - - 4,127
Cash dividends paid, $.52 per share - - (1,503) - - - (1,503)
Common stock issued under
stock option plans (Note 12) - (33) - - 233 - 200
Change in net unrealized gain
on securities (Note 1 and
Note 4) - - - (64) - - (64)
Restricted stock issued under
long-term incentive
compensation plan
(28,926 shares net of forfeitures) - 177 - - 672 (849)
Acquisition of 132,906 shares of
treasury stock at cost (2,682) (2,682)
Tax benefit of restricted
stock transaction - 170 - - - - 170
Amortization of unearned
compensation (Note 11) - - - - - 137 137
Balance at December 31, 1996 $2,030 $19,745 $17,590 $613 ($3,830) ($807) $35,341
Year ended December 31, 1997
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 (Note 12) - 27 - - 294 - 321
Change in net unrealized gain
on securities (Note 1 and
Note 4) - - - 1,322 - - 1,322
Restricted stock issued under
long-term incentive
compensation plan
(2,174 shares net of forfeitures) - (11) - - 60 (73) (24)
Acquisition of 56,974 shares of
treasury stock at cost (1,284) (1,284)
Amortization of unearned
compensation (Note 11) - - - - - 117 117
Balance at December 31, 1997 $3,045 $19,761 $17,087 $1,935 ($4,760) ($763) $36,305
Cash dividends in all periods have been adjusted to reflect a 3 for 2 stock split issued
in the form of a 50% stock dividend and distributed on February 3,1998.
The accompanying notes are an integral part of these statements.
</TABLE>
<TABLE>
<CAPTION>
Consolidated Statements of Cash Flows
Years ended December 31
1997 1996 1995
<S> <C> <C> <C>
(Amounts in thousands)
Cash flows from operating activities
Net income $4,363 $4,127 $4,179
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation 775 741 627
Premium amortization on investment securities 116 107 74
Discount accretion on investment securities (156) (129) (173)
Provision for possible loan losses 936 607 302
Securities gains, net (787) (166) (10)
Proceeds from sale of mortgage loans 11,947 15,225 15,076
Principal gains on sales of mortgage loans (62) (71) (61)
Loss (gain) on sale of premises and equipment 37 (196) (25)
Loan charge-offs, net of recoveries (692) (688) (586)
Increase in interest receivable (154) (138) (214)
Increase in interest payable 108 117 169
Decrease in unearned discount (116) (361) (591)
Increase in prepaid and other assets (240) (432) (615)
(Decrease) increase in accrued expenses and other liabilities (236) 436 (893)
Other , net 333 305 366
Net cash provided by operating activities 16,172 19,484 17,625
Cash flows from investing activities
Proceeds from sales of investment securities available for sale 4,364 334 -
Proceeds from maturities of investment securities held to
maturity 10,088 11,026 18,172
Proceeds from maturities of investment securities available
for sale 9,515 12,641 6,633
Purchase of investment securities held to maturity (1,577) (11,999) (9,250)
Purchase of investment securities available for sale (16,905) (24,360) (18,651)
Net change in loans (32,091) (25,811) (4,896)
Acquisition of branch office and customer list - (2,667) -
Capital expenditures (433) (1,120) (1,313)
Proceeds from sales of premises and equipment 143 331 158
Net cash used in investing activities (26,896) (41,625) (9,147)
Cash flows from financing activities
Net increase (decrease) in demand deposits, NOW accounts
and savings accounts 11,119 8,952 (4,642)
Net (decrease) increase in certificates of deposit (4,766) 2,039 5,156
Dividends paid (1,571) (1,503) (1,420)
Common stock issued under stock option plans 321 200 198
Purchase of treasury shares (1,284) (2,682) (2,235)
Cash inflows from other borrowings 7,496 10,752 698
Net cash provided by (used in) financing activities 11,315 17,758 (2,245)
Increase (decrease) in cash and cash equivalents 591 (4,383) 6,233
Cash and cash equivalents as of January 1 10,521 14,904 8,671
Cash and cash equivalents as of December 31 $11,112 $10,521 $14,904
Supplemental Disclosures of Cash Flow Information
Cash paid during the year for: 1997 1996 1995
Interest paid on deposits and other borrowed funds $12,117 $10,970 $11,041
Income tax paid 1,200 1,335 1,425
The accompanying notes are an integral part of these statements
</TABLE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. Summary of Significant Accounting Policies
The accounting policies of Franklin Financial Services Corporation and
its subsidiaries conform to generally accepted accounting principles and to
general industry practices. A summary of the more significant accounting
policies which have been consistently applied in the preparation of the
accompanying consolidated financial statements follows:
Principles of Consolidation - The consolidated financial statements
include the accounts of Franklin Financial Services Corporation (the
Corporation) and its wholly-owned subsidiary, Farmers and Merchants Trust
Company, a commercial bank (the Bank). Effective May 1, 1995, The Mont Alto
State Bank, also a commercial bank and a subsidiary of the Corporation, was
merged into Farmers and Merchants Trust Company. In addition, on December 29,
1995, Franklin Founders Life Insurance Company, a credit life reinsurance
company and a subsidiary of the Corporation, was dissolved. All significant
intercompany transactions and account balances have been eliminated.
Nature of Operations - The Corporation conducts all of its business
through its subsidiary bank, Farmers and Merchants Trust Company. The Bank
serves its customer base through twelve community offices located in Franklin
and Cumberland Counties in Pennsylvania.
The Bank is a community-oriented commercial bank that emphasizes quality
customer service and convenience. As part of its strategy, the Bank has
sought to develop a variety of products and services that meet the needs of
both its retail and commercial customers.
Use of Estimates in the Preparation of Financial Statements - The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Statement of Cash Flows - For purposes of reporting cash flows, cash and
cash equivalents include Cash and due from banks, Interest-bearing deposits in
other banks and Federal funds sold. Generally, Federal funds are purchased
and sold for one-day periods.
Investment Securities - Except as noted below, debt securities are
acquired with the intent to hold to maturity and are stated at cost adjusted
for amortization of premiums and accretion of discounts which are recognized
as adjustments of interest income. Certain specific debt securities and all
marketable equity securities have been classified as "available for sale" to
serve as a potential source of liquidity. Available for sale securities are
stated at estimated market value with the related unrealized holding gains and
losses reported as a separate component of shareholders' equity, net of tax,
until realized. Realized securities gains and losses are computed using the
specific identification method.
Interest and dividends on investment securities are recognized as income
when earned. Gains or losses on the disposition of investment securities are
based on the net proceeds and the adjusted carrying amount of the specific
securities sold. In the opinion of management, the Corporation has the
ability and intent to hold investment securities carried at amortized cost to
maturity.
In December 1995, the Corporation reclassified investment securities
with a book value of $15,706,000 and a market value of $15,745,000 from held
to maturity to available for sale. This reclassification was allowable under
Financial Accounting Standards Board (FASB) guidance which permitted
institutions to make a one-time reassessment of the appropriateness of
investment security classifications. As a result of this reclassification,
the unrealized gain on securities recorded as a component of shareholders'
equity increased approximately $26,000, net of tax.
Loans - Interest on all loans is accrued over the term of the loans
based on the amount of principal outstanding. Unearned interest on
installment loans is recognized on a basis which approximates the interest
method.
Accrual of interest income is generally discontinued when a loan becomes
90 days past due as to principal or interest and management considers the
collection of principal or interest to be doubtful. When interest accruals
are discontinued, interest credited to income in the current year is reversed
and interest accrued in any prior year is charged to the allowance for loan
losses.
Allowance for Possible Loan Losses - For financial reporting purposes,
the provision for loan losses charged to current operating income is based on
estimates, and ultimate losses may vary from the current estimates. These
estimates are reviewed periodically and, as adjustments become necessary, they
are reported in earnings in the period in which they become known. The
adequacy of the level of the reserve is determined by a continuing review of
the composition of the loan portfolio, overall portfolio quality, specific
problem loans, prior loan loss experience and current and prospective economic
conditions that may affect a borrower's ability to pay.
Premises and Equipment - Premises and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method. When assets are retired or sold, the asset cost and
related accumulated depreciation are eliminated from the respective accounts,
and any resultant gain or loss is included in net income. The cost of
maintenance and repairs is charged to operating expense as incurred, and the
cost of major additions and improvements is capitalized.
Federal Income Taxes - The Corporation and its subsidiary file a
consolidated Federal income tax return. The Corporation accounts for income
taxes in accordance with Statement No. 109, "Accounting for Income Taxes."
Deferred tax assets or liabilities are computed based on the difference
between the financial statement and income tax bases of assets and liabilities
using the applicable enacted marginal tax rate. Deferred income tax expenses
or benefits are based on the changes in the deferred tax asset or liability
from period to period.
Earnings per share - Earnings per share is computed based on the
weighted average number of shares outstanding during each year, adjusted
retroactively for stock splits and dividends. Adjustments resulted from a 3
for 2 stock split issued in the form of a 50% stock dividend declared on
November 13, 1997, and distributed on February 3, 1998, to shareholders of
record on January 13, 1998 and a 3 for 2 stock split issued in the form of a
50% stock dividend distributed on December 29, 1995 to shareholders of record
on December 8, 1995.
The Corporation adopted Statement of Financial Accounting Standards No.
128, "Earnings Per Share" (Statement 128), on December 31, 1997. Statement
128 requires dual presentation of basic and diluted earnings per share on the
face of the income statement for all entities with complex capital structures.
The Corporation's basic earnings per share is calculated as net income divided
by the weighted average number of shares outstanding. For diluted earnings
per share, net income is divided by the weighted average number of shares
outstanding plus the incremental number of shares added as a result of
converting common stock equivalents, calculated using the treasury stock
method. The Corporation's common stock equivalents consist of outstanding
restricted stock and stock options.
A reconciliation of the weighted average shares outstanding used to
calculate basic earnings per share and diluted earnings per share follows:
(In thousands)
1997 1996 1995
Weighted average shares outstanding (basic) 2,738 2,818 2,882
Impact of common stock equivalents 29 20 39
Weighted average shares outstanding (diluted) 2,767 2,838 2,921
===== ===== =====
Reclassification - Certain prior period amounts have been reclassified
to conform with the current year presentation.
Recent Accounting Pronouncements:
Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities - In June 1996, the FASB issued Statement No. 125, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities." This Statement provides accounting and reporting standards for
transfers and servicing of financial assets and extinguishment of liabilities.
Those standards are based on consistent application of a financial-components
approach that focuses on control. Under that approach, after a transfer of
financial assets, an entity recognizes the financial and servicing assets it
controls and the liabilities it has incurred, derecognizes financial assets
when control has been surrendered, and derecognizes liabilities when
extinguished. This Statement provides consistent standards for distinguishing
transfers of financial assets that are sales from transfers that are secured
borrowings. Statement No. 127 was also issued in 1996 and amended Statement
No. 125 by deferring for one year the effective date for certain provisions of
Statement No. 125. Statement No. 125, as amended, was adopted prospectively
on January 1, 1997, and Statement No. 127 was adopted on January 1, 1998.
There was no material financial statement impact from the adoption of
Statement No. 125 in 1997 and none is anticipated upon the adoption of
Statement No. 127 in 1998.
NOTE 2. Regulatory Matters
Certain restrictions exist under Federal law regarding the ability of
the Bank to transfer funds to the Corporation in the form of cash dividends,
loans, or advances. The dividend limitation generally restricts dividend
payments to the Bank's retained net income in the current and preceding two
calendar years. Accordingly, under this limitation, as of December 31, 1997
approximately $1,032,000 of the undistributed earnings of the Bank would be
available for distribution to the Corporation as dividends without prior
regulatory approval. The Bank also is limited as to the amount it may loan
the Corporation, unless such loans are collateralized by specific obligations.
The Corporation's subsidiary Bank is subject to various regulatory
capital requirements administered by federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken, could
have a direct material effect on the Corporation's financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines that involve
quantitative measures of the Bank's assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting practices.
The Bank's capital amounts and classification are also subject to qualitative
judgements by the regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set forth in
the table below) of total and Tier I capital (as defined in the regulations)
to risk-weighted assets (as defined), and of Tier I capital (as defined) to
average assets (as defined). Management believes, as of December 31, 1997,
that the Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 1997, the most recent notification from Federal
Deposit Insurance Corporation categorized the Bank as well capitalized under
the regulatory framework for prompt corrective action. To be categorized as
well capitalized, the Bank must maintain minimum total risk-based, Tier I
risk-based, Tier I leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the institution's category.
The table that follows presents the total risk-based, Tier I risk-based
and Tier I leverage requirements for the Corporation and the Bank. Actual
capital amounts and ratios are also presented.
<TABLE>
<CAPTION>
As of December 31, 1997
<S> <C> <C> <C> <C> <C> <C>
To be well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provision
(Amounts in thousands) Amount Ratio Amount Ratio Amount Ratio
Total Capital (to Risk Weighted Assets)
Corporation $35,394 14.80% $19,133 8.00% $23,916 10.00%
Bank 31,261 13.24% 18,889 8.00% 23,611 10.00%
Tier I Capital (to Risk Weighted Assets)
Corporation $32,401 13.53% $9,579 4.00% $14,368 6.00%
Bank 28,305 11.99% 9,445 4.00% 14,167 6.00%
Tier I Capital (to Average Assets)
Corporation $32,401 9.22% $14,049 4.00% $17,562 5.00%
Bank 28,305 8.18% 13,841 4.00% 17,301 5.00%
As of December 31, 1996
To be Well
Capitalized Under
For Capital Prompt Corrective
Adequacy Purposes Action Provision
Total Capital (to Risk Weighted Assets) Amount Ratio Amount Ratio Amount Ratio
Corporation $35,354 16.00% $17,676 8.00% $22,095 10.00%
Bank 32,479 14.80% 17,554 8.00% 21,943 10.00%
Tier I Capital (to Risk Weighted Assets)
Corporation $32,588 14.75% $8,838 4.00% $13,257 6.00%
Bank 29,732 13.55% 8,777 4.00% 13,166 6.00%
Tier I Capital (to Average Assets)
Corporation $32,588 10.03% $13,003 4.00% $16,253 5.00%
Bank 29,732 9.23% 12,878 4.00% 16,098 5.00%
Management believes that under the current and proposed regulations the Corporation and its
Bank subsidiary will continue to meet the minimum capital requirements in the forseeable future.
However, events beyond the control of the Corporation, such as increased interest rates or a
downturn in the economy where the Bank subsidiary has a concentrartion of its loans,
could adversely affect future earnings and consequently, the ability of the
Corporation and its Bank subsidiary to meet future capital requirements.
</TABLE>
NOTE 3. Restricted Cash Balances
The Corporation's subsidiary bank is required to maintain reserves in the
form of cash and balances with the Federal Reserve Bank, against its deposit
liabilities. At December 31, 1997 and 1996, required reserves held at the
Federal Reserve Bank,for the bank subsidiary, were approximately $2,879,000
and $2,624,000. In addition, as compensation for check clearing and other
services, a compensatory balance maintained at the Federal Reserve Bank at
December 31,1997 and 1996 equaled approximately $900,000.
<TABLE>
<CAPTION>
NOTE 4. Investment Securities
Included as Other in the Held to Maturity classification in the following
schedules are common stoc of the Federal Home Loan Bank of Pittsburgh and Atlantic
Central Bankers Bank which in the aggregate total $1,392,000 and $1,223,000 at
December 31, 1997 and 1996, respectively. Common stock of the Federal Home
Loan Bank and Atlantic Central Bankers Bank represent ownership in institutions
which are wholly owned by other financial institutions.
The amortized cost and estimated market values of investment securities as of December 31, 1997
1996 are as follows:
<S> <C> <C> <C> <C>
Gross Gross Estimated
Amortized unrealized unrealized market
(Amounts in thousands) cost gains losses value
1997 Held to Maturity
U.S. Treasury securities and obligations of U.S.
Government agencies and corporations $1,030 $9 $ - $1,039
Obligations of state and political subdivisions 15,025 227 8 15,244
Corporate debt securities 2,343 12 7 2,348
Mortgage-backed securities 7,989 66 48 8,007
26,387 314 63 26,638
Other 1,392 -- -- 1,392
$27,779 $314 $63 $28,030
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1997 Available for Sale
Equity securities $1,588 $2,050 $ - $3,638
U.S. Treasury securities and obligations of U.S.
Government agencies and corporations 20,967 172 3 21,136
Obligations of state and political subdivisions 14,926 674 - 15,600
Corporate debt securities 4,029 51 - 4,080
Mortgage-backed securities 14,877 42 54 14,865
$56,387 $2,989 $57 $59,319
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1996 Held to Maturity
U.S. Treasury securities and obligations of U.S.
Government agencies and corporations $1,051 $7 $ - $1,058
Obligations of state and political subdivisions 19,496 142 102 19,536
Corporate debt securities 3,688 4 15 3,677
Mortgage-backed securities 10,832 41 168 10,705
35,067 194 285 34,976
Other 1,223 -- -- 1,223
$36,290 $194 $285 $36,199
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1996 Available for Sale
Equity securities $1,380 $1,110 $ - $2,490
U.S. Treasury securities and obligations of U.S.
Government agencies and corporations 27,054 89 88 27,055
Obligations of state and political subdivisions 1,934 8 12 1,930
Corporate debt securities 5,046 14 2 5,058
Mortgage-backed securities 17,159 17 207 16,969
$52,573 $1,238 $309 $53,502
At December 31, 1997 and 1996, investment securities pledged to secure public
funds, trust balances and other deposits and obligations totaled $50,078,000
and $54,864,000, respectively. Proceeds from the sale of available for sale
securities for the years ended December 31, 1997 and 1996, totaled
approximately $4,364,000 and $334,000, respectively. The net gains realized
from these sales were $787,000 and $166,000, for the same periods.
The amortized cost and estimated market value of debt securities at December
31, 1997, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
Estimated
Amortized market
cost value
Held to Maturity
Due in one year or less $2,553 $2,560
Due after one year through five years 11,633 11,721
Due after five years through ten years 2,568 2,610
Due after ten years 1,644 1,740
$18,398 $18,631
Mortgage-backed securities 7,989 8,007
$26,387 $26,638
Estimated
Amortized market
cost value
Available for Sale
Due in one year or less $3,998 $4,004
Due after one year through five years 16,330 16,481
Due after five years through ten years 4,992 5,065
Due after ten years 14,602 15,266
$39,922 $40,816
Mortgage-backed securities 14,877 14,865
$54,799 $55,681
The amortized cost and estimated market value of mortgage backed securities
by issuer as of December 31, 1997 and 1996 are as follows:
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1997 Held to Maturity
Federal Home Loan Mortgage Corporation $2,662 $19 $7 $2,674
Federal National Mortgage Association 2,182 6 30 2,158
Government National Mortgage Association 430 11 -- 441
Other Private 2,715 30 11 2,734
$7,989 $66 $48 $8,007
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1997 Available for Sale
Federal Home Loan Mortgage Corporation $9,843 $19 $46 $9,816
Federal National Mortgage Association 5,034 23 8 5,049
$14,877 $42 $54 $14,865
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1996 Held to Maturity
Federal Home Loan Mortgage Corporation $4,028 $12 $41 $3,999
Federal National Mortgage Association 3,094 4 53 3,045
Government National Mortgage Association 530 13 -- 543
Other Private 3,180 12 74 3,118
$10,832 $41 $168 $10,705
Gross Gross Estimated
Amortized unrealized unrealized market
cost gains losses value
1996 Available for Sale
Federal Home Loan Mortgage Corporation $10,995 $ -- $161 $10,834
Federal National Mortgage Association 5,556 5 46 5,515
Government National Mortgage Association 608 12 -- 620
$17,159 $17 $207 $16,969
</TABLE>
<TABLE>
<CAPTION>
NOTE 5. Loans
A summary of loans outstanding at the end of the reporting periods is as follows:
<S> <C> <C>
December 31
(Amounts in thousands) 1997 1996
Real estate (primarily first mortgage
residential loans) $82,989 $79,478
Real estate - Construction 7,562 3,727
Commercial, industrial and agricultural 98,389 91,244
Consumer (including home equity lines of credit) 55,651 49,936
244,591 224,385
Less: Unearned discount (43) (159)
Allowance for possible loan losses (3,304) (3,060)
Net Loans $241,244 $221,166
Loans to directors and executive officers and to their related interests and affiliated
enterprises amounted to approximately $1,154,000 and $1,416,000 at December 31, 1997 and
1996, respectively. Such loans are made in the ordinary course of business at the Bank's
normal credit terms and do not present more than a normal risk of collection. During 1997,
$260,000 of new loans were made and repayments totaled $522,000.
</TABLE>
<TABLE>
<CAPTION>
NOTE 6. Allowance for Possible Loan Losses
December 31
<S> <C> <C> <C>
(Amounts in thousands) 1997 1996 1995
Balance at beginning of year $3,060 $3,141 $3,425
Charge-offs
Commercial, industrial and agricultural (113) (183) (89)
Consumer (637) (582) (511)
Real estate (32) (12) (76)
Total charge-offs (782) (777) (676)
Recoveries:
Commercial, industrial and agricultural 11 25 46
Consumer 79 64 43
Real estate -- -- 1
Total recoveries 90 89 90
Net charge-offs (692) (688) (586)
Provision for possible loan losses 936 607 302
Balance at end of year $3,304 $3,060 $3,141
Nonaccrual loans at December 31, 1997 and 1996 were approximately $1,148,000 and $856,000,
respectively. At December 31, 1997 and 1996 the Corporation had no restructured loans. The gross
interest that would have been recorded if these loans had been current in accordance with their
original terms and the amounts actually recorded in income were as follows:
(Amounts in thousands) 1997 1996
Gross interest due under terms $156 $120
Amount included in income (19) (46)
Interest income not recognized $137 $74
At December 31, 1997 and 1996, the recorded investment in loans that were considered
to be impaired, as defined by Statement No. 114, totaled $1,104,600 and $789,300, respectively.
Impaired loans have an allowance for credit losses of $67,000 and $14,000 as of December 31,
1997 and 1996, respectively. The Corporation does not recognize interest income on its impaired
loans. Cash receipts on impaired loans are credited to the earliest amount owed by the
borrower. The average recorded investment in impaired loans during the years ended December 31,
1997 and 1996, was $1,060,300 and $594,200 respectively.
</TABLE>
<TABLE>
<CAPTION>
NOTE 7. Premises and Equipment
Premises and equipment consist of:
<S> <C> <C> <C>
Estimated December 31
(Amounts in thousands) useful life 1997 1996
Land $928 $1,088
Buildings 18-40 years 7,204 7,479
Furniture, fixtures and equipment 3-13 years 5,166 4,987
Total cost 13,298 13,554
Less: Accumulated Depreciation (7,391) (6,856)
$5,907 $6,698
</TABLE>
<TABLE>
<CAPTION>
NOTE 8. Deposits
Deposits are summarized as follows:
<S> <C> <C>
December 31
(Amounts in thousands) 1997 1996
Demand $37,591 $34,847
Savings:
Interest-bearing checking 32,770 34,473
Money market accounts 40,836 25,288
Passbook and statement savings 39,532 45,002
113,138 104,763
Time:
Deposits of $100,000 and over 17,739 30,345
Other time deposits 106,087 98,247
123,826 128,592
Total deposits $274,555 $268,202
The interest expense on time deposits with denominations of $100,000 or more for the years
ended December 31, 1997, 1996 and 1995 was $1,144,000, $1,179,000, and $1,185,000, respectively.
</TABLE>
<TABLE>
<CAPTION>
NOTE 9. Securities Sold Under Agreements to Repurchase and Other Borrowings
The Corporation enters into sales of securities under agreements to repurchase. Securities sold under
agreements to repurchase averaged $14,685,000 and $16,144,000 during 1997 and 1996, respectively,
and the maximum amounts outstanding at any month end during 1997 and 1996, were $18,538,000
and $19,955,000, respectively. The weighted average interest rate on these repurchase agreements was
5.11% and 4.72% for 1997 and 1996, respectively. At December 31, 1997, securities sold under
agreements to repurchase totaled $16,075,000 with interest rates ranging from 4.44% to 5.29%. The
securities that serve as collateral for securities sold under agreements to repurchase represent primarily
U.S. Government and U.S. Agency securities with a book and market value of $18,998,988 and $19,054,055,
respectively, at December 31, 1997. The securities sold under agreements to repurchase are overnight
borrowings.
A summary of other borrowings at the end of the reporting period follows:
<S> <C> <C>
December 31
(Amounts in thousands) 1997 1996
Open Repo Plus (a) $11,150 $7,050
Term loans (b) 10,284 7,841
Total other borrowings $21,434 $14,891
(a) Open Repo Plus is a revolving term commitment with the Federal Home Loan Bank of Pittsburgh
(FHLB) used on an overnight basis. The term of these commitments may not exceed 364 days
and the outstanding balance reprices daily at market rates. The total amount available under the
commitment in place on December 31, 1997 was $35,000,000 and the rate on the outstanding
balance was 5.62%.
(b) Term loans with the FHLB bear interest at fixed rates ranging from 5.87% to 7.27% (weighted
average rate of 6.32%) with various maturities beginning September 30, 1998 to September 30, 2002.
All borrowings from the FHLB are collateralized by FHLB stock, mortgage-backed securities
and first mortgage loans.
The scheduled maturities of the term borrowings are as follows:
1998 687
1999 5,635
2000 3,780
2001 29
2002 153
$10,284
</TABLE>
<TABLE>
<CAPTION>
NOTE 10. Federal Income Taxes
The temporary differences which give rise to significant portions of deferred tax assets
and liabilities under Statement No.109 are as follows (amounts in thousands):
<S> <C> <C>
Deferred Taxes (000's) December 31
Temporary Difference 1997 1996
Allowance for possible loan losses $1,123 $1,034
Deferred compensation 183 182
Pensions 114 53
Restricted stock 101 91
Depreciation 42 (91)
Net unrealized gain on securities (997) (316)
Deferred loan fees and costs,net 314 387
Other, net (16) (36)
Deferred taxes, net $864 $1,304
In determining the level of valuation reserves required, the Corporation has determined based upon
its historical level of earnings, its interest margin, gap position and future taxable income that is
more likely than not that the net deferred tax assets will be realized over a period of approximately
5 years. Accordingly, no valuation allowance was established as of December 31, 1997 and 1996.
</TABLE>
<TABLE>
<CAPTION>
The components of the provision for Federal income taxes attributable to income from operations were
as follows:
<S> <C> <C> <C>
Years ended December 31
(Amounts in thousands) 1997 1996 1995
Currently payable $1,574 $1,302 $1,488
Deferred tax expense (benefit) (184) 77 (37)
Income tax provision $1,390 $1,379 $1,451
For the years ended December 31, 1997, 1996 and 1995, the income tax provisions are differently
the tax expense which would be computed by applying the Federal statutory rate to pretax operating
earnings. A reconciliation between the tax provision at the statutory rate and the tax provisi
effective tax rate is as follows:
Years ended December 31
(Amounts in thousands) 1997 1996 1995
Tax provision at statutory rate $1,956 $1,872 $1,914
Income on tax-exempt loans and securities (590) (418) (461)
Nondeductible interest expense relating to
carrying tax-exempt obligations 81 61 65
Dividends received exclusion (16) (15) (16)
Valuation allowance adjustment - (118) (101)
Other, net (41) (3) 50
Income tax expense $1,390 $1,379 $1,451
The tax provision in each year is applicable to:
Years ended December 31
(Amounts in thousands) 1997 1996 1995
Operations $1,122 $1,323 $1,448
Securities gains (losses) 268 56 3
Income tax provision $1,390 $1,379 $1,451
</TABLE>
NOTE 11. Employee Benefit Plans
The Bank has a noncontributory retirement plan covering all employees of
F& M Trust who meet certain age and service requirements. Benefits are based
on years of service and the employee's compensation during the highest five
consecutive years out of the last ten years of employment. The Bank's funding
policy is to contribute annually the amount required to meet the minimum
funding requirements of the Employee Retirement Income Security Act of 1974.
Contributions are intended to provide not only for benefits attributed to
service to date but also for those expected to be earned in the future.
The following table sets forth the plan's funded status at December 31,
1997 based on a September 30, 1997 actuarial valuation together with
comparative 1996 and 1995 amounts:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(Amounts in thousands) 1997 1996 1995
Actuarial present value of benefit obligations:
Accumulated benefit obligation, including vested benefits
of $5,636, $5,089 and $4,566 in 1997, 1996 and 1995,
respectively $5,636 $5,182 $4,635
Projected benefit obligation for service rendered to date 7,611 7,261 6,550
Plan assets at fair value* 11,223 7,817 7,023
Plan assets greater than projected benefit obligation 3,612 556 473
Unrecognized net (gain) loss (3,872) (612) (502)
Unrecognized net asset at October 1, 1988 being recognized
over 12 years 116 (155) (194)
Unrecognized prior service cost 108 119 130
Accrued pension cost included in other liabilities ($35) ($92) ($93)
Net pension cost included the following components:
Service cost - benefits earned during the period $321 $296 $236
Interest cost on projected benefit obligation 494 450 408
Actual return on plan assets (3,731) (1,180) (1,220)
Net amortization and deferral 3,091 603 718
Net periodic pension cost $175 $169 $142
*Plan assets are primarily invested in equities, general assets of insurance companies and insurance contracts.
</TABLE>
The assumed weighted-average discount rate and rate of increase in
future compensation levels used in determining the actuarial present value of
the projected benefit obligations were 7.00% and 5.75% in 1997 and 1996 and
7.25% and 6.00%, respectively in 1995. The expected long-term rate of return
on assets was 8.00% in 1997, 1996 and 1995.
The Corporation maintains a 401K plan covering all employees who have
completed one year of service. Employee contributions to the plan are matched
on a graduated basis with a minimum match of 100% up to 3% of the
participant's total compensation. In addition, a 100% discretionary match
from 3.5% up to 5.0% of eligible salary and tied to achieving specific net
income targets became effective in 1997. The Corporation's match is subject
to approval annually by the Board of Directors. Under this plan, not more
than 15.00% of each participant's total compensation may be contributed in any
given plan year. The Corporation's match expense in 1997, 1996 and 1995, as
approved by the Board of Directors, was $143,000, $132,500 and $125,000,
respectively.
Under the terms of the Corporation's Long-Term Incentive Plan of 1990
("the Plan"), the Compensation Committee of the Board of Directors (the
Committee) is authorized to award up to 204,893 shares of presently authorized
but unissued or reacquired Common Stock to certain employees of the
Corporation and its subsidiaries. Awards may be granted in the form of
Options, Stock Appreciation Rights, Restricted Stock, Performance Units and
Performance Shares.
Pursuant to the Plan, in 1991 the Corporation implemented a program
known as the Senior Management Incentive Program (the Program) and as of
December 31, 1997 has awarded 109,222 restricted shares of $1.00 par value per
share common stock of the Corporation to certain employees at no cost to the
employee participants. These shares are issued subject to specific transfer
restrictions, including the passage of time, ranging from one to ten years;
and shall fully vest upon the expiration of ten years from the date of the
agreements, or earlier, dependent upon the Corporation meeting certain income
requirements established by the Board of Directors.
The Committee has also awarded 18,345 restricted shares of the $1.00 par
value per share common stock of the Corporation to certain employees at no
cost to the participants. These shares also are issued subject to certain
transfer restrictions and will automatically vest upon the expiration of ten
years from the Agreement date (except for one senior officer whose shares
vested in a shorter period).
Unearned compensation, representing the fair market value of the shares
at the date of issuance, will be charged to income over the vesting period.
The cost associated with the plan was approximately $117,000 in 1997, $137,000
in 1996 and $297,000 in 1995. The total of restricted shares vested was 565,
1,035, and 25,325 in 1997, 1996 and 1995, respectively.
In addition to the restricted shares issued to the employee participants
of the Program, the employees could elect to receive a portion of their award
in cash. The payment of cash each year is dependent upon the Corporation
meeting certain income requirements established by the Board of Directors.
There were no cash awards in 1997 or 1996. For 1995, the cash awards under
the plan equaled $37,000.
NOTE 12. Stock Purchase Plan
In 1994, the Board of Directors of the Corporation approved and adopted the
Employee Stock Purchase Plan of 1994 (the Plan). Under the Plan 198,000
shares of stock can be purchased by participating employees over a 10-year
period. The number of shares which can be purchased by each participant is
limited, as defined, and the option price is to be set by the Board of
Directors. However, the option price cannot be less than the lesser of 90%
of the fair market value of the shares on the date the option to purchase
shares is granted, or 90% of the fair market value of the shares on the
exercise date. These options must be exercised one year from the date of
grant. Any shares related to unexercised options are available for future
grant. As of December 31, 1997 there are 142,110 shares available for future
grant. The following table summarizes the stock option activity (stock options
have been adjusted to reflect all stock splits):
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Option Price Per Share
Price Weighted
Stock Options Range Average
Balance at December 31, 1994 25,250 $13.23 $13.23
Granted 23,888 14.53 14.53
Exercised (13,426) 13.23 - 14.53 13.32
Canceled (12,751) 13.23 13.23
Balance at December 31, 1995 22,961 14.53 14.53
Granted 19,572 19.24 19.24
Exercised (13,417) 14.53 - 19.24 14.77
Canceled (10,224) 14.53 14.53
Balance at December 31, 1996 18,892 19.24 19.24
Granted 17,700 23.08 23.08
Exercised (15,305) 19.24 - 23.08 20.24
Canceled (7,564) 19.24 19.24
Balance at December 31, 1997 13,723 $23.08 $23.08
</TABLE>
The following table summarizes information concerning options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Weighted Weighted
Unexercised Average Average
Stock Remaining Exercise
Exercise Price Options Life (Years) Price
$23.08 13,723 0.75 $23.08
</TABLE>
The Corporation has adopted Statement No. 123, "Accounting for Stock-Based
Compensation." As provided for in the statement, the Corporation elected to
continue the intrinsic value method of expense recognition. Accordingly, no
compensation expense for the Plan has been recognized in the financial
statements of the Corporation. Had compensation cost for the Plan been
recognized in accordance with Statement No. 123, the Corporation's net
income and net income per share amounts would have been reduced to the
following pro-forma amounts:
<TABLE>
<CAPTION>
<S> <C> <C>
(Amounts in thousands, except per share) 1997 1996
Net Income: As reported $4,363 $4,127
Proforma 4,334 4,097
Basic earnings per share: As reported $1.59 $1.46
Proforma 1.58 1.45
Diluted earnings per share: As reported $1.58 $1.45
Proforma 1.57 1.44
Weighted average fair value of options granted $4.50 $3.97
</TABLE>
The fair value of the options granted has been estimated using the following
assumptions for both 1997 and 1996:risk-free interest rate of 5.49% , expected
volatility of the Corporation's stock of 20.10% and an expected dividend
yield of 3.67%. The expected life of the options in 1997 and 1996 was
.81 year and 1 year, respectively.
NOTE 13. Deferred Compensation Agreement
The Corporation has entered into deferred compensation agreements with several
officers and directors which provide for the payment of benefits over a
ten-year period, beginning at age 65. At inception, the present value of the
obligations under these deferred compensation agreements amounted to
appoximately $600,000, which is being accrued over the estimated remaining
service period of these officers and directors. These obligations are
partially funded through life insurance covering these individuals.
NOTE 14. Shareholders' Equity
On November 13, 1997, the Board of Directors declared a 3 for 2 stock split
issued in the form of a 50% stock dividend to be distributed on
February 3, 1998 to the Corporation's shareholders of record at the close of
business on January 13, 1998. The result was a transfer from retained
earnings to common stock of approximately $1,015,000. A cash amount of
approximately $10,500 was paid in lieu of issuing fractional shares arising
from the stock dividend. Also on November 13, 1997, the Board of Directors
declared a special cash dividend of $.66 per share on the Corporation's
common stock, payable January 21, 1998, to the Corporation's shareholders of
record as of the close of business on January 7, 1998 and a regular cash
dividend of $.15 per share payable February 27, 1998 to shareholders of
record as of the close of business on February 12, 1998.
In 1996, the Board of Directors authorized the repurchase of up to 100,000
shares (150,000 adjusted for the 50% stock dividend) of the Corporation's
common stock through July 1997. In March, 1997, the Board of Directors
extended the repurchase period from July, 1997 to March 5, 1998.
On March 5, 1998, the Board of Directors authorized the repurchase of up to
50,000 shares of the Corporation's common stock for a twelve month period.
Under this program, the Corporation repurchased 37,983 shares (56,974
adjusted for the 50% stock dividend) for $1.3 million and 88,604 shares
(132,906 adjusted for the 50% stock dividend) for $2.7 million during 1997
and 1996, respectively. The Corporation will use the treasury shares acquired
for general corporate purposes including stock dividends and stock splits,
employee benefit and executive compensation plans and the dividend
reinvestment plan.
Note 15. Commitments and Contingencies
In the normal course of business, the Bank is party to financial instruments
which are not reflected in the accompanying financial statements and are
commonly referred to as off-balance-sheet instruments. These financial
instruments are entered into primarily to meet the financing needs of the
Bank's customers and include commitments to extend credit and standby letters
of credit. Those instruments involve, to varying degrees, elements of credit
and interest rate risk not recognized in the statement of financial position.
The Corporation's exposure to credit loss in the event of nonperformance by
other parties to the financial instruments for commitments to extend credit
and standby letters of credit is represented by the contract or notional
amount of those instruments. The Bank uses the same credit policies in
making commitments and conditional obligations as they do for on-balance-sheet
instruments. Unless noted otherwise, the Bank does not require collateral or
other security to support financial instruments with credit risk. The
Corporation had the following outstanding commitments to fund loans as of
December 31:
<TABLE>
<CAPTION>
<S>
<C> <C>
(Amounts in thousands)
Financial instruments whose contract amounts represent credit risk:
Commercial commitments to extend credit . . . . . . . . . . . . . . . . . . . . . . $28,681 $26,576
Consumer commitments to extend credit (secured) . . . . . . . . . . . . . . . . . . 14,716 12,595
Consumer commitments to extend credit (unsecured) . . . . . . . . . . . . . . . . . 11,317 11,049
$54,714 $50,220
Standby letters of credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,053 905
</TABLE>
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses with the exception of home equity lines and personal lines of credit
and may require payment of a fee. Since many of the commitments are expected
to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Bank evaluates each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Bank upon extension of credit, is based
on management's credit evaluation of the counterparty. Collateral for most
commercial commitments varies but may include accounts receivable, inventory,
property, plant, and equipment and income-producing commercial properties.
Collateral for secured consumer commitments consists of liens on residential
real estate. Standby letters of credit are instruments issued by the Bank which
guarantee the beneficiary payment by the Bank in the event of default by the
Bank's customer in the nonperformance of an obligation or service. Most
standby letters of credit are extended for one-year periods. The credit risk
involved in issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers. The Bank holds collateral
supporting those commitments for which collateral is deemed necessary primarily
in the form of certificates of deposit and liens on real estate. Most of the
Bank's business activity is with customers located within Franklin County,
Pennsylvania and surrounding counties and does not involve any significant
concentrations of credit to any one entity or industry.
The Bank has entered into various noncancellable operating leases. Total
rental expense on these leases was $299,000, $316,000, and $378,000 in the
years 1997, 1996 and 1995, respectively. Future minimum payments under
these leases are as follows:
1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . $287,400
1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 281,000
2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,200
2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,600
2002 and beyond . . . . . . . . . . . . . . . . . . . . . .. 40,300
In the normal course of business, the Corporation has commitments, lawsuits,
contingent liabilities and claims. However, the Corporation does not expect
that the outcome of these matters will have a materially adverse effect on
its consolidated financial position or results of operations.
Note 16. Disclosures About Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate
that value:
Cash, Federal funds sold and Interest-bearing deposits:
For these short-term instruments, the carrying amount is a reasonable estimate
of fair value.
Investment securities and Investments available for sale:
For debt and marketable equity securities held for investment purposes and
available for sale, respectively, fair values are based on quoted market
prices or dealer quotes. If a quoted market price is not available, fair
value is estimated using quoted market prices for similar securities.
Loans, net of allowance for possible loan losses:
The fair value of loans is estimated for each major type of loan
(e.g. real estate, commercial, industrial and agricultural and consumer) by
discounting the future cash flows associated with such loans. The model
considers scheduled principal maturities, repricing characteristics,
prepayment assumptions and interest cash flows. The discount rates used are
estimated based upon consideration of a number of factors including the
treasury yield curve, credit quality factors, expense and service charge
factors.
Deposit liabilities and Other borrowings:
The fair market value of demand deposits, savings accounts, and money market
deposits is the amount payable on demand at the reporting date. This fair
value does not include the benefit that results from the low cost of funding
provided by these deposits compared to the cost of borrowing funds in the
market. The fair value of fixed-maturity certificates of deposit and
long-term debt are estimated by discounting the future cash flows using rates
approximating those currently offered for certificates of deposit and
borrowings with similar remaining maturities. The other borrowings consist of
borrowings on a line of credit with the FHLB at a variable interest rate and
securities sold under agreements to repurchase for which the carrying value
approximates a reasonable estimate of the fair value.
Unrecognized Financial Instruments:
At December 31, 1997 and 1996, the Corporation had outstanding commitments to
extend credit of $54,714,000 and $50,220,000, respectively, and commitments
under standby letters of credit of $1,053,000 and $905,000, respectively. Such
commitments include fixed and variable rate commercial and consumer
commitments. The value of the commitment is a reasonable estimate of the fair
value as the fees and rates charged are approximately consistent with the
amounts which would be charged to enter into similar arrangements at year-end.
<TABLE>
<CAPTION>
The estimated fair value of the Corporation's financial instruments at December 31 are as follows:
1997 1996
Carrying Fair Carrying Fair
(Amounts in thousands) Amount Value Amount Value
<S> <C> <C> <C> <C>
Financial assets:
Cash and short-term investments $11,112 $11,112 $10,521 $10,521
Investment securities held to maturity 27,779 28,030 36,290 36,199
Investment securities available for sale 59,319 59,319 53,502 53,502
Net Loans 241,244 246,819 221,166 224,888
Total Financial Assets $339,454 $345,280 $321,479 $325,110
Financial liabilities:
Deposits $274,555 $275,021 $268,202 $268,478
Securities sold under agreements to repurchase 16,075 16,075 15,122 15,122
Other borrowimgs 21,434 21,452 14,891 14,947
Total Financial Liabilities $312,064 $312,548 $298,215 $298,547
The above values do not necessarily reflect the premium or discount that could
result from offering for sale at one time the Corporation's entire holdings of
a particular instrument. In addition, these values, derived from the methods
and asumptions described above, do not consider the potential income taxes or
other expenses that would be incurred on an actual sale of an asset or
settlement of a liability.
</TABLE>
<TABLE>
<CAPTION>
NOTE 17. Parent Company (Franklin Financial Services Corporation) Financial Information
Balance Sheets
December 31
(Amounts in thousands) 1997 1996
<S> <C> <C> <C> <C>
Assets:
Due from bank subsidiary $3,320 $178
Investment securities 2,999 1,761
Equity investment in subsidiaries 31,587 32,410
Premises 881 1,238
Other assets 340 84
Total assets $39,127 $35,671
Liabilities:
Accrued expenses $0 $87
Deferred tax liability 542 243
Dividends payable 2,280 0
Total liabilities 2,822 330
Shareholders' equity:
Common stock 3,045 2,030
Additional paid-in capital 19,761 19,745
Retained earnings 17,087 17,590
Net unrealized gain on securities 1,935 613
Treasury stock, at cost (4,760) (3,830)
Unearned compensation (763) (807)
Total shareholders' equity 36,305 35,341
Total liabilities and shareholders' equity $39,127 $35,671
Statements of Income
Years ended
December 31
(Amounts in thousands) 1997 1996 1995
Income:
Dividends from Bank $6,020 $2,631 $3,325
Interest and dividend income 44 42 48
Gain on sale of securities 468 105 0
Other income - 37 18
Gain on sale of premises - 90 -
6,532 2,905 3,391
Expenses:
Operating expenses 566 292 321
Loss on sale of premises 40 - -
Income before equity in undistributed income of
subsidiaries 5,926 2,613 3,070
Equity in undistributed income of subsidiaries (1,563) 1,514 1,109
Net income $4,363 $4,127 $4,179
Statements of Cash Flows
Years ended
December 31
(Amounts in thousands) 1997 1996 1995
Cash flows from operating activities
Consolidated net income $4,363 $4,127 $4,179
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed income of subsidiaries 1,563 (1,514) (1,109)
Depreciation 31 29 36
Discount accretion on investment securities - (1) (3)
Loss (gain) on sale of premises 40 (90) -
Securities gains, net (468) (105) -
(Increase) decrease in due from bank subsidiary (3,142) 92 (134)
(Increase) decrease in other assets (256) 119 779
Increase (decrease) in liabilities (87) 119 (45)
Other, net 278 303 559
Net cash provided by operating activities 2,322 3,079 4,262
Cash flows from investing activities
Proceeds from sales of investment securities 644 232 -
Proceeds from maturities of investment securities - 850 534
Purchase of investment securities (534) (218) (987)
Proceeds from sale of premises 129 225 -
Capital expenditures (27) (183) (352)
Net cash provided by (used in) investing activities 212 906 (805)
Cash flows from financing activities
Dividends (1,571) (1,503) (1,420)
Proceeds from sales of common stock 321 200 198
Purchase of treasury shares (1,284) (2,682) (2,235)
Net cash used in financing activities (2,534) (3,985) (3,457)
Increase in cash and cash equivalents - - -
Cash and cash equivalents as of January 1 - - -
Cash and cash equivalents as of December 31 $- $- $-
</TABLE>
<TABLE>
<CAPTION>
NOTE 18. Quarterly Results of Operation (Unaudited)
The following is a summary of the quarterly results of consolidated operations of Franklin Financi
years ended December 31, 1997 and 1996:
(Amounts in thousands) Three months ended
<S> <C> <C> <C> <C>
1997 March 31 June 30 September 30 December 31
Interest income $6,383 $6,530 $6,724 $6,671
Interest expense 2,853 2,991 3,173 3,208
Net interest income 3,530 3,539 3,551 3,463
Provision for loan losses 193 192 253 298
Other noninterest income 883 871 828 937
Securities gains (losses) 111 93 189 394
Noninterest expense 2,795 2,784 2,985 3,136
Income before income taxes 1,536 1,527 1,330 1,360
Income taxes 401 344 291 354
Net Income $1,135 $1,183 $1,039 $1,006
Basic earnings per share* $0.41 $0.43 $0.38 $0.37
Diluted earnings per share* $0.41 $0.43 $0.38 $0.37
1996
Interest income $6,116 $6,032 $6,398 $6,253
Interest expense 2,784 2,725 2,774 2,804
Net interest income 3,332 3,307 3,624 3,449
Provision for loan losses 94 131 96 286
Other noninterest income 823 1,018 814 862
Securities gains 78 - (1) 89
Noninterest expense 2,714 2,728 2,934 2,906
Income before income taxes 1,425 1,466 1,407 1,208
Income taxes 375 330 345 329
Net Income $1,050 $1,136 $1,062 $879
Basic earnings per share* $0.37 $0.38 $0.40 $0.31
Diluted earnings per share* $0.36 $0.38 $0.40 $0.31
*Based on weighted-average shares outstanding during the period reported
adjusted retroactively to reflect a 3 for 2 stock split issue in the form
of a 50% stock dividend and distributed on February 3, 1998, to shareholders
of record on January 13,1998. Consequently, the sum of the quarterly
earnings per share may not equal the annual per share amount.
</TABLE>
Management's Discussion and Analysis
The following discussion and analysis is intended to assist the reader in
reviewing the financial information presented and should be read in
conjunction with the consolidated financial statements and other financial
data presented elsewhere herein.
Results of Operations: Summary
Franklin Financial Services Corporation achieved record net income of
$4.36 million for the year ended December 31, 1997, an increase of 5.7% over
the $4.13 million recorded in 1996. Basic earnings per share for the year
ended December 31, 1997, were $1.59 compared to $1.46 and $1.45 for the years
ended December 31, 1996 and 1995, respectively. On November 13, 1997, the
Board of Directors declared a 3 for 2 stock split issued in the form of a 50%
stock dividend (the 50% Stock Dividend) which was distributed on February 3,
1998, to shareholders of record as of the close of business on January 13,
1998. All per share information in this discussion has been adjusted to
reflect the 50% Stock Dividend. In addition to the 50% Stock Dividend, the
Board of Directors also declared a special cash dividend of $1.00 ($.66
adjusted for the 50% Stock Dividend) which was paid on January 21, 1998, to
shareholders of record as of the close of business on January 7, 1998. Return
on average assets (ROA) and return on average equity (ROE) for 1997 were
recorded at 1.26% and 12.03%, respectively, compared to 1.29% and 11.83%,
respectively, one year earlier. Total assets grew approximately $17.8 million
to $353.9 million at December 31, 1997 from $336.1 million at December 31,
1996. Net loans realized strong growth, increasing $20.1 million, or 9.1%, to
$241.2 million at year-end 1997 over year-end 1996. The growth in deposits
was moderate reflecting an increase of $6.4 million, or 2.4%, to $274.6
million at December 31, 1997, compared to $268.2 million at December 31, 1996.
The Corporation's capital position remains strong at $36.3 million at December
31, 1997, compared to $35.3 million at December 31, 1996. The Corporation's
Tier I capital to average assets ratio was 9.22% at December 31, 1997,
compared to 10.03% at December 31, 1996.
A more detailed discussion of the areas having the greatest impact on
the reported results for 1997 follows.
Net Interest Income
The most important source of the Corporation's earnings is net interest
income which is defined as the difference between income on interest-earning
assets and the cost of interest-bearing liabilities supporting those assets.
The principal categories of interest-earning assets are loans and securities,
while deposits and other borrowings are the principal interest-bearing
liabilities. Net interest income, on a tax-equivalent basis, increased
$570,000 or 4.0% to $14.8 million in 1997 from $14.2 million in 1996. The net
interest margin which reflects the interest rate spread plus the contribution
of assets funded by noninterest-bearing sources decreased to 4.56% for the
year ended December 31, 1997, from 4.70% for the year ended December 31, 1996,
as a result of an increasingly competitive environment for both loans and
deposits.
For the purpose of this discussion net interest income is adjusted to a
tax-equivalent basis. This adjustment facilitates performance comparisons
between taxable and tax-exempt assets by increasing the tax-exempt income by
an amount equivalent to the Federal income taxes which would have been paid if
this income were taxable at the Corporation's 34% Federal statutory rate.
Table 1 presents net interest income on a tax-equivalent basis for each of the
years in the three-year period ended December 31, 1997. Table 2 presents
average balances, tax-equivalent interest income and interest expense and
average rates earned and paid on the Corporation's interest-earning assets and
interest-bearing liabilities. Table 3 analyzes the changes attributable to
the volume and rate components of net interest income.
The level of net interest income is affected primarily by variations in
the volume and mix of the Corporation's assets and liabilities, as well as by
changes in the level of interest rates. Most short-term interest rates were
relatively stable throughout 1997 with only a single 25 basis point increase
in the Federal funds rate and the prime rate, late in the first quarter. The
average prime rate in 1997 was 8.44% and the average Federal funds rate was
5.48% versus 8.27% and 5.31%, respectively, in 1996. Intermediate and
long-term interest rates rose during the first few months of the year, then
drifted lower during the remainder of the year. On average, most interest
rates were marginally higher in 1997 than 1996, and the yield curve was
slightly flatter. Tables 2 and 3 reveal that most of the change in interest
income, interest expense and net interest income can be attributed to an
increase in volume rather than changes in interest rates.
Average interest-earning assets grew $21.7 million or 7.2% to $324.3
million for 1997 from $302.7 million for 1996 and represented 93.8% and 94.3%
of total assets for the related years, respectively. Average loans comprised
72.5% of average interest-earning assets and contributed 78.7% of the total
interest income in 1997. The growth in volume of average interest-earning
assets, offset by a 3 basis point decrease in the average yield, resulted in a
$1.7 million or 6.7% increase in interest income to $27.0 million for 1997
from $25.3 million in 1996. The growth in interest-earning assets was driven
primarily by a $17.3 million increase in net loans, reflecting the
Corporation's business development efforts and a healthy economic environment.
The decrease in the average yield on interest-earning assets resulted from
intensified competitive pressures for new loans and the runoff of higher
yielding loans which produced a 15 basis point decline in the yield to 9.04%
for 1997 versus 9.19% for 1996. The yield on investment securities for 1997
increased 16 basis points to 6.45% from 6.29% in 1996 due principally to the
purchase of longer term securities at interest rates higher than those of
maturing securities.
Average interest-bearing deposits grew $5.1 million to $231.0 million in
1997 over 1996 and resulted in an increase in interest expense of $209,000 to
$10.1 million for 1997 versus $9.8 million in 1996. The Corporation realized
some movement from lower cost savings accounts to a new money market account,
introduced in the second quarter of 1997, which contributed to the higher
interest expense for the year.
Other borrowings, comprised of overnight and long-term debt with the
Federal Home Loan Bank of Pittsburgh, grew an average of $16.5 million during
the year, reaching an average for the year of $23.7 million. The increase in
other borrowings funded the growth in the loan and investment portfolios in
excess of deposit growth and increased interest expense by $941,000 in 1997
versus 1996. The average rate paid on the other borrowings decreased 58 basis
points to 5.97% in 1997 from 6.55% in 1996.
Interest rates were generally lower in 1996 as compared to 1995. The
average prime rate in 1996 was 8.27% and the average Federal Funds rate was
5.31% versus 8.83% and 5.85%, respectively, in 1995. Net interest income on a
tax-equivalent basis declined $134,000 to $14.2 million in 1996 from $14.4
million in 1995. Average earning assets grew $3.8 million to $302.7 million
for 1996 compared to 1995, and realized a decrease in the yield of 20 basis
points to 8.36%. Average interest-bearing liabilities increased $3.7 million
to $249.5 million for 1996 over 1995 and showed a decrease in the interest
rates paid on those liabilities of 12 basis points to 4.44% for 1996 versus
4.56% for 1995.
Provision for Possible Loan Losses
The provision for loan losses charged against earnings was $936,000 in
1997 compared to $607,000 in 1996, an increase of 54.2%. The increase was
mainly due to the rising trend of consumer bankruptcies and subsequent
charge-offs. The provision for loan losses in 1995 was $302,000. The
provision for loan losses is determined based on the adequacy of the
allowance for possible loan losses from an analysis of the loan portfolio,
current economic conditions and other relevant factors. For more information,
refer to the loan quality discussion and Table 10.
Noninterest Income and Expense
Noninterest income totaled $4.3 million in 1997 and represents an
increase of $623,000, or 16.9%, over the $3.7 million recorded in 1996.
Noninterest income recorded in 1996 was $332,000, or 9.9%, over the $3.4
million recorded in 1995. The increase in noninterest income over the three
year period is related primarily to the growth in trust fees and realized
securities gains.
Trust fees in 1997 reached a record level of $1.4 million, an increase
of $256,000, or 21.8%, over 1996 at $1.2 million. Trust fees in 1995 also
equaled $1.2 million. The growth in 1997 is largely related to consumer
disenchantment with recent mergers of local banks into megabanks or large
regionals, coupled with aggressive sales and marketing within the
Corporation's Investment and Trust Services Department as well as the first
full year of sales from the Personal Investment Center (PIC). Trust assets
under management grew 33.5% to $350.9 million at December 31, 1997 from $262.8
million one year earlier and reflects both added volume and market
appreciation and, accordingly, increased fees.
Other noninterest income decreased $338,000, or 83.9%, to $65,000 in
1997 from $403,000 in 1996. The decrease year to year was related primarily
to the sale of a former real estate brokerage subsidiary ($196,000 gain) in
1996 and a $67,000 swing to a loss for 1997 on the sale of foreclosed
property. The remaining $75,000 decrease is related largely to various
recoveries of prior year loan collection expense in 1996 versus no recoveries
in 1997.
Gains on investment securities increased $621,000 to $787,000 in 1997
versus $166,000 and $10,000 in 1996 and 1995, respectively. As a percentage
of noninterest income, gains on investment securities, primarily available for
sale equity securities, equaled 18.3%, 4.5% and less than 1.0% for the three
years ended December 31, 1997, 1996, and 1995, respectively. Management
reviews the performance and quality of available for sale securities along
with current and expected market conditions to determine periodic sales of
investments within the available for sale portfolio. During 1997, the gains
realized from the sale of available for sale investment securities were used
to offset expenses associated with the writedown of bank owned real estate
targeted for demolition and the increase in the provision for loan losses.
Noninterest expense increased $418,000, or 3.7%, to $11.7 million in
1997 compared to $11.3 million in 1996 and $11.2 million in 1995. Salaries
and benefits expense rose $158,000, or 2.5%, to $6.4 million for the year
ended December 31, 1997, compared to $6.3 million and $6.1 million for the
same twelve month period in 1996 and 1995, respectively. Salaries and
benefits expense represents approximately 54.9%, 55.6% and 54.6% of the
Corporation's total noninterest expense for 1997, 1996 and 1995, respectively.
Salary expense grew $302,000, or 6.3%, to $5.1 million in 1997 from $4.8
million and $4.4 million in 1996 and 1995, respectively. The increase in
salaries was due primarily to a full year of additional staffing
(approximately 18 employees) related to the opening of three new community
offices in the fourth quarter of 1996. In addition, general merit salary
adjustments also contributed to the increase. Partially offsetting the
increase in salaries expense was a decrease of approximately $144,000 in
benefits expense related primarily to reduced costs associated with the
long-term incentive plan. Full-time equivalent employees totaled 191 at
December 31, 1997 compared to 195 and 177 at year-end 1996 and 1995.
Management has implemented strategies focused on controlling staffing levels
and related salaries and benefits expense through the increased use of
technology to enhance employee productivity and provide service delivery
options to our customers.
Net occupancy expense and furniture and equipment expense increased a
total of $125,000 in 1997 compared to 1996 and is related to a full year's
expense associated with the operation of three new community offices opened in
the fourth quarter of 1996. Total net occupancy and furniture and equipment
expense in 1997 equaled $1.4 million compared to $1.3 million in 1996 and
1995
Federal Deposit Insurance Corporation (FDIC) deposit insurance expensed
in 1997 decreased $120,000, or 73.6%, to $43,000 in 1997 compared to $163,000
and $323,000 in 1996 and 1995, respectively. The FDIC insurance fund is
comprised of two funds - the Bank Insurance Fund (BIF) and the Savings
Association Insurance Fund (SAIF). Most of the Corporation's deposits are
insured under BIF. The Corporation has SAIF insured deposits related to the
acquisition of the Waynesboro office in 1992. SAIF deposits equaled
approximately $20.0 million at December 31, 1997 and 1996. All BIF and SAIF
financial institutions were required to pay premiums to the Financing
Corporation (FICO) as legislated under the Deposit Insurance Funds Act of 1996
(DIFA). For the Corporation, BIF deposits were assessed an annual FICO rate
of 1.296 basis points and SAIF deposits were assessed an annual rate of 6.48
basis points which resulted in FICO expense of $43,000 and $40,000 in 1997 and
1996, respectively. The Corporation was also assessed a one-time charge on
its SAIF deposits in 1996 which equaled $123,000. This one-time assessment on
all SAIF financial institutions brought the SAIF fund to its fully-funded
level of 1.25% of total deposits as legislated by Congress in 1989. The BIF
fund reached its fully funded level of 1.25% of total deposits in the second
quarter of 1995 and, consequently, the FDIC reduced future assessments to
zero. Management expects that future FDIC insurance expense will continue at
the reduced level.
Other expense increased $255,000, or 7.1%, to $3.8 million for 1997
compared to $3.6 million in 1996 and 1997, respectively. Other expense is
comprised of costs related to advertising, insurance, legal and professional
fees, data processing, supplies, postage, telephone loan collection,
intangible amortization and similar expense. The increase in other
noninterest expense in 1997 over 1996 was due primarily to higher legal and
professional fees ($66,000), data processing ($59,000), telephone expense
($37,000), loan collection expense ($26,000), amortization of intangibles
($102,000), and other expenses associated with the sale of various properties
previously held by the Corporation for possible expansion ($85,000) and the
scheduled demolition of other properties ($301,000) to provide additional
parking at the Corporation's headquarters location. Somewhat offsetting
these increases in other noninterest expense were decreases primarily in
advertising ($52,000), insurance ($36,000), supplies ($127,000) and other
miscellaneous expense ($206,000). A majority of the increased expenses were
due to a full year of operations for the three new community offices opened in
the fourth quarter of 1996. Likewise, much of the decreased expenses in
advertising, supplies and miscellaneous for 1997 were attributable to higher
costs in 1996 associated with opening these three new branches.
Other noninterest expense increased $90,000, or 2.6%, to $3.6 million in
1996 compared to 1995 and was largely due to normal cost increases.
The Corporation utilizes numerous software programs that may be affected
by the Year 2000. The majority of our data processing systems are operated by
third party providers or have been acquired as "off-the-shelf" products. The
Corporation operates no proprietary computer systems.
In anticipation of the Year 2000, the Corporation has undertaken a
comprehensive plan of evaluating all data processing systems, software
programs and providers to ensure their compliance with the Year 2000. This
action began in early 1997 and will be completed prior to December 31, 1998.
As of December 31, 1997, many of the Corporation's data processing systems
have been found to be Year 2000 compliant. The review of our largest data
processing provider is not yet complete, but their compliance with the Year
2000 is expected prior to December 31, 1998.
Although the expenses attributable to Year 2000 compliance cannot be
precisely determined at this time, management has concluded that such expenses
are unlikely to be significant in any one year.
Provision for Income Taxes
Federal income tax expense amounted to $1.4 million in 1997, compared to
$1.4 million and $1.5 million in 1996 and 1995, respectively. The
Corporation's effective tax rate for the years ended December 31, 1997, 1996
and 1995 was 24.2%, 25.0% and 25.8%, respectively. The decrease in the
effective tax rate for the last three years was primarily due to an increase
in tax-free income relative to pretax income. For a more comprehensive
analysis of Federal income tax expense refer to Note 10 of the accompanying
financial statements.
Financial Condition
One method of evaluating the Corporation's financial condition is in
terms of its sources and uses of funds. Liabilities represent sources of
funds while assets reflect the uses of those funds. At December 31, 1997,
total assets reached $353.9 million, an increase of $17.7 million, or 5.3%,
compared to $336.1 million at December 31, 1996. Table 2 presents annual
average balances of the Corporation's balance sheet assets and liabilities
over a three year period to reflect the growth direction in those assets and
liabilities. The following discussion will reference the average balances
presented in Table 2 unless otherwise noted. Investment securities, comprised
of both taxable and nontaxable securities, increased $8.2 million, or 10.2%,
to an average of $88.7 million in 1997 over $80.5 million in 1996 and $69.1
million in 1995. The growth in investment securities, as reflected in Table
4, occurred primarily in nontaxable obligations of state and political
subdivisions and equaled $8.3 million. This growth was a direct result of a
strategy related to interest rate risk management. U.S. Government securities
(Treasuries and Agencies), corporate debt securities and mortgage-backed
securities decreased $6.1 million, $2.4 million and $5.1 million,
respectively, at year-end 1997 from year-end 1996. The decrease in these
investment categories was due largely to calls and maturities with the
exception of the mortgage-backed securities. The decrease in mortgage-backed
securities is due mainly to normal amortization. As disclosed in Note 4 of
the accompanying financial statements, the Corporation's mortgage-backed
securities portfolio consists primarily of mortgage-backed securities issued
by various agencies of the Federal government which carry either an explicit
or implied Federal guarantee. Of the mortgage-backed securities issued by
private issuers, the majority were rated triple A by a nationally recognized
rating agency. None was rated lower than double A. Accordingly, the credit
risk associated with the Corporation's mortgage-backed securities is low.
The interest rate risk accompanying the mortgage-backed securities held
by the Corporation is considered to be moderate. The current portfolio has an
estimated duration of 2.77 years, suggesting that the market value of the
mortgage-backed portfolio would rise (or fall) approximately 2.8% given a 100
basis point decrease (or increase) in market interest rates. However,
proportionately greater price volatility would be expected with a larger
change in market interest rates. The relatively short duration of the
mortgage-backed portfolio indicates that the Corporation's exposure to
prepayment of these assets in a lower rate environment is moderate. All
collateralized mortgage obligations (CMOs) pass the Federal Financial
Institutions Examination Council's high-risk stress test.
The Corporation held $59.3 million and $53.5 million in available for
sale investment securities at December 31, 1997 and 1996, respectively. The
net unrealized gain on available for sale securities was $1.9 million and
$613,000 at December 31, 1997 and 1996, respectively.
Total loans, net of unearned discount, grew to an average of $235.3
million in 1997 from an average of $218.0 million in 1996, an increase of
$17.3 million, or 7.9%. As a result of the addition of three new community
offices in the fourth quarter of 1996, as well as the Corporation's focus on
loan growth, all loan categories reported growth in 1997. As Table 7
reflects, the real estate portfolio showed an increase of $7.3 million, or
8.8% to $90.6 million at December 31, 1997, from $83.2 million at December 31,
1996, and consists primarily of first mortgage residential loans. The
Corporation originated and sold approximately $14.6 million in mortgage loans
to the secondary market, primarily to Federal National Mortgage Association
(FNMA) in 1997 compared to $15.2 million originated and sold in 1996. Growth
in the commercial, industrial and agricultural loan portfolio slowed to 7.8%,
or $98.4 million at December 31, 1997, after a 22.2% increase to $91.2 million
at December 31, 1996. Consumer loans showed good growth to $55.7 million at
December 31, 1997, compared to $49.9 million at December 31, 1996. The
increase in consumer loans resulted primarily from significant growth in
closed-end home equity loans and indirect auto loans, which recorded increases
of 59.8% and 17.3 %, respectively, at December 31, 1997. Continued reductions
in the direct installment, credit card and instant credit portfolio occurred
during the year. As a percentage of total loans, the real estate, commercial
and consumer portfolios remained relatively constant at 37.0%, 40.2% and
22.8%, respectively at December 31, 1997, compared to 37.1%, 40.7% and 22.3%,
respectively one year earlier.
The allowance for possible loan losses was $3.3 million at December 31,
1997, representing 1.35% of loans, net of unearned discount. On December 31,
1997, the ratio of the allowance for possible loan losses to nonperforming
loans was 192.9%. This indicator of allowance adequacy improved significantly
from 176.9% at December 31, 1996. Although nonperforming loans remained
steady, the Corporation gradually increased the allowance for possible loan
losses in 1997 to support inherent risk within the portfolio. At December 31,
1997, management determined the allowance to be adequate. A more detailed
discussion on loan quality can be found immediately following the financial
condition discussion.
Funding for asset growth came from increased other borrowings followed
by deposits. Other borrowings grew an average of $16.5 million for the year
reaching an average of $23.7 million in 1997 compared to an average of $7.3
million in 1996. Other borrowings represent overnight and long-term
borrowings from the Federal Home Loan Bank of Pittsburgh (FHLB). The banking
industry has been losing deposit dollar market share and the Corporation has
not been immune from this trend. As an alternative funding source, the
Corporation looks to its borrowing ability with FHLB to meet loan demand and
deposit withdrawal needs of customers when deposit growth falls short. At
December 31, 1997, the Corporation increased its Open Repo Plus (overnight)
and term borrowings by $4.1 million and $2.4 million, respectively, compared
to December 31, 1996. Deposits recorded slow growth with an increase of $6.4
million, or 2.4%, year over year. Total deposits at December 31, 1997 equaled
$274.6 million compared to $268.2 million at December 31, 1996. Time deposits
of $100,000 and over recorded a decrease of $12.6 million but increases of
8.0% in all other interest-bearing and noninterest-bearing deposits more than
offset the reduction in time deposits. In May of 1997 the Corporation's
management, recognizing that the trend of consumers is to expect the payment
of money market rates for deposits, introduced a new deposit product named the
Money Management Account to compete more effectively with both money market
mutual funds and the array of new bank deposit products that were introduced
by the Corporation's competitors in the local market area. This new product
has been successful at retaining deposits and attracting new deposits. A
review of Note 8 in the accompanying financial statements shows that
noninterest-bearing demand deposits grew $2.7 million, or 7.9%, and savings
deposits (which includes the new money management account) grew $8.4 million,
or 8.0%. In the spring of 1998, the Corporation will roll-out the Freedom
Accounts, which are relationship accounts designed to meet all of the
customer's financial needs through appropriate F&M Trust services and
solutions. These accounts reward customers for their total financial
relationship which includes consumer loan balances, investment and trust
balances, mutual fund balances, residential mortgage balances and personal
deposit balances. These relationship accounts are aimed at retaining current
customers by creating value and loyalty and attracting new customers who are
looking for the same value and loyalty. Funding sources will continue to be a
challenge for the Corporation but through a well trained sales force,
attention to customer service and product creativity management believes it
can meet the challenge.
Securities sold under agreements to repurchase (Repos) decreased
approximately $1.7 million to an average for 1997 of $14.7 million compared to
$16.4 million in 1996. Repos are another funding source for the Corporation
and represent corporate cash management accounts.
The local economy remains in good health. Unemployment in Franklin
County declined to 4.1% in 1997, the lowest in eight years, and below the
national average of 4.7%. In 1997, the Letterkenny Industrial Development
Authority (LIDA) was formed by the Franklin County Commissioners under the
provisions of the Economic Development Financing Law to implement the local
redevelopment plan of the Franklin County Reuse Committee for the Letterkenny
Army Depot, which was targeted for realignment under the 1995 Base Realignment
and Closure (BRAC) decision. LIDA will have the responsibility of developing
approximately 1500 acres of the Letterkenny Army Depot to be transferred in
phases from the United States Army to the local community as an industrial
park, known as the Letterkenny Opportunity Center. The county has a diverse
and growing economy that has been enhanced as the Letterkenny Opportunity
Center takes shape and other business parks develop. Planners are optimistic
for 1998, indicating that as many as 100 small to moderate sized companies
have shown interest in the Letterkenny Opportunity Center. In addition to the
business parks, recreation continues to be a major area of growth in Franklin
County with the addition of an Olympic-sized ice arena and further development
of a local ski resort. With the positive direction the reuse of the
Letterkenny Army Depot is taking and the entrance of new industry into the
county, management of the Corporation does not anticipate any significant
negative impact regarding deposit growth, loan demand or loan losses
associated with the 1995 BRAC decision to realign the Letterkenny Army Depot.
In the fourth quarter of 1996 the Corporation purchased four branch
facilities. Three of these facilities are located in adjoining Cumberland
County and were opened as F&M Trust community offices; the fourth location in
Franklin County is being used for administrative offices. Included in the
purchase price of $2.7 million was real estate, personal property and retail
customer lists. Unlike most branch acquisitions, there were no loans acquired
and no deposits assumed in the transaction. Management recognizes that the
additional expense associated with the operation of these three new community
offices will adversely impact earnings in the short-term, but believes that
the long-term effect of the acquisition will result in a positive impact on
earnings.
Loan Quality
As reflected in Table 9, loan quality remained stable in 1997 after the
improvement realized in 1996. The Corporation's net charge-offs, shown in
Table 10, totaled $692,000 (0.29% of average loans) in 1997, a 0.6% increase
from the $688,000 (0.32% of average loans) in net charge-offs recorded in
1996. As Table 10 illustrates, 80.6% of 1997 net charge-offs occurred within
the consumer loan portfolio. Consumer net charge-offs grew 7.7% to $558,000
in 1997 from $518,000 in 1996, and increased as a percentage of total net
charge-offs from 75.3% in 1996. Commercial net charge-offs decreased $56,000,
or 35.4%, to $102,000 in 1997, compared to $158,000 in 1996.
Table 9 shows that the Corporation's nonperforming assets increased to
$1.9 million at December 31, 1997, a 3.7% increase from the $1.8 million in
nonperforming assets reported at December 31, 1996. Nonperforming loans
remained steady at December 31, 1997, decreasing $18,000 to $1.7 million;
however, the mix of nonperforming loans changed significantly at December 31,
1997. Nonaccrual loans increased 34.1% at December 31, 1997, to $1.1 million,
compared to $856,000 one year earlier. The increase in nonaccruals was
concentrated in the residential mortgage portfolio, which increased $283,000
at December 31, 1997, to $295,000, compared to $12,000 at December 31, 1996.
Commercial nonaccrual loans increased $46,000 to $821,000 at December 31,
1997, up from $775,000 one year earlier. Offsetting the growth in nonaccrual
loans was a decrease in loans past due 90 days or more and still accruing
interest. Loans past due 90 days or more decreased $310,000 to $564,000 at
December 31, 1997, down 35.5% from $874,000 at December 31, 1996. The
reduction in loans past due 90 days or more was concentrated in the real
estate and consumer loan portfolios. The final component of nonperforming
assets, other real estate owned, increased to $185,000 at December 31, 1997,
from $99,000 one year earlier, and includes two residential properties. For
the third consecutive year, the Corporation recorded no restructured loans.
At $3.3 million as of year-end 1997, the allowance for possible loan
losses represented 1.35% of loans, net of unearned discounts and provided
coverage of nonperforming loans at 192.9%. Management utilizes loan loss
reserve analysis to establish the adequacy of the allowance by considering
financial condition, repayment capacity, payment performance, collateral
values and support from guarantors for specifically allocated credits, as well
as historical losses, delinquency rates and general economic conditions for
the remainder of the loan portfolio (refer to Tables 8 and 10 for allocation
of the reserve and loan loss activity as of December 31, 1997). Management
continuously monitors the adequacy of the allowance for possible loan losses
and maintains it within a range which complies with loan portfolio
requirements. Management's assessment of loan loss reserve adequacy is
reviewed quarterly by the Loan Policy and Audit Committees of the Board of
Directors.
Because of its contribution to the Corporation's financial performance,
improved loan quality remains a top priority of management. In 1997,
management focused its loan quality control efforts on consumer lending, which
has experienced higher delinquencies and losses over the past few years.
Rising personal bankruptcies continue to be a concern in the Corporation's
consumer loan portfolio. According to the American Bankruptcy Institute, the
central Pennsylvania region recorded a 40% growth in personal bankruptcy
filings in 1997, the third-highest rate of increase in the nation.
Nationally, the increase was 19%. More consumers are filing for bankruptcy
with little warning to creditors, as evidenced by higher loss rates versus
delinquency rates. The Corporation's customers have not been immune from this
trend, which has continued into 1998. In the first quarter ended March 31,
1998, net charge-offs for the Corporation are expected to equal approximately
$360,000. However, management anticipates that the level of net charge-offs
recorded after the first quarter of 1998 will decline as the year progresses.
As in prior years, management is prepared to maintain the adequacy of the
allowance for possible loan losses. During 1997, efforts undertaken to
address the issues surrounding consumer loan losses include a revision of the
Corporation's Consumer Loan Policy to institute tighter underwriting standards
and an extensive consumer lending training program designed to improve the
knowledge and skills of our lending staff, utilizing material developed by
Omega Performance, a nationally recognized provider of bank training programs.
Liquidity
The Corporation must meet the financial needs of the communities which
it serves, while providing a satisfactory return on the shareholders'
investment. In order to accomplish this, Franklin Financial Services
Corporation must maintain sufficient liquidity in order to respond quickly to
the changing level of funds required for both loan and deposit activity. The
goal of liquidity management is to meet the ongoing cash flow requirements of
depositors who want to withdraw funds and of borrowers who request loan
disbursements. Historically, Franklin Financial Services Corporation has
satisfied its liquidity needs from earnings, repayment of loans and amortizing
securities, maturing investment securities, deposit growth, and its ability to
borrow through existing lines of credit. Investments classified as available
for sale provide an additional source of readily available liquidity.
Growth in deposits generally provides a major portion of the funds
required to meet increased loan demand. Total deposits grew by $6.4 million
between December 31, 1996 and 1997. In addition, the Corporation increased
other borrowings by $6.5 million and securities sold under agreement to
repurchase by $1.0 million. Funding from these sources together with a $2.7
million decrease in investments were sufficient to meet the increase in loan
demand. Table 6 presents specific information concerning short-term
borrowings.
Market Risk
In the course of its normal business operations the Corporation is
exposed to certain market risks. The Corporation has no foreign currency
exchange rate risk, no commodity price risk or material equity price risk.
However it is exposed to interest rate risk. Financial instruments which are
sensitive to changes in market interest rates include fixed- and variable-rate
loans, fixed-income securities, interest-bearing deposits and other
borrowings. All interest rate risk arises in connection with financial
instruments entered into for purposes other than trading.
Changes in interest rates can have an impact on the Corporation's net
interest income and the economic value of equity. The objective of interest
rate risk management is to identify and manage the sensitivity of net interest
income and economic value of equity to changing interest rates in order to
achieve consistent earnings that are not contingent upon favorable trends in
interest rates.
The Corporation uses several tools to measure and evaluate interest rate
risk. One tool is interest rate sensitivity or gap analysis. Gap analysis
classifies assets and liabilities into maturity and repricing time intervals.
The interest rate gap, the difference between maturing or repricing assets and
liabilities, provides management with an indication of how net interest income
will be impacted by different interest rate scenarios. Table 11 presents a
gap analysis of the Corporation at December 31, 1997. The positive gap in the
under one-year time intervals would suggest that the Corporation's near-term
earnings would increase in a higher interest rate environment.
Another tool for analyzing interest rate risk is financial simulation
modeling which captures the impact of not only changing interest rates but
also other sources of cash flow variability including loan and securities
prepayments, loan repricing, deposit pricing and customer preferences.
Financial simulation modeling forecasts both net interest income and the
economic value of equity under a variety of different interest rate
environments. Economic value of equity is defined as the discounted present
value of assets minus the discounted present value of liabilities and is a
surrogate for long-term earnings. The Corporation measures the effects of an
up or down 200-basis point "rate shock" which is deemed to represent the
outside limits of any reasonably probable movement market interest rates might
make during a one-year time frame. The Corporation establishes tolerance
ranges for these measures of interest rate sensitivity and manages within the
ranges. As indicated on Table 12, the financial simulation analysis revealed
that both prospective net interest income over a one-year time period and the
economic value of equity are adversely affected by higher market interest
rates and favorably affected by lower interest rate. Both measures are within
the tolerance ranges established by the Board of Directors.
Computations of the prospective effects of hypothetical interest rate
changes are based on many assumptions, including relative levels of market
interest rates, loan prepayments and deposits decay. Certain shortcomings are
inherent in the computation of discounted present value and, if key
relationships do not unfold as assumed, actual values may differ from those
presented. Further, the computations do not contemplate certain actions
management could undertake in response to changes in market interest rates.
Capital and Dividends
Total shareholders' equity equaled $36.3 million at December 31, 1997,
representing an increase of $964,000 or 2.7% over $35.3 million at December
31, 1996. Most of the growth in equity year over year was from earnings
retained ($512,000) plus an increase in the net unrealized gain on available
for sale investment securities of $1.3 million offset by the repurchase of
outstanding common stock totaling $1.3 million. In 1996, the Corporation
retained earnings of $2.6 million which was offset by a decrease in the net
unrealized gain on available for sale securities of $64,000 and the repurchase
of $2.7 million in outstanding common stock. As a result, shareholders' equity
in 1996 increased $385,000.
In November 1997 the Board of Directors approved a 3 for 2 stock split
issued in the form of a 50% stock dividend distributed on February 3, 1998, to
shareholders of record at the close of business on January 13, 1998. The 50%
Stock Dividend resulted in a transfer of $1.0 million from retained earnings
to common stock.
Cash dividends declared by the Board of Directors in 1997 totaled $1.99
per share ($1.37 adjusted for the 50% Stock Dividend) and represented an
increase of 155.1% (163.4% adjusted for the 50% Stock Dividend) over the $.78
($.52 adjusted for the 50% Stock Dividend) declared in 1996. Included in 1997
cash dividends declared are quarterly dividends paid to shareholders in 1997
totaling $.84 ($.56 adjusted for the 50% Stock Dividend) per share, a special
cash dividend of $1.00 ($.66 adjusted for the 50% Stock Dividend) per share
paid on January 21, 1998, to shareholders of record at the close of business
on January 7, 1998 and a first quarter 1998 cash dividend of $.15 per share
paid on February 27, 1998 to shareholders of record at the close of business
on February 12, 1998. The ratio of cash dividends declared to net income in
1997 was 88.2% compared to 36.4% in 1996.
In March 1997, the Board of Directors authorized the repurchase of up
to 100,000 shares (150,000 adjusted for the 50% Stock Dividend) of the
Corporation's outstanding common stock through March 1998. On March 5, 1998,
the Board of Directors authorized the repurchase of up to 50,000 shares of the
Corporation's outstanding common stock for a twelve month period. Treasury
stock acquired is used for general corporate purposes including stock
dividends and stock splits, employee benefit and executive compensation plans
and the dividend reinvestment plan. Under these programs the Corporation
repurchased 37,983 shares (56,974 shares adjusted for the 50% Stock Dividend)
at a cost of $1.3 million and 88,604 shares (132,906 shares adjusted for the
50% Stock Dividend) at a cost of $2.7 million in 1997 and 1996, respectively.
A strong capital position is important to the Corporation and provides a
solid foundation for the anticipated future growth of the Corporation. A
strong capital position also instills confidence in the Bank by depositors,
regulators and investors, and is considered essential by management.
Common measures of adequate capitalization for banking institutions are
ratios of capital to assets. These ratios indicate the proportion of
permanently committed funds to the total asset base. Guidelines issued by
federal and state regulatory authorities require both banks and bank holding
companies to meet minimum leverage capital ratios and risk-based capital
ratios.
The Leverage ratio compares Tier I Capital to total balance sheet assets
while the risk-based ratio compares Tier I and Tier II capital to risk-weighted
assets and off-balance-sheet activity in order to make capital levels
more sensitive to the risk profiles of individual banks.
Current regulatory capital guidelines call for a minimum Tier I leverage
ratio of 4.0% and minimum Tier I and Tier II risk-based capital ratios of 4.0%
and 8.0%, respectively. Well capitalized banking institutions are determined
to have leverage capital ratios greater than or equal to 5.0% and Tier I and
Tier II risk-based capital ratios greater than or equal to 6.0% and 10.0%,
respectively.
Tier I capital is composed of common stock, additional paid-in-capital
and retained earnings reduced by goodwill, other intangible assets and the
effect of unrealized losses on available for sale equity securities.
Tier II capital is composed of Tier I capital plus the allowance for
loan losses. Table 15 presents the capital ratios for the consolidated
Corporation at December 31, 1997, 1996 and 1995. At year-end, the Corporation
and its banking subsidiary exceeded all regulatory capital requirements. For
additional information on capital adequacy refer to Note 2 of the accompanying
financial statements.
Adjusted for the 50% Stock Dividend, book value per common share was
$12.99 at December 31, 1997, versus $12.47 at December 31, 1996 and market
value per common share was $34.16 versus $21.42, respectively. Market value
disclosed in the financial highlights reflects the mean between the bid and
ask prices for the last business day of the year. As of year-end 1997, the
Corporation's common stock was trading at 262.97% of its December 31 book
value compared to 171.77% at year-end 1996. The price earnings multiple was
21.5 times at December 31, 1997 compared to 14.6 times at December 31, 1996.
Forward-Looking Statements
Certain statements appearing herein which are not historical in nature
are forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements refer to a
future period or periods, reflect management's current views as to likely
future developments, and use the words "may," "will," "expect," "believe,"
"estimate," "anticipate," or similar terms. Because forward-looking
statements involve certain risks, uncertainties and other factors over which
the Corporation has no direct control, actual results could differ materially
from those contemplated in such statements. These factors include (but are
not limited to) the following: general economic conditions, changes in
interest rates, 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.
<TABLE>
<CAPTION>
TABLE 1. Net Interest Income (unaudited)
Net interest income, defined as interest income less interest expense, is as
shown in the following table:
<S> <C> <C> <C> <C> <C>
(Amounts in thousands) 1997 % Change 1996 % Change 1995
Interest income $26,308 6.08% $24,799 (0.69)% $24,971
Interest expense 12,225 10.26% 11,087 (1.10)% 11,210
Net interest income $14,083 2.71% $13,712 (0.36)% $13,761
Tax equivalent adjustment 713 514 599
Net interest income
(full taxable equivalent) $14,796 4.01% $14,226 (0.93)% $14,360
</TABLE>
<TABLE>
<CAPTION>
Table 2. Analysis of Net Interest Income (unaudited)
1997
Average Income or Average
(Amounts in thousands) balance expense yield/rate
<S> <C> <C> <C>
Interest-earning assets:
Interest-bearing deposits in other banks $290 $28 9.66%
Federal funds sold 0 0 0.00%
Investment securities
Taxable 61,998 3,869 6.24%
Nontaxable 26,744 1,856 6.94%
Loans, net of unearned discount 235,308 21,268 9.04%
Total interest-earning assets 324,340 27,021 8.33%
Noninterest-earning assets 21,357
Total assets $345,697
Interest-bearing liabilities:
Deposits:
Interest-bearing checking $34,222 $730 2.13%
Money market deposit accounts 30,182 1,229 4.07%
Savings 43,488 1,220 2.81%
Time 123,121 6,878 5.59%
Total interest-bearing deposits 231,013 10,057 4.35%
Securities sold under agreements to repurchase 14,685 750 5.11%
Other borrowings 23,738 1,418 5.97%
Total interest-bearing liabilities 269,436 12,225 4.54%
Noninterest-bearing liabilities 39,988
Shareholders' equity 36,272
Total liabilities and shareholders' equity $345,696
Net interest income/Net interest margin 14,796 4.56%
Tax equivalent adjustment (713)
Net interest income 14,083
All amounts have been adjusted to a tax-equivalent basis using a tax rate of 34%
</TABLE>
<TABLE>
<CAPTION>
1996
Average Income or Average
(Amounts in thousands) balance expense yield/rate
<S> <C> <C> <C>
Interest-earning assets:
Interest-bearing deposits in other banks $4,122 $210 5.09%
Federal funds sold 0 0 0.00%
Investment securities
Taxable 60,317 3,640 6.03%
Nontaxable 20,181 1,426 7.07%
Loans, net of unearned discount 218,033 20,037 9.19%
Total interest-earning assets 302,653 25,313 8.36%
Noninterest-earning assets 18,164
Total assets $320,817
Interest-bearing liabilities:
Deposits:
Interest-bearing checking $32,006 $697 2.18%
Money market deposit accounts 23,633 841 3.56%
Savings 45,835 1,300 2.84%
Time 124,411 7,010 5.63%
Total interest-bearing deposits 225,885 9,848 4.36%
Securities sold under agreements to repurchase 16,376 762 4.65%
Other borrowings 7,280 477 6.55%
Total interest-bearing liabilities 249,541 11,087 4.44%
Noninterest-bearing liabilities 36,398
Shareholders' equity 34,878
Total liabilities and shareholders' equity $320,817
Net interest income/Net interest margin 14,226 4.70%
Tax equivalent adjustment (514)
Net interest income 13,712
All amounts have been adjusted to a tax-equivalent basis using a tax rate of 34%
</TABLE>
<TABLE>
<CAPTION>
1995
Average Income or Average
(Amounts in thousands) balance expense yield/rate
<S> <C> <C> <C>
Interest-earning assets:
Interest-bearing deposits in other banks $11,694 $683 5.84%
Federal funds sold 155 9 5.81%
Investment securities
Taxable 47,935 2,867 5.98%
Nontaxable 21,145 1,577 7.46%
Loans, net of unearned discount 217,932 20,434 9.38%
Total interest-earning assets 298,861 25,570 8.56%
Noninterest-earning assets 13,938
Total assets $312,799
Interest-bearing liabilities:
Deposits:
Interest-bearing checking $27,734 $564 2.03%
Money market deposit accounts 26,663 1,022 3.83%
Savings 46,183 1,345 2.91%
Time 125,780 7,188 5.71%
Total interest-bearing deposits 226,360 10,119 4.47%
Securities sold under under agreements to repurchase 12,454 639 5.13%
Other borrowings 7,032 452 6.43%
Total interest-bearing liabilities 245,846 11,210 4.56%
Noninterest-bearing liabilities 33,523
Shareholders' equity 33,430
Total liabilities and shareholders' equity $312,799
Net interest income/Net interest margin 14,360 4.80%
Tax equivalent adjustment (599)
Net interest income 13,761
All amounts have been adjusted to a tax-equivalent basis using a tax rate of 34%
Years ended December 31
1997 1996 1995
Rate Analysis:
Yield on total earning assets 8.33% 8.36% 8.56%
Cost of funds supporting earning assets 3.77% 3.66% 3.76%
Net rate on earning assets 4.56% 4.70% 4.80%
</TABLE>
<TABLE>
<CAPTION>
TABLE 3. Rate-Volume Analysis of Net Interest Inc (unaudited)
Table 3 attributes increases and decreases in components of net interest income either to changes
average volume or to changes in average rates for interest-earning assets and interest-bearing liabiities.
Numerous and simultaneous balance and rate changes occur during the year. The amount of change
that is not due solely to volume or rate is allocated proportionally to both.
1997 Compared to 1996 1996 Compared to 1995
Increase (Decrease) due to: Increase (Decrease) due to:
(Amounts in thousands) Volume Rate Net Volume Rate Net
<S> <C> <C> <C> <C> <C> <C>
Interest earned on:
Interest-bearing deposits
in other banks ($284) $102 ($182) ($395) ($78) ($473)
Federal funds sold 0 0 0 (9) 0 (9)
Investment securities
Taxable 103 126 229 747 26 773
Nontaxable 456 (26) 430 (70) (81) (151)
Loans 1,566 (335) 1,231 9 (406) (397)
Total net change in
interest income 1,841 (133) 1,708 282 (539) (257)
Interest expense on:
Interest-bearing checking 47 (14) 33 91 42 133
Money market deposit
accounts 255 133 388 (111) (70) (181)
Savings (66) (14) (80) (10) (35) (45)
Time (72) (60) (132) (78) (100) (178)
Securities sold under
agreements to
repurchase (83) 71 (12) 174 (51) 123
Other borrowings 987 (46) 941 16 9 25
Total net change
in interest expense 1,068 70 1,138 82 (205) (123)
Increase (Decrease) in net
interest income $773 ($203) $570 $200 ($334) ($134)
Nonaccruing loans are included in the loan balances used to calculate the above rate volume
analysis. The interest associated with these nonaccruing loans is not shown in the loan income
numbers. All nontaxable interest income has been adjusted to a tax-equivalent basis, using a
tax rate of 34%.
</TABLE>
<TABLE>
<CAPTION>
Table 4. Investment Securities at Amortized Cost
(unaudited)
The following tables present amortized costs of investment securities by type at December 31 for the
past three years:
<S> <C> <C> <C>
Amortized cost
(Amounts in thousands) 1997 1996 1995
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government
agencies and corporations $1,030 $1,051 $849
Obligations of state and political subdivisions 15,025 19,496 16,225
Corporate debt securities 2,343 3,688 6,795
Mortgage-backed securities 7,989 10,832 10,309
26,387 35,067 34,178
Other 1,392 1,223 1,139
$27,779 $36,290 $35,317
Amortized cost
1997 1996 1995
Available for Sale
Equity Securities $1,588 $1,380 $1,330
U.S. Treasury securities and obligations of U.S. Government
agencies and corporations 20,967 27,054 25,717
Obligations of state and political subdivisions 14,926 1,934 2,417
Corporate debt securities 4,029 5,046 1,025
Mortgage-backed securities 14,877 17,159 10,511
$56,387 $52,573 $41,000
The Other Held to Maturity classification in the above schedule represents common stock of the Federal
Home Loan Bank of Pittsburgh and Atlantic Central Bankers Bank which in the aggregate total $1,392,000,
$1,223,000 and $1,139,000 at December 31, 1997, 1996 and 1995, respectively. Common stock of the
Federal Home Loan Bank and Atlantic Central Bankers Bank represents ownership in institutions which are wholly
owned by other financial institutions and is a requirement for membership.
</TABLE>
<TABLE>
<CAPTION>
TABLE 5. Time Certificates of Deposit of $100,000 or More (unaudited)
The maturity of outstanding certificates of deposit of $100,000 or more at December 31,1997
is as follows:
<S> <C>
(Amounts in thousands) Amount
Maturity distribution:
Within three months $6,901
Over three through six months 2,552
Over six through twelve months 2,295
Over twelve months 5,991
Total $17,739
</TABLE>
<TABLE>
<CAPTION>
TABLE 6. Short-Term Borrowings (unaudited)
FHLB borrowings and Securities Sold Under Agreementsto Repurchase
<S> <C> <C> <C>
(Amounts in thousands) 1997 1996 1995
Ending balance $21,434 $22,172 $13,611
Average balance 23,738 18,639 12,990
Maximum month-end balance 31,701 26,724 16,212
Weighted-average interest rate on average balances 5.97% 4.84% 5.14%
</TABLE>
<TABLE>
<CAPTION>
TABLE 7. Loan Portfolio (unaudited)
The following table presents an analysis of the Bank's loan portfolio for each of the past five years:
<S> <C> <C> <C> <C> <C>
December 31
(Amounts in thousands) 1997 1996 1995 1994 1993
Real estate (primarily first mortgage
residential loans) $82,989 $79,478 $83,800 $92,481 $95,918
Real estate - construction 7,562 3,727 5,233 4,207 4,232
Commercial, industrial and agricultural 98,389 91,244 74,678 75,783 72,537
Consumer (including home equity lines
of credit) 55,651 49,936 50,017 51,376 41,969
Total loans 244,591 224,385 213,728 223,847 214,656
Less: Unearned discount (43) (159) (520) (1,111) (425)
Allowance for possible loan losses (3,304) (3,060) (3,141) (3,425) (3,598)
Net loans $241,244 $221,166 $210,067 $219,311 $210,633
</TABLE>
<TABLE>
<CAPTION>
TABLE 8. Allocation of the Allowance for Possible Loan Losses (unaudited)
The following table shows allocation of the allowance for possible loan losses by major loan category and the
percentage of the loans in each category to total loans at year-end:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(Amounts in thousands) December 31
1997 1996 1995 1994 1993
$ % $ % $ % $ % $ %
Real estate $251 37% $220 37% $583 42% $989 43% - 47%
Commercial
industrial and
agricultural 1,489 40% 1,326 41% 1,136 35% 1,520 34% 2,519 34%
Consumer 1,564 23% 1,514 22% 1,422 23% 916 23% 1,079 19%
$3,304 100% $3,060 100% $3,141 100% $3,425 100% $3,598 100%
</TABLE>
<TABLE>
<CAPTION>
TABLE 9. Nonperforming Assets (unaudited)
The following table presents an analysis of nonperforming assets for each of the past five years.
<S> <C> <C> <C> <C> <C>
December 31
(Amounts in thousands) 1997 1996 1995 1994 1993
Nonaccrual loans $1,148 $856 $671 $1,047 $1,877
Loans past due 90 days or more
(not included above) 564 874 1,123 601 1,193
Restructured loans - - - 595 872
Total nonperforming loans 1,712 1,730 1,794 2,243 3,942
Other real estate 185 99 258 267
Total non performing assets $1,897 $1,829 $2,052 $2,243 $4,209
The Corporation has no foreign loans. The Bank's policy is to classify loans as nonaccrual when
the payment of principal or interest has not been made for a period of 90 days and management
considers the collection of principal and interest doubtful. Any interest accrued prior to the date of
nonaccrual classification is reversed. Subsequent payments are applied as a reduction of
principal until the loan is returned to accruing status.
Restructured loans occur when a borrower has experienced financial hardship and the loan
repayment terms are adjusted to be more favorable to the borrower than those with which new loans
would be granted.
</TABLE>
<TABLE>
<CAPTION>
TABLE 10. Allowance for Possible Loan Losses (unaudited)
The following table presents an analysis of the allowance for possible loan losses for each
of the past five years.
<S> <C> <C> <C> <C> <C>
December 31
(Amounts in thousands) 1997 1996 1995 1994 1993
Balance at beginning of year $3,060 $3,141 $3,425 $3,598 $3,433
Charge-offs:
Commercial,industrial and agricultural (113) (183) (89) (51) (447)
Consumer (637) (582) (511) (230) (219)
Real estate (32) (12) (76) (38) (34)
Total charge-offs (782) (777) (676) (319) (700)
Recoveries:
Commercial,industrial and agricultural 11 25 46 60 104
Consumer 79 64 43 19 60
Real estate 0 1 19
Total recoveries 90 89 90 98 164
Net charge-offs (692) (688) (586) (221) (536)
Provision for possible loan losses 936 607 302 48 701
Balance at end of year $3,304 $3,060 $3,141 $3,425 $3,598
Ratios:
Net loans charged off as a percentage
of average loans 0.29% 0.32% 0.27% 0.10% 0.26%
Allowance as a percentage of net
loans (at December 31) 1.35% 1.36% 1.47% 1.54% 1.68%
</TABLE>
<TABLE>
<CAPTION>
Table 11. Interest Rate Sensitivity Analysis (Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Interest Rate Sensitivity Gaps
(Dollars in Thousands) 1-90 91-181 182-365 1-5 Beyond
Days Days Days Years 5 Years Total
Interest-earning assets:
Interest -bearing deposits in other banks $249 $ -- $ -- $ -- $ -- $249
Federal funds sold
Investment securities 9,428 5,530 8,501 37,954 22,755 84,168
Loans, net of unearned income 82,171 12,081 24,850 62,465 59,677 241,244
Total interest-earning assets $91,848 $17,611 $33,351 $100,419 $82,432 $325,661
Interest-bearing liabilities:
Interest-bearing checking $2,960 $ $ 23,848 5,962 32,770
Money market deposit accounts 31,553 1,536 3,106 4,642 --- 40,837
Savings 0 0 0 31,625 7,906 39,531
Time 20,287 19,409 22,623 61,380 127 123,826
Federal funds purchased and securities
sold under agreement to repurchase 16,075 --- --- --- --- 16,075
Other borrowings 11,150 --- 688 9,596 0 21,434
Total interest-bearing liabilities $82,025 $20,945 $26,417 $131,091 $13,995 $274,473
Interest rate gap $9,823 ($3,334) $6,934 ($30,672) $68,437 $51,188
Cumulative interest rate gap $9,823 $6,489 $13,423 ($17,249) $51,188 $102,376
Note 1: The maturity/repricing distribution of investment securities is based on the maturity date for nonamortizing,
noncallable securities; probable exercise/non-exercise of call option for callable securities; and estimated amortization
based on industry experience for amortizing securities.
Note 2: Distribution of loans is based on contractual repayment terms except for residential mortgages where the scheduled
maturities are accelerated based on estimated prepayments of approximately 15 percent per year (constant prepayment rate).
Note 3: Interest-bearing checking, MMDA and savings accounts are non-maturity deposits which are distributed in accordance
with guidelines provided by the FDIC.
</TABLE>
<TABLE>
<CAPTION>
TABLE 12 Sensitivity to Change in Market Interest Rates (unaudited)
Interest Rate Scenarios
<S> <C> <C> <C> <C>
(Amounts in Thousands) -200 bps -100 bps +100 bps +200 bps
Prospective one-year net interest income:
Change........................... $118 $69 ($88) ($210)
Percent change................... 0.8% 0.5% -0.6% -1.5%
Board policy limit............... -7.5% -3.8% -3.8% -7.5%
Economic value of portfolio equity:
Change........................... $5,448 $3,687 ($1,790) ($4,851)
Percent change................... 13.2% 8.9% -4.3% -11.7%
Board policy limit............... -20.0% -10.0% -10.0% -20.0%
Key assumptions:
1. Residential mortgage loans and mortgage-backed securities prepay at rate-sensitive speeds consistent
with observed historic prepayment speeds for pools of residential mortgages.
2. Variable rate loans and variable rate liabilities reprice in accordance with their contractual terms, if any.
Rate changes for adjustable rate mortgages are constrained by their contractual caps and floors
3. Interest-bearing nonmaturity deposits reprice in response to different interest rate scenarios consistent
with the Corporation's historic rate relationships to market interest rates. Nonmaturity deposits run off
over various future time periods, ranging from one month to ten years, in accordance with guidelines
suggested by the FDIC.
4. Interest rate scenarios assume an immediate, sustained and parallel shift in the term structure of interest
rates.
</TABLE>
<TABLE>
<CAPTION>
Table 13. Maturity Distribution of Investment Portfolio (Unaudited)
The following presents an analysis of investments in securities at December 31, 1997 by maturity, and the weighted
average yield for each maturity presented. Securities with "put options" have been classified in the earliest
period in which the options can be exercised. The yields in this table are presented on a tax-equivalent basis and
have been calculated using the amortized cost.
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
After one year After five years After ten
One year or less through five years through ten years years Total
Amortized Amortized Amortized Amortized Amortized
(Amounts in thousands) Cost Yield Cost Yield Cost Yield Cost Yield Cost Yield
Held to Maturity
U.S. Treasury securities &
obligations of U.S. Government
agencies & corporations $ --- --- $1,030 6.38% $ --- --- $ --- --- $1,030 6.38%
Obligations of state &
political subdivisions 2,313 6.54% 8,060 6.58% 3,008 6.54% 1,644 8.35% 15,025 6.76%
Corporate debt securities --- --- 2,343 5.97% --- --- --- --- 2,343 5.97%
Mortgage-backed securities 300 6.34% 1,113 6.13% 883 6.74% 5,693 6.77% 7,989 6.66%
Other --- --- --- --- --- --- 1,392 6.28% 1,392 6.28%
$2,613 6.52% $12,546 6.41% $3,891 6.59% $8,729 6.99% $27,779 6.63%
Market Market Market Market Market
Value Yield Value Yield Value Yield Value Yield Value Yield
Available for Sale
U.S. Treasury securities &
obligations of U.S. Government
agencies & corporations $3,502 6.04% $12,569 6.34% $5,065 7.16% $ --- $21,136 6.49%
Obligations of state &
political subdivisions --- --- 334 8.71% --- --- 15,266 8.02% 15,600 8.03%
Corporate debt securities 502 6.61% 3,578 6.66% --- --- --- --- 4,080 6.65%
Mortgage-backed securities --- --- 5,309 6.27% 5,391 6.27% 4,165 6.02% 14,865 6.20%
Equity securities --- --- --- --- --- --- 3,638 2.33% 3,638 2.33%
$4,004 6.11% $21,790 6.41% $10,456 6.70% $23,069 6.76% $59,319 6.58%
</TABLE>
<TABLE>
<CAPTION>
TABLE 14. Maturities and Interest Rate Terms of Selected Loans (unaudited)
Stated maturities (or earlier call dates) of selected loans as of December 31, 1997 are summarized in
the table below. Residential mortgages and consumer loans are excluded from the presentation.
<S> <C> <C> <C> <C>
After
one year
Within but within After
(Amounts in thousands) one year five year five years Total
Loans:
Real estate - construction 7,562 - - $7,562
Commercial, industrial and agricultural 16,780 32,039 49,570 $98,389
$24,342 $32,039 $49,570 $105,951
The following table shows for the above loans the amounts which have predetermined interest rates
and the amounts which have variable interest rates at December 31, 1997:
After
one year
but within After
five year five years Total
Loans with predetermined rates $16,028 $27,518 $43,546
Loans with variable rates 16,011 22,052 $38,063
$32,039 $49,570 $81,609
</TABLE>
<TABLE>
<CAPTION>
TABLE 15. Capital Ratios (unaudited)
<S> <C> <C> <C>
December 31
1997 1996 1995
Risk-based ratios
Tier 1 13.53% 14.75% 16.41%
Tier 2 14.80% 16.00% 17.66%
Leverage Ratio 9.22% 10.03% 10.77%
</TABLE>
Shareholders' Information
Dividend Reinvestment Plan
Franklin Financial Services Corporation offers a dividend reinvestment
program whereby shareholders with stock registered in their own names may
reinvest their dividends in additional shares of the Corporation. Information
concerning this optional program is available by contacting the Corporate
Secretary at 20 South Main Street, P.O. Box T, Chambersburg, PA 17201-0819,
telephone 717/264-6116.
Dividend Direct Deposit Program
Franklin Financial Services Corporation offers a dividend direct deposit
program whereby shareholders with registered stock in their own names may
choose to have their dividends deposited directly into the bank account of
their choice on the dividend payment date. Information concerning this
optional program is available by contacting the Corporate Secretary at 20
South Main Street, P.O. Box T, Chambersburg, PA 17201-0819, telephone
717/264-6116.
Annual Meeting
The Annual Shareholders' Meeting will be held on Tuesday, April 28,
1998, at The Lighthouse Restaurant, 4301 Philadelphia Avenue, Chambersburg.
The Business Meeting will begin at 10:30 a.m. and will be followed by a
luncheon served at 12:00 noon.
Stock Information
The following brokers are registered as market makers of Franklin
Financial Services Corporation's common stock:
Ferris Baker Watts Hopper Soliday & Co., Inc
17 East Washington Street 1703 Oregon Pike
Hagerstown, MD 21740 Lancaster, PA 17601
800/344-4413 800/646-8647
F.J. Morrissey & Co., Inc. Ryan, Beck & Co.
1700 Market Street, Suite 1420 3 Parkway
Philadelphia, PA 19103-3913 Philadelphia, PA 19102
215/563-3296 800/223-8969
Registrar and Transfer Agent
The registrar and transfer agent for Franklin Financial Services
Corporation is Fulton Bank, P.O. Box 4887, Lancaster, PA 17604.
Exhibit 21
Subsidiaries of
Franklin Financial Services Corporation
Farmers and Merchants Trust Company of Chambersburg - Direct
(A Pennsylvania Bank and Trust Company)
ARTHUR ANDERSEN LLP
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our report included in Franklin Financial Services Corporation 1997 annual
report to shareholders incorporated by reference in this Form 10-K, into the
Corproation's previously filed Registration Statements: File No. 2-92212,
No. 2-98880, No. 33-36509, No. 33-64294, and No. 33-82420.
/s/ Arthur Andersen LLP
Lancaster, PA
March 26, 1997
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 10863
<INT-BEARING-DEPOSITS> 249
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 59319
<INVESTMENTS-CARRYING> 27779
<INVESTMENTS-MARKET> 28030
<LOANS> 244548
<ALLOWANCE> 3304
<TOTAL-ASSETS> 353865
<DEPOSITS> 274555
<SHORT-TERM> 27225
<LIABILITIES-OTHER> 5496
<LONG-TERM> 10284
0
0
<COMMON> 3045
<OTHER-SE> 33260
<TOTAL-LIABILITIES-AND-EQUITY> 353865
<INTEREST-LOAN> 21088
<INTEREST-INVEST> 5192
<INTEREST-OTHER> 28
<INTEREST-TOTAL> 26308
<INTEREST-DEPOSIT> 10057
<INTEREST-EXPENSE> 12225
<INTEREST-INCOME-NET> 14083
<LOAN-LOSSES> 936
<SECURITIES-GAINS> 787
<EXPENSE-OTHER> 11700
<INCOME-PRETAX> 5753
<INCOME-PRE-EXTRAORDINARY> 5753
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4363
<EPS-PRIMARY> 1.59
<EPS-DILUTED> 1.58
<YIELD-ACTUAL> 8.34
<LOANS-NON> 1148
<LOANS-PAST> 564
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 3060
<CHARGE-OFFS> 782
<RECOVERIES> 90
<ALLOWANCE-CLOSE> 3304
<ALLOWANCE-DOMESTIC> 3304
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
