Executive Summary / Key Takeaways

• Franklin Financial Services Corporation (FRAF) demonstrates solid performance, reporting a 16.7% increase in Q1 2025 net income driven by robust loan and deposit growth and expanding net interest margin.
• The company's community banking segment, supported by a growing loan portfolio across diverse categories and strategic deposit gathering, remains the primary earnings driver, complemented by a growing wealth management business.
• FRAF maintains a strong capital position, comfortably exceeding regulatory requirements, and continues to return value to shareholders through a recently increased quarterly dividend and an active share repurchase authorization.
• While facing competitive pressures from larger regional banks and fintech, and potential economic headwinds including trade policy impacts, FRAF leverages its local market presence and disciplined management to navigate the landscape.
• Key factors for investors to monitor include the trajectory of loan growth and associated asset quality trends, the cost of deposits in the current rate environment, and the company's strategic response to enhancing operational efficiency and digital capabilities relative to peers.

A Foundation Built on Community: FRAF's Strategic Position

Franklin Financial Services Corporation, established in 1906, operates through its primary subsidiary, Farmers and Merchants Trust Company of Chambersburg, serving communities across south-central Pennsylvania and Washington County, Maryland. The company functions as a regional bank holding company, offering a blend of commercial and retail banking services alongside a growing wealth management segment. Its strategy centers on disciplined balance sheet management, fostering loan and deposit growth within its diverse local market, and enhancing overall efficiency and profitability to deliver shareholder value.

The regional banking landscape is characterized by intense competition from both larger, scaled institutions and smaller, agile community banks, increasingly influenced by technological advancements and evolving customer expectations. FRAF competes directly with institutions like Orrstown Financial Services (ORRF), Mid Penn Bancorp (MPB), F.N.B. Corporation (FNB), and Peoples Financial Services (PFIS). While larger peers like FNB benefit from scale and broader digital offerings, and others like ORRF and MPB are investing in digital efficiency and automated processes, FRAF distinguishes itself through its deep local ties, a comprehensive suite of trust services, and a unique non-bank investment arm, the Franklin Future Fund Inc. This community-focused approach and diversified service offering form the bedrock of its market positioning.

Operational technology underpins FRAF's service delivery, encompassing data processing for core banking functions and systems supporting payment processing (ATM/debit cards) and wealth management. While the company does not highlight a single, proprietary technological moat, its operational infrastructure is critical for efficiency and customer service. Competitive analysis suggests that some peers are advancing more rapidly in digital capabilities and automated processes, potentially offering faster service or lower transaction costs. FRAF's investment in software expenses, contributing to increased data processing costs, indicates ongoing efforts to maintain and potentially enhance its operational technology. The use of networks like IntraFi and CDARS also demonstrates leveraging technology to provide enhanced services, specifically full FDIC coverage for larger depositors, which supports deposit gathering efforts.

Momentum in the First Quarter: Financial Performance Snapshot

Franklin Financial Services delivered a strong start to 2025, reporting net income of $3.9 million for the first quarter, a significant 16.7% increase compared to $3.4 million in the same period of 2024. This performance translated to basic and diluted earnings per share of $0.88, up from $0.77 year-over-year. The primary driver of this earnings growth was a robust increase in net interest income, which rose by 15.2% to $15.6 million.

The expansion in net interest income was a result of both increased balance sheet volume, contributing $467 thousand, and favorable interest rate dynamics, adding $1.6 million. The company's net interest margin improved to 3.05% in Q1 2025 from 2.88% in Q1 2024, reflecting effective management of its interest-earning assets and interest-bearing liabilities. Noninterest income also contributed positively, increasing by 8.9% to $4.6 million, primarily boosted by higher wealth management fees and increased gains from the sale of mortgage loans. Growth in other income, including swap referral fees, further supported this segment's performance.

However, the quarter also saw an increase in noninterest expense, rising by $1.3 million, or 9.7%, compared to the prior year. This increase was mainly attributable to higher salaries and employee benefits, including health insurance costs and commissions tied to increased mortgage volume. Elevated data processing costs due to software expenses and higher FDIC insurance premiums resulting from balance sheet growth also contributed to the expense increase. The effective tax rate for the quarter was 18.5%, up from 15.7% in Q1 2024.

Building the Balance Sheet: Growth and Asset Quality

The first quarter of 2025 saw continued expansion of FRAF's balance sheet, with total assets reaching $2.26 billion at March 31, 2025, a 2.7% increase from $2.20 billion at year-end 2024. This growth was largely fueled by a significant increase in the loan portfolio. Net loans grew by $57.3 million, or 4.2%, since December 31, 2024, reaching $1.44 billion.

Loan growth was observed across several categories, including residential real estate ($6.5 million increase, primarily consumer first liens), residential real estate construction ($16.5 million increase, notably in commercial construction), and commercial real estate ($28.4 million increase). Commercial loans also increased by $7.4 million. The commercial real estate portfolio includes approximately $508 million in nonowner occupied loans, concentrated in the Bank's market area. Commercial loan concentrations are notable in public administration, utilities, real estate/rental/leasing, and manufacturing sectors. The Bank also supplements its commercial lending through purchased loan participations, totaling $111.5 million outstanding at quarter-end.

Deposit gathering efforts were also successful, with total deposits increasing by $51.9 million, or 2.9%, to $1.87 billion. Noninterest-bearing checking accounts saw an $8.6 million increase, while the Money Management product grew by $57.3 million. Interest-bearing checking decreased by $9.9 million, and time deposits saw a modest decrease of $4.4 million. The cost of total deposits for the quarter was 2.02%, a slight decrease from 2.06% in the previous quarter. The Bank utilizes brokered CDs ($87.5 million) and reciprocal deposit programs (IntraFi, CDARS totaling $332.9 million) to attract and retain larger deposit balances, enhancing funding stability. Approximately 89% of deposits are estimated to be FDIC insured or collateralized.

Asset quality metrics showed some shifts in the quarter. The provision for credit losses increased to $779 thousand, primarily attributed to the strong loan growth experienced since year-end. The Allowance for Credit Losses (ACL) ratio for loans remained relatively stable at 1.27% compared to 1.26% at the end of 2024. The watch list, representing loans with potential weaknesses, increased to $31.4 million from $21.5 million, mainly due to credit downgrades on two hotel loans. Nonaccrual loans decreased slightly to $253 thousand from $266 thousand, resulting in a stable nonperforming loan to gross loans ratio of 0.02%. Loans past due 90 days or more and still accruing totaled $20 thousand. Management employs a rigorous loan review process, including internal committees and external consultants, to monitor credit risk and evaluate the adequacy of the ACL, which they believe is sufficient as of March 31, 2025.

Capital Strength and Shareholder Returns

Franklin Financial Services maintains a robust capital position, with the Bank comfortably exceeding the minimum ratios required to be considered well capitalized by regulatory agencies. At March 31, 2025, the Bank's Common Equity Tier 1, Tier 1 Risk-Based, Total Risk-Based, and Tier 1 Leverage ratios all significantly surpassed the well-capitalized thresholds. The Bank's capital conservation buffer stood at 4.69%, well above the 2.50% regulatory requirement. The Corporation also reports its consolidated capital ratios, demonstrating strong capital adequacy at the holding company level.

Total shareholders equity increased by $6.7 million in the first quarter, reaching $151.4 million. This increase was primarily driven by the net income generated during the period, partially offset by cash dividends paid. An improvement in accumulated other comprehensive loss also contributed to the equity growth. The company's Dividend Reinvestment Plan (DRIP) provided additional capital through both optional cash contributions and reinvested dividends.

Demonstrating confidence in its performance and capital strength, the Board of Directors declared a regular quarterly cash dividend of $0.33 per share for the second quarter of 2025, representing a 3.1% increase over the dividend paid in the fourth quarter of 2024. The dividend payout ratio for the first three months of 2025 was 36.16%.

In January 2025, the Board authorized a share repurchase plan allowing for the repurchase of up to 150,000 shares over a one-year period, signaling management's intent to enhance shareholder value, contingent on market conditions and capital needs.

Market Dynamics and Risk Considerations

FRAF operates within a diverse market area that management believes is well-suited for continued growth, benefiting from industries such as warehousing, manufacturing, healthcare, and agriculture, as well as strategic access to major East Coast metropolitan areas. Like all financial institutions, FRAF is sensitive to changes in interest rates and inflation, actively monitoring Federal Reserve actions and their impact on market rates and the company's financial performance.

Liquidity management is a key operational focus, with the Bank regularly assessing projected cash flows and conducting stress tests to ensure it can meet anticipated demands. Available liquidity sources include earnings, loan and security repayments, loan sales, deposit growth, and access to wholesale funding through the FHLB, Federal Reserve Discount Window, correspondent banks, and brokered deposits, supplemented by unencumbered marketable securities. Management expresses confidence in the Bank's ability to meet its liquidity needs. Off-balance-sheet commitments, such as unfunded loan commitments and letters of credit, are managed with the same credit standards as on-balance-sheet assets and are not expected to pose significant liquidity risks.

Several risks could impact FRAF's performance. Changes in general economic conditions, fluctuations in interest rates, and shifts in government monetary policy and regulation are inherent risks for the banking sector. Intensified competition within its market area could pressure loan and deposit pricing and market share. A newly highlighted risk factor is the potential adverse impact of changes to trade policies and tariffs on local businesses, which could impair their ability to repay loans and negatively affect asset quality and overall financial performance. While management does not anticipate material adverse effects from current legal proceedings, litigation is a standard risk in the industry.

Competitive Standing and Outlook

Franklin Financial Services holds a competitive position within its regional market, balancing its community-focused model with the need to adapt to broader industry trends. Compared to peers, FRAF's TTM Net Profit Margin of 9.93% is competitive with MPB (16%) and FNB (18%) but trails ORRF (8%) and PFIS (4%), though direct TTM comparisons across all peers can be nuanced due to varying business mixes and reporting periods. FRAF's TTM Debt/Equity ratio of 1.48 is higher than ORRF (0.41), MPB (0.12), and PFIS (0.33), but lower than FNB (0.68), suggesting a relatively balanced capital structure compared to some peers.

While FRAF's operational technology supports its current business model, the competitive landscape analysis indicates that some rivals are potentially more advanced in digital efficiency and automated processes. This could present a challenge in terms of customer acquisition costs and operational throughput if not addressed through continued investment. FRAF's strengths lie in its established local presence, which fosters customer loyalty, and its diversified offerings, particularly in wealth management and non-bank investments, which provide alternative revenue streams. The increase in wealth management fees and assets under management in Q1 2025 highlights the contribution of this segment.

The outlook for FRAF appears stable, supported by solid Q1 2025 results, continued loan and deposit growth, and a strong capital base. The increase in the quarterly dividend signals management's positive view on future earnings potential and commitment to shareholder returns. The share repurchase authorization provides additional flexibility for capital management. However, the company must navigate potential headwinds from rising deposit costs in a competitive funding environment and monitor asset quality closely, particularly given the increase in the watch list. Strategic investments in technology and continued focus on operational efficiency will be crucial to maintain competitiveness against peers with potentially greater digital capabilities. The leadership transition with Craig Best assuming the CEO role will be a key factor to watch as the company executes its strategy in the coming quarters.

Conclusion

Franklin Financial Services Corporation has demonstrated encouraging performance in the first quarter of 2025, marked by strong growth in net income, loans, and deposits, alongside an expanding net interest margin. The company's foundation in community banking, complemented by a growing wealth management segment, provides a stable base. FRAF's disciplined approach to balance sheet management and its robust capital position underscore its financial health and resilience.

While the regional banking environment presents ongoing challenges from competition and potential economic volatility, including the specific risk highlighted regarding trade policies, FRAF appears well-positioned to leverage its local market strengths and diversified service offerings. The recent increase in the quarterly dividend and the share repurchase authorization reflect management's commitment to enhancing shareholder value. Investors should closely monitor the sustainability of loan growth, trends in asset quality, the evolution of funding costs, and the company's strategic initiatives to enhance operational efficiency and digital capabilities in response to the competitive landscape.