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| LKFN > SEC Filings for LKFN > Form 10-K on 10-Mar-2009 | All Recent SEC Filings |
10-Mar-2009
Annual Report
OVERVIEW
Lakeland Financial Corporation is the holding company for Lake City Bank. The Company is headquartered in Warsaw, Indiana and operates 43 offices in twelve counties in northern Indiana and a loan production office in Indianapolis, Indiana. The Company earned $19.7 million for the year 2008 versus $19.2 million for 2007, an increase of 2.6%. The increase was driven primarily by an $8.7 million increase in net interest income and a $3.1 million increase in noninterest income. Offsetting these positive impacts was a $5.9 million increase in the provision for loan losses and a $4.6 million increase in noninterest expense. The Company earned $19.2 million for the year 2007 versus $18.7 million for 2006, an increase of 2.6%. The increase was driven primarily by a $2.2 million increase in net interest income and a $1.3 million increase in noninterest income. In addition, the Company's effective tax rate decreased to 30.3% for 2007 compared to 33.7% for 2006. Offsetting these positive impacts was a $2.5 million increase in noninterest expense and a $1.7 million increase in the provision for loan losses.
Basic earnings per share for the year 2008 was $1.61 per share versus $1.58 per share for 2007 and $1.55 for 2006. Diluted earnings per share for the year ended 2008 was $1.58 per share versus $1.55 per share for the year ended 2007 and $1.51 for the year ended 2006. Diluted earnings per share reflect the potential dilutive impact of stock options granted under employee stock option plans.
The Company's total assets were $2.377 billion as of December 31, 2008 versus $1.989 billion as of December 31, 2007, an increase of $388.3 million or 19.5%. This increase was primarily due to a $292.4 million increase in commercial loans from $1.241 billion at December 31, 2007 to $1.533 billion at December 31, 2008.
RESULTS OF OPERATIONS
2008 versus 2007
The Company reported record net income of $19.7 million in 2008, an increase of $490,000, or 2.6%, versus net income of $19.2 million in 2007. Net interest income increased $8.7 million, or 16.0%, to $63.3 million versus $54.6 million in 2007. Net interest income increased primarily due to increases in average earning assets, particularly a 22.4% increase in commercial loans as a result of our continued strategic focus on commercial lending as a key driver of the business. Interest income increased $511,000, or 0.4%, from $118.0 million in 2007 to $118.5 million in 2008. The increase was driven primarily by increases in average earning assets. Interest expense decreased $8.2 million, or 12.9%, from $63.4 million in 2007 to $55.2 million in 2008. The decrease was primarily the result of a 101 basis point decrease in the Company's daily cost of funds over the year due to a decrease in market rates over the same time period. The Company had a net interest margin of 3.14% in 2008 versus 3.22% in
2007, primarily due to a decline in the prime rate from 7.25% to 3.25% during 2008, which was led by changes in the Fed Fund rate by the Federal Open Market Committee. Average earning assets increased by $318.5 million from $1.7 billion in 2007 to $2.0 billion in 2008. This increase was due primarily to loan growth led by significant growth in five counties: St. Joseph, Kosciusko, Allen, Hamilton and Elkhart and with balanced growth in the Bank's other regions. Deposits increased to fund the loan growth during 2008, driven primarily by increases of $69.3 million in interest bearing transaction accounts, $37.3 million in average brokered deposit balances and $36.9 million in average other time deposit account balances. The increase in interest bearing transaction accounts was driven primarily by the addition of a new product, which pays a higher interest rate on balances up to a maximum balance amount when certain conditions are met during each interest cycle. In addition, loan growth was funded by a $97.0 million increase in the average balance in Federal Home Loan Bank advances. Management believes that the growth in the loan portfolio will likely continue in a measured, but prudent fashion as a result of our strategic focus on commercial lending and in conjunction with the general expansion and penetration of the geographical markets the Company serves, as well as our expansion in the Indianapolis market and the continued progress that we are making in that relatively new market.
Nonaccrual loans were $20.8 million, or 1.14% of total loans, at year end versus $7.0 million, or 0.46% of total loans, at the end of 2007. There were 22 relationships totaling $20.3 million classified as impaired as of December 31, 2008 versus five relationships totaling $6.7 million at the end of 2007. The increase in impaired and nonperforming loans resulted primarily from the addition of four commercial relationships totaling $14.4 million. Net charge-offs were $7.1 million in 2008 versus $3.0 million in 2007, representing 0.43% and 0.21% of average daily loans in 2008 and 2007. Total nonperforming loans were $21.3 million, or 1.16% of total loans, at year end 2008 versus $7.4 million, or 0.49% of total loans, at the end of 2007. The provision for loan loss expense was $10.2 million in 2008, resulting in an allowance for loan losses at December 31, 2008 of $18.9 million, which represented 1.03% of the loan portfolio, versus a provision for loan loss expense of $4.3 million in 2007 and an allowance for loan losses of $15.8 million at the end of 2007, or 1.04% of the loan portfolio. The higher provision in 2008 versus 2007 was attributable to a number of factors, but was primarily a result of an increase in net charge-offs, general growth in the loan portfolio, as well as higher allocations on specific watch list credits. The level of loan loss provision was also influenced by other factors related to the growth in the loan portfolio, such as the continued emerging market risk, the continued emerging concentration risk, commercial loan focus and large credit concentration, new industry lending activity, general economic conditions and historical loss percentages. In addition, management gave consideration to changes in the allocation for specific watch list credits in determining the appropriate level of the loan loss provision. Management's overall view on current credit quality was also a factor in the determination of the provision for loan losses. The Company's management continues to monitor the adequacy of the provision based on loan levels, asset quality, economic conditions and other factors that may influence the assessment of the collectability of loans.
Noninterest income was $23.3 million in 2008 versus $20.2 million in 2007, an increase of $3.1 million, or 15.3%. The 2008 increase was driven by a $1.4 million, or 18.9%, increase in service charges on deposit accounts. The increase was due primarily to increases in retail NSF fees and account analysis service charges on commercial checking accounts, which are generally higher when the earnings allowance credit rate is lower. Additionally, noninterest income increased due to a nonrecurring gain of $642,000 related to the VISA initial public offering and the redemption of some of the shares we owned in connection with the offering. Investment brokerage fees increased $381,000, or 25.6%, due to increased trade volume. Loan, insurance and service fees increased $328,000, or 13.2%, driven by higher fee income on debit card activity.
Noninterest expense increased $4.6 million, or 10.6%, from $42.9 million in 2007 to $47.5 million in 2008. Other expense increased by $1.8 million, or 20.1%, driven by regulatory expenses which increased by $1.5 million due to the Company's resumption of regular FDIC insurance premiums, as prior credits expired early in 2008. We expect our premiums to continue to increase as we increase our deposit base and as the FDIC will charge higher assessments due to the current troubled economy. Salaries and employee benefits increased by $1.7 million, or 7.0%, driven by normal salary increases, increased health insurance and performance-based incentive expense, the addition of revenue producing staff and enhanced staff in administrative positions. Data processing fees and supplies increased $549,000, or 17.7%, driven by the implementation of a new corporate treasury management platform and contractual increases in existing operating services. Net occupancy expense increased by $348,000, or 12.7%, primarily as a result of higher maintenance and repair costs and higher property tax expense that resulted from the Indiana property tax reapportionment process.
As a result of these factors, income before income tax expense increased $1.3 million, or 4.8%, from $27.6 million in 2007 to $28.9 million in 2008. Income tax expense was $9.2 million in 2008 versus $8.4 million in 2007. Income tax as a percentage of income before tax was 31.8% in 2008 versus 30.3% in 2007. The increase in the tax rate was driven by a lower percentage of revenue being derived from tax-advantaged sources in 2008 versus 2007. Net income increased $490,000, or 2.6%, to $19.7 million in 2008 versus $19.2 million in 2007. Basic earnings per
share in 2008 was $1.61, an increase of 1.9%, versus $1.58 in 2007. The Company's net income performance represented a 13.5% return on January 1, 2008, stockholders' equity versus 14.8% in 2007. The net income performance resulted in a 0.91% return on average daily assets in 2008 versus 1.04% in 2007.
RESULTS OF OPERATIONS
2007 versus 2006
The Company reported record net income of $19.2 million in 2007, an increase of $490,000, or 2.6%, versus net income of $18.7 million in 2006. Net interest income increased $2.2 million, or 4.3%, to $54.6 million versus $52.3 million in 2006. Net interest income increased primarily due to increases in average earning assets, particularly a 14% increase in commercial loans as a result of our strategic focus on commercial lending. Interest income increased $12.4 million, or 11.8%, from $105.6 million in 2006 to $118.0 million in 2007. The increase was driven primarily by increases in average earning assets, as well as a 14 basis point increase in the tax equivalent yield on average earning assets over the year. Interest expense increased $10.2 million, or 19.2%, from $53.2 million in 2006 to $63.4 million in 2007. The increase was primarily the result of a 36 basis point increase in the Company's daily cost of funds over the year. The Company had a net interest margin of 3.22% in 2007 versus 3.38% in 2006. Average earning assets increased by $148.7 million from $1.6 billion in 2006 to $1.7 billion in 2007. This loan growth was led by significant growth in Elkhart and Allen Counties and with balanced growth in the Bank's other regions. Deposits increased to fund the loan growth during 2007, driven primarily by increases of $23.9 million in average brokered deposit balances, $20.5 million in interest bearing transaction accounts and $39.1 million in average other time deposit account balances.
Nonaccrual loans were $7.0 million, or 0.46% of total loans, at year end versus $13.8 million, or 1.02% of total loans, at the end of 2006. There were five relationships totaling $6.7 million classified as impaired as of December 31, 2007 versus five relationships totaling $13.3 million at the end of 2006. The decrease in impaired and nonperforming loans resulted from the transfer to other real estate of a single borrowing relationship, a residential and commercial real estate developer. Net charge-offs were $3.0 million in 2007 versus $955,000 in 2006, representing 0.21% and 0.08% of average daily loans in 2007 and 2006. Total nonperforming loans were $7.4 million, or 0.49% of total loans, at year end 2007 versus $14.1 million, or 1.04% of total loans, at the end of 2006. The provision for loan loss expense was $4.3 million in 2007, resulting in an allowance for loan losses at December 31, 2007 of $15.8 million, which represented 1.04% of the loan portfolio, versus a provision for loan loss expense of $2.6 million in 2006 and an allowance for loan losses of $14.5 million at the end of 2006, or 1.07% of the loan portfolio. The higher provision in 2007 versus 2006 was attributable to a number of factors, but was primarily a result of an increase in net charge-offs, general growth in the loan portfolio, as well as higher allocations on specific watch list credits. The level of loan loss provision was also influenced by other factors related to the growth in the loan portfolio, such as emerging market risk, commercial loan focus and large credit concentration, new industry lending activity, general economic conditions and historical loss percentages. In addition, management gave consideration to changes in the allocation for specific watch list credits in determining the appropriate level of the loan loss provision. Management's overall view on current credit quality was also a factor in the determination of the provision for loan losses. The Company's management continued to monitor the adequacy of the provision based on loan levels, asset quality, economic conditions and other factors that may influence the assessment of the collectability of loans.
Noninterest income was $20.2 million in 2007 versus $18.8 million in 2006, an increase of $1.4 million, or 7.7%. The 2007 increase was driven by a $592,000, or 23.2%, increase in wealth advisory fees. Additionally, noninterest income increased due to a $201,000, or 15.6%, increase in investment brokerage fees. Merchant card fee income increased due to higher volume activity in interchange and merchant fees as well as new business generation. Loan, insurance and service fees increased $191,000, or 8.3%, driven by higher fee income on debit card activity. Offsetting these increases was a decrease of $109,000, or 5.6%, in other income.
Noninterest expense increased $2.7 million, or 6.7%, from $40.2 million in 2006 to $42.9 million in 2007. Salaries and employee benefits increased by $1.4 million, or 6.4%, driven by normal salary increases and higher health care cost, which represented approximately $542,000 of the total increase. Data processing fees and supplies increased $449,000, or 18.3%, driven by higher data processing fees, software license fees and maintenance fees related to new services offered to clients. Net occupancy expense increased from $2.5 million in 2006 to $2.7 million in 2007, primarily as a result of higher maintenance and repair costs and higher property tax expense.
As a result of these factors, income before income tax expense decreased $658,000, or 2.3%, from $28.2 million in 2006 to $27.6 million in 2007. Income tax expense was $8.4 million in 2007 versus $9.5 million in 2006. Income tax as a percentage of income before tax was 30.3% in 2007 versus 33.7% in 2006. The decrease in the tax rate was driven by the formation of a captive real estate investment trust in the fourth quarter of 2006, which
provides the Company with an alternative vehicle for raising capital should the need arise. Additionally, the ownership structure of this real estate investment trust provided certain state income tax benefits which also lowered the Company's effective tax rate. Net income increased $490,000, or 2.6%, to $19.2 million in 2007 versus $18.7 million in 2006. Basic earnings per share in 2007 was $1.58, an increase of 1.9%, versus $1.55 in 2006. The Company's net income performance represented a 14.8% return on January 1, 2007, stockholders' equity versus 16.5% in 2006. The net income performance resulted in a 1.04% return on average daily assets in 2007 versus 1.10% in 2006.
FINANCIAL CONDITION
As of December 31, 2008, the Company had 43 offices serving twelve counties in northern Indiana and one loan production office in Indianapolis. Since 1996, the Company has added seventeen new offices through acquisition and internal growth. The Company will consider future acquisition and expansion opportunities with an emphasis on markets that it believes would be receptive to its business philosophy of client-focused, independent banking, as well as increased penetration in existing markets where opportunities for market share growth exist.
Total assets of the Company were $2.377 billion as of December 31, 2008, an increase of $388.3 million, or 19.5%, when compared to $1.989 billion as of December 31, 2007.
Total cash and cash equivalents decreased by $3.7 million, or 5.4%, to $64.0 million at December 31, 2008 from $67.7 million at December 31, 2007.
Total securities available for sale increased by $59.3 million, or 18.1%, to $387.0 million at December 31, 2008 from $327.8 million at December 31, 2007. The portfolio contains mostly collateralized mortgage obligations and other securities which are either directly or indirectly backed by the federal government or a local municipal government and collateralized mortgage obligations rated AAA by S&P or Aaa by Moody's at the time of purchase. As of December 31, 2008, the Company had $85.1 million of collateralized mortgage obligations which were not issued by the federal government or government sponsored agencies, but were rated AAA by S&P and/or Aaa by Moody's at the time of purchase. The investment portfolio did not contain any corporate debt instruments or trust preferred instruments as of December 31, 2008. The increase was a result of a number of activities in the securities portfolio. Paydowns from prepayments of $51.7 million were received, and the amortization of premiums, net of the accretion of discounts, was $41,000. Maturities and calls of securities totaled $14.8 million. These portfolio decreases were offset by securities purchases totaling $143.2 million. The fair value of the securities decreased $17.4 million due to the liquidity crisis that affected financial markets in 2008 and the current unsettled economic situation which resulted in lower market values for securities which were not backed directly or indirectly by the federal government (private label MBS). The investment portfolio is managed to provide for an appropriate balance between credit risk and investment return and to limit the Company's exposure to risk to an acceptable level.
Fourteen of the 24 private label MBS were still rated AAA/Aaa as of December 31, 2008, but ten were downgraded by S&P, Fitch and/or Moody's, including four which were ranked below investment grade by one or more rating agencies. The Company, with the assistance of an outside expert, analyzes projections for all of these securities that includes projections of future performance in the underlying collateral under various scenarios and under various prepayment assumptions. Based on the analyses as of December 31, 2008, the projections indicate that principal and interest payments expected to be collected over the life of the securities equaled or exceeded the current book value of these securities including interest, and no other than temporary impairment had been recorded as of the end of the year.
Real estate mortgages held for sale decreased by $136,000, or 25.3%, to $401,000 at December 31, 2008 from $537,000 at December 31, 2007. The balance of this asset category is subject to a high degree of variability depending on, among other things, recent mortgage loan rates and the timing of loan sales into the secondary market. During 2008, $41.0 million in real estate mortgages were originated for sale and $40.8 million in mortgages were sold, compared to $37.5 million and $38.9 million in 2007.
Total loans, excluding real estate mortgages held for sale, increased by $309.6 million, or 20.3%, to $1.833 billion at December 31, 2008 from $1.524 billion at December 31, 2007. The mix of loan types within the Company's portfolio continued a trend toward a higher percentage of the total loan portfolio being in commercial loans. This general increase in commercial loans is a result of the Company's long standing strategic focus toward emphasizing origination of commercial loans. The portfolio breakdown at year end 2008 reflected 84% commercial and industrial and agri-business, 13% residential real estate and home equity and 3% consumer loans compared to 82% commercial and industrial and agri-business, 15% residential real estate and home equity and 3% consumer loans at December 31, 2007.
At December 31, 2008, the allowance for loan losses was $18.9 million, or 1.03% of total loans outstanding, versus $15.8 million, or 1.04% of total loans outstanding at December 31, 2007. The process of identifying probable credit losses is a subjective process. Therefore, the Company maintains a general allowance to cover probable incurred credit losses within the entire portfolio. The methodology management uses to determine the adequacy of the loan loss reserve includes the following considerations.
The Company has a relatively high percentage of commercial and commercial real estate loans, most of which are extended to small- or medium-sized businesses. Commercial loans represent higher dollar loans to fewer customers and therefore higher credit risk than other types of loans. Pricing is adjusted to manage the higher credit risk associated with these types of loans. The majority of fixed rate mortgage loans, which represent increased interest rate risk, are sold in the secondary market, as well as some variable rate mortgage loans. The remainder of the variable rate mortgage loans and a small number of fixed rate mortgage loans are retained. Management believes the allowance for loan losses is at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions do not stabilize or improve, certain borrowers may experience difficulty and the level of nonperforming loans, charge-offs and delinquencies could rise and require further increases in the provision for loan losses.
Loans are charged against the allowance for loan losses when management believes that the principal is uncollectible. Subsequent recoveries, if any, are credited to the allowance. The allowance is an amount that management believes will be adequate to absorb probable incurred credit losses relating to specifically identified loans based on an evaluation, as well as other probable incurred losses inherent in the loan portfolio. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and current economic conditions that may affect the borrower's ability to repay. Management also considers trends in adversely classified loans based upon a monthly review of those credits. An appropriate level of general allowance is determined after considering the following factors: application of historical loss percentages, emerging market risk, commercial loan focus and large credit concentrations, new industry lending activity and current economic conditions. Federal regulations require insured institutions to classify their own assets on a regular basis. The regulations provide for three categories of classified loans - substandard, doubtful and loss. The regulations also contain a special mention category. Special mention is defined as loans that do not currently expose an insured institution to a sufficient degree of risk to warrant classification, but do possess credit deficiencies or potential weaknesses deserving management's close attention. Assets classified as substandard or doubtful require the institution to establish specific allowances for loan losses. If an asset or portion thereof is classified as loss, the insured institution must either establish specified allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge off such amount. At December 31, 2008, on the basis of management's review of the loan portfolio, the Company had loans totaling $98.8 million on the classified loan list versus $79.3 million on December 31, 2007. As of December 31, 2008, the Company had $47.2 million of assets classified special mention, $46.2 million classified as substandard, $5.4 million classified as doubtful and $0 classified as loss as compared to $39.4 million, $39.7 million, $244,000 and $0 at December 31, 2007.
Allowance estimates are developed by management taking into account actual loss experience, adjusted for current economic conditions. The Company discusses this methodology with regulatory authorities to ensure compliance. Allowance estimates are considered a prudent measurement of the risk in the Company's loan portfolio and are applied to individual loans based on loan type. In accordance with FASB Statements 5 and 114, the allowance is provided for losses that have been incurred as of the balance sheet date and is based on past events and current economic conditions, and does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. For a more thorough discussion of the allowance for loan losses methodology see the Critical Accounting Policies section of this Item.
The allowance for loan losses increased $3.1 million from $15.8 million December 31, 2007 to $18.9 million at December 31, 2008. Pooled loan allocations increased $2.1 million from $4.9 million at December 31, 2007 to $7.0 million at December 31, 2008, which was a result of an increase in pooled loan balances of $290.0 million year over year and an increase in commercial loan allocations due to the current economic environment. Specific loan allocations decreased $182,000 from $10.6 million at December 31, 2007 to $10.4 million at December 31, 2008. This decrease was primarily due to the payoffs received on previously classified commercial credits, charge-offs taken during 2008 as well as the well-collateralized nature of newly classified loans. The unallocated component of the allowance for loan losses increased $1.1 million from $322,000 at December 31, 2007 to $1.4 million at December 31, 2008 primarily due to the uncertainty in the current economic conditions.
The Company has experienced growth in total loans over the last three years of $634.6 million, or 52.9%. The concentration of this loan growth was in the commercial loan portfolio. Commercial loans comprised 84%, 82% and 80% of the total loan portfolio at December 31, 2008, 2007 and 2006. Traditionally, this type of lending may have more credit risk than other types of lending because of the size and diversity of the credits. The Company
manages this risk by adjusting its pricing to the perceived risk of each individual credit and by diversifying the portfolio by customer, product, industry and geography. Management has historically considered growth and portfolio composition when determining loan loss allocations. Management believes that it is prudent to continue to provide for loan losses in a manner consistent with its historical approach due to the loan growth described above and current economic conditions.
As a result of the methodology in determining the adequacy of the allowance for loan losses, the provision for loan losses was $10.2 million in 2008 versus $4.3 million in 2007. At December 31, 2008, total nonperforming loans increased by $13.8 million to $21.3 million from $7.4 million at December 31, 2007. Loans delinquent 90 days or more that were included in the accompanying financial statements as accruing totaled $478,000 versus $409,000 at December 31, 2007. Total impaired loans increased by $13.6 million to $20.3 million at December 31, 2008 from $6.7 million at December 31, 2007. The increase in impaired and nonperforming loans resulted from the addition of four commercial relationships totaling $14.4 million. The $20.3 million in impaired loans are all in nonaccrual status. The Company allocated $3.2 million and $2.3 million of the allowance for loan losses to the impaired loans in 2008 and 2007. A loan is impaired when full payment under the original loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature . . .
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