ITEM 1 - Business
GENERAL
Lakeland Bancorp, Inc. (the “Company” or “Lakeland Bancorp”) is a bank holding company headquartered in Oak Ridge, New Jersey. The Company was organized in March of 1989 and commenced operations on May 19, 1989, upon the consummation of the acquisition of all of the outstanding stock of Lakeland Bank, formerly named Lakeland State Bank (“Lakeland” or the “Bank”). Through Lakeland, the Company operates 47 banking offices, located in Morris, Passaic, Sussex, Warren, Essex and Bergen counties in New Jersey. Lakeland offers a full range of lending services, including commercial loans and leases, real estate and consumer loans to small and medium-sized businesses, professionals and individuals located in its markets.
Over the last decade, the Company has shown substantial growth through a combination of organic growth and acquisitions. Since 1998, Lakeland has opened eighteen new branch offices and the Company has also acquired four community banks with an aggregate asset total of approximately $780 million. All of the acquired banks have been merged into Lakeland and their holding companies, if applicable, have been merged into the Company.
At December 31, 2011, the Company had total consolidated assets of $2.8 billion, total consolidated deposits of $2.2 billion, total consolidated loans, net of the allowance for loan and lease losses, of $2.0 billion and total consolidated stockholders’ equity of $259.8 million.
This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (“Forward-Looking Statements”). Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in such Forward-Looking Statements. Certain factors which could materially affect such results and the future performance of the Company are described in Item 1A
ITEM 1A - Risk Factors.
Our business, financial condition, operating results and cash flows can be affected by a number of factors, including, but not limited to, those set forth below, any one of which could cause our actual results to vary materially from recent results or from our anticipated future results.
Recently enacted legislation, particularly the Dodd-Frank Act, could materially and adversely affect us by increasing compliance costs, heightening our risk of noncompliance with applicable regulations, and changing the competitive landscape in the banking industry.
From time to time, the U.S. Congress and state legislatures consider changing laws and enact new laws to further regulate the financial services industry. On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or the Dodd-Frank Act, was signed into law. The Dodd-Frank Act has resulted
in sweeping changes in the regulation of financial institutions. As discussed in the section herein entitled “Business-Supervision and Regulation,” the Dodd-Frank Act contains numerous provisions that affect all banks and bank holding companies. Many of the provisions in the Dodd-Frank Act remain subject to regulatory rule-making and implementation, the effects of which are not yet known. Although we cannot predict the specific impact and long-term effects that the Dodd-Frank Act and the regulations promulgated thereunder will have on us and our prospects, our target markets and the financial industry more generally, we believe that the Dodd-Frank Act and the regulations promulgated thereunder are likely to impose additional administrative and regulatory burdens that will obligate us to incur additional expenses and will adversely affect our margins and profitability. For example, the elimination of the prohibition on the payment of interest on demand deposits could materially increase our interest expense, depending on our competitors’ responses. Provisions in the legislation that require revisions to the capital requirements of the Company and the Bank could require the Company and the Bank to seek additional sources of capital in the future. More stringent consumer protection regulations could materially and adversely affect our profitability. We will also have a heightened risk of noncompliance with all of the additional regulations. Finally, the impact of some of these new regulations is not known and may affect our ability to compete long-term with larger competitors.
The Federal Reserve’s repeal of the prohibition against payment of interest on demand deposits may increase competition for such deposits and ultimately increase interest expense.
A major portion of our net income comes from our interest rate spread, which is the difference between the interest rates paid by us on amounts used to fund assets and the interest rates and fees we receive on our interest-earning assets. Our interest-earning assets include outstanding loans extended to our customers and securities held in our investment portfolio. We fund assets using deposits and other borrowings.
On July 14, 2011, the Federal Reserve issued final rules to repeal Regulation Q, which had prohibited the payment of interest on demand deposits by institutions that are member banks of the Federal Reserve System. The final rules implement Section 627 of the Dodd-Frank Act, which repealed Section 19(i) of the Federal Reserve Act in its entirety effective July 21, 2011. As a result, banks and thrifts are now permitted to offer interest-bearing demand deposit accounts to commercial customers, which were previously forbidden under Regulation Q. The repeal of Regulation Q may cause increased competition from other financial institutions for these deposits. If we decide to pay interest on demand accounts, we would expect our interest expense to increase.
The Company and the Bank may be subject to more stringent capital and liquidity requirements.
The Dodd-Frank Act also imposes more stringent capital requirements on bank holding companies such as Lakeland Bancorp by, among other things, imposing leverage ratios on bank holding companies and prohibiting new trust preferred issuances from counting as Tier I capital. These restrictions will limit our future capital strategies. Under the Dodd-Frank Act, our currently outstanding trust preferred securities will continue to count as Tier I capital, but we will be unable to issue replacement or additional trust preferred securities which would count as Tier I capital.
On December 20, 2011, the Federal Reserve announced its intention to implement substantially all of the Basel III rules which would generally be applicable to institutions with greater than $50 billion in assets. Banking regulators could implement additional changes to the capital adequacy standards applicable to financial institutions with $50 billion or less in assets, such as the Company and Lakeland in light of Basel III.
Future increases in minimum capital requirements could adversely affect our net income. Furthermore, our failure to comply with the minimum capital requirements could result in our regulators taking formal or informal actions against us which could restrict our future growth or operations.
Recent negative developments in the financial services industry and U.S. and global credit markets may adversely impact our operations and results.
The general economic downturn during the past few years, including a decline in the value of the collateral supporting loans, has resulted in the deterioration of loan portfolio performances at many institutions. The competition for our deposits has increased significantly due to liquidity concerns at many of these same institutions. Stock prices of bank holding companies, like ours, have been negatively affected by the current condition of the financial markets, as has our ability, if needed, to raise capital or borrow in the debt markets compared to prior years. While economic growth may have resumed recently, the rate of this growth has been very slow and unemployment remains at a high level. As a result, recent legislation, such as the Dodd-Frank Act, will require new regulations regarding lending and funding practices and liquidity standards, and financial institution regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement actions. Negative developments in the financial services industry and the impact of new legislation, including The Dodd-Frank Act, in response to those developments could negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance.
The downgrade of the U.S. credit rating and Europe’s debt crisis could have a material adverse effect on our business, financial condition and liquidity.
Standard & Poor’s lowered its long term sovereign credit rating on the United States of America from AAA to AA+ on August 5, 2011. A further downgrade or a downgrade by other rating agencies could have a material adverse impact on financial markets and economic conditions in the United States and worldwide. Any such adverse impact could have a material adverse effect on our liquidity, financial condition and results of operations. Many of our investment securities are issued by and some of our loans are made to U.S. government agencies and U.S. government sponsored entities.
In addition, the possibility that certain European Union (“EU”) member states will default on their debt obligations have negatively impacted economic conditions and global markets. The continued uncertainty over the outcome of international and the EU’s financial support programs and the possibility that other EU member states may experience similar financial troubles could further disrupt global markets. The negative impact on economic conditions and global markets could also have a material adverse effect on our liquidity, financial condition and results of operations.
A decrease in our ability to borrow funds could adversely affect our liquidity.
Our ability to obtain funding from the Federal Home Loan Bank or through our overnight federal funds lines with other banks could be negatively affected if we experienced a substantial deterioration in our financial condition or if such funding became restricted due to a further deterioration in the financial markets. While we have a contingency funds management plan to address such a situation if it were to occur (such plan includes deposit promotions, the sale of securities and the curtailment of loan growth, if necessary), a significant decrease in our ability to borrow funds could adversely affect our liquidity.
We are subject to interest rate risk and variations in interest rates may negatively affect our financial performance.
We are unable to predict actual fluctuations of market interest rates. Rate fluctuations are influenced by many factors, including:
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inflation or deflation
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excess growth or recession;
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a rise or fall in unemployment;
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tightening or expansion of the money supply;
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domestic and international disorder; and
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instability in domestic and foreign financial markets.
Both increases and decreases in the interest rate environment may reduce our profits. We expect that we will continue to realize income from the difference or “spread” between the interest we earn on loans, securities and other interest-earning assets, and the interest we pay on deposits, borrowings and other interest-bearing liabilities. Our net interest spreads are affected by the differences between the maturities and repricing characteristics of our interest-earning assets and interest-bearing liabilities. Our interest-earning assets may not reprice as slowly or rapidly as our interest-bearing liabilities. Changes in market interest rates could materially and adversely affect our net interest spread, asset quality, levels of prepayments, cash flows, the market value of our securities portfolio, loan and deposit growth, costs and yields on loans and deposits and our overall profitability.
The Company may incur impairment to goodwill.
We review our goodwill at least annually. Significant negative industry or economic trends, including the lack of recovery in the market place of our common stock price, reduced estimates of future cash flows or disruptions to our businesses, could indicate that goodwill might be impaired. Our valuation methodology for assessing impairment requires management to make judgments and assumptions based on historical experience and to rely on projections of future operating performance. We operate in a competitive environment and projections of future operating results and cash flows may vary significantly from actual results. Additionally, if our analysis results in an impairment to our goodwill, we would be required to record a non-cash charge to earnings in our financial statements during the period in which such impairment is determined to exist. Any such charge could have a material adverse effect on our results of operations and our stock price.
The extensive regulation and supervision to which we are subject impose substantial restrictions on our business.
The Company, Lakeland and certain non-bank subsidiaries are subject to extensive regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole. Such laws are not designed to protect our shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Lakeland is also subject to a number of laws which, among other things, govern its lending practices and require the Bank to establish and maintain comprehensive programs relating to anti-money laundering and customer identification. The United States Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputational damage, which could have a material adverse effect on our business, financial condition and results of operations.
Current levels of volatility in the capital markets are unprecedented and may adversely impact our operations and results.
The capital markets have been experiencing unprecedented volatility for the past several years. Such negative developments and disruptions have resulted in uncertainty in the financial markets and a general economic downturn. Bank and bank holding company stock prices have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets compared to prior years. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our business, financial condition and results of operations or our ability to access capital.
Lakeland’s ability to pay dividends is subject to regulatory limitations which, to the extent that our holding company requires such dividends in the future, may affect our holding company’s ability to pay its obligations and pay dividends to shareholders.
As a bank holding company, the Company is a separate legal entity from Lakeland and its subsidiaries, and we do not have significant operations of our own. We currently depend on Lakeland’s cash and liquidity to pay our operating expenses and dividends to shareholders. The availability of dividends from Lakeland is limited by various statutes and regulations. The inability of the Company to receive dividends from Lakeland could adversely affect our financial condition, results of operations, cash flows and prospects and the Company’s ability to pay dividends.
Our allowance for loan and lease losses may not be adequate to cover actual losses.
Like all commercial banks, Lakeland maintains an allowance for loan and lease losses to provide for loan and lease defaults and non-performance. If our allowance for loan and lease losses is not adequate to cover actual loan and lease losses, we may be required to significantly increase future provisions for loan and lease losses, which could materially and adversely affect our operating results. In 2011, we recorded a provision for loan and lease losses of $18.8 million, compared to $19.3 million in 2010. Our allowance for loan and lease losses is determined by analyzing historical loan and lease losses, current trends in delinquencies and charge-offs, plans for problem loan and lease resolution, the opinions of our regulators, changes in the size and composition of the loan and lease portfolio and industry information. We also consider the possible effects of economic events, which are difficult to predict. The amount of future losses is affected by changes in economic, operating and other conditions, including changes in interest rates, many of which are beyond our control. These losses may exceed our current estimates. Federal regulatory agencies, as an integral part of their examination process, review our loans and the allowance for loan and lease losses. While we believe that our allowance for loan and lease losses in relation to our current loan portfolio is adequate to cover current losses, we cannot assure you that we will not need to increase our allowance for loan and lease losses or that regulators will not require us to increase this allowance. Future increases in our allowance for loan and lease losses could materially and adversely affect our earnings and profitability.
We are subject to various lending and other economic risks that could adversely affect our results of operations and financial condition.
Economic, political and market conditions, trends in industry and finance, legislative and regulatory changes, changes in governmental monetary and fiscal policies and inflation affect our business. These factors are beyond our control. A further deterioration in economic conditions, particularly in New Jersey, could have the following consequences, any of which could materially adversely affect our business:
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loan and lease delinquencies may increase;
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problem assets and foreclosures may increase;
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demand for our products and services may decrease; and
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collateral for loans made by us may decline in value, in turn reducing the borrowing ability of our customers.
Further deterioration in the real estate market, particularly in New Jersey, could adversely affect our business. As real estate values in New Jersey decline, our ability to recover on defaulted loans by selling the underlying real estate is reduced, which increases the possibility that we may suffer losses on defaulted loans.
We may suffer losses in our loan portfolio despite our underwriting practices.
We seek to mitigate the risks inherent in our loan portfolio by adhering to specific underwriting practices. Although we believe that our underwriting criteria are appropriate for the various kinds of loans that we make, we may incur losses on loans that meet our underwriting criteria, and these losses may exceed the amounts set aside as reserves in our allowance for loan and lease losses.
We face strong competition from other financial institutions, financial service companies and other organizations offering services similar to the services that we provide.
Many competitors offer the types of loans and banking services that we offer. These competitors include other state and national banks, savings associations, regional banks and other community banks. We also face competition from many other types of financial institutions, including finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. Many of our competitors have greater financial resources than we do, which may enable them to offer a broader range of services and products, and to advertise more extensively, than we do. Our inability to compete effectively would adversely affect our business.
Declines in value may adversely impact our investment portfolio.
As of December 31, 2011, the Company had approximately $471.9 million and $71.7 million in available for sale and held to maturity investment securities, respectively. We may be required to record impairment charges on our investment securities if they suffer a decline in value that is considered other-than-temporary. Numerous factors, including lack of liquidity for sales of certain investment securities, absence of reliable pricing information for investment securities, adverse changes in business climate, adverse actions by regulators, or unanticipated changes in the competitive environment could have a negative effect on our investment portfolio in future periods. If an impairment charge is significant enough it could affect the ability of Lakeland to upstream dividends to us, which could have a material adverse effect on our liquidity and our ability to pay dividends to shareholders and could also negatively impact our regulatory capital ratios.
Concern of customers over deposit insurance may cause a decrease in deposits.
With recent increased concerns about bank failures, customers increasingly are concerned about the extent to which their deposits are insured by the FDIC. Customers may withdraw deposits in an effort to ensure that the amount they have on deposit with their bank is fully insured. Decreases in deposits may adversely affect our funding costs and net income.
Further increases in FDIC premiums could have a material adverse effect on our future earnings.
The FDIC insures deposits at FDIC insured financial institutions, including the Bank. The FDIC charges the insured financial institutions premiums to maintain the Deposit Insurance Fund at a certain level. In light of current economic conditions, the FDIC has increased its assessment rates and imposed special assessments. See “Business-Supervision and Regulation-Federal Deposit Insurance and Premiums.”
In addition, The Dodd-Frank Act amended the Federal Deposit Insurance Act by changing the base against which an insured depository institution’s deposit insurance assessment is calculated. These amendments require the appropriate assessment base to be calculated as the institution’s average consolidated total assets minus average tangible equity, rather than the institution’s deposits. The FDIC’s implementing regulation for these amendments became effective for the quarter beginning April 1, 2011 and was reflected in invoices for assessments due September 30, 2011. These developments have caused, and may cause in the future, an increase to our assessments. The FDIC may be required to make additional increases to the assessment rates and levy additional special assessments on us in the future, which could have a material adverse effect on our future earnings.
A breach of information security could negatively affect our operations, earnings and reputation.
Increasingly, we depend upon data processing, communication and information exchange on a variety of computing platforms and networks, and over the internet. We cannot be certain all our systems are entirely free from vulnerability to attack, despite safeguards we have instituted including independent third party testing. In
addition, we rely on the services of a variety of vendors to meet our data processing and communication needs. Disruptions to our vendors’ systems may arise from events that are wholly or partially beyond our vendors’ control (including, for example, computer viruses or electrical or telecommunications outages). The occurrence of system failures or security breaches, despite the controls we have instituted, could result in damage to our reputation, increased regulatory scrutiny and financial loss or costs to us.
Any unforeseen transition issues that arise in connection with upgrades to our computer hardware and software systems could adversely affect our business.
In the normal course of business, we upgrade certain hardware and software systems critical to our core banking operations and financial reporting. While we expect these changes to go smoothly, no assurances can be given that unforeseen issues will not arise. Depending on the nature of those issues, if any, and the time and resources necessary to correct or resolve them, our business could be adversely affected.
If we do not successfully integrate any banks that we may acquire in the future, the combined company may be adversely affected.
If we make acquisitions in the future, we will need to integrate the acquired entities into our existing business and systems. We may experience difficulties in accomplishing this integration or in effectively managing the combined company after any future acquisition. Any actual cost savings or revenue enhancements that we may anticipate from a future acquisition will depend on future expense levels and operating results, the timing of certain events and general industry, regulatory and business conditions. Many of these events will be beyond our control, and we cannot assure you that if we make any acquisitions in the future, we will be successful in integrating those businesses into our own.
ITEM 1B
ITEM 1B - Unresolved Staff Comments
Not Applicable.
ITEM 2
ITEM 2 - Properties
The Company’s principal office is located at 250 Oak Ridge Road, Oak Ridge, New Jersey 07438. It also maintains an operations center in Branchville, New Jersey.
The Company operates 47 banking locations in Passaic, Morris, Sussex, Bergen, Essex and Warren Counties, New Jersey. The following chart provides information about the Company’s leased banking locations:
Location
Lease Expiration Date
Bristol Glen
October 31, 2012
Caldwell
September 30, 2024
Carlstadt
July 15, 2016
Cedar Crest
August 19, 2016
Hackensack
March 31, 2013
Hampton
September 30, 2019
Little Falls
November 30, 2015
Madison Avenue
April 30, 2017
North Haledon
June 30, 2017
Park Ridge
December 31, 2014
Pompton Plains
March 31, 2015
Ringwood
February 28, 2013
Rochelle Park
January 12, 2019
Sussex/Wantage
June 19, 2017
Vernon
September 30, 2016
Wantage
October 31, 2016
Wayne
May 31, 2028
Wharton
July 31, 2015
Woodland Commons
August 31, 2016
West Caldwell
March 31, 2029
All other offices of the Company and Lakeland are owned and are unencumbered.
Additionally, the Company is constructing two new facilities, and has entered into lease agreements for both of them. A training and operations center is under construction in Milton, NJ, and is expected to be completed by mid-2012. The Bank purchased an assignment of an existing lease for this facility which expires on February 28, 2016 and contains five (5) five-year options to renew at the Bank’s discretion at fixed base rent amounts. To the extent that the Bank exercises all of the options, the lease will expire on February 28, 2041. The other site under construction is a new branch location in Sparta, NJ, which is expected to be completed in late 2012. The initial term of the lease for this facility expires on August 31, 2032. This lease contains two (2) ten-year renewal options.
ITEM 3
ITEM 3 - Legal Proceedings
During the fourth quarter of 2011, the Company and the International Association of Machinists and Aerospace Workers (the “plaintiff”) settled a complaint that had been filed by the plaintiff in February 2010, in the Circuit Court of Maryland for Prince George’s County, in connection with certain equipment leases plaintiff entered into with a vendor and lease broker not affiliated with the Company. Under the settlement agreement, which included a confidentiality provision, the Company provided a quitclaim assignment of its interests in the leases to the plaintiff in consideration of a lump sum payment by the plaintiff to the Company.
There are no pending legal proceedings involving the Company or Lakeland other than those arising in the normal course of business. Management does not anticipate that the potential liability, if any, arising out of such legal proceedings will have a material effect on the financial condition or results of operations of the Company and Lakeland on a consolidated basis.
ITEM 3A - Executive Officers of the Registrant
The following table sets forth the name and age of each executive officer of the Company. Each officer is appointed by the Company’s Board of Directors. Unless otherwise indicated, the persons named below have held the position indicated for more than the past five years.
ITEM 4
ITEM 4 - MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5
ITEM 5 - MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Shares of the common stock of Lakeland Bancorp, Inc. have been traded under the symbol “LBAI” on the NASDAQ Global Select Market (or the NASDAQ National Market) since February 22, 2000 and in the over the counter market prior to that date. As of December 31, 2011, there were 3,357 shareholders of record of the common stock. The following table sets forth the range of the high and low daily closing prices of the common stock as provided by NASDAQ and dividends declared for the periods presented. All information is adjusted for the Company’s 5% stock dividend distributed on February 16, 2011.
Dividends on the Company’s common stock are within the discretion of the Board of Directors of the Company and are dependent upon various factors, including the future earnings and financial condition of the Company and Lakeland and bank regulatory policies.
The Bank Holding Company Act of 1956 restricts the amount of dividends the Company can pay. Accordingly, dividends should generally only be paid out of current earnings, as defined.
The New Jersey Banking Act of 1948 restricts the amount of dividends paid on the capital stock of New Jersey chartered banks. Accordingly, no dividends shall be paid by such banks on their capital stock unless, following the payment of such dividends, the capital stock of the bank will be unimpaired and the bank will have a surplus of not less than 50% of its capital stock, or, if not, the payment of such dividend will not reduce the surplus of the bank. Under this limitation, approximately $224.3 million was available for the payment of dividends from Lakeland to the Company as of December 31, 2011.
Capital guidelines and other regulatory requirements may further limit the Company’s and Lakeland’s ability to pay dividends. See “Item 1 - Business-Supervision and Regulation-Dividend Restrictions.”
Performance Graph
The following chart compares the Company’s cumulative total shareholder return (on a dividend reinvested basis) over the past five years with the NASDAQ Market Index and the Peer Group Index. The Peer Group Index is the Zacks (formerly Morningstar) Regional Northeast Banks Index, which consists of 195 Regional Northeast Banks.
ITEM 6
ITEM 6 - Selected Financial Data
SELECTED CONSOLIDATED FINANCIAL DATA
The following should be read in conjunction with Management’s Discussion and Analysis and Results of Operations and the Company’s consolidated financial statements included in item 7
ITEM 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
This section presents a review of Lakeland Bancorp, Inc.’s consolidated results of operations and financial condition. You should read this section in conjunction with the selected consolidated financial data that is presented on the preceding page as well as the accompanying consolidated financial statements and notes to financial statements. As used in the following discussion, the term “Company” refers to Lakeland Bancorp, Inc. and “Lakeland” refers to the Company’s wholly owned banking subsidiary-Lakeland Bank.
Statements Regarding Forward-Looking Information
The information disclosed in this document includes various forward-looking statements that are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 with respect to credit quality (including delinquency trends and the allowance for loan and lease losses), corporate objectives, and other financial and business matters. The words “anticipates,” “projects,” “intends,” “estimates,” “expects,” “believes,” “plans,” “may,” “will,” “should,” “could,” and other similar expressions are intended to identify such forward-looking statements. The Company cautions that these forward-looking statements are necessarily speculative and speak only as of the date made, and are subject to numerous assumptions, risks and uncertainties, all of which may change over time. Actual results could differ materially from such forward-looking statements.
In addition to the risk factors disclosed elsewhere in this document, the following factors, among others, could cause the Company’s actual results to differ materially and adversely from such forward-looking statements: changes in the financial services industry and the U.S. and global capital markets, changes in economic conditions nationally, regionally and in the Company’s markets, the nature and timing of actions of the Federal Reserve Board and other regulators, the nature and timing of legislation affecting the financial services industry including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, government intervention in the U.S. financial system, changes in levels of market interest rates, pricing pressures on loan and deposit products, credit risks of the Company’s lending and leasing activities, customers’ acceptance of the Company’s products and services and competition.
The above-listed risk factors are not necessarily exhaustive, particularly as to possible future events, and new risk factors may emerge from time to time. Certain events may occur that could cause the Company’s actual results to be materially different than those described in the Company’s periodic filings with the Securities and Exchange Commission. Any statements made by the Company that are not historical facts should be considered to be forward-looking statements. The Company is not obligated to update and does not undertake to update any of its forward-looking statements made herein.
Critical Accounting Policies, Judgments and Estimates
The accounting and reporting policies of the Company and Lakeland conform with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and predominant practices within the banking industry. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. These estimates and assumptions also affect reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Significant estimates implicit in these financial statements are as follows. For additional accounting policies and detail, refer to Note 1 to the consolidated financial statements included in item 8 of this report.
Allowance for loan and lease losses. The allowance for loan and lease losses is established through a provision for loan and lease losses charged to expense. Loan principal considered to be uncollectible by management is charged against the allowance for loan and lease losses. The allowance is an amount that management believes will be adequate to absorb losses on existing loans and leases that may become uncollectible based upon an evaluation of known and inherent risks in the loan and lease portfolio. The evaluation takes into consideration such factors as changes in the nature and size of the loan and lease portfolio,
overall portfolio quality, specific problem loans and leases, and current economic conditions which may affect the borrowers’ ability to pay. The evaluation also analyzes historical losses by loan and lease category, and considers the resulting loss rates when determining the reserves on current loan and lease total amounts. Loss estimates for specified problem loans and leases are also detailed. All of the factors considered in the analysis of the adequacy of the allowance for loan and lease losses may be subject to change. To the extent actual outcomes differ from management estimates, additional provisions for loan and lease losses may be required that would adversely impact earnings in future periods.
Loans and leases are considered impaired when, based on current information and events, it is probable that Lakeland will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is measured based on the present value of expected cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral-dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable. Most of Lakeland’s impaired loans are collateral-dependent. Lakeland groups impaired commercial loans under $250,000 into a homogeneous pool and collectively evaluates them. Interest received on impaired loans and leases may be recorded as interest income. However, if management is not reasonably certain that an impaired loan and lease will be repaid in full, or if a specific time frame to resolve full collection cannot yet be reasonably determined, all payments received are recorded as reductions of principal.
Fair value measurements and fair value of financial instruments. Fair values of financial instruments are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates, credit ratings and yield curves. Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on the quoted prices of similar instruments or an estimate of fair value by using a range of fair value estimates in the market place as a result of the illiquid market specific to the type of security.
When the fair value of a security is below its amortized cost, and depending on the length of time the condition exists and the extent the fair value is below amortized cost, additional analysis is performed to determine whether an other-than-temporary impairment condition exists. Available-for-sale and held-to-maturity securities are analyzed quarterly for possible other-than-temporary impairment. The analysis considers (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Often, the information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment. If actual information or conditions are different than estimated, the extent of the impairment of the security may be different than previously estimated, which could have a material effect on the Company’s results of operations and financial condition.
Income taxes. The Company accounts for income taxes under the liability method of accounting for income taxes. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates that will be in effect when these differences reverse. Deferred tax expense is the result of changes in deferred tax assets and liabilities. The principal types of differences between assets and liabilities for financial statement and tax return purposes are allowance for loan and lease losses, core deposit intangible, deferred loan costs, deferred compensation and valuation reserves on leases held for sale.
The Company evaluates tax positions that may be uncertain using a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. Additional information regarding the Company’s uncertain tax positions is set forth in Note 9 to the Notes to the audited Consolidated Financial Statements contained herein.
Goodwill and other identifiable intangible assets. The Company reviews goodwill for impairment annually as of November 30 or when circumstances indicate a potential for impairment at the reporting unit level. U.S. GAAP requires at least an annual review of the fair value of a reporting unit that has goodwill in order to determine if it is more likely than not (that is, a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount, including goodwill. If this qualitative test determines it is unlikely (less than 50% probability) the carrying value of the Reporting Unit is less than its fair value, then the company does not have to perform a Step One impairment test. If the probability is greater than 50%, a Step One goodwill impairment test is required. The Step One test compares the fair value of each reporting unit to the carrying value of its net assets, including goodwill. The Company has determined that it has one reporting unit, Community Banking.
The Company performed a qualitative analysis to determine whether “the weight of evidence, the significance of all identified events and circumstances” indicated a greater than 50% likelihood existed that the carrying value of the Reporting Unit exceeded its fair value and if a Step One Test would be required. The Company identified nine qualitative assessments that are relative to the banking industry and to the Company. These factors included macroeconomic factors, banking industry conditions, banking merger and acquisition trends, Lakeland’s historical performance, the Company’s stock price, the expected performance of Lakeland, the change of control premium of the Company versus its peers and other miscellaneous factors. After reviewing and weighting these factors, the Company, as well as a third party adviser, determined as of November 30, 2011 that there was a less than 50% probability that the fair value of the Company was less than its carrying amount. Therefore, no Step One test was required.
Financial Overview
The year ended December 31, 2011 represented a year of continued growth for the Company. As discussed in this management’s discussion and analysis:
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Net income available to common shareholders increased $2.5 million or 16% to $17.7 million in 2011.
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Total loans, net of leases, increased $67.3 million, or 3%, from 2010 to 2011.
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Core deposits increased $107.1 million, or 6%, to $1.89 billion at year end 2011 and represented 84% of total deposits at December 31, 2011 compared to 81% at December 31, 2010.
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Total noninterest-bearing deposits of $449.6 million increased $65.7 million, or 17%, from 2010.
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Dividends on preferred stock and accretion declined from $4.0 million in 2010 to $2.2 million in 2011 reflecting repayments to the U.S. Department of the Treasury to repurchase preferred stock under the CPP. These repayments consisted of a $20.0 million repayment in August of 2010 and a $20.0 million repayment in March of 2011. The remaining shares of preferred stock issued to the Treasury were redeemed on February 8, 2012. On February 29, 2012, the Company repurchased the outstanding common stock warrant issued to the Treasury under the CPP for $2.8 million. For more information, please see Note 7 to the consolidated financial statements included in this report.
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The Company’s effective tax rate was 30.5% in 2011, compared to 34.5% in 2010. The decrease in the effective tax rate was driven by increased tax benefits attributable to the real estate investment trust (“REIT”) subsidiary established in December 2010.
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While non-performing assets of $50.2 million on December 31, 2011 increased $5.6 million from December 31, 2010, non-performing assets decreased $7.5 million from September 30, 2011 to December 31, 2011 due to the favorable resolution of several non-performing loans.
Net income for 2011 was $19.9 million compared to net income of $19.2 million in 2010. Net income available to common shareholders in 2011 was $17.7 million or $0.69 per diluted share compared to $15.2 million or $0.60 per diluted share in 2010.
Net interest income
Net interest income is the difference between interest income on earning assets and the cost of funds supporting those assets. The Company’s net interest income is determined by: (i) the volume of interest-earning assets that it holds and the yields that it earns on those assets, and (ii) the volume of interest-bearing liabilities that it has assumed and the rates that it pays on those liabilities. Net interest income increases when the Company can use noninterest- bearing deposits to fund or support interest-earning assets.
Net interest income for 2011 on a tax-equivalent basis was $98.5 million, representing a decrease of $2.3 million, or 2%, from the $100.8 million earned in 2010. The decrease in net interest income primarily resulted from a 34 basis point decrease in the yield on interest-earning assets, which was partially offset by a 25 basis point decline in the cost of interest-bearing liabilities. The net interest spread as a result declined nine basis points to 3.67%. Although the net interest spread declined, the decline was mitigated by an increase in income earned on free funds (interest-earning assets funded by non-interest bearing liabilities) resulting from an increase in average non-interest bearing deposits of $62.7 million. The components of net interest income will be discussed in greater detail below.
Interest income and expense volume/rate analysis. The following table shows the impact that changes in average balances of the Company’s assets and liabilities and changes in average interest rates have had on the Company’s net interest income over the past three years. This information is presented on a tax equivalent basis assuming a 35% tax rate. If a change in interest income or expense is attributable to a change in volume and a change in rate, the amount of the change is allocated proportionately.
INTEREST INCOME AND EXPENSE VOLUME/RATE ANALYSIS
(tax equivalent basis, in thousands)
The following table reflects the components of the Company’s net interest income, setting forth for the years presented, (1) average assets, liabilities and stockholders’ equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) the Company’s net interest spread (i.e., the average yield on interest-earning assets less the average cost of interest-bearing liabilities) and (5) the Company’s net interest margin. Rates are computed on a tax equivalent basis assuming a 35% tax rate.
CONSOLIDATED STATISTICS ON A TAX EQUIVALENT BASIS
(A) Includes non-accrual loans, the effect of which is to reduce the yield earned on loans, and deferred loan fees.
(B) Includes interest-bearing cash accounts.
(C) Net interest income on a tax equivalent basis divided by interest-earning assets.
Interest income on a tax equivalent basis decreased from $126.7 million in 2010 to $118.6 million in 2011, a decrease of $8.1 million, or 6%. The decrease in interest income was due to a 34 basis point decrease in the average yield on interest-earning assets, as a result of loans being refinanced at lower rates and lower yields on new loans and investments. The yield on average loans and leases at 5.24% in 2011 was 35 basis points lower than 2010. The yield on average taxable and tax-exempt investment securities decreased by 36 basis points to 2.36% and 52 basis points to 4.38%, respectively, in 2011.
Interest income on a tax equivalent basis decreased from $135.0 million in 2009 to $126.7 million in 2010, a decrease of $8.3 million, or 6%. The decrease in interest income was due primarily to a 37 basis point decrease in the average yield earned on interest-earning assets. This decrease reflects the declining interest rate environment along with a lower percentage of earning assets being deployed in loans and leases, as the size of the lease portfolio decreased by $53.3 million from the end of 2009. The yield on average loans and leases at 5.59% in 2010 was 24 basis points lower than 2009. The yield on average taxable investment securities decreased by 75 basis points to 2.72% in 2010.
Total interest expense decreased from $25.9 million in 2010 to $20.1 million in 2011, a decrease of $5.8 million, or 22%. Average interest-bearing liabilities decreased $42.6 million and the cost of those liabilities decreased from 1.21% in 2010 to 0.96% in 2011. The decrease in yield was due primarily to the continuing low rate environment and a $56.3 million reduction in higher yielding time deposits as customers preferred to keep their deposits in short-term transaction accounts. The decrease in time deposits was offset by increases in savings accounts, interest-bearing transaction accounts, and non-interest bearing deposits of $13.0 million, $6.7 million, and $62.7 million, respectively.
Total interest expense decreased from $40.4 million in 2009 to $25.9 million in 2010, a decrease of $14.5 million, or 36%. Average interest-bearing liabilities decreased $3.0 million and the cost of those liabilities decreased from 1.89% in 2009 to 1.21% in 2010. The decrease in yield was due to the low rate environment and a change in deposit mix. Average interest-bearing deposits increased from $1.81 billion in 2009 to $1.86 billion in 2010, an increase of $48.1 million, or 3%. Within this category, average time deposits decreased $132.8 million, while average savings accounts and interest-bearing transaction accounts increased $180.9 million. Average borrowings decreased from $329.9 million in 2009 to $278.8 million in 2010 as a result of several factors including growth in deposits, which outpaced loan and lease growth and because of prepayments of long-term debt since the third quarter of 2009.
Net Interest Margin
Net interest margin is calculated by dividing net interest income on a fully taxable equivalent basis by average interest-earning assets. The Company’s net interest margin was 3.85%, 3.95% and 3.74% for 2011, 2010 and 2009, respectively. The decrease in net interest margin from 2010 to 2011 was primarily a result of the decrease in yield on interest-earning assets. The increase in net interest margin from 2009 to 2010 was primarily a result of the decrease in cost of interest-bearing liabilities. The net interest margins for 2011, 2010 and 2009 would have been 3.94%, 4.02% and 3.81%, respectively, had all of the non-accrual loans performed in accordance with their terms.
Provision for Loan and Lease Losses
In determining the provision for loan and lease losses, management considers national and local economic conditions; trends in the portfolio including orientation to specific loan types or industries; experience, ability and depth of lending management in relation to the complexity of the portfolio; adequacy and adherence to policies, procedures and practices; levels and trends in delinquencies, impaired loans and leases and net charge-offs and the results of independent third party loan and lease review.
The provision for loan and lease losses decreased from $19.3 million in 2010 to $18.8 million in 2011. Net charge-offs increased from $17.5 million or 0.88% of average loans and leases in 2010 to $17.7 million or 0.89% of average loans and leases in 2011.
The provision for loan and lease losses decreased from $51.6 million in 2009 to $19.3 million in 2010. The 2009 loan and lease loss provision resulted from continued charge-offs in Lakeland’s leasing portfolio, increases in non-performing loans in its commercial portfolio and the Company’s decision to reduce the exposure in its leasing portfolio by designating certain lease pools as held for sale. The Company’s decision to sell designated
lease pools resulted in mark-to-market adjustments totaling $22.1 million as well as additional net charge-offs in the leasing portfolio of $23.0 million in 2009. The charge-offs in 2009 resulted from a continued deterioration in economic conditions and in the underlying collateral value of the leases. Net charge-offs declined from $51.1 million or 2.55% of average loans and leases in 2009 to $17.5 million or 0.88% of average loans and leases in 2010.
Noninterest Income
Noninterest income was $18.1 million in 2011 compared to $19.3 million earned in 2010. The decrease in this category is primarily due to a reduction in gains on leasing related assets and investment securities. In 2011, gains on investment securities totaled $1.2 million, which was a $513,000 reduction from the same period in 2010 and gains on leasing related assets at $974,000 in 2011 were $606,000 lower than in 2010. Additionally, there was $128,000 in other-than-temporary impairment losses taken on the Company’s equity securities portfolio in 2010 compared to no losses in 2011. Other income at $526,000 in 2011 was $221,000 lower than 2010 due primarily to a reduction in gains on loans sold. Income on bank owned life insurance in 2011 totaling $1.4 million was $93,000 lower than the same period in 2010 due primarily to decreases in rates on the underlying policies. Commissions and fees at $3.7 million in 2011 were $170,000 greater than the same period in 2010 due primarily to an increase in investment commission income. Noninterest income represented 16% of total revenue in 2011. (Total revenue is defined as net interest income plus noninterest income.)
Noninterest income was $19.3 million in 2010 compared to $18.9 million earned in 2009. The increase in this category is primarily due to gains on leasing related assets totaling $1.6 million compared to losses of $1.1 million in 2009. Offsetting the impact of gains on leasing related assets was a reduction in gains on sales of investment securities which totaled $1.7 million in 2010 compared to $3.8 million in 2009. Additionally, there were $128,000 in other-than-temporary impairment losses taken on the Company’s equity securities portfolio in 2010 compared to $940,000 in 2009. Service charges on deposit accounts decreased $640,000 to $10.3 million due primarily to reduced overdraft fees collected. Commissions and fees decreased $176,000 or 5% to $3.5 million in 2010, primarily as a result of decreased loan fees and investment services income. Other income at $747,000 increased $210,000 from 2009 primarily due to gains on loans sold. Income on bank owned life insurance decreased by $414,000 to $1.5 million in 2010. Included in bank owned life insurance for 2009 was $485,000 in proceeds received on a life insurance policy. Noninterest income represented 16% of total revenue in 2010.
Noninterest Expense
Noninterest expense totaling $68.2 million decreased $2.3 million in 2011 compared to 2010. Long term debt prepayment fees in 2011 were $800,000 compared to $1.8 million for the same period in 2010 because the Company prepaid less long term debt in 2011 than in 2010. FDIC insurance expense at $2.8 million was $974,000 lower than the same period in 2010 as a result of changes made by the FDIC in the method of calculating assessment rates. Collection expense at $343,000 decreased $249,000, which reflects lower leasing related collection costs. Stationery, supplies and postage at $1.4 million and marketing expense at $2.4 million decreased $240,000 and $291,000, respectively, in 2011, primarily as a result of costs incurred for the Company’s new brand identity project in 2010. During the third quarter of 2011 the Company completed its core deposit intangible amortization, which resulted in a $485,000 decrease in that category. Other real estate and repossessed asset expense at $780,000 increased $297,000 as a result of increased expenses related to other real estate properties.
Noninterest expense was $70.4 million in 2010, compared to $73.8 million in 2009, a decrease of 5%. Included in noninterest expense for 2010 was a $1.8 million prepayment fee on long-term debt, while noninterest expense in 2009 included a $3.1 million prepayment fee on long term debt, a $1.2 million industry-wide special FDIC assessment and a $704,000 expense incurred relating to the pretax payout on a life insurance benefit. Salary and benefit expense increased by $1.6 million, or 5%, to $36.1 million, due primarily to normal salary
increases and increases in hospital and medical benefit expenses. Collection expense at $592,000 and other real estate and repossessed asset expense at $483,000 decreased $960,000, or 62%, and $519,000, or 52%, respectively, due to decreased leasing related expenses. Legal expense at $1.7 million increased $695,000 compared to 2009 as a result of increased workout expenses related to non-performing loans and leases. Other expenses decreased by $916,000, or 9%, to $8.9 million, primarily due to the previously mentioned $704,000 pretax payout to the beneficiary of bank owned life insurance proceeds in 2009.
The efficiency ratio, a non-GAAP measure, expresses the relationship between noninterest expense (excluding other real estate and other repossessed asset expense, long-term debt repayment fees, provision for unfunded lending commitments and core deposit amortization) to total tax-equivalent revenue (excluding gains (losses) on securities). In 2011, the Company’s efficiency ratio on a tax equivalent basis was 56.9% compared to 56.4% in 2010 as a result of a decline in revenue, partially offset by continued management of expenses. The efficiency ratio was 62.1% in 2009.
Income Taxes
The Company’s effective income tax rate was 30.5%, 34.5% and 59.0%, in the years ended December 31, 2011, 2010 and 2009, respectively. The Company’s lower effective tax rate of 30.5% in 2011 was driven by increased tax benefits attributable to the real estate investment trust (“REIT”) subsidiary established in December 2010. The Company’s effective tax rate of 59.0% in 2009 is due to its net loss and the impact that tax advantaged income had on the tax benefit of the loss. The tax advantaged income includes tax-exempt securities income and income on bank owned life insurance policies.
Financial Condition
Total assets increased from $2.79 billion on December 31, 2010 to $2.83 billion on December 31, 2011, an increase of $33.3 million, or 1%. Total assets at year-end 2010 increased $68.7 million or 3% from year-end 2009.
Loans and Leases
Lakeland primarily serves Northern New Jersey and the surrounding areas. Its leasing division serves a broader market with a focus on the Northeast. All of its borrowers are U.S. residents or entities.
Gross loans and leases, including leases held for sale, which totaled $2.04 billion as of December 31, 2011, increased $29.0 million compared to 2010. The increase in gross loans and leases is due primarily to increases in commercial loans secured by real estate and commercial and industrial loans, which was partially offset by a decrease in leases. Commercial loans secured by real estate increased from $970.2 million in 2010 to $1.01 billion in 2011, an increase of $42.7 million, or 4%. Commercial and industrial loans increased from $194.3 million in 2010 to $209.9 million in 2011, an increase of $15.7 million, or 8%. Real estate construction loans, which include commercial construction loans, at $79.1 million increased $8.4 million or 12%. Leases, including leases held for sale, totaling $28.9 million as of December 31, 2011 decreased $38.3 million or 57% compared to 2010. The Company continues to execute its strategy of reducing riskier leases while focusing on growth within the local market area. Total loans and leases at $2.01 billion as of December, 31 2010 decreased $1.8 million, or less than 1% compared to December 31, 2009 due to a $53.3 million or 44% decline in leases.
The following table sets forth the classification of Lakeland’s gross loans and leases by major category as of December 31 for each of the last five years:
At December 31, 2011, there were no concentrations of loans or leases exceeding 10% of total loans and leases outstanding other than loans that are secured by real estate. Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly impacted by economic or other related conditions.
The following table sets forth maturities and sensitivity to changes in interest rates in commercial loans in the Company’s loan portfolio at December 31, 2011:
Risk Elements
Commercial loans and leases are placed on a non-accrual status with all accrued interest and unpaid interest reversed if (a) because of the deterioration in the financial position of the borrower they are maintained on a cash basis (which means payments are applied when and as received rather than on a regularly scheduled basis), (b) payment in full of interest or principal is not expected, or (c) principal and interest have been in default for a period of 90 days or more unless the obligation is both well-secured and in process of collection. Residential mortgage loans are placed on non-accrual status at the time principal and interest have been in default for a period of 90 days or more, except where there exists sufficient collateral to cover the defaulted principal and interest payments, and management’s knowledge of the specific circumstances warrant continued accrual. Consumer loans are generally charged off when principal and interest payments are four months in arrears unless the obligations are well-secured and in the process of collection. Interest thereafter on such charged-off consumer loans is taken into income when received only after full recovery of principal. As a general rule, a non-accrual asset may be restored to accrual status when none of its principal or interest is due and unpaid, satisfactory payments have been received for a sustained period (usually six months), or when it otherwise becomes well-secured and in the process of collection.
The following schedule sets forth certain information regarding Lakeland’s non-accrual (including troubled debt restructurings that are on non-accrual) and past due loans and leases and other real estate owned and other repossessed assets as of December 31, for each of the last five years:
Non-accrual loans and leases increased to $49.0 million on December 31, 2011 from $43.0 million at December 31, 2010. The change in non-accrual loans and leases from 2010 to 2011 included an increase in commercial loans secured by real estate, commercial and industrial loans and commercial real estate construction loans of $3.7 million, $2.9 million and $6.1 million, respectively, which was partially offset by a decline in leasing non-accruals of $5.7 million. Commercial loan non-accruals included four loan relationships between $500,000 and $1.0 million totaling $2.8 million, and nine loan relationships exceeding $1.0 million totaling $22.8 million. The largest of the commercial loan non-accrual loans was $5.9 million. All non-accrual loans and leases are in various stages of litigation, foreclosure, or workout. Non-accrual loans included $4.6 million and $3.6 million in troubled debt restructurings for the years ended December 31, 2011 and 2010, respectively.
At December 31, 2011, Lakeland had $8.9 million in loans that were restructured and still accruing. Restructured loans are those loans where Lakeland has granted concessions to the borrower in payment terms in rate and/or in maturity as a result of the financial condition of the borrower.
For 2011, the gross interest income that would have been recorded, had the loans and leases classified at year-end as non-accrual been performing in conformance with their original terms, is approximately $2.9 million. The amount of interest income actually recorded on those loans and leases for 2011 was $539,000. The resultant loss of $2.4 million for 2011 compares with prior year losses of $1.8 million for 2010 and $1.9 million for 2009.
As of December 31, 2011, Lakeland had impaired loans and leases totaling $43.1 million (consisting primarily of non-accrual and restructured loans and leases), compared to $30.0 million at December 31, 2010. The valuation allowance of these loans and leases is based on the fair value of the underlying collateral. Based upon such evaluation, $805,000 has been allocated to the allowance for loan and lease losses for impairment at December 31, 2011 compared to $1.1 million at December 31, 2010. At December 31, 2011, Lakeland also had $41.7 million in loans and leases that were rated substandard that were not classified as non-performing or impaired compared to $47.0 million at December 31, 2010.
There were no additional loans or leases at December 31, 2011, other than those designated non-performing, impaired or substandard, where the Company was aware of any credit conditions of any borrowers that would indicate a strong possibility of the borrowers not complying with the present terms and conditions of repayment and which may result in such loans or leases being included as non-accrual, past due or renegotiated at a future date.
The following table sets forth for each of the five years ended December 31, 2011, the historical relationships among the amount of loans and leases outstanding, the allowance for loan and lease losses, the provision for loan and lease losses, the amount of loans and leases charged off and the amount of loan and lease recoveries:
The ratio of the allowance for loan and lease losses to loans and leases outstanding reflects management’s evaluation of the underlying credit risk inherent in the loan portfolio. The determination of the adequacy of the allowance for loan and lease losses and the periodic provisioning for estimated losses included in the consolidated financial statements is the responsibility of management and the Board of Directors. The evaluation process is undertaken on a quarterly basis.
Methodology employed for assessing the adequacy of the allowance consists of the following criteria:
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The establishment of reserve amounts for all specifically identified classified loans and leases that have been designated as requiring attention by the Company or the Company’s external loan review consultants.
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The establishment of reserves for pools of homogeneous types of loans and leases not subject to specific review, including impaired commercial loans under $250,000, leases, 1 - 4 family residential mortgages, and consumer loans.
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The establishment of reserve amounts for the non-classified loans and leases in each portfolio based upon the historical average loss experience for these portfolios and management’s evaluation of key factors.
Consideration is given to the results of ongoing credit quality monitoring processes, the adequacy and expertise of the Company’s lending staff, underwriting policies, loss histories, delinquency trends, and the cyclical nature of economic and business conditions. Since many of the Company’s loans depend on the sufficiency of collateral as a secondary source of repayment, any adverse trend in the real estate markets could affect underlying values available to protect the Company from loss.
A loan is reviewed for charge-off when it is placed on non-accrual status with a resulting charge-off if the loan is not secured by collateral having sufficient liquidation value to repay the loan and all accrued interest and the loan is not in the process of collection. Charge-offs are recommended by the Chief Credit Officer and approved by the Board on a monthly basis.
While non-performing loans and leases increased from $43.0 million on December 31, 2010 to $49.0 million on December 31, 2011, the allowance for loan and lease losses was 1.39% of total loans and leases on December 31, 2011 compared to 1.36% of total loans and leases on December 31, 2010. The increase in non-accrual loans, as discussed above, was in commercial loans secured by real estate, commercial and industrial loans and real estate construction loans. Non-accrual leases declined from 2010 to 2011 by $5.7 million due to the favorable resolution of several non-performing leases. Management believes, based on appraisals and estimated selling costs, that the majority of these loans are well secured and reserves on these loans are adequate. Based upon the process employed and giving recognition to all accompanying factors related to the loan and lease portfolio, management considers the allowance for loan and lease losses to be adequate at December 31, 2011. The preceding statement constitutes a forward-looking statement under the Private Securities Litigation Reform Act of 1995.
The following table shows how the allowance for loan and lease losses is allocated among the various types of loans and leases that the Company has outstanding. This allocation is based on management’s specific review of the credit risk of the outstanding loans and leases in each category as well as historical trends.
(1) Data related to the allocation of the allowance for loan and lease losses between commercial loan categories was not available prior to 2009.
Investment Securities
The Company has classified its investment securities into the available for sale and held to maturity categories based on its intent and ability to hold the securities to maturity. The Company has no investment securities classified as trading securities.
The following table sets forth the carrying value of the Company’s investment securities, both available for sale and held to maturity, as of December 31 for each of the last three years. Investment securities available for sale are stated at fair value while securities held for maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts.
The Company does not own any collateralized debt obligations, pooled trust preferred securities or preferred stock with the Federal National Mortgage Association or the Federal Home Loan Mortgage Association.
The following table sets forth the maturity distribution and weighted average yields (calculated on the basis of the stated yields to maturity, considering applicable premium or discount), on a fully taxable equivalent basis, of investment securities available for sale as of December 31, 2011, at fair value:
The following table sets forth the maturity distribution and weighted average yields (calculated on the basis of the stated yields to maturity, considering applicable premium or discount), on a fully taxable equivalent basis, of investment securities held to maturity as of December 31, 2011, at amortized cost:
Other Assets
Other assets decreased from $35.6 million at December 31, 2010 to $28.4 million at December 31, 2011 due primarily to a decrease in net deferred taxes of $2.8 million and the prepaid FDIC assessment of $2.6 million.
The Company evaluates the realizability of its deferred tax assets by examining its earnings history and projected future earnings and by assessing whether it is more likely than not that carryforwards would not be realized. Based upon the majority of the Company’s deferred tax assets having no expiration date, the Company’s earnings history, and the projections of future earnings, the Company’s management believes that it is more likely than not that all of the Company’s deferred tax assets as of December 31, 2011 will be realized.
Deposits
Total deposits increased from $2.20 billion on December 31, 2010 to $2.25 billion on December 31, 2011, a $53.8 million, or 2%, increase. Savings and interest-bearing transaction accounts increased from $1.40 billion to $1.44 billion, an increase of $41.4 million, or 3%. Total core deposits, which are defined as noninterest-bearing deposits and savings and interest-bearing transaction accounts, increased from $1.78 billion on December 31, 2010 to $1.89 billion on December 31, 2011, an increase of $107.1 million, or 6%. Core deposits represent 84% of total deposits at December 31, 2011 compared to 81% at the end of 2010. Total time deposits decreased from $412.8 million on December 31, 2010 to $359.6 million on December 31, 2011, a decrease of $53.3 million, or 13%. Time deposits have decreased as a result of the continuing low rate environment where depositors prefer to keep their deposits in liquid transaction accounts versus long-term accounts.
Total deposits increased from $2.16 billion on December 31, 2009 to $2.20 billion on December 31, 2010, an increase of $38.7 million, or 2%.
The average amount of deposits and the average rates paid on deposits for the years indicated are summarized in the following table:
As of December 31, 2011, the aggregate amount of outstanding time deposits issued in amounts of $100,000 or more, broken down by time remaining to maturity, was as follows (in thousands):
Liquidity
“Liquidity” measures whether an entity has sufficient cash flow to meet its financial obligations and commitments on a timely basis. The Company is liquid when its subsidiary bank has the cash available to meet the borrowing and cash withdrawal requirements of customers and the Company can pay for current and planned expenditures and satisfy its debt obligations.
Lakeland funds loan demand and operation expenses from several sources:
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Net income. Cash provided by operating activities was $49.9 million in 2011 compared to $56.0 million and $22.5 million in 2010 and 2009, respectively.
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Deposits. Lakeland can offer new products or change its rate structure in order to increase deposits. In 2011, Lakeland generated $53.8 million in deposit growth.
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Sales of securities and overnight funds. At year-end 2011, the Company had $471.9 million in securities designated “available for sale.”
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Repayments on loans and leases can also be a source of liquidity to fund further loan growth.
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Overnight credit lines. As a member of the Federal Home Loan Bank of New York (FHLB), Lakeland has the ability to borrow overnight based on the market value of collateral pledged. Lakeland had no overnight borrowings from the FHLB on December 31, 2011. Lakeland also has overnight federal funds lines available for it to borrow up to $162.0 million. Lakeland had borrowings against these lines of $28.0 million at December 31, 2011. Lakeland may also borrow from the discount window of the Federal Reserve Bank of New York based on the market value of collateral pledged. Lakeland had no borrowings with the Federal Reserve Bank of New York as of December 31, 2011.
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Other borrowings. Lakeland can also generate funds by utilizing long-term debt or securities sold under agreements to repurchase that would be collateralized by security or mortgage collateral. At times the market values of securities collateralizing our securities sold under agreements to repurchase may decline due to changes in interest rates and may necessitate our lenders to issue a “margin call” which requires the Company to pledge additional collateral to meet that margin call. For more information regarding the Company’s borrowings, see Note 6 to the consolidated financial statements.
Management and the Board monitor the Company’s liquidity through the asset/liability committee, which monitors the Company’s compliance with certain regulatory ratios and other various liquidity guidelines.
The Company’s management believes that its current level of liquidity is sufficient to meet its current and anticipated operational needs, including current loan commitments, deposit maturities and other obligations. This constitutes a forward-looking statement under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from anticipated results due to a variety of factors, including uncertainties relating to general economic conditions; unanticipated decreases in deposits; changes in or failure to comply with governmental regulations; and uncertainties relating to the analysis of the Company’s assessment of rate sensitive assets and rate sensitive liabilities and the extent to which market factors indicate that a financial institution such as Lakeland should match such assets and liabilities.
The following table sets forth contractual obligations and other commitments representing required and potential cash outflows as of December 31, 2011. Interest on subordinated debentures and other borrowings is calculated based on current contractual interest rates.
* Includes interest on other borrowings and subordinated debentures at a weighted rate of 4.41%.
Interest Rate Risk
Closely related to the concept of liquidity is the concept of interest rate sensitivity (i.e., the extent to which assets and liabilities are sensitive to changes in interest rates). As a financial institution, the Company’s potential interest rate volatility is a primary component of its market risk. Fluctuations in interest rates will ultimately impact the level of income and expense recorded on a large portion of the Company’s assets and liabilities, and the market value of all interest-earning assets, other than those which possess a short term to maturity. Based upon the Company’s nature of operations, the Company is not subject to foreign currency exchange or commodity price risk. The Company does not own any trading assets and does not have any off balance sheet hedging transactions in place, such as interest rate swaps and caps.
The Company’s net income is largely dependent on net interest income. Net interest income is susceptible to interest rate risk to the extent that interest-bearing liabilities mature or reprice on a different basis than interest-earning assets. For example, when interest-bearing liabilities mature or reprice more quickly than interest-earning assets, an increase in market rates could adversely affect net interest income. Conversely, when interest-earning assets reprice more quickly than interest-bearing liabilities, an increase in market rates could increase net interest income.
The Company’s Board of Directors has adopted an Asset/Liability Policy designed to stabilize net interest income and preserve capital over a broad range of interest rate movements. This policy outlines guidelines and ratios dealing with, among others, liquidity, volatile liability dependence, investment portfolio composition, loan portfolio composition, loan-to-deposit ratio and gap analysis ratio. Key quantitative measurements include the percentage change of net interest income in various interest rate scenarios (net interest income at risk) and changes in the market value of equity in various rate environments (net portfolio value at risk). The Company’s performance as compared to the Asset/Liability Policy is monitored by its Board of Directors. In addition, to effectively administer the Asset/Liability Policy and to monitor exposure to fluctuations in interest rates, the Company maintains an Asset/Liability Committee (the “ALCO”), consisting of the Chief Executive Officer, Chief Operating Officer, Chief Financial Officer, Chief Lending Officer, Chief Retail Officer, Chief Credit Officer, certain other senior officers and certain directors. This committee meets quarterly to review the Company’s financial results and to develop strategies to implement the Asset/Liability Policy and to respond to market conditions.
The Company monitors and controls interest rate risk through a variety of techniques, including use of an interest rate risk management model. With the interest rate risk management model, the Company projects future net interest income, and then estimates the effect of various changes in interest rates and balance sheet growth rates on that projected net interest income. The Company also uses the interest rate risk management model to calculate the change in net portfolio value over a range of interest rate change scenarios.
Interest rate sensitivity modeling is done at a specific point in time and involves a variety of significant estimates and assumptions. Interest rate sensitivity modeling requires, among other things, estimates of how much and when yields and costs on individual categories of interest-earning assets and interest-bearing liabilities will respond to general changes in market rates, future cash flows and discount rates.
Net interest income simulation considers the relative sensitivities of the balance sheet including the effects of interest rate caps on adjustable rate mortgages and the relatively stable aspects of core deposits. As such, net interest income simulation is designed to address the probability of interest rate changes and the behavioral response of the balance sheet to those changes. Market Value of Portfolio Equity represents the fair value of the net present value of assets, liabilities and off-balance-sheet items. Changes in estimates and assumptions made for interest rate sensitivity modeling could have a significant impact on projected results and conclusions. These assumptions could include prepayment rates, sensitivity of non-maturity deposits and other similar assumptions. Therefore, if our assumptions should change, this technique may not accurately reflect the impact of general interest rate movements on the Company’s net interest income or net portfolio value.
The starting point (or “base case”) for the following table is an estimate of the following year’s net interest income assuming that both interest rates and the Company’s interest-sensitive assets and liabilities remain at year-end levels. The net interest income estimated for 2012 (the base case) is $95.8 million. The information provided for net interest income assumes that changes in interest rates change gradually in equal increments (“rate ramp”) over the twelve month period.
The base case for the following table is an estimate of the Company’s net portfolio value for the periods presented using current discount rates, and assuming the Company’s interest-sensitive assets and liabilities remain at year-end levels. The net portfolio value at December 31, 2011 (the base case) was $331.5 million. The information provided for the net portfolio value assumes fluctuations or “rate shocks” for changes in interest rates as shown in the table below. Rate shocks assume that current interest rates change immediately.
The information set forth in the above tables is based on significant estimates and assumptions, and constitutes a forward-looking statement under the Private Securities Litigation Reform Act of 1995.
The information in the above tables represent the policy scenario that the ALCO reviews on a quarterly basis. There are also other scenarios run that the ALCO examines that vary depending on the economic environment. These scenarios include a yield curve flattening scenario and scenarios that show more dramatic changes in rates. The committee uses the appropriate scenarios, depending on the economic environment, in its interest rate management decisions.
Capital Resources
Stockholders’ equity decreased from $260.7 million on December 31, 2010 to $259.8 million on December 31, 2011. The decrease in stockholders’ equity from December 31, 2010 to December 31, 2011 was primarily due to redemption of preferred stock from the U.S Treasury Department totaling $20.0 million and the payment of dividends on common and preferred stock of $6.3 million. Partially offsetting these items was net income of $19.9 million and other comprehensive income of $4.5 million in 2011. For more information on the redemption of preferred stock, please see Note 7 in Notes to the Consolidated Financial Statements in this Annual Report on Form 10-K.
Book value per common share (total common stockholders’ equity divided by the number of shares outstanding) increased from $8.82 on December 31, 2010 to $9.44 on December 31, 2011 primarily as a result of net income. Book value per common share was $8.46 on December 31, 2009. Tangible book value per share increased from $5.35 on December 31, 2010 to $6.03 on December 31, 2011. For more information see “Non-GAAP Financial Measures.”
The FDIC’s risk-based capital policy statement imposes a minimum capital standard on insured banks. The minimum ratio of risk-based capital to risk-weighted assets (including certain off-balance sheet items, such as standby letters of credit) is 8%. At least half of the total capital is to be comprised of common stock equity and qualifying perpetual preferred stock, less goodwill (“Tier I capital”). The remainder (“Tier II capital”) may consist of mandatory convertible debt securities, qualifying subordinated debt, other preferred stock and a portion of the allowance for loan and lease losses. The Federal Reserve Board has adopted a similar risk-based capital guideline for the Company which is computed on a consolidated basis.
In addition, the bank regulators have adopted minimum leverage ratio guidelines (Tier I capital to average quarterly assets, less goodwill) for financial institutions. These guidelines provide for a minimum leverage ratio of 3% for financial institutions that meet certain specified criteria, including that they have the highest regulatory rating. All other holding companies are required to maintain a leverage ratio of 3% plus an additional cushion of at least 100 to 200 basis points.
The following table reflects capital ratios of the Company and Lakeland as of December 31, 2011 and 2010:
Non-GAAP Financial Measures
Reported amounts are presented in accordance with U.S. GAAP. The Company’s management believes that the supplemental non-GAAP information, which consists of measurements and ratios based on tangible equity and tangible assets, is utilized by regulators and market analysts to evaluate a company’s financial condition and therefore, such information is useful to investors. These disclosures should not be viewed as a substitute for financial results determined in accordance with U.S. GAAP, nor are they necessarily comparable to non-GAAP performance measures which may be presented by other companies.
(1) Adjusted for 5% stock dividend payable on February 16, 2011 to shareholders of record January 31, 2011.
Recent Accounting Pronouncements
In December 2010, the Financial Accounting Standards Board (the “FASB”) issued accounting guidance that modifies Step One of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step Two of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist such as if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. This guidance was effective for interim and annual reporting periods beginning on or after December 15, 2010 and did not have a significant impact on the Company’s financial statements.
In April 2011, the FASB issued accounting guidance to help creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The purpose of this guidance is to eliminate diversity in practice and provide greater comparability between companies’ financial statements. This guidance is effective for interim and annual reporting periods beginning on or after June 15, 2011 and should be applied retrospectively to the beginning of the annual period of adoption. Adoption of this guidance did not have a significant impact on the Company’s financial statements.
In May 2011, the FASB and the International Accounting Standards Board (the “IASB”) issued new accounting guidance on fair value measurement and disclosure requirements. This guidance is the result of work by the FASB and IASB to develop common requirements for measuring fair value and disclosing information about fair value measurements in accordance with U.S. GAAP and International Financial Reporting Standards (“IFRS”). As a result, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. The guidance is effective during interim and annual periods beginning after December 15, 2011. The guidance is to be applied prospectively, and early application by public entities is not permitted. Adoption of the guidance is not expected to have a significant impact on the Company’s financial statements.
In June 2011, the FASB issued accounting guidance updating the requirements regarding the presentation of comprehensive income to increase the prominence of items reported in other comprehensive income and to
facilitate convergence of U.S. GAAP and IFRS. Under the new guidance, the components of net income and the components of other comprehensive income can be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance eliminates the option to present components of other comprehensive income as part of the changes in stockholders’ equity. This amendment will be applied prospectively and the amendments are effective for fiscal years and interim periods beginning after December 15, 2011. Adoption of the guidance is not expected to have a significant impact on the Company’s financial statements. In December 2011, the FASB deferred certain aspects of this guidance related to the requirement to present items that are reclassified from accumulated other comprehensive income to net income separately with their respective components of net income and other comprehensive income.
In September 2011, the FASB issued accounting guidance related to the annual testing of goodwill for impairment. Under the new guidance, an entity has the option to first determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. If, however, the entity concludes otherwise, then it is required to perform the first step of the two-step impairment test and then perform the second test, if required. This amendment is effective for annual and interim goodwill impairment tests performed for the fiscal years beginning after December 15, 2011. The Company adopted this guidance for its goodwill review as of November 30, 2011. Adoption did not have a significant impact on the Company’s financial statements.
Effects of Inflation
The impact of inflation, as it affects banks, differs substantially from the impact on non-financial institutions. Banks have assets which are primarily monetary in nature and which tend to move with inflation. This is especially true for banks with a high percentage of rate sensitive interest-earning assets and interest-bearing liabilities. A bank can further reduce the impact of inflation with proper management of its rate sensitivity gap. This gap represents the difference between interest rate sensitive assets and interest rate sensitive liabilities. Lakeland attempts to structure its assets and liabilities and manages its gap to protect against substantial changes in interest rate scenarios, in order to minimize the potential effects of inflation.
ITEM 7A
ITEM 7A - Quantitative and Qualitative Disclosures About Market Risk
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
ITEM 8
ITEM 8 - Financial Statements and Supplementary Data
Lakeland Bancorp, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these statements.
Lakeland Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these statements.
Lakeland Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
For the years ended December 31, 2011, 2010 and 2009
The accompanying notes are an integral part of these consolidated financial statements.
Lakeland Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these statements.
Lakeland Bancorp, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1-SUMMARY OF ACCOUNTING POLICIES
Lakeland Bancorp, Inc. (the Company) is a bank holding company whose principal activity is the ownership and management of its wholly owned subsidiary, Lakeland Bank (Lakeland). Lakeland operates under a state bank charter and provides full banking services and, as a state bank, is subject to regulation by the New Jersey Department of Banking and Insurance. Lakeland generates commercial, mortgage and consumer loans and receives deposits from customers located primarily in Northern New Jersey. Lakeland also provides securities brokerage services, including mutual funds and variable annuities.
Lakeland operates as a commercial bank offering a wide variety of commercial loans and leases and, to a lesser degree, consumer credits. Its primary strategic aim is to establish a reputation and market presence as the “small and middle market business bank” in its principal markets. Lakeland funds its loans primarily by offering time, savings and money market, and demand deposit accounts to both commercial enterprises and individuals. Additionally, it originates residential mortgage loans, and services such loans which are owned by other investors. Lakeland also has a leasing division which provides equipment lease financing primarily to small and medium sized business clients and an asset based lending department which specializes in utilizing particular assets to fund the working capital needs of borrowers.
The Company and Lakeland are subject to regulations of certain state and federal agencies and, accordingly, are periodically examined by those regulatory authorities. As a consequence of the extensive regulation of commercial banking activities, Lakeland’s business is particularly susceptible to being affected by state and federal legislation and regulations.
Basis of Financial Statement Presentation
The accounting and reporting policies of the Company and its subsidiaries conform with accounting principles generally accepted in the United States of America (U.S. GAAP) and predominant practices within the banking industry. The consolidated financial statements include the accounts of the Company, Lakeland, Lakeland NJ Investment Corp., Lakeland Investment Corp., Lakeland Equity, Inc., and Lakeland Preferred Equity, Inc. All intercompany balances and transactions have been eliminated.
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. These estimates and assumptions also affect reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Significant estimates implicit in these financial statements are as follows.
The principal estimates that are particularly susceptible to significant change in the near term relate to the allowance for loan and lease losses, the valuation of the Company’s investment securities portfolio, the realizability of the Company’s deferred tax asset and the analysis of goodwill and intangible impairment.
The evaluation of the adequacy of the allowance for loan and lease losses includes, among other factors, an analysis of historical loss rates, by category, applied to current loan and lease totals. However, actual losses may be higher or lower than historical trends, which vary. Actual losses on specified problem loans and leases, which also are provided for in the evaluation, may vary from estimated loss percentages, which are established based upon a limited number of potential loss classifications.
The Company’s operating segments are components of its enterprise for which separate financial information is available and is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. The Company’s chief operating decision maker is its Chief Executive
Officer. All of the Company’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, commercial lending is dependent upon the ability of Lakeland to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. The situation is also similar for consumer and residential mortgage lending. All significant operating decisions are based upon analysis of the Company as one operating segment or unit. Accordingly, the Company has determined that it has one operating segment and thus one reporting segment.
Investment Securities
Investment securities are classified in one of three categories: held to maturity, trading, or available for sale. Investments in debt securities, for which management has both the ability and intent to hold to maturity, are carried at cost, adjusted for the amortization of premiums and accretion of discounts computed by the effective interest method. Investments in debt and equity securities, which management believes may be sold prior to maturity due to changes in interest rates, prepayment risk, liquidity requirements, or other factors, are classified as available for sale. Net unrealized gains and losses for such securities, net of tax effect, are reported as other comprehensive income (loss) and excluded from the determination of net income. The Company does not engage in securities trading. Gains or losses on disposition of investment securities are based on the net proceeds and the adjusted carrying amount of the securities sold using the specific identification method. Losses are recorded through the statement of operations when the impairment is considered other-than-temporary, even if a decision to sell has not been made.
The Company evaluates the portfolio for impairment each quarter. In estimating other-than-temporary losses, the Company considers the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and whether the Company is more likely than not to sell the security before recovery of its cost basis. If a security has been impaired for more than twelve months, and the impairment is deemed other than temporary and material, a write down will occur in that quarter. If a loss is deemed to be other-than-temporary, it is recognized as a realized loss in the income statement with the security assigned a new cost basis.
If the Company intends to sell an impaired security, the Company records an other-than-temporary loss in an amount equal to the entire difference between the fair value and amortized cost. If a security is determined to be other-than-temporarily impaired, but the Company does not intend to sell the security, only the credit portion of the estimated loss is recognized in earnings, with the other portion of the loss recognized in other comprehensive income.
Loans and Leases and Allowance for Loan and Lease Losses
Loans and leases that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal and are net of unearned discount, unearned loan fees and an allowance for loan and lease losses.
Interest income is accrued as earned on a simple interest basis. All unamortized fees and costs related to the loan are amortized over the life of the loan using the interest method. Accrual of interest is discontinued on a loan or lease when management believes, after considering economic and business conditions and collection efforts that the borrower’s financial condition is such that collection of interest and principal is doubtful. When a loan or lease is placed on such non-accrual status, all accumulated accrued interest receivable is reversed out of current period income.
Commercial loans and leases are placed on a non-accrual status with all accrued interest and unpaid interest reversed if (a) because of the deterioration in the financial position of the borrower they are maintained on a cash basis (which means payments are applied when and as received rather than on a regularly scheduled basis), (b) payment in full of interest or principal is not expected, or (c) principal and interest have been in default for a
period of 90 days or more unless the obligation is both well-secured and in process of collection. Residential mortgage loans are placed on non-accrual status at the time principal and interest have been in default for a period of 90 days or more, except where there exists sufficient collateral to cover the defaulted principal and interest payments, and management’s knowledge of the specific circumstances warrant continued accrual. Consumer loans are generally charged off when principal and interest payments are four months in arrears unless the obligations are well-secured and in the process of collection. Interest thereafter on such charged-off consumer loans is taken into income when received only after full recovery of principal. As a general rule, a non-accrual asset may be restored to accrual status when none of its principal or interest is due and unpaid, satisfactory payments have been received for a sustained period (usually six months), or when it otherwise becomes well-secured and in the process of collection.
Loans and leases are considered impaired when, based on current information and events, it is probable that Lakeland will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is measured based on the present value of expected cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral-dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable. Most of Lakeland’s impaired loans are collateral-dependent. Lakeland groups impaired commercial loans under $250,000 into a homogeneous pool and collectively evaluates them. Interest received on impaired loans and leases may be recorded as interest income. However, if management is not reasonably certain that an impaired loan and lease will be repaid in full, or if a specific time frame to resolve full collection cannot yet be reasonably determined, all payments received are recorded as reductions of principal.
Loans are classified as troubled debt restructured loans in cases where borrowers experience financial difficulties but are current on their payments and the Company makes certain concessionary modifications to contractual terms. Restructured loans typically involve a modification of terms such as a reduction of the stated interest rate, a moratorium of principal payments and/or an extension of the maturity date at a stated interest rate lower than the current market rate for a new loan with similar risk. Nonetheless, restructured loans are classified as impaired loans.
Once an obligation has been restructured because of credit problems, it continues to be considered restructured until paid in full or if all of the following conditions are met: (1) the financial problems of the borrower have been cured; (2) the obligation is returned to a market rate and term; and (3) there has been performance for the longer of the next annual reporting period or six consecutive months.
The allowance for loan and lease losses is established through a provision for loan and lease losses charged to expense. Loan principal considered to be uncollectible by management is charged against the allowance for loan and lease losses. The allowance is an amount that management believes will be adequate to absorb losses on existing loans and leases that may become uncollectible based upon an evaluation of known and inherent risks in the loan and lease portfolio. The evaluation takes into consideration such factors as changes in the nature and size of the loan and lease portfolio, overall portfolio quality, specific problem loans and leases, and current economic conditions which may affect the borrowers’ ability to pay. The evaluation also analyzes historical losses by loan and lease category, and considers the resulting loss rates when determining the reserves on current loan and lease total amounts. Loss estimates for specified problem loans and leases are also detailed. All of the factors considered in the analysis of the adequacy of the allowance for loan and lease losses may be subject to change. To the extent actual outcomes differ from management estimates, additional provisions for loan and lease losses may be required that would adversely impact earnings in future periods.
The determination of the adequacy of the allowance for loan and lease losses and the periodic provisioning for estimated losses included in the consolidated financial statements is the responsibility of management and the Board of Directors. The evaluation process is undertaken on a quarterly basis.
Methodology employed for assessing the adequacy of the allowance consists of the following criteria:
•
The establishment of reserve amounts for all specifically identified classified loans and leases that have been designated as requiring attention by the Company or the Company’s external loan review consultants.
•
The establishment of reserves for pools of homogeneous types of loans and leases not subject to specific review, including impaired commercial loans under $250,000, leases, 1 - 4 family residential mortgages, and consumer loans.
•
The establishment of reserve amounts for the non-classified loans and leases in each portfolio based upon the historical average loss experience for these portfolios and management’s evaluation of key factors.
Consideration is given to the results of ongoing credit quality monitoring processes, the adequacy and expertise of the Company’s lending staff, underwriting policies, loss histories, delinquency trends, and the cyclical nature of economic and business conditions. Since many of the Company’s loans depend on the sufficiency of collateral as a secondary source of repayment, any adverse trend in the real estate markets could affect underlying values available to protect the Company from loss.
A loan is reviewed for charge-off when it is placed on non-accrual status with a resulting charge-off if the loan is not secured by collateral having sufficient liquidation value to repay the loan and all outstanding interest owed, and the loan is not in the process of collection. Charge-offs are recommended by the Chief Credit Officer and approved by the Board on a monthly basis.
The Company transfers leases to held for sale status when it identifies leases that it intends to sell. At that time, the specific leases are written down to the lower of cost or market value by recording a charge to the allowance for loan and lease losses. Market indications are derived from sale price indications from potential buyers and based on recent sale prices of prior lease pools adjusted for differences in types of collateral and other characteristics. Subsequent declines in fair market value are recorded as a loss on leasing related assets in the statement of operations.
Bank Premises and Equipment
Bank premises and equipment, including leasehold improvements, are stated at cost less accumulated depreciation. Depreciation expense is computed on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are depreciated over the shorter of the estimated useful lives of the improvements or the terms of the related leases.
Other Real Estate Owned and Other Repossessed Assets
Other real estate owned (OREO) and other repossessed assets, representing property acquired through foreclosure (or deed-in-lieu-of-foreclosure), are carried at fair value less estimated disposal costs of the acquired property. Costs relating to holding the assets are charged to expense. An allowance for OREO or other repossessed assets is established, through charges to expense, to maintain properties at the lower of cost or fair value less estimated costs to sell. Operating results of OREO and other repossessed assets, including rental income and operating expenses, are included in other expenses.
Mortgage Servicing
The Company performs various servicing functions on loans owned by others. A fee, usually based on a percentage of the outstanding principal balance of the loan, is received for these services. At December 31, 2011 and 2010, Lakeland was servicing approximately $30.3 million and $30.8 million, respectively, of loans for others.
The Company originates mortgages under a definitive plan to sell or securitize those loans and service the loans owned by the investor. Upon the transfer of the mortgage loans in a sale or a securitization, the Company records the servicing assets retained. The Company records mortgage servicing rights and the loans based on relative fair values at the date of origination and evaluated for impairment at each reporting period.
Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or estimated fair value. Gains and losses on sales of loans are specifically identified and accounted for in accordance with U.S. GAAP which requires that an entity engaged in mortgage banking activities classify the retained mortgage-backed security or other interest, which resulted from the securitization of a mortgage loan held for sale, based upon its ability and intent to sell or hold these investments. No mortgage loans were identified as held for sale as of December 31, 2011 and 2010.
Restrictions On Cash And Due From Banks
Lakeland is required to maintain reserves against customer demand deposits by keeping cash on hand or balances with the Federal Reserve Bank of New York in a noninterest bearing account. The amounts of those reserves at December 31, 2011 and 2010 were approximately $325,000 and $454,000, respectively.
Earnings Per Share
Earnings per share is calculated on the basis of the weighted average number of common shares outstanding during the year. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. Unless otherwise indicated, all weighted average, actual shares or per share information in the financial statements have been adjusted retroactively for the effect of stock dividends.
Employee Benefit Plans
The Company has certain employee benefit plans covering substantially all employees. The Company accrues such costs as incurred.
U.S. GAAP requires balance sheet recognition of the overfunded or underfunded status of pension and postretirement benefit plans. Actuarial gains and losses, prior service costs or credits, and any remaining transition assets or obligations are recognized as a component of Accumulated Other Comprehensive Income, net of tax effects, until they are amortized as a component of net periodic benefit cost.
Stock-Based Compensation
The Company’s shareholders approved the 2009 Equity Compensation Program, which authorizes the granting of incentive stock options, supplemental stock options, restricted shares and restricted stock units to employees of the Company, including those employees serving as officers and directors of the Company. The plan authorizes the issuance of up to 2.1 million shares in connection with options and awards granted under the 2009 program. The Company’s stock option grants under this plan expire 10 years from the date of grant, ninety days after termination of service other than for cause, or one year after death or disability of the grantee. The Company currently has no option or restricted stock awards with market or performance conditions attached to them.
The Company established the 2000 Equity Compensation Program which authorizes the granting of incentive stock options, supplemental stock options and restricted stock to employees of the Company, which includes those employees serving as officers and directors of the Company. The plan authorized 2,370,237 shares
of common stock of the Company. All of the Company’s stock option grants expire 10 years from the date of grant, thirty days after termination of service other than for cause, or one year after death or disability of the grantee. The Company has no option or restricted stock awards with market or performance conditions attached to them. The Company generally issues shares for option exercises from its treasury stock using the cost method. No further awards will be granted from the 2000 program.
Statement Of Cash Flows
Cash and cash equivalents are defined as cash on hand, cash items in the process of collection, amounts due from banks and federal funds sold with an original maturity of three months or less. The following shows supplemental non-cash investing and financing activities for the periods presented:
Comprehensive Income
The Company reports comprehensive income in addition to net income (loss) from operations. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income (loss).
Goodwill and Other Identifiable Intangible Assets
Goodwill and core deposit intangibles resulting from prior acquisitions totaled $87.1 million and $7.9 million, respectively, at the time of acquisition. Total goodwill was $87.1 million at December 31, 2011 and 2010. In the third quarter of 2011 the Company completed its core deposit intangible amortization. Core deposit intangibles were $578,000 at December 31, 2010 which was amortized in 2011. Core deposit amortization was $1.1 million for both 2010 and 2009.
The Company reviews goodwill for impairment annually as of November 30 or when circumstances indicate a potential for impairment at the reporting unit level. U.S. GAAP requires at least an annual review of the fair value of a Reporting Unit that has goodwill in order to determine if it is more likely than not (that is, a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount, including goodwill. If this qualitative test determines it is unlikely (less than 50% probability) the carrying value of the Reporting Unit is less than its fair value, then the company does not have to perform a Step One impairment test. If the probability is greater than 50%, a Step One goodwill impairment test is required. The Step One test compares the fair value of each reporting unit to the carrying value of its net assets, including goodwill. If the fair value is less than carrying value, the Step Two test is required. The Company has determined that it has one reporting unit, Community Banking.
The Company performed a qualitative analysis to determine whether “the weight of evidence, the significance of all identified events and circumstances” indicated a greater than 50% likelihood existed that the carrying value of the Reporting Unit exceeded its fair value and if a Step One Test would be required. The Company identified nine qualitative assessments that are relative to the banking industry and to the Company. These factors included macroeconomic factors, banking industry conditions, banking merger and acquisition trends, Lakeland’s historical performance, the Company’s stock price, the expected performance of Lakeland, the change of control premium of the Company versus its peers and other miscellaneous factors. After reviewing and weighting these factors, the Company, as well as a third party adviser, determined as of November 30, 2011 that there was a less than 50% probability that the fair value of the Company was less than its carrying amount. Therefore, no Step One test was required.
Bank Owned Life Insurance
The Company invests in bank owned life insurance (“BOLI”). BOLI involves the purchasing of life insurance by the Company on a chosen group of employees. The Company is owner and beneficiary of the policies. At December 31, 2011 and 2010, the Company had $44.8 million and $43.3 million, respectively, in BOLI. Income earned on BOLI was $1.4 million, $1.5 million and $1.9 million for the years ended December 31, 2011, 2010 and 2009, respectively. The decrease in income earned on BOLI in 2011 compared to 2010 was due to a decrease in the yield on the underlying policies. Income earned on BOLI in 2009 included $485,000 in proceeds from insurance policy payouts.
Income Taxes
The Company accounts for income taxes under the liability method of accounting for income taxes. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates that will be in effect when these differences reverse. Deferred tax expense is the result of changes in deferred tax assets and liabilities. The principal types of differences between assets and liabilities for financial statement and tax return purposes are allowance for loan and lease losses, core deposit intangibles, deferred loan fees and deferred compensation.
Variable Interest Entities
Management has determined that Lakeland Bancorp Capital Trust I, Lakeland Bancorp Capital Trust II, Lakeland Bancorp Capital Trust III and Lakeland Bancorp Capital Trust IV (collectively, “the Trusts”) qualify as variable interest entities. The Trusts issued mandatorily redeemable preferred stock to investors and loaned the proceeds to the Company. The Trusts hold, as their sole asset, subordinated debentures issued by the Company.
The Company’s maximum exposure to the Trusts is $75 million which is the Company’s liability to the Trusts and includes the Company’s investment in the Trusts.
The Federal Reserve has issued guidance on the regulatory capital treatment for the trust preferred securities issued by the Trusts. The rule retains the current maximum percentage of total capital permitted for trust preferred securities at 25%, but enacts other changes to the rules governing trust preferred securities that affect their use as part of the collection of entities known as “restricted core capital elements.” The rule allows bank holding companies to continue to count trust preferred securities as Tier 1 Capital at March 31, 2011. The Company’s capital ratios continue to be categorized as “well-capitalized” under the regulatory framework for prompt corrective action. Under the Collins Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act, any new issuance of trust preferred securities by the Company would not be eligible as regulatory capital.
New Accounting Pronouncements
In December 2010, the Financial Accounting Standards Board (the “FASB”) issued accounting guidance that modifies Step One of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step Two of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist such as if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. This guidance was effective for interim and annual reporting periods beginning on or after December 15, 2010 and did not have a significant impact on the Company’s financial statements.
In April 2011, the FASB issued accounting guidance to help creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The purpose of this guidance is to eliminate diversity in practice and provide greater comparability between companies’ financial statements. This guidance is effective for interim and annual reporting periods beginning on or after June 15, 2011 and should be applied retrospectively to the beginning of the annual period of adoption. Adoption of this guidance did not have a significant impact on the Company’s financial statements.
In May 2011, the FASB and the International Accounting Standards Board (the “IASB”) issued new accounting guidance on fair value measurement and disclosure requirements. This guidance is the result of work by the FASB and IASB to develop common requirements for measuring fair value and disclosing information about fair value measurements in accordance with U.S. GAAP and International Financial Reporting Standards
(“IFRS”). As a result, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. The guidance is effective during interim and annual periods beginning after December 15, 2011. The guidance is to be applied prospectively, and early application by public entities is not permitted. Adoption of the guidance is not expected to have a significant impact on the Company’s financial statements.
In June 2011, the FASB issued accounting guidance updating the requirements regarding the presentation of comprehensive income to increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. GAAP and IFRS. Under the new guidance, the components of net income and the components of other comprehensive income can be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance eliminates the option to present components of other comprehensive income as part of the changes in stockholders’ equity. This amendment will be applied prospectively and the amendments are effective for fiscal years and interim periods beginning after December 15, 2011. Adoption of the guidance is not expected to have a significant impact on the Company’s financial statements. In December 2011, the FASB deferred certain aspects of this guidance related to the requirement to present items that are reclassified from accumulated other comprehensive income to net income separately with their respective components of net income and other comprehensive income.
In September 2011, the FASB issued accounting guidance related to the annual testing of goodwill for impairment. Under the new guidance, an entity has the option to first determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. If, however, the entity concludes otherwise, then it is required to perform the first step of the two-step impairment test and then perform the second test, if required. This amendment is effective for annual and interim goodwill impairment tests performed for the fiscal years beginning after December 15, 2011. Early adoption is permitted. The Company adopted this guidance for its goodwill review as of November 30, 2011. Adoption did not have a significant impact on the Company’s financial statements.
NOTE 2-INVESTMENT SECURITIES
The amortized cost, gross unrealized gains and losses, and the fair value of the Company’s available for sale and held to maturity securities are as follows:
The following table lists contractual maturities of investment securities classified as available for sale and held to maturity. 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.
The following table shows proceeds from sales of securities, gross gains and gross losses on sales and calls of securities for the periods indicated:
Securities with a carrying value of approximately $343.7 million and $340.6 million at December 31, 2011 and 2010, respectively, were pledged to secure public deposits and for other purposes required by applicable laws and regulations.
The following table indicates the length of time individual securities have been in a continuous unrealized loss position at December 31, 2011 and 2010:
Management has evaluated the securities in the above table and has concluded that, with the exception of the equity securities discussed below, none of the securities with unrealized losses has impairments that are other-than-temporary. Fair value below cost is solely due to interest rate movements and is deemed temporary.
Investment securities, including the mortgage backed securities and corporate securities, are evaluated on a periodic basis to determine if factors are identified that would require further analysis. In evaluating the Company’s securities, management considers the following items:
•
The credit ratings of the underlying issuer and if any changes in the credit rating have occurred;
•
The results of discounted cash flow analyses;
•
The Company’s ability and intent to hold the securities, including an evaluation of the need to sell the security to meet certain liquidity measures, or whether the Company has sufficient levels of cash to hold the identified security in order to recover the entire amortized cost of the security;
•
The length of time the security’s fair value has been less than amortized cost; and
•
Adverse conditions related to the security or its issuer, if the issuer has failed to make scheduled payments or other factors.
In 2011 the Company recorded no other-than-temporary impairment charges on investments in its equity securities portfolio, compared to $128,000 in 2010.
As of December 31, 2011, equity securities included $12.8 million in investment funds that do not have a quoted market price but use net asset value per share or its equivalent to measure fair value.
The funds include $2.9 million in funds that are primarily invested in community development loans that are guaranteed by the Small Business Administration (SBA). Because the funds are primarily guaranteed by the federal government there are minimal changes in market value between accounting periods. These funds can be redeemed within 60 days notice at the net asset value less unpaid management fees with the approval of the fund manager. As of December 31, 2011, the net amortized cost equaled the market value of the investment. There are no unfunded commitments related to this investment.
The funds also include $9.9 million in funds that are invested in government guaranteed loans, mortgage-backed securities, small business loans and other instruments supporting affordable housing and economic development. The Company may redeem these funds at the net asset value calculated at the end of the current business day less any unpaid management fees. As of December 31, 2011, the amortized cost of these securities was $9.7 million and the fair value was $9.9 million. There are no restrictions on redemptions for the holdings in these investments other than the notice required by the fund manager. There are no unfunded commitments related to this investment.
NOTE 3-LOANS AND LEASES
The following sets forth the composition of Lakeland’s loan and lease portfolio for the years ended December 31, 2011 and 2010:
Non-accrual and Past Due Loans
The following schedule sets forth certain information regarding the Company’s non-accrual loans and leases, its other real estate owned and other repossessed assets, and accruing troubled debt restructurings:
Non-accrual loans included $4.6 million and $3.6 million of troubled debt restructurings for the years ended December 31, 2011 and 2010, respectively.
An age analysis of past due loans, segregated by class of loans as of December 31, 2011 and 2010 is as follows:
Impaired Loans
Impaired loans for the year ended December 31, 2011 and 2010, are as follows:
The balance of impaired loans and leases was $31.4 million at December 31, 2009. The allowance for loan and lease losses associated with impaired loans and leases was $3.7 million at December 31, 2009. At December 31, 2009, the Company had $14.6 million in impaired loans and leases for which there was no related allowance for loan losses. The average recorded investment in impaired loans and leases was $25.2 million during 2009, and the income recognized, primarily on the cash basis, on impaired loans and leases was $55,000 during 2009. Interest which would have been accrued on impaired loans and leases during 2011, 2010 and 2009 was $2.9 million, $2.2 million and $2.0 million, respectively.
Credit Quality Indicators
The class of loan and leases are determined by internal risk rating. Management closely and continually monitors the quality of its loans and leases and assesses the quantitative and qualitative risks arising from the credit quality of its loans and leases. It is the policy of Lakeland to require that a Credit Risk Rating be assigned to all commercial loans and loan commitments. The Credit Risk Rating System has been developed by management to provide a methodology to be used by Loan Officers, department heads and Senior Management in identifying various levels of credit risk that exist within Lakeland’s loan portfolios. The risk rating system assists Senior Management in evaluating Lakeland’s loan portfolio, analyzing trends, and determining the proper level of required reserves to be recommended to the Board. In assigning risk ratings, management considers, among other things, a borrower’s debt service coverage, earnings strength, loan to value ratios, industry conditions and economic conditions. Management categorizes loans and commitments into a one (1) to nine (9) numerical structure with rating 1 being the strongest rating and rating 9 being the weakest. Ratings 1 through 5W are considered ‘Pass’ ratings.
The following table shows the Company’s commercial loan portfolio as of December 31, 2011 and 2010, by the risk ratings discussed above (in thousands):
This table does not include consumer or residential loans or leases because they are evaluated on their performing status.
Allowance for Loan and Lease Losses
The following table details activity in the allowance for loan and lease losses by portfolio segment and the related recorded investment in loans and leases for the year ended December 31, 2011 and 2010:
(1) Excludes leases held for sale and deferred costs
(1) Excludes leases held for sale and deferred costs
Changes in the allowance for loan and lease losses are as follows for the year ended December 31, 2009.
Troubled Debt Restructurings
Troubled debt restructurings are those loans where significant concessions have been made due to borrowers’ financial difficulties. Restructured loans typically involve a modification of terms such as a reduction of the stated interest rate, a moratorium of principal payments and/or an extension of the maturity date at a stated interest rate lower than the current market rate of a new loan with similar risk. The Company considers the potential losses on these loans as well as the remainder of its impaired loans when considering the adequacy of the allowance for loan losses.
The following table summarizes, as of December 31, 2011, loans that have been restructured in 2011:
The following table summarizes as of December 31, 2011, loans that were restructured within the last 12 months that have subsequently defaulted:
Related Party Loans
Lakeland has entered into lending transactions in the ordinary course of business with directors, executive officers, principal stockholders and affiliates of such persons on similar terms, including interest rates and collateral, as those prevailing for comparable transactions with other borrowers not related to Lakeland. At December 31, 2011, loans to these related parties amounted to $27.6 million. There were new loans of $9.0 million to related parties and repayments of $11.9 million from related parties in 2011.
Leases Held for Sale
Lakeland had no leases held for sale on December 31, 2011 compared to leases held for sale with a fair market value of $1.5 million as of December 31, 2010. During the first quarter of 2011, management reclassified $1.5 million of leases held for sale to held for investment because management’s intent regarding these leases had changed. During the year ended December 31, 2009, Lakeland sold lease pools with a carrying value of $54.2 million for $53.4 million and recorded a loss on sales of leases of $792,000. During 2010, the Company sold leases with a carrying value of $1.1 million for $1.0 million and recorded a loss of $61,000. The following table shows the components of gains on leasing related assets for the periods presented:
Gains (losses) on held for sale leasing assets are included in gain (loss) on leasing related assets along with other miscellaneous leasing income typically recorded in Lakeland’s leasing business.
Future minimum lease payments of lease receivables (including leases held for sale) are as follows (in thousands):
Other Real Estate and Other Repossessed Assets
At December 31, 2011, the Company had other repossessed assets and other real estate owned of $236,000 and $946,000, respectively. At December 31, 2010, the Company had other repossessed assets and other real estate owned of $558,000 and $1.0 million, respectively. For the years ended December 31, 2011, 2010 and 2009, the Company had writedowns of $230,000, $0 and $782,000, respectively, on other real estate and other repossessed assets which are included in other real estate and repossessed asset expense in the Statement of Operations.
NOTE 4-PREMISES AND EQUIPMENT
NOTE 5-DEPOSITS
At December 31, 2011, the schedule of maturities of certificates of deposit is as follows (in thousands):
NOTE 6-DEBT
Lines of Credit
As a member of the Federal Home Loan Bank of New York (FHLB), Lakeland has the ability to borrow overnight based on the market value of collateral pledged. As of December 31, 2011 and 2010, there were no overnight borrowings from the FHLB. As of December 31, 2011, the Company also had overnight federal funds lines available for it to borrow up to $162.0 million. The Company had borrowed $28.0 and $5.5 million against these lines as of December 31, 2011 and 2010, respectively. The Company may also borrow from the discount window of the Federal Reserve Bank of New York based on the market value of collateral pledged. Lakeland had no borrowings with the Federal Reserve Bank of New York as of December 31, 2011 or 2010.
Federal Funds Purchased and Securities Sold Under Agreements to Repurchase
Short-term borrowings at December 31, 2011 and 2010 consisted of short-term securities sold under agreements to repurchase and federal funds purchased. Securities underlying the agreements were under Lakeland’s control. The following tables summarize information relating to securities sold under agreements to repurchase and federal funds purchased for the years presented. For purposes of the tables, the average amount outstanding was calculated based on a daily average.
Other Borrowings
FHLB Debt
At December 31, 2011, advances from the FHLB totaling $95.0 million will mature within one month to six years and are reported as other borrowings. These advances are collateralized by certain securities and first mortgage loans. The advances had a weighted average interest rate of 1.63%. In the third quarter of 2011, the Company prepaid $20.0 million of its FHLB debt that had a weighted rate of 4.10% and incurred a prepayment penalty of $800,000.
FHLB debt matures as follows (in thousands):
Long-term Securities Sold Under Agreements to Repurchase
At December 31, 2011, the Company had $60.0 million in long-term securities sold under agreements to repurchase. These securities were able to be called starting in 2009. These advances are collateralized by certain securities. The advances had a weighted average interest rate of 3.86%. These borrowings have rates that can reset quarterly. These long-term securities sold under agreements to repurchase mature as follows (in thousands):
Subordinated Debentures
In May 2007, the Company issued $20.6 million of junior subordinated debentures due August 31, 2037 to Lakeland Bancorp Capital Trust IV, a Delaware business trust. The distribution rate on these securities is 6.61% for 5 years and floats at LIBOR plus 152 basis points thereafter. The debentures are the sole asset of the Trust. The Trust issued 20,000 shares of trust preferred securities, $1,000 face value, for total proceeds of $20.0 million. The Company’s obligations under the debentures and related documents, taken together, constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the Trust’s obligations under the preferred securities. The preferred securities are callable by the Company on or after August 1, 2012, or earlier if the deduction of related interest for federal income taxes is prohibited, treatment as Tier I capital is no longer permitted, or certain other contingencies arise. The preferred securities must be redeemed upon maturity of the debentures in 2037.
In December 2003, the Company issued $25.8 million of junior subordinated debentures due January 7, 2034 to Lakeland Bancorp Capital Trust III, a Delaware business trust. The distribution rate on these securities is 7.535% for 10 years and floats at LIBOR plus 285 basis points thereafter. The debentures are the sole asset of the
Trust. The Trust issued 25,000 shares of trust preferred securities, $1,000 face value, for total proceeds of $25.0 million. The Company’s obligations under the debentures and related documents, taken together, constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the Trust’s obligations under the preferred securities. The preferred securities are callable by the Company on or after January 7, 2009, or earlier if the deduction of related interest for federal income taxes is prohibited, treatment as Tier I capital is no longer permitted, or certain other contingencies arise. The preferred securities must be redeemed upon maturity of the debentures in 2034.
In June 2003, the Company issued $10.3 million of junior subordinated debentures due July 7, 2033 to Lakeland Bancorp Capital Trust I, a Delaware business trust. The distribution rate on these securities was 6.20% for 7 years and floats at LIBOR plus 310 basis points thereafter. The debentures are the sole asset of the Trust. The Trust issued 10,000 shares of trust preferred securities, $1,000 face value, for total proceeds of $10.0 million. The Company’s obligations under the debentures and related documents, taken together, constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the Trust’s obligations under the preferred securities. The preferred securities are callable by the Company on or after July 7, 2010, or earlier if the deduction of related interest for federal income taxes is prohibited, treatment as Tier I capital is no longer permitted, or certain other contingencies arise. The preferred securities must be redeemed upon maturity of the debentures in 2033.
In June 2003, the Company also issued $20.6 million of junior subordinated debentures due June 30, 2033 to Lakeland Bancorp Capital Trust II, a Delaware business trust. The distribution rate on these securities was 5.71% for 5 years and floats at LIBOR plus 310 basis points thereafter. The debentures are the sole asset of the Trust. The Trust issued 20,000 shares of trust preferred securities, $1,000 face value, for total proceeds of $20.0 million. The Company’s obligations under the debentures and related documents, taken together, constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the Trust’s obligations under the preferred securities. The preferred securities are callable by the Company on or after June 30, 2008, or earlier if the deduction of related interest for federal income taxes is prohibited, treatment as Tier I capital is no longer permitted, or certain other contingencies arise. The preferred securities must be redeemed upon maturity of the debentures in 2033.
NOTE 7-STOCKHOLDERS’ EQUITY
On January 14, 2011, the Company’s Board of Directors authorized a 5% stock dividend which was distributed on February 16, 2011, to holders of record as of January 31, 2011.
On February 6, 2009, under the Troubled Asset Relief Program (TARP) Capital Purchase Program (CPP), the Company issued 59,000 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A preferred stock”) to the U.S. Department of the Treasury (the U.S. Treasury) for a purchase price of $59.0 million. The Series A preferred stock has a 5% annual dividend rate for the first five years and a 9% annual dividend thereafter if the Series A preferred stock are not redeemed by the Company. The Company may redeem the Series A preferred stock with the consent of the Treasury Department in conjunction with the Company’s primary regulator at any time.
In conjunction with the issuance of our Series A preferred stock, the Company also issued a warrant to purchase 997,049 shares of the Company’s common stock to the U.S. Treasury. The warrant has a 10-year term and is immediately exercisable at an exercise price, subject to anti-dilution adjustments, of $8.88 per share.
The proceeds from the U.S. Treasury are allocated to the Series A preferred stock and the warrant based on their relative fair values. The fair value of the Series A preferred stock was determined through a discounted future cash flow model. The Company calculated the fair value of the Series A preferred stock by using a 14% discount rate and discounting the cash flows over a 10 year period. A Black-Scholes pricing model was used to calculate the fair value of the warrant. The Black-Scholes model used the following assumptions, a dividend yield of 5.12%, volatility of 32% and a risk-free interest rate of 3.05%.
A $3.3 million discount was being amortized over a five year period using a level yield method. The effective yield on the amortization of the Series A preferred stock is approximately 6.36%. In determining net income (loss) available to common shareholders, the periodic amortization and the cash dividend on the Series A preferred stock are subtracted from net income (loss).
On August 4, 2010, the Company redeemed 20,000 shares of its Series A preferred stock. The Company paid to the Treasury $20.2 million, which included $20.0 million of principal and $219,000 in accrued and unpaid dividends, on August 4, 2010. As a result of the early payment, the Company also accelerated the accretion of $898,000 of the preferred stock discount. The warrant previously issued to the Treasury to purchase 997,049 shares of common stock at an exercise price of $8.88, subject to anti-dilution adjustments, remained outstanding.
On March 16, 2011, the Company redeemed 20,000 shares of Series A Preferred Stock. The Company paid to the Treasury $20.1 million, which included $20.0 million of principal and $86,000 in accrued and unpaid dividends, on March 16, 2011. As a result of the early payment, the Company also accelerated the accretion of $745,000 of the preferred stock discount. The above mentioned warrant issued to the U.S. Treasury remained outstanding.
On February 8, 2012, the Company redeemed its remaining 19,000 shares of its Series A Preferred Stock. The Company paid to the Treasury $19.2 million, which included $19.0 million of principal and $219,000 in accrued and unpaid dividends, on February 8, 2012. As a result of the early payment, the Company also accelerated the accretion of $501,000 of the preferred stock discount.
On February 29, 2012, the Company repurchased the outstanding common stock warrant for the purchase of 997,049 shares of its common stock, for $2.8 million, completing the Company’s participation in the Treasury’s CPP. Upon repurchase, the common stock warrant had a carrying value of $3.3 million. The repurchase price of $2.8 million was recorded as a reduction to common stock on the statement of changes in stockholders’ equity.
NOTE 8-SHAREHOLDER PROTECTION RIGHTS PLAN
The Company adopted a Shareholder Rights Plan (the “Rights Plan”) in 2001 to protect shareholders from attempts to acquire control of the Company at an inadequate price. Under the Rights Plan, the Company distributed a dividend of one right to purchase a unit of common stock on each outstanding common share of the Company. The rights were not exercisable or transferable, and no separate certificates evidencing such rights were to be distributed, unless certain events occur. The rights expired on September 4, 2011.
The Rights Plan was not adopted in response to any specific effort to acquire control of the Company. The issuance of rights had no dilutive effect, did not affect the Company’s reported earnings per share, and was not taxable to the Company or its shareholders.
NOTE 9-INCOME TAXES
The components of income taxes are as follows:
The income tax provision reconciled to the income taxes that would have been computed at the statutory federal rate of 35% is as follows:
The net deferred tax asset consisted of the following:
The Company evaluates the realizability of its deferred tax assets by examining its earnings history and projected future earnings and by assessing whether it is more likely than not that carryforwards would not be realized. Based upon the majority of the Company’s deferred tax assets having no expiration date, the Company’s earnings history, and the projections of future earnings, the Company’s management believes that it is more likely than not that all of the Company’s deferred tax assets as of December 31, 2011 will be realized.
A reconciliation of the beginning and ending amount of unrecognized tax benefits are as follows:
The amount of unrecognized tax benefits as of December 31, 2011 and 2010, was $241,000 and $398,000, respectively, all of which, if ultimately recognized, would reduce the Company’s annual effective tax rate.
The Company is subject to U.S. federal income tax law as well as income tax of various state jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. With few significant exceptions, the Company is no longer subject to U.S. federal examinations by tax authorities for the years before 2007 or to state and local examinations by tax authorities for the years before 2006.
The Company recognizes interest accrued and penalties related to unrecognized tax benefits in income tax expense for all periods presented. The Company had accrued approximately $43,000 and $112,000 for the payment of interest and penalties at December 31, 2011 and 2010, respectively.
NOTE 10-EARNINGS PER SHARE
The Company uses the two class method to compute earnings per common share. Participating securities include non-vested restricted stock. The following tables present the computation of basic and diluted earnings per share for the periods presented.
Options to purchase 569,978 shares of common stock and 18,946 shares of restricted stock at a weighted average of $13.20 and $12.10 per share, respectively, were not included in the computation of diluted earnings per share because the option and warrant exercise price and the grant date price were greater than the average market price during the period.
Options to purchase 702,167 shares of common stock, a warrant to purchase 997,049 shares of common stock and 44,761 shares of restricted stock at a weighted average of $12.97, $8.88 and $11.99 per share, respectively, were not included in the computation of diluted earnings per share because the option and warrant exercise price and the grant date price were greater than the average market price during the period.
Options to purchase 856,246 shares of common stock, a warrant to purchase 997,049 shares of common stock and 101,735 shares of restricted stock at a weighted average of $11.79, $8.88 and $11.40 per share, respectively, were not included in the computation of diluted earnings per share because of the net loss recorded. The two step-method was not used in the computation of earnings per share because of the net loss recorded.
NOTE 11-EMPLOYEE BENEFIT PLANS
Profit Sharing Plan
The Company has a profit sharing plan for all its eligible employees. The Company’s annual contribution to the plan is determined by its Board of Directors. Annual contributions are allocated to participants on a point basis with accumulated benefits payable at retirement, or, at the discretion of the plan committee, upon termination of employment. Contributions made by the Company were approximately $675,000 for 2011 and $600,000 for 2010. There were no contributions to the profit sharing plan in 2009.
Salary Continuation Agreements
The National Bank of Sussex County (NBSC) entered into a salary continuation agreement during 1996 with its former Chief Executive Officer (CEO) and its President which entitle them to certain payments upon their retirement. As part of the merger of the Company and NBSC’s parent (High Point Financial Corp.) in July 1999, Lakeland placed in trusts amounts equal to the present value of the amounts that would be owed to them in their retirement. These amounts were $722,000 for the CEO and $381,000 for the President. The Company has no further obligation to pay additional amounts pursuant to these agreements.
Former CEO Retirement Benefits
Metropolitan State Bank entered into an agreement in January 1997 with its former CEO, which provides for an annual retirement benefit of $35,000 for a fifteen year period. In February 1999, the Company entered into an additional agreement with this CEO. Such agreement provides for an additional retirement benefit of $35,000 per annum for a fifteen year period. During 2011, 2010 and 2009, $5,000, $7,000 and $8,000, respectively, was charged to operations related to these obligations.
Retirement Savings Plans (401K plans)
Beginning in January 2002, the Company began contributing to its 401(k) plan. All eligible employees can contribute a portion of their annual salary with the Company matching up to 50% of the employee’s contributions. The Company’s contributions in 2011, 2010 and 2009 totaled $596,000, $575,000 and $558,000, respectively.
Pension Plan
Newton Trust Company had a defined benefit pension plan (the Plan) that was frozen prior to the acquisition by the Company. All participants of the Plan ceased accruing benefits as of that date.
The investment policy and strategy of the Plan and its advisors includes target portfolio allocations of approximately 55% in equities, 35% in debt securities, 5% in commodities and 5% in cash. Based on historical performance, the Plan assumes that the long term equity securities have earned a rate of return of approximately 10% and fixed income securities have earned a return of between 1% and 5%.
The assets of the Plan consist of cash and cash equivalents and investments in mutual funds that are actively traded. All of the mutual funds are classified as Level 1 securities meaning that their market values are unadjusted quoted prices in active markets.
The following table shows the fair value and the portfolio allocations of the assets in the Plan by type of investment as of December 31, 2011 (dollars in thousands):
The accumulated benefit obligation as of December 31 is as follows:
The components of net periodic pension cost are as follows:
The benefits expected to be paid in each of the next five years and the aggregate for the five fiscal years thereafter are as follows (in thousands):
The assumptions used to determine the pension obligation and the net periodic pension cost were as follows:
Deferred Compensation Arrangements
High Point Financial Corp. had established deferred compensation arrangements for certain directors and executives of High Point Financial Corp. and NBSC. The deferred compensation plans differ, but generally provide for annual payments for ten to fifteen years following retirement. The Company’s liabilities under these arrangements are being accrued from the commencement of the plans over the participants’ remaining periods of
service. The Company intends to fund its obligations under the deferred compensation arrangements with the increase in cash surrender value of life insurance policies that it has purchased on the respective participants. The deferred compensation plans do not hold any assets. For the years ended December 31, 2011, 2010 and 2009 there were no charges related to this plan. As of December 31, 2011 and 2010, the accrued liability for these plans was $249,000 and $223,000, respectively.
Supplemental Executive Retirement Plans
In 2003, the Company entered into a supplemental executive retirement plan (SERP) agreement with its former CEO that provides annual retirement benefits of $150,000 a year for a 15 year period when the former CEO reached the age of 65. Our former CEO retired and is receiving annual retirement benefits pursuant to the plan. In 2008, the Company entered into a SERP agreement with its current CEO that provides annual retirement benefits of $150,000 for a 15 year period when the CEO reaches the age of 65. In November 2008, the Company entered into a SERP with its Senior Executive Vice President and Chief Operating Officer that provides annual retirement benefits of $90,000 a year for a 10 year period upon his reaching the age of 65. The Company intends to fund its obligations under the deferred compensation arrangements with the increase in cash surrender value of bank owned life insurance policies. In 2011, 2010 and 2009, the Company recorded compensation expense of $233,000, $229,000 and $230,000, respectively, for these plans.
NOTE 12-DIRECTORS RETIREMENT PLAN
The Company provides a plan that any director who became a member of the Board of Directors prior to 2009 who completes five years of service may retire and continue to be paid for a period of ten years at a rate ranging from $5,000 through $17,500 per annum, depending upon years of credited service. This plan is unfunded. The following tables present the status of the plan and the components of net periodic plan cost for the years then ended. The measurement date for the accumulated benefit obligation is December 31 of the years presented.
A discount rate of 4.00% and 5.00% was assumed in the plan valuation for 2011 and 2010, respectively. As the benefit amount is not dependent upon compensation levels, a rate of increase in compensation assumption was not utilized in the plan valuation.
The director’s retirement plan holds no plan assets. The benefits expected to be paid in each of the next five years and in aggregate for the five years thereafter are as follows (in thousands):
The Company expects its contribution to the director’s retirement plan to be $88,000 in 2012.
The amount in accumulated other comprehensive loss expected to be recognized as a component of net periodic benefit cost in 2012 is $26,000.
NOTE 13-STOCK-BASED COMPENSATION
Employee Stock Option Plans
On May 21, 2009, the Company’s shareholders approved the 2009 Equity Compensation Program, which authorizes the granting of incentive stock options, supplemental stock options, restricted shares and restricted stock units to employees of the Company, including those employees serving as officers and directors of the Company. The plan authorizes the issuance of 2.1 million shares in connection with options and awards granted under the 2009 program.
The Company established the 2000 Equity Compensation Program which authorizes the granting of incentive stock options, supplemental stock options and restricted stock to employees of the Company which includes those employees serving as officers and directors of the Company. The plan authorized 2,370,237 shares of common stock of the Company. No further awards will be granted from the 2000 program.
During 2010, the Company granted options to purchase 26,250 shares to a new non-employee director of the Company at an exercise price of $8.64 per share under the 2009 program. The director’s options are exercisable in five equal installments beginning on the date of grant and continuing on the next four anniversaries of the date of grant. As of December 31, 2011 and 2010, 201,614 and 236,790 options granted to directors were outstanding, respectively.
As of December 31, 2011 and 2010, outstanding options to purchase common stock granted to key employees were 368,364 and 465,820, respectively.
In addition to the 2009 and 2000 Equity Compensation programs, the Company has assumed the outstanding options granted under Newton Financial Corp.’s 1999 Stock Option Plan (the Newton Plan). As of December 31, 2011 and 2010, 0 and 18,511 options, respectively, were outstanding under the Newton Plan. All of the options in the Newton plan had expired by December 31, 2011.
On January 14, 2009, the Company granted 15,174 shares of restricted stock at a market value of $8.82 per share under the 2000 program. These shares vest over a four year period. Compensation expense on these shares is expected to be approximately $26,000 per year for the next four years. In 2010, the Company granted 36,357 shares of restricted stock at a fair value of $6.84 per share under the 2009 program. These shares vest over a five year period. Compensation expense on these shares is expected to be approximately $50,000 per year for the next five years. In 2011, the Company granted 95,345 shares of restricted stock at a fair value of $9.87 per share under the Company’s 2009 equity compensation program. These shares vest over a five year period. Compensation expense on these shares is expected to average approximately $188,000 per year for the next five years.
Excess tax benefits of stock based compensation was ($3,000), $21,000, and $2,000 for the years 2011, 2010 and 2009, respectively.
For the year ended December 31, 2010, the Company estimated the fair value of each option grant on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
There were no stock options granted in 2011 or 2009.
A summary of the status of the Company’s option plans as of December 31, 2011 and the changes during the year ending on that date is represented below.
A summary of the Company’s non-vested options under the Company’s option plans as of December 31, 2011 and changes for the year then ended is presented below.
As of December 31, 2011, there was $46,000 of unrecognized compensation expense related to unvested stock options under the 2009 and 2000 Equity Compensation Programs. Compensation expense recognized for stock options was $43,000, $60,000, and $32,000 for 2011, 2010, and 2009, respectively.
The aggregate intrinsic values of options exercised in 2011, 2010 and 2009 were $78,000, $232,000 and $5,000, respectively. Exercise of stock options during 2011, 2010 and 2009 resulted in cash receipts of $72,000, $662,000 and $15,000, respectively. The total fair value of options that vested in 2011, 2010 and 2009 were $50,000, $50,000 and $32,000, respectively.
Information regarding the Company’s restricted stock for the year ended December 31, 2011 is as follows:
The total fair value of the restricted stock vested during the year ended December 31, 2011 was approximately $352,000. Compensation expense recognized for restricted stock was $584,000, $478,000 and $411,000 in 2011, 2010 and 2009, respectively. There was approximately $1.1 million in unrecognized compensation expense related to restricted stock grants as of December 31, 2011.
NOTE 14-COMMITMENTS AND CONTINGENCIES
Lease Obligations
Rent expense under long-term operating leases amounted to approximately $1.9 million, $1.9 million and $2.0 million for the years ended December 31, 2011, 2010 and 2009, respectively, including rent expense to related parties of $325,000 in 2011, $295,000 in 2010, and $300,000, in 2009. At December 31, 2011, the minimum commitments, which include rental, real estate tax and other related amounts, under all noncancellable leases with remaining terms of more than one year and expiring through 2032 are as follows(in thousands):
Litigation
During the fourth quarter of 2011, the Company and the International Association of Machinists and Aerospace Workers (the “plaintiff”) settled a complaint that had been filed by the plaintiff in February 2010, in the Circuit Court of Maryland for Prince George’s County, in connection with certain equipment leases plaintiff entered into with a vendor and lease broker not affiliated with the Company. Under the settlement agreement, which included a confidentiality provision, the Company provided a quitclaim assignment of its interests in the leases to the plaintiff in consideration of a lump sum payment by the plaintiff to the Company.
There are no pending legal proceedings involving the Company or Lakeland other than those arising in the normal course of business. Management does not anticipate that the potential liability, if any, arising out of such legal proceedings will have a material effect on the financial condition or results of operations of the Company and Lakeland on a consolidated basis.
NOTE 15-FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK
Lakeland is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the consolidated financial statements when they become payable. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement Lakeland has in particular classes of financial instruments.
Lakeland’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. Lakeland uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Lakeland generally requires collateral or other security to support financial instruments with credit risk. The approximate contract amounts are as follows:
At December 31, 2011 and 2010 there were $91,000 and $0, respectively, in commitments to lend additional funds to borrowers whose terms have been modified in troubled debt restructurings.
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 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. Lakeland evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by Lakeland upon extension of credit, is based on management’s credit evaluation.
Standby letters of credit are conditional commitments issued by Lakeland to guarantee the payment by or performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Lakeland holds deposit accounts, residential or commercial real estate, accounts receivable, inventory and equipment as collateral to support those commitments for which collateral is deemed necessary. The extent of collateral held for those commitments at December 31, 2011 and 2010 varies based on management’s credit evaluation.
Lakeland issues financial and performance letters of credit. Financial letters of credit require Lakeland to make payment if the customer fails to make payment, as defined in the agreements. Performance letters of credit require Lakeland to make payments if the customer fails to perform certain non-financial contractual obligations. Lakeland defines the initial fair value of these letters of credit as the fees received from the customer. Lakeland records these fees as a liability when issuing the letters of credit and amortizes the fee over the life of the letter of credit.
The maximum potential undiscounted amount of future payments of these letters of credit as of December 31, 2011 is $9.0 million and they expire through 2024. Lakeland’s exposure under these letters of credit would be reduced by actual performance, subsequent termination by the beneficiaries and by any proceeds that Lakeland obtained in liquidating the collateral for the loans, which varies depending on the customer.
As of December 31, 2011, Lakeland had $436.8 million in loan and lease commitments, with $364.6 million maturing within one year, $41.0 million maturing after one year but within three years, $1.3 million maturing after three years but within five years, and $29.9 million maturing after five years. As of December 31, 2011, Lakeland had $9.0 million in standby letters of credit, with $7.4 million maturing within one year, $1.4 million maturing after one year but within three years, $137,000 maturing after three years but within five years, and $80,000 maturing after five years.
Lakeland grants loans primarily to customers in its immediately adjacent suburban counties which include Bergen, Morris, Passaic, Sussex, Warren and Essex counties in Northern New Jersey and surrounding areas. Certain of Lakeland’s consumer loans and lease customers are more diversified nationally. Although Lakeland has a diversified loan portfolio, a large portion of its loans are secured by commercial or residential real property. Although Lakeland has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent upon the economy. Commercial and standby letters of credit were granted primarily to commercial borrowers.
NOTE 16-FAIR VALUE MEASUREMENT AND FAIR VALUE OF FINANCIAL INSTRUMENTS
U.S. GAAP establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels giving the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest level priority to unobservable inputs (level 3 measurements).
The following describes the three levels of fair value hierarchy:
Level 1 - unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2 - quoted prices for similar assets or liabilities in active markets; or quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs other than quoted prices that are observable for the asset or liability.
Level 3 - unobservable inputs for the asset or liability that reflect the Company’s own assumptions about assumptions that market participants would use in the pricing of the asset or liability and that are consequently not based on market activity but upon particular valuation techniques.
The following table sets forth the Company’s financial assets that were accounted for at fair values for the periods presented by level within the fair value hierarchy. The Company had no liabilities accounted for at fair value as of December 31, 2011 and 2010. During the year ended December 31, 2011, the Company did not make any transfers between recurring level 1 fair value measurements and recurring level 2 financial measurements. Financial assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement:
The following table sets forth the Company’s financial assets subject to fair value adjustments (impairment) on a nonrecurring basis. Assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement:
Impaired loans and leases are evaluated and valued at the time the loan is identified as impaired at the lower of cost or market value. Because most of Lakeland’s impaired loans are collateral-dependent, fair value is measured based on the value of the collateral securing these loans and leases and is classified at a level 3 in the
fair value hierarchy. Collateral may be real estate, accounts receivable, inventory, equipment and/or other business assets. The value of the real estate is assessed based on appraisals by qualified third party licensed appraisers. The value of the equipment may be determined by an appraiser, if significant, inquiry through a recognized valuation resource, or by the value on the borrower’s financial statements. Field examiner reviews on business assets may be conducted based on the loan exposure and reliance on this type of collateral. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Impaired loans and leases are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.
Other real estate owned (OREO) and other repossessed assets, representing property acquired through foreclosure, is carried at fair value less estimated disposal costs of the acquired property.
Changes in the assumptions or methodologies used to determine fair values may materially affect the estimated amounts. Also, management is concerned that there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values.
Fair values have been determined by the Company using the best available data and an estimation methodology suitable for each category of financial instruments. The estimation methodologies used, the fair values, and recorded book balances at December 31, 2011 and 2010 are outlined below.
The net loan portfolio at December 31, 2011 and 2010 has been valued using a present value discounted cash flow where market prices were not available. The discount rate used in these calculations is the current market rate adjusted for credit risk. The carrying value of accrued interest approximates fair value.
The fair values of demand deposits (i.e. interest (checking) and non-interest bearing demand accounts, savings and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e. their carrying amounts). The carrying amounts of variable rate accounts approximate their fair values at the reporting date. For fixed maturity certificates of deposit, fair value was estimated using the rates currently offered for deposits of similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value.
The fair value of securities sold under agreements to repurchase and long-term debt are based upon discounted value of contractual cash flows. The Company estimates the discount rate using the rates currently offered for similar borrowing arrangements.
The fair values of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counter parties at the reporting date.
The carrying values and fair values of the Company’s financial instruments are as follows:
NOTE 17-REGULATORY MATTERS
The Bank Holding Company Act of 1956 restricts the amount of dividends the Company can pay. Accordingly, dividends should generally only be paid out of current earnings, as defined.
The New Jersey Banking Act of 1948 restricts the amount of dividends paid on the capital stock of New Jersey chartered banks. Accordingly, no dividends shall be paid by such banks on their capital stock unless, following the payment of such dividends, the capital stock of Lakeland will be unimpaired, and: (1) Lakeland will have a surplus, as defined, of not less than 50% of its capital stock, or, if not, (2) the payment of such dividend will not reduce the surplus, as defined, of Lakeland. Under these limitations, approximately $224.3 million was available for payment of dividends from Lakeland to the Company as of December 31, 2011.
The Company and Lakeland are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possible additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Lakeland’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s and Lakeland’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and Lakeland’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulations to ensure capital adequacy require the Company and Lakeland to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets, and of Tier 1 capital to average assets. Management believes, as of December 31, 2011, that the Company and Lakeland met all capital adequacy requirements to which they are subject.
As of December 31, 2011, the most recent notification from the Federal Reserve Bank of New York and the FDIC categorized the Company and Lakeland as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and Lakeland must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institutions’ category.
As of December 31, 2011 and 2010, the Company and Lakeland have the following capital ratios:
NOTE 18-QUARTERLY FINANCIAL DATA (UNAUDITED)
The following represents summarized quarterly financial data of the Company, which in the opinion of management reflected all adjustments, consisting only of nonrecurring adjustments, necessary for a fair presentation of the Company’s results of operations.
(1) Adjusted for 5% stock dividend payable on February 16, 2011 to shareholders of record January 31, 2011.
NOTE 19-CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY:
CONDENSED BALANCE SHEETS
CONDENSED STATEMENTS OF OPERATIONS
CONDENSED STATEMENTS OF CASH FLOWS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Lakeland Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of Lakeland Bancorp, Inc. (a New Jersey corporation) and its subsidiaries (collectively, the Company) as of December 31, 2011 and 2010, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Lakeland Bancorp, Inc. and its subsidiaries as of December 31, 2011 and 2010, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Lakeland Bancorp, Inc. and its subsidiaries internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 15, 2012 expressed an unqualified opinion on internal control over financial reporting.
/s/ Grant Thornton LLP
Philadelphia, Pennsylvania
March 15, 2012
ITEM 9
ITEM 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not Applicable
ITEM 9A
ITEM 9A - Controls and Procedures
Disclosure Controls
As of the end of the period covered by this Annual Report on Form 10-K, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) pursuant to Securities Exchange Act Rule 15d-15(b).
Based on their evaluation as of December 31, 2011, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are effective in ensuring that the information required to be disclosed by the Company in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and are operating in an effective manner and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control Over Financial Reporting
The management of Lakeland Bancorp, Inc. and its subsidiaries (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934.
The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
•
Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
•
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and the board of directors of the Company; and
•
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions or because of declines in the degree of compliance with policies or procedures.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2011. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework.
As of December 31, 2011, based on management’s assessment, the Company’s internal control over financial reporting was effective.
Our independent registered public accounting firm, Grant Thornton LLP, audited our internal control over financial reporting as of December 31, 2011. Their report, dated March 15, 2012, expressed an unqualified opinion on our internal control over financial reporting.
Changes in Internal Controls Over Financial Reporting
There have been no changes in the Company’s internal control over financial reporting that occurred during the quarter ended December 31, 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Report Of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Lakeland Bancorp, Inc.
We have audited Lakeland Bancorp, Inc. (a New Jersey Corporation) and its subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2011 and 2010, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011, and our report dated March 15, 2012 expressed an unqualified opinion.
/s/ Grant Thornton LLP
Philadelphia, Pennsylvania
March 15, 2012
ITEM 9B
ITEM 9B - Other Information
None.
PART III
ITEM 10
ITEM 10 - Directors, Executive Officers and Corporate Governance
The Company responds to this Item by incorporating by reference the material responsive to this Item in the Company’s definitive proxy statement for its 2012 Annual Meeting of Shareholders.
ITEM 11
ITEM 11 - Executive Compensation
The Company responds to this Item by incorporating by reference the material responsive to this Item in the Company’s definitive proxy statement for its 2012 Annual Meeting of Shareholders.
ITEM 12
ITEM 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The Company responds to this Item by incorporating by reference the material responsive to this Item in the Company’s definitive proxy statement for its 2012 Annual Meeting of Shareholders.
Equity Compensation Plan Information
The following table gives information about the Company’s common stock that may be issued upon the exercise of options under the Company’s Amended and Restated 2000 Equity Compensation Program and the Company’s 2009 Equity Compensation Program as of December 31, 2011. These plans were the Company’s only equity compensation plans in existence as of December 31, 2011. The 2009 Equity Compensation Program is the successor to the 2000 Equity Compensation Program, and no additional awards will be granted under the 2000 Equity Compensation Program. No warrants or rights may be granted, or are outstanding, under the 2000 or the 2009 Equity Compensation Programs.
The number in column (a) includes 164,545 shares subject to restricted stock awards, including unvested shares. Shares subject to restricted stock awards have been excluded for purposes of calculating the weighted-average exercise price in column (b).
ITEM 13
ITEM 13 - Certain Relationships and Related Transactions, and Director Independence
The Company responds to this Item by incorporating by reference the material responsive to this Item in the Company’s definitive proxy statement for its 2012 Annual Meeting of Shareholders.
ITEM 14
ITEM 14 - Principal Accountant Fees and Services
The Company responds to this Item by incorporating by reference the material responsive to this Item in the Company’s definitive proxy statement for its 2012 Annual Meeting of Shareholders.
PART IV
ITEM 15
ITEM 15 - Exhibits and Financial Statement Schedules
* Pursuant to Rule 406T of Regulation S-T, this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
S-1