LAKELAND FINANCIAL CORP quarterly report, Q2 FY2013

Business context and reporting period

Lakeland Financial Corporation, parent of Lake City Bank, operates 45 offices in 13 counties in Northern and Central Indiana. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2013; comparisons are with the corresponding 2012 periods unless stated otherwise. Amounts below are in U.S. dollars; financial-statement amounts are generally in millions.

Financial performance and position

  • Profit and earnings: Q2 net income was $9.236 million, up 4.7%; six-month net income was $18.482 million, up 5.9%. Diluted EPS was $0.56 for Q2 (versus $0.54) and $1.12 for six months (versus $1.06).
  • Interest income and margin: Q2 net interest income was $21.912 million, down 1.1%; six-month net interest income was $43.169 million, down 3.3%. Net interest margin was 3.20% for Q2 versus 3.32%, and 3.19% year to date versus 3.37%. Management attributed the compression mainly to lower asset yields.
  • Other income and expenses: Noninterest income rose 30.2% to $7.569 million in Q2 and 29.1% to $15.050 million for six months. Noninterest expense rose 5.9% to $15.091 million in Q2 and 3.6% to $29.984 million for six months. Six-month growth in fee income included higher loan, insurance and service fees, and other income.
  • Credit costs: The company recorded no loan-loss provision in either 2013 period, compared with $0.500 million in Q2 2012 and $1.299 million for the first six months of 2012. The allowance was $50.635 million, or 2.17% of loans, at June 30, 2013, compared with $51.445 million, or 2.28%, at year-end 2012.
  • Cash flow: For the six months, operating cash flow was $31.201 million, investing cash flow was negative $101.084 million, and financing cash flow was negative $98.799 million. Cash and cash equivalents declined $168.682 million to $63.555 million.
  • Balance sheet and funding: Total assets were $2.975 billion, down 2.9% from year-end 2012. Net loans were $2.284 billion; gross loans increased $77.5 million to $2.335 billion. Deposits fell $98.3 million to $2.483 billion. Short-term borrowings rose $17.8 million to $139.7 million; long-term borrowings were $0.037 million and subordinated debentures were $30.928 million.
  • Equity and capital: Total equity was $307.6 million, up from $297.8 million at year-end. At June 30, the Bank’s Tier 1 leverage, Tier 1 risk-based, and total risk-based capital ratios were 10.8%, 13.1%, and 14.4%; the Company’s were 11.0%, 13.4%, and 14.7%.

Material changes versus comparable periods

  • Six-month net income improved despite lower net interest income, supported by a $3.4 million increase in noninterest income and a $1.3 million reduction in loan-loss provision. Higher noninterest expense partly offset those gains.
  • Interest income declined as yields fell, while lower funding costs reduced interest expense. Average earning assets increased 2.4% year over year, but margin pressure persisted.
  • Loan quality indicators improved from year-end: nonperforming assets declined to $21.8 million from $31.6 million, and nonperforming loans to total loans fell to 0.93% from 1.37%. Troubled debt restructurings totaled $42.4 million, down from $50.8 million.
  • Accumulated other comprehensive income moved from $5.689 million at year-end to a $0.625 million loss, mainly reflecting a $6.296 million after-tax decline in securities-related value. Management attributed securities valuation declines primarily to rising interest rates.

Outlook, commentary, and risks

  • Management expected continued net interest margin pressure from the prolonged low-rate environment and aggressive competitor pricing on commercial loans. It described expected loan growth as moderate.
  • The company was considering selective purchases of higher-yielding investments, while stating it did not expect a significant change in investment strategy. It cited accelerated mortgage-backed securities prepayments and reinvestment at lower yields as headwinds.
  • Q2 and six-month earnings included a $465,000 noncash state income tax charge from revaluing deferred tax items after Indiana enacted lower financial-institution tax rates effective in 2014. Excluding the charge, management reported net income of approximately $9.7 million for Q2 and $18.9 million for six months.
  • Credit risks include commercial and commercial-real-estate concentration and exposure to a small number of larger nonperforming relationships. Management cautioned that repayment of those credits is not assured and that weaker economic conditions could increase delinquencies, charge-offs, or required provisions.
  • Management said the company’s and Bank’s capital ratios were expected to exceed Basel III “well-capitalized” requirements when effective, based on a preliminary analysis. Interest-rate risk is the principal market risk; modeled exposure was within company policy limits at June 30.
  • No material subsequent events or material pending legal proceedings were reported. The filing provides no formal earnings or margin guidance.

Important facts for investors to verify

  • Whether margin pressure and commercial-loan pricing competition continue, and how they affect net interest income.
  • Loan growth, deposit trends, and the drivers of the large decline in cash and cash equivalents; also monitor reliance on short-term borrowings.
  • Performance and collateral support for the largest nonperforming commercial relationships, alongside trends in nonperforming loans, TDRs, charge-offs, and allowance coverage.
  • Whether the $465,000 state tax revaluation is a one-time item and how the new tax rates affect future effective tax expense.
  • Changes in available-for-sale securities fair values and ratings, including the non-agency mortgage-backed securities and the related accumulated other comprehensive income.