Lakeland Financial Corporation — Q2 2018 Form 10-Q
Business context and reporting period. Lakeland Financial is a bank holding company whose principal subsidiary is Lake City Bank. This unaudited filing covers the quarter and six months ended June 30, 2018; comparisons are with the periods ended June 30, 2017, or with December 31, 2017 for balance-sheet figures. Amounts below are in millions unless otherwise noted.
Key financial results
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net income | $20.1 | $15.4 | $38.5 | $29.9 |
| Diluted EPS | $0.78 | $0.60 | $1.50 | $1.17 |
| Net interest income | $37.5 | $33.8 | $73.8 | $65.9 |
| Provision for loan losses | $1.7 | $0.5 | $5.0 | $0.7 |
| Noninterest income | $9.7 | $8.8 | $19.6 | $17.1 |
| Noninterest expense | $20.3 | $19.4 | $41.5 | $39.4 |
- Profitability and margins: Net income increased 31.1% in Q2 and 28.8% year to date. Reported net interest margin was 3.42% for Q2 and 3.39% for the first half, versus 3.34% and 3.31%, respectively, in 2017. Return on average assets was 1.70% for Q2 and 1.64% for the first half. The efficiency ratio improved to 42.93% and 44.44%, respectively.
- Revenue and costs: First-half noninterest income rose 14.8%, led by loan and service fees, deposit service charges, wealth-related fees, and mortgage banking income. Noninterest expense rose 5.3%; salary and benefit costs and data processing were notable contributors.
- Cash flow: First-half operating cash flow was $45.6 million, investing cash flow was negative $83.6 million, and financing cash flow was positive $42.1 million. Cash and cash equivalents increased $4.0 million to $180.2 million.
- Balance sheet and funding: Total assets were $4.761 billion, up 1.7% from year-end 2017. Net loans were $3.811 billion, up $39.7 million; available-for-sale securities were $563.2 million, up $24.7 million. Deposits declined $73.7 million to $3.935 billion, while total borrowings increased $130.6 million to $312.2 million. Borrowings comprised $106.2 million of repurchase agreements, $175.0 million of FHLB advances, and $30.9 million of subordinated debentures.
- Capital and liquidity: Total equity was $486.5 million. The company reported a 10.15% tangible common equity-to-tangible assets ratio. At June 30, the consolidated total risk-based capital ratio was 13.76%, CET1 was 11.88%, and leverage capital was 11.01%; management characterized capital levels as well-capitalized. Cash and cash equivalents were $180.2 million.
Material changes and credit quality
- Growth in net interest income reflected higher average earning assets, primarily commercial lending, and improved asset yields following Federal Reserve rate increases. Funding costs also rose: first-half interest expense increased to $21.1 million from $13.1 million.
- The effective tax rate fell to 17.9% for the first half and 20.2% for Q2, versus 30.2% and 32.5% in 2017, primarily reflecting the Tax Cuts and Jobs Act reduction of the federal corporate rate to 21%.
- Commercial and commercial real estate loans represented 77.2% of loans at June 30; total commercial loans were 88.2%. Nonperforming assets increased 35.7% from year-end to $12.9 million, and nonperforming loans rose to 0.33% of total loans from 0.25%.
- First-quarter net charge-offs included a $4.6 million charge-off related to one commercial borrower; Q2 had net recoveries of $379,000. Management cited loan growth, charge-offs, and watch-list credit changes in explaining the higher first-half provision. Classified credits totaled $213.9 million, up from $171.7 million at year-end, primarily due to two commercial relationships moving to Special Mention.
- The allowance for loan losses was $47.7 million, or 1.24% of loans, versus $47.1 million, or 1.23%, at year-end. Management considered it adequate but noted that deterioration in economic conditions could increase delinquencies, charge-offs, and required reserves.
Outlook, risks, and unusual items
- The filing provides no formal earnings or financial guidance. Management described local economic conditions as generally improved and stable, but remained cautious; it cited commercial lending growth and continued attention to credit diversification and loan workouts.
- Interest-rate risk is the primary market risk. The company’s model estimated 12-month net interest income would fall 7.79% under a 100-basis-point rate decline and rise 6.13% under a 100-basis-point increase. Management cautioned that model assumptions and actual results may differ.
- Available-for-sale securities had $12.4 million of gross unrealized losses at June 30, compared with $4.1 million at year-end. The company attributed losses primarily to interest rates, stated it did not intend to sell and was not likely to be required to sell before recovery, and reported no other-than-temporary impairment in the first half. First-half other comprehensive income included an $8.9 million after-tax loss, largely from securities valuation changes.
- Accounting updates: ASC 606 was adopted January 1, 2018, with no reported net-income effect; the company recorded a $24,000 opening retained-earnings increase. For the upcoming callable-debt-security premium standard, the company estimated an approximately $840,000 after-tax reduction to retained earnings based on June 30 data. The company expects to recognize credit losses earlier under the expected-loss standard and was still assessing its impact. Adoption of the lease standard in 2019 was expected to bring approximately $5.2 million of lease obligations onto the balance sheet as assets and liabilities.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting during the quarter. The filing reported no material pending legal proceedings and no material changes to the risk factors disclosed in the 2017 Form 10-K.
Important facts for investors to verify
- Whether the higher provision, charge-off activity, Special Mention migration, and increase in nonperforming loans indicate emerging credit deterioration, particularly among large commercial relationships.
- How deposit declines and increased use of FHLB advances and repurchase funding affect funding costs, liquidity, and future net interest margins.
- Whether deposit repricing and further rate movements offset asset-yield benefits; review the assumptions underlying the company’s interest-rate sensitivity model.
- Whether unrealized securities losses remain interest-rate-driven and whether the company can hold the securities until recovery without liquidity pressure.
- The eventual effects of expected-credit-loss and lease accounting changes, including whether actual implementation impacts differ from the filing’s estimates.