Quarterly Report
Financial Condition and Results of Operations
This section should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Company's Annual Report on Form 10-K for the year ended December 31, 2012.
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, competition, and the failure to realize anticipated efficiencies and synergies of the merger of Somerset Hills Bank into Lakeland Bank and of Somerset Hills Bancorp into the Company.
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.
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Critical Accounting Policies, Judgments and Estimates
The accounting and reporting policies of the Company and its subsidiaries conform to accounting principles generally accepted in the United States of America 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., Lakeland Preferred Equity, Inc., and Sullivan Financial Services, 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. There have been no material changes in the Company's critical accounting policies, judgments and estimates, including assumptions or estimation techniques utilized, as compared to those disclosed in the Company's most recent Annual Report on Form 10-K.
Management Overview
The quarter and nine months ended September 30, 2013, represented a period of continued growth for the Company. As discussed in this Management's Discussion and Analysis:
? Net income available to common shareholders increased $1.1 million to $6.6 million, or 21% from the third quarter of 2012 to the same period in 2013. Included in the third quarter of 2013 earnings was $744,000 in merger related expenses. Exclusive of these expenses, fully diluted earnings per share would have been $0.20 per common share or the same as fully diluted earnings per share for the third quarter of 2012.
? Net income available to common stockholders increased $2.3 million, or 15%, from the first nine months of 2012 to the same period in 2013. Included in the 2013 first nine months earnings was $2.8 million in expenses related to the merger with Somerset Hills Bancorp. Exclusive of these expenses, fully diluted earnings per share for the first nine months of 2013 was $0.61 per common share, a 9% increase over the fully diluted earnings per share for the same period last year.
? Non-performing assets declined for the eighth consecutive quarter. Non-performing assets have declined $9.9 million, or 35%, from $28.5 million reported at year end.
? As a result of improving loan quality, the provision for loan and lease losses was reduced from $3.4 million in the third quarter of 2012 to $1.9 million in the third quarter of 2013.
? The Company's net interest margin has been stable for the last four quarters. In the third quarter of 2013 net interest margin was 3.68%, which equaled the net interest margin for the second quarter of 2013 and was two basis points higher than the third quarter of 2012.
? The Somerset Hills acquisition, which was consummated on May 31, 2013, added six full service branches, $355.9 million in total assets, $10.4 million in investment securities, $246.4 million in loans (including $2.5 million in residential mortgages held for sale), and $311.8 million in deposits ($80.8 million in non-interest bearing demand deposits and $231.0 million in interest-bearing deposits) at fair value. For more information on the Somerset Hills acquisition, please see Note 14 – Acquisitions in this Quarterly Report on Form 10-Q.
? During the first nine months of 2013, the Company acquired and extinguished $9.0 million of Lakeland Bancorp Capital Trust I debentures and recorded a $1.2 million pre-tax gain on extinguishment of debt.
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Results of Operations
(Third Quarter 2013 Compared to Third Quarter 2012)
Net Income
Net income was $6.6 million in the third quarter of 2013 compared to net income of $5.5 million for the third quarter of 2012. Diluted earnings per share was $0.18 for the third quarter of 2013, compared to diluted earnings per share of $0.20 for the same period last year. Net interest income for the third quarter of 2013 increased $3.8 million compared to the third quarter of 2012 due to a $2.4 million increase in interest income and a $1.5 million reduction in interest expense.
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. The Company's net interest income is influenced by the current low interest rate environment. For information on how interest rate change can influence the Company's net interest income, and how the Company manages it net interest income, please see "Quantitative and Qualitative Disclosures About Market Risk" in Item 3 of this Quarterly Report on Form 10-Q. The Company's net interest margin can also be impacted by its level of non-performing loans. If non-performing loans decline, this could increase the net interest margin.
Net interest income on a tax equivalent basis for the third quarter of 2013 was $27.7 million, compared to $23.9 million for the third quarter of 2012. The net interest margin increased from 3.66% in the third quarter of 2012 to 3.68% in the third quarter of 2013 primarily as a result of a 32 basis point decrease in the yield on interest bearing liabilities partially offset by a 25 basis point decline in the yield on interest earning assets. The net interest margin would have been 3.76% and 3.74% for the third quarter of 2013 and 2012, respectively, had the Company's non-performing loans performed in accordance with their terms. The increase in the net interest margin was augmented 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 $143.2 million. The components of net interest income will be discussed in greater detail below.
The following table reflects the components of the Company's net interest income, setting forth for the periods 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 using a tax rate of 35%.
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For the Three Months Ended, For the Three Months Ended,
September 30, 2013 September 30, 2012
Average Average
Interest rates Interest rates
Average Income/ earned/ Average Income/ earned/
Balance Expense paid Balance Expense paid
(dollars in thousands)
Assets
Interest-earning assets:
Loans and leases (A) $ 2,435,658 $ 27,350 4.45 % $ 2,062,928 $ 24,929 4.81 %
Taxable investment securities and other 430,369 2,017 1.87 % 433,233 2,121 1.96 %
Tax-exempt securities 75,894 709 3.74 % 68,629 658 3.84 %
Federal funds sold (B) 45,487 27 0.24 % 33,271 17 0.20 %
Total interest-earning assets 2,987,408 30,103 4.00 % 2,598,061 27,725 4.25 %
Noninterest-earning assets:
Allowance for loan and lease losses (30,039 ) (28,515 )
Other assets 286,628 258,339
TOTAL ASSETS $ 3,243,997 $ 2,827,885
Liabilities and Stockholders' Equity
Interest-bearing liabilities:
Savings accounts $ 374,141 $ 51 0.05 % $ 350,135 $ 92 0.11 %
Interest-bearing transaction accounts 1,403,227 955 0.27 % 1,169,953 1,168 0.40 %
Time deposits 322,371 512 0.64 % 324,355 766 0.94 %
Borrowings 165,261 850 2.06 % 234,204 1,814 3.10 %
Total interest-bearing liabilities 2,265,000 2,368 0.42 % 2,078,647 3,840 0.74 %
Noninterest-bearing liabilities:
Demand deposits 620,499 477,311
Other liabilities 15,016 14,370
Stockholders' equity 343,482 257,557
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 3,243,997 $ 2,827,885
Net interest income/spread 27,735 3.58 % 23,885 3.51 %
Tax equivalent basis adjustment 248 230
NET INTEREST INCOME $ 27,487 $ 23,655
Net interest margin (C) 3.68 % 3.66 %
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(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 divided by interest-earning assets.
Interest income on a tax equivalent basis increased from $27.7 million in the third quarter of 2012 to $30.1 million in the third quarter of 2013, an increase of $2.4 million, or 9%. The increase in interest income was primarily due to a $372.7 million increase in average loans and leases partially offset by a decrease in the yield on interest earning assets. The increase in average loans and leases is due primarily to the acquisition of Somerset Hills' loans and leases which totaled $243.9 million at the time of acquisition. The yield on average loans and leases at 4.45% in the third quarter of 2013 was 36 basis points lower than the third quarter of 2012. The yield on average taxable and tax exempt investment securities decreased by 9 basis points and 10 basis points, respectively, compared to the third quarter of 2012.
Total interest expense decreased from $3.8 million in the third quarter of 2012 to $2.4 million in the third quarter of 2013, a decrease of $1.5 million, or 38%. The cost of average interest-bearing liabilities decreased from 0.74% in the third quarter of 2012 to 0.42% in 2013. The decrease in yield was due primarily to a 104 basis point reduction in the cost of borrowings, a $68.9 million reduction in higher yielding average borrowings and the continuing low rate environment. In the fourth quarter of 2012, the Company redeemed a $25.8 million subordinated debenture that was paying 7.535%. In the second quarter of 2013, the Company acquired and extinguished $9 million in subordinated debentures that were paying LIBOR plus 310 basis points. From the third quarter of 2012 to the third quarter of 2013, average savings accounts and interest-bearing transaction accounts increased by $24.0 million and $233.3 million, respectively. Average rates paid on interest-bearing liabilities declined in all categories.
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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 net charge-offs; and the results of independent third party loan review.
In the third quarter of 2013, a $1.9 million provision for loan and lease losses was recorded, which was $1.5 million lower than the provision for the same period last year. During the third quarter of 2013, the Company charged off loans and leases of $2.8 million and recovered $1.1 million in previously charged off loans and leases compared to $3.4 million and $180,000, respectively, during the same period in 2012. The lower provision resulted from a decline in non-performing assets and from lower net charge-offs during the quarter. For more information regarding the determination of the provision, see "Risk Elements" below.
Noninterest Income
Noninterest income at $4.6 million in the third quarter of 2013 was equivalent to the third quarter of 2012. Income on bank owned life insurance at $383,000 in the third quarter increased $26,000 or 7% compared to the same period in 2012 primarily resulting from the addition of policies acquired in the Somerset Hills merger. Other income totaling $285,000 in the third quarter of 2013 was $79,000 lower than the same period in 2012, primarily due to a reduction in gains on leasing related assets.
Noninterest Expense
Noninterest expense totaling $20.4 million increased $3.4 million in the third quarter of 2013 from the third quarter of 2012. In the third quarter of 2013 noninterest expense included $744,000 in merger related expenses. Salary and employee benefits at $11.0 million increased by $1.4 million, or 15%, primarily as a result of increased staffing levels from the six new Somerset Hills' branches, as well as the retention of some administrative personnel from the Somerset Hills acquisition. Net occupancy expense at $2.1 million in the third quarter of 2013 increased $253,000 from the same period last year, due primarily to expenses relating to the six new branch locations acquired in the Somerset Hills acquisition and a new branch opening in the fourth quarter of 2012. Furniture and equipment at $1.6 million increased $377,000 from the same period last year due primarily to the new branches previously mentioned and increased service contract expenses. Stationary, supplies and postage at $348,000 decreased $40,000 compared to the third quarter of 2012 due primarily to the opening of a new branch and the new operations and training center in the third quarter of 2012 as well as general declines in postage resulting from greater usage of electronic delivery. FDIC insurance expense at $436,000 in the third quarter of 2013 decreased $83,000 compared to the same period last year due primarily to improved assessment rates resulting from a reduction in nonperforming assets. Legal expense at $406,000 increased $271,000 compared to the same period last year. In the third quarter of 2012 the Company recovered $150,000 in previously expensed legal fees. Other expenses at $3.0 million increased $371,000 compared to the third quarter of 2012, due primarily to an increase in data processing expenses reflecting technological improvements, an increase in telecommunications expense and Somerset Hills costs. The Company's efficiency ratio, a non-GAAP financial measure, was 59.98% in the third quarter of 2013, compared to 58.91% for the same period last year. The increase was primarily due to an increase in noninterest expense partially offset by an increase in revenue. The Company uses this ratio because it believes that the ratio provides a good comparison of period-to-period performance and because the ratio is widely accepted in the banking industry. The following table shows the calculation of the efficiency ratio for the periods presented:
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For the Three Months Ended September 30,
2013 2012
(dollars in thousands)
Calculation of efficiency ratio:
Total noninterest expense $ 20,407 $ 16,968
Less:
Amortization of core deposit
intangibles (123 ) -
Other real estate owned and other
repossessed asset expense 2 (13 )
Merger related expenses (744 ) -
Provision for unfunded lending
commitments (121 ) (150 )
Noninterest expense, as adjusted $ 19,421 $ 16,805
Net interest income $ 27,487 $ 23,655
Noninterest income 4,645 4,640
Total revenue 32,132 28,295
Plus: Tax-equivalent adjustment on
municipal securities 248 230
Less:
Gains on debt extinguishment - -
Gains on sales of investment securities - -
Total revenue, as adjusted $ 32,380 $ 28,525
Efficiency ratio 59.98 % 58.91 %
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Income Tax Expense
The effective tax rate increased from 31.2% in the third quarter of 2012 to 32.8% in the third quarter of 2013 primarily as a result of increased earnings and because of a reduction of tax advantaged items as a percent of pre-tax income.
(Year to Date 2013 Compared to Year to Date 2012)
Net Income
Net income for the first nine months of 2013 was $17.6 million, compared to net income of $15.9 million for the same period in 2012. The Company recorded a $1.2 million gain on debt extinguishment in the first nine months of 2013 as well as $2.8 million in merger related expenses. Net income available to common stockholders was $17.6 million compared to $15.3 million for the first nine months of 2012. Because the Company repaid its remaining preferred stock to the U.S. Department of the Treasury under the CPP in the first nine months of 2012, the Company had no dividends or accretion on preferred stock in the first nine months of 2013 compared to $620,000 for the same period last year. Diluted earnings per share was $0.54 for the first nine months of 2013 compared to $0.56 in the first nine months of 2012. Net interest income at $76.6 million for the first nine months of 2013 increased $5.2 million compared to the same period in 2012 due primarily to a reduction in interest expense.
Net Interest Income
Net interest income on a tax equivalent basis for the first nine months of 2013 was $77.3 million compared to $72.1 million for the first nine months of 2012. The net interest margin decreased from 3.70% in the first nine months of 2012 to 3.69% in the first nine months of 2013 primarily as a result of a decline in yield on average interest earning assets. The net interest margin would have been 3.77% and 3.82% for the first nine months of 2013 and 2012, respectively, had the Company's non-performing loans performed in accordance with their terms. The decline in net interest margin resulting from a 29 basis point decline in the yield on interest-earning assets was offset by a 33 basis point reduction in the cost of interest-bearing liabilities. The decline in the net interest margin resulting from a decline in rates 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 $88.9 million. The components of net interest income will be discussed in greater detail below.
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The following table reflects the components of the Company's net interest income, setting forth for the periods 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 using a tax rate of 35%.
CONSOLIDATED STATISTICS ON A TAX EQUIVALENT BASIS
For the Nine Months Ended, For the Nine Months Ended,
September 30, 2013 September 30, 2012
Average Average
Interest rates Interest rates
Average Income/ earned/ Average Income/ earned/
Balance Expense paid Balance Expense paid
(dollars in thousands)
Assets
Interest-earning assets:
Loans (A) $ 2,279,972 $ 77,122 4.52 % $ 2,063,609 $ 75,659 4.90 %
Taxable investment securities and other 410,508 5,544 1.80 % 438,418 6,668 2.03 %
Tax-exempt securities 73,638 2,048 3.71 % 69,836 2,109 4.03 %
Federal funds sold (B) 35,578 57 0.21 % 27,300 29 0.14 %
Total interest-earning assets 2,799,696 84,771 4.05 % 2,599,163 84,465 4.34 %
Noninterest-earning assets:
Allowance for loan and lease losses (30,004 ) (29,077 )
Other assets 269,474 248,240
TOTAL ASSETS $ 3,039,166 $ 2,818,326
Liabilities and Stockholders' Equity
Interest-bearing liabilities:
Savings accounts $ 367,245 $ 171 0.06 % $ 346,829 $ 274 0.11 %
Interest-bearing transaction accounts 1,305,173 2,902 0.30 % 1,149,501 3,683 0.43 %
Time deposits 311,994 1,667 0.71 % 335,947 2,464 0.98 %
Borrowings 174,025 2,745 2.10 % 254,394 5,957 3.12 %
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