compensation as well as normal salary increases and staff additions. Other expense increased by $433,000, or 5.1%, driven by higher corporate and business development expenses as well as higher professional fees. Net occupancy expense increased from $2.5 million in 2004 to $2.8 million in 2005, primarily as a result of higher property taxes and maintenance expense. Equipment expense decreased from $2.1 million in 2004 to $1.9 million in 2005, primarily as a result of lower depreciation expense. Depreciation expense was lower as a result of technology asset additions related to system upgrades in prior years. Most of these assets have now fully depreciated, and still reporesent stable technology platforms. Data processing fees and supplies decreased from $2.5 million in 2004 to $2.4 million in 2005 primarily due to improved pricing with the Company’s processing agents. Credit card interchange fees increased from $1.4 million in 2004 to $1.5 million in 2005 driven by higher processing costs charged by VISA and increased credit card usage.
As a result of these factors, income before income tax expense increased $5.6 million, or 25.6%, from $21.8 million in 2004 to $27.4 million in 2005. Income tax expense was $9.5 million in 2005 versus $7.3 million in 2004. Income tax as a percentage of income before tax was 34.5% in 2005 versus 33.4% in 2004. The higher tax rate resulted from a decreased percentage of the Company’s income being derived from tax-advantaged sources. Net income increased $3.4 million, or 23.5%, to $18.0 million in 2005 versus $14.5 million in 2004. Basic earnings per share in 2005 was $3.01, an increase of 21.4%, versus $2.48 in 2004. The Company’s net income performance represented a 17.7% return on January 1, 2005, stockholders’ equity versus 16.2% in 2004. The net income performance resulted in a 1.20% return on average daily assets in 2005 versus 1.09% in 2004.
The Company reported record net income of $14.5 million in 2004, an increase of $680,000, or 4.9%, versus net income of $13.9 million in 2003. Net interest income increased $973,000, or 2.3%, to $43.2 million versus $42.2 million in 2003. Net interest income increased due to a decrease in interest expense on interest bearing checking accounts and long-term borrowings, as well as growth in commercial loans, which offset some of the effect of the declining interest rates during the year. Despite growth in earning assets, interest income decreased $331,000, or 0.6%, from $60.3 million in 2003 to $60.0 million in 2004. The decrease was driven primarily by a 33 basis point reduction in the tax equivalent yield on average earning assets over the year. Interest expense decreased $1.3 million, or 7.2%, from $18.1 million in 2003 to $16.8 million in 2004. The decrease was primarily the result of a 21 basis point decrease in the Company’s daily cost of funds over the year. The Company had a net interest margin of 3.63% in 2004 versus 3.82% in 2003. Average earning assets increased by $88.5 million from $1.1 billion in 2003 to $1.2 billion in 2004. The primary driver was an $83.4 million increase in the average daily loan balance. Deposits increased to fund the loan growth during 2004, driven primarily by increases of $57.6 million in the average daily interest bearing checking account balances and increases of $33.9 million in the average daily demand deposit balances.
Nonaccrual loans were $7.2 million, or 0.72% of total loans, at year end versus $553,000, or 0.06% of total loans, at the end of 2003. There were four relationships totaling $9.3 million classified as impaired as of December 31, 2004 versus two relationships totaling $3.0 million at the end of 2003. The increase in both nonaccrual and impaired loans was due primarily to one commercial credit totaling $6.1 million. The borrower filed for chapter 11 bankruptcy late in the third quarter of 2004 and was in the process of determining its future business strategy. Borrower collateral and the personal guarantees of its principals support the credit. Net charge-offs were $703,000 in 2004 versus $1.6 million in 2003, representing 0.08% and 0.18% of average daily loans in 2004 and 2003. Total nonperforming loans were $10.0 million, or 1.00% of total loans, at year end 2004 versus $3.7 million, or 0.43% of total loans, at the end of 2003. The provision for loan loss expense was $1.2 million in 2004, resulting in an allowance for loan losses at December 31, 2004 of $10.8 million, which represented 1.07% of the loan portfolio, versus a provision for loan loss expense of $2.3 million in 2003 and an allowance for loan losses of $10.2 million at the end of 2003, or 1.18% of the loan portfolio. The lower provision in 2004 versus 2003 was attributable to a number of factors, but was primarily a result of the decrease in the level of charge-offs from $1.6 million in 2003 to $703,000 in 2004. The level of loan loss provision was also influenced by the overall growth in the loan portfolio and other factors related to this growth, such as emerging market risk, commercial loan focus and large credit concentration, new industry lending activity, general economic conditions and historical loss percentages. In addition, management gave consideration to changes in the allocation for specific watch list credits in determining the appropriate level of the loan loss provision. Management’s overall view on the then-current credit quality was also a factor in the determination of the provision for loan losses. The
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Company’s management continued to monitor the adequacy of the provision based on loan levels, asset quality, economic conditions and other factors that may influence the assessment of the collectability of loans.
Noninterest income was $16.6 million in 2004 versus $18.4 million in 2003, a decrease of $1.9 million, or 10.1%. The decrease was driven by a $2.0 million, or 67.3%, decrease in gains on sale of mortgages, from $3.0 million in 2003 to $987,000 in 2004 as mortgage originations decreased from $143.2 million in 2003 to $59.3 million in 2004, a decrease of 58.6%. As experienced by the industry generally, this decrease was a result of the decreased level of mortgage activity during 2004 resulting from consumers having refinanced their homes in 2002 and 2003 when rates were falling. Additionally, noninterest income decreased due to a $500,000 decrease in gains on securities sold. Partially offsetting these decreases were increases of $645,000, or 27.2%, in trust and brokerage fees and $472,000, or 27.0%, in merchant card fee income. The increase in trust and brokerage fees resulted primarily from the Company’s December 1, 2003 acquisition of Indiana Capital Management while the increase in merchant card fees was driven by higher volume activity in interchange and merchant fee income.
Noninterest expense decreased $1.0 million, or 2.7% from $37.7 million in 2003 to $36.7 million in 2004. Equipment expense decreased from $2.5 million in 2003 to $2.1 million in 2004, primarily as a result of lower depreciation expense and personal property tax expenses. Depreciation expense was lower as a result of technology asset additions related to system upgrades driven by Y2K issues; these assets were fully depreciated in mid 2004. Credit card interchange fees increased from $1.0 million in 2003 to $1.4 million in 2004 driven by higher processing costs charged by VISA and increased credit card usage. In addition, during 2003, the Company redeemed its existing high fixed rate subordinated debentures and reissued variable rate subordinated debentures at a lower rate to better match long-term assets and liabilities. The redemption resulted in a loss on extinguishment of $804,000.
As a result of these factors, income before income tax expense increased $1.2 million, or 5.6%, from $20.7 million in 2003 to $21.8 million in 2004. Income tax expense was $7.3 million in 2004 versus $6.8 million in 2003. Income tax as a percentage of income before tax was 33.4% in 2004 versus 33.0% in 2003. The higher tax rate resulted from a decreased percentage of the Company’s income being derived from tax-advantaged sources. Net income increased $680,000, or 4.9%, to $14.5 million in 2004 versus $13.9 million in 2003. Basic earnings per share in 2004 was $2.48, an increase of 4.2%, versus $2.38 in 2003. The Company’s net income performance represented a 16.2% return on January 1, 2004, stockholders’ equity versus 16.5% in 2003. The net income performance resulted in a 1.09% return on average daily assets in 2004 versus 1.12% in 2003.
FINANCIAL CONDITION
As of December 31, 2005, the Company had 43 offices serving twelve counties in northern Indiana. The Company added no new offices during 2005. Since 1996, the Company has added seventeen new offices through acquisition and internal growth. The Company will consider future acquisition and expansion opportunities with an emphasis on markets that it believes would be receptive to its business philosophy of local, independent banking. The Company sold five branches in its south region during the third quarter of 2001 in order to help position the Company to focus on growth opportunities in its core northern markets, which are anchored by the cities of Warsaw, Fort Wayne, Elkhart and South Bend, Indiana.
Total assets of the Company were $1.635 billion as of December 31, 2005, an increase of $181.5 million, or 12.5%, when compared to $1.453 billion as of December 31, 2004.
Total cash and cash equivalents decreased by $21.2 million, or 20.4%, to $82.7 million at December 31, 2005 from $103.9 million at December 31, 2004. The decrease was primarily attributable to loan growth and the corresponding funding needs associated with that growth.
Total securities available for sale increased by $4.4 million, or 1.5%, to $290.9 million at December 31, 2005 from $286.6 million at December 31, 2004. The increase was a result of a number of activities in the securities portfolio. Paydowns from prepayments of $49.1 million were received, and the amortization of premiums, net of the accretion of discounts, was $2.6 million. Maturities, calls and sales of securities totaled $8.2 million. The fair value of the securities decreased $4.1 million as a result of the rising interest rate environment during 2005. These portfolio decreases were offset by securities purchases totaling $68.4 million. The investment portfolio is managed to limit the Company’s exposure to risk and contains mostly collateralized mortgage obligations and other securities which are either directly or indirectly backed by the federal government or a local
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municipal government. The investment portfolio did not contain any corporate debt instruments or trust preferred instruments as of December 31, 2005.
Real estate mortgages held for sale decreased by $2.0 million, or 67.9%, to $960,000 at December 31, 2005 from $3.0 million at December 31, 2004. The balance of this asset category is subject to a high degree of variability depending on, among other things, recent mortgage loan rates and the timing of loan sales into the secondary market. During 2005, $43.9 million in real estate mortgages were originated for sale and $45.5 million in mortgages were sold, compared to $59.3 million and $59.8 million in 2004. This lower volume of real estate mortgages originated was caused primarily by the increase in interest rates from historically low levels.
Total loans, excluding real estate mortgages held for sale, increased by $195.4 million, or 19.5%, to $1.199 billion at December 31, 2005 from $1.003 billion at December 31, 2004. The mix of loan types within the Company’s portfolio continued a trend toward a higher percentage of the total loan portfolio being in commercial loans. The portfolio breakdown at year end 2005 reflected 81% commercial and industrial and agri-business, 6% real estate and 13% consumer loans compared to 79% commercial and industrial and agri-business, 5% real estate and 16% consumer loans at December 31, 2004.
At December 31, 2005, the allowance for loan losses was $12.8 million, or 1.07% of total loans outstanding, versus $10.8 million, or 1.07%, of total loans outstanding at December 31, 2004. The process of identifying probable credit losses is a subjective process. Therefore, the Company maintains a general allowance to cover probable incurred credit losses within the entire portfolio. The methodology management uses to determine the adequacy of the loan loss reserve includes the following considerations.
The Company has a relatively high percentage of commercial and commercial real estate loans, most of which are extended to small or medium-sized businesses. Commercial loans represent higher dollar loans to fewer customers and therefore higher credit risk. Pricing is adjusted to manage the higher credit risk associated with these types of loans. The majority of fixed rate mortgage loans, which represent increased interest rate risk, are sold in the secondary market, as well as some variable rate mortgage loans. The remainder of the variable rate mortgage loans and a small number of fixed rate mortgage loans are retained. Management believes the allowance for loan losses is at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions would become unfavorable certain borrowers may experience difficulty and the level of nonperforming loans, charge-offs and delinquencies could rise and require further increases in the provision for loan losses.
Loans are charged against the allowance for loan losses when management believes that the uncollectability of the principal is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance is an amount that management believes will be adequate to absorb probable incurred credit losses relating to specifically identified loans based on an evaluation, as well as other probable incurred losses inherent in the loan portfolio. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and current economic conditions that may affect the borrower’s ability to repay. Management also considers trends in adversely classified loans based upon a monthly review of those credits. An appropriate level of general allowance is determined after considering the following factors: application of historical loss percentages, emerging market risk, commercial loan focus and large credit concentrations, new industry lending activity and current economic conditions. Federal regulations require insured institutions to classify their own assets on a regular basis. The regulations provide for three categories of classified loans – substandard, doubtful and loss. The regulations also contain a special mention category. Special mention is defined as loans that do not currently expose an insured institution to a sufficient degree of risk to warrant classification, but do possess credit deficiencies or potential weaknesses deserving management’s close attention. Assets classified as substandard or doubtful require the institution to establish specific allowances for loan losses. If an asset or portion thereof is classified as loss, the insured institution must either establish specified allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge off such amount. At December 31, 2005, on the basis of management’s review of the loan portfolio, the Company had loans totaling $49.6 million on the classified loan list versus $56.2 million on December 31, 2004. As of December 31, 2005, the Company had $24.6 million of assets classified special mention, $24.7 million classified as substandard, $333,000 classified as doubtful and $0 classified as loss as compared to $32.1 million, $23.3 million, $751,000 and $0 at December 31, 2004.
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Allowance estimates are developed by management taking into account actual loss experience, adjusted for current economic conditions. The Company discusses this methodology with regulatory authorities to ensure compliance. Allowance estimates are considered a prudent measurement of the risk in the Company’s loan portfolio and are applied to individual loans based on loan type. In accordance with FASB Statements 5 and 114, the allowance is provided for losses that have been incurred as of the balance sheet date and is based on past events and current economic conditions, and does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions.
The Company has experienced growth in total loans over the last three years of $376.0 million, or 45.7%. The concentration of this loan growth was in the commercial loan portfolio. Commercial loans comprised 81%, 79% and 78% of the total loan portfolio at December 31, 2005, 2004 and 2003. Traditionally, this type of lending may have more credit risk than other types of lending because of the size and diversity of the credits. The Company manages this risk by adjusting its pricing to the perceived risk of each individual credit and by diversifying the portfolio by customer, product, industry and geography. Management has historically considered growth and portfolio composition when determining loan loss allocations. Management believes that it is prudent to continue to provide for loan losses in a manner consistent with its historical approach due to the loan growth described above and current economic conditions.
As a result of the methodology in determining the adequacy of the allowance for loan losses, the provision for loan losses was $2.5 million in 2005 versus $1.2 million in 2004. At December 31, 2005, total nonperforming loans decreased by $2.5 million to $7.5 million from $10.0 million at December 31, 2004. Loans delinquent 90 days or more that were included in the accompanying financial statements as accruing totaled $174,000 versus $2.8 million at December 31, 2004. Total impaired loans decreased by $2.4 million to $6.9 million at December 31, 2005 from $9.3 million at December 31, 2004. The decreases in nonperforming loans and impaired loans resulted primarily from the upgrade of a single commercial credit that was classified as impaired because, pursuant to the terms of the loan documentation, it had matured, although the parties were working to have it renewed. The renewal of the loan in question had been complicated as more than one bank was involved which resulted in it being past maturity. The renewal issues were resolved in the third quarter of 2005, the participant bank is no longer involved in the credit and the loan is current as to principal and interest. The $6.9 million in impaired loans are all in nonaccrual status. The Company allocated $2.9 million and $1.7 million of the allowance for loan losses to the impaired loans in 2005 and 2004. A loan is impaired when full payment under the original loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.
The Company believes that the improvement in total nonperforming loans is a reflection of the continued focus on enforcement of a strong credit environment, an aggressive position on loan work-out situations and a general improvement in the regional economic conditions. The allowance for loan loss to total loans percentage was 1.07% in both 2004 and 2005. The Company does not believe that it has experienced any meaningful change in overall asset quality and that its overall expansion strategy has employed a credit risk management approach that promotes diversification and therefore creates a balanced portfolio with appropriate risk parameters. Furthermore, the Company requires that the overall asset quality position can be influenced by a small number of credits due to the focus on commercial lending activity.
Total deposits increased by $150.8 million, or 13.5%, to $1.266 billion at December 31, 2005 from $1.115 billion at December 31, 2004. The increase resulted from increases of $72.5 million in brokered deposits, $53.3 million in other certificates of deposit, $56.8 million in money market transaction accounts, $10.3 million in demand deposit accounts and $1.1 million in money market accounts. Offsetting these increases were declines of $36.1 million in Investors’ Money Market accounts and $7.1 million in savings accounts.
Total short-term borrowings increased by $25.9 million, or 14.0%, to $211.5 million at December 31, 2005 from $185.7 million at December 31, 2004. The increase resulted from a $23.0 million increase in federal funds purchased and $3.0 million in securities sold under agreements to repurchase combined with decreases of $122,000 in U.S. Treasury demand notes.
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The Company believes that a strong, appropriately managed capital position is critical to long-term earnings and expansion. Bank regulatory agencies exclude the market value adjustment created by SFAS No. 115 (AFS adjustment) from capital adequacy calculations. Excluding this adjustment from the calculation, the Company had a total risk-based capital ratio of 11.8% and a Tier I risk-based capital ratio of 10.8% as of December 31, 2005. These ratios met or exceeded the Federal Reserve’s “well-capitalized” minimums of 10.0% and 6.0%, respectively.
The ability to maintain and grow these ratios is a function of the balance between net income and a prudent dividend policy. Total stockholders’ equity increased by 11.6% to $113.3 million as of December 31, 2005 from $101.8 million as of December 31, 2004. The increase in 2005 resulted from net income of $18.0 million less the following factors:
• | cash dividends of $5.5 million, |
• | an unfavorable change in the AFS adjustment for the market valuation on securities held for sale of $2.6 million, net of tax, |
• | a positive minimum pension liability adjustment of $18,000, net of tax, |
• | $171,000 for the acquisition of treasury stock and | |
• | $1.7 million related to stock option exercises. | |
| | | | |
Total stockholders’ equity increased by 13.0% to $101.8 million as of December 31, 2004, from $90.0 million as of December 31, 2003. The increase in 2004 resulted from net income of $14.5 million less the following factors:
• | cash dividends of $4.9 million, |
• | an unfavorable change in the AFS adjustment for the market valuation on securities held for sale of $18,000, net of tax, |
• | a positive minimum pension liability adjustment of $33,000, net of tax, | |
• | $165,000 for the acquisition of treasury stock, | |
• | $2.1 million related to stock option exercises and stock compensation expense and | |
• | $335,000 of treasury stock sold and distributed under the deferred directors’ plan. |
| | | | | |
The 2005 AFS adjustment reflected a 234 basis point increase in the two to five year U.S. Treasury rates during 2005. Due to the fact that the securities portfolio is primarily fixed rate, a negative equity adjustment would likely occur if interest rates increased. Management has factored this into the determination of the size of the AFS portfolio to assure that stockholders’ equity is adequate under various scenarios.
Other than those indicated in this management’s discussion and in the risk factors set forth in this annual report, management is not aware of any known trends, events or uncertainties that would have a material effect on the Company’s liquidity, capital and results of operations. In addition, management is not aware of any regulatory recommendations that, if implemented, would have such an effect.
Critical Accounting Policies
Certain of the Company’s accounting policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Some of the facts and circumstances which could affect these judgments include changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses and the valuation of mortgage servicing rights.
Allowance for Loan Losses
The Company maintains an allowance for loan losses to provide for probable incurred credit losses. Loan losses are charged against the allowance when management believes that a loan will not be repaid.
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Subsequent recoveries, if any, are credited to the allowance. Allocations of the allowance are made for specific loans and for pools of similar types of loans, although the entire allowance is available for any loan that, in management’s judgment, should be charged against the allowance. A provision for loan losses is taken based on management’s ongoing evaluation of the appropriate allowance balance. A formal evaluation of the adequacy of the loan loss allowance is conducted at least monthly and more often if deemed necessary. The ultimate recovery of all loans is susceptible to future market factors beyond the Company’s control.
The level of loan loss provision is influenced by growth in the overall loan portfolio, emerging market risk, commercial loan focus and large credit concentration, new industry lending activity, general economic conditions and historical loss analysis. In addition, management gives consideration to changes in the allocation for specific watch list credits in determining the appropriate level of the loan loss provision. Furthermore, management’s overall view on credit quality is a factor in the determination of the provision.
The determination of the appropriate allowance is inherently subjective, as it requires significant estimates. The Company has an established process to determine the adequacy of the allowance for loan losses that generally includes consideration of the following factors: changes in the nature and volume of the loan portfolio, overall portfolio quality and current economic conditions that may affect the borrowers’ ability to repay. Consideration is not limited to these factors, although they represent the most commonly cited factors. With respect to specific allocation levels for individual credits, management generally considers the amounts and timing of expected future cash flows and the valuation of collateral as the primary measures. Management also considers trends in adversely classified loans based upon an ongoing review of those credits. With respect to pools of similar loans, we generally use percentage allocations based upon historical analysis. We may also adjust these allocations for other factors cited above. An appropriate level of general allowance for pooled loans is determined after considering the following: application of historical loss percentages, emerging market risk, commercial loan focus and large credit concentration, new industry lending activity and general economic conditions. It is also possible that the following could affect the overall process: social, political, economic and terrorist events or activities. All of these factors are susceptible to significant change. As a result of this detailed process, the allowance results in two forms of allocations, specific and general. These two components represent the total allowance for loan losses deemed adequate to cover probable losses inherent in the loan portfolio.
Commercial loans are subject to a dual standardized grading process administered by the credit administration and internal loan review functions. A credit grade is assigned to each commercial loan by both the commercial loan officer and the loan review department. These grade assignments are performed independent of each other and may or may not be the same grade. The loan review grade is the grade assigned in the Company’s loan system for individual credits. The need for specific allocation of the loan loss reserve is considered for individual credits when graded special mention, substandard, doubtful or loss. Other considerations with respect to specific allocations for individual credits include, but are not limited to, the following: (a) does the customer’s cash flow or net worth appear insufficient to repay the loan; (b) is there adequate collateral to repay the loan (c) has the loan been criticized in a regulatory examination; (d) is the loan on non-accrual; (e) are there other reasons where the ultimate collectibility of the loan is in question; or (f) are there unique loan characteristics require special monitoring. Specific allowances are established in cases where management has identified significant conditions or circumstances related to an individual credit that we believe indicates the loan is impaired.
Allocations are also applied to categories of loans not considered individually impaired but for which the rate of loss is expected to be consistent with or greater than historical averages. Such allocations are based on past loss experience and information about specific borrower situations and estimated collateral values. In addition, general allocations are made for other pools of loans, including non-classified loans. These general pooled loan allocations are performed for similar portfolios of consumer and residential real estate loans, and loans within certain industry categories believed to present unique risk of loss. General allocations of the allowance are primarily made based on a five-year historical average for loan losses for these portfolios, judgmentally adjusted for economic factors and portfolio trends.
Due to the imprecise nature of estimating the allowance for loan losses, the Company’s allowance for loan losses includes an unallocated component. The unallocated component of the allowance for loan losses incorporates the Company’s judgmental determination of inherent losses that may not be fully reflected in other allocations, including factors such as economic uncertainties, industry trends impacting specific portfolio segments, broad portfolio quality trends and trends in the composition of the Company’s large commercial loan portfolio and related large dollar exposures to individual borrowers.
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Mortgage Servicing Rights Valuation
Mortgage servicing rights (MSRs) are recognized and included with other assets for the allocated value of retained servicing rights on loans sold. Servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights, using groupings of the underlying loans as to type and interest rate. Fair value is determined based upon discounted cash flows using market-based assumptions.
To determine the fair value of MSRs, the Company uses a valuation model that calculates the present value of estimated future net servicing income. In using this valuation method, the Company incorporates assumptions that market participants would use in estimating future net servicing income, which include estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, late fees, and float income.
The most significant assumption used to value MSRs is prepayment rate. In general, during periods of declining interest rates, the value of MSRs decline due to increasing prepayment speeds attributable to increased mortgage refinancing activity. Prepayment rates are estimated based on published industry consensus prepayment rates. Prepayments will increase or decrease in correlation with market interest rates and actual prepayments generally differ from initial estimates. If actual prepayment rates are different than originally estimated, the Company may receive less mortgage servicing income, which could reduce the value of the MSRs. Other assumptions used in estimating the fair value of MSRs do not generally fluctuate to the same degree as prepayment rates, and therefore the fair value of MSRs is less sensitive to changes in these other assumptions.
On a monthly basis, the Company evaluates the possible impairment of MSRs based on the difference between the carrying amount and the current fair value of MSRs. For purposes of evaluating and measuring impairment, the Company stratifies its portfolios on the basis of certain risk characteristics, including loan type and interest rate. If impairment exists, a valuation allowance is established for any excess of amortized cost over the current fair value, by risk stratification, through a charge to income. If the Company later determines that all or a portion of the impairment no longer exists for a particular strata, a reduction of the valuation allowance may be recorded as an increase to income.
Newly Issued But Not Yet Effective Accounting Standards
FASB Statement 123 (revised 2004), Share-Based Payment requires expensing of stock options effective for years beginning after June 15, 2005. The Company plans to adopt this standard as of January 1, 2006 and will begin expensing any unvested stock options at that time. The Company estimates the 2006 expense to be approximately $154,000. This amount does not take into account any additional grants that may be done during the year.
FASB Staff Position (FSP) 115-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” is effective for reporting periods after December 15, 2005. FSP FAS 115-1 addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The Company does not anticipate the adoption of this standard will have any material effect on the Company’s financial condition or results of operations.
No other new accounting standards have been issued that are not yet effective that are expected to have a significant impact on the Company’s financial condition or results of operations.
Liquidity
Management maintains a liquidity position that it believes will adequately provide funding for loan demand and deposit run-off that may occur in the normal course of business. The Company relies on a number of different sources in order to meet these potential liquidity demands. The primary sources are increases in deposit accounts and cash flows from loan payments and the securities portfolio. Given current prepayment assumptions, the cash flow from the securities portfolio is expected to provide approximately $37.6 million of funding in 2006.
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In addition to these primary sources of funds, management has several secondary sources available to meet potential funding requirements. As of December 31, 2005, the Company had $210.0 million in Federal Funds lines with correspondent banks and may borrow up to $100.0 million at the Federal Home Loan Bank of Indianapolis. The Company has its securities in the available for sale (AFS) portfolio. Therefore the Company may sell securities to meet funding demands. Management believes that the securities in the AFS portfolio are of high quality and would therefore be marketable. Approximately 82% of this portfolio is comprised of Federal agency securities or mortgage-backed securities directly or indirectly backed by the Federal government. In addition, the Company has historically sold mortgage loans on the secondary market to reduce interest rate risk and to create an additional source of funding.
During 2005, cash and cash equivalents decreased $21.2 million from $103.9 million as of December 31, 2004 to $82.7 million as of December 31, 2005. The primary driver of this decrease was an increase in net loans of $199.1 million, which is net of approximately $43.9 million of loans originated and sold during 2005. Other uses of funds were purchases of securities of $68.4 million and payments on long-term borrowings of $10.0 million. Sources of funds were a net increase in deposits of $150.8 million, proceeds from maturities, calls and principal paydowns of securities of $51.0 million and proceeds from loan sales of $46.4 million. Other sources of funds were proceeds from short-term borrowings of $25.9 million and proceeds from the sale of securities of $6.3 million.
During 2004, cash and cash equivalents increased $46.4 million from $57.4 million as of December 31, 2003 to $103.9 million as of December 31, 2004. The primary driver of this increase was an increase in deposit balances of $189.0 million. Other sources of funds were proceeds from maturities, calls and principal paydowns of securities of $63.2 million and proceeds from loan sales of $60.2 million. The primary use of funds was a $133.0 million increase in net loans, which is net of approximately $59.3 million in loans originated and sold during 2004. Other uses of funds were purchases of securities of $72.0 million and payments on long-term borrowings of $20.0 million.
During 2003, cash and cash equivalents decreased $29.7 million from $87.1 million as of December 31, 2002 to $57.4 million as of December 31, 2003. The primary driver of this decrease was an increase in net loans of $51.7 million, which is net of approximately $143.2 million of loans originated and sold during 2003. A falling rate environment during the first half of the year contributed to an increase in demand for residential real estate mortgage loans. Other uses of funds were purchases of securities of $162.5 million and payments on long-term borrowings of $31.9 million. Sources of funds were proceeds from loan sales of $152.1 million and proceeds from maturities, calls and principal paydowns of securities of $132.4 million. Other sources of funds were proceeds from long-term borrowings of $40.9 million, proceeds from the sale of securities of $14.3 million and a net increase in deposits of $13.1 million.
The following tables disclose information on the maturity of the Company’s contractual long-term obligations and commitments. Certificates of deposit listed are those with original maturities of 1 year or more.
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| | | Payments Due by Period |
| | | | | One year | | | | | | After 5 |
| | | Total | | or less | | 1-3 years | | 4-5 years | | years |
| | | (in thousands) |
Certificates of deposit | | $169,358 | | $ 83,635 | | $ 76,285 | | $ 9,214 | | $ 225 |
Long-term debt | | 46 | | 0 | | 0 | | 0 | | 46 |
Operating leases | | 294 | | 120 | | 153 | | 20 | | 1 |
Subordinated debentures | 30,928 | | 0 | | 0 | | 0 | | 30,928 |
Total contractual long-term cash | | | | | | | | | |
obligations | | $200,626 | | $ 83,755 | | $ 76,438 | | $ 9,234 | | $ 31,199 |
| | | | | | | | | | | |
| | | | | | | Amount of Commitment Expiration Per Period |
| | | | | | | Total | | | | |
| | | | | | | Amount | | One year | | Over one |
| | | | | | | Committed | | or less | | year |
| | | | | | | (in thousands) |
Unused loan commitments | | | | | $ 488,587 | | $ 349,479 | | $ 139,108 |
Commercial letters of credit | | | | | 2,950 | | 1,289 | | 1,661 |
Standby letters of credit | | | | | 10,944 | | 10,944 | | 0 |
Total commitments and letters of credit | | | | $ 502,481 | | $ 361,712 | | $ 140,769 |
| | | | | | | | | | | |
Inflation
The effects of price changes and inflation can vary substantially for most financial institutions. While management believes that inflation affects the growth of total assets, it believes that it is difficult to assess the overall impact. Management believes this to be the case due to the fact that generally neither the timing nor the magnitude of the inflationary changes in the consumer price index (“CPI”) coincides with changes in interest rates. The price of one or more of the components of the CPI may fluctuate considerably and thereby influence the overall CPI without having a corresponding affect on interest rates or upon the cost of those goods and services normally purchased by the Company. In years of high inflation and high interest rates, intermediate and long-term interest rates tend to increase, thereby adversely impacting the market values of investment securities, mortgage loans and other long-term fixed rate loans. In addition, higher short-term interest rates caused by inflation tend to increase the cost of funds. In other years, the reverse situation may occur.
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Table of Contents
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Asset/Liability Management (ALCO) and Securities
Interest rate risk represents the Company’s primary market risk exposure. The Company does not have material exposure to foreign currency exchange risk, does not own any significant derivative financial instruments and does not maintain a trading portfolio. The Board of Directors annually reviews and approves the ALCO policy used to manage interest rate risk. This policy sets guidelines for balance sheet structure, which are designed to protect the Company from the impact that interest rate changes could have on net income, but does not necessarily indicate the effect on future net interest income. Given the Company’s mix of interest bearing liabilities and interest bearing assets on December 31, 2005, the net interest margin could be expected to decline in a falling interest rate environment and conversely, to increase in a rising rate environment. During 2005 the Federal Open Market Committee (FOMC) increased the target fed funds rate eight times for a total increase of 2.00%. These actions resulted in an increase in the yield on earning assets from 5.00% for 2004 to 5.89% for 2005. The majority of the increase in the earning assets yield was in the loan portfolio which increased its yield for 2005 by .98% over the yield for 2004. These increases by the FOMC also impacted the rates paid on deposit accounts and purchased funds. The rate paid on interest bearing deposits and purchased funds increased from 1.65% for 2004 to 2.62% for 2005. The combined result of the increase in the yield on earning assets and the increase in the rates paid on deposits and purchased funds was an increase in the net margin from 3.63% for 2004 to 3.70% for 2005. Future changes in the net interest margin will be dependent upon multiple factors including further actions by the FOMC during 2006, competitive pressures in the various markets served, and changes in the structure of the balance sheet in response to customer demands for products and services.
The Company utilizes a computer program to stress test the balance sheet under a wide variety of interest rate scenarios. The model quantifies the income impact of changes in customer preference for products, basis risk between the assets and the liabilities that support them and the risk inherent in different yield curves, as well as other factors. The ALCO committee reviews these possible outcomes and makes loan, investment and deposit decisions that maintain reasonable balance sheet structure in light of potential interest rate movements. Although management does not consider GAP ratios in this planning, the information can be used in a general fashion to look at asset and liability mismatches. The Company’s cumulative repricing GAP ratio as of December 31, 2005 for the next 12 months using a rates unchanged scenario was a negative 8.31% of earning assets.
The Company’s investment portfolio consists of U.S. Treasury securities, agencies, mortgage-backed securities and municipal bonds. During 2005, purchases in the securities portfolio consisted primarily of agency securities and municipal bonds. As of December 31, 2005, the Company’s investment in mortgage-backed securities represented approximately 71% of total securities and consisted of CMOs and mortgage pools issued by Ginnie Mae, Fannie Mae and Freddie Mac. Ginnie Mae, Fannie Mae and Freddie Mac securities are each guaranteed by their respective agencies as to principal and interest. All mortgage securities purchased by the Company are within risk tolerances for price, prepayment, extension and original life risk characteristics contained in the Company’s investment policy. The Company uses Bloomberg analytics to evaluate and monitor all purchases. As of December 31, 2005, the securities in the AFS portfolio had approximately a three-year average life with approximately 10% price depreciation in the event of a 300 basis points upward movement. The portfolio had approximately 5% price appreciation in the event of a 300 basis point downward movement in rates. As of December 31, 2005, all mortgage securities were performing in a manner consistent with management’s original expectations.
The following table provides information regarding the Company’s financial instruments used for purposes other than trading that are sensitive to changes in interest rates. For loans, securities and liabilities with contractual maturities, the tables present principal cash flows and related weighted-average interest rates by contractual maturities, as well as the Company’s historical experience of the impact of interest-rate fluctuations on the prepayment of residential and home equity loans and mortgage-backed securities. Core deposits such as deposits, interest-bearing checking, savings and money market deposits that have no contractual maturity, are shown under Year 1, however historical experience indicates that some potion of the balances are retained over time. Weighted-average variable rates are based upon rates existing at the reporting date.
50
Table of Contents | 2005 |
| Principal/Notional Amount Maturing in: |
| (in thousands) |
| | | Fair |
| | | | | | | | | | | | | | | Value |
| Year 1 | | Year 2 | | Year 3 | | Year 4 | | Year 5 | | Thereafter | | Total | | 12/31/2005 |
Rate sensitive assets: | | | | | | | | | | | | | | | |
Fixed interest rate loans | $ 131,443 | | $ 92,181 | | $ 86,528 | | $ 74,949 | | $ 62,429 | | $ 24,706 | | $ 472,236 | | $ 466,802 |
Average interest rate | 6.41% | | 6.28% | | 6.23% | | 6.19% | | 6.53% | | 6.56% | | 6.34% | | |
Variable interest rate loans | $ 679,813 | | $ 1,197 | | $ 1,259 | | $ 2,004 | | $ 1,354 | | $ 40,867 | | $ 726,494 | | $ 724,734 |
Average interest rate | 7.23% | | 7.01% | | 7.04% | | 6.20% | | 7.31% | | 7.20% | | 7.21% | | |
Fixed interest rate securities | $ 48,976 | | $ 39,968 | | $ 45,691 | | $ 54,533 | | $ 35,632 | | $ 69,995 | | $ 294,795 | | $ 290,604 |
Average interest rate | 3.46% | | 3.53% | | 3.66% | | 3.85% | | 4.01% | | 4.38% | | 3.86% | | |
Variable interest rate securities | $ 98 | | $ 75 | | $ 54 | | $ 40 | | $ 30 | | $ 36 | | $ 333 | | $ 331 |
Average interest rate | 6.24% | | 8.18% | | 7.53% | | 6.89% | | 6.30% | | 6.09% | | 6.95% | | |
Other interest-bearing assets | $ 5,292 | | $ 0 | | $ 0 | | $ 0 | | $ �� 0 | | $ 0 | | $ 5,292 | | $ 5,292 |
Average interest rate | 4.12% | | 0.00% | | 0.00% | | 0.00% | | 0.00% | | 0.00% | | 4.12% | | |
Rate sensitive liabilities: | | | | | | | | | | | | | | | |
Non-interest bearing checking | $ 247,605 | | $ 0 | | $ 0 | | $ 0 | | $ 0 | | $ 0 | | $ 247,605 | | $ 247,605 |
Average interest rate | | | | | | | | | | | | | | | |
Savings & interest bearing checking | $ 458,570 | | $ 0 | | $ 0 | | $ 0 | | $ 0 | | $ 0 | | $ 458,570 | | $ 458,570 |
Average interest rate | 2.14% | | 0.00% | | 0.00% | | 0.00% | | 0.00% | | 0.00% | | 2.14% | | |
Time deposits | $ 416,731 | | $ 91,595 | | $ 31,743 | | $ 12,277 | | $ 6,191 | | $ 1,533 | | $ 560,070 | | $ 558,027 |
Average interest rate | 3.91% | | 4.11% | | 3.95% | | 4.08% | | 4.30% | | 4.05% | | 3.96% | | |
Fixed interest rate borrowings | $ 136,148 | | $ 394 | | $ 0 | | $ 0 | | $ 0 | | $ 46 | | $ 136,588 | | $ 136,580 |
Average interest rate | 1.94% | | 3.26% | | 0.00% | | 0.00% | | 0.00% | | 6.15% | | 1.94% | | |
Variable interest rate borrowings | $ 75,000 | | $ 0 | | $ 0 | | $ 0 | | $ 0 | | $ 30,928 | | $ 105,928 | | $ 104,857 |
Average interest rate | 4.18% | | 0.00% | | 0.00% | | 0.00% | | 0.00% | | 7.26% | | 5.08% | | |
51
Table of Contents ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA | | | |
| | | |
CONSOLIDATED BALANCE SHEETS (in thousands except share data) | | | |
December 31 | 2005 | | 2004 |
ASSETS | | | |
Cash and due from banks | $ 77,387 | | $ 81,144 |
Short-term investments | 5,292 | | 22,714 |
Total cash and cash equivalents | 82,679 | | 103,858 |
Securities available for sale (carried at fair value) | 290,935 | | 286,582 |
Real estate mortgages held for sale | 960 | | 2,991 |
Loans, net of allowance for loan losses of $12,774 and $10,754 | 1,185,956 | | 992,465 |
Land, premises and equipment, net | 24,563 | | 25,057 |
Bank owned life insurance | 19,654 | | 16,896 |
Accrued income receivable | 7,416 | | 5,765 |
Goodwill | 4,970 | | 4,970 |
Other intangible assets | 1,034 | | 1,245 |
Other assets | 16,446 | | 13,293 |
Total assets | $ 1,634,613 | | $ 1,453,122 |
| | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | |
LIABILITIES | | | |
Noninterest bearing deposits | $ 247,605 | | $ 237,261 |
Interest bearing deposits | 1,018,640 | | 878,138 |
Total deposits | 1,266,245 | | 1,115,399 |
Short-term borrowings | | | |
Federal funds purchased | 43,000 | | 20,000 |
Securities sold under agreements to repurchase | 91,071 | | 88,057 |
U.S. Treasury demand notes | 2,471 | | 2,593 |
Other short-term borrowings | 75,000 | | 75,000 |
Total short-term borrowings | 211,542 | | 185,650 |
Accrued expenses payable | 10,423 | | 7,445 |
Other liabilities | 2,095 | | 1,889 |
Long-term borrowings | 46 | | 10,046 |
Subordinated debentures | 30,928 | | 30,928 |
Total liabilities | 1,521,279 | | 1,351,357 |
| | | |
Commitments, off-balance sheet risks and contingencies (Notes 1 and 19) | | | |
| | | |
STOCKHOLDERS’ EQUITY | | | |
Common stock: 90,000,000 shares authorized, no par value | | | |
5,986,054 shares issued and 5,947,342 outstanding as of December 31, 2005 | | | |
5,915,854 shares issued and 5,881,283 outstanding as of December 31, 2004 | 1,453 | | 1,453 |
Additional paid-in capital | 14,287 | | 12,463 |
Retained earnings | 102,327 | | 89,864 |
Accumulated other comprehensive loss | (3,814) | | (1,267) |
Treasury stock, at cost (2005 - 38,712 shares, 2004 - 34,571 shares) | (919) | | (748) |
Total stockholders’ equity | 113,334 | | 101,765 |
Total liabilities and stockholders’ equity | $ 1,634,613 | | $ 1,453,122 |
The accompanying notes are an integral part of these consolidated financial statements. | | |
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Table of Contents
CONSOLIDATED STATEMENTS OF INCOME (in thousands except share and per share data) |
Years Ended December 31 | 2005 | | 2004 | | 2003 |
NET INTEREST INCOME | | | | | |
Interest and fees on loans | | | | | |
Taxable | $ 68,230 | | $ 49,087 | | $ 46,861 |
Tax exempt | 182 | | 287 | | 280 |
Interest and dividends on securities | | | | | |
Taxable | 9,343 | | 8,103 | | 10,946 |
Tax exempt | 2,341 | | 2,344 | | 2,061 |
Interest on short-term investments | 333 | | 184 | | 188 |
Total interest income | 80,429 | | 60,005 | | 60,336 |
Interest on deposits | 24,331 | | 13,397 | | 14,079 |
Interest on borrowings | | | | | |
Short-term | 3,790 | | 1,556 | | 1,110 |
Long-term | 2,232 | | 1,880 | | 2,948 |
Total interest expense | 30,353 | | 16,833 | | 18,137 |
NET INTEREST INCOME | 50,076 | | 43,172 | | 42,199 |
Provision for loan losses | 2,480 | | 1,223 | | 2,254 |
NET INTEREST INCOME AFTER PROVISION FOR | | | | | |
LOAN LOSSES | 47,596 | | 41,949 | | 39,945 |
| | | | | |
NONINTEREST INCOME | | | | | |
Trust and brokerage income | 3,113 | | 3,015 | | 2,370 |
Service charges on deposit accounts | 6,929 | | 6,917 | | 6,860 |
Loan, insurance and service fees | 1,984 | | 1,945 | | 2,296 |
Merchant card fee income | 2,435 | | 2,219 | | 1,747 |
Other income | 1,709 | | 1,475 | | 1,636 |
Gain on sale of credit card portfolio | 863 | | 0 | | 0 |
Net gains on sales of real estate mortgages held for sale | 934 | | 987 | | 3,018 |
Net securities gains (losses) | (69) | | 0 | | 500 |
Total noninterest income | 17,898 | | 16,558 | | 18,427 |
| | | | | |
NONINTEREST EXPENSE | | | | | |
Salaries and employee benefits | 20,543 | | 19,673 | | 19,829 |
Net occupancy expense | 2,774 | | 2,496 | | 2,444 |
Equipment costs | 1,942 | | 2,106 | | 2,538 |
Data processing fees and supplies | 2,396 | | 2,546 | | 2,433 |
Credit card interchange | 1,527 | | 1,397 | | 955 |
Loss on extinguishment of debt | 0 | | 0 | | 804 |
Other expense | 8,875 | | 8,442 | | 8,676 |
Total noninterest expense | 38,057 | | 36,660 | | 37,679 |
INCOME BEFORE INCOME TAX EXPENSE | 27,437 | | 21,847 | | 20,693 |
Income tax expense | 9,479 | | 7,302 | | 6,828 |
NET INCOME | $ 17,958 | | $ 14,545 | | $ 13,865 |
BASIC WEIGHTED AVERAGE COMMON SHARES | 5,963,878 | | 5,867,705 | | 5,819,916 |
BASIC EARNINGS PER COMMON SHARE | $ 3.01 | | $ 2.48 | | $ 2.38 |
DILUTED WEIGHTED AVERAGE COMMON SHARES | 6,144,733 | | 6,064,077 | | 6,001,449 |
DILUTED EARNINGS PER COMMON SHARE | $ 2.92 | | $ 2.40 | | $ 2.31 |
The accompanying notes are an integral part of these consolidated financial statements. | | |
53
Table of Contents CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (in thousands except share and per share data) | | | | | |
| | | | | | | | Accumulated | | | | |
| | | | Additional | | | | Other | | | | Total |
| | Common | | Paid-in | | Retained | | Comprehensive | | Treasury | | Stockholders’ |
| | Stock | | Capital | | Earnings | | Income (Loss) | | Stock | | Equity |
| | | | | | | | | | | | |
Balance at January 1, 2003 | | 1,453 | | $ 8,537 | | $ 70,819 | | $ 3,937 | | $ (866) | | $ 83,880 |
Comprehensive income: | | | | | | | | | | | | |
Net income | | | | | | 13,865 | | | | | | 13,865 |
Other comprehensive income, net of tax | | | | | | | | (5,219) | | | | (5,219) |
Comprehensive income | | | | | | | | | | | | 8,646 |
Cash dividends declared, $.76 per share | | | | | | (4,424) | | | | | | (4,424) |
Transfer of deferred directors’ liability | | | | 949 | | | | | | | | 949 |
Treasury shares purchased under deferred directors’ plan | | | | | | | | | | | | |
(6,022 shares) | | | | 169 | | | | | | (169) | | 0 |
Treasury stock sold and distributed under deferred directors’ | | | | | | | | | | | | |
plan (6,515 shares) | | | | 35 | | | | | | 117 | | 152 |
Stock issued for stock option exercises (20,760 shares) | | | | 484 | | | | | | | | 484 |
Tax benefit of stock option exercises | | | | 81 | | | | | | | | 81 |
Stock compensation expense | | | | 254 | | | | | | | | 254 |
Balance at December 31, 2003 | | 1,453 | | 10,509 | | 80,260 | | (1,282) | | (918) | | 90,022 |
Comprehensive income: | | | | | | | | | | | | |
Net income | | | | | | 14,545 | | | | | | 14,545 |
Other comprehensive income, net of tax | | | | | | | | 15 | | | | 15 |
Comprehensive income | | | | | | | | | | | | 14,560 |
Cash dividends declared, $.84 per share | | | | | | (4,941) | | | | | | (4,941) |
Treasury shares purchased under deferred directors’ plan | | | | | | | | | | | | |
(4,786 shares) | | | | 165 | | | | | | (165) | | 0 |
Treasury stock sold and distributed under deferred directors’ | | | | | | | | | | | | |
plan (16,696 shares) | | | | (335) | | | | | | 335 | | 0 |
Stock issued for stock option exercises (81,110 shares) | | | | 1,711 | | | | | | | | 1,711 |
Tax benefit of stock option exercises | | | | 359 | | | | | | | | 359 |
Stock compensation expense | | | | 54 | | | | | | | | 54 |
Balance at December 31, 2004 | | 1,453 | | 12,463 | | 89,864 | | (1,267) | | (748) | | 101,765 |
Comprehensive income: | | | | | | | | | | | | |
Net income | | | | | | 17,958 | | | | | | 17,958 |
Other comprehensive income, net of tax | | | | | | | | (2,547) | | | | (2,547) |
Comprehensive income | | | | | | | | | | | | 15,411 |
Cash dividends declared, $.92 per share | | | | | | (5,495) | | | | | | (5,495) |
Treasury shares purchased under deferred directors’ plan | | | | | | | | | | | | |
(4,141 shares) | | | | 171 | | | | | | (171) | | 0 |
Stock issued for stock option exercises (70,200 shares) | | | | 1,168 | | | | | | | | 1,168 |
Tax benefit of stock option exercises | | | | 485 | | | | | | | | 485 |
Balance at December 31, 2005 | | 1,453 | | $ 14,287 | | $ 102,327 | | $ (3,814) | | $ (919) | | $ 113,334 |
The accompanying notes are an integral part of these consolidated financial statements. | | | | | | | | | | |
54
Table of Contents CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) | | | | | |
Years Ended December 31 | 2005 | | 2004 | | 2003 |
Cash flows from operating activities: | | | | | |
Net income | $ 17,958 | | $ 14,545 | | $ 13,865 |
Adjustments to reconcile net income to net cash from operating | | | | | |
activities: | | | | | |
Depreciation | 1,643 | | 2,091 | | 2,210 |
Provision for loan losses | 2,480 | | 1,223 | | 2,254 |
Write down of other real estate owned | 0 | | 15 | | 0 |
Amortization of intangible assets | 211 | | 215 | | 154 |
Amortization of loan servicing rights | 572 | | 573 | | 671 |
Net change in loan servicing rights valuation allowance | (159) | | (154) | | (224) |
Loans originated for sale | (43,909) | | (59,341) | | (143,230) |
Net gain on sales of loans | (934) | | (987) | | (3,018) |
Proceeds from sale of loans | 46,431 | | 60,243 | | 152,118 |
Net gain on sale of credit cards | (863) | | 0 | | 0 |
Net (gain) loss on sale of premises and equipment | (79) | | 106 | | (101) |
Net gain on sales of securities available for sale | 69 | | 0 | | (500) |
Net securities amortization | 2,613 | | 3,566 | | 1,549 |
Stock compensation expense | 0 | | 54 | | 254 |
Earnings on life insurance | (801) | | (632) | | (692) |
Net change: | | | | | |
Accrued income receivable | (1,651) | | (755) | | (11) |
Accrued expenses payable | 4,518 | | (248) | | (1,404) |
Other assets | (2,638) | | 2,641 | | 2,603 |
Other liabilities | 206 | | 428 | | (958) |
Total adjustments | 7,709 | | 9,038 | | 11,675 |
Net cash from operating activities | 25,667 | | 23,583 | | 25,540 |
| | | | | |
Cash flows from investing activities: | | | | | |
Proceeds from sale of securities available for sale | 6,259 | | 0 | | 14,338 |
Proceeds from maturities, calls and principal paydowns of | | | | | |
securities available for sale | 51,047 | | 63,185 | | 132,377 |
Purchases of securities available for sale | (68,391) | | (72,032) | | (162,540) |
Purchase of life insurance | (1,957) | | (811) | | (1,393) |
Proceeds from credit card sale | 4,008 | | 0 | | 0 |
Net increase in total loans | (199,116) | | (133,047) | | (51,681) |
Proceeds from sales of land, premises and equipment | 645 | | 144 | | 159 |
Purchases of land, premises and equipment | (1,715) | | (1,241) | | (3,627) |
Increase in investment in unconsolidated subsidiary | 0 | | 0 | | (309) |
Net payments in acquisition | 0 | | 0 | | (600) |
Net cash from investing activities | (209,220) | | (143,802) | | (73,276) |
| | | | | |
Cash flows from financing activities: | | | | | |
Net increase in total deposits | 150,846 | | 189,008 | | 13,066 |
Net increase (decrease) in short-term borrowings | 25,892 | | 889 | | (207) |
Proceeds from long-term borrowings | 0 | | 0 | | 40,928 |
Payments on long-term borrowings | (10,000) | | (20,001) | | (31,920) |
Dividends paid | (5,361) | | (4,806) | | (4,306) |
Proceeds from the sale of common stock | 0 | | 0 | | 152 |
Proceeds from stock option exercise | 1,168 | | 1,711 | | 484 |
Purchase of treasury stock | (171) | | (165) | | (169) |
Net cash from financing activities | 162,374 | | 166,636 | | 18,028 |
Net change in cash and cash equivalents | (21,179) | | 46,417 | | (29,708) |
Cash and cash equivalents at beginning of the year | 103,858 | | 57,441 | | 87,149 |
Cash and cash equivalents at end of the year | $ 82,679 | | $ 103,858 | | $ 57,441 |
Cash paid during the year for: | | | | | |
Interest | $ 27,682 | | $ 15,663 | | $ 18,935 |
Income taxes | 9,420 | | 5,587 | | 6,955 |
Supplemental non-cash disclosures: | | | | | |
Loans transferred to other real estate | 0 | | 0 | | 1,922 |
Directors’ deferred liability transferred from other liabilities to equity | 0 | | 0 | | 949 |
The accompanying notes are an integral part of these consolidated financial statements. | | | | |
55
Table of Contents
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Principles of Consolidation:
The consolidated financial statements include Lakeland Financial Corporation and its wholly-owned subsidiary, Lake City Bank (the “Bank”), together referred to as (the “Company”). Also included in the consolidated financial statements is LCB Investments Limited, a wholly-owned subsidiary of Lake City Bank, which is a Bermuda corporation that manages a portion of the Bank’s investment portfolio. All intercompany transactions and balances are eliminated in consolidation.
The Company provides financial services through its subsidiary, Lake City Bank, a full-service commercial bank with 43 branch offices in twelve counties in northern Indiana. The Company provides commercial, retail, trust and investment services to its customers. Commercial products include commercial loans and technology-driven solutions to commercial customers’ cash management needs such as internet business banking and on-line cash management services. Retail banking clients are provided a wide array of traditional retail banking services, including lending, deposit and investment services. Retail lending programs are focused on mortgage loans, home equity lines of credit and traditional retail installment loans. The Company provides credit card services to retail and commercial customers through its retail card program and merchant processing activity. The Company also has an Honors Private Banking program that is positioned to serve the more financially sophisticated customer with a menu including brokerage and trust services, executive mortgage programs and access to financial planning seminars and programs. The Company’s Prospero Program is dedicated to serving the expanding financial needs of the Latino community. The Company provides trust clients with traditional personal and corporate trust services. The Company also provides retail brokerage services, including an array of financial and investment products such as annuities and life insurance. Other financial instruments, which represent potential concentrations of credit risk, include deposit accounts in other financial institutions.
Use of Estimates:
To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided and future results could differ. The allowance for loan losses, the fair values of financial instruments and the fair value of loan servicing rights are particularly subject to change.
Cash Flows:
Cash and cash equivalents include cash, demand deposits in other financial institutions and short-term investments with maturities of 90 days or less. Cash flows are reported net for customer loan and deposit transactions.
Securities:
Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income (loss). Trading securities are bought for sale in the near term and are carried at fair value, with changes in unrealized holding gains and losses included in income. Federal Home Loan Bank stock is carried at cost in other assets. Securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity.
Purchase premiums or discounts are recognized in interest income using the interest method over the terms of the securities or over estimated lives for mortgage-backed securities. Gains and losses on sales are based on the amortized cost of the security sold and recorded on the trade date. Securities are written down to fair value when a decline in fair value is deemed to be other than temporary, as more fully disclosed in Note 2.
The Company does not have any material derivative instruments, nor does the Company participate in any significant hedging activities.
56
Table of Contents
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Real Estate Mortgages Held for Sale:
Loans held for sale are reported at the lower of cost or market on an aggregate basis. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.
Loan sales occur on the delivery date agreed to in the commitment agreement. The gain or loss on the sale of loans is the difference between the carrying value of the loans sold and the funds received from the sale. The Company retains servicing on the majority of loans sold.
Loans:
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, deferred loan fees and costs, and an allowance for loan losses.
Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. All mortgage and commercial loans for which collateral is insufficient to cover all principal and accrued interest are reclassified as nonaccrual loans to the extent they are under collateralized, on or before the date when the loan becomes 90 days delinquent. When a loan is classified as a nonaccrual loan, interest on the loan is no longer accrued, all unpaid accrued interest is reversed and interest income is subsequently recorded only to the extent cash payments are received. Accrual status is resumed when all contractually due payments are brought current and future payments are reasonably assured. Consumer installment loans, except those loans that are secured by real estate, are not placed on a nonaccrual status since these loans are charged-off when they have been delinquent from 90 to 180 days, and when the related collateral, if any, is not sufficient to offset the indebtedness. Advances under Mastercard and Visa programs, as well as advances under all other consumer line of credit programs, are charged-off when collection appears doubtful.
Allowance for Loan Losses:
The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, known and inherent risks in the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, internal loan grade classifications, economic conditions and other factors. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision, as more information becomes available or as future events change. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as special mention, substandard or doubtful on the Company’s watch list. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors.
A loan is impaired when full payment under the original loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. If a loan is impaired, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Mortgage and commercial loans, when they have been delinquent from 90 to 180 days, are reviewed to determine if a charge-off is necessary, if the related collateral, if any, is not sufficient to offset the indebtedness.
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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Investments in Limited Partnerships:
Investments in limited partnerships represent the Company’s investments in affordable housing projects for the primary purpose of available tax benefits. The Company is a limited partner in these investments and as such, the Company is not involved in the management or operation of such investments. These investments are accounted for using the equity method of accounting. Under the equity method of accounting, the Company records its share of the partnership’s earnings or losses in its income statement and adjusts the carrying amount of the investments on the balance sheet. These investments are evaluated for impairment when events indicate the carrying amount may not be recoverable. The investment recorded at December 31, 2005 and 2004 was $406,000 and $431,000 and is included with other assets in the balance sheet.
Foreclosed Assets:
Assets acquired through or instead of loan foreclosure are initially recorded at fair value when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed. At December 31, 2005 and 2004, the balance of repossessed assets and real estate owned was $25,000 and $274,000 and are included with other assets on the balance sheet.
Land, Premises and Equipment:
Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the useful lives of the assets. Premises assets have useful lives between 7 and 40 years. Equipment assets have useful lives between 3 and 10 years.
Loan Servicing Rights:
Loan servicing rights are recognized as assets for the allocated value of retained servicing rights on loans sold. Loan servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights, using groupings of the underlying loans as to loan type, term and interest rates. Any impairment of a grouping is reported as a valuation allowance. Fair value is calculated on a loan by loan basis and is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions, specifically prepayment speeds and current interest rates.
Bank Owned Life Insurance:
At December 31, 2005 and 2004, the Company owned $19.3 million and $16.8 million of life insurance policies on certain officers to replace group term life insurance for these individuals. At December 31, 2005 and 2004 the Company also owned $308,000 and $136,000 of variable life insurance on certain officers to fund a deferred compensation plan. Bank owned life insurance is recorded at its cash surrender value, or the amount that can be realized.
Goodwill and Other Intangible Assets:
Goodwill results from prior business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified.
Other intangible assets consist of core deposit intangibles arising from branch acquisitions and trust deposit relationships arising from a trust acquisition. Core deposit intangibles are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives, which is 12 years. Trust deposit relationships are initially measured at fair value and then amortized on an accelerated method over their estimated useful lives, which is 10 years.
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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Repurchase Agreements:
Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.
Long-term Assets:
Premises and equipment, core deposit and other intangible assets and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
Benefit Plans:
The Company maintains a 401(k) profit sharing plan for all employees meeting age and service requirements. The Company contributions are based upon the percentage of budgeted net income earned during the year for 2005 and 2004 and upon the rate of return on stockholders’ equity as of January 1st for 2003. The Company has a noncontributory defined benefit pension plan which covered substantially all employees until the plan was frozen effective April 1, 2000. Funding of the plan equals or exceeds the minimum funding requirement determined by the actuary. Pension expense is the net of service and interest cost, return on plan assets and amortization of gains and losses not immediately recognized. Benefits are based on years of service and compensation levels. An employee deferred compensation plan is available to certain employees with returns based on investments in mutual funds. The Company maintains a directors’ deferred compensation plan. Effective January 1, 2003, the directors’ deferred compensation plan was amended to restrict the deferral to be in stock only and deferred directors’ fees are included in equity. Prior to amending the plan, deferred directors’ fees were included in other liabilities. The Company acquires shares on the open market and records such shares as treasury stock.
Stock Compensation:
Effective December 9, 1997, the Company adopted the Lakeland Financial Corporation 1997 Share Incentive Plan. At its inception there were 600,000 shares of common stock reserved for grants of stock options to employees of Lakeland Financial Corporation, its subsidiaries and Board of Directors. As of December 31, 2005, 58,315 were available for future grants. In accordance with SFAS No.123, “Accounting for Stock-Based Compensation,” the Company has elected to account for stock-based compensation within the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” and all subsequent amendments and clarifications. Under this method, no compensation cost is recognized for stock options granted at or above fair market value. Compensation cost is recognized for stock option modifications, if applicable. Had compensation expense for the plan been determined based upon fair value at the grant date in accordance with SFAS 123, net income and earnings per common share would have been the pro forma amounts indicated below.
| | | | | 2005 | | 2004 | | 2003 |
Net income (in thousands) as reported | | $ 17,958 | | $ 14,545 | | $ 13,865 |
Deduct: stock-based compensation expense determined | | | | | |
under fair value based method (in thousands) | | 311 | | 487 | | 543 |
Pro forma net income (in thousands) | | $ 17,647 | | $ 14,058 | | $ 13,322 |
| | | | | | | | | |
Basic earnings per common share as reported | | $ 3.01 | | $ 2.48 | | $ 2.38 |
Pro forma basic earnings per common share | | $ 2.96 | | $ 2.40 | | $ 2.29 |
Diluted earnings per common share as reported | | $ 2.92 | | $ 2.40 | | $ 2.31 |
Pro forma diluted earnings per common share | | $ 2.87 | | $ 2.32 | | $ 2.22 |
| | | | | | | | | | | |
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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
The pro forma effects are computed with the black scholes option pricing model, using the following weighted-average assumptions as of the grant date for all options granted to date:
| | | | | 2005 | | 2004 | | 2003 |
Risk-free interest rate | | | | 5.08% | | 5.26% | | 5.26% |
Expected option life | | | | 5.00 years | | 5.00 years | | 5.00 years |
Expected price volatility | | | 67.52% | | 70.32% | | 73.13% |
Dividend yield | | | | 2.99% | | 3.02% | | 2.85% |
| | | | | | | | | | | | | | | |
Income Taxes:
Annual consolidated federal and state income tax returns are filed by the Company. Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Income tax expense is recorded based on the amount of taxes due on its tax return plus net deferred taxes computed based upon the expected future tax consequences of temporary differences between carrying amounts and tax basis of assets and liabilities, using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
Off-Balance Sheet Financial Instruments:
Financial instruments include credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. The fair value of standby letters of credit is recorded as a liability during the commitment period in accordance with FASB Interpretation No. 45.
Earnings Per Common Share:
Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and dividends through the date of issue of the financial statements. The common shares included in Treasury Stock for 2005 and 2004 reflect the acquisition of 38,712 and 34,571 shares, respectively of Lakeland Financial Corporation common stock that have been purchased under the directors’ deferred compensation plan described above. Because these shares are held in trust for the participants, they are treated as outstanding when computing the weighted-average common shares outstanding for the calculation of both basic and diluted earnings per share.
Comprehensive Income:
Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale during the year and changes in the minimum pension liability, which are also recognized as a separate component of equity.
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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
The components of other comprehensive income and related tax effects are as follows:
| | | | | Years Ended December 31, |
| | | | | 2005 | | 2004 | | 2003 |
| | | | | (in thousands) |
Unrealized holding gain/(loss) on securities available for sale | | | | | |
arising during the period | | | $ (4,120) | | $ (66) | | $ (7,014) |
Reclassification adjustment for (gains)/losses | | | | | | |
included in net income | | | 69 | | 0 | | (500) |
Net securities gain /(loss) activity during the period | (4,051) | | (66) | | (7,514) |
Tax effect | | | | | 1,486 | | (48) | | (2,626) |
Net of tax amount | | | | (2,565) | | (18) | | (4,888) |
| | | | | | | | | |
Minimum pension liability adjustment | | 30 | | 56 | | (557) |
Tax effect | | | | | 12 | | 23 | | (226) |
Net of tax amount | | | | 18 | | 33 | | (331) |
Other comprehensive income, net of tax | | $ (2,547) | | $ 15 | | $ (5,219) |
| | | | | | | | | |
Loss Contingencies:
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.
Restrictions on Cash:
The Company was required to have $18.9 million and $17.3 million of cash on hand or on deposit with the Federal Reserve Bank to meet regulatory reserve and clearing requirements at year-end 2005 and 2004. These balances do not earn interest.
Dividend Restriction:
Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Company or by the Company to its shareholders. These restrictions pose no practical limit on the ability of the Bank or Company to pay dividends at historical levels.
Fair Value of Financial Instruments:
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 18. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Industry Segments:
While the Company’s chief decision-makers monitor the revenue streams of the various Company products and services, the identifiable segments operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the Company’s financial service operations are considered by management to be aggregated in one reportable operating segment.
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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Adoption of New Accounting Standards:
The Company did not adopt any new accounting standards during 2005 that had a significant impact on the Company’s financial condition or results of operations.
.
Newly Issued But Not Yet Effective Accounting Standards:
FASB Statement 123 (revised 2004), Share-Based Payment requires expensing of stock options effective for years beginning after June 15, 2005. The Company plans to adopt this standard as of January 1, 2006 and will begin expensing any unvested stock options at that time. The Company estimates the 2006 expense to be approximately $154,000. This amount does not take into account any additional grants that may be done during the year.
FASB Staff Position (FSP) 115-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” is effective for reporting periods after December 15, 2005. FSP FAS 115-1 addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The Company does not anticipate the adoption of this standard will have any material effect on the Company’s financial condition or results of operations.
No other new accounting standards have been issued that are not yet effective that are expected to have a significant impact on the Company’s financial condition or results of operations.
Reclassifications:
Certain amounts appearing in the financial statements and notes thereto for prior periods have been reclassified to conform with the current presentation. The reclassifications had no effect on net income or stockholders’ equity as previously reported.
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NOTE 2 - SECURITIES
Information related to the fair value of securities available for sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) at December 31 is provided in the table below.
| | | Gross | | Gross |
| Fair | | Unrealized | | Unrealized |
| Value | | Gain | | Losses |
| (in thousands) |
2005 | | | | | |
U.S. Treasury securities | $ 966 | | $ 0 | | $ (36) |
U.S. Government agencies | 30,484 | | 0 | | (802) |
Mortgage-backed securities | 206,596 | | 253 | | (4,696) |
State and municipal securities | 52,889 | | 1,435 | | (347) |
Total | $ 290,935 | | $ 1,688 | | $ (5,881) |
| | | | | |
2004 | | | | | |
U.S. Treasury securities | $ 989 | | $ 0 | | $ (14) |
U.S. Government agencies | 22,885 | | 0 | | (157) |
Mortgage-backed securities | 208,961 | | 618 | | (2,654) |
State and municipal securities | 53,747 | | 2,218 | | (153) |
Total | $ 286,582 | | $ 2,836 | | $ (2,978) |
| | | | | |
Information regarding the fair value of available for sale debt securities by maturity as of December 31, 2005 is presented below. Maturity information is based on contractual maturity for all securities other than mortgage-backed securities. Actual maturities of securities may differ from contractual maturities because borrowers may have the right to prepay the obligation without prepayment penalty.
| | | | | Fair |
| | | | | Value |
| | | | | (in thousands) |
Due in one year or less | | | | | $ 110 |
Due after one year through five years | | | | | 33,517 |
Due after five years through ten years | | | | | 9,288 |
Due after ten years | | | | | 41,424 |
| | | | | 84,339 |
Mortgage-backed securities | | | | | 206,596 |
Total debt securities | $ 290,935 |
| | | | | |
Security proceeds, gross gains and gross losses for 2005, 2004 and 2003 were as follows:
| | 2005 | | 2004 | | 2003 |
| | (in thousands) |
Sales of securities available for sale | | | | | | |
Proceeds | | $ 6,328 | | $ 0 | | $ 14,338 |
Gross gains | | 2 | | 0 | | 508 |
Gross losses | | 71 | | 0 | | 8 |
Securities with carrying values of $191.6 million and $189.0 million were pledged as of December 31, 2005 and 2004, as collateral for deposits of public funds, securities sold under agreements to repurchase, borrowings from the FHLB and for other purposes as permitted or required by law. At year-end 2005 and 2004,
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NOTE 2 – SECURITIES (continued)
there were no holdings of securities of any one issuer, other than the U.S. Government, government agencies and government sponsored agencies, in an amount greater than 10% of stockholders’ equity.
Information regarding securities with unrealized losses as of December 31, 2005 and 2004 is presented below. The tables distribute the securities between those with unrealized losses for less than twelve months and those with unrealized losses for twelve months or more.
| Less than 12 months | | 12 months or more | | Total |
| Fair | | Unrealized | | Fair | | Unrealized | | Fair | | Unrealized |
| Value | | Losses | | Value | | Losses | | Value | | Losses |
| (in thousands) |
2005 | | | | | | | | | | | |
| | | | | | | | | | | |
U.S. Treasury securities | $ 0 | | $ 0 | | $ 966 | | $ 36 | | $ 966 | | $ 36 | |
U.S. Government agencies | 8,210 | | 124 | | 22,273 | | 678 | | 30,483 | | 802 | |
Mortgage-backed securities | 63,523 | | 813 | | 116,245 | | 3,883 | | 179,768 | | 4,696 | |
State and municipal securities | 11,273 | | 240 | | 2,534 | | 107 | | 13,807 | | 347 | |
Total temporarily impaired | $ 83,006 | | $ 1,177 | | $ 142,018 | | $ 4,704 | | $ 225,024 | | $ 5,881 | |
| | | | | | | | | | | | |
2004 | | | | | | | | | | | | |
| | | | | | | | | | | | |
U.S. Treasury securities | $ 989 | | $ 14 | | $ 0 | | $ 0 | | $ 989 | | $ 14 | |
U.S. Government agencies | 22,885 | | 157 | | 0 | | 0 | | 22,885 | | 157 | |
Mortgage-backed securities | 110,501 | | 1,326 | | 46,540 | | 1,328 | | 157,041 | | 2,654 | |
State and municipal securities | 3,770 | | 37 | | 4,169 | | 116 | | 7,939 | | 153 | |
Total temporarily impaired | $ 138,145 | | $ 1,534 | | $ 50,709 | | $ 1,444 | | $ 188,854 | | $ 2,978 | |
| | | | | | | | | | | |
All of the following are considered to determine whether or not the impairment of these securities is other-than-temporary. All of the securities are backed by the U.S. Government, government agencies, government sponsored agencies or are A rated or better, in the case of non-local municipal securities. None of the securities have call provisions (with the exception of the municipal securities) and payments as originally agreed are being received. There are no concerns of credit losses and there is nothing to indicate that full principal will not be received. Management considers the unrealized losses to be market driven and no loss is expected to be realized unless the securities are sold. The Company does not have a history of actively trading securities, but keeps the securities available for sale should liquidity or other needs develop that would warrant the sale of securities. While these securities are held in the available for sale portfolio, the current intent and ability is to hold them until a recovery in fair value or maturity.
NOTE 3 - LOANS
Total loans outstanding as of year-end consisted of the following:
| 2005 | | 2004 |
| (in thousands) |
Commercial and industrial loans | $ 850,984 | | $ 688,211 |
Agri-business and agricultural loans | 113,574 | | 102,749 |
Real estate mortgage loans | 66,833 | | 47,642 |
Real estate construction loans | 7,987 | | 6,719 |
Installment loans and credit cards | 159,390 | | 158,065 |
Subtotal | 1,198,768 | | 1,003,386 |
Less: Allowance for loan losses | (12,774) | | (10,754) |
Net deferred loan fees | (38) | | (167) |
Loans, net | $ 1,185,956 | | $ 992,465 |
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NOTE 4 - ALLOWANCE FOR LOAN LOSSES
The following is an analysis of the allowance for loan losses for 2005, 2004 and 2003:
| 2005 | | 2004 | | 2003 |
| (in thousands) |
Balance, January 1, | $ 10,754 | | $ 10,234 | | $ 9,533 |
Provision for loan losses | 2,480 | | 1,223 | | 2,254 |
Loans charged-off | (601) | | (994) | | (1,774) |
Recoveries | 141 | | 291 | | 221 |
Net loans charged-off | (460) | | (703) | | (1,553) |
Balance December 31 | $ 12,774 | | $ 10,754 | | $ 10,234 |
| | | | | |
| | | | | |
Nonaccrual loans | $ 7,321 | | $ 7,212 | | $ 553 |
Interest not recorded on nonaccrual loans | 460 | | 203 | | 183 |
Loans past due 90 days and still accruing | 174 | | 2,778 | | 3,191 |
As of December 31, 2005, 2004 and 2003 there were no loans renegotiated as troubled debt restructurings.
Impaired loans were as follows:
| | | | | | | | 2005 | | 2004 |
| | | | | | | | (in thousands) |
Year-end loans with no allocated allowance for loan losses | | | $ 0 | | $ 0 |
Year-end loans with allocated allowance for loan losses | | | 6,948 | | 9,309 |
| | | | | | | | $ 6,948 | | $ 9,309 |
| | | | | | | | | | |
Amount of the allowance for loan losses allocated | | | | $ 2,945 | | $ 1,711 |
| | | | | | | | | | |
| | | | | | 2005 | | 2004 | | 2003 |
| | | | | | (in thousands) |
Average of impaired loans during the year | | $ 7,853 | | $ 5,606 | | $ 6,320 |
Interest income recognized during impairment | | 69 | | 183 | | 226 |
Cash-basis interest income recognized | | | 70 | | 183 | | 225 |
The Company is not committed to lend additional funds to debtors whose loans have been modified in a troubled debt restructuring. The 2005 and 2004 impaired loan totals included $6.9 million and $6.7 million which were also included in the total for nonaccrual loans. Total impaired loans decreased by $2.4 million to $6.9 million at December 31, 2005 from $9.3 million at December 31, 2004. The decreases in loans delinquent 90 days or more and impaired loans resulted primarily from the upgrading of a single commercial credit that was classified as impaired because, pursuant to the terms of the loan documentation, it had matured, although the parties were working to have it renewed. The renewal of the loan in question had been complicated as more than one bank was involved which resulted in it being past maturity. The renewal issues were resolved in the third quarter of 2005, the participant bank is no longer involved in the credit and the loan is current as to principal and interest. The majority of the balance of nonperforming and impaired loans is a single commercial credit of $5.7 million and $6.1 million at December 31, 2005 and 2004. The borrower filed chapter 11 bankruptcy late in the third quarter of 2004 and the plan for reorganization was approved late in the third quarter of 2005. Borrower collateral and the personal guarantees of its principals support this credit.
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NOTE 5 - SECONDARY MORTGAGE MARKET ACTIVITIES
Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of these loans were $248.0 million and $242.9 million at December 31, 2005 and 2004. The fair value of loan servicing rights was approximately $1.7 million at December 31, 2005 and 2004. Net loan servicing income/(loss) excluding adjustments to the valuation allowance was $41,000, $25,000 and ($166,000) for 2005, 2004 and 2003. Information on loan servicing rights follows:
Loan servicing rights: | 2005 | | 2004 | | 2003 |
| (in thousands) |
Beginning of year | $ 2,052 | | $ 2,100 | | $ 1,677 |
Originations | 443 | | 525 | | 1,094 |
Amortization | (572) | | (573) | | (671) |
End of year | $ 1,923 | | $ 2,052 | | $ 2,100 |
| | | | | |
Valuation allowance: | 2005 | | 2004 | | 2003 |
| (in thousands) |
Beginning of year | $ 344 | | $ 498 | | $ 722 |
Additions expensed | 0 | | 173 | | 421 |
Reductions credited to expense | (159) | | (327) | | (645) |
End of year | $ 185 | | $ 344 | | $ 498 |
| | | | | |
NOTE 6 - LAND, PREMISES AND EQUIPMENT, NET
Land, premises and equipment and related accumulated depreciation were as follows at December 31:
| 2005 | | 2004 |
| (in thousands) |
Land | $ 8,388 | | $ 8,491 |
Premises | 21,667 | | 21,292 |
Equipment | 15,166 | | 14,951 |
Total cost | 45,221 | | 44,734 |
Less accumulated depreciation | 20,658 | | 19,677 |
Land, premises and equipment, net | $ 24,563 | | $ 25,057 |
| | | |
The Company held land of $165,000 for sale at December 31, 2005.
NOTE 7 – GOODWILL AND OTHER INTANGIBLE ASSETS
There have been no changes in the $5.0 million carrying amount of goodwill since 2002.
Acquired Intangible Assets
| | | As of December 31, 2005 | | As of December 31, 2004 |
| | | (in thousands) | | (in thousands) |
| | | Gross Carrying | | Accumulated | | Gross Carrying | | Accumulated |
| | | Amount | | Amortization | | Amount | | Amortization |
Amortized intangible assets | | | | | | | |
Core deposit | | $ 2,032 | | $ 1,437 | | $ 2,032 | | $ 1,288 |
Trust deposit relationships | 572 | | 133 | | 572 | | 71 |
Total | | | $ 2,604 | | $ 1,570 | | $ 2,604 | | $ 1,359 |
| | | | | | | | | |
Aggregate amortization expense was $211,000, $215,000 and $154,000 for 2005, 2004 and 2003.
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NOTE 7 – GOODWILL AND OTHER INTANGIBLE ASSETS (continued)
Estimated amortization expense for each of the next five years:
| | Amount |
| | (in thousands) |
2006 | | $ 209 |
2007 | | 206 |
2008 | | 206 |
2009 | | 206 |
2010 | | 54 |
NOTE 8 – DEPOSITS
The aggregate amount of time deposits, each with a minimum denomination of $100,000, was approximately $318.1 million and $216.0 million at December 31, 2005 and 2004.
At December 31, 2005, the scheduled maturities of time deposits were as follows:
| Amount |
| (in thousands) |
Maturing in 2006 | $ 418,124 |
Maturing in 2007 | 91,595 |
Maturing in 2008 | 31,743 |
Maturing in 2009 | 12,276 |
Maturing in 2010 | 6,191 |
Thereafter | 141 |
Total time deposits | $ 560,070 |
| |
NOTE 9 - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase (“repo accounts”) represent collateralized borrowings with customers located primarily within the Company’s service area. Repo accounts are not covered by federal deposit insurance and are secured by securities owned. Information on these liabilities and the related collateral for 2005 and 2004 is as follows:
| 2005 | | 2004 |
| (in thousands) |
Average daily balance during the year | $ 85,666 | | $ 84,907 |
Average interest rate during the year | 1.67% | | 0.64% |
Maximum month-end balance during the year | $ 92,589 | | $ 90,007 |
Securities underlying the agreements at year-end | | | |
Fair value | $ 111,188 | | $ 109,089 |
| | | | Weighted | | |
| | Repurchase | | Average | | Collateral at |
Term | | Liability | | Interest Rate | | Fair Values |
| | (in thousands) | | | | (in thousands) |
Mortgage-backed securities: | | | | | |
On demand | | $ 90,677 | | 2.91% | | $ 110,362 |
Over 90 days | | 394 | | 3.26% | | 826 |
Total | | $ 91,071 | | 2.91% | | $ 111,188 |
| | | | | | |
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NOTE 9 - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE (continued)
The Company retains the right to substitute similar type securities, and has the right to withdraw all collateral applicable to repo accounts whenever the collateral values are in excess of the related repurchase liabilities. At December 31, 2005, there were no material amounts of securities at risk with any one customer. The Company maintains control of these securities through the use of third-party safekeeping arrangements.
NOTE 10 – BORROWINGS
Long-term borrowings at December 31 consisted of:
| 2005 | | 2004 |
| (in thousands) |
Federal Home Loan Bank of Indianapolis Notes, 2.36%, Due December 29, 2005 | $ 0 | | $ 10,000 |
Federal Home Loan Bank of Indianapolis Notes, 6.15%, Due January 15, 2018 | 46 | | 46 |
Total | $ 46 | | $ 10,046 |
| | | |
All notes have a fixed rate, require monthly interest payments. All notes were secured by residential real estate loans and securities with a carrying value of $131.1 million at December 31, 2005. At December 31, 2005, the Company owned $5.1 million of Federal Home Loan Bank (FHLB) stock, which also secures debts to the FHLB. The Company is authorized to borrow up to $100 million at the FHLB.
There are no long-term borrowings maturing during the next five years.
Short-term borrowings at December 31 consisted of:
| 2005 | | 2004 |
| (in thousands) |
Federal Home Loan Bank of Indianapolis Notes, 1.95%, Due February 9, 2005 | $ 0 | | $ 75,000 |
Federal Home Loan Bank of Indianapolis Notes, 4.18%, Due March 28, 2006 | 75,000 | | 0 |
Total | $ 75,000 | | $ 75,000 |
| | | |
NOTE 11 – SUBORDINATED DEBENTURES
In September 1997, Lakeland Capital Trust completed a public offering of two million shares of cumulative trust preferred securities with a liquidation preference of $10 per security. The proceeds of the offering were loaned to the Company in exchange for subordinated debentures with terms similar to the preferred securities. On October 1, 2003, the subordinated debentures were redeemed and the preferred securities called. Loss on extinguishment of debt of $804,000 was recorded in connection with the call of the preferred securities.
Lakeland Statutory Trust II, a trust formed by the Company, issued $30.0 million of floating rate trust preferred securities on October 1, 2003 as part of a privately placed offering of such securities. The Company issued subordinated debentures to the trust in exchange for the proceeds of the trust. Subject to the Company having received prior approval of the Federal Reserve if then required, the Company may redeem the subordinated debentures, in whole or in part, but in all cases in a principal amount with integral multiples of $1,000, on any interest payment date on or after October 1, 2008 at 100% of the principal amount, plus accrued and unpaid interest. The subordinated debentures must be redeemed no later than 2033. These securities are considered as Tier I capital (with certain limitations applicable) under current regulatory guidelines. The floating rate of the trust preferred securities and subordinated debentures was 7.580%, 5.610% and 4.205% at December 31, 2005, 2004 and 2003. The holding company’s investment in the common stock of the trust was $928,000 and is included in other assets.
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NOTE 12 - EMPLOYEE BENEFIT PLANS
In April, 2000, the Lakeland Financial Corporation Pension Plan was frozen. As a result of this curtailment, a gain was recognized in the income statement for the second quarter of 2000. At December 31, 2005 and 2004, the pension plan recorded a minimum pension liability of approximately $1.8 million. The Company also maintains a Supplemental Executive Retirement Plan (SERP) for select officers that was established as a funded, non-qualified deferred compensation plan. Only one current officer of the Company is a participant in the plan and there are 7 total participants.
Information as to the Company’s plans at December 31 is as follows:
| Pension Benefits | | SERP Benefits |
| 2005 | | 2004 | | 2005 | | 2004 |
| (in thousands) | | (in thousands) |
Change in benefit obligation: | | | | | | | |
Beginning benefit obligation | $ 2,663 | | $ 2,642 | | $ 1,419 | | $ 1,457 |
Interest cost | 149 | | 149 | | 79 | | 83 |
Actuarial (gain)/loss | (72) | | (114) | | 39 | | (13) |
Change in discount rate | 97 | | 96 | | 26 | | 26 |
Benefits paid | (144) | | (110) | | (134) | | (134) |
Ending benefit obligation | 2,693 | | 2,663 | | 1,429 | | 1,419 |
| | | | | | | |
Change in plan assets (primarily equity and fixed | | | | | | | |
income investments and money market funds), | | | | | | | |
at fair value: | | | | | | | |
| | | | | | | |
Beginning plan assets | 1,563 | | 1,265 | | 1,084 | | 1,008 |
Actual return | 163 | | 124 | | 104 | | 91 |
Employer contribution | 468 | | 284 | | 106 | | 119 |
Benefits paid | (144) | | (110) | | (134) | | (134) |
Ending plan assets | 2,050 | | 1,563 | | 1,160 | | 1,084 |
| | | | | | | |
Funded status | (643) | | (1,100) | | (269) | | (335) |
Unrecognized net actuarial loss | 1,790 | | 1,820 | | 819 | | 800 |
Prepaid benefit cost | $ 1,147 | | $ 720 | | $ 550 | | $ 465 |
| | | | | | | |
Amounts recognized in the consolidated balance | | | | | | | |
sheets consist of: | Pension Benefits | | SERP Benefits |
| 2005 | | 2004 | | 2005 | | 2004 |
| (in thousands) | | (in thousands) |
Prepaid benefit cost | $ 1,147 | | $ 720 | | $ 550 | | $ 465 |
Accumulated other comprehensive income (pre-tax) | (1,790) | | (1,820) | | 0 | | 0 |
Net amount recognized | $ (643) | | $ (1,100) | | $ 550 | | $ 465 |
| | | | | | | |
| December 31, | | December 31, |
| 2005 | | 2004 | | 2005 | | 2004 |
| (in thousands) | | (in thousands) |
Projected benefit obligation | $ 2,693 | | $ 2,663 | | $ 1,429 | | $ 1,419 |
Accumulated benefit obligation | 2,693 | | 2,663 | | 1,429 | | 1,419 |
Fair value of plan assets | 2,050 | | 1,563 | | 1,160 | | 1,084 |
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NOTE 12 - EMPLOYEE BENEFIT PLANS (continued)
Net pension expense includes the following:
| Pension Benefits | | SERP Benefits |
| 2005 | | 2004 | | 2003 | | 2005 | | 2004 | | 2003 |
| (in thousands) | | (in thousands) |
Service cost | $ 0 | | $ 0 | | $ 0 | | $ 0 | | $ 0 | | $ 0 |
Interest cost | 149 | | 149 | | 155 | | 79 | | 83 | | 91 |
Expected return on plan assets | (145) | | (125) | | (141) | | (102) | | (100) | | (95) |
Recognized net actuarial (gain) loss | 38 | | 38 | | 28 | | 44 | | 36 | | 29 |
Net pension expense (benefit) | $ 42 | | $ 62 | | $ 42 | | $ 21 | | $ 19 | | $ 25 |
| | | | | | | | | | | |
Additional Information: | Pension Benefits | | SERP Benefits |
| 2005 | | 2004 | | 2003 | | 2005 | | 2004 | | 2003 |
| (in thousands) | | (in thousands) |
(Decrease)/increase in minimum liability | | | | | | | | | | | |
included in other comprehensive income | $ (30) | | $ (56) | | $ 557 | | $ 0 | | $ 0 | | $ 0 |
| | | | | | | | | | | |
The following assumptions were used in calculating the net benefit obligation: | | | | | | | | | | | |
| | | | | | | | | | | |
Weighted average discount rate | 5.75% | | 6.00% | | 6.75% | | 5.75% | | 6.00% | | 6.75% |
Rate of increase in future compensation | N/A | | N/A | | N/A | | N/A | | N/A | | N/A |
| | | | | | | | | | | |
The following assumptions were used in calculating the net pension expense: | | | | | | | | | | | |
| | | | | | | | | | | |
Weighted average discount rate | 5.50% | | 5.75% | | 6.00% | | 5.50% | | 5.75% | | 6.00% |
Rate of increase in future compensation | N/A | | N/A | | N/A | | N/A | | N/A | | N/A |
Expected long-term rate of return | 8.25% | | 8.25% | | 8.25% | | 8.25% | | 8.25% | | 8.25% |
The expected long-term rate of return on plan assets is developed in consultation with the plan actuary. It is primarily based upon industry trends and consensus rates of return which are then adjusted to reflect the specific asset allocations and historical rates of return of the Company’s plan assets.
The asset allocations at the measurement dates of September 30, 2005 and 2004, by asset category are as follows:
| Pension Plan Assets | | SERP Plan Assets |
| at September 30, | | at September 30, |
Asset Category | 2005 | | 2004 | | 2005 | | 2004 |
Equity securities | 66% | | 64% | | 66% | | 61% |
Debt Securities | 32% | | 29% | | 31% | | 34% |
Other | 2% | | 7% | | 3% | | 5% |
Total | 100% | | 100% | | 100% | | 100% |
| | | | | | | |
The Company’s investment strategies are to invest in a prudent manner for the purpose of providing benefits to participants. The investment strategies are targeted to maximize the total return of the portfolio net of inflation, spending and expenses. Risk is controlled through diversification of asset types and investments in domestic and international equities and fixed income securities. Certain asset types and investment strategies are prohibited including: commodities, options, futures, short sales, margin transactions and non-marketable securities. The target allocation is 60% equities and 40% debt securities although acceptable ranges are: 55-65% equities and 35-45% debt securities.
Contributions
The Company expects to contribute $229,000 to its pension plan and $68,000 to its SERP plan in 2006.
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NOTE 12 - EMPLOYEE BENEFIT PLANS (continued)
Estimated Future Benefit Payments
The following benefit payments are expected to be paid:
| | | | | Pension | | SERP |
Plan Year | | | | | Benefits | | Benefits |
| | | | | (in thousands) |
2006 | | | | | $ 104 | | $ 136 |
2007 | | | | | 111 | | 134 |
2008 | | | | | 112 | | 132 |
2009 | | | | | 122 | | 130 |
2010 | | | | | 134 | | 128 |
2011-2015 | | | | | 757 | | 585 |
Other Employee Benefit Plans |
The Company maintains a 401(k) profit sharing plan for all employees meeting age and service requirements. The Company contributions are based upon the percentage of budgeted net income earned during the year for 2005 and 2004 and upon the rate of return on stockholders’ equity as of January 1st for 2003. The expense recognized was $844,000, $731,000 and $732,000 in 2005, 2004 and 2003.
Effective January 1, 2004, the Company adopted the Lake City Bank Deferred Compensation Plan. The purpose of the deferred compensation plan is to extend full 401(k) type retirement benefits to certain individuals without regard to statutory limitations under tax qualified plans. The plan is funded solely by participant contributions and does not receive a company match.
Under employment agreements with certain executives, certain events leading to separation from the Company could result in cash payments totaling $2.5 million as of December 31, 2005. On December 31, 2005, no amounts were accrued on these contingent obligations.
NOTE 13 - OTHER EXPENSE
Other expense for the years ended December 31, was as follows:
| 2005 | | 2004 | | 2003 |
| (in thousands) |
Corporate and business development | $ 1,235 | | $ 1,036 | | $ 1,003 |
Advertising | 671 | | 694 | | 706 |
Office supplies | 644 | | 594 | | 591 |
Telephone and postage | 1,139 | | 1,126 | | 1,137 |
Regulatory fees and FDIC insurance | 275 | | 261 | | 242 |
Professional fees | 1,386 | | 1,337 | | 1,275 |
Amortization of other intangible assets | 211 | | 215 | | 154 |
Courier and delivery | 590 | | 578 | | 548 |
Miscellaneous | 2,724 | | 2,601 | | 3,020 |
Total other expense | $ 8,875 | | $ 8,442 | | $ 8,676 |
| | | | | |
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NOTE 14 - INCOME TAXES
Income tax expense for the years ended December 31, consisted of the following:
| 2005 | | 2004 | | 2003 |
| (in thousands) |
Current federal | $ 8,487 | | $ 5,446 | | $ 5,121 |
Deferred federal | (546) | | 720 | | 816 |
Current state | 1,805 | | 1,013 | | 773 |
Deferred state | (267) | | 123 | | 118 |
Total income tax expense | $ 9,479 | | $ 7,302 | | $ 6,828 |
| | | | | |
Income tax expense included ($28,000), $0 and $203,000 applicable to security transactions for 2005, 2004 and 2003. The differences between financial statement tax expense and amounts computed by applying the statutory federal income tax rate of 35% for 2005, 2004 and 2003 to income before income taxes were as follows:
| 2005 | | 2004 | | 2003 |
| (in thousands) |
Income taxes at statutory federal rate | $ 9,603 | | $ 7,647 | | $ 7,243 |
Increase (decrease) in taxes resulting from: | | | | | |
Tax exempt income | (875) | | (914) | | (813) |
Nondeductible expense | 214 | | 186 | | 176 |
State income tax, net of federal tax effect | 999 | | 738 | | 579 |
Net operating loss | (30) | | (30) | | (30) |
Tax credits | (83) | | (104) | | (73) |
Bank owned life insurance | (280) | | (221) | | (242) |
Other | (69) | | 0 | | (12) |
Total income tax expense | $ 9,479 | | $ 7,302 | | $ 6,828 |
| | | | | |
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NOTE 14 - INCOME TAXES (continued)
The net deferred tax asset recorded in the consolidated balance sheets at December 31, consisted of the following:
| 2005 | | 2004 |
| Federal | | State | | Federal | | State |
| (in thousands) |
Deferred tax assets: | | | | | | | |
Bad debts | $ 4,471 | | $ 1,027 | | $ 3,764 | | $ 766 |
Pension and deferred compensation liability | 171 | | 39 | | 209 | | 47 |
Net operating loss carryforward | 149 | | 0 | | 178 | | 0 |
Deferred loan fees | 0 | | 0 | | 10 | | 2 |
Nonaccrual loan interest | 206 | | 47 | | 74 | | 17 |
Other | 59 | | 0 | | 96 | | 13 |
| 5,056 | | 1,113 | | 4,331 | | 845 |
Deferred tax liabilities: | | | | | | | |
Accretion | 66 | | 11 | | 38 | | 9 |
Depreciation | 913 | | 116 | | 1,024 | | 163 |
Loan servicing rights | 608 | | 140 | | 598 | | 137 |
State taxes | 225 | | 0 | | 131 | | 0 |
Leases | 90 | | 21 | | 122 | | 27 |
Deferred loan fees | 20 | | 5 | | 0 | | 0 |
Intangible assets | 472 | | 108 | | 326 | | 73 |
FHLB stock dividends | 148 | | 34 | | 115 | | 26 |
Prepaid expenses | 143 | | 32 | | 152 | | 35 |
Other | 0 | | 4 | | 0 | | 0 |
| 2,685 | | 471 | | 2,506 | | 470 |
Valuation allowance | 0 | | 0 | | 0 | | 0 |
Net deferred tax asset | $ 2,371 | | $ 642 | | $ 1,825 | | $ 375 |
| | | | | | | |
In addition to the net deferred tax assets included above, the deferred income tax asset (liability) allocated to the unrealized net loss on securities available for sale included in equity was $1.4 million and $41,000 for 2005 and 2004. The deferred income tax asset allocated to the minimum pension liability included in equity was $725,000 and $738,000 for 2005 and 2004.
NOTE 15 - RELATED PARTY TRANSACTIONS
Loans to principal officers, directors, and their affiliates as of December 31, 2005 and 2004 were as follows:
| 2005 | | 2004 |
| (in thousands) |
Beginning balance | $ 47,278 | | $ 43,941 |
New loans and advances | 98,928 | | 91,627 |
Effect of changes in related parties | (38) | | 61 |
Repayments | (91,680) | | (88,351) |
Ending balance | $ 54,488 | | $ 47,278 |
| | | |
Deposits from principal officers, directors, and their affiliates at year-end 2005 and 2004 were $1.8 million and $2.5 million. In addition, the amount owed directors for fees under the deferred directors’ plan as of December 31, 2005 and 2004 was $998,000 and $813,000. The related expense for the deferred directors’ plan as of December 31, 2005, 2004 and 2003 was $212,000, $184,000 and $235,000.
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NOTE 16 - STOCK OPTIONS
The stock option plan requires that the exercise price for options be the market price on the date the options are granted. The maximum option term is ten years and the options vest over 5 years. A summary of the activity in the plan follows:
| 2005 | | 2004 | | 2003 |
| | | Weighted- | | | | Weighted- | | | | Weighted- |
| | | Average | | | | Average | | | | Average |
| | | Exercise | | | | Exercise | | | | Exercise |
| Shares | | Price | | Shares | | Price | | Shares | | Price |
Outstanding at beginning | | | | | | | | | | | |
of the year | 434,315 | | $ 18.75 | | 521,475 | | $ 19.12 | | 495,545 | | $ 17.26 |
Granted | 14,500 | | 41.49 | | 0 | | 0.00 | | 64,790 | | 34.21 |
Exercised | 70,200 | | 16.64 | | 81,110 | | 21.09 | | 20,760 | | 23.33 |
Forfeited | 9,000 | | 18.23 | | 6,050 | | 19.68 | | 18,100 | | 17.51 |
Outstanding at end of | | | | | | | | | | | |
the year | 369,615 | | $ 20.05 | | 434,315 | | $ 18.75 | | 521,475 | | $ 19.12 |
| | | | | | | | | | | |
Options exercisable at | | | | | | | | | | | |
end of the year | 182,550 | | $ 17.40 | | 96,300 | | $ 22.02 | | 107,575 | | $ 23.15 |
Weighted-average fair | | | | | | | | | | | |
value of options | | | | | | | | | | | |
granted during the year | | | $ 11.52 | | | | $ 0.00 | | | | $ 11.06 |
Options outstanding at year-end 2005 were as follows:
| Outstanding | | Exercisable |
| | | Weighted- | | | | | | |
| | | Average | | Weighted- | | | | Weighted- |
| | | Remaining | | Average | | | | Average |
| | | Contractual | | Exercise | | | | Exercise |
| Number | | Life | | Price | | Number | | Price |
Range of exercise prices | | | | | | | | | |
$11.20-$14.00 | 162,025 | | 4.8 | | $ 13.58 | | 62,300 | | $ 13.49 |
$14.01-$16.80 | 57,450 | | 4.5 | | 15.07 | | 46,100 | | 14.91 |
$16.81-$22.40 | 29,270 | | 3.1 | | 19.44 | | 29,270 | | 19.44 |
$22.41-$25.20 | 42,180 | | 2.5 | | 23.71 | | 41,180 | | 23.71 |
$25.21-$28.00 | 4,700 | | 3.2 | | 27.79 | | 3,700 | | 28.00 |
$28.01-$35.00 | 59,490 | | 7.9 | | 34.37 | | 0 | | 0.00 |
$35.01-$44.00 | 14,500 | | 9.9 | | 41.49 | | 0 | | 0.00 |
Outstanding at year-end | 369,615 | | 5.1 | | 20.05 | | 182,550 | | 17.40 |
| | | | | | | | | |
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NOTE 17 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS
The Company and Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly discretionary, actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2005 and 2004, that the Company and Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2005, the most recent notification from the federal regulators categorized the Company and Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Company's or Bank’s category.
| | | | | | | | | Minium Required to |
| | | | | Minimum Required | | Be Well Capitalized |
| | | | | For Capital | | Under Prompt Corrective |
| Actual | | Adequacy Purposes | | Action Regulations |
| Amount | | Ratio | | Amount | | Ratio | | Amount | | Ratio |
| (dollars in thousands) |
As of December 31, 2005: | | | | | | | | | | | |
Total Capital (to Risk | | | | | | | | | | | |
Weighted Assets) | | | | | | | | | | | |
Consolidated | $152,669 | | 11.80% | | $103,530 | | 8.00% | | $129,412 | | 10.00% |
Bank | $152,373 | | 11.78% | | $103,511 | | 8.00% | | $129,388 | | 10.00% |
Tier I Capital (to Risk | | | | | | | | | | | |
Weighted Assets) | | | | | | | | | | | |
Consolidated | $139,895 | | 10.81% | | $ 51,765 | | 4.00% | | $ 77,647 | | 6.00% |
Bank | $139,599 | | 10.79% | | $ 51,755 | | 4.00% | | $ 77,633 | | 6.00% |
Tier I Capital (to Average Assets) | | | | | | | | | | | |
Consolidated | $139,895 | | 8.86% | | $ 63,166 | | 4.00% | | $ 78,957 | | 5.00% |
Bank | $139,599 | | 8.83% | | $ 63,261 | | 4.00% | | $ 79,076 | | 5.00% |
As of December 31, 2004: | | | | | | | | | | | |
Total Capital (to Risk | | | | | | | | | | | |
Weighted Assets) | | | | | | | | | | | |
Consolidated | $ 136,315 | | 12.28% | | $ 88,781 | | 8.00% | | $ 110,977 | | 10.00% |
Bank | $ 134,083 | | 12.11% | | $ 88,569 | | 8.00% | | $ 110,712 | | 10.00% |
Tier I Capital (to Risk | | | | | | | | | | | |
Weighted Assets) | | | | | | | | | | | |
Consolidated | $ 125,561 | | 11.31% | | $ 44,391 | | 4.00% | | $ 66,586 | | 6.00% |
Bank | $ 123,329 | | 11.14% | | $ 44,285 | | 4.00% | | $ 66,427 | | 6.00% |
Tier I Capital (to Average Assets) | | | | | | | | | | | |
Consolidated | $ 125,561 | | 9.07% | | $ 55,391 | | 4.00% | | $ 69,239 | | 5.00% |
Bank | $ 123,329 | | 8.92% | | $ 55,289 | | 4.00% | | $ 69,112 | | 5.00% |
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NOTE 17 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS (continued)
The Bank is required to obtain the approval of the Department of Financial Institutions for the payment of any dividend if the total amount of all dividends declared by the Bank during the calendar year, including the proposed dividend, would exceed the sum of the retained net income for the year to date combined with its retained net income for the previous two years. Indiana law defines “retained net income” to mean the net income of a specified period, calculated under the consolidated report of income instructions, less the total amount of all dividends declared for the specified period. As of December 31, 2005, approximately $27.6 million was available to be paid as dividends to the Company by the Bank.
The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2005. Notwithstanding the availability of funds for dividends, however, the FDIC may prohibit the payment of any dividends by the Bank if the FDIC determines such payment would constitute an unsafe or unsound practice.
NOTE 18 – FAIR VALUES OF FINANCIAL INSTRUMENTS
The following table contains the estimated fair values and the related carrying values of the Company’s financial instruments at December 31, 2005 and 2004. Items which are not financial instruments are not included.
| 2005 | | 2004 |
| Carrying | | Estimated | | Carrying | | Estimated |
| Value | | Fair Value | | Value | | Fair Value |
| (in thousands) |
Financial Assets: | | | | | | | |
Cash and cash equivalents | $ 82,679 | | $ 82,679 | | $ 103,858 | | $ 103,858 |
Securities available for sale | 290,935 | | 290,935 | | 286,582 | | 286,582 |
Real estate mortgages held for sale | 960 | | 973 | | 2,991 | | 3,018 |
Loans, net | 1,185,956 | | 1,178,762 | | 992,465 | | 993,496 |
Federal Home Loan Bank stock | 5,054 | | 5,054 | | 4,442 | | 4,442 |
Accrued interest receivable | 7,402 | | 7,402 | | 5,752 | | 5,752 |
Financial Liabilities: | | | | | | | |
Certificates of deposit | (560,070) | | (558,027) | | (434,318) | | (435,233) |
All other deposits | (706,175) | | (706,175) | | (681,081) | | (681,081) |
Securities sold under agreements to repurchase | (91,071) | | (91,071) | | (88,057) | | (88,057) |
Other short-term borrowings | (120,471) | | (120,471) | | (97,593) | | (97,593) |
Long-term borrowings | (46) | | (38) | | (10,046) | | (9,999) |
Subordinated debentures | (30,928) | | (29,857) | | (30,928) | | (29,336) |
Accrued interest payable | (6,215) | | (6,215) | | (3,546) | | (3,546) |
For purposes of the above disclosures of estimated fair value, the following assumptions were used as of December 31, 2005 and 2004. The estimated fair value for cash and cash equivalents, accrued interest and Federal Home Loan Bank stock is considered to approximate cost. Real estate mortgages held for sale are based upon the actual contracted price for those loans sold but not yet delivered, or the current Federal Home Loan Mortgage Corporation price for normal delivery of mortgages with similar coupons and maturities at year-end. The estimated fair value of loans is based on estimates of the rate the Company would charge for similar loans at December 31, 2005 and 2004, applied for the time period until estimated repayment. The estimated fair value for demand and savings deposits is based on their carrying value. The estimated fair value for certificates of deposit and borrowings is based on estimates of the rate the Company would pay on such deposits or borrowings at December 31, 2005 and 2004, applied for the time period until maturity. The estimated fair value of variable rate short-term borrowed funds is considered to approximate carrying value. The estimated fair value of other financial instruments and off-balance sheet loan commitments approximate cost and are not considered significant to this presentation.
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NOTE 18 – FAIR VALUES OF FINANCIAL INSTRUMENTS (continued)
While these estimates of fair value are based on management's judgment of the most appropriate factors, there is no assurance that, were the Company to have disposed of such items at December 31, 2005 and 2004, the estimated fair values would necessarily have been achieved at that date, since market values may differ depending on various circumstances. The estimated fair values at December 31, 2005 and 2004 should not necessarily be considered to apply at subsequent dates.
NOTE 19 - COMMITMENTS, OFF-BALANCE SHEET RISKS AND CONTINGENCIES
During the normal course of business, the Company becomes a party to financial instruments with off-balance sheet risk in order to meet the financing needs of its customers. These financial instruments include commitments to make loans and open-ended revolving lines of credit. Amounts as of December 31, 2005 and 2004, were as follows:
| 2005 | | 2004 |
| Fixed | | Variable | | Fixed | | Variable |
| Rate | | Rate | | Rate | | Rate |
| (in thousands) |
Commercial loan lines of credit | $ 45,636 | | $ 342,861 | | $ 47,139 | | $ 320,711 |
Commercial loan letters of credit | 56 | | 13,838 | | 0 | | 10,190 |
Real estate mortgage loans | 3,930 | | 2,050 | | 4,371 | | 1,214 |
Real estate construction mortgage loans | 4,398 | | 1,315 | | 2,123 | | 1,554 |
Credit card open-ended revolving lines | 0 | | 0 | | 11,136 | | 2,014 |
Home equity mortgage open-ended revolving lines | 0 | | 84,238 | | 0 | | 80,546 |
Consumer loan open-ended revolving lines | 0 | | 4,159 | | 0 | | 4,380 |
Total | $ 54,020 | | $ 448,461 | | $ 64,769 | | $ 420,609 |
| | | | | | | |
The index on variable rate commercial loan commitments is principally the Company’s base rate, which is the national prime rate. Interest rate ranges on commitments and open-ended revolving lines of credit for December 31, 2005 and 2004, were as follows:
| 2005 | | 2004 | |
| Fixed | | Variable | | Fixed | | Variable | |
| Rate | | Rate | | Rate | | Rate | |
| | |
Commercial loan | 2.75-10.99 | % | 3.00-12.25 | % | 2.00-10.75 | % | 3.00-9.50 | % |
Real estate mortgage loan | 5.13-6.75 | % | 5.25-6.88 | % | 4.75-6.13 | % | 5.00-6.25 | % |
Credit card | 0.00 | % | 0.00 | % | 14.95-17.95 | % | 8.25-10.25 | % |
Consumer loan open-ended revolving line | 0.00 | % | 3.75-15.00 | % | 0.00 | % | 5.25-15.00 | % |
Commitments, excluding open-ended revolving lines, generally have fixed expiration dates of one year or less. Open-ended revolving lines are monitored for proper performance and compliance on a monthly basis. Since many commitments expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The Company follows the same credit policy (including requiring collateral, if deemed appropriate) to make such commitments as is followed for those loans that are recorded in its financial statements.
The Company's exposure to credit losses in the event of nonperformance is represented by the contractual amount of the commitments. Management does not expect any significant losses as a result of these commitments.
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NOTE 20 - PARENT COMPANY STATEMENTS
The Company operates primarily in the banking industry, which accounts for substantially all of its revenues, operating income, and assets. Presented below are parent only financial statements:
CONDENSED BALANCE SHEETS | |
| December 31, | |
| 2005 | | 2004 | |
| (in thousands) | |
ASSETS | | | | |
Deposits with Lake City Bank | $ 1,551 | | $ 924 | |
Investments in banking subsidiary | 143,038 | | 129,532 | |
Investments in Lakeland Statutory Trust II | 928 | | 928 | |
Other assets | 240 | | 2,649 | |
Total assets | $ 145,757 | | $ 134,033 | |
| | | | |
LIABILITIES | | | | |
Dividends payable and other liabilities | $ 1,495 | | $ 1,340 | |
Subordinated debt | 30,928 | | 30,928 | |
| | | | |
STOCKHOLDERS' EQUITY | 113,334 | | 101,765 | |
Total liabilities and stockholders' equity | $ 145,757 | | $ 134,033 | |
| | | | |
CONDENSED STATEMENTS OF INCOME |
| Years Ended December 31, |
| 2005 | | 2004 | | 2003 |
| (in thousands) |
Dividends from Lake City Bank, Lakeland Statutory Trust II | | | | | |
and Lakeland Capital Trust | $ 3,332 | | $ 4,080 | | $ 3,980 |
Interest on deposits and repurchase agreements, Lake City Bank | 0 | | 0 | | 1 |
Equity in undistributed income of subsidiaries | 16,053 | | 11,527 | | 11,648 |
Interest expense on subordinated debt | 2,009 | | 1,437 | | 1,725 |
Miscellaneous expense | 338 | | 357 | | 1,264 |
INCOME BEFORE INCOME TAXES | 17,038 | | 13,813 | | 12,640 |
Income tax benefit | 920 | | 732 | | 1,225 |
NET INCOME | $ 17,958 | | $ 14,545 | | $ 13,865 |
| | | | | |
CONDENSED STATEMENTS OF CASH FLOWS | |
| Years ended December 31, | |
| 2005 | | 2004 | | 2003 | |
| (in thousands) | |
Cash flows from operating activities: | | | | | | |
Net income | $ 17,958 | | $ 14,545 | | $ 13,865 | |
Adjustments to net cash from operating activities: | | | | | | |
Equity in undistributed income of subsidiaries | (16,053) | | (11,527) | | (11,648) | |
Other changes | 3,086 | | 305 | | 510 | |
Net cash from operating activities | 4,991 | | 3,323 | | 2,727 | |
Cash flows from investing activities | 0 | | 0 | | (9,779) | |
Cash flows from financing activities | (4,364) | | (3,260) | | 6,470 | |
Net increase in cash and cash equivalents | 627 | | 63 | | (582) | |
Cash and cash equivalents at beginning of the year | 924 | | 861 | | 1,443 | |
Cash and cash equivalents at end of the year | $ 1,551 | | $ 924 | | $ 861 | |
| | | | | | | | | | | | | | |
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NOTE 21 - EARNINGS PER SHARE
Following are the factors used in the earnings per share computations:
| 2005 | | 2004 | | 2003 |
Basic earnings per common share: | | | | | |
Net income | $17,958,000 | | $14,545,000 | | $13,865,000 |
Weighted-average common shares outstanding | 5,963,878 | | 5,867,705 | | 5,819,916 |
Basic earnings per common share | $ 3.01 | | $ 2.48 | | $ 2.38 |
| | | | | |
Diluted earnings per common share: | | | | | |
Net income | $17,958,000 | | $14,545,000 | | $13,865,000 |
Weighted-average common shares outstanding for | | | | | |
basic earnings per common share | 5,963,878 | | 5,867,705 | | 5,819,916 |
Add: Dilutive effect of assumed exercises of stock options | 180,855 | | 196,372 | | 181,533 |
Average shares and dilutive potential common shares | 6,144,733 | | 6,064,077 | | 6,001,449 |
Diluted earnings per common share | $ 2.92 | | $ 2.40 | | $ 2.31 |
| | | | | |
Stock options for 7,500 and 61,490 shares of common stock were not considered in computing diluted earnings per common share for 2005 and 2004 because they were antidilutive.
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NOTE 22 – SELECTED QUARTERLY DATA (UNAUDITED) (in thousands except per share data)
2005 | 4th | | 3rd | | 2nd | | 1st |
| Quarter | | Quarter | | Quarter | | Quarter |
Interest income | $ 22,844 | | $ 20,922 | | $ 19,190 | | $ 17,473 |
Interest expense | 9,657 | | 8,388 | | 6,686 | | 5,622 |
Net interest income | $ 13,187 | | $ 12,534 | | $ 12,504 | | $ 11,851 |
| | | | | | | |
Provision for loan losses | 701 | | 659 | | 662 | | 458 |
Net interest income after provision | $ 12,486 | | $ 11,875 | | $ 11,842 | | $ 11,393 |
| | | | | | | |
Noninterest income | 5,181 | | 4,380 | | 4,218 | | 4,119 |
Noninterest expense | 10,041 | | 9,355 | | 9,298 | | 9,363 |
Income tax expense | 2,649 | | 2,378 | | 2,358 | | 2,094 |
Net income | $ 4,977 | | $ 4,522 | | $ 4,404 | | $ 4,055 |
| | | | | | | |
Basic earnings per common share | $ 0.83 | | $ 0.76 | | $ 0.74 | | $ 0.68 |
Diluted earnings per common share | $ 0.81 | | $ 0.73 | | $ 0.72 | | $ 0.66 |
| | | | | | | |
| | | | | | | |
2004 | 4th | | 3rd | | 2nd | | 1st |
| Quarter | | Quarter | | Quarter | | Quarter |
Interest income | $ 16,364 | | $ 15,103 | | $ 14,236 | | $ 14,302 |
Interest expense | 4,815 | | 4,194 | | 3,857 | | 3,967 |
Net interest income | $ 11,549 | | $ 10,909 | | $ 10,379 | | $ 10,335 |
| | | | | | | |
Provision for loan losses | 575 | | 150 | | 246 | | 252 |
Net interest income after provision | $ 10,974 | | $ 10,759 | | $ 10,133 | | $ 10,083 |
| | | | | | | |
Noninterest income | 4,044 | | 4,436 | | 4,045 | | 4,033 |
Noninterest expense | 9,356 | | 9,201 | | 9,195 | | 8,908 |
Income tax expense | 1,914 | | 2,043 | | 1,639 | | 1,706 |
Net income | $ 3,748 | | $ 3,951 | | $ 3,344 | | $ 3,502 |
| | | | | | | |
Basic earnings per common share | $ 0.64 | | $ 0.67 | | $ 0.57 | | $ 0.60 |
Diluted earnings per common share | $ 0.62 | | $ 0.65 | | $ 0.55 | | $ 0.58 |
| | | | | | | |
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON FINANCIAL STATEMENTS
Stockholders and Board of Directors
Lakeland Financial Corporation
Warsaw, Indiana
We have audited the accompanying consolidated balance sheets of Lakeland Financial Corporation (“Company”) and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these 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 Financial Corporation and subsidiaries as of December 31, 2005 and 2004 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with U.S. generally accepted accounting principles.
We also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Lakeland Financial Corporation’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 9, 2006 expressed an unqualified opinion thereon.
Crowe Chizek and Company LLC
South Bend, Indiana
February 9, 2006
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9a. CONTROLS AND PROCEDURES
a) An evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rules 13a -15(e) and 15d-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of December 31, 2005. Based on that evaluation, the Company's management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company's disclosure controls and procedures were effective.
b) | MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING |
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities and Exchange Act of 1934. The Company’s internal control over financial reporting is 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.
The Company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) 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 (iii) 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. Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment and those criteria, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2005.
The Company’s independent registered public accounting firm has issued their report on management’s assessment of the Company’s internal control over financial reporting. That report follows under the heading, Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting.
c) There have been no changes in the Company's internal controls during the previous fiscal quarter, ended December 31, 2005 that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Stockholders and Board of Directors
Lakeland Financial Corporation
Warsaw, Indiana
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Lakeland Financial Corporation (the “Company”) maintained effective internal control over financial reporting as of December 31, 2005, based on Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Lakeland Financial Corporation’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. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of 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, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, 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, management’s assessment that Lakeland Financial Corporation maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, Lakeland Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Lakeland Financial Corporation as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005 and our report dated February 9, 2006 expressed an unqualified opinion on those consolidated financial statements.
Crowe Chizek and Company LLC
South Bend, Indiana
February 9, 2006
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ITEM 9b. OTHER INFORMATION
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information appearing in the definitive Proxy Statement, dated as of March 6, 2006, is incorporated herein by reference in response to this item.
ITEM 11. EXECUTIVE COMPENSATION
The information appearing in the definitive Proxy Statement, dated as of March 6, 2006, is incorporated herein by reference in response to this item.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHARELHOLDER MATTERS
The information appearing in the definitive Proxy Statement, dated as of March 6, 2006, is incorporated herein by reference in response to this item.
Equity Compensation Plan Information
The table below sets forth the following information as of December 31, 2005 for (i) all compensation plans previously approved by the Company’s shareholders and (ii) all compensation plans not previously approved by the Company’s shareholders:
| (a) | | the number of securities to be issued upon the exercise of outstanding options, warrants and rights; |
| (b) | | the weighted-average exercise price of such outstanding options, warrants and rights; |
| | | |
| (c) | | other than securities to be issued upon the exercise of such outstanding options, warrants and rights, the |
| | | number of securities remaining available for future issuance under the plans. |
EQUITY COMPENSATION PLAN INFORMATION |
Plan category
| Number of securities to be issued upon exercise of outstanding options | Weighted-average exercise price of outstanding options | Number of securities remaining available for future issuance |
Equity compensation plans approved by security holders(1) | 369,615 | $20.05 | 58,315 |
Equity compensation plans not approved by security holders | 0 | $ 0.00 | 0 |
Total | 369,615 | $20.05 | 58,315 |
(1) Lakeland Financial Corporation 1997 Share Incentive Plan adopted on April 14, 1998 by the Board of Directors.
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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information appearing in the definitive Proxy Statement, dated as of March 6, 2006, is incorporated herein by reference in response to this item.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information appearing in the definitive proxy statement, dated as of March 6, 2006, is incorporated herein by reference in response to this item.
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PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The documents listed below are filed as a part of this report:
Exhibit No. | Document | Incorporated by reference to |
| | |
3.1 | Amended and Restated Articles | Exhibit 4.1 to the Company’s |
| of Incorporation of Lakeland | Form S-8 filed with the |
| Financial Corporation | Commission on April 15, 1998 |
| | |
3.2 | Bylaws of Lakeland | Exhibit 3(ii) to the Company’s |
| Financial Corporation | Form 10-Q for the quarter |
| | ended June 30, 1996 |
| | |
4.1 | Form of Common Stock Certificate | Exhibit 4.1 to the Company’s |
| | Form 10-K for the fiscal year ended |
| | December 31, 2003 |
| | |
10.1 | Lakeland Financial | Exhibit 4.3 to the Company’s |
| Corporation 1997 Share | Form S-8 filed with the |
| Incentive Plan | Commission on April 15, 1998 |
| | |
10.2 | Form of Indenture for Trust Preferred Issuance | Exhibit 4.1 to the Company’s Form 10-K for the fiscal year ended |
| | December 31, 2003 |
| | |
10.3 | Lakeland Financial Corporation 401(k) Plan | Exhibit 10.1 to the Company’s Form S-8 filed with the Commission on October 23, 2000 |
| | |
10.4 | Amended and Restated Lakeland Financial Corporation Director’s Fee Deferral Plan | Exhibit 10.5 to the Company’s Form 10-K for the fiscal year ended December 31, 2002 |
| | |
10.5 | Form of Change of Control Agreement entered into with David M. Findlay and Kevin L. Deardorff | Exhibit 10.5 to the Company’s Form 10-K for the fiscal year ended December 31, 2001 |
| | |
10.6 | Form of Change in Control Agreement entered into with Michael L. Kubacki, Charles D. Smith and Robert C. Condon | Exhibit 10.3 to the Company’s Form 10-K for the fiscal year ended December 31, 2000 |
| | |
10.7 | Employee Deferred Compensation Plan and Form of Agreement | Exhibit 10.8 to the Company’s Form 10-K for the fiscal year ended December 31, 2004 |
| | |
10.8 | Schedule of Board Fees | Attached hereto |
| | |
10.9 | Form of Option Grant Agreement | Exhibit 10.10 to the Company’s Form 10-K for the fiscal year ended December 31, 2004 |
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| | |
10.10 | Executive Incentive Bonus Plan | Exhibit 10.11 to the Company’s Form 10-K for the fiscal year ended December 31, 2004 |
| | |
21.0 | Subsidiaries | Attached hereto |
| | |
23.1 | Consent of Independent Registered Public Accounting Firm | Attached hereto |
| | |
31.1 | Certification of Chief Executive Officer Pursuant to Rule 13a-15(e)/15d-15(e) and 13(a)-15(f)/15d-15(f) | Attached hereto |
| | |
31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-15(e)/15d-15(e) and 13(a)-15(f)/15d-15(f) | Attached hereto |
| | |
32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | Attached hereto |
| | |
32.2 | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | Attached hereto |
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SIGNATURES
Pursuant to the requirements of Section 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
LAKELAND FINANCIAL CORPORATION |
Date: March 1, 2006 | By | /s/Michael L. Kubacki | |
| Michael L. Kubacki, Chairman |
| | | | |
Pursuant to the requirements of the Securities and 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/Michael L. Kubacki | |
Michael L. Kubacki | Principal Executive Officer and Director | March 1, 2006 |
| | | |
/s/David M. Findlay | |
David M. Findlay | Principal Financial Officer | March 1, 2006 |
| | | |
/s/Teresa A. Bartman | |
Teresa A. Bartman | Principal Accounting Officer | March 1, 2006 |
| | | |
/s/Robert E. Bartels, Jr. | |
Robert E. Bartels, Jr | Director | March 1, 2006 |
| | | |
L. Craig Fulmer | Director | March 1, 2006 |
/s/George B. Huber | |
George B. Huber | Director | March 1, 2006 |
| | | |
/s/Allan J. Ludwig | |
Allan J. Ludwig | Director | March 1, 2006 |
| | | |
/s/Charles E. Niemier | |
Charles E. Niemier | Director | March 1, 2006 |
| | | |
/s/Emily E. Pichon | |
Emily E. Pichon | Director | March 1, 2006 |
| | | |
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/s/Richard L. Pletcher | |
Richard L. Pletcher | Director | March 1, 2006 |
| | | |
/s/Steven D. Ross | |
Steven D. Ross | Director | March 1, 2006 |
| | | |
/s/Donald B. Steininger | |
Donald B. Steininger | Director | March 1, 2006 |
| | | |
/s/Terry L. Tucker | |
Terry L. Tucker | Director | March 1, 2006 |
| | | |
/s/M. Scott Welch | |
M. Scott Welch | Director | March 1, 2006 |
| | | |
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Exhibit 21
Subsidiaries
1. | Lake City Bank, Warsaw, Indiana, a banking corporation organized under the laws of the State of Indiana. |
2. | Lakeland Statutory Trust II, a statutory business trust formed under Connecticut law. |
3. | LCB Investments Limited, a subsidiary of Lake City Bank formed under the laws of Bermuda to manage a portion of the Bank’s investment portfolio. |
