UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
FOR THE FISCAL YEAR ENDED December 31 , 2020
OR
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
FOR THE TRANSITION PERIOD FROM TO
Commission file number: 000-17820
(Exact name of registrant as specified in its charter)
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||||
(Address of principal executive offices and zip code)
(973 ) 697-2000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class | Trading Symbol | Name of exchange on which registered | ||||||||||||
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer ☐ Accelerated filer ☒ Non-accelerated filer ☐ Smaller reporting company ☐ Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of June 30, 2020, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $553,577,000 , based on the closing sale price as reported on the NASDAQ Global Select Market.
The number of shares outstanding of the registrant’s common stock, as of February 26, 2021, was 50,501,019 .
DOCUMENTS INCORPORATED BY REFERENCE:
LAKELAND BANCORP, INC.
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PART I
ITEM 1 - Business.
GENERAL
Lakeland Bancorp, Inc. (the “Company” or “Lakeland Bancorp”) is a bank holding company headquartered in Oak Ridge, New Jersey. The Company was organized in March 1989 and commenced operations on May 19, 1989, upon the consummation of the acquisition of all of the outstanding stock of Lakeland Bank, formerly named Lakeland State Bank (“Lakeland” or the “Bank” or “Lakeland Bank”). Lakeland currently operates 48 branch offices located throughout Bergen, Essex, Morris, Ocean, Passaic, Somerset, Sussex, and Union counties in New Jersey and in Highland Mills, New York; six New Jersey regional commercial lending centers strategically located in our market area and one New York commercial lending center to serve the Hudson Valley region. Lakeland offers an extensive suite of financial products and services for businesses and consumers.
The Company has grown through a combination of organic growth and acquisitions. Since 1998, the Company has acquired eight community banks with an aggregate asset total of approximately $2.28 billion, including its most recent acquisition of Highlands State Bank and its parent, Highlands Bancorp, Inc. ("Highlands Bancorp"), which was completed on January 4, 2019. All of the acquired banks have been merged into Lakeland and the acquired holding companies, if applicable, have been merged into the Company.
At December 31, 2020, Lakeland Bancorp had total consolidated assets of $7.66 billion, total consolidated deposits of $6.46 billion, total consolidated loans, net of the allowance for credit losses on loans, of $5.95 billion and total consolidated stockholders’ equity of $763.8 million.
This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (“Forward-Looking Statements”). Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in such Forward-Looking Statements. Certain factors which could materially affect such results and the future performance of the Company are described in Item 1A - Risk Factors of this Annual Report on Form 10-K.
Commercial Bank Services
Through Lakeland, the Company offers a broad range of lending, depository, and related financial services to individuals and small to medium sized businesses located primarily in northern and central New Jersey, the Hudson Valley region in New York and surrounding areas. In the lending area, these services include commercial real estate loans, commercial and industrial loans, short and medium term loans, lines of credit, letters of credit, inventory and accounts receivable financing, real estate construction loans, mortgage loans, Small Business Administration (“SBA”) loans and merchant credit card services. The Company participated in the SBA's Paycheck Protection Program ("PPP") beginning in April 2020. Through Lakeland’s equipment finance division, the Company provides a financing solution to small and medium-sized companies that prefer to lease equipment over other financial alternatives. Lakeland’s asset-based loan department provides commercial borrowers with another lending alternative.
Depository products include demand deposits, as well as savings, money market and time accounts. Lakeland offers internet banking, mobile banking, wire transfer and night depository services to the business community and municipal relationships. In addition, Lakeland offers cash management services, such as remote capture of deposits and overnight sweep repurchase agreements.
Consumer Banking
Lakeland also offers a broad range of consumer banking services, including checking accounts, savings accounts, interest-bearing checking accounts, money market accounts, certificates of deposit, internet banking, secured and unsecured loans, consumer installment loans, mortgage loans, and safe deposit services.
Other Services
Investment advisory services for individuals and businesses are also available. Additionally, the Bank provides commercial title insurance services through Lakeland Title Group LLC and life insurance products through Lakeland Financial Services Agency, Inc.
Competition
Lakeland faces intense competition in its market areas for deposits and loans from other depository institutions. Many of Lakeland’s depository institution competitors have substantially greater resources, broader geographic markets, and higher lending limits than Lakeland and are also able to provide more services and make greater use of media advertising. In recent years, intense market demands, economic pressures, increased customer awareness of products and services and the availability of electronic services have forced banking institutions to diversify their services and become more cost-effective.
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Lakeland also competes with credit unions, brokerage firms, insurance companies, money market mutual funds, consumer finance companies, mortgage companies, fintechs and other financial companies, some of which are not subject to the same degree of regulation and restrictions as Lakeland in attracting deposits and making loans. Interest rates on deposit accounts, convenience of facilities, products and services, and marketing are all significant factors in the competition for deposits. Competition for loans comes from other commercial banks, savings institutions, insurance companies, consumer finance companies, credit unions, mortgage banking firms, financial technology and other institutional lenders. Lakeland primarily competes for loan originations through its structuring of loan transactions and the overall quality of service it provides. Competition is affected by the availability of lendable funds, general and local economic conditions, interest rates, and other factors that are not readily predictable. The Company expects that competition will continue or intensify in the future.
Concentration
The Company is not dependent on deposits or exposed by loan concentrations to a single customer or a few customers, the loss of any one or more of which would have a material adverse effect upon the financial condition of the Company.
Human Capital Resources
At December 31, 2020, the Company employed 711 associates, including 45 part-time associates, of which approximately 68% are women. At December 31, 2019, the company employed 716 associates, including 52 part-time associates. As a financial institution, approximately 53% of our associates are located at branch or loan production offices and the remainder are located at our administrative offices. The success of our business is highly dependent on our associates, who are dedicated to our mission to deliver superior customer service that exceeds customer expectations by understanding and anticipating their financial needs. We seek to hire well-qualified associates to sustain and build on our culture of service and performance. Our selection and promotion processes are without bias and include the active recruitment of minorities and women. None of our associates are covered by a collective bargaining agreement.
We encourage the growth and development of our associates and, whenever possible, seek to fill positions by promotion and transfer from within the Company. Continual learning and career development is advanced through annual performance and development conversations between associates and their managers, internally developed training programs, customized corporate training engagements and educational reimbursement programs. Our Leader Engagement and Development (LEAD) Program was launched in 2018 to foster leadership abilities and cultivate effective management approaches. To date, 36 associates have completed the program and 15 are currently participating in the program. Reimbursement is available to associates enrolled in pre-approved degree or certification programs at accredited institutions that teach skills or knowledge relevant to our business, in compliance with Section 127 of the Internal Revenue Code, and for seminars, conferences and other training events associates attend in connection with their job duties or professional certification requirements.
The safety, health and wellness of our associates is a top priority. The COVID-19 pandemic presented unique challenges with regard to maintaining associate safety while continuing successful operations. We instituted remote working plans in March 2020 and were able to transition, over a short period of time, 63% of our associates to effectively working from remote locations. We ensured a safely-distanced working environment for associates performing customer-facing activities at branches and operations centers, closing branch lobbies as necessary. All associates are prohibited from working on-site when they, or a close family member, experience symptoms of a possible COVID-19 illness and generally used their paid time off to cover compensation during such absences. On an ongoing basis, we further promote the health and wellness of our associates by strongly encouraging work-life balance, offering flexible work schedules, keeping the associate portion of health care premiums to a minimum and sponsoring various wellness programs, whereby associates are encouraged to incorporate healthy habits into their daily routines.
In April 2020, we appointed our first Chief Diversity Officer, with a mandate to focus on workforce diversity, vendor/supplier diversity and cultivating more diverse leadership, among other vital issues. We sponsored Share Your Voice “listening” roundtables for associates, with the assistance of outside experts. A Diversity Task Force was created to give associates more opportunity for input into relevant issues. We provided associates with access to information and assistance on topics ranging from diversity to wellness, parenting and other personal issues and concerns.
Associate retention helps us operate efficiently and achieve our business objectives. We provide competitive wages, annual bonuses, stock awards, a 401(k) Plan with an employer matching contribution in addition to a discretionary employer annual contribution, healthcare and insurance benefits, health savings, flexible spending accounts, paid time off, family leave and an employee assistance program. At December 31, 2020, approximately 30% of our current staff had been with us for 10 years or more.
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SUPERVISION AND REGULATION
General
The Company is a registered bank holding company under the Federal Bank Holding Company Act of 1956, as amended (the “Holding Company Act”), and is required to file with the Federal Reserve Board an annual report and such additional information as the Federal Reserve Board may require pursuant to the Holding Company Act. The Company has also elected financial holding company status under the Modernization Act, as further discussed below. The Company is subject to examination by the Federal Reserve Board.
Lakeland is a state chartered commercial bank subject to supervision and examination by the Department of Banking and Insurance of the State of New Jersey (the “Department”) and the Federal Deposit Insurance Corporation (the “FDIC”). The regulations of the State of New Jersey and FDIC govern most aspects of Lakeland’s business, including reserves against deposits, loans, investments, mergers and acquisitions, borrowings, dividends, and location of branch offices. Lakeland is subject to certain restrictions imposed by law on, among other things, (i) the maximum amount of obligations of any one person or entity which may be outstanding at any one time, (ii) investments in stock or other securities of the Company or any subsidiary of the Company, and (iii) the taking of such stock or securities as collateral for loans to any borrower.
The Holding Company Act
The Holding Company Act limits the activities which may be engaged in by the Company and its subsidiaries to those of banking, the ownership and acquisition of assets and securities of banking organizations, and the management of banking organizations, and to certain non-banking activities which the Federal Reserve Board finds, by order or regulation, to be so closely related to banking or managing or controlling a bank as to be a proper incident thereto.
With respect to non-banking activities, the Federal Reserve Board has by regulation determined that several non-banking activities are closely related to banking within the meaning of the Holding Company Act and thus may be performed by bank holding companies. The Company has also elected "financial holding company" status, which allows it to engage in a broader array of financial activities than a standard bank holding company. Although the Company’s management periodically reviews other avenues of business opportunities that are included in that regulation, the Company has no present plans to engage in any of these activities other than providing investment brokerage services.
With respect to the acquisition of banking organizations, the Company is required to obtain the prior approval of the Federal Reserve Board before it may, by merger, purchase or otherwise, directly or indirectly acquire all or substantially all of the assets of any bank or bank holding company, if, after such acquisition, it will own or control more than 5% of the voting shares of such bank or bank holding company.
Regulation of Bank Subsidiaries
There are various legal limitations, including Sections 23A and 23B of the Federal Reserve Act, which govern the extent to which a bank subsidiary may finance or otherwise supply funds to its holding company or its holding company’s non-bank subsidiaries. Under federal law, no bank subsidiary may, subject to certain limited exceptions, make loans or extensions of credit to, or investments in the securities of, its parent or the non-bank subsidiaries of its parent (other than direct subsidiaries of such bank which are not financial subsidiaries) or take their securities as collateral for loans to any borrower. Each bank subsidiary is also subject to collateral security requirements for any loans or extensions of credit permitted by such exceptions.
Commitments to Affiliated Institutions
Federal law and Federal Reserve Board policy provides that a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to commit resources to support such subsidiary banks in circumstances in which it might not do so absent such policy.
Interstate Banking
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 permits bank holding companies to acquire banks in states other than their home state, regardless of applicable state law. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) removes the restrictions on interstate branching contained in the Riegle-Neal Act, and allows national banks and state banks to establish branches in any state if, under the laws of the state in which the branch is to be located, a state bank chartered by that state would be permitted to establish the branch.
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Gramm-Leach-Bliley Act of 1999
The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 (the “Modernization Act”) became effective in early 2000. The Modernization Act:
•allows bank holding companies meeting management, capital, and Community Reinvestment Act standards to engage in a substantially broader range of non-banking activities than previously was permissible, including insurance underwriting and making merchant banking investments in commercial and financial companies; if a bank holding company elects to become a financial holding company, it files a certification, effective in 30 days, and thereafter may engage in certain financial activities without further approvals (Lakeland Bancorp is such a financial holding company);
•allows insurers and other financial services companies to acquire banks;
•removes various restrictions that previously applied to bank holding company ownership of securities firms and mutual fund advisory companies; and
•establishes the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations.
The Modernization Act also modified other financial laws, including laws related to financial privacy and community reinvestment.
The USA PATRIOT Act
As part of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, Congress adopted the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (collectively, the “USA PATRIOT Act”). By way of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT Act encourages information sharing among bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes the following requirements with respect to financial institutions:
•All financial institutions must establish anti-money laundering programs that include, at a minimum: (i) internal policies, procedures, and controls; (ii) specific designation of an anti-money laundering compliance officer; (iii) ongoing employee training programs; and (iv) an independent audit function to test the anti-money laundering program.
•The Secretary of the Department of the Treasury, in conjunction with other bank regulators, was authorized to issue regulations that provide for minimum standards with respect to customer identification at the time new accounts are opened.
•Financial institutions that establish, maintain, administer, or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) are required to establish appropriate, specific and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering.
•Financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and will be subject to certain record keeping obligations with respect to correspondent accounts of foreign banks.
•Bank regulators are directed to consider a holding company’s effectiveness in combating money laundering when ruling on Federal Reserve Act and Bank Merger Act applications.
The United States Treasury Department has issued a number of implementing regulations which address various requirements of the USA PATRIOT Act and are applicable to financial institutions such as Lakeland. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. Banking agencies have strictly enforced various anti-money laundering and suspicious activity reporting requirements using formal and informal enforcement tools to cause banks to comply with these provisions.
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Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 (the “SOA”) imposes a variety of corporate governance, accounting and corporate reporting obligations upon public companies, designed in general to promote corporate responsibility and to protect investors.
The SOA addresses, among other matters:
• audit committees for all reporting companies;
• certification of financial statements by the chief executive officer and the chief financial officer;
• the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;
• a prohibition on insider trading during pension plan blackout periods;
• disclosure of off-balance sheet transactions;
• a prohibition on personal loans to directors and officers (other than loans made by an insured depository institution (as defined in the Federal Deposit Insurance Act), if the loan is subject to the insider lending restrictions of Section 22(h) of the Federal Reserve Act);
• expedited filing requirements for Form 4’s;
• disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code;
• “real time” filing of periodic reports;
• the formation of a public accounting oversight board;
• auditor independence; and
• various increased criminal penalties for violations of the securities laws.
The Securities and Exchange Commission (the “SEC”) has enacted various rules to implement various provisions of the SOA with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act. Each of the national stock exchanges, including the NASDAQ Stock Market where Lakeland Bancorp’s common stock is listed, have corporate governance listing standards, including rules strengthening director independence requirements for boards, and requiring the adoption of charters for the nominating and corporate governance, compensation and audit committees.
Regulation W
Transactions between a bank and its “affiliates” are quantitatively and qualitatively restricted under the Federal Reserve Act. The Federal Deposit Insurance Act applies Sections 23A and 23B to insured nonmember banks in the same manner and to the same extent as if they were members of the Federal Reserve System. The Federal Reserve Board has also issued Regulation W, which codifies prior regulations under Sections 23A and 23B of the Federal Reserve Act and interpretative guidance with respect to affiliate transactions. Affiliates of a bank include, among other entities, the bank’s holding company and companies that are under common control with the bank. The Company is considered to be an affiliate of Lakeland. In general, subject to certain specified exemptions, a bank or its subsidiaries are limited in their ability to engage in “covered transactions” with affiliates:
• to an amount equal to 10% of the bank’s capital and surplus, in the case of covered transactions with any one affiliate; and
• to an amount equal to 20% of the bank’s capital and surplus, in the case of covered transactions with all affiliates.
In addition, a bank and its subsidiaries may engage in covered transactions and other specified transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the bank or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A “covered transaction” includes:
• a loan or extension of credit to an affiliate;
• a purchase of, or an investment in, securities issued by an affiliate;
• a purchase of assets from an affiliate, with some exceptions;
• the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; and
• the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.
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In addition, under Regulation W:
• a bank and its subsidiaries may not purchase a low-quality asset from an affiliate;
• covered transactions and other specified transactions between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices; and
• with some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by certain types of collateral with a market value ranging from 100% to 130%, depending on the type of collateral, of the amount of the loan or extension of credit.
Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates or if the subsidiary is a "financial subsidiary" that engages in an activity that is not permitted for the bank directly.
Community Reinvestment Act
Under the Community Reinvestment Act (“CRA”), as implemented by FDIC regulations, a state bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community. The CRA requires the FDIC, in connection with its examination of a state non-member bank, to assess the bank’s record of meeting the credit needs of its community and to take that record into account in its evaluation of certain applications by the bank. Under the FDIC’s CRA evaluation system, the FDIC focuses on three tests: (i) a lending test, to evaluate the institution’s record of making loans in its service areas; (ii) an investment test, to evaluate the institution’s record of investing in community development projects, affordable housing and programs benefiting low or moderate income individuals and businesses; and (iii) a service test, to evaluate the institution’s delivery of services through its branches, ATMs and other offices. Receipt of a "Needs to Improve" or "Substantial Noncompliance" ratings can, among other things, obstruct regulatory approval for new branches and mergers. The CRA requires all institutions to make public disclosure of their CRA ratings. Lakeland Bank received an “Outstanding” CRA rating in its most recent examination.
Securities and Exchange Commission
The common stock of the Company is registered with the SEC under the Exchange Act. As a result, the Company and its officers, directors, and major stockholders are obligated to file certain reports with the SEC. The Company is subject to proxy and tender offer rules promulgated pursuant to the Exchange Act. The SEC maintains a website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, such as the Company.
The Company maintains a website at http://www.lakelandbank.com. The Company makes available on its website, free of charge, the proxy statements and reports on Forms 8-K, 10-K and 10-Q that it files with the SEC as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. Additionally, the Company has adopted and posted on its website a Code of Ethics that applies to its principal executive officer, principal financial officer and principal accounting officer. The Company intends to disclose any amendments to or waivers of the Code of Ethics on its website.
Effect of Government Monetary Policies
The earnings of the Company are and will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The monetary policies of the Federal Reserve Board have had, and will likely continue to have, an important impact on the operating results of commercial banks through the Board’s power to implement national monetary policy in order to, among other things, curb inflation or combat a recession. The Federal Reserve Board has a major effect upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of, among other things, the discount rate of borrowings of banks and the reserve requirements against bank deposits. It is not possible to predict the nature and impact of future changes in monetary fiscal policies.
Dividend Restrictions
The Company is a legal entity separate and distinct from Lakeland. Virtually all of the revenue of the Company available for payment of dividends on its capital stock will result from amounts paid to the Company by Lakeland. All such dividends are subject to various limitations imposed by federal and state laws and by regulations and policies adopted by federal and state regulatory agencies. Under New Jersey state law, a bank may not pay dividends unless, following the dividend payment, the capital stock of the bank would be unimpaired and either (a) the bank will have a surplus of not less than 50% of its capital stock, or, if not, (b) the payment of the dividend will not reduce the surplus of the bank.
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If, in the opinion of the FDIC, a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which could include the payment of dividends), the FDIC may require that such bank cease and desist from such practice or, as a result of an unrelated practice, require the bank to limit dividends in the future. The Federal Reserve Board has similar authority with respect to bank holding companies. In addition, the Federal Reserve Board and the FDIC have issued policy statements which provide that insured banks and bank holding companies should generally only pay dividends out of current operating earnings. Regulatory pressures to reclassify and charge off loans and to establish additional loan loss reserves can have the effect of reducing current operating earnings and thus impacting an institution’s ability to pay dividends. Further, as described herein, the regulatory authorities have established guidelines with respect to the maintenance of appropriate levels of capital by a bank or bank holding company under their jurisdiction. Compliance with the standards set forth in these policy statements and guidelines could limit the amount of dividends which the Company and Lakeland may pay. Banking institutions that fail to maintain the minimum capital ratios, or that maintain the requisite minimum capital ratios but do so at a level below the minimum capital ratios plus the applicable capital conservation buffer, will face constraints on their ability to pay dividends. See “Capital Requirements” below.
Capital Requirements
Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), each federal banking agency has promulgated regulations, specifying the levels at which a financial institution would be considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” and to take certain mandatory and discretionary supervisory actions based on the capital level of the institution. To qualify to engage in activities as a financial holding company under the Gramm-Leach-Bliley Act, all depository institutions must be “well capitalized.” The financial holding company of a bank will be put under directives to raise its capital levels or divest its activities if the depository institution falls from that level.
In July 2013, the Federal Reserve Board, the FDIC and the Comptroller of the Currency adopted final rules establishing a new comprehensive capital framework for U.S. banking organizations (the “Basel Rules”). The Basel Rules implemented the Basel Committee’s December 2010 framework, commonly referred to as Basel III, for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act, as discussed below. The Basel Rules substantially revised the risk-based capital requirements applicable to bank holding companies and depository institutions, including the Company and Lakeland, compared to prior U.S. risk-based capital rules. The Basel Rules define the components of capital and address other issues affecting the numerator in banking institutions’ regulatory capital ratios. The Basel Rules also address risk weights and other issues affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing risk-weighting approach, which was derived from Basel I capital accords of the Basel Committee, with a more risk-sensitive approach based, in part, on the standardized approach in the Basel Committee’s 2004 Basel II capital accords. The Basel Rules also implement the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies’ rules.
The Basel Rules became effective for us on January 1, 2015 (subject to phase-in periods for certain components).
For bank holding companies and banks like the Company and Lakeland, January 1, 2015 was the start date for compliance with the revised minimum regulatory capital ratios and for determining risk-weighted assets under what the Basel Rules call a “standardized approach.” As of January 1, 2015, the Company and Lakeland were required to maintain the following minimum capital ratios, expressed as a percentage of risk-weighted assets:
•Common Equity Tier 1 Capital Ratio of 4.5% (this is referred to as the “CET1”);
•Tier 1 Capital Ratio (CET1 capital plus “Additional Tier 1 capital”) of 6.0%; and
•Total Capital Ratio (Tier 1 capital plus Tier 2 capital) of 8.0%.
In addition, the Company and Lakeland are subject to a leverage ratio requirement of 4.0% (calculated as Tier 1 capital to average consolidated assets as reported on the consolidated financial statements).
The Basel Rules also require a “capital conservation buffer.” As of the full phase-in on January 1, 2019, the Company and Lakeland were required to maintain a 2.5% capital conservation buffer, in addition to the minimum capital ratios described above, effectively resulting in the following minimum capital ratios on January 1, 2019:
•CET1 of 7.0%;
•Tier 1 Capital Ratio of 8.5%; and
•Total Capital Ratio of 10.5%.
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The purpose of the capital conservation buffer is to ensure that banking organizations conserve capital when it is needed most, allowing them to weather periods of economic stress. Banking institutions with a CET1, Tier 1 Capital Ratio and Total Capital Ratio above the minimum capital ratios but below the minimum capital ratios plus the capital conservation buffer will face constraints on their ability to pay dividends, repurchase equity and pay discretionary bonuses to executive officers, based on the amount of the shortfall.
The Basel Rules provide for several deductions from and adjustments to CET1, which were phased in as of January 1, 2018. For example, mortgage servicing rights and deferred tax assets dependent upon future taxable income were required to be deducted from CET1 to the extent that any one of those categories exceeds 10% of CET1 or all such categories in the aggregate exceeded 15% of CET1. However, subsequent regulatory amendments raised the limit on mortgage servicing rights and deferred tax assets to 25% of CETI and removed the aggregate limit.
Under prior capital standards, the effects of accumulated other comprehensive income items included in capital were excluded for the purposes of determining regulatory capital ratios. Under the Basel Rules, the effects of certain accumulated other comprehensive income items are not excluded; however, banking organizations such as the Company and Lakeland were permitted to make a one-time permanent election to continue to exclude these items effective as of January 1, 2015. Lakeland Bancorp and Lakeland Bank made such an election to continue to exclude these items.
While the Basel Rules generally require the phase-out of non-qualifying capital instruments such as trust preferred securities and cumulative perpetual preferred stock, holding companies with less than $15 billion in total consolidated assets as of December 31, 2009, such as the Company, were permitted to permanently include non-qualifying instruments that were issued and included in Tier 1 or Tier 2 capital prior to May 19, 2010 in Additional Tier 1 or Tier 2 capital until they redeem such instruments or until the instruments mature.
The Basel Rules prescribe a standardized approach for calculating risk-weighted assets that expands the risk-weighting categories from the previous four categories (0%, 20%, 50% and 100%) to a much larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. Government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset categories. In addition, the Basel Rules provide more advantageous risk weights for derivatives and repurchase-style transactions cleared through a qualifying central counterparty and increase the scope of eligible guarantors and eligible collateral for purposes of credit risk mitigation.
Consistent with the Dodd-Frank Act, the Basel Rules adopt alternatives to credit ratings for calculating the risk-weighting for certain assets.
With respect to Lakeland, the Basel Rules revise the “prompt corrective action” regulations under Section 38 of the Federal Deposit Insurance Act by (i) introducing a CET1 ratio requirement at each capital quality level (other than critically undercapitalized), with the required CET1 ratio being 6.5% for well-capitalized status (a new standard); (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum Tier 1 capital ratio for well-capitalized status being 8% (increased from 6%); and (iii) requiring a leverage ratio of 5% to be well-capitalized (increased from the previously required leverage ratio of 3% or 4%). The Basel Rules do not change the total risk-based capital requirement for any “prompt corrective action” category.
Effective as of January 1, 2015, the FDIC’s regulations implementing these provisions of FDICIA provide that an institution will be classified as “well capitalized” if it (i) has a total risk-based capital ratio of at least 10.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 8.0 percent, (iii) has a CET1 ratio of at least 6.5 percent, (iv) has a Tier 1 leverage ratio of at least 5.0 percent, and (v) meets certain other requirements. An institution will be classified as “adequately capitalized” if it (i) has a total risk-based capital ratio of at least 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 6.0 percent, (iii) has a CET1 ratio of at least 4.5 percent, (iv) has a Tier 1 leverage ratio of at least 4.0 percent, and (v) does not meet the definition of “well capitalized.” An institution will be classified as “undercapitalized” if it (i) has a total risk-based capital ratio of less than 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 6.0 percent, (iii) has a CET1 ratio of less than 4.5 percent or (iv) has a Tier 1 leverage ratio of less than 4.0 percent. An institution will be classified as “significantly undercapitalized” if it (i) has a total risk-based capital ratio of less than 6.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 4.0 percent, (iii) has a CET1 ratio of less than 3.0 percent or (iv) has a Tier 1 leverage ratio of less than 3.0 percent. An institution will be classified as “critically undercapitalized” if it has a tangible equity to total assets ratio that is equal to or less than 2.0 percent. An insured depository institution may be deemed to be in a lower capitalization category if it receives an unsatisfactory examination rating.
As of December 31, 2020, the Company and Lakeland met all capital requirements under the Basel Rules as then in effect, including the fully phased-in capital conservation buffer requirement. The Bank was classified as "well capitalized" on that date.
The Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”) was signed into law in May 2018. The EGRRCPA, among other matters, amended the Federal Deposit Insurance Act to require federal banking agencies to develop a specified Community Bank Leverage Ratio (the ratio of a bank's Tier 1 capital to its average total consolidated assets)
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for banks with assets of less than $10 billion. Qualifying participating banks that exceed this ratio shall be deemed to comply with all other capital and leverage requirements. In September 2019, the FDIC approved a final rule allowing community banks with a leverage capital ratio of at least 9% to be considered in compliance with Basel III capital requirements and exempt from the Basel Rules calculations. Under the final rule, banks with less than $10 billion in assets may elect the Community Bank Leverage Ratio framework if they meet the 9% ratio and if they hold 25% or less of assets in off-balance sheet exposures, and 5% or less of assets in trading assets and liabilities. For institutions that fall below the 9% capital requirement but remain above 8%, the final rule establishes a two-quarter grace period to either meet the qualifying criteria again or comply with the generally applicable capital rule. An eligible financial institution that opts into this new framework and then fails to satisfy this new framework after expiration of the grace period will then be required to satisfy the generally applicable capital requirements. Management did not elect to use the Community Bank Leverage Ratio framework.
Federal Deposit Insurance and Premiums
Lakeland’s deposits are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and are subject to deposit insurance assessments to maintain the DIF. As a result of the Dodd-Frank Act, the basic federal deposit insurance limit was permanently increased to $250,000.
In November 2010, the FDIC approved a rule to change the assessment base from adjusted domestic deposits to average consolidated total assets minus average tangible equity, as required by the Dodd-Frank Act. The FDIC’s rule also lowered the total base assessment rates, which are now established for banks of less than $10 billion of assets at 1.5 to 16 basis points for banks with the strongest composite examination rating, and 11 to 30 basis points for banks in the highest risk category with the weakest examination rating.
Pursuant to the Dodd-Frank Act, the FDIC has established 2.0% as the designated reserve ratio (“DRR”), that is, the ratio of the DIF to insured deposits. The FDIC adopted a plan under which the DIF will meet the statutory minimum DRR of 1.35% by September 30, 2020, the deadline imposed by the Dodd-Frank Act. The Dodd-Frank Act required the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the statutory minimum DRR to 1.35% from the former statutory minimum of 1.15%. In March 2016, the FDIC adopted a rule that imposes a surcharge on the quarterly assessments of insured depository institutions with total consolidated assets of $10 billion or more. The surcharge equaled an annual rate of 4.5 basis points applied to the institution’s assessment base, with certain adjustments. When the DIF Reserve Ratio is at or above 1.38% in a given quarter, credits were applied to banks' assessment payments. The Company began receiving the Small Bank Assessment credit in the third quarter of 2019 and, as a result, made no FDIC assessment payments in the third and fourth quarter of 2019. Full payments to the FDIC resumed in the second quarter of 2020. The Company paid $2.1 million in total FDIC assessments in 2020 and $431,000 in 2019.
CARES Act
The Coronavirus Aid, Relief and Economic Security Act ("CARES Act") was signed into law on March 27, 2020 and provided over $2.0 trillion in emergency economic relief to individuals and businesses impacted by the COVID-19 pandemic. The CARES Act authorized the Small Business Administration ("SBA") to temporarily guarantee loans under a new 7(a) loan program called the Paycheck Protection Program ("PPP"). As a qualified SBA lender, we were automatically authorized to originate PPP loans. An eligible business could apply for a PPP loan up to the lesser of (1) 2.5 times its average monthly payroll costs or (2) $10.0 million. PPP loans have (a) an interest rate of 1.00%, (b) a two-year loan term to maturity; and (c) principal and interest payments deferred for six months from the date of the disbursement. The SBA guarantees 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrower's PPP loan is eligible to be reduced by the loan forgiveness amount under the PPP so long as employee and compensation levels of the business are maintained and 75% of the loan proceeds are used for payroll expenses, with the remaining 25% of the loan proceeds used for other qualifying expenses.
In June 2020, Congress passed the Paycheck Protection Program Flexibility Act ("PPP Flexibility") to ease provisions of PPP related to the time period permitted to use the proceeds of loans, the deferral period of principal and interest payments on loans not forgiven and an extension of the maturity date of loan and loan forgiveness on loans. Key changes include (a) extending from two to five years the minimum maturity of any remaining loan balance after an application for loan forgiveness (for those loans closed after the enactment of PPP Flexibility); (b) extending the “covered period” (i.e., when costs that are eligible for forgiveness must be paid or incurred) from eight weeks to 24 weeks (or December 31, 2020, whichever is earlier); (c) reducing from 75 percent to 60 percent the amount of loan proceeds that must be used for payroll costs although the remainder must continue to be allocated to interest on mortgages, rent, and utilities; (d) permitting an exemption from reductions in loan forgiveness amounts based on reductions in full-time equivalent employees if the borrower, in good faith, documents an inability to return to the same level of business activity due to standards for sanitation, social distancing, or other worker or customer safety requirements established by the Department of Health and Human Services ("HHS"), the Center for Disease Control ("CDC") or Occupational, Safety and Health Administration ("OSHA"); and (e) allowing deferral of payments until the amount of forgiveness is remitted by the SBA to the lender or, if the borrower has not applied for forgiveness, ten months after the expiration of the covered period. The provisions of PPP Flexibility became effective upon enactment and will apply to all loans made under the PPP. The SBA released guidance on PPP loan forgiveness, which presently includes three
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different application methods depending primarily on the size of the PPP loan, reductions in staffing or salaries, or a business’ inability to operate at pre-COVID levels due to compliance with certain federally imposed requirements related to COVID-19. To qualify for full forgiveness, businesses must document that at least 60% of the PPP loan amount was used towards payroll costs and that the remaining 40% was used for other eligible costs such as mortgage interest, rent payments and/or utilities. Forgiveness was originally intended to be reduced by any Economic Injury Disaster Loan (“EIDL”) advance amount the business received.
Section 4013 of the CARES Act, as interpreted by the "Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working With Customers Affected by the Coronavirus (Revised)" (the “Revised Statement”), dated April 17, 2020, includes criteria that enable financial institutions to exclude from TDR status loans that are modified in connection with COVID-19. Under these provisions, TDR status is not required for the term of a loan modification if (i) the loan modification is made in connection with COVID-19, (ii) the loan was not past due more than 30 days as of December 31, 2019 and (iii) the loan modification is entered into during the period between March 1, 2020, and the earlier of (a) 60 days after COVID-19 is no longer characterized as a National Emergency or (b) December 31, 2020. Furthermore, pursuant to the Revised Statement, for loan modifications that do not meet these criteria but are made in connection with COVID-19, such loans may be presumed not to be TDR if they are current at a time the loan modification program was implemented and the modifications are short-term (e.g., six months). If the criteria are not met under either Section 4013 or the Revised Statement, banks are required to follow their existing accounting policies to determine whether COVID-related modifications should be accounted for as a TDR. The Company has elected to suspend the classification of loan modifications as TDR if they qualify under Section 4013 or the Revised Statement.
The CARES Act also provided financial institutions with the option to defer adoption of the Financial Accounting Standards Board's Accounting Standard Update ("ASU") 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments (Topic 326) ("ASU 2016-13") until the earlier of the end of the national emergency or December 31, 2020. The CARES Act also required the federal banking agencies to temporarily lower the Community Bank Leverage Ratio from 9% of average total consolidated assets to 8% for the remainder of 2020. The ratio rose to 8.5% for calendar year 2021 and will revert to 9% thereafter.
On December 27, 2020, the Consolidated Appropriations Act, 2021 (the "CAA") was signed into law. In addition to providing funding for normal government operations, this bill provides for additional COVID-19 relief. The CAA extends certain provisions of the CARES Act, provides additional funding for others and contains new relief provisions. CAA eliminates the reduction PPP forgiveness by EIDL received and extends loan modification deadline to the end of the National Emergency or December 31, 2021. CAA further extended the option to delay ASU 2016-13 implementation until January 1, 2022; however, the Company has adopted this standard as of December 31, 2020, and has applied it retroactively to January 1, 2020.
Change in Control Act
Under the Change in Bank Control Act, no person (including a company or other business entity) may acquire “control” of a bank or bank holding company, unless the appropriate federal agency has been given 60 days’ prior written notice and has not issued a notice disapproving the proposed acquisition. The agency takes, into consideration certain factors, including the competence, experience, integrity and financial resources of the acquirer and the competitive effects of the acquisition. Control, as defined under federal law, means ownership, control of or holding irrevocable proxies representing more than 25% of any class of voting stock, control in any manner of the election of a majority of the institution’s directors, or a determination by the regulator that the acquirer has the power, directly or indirectly, to exercise a controlling influence over the management or policies of the institution. There is a presumption of control upon the acquisition of 10% or more of a class of voting stock under certain circumstances, such as where the company involved has its shares registered under the Securities Exchange Act of 1934. Any “company”, as defined in the Bank Holding Company Act of 1956, would be required to receive the prior approval of the Federal Reserve Board to acquire “control” of the company or Bank, as defined in that statute and Federal Reserve Board regulations, and would then be regulated as a bank holding company.
New Jersey law specifies similar prior approval requirements by the New Jersey Department of Banking and Insurance for acquisitions of New Jersey banks or holding companies.
Proposed Legislation
From time to time proposals are made in the United States Congress, the New Jersey Legislature, and before various bank regulatory authorities, which would alter the powers of, and place restrictions on, different types of banking organizations. It is impossible to predict the impact, if any, of potential legislative trends on the business of the Company and its subsidiaries.
In accordance with federal law providing for deregulation of interest on all deposits, banks and thrift organizations are now unrestricted by law or regulation from paying interest at any rate on most time deposits. It is not clear whether deregulation and other pending changes in certain aspects of the banking industry will result in further increases in the cost of funds in relation to prevailing lending rates.
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ITEM 1A - Risk Factors.
Our business, financial condition, operating results and cash flows can be affected by a number of factors, including, but not limited to, those set forth below, any one of which could cause our actual results to vary materially from recent results or from our anticipated future results.
Credit Risks
Our allowance for credit losses on loans may not be adequate to cover actual losses.
Like all commercial banks, Lakeland Bank maintains an allowance for credit losses on loans to provide for loan defaults and non-performance. If our allowance for credit losses on loans is not adequate to cover actual loan losses, we may be required to significantly increase future provisions for credit losses on loans, which could materially and adversely affect our operating results. The Company adopted ASU 2016-13, pertaining to the measurement of credit losses on financial instruments ("CECL"), on December 31, 2020. This update requires the measurement of all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions, such as Lakeland, and other organizations will now use forward-looking information to better inform their credit loss estimates.
Our CECL methodology includes the following key factors and assumptions for all loan portfolio segments: a) the calculation of a baseline lifetime loss by applying a segment-specific historical average annual loss rate, calculated using an open pool method, applied over the remaining life of each instrument; b) a single set of economic forecast inputs for the reasonable and supportable period; c) a reasonable and supportable forecast period, which reflects management's expectations of losses based on forward-looking economic scenarios over that time; d) baseline lifetime loss rates adjusted for changes in macroeconomic conditions over the reasonable and supportable forecast period via a series of adjustment factors developed using a third-party developed and supported top-down statistical model suite that uses a set of relevant economic forecast inputs sourced from a leading global forecasting firm; e) a reversion period (after the reasonable and supportable forecast period) using a straight-line approach; f) a historical loss period which represents a full economic credit cycle (with the exception of equipment finance loans which uses a shorter time period due to circumstances unique to that segment); and g) expected prepayment rates estimated on more recent historical experience adjusted for refinance incentive, seasoning and burnout, as applicable. The amount of future losses is affected by changes in economic, operating and other conditions, including changes in interest rates, many of which are beyond our control. These losses may exceed our current estimates. The Company also considers five standard qualitative general reserve factors ("qualitative adjustments"): nature and volume of loans, lending management, policy and procedures, independent review and changes in environment. Qualitative adjustments are designed to address risks that are not captured in the quantitative reserves (“quantitative reserve”). Other qualitative adjustments or model overlays may also be recorded based on expert credit judgment in circumstances where, in the Company’s view, the standard qualitative reserve factors do not capture all relevant risk factors. Federal regulatory agencies, as an integral part of their examination process, review our loans and the corresponding allowance for credit losses. While we believe that our allowance for credit losses on loans in relation to our current loan portfolio is adequate to cover current and expected losses, we cannot assure you that we will not need to increase our allowance for credit losses on loans or that the regulators will not require us to increase this allowance. Future increases in our allowance for credit losses on loans could materially and adversely affect our earnings and profitability.
Under the CECL model, we are required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. This differs significantly from the "incurred loss" model required under previous GAAP, which delays recognition until it is probable a loss has been incurred. Accordingly, the adoption of the CECL model significantly affects how we determine our allowance for credit losses on loans and may create more volatility in the level of our allowance for credit losses on loans.
Any future quarterly changes to our allowance will depend on the current state of the economy, forecasted macroeconomic conditions, the composition and performance of our loan portfolio at the time and other factors captured through qualitative adjustments, including idiosyncratic factors.
The concentration of our commercial real estate loan portfolio may subject us to increased regulatory analysis, or otherwise adversely affect our business and operating results.
The FDIC, the Federal Reserve and the OCC have promulgated joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate (CRE) lending. The 2006 interagency guidance did not establish specific CRE lending limits or caps; rather, the guidance set forth supervisory criteria to serve as levels of bank CRE concentration above which certain financial institutions may be identified for further supervisory analysis. According to the guidelines, institutions could be subject to further analysis if (i) their loans for construction, land, and land development (CLD) represent 100% or more of the institution's total risk-based capital, or (ii) their total non-owner occupied CRE loans (including
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CLD loans), as defined, represent 300% or more of the institution’s total risk-based capital, and further, that the institution’s non-owner occupied CRE loan portfolio has increased by 50% or more during the previous 36 months.
The Bank’s total reported CLD loans represented 36% of total risk-based capital at December 31, 2020. The Bank’s total reported CRE loans to total capital was 463% at December 31, 2020, while the Bank’s CRE portfolio has increased by 52% over the preceding 36 months. The growth rate of the preceding 36 months included the acquisition of Highlands State Bank.
The Bank’s CRE portfolio is segmented and spread among various property types including retail, office, multi-family, mixed use, industrial, hospitality, healthcare, special use and residential and commercial construction. Management regularly reviews and evaluates its CRE portfolio, including concentrations within the various property types based on current market conditions and risk appetite as well as by utilizing stress testing on material exposures and believes its underwriting practices are sound.
There is no assurance that in the future we will not exceed the levels set forth in the guidelines. Furthermore, the concentration of our commercial real estate portfolio could materially and adversely affect our business and operating results, including our overall profitability, and/or adversely impact the growth of our business, including the growth and composition of our overall loan portfolio.
Our mortgage banking operations expose us to risks that are different than the risks associated with our retail banking operations.
The Bank’s mortgage banking operations are dependent upon the level of demand for residential mortgages. During higher and rising interest rate environments, the level of refinancing activity tends to decline, which can lead to reduced volumes of business and lower revenues that may not exceed our fixed costs to run the business. In addition, mortgages sold to third-party investors are typically subject to certain repurchase provisions related to borrower refinancing, defaults, fraud or other reasons stipulated in the applicable third-party investor agreements. If the fair value of a loan when repurchased is less than the fair value when sold, a bank may be required to charge such shortfall to earnings.
In addition, the “ability to repay” and “Qualified Mortgage” rules promulgated as required by the Dodd-Frank Act (as amended or supplemented to date, including by the EGRRCPA (see "Item 1. Business - Supervision and Regulation - Capital Requirements" above), may expose the Company to greater losses, reduced volume and litigation related expenses and delays in taking title to collateral real estate, if these loans do not perform and borrowers challenge whether the rules were satisfied when originating the loans.
We are subject to various lending and other economic risks that could adversely affect our results of operations and financial condition.
Economic, political and market conditions, trends in industry and finance, legislative and regulatory changes, changes in governmental monetary and fiscal policies and inflation affect our business. These factors are beyond our control. A deterioration in economic conditions, particularly in the markets we lend in, could have the following consequences, any of which could materially adversely affect our business:
•loan delinquencies may increase;
•problem assets and foreclosures may increase;
•demand for our products and services may decrease; and
•collateral for loans made by us may decline in value, in turn reducing the borrowing ability of our customers.
Deterioration in the real estate market, particularly in New Jersey and the metropolitan New York area, could adversely affect our business. A decline in real estate values in New Jersey and the metropolitan New York area would reduce our ability to recover on defaulted loans by selling the underlying real estate, which would increase the possibility that we may suffer losses on defaulted loans.
We may suffer losses in our loan portfolio despite our underwriting practices.
We seek to mitigate the risks inherent in our loan portfolio by adhering to specific underwriting practices. Although we believe that our underwriting criteria are appropriate for the various kinds of loans that we make, we may incur losses on loans that meet our underwriting criteria, and these losses may exceed the amounts set aside as reserves in our allowance for credit losses on loans.
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We are subject to litigation, regulatory enforcement and reputation risk due to our participation in PPP and we are subject to the risk that the SBA may not fund some or all PPP loan guarantees.
The CARES Act provided for the PPP as a loan program administered through the SBA. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other lenders, subject to detailed qualifications and eligibility criteria. During the period from April 2020 through August 2020, when the initial program ended, we processed more than 2,000 applications for PPP loans.
Because of the short timeframe between the passing of the CARES Act and implementation of the PPP, some of the rules and guidance relating to PPP were issued after lenders began processing PPP applications. Also, there was, and continues to be, uncertainty in the laws, rules and guidance relating to the PPP. Since the opening of the PPP, several banks have been subject to litigation regarding the procedures used in processing PPP applications and the payment of fees to agents that assisted borrowers in obtaining PPP loans. In addition, some banks and borrowers have received negative media attention associated with PPP loans. Although we believe that we have administered the PPP in accordance with all applicable laws, regulations and guidance, we may be exposed to litigation risk and negative media attention related to our participation in the PPP. If any such litigation is not resolved in in our favor, it may result in significant financial liability to us or adversely affect our reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP-related litigation or media attention could have a material adverse impact on our business, financial condition, and results of operations.
Federal and state regulators can impose or request that we consent to substantial sanctions, restrictions and requirements if they determine there are violations of laws, rules or regulations or weaknesses or failures with respect to general standards of safety and soundness, including with respect to the PPP, which could adversely affect our business, reputation, results of operation and financial condition, and thereby adversely affect your investment.
Further, in light of the speed at which the PPP was implemented, particularly due to the “first come first served” nature of the program, the loans originated under this program may present potential fraud risk, increasing the risk that loan forgiveness may not be obtained by the borrowers and that the guaranty may not be honored. In addition, there is risk that the borrowers may not qualify for the loan forgiveness feature due to the conduct of the borrower after the loan is originated. We also have credit risk with respect to PPP loans given that the SBA may determine that there is a deficiency in the manner in which we originated, funded or serviced loans, including any issue with the eligibility of a borrower to receive a PPP loan. These factors may result in us having to hold a significant amount of these low-yield loans on our books for a significant period of time. Moreover, in the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which we originated, funded or serviced a PPP loan, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty or, if the SBA has already paid under the guaranty, seek recovery of any loss related to the deficiency from us.
Liquidity and Interest Rate Risks
We are subject to interest rate risk and variations in interest rates that may negatively affect our financial performance.
We are unable to predict actual fluctuations of market interest rates. Rate fluctuations are influenced by many factors, including:
•inflation or deflation
•excess growth or recession;
•a rise or fall in unemployment;
•tightening or expansion of the money supply;
•domestic and international disorder;
•instability in domestic and foreign financial markets; and
•actions taken or statements made by the Federal Reserve Board.
Both increases and decreases in the interest rate environment may reduce our profits. We expect that we will continue to realize income from the difference or “spread” between the interest we earn on loans, securities and other interest-earning assets and the interest we pay on deposits, borrowings and other interest-bearing liabilities. Our net interest spreads are affected by the differences between the maturities and repricing characteristics of our interest-earning assets and interest-bearing liabilities. Our interest-earning assets may not reprice as slowly or rapidly as our interest-bearing liabilities. Changes in market interest rates could materially and adversely affect our net interest spread, asset quality, levels of prepayments, cash flows, market value of our securities portfolio, loan and deposit growth, costs and yields on loans and deposits and our overall profitability. Competition for our deposits can increase significantly as a result of the interest rate environment.
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A decrease in our ability to borrow funds could adversely affect our liquidity.
Our ability to obtain funding from the Federal Home Loan Bank ("FHLB") or through our overnight federal funds lines with other banks could be negatively affected if we experienced a substantial deterioration in our financial condition or if such funding became restricted due to deterioration in the financial markets. While we have a contingency funds management plan to address such a situation if it were to occur (such plan includes deposit promotions, the sale of securities and the curtailment of loan growth, if necessary), a significant decrease in our ability to borrow funds could adversely affect our liquidity.
Public funds deposits are an important source of funds for us and a reduced level of those deposits may hurt our profits.
Public funds deposits are a significant source of funds for our lending and investment activities. The Company’s public funds deposits consist of deposits from local government entities, domiciled in the state of New Jersey, such as school districts, counties and other municipalities, and are collateralized by letters of credit from the FHLB and investment securities. Given our use of these high-average balance public funds deposits as a source of funds, our inability to retain such funds could adversely affect our liquidity. In addition, Governor Phil Murphy of New Jersey has proposed the creation of a state-owned bank which would accept public revenues to be invested in New Jersey. A bill was introduced in the New Jersey legislature in January 2018 that calls for the establishment of such a state-run bank. The legislation remains pending, and while no assurance can be provided that such a bank will be created, to the extent that a state-run bank is established and accepts public revenues, the amount of the Company’s public funds deposits could be reduced, which could adversely affect our liquidity.
Further, our public funds deposits are primarily demand deposit accounts or short-term time deposits and are therefore more sensitive to interest rate risks. If we are forced to pay higher rates on our public funds accounts to retain those funds, or if we are unable to retain such funds and we are forced to resort to other sources of funds for our lending and investment activities, such as borrowings from the FHLB, the interest expense associated with these other funding sources may be higher than the rates we are currently paying on our public funds deposits, which would adversely affect our net income.
The transition from LIBOR as a reference rate may adversely impact our net income.
In 2017, the United Kingdom's Financial Conduct Authority announced that after 2021 it would no longer compel banks to submit the rates required to calculate the London Interbank Offered Rate ("LIBOR"). LIBOR will be discontinued on December 31, 2021. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, subordinated debentures or other securities or financial arrangements, given LIBOR's role in determining market interest rates globally.
Regulators, industry groups and certain committees (e.g., the Alternative Reference Rates Committee) have, among other things, published recommended fall-back language for LIBOR-linked financial instruments, identified recommended alternatives for certain LIBOR rates (e.g., the Secured Overnight Financing Rate as the recommended alternative to U.S. Dollar LIBOR), and proposed implementations of the recommended alternatives in floating rate instruments. At this time, it is not possible to predict whether these specific recommendations and proposals will be broadly accepted, whether they will continue to evolve, and what the effect of their implementation may be on the markets for floating-rate financial instruments.
We have a significant number of loans, derivative contracts, borrowings and other financial instruments with attributes that are either directly or indirectly dependent on LIBOR. The transition from LIBOR could create considerable costs and additional risk. Since proposed alternative rates are calculated differently, payments under contracts referencing new rates will differ from those referencing LIBOR. The transition will change our market risk profiles, requiring changes to risk and pricing models, valuation tools, product design and hedging strategies. Furthermore, failure to adequately manage this transition process with our customers could adversely impact our reputation. Although we are currently unable to assess what the ultimate impact of the transition from LIBOR will be, failure to adequately manage the transition could have a material adverse effect on our business, financial condition and results of operations.
Declines in value may adversely impact our investment portfolio.
As of December 31, 2020, the Company had approximately $855.7 million and $90.8 million in available for sale and held to maturity investment securities, respectively. For securities available for sale, ASU 2016-13 requires entities to determine if impairment is related to credit loss or non-credit loss. If an assessment of the security indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security, and if the present value of cash flows is less than the amortized cost basis, a credit loss exists and an allowance is created, limited by the amount that the fair value is less than the amortized cost basis. Held to maturity securities are evaluated under the allowance for credit losses model. Held to maturity securities are charged off against the allowance when deemed to be uncollectible and adjustments to the allowance are reported as a component of credit loss expense. If the credit loss expense is significant enough it could affect the ability of Lakeland to upstream dividends to the Company, which could have a material
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adverse effect on our liquidity and our ability to pay dividends to shareholders and could also negatively impact our regulatory capital ratios.
Information Technology or Cybersecurity Risks
The occurrence of any failure, breach, or interruption in service involving our systems or those of our service providers could damage our reputation, cause losses, increase our expenses, and result in a loss of customers, an increase in regulatory scrutiny, or expose us to civil litigation and possibly financial liability, any of which could adversely impact our financial condition, results of operations and the market price of our stock.
In the ordinary course of business, we rely on electronic communications and information systems to conduct our operations and to store sensitive data. Any failure, interruption or breach in security of these systems could result in significant disruption to our operations. Information security breaches and cybersecurity-related incidents may include, but are not limited to, attempts to access information, including customer and company information, malicious code, computer viruses and denial of service attacks that could result in unauthorized access, misuse, loss or destruction of data (including confidential customer information), account takeovers, unavailability of service or other events. These types of threats may derive from human error, fraud or malice on the part of external or internal parties, or may result from accidental technological failure. Further, to access our products and services our customers may use computers and mobile devices that are beyond our security control systems. Our technologies, systems, networks and software, and those of other financial institutions have been, and are likely to continue to be, the target of cybersecurity threats and attacks, which may range from uncoordinated individual attempts to sophisticated and targeted measures directed at us. The risk of a security breach or disruption, particularly through cyber attack or cyber intrusion, has increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased.
Our business requires the collection and retention of large volumes of customer data, including personally identifiable information in various information systems that we maintain and in those maintained by third parties with whom we contract to provide data services. We also maintain important internal company data such as personally identifiable information about our employees and information relating to our operations. The integrity and protection of that customer and company data is important to our business and our reputation. Our collection of such customer and company data is subject to extensive regulation and oversight.
Our customers and employees have been, and will continue to be, targeted by parties using fraudulent e-mails and other communications in attempts to misappropriate passwords, bank account information or other personal information or to introduce viruses or other malware through “Trojan horse” programs to our information systems and/or our customers' computers. Though we endeavor to mitigate these threats through product improvements, use of encryption and authentication technology and customer and employee education, such cyber attacks against us, our merchants and our third party service providers remain a serious issue. The pervasiveness of cybersecurity incidents in general and the risks of cyber crime are complex and continue to evolve. More generally, publicized information concerning security and cyber-related problems could inhibit the use or growth of electronic or web-based applications or solutions as a means of conducting commercial transactions.
Although we make significant efforts to maintain the security and integrity of our information systems and have implemented various measures to manage the risk of a security breach or disruption, there can be no assurance that our security efforts and measures will be effective or that attempted security breaches or disruptions would not be successful or damaging. Even the most well protected information, networks, systems and facilities remain potentially vulnerable because attempted security breaches, particularly cyber attacks and intrusions, or disruptions will occur in the future, and because the techniques used in such attempts are constantly evolving and generally are not recognized until launched against a target, and in some cases are designed not to be detected and, in fact, may not be detected. Accordingly, we may be unable to anticipate these techniques or to implement adequate security barriers or other preventative measures, and thus it is virtually impossible for us to entirely mitigate this risk. While we maintain specific “cyber” insurance coverage, which would apply in the event of various breach scenarios, the amount of coverage may not be adequate in any particular case. Furthermore, because cyber threat scenarios are inherently difficult to predict and can take many forms, some breaches may not be covered under our cyber insurance coverage. A security breach or other significant disruption of our information systems or those related to our customers, merchants and our third party vendors, including as a result of cyber attacks, could (i) disrupt the proper functioning of our networks and systems and therefore our operations and/or those of certain of our customers; (ii) result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of confidential, sensitive or otherwise valuable information of ours or our customers; (iii) result in a violation of applicable privacy, data breach and other laws, subjecting us to additional regulatory scrutiny and expose us to civil litigation, governmental fines and possible financial liability; (iv) require significant management attention and resources to remedy the damages that result; or (v) harm our reputation or cause a decrease in the number of customers that choose to do business with us. The occurrence of any of the foregoing could have a material adverse effect on our business, financial condition and results of operations.
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The inability to stay current with technological change could adversely affect our business model.
Financial institutions continually are required to maintain and upgrade technology in order to provide the most current products and services to their customers, as well as create operational efficiencies. This technology requires personnel resources, as well as significant costs to implement. Failure to successfully implement technological change could adversely affect the Company’s business, results of operations and financial condition.
The Company embarked on a digital strategy initiative in 2019, which impacts all operational areas of the Bank. There are no guarantees that enhancing the Company's digital capabilities will expand Lakeland's market presence as a community bank or result in an ability to better compete long-term in a fast-paced digital marketplace. In addition, the cost of implementation and the anticipated increase in revenue may not occur as expected.
Our operations rely on certain third party vendors.
We rely on certain external vendors to provide products and services necessary to maintain our day-to-day operations. These third party vendors are sources of operational and informational security risk to us, including risks associated with operational errors, information system interruptions or breaches and unauthorized disclosures of sensitive or confidential client or customer information. If these vendors encounter any of these issues, or if we have difficulty communicating with them, we could be exposed to disruption of operations, loss of service or connectivity to customers, reputational damage, and litigation risk that could have a material adverse effect on our business and, in turn, our financial condition and results of operations.
In addition, our operations are exposed to risk that these vendors will not perform in accordance with the contracted arrangements under service level agreements. While we have selected these external vendors carefully, we do not control their actions. The failure of an external vendor to perform in accordance with the contracted arrangements under service level agreements, because of changes in the vendor’s organizational structure, financial condition, support for existing products and services or strategic focus or for any other reason, could be disruptive to our operations, which could have a material adverse effect on our business and, in turn, our financial condition and results of operations. Replacing these external vendors could also entail significant delay and expense.
Legal and Regulatory Risks
The Company and the Bank are subject to more stringent capital and liquidity requirements.
More stringent capital requirements have been imposed on bank holding companies such as Lakeland Bancorp by, among other things, imposing leverage ratios on bank holding companies and prohibiting new trust preferred issuances from counting as Tier I capital. These restrictions limit our future capital strategies. Under the Dodd-Frank Act, our currently outstanding trust preferred securities will continue to count as Tier I capital, but we will be unable to issue replacement or additional trust preferred securities which would count as Tier I capital.
As further described above under “Item 1. Business-Supervision and Regulation-Capital Requirements,” banks and bank holding companies are required to maintain a capital conservation buffer on top of minimum risk-weighted asset ratios. The capital conservation buffer was fully phased in on January 1, 2019. In September 2019, the regulatory agencies adopted a final rule, effective January 1, 2020, creating a Community Bank Leverage Ratio framework for institutions with total consolidated assets of less than $10 billion and that meet other qualifying criteria. The Community Bank Leverage Ratio Framework provides for a simpler measure of capital adequacy for qualifying institutions. Qualifying institutions that elect to use the Community Bank Leverage Ratio framework and that maintain a leverage ratio of greater than 9% will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the regulatory agencies' capital rules and to have met the well-capitalized ratio requirements. In 2020, the CARES Act required the federal banking agencies to temporarily lower the Community Bank Leverage Ratio from 9% of average total consolidated assets to 8% for the remainder of 2020. The ratio rose to 8.5% for calendar year 2021 and will revert to 9% thereafter. Management did not elect to use the Community Bank Leverage Ratio framework for the Company or the Bank.
Banking institutions which do not maintain capital in excess of the Basel Rule standards including the capital conservation buffer face constraints on the payment of dividends, equity repurchases and compensation based on the amount of the shortfall. Accordingly, if the Bank fails to maintain the applicable minimum capital ratios and the capital conservation buffer, distributions to Lakeland Bancorp may be prohibited or limited.
Future increases in minimum capital requirements could adversely affect our net income. Furthermore, our failure to comply with the minimum capital requirements could result in our regulators taking formal or informal actions against us which could restrict our future growth or operations.
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The extensive regulation and supervision to which we are subject impose substantial restrictions on our business.
The Company, Lakeland and certain non-bank subsidiaries are subject to extensive regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole. Such laws are not designed to protect our shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Lakeland is also subject to a number of laws which, among other things, govern its lending practices and require the Bank to establish and maintain comprehensive programs relating to anti-money laundering and customer identification. The United States Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputational damage, which could have a material adverse effect on our business, financial condition and results of operations.
Lakeland’s ability to pay dividends is subject to regulatory limitations which, to the extent that our holding company requires such dividends in the future, may affect our holding company’s ability to pay its obligations and pay dividends to shareholders.
As a bank holding company, the Company is a separate legal entity from Lakeland Bank and its subsidiaries, and we do not have significant operations of our own. We currently depend on Lakeland Bank’s cash and liquidity to pay our operating expenses and dividends to shareholders. The availability of dividends from Lakeland Bank is limited by various statutes and regulations. The inability of the Company to receive dividends from Lakeland Bank could adversely affect our financial condition, results of operations, cash flows and prospects and the Company’s ability to pay dividends.
In addition, as described under “Item 1. Business-Supervision and Regulation-Capital Requirements,” as a general matter, banks and bank holding companies are required to maintain a capital conservation buffer on top of minimum risk-weighted asset ratios. Banking institutions which do not maintain capital in excess of the capital conservation buffer will face constraints on the payment of dividends, equity repurchases and compensation based on the amount of the shortfall. Accordingly, if Lakeland Bank fails to maintain the applicable minimum capital ratios and the capital conservation buffer, distributions to Lakeland Bancorp may be prohibited or limited.
Strategic and External Risks
The effect of future tax reform is uncertain and may adversely affect our business.
State and federal legislation for tax reform may increase our overall tax expense and negatively impact certain balance sheet and tax provisions taken by the Company.
The current national administration has indicated that tax reform, increasing the federal corporate tax rate, is a possibility. Such an increase would increase the Company's income tax expense as a percent of its taxable income. Other tax reform could adversely impact the property values of real estate used to secure loans or may create an additional tax burden for many borrowers, particularly in high tax jurisdictions such as the State of New Jersey where the Company operates. These and other federal and state tax changes could significantly impact the financial health of our customers, potentially resulting, in among other things, an inability to repay loans or maintain deposits at the Bank. Any negative financial impact to our customers resulting from tax reform could adversely impact our financial condition and earnings.
In addition, in September 2020, the State of New Jersey enacted further changes in tax law, that were retroactive to the beginning of 2020, which extended a temporary surcharge of 2.5% on corporations earning New Jersey allocated income in excess of $1.0 million through 2023. In 2024, the New Jersey tax rate is scheduled to revert back to no surcharge.
The ultimate impact of any tax reform on our business, customers and shareholders, whether federal or state, is uncertain and could be adverse.
Severe weather, acts of terrorism and other external events could impact our ability to conduct business.
Weather-related events have adversely impacted our market area in recent years, especially areas located near coastal waters and flood prone areas. Such events that may cause significant flooding and other storm-related damage may become more common events in the future. Financial institutions have been, and continue to be, targets of terrorist threats aimed at compromising operating and communication systems and the metropolitan New York area, including New Jersey, remain central targets for potential acts of terrorism. Such events could cause significant damage, impact the stability of our facilities and result in additional expenses, impair the ability of our borrowers to repay their loans, reduce the value of collateral securing repayment of our loans, and result in the loss of revenue. While we have established and regularly test disaster recovery procedures, the occurrence of any such event could have a material adverse effect on our business, operations and financial condition.
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The outbreak of COVID-19 could continue to materially, adversely affect our business operations, financial condition, results of operations and cash flows.
The outbreak of COVID-19 has materially, adversely impacted certain industries in which our customers operate and could materially impair their ability to fulfill their obligations to us. Further, the spread of COVID-19 outbreak could lead to an economic recession or other severe disruptions in the U.S. economy and may disrupt banking and other financial activity in the areas in which we operate and could potentially create widespread business continuity issues for us.
Our business is dependent upon the willingness and ability of our employees and customers to conduct banking and other financial transactions. The spread of the highly infectious COVID-19 caused severe disruptions in the U.S. economy at large, and for small businesses in particular, which disrupted our operations and if the global response to contain COVID-19 with the introduction of a vaccine is unsuccessful, we could experience additional or material, adverse effects on our business, financial condition, results of operations and cash flows. COVID-19 resulted in a decrease in our customers’ businesses, a decrease in consumer confidence and business generally and a disruption in the services provided by our vendors. Continued disruptions to our customers could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans, declines in wealth management revenues, negatively impact regional economic conditions, result in declines in local loan demand, liquidity of loan guarantors, loan collateral (particularly in real estate), loan originations and deposit availability and negatively impact the implementation of our growth strategy. Furthermore, COVID-19 could negatively impact the ability of our employees and customers to engage in banking and other financial transactions in the geographic areas in which we operate and could create widespread business continuity issues for us. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects of COVID-19 and the additional restrictions imposed to contain COVID-19 in our market areas. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.
Moreover, we rely on many third parties in our business operations, including the appraisers of the real property collateral, vendors that supply essential services such as loan servicers, providers of financial information, systems and analytical tools and providers of electronic payment and settlement systems, and local and federal government agencies, offices, and courthouses. In light of the extent of the measures taken in responding to a continuing pandemic, many of these entities may limit the availability and access of their services. For example, loan origination could be delayed due to the limited availability of real estate appraisers for the collateral. Loan closings could be delayed related to reductions in available staff in recording offices or the closing of courthouses in certain counties, which slows the process for title work, mortgage and UCC filings in those counties. If the third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations.
Further, the COVID-19 outbreak created increased operational challenges, as we worked to respond to customers' urgent needs. During the period from April 2020 through August 2020, when the initial program ended, we processed more than 2,000 applications for PPP loans, which resulted in significant demands and pressures on our operations. In January 2021, the Company began accepting PPP applications for PPP First Draw Loans to first-time borrowers in addition to PPP Second Draw Loans for previous PPP borrowers under CAA approved on December 27, 2020. We will continue to face increased operational demands and pressures as we monitor and service our book of PPP loans, process applications for loan forgiveness and pursue recourse under the SBA guarantees and against borrowers for PPP loan defaults.
An outbreak of any other epidemic, pandemic or outbreak of a highly contagious disease, occurring in the United States or in the geographies in which we conduct operations could materially adversely affect our business operations, financial condition, results of operations and cash flows.
An outbreak of other highly infectious or contagious diseases, could have a materially adverse impact on certain industries in which our customers operate and could materially impair their ability to fulfill their obligations to us. Further, the spread of such an outbreak, could lead to an economic recession or other severe disruptions in the U.S. economy and may disrupt banking and other financial activity in the areas in which we operate and could potentially create widespread business continuity issues for us.
Our business is dependent upon the willingness and ability of our employees and customers to conduct banking and other financial transactions. The spread of highly infectious or contagious diseases could cause severe disruptions in the U.S. economy at large, and for small businesses in particular, which could disrupt our operations and if the global response to contain the outbreak is unsuccessful, we could experience a material adverse effect on our business, financial condition, results of operations and cash flows. An outbreak of other highly infectious or contagious diseases may result in a decrease in our customers’ businesses, a decrease in consumer confidence and business generally or a disruption in the services provided by our vendors. Disruptions to our customers could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans, declines in wealth management revenues, negatively impact regional economic conditions, result in declines in local loan demand, liquidity of loan guarantors, loan collateral (particularly in real estate), loan originations and deposit availability and negatively impact the implementation of our growth strategy. Furthermore, such an outbreak could negatively impact the ability of our employees and customers to engage in banking and other financial transactions in the geographic areas in which we
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operate and could create widespread business continuity issues for us. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects of the outbreak and the restrictions imposed to contain it in our market areas. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.
Moreover, we rely on many third parties in our business operations, including the appraisers of the real property collateral, vendors that supply essential services such as loan servicers, providers of financial information, systems and analytical tools and providers of electronic payment and settlement systems, and local and federal government agencies, offices, and courthouses. In light of developing measures responding to an outbreak or pandemic, many of these entities may limit the availability and access of their services. For example, loan origination could be delayed due to the limited availability of real estate appraisers for the collateral. Loan closings could be delayed related to reductions in available staff in recording offices or the closing of courthouses in certain counties, which slows the process for title work, mortgage and UCC filings in those counties. If the third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations.
We face intense competition from other financial services and financial services technology companies, and competitive pressures could adversely affect our business or financial performance.
The Company faces intense competition in its markets and geographic region. The Company expects competitive pressures to intensify in the future, especially in light of legislative and regulatory initiatives arising out of the recent global economic crisis, technological innovations that alter the barriers to entry, current economic and market conditions, and government monetary and fiscal policies. Competition with financial services technology companies, or technology companies partnering with financial services companies, may be particularly intense, due to, among other things, differing regulatory environments. Competitive pressures may drive the Company to take actions that the Company might otherwise eschew, such as lowering the interest rates or fees on loans or raising the interest rates on deposits in order to keep or attract high-quality customers. These pressures also may accelerate actions that the Company might otherwise elect to defer, such as substantial investments in technology or infrastructure. Whatever the reason, actions that the Company takes in response to competition may adversely affect its results of operations and financial condition. These consequences could be exacerbated if the Company is not successful in introducing new products and other services, achieving market acceptance of its products and other services, developing and maintaining a strong customer base, or prudently managing expenses.
The Company’s future growth may require the Company to raise additional capital in the future, but that capital may not be available when it is needed or may be available only at an excessive cost.
The Company is required by regulatory authorities to maintain adequate levels of capital to support its operations. The Company anticipates that current capital levels will satisfy regulatory requirements for the foreseeable future. The Company, however, may at some point choose to raise additional capital to support its continued growth. The Company’s ability to raise additional capital will depend, in part, on conditions in the capital markets at that time, which are outside of the Company’s control. Accordingly, the Company may be unable to raise additional capital, if and when needed, on terms acceptable to the Company, or at all. If the Company cannot raise additional capital when needed, its ability to further expand operations through internal growth and acquisitions could be materially impacted. In the event of a material decrease in the Company’s stock price, future issuances of equity securities could result in dilution of existing shareholder interests.
Operational Risks
The Company may incur impairment to goodwill.
We are required to test our goodwill at least annually. Our valuation methodology for assessing impairment requires management to consider a variety of factors, including the current market price of our common shares, the estimated net present value of our assets and liabilities and information concerning the terminal valuation of similarly situated insured depository institutions. We operate in a competitive environment and projections of future operating results and cash flows may vary significantly from actual results. Additionally, if our analysis results in an impairment to our goodwill, we would be required to record a non-cash charge to earnings in our financial statements during the period in which such impairment is determined to exist. Any such charge could have a material adverse effect on our results of operations and our stock price.
We could be adversely affected by failure in our internal controls.
We continue to devote a significant amount of effort, time and resources to continually strengthen our controls and ensure compliance with complex accounting standards and banking regulations. A failure in our internal controls could have a significant negative impact not only on our earnings, but also on the perception that customers, regulators and investors may have of us.
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Our risk management strategies may not be fully effective in mitigating our risk exposures in all market environments or against all types of risk.
We have devoted significant resources to develop our risk management policies and procedures and expect to continue to do so in the future. Nonetheless, our risk management strategies may not be fully effective in mitigating our risk exposure in all market environments or against all types of risk, including risks that are unidentified or unanticipated. As our products and services change and grow and the markets in which we operate evolve, our risk management strategies may not always adapt to those changes. Some of our methods of managing risk are based upon our use of observed historical market behavior and management’s judgment. As a result, these methods may not predict future risk exposures, which could be significantly greater than the historical measures indicate. Management of market, credit, liquidity, operational, legal, regulatory and compliance risks requires, among other things, policies and procedures to record properly and verify a large number of transactions and events and these policies and procedures may not be fully effective. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application cannot anticipate every economic and financial outcome or the timing of such outcomes. Any of these circumstances could have an adverse effect on our business, financial condition and results of operations.
The inability to attract and retain key personnel could adversely affect our Company’s business.
The success of the Company depends partially on the ability to attract and retain a high level of experienced personnel. The inability to attract and retain key employees, as well as find suitable replacements, if necessary, could adversely affect the Company’s customer relationships and internal operations.
The accuracy of our financial statements and related disclosures could be affected if the judgments, assumptions or estimates used in our critical accounting policies are inaccurate.
The preparation of financial statements and related disclosure in conformity with GAAP requires us to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Item 7 of this report captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” describes our significant accounting policy and methods used in the preparation of our consolidated financial statements that we consider “critical” because they require judgments, assumptions and estimates that materially affect our consolidated financial statements and related disclosures. As a result, if future events differ significantly from the judgments, assumptions and estimates in our critical accounting policy, those events or assumptions could have a material impact on our consolidated financial statements and related disclosures.
If we do not successfully integrate any banks that we may acquire in the future, the combined company may be adversely affected.
If we make acquisitions in the future, we will need to integrate the acquired entities into our existing business and systems. We may experience difficulties in accomplishing this integration or in effectively managing the combined company after any future acquisition. Any actual cost savings or revenue enhancements that we may anticipate from a future acquisition will depend on future expense levels and operating results, the timing of certain events and general industry, regulatory and business conditions. Many of these events will be beyond our control, and we cannot assure you that if we make any acquisitions in the future, we will be successful in integrating those businesses into our own.
ITEM 1B - Unresolved Staff Comments.
Not Applicable.
ITEM 2 – Properties.
As of December 31, 2020, Lakeland operated 51 branch offices located throughout Bergen, Essex, Morris, Ocean, Passaic, Somerset, Sussex, and Union counties in New Jersey and in Highland Mills, New York; however in February 2021, Lakeland closed three branches. Lakeland also operates six New Jersey regional commercial lending centers in Bernardsville, Iselin, Jackson, Montville, Teaneck and Waldwick and one New York commercial lending center to serve the Hudson Valley region. In addition to the Company’s principal office located at 250 Oak Ridge Road, Oak Ridge, New Jersey 07438, we lease two operations locations in Milton, New Jersey.
The aggregate net book value of premises and equipment was $48.5 million at December 31, 2020. As of December 31, 2020, 27 of the Company’s facilities were owned and 34 were leased for various terms.
ITEM 3 - Legal Proceedings.
There are no pending legal proceedings involving the Company or Lakeland other than those arising in the normal course of business. Management does not anticipate that the potential liability, if any, arising out of such legal proceedings will have a material effect on the financial condition or results of operations of the Company and Lakeland on a consolidated basis.
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ITEM 4 - Mine Safety Disclosures.
Not applicable.
PART II
Item 5 - Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Shares of the common stock of Lakeland Bancorp, Inc. have been traded under the symbol “LBAI” on the NASDAQ Global Select Market (or the NASDAQ National Market) since February 22, 2000 and in the over the counter market prior to that date. As of February 26, 2021, there were approximately 3,046 shareholders of record of the common stock.
The following chart compares the Company’s cumulative total shareholder return (on a dividend reinvested basis) over the past five years commencing December 31, 2015 and ending December 31, 2020 with the NASDAQ Market Index and the Peer Group Index. The Peer Group Index is the Zacks Regional Northeast Banks Index, which consists of 95 Regional Northeast Banks.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
Assumes Initial Investment of $100
December 2020
| Company/Market/Peer Group | 12/31/2015 | 12/31/2016 | 12/31/2017 | 12/31/2018 | 12/31/2019 | 12/31/2020 | ||||||||||||||||||||||||||||||||
| Lakeland Bancorp, Inc. | $ | 100.00 | $ | 170.99 | $ | 172.28 | $ | 135.72 | $ | 164.14 | $ | 125.13 | ||||||||||||||||||||||||||
| NASDAQ Market Index | 100.00 | 108.87 | 141.14 | 137.13 | 187.45 | 271.64 | ||||||||||||||||||||||||||||||||
| Regional Northeast Banks | 100.00 | 139.00 | 145.53 | 127.03 | 153.64 | 123.56 | ||||||||||||||||||||||||||||||||
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The following table presents information regarding shares of our common stock repurchased during the fourth quarter of 2020.
| Period | Total Number of Shares (or Units) Purchased (1) | Weighted Average Price Paid per Share (or Unit) | Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs | Maximum Number of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs | ||||||||||||||||||||||
| October 1 to October 31, 2020 | — | $ | — | — | 2,393,423 | |||||||||||||||||||||
| November 1 to November 30, 2020 | — | — | — | 2,393,423 | ||||||||||||||||||||||
| December 1 to December 31, 2020 | — | — | — | 2,393,423 | ||||||||||||||||||||||
(1)On October 24, 2019, the Company announced that its Board of Directors had authorized a new share repurchase program. Under the repurchase program, the Company may repurchase up to 2,524,458 shares of its common stock, or approximately 5% of its outstanding shares of common stock at September 30, 2019. Repurchases may be made from time to time through a combination of open market and privately negotiated repurchases. The specific timing, price and quantity of repurchases will be at the discretion of the Company and will depend on a variety of factors, including general market conditions, the trading price of the common stock, legal and contractual requirements and the Company's financial performance.
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Item 6 - Selected Financial Data.
SELECTED CONSOLIDATED FINANCIAL DATA
The following should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Company’s consolidated financial statements included in Items 7 and 8 of this report. The selected financial data set forth below has been derived from the Company’s audited consolidated financial statements.
| At or for the Years Ended December 31, | ||||||||||||||||||||||||||||||||
| (in thousands, except per share data) | 2020 | 2019 | 2018 | 2017 | 2016 | |||||||||||||||||||||||||||
| Income Statement | ||||||||||||||||||||||||||||||||
| Interest income | $ | 248,842 | $ | 256,487 | $ | 213,121 | $ | 190,204 | $ | 163,296 | ||||||||||||||||||||||
| Interest expense | 41,155 | 60,453 | 39,562 | 24,966 | 17,647 | |||||||||||||||||||||||||||
| Net interest income | 207,687 | 196,034 | 173,559 | 165,238 | 145,649 | |||||||||||||||||||||||||||
| Provision for credit losses/Provision for loan losses | 27,222 | 2,130 | 4,413 | 6,090 | 4,223 | |||||||||||||||||||||||||||
| Noninterest income excluding gains on investment securities and gain (loss) on equity securities | 26,449 | 26,300 | 22,893 | 22,911 | 20,960 | |||||||||||||||||||||||||||
| Gains on sales of investment securities | 1,213 | — | — | 2,524 | 370 | |||||||||||||||||||||||||||
| (Loss) gain on equity securities | (552) | 496 | (583) | — | — | |||||||||||||||||||||||||||
| Merger-related expenses | — | 3,178 | 464 | — | 4,103 | |||||||||||||||||||||||||||
| Long-term debt prepayment fee | 4,133 | — | — | 2,828 | — | |||||||||||||||||||||||||||
| Noninterest expenses | 128,665 | 123,578 | 110,703 | 101,706 | 95,814 | |||||||||||||||||||||||||||
| Income before income taxes | 74,777 | 93,944 | 80,289 | 80,049 | 62,839 | |||||||||||||||||||||||||||
| Income tax provision | 17,259 | 23,272 | 16,888 | 27,469 | 21,321 | |||||||||||||||||||||||||||
| Net income | $ | 57,518 | $ | 70,672 | $ | 63,401 | $ | 52,580 | $ | 41,518 | ||||||||||||||||||||||
| Per-Share Data | ||||||||||||||||||||||||||||||||
| Weighted average shares outstanding: | ||||||||||||||||||||||||||||||||
| Basic | 50,540 | 50,477 | 47,578 | 47,438 | 42,912 | |||||||||||||||||||||||||||
| Diluted | 50,650 | 50,642 | 47,766 | 47,674 | 43,114 | |||||||||||||||||||||||||||
| Earnings per share: | ||||||||||||||||||||||||||||||||
| Basic | $ | 1.13 | $ | 1.39 | $ | 1.32 | $ | 1.10 | $ | 0.96 | ||||||||||||||||||||||
| Diluted | $ | 1.13 | $ | 1.38 | $ | 1.32 | $ | 1.09 | $ | 0.95 | ||||||||||||||||||||||
| Cash dividend per common share | $ | 0.50 | $ | 0.49 | $ | 0.45 | $ | 0.40 | $ | 0.37 | ||||||||||||||||||||||
| Book value per common share | $ | 15.13 | $ | 14.36 | $ | 13.14 | $ | 12.31 | $ | 11.65 | ||||||||||||||||||||||
| Tangible book value per common share (1) | $ | 11.97 | $ | 11.18 | $ | 10.22 | $ | 9.38 | $ | 8.70 | ||||||||||||||||||||||
| Balance Sheet | ||||||||||||||||||||||||||||||||
| Investment securities available for sale and other (4) | $ | 882,419 | $ | 794,878 | $ | 667,840 | $ | 658,711 | $ | 621,803 | ||||||||||||||||||||||
| Investment securities held to maturity | 90,766 | 123,975 | 153,646 | 139,685 | 147,614 | |||||||||||||||||||||||||||
| Loans, net of deferred fees | 6,021,232 | 5,137,823 | 4,456,733 | 4,152,720 | 3,870,598 | |||||||||||||||||||||||||||
| Goodwill and other identifiable intangible assets | 159,565 | 160,591 | 138,201 | 138,795 | 139,091 | |||||||||||||||||||||||||||
| Total assets | 7,664,297 | 6,711,236 | 5,806,093 | 5,405,639 | 5,093,131 | |||||||||||||||||||||||||||
| Total deposits | 6,455,783 | 5,293,779 | 4,620,670 | 4,368,748 | 4,092,835 | |||||||||||||||||||||||||||
| Total core deposits (2) | 5,377,527 | 4,422,975 | 3,863,632 | 3,631,320 | 3,547,927 | |||||||||||||||||||||||||||
| Term borrowings | 143,257 | 284,036 | 286,145 | 296,913 | 365,650 | |||||||||||||||||||||||||||
| Total stockholders’ equity | 763,784 | 725,263 | 623,739 | 583,122 | 550,044 | |||||||||||||||||||||||||||
| Performance Ratios | ||||||||||||||||||||||||||||||||
| Return on average assets | 0.80 | % | 1.12 | % | 1.15 | % | 1.00 | % | 0.90 | % | ||||||||||||||||||||||
| Return on average tangible common equity (1) | 9.86 | % | 13.16 | % | 13.78 | % | 12.24 | % | 12.19 | % | ||||||||||||||||||||||
| Return on average equity | 7.74 | % | 10.14 | % | 10.59 | % | 9.25 | % | 8.75 | % | ||||||||||||||||||||||
| Efficiency ratio (1)(3) | 54.54 | % | 54.83 | % | 56.09 | % | 53.40 | % | 56.74 | % | ||||||||||||||||||||||
| Net interest margin (tax equivalent basis) | 3.09 | % | 3.33 | % | 3.36 | % | 3.38 | % | 3.41 | % | ||||||||||||||||||||||
| Loans to deposits | 93.27 | % | 97.05 | % | 96.45 | % | 95.06 | % | 94.57 | % | ||||||||||||||||||||||
| Capital Ratios | ||||||||||||||||||||||||||||||||
| Common equity to asset ratio | 9.97 | % | 10.81 | % | 10.74 | % | 10.79 | % | 10.80 | % | ||||||||||||||||||||||
| Tangible common equity to tangible assets (1) | 8.05 | % | 8.62 | % | 8.57 | % | 8.44 | % | 8.30 | % | ||||||||||||||||||||||
| Tier 1 leverage ratio | 8.37 | % | 9.41 | % | 9.39 | % | 9.12 | % | 9.07 | % | ||||||||||||||||||||||
| Tier 1 risk-based capital ratio | 10.22 | % | 11.02 | % | 11.27 | % | 10.87 | % | 10.85 | % | ||||||||||||||||||||||
| Total risk-based capital ratio | 12.84 | % | 13.40 | % | 13.71 | % | 13.40 | % | 13.48 | % | ||||||||||||||||||||||
| CET1 ratio | 9.73 | % | 10.46 | % | 10.62 | % | 10.18 | % | 10.11 | % | ||||||||||||||||||||||
1.A non-GAAP financial measure. See “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Non-GAAP Financial Measures” for a reconciliation of such measures to data calculated in accordance with generally accepted accounting principles.
2.Core deposits represent all deposits with the exception of time deposits.
3.Ratio represents noninterest expense, excluding long-term debt prepayment fee, merger related expenses and core deposit amortization, as a percentage of total revenue (calculated on a tax equivalent basis), excluding gains (losses) on securities and gain on debt extinguishment. Total revenue represents net interest income (calculated on a tax equivalent basis) plus noninterest income.
4.Includes investment in equity securities, Federal Home Loan Bank and other membership stock, at cost.
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ITEM 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This section presents a review of Lakeland Bancorp, Inc.’s consolidated results of operations and financial condition. You should read this section in conjunction with the selected consolidated financial data that is presented on the preceding page as well as the accompanying consolidated financial statements and notes to financial statements. As used in the following discussion, the term “Company” refers to Lakeland Bancorp, Inc. and “Lakeland” refers to the Company’s wholly owned banking subsidiary, Lakeland Bank. The Company has omitted comparative discussion of 2019 and 2018 results, which are presented in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2019, as filed with the Securities and Exchange Commission on March 6, 2020.
Statements Regarding Forward-Looking Information
The information disclosed in this document includes various forward-looking statements that are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 with respect to credit quality (including delinquency trends and the allowance for credit losses), corporate objectives and other financial and business matters. The words “anticipates,” “projects,” “intends,” “estimates,” “expects,” “believes,” “plans,” “may,” “will,” “should,” “could,” and other similar expressions are intended to identify such forward-looking statements. The Company cautions that these forward-looking statements are necessarily speculative and speak only as of the date made, and are subject to numerous assumptions, risks and uncertainties, all of which may change over time. Actual results could differ materially from such forward-looking statements.
In addition to the risk factors disclosed in Item 1A in this Annual Report on Form 10-K, the following factors, among others, could cause the Company’s actual results to differ materially and adversely from such forward-looking statements: changes in the financial services industry and the U.S. and global capital markets; changes in economic conditions nationally, regionally and in the Company’s markets; the ongoing COVID-19 outbreak and its effects on economic activity; the nature and timing of actions of the Federal Reserve Board and other regulators; the nature and timing of legislation affecting the financial services industry; government intervention in the U.S. financial system; changes in levels of market interest rates; pricing pressures on loan and deposit products; credit risks of Lakeland’s lending and leasing activities; successful implementation, deployment and upgrades of new and existing technology, systems, services and products; and customers’ acceptance of Lakeland’s products and services.
The above-listed risk factors are not necessarily exhaustive, particularly as to possible future events, and new risk factors may emerge from time to time. Certain events may occur that could cause the Company’s actual results to be materially different than those described in the Company’s periodic filings with the Securities and Exchange Commission. Any statements made by the Company that are not historical facts should be considered to be forward-looking statements. The Company is not obligated to update and does not undertake to update any of its forward-looking statements made herein.
Strategy
The Company, through its wholly owned subsidiary, Lakeland Bank, currently operates 48 banking offices located in Northern and Central New Jersey and Highland Mills, New York. Lakeland offers a broad range of lending, depository and related financial services to individuals and small to medium-sized businesses located in its market areas. Lakeland also offers a broad range of consumer banking services, including lending, depository, safe deposit services and wealth management services.
Lakeland’s growth has come from a combination of organic growth and acquisitions. In addition to organic growth, through December 31, 2020, the Company has acquired eight community banks with an aggregate asset total of approximately $2.28 billion at the date of the respective acquisitions. All acquired banks have been merged into Lakeland and their holding companies, if applicable, have been merged into the Company. The Company’s strategy is to continue growing both organically and through acquisition should opportunities allow. The Company continues to evaluate opportunities to increase market share by expanding within existing and contiguous markets.
The Company’s strategic aim is to provide an adequate return to its shareholders by focusing on profitable growth through services that meet the needs of its customers in its market areas. This will be accomplished by continuing to offer commercial and consumer loan, deposit and other financial product services in a changing economic and technological environment. In early 2021, Lakeland added two lenders to grow our commercial loan portfolio with life insurance-based financing.
The Company offers internet banking, mobile banking and cash management services to meet the needs of its business and consumer customers. In 2019, the Company embarked on a digital strategy initiative, impacting all operational areas of Lakeland, with a focus on providing a superior customer experience, evolving our product and service delivery and enhancing our operational functionality and cost-effectiveness. The Company devoted 2020 to building our infrastructure to implement the strategy. We hired a highly-skilled team, strengthened our project management and delivery capabilities and began organizing data housed in various areas of the Company. Investments were also made in customer relationship management tools, which
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will provide an enhanced view of our customers. In the coming year, we will begin to apply these emerging capabilities to gain insights into our customers and align our products and services with their needs.
The Company’s results of operations are primarily dependent upon net interest income, the difference between interest earned on interest-earning assets and the interest paid on interest-bearing liabilities. For information on how interest rate change can influence the Company’s net interest income and how the Company manages its net interest income, see “Interest Rate Risk” in the discussion below.
The Company generates noninterest income such as income from retail and business account fees, loan servicing fees, loan origination fees, appreciation in the cash surrender value of bank owned life insurance, income from securities sales, fees from wealth management services and investment product sales, income from the origination and sale of residential mortgages and SBA loans and other fees. The Company’s operating expenses consist primarily of compensation and benefits expense, occupancy and equipment expense, data processing expense, ATM and debit card expense, marketing and advertising expense and other general and administrative expenses. The Company’s results of operations are also affected by general economic conditions, changes in market interest rates, changes in asset quality, changes in asset values, actions of regulatory agencies and government policies.
The Company continues to control its expenses by continually reviewing its ongoing noninterest expense, including evaluating its salary expense, ongoing service contract expense, marketing expenses and other expenses. The Company also controls its expenses by leveraging its technology investments that maximize the efficient delivery of products and services to its customers, which allows it further to evaluate its infrastructure. Lakeland will continue to consolidate and close branches when an evaluation determines a significant cost savings may be obtained through the consolidation or closure. In addition, opportunities to open new branches are also evaluated.
Critical Accounting Estimates
The accounting and reporting policies of the Company and Lakeland conform with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and predominant practices within the banking industry. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. These estimates and assumptions also affect reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
On December 31, 2020, effective January 1, 2020, the Company adopted new accounting guidance, which requires entities to estimate and recognize an allowance for lifetime expected credit losses for loans and other financial assets measured at amortized cost. Previously, an allowance was recognized based on probable and reasonably estimable incurred losses inherent in the loan portfolio at the balance sheet date. See Note 1 to the Company's financial statements included in Item 8 of this Annual Report on Form 10-K for further discussion of the Company's accounting policies and methodologies for establishing the allowance and the liability for off-balance-sheet commitments beginning in 2020.
The allowance for credit losses is a critical accounting estimate for the following reasons:
•estimates relating to the allowance for credit losses require management to project future loan performance, including cash flows, delinquencies, charge-offs and collateral values, based on a reasonable and supportable forecast period utilizing forward-looking economic scenarios in order to estimate potential credit losses;
•the allowance for credit losses is influenced by factors outside of management's control such as industry and business trends, geopolitical events and the effects of laws and regulations as well as economic conditions including, but not limited to, interest rates, housing prices, GDP, inflation and unemployment; and
•judgment is required to determine whether the models used to generate the allowance for credit losses produce results that appropriately reflect a current estimate of lifetime expected credit losses.
Because management's estimates of the allowance for credit losses involve a high degree of judgment, the subjectivity of the assumptions used and the potential for changes in the forecasted economic environment that could result in changes to the amount of the allowance recorded, there is uncertainty inherent in such estimates. Changes in these estimates could significantly impact the allowance and provision for credit losses.
The COVID-19 pandemic resulted in a deterioration in U.S. economic conditions and an increase in economic uncertainty. As a result, the Company's future loss estimates may vary considerably as a result of the changes in the economy compared to management's December 31, 2020 assumptions; the magnitude of the pandemic; and the impact of the national monetary and fiscal response.
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Use of Non-GAAP Disclosures
Reported amounts are presented in accordance with U.S. GAAP. The Company’s management believes that the supplemental non-GAAP information, which consists of measurements and ratios based on tangible equity, tangible assets and the efficiency ratio, which excludes certain items considered to be non-recurring from earnings, is utilized by regulators and market analysts to evaluate a company’s financial condition and therefore, such information is useful to investors. These disclosures should not be viewed as a substitute for financial results determined in accordance with U.S. GAAP, nor are they necessarily comparable to non-GAAP performance measures which may be presented by other companies.
Executive Summary
COVID-19 continues to have a significant, negative effect on families and businesses in New Jersey and throughout the United States. The prolonged COVID-19 outbreak, or any other epidemic that harms the global economy, the U.S. economy or the markets in which we operate could adversely affect our operations. If conditions worsen, we may again experience temporary closures of our offices and/or suspension of certain services until it is safe to open and return to work. The ultimate effect of COVID-19 on the Company's business will depend on numerous factors and future developments that are highly uncertain and cannot be predicted with confidence. At this time, it is unknown how long the COVID-19 pandemic will last or when all restrictions on individuals and businesses will be lifted and businesses and their employees will be able to fully resume normal activities. Further, additional information may emerge regarding the severity of COVID-19, effectiveness of the vaccines developed and additional actions may be taken by federal, state and local governments to contain COVID-19 or treat its impact. Changes in the behavior of customers, businesses and their employees as a result of the COVID-19 pandemic, including social distancing practices, even after formal restrictions have been lifted, are also unknown. As a result of the COVID-19 pandemic and the actions taken to contain it or reduce its impact, the Company may experience changes in the value of collateral securing outstanding loans, reductions in the credit quality of borrowers and the inability of borrowers to repay loans in accordance with their terms. Management is actively managing credit risk in the Company's commercial loan portfolio, including reviewing the industries that the Company believes are most likely to be impacted by emerging COVID-19 events. These and similar factors and events may have substantial negative effects on the business, financial condition, and results of operations of the Company and its customers.
The CARES Act was signed into law on March 27, 2020 and provided over $2.0 trillion in emergency economic relief to individuals and businesses impacted by the COVID-19 pandemic. The CARES Act authorized the Small Business Administration ("SBA") to temporarily guarantee loans under a new 7(a) loan program called the Paycheck Protection Program ("PPP"). As a qualified SBA lender, we were automatically authorized to originate PPP loans. An eligible business could apply for a PPP loan up to the lesser of (1) 2.5 times its average monthly payroll costs or (2) $10.0 million. PPP loans have (a) an interest rate of 1.00%, (b) a two-year loan term to maturity; and (c) principal and interest payments deferred for six months from the date of the disbursement. The SBA guarantees 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrower's PPP loan is eligible to be reduced by the loan forgiveness amount under the PPP so long as employee and compensation levels of the business are maintained and 75% of the loan proceeds are used for payroll expenses, with the remaining 25% of the loan proceeds used for other qualifying expenses.
In June 2020, Congress passed the Paycheck Protection Program Flexibility Act ("PPP Flexibility") to ease provisions of PPP related to the time period permitted to use the proceeds of loans, the deferral period of principal and interest payments on loans not forgiven and an extension of the maturity date of loan and loan forgiveness on loans. Key changes include (a) extending from two to five years the minimum maturity of any remaining loan balance after an application for loan forgiveness (for those loans closed after the enactment of PPP Flexibility); (b) extending the “covered period” (i.e., when costs that are eligible for forgiveness must be paid or incurred) from eight weeks to 24 weeks (or December 31, 2020, whichever is earlier); (c) reducing from 75 percent to 60 percent the amount of loan proceeds that must be used for payroll costs although the remainder must continue to be allocated to interest on mortgages, rent, and utilities; (d) permitting an exemption from reductions in loan forgiveness amounts based on reductions in full-time equivalent employees if the borrower, in good faith, documents an inability to return to the same level of business activity due to standards for sanitation, social distancing, or other worker or customer safety requirements established by the Department of Health and Human Services ("HHS"), the Center for Disease Control ("CDC") or Occupational, Safety and Health Administration ("OSHA"); and (e) allowing deferral of payments until the amount of forgiveness is remitted by the SBA to the lender or, if the borrower has not applied for forgiveness, ten months after the expiration of the covered period. The provisions of PPP Flexibility became effective upon enactment and will apply to all loans made under the PPP. The SBA released guidance on PPP loan forgiveness, which presently includes three different application methods depending primarily on the size of the PPP loan, reductions in staffing or salaries, or a business’ inability to operate at pre-COVID levels due to compliance with certain federally imposed requirements related to COVID-19. To qualify for full forgiveness, businesses must document that at least 60% of the PPP loan amount was used towards payroll costs and that the remaining 40% was used for other eligible costs such as mortgage interest, rent payments and/or utilities. Forgiveness was to be reduced by any Economic Injury Disaster Loan (“EIDL”) advance amount the business received.
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Section 4013 of the CARES Act, as interpreted by the "Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working With Customers Affected by the Coronavirus (Revised)" (the “Revised Statement”), dated April 17, 2020, includes criteria that enable financial institutions to exclude from TDR status loans that are modified for customers affected by COVID-19. Under these provisions, TDR status is not required for the term of a loan modification if (i) the loan modification is made in connection with COVID-19, (ii) the loan was not past due more than 30 days as of December 31, 2019 and (iii) the loan modification is entered into during the period between March 1, 2020, and the earlier of (a) 60 days after COVID-19 is no longer characterized as a National Emergency or (b) December 31, 2020. Furthermore, pursuant to the Revised Statement, for loan modifications that do not meet these criteria but are made in connection with COVID-19, such loans may be presumed not to be TDR if they are current at a time the loan modification program was implemented and the modifications are short-term (e.g., six months). If the criteria are not met under either Section 4013 or the Revised Statement, banks are required to follow their existing accounting policies to determine whether COVID-related modifications should be accounted for as a TDR. The Company has elected to suspend the classification of loan modifications as TDR if they qualify under Section 4013 or the Revised Statement.
On December 27, 2020, the Consolidated Appropriations Act, 2021 (the "CAA") was signed into law. In addition to providing funding for normal government operations, this bill provides for additional COVID-19 relief. The CAA extends certain provisions of the CARES Act, provides additional funding for others and contains new relief provisions. The Company is currently accepting online applications for PPP First Draw Loans to first-time borrowers as well as PPP Second Draw Loans for previous PPP borrowers under the CAA.
The CARES Act also provided financial institutions with the option to defer adoption of the Financial Accounting Standards Board's Accounting Standard Update ("ASU") 2016-13, Financial Instruments - Credit Losses (Topic 326) ("ASU 2016-13) until the earlier of the end of the pandemic or December 31, 2020. The CAA extended the option to delay implementation of ASU 2016-13 until January 1, 2022, however the Company has adopted this standard as of December 31, 2020, and has applied it retroactively to January 1, 2020.
Management has identified that the COVID-19 pandemic could adversely affect the liquidity of the Company. As such, management has taken specific steps to minimize the risk. In addition to processes already in place to closely monitor changes in liquidity needs, including those that may result from the COVID-19 pandemic, the Company has increased collateral and expanded access to additional borrowings should it be necessary in order to meet liquidity needs. While the Company is unable to predict actual fluctuations in deposit or cash balances, management continues to monitor liquidity and believes that its current level of liquidity is sufficient to meet its current and future operational needs.
In addition, the carrying value of investment securities, right-of-use assets, goodwill and other intangibles could decrease, resulting in future impairment losses. Management will continue to evaluate current economic conditions to determine if a triggering event would impact the current valuations for these assets. As a result, it is not currently possible to ascertain the overall impact of COVID-19 on the Company's business.
As the COVID-19 pandemic has advanced, Lakeland has made it a priority to safeguard the health of our associates and customers, while assisting customers impacted by the economic burdens of COVID-19 and providing support to our communities. Lakeland initiated remote working plans and encouraged the use of our mobile and online banking alternatives as we adjusted our branch hours, decreased lobby usage and temporarily closed branches. To assist COVID-19 impacted borrowers, we offered temporary payment deferrals on commercial, mortgage and consumer loans and we have assisted customers with the origination of PPP loans to help strengthen local businesses and preserve jobs in our communities. Additionally to further support our customers, the Company decided to participate in the Main Street Lending Program established by the Federal Reserve to support lending to small and medium-sized businesses that were in sound financial condition before the onset of the COVID-19 pandemic. Despite this challenging environment, our associates show tireless professionalism, compassion and dedication to serving our customers under these unprecedented conditions. We remain open for business, continuing to lend to qualified businesses for working capital and general business purposes.
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Financial Overview
The year ended December 31, 2020 represented a year of continued loan and deposit growth for the Company. As discussed in this management’s discussion and analysis:
•Net income was $57.5 million, or $1.13 per diluted share, for the year ended December 31, 2020 compared to net income of $70.7 million, or $1.38 per diluted share, for 2019.
•In 2020, return on average assets was 0.80%, return on average common equity was 7.74% and return on average tangible common equity was 9.86%. This compared to 2019 ratios of return on average assets of 1.12%, return on average common equity of 10.14% and return on average tangible common equity of 13.16%.
•The Company adopted ASU 2016-13 at December 31, 2020, and, as a result, recorded an increase in the allowance for credit losses on loans of $6.7 million effective January 1, 2020.
•2020 financial results were adversely impacted by an elevated provision for credit losses of $27.2 million, compared to a provision for loan losses of $2.1 million for 2019.
•Total loans increased by $883.4 million, or 17%, from December 31, 2019 to December 31, 2020, and included $284.6 million in PPP loans.
•Loans on payment deferral at December 31, 2020 totaled $9.7 million, or 0.2% of total loans.
•Total deposits increased $1.2 billion, or 22%, from December 31, 2019 to December 31, 2020, including an increase of $386.1 million, or 34% in noninterest bearing deposits.
•Balance sheet restructures during 2020 involving the payoff of $114.9 million in FHLB borrowings, resulted in prepayment fees of $4.1 million.
•The Company’s net interest margin was 3.09% for 2020 compared to 3.33% for 2019.
Net Income
Net income for 2020 was $57.5 million, or $1.13 per diluted share, compared to net income of $70.7 million, or $1.38 per diluted share, in 2019. The major contributing factor to the decrease in net income was provision for credit losses of $27.2 million, compared to a provision for loan losses of $2.1 million for 2019.
Net Interest Income
Net interest income is the difference between interest income on earning assets and the cost of funds supporting those assets. The Company’s net interest income is determined by: (i) the volume of interest-earning assets that it holds and the yields that it earns on those assets, and (ii) the volume of interest-bearing liabilities that it has assumed and the rates that it pays on those liabilities.
In March 2020, the FOMC lowered the target range for the federal funds rate twice by a total of 150 basis points, bringing the current target range to between 0.00% and 0.25%. In 2019, the target range was lowered by a total of 75 basis points and in 2018, the range was raised four times by a total of 100 basis points.
For 2020, the Company's net interest margin was 3.09% compared to 3.33% for 2019, reflecting a decrease in interest income as a effect of the low interest rate environment on higher cash balances held and loan yields. The low interest rate environment has had a positive effect on interest costs on deposits.
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The following table reflects the components of the Company’s net interest income, setting forth for the years presented, (1) average assets, liabilities and stockholders’ equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) the Company’s net interest spread (i.e., the average yield on interest-earning assets less the average cost of interest-bearing liabilities) and (5) the Company’s net interest margin. Rates are computed on a tax equivalent basis assuming a 21% tax rate.
| 2020 | 2019 | 2018 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Average Balance | Interest Income/ Expense | Average Rates Earned/ Paid | Average Balance | Interest Income/ Expense | Average Rates Earned/ Paid | Average Balance | Interest Income/ Expense | Average Rates Earned/ Paid | |||||||||||||||||||||||||||||||||||||||||||||||
| Assets | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest-earning assets: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loans (1) | $ | 5,626,273 | $ | 229,036 | 4.07 | % | $ | 4,938,298 | $ | 233,535 | 4.73 | % | $ | 4,283,401 | $ | 193,143 | 4.51 | % | ||||||||||||||||||||||||||||||||||||||
| Taxable investment securities and other | 808,629 | 17,811 | 2.20 | % | 799,103 | 19,722 | 2.47 | % | 736,241 | 16,710 | 2.27 | % | ||||||||||||||||||||||||||||||||||||||||||||
| Tax-exempt securities | 80,594 | 2,085 | 2.59 | % | 70,271 | 1,911 | 2.72 | % | 80,456 | 2,163 | 2.69 | % | ||||||||||||||||||||||||||||||||||||||||||||
| Federal funds sold (2) | 220,329 | 348 | 0.16 | % | 87,997 | 1,720 | 1.95 | % | 82,096 | 1,559 | 1.90 | % | ||||||||||||||||||||||||||||||||||||||||||||
| Total interest-earning assets | 6,735,825 | 249,280 | 3.70 | % | 5,895,669 | 256,888 | 4.36 | % | 5,182,194 | 213,575 | 4.12 | % | ||||||||||||||||||||||||||||||||||||||||||||
| Noninterest-earning assets: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Allowance for credit losses | (61,898) | (39,840) | (36,804) | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Other assets | 534,439 | 466,825 | 383,524 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total Assets | $ | 7,208,366 | $ | 6,322,654 | $ | 5,528,914 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Liabilities and Stockholders' Equity | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest-bearing liabilities: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Savings accounts | $ | 535,754 | $ | 325 | 0.06 | % | $ | 500,650 | $ | 335 | 0.07 | % | $ | 489,742 | $ | 293 | 0.06 | % | ||||||||||||||||||||||||||||||||||||||
| Interest-bearing transaction accounts | 3,035,626 | 17,396 | 0.57 | % | 2,653,404 | 31,157 | 1.17 | % | 2,301,065 | 18,711 | 0.81 | % | ||||||||||||||||||||||||||||||||||||||||||||
| Time deposits | 1,064,187 | 14,338 | 1.35 | % | 922,412 | 17,756 | 1.92 | % | 778,180 | 11,616 | 1.49 | % | ||||||||||||||||||||||||||||||||||||||||||||
| Borrowings | 336,425 | 9,096 | 2.66 | % | 385,365 | 11,205 | 2.87 | % | 340,414 | 8,942 | 2.63 | % | ||||||||||||||||||||||||||||||||||||||||||||
| Total interest-bearing liabilities | 4,971,992 | 41,155 | 0.83 | % | 4,461,831 | 60,453 | 1.35 | % | 3,909,401 | 39,562 | 1.01 | % | ||||||||||||||||||||||||||||||||||||||||||||
| Noninterest-bearing liabilities: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Demand deposits | 1,362,918 | 1,092,827 | 984,445 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Other liabilities | 130,231 | 70,959 | 36,541 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Stockholders’ equity | 743,225 | 697,037 | 598,527 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total Liabilities and Stockholders' Equity | $ | 7,208,366 | $ | 6,322,654 | $ | 5,528,914 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Net interest income/spread | 208,125 | 2.87 | % | 196,435 | 3.00 | % | 174,013 | 3.11 | % | |||||||||||||||||||||||||||||||||||||||||||||||
| Tax equivalent basis adjustment | 438 | 401 | 454 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Net Interest Income | $ | 207,687 | $ | 196,034 | $ | 173,559 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Net Interest Margin (3) | 3.09 | % | 3.33 | % | 3.36 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||
(1)Includes non-accrual loans, loans held for sale and deferred loan fees.
(2)Includes interest-bearing cash accounts.
(3)Net interest income on a tax equivalent basis divided by interest-earning assets.
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Interest income and expense volume/rate analysis
The following table shows the impact that changes in average balances of the Company’s assets and liabilities and changes in average interest rates have had on the Company’s net interest income over the past three years. This information is presented on a tax equivalent basis assuming a 21% tax rate. If a change in interest income or expense is attributable to a change in volume and a change in rate, the amount of the change is allocated proportionately.
| 2020 vs. 2019 | 2019 vs. 2018 | |||||||||||||||||||||||||||||||||||||
| Increase (Decrease) Due to Change in: | Total Change | Increase (Decrease) Due to Change in: | Total Change | |||||||||||||||||||||||||||||||||||
| (in thousands) | Volume | Rate | Volume | Rate | ||||||||||||||||||||||||||||||||||
| Interest Income | ||||||||||||||||||||||||||||||||||||||
Loans | $ | 30,269 | $ | (34,768) | $ | (4,499) | $ | 30,622 | $ | 9,770 | $ | 40,392 | ||||||||||||||||||||||||||
Taxable investment securities and other | 233 | (2,144) | (1,911) | 1,488 | 1,524 | 3,012 | ||||||||||||||||||||||||||||||||
Tax-exempt investment securities | 270 | (96) | 174 | (277) | 25 | (252) | ||||||||||||||||||||||||||||||||
Federal funds sold | 1,111 | (2,483) | (1,372) | 114 | 47 | 161 | ||||||||||||||||||||||||||||||||
Total interest income | 31,883 | (39,491) | (7,608) | 31,947 | 11,366 | 43,313 | ||||||||||||||||||||||||||||||||
| Interest Expense | ||||||||||||||||||||||||||||||||||||||
Savings deposits | 30 | (40) | (10) | 7 | 35 | 42 | ||||||||||||||||||||||||||||||||
Interest-bearing transaction accounts | 5,388 | (19,149) | (13,761) | 3,191 | 9,255 | 12,446 | ||||||||||||||||||||||||||||||||
Time deposits | 3,589 | (7,007) | (3,418) | 2,396 | 3,744 | 6,140 | ||||||||||||||||||||||||||||||||
Borrowings | (1,343) | (766) | (2,109) | 1,233 | 1,030 | 2,263 | ||||||||||||||||||||||||||||||||
Total interest expense | 7,664 | (26,962) | (19,298) | 6,827 | 14,064 | 20,891 | ||||||||||||||||||||||||||||||||
| Net Interest Income | $ | 24,219 | $ | (12,529) | $ | 11,690 | $ | 25,120 | $ | (2,698) | $ | 22,422 | ||||||||||||||||||||||||||
Net interest income on a tax equivalent basis for 2020 was $208.1 million, compared to $196.4 million in 2019, resulting primarily from growth in average earning assets of $840.2 million. The net interest margin decreased from 3.33% in 2019 to 3.09% in 2020 primarily as a result of the current low interest rate environment resulting in lower yields on interest-earning assets as well as higher cash levels. The effect on net interest income was due to the decrease in yield on interest-earning assets and was partially mitigated by an increase in interest income earned on free funds (interest-earning assets funded by noninterest-bearing liabilities) resulting from an increase in average noninterest-bearing deposits of $270.1 million.
Interest income on a tax equivalent basis decreased from $256.9 million in 2019 to $249.3 million in 2020, a decrease of $7.6 million, or 3%. The decrease in interest income resulted from a 66 basis point decline in the yield on interest-earning assets, partially offset by a $840.2 million increase in average interest-earning assets. The decrease in yield on interest-earning assets was due primarily to a reduction in the yield on loans due to decreases in the prime rate and LIBOR during 2019 and 2020, increased balance of lower-yielding federal funds sold, as well as the origination of lower-yielding PPP loans during 2020. The average balance of loans increased $688.0 million compared to 2019, while the yield on average loans of 4.07% in 2020 was 66 basis points lower than 2019. The yield on average taxable investment securities decreased 27 basis points, while the yield on tax-exempt investment securities decreased 13 basis points compared to 2019.
Total interest expense decreased from $60.5 million in 2019 to $41.2 million in 2020, a decrease of $19.3 million. Total average interest-bearing liabilities increased $510.2 million as a result of organic growth, while the cost of average interest-bearing liabilities decreased from 1.35% in 2019 to 0.83% in 2020 largely driven by lower market interest rates. The cost of interest-bearing transaction accounts, time deposits and borrowings decreased by 60 basis points, 57 basis points, and 21 basis points, respectively, compared to 2019.
Provision for Credit Losses
The Company adopted ASU 2016-13 on December 31, 2020, and has applied it retroactively to January 1, 2020. ASU 2016-13 requires the measurement of expected credit losses for financial assets, including loans and certain off-balance-sheet credit exposures, measured at amortized cost. See Note 1 - Summary of Significant Accounting Policies to the Company's financial statements for a description of the adoption of ASU 2016-13 and the Company's allowance methodology.
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In determining the provision for credit losses on loans and off-balance-sheet credit exposures, management measures expected credit losses based on relevant information about past events, current conditions, reasonable and supportable forecasts, prepayments and future economic conditions. The key assumptions of the methodology include the lookback periods, historic net charge-off factors, economic forecasts, reversion periods, prepayments and qualitative adjustments. The Company uses its best judgment to assess economic conditions and loss data in estimating the CECL allowance and these estimates are subject to periodic refinement based on changes in underlying external or internal data.
Provision for credit losses totaled $27.2 million in 2020, of which $26.0 million was related to loans, compared to a provision for loan losses of $2.1 million for 2019. The increased provision for 2020 was primarily due to the negative impact of COVID-19 on forecasted economic conditions and credit loss projections with the remainder of the provision attributable to loan growth. The provision attributable to off-balance-sheet exposures was $1.3 million and a negative provision of $28,000 was attributable to held to maturity securities.
Noninterest Income
Noninterest income of $27.1 million in 2020 increased by $314,000 compared to 2019. Gains on sales of loans and swap income increased $1.7 million and $1.5 million, respectively, compared to 2019, both due primarily to the low interest rate environment. Gain on sales of securities totaled $1.2 million in 2020 compared to no such gains in 2019. Service charges on deposit accounts decreased $2.1 million due primarily to changes in customer behavior resulting from the pandemic. Included in noninterest income in 2020, was a $552,000 loss on equity securities compared to gains of $496,000 in 2019. Other income of $735,000 in 2020 was $499,000 lower than 2019 due primarily to gains during 2019 resulting from payoffs of purchased credit impaired loans. Noninterest income represented 12% of total revenue in 2020. Total revenue is defined as net interest income plus noninterest income.
Noninterest Expense
Noninterest expense in 2020 totaled $132.8 million, which was $6.0 million greater than the $126.8 million reported for 2019. The increase in noninterest expense was due primarily to $4.1 million in FHLB debt prepayment fees resulting from the Company's balance sheet restructurings during 2020. Salaries and employee benefits increased $3.1 million in 2020, from the same period last year, as a result of an increase in staffing levels as well as normal merit increases. Furniture and equipment expense in 2020 increased $2.6 million compared to 2019 due primarily to an increase in information technology service agreement expense, including expenses related to the Company's digital initiative. FDIC insurance expense increased $1.7 million in 2020 compared to 2019 due to an increase in deposit balances as well as the application of FDIC assessment credits in 2019 resulting from the insurance fund reserve ratio exceeding the required level. Marketing expense decreased $692,000 in 2020 primarily due to the timing of marketing campaigns impacted by the pandemic as well as increased advertising during 2019 in new locations as a result of the merger with Highlands Bancorp. Noninterest expense in 2019 included merger-related expenses of $3.2 million resulting from the merger with Highlands Bancorp.
The efficiency ratio, a non-GAAP measure, expresses the relationship between noninterest expense (excluding long-term debt prepayment fees, merger related expenses and core deposit amortization) to total tax-equivalent revenue (excluding gains and/or losses on securities and gain and/or losses on debt extinguishment).
| For the Years Ended December 31, | ||||||||||||||||||||||||||||||||
| (dollars in thousands) | 2020 | 2019 | 2018 | 2017 | 2016 | |||||||||||||||||||||||||||
| Calculation of Efficiency Ratio (a Non-GAAP Measure) | ||||||||||||||||||||||||||||||||
| Total noninterest expense | $ | 132,798 | $ | 126,756 | $ | 111,167 | $ | 104,534 | $ | 99,917 | ||||||||||||||||||||||
| Amortization of core deposit intangibles | (1,025) | (1,182) | (594) | (654) | (734) | |||||||||||||||||||||||||||
| Merger related expenses | — | (3,178) | (464) | — | (4,103) | |||||||||||||||||||||||||||
| Long-term debt prepayment fee | (4,133) | — | — | (2,828) | — | |||||||||||||||||||||||||||
| Noninterest expense, as adjusted | $ | 127,640 | $ | 122,396 | $ | 110,109 | $ | 101,052 | $ | 95,080 | ||||||||||||||||||||||
| Net interest income | $ | 207,687 | $ | 196,034 | $ | 173,559 | $ | 165,238 | $ | 145,649 | ||||||||||||||||||||||
| Noninterest income | 27,110 | 26,796 | 22,310 | 25,435 | 21,330 | |||||||||||||||||||||||||||
| Total revenue | 234,797 | 222,830 | 195,869 | 190,673 | 166,979 | |||||||||||||||||||||||||||
| Tax-equivalent adjustment on municipal securities | 438 | 401 | 454 | 1,074 | 962 | |||||||||||||||||||||||||||
| Gains on sales of investment securities and debt extinguishment | (1,213) | — | — | (2,524) | (370) | |||||||||||||||||||||||||||
| Total revenue, as adjusted | $ | 234,022 | $ | 223,231 | $ | 196,323 | $ | 189,223 | $ | 167,571 | ||||||||||||||||||||||
| Efficiency ratio (Non-GAAP) | 54.54 | % | 54.83 | % | 56.09 | % | 53.40 | % | 56.74 | % | ||||||||||||||||||||||
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Income Taxes
The Company’s effective income tax rate was 23.1% and 24.8% in the years ended December 31, 2020 and 2019, respectively. The effective tax rate decrease from 2019 to 2020 primarily resulted from a decline in pretax income from 2019 to 2020 and the resulting increase in the percentage of tax-advantaged items over pretax income.
Financial Condition
Total assets at December 31, 2020 were $7.66 billion, an increase of $953.1 million, or 14%, from $6.71 billion at December 31, 2019. Loans, net of deferred fees, were $6.02 billion and $5.14 billion at December 31, 2020 and 2019, respectively, an increase of $883.4 million, or 17% during 2020. Total deposits were $6.46 billion at December 31, 2020, an increase of $1.16 billion, or 22%, from December 31, 2019.
The Company recorded the assets acquired and the liabilities assumed in the acquisition of Highlands Bancorp, Inc. in January 2019, at their estimated fair values as of the acquisition date. Total assets acquired were $496.5 million and total loans and total deposits acquired were $426.1 million and $409.6 million, respectively.
Loans
Lakeland primarily serves New Jersey, the Hudson Valley region in New York and the surrounding areas. Its equipment finance division serves a broader market with a primary focus on the Northeast. At the time of adoption of CECL, the loan portfolio segmentation was expanded to nine portfolio segments, taking into consideration common loan attributes and risk characteristics, as well as historical reporting metrics and data availability. See Note 1 to the Company's financial statements for a full description of the segments. The information below for December 31, 2020 is presented in accordance with ASU 2016-13. The Company did not reclassify comparative financial periods and has presented those disclosures under previously applicable U.S. GAAP.
At December 31, 2020, the amortized cost of loans totaled $6.02 billion, an increase of $883.4 million when compared to the balance at December 31, 2019 of $5.14 billion. Commercial loans secured by real estate increased $649.9 million to $4.24 billion at December 31, 2020. Commercial and industrial loans increased $286.3 million in 2020 and includes PPP loans totaling $284.6 million. Residential mortgage loans increased $42.2 million as customers took advantage of the low interest rate environment to refinance their mortgages. Additionally, the Company decided to retain a higher percentage of originated residential mortgage loans in 2020 compared to 2019. Equipment finance loans increased $5.6 million, while construction and consumer loans declined by $68.3 million and $35.4 million, respectively, during 2020.
The following tables present the classification of Lakeland’s gross loans by major category as of December 31 for each of the last five years:
| (in thousands) | December 31, 2020 | |||||||
| Non-owner occupied commercial (1) | $ | 2,398,946 | ||||||
| Owner occupied commercial (1) | 827,092 | |||||||
| Multifamily (1) | 813,225 | |||||||
| Non-owner occupied residential (1) | 200,229 | |||||||
| Commercial, industrial and other | 718,189 | |||||||
| Construction | 266,883 | |||||||
| Equipment finance | 116,690 | |||||||
| Residential mortgage | 377,380 | |||||||
| Consumer | 302,598 | |||||||
| Total loans | 6,021,232 | |||||||
(1) With the adoption of ASU 2016-13 in 2020, the Company expanded its portfolio segments. Prior years have not been reclassified to conform to the current year presentation.
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| December 31, | ||||||||||||||||||||||||||
| (in thousands) | 2019 | 2018 | 2017 | 2016 | ||||||||||||||||||||||
| Commercial, secured by real estate | $ | 3,589,593 | $ | 3,057,779 | $ | 2,831,184 | $ | 2,556,601 | ||||||||||||||||||
| Commercial, industrial and other | 431,934 | 336,735 | 340,400 | 350,228 | ||||||||||||||||||||||
| Construction | 335,169 | 319,545 | 264,908 | 211,109 | ||||||||||||||||||||||
| Equipment finance | 111,076 | 87,925 | 75,039 | 67,016 | ||||||||||||||||||||||
| Residential mortgage | 335,191 | 329,854 | 322,880 | 349,581 | ||||||||||||||||||||||
| Consumer | 337,977 | 328,609 | 322,269 | 339,360 | ||||||||||||||||||||||
| Total loans | 5,140,940 | 4,460,447 | 4,156,680 | 3,873,895 | ||||||||||||||||||||||
| Deferred fees (2) | (3,117) | (3,714) | (3,960) | (3,297) | ||||||||||||||||||||||
| Loans, net | $ | 5,137,823 | $ | 4,456,733 | $ | 4,152,720 | $ | 3,870,598 | ||||||||||||||||||
(2) With the adoption of ASU 2016-13 in 2020, net deferred fees and costs are allocated to the appropriate segments.
At December 31, 2020, there were no concentrations of loans exceeding 10% of total loans outstanding other than loans that are secured by real estate and commercial, industrial and other loans. Commercial, industrial and other includes $284.6 million of PPP loans, which are expected to be fully guaranteed by the SBA. Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly impacted by economic or other related conditions.
The following table presents commercial loan maturities and sensitivity to changes in interest rates at December 31, 2020:
| (in thousands) | Within One Year | After One but Within Five Years | After Five Years | Total | ||||||||||||||||||||||
| Non-owner occupied commercial | $ | 112,800 | $ | 569,836 | $ | 1,716,310 | $ | 2,398,946 | ||||||||||||||||||
| Owner occupied commercial | 58,020 | 221,306 | 547,766 | $ | 827,092 | |||||||||||||||||||||
| Multifamily | 28,378 | 165,404 | 619,443 | $ | 813,225 | |||||||||||||||||||||
| Non-owner occupied residential | 18,534 | 34,597 | 147,098 | $ | 200,229 | |||||||||||||||||||||
| Commercial, industrial and other | 205,813 | 423,757 | 88,619 | 718,189 | ||||||||||||||||||||||
| Construction | 98,057 | 67,969 | 100,857 | 266,883 | ||||||||||||||||||||||
| Total commercial loans | $ | 521,602 | $ | 1,482,869 | $ | 3,220,093 | $ | 5,224,564 | ||||||||||||||||||
| Predetermined rates | $ | 135,607 | $ | 1,071,125 | $ | 273,748 | $ | 1,480,480 | ||||||||||||||||||
| Floating or adjustable rates | 385,995 | 411,744 | 2,946,345 | 3,744,084 | ||||||||||||||||||||||
| Total commercial loans | $ | 521,602 | $ | 1,482,869 | $ | 3,220,093 | $ | 5,224,564 | ||||||||||||||||||
Risk Elements
Commercial loans are placed on a non-accrual status with all accrued interest and unpaid interest reversed if (a) because of the deterioration in the financial position of the borrower, they are maintained on a cash basis (which means payments are applied when and as received rather than on a regularly scheduled basis), (b) payment of all contractual principal and interest is not expected, or (c) principal and interest have been in default for a period of 90 days or more unless the obligation is both well-secured and in process of collection. Residential mortgage loans and closed-end consumer loans are placed on non-accrual status at the time principal and interest have been in default for a period of 90 days or more, except where there exists sufficient collateral to cover the defaulted principal and interest payments, and the loans are well-secured and in the process of collection. Open-end consumer loans secured by real estate are generally placed on non-accrual status and reviewed for charge-off when principal and interest payments are four months in arrears unless the obligations are well-secured and in the process of collection. Interest thereafter on such charged-off consumer loans is taken into income when received only after full recovery of principal. As a general rule, a non-accrual asset may be restored to accrual status when none of its principal or interest is due and unpaid and satisfactory payments have been received for a sustained period (usually six months), or when it otherwise becomes well-secured and in the process of collection.
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The following tables present certain information regarding Lakeland’s non-accrual loans, including troubled debt restructurings that are on non-accrual, and past due loans and other real estate owned and other repossessed assets as of December 31, for each of the last five years:
| (dollars in thousands) | December 31, 2020 | |||||||
| Non-owner occupied commercial (1) | $ | 16,537 | ||||||
| Owner occupied commercial (1) | 14,271 | |||||||
| Multifamily (1) | 626 | |||||||
| Non-owner occupied residential (1) | 2,217 | |||||||
| Commercial, industrial and other | 2,633 | |||||||
| Construction | 1,440 | |||||||
| Equipment finance | 327 | |||||||
| Residential mortgage | 2,469 | |||||||
| Consumer | 2,243 | |||||||
| Total non-accrual loans (2) | 42,763 | |||||||
| Other real estate and other repossessed assets | — | |||||||
| Total non-performing assets | $ | 42,763 | ||||||
| Non-performing assets as a percentage of total assets | 0.56 | % | ||||||
| Loans past due 90 days or more and still accruing | $ | 1 | ||||||
| Troubled debt restructurings, still accruing | $ | 3,857 | ||||||
(1) With the adoption of ASU 2016-13 in 2020, the Company expanded its portfolio segments. Prior years have not been reclassified to conform to the current year presentation.
(2) Non-accrual loans in 2020 includes $6.6 million in purchased credit deteriorated loans ("PCD").
| December 31, | ||||||||||||||||||||||||||
| (dollars in thousands) | 2019 | 2018 | 2017 | 2016 | ||||||||||||||||||||||