Lakeland Financial 10Q 2020 Q1 Quarterly report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 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: 0-11487

LAKELAND FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Indiana		35-1559596
(State or Other Jurisdiction		(IRS Employer
of Incorporation or Organization)		Identification No.)

202 East Center Street, Warsaw, Indiana		46580
(Address of principal executive offices)		(Zip Code)

(574) 267‑6144

(Registrant’s Telephone Number, Including Area Code)

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common stock, No par value	LKFN	The Nasdaq Stock Market LLC
		(Nasdaq Global Select Market)

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, 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 is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Number of shares of common stock outstanding at April 29, 2020: 25,701,115

Table of Contents

TABLE OF CONTENTS


		Page
PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements
	Consolidated Balance Sheets — March 31, 2020 and December 31, 2019	1
	Consolidated Statements of Income — three months ended March 31, 2020 and 2019	2
	Consolidated Statements of Comprehensive Income — three months ended March 31, 2020 and 2019	3
	Consolidated Statements of Changes in Stockholders’ Equity — three months ended March 31, 2020 and 2019	4
	Consolidated Statements of Cash Flows — three months ended March 31, 2020 and 2019	5
	Notes to the Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	48
Item 4.	Controls and Procedures	48

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	49
Item 1A.	Risk Factors	49
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	50
Item 3.	Defaults Upon Senior Securities	50
Item 4.	Mine Safety Disclosures	50
Item 5.	Other Information	50
Item 6.	Exhibits	51

SIGNATURES		52

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ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS (in thousands, except share data)


	March 31,		December 31,
	2020		2019
	(Unaudited)
ASSETS
Cash and due from banks	$	52,988	$	68,605
Short-term investments		79,593		30,776
Total cash and cash equivalents		132,581		99,381

Securities available-for-sale (carried at fair value)		624,325		608,233
Real estate mortgage loans held-for-sale		7,982		4,527

Loans, net of allowance for loan losses of $53,609 and $50,652		4,032,129		4,015,176

Land, premises and equipment, net		60,945		60,365
Bank owned life insurance		83,037		83,848
Federal Reserve and Federal Home Loan Bank stock		13,772		13,772
Accrued interest receivable		15,433		15,391
Goodwill		4,970		4,970
Other assets		54,904		41,082
Total assets	$	5,030,078	$	4,946,745


LIABILITIES
Noninterest bearing deposits	$	1,057,994	$	983,307
Interest bearing deposits		3,223,709		3,150,512
Total deposits		4,281,703		4,133,819

Borrowings
Federal Home Loan Bank advances		75,000		170,000
Miscellaneous borrowings		10,500		0
Total borrowings		85,500		170,000

Accrued interest payable		10,082		11,604
Other liabilities		46,221		33,222
Total liabilities		4,423,506		4,348,645

STOCKHOLDERS’ EQUITY
Common stock: 90,000,000 shares authorized, 0 par value 25,701,115 shares issued and 25,234,572 outstanding as of March 31, 2020 25,623,016 shares issued and 25,444,275 outstanding as of December 31, 2019		113,337		114,858
Retained earnings		484,857		475,247
Accumulated other comprehensive income		22,550		12,059
Treasury stock at cost (466,543 shares as of March 31, 2020, 178,741 shares as of December 31, 2019)		(14,261)		(4,153)
Total stockholders’ equity		606,483		598,011
Noncontrolling interest		89		89
Total equity		606,572		598,100
Total liabilities and equity	$	5,030,078	$	4,946,745

The accompanying notes are an integral part of these consolidated financial statements.

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CONSOLIDATED STATEMENTS OF INCOME (unaudited - in thousands, except share and per share data)


	Three Months Ended
	March 31,
	2020		2019
NET INTEREST INCOME
Interest and fees on loans
Taxable	$	46,054	$	48,866
Tax exempt		222		251
Interest and dividends on securities
Taxable		1,973		2,497
Tax exempt		2,006		1,642
Other interest income		184		238
Total interest income		50,439		53,494

Interest on deposits		11,199		13,883
Interest on borrowings
Short-term		362		950
Long-term		24		452
Total interest expense		11,585		15,285

NET INTEREST INCOME		38,854		38,209

Provision for loan losses		6,600		1,200

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		32,254		37,009

NONINTEREST INCOME
Wealth advisory fees		1,859		1,620
Investment brokerage fees		417		386
Service charges on deposit accounts		2,772		4,287
Loan and service fees		2,408		2,404
Merchant card fee income		669		622
Bank owned life insurance income (loss)		(292)		444
Mortgage banking income		586		222
Net securities gains		0		23
Other income		2,358		1,517
Total noninterest income		10,777		11,525

NONINTEREST EXPENSE
Salaries and employee benefits		11,566		12,207
Net occupancy expense		1,387		1,366
Equipment costs		1,417		1,349
Data processing fees and supplies		2,882		2,425
Corporate and business development		1,111		1,206
FDIC insurance and other regulatory fees		267		406
Professional fees		1,147		937
Other expense		2,312		2,577
Total noninterest expense		22,089		22,473

INCOME BEFORE INCOME TAX EXPENSE		20,942		26,061
Income tax expense		3,643		4,379
NET INCOME	$	17,299	$	21,682

BASIC WEIGHTED AVERAGE COMMON SHARES		25,622,988		25,491,750
BASIC EARNINGS PER COMMON SHARE	$	0.68	$	0.85
DILUTED WEIGHTED AVERAGE COMMON SHARES		25,735,826		25,665,510
DILUTED EARNINGS PER COMMON SHARE	$	0.67	$	0.84

The accompanying notes are an integral part of these consolidated financial statements.

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited - in thousands)


	Three months ended March 31,
	2020		2019
Net income	$	17,299	$	21,682
Other comprehensive income
Change in securities available-for-sale:
Unrealized holding gain on securities available-for-sale arising during the period		13,219		10,960
Reclassification adjustment for gains included in net income		0		(23)
Net securities gain activity during the period		13,219		10,937
Tax effect		(2,775)		(2,297)
Net of tax amount		10,444		8,640
Defined benefit pension plans:
Amortization of net actuarial loss		63		50
Net gain activity during the period		63		50
Tax effect		(16)		(12)
Net of tax amount		47		38

Total other comprehensive income, net of tax		10,491		8,678

Comprehensive income	$	27,790	$	30,360

The accompanying notes are an integral part of these consolidated financial statements.

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CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited - in thousands)


Three Months Ended March 31	2020		2019
Cash flows from operating activities:
Net income	$	17,299	$	21,682
Adjustments to reconcile net income to net cash from operating activities:
Depreciation		1,514		1,417
Provision for loan losses		6,600		1,200
Amortization of loan servicing rights		167		122
Net change in loan servicing rights valuation allowance		246		0
Loans originated for sale, including participations		(16,801)		(7,454)
Net gain on sales of loans		(420)		(258)
Proceeds from sale of loans, including participations		13,601		6,835
Net loss on sales of premises and equipment		21		1
Net gain on sales and calls of securities available-for-sale		0		(23)
Net securities amortization		946		817
Stock based compensation expense		413		1,200
Losses (earnings) on life insurance		292		(444)
Gain on life insurance		(570)		(841)
Tax benefit of stock award issuances		(71)		(529)
Net change:
Interest receivable and other assets		(1,175)		(1,342)
Interest payable and other liabilities		(2,547)		1,276
Total adjustments		2,216		1,977
Net cash from operating activities		19,515		23,659

Cash flows from investing activities:
Proceeds from sale of securities available for sale		0		13,693
Proceeds from maturities, calls and principal paydowns of securities available-for-sale		16,393		16,026
Purchases of securities available-for-sale		(20,211)		(22,183)
Purchase of life insurance		(232)		(5,362)
Net increase in total loans		(23,588)		(24,356)
Proceeds from sales of land, premises and equipment		18		10
Purchases of land, premises and equipment		(2,133)		(2,091)
Proceeds from life insurance		0		1,483
Net cash from investing activities		(29,753)		(22,780)

Cash flows from financing activities:
Net increase in total deposits		147,884		103,372
Net increase in short-term borrowings		10,500		46,445
Payments on short-term FHLB borrowings		(170,000)		(170,000)
Proceeds from long-term FHLB borrowings		75,000		0
Common dividends paid		(7,689)		(6,581)
Payments related to equity incentive plans		(2,030)		(2,089)
Purchase of treasury stock		(10,227)		(195)
Net cash from financing activities		43,438		(29,048)
Net change in cash and cash equivalents		33,200		(28,169)
Cash and cash equivalents at beginning of the period		99,381		216,922
Cash and cash equivalents at end of the period	$	132,581	$	188,753
Cash paid during the period for:
Interest	$	13,107	$	13,896
Supplemental non-cash disclosures:
Loans transferred to other real estate owned		35		0
Securities purchases payable		0		8,725
Right-of-use assets obtained in exchange for lease liabilities		0		5,483

The accompanying notes are an integral part of these consolidated financial statements.

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NOTE 1. BASIS OF PRESENTATION

This report is filed for Lakeland Financial Corporation (the "Company"), which has 2 wholly owned subsidiaries, Lake City Bank (the "Bank") and LCB Risk Management, a captive insurance company. Also included in this report are results for the Bank’s wholly owned subsidiary, LCB Investments II, Inc. ("LCB Investments"), which manages the Bank’s investment portfolio. LCB Investments owns LCB Funding, Inc. ("LCB Funding"), a real estate investment trust. All significant inter-company balances and transactions have been eliminated in consolidation.

The unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and with the instructions for Form 10-Q. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and are unaudited. In the opinion of management, all adjustments (all of which are normal and recurring in nature) considered necessary for a fair presentation have been included. Operating results for the three-months ended March 31, 2020 are not necessarily indicative of the results that may be expected for any subsequent reporting periods, including the year ending December 31, 2020. The Company’s 2019 Annual Report on Form 10-K should be read in conjunction with these statements.

Adoption of New Accounting Standards

In January 2017, the FASB issued ASU No. 2017-04 "Intangibles - Goodwill and Other - Simplifying the Test for Goodwill Impairment." These amendments eliminate Step 2 from the goodwill impairment test. The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The Company adopted this new accounting standard on January 1, 2020.

Adopting this standard did not have an impact on the Company's financial condition or results of operations.

In August 2018, the FASB issued ASU No. 2018-13 "Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement." These amendments modify the disclosure requirements in Topic 820 as follows:

Removals: the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level 3 fair value measurements.

Modifications: for investments in certain entities that calculate net asset value, an entity is required to disclose the timing of

liquidation of an investee's assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly; and the amendments clarify that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date.

Additions: the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period; and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements.

The guidance is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should all be applied prospectively for only the most recent interim or annual period presented in the initial year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The Company adopted ASU 2018-13 on January 1, 2020 and it did not have a material impact on its financial condition or results of operations.

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In August 2018, the FASB issued ASU No. 2018-15 “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350- 40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” These amendments align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contact with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by these amendments. The guidance is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2019. Early adoption is permitted. The Company adopted ASU 2018-15 on January 1, 2020 and it did not have a material impact on its financial condition or results of operations.

Newly Issued But Not Yet Effective Accounting Standards

In June 2016, the FASB issued guidance related to credit losses on financial instruments. This update, commonly referred to as the current expected credit losses methodology (“CECL”), will change the accounting for credit losses on loans and debt securities. Under the new guidance, the Company’s measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. For loans, this measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model previously required, but still permitted, under GAAP, which delays recognition until it is probable a loss has been incurred. In addition, the guidance will modify the other-than-temporary impairment model for available-for-sale debt securities to require an allowance for credit impairment instead of a direct write-down, which will allow for reversal of credit impairments in future periods. This guidance is effective, subject to optional delay discussed below, for the Company for fiscal years beginning after December 15, 2019, including interim periods in those fiscal years.

Under a provision provided by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), the Company elected to delay the adoption of FASB’s new rule covering the CECL standard until the earlier of the termination date of the national emergency declared by President Trump under the National Emergencies Act on March 13, 2020, related to the outbreak of COVID-19, and December 31, 2020. Once the delay provision has been terminated, adoption will be retroactive to January 1, 2020. During 2019, the Company implemented the CECL methodology and ran it concurrently with the historical incurred method. While the Company has not finalized the impact of implementing CECL, the Company expects to recognize a one-time cumulative effect adjustment to the allowance and beginning retained earnings, net of tax, upon adoption. Once final, the calculation will require approval by the loan review committee and governance in accordance with the Company’s internal controls over financial reporting. Additionally, the Company has evaluated the need to recognize an allowance for credit impairment for available-for-sale debt securities. The impact on available-for-sale debt securities is subject to a limitation, which is based on the fair value of the debt securities. When evaluating the credit quality of our existing portfolio, the Company does not expect the allowance for credit impairment for available-for-sale securities to be significant. The future impact of CECL on the Company’s allowance for credit losses and provision expense subsequent to the initial adoption will depend on changes in the loan portfolio, economic conditions and refinements to key assumptions including forecasting and qualitative factors.

In August 2018, the FASB issued ASU 2018-14 "Compensation - Retirement Benefits - Defined Benefit Plans - General (Topic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans." The ASU updates the annual disclosure requirements for employers that sponsor defined benefit pension or other postretirement benefit plans by adding, clarifying and removing certain disclosures. These amendments are effective for fiscal years ending after December 15, 2020, for public business entities, and are to be applied on a retrospective basis to all periods presented. Management does not anticipate ASU 2018-14 will have a material impact on its financial statements.

In December 2019, the FASB issued ASU 2019-12 "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes." These amendments remove specific exceptions to the general principles in Topic 740 in GAAP. It eliminates the need for an organization to analyze whether the following apply in a given period: exception to the incremental approach for intraperiod tax allocation; exceptions to accounting for basis differences where there are ownership changes in foreign investments; and exception in interim period income tax accounting for year-to-date losses that exceed anticipated losses. It also improves financial statement preparers' application of income tax- related guidance and simplifies GAAP for: franchise taxes that are partially based on income; transactions with a government that result in a step up in the tax basis of goodwill; separate financial statements of legal entities that are not subject to tax; and enacts changes in tax laws in interim periods. The guidance is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption is permitted. The Company is assessing ASU 2019-12 and its impact on its financial statements.

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On March 12, 2020, the FASB issued Accounting Standards Update (ASU) 2020-04, Reference Rate Reform ("ASC 848"): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. ASC 848 contains optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The Company has formed a cross-functional working group to lead the transition from LIBOR to a planned adoption of the Secured Overnight Financial Rate (“SOFR”). The Company has identified loans that will renew prior to 2021 and will obtain updated reference rate language at the time of renewal. Loans maturing after 2021 will need loan modifications and fallback language has been implemented for newly originated loans. The guidance under ASC-848 will be available for a limited time, generally through December 31, 2022. The Company expects to adopt the LIBOR transition relief allowed under this standard.

Reclassifications

Certain amounts appearing in the consolidated financial statements and notes thereto for prior periods have been reclassified to conform with the current presentation. The reclassifications had no effect on net income or stockholders’ equity as previously reported.

NOTE 2. SECURITIES

Information related to the fair value and amortized cost of securities available-for-sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income is provided in the tables below.


			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
(dollars in thousands)	Cost		Gain		Losses		Value
March 31, 2020
Mortgage-backed securities: residential	$	280,674	$	12,766	$	(170)	$	293,270
Mortgage-backed securities: commercial		41,003		811		0		41,814
State and municipal securities		272,205		17,068		(32)		289,241
Total	$	593,882	$	30,645	$	(202)	$	624,325

December 31, 2019
Mortgage-backed securities: residential	$	283,817	$	4,751	$	(387)	$	288,181
Mortgage-backed securities: commercial		36,712		262		(2)		36,972
State and municipal securities		270,480		12,828		(228)		283,080
Total	$	591,009	$	17,841	$	(617)	$	608,233

Information regarding the fair value and amortized cost of available-for-sale debt securities by maturity as of March 31, 2020 is presented below. Maturity information is based on contractual maturity for all securities other than mortgage-backed securities. Actual maturities of securities may differ from contractual maturities because borrowers may have the right to prepay the obligation without a prepayment penalty.


	Amortized		Fair
(dollars in thousands)	Cost		Value
Due in one year or less	$	3,924	$	3,946
Due after one year through five years		15,371		15,741
Due after five years through ten years		27,257		28,584
Due after ten years		225,653		240,970
		272,205		289,241
Mortgage-backed securities		321,677		335,084
Total debt securities	$	593,882	$	624,325

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Securities proceeds, gross gains and gross losses are presented below.


	Three months ended March 31,
(dollars in thousands)	2020		2019
Sales of securities available-for-sale
Proceeds	$	0	$	13,693
Gross gains		0		70
Gross losses		0		(47)
Number of securities		0		17

In accordance with ASU No. 2017-08, purchase premiums for callable securities are amortized to the earliest call date and premiums on non-callable securities as well as discounts are recognized in interest income using the interest method over the terms of the securities or over the estimated lives of mortgage-backed securities. Gains and losses on sales are based on the amortized cost of the security sold and recorded on the trade date.

Securities with carrying values of $214.9 million and $59.3 million were pledged as of March 31, 2020 and December 31, 2019, respectively, as collateral for borrowings from the Federal Home Loan Bank and for other purposes as permitted or required by law.

Information regarding securities with unrealized losses as of March 31, 2020 and December 31, 2019 is presented below. The tables divide the securities between those with unrealized losses for less than twelve months and those with unrealized losses for twelve months or more.


	Less than 12 months				12 months or more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
(dollars in thousands)	Value		Losses		Value		Losses		Value		Losses
March 31, 2020
Mortgage-backed securities: residential	$	3,021	$	69	$	5,134	$	101	$	8,155	$	170
Mortgage-backed securities: commercial		2,214		0		0		0		2,214		0
State and municipal securities		4,509		32		0		0		4,509		32
Total temporarily impaired	$	9,744	$	101	$	5,134	$	101	$	14,878	$	202

December 31, 2019
Mortgage-backed securities: residential	$	23,436	$	112	$	14,174	$	275	$	37,610	$	387
Mortgage-backed securities: commercial		4,591		2		0		0		4,591		2
State and municipal securities		14,188		228		0		0		14,188		228
Total temporarily impaired	$	42,215	$	342	$	14,174	$	275	$	56,389	$	617

The total number of securities with unrealized losses as of March 31, 2020 and December 31, 2019 is presented below.


	Less than	12 months
	12 months	or more	Total
March 31, 2020
Mortgage-backed securities: residential	1	2	3
Mortgage-backed securities: commercial	1	0	1
State and municipal securities	4	0	4
Total temporarily impaired	6	2	8

December 31, 2019
Mortgage-backed securities: residential	7	6	13
Mortgage-backed securities: commercial	1	0	1
State and municipal securities	11	0	11
Total temporarily impaired	19	6	25

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The following factors are considered in determining whether or not the impairment of these securities is other-than-temporary. In making this determination, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer, as well as the underlying fundamentals of the relevant market and the outlook for such market in the near future. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. Credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. As of March 31, 2020 and December 31, 2019, all of the securities in the Company’s portfolio were backed by the U.S. government, government agencies, government sponsored entities or were A-rated or better, except for certain non-local or local municipal securities, which are not rated. For the government, government agency, government-sponsored entity and municipal securities, management did not believe that there would be credit losses or that full principal would not be received. Management considers the unrealized losses on these securities to be primarily interest rate driven and does not expect material losses given current market conditions unless the securities are sold. However, at this time management does not have the intent to sell, and it is more likely than not that the Company will not be required to sell these securities before the recovery of their amortized cost basis.

NOTE 3. LOANS


	March 31,				December 31,
(dollars in thousands)	2020				2019
Commercial and industrial loans:
Working capital lines of credit loans	$	730,767	17.9	%	$	709,849	17.5	%
Non-working capital loans		697,952	17.1			717,019	17.6
Total commercial and industrial loans		1,428,719	35.0			1,426,868	35.1

Commercial real estate and multi-family residential loans:
Construction and land development loans		334,524	8.2			287,641	7.1
Owner occupied loans		572,057	14.0			573,665	14.1
Nonowner occupied loans		584,418	14.3			571,364	14.0
Multifamily loans		269,479	6.6			240,652	5.9
Total commercial real estate and multi-family residential loans		1,760,478	43.1			1,673,322	41.1

Agri-business and agricultural loans:
Loans secured by farmland		145,542	3.5			174,380	4.3
Loans for agricultural production		183,855	4.5			205,151	5.0
Total agri-business and agricultural loans		329,397	8.0			379,531	9.3

Other commercial loans		104,286	2.5			112,302	2.8
Total commercial loans		3,622,880	88.6			3,592,023	88.3

Consumer 1-4 family mortgage loans:
Closed end first mortgage loans		173,431	4.3			177,227	4.4
Open end and junior lien loans		181,541	4.4			186,552	4.6
Residential construction and land development loans		12,146	0.3			12,966	0.3
Total consumer 1-4 family mortgage loans		367,118	9.0			376,745	9.3

Other consumer loans		97,096	2.4			98,617	2.4
Total consumer loans		464,214	11.4			475,362	11.7
Subtotal		4,087,094	100.0	%		4,067,385	100.0	%
Less: Allowance for loan losses		(53,609)				(50,652)
Net deferred loan fees		(1,356)				(1,557)
Loans, net	$	4,032,129			$	4,015,176

The recorded investment in loans does not include accrued interest.

The Company had $1.5 million in residential real estate loans in the process of foreclosure as of March 31, 2020, compared to $1.6 million as of December 31, 2019.

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NOTE 4. ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY

The following tables present the activity in the allowance for loan losses by portfolio segment for the three-month periods ended March 31, 2020 and 2019:

Commercial

Real Estate

Commercial

and

Agri-business

Consumer

and

Multifamily

and

Other

1-4 Family

Other

(dollars in thousands)

Industrial

Residential

Agricultural

Commercial

Mortgage

Consumer

Unallocated

Total

Three Months Ended March 31, 2020

Beginning balance, January 1

$

25,789

$

15,796

$

3,869

$

447

$

2,086

$

345

$

2,320

$

50,652

Provision for credit losses

2,628

2,750

(167)

74

395

175

745

6,600

Loans charged-off

(3,735)

0

(13)

(101)

0

(3,849)

Recoveries

57

112

2

0

7

28

0

206

Net loans charged-off

(3,678)

112

2

0

(6)

(73)

0

(3,643)

Ending balance

$

24,739

$

18,658

$

3,704

$

521

$

2,475

$

447

$

3,065

$

53,609


			Commercial
			Real Estate
	Commercial		and		Agri-business				Consumer
	and		Multifamily		and		Other		1-4 Family		Other
(dollars in thousands)	Industrial		Residential		Agricultural		Commercial		Mortgage		Consumer		Unallocated		Total
Three Months Ended March 31, 2019
Beginning balance, January 1	$	22,518	$	15,393	$	4,305	$	368	$	2,292	$	283	$	3,294	$	48,453
Provision for loan losses		1,493		18		(161)		5		45		85		(285)		1,200
Loans charged-off		(83)		0		0		0		(82)		(119)		0		(284)
Recoveries		102		36		2		0		11		42		0		193
Net loans charged-off		19		36		2		0		(71)		(77)		0		(91)
Ending balance	$	24,030	$	15,447	$	4,146	$	373	$	2,266	$	291	$	3,009	$	49,562

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The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of March 31, 2020 and December 31, 2019:

Commercial

Real Estate

Commercial

and

Agri-business

Consumer

and

Multifamily

and

Other

1-4 Family

Other

(dollars in thousands)

Industrial

Residential

Agricultural

Commercial

Mortgage

Consumer

Unallocated

Total

March 31, 2020

Allowance for loan losses:

Ending allowance balance attributable to loans:

Individually evaluated for impairment

$

6,676

$

502

$

57

$

0

$

427

$

0

$

0

$

7,662

Collectively evaluated for impairment

18,063

18,156

3,647

521

2,048

447

3,065

45,947

Total ending allowance balance

$

24,739

$

18,658

$

3,704

$

521

$

2,475

$

447

$

3,065

$

53,609

Loans:

Loans individually evaluated for impairment

$

15,726

$

4,127

$

430

$

0

$

2,695

$

0

$

0

$

22,978

Loans collectively evaluated for impairment

1,412,920

1,754,085

329,067

104,163

365,666

96,859

0

4,062,760

Total ending loans balance

$

1,428,646

$

1,758,212

$

329,497

$

104,163

$

368,361

$

96,859

$

0

$

4,085,738


			Commercial
			Real Estate
	Commercial		and		Agri-business				Consumer
	and		Multifamily		and		Other		1-4 Family		Other
(dollars in thousands)	Industrial		Residential		Agricultural		Commercial		Mortgage		Consumer		Unallocated			Total
December 31, 2019
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	9,324	$	538	$	90	$	0	$	426	$	6	$	0	$	10,384
Collectively evaluated for impairment		16,465		15,258		3,779		447		1,660		339		2,320		40,268
Total ending allowance balance	$	25,789	$	15,796	$	3,869	$	447	$	2,086	$	345	$	2,320	$	50,652

Loans:
Loans individually evaluated for impairment	$	19,580	$	4,998	$	445	$	0	$	2,789	$	17	$	0	$	27,829
Loans collectively evaluated for impairment		1,407,246		1,665,842		379,186		112,166		375,210		98,349		0		4,037,999
Total ending loans balance	$	1,426,826	$	1,670,840	$	379,631	$	112,166	$	377,999	$	98,366	$	0	$	4,065,828

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The following table presents loans individually evaluated for impairment by class of loans as of March 31, 2020:


	Unpaid				Allowance for
	Principal		Recorded		Loan Losses
(dollars in thousands)	Balance		Investment		Allocated
With no related allowance recorded:
Commercial and industrial loans:
Working capital lines of credit loans	$	1,097	$	1,097	$	—
Non-working capital loans		2,012		619		—
Commercial real estate and multi-family residential loans:
Owner occupied loans		2,284		2,103		—
Agri-business and agricultural loans:
Loans secured by farmland		603		283		—
Consumer 1‑4 family loans:
Closed end first mortgage loans		403		322		—
Open end and junior lien loans		49		49		—
With an allowance recorded:
Commercial and industrial loans:
Working capital lines of credit loans		5,140		3,433		1,431
Non-working capital loans		13,211		10,577		5,245
Commercial real estate and multi-family residential loans:
Owner occupied loans		2,024		2,024		502
Agri-business and agricultural loans:
Loans secured by farmland		147		147		57
Consumer 1‑4 family mortgage loans:
Closed end first mortgage loans		1,635		1,638		371
Open end and junior lien loans		635		634		46
Residential construction loans		51		52		10
Other consumer loans		0		0		0
Total	$	29,291	$	22,978	$	7,662

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The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2019:


	Unpaid				Allowance for
	Principal		Recorded		Loan Losses
(dollars in thousands)	Balance		Investment		Allocated
With no related allowance recorded:
Commercial and industrial loans:
Working capital lines of credit loans	$	22	$	22	$	—
Non-working capital loans		2,130		735		—
Commercial real estate and multi-family residential loans:
Owner occupied loans		3,189		3,010		—
Agri-business and agricultural loans:
Loans secured by farmland		603		283		—
Loans for ag production		15		15		—
Consumer 1‑4 family loans:
Closed end first mortgage loans		411		330		—
Open end and junior lien loans		121		121		—
With an allowance recorded:
Commercial and industrial loans:
Working capital lines of credit loans		6,214		6,214		3,089
Non-working capital loans		13,230		12,609		6,235
Commercial real estate and multi-family residential loans:
Owner occupied loans		1,988		1,988		538
Agri-business and agricultural loans:
Loans secured by farmland		147		147		90
Consumer 1‑4 family mortgage loans:
Closed end first mortgage loans		1,643		1,646		363
Open end and junior lien loans		641		640		53
Residential construction loans		51		52		10
Other consumer loans		17		17		6
Total	$	30,422	$	27,829	$	10,384

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The following table presents loans individually evaluated for impairment by class of loans as of and for the three-month period ended March 31, 2020:


					Cash Basis
	Average		Interest		Interest
	Recorded		Income		Income
(dollars in thousands)	Investment		Recognized		Recognized
With no related allowance recorded:
Commercial and industrial loans:
Working capital lines of credit loans	$	380	$	0	$	0
Non-working capital loans		558		1		1
Commercial real estate and multi-family residential loans:
Owner occupied loans		2,144		5		4
Agri-business and agricultural loans:
Loans secured by farmland		283		0		0
Consumer 1‑4 family loans:
Closed end first mortgage loans		325		1		1
Open end and junior lien loans		85		0		0
With an allowance recorded:
Commercial and industrial loans:
Working capital lines of credit loans		5,287		0		0
Non-working capital loans		11,719		90		90
Commercial real estate and multi-family residential loans:
Owner occupied loans		1,999		30		30
Agri-business and agricultural loans:
Loans secured by farmland		147		0		0
Consumer 1‑4 family mortgage loans:
Closed end first mortgage loans		1,641		21		20
Open end and junior lien loans		638		0		0
Residential construction loans		52		0		0
Total	$	25,258	$	148	$	146

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The following table presents loans individually evaluated for impairment by class of loans as of and for the three-month period ended March 31, 2019:


					Cash Basis
	Average		Interest		Interest
	Recorded		Income		Income
(dollars in thousands)	Investment		Recognized		Recognized
With no related allowance recorded:
Commercial and industrial loans:
Working capital lines of credit loans	$	155	$	1	$	0
Non-working capital loans		1,549		29		24
Commercial real estate and multi-family residential loans:
Owner occupied loans		1,621		11		8
Agri-business and agricultural loans:
Loans secured by farmland		283		0		0
Consumer 1‑4 family loans:
Closed end first mortgage loans		380		1		1
Open end and junior lien loans		193		0		0
With an allowance recorded:
Commercial and industrial loans:
Working capital lines of credit loans		6,487		72		59
Non-working capital loans		11,416		132		128
Commercial real estate and multi-family residential loans:
Owner occupied loans		2,080		13		12
Agri-business and agricultural loans:
Loans secured by farmland		147		2		1
Consumer 1‑4 family mortgage loans:
Closed end first mortgage loans		1,598		12		12
Other consumer loans		43		1		1
Total	$	25,952	$	274	$	246

The following table presents the aging of the recorded investment in past due loans as of March 31, 2020 by class of loans:

30‑89

Greater than

Total Past

Loans Not

Days

90 Days

Due and

(dollars in thousands)

Past Due

Nonaccrual

Total

Commercial and industrial loans:

Working capital lines of credit loans

$

725,870

$

449

$

0

$

4,529

$

4,978

$

730,848

Non-working capital loans

693,515

99

0

4,184

4,283

697,798

Commercial real estate and multi-family residential loans:

Construction and land development loans

333,699

0

333,699

Owner occupied loans

568,122

430

0

3,186

3,616

571,738

Nonowner occupied loans

583,709

0

583,709

Multifamily loans

269,066

0

269,066

Agri-business and agricultural loans:

Loans secured by farmland

145,124

0

430

145,554

Loans for agricultural production

183,943

0

183,943

Other commercial loans

104,163

0

104,163

Consumer 1‑4 family mortgage loans:

Closed end first mortgage loans

171,452

785

19

819

1,623

173,075

Open end and junior lien loans

182,388

66

43

683

792

183,180

Residential construction loans

12,052

2

0

52

54

12,106

Other consumer loans

96,736

114

9

0

123

96,859

Total

$

4,069,839

$

1,945

$

71

$

13,883

$

15,899

$

4,085,738

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The following table presents the aging of the recorded investment in past due loans as of December 31, 2019 by class of loans:



			30‑89		Greater than				Total Past
	Loans Not		Days		90 Days				Due and
(dollars in thousands)	Past Due		Past Due		Past Due		Nonaccrual		Nonaccrual		Total
Commercial and industrial loans:
Working capital lines of credit loans	$	703,737	$	10	$	0	$	6,236	$	6,246	$	709,983
Non-working capital loans		710,557		4		0		6,282		6,286		716,843
Commercial real estate and multi-family residential loans:
Construction and land development loans		286,534		0		0		0		0		286,534
Owner occupied loans		569,303		0		0		4,056		4,056		573,359
Nonowner occupied loans		570,687		0		0		0		0		570,687
Multifamily loans		240,260		0		0		0		0		240,260
Agri-business and agricultural loans:
Loans secured by farmland		173,959		0		0		430		430		174,389
Loans for agricultural production		205,228		0		0		14		14		205,242
Other commercial loans		112,166		0		0		0		0		112,166
Consumer 1‑4 family mortgage loans:
Closed end first mortgage loans		174,902		1,099		45		827		1,971		176,873
Open end and junior lien loans		187,255		188		0		761		949		188,204
Residential construction loans		12,870		0		0		52		52		12,922
Other consumer loans		98,176		173		0		17		190		98,366
Total	$	4,045,634	$	1,474	$	45	$	18,675	$	20,194	$	4,065,828

Troubled Debt Restructurings:

Troubled debt restructured loans are included in the totals for impaired loans. The Company has allocated $2.6 million and $2.5 million of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of March 31, 2020 and December 31, 2019, respectively. The Company is not committed to lend additional funds to debtors whose loans have been modified in a troubled debt restructuring.


	March 31,		December 31,
(dollars in thousands)	2020		2019
Accruing troubled debt restructured loans	$	5,852	$	5,909
Nonaccrual troubled debt restructured loans		2,311		3,188
Total troubled debt restructured loans	$	8,163	$	9,097

During the three months ended March 31, 2020, certain loans were modified as troubled debt restructurings. The modified terms of these loans include one or a combination of the following: inadequate compensation for the terms of the restructure or renewal; a modification of the repayment terms which delays principal repayment for some period; or renewal terms offered to borrowers in financial distress where no additional credit enhancements were obtained at the time of renewal.

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The following table presents loans by class modified as new troubled debt restructurings that occurred during the three months ended March 31, 2020:

Modified Repayment Terms

Pre-Modification

Post-Modification

Extension

Outstanding

Period or

Number of

Recorded

Number of

Range

(dollars in thousands)

Loans

Investment

Loans

(in months)

Troubled Debt Restructurings

Commercial and industrial loans:

Non-working capital loans

1

788

122

1

0

Total

1

$

788

$

122

1

0

For the three month period ended March 31, 2020, the troubled debt restructurings described above increased the allowance for loan losses by $122,000, and charge-offs of $666,000 were recorded.

As of March 31, 2020, total deferrals attributed to COVID-19 were $99.8 million representing 77 borrowers. This represented 2% of the total loan portfolio. Of that total 50 were commercial loan borrowers representing $99.3 million in loans, or 3% of commercial loans and 27 were retail loan borrowers representing $528,000, or less than 1% of total retail loans. Of the total deferrals, 95% are for three-month deferrals of principal only. In accordance with the March 22, 2020 Joint Interagency Regulatory Guidance, these were not considered to be troubled debt restructurings and were excluded from the table above.

During the three months ended March 31, 2019, certain loans were modified as troubled debt restructurings. The modified terms of these loans include one or a combination of the following: inadequate compensation for the terms of the restructure or renewal; a modification of the repayment terms which delays principal repayment for some period; or renewal terms offered to borrowers in financial distress where no additional credit enhancements were obtained at the time of renewal.

Additional concessions were granted to borrowers with previously identified troubled debt restructured loans during the period. One of the loans is for a commercial real estate building where the cash flow does not support the loan with a recorded investment of $533,000. The other loan is for commercial and industrial non-working capital purposes and this borrower had a recorded investment of $70,000 that was subsequently paid off prior to March 31, 2019. These concessions are not included in the table on the next page.

The following table presents loans by class modified as new troubled debt restructurings that occurred during the three months ended March 31, 2019:

Modified Repayment Terms

Pre-Modification

Post-Modification

Extension

Outstanding

Period or

Number of

Recorded

Number of

Range

(dollars in thousands)

Loans

Investment

Loans

(in months)

Troubled Debt Restructurings

Commercial and industrial loans:

Working capital lines of credit loans

1

35

1

0

Total

1

$

35

$

35

1

0

For the three-month period ended March 31, 2019, the troubled debt restructuring described above did not impact the allowance for loan losses and no charge-off was recorded.

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. The Company analyzes commercial loans individually by classifying the loans as to credit risk. This analysis is performed on a quarterly basis for Special Mention, Substandard and Doubtful grade loans and annually on Pass grade loans over $250,000.

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The Company uses the following definitions for risk ratings:

Special Mention. Loans classified as Special Mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard. Loans classified as Substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above-described process are considered to be Pass rated loans with the exception of consumer troubled debt restructurings which are evaluated and listed with Substandard commercial grade loans and consumer nonaccrual loans which are evaluated individually and listed with Not Rated loans. Loans listed as Not Rated are consumer loans or commercial loans with consumer characteristics included in groups of homogenous loans which are analyzed for credit quality indicators utilizing delinquency status.

As of March 31, 2020, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

Special

Not

(dollars in thousands)

Pass

Mention

Substandard

Doubtful

Rated

Total

Commercial and industrial loans:

Working capital lines of credit loans

$

651,403

$

54,559

$

24,527

$

0

$

359

$

730,848

Non-working capital loans

653,230

17,834

21,406

0

5,328

697,798

Commercial real estate and multi-family residential loans:

Construction and land development loans

333,699

0

333,699

Owner occupied loans

527,818

33,555

10,365

0

571,738

Nonowner occupied loans

582,374

758

577

0

583,709

Multifamily loans

269,066

0

269,066

Agri-business and agricultural loans:

Loans secured by farmland

138,247

5,879

1,428

0

145,554

Loans for agricultural production

172,730

11,213

0

183,943

Other commercial loans

104,163

0

104,163

Consumer 1‑4 family mortgage loans:

Closed end first mortgage loans

44,863

0

1,960

0

126,252

173,075

Open end and junior lien loans

11,016

0

683

0

171,481

183,180

Residential construction loans

0

52

0

12,054

12,106

Other consumer loans

27,439

��

0

69,420

96,859

Total

$

3,516,048

$

123,798

$

60,998

$

0

$

384,894

$

4,085,738

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Table of Contents

As of December 31, 2019, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:


			Special						Not
(dollars in thousands)	Pass		Mention		Substandard		Doubtful		Rated		Total
Commercial and industrial loans:
Working capital lines of credit loans	$	631,728	$	40,551	$	37,278	$	0	$	426	$	709,983
Non-working capital loans		673,370		18,782		19,381		0		5,310		716,843
Commercial real estate and multi-family residential loans:
Construction and land development loans		286,534		0		0		0		0		286,534
Owner occupied loans		535,496		14,804		23,059		0		0		573,359
Nonowner occupied loans		569,315		781		591		0		0		570,687
Multifamily loans		240,260		0		0		0		0		240,260
Agri-business and agricultural loans:
Loans secured by farmland		165,005		7,952		1,432		0		0		174,389
Loans for agricultural production		191,489		13,738		15		0		0		205,242
Other commercial loans		112,166		0		0		0		0		112,166
Consumer 1‑4 family mortgage loans:
Closed end first mortgage loans		47,405		0		1,976		0		127,492		176,873
Open end and junior lien loans		10,845		0		762		0		176,597		188,204
Residential construction loans		0		0		51		0		12,871		12,922
Other consumer loans		27,250		0		17		0		71,099		98,366
Total	$	3,490,863	$	96,608	$	84,562	$	0	$	393,795	$	4,065,828

NOTE 5. BORROWINGS

For the periods ended March 31, 2020 and December 31, 2019, the Company had advances outstanding from the Federal Home Loan Bank (“FHLB”) in the amount of $75.0 million and $170.0 million, respectively. The outstanding FHLB advance at March 31, 2020 is a ten-year fixed-rate putable advance with a rate of 0.39% and is due on March 4, 2030. The outstanding FHLB advance at December 31, 2019 was a short-term fixed rate advance with a rate of 1.61% and was due on January 7, 2020. All FHLB notes require monthly interest payments and are secured by residential real estate loans and securities.

On August 2, 2019 the Company entered into an unsecured revolving credit agreement with another financial institution allowing the Company to borrow up to $30.0 million. Funds provided under the agreement may be used to repurchase shares of the Company’s common stock under the share repurchase program, which was authorized by the Company’s board of directors on January 14, 2020. The Company had drawn $10.5 million on this line at a rate of Prime minus 150 basis points, or 1.75%, as of March 31, 2020. There were no amounts drawn against this line as of December 31, 2019.

NOTE 6. FAIR VALUE DISCLOSURES

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

Level 1 Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2 Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

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The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Securities: Securities available-for-sale are valued primarily by a third party pricing service. The fair values of securities available for sale are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or pricing models which utilize significant observable inputs such as matrix pricing. This is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). These models utilize the market approach with standard inputs that include, but are not limited to benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. For certain municipal securities that are not rated and observable inputs about the specific issuer are not available, fair values are estimated using observable data from other municipal securities presumed to be similar or other market data on other non-rated municipal securities (Level 3 inputs).

The Company’s Finance Department, which is responsible for all accounting and SEC compliance, and the Company’s Treasury Department, which is responsible for investment portfolio management and asset/liability modeling, are the two areas that determine the Company’s valuation policies and procedures. Both of these areas report directly to the Executive Vice President and Chief Financial Officer of the Company. For assets or liabilities that may be considered for Level 3 fair value measurement on a recurring basis, these two departments and the Executive Vice President and Chief Financial Officer determine the appropriate level of the assets or liabilities under consideration. If there are new assets or liabilities that are determined to be Level 3 by this group, the Risk Management Committee of the Company and the Audit Committee of the Board are made aware of such assets at their next scheduled meeting.

Securities pricing is obtained on securities from a third party pricing service and all security prices are tested annually against prices from another third party provider and reviewed with a market value price tolerance variance that varies by sector: municipal securities +/- 5%, government mbs/cmo +/- 3% and U.S. treasuries +/-1%. If any securities fall outside the tolerance threshold and have a variance of $100,000 or more, a determination of materiality is made for the amount over the threshold. Any security that would have a material threshold difference would be further investigated to determine why the variance exists and if any action is needed concerning the security pricing for that individual security. Changes in market value are reviewed monthly in aggregate by security type and any material differences are reviewed to determine why they exist. At least annually, the pricing methodology of the pricing service is received and reviewed to support the fair value levels used by the Company. A detailed pricing evaluation is requested and reviewed on any security determined to be fair valued using unobservable inputs by the pricing service.

Mortgage banking derivative: The fair values of mortgage banking derivatives are based on observable market data as of the measurement date (Level 2).

Interest rate swap derivatives: Our derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services. The fair value of interest rate swap derivatives is determined by pricing or valuation models using observable market data as of the measurement date (Level 2).

Impaired loans: Impaired loans with specific allocations of the allowance for loan losses are generally based on the fair value of the underlying collateral if repayment is expected solely from the collateral. Fair value is determined using several methods. Generally, the fair value of real estate is based on appraisals by qualified third party appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and result in a Level 3 classification of the inputs for determining fair value. In addition, the Company’s management routinely applies internal discount factors to the value of appraisals used in the fair value evaluation of impaired loans. The deductions to the appraisals take into account changing business factors and market conditions, as well as value impairment in cases where the appraisal date predates a likely change in market conditions. Commercial real estate is generally discounted from its appraised value by 0-50% with the higher discounts applied to real estate that is determined to have a thin trading market or to be specialized collateral. In addition to real estate, the Company’s management evaluates other types of collateral as follows: (a) raw and finished inventory is discounted from its cost or book value by 35-65%, depending on the marketability of the goods (b) finished goods are generally discounted by 30-60%, depending on the ease of marketability, cost of transportation or scope

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of use of the finished good (c) work in process inventory is typically discounted by 50-100%, depending on the length of manufacturing time, types of components used in the completion process, and the breadth of the user base (d) equipment is valued at a percentage of depreciated book value or recent appraised value, if available, and is typically discounted at 30-70% after various considerations including age and condition of the equipment, marketability, breadth of use, and whether the equipment includes unique components or add-ons; and (e) marketable securities are discounted by 10-30%, depending on the type of investment, age of valuation report and general market conditions. This methodology is based on a market approach and typically results in a Level 3 classification of the inputs for determining fair value.

Mortgage servicing rights: As of March 31, 2020, the fair value of the Company’s Level 3 servicing assets for residential mortgage loans (“MSRs”) was $3.8 million, carried at amortized cost less $246,000 in a valuation reserve, or $3.6 million. These residential mortgage loans have a weighted average interest rate of 3.90%, a weighted average maturity of 20 years and are secured by homes generally within the Company’s market area of Northern Indiana and Indianapolis. A valuation model is used to estimate fair value by stratifying the portfolios on the basis of certain risk characteristics, including loan type and interest rate. Impairment is estimated based on an income approach. The inputs used include estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, late fees, and float income. The most significant assumption used to value MSRs is prepayment rate. Prepayment rates are estimated based on published industry consensus prepayment rates. The most significant unobservable assumption is the discount rate. At March 31, 2020, the constant prepayment speed (“PSA”) used was 166 and discount rate used was 9.4%. At December 31, 2019, the PSA used was 118 and the discount rate used was 9.4%.

Other real estate owned: Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned are measured at the lower of carrying amount or fair value less costs to sell. Fair values are generally based on third party appraisals of the property and are reviewed by the Company’s internal appraisal officer. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable properties used to determine value. Such adjustments are usually significant and result in a Level 3 classification. In addition, the Company’s management may apply discount factors to the appraisals to take into account changing business factors and market conditions, as well as value impairment in cases where the appraisal date predates a likely change in market conditions. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

Real estate mortgage loans held for sale: Real estate mortgage loans held for sale are carried at the lower of cost or fair value, as determined by outstanding commitments, from third party investors, and result in a Level 2 classification.

The table below presents the balances of assets measured at fair value on a recurring basis:


	March 31, 2020
	Fair Value Measurements Using						Assets
(dollars in thousands)	Level 1		Level 2		Level 3		at Fair Value
Assets:
Mortgage-backed securities: residential	$	0	$	293,270	$	0	$	293,270
Mortgage-backed securities: commercial		0		41,814		0		41,814
State and municipal securities		0		289,096		145		289,241
Total Securities		0		624,180		145		624,325
Mortgage banking derivative		0		1,307		0		1,307
Interest rate swap derivative		0		21,565		0		21,565
Total assets	$	0	$	647,052	$	145	$	647,197

Liabilities:
Mortgage banking derivative		0		544		0		544
Interest rate swap derivative		0		21,599		0		21,599
Total liabilities	$	0	$	22,143	$	0	$	22,143

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	December 31, 2019
	Fair Value Measurements Using						Assets
(dollars in thousands)	Level 1		Level 2		Level 3		at Fair Value
Assets:
Mortgage-backed securities: residential	$	0	$	288,181	$	0	$	288,181
Mortgage-backed securities: commercial		0		36,972		0		36,972
State and municipal securities		0		282,935		145		283,080
Total Securities		0		608,088		145		608,233
Mortgage banking derivative		0		198		0		198
Interest rate swap derivative		0		7,263		0		7,263
Total assets	$	0	$	615,549	$	145	$	615,694

Liabilities:
Mortgage banking derivative		0		14		0		14
Interest rate swap derivative		0		7,860		0		7,860
Total liabilities	$	0	$	7,874	$	0	$	7,874

The fair value of Level 3 available-for-sale securities was immaterial and thus did not require additional recurring fair value disclosure.

The table below presents the balances of assets measured at fair value on a nonrecurring basis:


	March 31, 2020
	Fair Value Measurements Using						Assets
(dollars in thousands)	Level 1		Level 2		Level 3		at Fair Value
Assets
Impaired loans:
Commercial and industrial loans:
Working capital lines of credit loans	$	0	$	0	$	2,002	$	2,002
Non-working capital loans		0		0		5,332		5,332
Commercial real estate and multi-family residential loans:
Owner occupied loans		0		0		1,527		1,527
Agri-business and agricultural loans:
Loans secured by farmland		0		0		90		90
Consumer 1‑4 family mortgage loans:
Closed end first mortgage loans		0		0		459		459
Open end and junior lien loans		0		0		587		587
Residential construction loans		0		0		42		42
Total impaired loans	$	0	$	0	$	10,039	$	10,039
Other real estate owned		0		0		0		0
Total assets	$	0	$	0	$	10,039	$	10,039

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	December 31, 2019
	Fair Value Measurements Using						Assets
(dollars in thousands)	Level 1		Level 2		Level 3		at Fair Value
Assets
Impaired loans:
Commercial and industrial loans:
Working capital lines of credit loans	$	0	$	0	$	3,126	$	3,126
Non-working capital loans		0		0		6,374		6,374
Commercial real estate and multi-family residential loans:
Construction and land development loans		0		0		43		43
Owner occupied loans		0		0		1,449		1,449
Agri-business and agricultural loans:
Loans secured by farmland		0		0		57		57
Other commercial loans		0		0		0		0
Consumer 1‑4 family mortgage loans:
Closed end first mortgage loans		0		0		474		474
Open end and junior lien loans		0		0		587		587
Other consumer loans		0		0		11		11
Total impaired loans	$	0	$	0	$	12,121	$	12,121
Other real estate owned		0		0		0		0
Total assets	$	0	$	0	$	12,121	$	12,121

The following table presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a non-recurring basis at March 31, 2020:


(dollars in thousands)	Fair Value		Valuation Methodology	Unobservable Inputs	Average		Range of Inputs
Impaired loans:
Commercial and industrial	$	7,334	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability	48	%	7%-100%
Impaired loans:
Commercial real estate		1,527	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability	25	%	7%-52%
Impaired loans:
Agribusiness and agricultural		90	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability	39	%
Impaired loans:
Consumer 1‑4 family mortgage		1,088	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability	14	%	5%-100%

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The following table presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a non-recurring basis at December 31, 2019:


(dollars in thousands)	Fair Value		Valuation Methodology	Unobservable Inputs	Average		Range of Inputs
Impaired loans:
Commercial and industrial	$	9,500	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability	53	%	1%-100%
Impaired loans:
Commercial real estate		1,492	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability	27	%	7%-61%
Impaired loans:
Agribusiness and agricultural		57	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability	61	%
Impaired loans:
Consumer 1‑4 family mortgage		1,061	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability	14	%	5%-100%
Impaired loans:
Other consumer		11	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability	36	%

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a gross carrying amount of $17.4 million, with a valuation allowance of $7.4 million at March 31, 2020. The change in the fair value of impaired loans resulted in increases in the provision for loan losses of $142,000 over the three months ended March 31, 2020. The decreases was primarily due to a $3.7 million charge-off taken on an impaired commercial relationship. At March 31, 2019, impaired loans had a gross carrying amount of $19.1 million, with a valuation allowance of $9.3 million. The change in the fair value of impaired loans resulted in a reduction in the provision for loan losses of $200,000 over the three months ended March 31, 2019.

The following table contains the estimated fair values and the related carrying values of the Company’s financial instruments. Items which are not financial instruments are not included.

March 31, 2020

Carrying

Estimated Fair Value

(dollars in thousands)

Value

Level 1

Level 2

Level 3

Total

Financial Assets:

Cash and cash equivalents

$

132,581

$

129,750

$

2,831

$

0

$

132,581

Securities available-for-sale

624,325

0

624,180

145

624,325

Real estate mortgages held-for-sale

7,982

0

8,141

0

8,141

Loans, net

4,032,129

0

4,036,193

Federal Reserve and Federal Home Loan Bank Stock

13,772

N/A

Accrued interest receivable

15,433

0

3,575

11,858

15,433

Financial Liabilities:

Certificates of deposit

(1,273,413)

0

(1,289,272)

0

(1,289,272)

All other deposits

(3,008,290)

0

(3,008,290)

Other short-term borrowings

(10,500)

0

(10,500)

0

(10,500)

Federal Home Loan Bank advances

(75,000)

0

(64,166)

0

(64,166)

Standby letters of credit

(915)

0

(915)

Accrued interest payable

(10,082)

(61)

(10,021)

0

(10,082)

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	December 31, 2019
	Carrying		Estimated Fair Value
(dollars in thousands)	Value		Level 1		Level 2		Level 3		Total
Financial Assets:
Cash and cash equivalents	$	99,381	$	96,603	$	2,778	$	0	$	99,381
Securities available-for-sale		608,233		0		608,088		145		608,233
Real estate mortgages held-for-sale		4,527		0		4,614		0		4,614
Loans, net		4,015,176		0		0		3,979,006		3,979,006
Federal Reserve and Federal Home Loan Bank Stock		13,772		N/A		N/A		N/A		N/A
Accrued interest receivable		15,391		0		3,729		11,662		15,391
Financial Liabilities:
Certificates of deposit		(1,192,067)		0		(1,202,060)		0		(1,202,060)
All other deposits		(2,941,752)		(2,941,752)		0		0		(2,941,752)
Federal Home Loan Bank advances		(170,000)		0		(169,998)		0		(169,998)
Standby letters of credit		(915)		0		0		(915)		(915)
Accrued interest payable		(11,604)		(102)		(11,502)		0		(11,604)

NOTE 7. OFFSETTING ASSETS AND LIABILITIES

The following tables summarize gross and net information about financial instruments and derivative instruments that are offset in the statement of financial position or that are subject to an enforceable master netting arrangement at March 31, 2020 and December 31, 2019.


	March 31, 2020
			Gross
	Gross		Amounts		Net Amounts		Gross Amounts Not
	Amounts of		Offset in the		presented in		Offset in the Statement
	Recognized		Statement of		the Statement		of Financial Position
	Assets/		Financial		of Financial		Financial		Cash Collateral
(dollars in thousands)	Liabilities		Position		Position		Instruments		Position		Net Amount
Assets
Interest Rate Swap Derivatives	$	21,565	$	0	$	21,565	$	0	$	0	$	21,565
Total Assets	$	21,565	$	0	$	21,565	$	0	$	0	$	21,565
Liabilities
Interest Rate Swap Derivatives	$	21,599	$	0	$	21,599	$	0	$	(21,370)	$	229
Total Liabilities	$	21,599	$	0	$	21,599	$	0	$	(21,370)	$	229

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	December 31, 2019
			Gross
	Gross		Amounts		Net Amounts		Gross Amounts Not
	Amounts of		Offset in the		presented in		Offset in the Statement
	Recognized		Statement of		the Statement		of Financial Position
	Assets/		Financial		of Financial		Financial		Cash Collateral
(dollars in thousands)	Liabilities		Position		Position		Instruments		Position		Net Amount
Assets
Interest Rate Swap Derivatives	$	7,263	$	0	$	7,263	$	0	$	0	$	7,263
Total Assets	$	7,263	$	0	$	7,263	$	0	$	0	$	7,263
Liabilities
Interest Rate Swap Derivatives	$	7,860	$	0	$	7,860	$	0	$	(7,560)	$	300
Total Liabilities	$	7,860	$	0	$	7,860	$	0	$	(7,560)	$	300

If an event of default occurs causing an early termination of an interest rate swap derivative, any early termination amount payable to one party by the other party may be reduced by set-off against any other amount payable by the one party to the other party. If a default in performance of any obligation of a repurchase agreement occurs, each party will set-off property held in respect of transactions against obligations owing in respect of any other transactions.

NOTE 8. EARNINGS PER SHARE

Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period, including shares held in treasury on behalf of participants in the Company’s Directors Fee Deferral Plan and share repurchases. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock based awards and warrants, none of which were antidilutive.


	Three Months Ended March 31,
	2020		2019
Weighted average shares outstanding for basic earnings per common share		25,622,988		25,491,750
Dilutive effect of stock based awards and warrants		112,838		173,760
Weighted average shares outstanding for diluted earnings per common share		25,735,826		25,665,510

Basic earnings per common share	$	0.68	$	0.85
Diluted earnings per common share	$	0.67	$	0.84

NOTE 9. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following tables summarize the changes within each classification of accumulated other comprehensive income (loss) net of tax for the three months ended March 31, 2020 and 2019:


	Unrealized
	Gains and
	Losses on		Defined
	Available-		Benefit
	for-Sales		Pension
(dollars in thousands)	Securities		Items		Total
Balance at January 1, 2020	$	13,607	$	(1,548)	$	12,059
Other comprehensive income before reclassification		10,444		0		10,444
Amounts reclassified from accumulated other comprehensive income		0		47		47
Net current period other comprehensive income		10,444		47		10,491
Balance at March 31, 2020	$	24,051	$	(1,501)	$	22,550

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	Unrealized
	Gains and
	Losses on		Defined
	Available-		Benefit
	for-Sales		Pension
(dollars in thousands)	Securities		Items		Total
Balance at January 1, 2019	$	(4,796)	$	(1,395)	$	(6,191)
Other comprehensive income before reclassification		8,663		0		8,663
Amounts reclassified from accumulated other comprehensive income		(23)		38		15
Net current period other comprehensive income		8,640		38		8,678
Balance at March 31, 2019	$	3,844	$	(1,357)	$

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Avg


						Accumulated
						Other				Total
	Common Stock			Retained		Comprehensive		Treasury		Stockholders’		Noncontrolling		Total
	Shares	Stock		Earnings		Income (Loss)		Stock		Equity		Interest		Equity
Balance at January 1, 2019	25,128,773	$	112,383	$	419,179	$	(6,191)	$	(3,756)	$	521,615	$	89	$	521,704
Adoption of ASU 2017-08					(1,327)						(1,327)				(1,327)
Comprehensive income:
Net income					21,682						21,682				21,682
Other comprehensive income, net of tax							8,678				8,678				8,678
Cash dividends declared and paid, $0.26 per share					(6,581)						(6,581)				(6,581)
Cashless exercise of warrants	224,066		0								0				0
Treasury shares purchased under deferred directors’ plan	(4,578)		195						(195)		0				0
Treasury shares sold and distributed under deferred directors' plan	5,699		(118)						118		0				0
Stock activity under equity compensation plans	88,867		(2,089)								(2,089)				(2,089)
Stock based compensation expense			1,200								1,200				1,200
Balance at March 31, 2019	25,442,827	$	111,571	$	432,953	$	2,487	$	(3,833)	$	543,178	$	89	$	543,267

Balance at January 1, 2020	25,444,275	$	114,858	$	475,247	$	12,059	$	(4,153)	$	598,011	$	89	$	598,100
Comprehensive income:
Net income					17,299						17,299				17,299
Other comprehensive income, net of tax							10,491				10,491				10,491
Cash dividends declared and paid, $0.30 per share					(7,689)						(7,689)				(7,689)
Treasury shares purchased under share repurchase plan	(289,101)								(10,012)		(10,012)				(10,012)
Treasury shares purchased under deferred directors’ plan	(4,449)		215						(215)		0				0
Treasury shares sold and distributed under deferred directors' plan	5,748		(119)						119		0				0
Stock activity under equity compensation plans	78,099		(2,030)								(2,030)				(2,030)
Stock based compensation expense			413								413				413
Balance at March 31, 2020	25,234,572	$	113,337	$	484,857	$	22,550	$	(14,261)	$	606,483	$	89	$	606,572

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LKFN Lakeland Financial 10-Q30 Apr 202020 Q1 Quarterly report