LAKELAND BANCORP INC - Quarter Report: 2009 March (Form 10-Q)

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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)

For the quarterly period ended                    March 31, 2009

OR

For the transition period from                            to                             

Commission file number                    33-27312

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  [X]    No  [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, any Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during preceding 12 months (or such shorter period that the registrant was required to submit and post such files).            Yes  [ ]        No  [ ] The registrant is not yet subject to this requirement.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act: (Check one):

Large accelerated filer  [ ]      Accelerated filer  [X]      Non-accelerated filer  [ ]      Smaller reporting Company  [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):

Yes  [ ]        No  [X]

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of April 30, 2009 there were 23,759,102 outstanding shares of Common Stock, no par value.

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LAKELAND BANCORP, INC.

Form 10-Q Index

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Lakeland Bancorp, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements

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Lakeland Bancorp, Inc. and Subsidiaries

UNAUDITED CONSOLIDATED INCOME STATEMENTS

See accompanying notes to consolidated financial statements

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Lakeland Bancorp, Inc. and Subsidiaries

UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Three Months ended March 31, 2009

See accompanying notes to consolidated financial statements

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Lakeland Bancorp, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS-(UNAUDITED)

See accompanying notes to consolidated financial statements

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (UNAUDITED)

Note 1. Significant Accounting Policies

Basis of Presentation.

This quarterly report presents the consolidated financial statements of Lakeland Bancorp, Inc. (the Company) and its subsidiary, Lakeland Bank (Lakeland).

The Company’s financial statements reflect all adjustments and disclosures which management believes are necessary for a fair presentation of interim results. The results of operations for the quarter presented do not necessarily indicate the results that the Company will achieve for all of 2009. You should read these interim financial statements in conjunction with the consolidated financial statements and accompanying notes that are presented in the Lakeland Bancorp, Inc. Annual Report on Form 10-K for the year ended December 31, 2008 (the 10-K).

The financial information in this quarterly report has been prepared in accordance with the Company’s customary accounting practices; these financial statements have not been audited. Certain information and footnote disclosures required under generally accepted accounting principles have been condensed or omitted, as permitted by rules and regulations of the Securities and Exchange Commission.

All weighted average, actual shares and per share information set forth in this quarterly report on Form 10-Q have been adjusted retroactively for the effects of stock dividends.

Note 2. Stock-Based Compensation

The Company established the 2000 Equity Compensation Program which authorizes the granting of incentive stock options and supplemental stock options to employees of the Company, including those employees serving as officers and directors of the Company. The plan authorizes options to purchase up to 2,257,368 shares of common stock of the Company. The Company has no option awards with market or performance conditions attached to them. The Company’s stock option program allows for the grant of restricted shares, as well as stock option grants. The Company generally issues shares for option exercises from its treasury stock.

Share-based compensation expense of $108,000 and $45,000 and related income tax benefits of $38,000 and $16,000 were recognized for the three months ended March 31, 2009 and 2008, respectively. As of March 31, 2009, there was unrecognized compensation cost of $1.3 million related to unvested restricted stock; that cost is expected to be recognized over a weighted average period of less than four years. Unrecognized compensation expense related to unvested stock options was approximately $87,000 as of March 31, 2009 and is expected to be recognized over a period of less than three years.

There were no grants of stock options in the first quarter of 2009 or 2008. On January 14, 2009, the Company granted 14,452 shares of restricted stock at a market value of $9.26. There were no grants of restricted shares in the first quarter of 2008.

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Option activity under the Company’s stock option plans as of March 31, 2009 is as follows:

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the first quarter of 2009 and the exercise price, multiplied by the number of in the money options).

Stock options outstanding were 852,459 and 1,149,276 at March 31, 2009 and 2008, respectively. The aggregate intrinsic value of options exercised during the first three months ended March 31, 2009 and 2008 was $1,000 and $15,000, respectively. Exercise of stock options during the first three months of 2009 and 2008 resulted in cash receipts of $6,000 and $16,000, respectively.

Information regarding the Company’s restricted stock (all unvested) and changes during the three months ended March 31, 2009 is as follows:

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Note 3. Comprehensive Income

The components of other comprehensive income (loss) are as follows:

Note 4. Statement of Cash Flow Information.

Note 5. Earnings Per Share.

Basic earnings per share for a particular period of time is calculated by dividing net income by the weighted average number of common shares outstanding during that period.

Diluted earnings per share is calculated by dividing net income by the weighted average number of outstanding common shares and common share equivalents. The Company’s outstanding “common share equivalents” are options to purchase its common stock and a warrant issued to the United States Treasury to purchase its common stock.

All weighted average, actual shares and per share information set forth in this quarterly report on Form 10-Q have been adjusted retroactively for the effects of stock dividends. The following schedule shows the Company’s earnings per share for the

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periods presented:

Options to purchase 741,771 shares of common stock at a weighted average price of $13.28 per share, a warrant to purchase 949,571 shares of common stock at a price of $9.32 per share and 128,408 shares of restricted stock at a weighted average price of $12.16 per share were outstanding and were not included in the computation of diluted earnings per share for the three months ended March 31, 2009 because the exercise price and the grant-date price were greater than the average market price. Options to purchase 924,530 shares of common stock at a weighted average price of $14.03 per share and 18,354 shares of restricted stock at a weighted average price of $13.95 per share were outstanding and were not included in the computations of diluted earnings per share for the three months ended March 31, 2008.

Note 6. Investment Securities

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Management has evaluated the securities in the above table and has concluded that none of these securities has impairments that are other-than-temporary. In its evaluation, management considered the types of securities including if the securities were US government issued, and what the credit rating was on the securities. Most of the securities that are in an unrealized loss position are in a loss position because of changes in interest rates since the securities were purchased. The securities that have been in an unrealized loss position for 12 months or longer include US government agency securities and mortgage backed securities whose market values are sensitive to interest rates. The corporate securities and the obligations of state and political subdivisions listed in the above table are investment grade securities.

Note 7. Loans and Leases.

The Company follows Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan” (known as “SFAS No. 114”), and Statement of Financial Accounting Standards No. 118, “Accounting by Creditors for Impairment of a Loan, Income Recognition and Disclosures.” Impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral-dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable.

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The following table shows the Company’s recorded investment in impaired loans and leases and the related valuation allowance calculated under SFAS No. 114 as of March 31, 2009 and 2008, and the average recorded investment in impaired loans and leases during the three months preceding those dates:

Interest received on impaired loans and leases may be recorded as interest income. However, if management is not reasonably certain that an impaired loan will be repaid in full, or if a specific time frame to resolve full collection cannot yet be reasonably determined, all payments received are recorded as reductions of principal. The Company recognized interest on impaired loans and leases of $2,000 in the three months ended March 31, 2009. Interest that would have accrued had the loans and leases performed under original terms would have been $440,000 for the three months ended March 31, 2009.

Note 8. Employee Benefit Plans

The components of net periodic pension cost for the Newton Trust Company defined pension plan are as follows:

Note 9. Directors’ Retirement Plan

The components of net periodic plan costs for the directors’ retirement plan are as follows:

The Company made contributions of $80,000 to the plan in the three months ended March 31, 2009 and does not expect to make any more contributions in 2009.

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Note 10. Fair Value Measurements

Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements” (SFAS No. 157) defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels giving the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest level priority to unobservable inputs (level 3 measurements). The following describes the three levels of fair value hierarchy:

Level 1 – unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 – Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (such as interest rates, yield curves, volatilities, etc.)

Level 3 – unobservable inputs for the asset or liability – these shall be used to the extent that observable inputs are not available allowing for situations in which there is little, if any, market activity available.

The following table sets forth the Company’s financial assets that were accounted for at fair values as of March 31, 2009 by level within the fair value hierarchy. The Company had no liabilities accounted for at fair value as of March 31, 2009. As required by SFAS No. 157, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement:

*Impaired loans and leases are measured on a nonrecurring basis because they are valued at the lower of cost or market value.

Impaired loans and leases are evaluated and valued at the time the loan is identified as impaired at the lower of cost or market value. Market value is measured based on the value of the collateral securing these loans and leases and is classified at a level 3 in the fair value hierarchy. Collateral may be real estate, accounts receivable, equipment and/or other business assets. The value of the real estate is assessed based on appraisals by qualified third party licensed appraisers. The value of the equipment is determined by an appraiser, if significant, or by the value on the borrower’s financial statements. Field examiner reviews on business assets are conducted based on the loan exposure and reliance on this type of collateral. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Impaired loans and leases are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above. Impaired loans and leases were $21.8 million and $14.1 million at March 31, 2009 and December 31, 2008, respectively. During the first quarter of 2009, there were new impaired loans and leases of $13.1 million, payments of $1.4 million, charge-offs of $3.5 million and repossessions of $606,000.

Note 11. Preferred Stock

Under the Emergency Economic Stabilization Act of 2008, the United States Treasury Department implemented the Troubled Asset Relief Program (TARP) Capital Purchase Program (CPP), whereby the Treasury Department committed to purchase up to $250 billion of senior preferred shares from qualifying banks, savings associations, and bank holding companies engaged only in financial activities. On February 6, 2009, under the CPP, the Company issued 59,000 shares of its Fixed Rate

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Cumulative Perpetual Preferred Stock, Series A (the “Series A preferred stock”) to the Treasury Department for a purchase price of $59.0 million. The Series A stock has a 5% annual dividend rate for the first five years and a 9% annual dividend thereafter if the preferred shares are not redeemed by the Company. The Company may redeem the Series A preferred stock with the consent of the Treasury Department in conjunction with the Company’s primary regulator.

In conjunction with the issuance of our Series A preferred stock, the Company also issued a warrant to purchase 949,571 shares of the Company’s common stock to the Treasury Department. The warrant has a 10-year term and is immediately exercisable at an exercise price, subject to anti-dilution adjustments, of $9.32 per share.

The proceeds from the Treasury Department are allocated to the Series A preferred stock and the warrant based on their relative fair value. The fair value of the Series A preferred stock was determined through a discounted future cash flow model. A Black-Scholes pricing model was used to calculate the fair value of the warrant. The Black-Scholes model includes assumptions regarding the Company’s dividend yield, stock price volatility, and the risk-free interest rate.

The Company calculated a discount on the Series A preferred stock in the amount of approximately $3.3 million which is being amortized over a 5 year period. The effective yield on the amortization of the Series A Preferred Stock is approximately 6.36%. In determining net income available to common shareholders, the periodic amortization and the cash dividend on the preferred stock are subtracted from net income.

Note 12. Recent Accounting Pronouncements

In March, 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS No. 161”), which amends SFAS No. 133. The statement requires enhanced disclosures about an entity’s derivative and hedging activities, specifically, how and why an entity uses derivative instruments; how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations; how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for all entities for fiscal years and interim periods beginning after November 15, 2008. The adoption of SFAS No. 161 did not have a significant impact on the Company’s consolidated financial statements.

In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” (“SFAS No. 162”). This statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements presented in conformity with generally accepted accounting principles (GAAP) in the United States. The statement is not expected to result in a change in current practice nor have a material impact on the Company.

In April 2008, the FASB posted FASB Staff Position (FSP) No. 142-3, “Determination of the Useful Life of Intangible Assets,” (“FSP FAS 142-3”). This statement amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets. The intent of the FSP is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows, particularly as used to measure fair value in business combinations. The FSP is effective for fiscal years beginning after December 15, 2008, and did not have a material effect on the Company’s financial position, results of operations or cash flows.

In June 2008, the FASB posted FASB Staff Position No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” (“FSP EITF 03-6-1”). This statement addressed whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the calculation of earnings per share (EPS) as described in FASB Statement No. 128, Earnings per Share. The FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008 with prior period EPS data adjusted retrospectively to conform to its provisions, and did not have a material effect on the Company’s EPS.

In December 2008, the FASB issued FASB Staff Position No. 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets.” This FASB staff position amends FASB Statement No. 132 to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. FSP FAS 132(R)-1 requires disclosure of

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the fair value of each major category of plan assets for pension plans and other postretirement benefit plans as of the annual reporting date. This FASB staff position becomes effective for fiscal years ending after December 15, 2009. The Company is currently evaluating the impact of adopting FSP FAS 132(R)-1 on the consolidated financial statements, but it is not expected to have a material impact.

On April 9, 2009, the FASB issued the following three final staff positions that were intended to provide additional guidance and enhance disclosures regarding fair value measurements and impairments of securities:

The three final staff positions are effective for interim and annual periods ending after June 15, 2009. The Company is currently evaluating the effect that these three staff positions will have on its consolidated financial statements.

On April 13, 2009, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 111, “Other Than Temporary Impairment of Certain Investments in Equity Securities” (SAB 111). SAB 111 provides guidance on how to evaluate equity securities for other than temporary impairment and when a write-down of the carrying value is required. There was no material impact on the Company’s consolidated financial statements upon adoption.

PART I – ITEM 2

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

You should read this section in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. All weighted average, actual share and per share information set forth in this Quarterly Report on Form 10-Q has been adjusted retroactively for the effects of stock dividends.

Statements Regarding Forward Looking Information

The information disclosed in this document includes various forward-looking statements that are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 with respect to credit quality (including delinquency trends and the allowance for loan and lease losses), corporate objectives, and other financial and business matters. The words “anticipates,” “projects,” “intends,” “estimates,” “expects,” “believes,” “plans,” “may,” “will,” “should,” “could,” and other similar expressions are intended to identify such forward-looking statements. The Company cautions that these forward-looking statements are necessarily speculative and speak only as of the date made, and are subject to numerous assumptions, risks and uncertainties, all of which may change over time. Actual results could differ materially from such forward-looking statements.

In addition to the risk factors disclosed elsewhere in this document, the following factors, among others, could cause the

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Company’s actual results to differ materially and adversely from such forward-looking statements: changes in the financial services industry and the U.S. and global capital markets, changes in economic conditions nationally, regionally and in the Company’s markets, the nature and timing of actions of the Federal Reserve Board and other regulators, the nature and timing of legislation affecting the financial services industry, government intervention in the U.S. financial system, passage by the U.S. Congress of legislation which unilaterally amends the terms of the U.S. Treasury Department’s preferred stock investment in the Company, changes in levels of market interest rates, pricing pressures on loan and deposit products, credit risks of the Company’s lending and leasing activities, customers’ acceptance of the Company’s products and services and competition.

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.

Significant Accounting Policies, Judgments and Estimates

The accounting and reporting policies of the Company and its subsidiaries conform with accounting principles generally accepted in the United States of America and predominant practices within the banking industry. The consolidated financial statements include the accounts of the Company, Lakeland, Lakeland Investment Corp. and Lakeland NJ Investment Corp. All intercompany balances and transactions have been eliminated.

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. These estimates and assumptions also affect reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Significant estimates implicit in these financial statements are as follows:

The principal estimates that are particularly susceptible to significant change in the near term relate to the allowance for loan and lease losses, the valuation of the Company’s securities portfolio, the analysis of goodwill impairment and the Company’s deferred tax assets. The evaluation of the adequacy of the allowance for loan and lease losses includes, among other factors, an analysis of historical loss rates, by category, applied to current loan totals. However, actual losses may be higher or lower than historical trends, which vary. Actual losses on specified problem loans and leases, which also are provided for in the evaluation, may vary from estimated loss percentages.

The allowance for loan and lease losses is established through a provision for loan and lease losses charged to expense. Loan principal considered to be uncollectible by management is charged against the allowance for loan and lease losses. The allowance is an amount that management believes will be adequate to absorb losses on existing loans and leases that may become uncollectible based upon an evaluation of known and inherent risks in the loan portfolio. The evaluation takes into consideration such factors as changes in the nature and size of the loan portfolio, overall portfolio quality, specific problem loans and leases, and current economic conditions which may affect the borrowers’ ability to pay. The evaluation also details historical losses by loan category, the resulting loss rates for which are projected at current loan total amounts. Loss estimates for specified problem loans and leases are also detailed. All of the factors considered in the analysis of the adequacy of the allowance for loan and lease losses may be subject to change. To the extent actual outcomes differ from management estimates, additional provisions for loan and lease losses may be required that would adversely impact earnings in future periods.

The Company accounts for impaired loans and leases in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended by SFAS No. 118, “Accounting by Creditors for Impairment of a Loan—Income Recognition and Disclosures.” Impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral-dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable.

Effective January 1, 2008, we adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements”. We also adopted Financial Accounting Standards Board (FASB) Staff Position (FSP) No. FAS 157-3 which provided additional guidance on valuation and disclosures. Fair values are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates, credit ratings and yield curves. Fair values for investment securities

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are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on the quoted prices of similar instruments or an estimate of fair value by using a range of fair value estimates in the market place as a result of the illiquid market specific to the type of security.

When the fair value of a security is below its amortized cost, and depending on the length of time the condition exists and the extent the fair value is below amortized cost, additional analysis is performed to determine whether an other-than-temporary impairment condition exists. Available-for-sale and held-to-maturity securities are analyzed quarterly for possible other-than-temporary impairment. The analysis considers (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Often, the information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment. If actual information or conditions are different than estimated, the extent of the impairment of the security may be different than previously estimated, which could have a material effect on the Company’s results of operations and financial condition.

The Company accounts for income taxes under the liability method of accounting for income taxes. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates that will be in effect when these differences reverse. Deferred tax expense is the result of changes in deferred tax assets and liabilities. The principal types of differences between assets and liabilities for financial statement and tax return purposes are the allowance for loan and lease losses, deferred loan fees, deferred compensation and securities available for sale.

The Company evaluates tax positions that may be uncertain. FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes (FIN 48),” prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. Additional information regarding the Company’s uncertain tax positions is set forth in Note 9 to the Financial Statements of the Company’s Form 10-K for the year ended December 31, 2008.

The Company accounts for goodwill and other identifiable intangible assets in accordance with SFAS No. 142, “Goodwill and Intangible Assets.” SFAS No. 142 includes requirements to test goodwill and indefinite lived intangible assets for impairment rather than amortize them. The Company tests goodwill for impairment annually at the reporting unit level. The Company has determined that it has one reporting unit, Community Banking. The Company analyzes goodwill using various market valuation methodologies including an analysis of the Company’s enterprise value and a comparison of pricing multiples in recent acquisitions of similar companies and applying these multiples to the Company. The Company has tested the goodwill as of December 31, 2008 and has determined that it is not impaired.

Results of Operations

(First Quarter 2009 Compared to First Quarter 2008)

Net Income

Net income for the first quarter of 2009 was $3.2 million, compared to $5.5 million for the same period in 2008, a decrease of $2.4 million or 43%. Diluted earnings per share were $0.11 for the first quarter of 2009, a $0.13 or 54% decrease over what was reported for the same period last year. Return on Average Assets was 0.48% and Return on Average Common Equity was 5.76% for the first quarter of 2009.

First quarter net income in 2009 declined compared to the same period in 2008 due to a $5.1 million increase in the provision for loan and lease losses. This will be discussed in further detail below.

Net Interest Income

Net interest income on a tax equivalent basis for the first quarter of 2009 was $23.2 million, a $2.4 million or 11% increase from the $20.8 million earned in the first quarter of 2008. The increase in net interest income primarily resulted from a decrease in the cost of interest bearing liabilities. The components of net interest income will be discussed in greater detail below.

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The following table reflects the components of the Company’s net interest income, setting forth for the periods presented, (1) average assets, liabilities and stockholders’ equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) the Company’s net interest spread (i.e., the average yield on interest-earning assets less the average cost of interest-bearing liabilities) and (5) the Company’s net interest margin. Rates are computed on a tax equivalent basis using a tax rate of 35%.

Interest income on a tax equivalent basis decreased from $36.5 million in the first quarter of 2008 to $34.5 million in 2009, a decrease of $2.0 million or 6%. The decrease in interest income was due to a 71 basis point decrease in average rates earned on interest earning assets. Average loans and investment securities increased by $135.6 million and $8.2 million, respectively.

Total interest expense decreased from $15.7 million in the first quarter of 2008 to $11.3 million in the first quarter of 2009, a decrease of $4.4 million, or 28%. Average interest-bearing liabilities increased $90.4 million, but the cost of those liabilities decreased from 3.11% in 2008 to 2.15% in 2009. The decrease in liability yields reflects the decrease in short term interest rates, as the Federal Reserve Bank lowered the federal funds target rate from 2.25% at the end of the first quarter of 2008 to a range between 0% and .25% at the end of the first quarter of 2009. Lakeland lowered its deposit rates to reflect the lower interest rate environment. Average deposits increased from $1.98 billion in the first quarter of 2008 to $2.06 billion in the first quarter of 2009, an increase of $82.9 million, or 4 %. Average borrowings increased from $326.5 million in 2008 to $341.7

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million in 2009 to fund loan growth. The average rate paid on these borrowings declined 65 basis points due to the declining rate environment. In the first quarter of 2009, the Company received $59.0 million in proceeds from the issuance of preferred stock and a warrant to the U. S. Treasury Department. These funds were invested in loans and investment securities.

Provision for Loan and Lease Losses

In determining the provision for loan and lease losses, management considers historical loan loss experience, changes in composition and volume of the portfolio, the level and composition of non-performing loans and leases, the adequacy of the allowance for loan and lease losses, and prevailing economic conditions.

The provision for loan and lease losses increased to $6.4 million for the first quarter of 2009 from $1.3 million for the same period last year as a result of management’s evaluation of the adequacy of the allowance for loan and lease losses. During the first quarter of 2009, the Company charged off loans of $6.5 million and recovered $680,000 in previously charged off loans compared to $587,000 and $91,000, respectively, during the same period in 2008. The higher provision for loan and lease losses in the first quarter of 2009 compared to the first quarter of 2008 reflects a higher level of non-performing loans and leases and net charge-offs. The provision in the first quarter of 2009 included $5.8 million for the Company’s leases compared to $433,000 for the same period last year. For more information regarding the determination of the provision, see “Risk Elements” under “Financial Condition.”

Noninterest Income

Noninterest income increased $330,000, or 7%, from the first quarter of 2008 to the first quarter of 2009. This increase was primarily due to an increase in gain on sales of investment securities of $876,000 partially offset by a $499,000 decrease in other income. The majority of the decrease in other income can be attributed to a $452,000 decrease in gain on sales of leases. Commissions and fees decreased from $952,000 in the first quarter of 2008 to $823,000 in the first quarter of 2009 due to a decrease in loan fees.

Noninterest Expense

Noninterest expense increased from $15.3 million in the first quarter of 2008 to $16.8 million in the first quarter of 2009, an increase of $1.4 million or 9%. Salaries and employee benefits expense increased $179,000 or 2% to $8.6 million in the first quarter of 2009. Net occupancy expense increased by $236,000 or 14% to $1.9 million in the first quarter of 2009 from the first quarter of 2008 due primarily to expenses incurred in two new branch offices. Marketing expense increased from $458,000 in the first quarter of 2008 to $557,000 in the first quarter of 2009 as a result of deposit promotions and new branch openings. Stationery, supplies and postage decreased from $464,000 in the first quarter of 2008 to $420,000 in the first quarter of 2009 due to a reduction in mailings. FDIC expense increased from $300,000 in the first quarter of 2008 to $900,000 in 2009 as a result of increased assessment rates. Other expenses increased by $377,000 or 15% to $2.9 million in the first quarter of 2009 primarily due to an increase in collection fees of $454,000 compared to the first quarter of 2008. The Company’s efficiency ratio was 60.0% in the first quarter of 2009, compared to 59.2% for the same period last year. The efficiency ratio expresses the relationship between noninterest expense (excluding other real estate expense and core deposit amortization) to total tax-equivalent revenue (excluding gains (losses) on sales of securities).

Income Taxes

The Company’s effective tax rate decreased from 34.8% in the first quarter of 2008 to 33.0% in the first quarter of 2009 because the Company’s pre-tax income decreased $3.8 million or 44% from the first quarter of 2008 to the first quarter of 2009. Tax-exempt income as a percent of pre-tax income increased, resulting in a decline in the effective tax rate.

Financial Condition

The Company’s total assets increased $33.4 million or 1% from $2.64 billion at December 31, 2008, to $2.68 billion at March 31, 2009. Total deposits decreased from $2.06 billion on December 31, 2008 to $2.04 billion on March 31, 2009, a

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decrease of $21.0 million or 1%. Long-term debt remained the same at $210.9 million from December 31, 2008 to March 31, 2009.

Loans and Leases

Gross loans and leases remained the same at $2.03 billion from December 31, 2008 to March 31, 2009. Within the loan portfolio, mortgages increased $21.0 million from December 31, 2008 to March 31, 2009. Commercial loans increased $12.9 million in the first three months of 2009. Leases declined from $311.5 million on December 31, 2008 to $276.2 million on March 31, 2009. For more information on the loan portfolio, see Note 7 in Notes to the Consolidated Financial Statements in this Quarterly Report on Form 10-Q.

Risk Elements

The following schedule sets forth certain information regarding the Company’s non-accrual, past due and renegotiated loans and leases and other real estate owned on the dates presented:

Non-performing assets increased from $20.5 million on December 31, 2008, or 0.78% of total assets, to $27.3 million, or 1.02% of total assets, on March 31, 2009. Non-performing assets included $15.0 million related to leases. Loans and leases past due ninety days or more and still accruing at March 31, 2009 increased $2.2 million to $3.1 million from $825,000 on December 31, 2008. Loans and leases past due 90 days or more and still accruing are those loans and leases that are both well-secured and in process of collection.

On March 31, 2009, the Company had $21.8 million in impaired loans and leases (consisting primarily of non-accrual loans and leases) compared to $14.1 million at year-end 2008. For more information on these loans and leases see Note 7 in Notes to the Consolidated Financial Statements of this Quarterly Report on Form 10-Q. The impairment of the loans and leases is measured using the present value of future cash flows on certain impaired loans and leases and is based on the fair value of the underlying collateral for the remaining loans and leases. Based on such evaluation, $6.5 million has been allocated as a portion of the allowance for loan and lease losses for impairment at March 31, 2009. At March 31, 2009, the Company also had $37.7 million in loans and leases that were rated substandard that were not classified as non-performing or impaired.

There were no loans and leases at March 31, 2009, other than those designated non-performing, impaired or substandard, where the Company was aware of any credit conditions of any borrowers or obligors that would indicate a strong possibility of the borrowers not complying with present terms and conditions of repayment and which may result in such loans and leases being included as non-accrual, past due or renegotiated at a future date.

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The following table sets forth for the periods presented, the historical relationships among the allowance for loan and lease losses, the provision for loan losses, the amount of loans and leases charged-off and the amount of loan recoveries:

The ratio of the allowance for loan and lease losses to loans and leases outstanding reflects management’s evaluation of the underlying credit risk inherent in the loan portfolio. The determination of the adequacy of the allowance for loan and lease losses and periodic provisioning for estimated losses included in the consolidated financial statements is the responsibility of management and the Board of Directors. The evaluation process is undertaken on a quarterly basis.