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LAKELAND BANCORP, INC.

Form 10-Q Index

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 2003. 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, 2002.

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.

Stock-Based Compensation

The Company follows the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” which contains a fair value-based method for valuing stock-based compensation that entities may use, which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. Alternatively, the standard permits entities to continue accounting for employee stock options and similar equity instruments under Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.” Entities that continue to account for stock options using APB Opinion No. 25 are required to make pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied.

At June 30, 2003, the Company had four stock-based employee and director compensation plans, which are more fully described in the Company’s Annual Report on Form 10-K. The Company accounts for these plans under the recognition and measurement principles of APB No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Stock-based employee and director compensation costs are not reflected in net income, as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, to stock-based employee compensation (in thousands, except per share amounts).

Stock Options outstanding were 704,483 and 643,871 at June 30, 2003 and 2002, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted average assumptions used for grants in 2002: dividend rate of 2%, expected volatility of 35%, risk-free interest rate of 3.40% and expected lives of 7 years. The Company did not grant stock options during the six months ended June 30, 2003.

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Note 2. Statement of Cash Flow Information.

Note 3. 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 only outstanding “common share equivalents” are options to purchase its common stock. All weighted average, actual shares and per share information has been adjusted retroactively for the effects of stock dividends.

       The following schedule shows the Company’s earnings per share for the periods presented:

Note 4. Investment Securities

Note 5. Impaired Loans

       The Company follows Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan” (known as “SFAS No. 114”), as amended by SFAS No. 118, “Accounting by Creditors for Impairment of a Loan, Income Recognition and Disclosures.” SFAS No. 114 requires that certain impaired loans be measured based on the present value of expected future cash flows, discounted at the loan’s original effective interest rate.

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       The following table shows the Company’s recorded investment in impaired loans and the related valuation allowance calculated under SFAS No. 114 as of June 30, 2003 and 2002, and the average recorded investment in impaired loans during the three months preceding those dates:

       Interest received on impaired loans ordinarily is recorded as interest income. However, if management is not reasonably certain that an impaired loan will be repaid in full, or if a specific timeframe 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 of $215,000 in the first six months of 2003. Interest that would have accrued had the loans performed under original terms would have been $983,000 for the first six months of 2003.

Note 6. Subordinated Debentures

       On June 18, 2003, the Company issued $10.3 million of junior subordinated debentures due July 7, 2033 to Lakeland Bancorp Capital Trust I, a Delaware business trust, which is a wholly-owned subsidiary of the Company. The distribution rate on these securities is 6.20% for 7 years and float at LIBOR plus 310 basis points thereafter. The debentures are the sole asset of the Trust. The Trust issued 10,000 shares of trust preferred securities, $1,000 face value, for total proceeds of $10.0 million. The Company’s obligations under the debentures and related documents, taken together, constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the Trust’s obligations under the preferred securities. The preferred securities are redeemable by the Company on or after July 7, 2010, or earlier if the deduction of related interest for federal income taxes is prohibited, treatment as Tier I capital is no longer permitted, or certain other contingencies arise. The preferred securities must be redeemed upon maturity of the debentures in 2033.

On June 18, 2003, the Company also issued $20.6 million of junior subordinated debentures due June 30, 2033 to Lakeland Bancorp Capital Trust II, a Delaware business trust, which is a wholly-owned subsidiary of the Company. The distribution rate on these securities is 5.71% for 5 years and float at LIBOR plus 310 basis points thereafter. The Debentures are the sole asset of the Trust. The Trust issued 20,000 shares of trust preferred securities, $1,000 face value, for total proceeds of $20.0 million. The Company’s obligations under the debentures and related documents, taken together, constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the Trust’s obligations under the preferred securities. The preferred securities are redeemable by the Company on or after June 30, 2008, or earlier if the deduction of related interest for federal income taxes is prohibited, treatment as Tier I capital is no longer permitted, or certain other contingencies arise. The preferred securities must be redeemed upon maturity of the debentures in 2033.

       The ability of the Company’s banking subsidiaries to pay dividends or extend credit to the Company is subject to legal and regulatory limitations.

       The proceeds from the above transactions will be used to finance the acquisition of CSB Financial Corp and for other corporate purposes.

Note 7. New Accounting Pronouncements

       The Company adopted Statement of Financial Accounting Standard 149 (SFAS No. 149), Amendment of Statement 133 on Derivative Instruments and Hedging Activities, on July 1, 2003. SFAS No. 149 clarifies and amends SFAS No. 133 for implementation issues raised by constituents or includes the conclusions reached by the FASB on certain FASB Staff Implementation Issues. Statement 149 also amends SFAS No. 133 to require a lender to account for loan commitments related to mortgage loans that will be held for sale as derivatives. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. The Company periodically enters into commitments with its customers, which it intends to sell in the future. Management does not anticipate the adoption of SFAS No. 149 to have a material impact on the Company’s financial position or results of operations.

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       The FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, on May 15, 2003. SFAS No. 150 changes the classification in the statement of financial position of certain common financial instruments from either equity or mezzanine presentation to liabilities and requires an issuer of those financial statements to recognize changes in fair value or redemption amount, as applicable, in earnings. SFAS No. 150 is effective for public companies for financial instruments entered into or modified after May 31, 2003 and is effective at the beginning of the first interim period beginning after June 15, 2003. Management has not entered into any financial instruments that would qualify under SFAS No. 150. The Company currently classifies its Guaranteed Preferred Beneficial Interest in the Company’s Subordinated Debt as a liability. As a result, management does not anticipate the adoption of SFAS No. 150 to have a material impact on the Company’s financial position or results of operations.

       The Company adopted FASB Interpretation 45 (FIN 45) Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others on January 1, 2003. FIN 45 requires a guarantor entity, at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company has financial and performance letters of credit. Financial letters of credit require the Company to make payment if the customer’s financial condition deteriorates, as defined in the agreements. Performance letters of credit require the Company to make payments if the customer fails to perform certain non-financial contractual obligations. The Company previously did not record a liability when guaranteeing obligations unless it became probable that the Company would have to perform under the guarantee. FIN 45 applies prospectively to guarantees the Company issues or modifies subsequent to December 31, 2002.

       The maximum potential undiscounted amount of future payments of these letters of credit as of June 30, 2003 is $6.1 million and they expire through 2016. Amounts due under these letters of credit would be reduced by any proceeds that the Company obtained in liquidating the collateral for the loans, which varies depending on the customer.

       In January 2003, the FASB issued FASB Interpretation 46 (FIN 46), Consolidation of Variable Interest Entities. FIN 46 clarifies the application of Accounting Research Bulletin 51, Consolidated Financial Statements, for certain entities that do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest (“variable interest entities”). Variable interest entities within the scope of FIN 46 will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected returns, or both. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. In June 2003, the Company, through Lakeland Bancorp Capital Trust I and Lakeland Bancorp Capital Trust II (the Trusts), issued trust preferred securities as further discussed in Note 6. Management has determined that the Trusts quality as variable interest entities under FIN 46. The Trusts issued mandatory redeemable preferred stock to investors and loaned the proceeds to the Company. The Trusts hold, as their sole assets, subordinated debentures issued by the Company in June 2003. The timing and amount of payments on the subordinated debentures are the same as the timing and amount of payments by The Trusts on the mandatory redeemable preferred stock. The Trusts are currently included in the Company's consolidated financial statements. Management believes that the Trusts should continue to be included in the Company's consolidated financial statements after the effective date of FIN 46. However, as additional interpretations related to entities similar to the Trusts become available, management will reevaluate its conclusion that the Trusts should be included in the consolidated financial statements and its potential impact to its Tier I capital calculation under such interpretations.

Note 8. Merger and Acquisition

       As previously announced, the Company and Lakeland have entered into a definitive agreement with Community State Bank and its holding company, CSB Financial Corp., pursuant to which Community and CSB will be merged into Lakeland and the Company. CSB shareholders have the right to elect to receive shares of the Company’s common stock or cash in the merger, subject to specified allocation provisions. CSB shareholders receiving cash will receive $29.00 for each of their shares; CSB shareholders receiving stock will receive 1.781 shares of Lakeland Bancorp stock. The Company values this transaction at approximately $34 million, based on 1.1 million shares of CSB stock outstanding and 166,000 CSB stock options outstanding. CSB’s shareholders approved the merger on August 5, 2003. The Company had received all necessary regulatory approvals as of August 6, 2003. The merger is subject to customary closing conditions. The parties expect the merger to close by August 25, 2003.

Note 9. Commitments and Contingencies

       Litigation

       Reference is made to the Company’s Annual Report on Form 10-K for a description of the Company’s involvement in the cases pending in In re Commercial Money Center, Inc. Equipment Lease Litigation in the United States District Court for the Northern District of Ohio, Eastern Division, MDL Case No. 1:02-CV-16000 (the “MDL Proceedings”) and the pending bankruptcy proceedings of Commercial Money Center, Inc. and Commercial Servicing Corporation, Case No. 02-09721-H (United States Bankruptcy Court, Southern District of California) (the “Bankruptcy Proceedings”).

       On June 11, 2003, the California Bankruptcy Court approved a settlement agreement (the “Amended Lakeland Agreement”) among Lakeland Bank (“Lakeland”), NetBank and the chapter 7 bankruptcy trustee (the “Trustee”). The Amended Lakeland Agreement resolved all claims of the Trustee with respect to the leases that were guaranteed by surety bonds issued by RLI Insurance Company (“RLI”) and American Motorists Insurance Company (“AMICO”), as well as all claims related to the surety bonds. The Amended Lakeland Agreement did not settle the Trustee’s alleged claims related to the leases guaranteed with surety bonds issued by Royal Indemnity Company (“Royal”) or its claims related to those surety bonds.

       Pursuant to the Amended Lakeland Agreement, Lakeland paid the bankruptcy estate $700,980 in cash from the lease portfolio funds held in escrow by the Trustee and is required to pay 14.17% of Lakeland’s recovery (up to a maximum of $851,190) from RLI and AMICO in the MDL Proceedings. Lakeland is also required to pay the Trustee 38% of all future income derived from the RLI and AMICO leases and related collateral. Lakeland intends to seek recovery against RLI, AMICO and Royal for the amounts paid pursuant to this settlement.

       In addition to approving the Amended Lakeland Agreement, the California Bankruptcy Court approved a settlement agreement between the Trustee and Royal (the “Amended Royal Agreement”). Under the Amended Royal Agreement, Royal has agreed, among other things, to fund litigation by the Trustee against Lakeland to avoid its interests in the leases that were guaranteed by surety bonds issued by Royal, as well as Lakeland’s interests in the surety bonds themselves. Lakeland intends to vigorously defend these claims and to pursue recovery from Royal for all damages suffered and costs incurred as a result of Royal’s financing of these claims.

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, 2002.

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 factors disclosed by the Company elsewhere in this document, the following factors, among others, could cause the Company’s actual results to differ materially and adversely from such forward-looking statements: pricing pressures on loan and deposit products; competition; changes in economic conditions nationally, regionally and in the Company’s markets; the extent and timing of actions of the Federal Reserve Board; changes in levels of market interest rates; clients’ acceptance of the Company’s products and services; credit risks of lending activities and competitive factors; whether or not the Company ultimately receives payment of all amounts due from the lease portfolio as described in Note 9 - Commitments and Contingencies in the Notes to the Consolidated Financial Statements in this Quarterly Report on Form 10-Q; changes in the conditions of the capital markets in general and in the capital markets for financial institutions in particular and the impact of the war in Iraq on such markets; the ability of the Company to integrate Community State Bank promptly into the Company’s overall business and plans if the pending merger with Community State Bank (and its CSB Financial Corp. holding company) is consummated; and the extent and timing of legislative and regulatory actions and reforms.

       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 Lakeland 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.

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       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 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, which also are provided for in the evaluation, may vary from estimated loss percentages, which are established based upon a limited number of potential loss classifications.

       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 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 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 are also detailed.

       Interest income is accrued as earned on a simple interest basis. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful. When a loan is placed on such non-accrual status, all accumulated accrued interest receivable applicable to periods prior to the current year is charged off to the allowance for loan and lease losses. Interest which had accrued in the current year is reversed out of current period income. Loans 90 days or more past due and still accruing interest must have both principal and accruing interest adequately secured and must be in the process of collection.

       The Company accounts for impaired loans 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.

       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 allowance for loan and lease losses, deferred loan fees, deferred compensation and securities available for sale.

Results of Operations

Net Income

       Net income for the second quarter of 2003 was $3.7 million, a 7% increase over the $3.5 million reported for the same period in 2002. Diluted earnings per share increased from $0.24 in the second quarter of 2002 to $0.26 in the second quarter of 2003. Return on Average Assets was 1.18% and Return on Average Equity was 16.20% for the second quarter 2003.

       Net income for the first six months of 2003 was $7.3 million, an 8% increase over the $6.8 million reported for the same period in 2002. Diluted earnings per share increased from $0.46 in the first six months of 2002 to $0.51 for the same period in 2003. Return on Average Assets was 1.17% and Return on Average Equity was 16.02% for the first half of 2003.

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Net Interest Income

       Net interest income on a tax equivalent basis for second quarter 2003 was $12.8 million, representing a $447 thousand or 4% increase from the $12.4 million earned in 2002. The increase in net interest income is primarily due to a decrease in interest expense due to a declining rate environment as well as an increase in lower costing core deposits. The net interest margin decreased from 4.90% in second quarter 2002 to 4.34% in second quarter 2003. The decrease in the net interest margin results from reduced spreads, higher non-accrual loans and a decline in interest income earned on free funds (interest bearing assets funded by non-interest bearing liabilities) due to the declining rate environment.

       Interest income on a tax equivalent basis decreased from $16.7 million in second quarter 2002 to $16.4 million in 2003, a decrease of $294,000 or 1.8%. Average earning assets increased $173.0 million or 17% from $1.014 billion in second quarter 2002 to $1.187 billion in second quarter 2003. The impact of the increase in earning assets was offset by the impact of a decline in the yield on earning assets from 6.60% in second quarter 2002 to 5.54% in second quarter 2003, a 106 basis point decrease. The drop in the yield on earning assets can be attributed to the decline in the overall interest rate environment. Also contributing to the decline in the yield on earning assets in 2003 was the placement on non-accrual of $16.0 million in pools of predominately commercial leases during 2002. As of June 30, 2002, only $10.9 million of these leases were on non-accrual. Interest that would have accrued on the leases in the second quarter of 2003 and 2002 was $381,000 and $234,000, respectively. The effect of placing these leases on non-accrual was to decrease the yield on earning assets by 13 basis points in the second quarter of 2003 and 9 basis points in the second quarter of 2002.

       Total interest expense decreased from $4.3 million in second quarter 2002 to $3.5 million in second quarter 2003, a decrease of $741,000 or 17%. A $157.1 million increase in average interest bearing liabilities was offset by a 66 basis point decrease in the cost of funds to 1.48%. The cost of funds was influenced by a decline in rates as well as an increase in lower cost core deposits. Time deposits as a percent of total deposits decreased from 25% in second quarter of 2003 to 22% during the same period in 2002. Lower yielding savings and interest bearing demand accounts as a percent of deposits increased from 53% in second quarter 2002 to 58% in 2003. Total interest expense declined from $8.7 million in the first six months of 2002 to $7.4 million in 2003, a $1.2 million decline.

       Net interest income on a tax equivalent basis increased from $23.9 million for the first six months of 2002 to $25.5 million for the first six months of 2003, a $1.6 million or 7% increase. Interest income on a tax equivalent basis increased from $32.6 million to $33.0 million, an increase of $384,000. An increase in average earning assets of $173.4 million from the first half of 2002 to the first half of 2003 caused the increase in interest income. This increase was partially offset by a decline in the yield on average earning assets from 6.62% for the first half of 2002 to 5.67% for the first half of 2003. Interest that would have accrued on the leases in the first half of 2003 and 2002 was $762,000 and $438,000, respectively. The effect of placing these leases on non-accrual was to decrease the yield on earning assets by 13 basis points in the first six months of 2003 and 5 basis points in the first six months of 2002. The impact of an increase in average interest-bearing liabilities of $158.5 million was more than offset by a decline in the cost of funds of 64 basis points.

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, the adequacy of the allowance for loan and lease losses, and prevailing economic conditions.

       The provision for loan and lease losses was $750,000 for both the three months ended June 30, 2003 and June 30, 2002. During the second quarter of 2003, the Company charged off loans of $774,000 and recovered $99,000 in previously charged off loans compared to $149,000 and $223,000, respectively, during the same period in 2002.

       For the first six months of 2003, the provision for loan and lease losses was $1.5 million, the same as the total for the first six months of 2002. The Company charged off $1.5 million and recovered $733,000 in the first six months of 2003 compared to respective charge-offs and recoveries in 2002 of $326,000 and $288,000. For more information, see “Risk Elements” under “Financial Condition.”

Noninterest Income

       Noninterest income, exclusive of gains on sales of securities sold, increased $402,000 or 17% to $2.7 million in second quarter 2003 from $2.3 million for the same period last year. The gains on securities sold totaled $487,000 in the second quarter of 2003 compared to an $11,000 loss on securities sold for the same period last year. Noninterest income, including gains/losses on sales of securities, increased $900,000 to $3.2 million in second quarter 2003. Financial institutions typically disclose noninterest income excluding gains/losses on securities sold (as well as noninterest income including gains/losses on securities sold) in order to reflect that portion of noninterest income which such institutions can manage from quarter to quarter. Service charges on deposit accounts increased $235,000 or 16% to $1.7 million in second quarter 2003 because of the implementation of a new service charge schedule in the second quarter of 2003 and due to a higher retention of overdraft and return item charges. Commissions and fees increased $180,000 or 34% to $717,000 in the same time period, primarily due to increased loan volumes.

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       Noninterest income, exclusive of gains on sales of securities sold, increased from $4.5 million for the first half of 2002 to $5.0 million for the first half of 2003, an increase of $565,000 or 13%. Non-interest income including gains on securities sold increased from $4.5 million for the first six months of 2002 to $5.8 million in the same period in 2003, an increase of $1.3 million. The gains on securities sold totaled $752,000 in the first half of 2003 compared to $63,000 for the same period last year. Service charges on deposit accounts increased from $2.9 million for the first six months of 2002 to $3.2 million for 2003, an increase of $333,000 or 12% due to the aforementioned new service charge schedule, as well as more strictly enforcing payment of overdraft fees by depositors. Commissions and fees increased from $993,000 in the first half of 2002 to $1.3 million for the same period in 2003, an increase of $263,000 or 26% due to increased loan volumes. Other income decreased from $582,000 in the first six months of 2002 to $551,000 in 2003. Within this category, gain on sale of leases decreased from $98,000 for the first half of 2002 to $36,000 in 2003, as the Company has retained a larger percentage of originated leases in its own portfolio in the first half of 2003.

Noninterest Expense

       Noninterest expense increased from $8.5 million in the first quarter of 2002 to $9.4 million in 2003, an increase of $931,000 or 11%. Salaries and employee benefits increased $337,000 or 7% from $4.7 million in the first quarter 2002 to $5.1 million in 2003 as a result of expansion of Lakeland’s branch network as well as normal salary and benefit increases. Other expenses increased from $1.8 million in second quarter 2002 to $2.4 million in second quarter 2003, an increase of $636,000. This increase is primarily due to increased legal costs associated with the litigation of the purchased pools of commercial leases, increased consulting costs relating to an operational efficiency review and expenses incurred in 2003 for a branch location that was opened late in 2002.

       Noninterest expense increased from $16.4 million in the first six months of 2002 to $18.4 million in 2003, an increase of $1.9 million or 12%. Salary and employee benefit expense increased from $9.4 million in 2002 to $10.0 million in 2003, an increase of $642,000 or 7% due to increased staff relating to branch additions and normal salary and benefit increases. Net occupancy expense increased from $1.7 million in 2002 to $1.8 million in 2003, an increase of $123,000 or 7% due to increased utility and snow removal costs incurred in the first quarter of 2003 as well as the new branch location opened late in 2002. Furniture and equipment expense increased from $1.5 million for the first six months of 2002 to $1.6 million for the first six months of 2003, an increase of $90,000 or 6% as a result of continued expansion of the Company. Other expenses increased from $3.3 million for the first half of 2002 to $4.3 million for the same period in 2003, an increase of $1.0 million or 32%. This increase relates to increased legal fees, increased consulting costs relating to the efficiency review, and expenses incurred in the new branch location opened late in 2002.

Financial Condition

       The Company’s total assets increased $124.5 million or 10% from $1.207 billion at December 31, 2002, to $1.332 billion at June 30, 2003. Total deposits increased from $1.059 billion on December 31, 2002 to $1.148 billion on June 30, 2003, an increase of $88.9 million or 8%. During the second quarter of 2003, the Company raised $30.0 million in two privately placed offerings of trust preferred securities. The weighted average interest rate of these securities was 5.87%. The Company will use these funds for general corporate purposes, including capital contributions to Lakeland Bank to support growth strategies, funding the cash portion of the Company’s pending acquisition of CSB Financial Corp. and for working capital and other corporate purposes.

Loans

       Loans increased from $718.7 million on December 31, 2002 to $736.8 million on June 30, 2003, an increase of $18.1 million, or 3%. The largest growth was seen in commercial and leasing loans which increased $18.8 million or 6% from $314.4 million at year-end to $333.2 million on June 30, 2003. Consumer and home equity loans showed an increase of $9.7 million or 4%, while residential mortgage loans decreased by $10.4 million or 6% to $159.6 million due to loan refinancing activity.

Risk Elements

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

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       Non-accrual loans decreased from $20.0 million on December 31, 2002 to $19.8 million, or 1.49% of total assets, on June 30, 2003. Of the overall total of loans on non-accrual, $16.0 million or 1.20% of total assets represent the purchased leases that were placed on a non-accrual status in 2002 that are currently being litigated. For more information see Note 9 - Commitments and Contingencies in this Quarterly Report on Form 10-Q. Loans past due ninety days or more and still accruing at June 30, 2003 increased $495,000 to $1.8 million. Loans past due 90 days or more and still accruing are those loans that are both well-secured and in process of collection. Other real estate owned increased $324,000 from year-end 2002.

       On June 30, 2003, the Company had $19.5 million in impaired loans (including $18.5 million in non-accrual loans) compared to $20.7 million at year-end 2002. For more information on these loans see Note 5 in Notes to the Consolidated Financial Statements of this Quarterly Report on Form 10-Q. The impairment of the loans is measured using the present value of future cash flows on certain impaired loans and is based on the fair value of the underlying collateral for the remaining loans. Based on such evaluation, $9.4 million has been allocated to the allowance for loan and lease losses for impairment at June 30, 2003. At June 30, 2003, the Company also had $8.9 million in loans that were rated substandard and not classified as non-performing, impaired, or 90 days past due and still accruing.

       There were no loans at June 30, 2003, 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 being included as non-accrual, past due or renegotiated at a future date.

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

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       The ratio of the allowance for loan and lease losses to loans 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. The evaluation process is undertaken on a quarterly basis.

       Methodology employed for assessing the adequacy of the allowance for loan and lease losses consists of the following criteria:

• The establishment of reserve amounts for all specifically identified criticized loans that have been designated as requiring attention by Lakeland’s external loan review program.
• The establishment of reserves for pools of homogeneous types of loans not subject to specific review, including 1 - 4 family residential mortgages and consumer loans.
• The establishment of reserve amounts for the non-criticized loans in each portfolio based upon the historical average loss experience of these portfolios.

       Consideration is given to the results of ongoing credit quality monitoring processes, the adequacy and expertise of the Company’s lending staff, underwriting policies, loss histories, delinquency trends, and the cyclical nature of economic and business conditions. Since many of the Company’s loans depend on the sufficiency of collateral as a secondary means of repayment, any adverse trend in the real estate markets could affect underlying values available to protect the Company against loss.

       Based upon the process employed and giving recognition to all accompanying factors related to the loan portfolio, management considers the allowance for loan and lease losses to be adequate at June 30, 2003. The preceding statement constitutes a forward-looking statement within the meaning of that term set forth in Rule 173 of the Securities Act of 1933 and Rule 3-6 of the Securities Exchange Act of 1934.

Investment Securities

       For detailed information on the composition and maturity distribution of the Company’s investment securities portfolio, see Note 4 to the Notes to Consolidated Financial Statements contained in this 10-Q. Total investment securities increased from $407.8 million on December 31, 2002 to $471.1 million on June 30, 2003, an increase of $63.3 million, or 16%. Investment securities available for sale increased from $361.8 million on December 31, 2002 to $420.9 million on June 30, 2003, an increase of $59.1 million, or 16%. Investment securities held to maturity increased from $46.1 million on December 31, 2002 to $50.3 million on June 30, 2003, an increase of $4.2 million or 9%.

Deposits

       Total deposits increased from $1.059 billion on December 31, 2002 to $1.148 billion on June 30, 2003, an increase of $88.9 million, or 8%. Total non-interest bearing deposits increased from $214.1 million to $236.3 million, an increase of $22.2 million or 10%. Savings and interest bearing transaction accounts increased from $593.6 million on December 31, 2002 to $665.3 million on June 30, 2003, an increase of $71.6 million or 12%. Total core deposits, which comprise non-interest bearing deposits and savings and interest bearing transaction accounts, increased by $93.8 million or 12% to $901.6 million. Core deposits are 79% of total deposits as compared to 76% at year-end as the Company continues to see funds shifting into transaction accounts as an alternative to other investment options. Time deposits under $100,000 increased $3.4 million to $182.8 million, while time deposits $100,000 and over decreased $8.4 million to $63.6 million as municipal depositors moved their funds from time deposits to interest-bearing transaction accounts.

Liquidity

       Cash and cash equivalents, at $72.7 million on June 30, 2003, increased $37.2 million from year-end which included an increase of $21.5 million in federal funds sold and interest-bearing deposits due from banks. Operating activities provided $10.2 million in net cash, primarily the result of the Company’s net income. Investing activities used $87.9 million in net cash, primarily reflecting net use of funds for investment securities activities of $62.6 million and use of funds for loans of $18.9 million. Financing activities provided $114.9 million in net cash, reflecting an increase in deposits of $88.9 million as well as the $30.0 million issuance of trust preferred securities. Approximately $22 million of the proceeds of the trust preferred securities will be used to finance the CSB acquisition. Lakeland anticipates that it will have sufficient funds available to meet its current loan commitments and deposit maturities. The preceding statement constitutes a forward-looking statement within the meaning of that term set forth in Rule 173 of the Securities Act of 1933 and Rule 3-6 of the Securities Exchange Act of 1934. At June 30, 2003, Lakeland had outstanding loan origination commitments of $131.1 million. These commitments include $117.4 million that mature within one year; $3.3 million that mature after one but within three years; $1.4 million that mature after three but within five years and $9.0 million that mature after five years. Lakeland also had $6.1 million in letters of credit outstanding at June 30, 2003. This included $5.0 million that are maturing within one year; $191,000 that mature after one but within three years; $162,000 that mature after three but within 5 years and $743,000 that mature after five years. Time deposits issued in amounts of $100,000 or more maturing within one year total $42.4 million.

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Capital Resources

       Stockholders’ equity increased from $90.8 million on December 31, 2002 to $95.7 million on June 30, 2003. Book value per common share increased to $6.74 on June 30, 2003 from $6.38 on December 31, 2002. The increase in stockholders’ equity from December 31, 2002 to June 30, 2003 results from net income and increases in unrealized gains on investment securities available for sale offset by dividends paid to shareholders and purchases of treasury stock.

       The Company and Lakeland are subject to various regulatory capital requirements that are monitored by federal banking agencies. Failure to meet minimum capital requirements can lead to certain supervisory actions by regulators; any supervisory action could have a direct material effect on the Company or Lakeland’s financial statements. Management believes, as of June 30, 2003, that the Company and Lakeland meet all capital adequacy requirements to which they are subject.

       The capital ratios for the Company and Lakeland at June 30, 2003, and the minimum regulatory guidelines for such capital ratios for qualification as a well-capitalized institution are as follows:

a)     Disclosure controls and procedures. As of the end of the Company’s most recently completed fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) covered by this report, the Company carried out an evaluation, with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-15. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.

(b)     Changes in internal controls over financial reporting. There have been no changes in the Company’s internal control over financial reporting that occurred during the Company’s last fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. 

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PART II OTHER INFORMATION

 

Item 1.

Legal Proceedings

       Reference is made to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2003 and Current Report on Form 8-K filed with the SEC on April 29, 2003 for a description of certain legal proceedings involving the Company and Lakeland.

 

Item 2.	Change in Securities	Not Applicable
Item 3.	Defaults Upon Senior Securities	Not Applicable
Item 4.	Submission of Matters to a Vote of Security Holders.

The following table shows the persons who were elected to the board of directors at the Company’s Annual Meeting of Shareholders held April 29, 2003. Also shown are their terms of office and the results of voting for each respective director.

 

Item 5.	Other Information	Not Applicable
Item 6.	Exhibits and Reports of Form 8-K

                  (a)          Exhibits

                                 2.1     Agreement and Plan of Merger, dated as of March 31, 2003, among the Company, Lakeland Bank, CSB and Community State Bank, is incorporated by reference to Exhibit 2.1 on the registrant’s Form 8-K filed April 3, 2003.

                                2.2     Shareholders’ Agreement, dated as of March 31, 2003, among certain shareholders of CSB and the Company, is incorporated by reference to Exhibit 2.2 of the registrant’s Form 8-K filed April 3, 2003.

                                31.1    Certification by Roger Bosma pursuant to Section 302 of the Sarbanes Oxley Act.

                                31.2    Certification by Joseph F. Hurley pursuant to Section 302 of the Sarbanes Oxley Act.

                                32.1    Certification by Roger Bosma and Joseph F. Hurley pursuant to Section 906 of the Sarbanes Oxley Act.

                  (b)          Current Reports on form 8-K filed during the quarter ended June 30, 2003.

                                An 8-K was filed on April 3, 2003 announcing an Agreement and Plan of Merger that the Company and Lakeland Bank entered into with CSB and Community State Bank on March 31, 2003.

                                An 8-K was filed on April 14, 2003 announcing first quarter 2003 earnings.

                                An 8-K was filed on April 14, 2003 regarding the status of pending litigation concerning certain commercial leases and a competing offer to a proposed settlement agreement with the bankruptcy trustee.

                                An 8-K was filed on June 18, 2003 regarding the status of pending litigation concerning certain commercial leases and an approval of a settlement agreement with the bankruptcy trustee resolving the claims of the trustee with respect to the leases guaranteed by surety bonds issued by RLI Insurance Company and American Motorists Insurance Company.

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                                An 8-K was filed on June 20, 2003 announcing that the Company had consummated two transactions resulting in the issuance of trust preferred securities by two statutory trusts established by the Company.

                                An 8-K was filed on June 24, 2003 disclosing a certain non-GAAP financial measure used in the Company’s 10-K for the year ended December 31, 2002, providing a reconciliation with the non-GAAP financial measure to the closest ratio calculated in accordance with GAAP and providing the reason for using the non-GAAP financial measure.

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SIGNATURE

August 13, 2003
Date