Lakeland Financial Corporation (NASDAQ:LKFN) earnings are likely to rise this year on strong revenue growth. Economic factors are likely to drive credit growth this year, which will boost revenue. In addition, margin is likely to increase significantly this year as a large portion of loans and investments are repriced soon after a rate hike. Overall, I expect Lakeland Financial to report earnings per share of $3.83 in 2022, up 3% year over year. The year-end price target indicates a significant downtrend from the current market price. I am assigning a Hold rating to Lakeland Financial Corporation based on expected total returns and earnings prospects.

Indiana’s economic recovery to boost credit growth

After falling sharply in the first nine months of 2021, the loan portfolio finally turned around in the final quarter of the year. Most of the credit decline early last year was due to forgiveness under the Paycheck Protection Program (“PPP”). PPP loans decreased from $412.0 million at the end of December 2020 to $26.2 million at the end of December 2021. The remaining outstanding PPP loans accounted for just 0.6% of total loans at the end of last year. Because the PPP portfolio is so small now, the remaining waiver will have little impact on the overall size of the loan portfolio.

In addition, the economic recovery is likely to play a crucial role in lending growth. Lakeland Financial is based in Indiana, which has an unemployment rate well above the national average. The state reported an unemployment rate of just 2.7% in December 2021, showing the economy is doing reasonably well.

Accelerating credit growth shouldn’t be too difficult for management given existing credit lines are underutilized. As mentioned in the results presentation, the average line utilization was 42% at the end of December 2021. By comparison, line utilization before the pandemic hovered between 48% and 54%. If the economy allows utilization to rise to pre-pandemic levels, then credit can grow significantly this year.

Taking these factors into account, I expect the loan portfolio to increase by around 4% by the end of December 2022 compared to the end of 2021. Meanwhile, deposits are likely to grow in line with loans. The table below shows my balance sheet estimates.

Loan and investment portfolios are flexible enough to benefit significantly from higher interest rates

Throughout the past year, management has reallocated funds freed from forgiving PPP loans to short-term investments. These short-term investments increased to $631.4 million at the end of December 2021 from $175.5 million at the end of December 2020 and $30.8 million at the end of December 2019. Forward investing is a good strategy ahead of the federal rate hike. Shortly after interest rates rise, management can easily reallocate funds from short-term investments to higher-yielding long-term investments and loans.

Additionally, Lakeland Financial Corporation’s credit mix is ​​well positioned for a rising interest rate environment. About 68% of the loans were floating rate at the end of the most recent quarter, as mentioned in the presentation. As a result, most of the portfolio will be re-rated soon after a rate hike. Additionally, every 25 basis points increase in the federal funds rate can improve net interest margin by three to five basis points, management estimates. In other words, a 100 basis point increase in the interest rate can increase net interest income by 6.86%.

Taking those factors into account, I expect its first-half margin to remain broadly flat from 2.98% in the final quarter of 2021. For the second half of the year, I expect the margin to increase by 10 basis points.

Expects revenue to grow 3% this year

Expected mid-single-digit loan growth and margin expansion are likely to drive earnings growth this year. On the other hand, higher provision expenses are likely to limit earnings growth. Loan additions will likely result in higher provisioning costs this year. However, I expect provisions to remain below normal as loan loss provisions are likely to be unwound as these provisions appear excessive. Reserves accounted for 1.58% of total loans, while bad loans accounted for just 0.35% of total loans late last year. Overall, I expect the provisioning cost net of chargebacks to be 0.09% of total loans in 2022, below the average provisioning cost of 0.11% of total loans from 2017-2019.

Noninterest earnings are also likely to be lower this year as Lakeland Financial is unable to repeat last year’s mortgage performance given this year’s rising interest rates. Overall, I expect the company to report earnings of $3.83 per share in 2022, up 2.6% year over year. The table below shows my estimates of the income statement.

Actual returns may differ materially from estimates due to the risks and uncertainties related to the COVID-19 pandemic and the timing of any rate hike.

Price decline, earnings outlook justify a hold position

Lakeland Financial offers a 2.0% dividend yield at the current quarterly dividend rate of $0.40 per share. Earnings and dividend estimates point to a 42% payout ratio for 2022, higher than the five-year average of 35%. As such, I don’t expect another dividend increase this year.

I use historical price-to-trade (“P/TB”) and price-to-earnings (“P/E”) ratios to value Lakeland Financial. The stock’s P/TB ratio has historically trended towards 2.5 as illustrated below.

Multiplying the P/TB multiple of 2.5 times the projected tangible book value per share of $29.50 yields a price target of $73.90 by the end of 2022. This price target implies a 7.0% decline from the closing price as of February 17th. The table below shows the sensitivity of price target to P/TB ratio.

The P/E ratio of the stock has historically trended towards 17.0x as illustrated below.

Multiplying the P/E of 17.0 times the forward earnings per share of $3.83 gives a price target of $65.20 by the end of 2022. This price target implies a decline of 18.0% from the Feb. 17 close . The following table shows the sensitivity of the target price to the P/E ratio.

The same weighting of the price targets from the two evaluation methods results in a combination Price target of $69.50, down 12.5% ​​from the current market price. Adding the expected dividend yield gives an expected total return of minus 10.5%.

The clear price disadvantage requires a sell recommendation. Due to the profit prospects, however, a sell stance is not appropriate. As such, I am assuming a hold rating on Lakeland Financial Corporation. I will stay away from this stock unless its market price corrects significantly by more than 20% from current levels.