LCNB 9.30.2014 10Q

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.   20549

FORM 10-Q

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                                                        to                                                      

Commission File Number 000-26121
LCNB Corp.
(Exact name of registrant as specified in its charter)
Ohio
 
 31-1626393
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)

2 North Broadway, Lebanon, Ohio 45036
(Address of principal executive offices, including Zip Code)

(513) 932-1414
(Registrant's telephone number, including area code)

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.
x Yes         ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
x Yes         ¨ No

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.
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
¨ Yes         x No
The number of shares outstanding of the issuer's common stock, without par value, as of November 3, 2014 was 9,305,413 shares.
 
 
 
 
 


Table of Contents



LCNB CORP. AND SUBSIDIARIES

TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

1

Table of Contents



PART I – FINANCIAL INFORMATION
 
Item 1.
Financial Statements

LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)

 
 
September 30, 2014
 
December 31,
2013
 
 
(Unaudited)
 
ASSETS:
 
 
 
 
Cash and due from banks
 
$
13,388

 
10,410

Interest-bearing demand deposits
 
19,665

 
4,278

Total cash and cash equivalents
 
33,053

 
14,688

Investment securities:
 
 

 
 

Available-for-sale, at fair value
 
292,853

 
258,241

Held-to-maturity, at cost
 
23,504

 
16,323

Federal Reserve Bank stock, at cost
 
2,346

 
1,603

Federal Home Loan Bank stock, at cost
 
3,638

 
2,854

Loans, net
 
682,617

 
570,766

Premises and equipment, net
 
20,907

 
19,897

Goodwill
 
27,638

 
14,186

Bank owned life insurance
 
21,773

 
21,280

Other assets
 
15,027

 
12,500

TOTAL ASSETS
 
$
1,123,356

 
932,338

LIABILITIES:
 
 

 
 

Deposits:
 
 

 
 

Noninterest-bearing
 
$
190,875

 
164,912

Interest-bearing
 
765,758

 
620,849

Total deposits
 
956,633

 
785,761

Short-term borrowings
 
24,954

 
8,655

Long-term debt
 
11,432

 
12,102

Accrued interest and other liabilities
 
7,158

 
6,947

TOTAL LIABILITIES
 
1,000,177

 
813,465

SHAREHOLDERS' EQUITY:
 
 

 
 

Preferred shares – no par value, authorized 1,000,000 shares, none outstanding
 

 

Common shares – no par value, authorized 12,000,000 shares, issued 10,058,835 and 10,041,163 shares at September 30, 2014 and December 31, 2013, respectively
 
67,086

 
66,785

Retained earnings
 
67,667

 
65,475

Treasury shares at cost, 753,627 shares at September 30, 2014 and December 31, 2013
 
(11,665
)
 
(11,665
)
Accumulated other comprehensive income (loss), net of taxes
 
91

 
(1,722
)
TOTAL SHAREHOLDERS' EQUITY
 
123,179

 
118,873

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
 
$
1,123,356

 
932,338


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

The consolidated balance sheet as of December 31, 2013 has been derived from the audited consolidated balance sheet as of that day.

2

Table of Contents



LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
(Unaudited)
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
 
2014
 
2013
INTEREST INCOME:
 
 
 
 
 
 
 
 
Interest and fees on loans
 
$
8,168

 
6,902

 
24,008

 
20,298

Interest on investment securities:
 
 

 
 

 
 

 
 

Taxable
 
984

 
862

 
2,901

 
2,556

Non-taxable
 
716

 
654

 
2,019

 
1,932

Other investments
 
38

 
32

 
182

 
145

TOTAL INTEREST INCOME
 
9,906

 
8,450

 
29,110

 
24,931

INTEREST EXPENSE:
 
 

 
 

 
 

 
 

Interest on deposits
 
800

 
875

 
2,423

 
2,789

Interest on short-term borrowings
 
10

 
11

 
18

 
18

Interest on long-term debt
 
101

 
109

 
305

 
331

TOTAL INTEREST EXPENSE
 
911

 
995

 
2,746

 
3,138

NET INTEREST INCOME
 
8,995

 
7,455

 
26,364

 
21,793

PROVISION FOR LOAN LOSSES
 
401

 
178

 
737

 
369

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
 
8,594

 
7,277

 
25,627

 
21,424

NON-INTEREST INCOME:
 
 

 
 

 
 

 
 

Trust income
 
688

 
626

 
2,071

 
1,810

Service charges and fees on deposit accounts
 
1,245

 
1,062

 
3,619

 
3,114

Net gain on sales of securities
 
97

 
58

 
93

 
753

Bank owned life insurance income
 
165

 
168

 
507

 
512

Gains from sales of mortgage loans
 
24

 
57

 
92

 
305

Other operating income
 
96

 
76

 
311

 
238

TOTAL NON-INTEREST INCOME
 
2,315

 
2,047

 
6,693

 
6,732

NON-INTEREST EXPENSE:
 
 

 
 

 
 

 
 

Salaries and employee benefits
 
4,022

 
3,247

 
11,896

 
9,783

Equipment expenses
 
337

 
318

 
976

 
908

Occupancy expense, net
 
541

 
505

 
1,706

 
1,529

State franchise tax
 
231

 
208

 
714

 
635

Marketing
 
212

 
145

 
541

 
446

FDIC insurance premiums
 
183

 
128

 
492

 
375

Merger-related expenses
 
4

 

 
1,366

 
1,326

Other non-interest expense
 
1,708

 
1,612

 
5,819

 
4,576

TOTAL NON-INTEREST EXPENSE
 
7,238

 
6,163

 
23,510

 
19,578

INCOME BEFORE INCOME TAXES
 
3,671

 
3,161

 
8,810

 
8,578

PROVISION FOR INCOME TAXES
 
953

 
804

 
2,158

 
2,145

NET INCOME
 
$
2,718

 
2,357

 
6,652

 
6,433

Dividends declared per common share
 
$
0.16

 
0.16

 
0.48

 
0.48

Earnings per common share:
 
 

 
 

 
 

 
 

Basic
 
$
0.30

 
0.31

 
0.72

 
0.85

Diluted
 
0.29

 
0.30

 
0.71

 
0.83

Weighted average common shares outstanding:
 
 

 
 

 
 

 
 

Basic
 
9,299,691

 
7,636,098

 
9,293,866

 
7,592,818

Diluted
 
9,405,013

 
7,787,098

 
9,407,110

 
7,722,686


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

3

Table of Contents



LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)

 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
 
2014
 
2013
Net income
 
$
2,718

 
2,357

 
6,652

 
6,433

Other comprehensive income (loss):
 
 

 
 

 
 

 
 

Net unrealized gain (loss) on available-for-sale securities (net of taxes of $(353) and $391 for the three months ended September 30, 2014 and 2013, respectively, and $962 and $(2,452) for the nine months ended September 30, 2014 and 2013, respectively)
 
(687
)
 
760

 
1,867

 
(4,758
)
Reclassification adjustment for net realized gain on sale of available-for-sale securities included in net income (net of taxes of $33 and $20 for the three months ended September 30, 2014 and 2013, respectively, and $32 and $256 for the nine months ended September 30, 2014 and 2013, respectively)
 
(64
)
 
(38
)
 
(61
)
 
(497
)
Change in nonqualified pension plan unrecognized net loss and unrecognized prior service cost (net of taxes of $3 and $5 for the three months ended September 30, 2014 and 2013, respectively, and $4 and $14 for the nine months ended September 30, 2014 and 2013)
 
4

 
8

 
7

 
26

TOTAL COMPREHENSIVE INCOME
 
$
1,971

 
3,087

 
8,465

 
1,204


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


4

Table of Contents



LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Dollars in thousands, except per share amounts)
(Unaudited)

 
 
Common Shares Outstanding
 
Common Stock
 
Retained
Earnings
 
Treasury
Shares
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total Shareholders'
Equity
Balance at December 31, 2012
 
6,731,900

 
$
27,107

 
61,843

 
(11,665
)
 
4,721

 
82,006

Net income
 
 

 
 

 
6,433

 
 

 
 

 
6,433

Other comprehensive loss, net of taxes
 
 

 
 

 
 

 
 

 
(5,229
)
 
(5,229
)
Dividend Reinvestment and Stock Purchase Plan
 
13,832

 
248

 
 

 
 

 
 

 
248

Exercise of stock options
 
5,620

 
70

 


 


 
 

 
70

Acquisition of First Capital Bancshares, Inc.
 
888,811

 
12,321

 
 
 
 
 
 
 
12,321

Compensation expense relating to stock options
 
 

 
28

 
 

 
 

 
 

 
28

Common stock dividends, $0.48 per share
 
 

 
 

 
(3,662
)
 
 

 
 

 
(3,662
)
Balance at September 30, 2013
 
7,640,163

 
$
39,774

 
64,614

 
(11,665
)
 
(508
)
 
92,215

 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2013
 
9,287,536

 
$
66,785

 
65,475

 
(11,665
)
 
(1,722
)
 
118,873

Net income
 
 

 
 

 
6,652

 
 

 
 

 
6,652

Other comprehensive income, net of taxes
 
 

 
 

 
 

 
 

 
1,813

 
1,813

Dividend Reinvestment and Stock Purchase Plan
 
17,672

 
283

 
 

 
 

 
 

 
283

Compensation expense relating to stock options
 
 
 
18

 
 
 
 
 
 
 
18

Common stock dividends, $0.48 per share
 
 

 
 

 
(4,460
)
 
 

 
 

 
(4,460
)
Balance at September 30, 2014
 
9,305,208

 
$
67,086

 
67,667

 
(11,665
)
 
91

 
123,179


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


5

Table of Contents



LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
Net income
 
$
6,652

 
6,433

Adjustments to reconcile net income to net cash flows from operating activities:
 
 

 
 

Depreciation, amortization, and accretion
 
2,299

 
1,886

Provision for loan losses
 
737

 
369

Increase in cash surrender value of bank owned life insurance
 
(507
)
 
(512
)
Realized gain from sales of securities available-for-sale
 
(93
)
 
(753
)
Realized gain from sales of premises and equipment
 
(116
)
 
(1
)
Realized (gain) loss from sales and write-downs of other real estate owned and repossessed assets
 
9

 
(175
)
Origination of mortgage loans for sale
 
(5,024
)
 
(16,831
)
Realized gains from sales of mortgage loans
 
(92
)
 
(305
)
Proceeds from sales of mortgage loans
 
5,066

 
16,970

Compensation expense related to stock options
 
18

 
28

Changes in:
 
 

 
 

Accrued income receivable
 
(575
)
 
(802
)
Other assets
 
689

 
745

Other liabilities
 
(46
)
 
(239
)
TOTAL ADJUSTMENTS
 
2,365

 
380

NET CASH FLOWS FROM OPERATING ACTIVITIES
 
9,017

 
6,813

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 

 
 

Proceeds from sales of investment securities available-for-sale
 
55,795

 
41,888

Proceeds from maturities and calls of investment securities:
 
 

 
 

Available-for-sale
 
24,133

 
15,724

Held-to-maturity
 
3,345

 
4,437

Purchases of investment securities:
 
 

 
 

Available-for-sale
 
(76,801
)
 
(57,106
)
Held-to-maturity
 
(10,526
)
 
(9,687
)
Purchase of Federal Reserve Bank stock
 
(743
)
 
(497
)
Proceeds from redemption of Federal Reserve Bank stock
 
41

 

Net (increase) decrease in loans
 
3,152

 
(13,446
)
Proceeds from redemption of bank owned life insurance
 
3,633

 

Proceeds from sale of other real estate owned and repossessed assets
 
711

 
1,062

Additions to other real estate owned
 
(20
)
 

Purchases of premises and equipment
 
(857
)
 
(614
)
Proceeds from sale of premises and equipment
 
167

 
1

Net cash acquired from (paid for) acquisition
 
(9,114
)
 
9,771

NET CASH FLOWS FROM INVESTING ACTIVITIES
 
(7,084
)
 
(8,467
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 

 
 

Net increase (decrease) in deposits
 
5,631

 
206

Net increase (decrease) in short-term borrowings
 
15,648

 
9,055

Principal payments on long-term debt
 
(670
)
 
(3,051
)
Proceeds from issuance of common stock
 
50

 
32

Proceeds from exercise of stock options
 

 
70

Cash dividends paid on common stock
 
(4,227
)
 
(3,446
)
NET CASH FLOWS FROM FINANCING ACTIVITIES
 
16,432

 
2,866

NET CHANGE IN CASH AND CASH EQUIVALENTS
 
18,365

 
1,212

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
 
14,688

 
13,475

CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
33,053

 
14,687

SUPPLEMENTAL CASH FLOW INFORMATION:
 
 

 
 

Interest paid
 
$
2,665

 
3,150

Income taxes paid
 
2,000

 
2,715

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES:
 
 

 
 

Transfer from loans to other real estate owned and repossessed assets
 
435

 
133


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

6

Table of Contents



LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1 - Basis of Presentation
 
Substantially all of the assets, liabilities and operations of LCNB Corp. ("LCNB" or the "Company") are attributable to its wholly-owned subsidiary, LCNB National Bank (the "Bank").  The accompanying unaudited consolidated financial statements include the accounts of LCNB and the Bank.

The unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and the rules and regulations of the Securities and Exchange Commission (the "SEC").  Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  In the opinion of management, the unaudited interim consolidated financial statements include all adjustments (consisting of normal, recurring accruals) considered necessary for a fair presentation of financial position, results of operations, and cash flows for the interim periods, as required by Regulation S-X, Rule 10-01.

The consolidated balance sheet as of December 31, 2013 has been derived from the audited consolidated balance sheet as of that day.

Certain prior period data presented in the financial statements have been reclassified to conform with the current year presentation.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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 and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the results to be expected for the full year ending December 31, 2014.  These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements, accounting policies, and financial notes thereto included in LCNB's 2013 Annual Report on Form 10-K filed with the SEC.

Note 2 – Acquisitions
 
On October 9, 2012, LCNB and First Capital Bancshares, Inc. ("First Capital") entered into an Agreement and Plan of Merger ("Merger Agreement") pursuant to which First Capital was merged into LCNB on January 11, 2013 in a stock and cash transaction valued at approximately $20.2 million.  Immediately following the merger of First Capital into LCNB, Citizens National Bank of Chillicothe ("Citizens"), a wholly-owned subsidiary of First Capital, was merged into LCNB National Bank. Citizens operated six full–service branches with a main office and two other facilities in Chillicothe, Ohio and one branch in each of Frankfort, Ohio, Clarksburg, Ohio, and Washington Court House, Ohio.  These offices became branches of the Bank after the merger.

On October 28, 2013, LCNB and Colonial Banc Corp. (“Colonial”) entered into a Stock Purchase Agreement (“Purchase Agreement”) pursuant to which LCNB purchased from Colonial on January 24, 2014 all of the issued and outstanding shares of Eaton National Bank & Trust Co. ("ENB") in a cash transaction valued at $24.75 million. Immediately following the acquisition, ENB was merged into the Bank.  ENB operated five full–service branches with a main office and another facility in Eaton, Ohio and branch offices in each of West Alexandria, Ohio, New Paris, Ohio, and Lewisburg, Ohio.  These offices became branches of the Bank after the merger.



7

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 2 – Acquisitions (continued)


The merger with ENB was accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration paid were recorded at their estimated fair values as of the merger date, as summarized in the following table (in thousands):
Consideration Paid:
 
Cash paid to shareholder
$
24,750

 
 

Identifiable Assets Acquired:
 

Cash and cash equivalents
15,635

Investment securities:
 

Available-for-sale
35,859

Federal Reserve Bank stock
41

Federal Home Loan Bank stock
784

Loans
115,944

Premises and equipment
1,314

Bank owned life insurance
3,618

Core deposit intangible
2,466

Other real estate owned
262

Other assets
1,624

Total identifiable assets acquired
177,547

 
 

Liabilities Assumed:
 

Deposits
165,335

Short-term borrowings
651

Other liabilities
263

Total liabilities assumed
166,249

 
 

Total Identifiable Net Assets Acquired
11,298

 
 

Goodwill resulting from merger
$
13,452


The amount of goodwill recorded reflects LCNB's entrance into a new market and related synergies that are expected to result from the acquisition and represents the excess purchase price over the estimated fair value of the net assets acquired.  The goodwill will not be amortizable on LCNB's financial records, but is deductible for tax purposes.  The core deposit intangible is being amortized over eight years using the straight-line method.

Prior to the end of the one-year measurement period for finalizing the purchase allocation, if information becomes available which would indicate adjustments to the purchase price allocation, such adjustments will be included in the purchase price retrospectively.

Direct costs related to the acquisition were expensed as incurred and are recorded as a merger-related expense in the consolidated statements of income.  
 
The results of operations are included in the consolidated statement of income from the date of the merger.  The estimated amount of ENB revenue (net interest income plus non-interest income) and net income, excluding merger and data conversion costs, included in LCNB's consolidated statement of income for the nine months ended September 30, 2014 were as follows (in thousands):
Total revenue
$
4,592

Net income
1,936


8

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 2 – Acquisitions (continued)



The following table presents unaudited pro forma information as if the merger with ENB had occurred on January 1, 2013 (in thousands).  This pro forma information gives effect to certain adjustments, including purchase accounting fair value adjustments, amortization of the core deposit intangible, and related income tax effects.  It does not include merger and data conversion costs.  The pro forma information does not necessarily reflect the results of operations that would have occurred had the merger with ENB occurred in 2013.  In particular, expected operational cost savings are not reflected in the pro forma amounts.
 
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
Total revenue
 
$
33,324

 
35,314

Net income
 
7,537

 
8,085

Basic earnings per common share
 
0.81

 
0.88

Diluted earnings per common share
 
0.80

 
0.86



9

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)


Note 3 - Investment Securities
 
The amortized cost and estimated fair value of available-for-sale investment securities at September 30, 2014 and December 31, 2013 are summarized as follows (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
September 30, 2014
 
 
 
 
 
 
 
Available-for-Sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
60,602

 
105

 
228

 
60,479

U.S. Agency notes
87,775

 
83

 
1,877

 
85,981

U.S. Agency mortgage-backed securities
39,533

 
404

 
403

 
39,534

Certificates of deposit
3,077

 
8

 

 
3,085

Municipal securities:
 

 
 

 
 

 
 

Non-taxable
83,198

 
2,011

 
358

 
84,851

Taxable
14,431

 
372

 
118

 
14,685

Mutual funds
2,473

 

 
24

 
2,449

Trust preferred securities
50

 

 

 
50

Equity securities
1,465

 
314

 
40

 
1,739

 
$
292,604

 
$
3,297

 
3,048

 
292,853

 
 
 
 
 
 
 
 
Investment Securities Held-to-Maturity:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
Non-taxable
23,104

 
66

 
993

 
22,177

Taxable
400

 

 

 
400

 
$
23,504

 
66

 
993

 
22,577

 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
Available-for-Sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
13,184

 

 
290

 
12,894

U.S. Agency notes
110,248

 
141

 
3,714

 
106,675

U.S. Agency mortgage-backed securities
40,602

 
555

 
848

 
40,309

Certificates of deposit
1,492

 
9

 

 
1,501

Municipal securities:
 

 
 

 
 

 
 

Non-taxable
74,185

 
2,116

 
968

 
75,333

Taxable
17,020

 
503

 
214

 
17,309

Mutual funds
2,419

 

 
39

 
2,380

Trust preferred securities
149

 
4

 
6

 
147

Equity securities
1,429

 
329

 
65

 
1,693

 
$
260,728

 
3,657

 
6,144

 
258,241

 
 
 
 
 
 
 
 
Investment Securities Held-to-Maturity:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
Non-taxable
15,923

 
159

 
285

 
15,797

Taxable
400

 

 
1

 
399

 
$
16,323

 
159

 
286

 
16,196


10

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 3 - Investment Securities (continued)



Information concerning available-for-sale investment securities with gross unrealized losses at September 30, 2014 and December 31, 2013, aggregated by length of time that individual securities have been in a continuous loss position, is as follows (dollars in thousands):
 
Less than Twelve Months
 
Twelve Months or Greater
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
September 30, 2014
 
 
 
 
 
 
 
Investment Securities Available-for-Sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
18,178

 
44

 
$
8,720

 
184

U.S. Agency notes
11,770

 
23

 
68,434

 
1,854

U.S. Agency mortgage-backed securities
13,418

 
38

 
11,663

 
365

Municipal securities:
 

 
 

 
 
 
 
Non-taxable
1,385

 
38

 
15,643

 
320

Taxable
1,499

 
7

 
4,291

 
111

Mutual funds
257

 
4

 
1,163

 
20

Trust preferred securities

 

 

 

Equity securities
252

 
22

 
214

 
18

 
$
46,759

 
176

 
$
110,128

 
2,872

 
 
 
 
 
 
 
 
Investment Securities Held-to-Maturity:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
  Non-taxable
$
12,158

 
993

 

 

  Taxable

 

 

 

 
$
12,158

 
993

 
$

 

 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
Investment Securities Available-for-Sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
12,894

 
290

 
$

 

U.S. Agency notes
89,080

 
2,880

 
9,636

 
834

U.S. Agency mortgage-backed securities
17,557

 
575

 
5,130

 
273

Municipal securities:
 

 
 

 
 

 
 
Non-taxable
15,641

 
398

 
10,751

 
570

Taxable
4,903

 
202

 
1,252

 
12

Mutual funds
1,380

 
39

 

 

Trust preferred securities

 

 
93

 
6

Equity securities
300

 
44

 
93

 
21

 
$
141,755

 
4,428

 
$
26,955

 
1,716

 
 
 
 
 
 
 
 
Investment Securities Held-to-Maturity:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
  Non-taxable
$
4,890

 
285

 
$

 

  Taxable
399

 
1

 

 

 
$
5,289

 
286

 
$

 



11

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 3 - Investment Securities (continued)


Management has determined that the unrealized losses at September 30, 2014 are primarily due to fluctuations in market interest rates and do not reflect credit quality deterioration of the securities.   Because LCNB does not have the intent to sell the investments and it is more likely than not that LCNB will not be required to sell the investments before recovery of their amortized cost bases, which may be at maturity, LCNB does not consider these investments to be other-than-temporarily impaired.

Contractual maturities of investment securities at September 30, 2014 were as follows (in thousands).  Actual maturities may differ from contractual maturities when issuers have the right to call or prepay obligations.
 
Available-for-Sale
 
Held-to-Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Due within one year
$
13,134

 
13,181

 
1,861

 
1,868

Due from one to five years
132,414

 
132,725

 
4,092

 
4,099

Due from five to ten years
94,219

 
94,027

 
5,117

 
4,980

Due after ten years
9,316

 
9,148

 
12,434

 
11,630

 
249,083

 
249,081

 
23,504

 
22,577

U.S. Agency mortgage-backed securities
39,533

 
39,534

 

 

Mutual funds
2,473

 
2,449

 

 

Trust preferred securities
50

 
50

 

 

Equity securities
1,465

 
1,739

 

 

 
$
292,604

 
292,853

 
23,504

 
22,577


Investment securities with a market value of $191,941,000 and $157,956,000 at September 30, 2014 and December 31, 2013, respectively, were pledged to secure public deposits and for other purposes required or permitted by law.

Certain information concerning the sale of investment securities available-for-sale for the three and nine months ended September 30, 2014 and 2013 was as follows (in thousands):
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Proceeds from sales
$
29,724

 
3,883

 
55,795

 
41,888

Gross realized gains
169

 
58

 
171

 
759

Gross realized losses
72

 

 
78

 
6




12

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)


Note 4 - Loans
 
Major classifications of loans at September 30, 2014 and December 31, 2013 are as follows (in thousands):
 
September 30, 2014
 
December 31, 2013
Commercial and industrial
34,997

 
29,337

Commercial, secured by real estate
371,533

 
314,252

Residential real estate
248,113

 
215,587

Consumer
19,305

 
12,643

Agricultural
9,249

 
2,472

Other loans, including deposit overdrafts
2,651

 
91

 
685,848

 
574,382

Deferred net origination costs (fees)
67

 
(28
)
 
685,915

 
574,354

Less allowance for loan losses
3,298

 
3,588

Loans, net
682,617

 
570,766


All advances from the Federal Home Loan Bank of Cincinnati are secured by a blanket pledge of LCNB's 1-4 family first lien mortgage loans in the amount of approximately $207 million and $183 million at September 30, 2014 and December 31, 2013, respectively.  Additionally, LCNB is required to hold minimum levels of FHLB stock, based on the outstanding borrowings.

Loans acquired from the mergers with First Capital and ENB are recorded at fair value with no carryover of the acquired entity's previously established allowance for loan losses.  The excess of expected cash flows over the estimated fair value of acquired loans is recognized as interest income over the remaining contractual lives of the loans using the level yield method.
Subsequent decreases in expected cash flows will require additions to the allowance for loan losses.  Subsequent improvements in expected cash flows result in the recognition of additional interest income over the then-remaining contractual lives of the loans.

Impaired loans acquired are accounted for under FASB ASC 310-30.  Factors considered in evaluating whether an acquired loan was impaired include delinquency status and history, updated borrower credit status, collateral information, and updated loan-to-value information.  The difference between contractually required payments at the time of acquisition and the cash flows expected to be collected is referred to as the nonaccretable difference.  The interest component of the cash flows expected to be collected is referred to as the accretable yield and is recognized as interest income over the remaining contractual life of the loan using the level yield method.   Subsequent decreases in expected cash flows will require additions to the allowance for loan losses.  Subsequent improvements in expected cash flows will result in a reclassification from the nonaccretable difference to the accretable yield.
 
The following table provides certain information at the acquisition date on loans acquired from ENB, not including loans considered to be impaired (in thousands):
Contractually required principal at acquisition
$
102,483

Less fair value adjustment
1,347

Fair value of acquired loans
$
101,136

 
 

Contractual cash flows not expected to be collected
$
1,702


13

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)


The following table provides details on acquired credit impaired loans obtained through the merger with ENB that are accounted for in accordance with FASB ASC 310-30 (in thousands):
Contractually required principal at acquisition
$
23,414

Contractual cash flows not expected to be collected (nonaccretable difference)
(6,088
)
Expected cash flows at acquisition
17,326

Interest component of expected cash flows (accretable discount)
(2,163
)
Fair value of acquired impaired loans
$
15,163


Non-accrual, past-due, and accruing restructured loans as of September 30, 2014 and December 31, 2013 are as follows (in thousands):
 
September 30, 2014
 
December 31, 2013
Non-accrual loans:
 
 
 
Commercial and industrial

 
144

Commercial, secured by real estate
4,476

 
1,418

Agricultural
68

 

Residential real estate
1,720

 
1,399

Total non-accrual loans
6,264

 
2,961

Past-due 90 days or more and still accruing
111

 
250

Total non-accrual and past-due 90 days or more and still accruing
6,375

 
3,211

Accruing restructured loans
14,462

 
15,151

Total
20,837

 
18,362



14

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)


The allowance for loan losses for the three and nine months ended September 30, 2014 and 2013 are as follows (in thousands):
 
Commercial
& Industrial
 
Commercial, Secured by
Real Estate
 
Residential
Real Estate
 
Consumer
 
Agricultural
 
Other
 
Total
Three Months Ended September 30, 2014
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, beginning of period
$
331

 
2,068

 
916

 
69

 
8

 
2

 
3,394

Provision charged to expenses
75

 
97

 
201

 
5

 
3

 
20

 
401

Losses charged off
(261
)
 
(112
)
 
(106
)
 
(24
)
 

 
(32
)
 
(535
)
Recoveries
1

 

 
1

 
25

 

 
11

 
38

Balance, end of period
$
146

 
2,053

 
1,012

 
75

 
11

 
1

 
3,298

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2014
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, beginning of year
$
175

 
2,520

 
826

 
66

 

 
1

 
3,588

Provision charged to expenses
221

 
16

 
440

 
19

 
11

 
30

 
737

Losses charged off
(261
)
 
(483
)
 
(281
)
 
(85
)
 

 
(65
)
 
(1,175
)
Recoveries
11

 

 
27

 
75

 

 
35

 
148

Balance, end of period
$
146

 
2,053

 
1,012

 
75

 
11

 
1

 
3,298

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2013
Allowance for loan losses:
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance, beginning of period
$
169

 
2,373

 
804

 
78

 

 
2

 
3,426

Provision charged to expenses
(9
)
 
7

 
150

 
20

 

 
10

 
178

Losses charged off
(1
)
 

 
(169
)
 
(63
)
 

 
(23
)
 
(256
)
Recoveries
4

 
15

 
8

 
37

 

 
11

 
75

Balance, end of period
$
163

 
2,395

 
793

 
72

 

 

 
3,423

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2013
Allowance for loan losses:
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance, beginning of year
$
320

 
2,296

 
712

 
108

 

 
1

 
3,437

Provision charged to expenses
(41
)
 
107

 
268

 
14

 

 
21

 
369

Losses charged off
(120
)
 
(34
)
 
(208
)
 
(148
)
 

 
(56
)
 
(566
)
Recoveries
4

 
26

 
21

 
98

 

 
34

 
183

Balance, end of period
$
163

 
2,395

 
793

 
72

 

 

 
3,423




15

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)


A breakdown of the allowance for loan losses and the loan portfolio by loan segment at September 30, 2014 and December 31, 2013 are as follows (in thousands):
 
Commercial
& Industrial
 
Commercial, Secured by
Real Estate
 
Residential
Real Estate
 
Consumer
 
Agricultural
 
Other
 
Total
September 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
12

 
430

 
283

 

 

 

 
725

Collectively evaluated for impairment
134

 
1,535

 
729

 
75

 
11

 
1

 
2,485

Acquired credit impaired loans

 
88

 

 

 

 

 
88

Balance, end of period
$
146

 
2,053

 
1,012

 
75

 
11

 
1

 
3,298

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
408

 
13,316

 
2,042

 
18

 

 

 
15,784

Collectively evaluated for impairment
32,858

 
344,134

 
242,897

 
19,265

 
9,132

 
2,103

 
650,389

Acquired credit impaired loans
1,698

 
13,729

 
3,549

 
101

 
117

 
548

 
19,742

Balance, end of period
$
34,964

 
371,179

 
248,488

 
19,384

 
9,249

 
2,651

 
685,915

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
2

 
760

 
270

 

 

 

 
1,032

Collectively evaluated for impairment
173

 
1,760

 
556

 
66

 

 
1

 
2,556

Acquired credit impaired loans

 

 

 

 

 

 

Balance, end of period
$
175

 
2,520

 
826

 
66

 

 
1

 
3,588

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
165

 
14,522

 
2,132

 
27

 

 

 
16,846

Collectively evaluated for impairment
28,809

 
295,028

 
212,378

 
12,703

 
2,472

 
91

 
551,481

Acquired credit impaired loans
332

 
4,363

 
1,332

 

 

 

 
6,027

Balance, end of period
$
29,306

 
313,913

 
215,842

 
12,730

 
2,472

 
91

 
574,354



16

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)


The risk characteristics of LCNB's material loan portfolio segments are as follows:

Commercial and Industrial Loans. LCNB’s commercial and industrial loan portfolio consists of loans for various purposes, including loans to fund working capital requirements (such as inventory and receivables financing) and purchases of machinery and equipment.  LCNB offers a variety of commercial and industrial loan arrangements, including term loans, balloon loans, and lines of credit.  Most commercial and industrial loans have a variable rate, with adjustments occurring monthly, annually, every three years, or every five years.  Adjustments are generally based on a publicly available index rate plus a margin.  The margin varies based on the terms and collateral securing the loan.  Commercial and industrial loans are offered to businesses and professionals for short and medium terms on both a collateralized and uncollateralized basis. Commercial and industrial loans typically are underwritten on the basis of the borrower’s ability to make repayment from the cash flow of the business.  Collateral, when obtained, may include liens on furniture, fixtures, equipment, inventory, receivables, or other assets.  As a result, such loans involve complexities, variables, and risks that require thorough underwriting and more robust servicing than other types of loans.

Commercial, Secured by Real Estate Loans.  Commercial real estate loans include loans secured by a variety of commercial, retail, and office buildings, religious facilities, multifamily (more than two-family) residential properties, construction and land development loans, and other land loans. Commercial real estate loan products generally amortize over five to twenty-five years and are payable in monthly principal and interest installments.  Some have balloon payments due within one to ten years after the origination date.  Many have adjustable interest rates with adjustment periods ranging from one to ten years, some of which are subject to established “floor” interest rates.

Commercial real estate loans are underwritten based on the ability of the property, in the case of income producing property, or the borrower’s business to generate sufficient cash flow to amortize the debt. Secondary emphasis is placed upon global debt service, collateral value, financial strength of any guarantors, and other factors. Commercial real estate loans are generally originated with a 75 percent maximum loan to appraised value ratio.

Residential Real Estate Loans.  Residential real estate loans include loans secured by first or second mortgage liens on one to two-family residential property.  Home equity lines of credit and mortgage loans secured by owner-occupied agricultural property are included in this category.  First and second mortgage loans are generally amortized over five to thirty years with monthly principal and interest payments.  Home equity lines of credit generally have a five year draw period with interest only payments followed by a repayment period with monthly payments based on the amount outstanding.  LCNB offers both fixed and adjustable rate mortgage loans.  Adjustable rate loans are available with adjustment periods ranging between one to ten years and adjust according to an established index plus a margin, subject to certain floor and ceiling rates.  Home equity lines of credit have a variable rate based on the Wall Street Journal prime rate plus a margin.

LCNB does not originate reverse mortgage loans or residential real estate loans generally considered to be “subprime.”

Residential real estate loans are underwritten primarily based on the borrower’s ability to repay, prior credit history, and the value of the collateral.  LCNB requires private mortgage insurance for first mortgage loans that have a loan to appraised value ratio of greater than 80%.
Consumer Loans.  LCNB’s portfolio of consumer loans generally includes secured and unsecured loans to individuals for household, family and other personal expenditures.  Secured loans include loans to fund the purchase of automobiles, recreational vehicles, boats, and similar acquisitions. Consumer loans made by LCNB generally have fixed rates and terms ranging up to 72 months, depending upon the nature of the collateral, size of the loan, and other relevant factors.

Consumer loans generally have higher interest rates, but pose additional risks of collectability and loss when compared to certain other types of loans. Collateral, if present, is generally subject to damage, wear, and depreciation.  The borrower’s ability to repay is of primary importance in the underwriting of consumer loans.

Agricultural Loans.  LCNB’s portfolio of agricultural loans includes loans for financing agricultural production or for financing the purchase of equipment used in the production of agricultural products.  LCNB’s agricultural loans are generally secured by farm machinery, livestock, crops, vehicles, or other agri-related collateral.

17

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)


LCNB uses a risk-rating system to quantify loan quality.  A loan is assigned to a risk category based on relevant information about the ability of the borrower to service the debt including, but not limited to, current financial information, historical payment experience, credit documentation, public information, and current economic trends.  The categories used are:

Pass – loans categorized in this category are higher quality loans that do not fit any of the other categories described below.
Other Assets Especially Mentioned (OAEM) - loans in this category are currently protected but are potentially weak.  These loans constitute a risk but not to the point of justifying a classification of substandard.  The credit risk may be relatively minor yet constitute an undue risk in light of the circumstances surrounding a specific asset.
Substandard – loans in this category are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any.  Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the possibility that LCNB will sustain some loss if the deficiencies are not corrected.
Doubtful – loans classified in this category have all the weaknesses inherent in loans classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
 
A breakdown of the loan portfolio by credit quality indicators at September 30, 2014 and December 31, 2013 is as follows (in thousands):
 
Pass
 
OAEM
 
Substandard
 
Doubtful
 
Total
September 30, 2014
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
33,821

 

 
1,143

 

 
34,964

Commercial, secured by real estate
342,558

 
5,256

 
23,365

 

 
371,179

Residential real estate
239,646

 
937

 
7,905

 

 
248,488

Consumer
19,222

 

 
162

 

 
19,384

Agricultural
9,132

 

 
117

 

 
9,249

Other
2,103

 

 
548

 

 
2,651

Total
$
646,482

 
6,193

 
33,240

 

 
685,915

 
 
 
 
 
 
 
 
 
 
December 31, 2013
 

 
 

 
 

 
 

 
 

Commercial & industrial
$
27,563

 
44

 
1,699

 

 
29,306

Commercial, secured by real estate
295,189

 
3,967

 
14,757

 

 
313,913

Residential real estate
208,881

 
1,136

 
5,825

 

 
215,842

Consumer
12,681

 

 
49

 

 
12,730

Agricultural
2,472

 

 

 

 
2,472

Other
91

 

 

 

 
91

Total
$
546,877

 
5,147

 
22,330

 

 
574,354



18

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)


A loan portfolio aging analysis at September 30, 2014 and December 31, 2013 is as follows (in thousands):
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Greater Than
90 Days
Past Due
 
Total
Past Due
 
Current
 
Total Loans
Receivable
 
Total Loans Greater Than
90 Days and
Accruing
September 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
22

 

 

 
22

 
34,942

 
34,964

 

Commercial, secured by real estate
738

 
573

 
3,126

 
4,437

 
366,742

 
371,179

 
70

Residential real estate
1,727

 
629

 
1,322

 
3,678

 
244,810

 
248,488

 

Consumer
102

 
12

 
41

 
155

 
19,229

 
19,384

 
41

Agricultural

 

 

 

 
9,249

 
9,249

 

Other
68

 

 

 
68

 
2,583

 
2,651

 

Total
$
2,657

 
1,214

 
4,489

 
8,360

 
677,555

 
685,915

 
111

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial & industrial
$
277

 

 
144

 
421

 
28,885

 
29,306

 

Commercial, secured by real estate
951

 
582

 
1,174

 
2,707

 
311,206

 
313,913

 

Residential real estate
1,131

 
299

 
1,604

 
3,034

 
212,808

 
215,842

 
236

Consumer
38

 
35

 
13

 
86

 
12,644

 
12,730

 
14

Agricultural

 

 

 

 
2,472

 
2,472

 

Other
91

 

 

 
91

 

 
91

 

Total
$
2,488

 
916

 
2,935

 
6,339

 
568,015

 
574,354

 
250


 

19

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)


Impaired loans, including acquired credit impaired loans, at September 30, 2014 and December 31, 2013 are as follows (in thousands):
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
September 30, 2014
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
Commercial & industrial
$
1,716

 
2,942

 

Commercial, secured by real estate
22,808

 
28,315

 

Residential real estate
4,114

 
5,726

 

Consumer
101

 
168

 

Agricultural
117

 
634

 

Other
548

 
774

 

Total
$
29,404

 
38,559

 

 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

Commercial & industrial
$
390

 
395

 
11

Commercial, secured by real estate
4,237

 
4,691

 
518

Residential real estate
1,427

 
1,592

 
283

Consumer
18

 
18

 
1

Total
$
6,072

 
6,696

 
813

 
 
 
 
 
 
Total:
 

 
 

 
 

Commercial & industrial
$
2,106

 
3,337

 
11

Commercial, secured by real estate
27,045

 
33,006

 
518

Residential real estate
5,541

 
7,318

 
283

Consumer
119

 
186

 
1

Agricultural
117

 
634

 

Other
548

 
774

 

Total
$
35,476

 
45,255

 
813

 
 
 
 
 
 
December 31, 2013
 

 
 

 
 

With no related allowance recorded:
 

 
 

 
 

Commercial & industrial
$
332

 
531

 

Commercial, secured by real estate
10,883

 
12,317

 

Residential real estate
2,096

 
2,967

 

Consumer

 

 

Total
$
13,311

 
15,815

 

 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

Commercial & industrial
$
165

 
270

 
2

Commercial, secured by real estate
7,725

 
7,725

 
760

Residential real estate
1,645

 
1,663

 
270

Consumer
27

 
27

 

Total
$
9,562

 
9,685

 
1,032

 
 
 
 
 
 
Total:
 

 
 

 
 

Commercial & industrial
$
497

 
801

 
2

Commercial, secured by real estate
18,608

 
20,042

 
760

Residential real estate
3,741

 
4,630

 
270

Consumer
27

 
27

 

Total
$
22,873

 
25,500

 
1,032


20

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)


The following presents information related to the average recorded investment and interest income recognized on impaired loans, including acquired credit impaired loans, for the three and nine months ended September 30, 2014 and 2013 (in thousands):
 
2014
 
2013
 
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
Three Months Ended September 30,
 
 
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
 
 
Commercial & industrial
$
2,053

 
38

 
349

 
6

Commercial, secured by real estate
22,768

 
310

 
7,733

 
280

Residential real estate
4,328

 
98

 
2,158

 
49

Consumer
158

 
2

 

 

Agricultural
116

 
7

 

 

Other
543

 
10

 

 

Total
$
29,966

 
465

 
10,240

 
335

 
 
 
 
 
 
 
 
With an allowance recorded:
 
 
 
 
 
 
 
Commercial & industrial
$
393

 
6

 
166

 

Commercial, secured by real estate
4,298

 
46

 
11,249

 
95

Residential real estate
1,341

 
9

 
1,226

 
6

Consumer
18

 

 
34

 
1

Agricultural

 

 

 

Other

 

 

 

Total
$
6,050

 
61

 
12,675

 
102

 
 
 
 
 
 
 
 
Total:
 
 
 
 
 
 
 
Commercial & industrial
$
2,446

 
44

 
515

 
6

Commercial, secured by real estate
27,066

 
356

 
18,982

 
375

Residential real estate
5,669

 
107

 
3,384

 
55

Consumer
176

 
2

 
34

 
1

Agricultural
116

 
7

 

 

Other
543

 
10

 

 

Total
$
36,016

 
526

 
22,915

 
437

 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
 
 
Commercial & industrial
$
2,085

 
76

 
793

 
30

Commercial, secured by real estate
23,549

 
698

 
8,126

 
519

Residential real estate
4,620

 
179

 
2,261

 
133

Consumer
196

 
8

 
1

 

Agricultural
126

 
9

 
16

 
7

Other
560

 
17

 

 

Total
$
31,136

 
987

 
11,197

 
689

 
 
 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

 
 

Commercial & industrial
$
274

 
17

 
193

 
1

Commercial, secured by real estate
4,209

 
97

 
10,920

 
278

Residential real estate
1,176

 
39

 
1,201

 
23

Consumer
18

 
1

 
21

 
2

Agricultural

 

 

 

Other

 

 

 

Total
$
5,677

 
154

 
12,335

 
304

 
 
 
 
 
 
 
 
Total:
 

 
 

 
 

 
 

Commercial & industrial
$
2,359

 
93

 
986

 
31

Commercial, secured by real estate
27,758

 
795

 
19,046

 
797

Residential real estate
5,796

 
218

 
3,462

 
156

Consumer
214

 
9

 
22

 
2

Agricultural
126

 
9

 
16

 
7

Other
560

 
17

 

 

Total
$
36,813

 
1,141

 
23,532

 
993


21

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)


Loan modifications that were classified as troubled debt restructurings during the three and nine months ended September 30, 2014 and 2013 are as follows (dollars in thousands):
 
2014
 
2013
 
Number
of Loans
 
Pre-Modification Recorded Balance
 
Post-Modification Recorded Balance
 
Number
of Loans
 
Pre-Modification Recorded Balance
 
Post-Modification Recorded Balance
Three Months Ended September 30,
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial

 
$

 

 

 
$

 

Commercial, secured by real estate
1

 
79

 
79

 
1

 
702

 
702

Residential real estate
1

 
5

 
5

 

 

 

Consumer

 

 

 

 

 

Total
2

 
$
84

 
84

 
1

 
$
702

 
702

 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
 
 
 

 
 

Commercial & industrial
7

 
$
638

 
638

 
1

 
$
22

 
22

Commercial, secured by real estate
2

 
897

 
897

 
1

 
702

 
702

Residential real estate
2

 
83

 
83

 
2

 
335

 
335

Consumer
1

 
2

 
2

 
2

 
27

 
27

Total
12

 
$
1,620

 
1,620

 
6

 
$
1,086

 
1,086


Each restructured loan is separately negotiated with the borrower and includes terms and conditions that reflect the borrower's ability to pay the debt as modified.  Modifications may include interest only payments for a period of time, temporary or permanent reduction of the loan's interest rate, capitalization of delinquent interest, or extensions of the maturity date.

LCNB is not committed to lend additional funds to borrowers whose loan terms were modified in a troubled debt restructuring.

A restructured automobile loan with a balance of $13,000 was charged off during the first quarter 2013, which was within twelve months of the loan's modification date.  There were no other troubled debt restructurings that subsequently defaulted within twelve months of the restructuring date for the nine months ended September 30, 2014 and 2013.


22

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)


Note 5 - Acquired Credit Impaired Loans

The following table provides the major classifications of loans acquired during 2014 and 2013 that are accounted for in accordance with FASB ASC 310-30 (in thousands):
 
September 30, 2014
 
December 31, 2013
Commercial & industrial
$
1,698

 
332

Commercial, secured by real estate
13,729

 
4,363

Residential real estate
3,549

 
1,332

Consumer
101

 

Agricultural
117

 

Other loans, including deposit overdrafts
548

 

 
19,742

 
6,027

Less allowance for loan losses
88

 

Loans, net
19,654

 
6,027


The following table provides the outstanding balance and related carrying amount for acquired credit impaired loans at the dates indicated (in thousands):
 
September 30, 2014
 
December 31,
2013
Outstanding balance
$
29,055

 
8,220

Carrying amount
19,742

 
6,027


Activity during 2014 for the accretable discount related to acquired credit impaired loans is as follows (in thousands):
Accretable discount at December 31, 2013
$
1,107

Accretable discount acquired during period
2,163

Reclass from nonaccretable discount to accretable discount
140

Less disposals
(99
)
Less accretion
(413
)
Accretable discount at September 30, 2014
$
2,898



23

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)


Note 6 – Other Real Estate Owned
 
Other real estate owned includes property acquired through foreclosure or deed-in-lieu of foreclosure and also includes property deemed to be in-substance foreclosed and are included in "other assets" in the consolidated balance sheets.  Changes in other real estate owned are as follows (in thousands):
 
Nine Months Ended September 30,
 
2014
 
2013
Balance, beginning of year
$
1,463

 
2,189

Additions
455

 
126

Additions due to merger
262

 
127

Reductions due to sales
(697
)
 
(843
)
Reductions due to valuation write downs
(23
)
 
(38
)
Balance, end of period
$
1,460

 
1,561


Other real estate owned at September 30, 2014 and December 31, 2013 consisted of (dollars in thousands):
 
September 30, 2014
 
December 31, 2013
Commercial real estate
$
1,316

 
$
1,415

Residential real estate
144

 
48

 
$
1,460

 
$
1,463

 
Note 7 – Income Taxes
 
A reconciliation between the statutory income tax and LCNB's effective tax rate on income from continuing operations follows:
 
For the three months ended
September 30,
 
For the nine months ended
September 30,
 
2014
 
2013
 
2014
 
2013
Statutory tax rate
34.0
 %
 
34.0
 %
 
34.0
 %
 
34.0
 %
Increase (decrease) resulting from:
 

 
 

 
 

 
 

Tax exempt interest
(6.5
)%
 
(6.8
)%
 
(7.5
)%
 
(7.4
)%
Tax exempt income on bank owned life insurance
(1.5
)%
 
(1.8
)%
 
(2.0
)%
 
(2.0
)%
Other, net
 %
 
 %
 
 %
 
0.4
 %
Effective tax rate
26.0
 %
 
25.4
 %
 
24.5
 %
 
25.0
 %

Note 8 - Commitments and Contingent Liabilities
 
LCNB is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit.  They involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets.  Exposure to credit loss in the event of nonperformance by the other parties to financial instruments for commitments to extend credit is represented by the contract amount of those instruments.

LCNB offers the Bounce Protection product, a customer deposit overdraft program, which is offered as a service and does not constitute a contract between the customer and LCNB.

LCNB uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.  

24

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 8 – Commitments and Contingent Liabilities (continued)



Financial instruments whose contract amounts represent off-balance-sheet credit risk at September 30, 2014 and December 31, 2013 are as follows (in thousands):
 
September 30,
2014
 
December 31,
2013
Commitments to extend credit:
 
 
 
Commercial loans
$
9,328

 
9,316

Other loans
 

 
 

Fixed rate
3,083

 
852

Adjustable rate
3,191

 
1,653

Unused lines of credit:
 

 
 

Fixed rate
6,958

 
3,404

Adjustable rate
69,841

 
60,236

Unused overdraft protection amounts on demand and NOW accounts
10,249

 
9,494

Standby letters of credit
453

 
365

 
$
103,103

 
85,320


Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Unused lines of credit include amounts not drawn on line of credit loans.  Commitments to extend credit and unused lines of credit generally have fixed expiration dates or other termination clauses.

Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party.  These guarantees generally are fully secured and have varying maturities.  

LCNB evaluates each customer's credit worthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation of the borrower.  Collateral held varies, but may include accounts receivable, inventory, residential realty, income-producing commercial property, and property, plant, and equipment.

Capital expenditures include the construction or acquisition of new office buildings, improvements to LCNB's offices, purchases of furniture and equipment, and additions or improvements to LCNB's information technology system. Commitments outstanding for capital expenditures as of September 30, 2014 totaled approximately $120,000.

Management believes that LCNB has sufficient liquidity to fund its lending and capital expenditure commitments.

LCNB and its subsidiaries are parties to various claims and proceedings arising in the normal course of business.  Management, after consultation with legal counsel, believes that the liabilities, if any, arising from such proceedings and claims will not be material to the consolidated financial position or results of operations.

Note 9 – Regulatory Capital
 
The Bank and LCNB are required by regulators to meet certain minimum levels of capital adequacy. These are expressed in the form of certain ratios. Capital is separated into Tier 1 capital (essentially shareholders' equity less goodwill and other intangibles) and Tier 2 capital (essentially the allowance for loan losses limited to 1.25% of risk-weighted assets). The first two ratios, which are based on the degree of credit risk in LCNB's assets, provide for weighting assets based on assigned risk factors and include off-balance sheet items such as loan commitments and standby letters of credit.  The leverage ratio supplements the risk-based capital guidelines.

25

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 9 – Regulatory Capital (continued)


For various regulatory purposes, financial institutions are classified into categories based upon capital adequacy.
 
 
Minimum Requirement
 
To Be Considered
Well-Capitalized
Ratio of tier 1 capital to risk-weighted assets
 
4.0
%
 
6.0
%
Ratio of total capital (tier 1 capital plus tier 2 capital) to risk-weighted assets
 
8.0
%
 
10.0
%
Leverage ratio (tier 1 capital to adjusted quarterly average total assets)
 
3.0
%
 
5.0
%
 
As of the most recent notification from their regulators, the Bank and LCNB were categorized as "well-capitalized" under the regulatory framework for prompt corrective action.  Management believes that no conditions or events have occurred since the last notification that would change the Bank's or LCNB's category.
 
A summary of the regulatory capital and capital ratios of LCNB follows (dollars in thousands):
 
 
September 30,
2014
 
December 31,
2013
Regulatory Capital:
 
 
Shareholders' equity
 
$
123,179

 
118,873

Goodwill and other intangibles
 
(32,039
)
 
(16,532
)
Accumulated other comprehensive (income) loss
 
(91
)
 
1,722

Tier 1 risk-based capital
 
91,049

 
104,063

Eligible allowance for loan losses
 
3,298

 
3,588

Total risk-based capital
 
$
94,347

 
107,651

Capital ratios:
 
 

 
 

Tier 1 capital to risk-weighted assets
 
13.77
%
 
18.03
%
Total capital to risk-weighted assets
 
14.27
%
 
18.65
%
Leverage
 
8.22
%
 
11.10
%


26

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)


Note 10 – Accumulated Other Comprehensive Income
 
Changes in accumulated other comprehensive income for the nine months ended September 30, 2014 and 2013 are as follows (in thousands):
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Changes in Pension Plan Assets and Benefit Obligations
 
Total
September 30, 2014
 
 
 
 
 
Balance at beginning of period
$
(1,641
)
 
(81
)
 
(1,722
)
Before reclassifications
1,867

 
7

 
1,874

Reclassifications
(61
)
 

 
(61
)
Balance at end of period
$
165

 
(74
)
 
91

 
 
 
 
 
 
September 30, 2013
 

 
 

 
 

Balance at beginning of period
$
4,875

 
(154
)
 
4,721

Before reclassifications
(4,758
)
 
26

 
(4,732
)
Reclassifications
(497
)
 

 
(497
)
Balance at end of period
$
(380
)
 
(128
)
 
(508
)

Reclassifications out of accumulated other comprehensive income during the three and nine months ended September 30, 2014 and 2013 and the affected line items in the consolidated statements of income are as follows (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
Affected Line Item in the Consolidated Statements of Income
 
2014
 
2013
 
2014
 
2013
 
Realized gain on sale of securities
$
97

 
58

 
93

 
753

 
Net gain on sale of securities
Less provision for income taxes
33

 
20

 
32

 
256

 
Provision for income taxes
Reclassification adjustment, net of taxes
$
64

 
38

 
61

 
497

 
 


27

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)


Note 11 – Retirement Plans
 
LCNB participates in a noncontributory defined benefit multi-employer retirement plan that covers substantially all regular full-time employees hired before January 1, 2009.

Employees of LCNB also participate in a defined contribution retirement plan.  Employees hired on or after January 1, 2009 receive a 50% employer match on their contributions into the 401(k) plan, up to a maximum LCNB contribution of 3% of each individual employee's annual compensation.  Employees hired before January 1, 2009 who received a benefit reduction under certain amendments to the defined benefit retirement plan receive an automatic contribution of 5% or 7% of annual compensation, depending on the sum of an employee's age and vesting service, into the 401(k) plan, regardless of the contributions made by the employees.  This contribution is made annually and these employees do not receive any employer matches to their 401(k) contributions.
 
Funding and administrative costs of the qualified noncontributory defined benefit retirement plan and 401(k) plan charged to pension and other employee benefits in the consolidated statements of income for the three and nine-month periods ended September 30, 2014 and 2013 are as follows (in thousands):
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2014
 
2013
 
2014
 
2013
Qualified noncontributory defined benefit retirement plan
$
309

 
31

 
725

 
93

401(k) plan
81

 
75

 
242

 
229


Certain highly compensated employees participate in a nonqualified defined benefit retirement plan.  The nonqualified plan ensures that participants receive the full amount of benefits to which they would have been entitled under the noncontributory defined benefit retirement plan in the absence of limits on benefit levels imposed by certain sections of the Internal Revenue Code.

The components of net periodic pension cost of the nonqualified defined benefit retirement plan for the three and nine months ended September 30, 2014 and 2013 are summarized as follows (in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2014
 
2013
 
2014
 
2013
Service cost
 
$
17

 
18

 
51

 
54

Interest cost
 
15

 
12

 
45

 
35

Amortization of unrecognized net loss
 

 
6

 

 
18

Amortization of unrecognized prior service cost
 
4

 
7

 
12

 
21

Net periodic pension cost
 
$
36

 
43

 
108

 
128


Amounts recognized in accumulated other comprehensive income, net of tax, at September 30, 2014 and December 31, 2013 for the nonqualified defined benefit retirement plan consists of (in thousands):
 
September 30,
2014
 
December 31,
2013
Net actuarial loss
$
70

 
70

Past service cost
3

 
10

 
$
73

 
80





28

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)


Note 12 - Stock Based Compensation
 
LCNB established an Ownership Incentive Plan (the "Plan") during 2002 that allowed for stock-based awards to eligible employees, as determined by the Board of Directors.  The awards were made in the form of stock options, share awards, and/or appreciation rights.  The Plan provided for the issuance of up to 200,000 shares. The plan expired on April 16, 2012. Any outstanding unexercised options, however, continue to be exercisable in accordance with their terms.

Options granted to date vest ratably over a five-year period and expire ten years after the date of grant. Stock options outstanding at September 30, 2014 are as follows:
 
 
Outstanding Stock Options
 
Exercisable Stock Options
Exercise Price Range
 
Number
 
Weighted Average
Exercise
Price
 
Weighted Average Remaining Contractual
Life (Years)
 
Number
 
Weighted Average Exercise Price
 
Weighted Average Remaining Contractual
Life (Years)
$9.00 - $10.99
 
23,494

 
$
9.00

 
4.3
 
23,494

 
$
9.00

 
4.3
$11.00 - $12.99
 
63,354

 
12.05

 
5.8
 
42,249

 
12.02

 
5.4
$17.00 - $18.99
 
12,962

 
18.41

 
1.8
 
12,962

 
18.41

 
1.8
 
 
99,810

 
12.16

 
4.9
 
78,705

 
12.17

 
4.5

The following table summarizes stock option activity for the periods indicated:
 
2014
 
2013
 
Options
 
Weighted Average Exercise
Price
 
Options
 
Weighted Average Exercise
Price
Outstanding, January 1
104,966

 
$
12.43

 
110,586

 
$
12.42

Granted

 

 

 

Exercised

 

 
(5,620
)
 
12.32

Expired
(5,156
)
 
17.66

 

 

Outstanding, September 30
99,810

 
12.16

 
104,966

 
12.43

Exercisable, September 30
78,705

 
12.17

 
67,899

 
12.86


The aggregate intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) for options outstanding at September 30, 2014 that were "in the money" (market price greater than exercise price) was $330,000.  The aggregate intrinsic value at that date for only the options that were exercisable was $268,000.  The aggregate intrinsic value for options outstanding at September 30, 2013 that were in the money was $708,000 and the aggregate intrinsic value at that date for only the options that were exercisable was $428,000.  The intrinsic value changes based upon fluctuations in the market value of LCNB's stock.

Total expenses related to options included in salaries and employee benefits in the consolidated statements of income for the three and nine months ended September 30, 2014 was $5,000 and $18,000, respectively, and $9,000 and $28,000 for the three and nine months ended September 30, 2013, respectively.


29

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)


Note 13 - Earnings per Common Share
 
Basic earnings per common share is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period.  Diluted earnings per common share is adjusted for the dilutive effects of stock options, warrants, and restricted stock.  The diluted average number of common shares outstanding has been increased for the assumed exercise of stock options and warrants with proceeds used to purchase treasury shares at the average market price for the period.  The computations are as follows for the three and nine months ended September 30, 2014 and 2013 (dollars in thousands, except share and per share data):
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
2,718

 
2,357

 
6,652

 
6,433

Weighted average number of shares outstanding used in the calculation of basic earnings per common share
9,299,691

 
7,636,098

 
9,293,866

 
7,592,818

Add dilutive effect of:
 

 
 

 
 

 
 

Stock options
17,775

 
29,601

 
19,331

 
23,262

Stock warrants
87,547

 
121,399

 
93,913

 
106,606

Adjusted weighted average number of shares outstanding used in the calculation of diluted earnings per common share
9,405,013

 
7,787,098

 
9,407,110

 
7,722,686

Earnings per common share:
 

 
 

 
 

 
 

Basic
$
0.30

 
0.31

 
0.72

 
0.85

Diluted
0.29

 
0.30

 
0.71

 
0.83


Options to purchase 18,118 and 6,400 shares of common stock at a weighted average price of $18.19 and $18.95 per share were outstanding at September 30, 2014 and 2013, respectively, but were not included in the computation of diluted earnings per common share because the exercise prices of the options were greater than the average market price of the common shares.

Note 14 - Fair Value Measurements
 
LCNB measures certain assets at fair value using various valuation techniques and assumptions, depending on the nature of the asset.  Fair value is defined as the price that would be received from the sale of an asset in an orderly transaction between market participants at the measurement date.

The inputs to the valuation techniques used to measure fair value are assigned to one of three broad levels:
Level 1 – quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the reporting date.
Level 2 – inputs other than quoted prices included within level 1 that are observable for the asset or liability either directly or indirectly.  Level 2 inputs may include quoted prices for similar assets in active markets,  quoted prices for identical assets or liabilities in markets that are not active, inputs other than quoted prices (such as interest rates or yield curves) that are observable for the asset or liability, and inputs that are derived from or corroborated by observable market data.
Level 3 - inputs that are unobservable for the asset or liability.
The majority of LCNB's financial debt securities are classified as available-for-sale.  The securities are reported at fair value with unrealized holding gains and losses reported net of income taxes in accumulated other comprehensive income.


30

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 14 - Fair Value Measurements (continued)

LCNB utilizes a pricing service for determining the fair values of most of its investment securities.  Fair value for U.S. Treasury notes are determined based on market quotations (level 1).  Fair value for most of the other investment securities is calculated using the discounted cash flow method for each security.  The discount rates for these cash flows are estimated by the pricing service using rates observed in the market (level 2).  Cash flow streams are dependent on estimated prepayment speeds and the overall structure of the securities given existing market conditions.  In addition, LCNB has invested in trust preferred securities, equity securities, and four mutual funds that are not priced by the pricing service. Market quotations (level1) are used to determine fair values for the trust preferred securities and equity securities. Investments in mutual funds that are publicly traded in active markets and that publish daily net asset values are considered to have level 1 inputs.  An investment in a mutual fund that is not traded in an active market is considered to have level 2 inputs because an investor can have its interest in the fund redeemed for the balance of its capital account at any quarter-end assuming the fund is given a 60 day notice.  The investment in this fund is carried at fair value, which approximates cost.
 
Assets that may be recorded at fair value on a nonrecurring basis include impaired loans, other real estate owned, and other repossessed assets.  A loan is considered impaired when management believes it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement.  Impaired loans are carried at the present value of estimated future cash flows using the loan's existing rate or the fair value of collateral if the loan is collateral dependent, if this value is less than the loan balance.  The inputs are considered to be level 3.

Other real estate owned is adjusted to fair value upon transfer of the loan to foreclosed assets, usually based on an appraisal of the property.  Subsequently, foreclosed assets are carried at the lower of carrying value or fair value.  These inputs are also considered to be level 3.


31

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 14 - Fair Value Measurements (continued)

The following table summarizes the valuation of LCNB's assets recorded at fair value by input levels as of September 30, 2014 and December 31, 2013 (in thousands):
 
 
Fair Value Measurements at the End of
the Reporting Period Using
 
 
Fair Value Measurements
 
Quoted
Prices
in Active
Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
September 30, 2014
 
 
 
 
 
 
 
 
Recurring fair value measurements:
 
 
 
 
 
 
 
 
Investment securities available-for-sale:
 
 
 
 
 
 
 
 
U.S. Treasury notes
 
$
60,479

 
60,479

 

 

U.S. Agency notes
 
85,981

 

 
85,981

 

U.S. Agency mortgage-backed securities
 
39,534

 

 
39,534

 

Certificates of deposit with other banks
 
3,085

 

 
3,085

 

Municipal securities:
 
 

 
 

 
 

 
 

Non-taxable
 
84,851

 

 
84,851

 

Taxable
 
14,685

 

 
14,685

 

Mutual funds
 
2,449

 
1,449

 
1,000

 

Trust preferred securities
 
50

 
50

 

 

Equity securities
 
1,739

 
1,739

 

 

Total recurring fair value measurements
 
$
292,853

 
63,717

 
229,136

 

Nonrecurring fair value measurements:
 
 

 
 

 
 
 
 

Impaired loans
 
$
5,260

 

 

 
5,260

Other real estate owned and repossessed assets
 
1,460

 

 

 
1,460

Total nonrecurring fair value measurements
 
$
6,720

 

 

 
6,720

 
 
 
 
 
 
 
 
 
December 31, 2013
 
 

 
 

 
 

 
 

Recurring fair value measurements:
 
 

 
 

 
 

 
 

Investment securities available-for-sale:
 
 

 
 

 
 

 
 

U.S. Treasury notes
 
$
12,894

 
12,894

 

 

U.S. Agency notes
 
106,675

 

 
106,675

 

U.S. Agency mortgage-backed securities
 
40,309

 

 
40,309

 

Certificates of deposit with other banks
 
1,501

 

 
1,501

 

Municipal securities:
 
 

 
 

 
 

 
 

Non-taxable
 
75,333

 

 
75,333

 

Taxable
 
17,309

 

 
17,309

 

Mutual funds
 
2,380

 
1,380

 
1,000

 

Trust preferred securities
 
147

 
147

 

 

Equity securities
 
1,693

 
1,693

 

 

Total recurring fair value measurements
 
$
258,241

 
16,114

 
242,127

 

Nonrecurring fair value measurements:
 
 

 
 

 
 

 
 

Impaired loans
 
$
8,530

 

 
773

 
7,757

Other real estate owned and repossessed assets
 
1,463

 

 
1,463

 

Total nonrecurring fair value measurements
 
$
9,993

 

 
2,236

 
7,757







32

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 14 - Fair Value Measurements (continued)

The following table presents quantitative information about unobservable inputs used in nonrecurring Level 3 fair value measurements at September 30, 2014 and December 31, 2013 (dollars in thousands):
 
 
 
 
 
 
 
 
Range
 
 
Fair Value
 
Valuation Technique
 
Unobservable Inputs
 
High
 
Low
 
Weighted Average
September 30, 2014:
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans
 
$
5,260

 
Estimated sales price
 
Adjustments for comparable properties, discounts to reflect current market conditions
 
Not applicable
 
 

 
Discounted cash flows
 
Discount rate
 
10.50
%
 
4.00
%
 
5.39
%
Other real estate owned
 
1,460

 
Estimated sales price
 
Adjustments for comparable properties, discounts to reflect current market conditions
 
Not applicable
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013:
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans
 
$
7,757

 
Estimated sales price
 
Adjustments for comparable properties, discounts to reflect current market conditions
 
Not applicable


33

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 14 - Fair Value Measurements (continued)

Carrying amounts and estimated fair values of financial instruments as of September 30, 2014 and December 31, 2013 are as follows (in thousands):
 
 
 
 
Fair Value Measurements at the End of
the Reporting Period Using
 
 
Carrying
Amount
 
Fair
Value
 
Quoted
Prices
in Active
Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
September 30, 2014
 
 
 
 
 
 
 
 
 
 
FINANCIAL ASSETS:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
33,053

 
33,053

 
33,053

 

 

Investment securities, held-to-maturity
 
23,504

 
22,578

 

 

 
22,578

Federal Reserve Bank stock
 
2,346

 
2,346

 
2,346

 

 

Federal Home Loan Bank stock
 
3,638

 
3,638

 
3,638

 

 

Loans, net
 
682,617

 
687,415

 

 

 
687,415

 
 
 
 
 
 
 
 
 
 
 
FINANCIAL LIABILITIES:
 
 

 
 

 
 
 
 
 
 
Deposits
 
956,633

 
958,616

 
735,018

 
223,598

 

Short-term borrowings
 
24,954

 
24,954

 
24,954

 

 

Long-term debt
 
11,432

 
12,017

 

 
12,017

 

 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
 
 
 
FINANCIAL ASSETS:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
14,688

 
14,688

 
14,688

 

 

Investment securities, held-to-maturity
 
16,323

 
16,196

 

 

 
16,196

Federal Reserve Bank stock
 
1,603

 
1,603

 
1,603

 

 

Federal Home Loan Bank stock
 
2,854

 
2,854

 
2,854

 

 

Loans, net
 
570,766

 
573,163

 

 
773

 
572,390

 
 
 
 
 
 
 
 
 
 
 
FINANCIAL LIABILITIES:
 
 

 
 

 
 
 
 
 
 
Deposits
 
785,761

 
788,096

 
599,838

 
188,258

 

Short-term borrowings
 
8,655

 
8,655

 
8,655

 

 

Long-term debt
 
12,102

 
12,842

 

 
12,842

 


The fair value of off-balance-sheet financial instruments at September 30, 2014 and December 31, 2013 was not material.

Fair values of financial instruments are based on various assumptions, including the discount rate and estimates of future cash flows. Therefore, the fair values presented may not represent amounts that could be realized in actual transactions.  In addition, because the required disclosures exclude certain financial instruments and all nonfinancial instruments, any aggregation of the fair value amounts presented would not represent the underlying value of LCNB.  The following methods and assumptions were used to estimate the fair value of certain financial instruments:

Cash and cash equivalents
The carrying amounts presented are deemed to approximate fair value.


34

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 14 - Fair Value Measurements (continued)

Investment securities
Fair values for securities, excluding Federal Home Loan Bank and Federal Reserve Bank stock, are based on quoted market prices, if available.  If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities and/or discounted cash flow analyses or other methods.  The carrying value of Federal Home Loan Bank and Federal Reserve Bank stock approximates fair value based on the respective redemptive provisions.

Loans
Fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, incorporating assumptions of current and projected prepayment speeds.  These current rates approximate market rates.

Deposits
The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date.  The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities, which approximates market rates.

Borrowings
The carrying amounts of federal funds purchased, repurchase agreements, and U.S. Treasury demand note borrowings are deemed to approximate fair value of short-term borrowings.  For long-term debt, fair values are estimated based on the discounted value of expected net cash flows using current interest rates.



35

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)


Note 15 – Recent Accounting Pronouncements
 
Financial Accounting Standards Board Accounting Standards Update ("ASU") No. 2013-04, "Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date"
ASU No. 2013-04 was issued in February 2013 and requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date as the sum of (a) the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and (b) any additional amount the reporting entity expects to pay on behalf of its co-obligors.  The entity is also required to disclose information about the obligation, including its nature and amount.  ASU No. 2013-04 is effective for public companies for fiscal years, and interim periods within those years, beginning after December 15, 2013.  The ASU is effective for nonpublic companies for fiscal years, and interim periods within those years, beginning after December 15, 2014.  The adoption of this guidance did not have a material impact on LCNB's results of operations or financial position.

ASU No. 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists”
ASU No. 2013-11 was issued in July 2013 and requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. No new recurring disclosures are required. ASU No. 2013-11 is effective for public companies for fiscal years, and interim periods within those years, beginning after December 15, 2013 and is to be applied prospectively to all unrecognized tax benefits that exist at the effective date. The adoption of ASU No. 2013-11 did not have a material impact on LCNB’s results of operations or financial position.

ASU No. 2014-01, "Investments-Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force)"
ASU No. 2014-01 was issued in January 2014 and provides guidance on accounting for investments in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for low-income housing tax credits. Entities are permitted to make an accounting policy election to account for such investments using the proportional amortization method, as defined, if certain enumerated conditions are met. Under the proportional amortization method, an investor amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). Investments not accounted for using the proportional amortization method should be accounted for as an equity method investment or a cost method investment in accordance with Subtopic 970-323. ASU No. 2014-01 is effective for public companies for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2014 and is to be applied retrospectively to all periods presented. LCNB currently does not have any investments in qualified affordable housing projects and adoption of ASU No. 2014-01 is not expected to have a material impact on LCNB's results of operations or financial position.

ASU No. 2014-04, "Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force)"
ASU No. 2014-04 was issued in January 2014 and clarifies that an in-substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor through completion of a deed in lieu of foreclosure or through a similar legal agreement. In addition, the update requires interim and annual disclosure of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate properties that are in the process of foreclosure. ASU No. 2014-04 is effective for public companies for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. Adoption of ASU No. 2014-04 is not expected to have a material impact on LCNB's results of operations or financial position.

36

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 15 – Recent Accounting Pronouncements (continued)

ASU No. 2014-08, "Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity"
ASU No. 2014-08 was issued in April 2014 and changes the criteria for reporting discontinued operations and provides for expanded disclosures in this area. The new guidance provides that only disposals representing a strategic shift in operations should be presented as discontinued operations and that theses strategic shifts should have a major effect on an organization's operations and financial results. ASU No. 2014-08 is effective in the first quarter of 2015 for public companies with calendar year-ends.

ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)"
ASU No. 2014-09 was issued in May 2014 and and supercedes most current revenue recognition guidance for contracts to transfer goods or services or other nonfinancial assets. Lease contracts, insurance contracts, and most financial instruments are not included in the scope of this update. ASU No. 2014-09 provides that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance enumerates five steps that entities should follow in achieving this core principle. Additional disclosures providing information about contracts with customers are required. ASU No. 2014-09 is effective for public companies for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Transitional guidance is included in the update; early adoption is not permitted. Since LCNB's products are substantially financial in nature, adoption of ASU No. 2014-09 is not expected to have a material impact on LCNB's results of operations or financial position.

ASU No. 2014-11, "Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures"
ASU No. 2014-11 was issued in June 2014 and requires two accounting changes:
the accounting for repurchase-to-maturity transactions is changed to secured borrowing accounting, and
for repurchase financing arrangements, separate accounting is required for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which results in secured borrowing accounting.

Additional disclosures are required. ASU No. 2014-11 is effective for public business entities for the first interim or annual period beginning after December 15, 2014. Changes in accounting for transactions outstanding on the effective date are to be recorded as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. Since LCNB already accounts for repurchase agreements as borrowings, this update is not expected to have a material impact on LCNB's results of operation or financial position.

ASU No. 2014-12, "Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period, a consensus of the FASB Emerging Issues Task Force"
ASU No. 2014-12 was issued in June 2014 and requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition and that current guidance for awards with performance conditions be followed. ASU No. 2014-12 is effective for all entities for annual and interim periods beginning after December 15, 2015 and early adoption is permitted. Entities may apply the amendments in the update either prospectively to all awards granted or modified after the effective date or retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. None of LCNB's currently outstanding stock option grants contain the performance targets described in this update and adoption of ASU No. 2014-11 is not expected to have a material impact on its results of operations or financial position.









37

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 15 – Recent Accounting Pronouncements (continued)

ASU No. 2014-13, "Consolidation (Topic 810): Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity (a consensus of the FASB Emerging Issues Task Force)"
ASU No. 2014-13 was issued in August 2014 and applies to entities that are required to (1) consolidate a collateralized financing entity ("CFE") under the guidance for Variable Interest Entities, (2) measure all of the financial assets and financial liabilities of the CFE at fair value, and (3) reflect the changes in fair value in earnings. Under ASU 2014-13, entities that meet these criteria can elect to measure both the financial assets and the financial liabilities of the CFE using the more observable of the fair value of the financial assets and the fair value of the financial liabilities, thereby eliminating the difference between the fair value of financial assets and financial liabilities. If that alternative is not elected, then ASU 2014-13 indicates that the fair value of the financial assets and the fair value of the financial liabilities of the consolidated CFE should be measured in accordance with ASC 820, Fair Value Measurement, and differences between the fair value of the financial assets and the financial liabilities of the consolidated CFE should be reflected in earnings and attributed to the reporting entity in the consolidated statement of income or loss. The provisions of ASU 2014-13 are effective for public business entities for annual periods beginning after December 15, 2015 and interim periods within those annual periods. Early adoption is permitted. LCNB currently does not have any CFE investments and adoption of ASU No. 2014-13 is not expected to have a material impact on LCNB's results of operations or financial position.

ASU No. 2014-14, "Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force)"
ASU No. 2014-14 was issued in August 2014 and affects creditors with government-guaranteed residential mortgage loans, including those guaranteed by the Federal Housing Administration and the U.S. Department of Veterans Affairs. ASU No. 2014-14 requires that a residential mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if certain conditions described in the update are met. The amendments in ASU No. 2014-14 are in effect for public business entities for annual periods, and interim periods within such periods, starting after December 15, 2014. LCNB currently does not hold any government-guaranteed residential mortgage loans and adoption of ASU No. 2014-14 is not expected to have a material impact on LCNB's results of operations or financial position.

ASU No. 2014-15, "Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern"
ASU No. 2014-15 was issued in August 2014 and requires management to evaluate for each annual and interim reporting period whether it is probable that the entity will not be able to meet its obligations as they become due within one year after the date that financial statements are issued (or are available to be issued, where applicable). Certain disclosures, as described in the update, are required if management identifies substantial doubt about the entity's ability to continue as a going concern. ASU No. 2014-15 will take effect in the annual periods ending after December 15, 2016, and interim periods within annual periods beginning after December 15, 2016. Early application is permitted. Adoption of ASU No. 2014-15 is not expected to have a material impact on LCNB's results of operations or financial position.

38

Table of Contents



LCNB CORP. AND SUBSIDIARIES

Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements
Certain matters disclosed herein may be deemed to be forward-looking statements that involve risks and uncertainties.  Forward looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualifying words and their derivatives such as "expects," "anticipates," "believes," "estimates," "plans," "projects," or other statements concerning opinions or judgments of LCNB and its management about future events.   Factors that could influence the accuracy of such forward looking statements include, but are not limited to, regulatory policy changes, interest rate fluctuations, loan demand, loan delinquencies and losses, general economic conditions and other risks.  Such forward-looking statements represent management's judgment as of the current date.  Actual strategies and results in future time periods may differ materially from those currently expected.  LCNB disclaims, however, any intent or obligation to update such forward-looking statements.  LCNB intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.
 
Critical Accounting Policies

Allowance for Loan Losses.  The allowance for loan losses is established through a provision for loan losses charged to expense.  Loans are charged against the allowance for loan losses when management believes that the collection of the principal is unlikely.  Subsequent recoveries, if any, are credited to the allowance.  The allowance is an amount that management believes will be adequate to absorb inherent losses in the loan portfolio, based on evaluations of the collectability of loans and prior loan loss experience.  The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers' ability to pay.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific and general components.  The specific component relates to loans that are classified as doubtful, substandard, or special mention.  For such loans an allowance is established when the discounted cash flows or collateral value is lower than the carrying value of that loan.  The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors, which include trends in underperforming loans, trends in the volume and terms of loans, economic trends and conditions, concentrations of credit, trends in the quality of loans, and borrower financial statement exceptions.

Based on its evaluations, management believes that the allowance for loan losses will be adequate to absorb estimated losses inherent in the current loan portfolio.

Acquired Credit Impaired Loans. LCNB accounts for acquisitions using the acquisition method of accounting, which requires that assets acquired and liabilities assumed be measured at their fair values at the acquisition date. Acquired loans are reviewed to determine if there is evidence of deterioration in credit quality since inception and if it is probable that LCNB will be unable to collect all amounts due under the contractual loan agreements. The analysis includes expected prepayments and estimated cash flows including principal and interest payments at the date of acquisition. The amount in excess of the estimated future cash flows is not accreted into earnings. The amount in excess of the estimated future cash flows over the book value of the loan is accreted into interest income over the remaining life of the loan (accretable yield). LCNB records these loans on the acquisition date at their net realizable value. Thus, an allowance for estimated future losses is not established on the acquisition date. Subsequent to the date of acquisition, expected future cash flows on loans acquired are updated and any losses or reductions in estimated cash flows which arise subsequent to the date of acquisition are reflected as a charge through the provision for loan losses. An increase in the expected cash flows adjusts the level of the accretable yield recognized on a prospective basis over the remaining life of the loan. Due to the number, size, and complexity of loans within the acquired loan portfolio, there is always a possibility of inherent undetected losses.


39

Table of Contents

LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)




Accounting for Intangibles.  LCNB’s intangible assets at September 30, 2014 are composed primarily of goodwill and core deposit intangibles related to the acquisitions of Sycamore during the fourth quarter 2007, First Capital during the first quarter 2013, and ENB during the first quarter 2014. It also includes mortgage servicing rights recorded from sales of mortgage loans to the Federal Home Loan Mortgage Corporation and mortgage servicing rights acquired through the merger with ENB.  Goodwill is not subject to amortization, but is reviewed annually for impairment.  The core deposit intangible for Sycamore was amortized on a straight line basis over six years.  The core deposit intangible for First Capital is being amortized on a straight line basis over nine years and the core deposit intangible for ENB is being amortized on a straight line basis over eight years. Mortgage servicing rights are capitalized by allocating the total cost of loans between mortgage servicing rights and the loans based on their estimated fair values.  Capitalized mortgage servicing rights are amortized to loan servicing income in proportion to and over the period of estimated servicing income, subject to periodic review for impairment.

Results of Operations
Net income for the three months ended September 30, 2014 was $2,718,000 (total basic and diluted earnings per share of $0.30 and $0.29, respectively) and $6,652,000 (total basic and diluted earnings per common share of $0.72 and $0.71, respectively) for the nine months ended September 30, 2014.  This compares to net income of $2,357,000 (total basic and diluted earnings per common share of $0.31 and $0.30, respectively) and $6,433,000 (total basic and diluted earnings per common share of $0.85 and $0.83, respectively) for the same three and nine-month periods in 2013.  Results for 2013 and 2014 were significantly affected by the completion of mergers with First Capital Bancshares, Inc. and its subsidiary, Citizens National Bank of Chillicothe, on January 11, 2013 and Eaton National Bank & Trust Co. ("ENB") on January 24, 2014. In addition, 1,642,857 shares of new voting common stock were issued during the fourth quarter 2013.

Net interest income for the three and nine months ended September 30, 2014 increased $1,540,000 and $4,571,000, respectively, from the comparative periods in 2013 due primarily to the increased volume of average interest earning assets provided from the merger with ENB and by an increase in the net interest margin.

The provision for loan losses for the three and nine months ended September 30, 2014 was $223,000 and $368,000 greater than the comparable periods in 2013.  Net loan charge-offs for the first nine months of 2014 and 2013 totaled $1,027,000 and $383,000, respectively.  Non-accrual loans and loans past due 90 days or more and still accruing interest totaled $6,375,000 or 0.93% of total loans at September 30, 2014, compared to $3,211,000 or 0.56% of total loans at December 31, 2013.  The increase was predominately due to acquired impaired loans that were classified as non-accrual at September 30, 2014. Other real estate owned (which includes property acquired through foreclosure or deed-in-lieu of foreclosure and also includes property deemed to be in-substance foreclosed) and other repossessed assets totaled $1,460,000 and $1,463,000 at September 30, 2014 and December 31, 2013, respectively.

Non-interest income for the three-month period in 2014 was $268,000 greater than the comparable period in 2013 and $39,000 less for the nine-month period. The three-month period was greater primarily due to increases in trust income and service charges and fees on deposit accounts. For the nine-month period, increases in trust income and service charges and fees on deposit accounts were more than offset by decreased gains from sales of investment securities and mortgage loans. The increases in service charges and fees were primarily due to a greater number of deposit accounts resulting from the merger. The increase in trust income was due to growth in the fair value of trust assets serviced and to fee adjustments. The decreases in gains from sales of investment securities and mortgage loans were due to lower sales volumes during the 2014 period.

Non-interest expense for the three and nine months ended September 30, 2014 was $1,075,000 and $3,932,000 greater than the comparable periods in 2013. Salaries and employee benefits, as well as a variety of other expense items, increased significantly due to the increased number of employees and offices resulting from the merger with ENB. Also contributing to the increase in non-interest expense were increases in other real estate owned expenses, contracted services, amortization of ENB's core deposit intangible, and marketing costs.




40

Table of Contents

LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)




Net Interest Income

Three Months Ended September 30, 2014 vs. 2013
LCNB's primary source of earnings is net interest income, which is the difference between earnings from loans and other investments and interest paid on deposits and other liabilities.  The following table presents, for the three months ended September 30, 2014 and 2013, average balances for interest-earning assets and interest-bearing liabilities, the income or expense related to each item, and the resulting average yields earned or rates paid.

 
 
Three Months Ended September 30,
 
 
2014
 
2013
 
 
Average
Outstanding
Balance
 
Interest
Earned/
Paid
 
Average
Yield/
Rate
 
Average
Outstanding
Balance
 
Interest
Earned/
Paid
 
Average
Yield/
Rate
 
 
 
 
(Dollars in thousands)
 
 
 
 
Loans (1)
 
$
688,972

 
8,168

 
4.70
%
 
$
561,345

 
6,902

 
4.88
%
Federal funds sold
 

 

 
%
 

 

 
%
Interest-bearing demand deposits
 
3,426

 
2

 
0.23
%
 
4,724

 
2

 
0.17
%
Federal Reserve Bank stock
 
2,346

 

 
%
 
1,602

 

 
%
Federal Home Loan Bank stock
 
3,638

 
36

 
3.93
%
 
2,854

 
30

 
4.17
%
Investment securities:
 
 

 
 

 
 

 
 

 
 

 
 

Taxable
 
234,629

 
984

 
1.66
%
 
195,711

 
862

 
1.75
%
Non-taxable (2)
 
107,856

 
1,085

 
3.99
%
 
100,603

 
991

 
3.91
%
Total earnings assets
 
1,040,867

 
10,275

 
3.92
%
 
866,839

 
8,787

 
4.02
%
Non-earning assets
 
103,343

 
 

 
 

 
83,069

 
 

 
 

Allowance for loan losses
 
(3,288
)
 
 

 
 

 
(3,412
)
 
 

 
 

Total assets
 
$
1,140,922

 
 

 
 

 
$
946,496

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
$
782,548

 
800

 
0.41
%
 
$
652,371

 
875

 
0.53
%
Short-term borrowings
 
22,547

 
10

 
0.18
%
 
24,622

 
11

 
0.18
%
Long-term debt
 
11,457

 
101

 
3.50
%
 
12,564

 
109

 
3.44
%
Total interest-bearing liabilities
 
816,552

 
911

 
0.44
%
 
689,557

 
995

 
0.57
%
Demand deposits
 
193,561

 
 

 
 

 
161,725

 
 

 
 

Other liabilities
 
7,002

 
 

 
 

 
4,166

 
 

 
 

Capital
 
123,807

 
 

 
 

 
91,048

 
 

 
 

Total liabilities and capital
 
$
1,140,922

 
 

 
 

 
$
946,496

 
 

 
 

Net interest rate spread (3)
 
 

 
 

 
3.48
%
 
 

 
 

 
3.45
%
Net interest income and net interest margin on a taxable-equivalent basis (4)
 
 

 
9,364

 
3.57
%
 
 

 
7,792

 
3.57
%
Ratio of interest-earning assets to interest-bearing liabilities
 
127.47
%
 
 

 
 

 
125.71
%
 
 

 
 

(1)Includes nonaccrual loans, if any.
(2)Income from tax-exempt securities is included in interest income on a taxable-equivalent basis.  Interest income has
been divided by a factor comprised of the complement of the incremental tax rate of 34%.
(3)The net interest spread is the difference between the average rate on total interest-earning assets and interest-bearing
liabilities.
(4)The net interest margin is the taxable-equivalent net interest income divided by average interest-earning assets.


41

Table of Contents

LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)




The following table presents the changes in taxable-equivalent basis interest income and expense for each major category of interest-earning assets and interest-bearing liabilities and the amount of change attributable to volume and rate changes for the three months ended September 30, 2014 as compared to the same period in 2013.  Changes not solely attributable to rate or volume have been allocated to volume and rate changes in proportion to the relationship of absolute dollar amounts of the changes in each.

 
 
Three Months Ended
September 30, 2014 vs. 2013
Increase (decrease) due to:
 
 
Volume
 
Rate
 
Total
 
 
(In thousands)
Interest-earning Assets:
 
 
 
 
 
 
Loans
 
$
1,521

 
(255
)
 
1,266

Federal funds sold
 

 

 

Interest-bearing demand deposits
 
(1
)
 
1

 

Federal Reserve Bank stock
 

 

 

Federal Home Loan Bank stock
 
8

 
(2
)
 
6

Investment securities:
 
 

 
 

 
 

Taxable
 
165

 
(43
)
 
122

Non-taxable
 
73

 
21

 
94

Total interest income
 
1,766

 
(278
)
 
1,488

Interest-bearing Liabilities:
 
 

 
 

 
 

Deposits
 
156

 
(231
)
 
(75
)
Short-term borrowings
 
(1
)
 

 
(1
)
Long-term debt
 
(10
)
 
2

 
(8
)
Total interest expense
 
145

 
(229
)
 
(84
)
Net interest income
 
$
1,621

 
(49
)
 
1,572


Net interest income on a fully tax-equivalent basis for the three months ended September 30, 2014 totaled $9,364,000, an increase of $1,572,000 over the comparable period in 2013.  Total interest income increased $1,488,000 and total interest expense decreased $84,000.

The increase in total interest income was primarily due to a $174.0 million increase in average total earning assets, slightly offset by a 10 basis point (a basis point equals 0.01%) decrease in the average rate earned on earning assets.  The increase in average interest earning assets was primarily due to interest-earning assets acquired through the merger with ENB.  The decrease in the average rate earned reflects a general decrease in market rates.

The decrease in total interest expense was primarily due to a 13 basis point decrease in the average rate paid on interest-bearing liabilities, partially offset by a $127.0 million increase in average interest-bearing liabilities.  The increase in average interest-bearing liabilities was primarily due to an increase in average interest-bearing deposits resulting from the merger with ENB.  The decrease in the average rate paid on interest-bearing liabilities also reflects a general decrease in market rates.

Nine Months Ended September 30, 2014 vs. 2013
The following table presents, for the nine months ended September 30, 2014 and 2013, average balances for interest-earning assets and interest-bearing liabilities, the income or expense related to each item, and the resulting average yields earned or rates paid.


42

Table of Contents

LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)




 
 
Nine Months Ended September 30,
 
 
2014
 
2013
 
 
Average
Outstanding
Balance
 
Interest
Earned/
Paid
 
Average
Yield/
Rate
 
Average
Outstanding
Balance
 
Interest
Earned/
Paid
 
Average
Yield/
Rate
 
 
 
 
(Dollars in thousands)
 
 
 
 
Loans (1)
 
$
674,181

 
24,008

 
4.76
%
 
$
549,597

 
20,298

 
4.94
%
Federal funds sold
 

 

 
%
 
1,027

 
1

 
0.13
%
Interest-bearing demand deposits
 
9,656

 
18

 
0.25
%
 
8,663

 
15

 
0.23
%
Federal Reserve Bank stock
 
2,017

 
55

 
3.65
%
 
1,380

 
38

 
3.68
%
Federal Home Loan Bank stock
 
3,549

 
109

 
4.11
%
 
2,817

 
91

 
4.32
%
Investment securities:
 
 

 
 

 
 

 
 

 
 

 
 

Taxable
 
225,306

 
2,901

 
1.72
%
 
196,601

 
2,556

 
1.74
%
Non-taxable (2)
 
102,328

 
3,059

 
4.00
%
 
98,783

 
2,927

 
3.96
%
Total earnings assets
 
1,017,037

 
30,150

 
3.96
%
 
858,868

 
25,926

 
4.04
%
Non-earning assets
 
105,701

 
 

 
 

 
86,032

 
 

 
 

Allowance for loan losses
 
(3,342
)
 
 

 
 

 
(3,392
)
 
 

 
 

Total assets
 
$
1,119,396

 
 

 
 

 
$
941,508

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
$
771,982

 
2,423

 
0.42
%
 
$
654,913

 
2,789

 
0.57
%
Short-term borrowings
 
15,697

 
18

 
0.15
%
 
16,753

 
18

 
0.14
%
Long-term debt
 
11,602

 
305

 
3.51
%
 
12,952

 
331

 
3.42
%
Total interest-bearing liabilities
 
799,281

 
2,746

 
0.46
%
 
684,618

 
3,138

 
0.61
%
Demand deposits
 
191,539

 
 

 
 

 
158,059

 
 

 
 

Other liabilities
 
6,731

 
 

 
 

 
5,698

 
 

 
 

Capital
 
121,845

 
 

 
 

 
93,133

 
 

 
 

Total liabilities and capital
 
$
1,119,396

 
 

 
 

 
$
941,508

 
 

 
 

Net interest rate spread (3)
 
 

 
 

 
3.50
%
 
 

 
 

 
3.43
%
Net interest income and net interest margin on a taxable-equivalent basis (4)
 
 

 
27,404

 
3.60
%
 
 

 
22,788

 
3.55
%
Ratio of interest-earning assets to interest-bearing liabilities
 
127.24
%
 
 

 
 

 
125.45
%
 
 

 
 

(1)Includes nonaccrual loans, if any.
(2)Income from tax-exempt securities is included in interest income on a taxable-equivalent basis.  Interest income has
been divided by a factor comprised of the complement of the incremental tax rate of 34%.
(3)The net interest spread is the difference between the average rate on total interest-earning assets and interest-bearing
liabilities.
(4)The net interest margin is the taxable-equivalent net interest income divided by average interest-earning assets.

The following table presents the changes in taxable-equivalent basis interest income and expense for each major category of interest-earning assets and interest-bearing liabilities and the amount of change attributable to volume and rate changes for the nine months ended September 30, 2014 as compared to the same period in 2013.  Changes not solely attributable to rate or volume have been allocated to volume and rate changes in proportion to the relationship of absolute dollar amounts of the changes in each.


43

Table of Contents

LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)




 
 
Nine Months Ended
September 30, 2014 vs. 2013
Increase (decrease) due to:
 
 
Volume
 
Rate
 
Total
 
 
(In thousands)
Interest-earning Assets:
 
 
 
 
 
 
Loans
 
$
4,459

 
(749
)
 
3,710

Federal funds sold
 
(1
)
 

 
(1
)
Interest-bearing demand deposits
 
2

 
1

 
3

Federal Reserve Bank stock
 
17

 

 
17

Federal Home Loan Bank stock
 
23

 
(5
)
 
18

Investment securities:
 
 

 
 

 
 

Taxable
 
370

 
(25
)
 
345

Non-taxable
 
106

 
26

 
132

Total interest income
 
4,976

 
(752
)
 
4,224

Interest-bearing Liabilities:
 
 

 
 

 
 

Deposits
 
445

 
(811
)
 
(366
)
Short-term borrowings
 
(1
)
 
1

 

Long-term debt
 
(35
)
 
9

 
(26
)
Total interest expense
 
409

 
(801
)
 
(392
)
Net interest income
 
$
4,567

 
49

 
4,616


Net interest income on a fully tax-equivalent basis for the nine months ended September 30, 2014 totaled $27,404,000, an increase of $4,616,000 over the comparable period in 2013.  Total interest income increased $4,224,000 and total interest expense decreased $392,000.

The increase in total interest income was primarily due to a $158.2 million increase in average total earning assets, partially offset by an 8 basis point decrease in the average rate earned on earning assets.  The increase in average interest earning assets was primarily due to interest-earning assets acquired through the merger with ENB.  The decrease in the average rate earned reflects a general decrease in market rates.

The decrease in total interest expense was primarily due to a 15 basis point decrease in the average rate paid on interest-bearing liabilities, partially offset by a $114.7 million increase in average interest-bearing liabilities.  The increase in average interest-bearing liabilities was primarily due to an increase in average interest-bearing deposits resulting from the merger with ENB.  The decrease in the average rate paid on interest-bearing liabilities reflects a general decrease in market rates.

Provision and Allowance For Loan Losses
The total provision for loan losses is determined based upon management's evaluation as to the amount needed to maintain the allowance for loan losses at a level considered appropriate in relation to the risk of losses inherent in the portfolio.  In addition to historic charge-off percentages, factors taken into consideration to determine the adequacy of the allowance for loan losses include the nature, volume, and consistency of the loan portfolio, overall portfolio quality, a review of specific problem loans, and current economic conditions that may affect borrowers' ability to pay.  The provision for loan losses for the three and nine months ended September 30, 2014 was $401,000 and $737,000, respectively, and $178,000 and $369,000 for the three and nine months ended September 30, 2013, respectively.  Net charge-offs for the three and nine months ended September 30, 2014 were $496,000 and $1,027,000, respectively, as compared to $181,000 and $383,000 for the same periods in 2013. Included in net charge-offs for the first nine months of 2014 were charge-offs totaling $603,000 on three commercial real estate loans.

The fair value of loans acquired through the merger with ENB was estimated by discounting at current rates the cash flows expected to be received on ENB's loan portfolio.  Since the estimation of cash flows recognized the probability that LCNB would not be able to collect all contractually required principal and interest payments, ENB's allowance for loan losses was not carried forward.


44

Table of Contents

LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)




Non-Interest Income

Three Months Ended September 30, 2014 vs. 2013
Total non-interest income for the third quarter 2014 was $268,000 greater than for the third quarter 2013 primarily due to a $183,000 increase in service charges and fees on deposit accounts and a $62,000 increase in trust income. The increase in service charges and fees on deposit accounts reflects a greater number of deposit accounts resulting from the merger with ENB. The increase in trust income reflects growth in the fair value of trust assets.

Nine Months Ended September 30, 2014 vs. 2013
Total non-interest income for the first nine months of 2014 was $39,000 less than the comparable amount for the first nine months of 2013 primarily due to a $660,000 decrease in net gains from sales of investments securities and a $213,000 decrease in net gains from sales of mortgage loans, partially offset by a $261,000 increase in trust income and a $505,000 increase in service charges and fees on deposit accounts. The decreases in gains from sales of investment securities and mortgage loans reflect declines in the volume of investment securities and loans sold. The increase in trust income reflects growth in the fair value of trust assets and fee adjustments that became effective July 1, 2013. Service charges and fees on deposit accounts increased for substantially the same reason mentioned above.

Non-Interest Expense

Three Months Ended September 30, 2014 vs. 2013
Non-interest expense for the third quarter 2014 was $1,075,000 greater than for the third quarter 2013 primarily due to a $775,000 increase in salaries and employee benefits, a $67,000 increase in marketing expense, and a $96,000 increase in other non-interest expense.  The increase in salaries and employee benefits reflects the additional staff needed to operate the five offices LCNB acquired as a result of the merger with ENB and an increase in retirement plan costs. Marketing expense increased due to greater usage of television and print advertising during the quarter. Other non-interest expense increased primarily due to increased costs for contracted services, amortization of ENB's core deposit intangible during 2014, and smaller increases in a number of other accounts.

Nine Months Ended September 30, 2014 vs. 2013
Non-interest expense for the first nine months of 2014 was $3,932,000 greater than for the comparable period in 2013 primarily due to a $2,113,000 increase in salaries and employee benefits and a $1,243,000 increase in other non-interest expense.  The increase in salaries and employee benefits was for substantially the same reasons mentioned above. Other non-interest expense increased primarily due to increased costs for contracted services, computer maintenance and supplies, other real estate owned, amortization of ENB's core deposit intangible during 2014, and smaller increases in a number of other accounts.

Income Taxes
LCNB's effective tax rates for the nine months ended September 30, 2014 and 2013 were 24.5% and 25.0%, respectively.  The difference between the statutory rate of 34.0% and the effective tax rate is primarily due to tax-exempt interest income from municipal securities and tax-exempt earnings from bank owned life insurance.


45

Table of Contents

LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)




Financial Condition
The carrying values of loans, securities available-for-sale, premises and equipment, and deposits were greatly influenced by the merger with ENB.  See Note 2 - Acquisition to the Financial Statements for a description of the merger and a summary of the fair values of ENB's assets and liabilities added to LCNB's consolidated balance sheet.

Net loans at September 30, 2014 were $111.9 million greater than at December 31, 2013 primarily due to the merger with ENB, which increased LCNB's loan balance by $115.9 million.

Available for sale investment securities at September 30, 2014 were $34.6 million greater than at December 31, 2013. Included in the increase were $35.9 in investment securities obtained through the ENB merger. During 2014, LCNB purchased $87.3 million of new securities. The purchases were largely offset by sales, maturities, and calls of investment securities.

Goodwill at September 30, 2014 was $13.5 greater than at December 31, 2013 due to goodwill recorded on the ENB acquisition.

Total deposits at September 30, 2014 was $170.9 million greater than at December 31, 2013. Included in this increase were $165.3 million in new deposits obtained through the merger with ENB and a $24.0 million increase in public fund deposits by local government entities. Public fund deposits can be relatively volatile due to seasonal tax collections and the financial needs of the local entities.

Shareholders' equity at September 30, 2014 was $4.3 million greater than at December 31, 2013, but total risk-based capital (see Note 9 - Regulatory Capital) was $13.3 million less. In addition, all capital ratios at September 30, 2014 were less than their respective ratios as December 31, 2013. LCNB issued 1,642,857 shares of stock in November 2013, resulting in net proceeds of $26.9 million and increases in capital and capital ratios at year-end 2013. The net proceeds were substantially used to fund the acquisition of ENB in January 2014, decreasing regulatory capital and capital ratios due to additional assets obtained through the merger.

Liquidity
LCNB depends on dividends from the Bank for the majority of its liquid assets, including the cash needed to pay dividends to its shareholders.  National banking law limits the amount of dividends the Bank may pay to the sum of retained net income for the current year plus retained net income for the previous two years.  Prior approval from the Office of the Comptroller of the Currency, the Bank's primary regulator, is necessary for the Bank to pay dividends in excess of this amount.  In addition, dividend payments may not reduce capital levels below minimum regulatory guidelines.  Management believes the Bank will be able to pay anticipated dividends to LCNB Corp. without needing to request approval.  The Bank is not aware of any reasons why it would not receive such approval.

Liquidity is the ability to have funds available at all times to meet the commitments of LCNB.  Asset liquidity is provided by cash and assets which are readily marketable or pledgeable or which will mature in the near future. Liquid assets include cash and cash equivalents and securities available for sale.  At September 30, 2014, LCNB's liquid assets amounted to $325.9 million or 29.0% of total assets.  This compares to liquid assets totaling $272.9 million or 29.3% of total assets at December 31, 2013.

Liquidity is also provided by access to core funding sources, primarily core depositors in LCNB's market area.  Approximately 81.5% of total deposits at September 30, 2014 were "core" deposits, compared to 83.9% of deposits at December 31, 2013. Core deposits, for this purpose, are defined as total deposits less public funds and certificates of deposit greater than $100,000. The percentage of core deposits to total deposits decreased because of the growth in public fund deposits discussed above in relation to total growth in deposits.

Secondary sources of liquidity include LCNB's ability to sell loan participations, borrow funds from the Federal Home Loan Bank, purchase federal funds, issue repurchase agreements, or use a line of credit established with another bank.

Management closely monitors the level of liquid assets available to meet ongoing funding needs.  It is management's intent to maintain adequate liquidity so that sufficient funds are readily available at a reasonable cost.  LCNB experienced no liquidity or operational problems as a result of the current liquidity levels.


46

Table of Contents



LCNB CORP. AND SUBSIDIARIES
Item 3.
Quantitative and Qualitative Disclosures about Market Risks

Market risk for LCNB is primarily interest rate risk.  LCNB attempts to mitigate this risk through asset/liability management strategies designed to decrease the vulnerability of its earnings to material and prolonged changes in interest rates.  LCNB does not use derivatives such as interest rate swaps, caps, or floors to hedge this risk.  LCNB has not entered into any market risk instruments for trading purposes.

The Bank's Asset and Liability Management Committee ("ALCO") primarily uses a combination of Interest Rate Sensitivity Analysis ("IRSA") and Economic Value of Equity ("EVE") analysis for measuring and managing interest rate risk.  IRSA is used to estimate the effect on net interest income ("NII") during a one-year period of instantaneous and sustained movements in interest rates, also called interest rate shocks, of 100, 200, and 300 basis points.  Management considers the results of any significant downward scenarios to not be meaningful in the current interest rate environment.  The base projection uses a current interest rate scenario.  As shown below, the September 30, 2014 IRSA indicates that an increase in interest rates will have a positive effect on net interest income ("NII"). The changes in NII for all rate assumptions are within LCNB's acceptable ranges.

Rate Shock Scenario in Basis Points
 
Amount
 
$ Change in
NII
 
% Change in
NII
 
 
(Dollars in thousands)
Up 300
 
$
37,865

 
3,084

 
8.87
%
Up 200
 
36,824

 
2,043

 
5.87
%
Up 100
 
35,790

 
1,009

 
2.90
%
Base
 
34,781

 

 
%

IRSA shows the effect on NII during a one-year period only.  A more long-range model is the EVE analysis, which shows the estimated present value of future cash inflows from interest-earning assets less the present value of future cash outflows for interest-bearing liabilities for the same rate shocks.  As shown below, the September 30, 2014 EVE analysis indicates that an increase in interest rates will have a negative effect on the EVE.  The changes in EVE for all rate assumptions are within LCNB's acceptable ranges.

Rate Shock Scenario in Basis Points
 
Amount
 
$ Change in
EVE
 
% Change in
EVE
 
 
(Dollars in thousands)
Up 300
 
$
122,656

 
(3,715
)
 
(2.94
)%
Up 200
 
123,448

 
(2,923
)
 
(2.31
)%
Up 100
 
123,927

 
(2,444
)
 
(1.93
)%
Base
 
126,371

 

 
 %

The IRSA and EVE simulations discussed above are not projections of future income or equity and should not be relied on as being indicative of future operating results.  Assumptions used, including the nature and timing of interest rate levels, yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment or replacement of asset and liability cash flows, are inherently uncertain and, as a result, the models cannot precisely measure future net interest income or equity.  Furthermore, the models do not reflect actions that borrowers, depositors, and management may take in response to changing economic conditions and interest rate levels.


47

Table of Contents



LCNB CORP. AND SUBSIDIARIES
Item 4.
Controls and Procedures

a)  Disclosure controls and procedures.  The Chief Executive Officer and the Chief Financial Officer have carried out an evaluation of the effectiveness of LCNB's disclosure controls and procedures that ensure that information relating to LCNB required to be disclosed by LCNB in the reports that it files or submits under the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that such information is accumulated and communicated to LCNB's management, including its principal executive officer and principal financial officer, as appropriate, in order to allow timely decisions to be made regarding required disclosures.  Based upon this evaluation, these officers have concluded that, as of September 30, 2014, LCNB's disclosure controls and procedures were effective.

b)  Changes in internal control over financial reporting.  During the period covered by this report, there were no changes in LCNB's internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, LCNB's internal control over financial reporting.

48

Table of Contents



PART II.  OTHER INFORMATION

LCNB CORP. AND SUBSIDIARIES
 
Item 1.
Legal Proceedings

None

Item 1A.
Risk Factors

No material changes

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds

During the period of this report, LCNB did not sell any of its securities that were not registered under the Securities Act.

During the period covered by this report, LCNB did not purchase any shares of its equity securities.

Item 3.
Defaults Upon Senior Securities

None

Item 4.
Mine Safety Disclosures

Not applicable

Item 5.
Other Information

None
 

49

Table of Contents



LCNB CORP. AND SUBSIDIARIES
Item 6.
Exhibits

Exhibit No.
Exhibit Description
2
Stock Purchase Agreement dated as of October 28, 2013 by and between LCNB Corp. and Colonial Banc Corp.  – incorporated by reference to the Registrant's Form 8-K filed on October 28, 2013, Exhibit 2.1.
 
 
3.1
Amended and Restated Articles of Incorporation of LCNB Corp., as amended – incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2010, Exhibit 3.1.
 
 
3.2
Code of Regulations of LCNB Corp. – incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005, Exhibit 3(ii).
 
 
10.1
LCNB Corp. Ownership Incentive Plan – incorporated by reference to Registrant's Form DEF 14A Proxy Statement pursuant to Section 14(a), dated March 15, 2002, Exhibit A (000-26121).
 
 
10.2
Form of Option Grant Agreement under the LCNB Corp. Ownership Incentive Plan – incorporated by reference to the Registrant's Form 10-K for the fiscal year ended December 31, 2005, Exhibit 10.2.
 
 
10.3
Nonqualified Executive Retirement Plan – incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 2009, Exhibit 10.4.
 
 
31.1
Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
31.2
Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
32
Certification of Chief Executive Officer and Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
101
The following financial information from LCNB Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 is formatted in Extensible Business Reporting Language:  (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Shareholders' Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to Consolidated Financial Statements.

50

Table of Contents



SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
LCNB Corp.
 
 
 
 
November 3, 2014
/s/ Stephen P. Wilson
 
 
Stephen P. Wilson, Chief Executive Officer and
 
 
Chairman of the Board of Directors
 
 
 
 
November 3, 2014
/s/ Robert C. Haines, II
 
 
Robert C. Haines, II, Executive Vice President
 
 
and Chief Financial Officer
 

51