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

FORM 10-Q

(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016
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 001-35292
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.
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).
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
Accelerated filer
Non-accelerated filer (Do not check if a smaller reporting company)
Smaller reporting company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes         No
The number of shares outstanding of the issuer's common stock, without par value, as of November 7, 2016 was 9,983,332 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 CONDENSED BALANCE SHEETS
(Dollars in thousands, except per share data)

 
 
September 30, 2016
 
December 31,
2015
 
 
(Unaudited)
 
ASSETS:
 
 
 
 
Cash and due from banks
 
$
17,059

 
14,155

Interest-bearing demand deposits
 
16,154

 
832

Total cash and cash equivalents
 
33,213

 
14,987

Investment securities:
 
 

 
 

Available-for-sale, at fair value
 
346,391

 
377,978

Held-to-maturity, at cost
 
42,037

 
22,633

Federal Reserve Bank stock, at cost
 
2,732

 
2,732

Federal Home Loan Bank stock, at cost
 
3,638

 
3,638

Loans, net
 
807,864

 
767,809

Premises and equipment, net
 
26,347

 
22,100

Goodwill
 
30,183

 
30,183

Core deposit and other intangibles
 
4,777

 
5,396

Bank owned life insurance
 
27,114

 
22,561

Other assets
 
9,240

 
10,514

TOTAL ASSETS
 
$
1,333,536

 
1,280,531

 
 
 
 
 
LIABILITIES:
 
 

 
 

Deposits:
 
 

 
 

Noninterest-bearing
 
$
259,043

 
250,306

Interest-bearing
 
899,878

 
836,854

Total deposits
 
1,158,921

 
1,087,160

Short-term borrowings
 
16,989

 
37,387

Long-term debt
 
662

 
5,947

Accrued interest and other liabilities
 
10,058

 
9,929

TOTAL LIABILITIES
 
1,186,630

 
1,140,423

 
 
 
 
 
COMMITMENTS AND CONTINGENT LIABILITIES
 

 

 
 
 
 
 
SHAREHOLDERS' EQUITY:
 
 

 
 

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

 

Common shares – no par value; authorized 19,000,000 and 12,000,000 shares at September 30, 2016 and December 31, 2015, respectively; issued 10,747,322 and 10,679,174 shares at September 30, 2016 and December 31, 2015, respectively
 
76,367

 
76,908

Retained earnings
 
78,682

 
74,629

Treasury shares at cost, 753,627 shares at September 30, 2016 and December 31, 2015
 
(11,665
)
 
(11,665
)
Accumulated other comprehensive income, net of taxes
 
3,522

 
236

TOTAL SHAREHOLDERS' EQUITY
 
146,906

 
140,108

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
 
$
1,333,536

 
1,280,531


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

The consolidated condensed balance sheet as of December 31, 2015 has been derived from the audited consolidated balance sheet as of that day.

2

Table of Contents



LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
(Unaudited)
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2016
 
2015
 
2016
 
2015
INTEREST INCOME:
 
 
 
 
 
 
 
 
Interest and fees on loans
 
$
8,876

 
8,540

 
26,395

 
26,572

Interest on investment securities:
 
 

 
 

 
 

 
 

Taxable
 
1,152

 
1,094

 
3,528

 
2,983

Non-taxable
 
813

 
732

 
2,365

 
2,087

Other investments
 
54

 
43

 
236

 
205

TOTAL INTEREST INCOME
 
10,895

 
10,409

 
32,524

 
31,847

INTEREST EXPENSE:
 
 

 
 

 
 

 
 

Interest on deposits
 
872

 
834

 
2,565

 
2,187

Interest on short-term borrowings
 
8

 
5

 
30

 
13

Interest on long-term debt
 
5

 
73

 
22

 
222

TOTAL INTEREST EXPENSE
 
885

 
912

 
2,617

 
2,422

NET INTEREST INCOME
 
10,010

 
9,497

 
29,907

 
29,425

PROVISION FOR LOAN LOSSES
 
372

 
240

 
858

 
986

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
 
9,638

 
9,257

 
29,049

 
28,439

NON-INTEREST INCOME:
 
 

 
 

 
 

 
 

Trust income
 
871

 
754

 
2,471

 
2,406

Service charges and fees on deposit accounts
 
1,276

 
1,314

 
3,712

 
3,655

Net gain on sales of securities
 
307

 

 
957

 
332

Bank owned life insurance income
 
193

 
156

 
553

 
470

Gains from sales of loans
 
73

 
34

 
175

 
288

Other operating income
 
126

 
128

 
370

 
372

TOTAL NON-INTEREST INCOME
 
2,846

 
2,386

 
8,238

 
7,523

NON-INTEREST EXPENSE:
 
 

 
 

 
 

 
 

Salaries and employee benefits
 
4,642

 
4,340

 
13,737

 
13,011

Equipment expenses
 
279

 
324

 
767

 
914

Occupancy expense, net
 
550

 
570

 
1,707

 
1,749

State franchise tax
 
279

 
251

 
836

 
753

Marketing
 
162

 
176

 
530

 
559

Amortization of intangibles
 
189

 
189

 
564

 
510

FDIC insurance premiums
 
168

 
136

 
495

 
432

Other real estate owned
 
222

 
188

 
607

 
243

Merger-related expenses
 

 
49

 

 
641

Other non-interest expense
 
2,102

 
1,865

 
6,110

 
5,351

TOTAL NON-INTEREST EXPENSE
 
8,593

 
8,088

 
25,353

 
24,163

INCOME BEFORE INCOME TAXES
 
3,891

 
3,555

 
11,934

 
11,799

PROVISION FOR INCOME TAXES
 
995

 
922

 
3,106

 
3,209

NET INCOME
 
$
2,896

 
2,633

 
8,828

 
8,590

 
 
 
 
 
 
 
 
 
Dividends declared per common share
 
$
0.16

 
0.16

 
0.48

 
0.48

Earnings per common share:
 
 

 
 

 
 

 
 

Basic
 
$
0.29

 
0.26

 
0.89

 
0.89

Diluted
 
0.29

 
0.26

 
0.88

 
0.88

Weighted average common shares outstanding:
 
 

 
 

 
 

 
 

Basic
 
$
9,962,571

 
9,898,233

 
9,930,182

 
9,637,344

Diluted
 
9,977,592

 
10,005,788

 
9,974,319

 
9,742,839


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

3

Table of Contents



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

 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2016
 
2015
 
2016
 
2015
Net income
 
$
2,896

 
2,633

 
8,828

 
8,590

Other comprehensive income (loss):
 
 

 
 

 
 

 
 

Net unrealized gain (loss) on available-for-sale securities (net of taxes of $357 and $1,015 for the three months ended September 30, 2016 and 2015, respectively, and $1,975 and $940 for the nine months ended September 30, 2016 and 2015, respectively.)
 
(691
)
 
1,972

 
3,835

 
1,825

Reclassification adjustment for net realized (gain) loss on sale of available-for-sale securities included in net income (net of taxes of $104 and $- for the three months ended September 30, 2016 and 2015, respectively, and $325 and $113 for the nine months ended September 30, 2016 and 2015, respectively)
 
(203
)
 

 
(632
)
 
(219
)
Change in nonqualified pension plan unrecognized net loss and unrecognized prior service cost (net of taxes of $15 and $15 for the three months ended September 30, 2016 and 2015, respectively, and $43 and $44 for the nine months ended September 30, 2016 and 2015, respectively)
 
27

 
28

 
83

 
84

  Other comprehensive income (loss), net of tax
 
(867
)
 
2,000

 
3,286

 
1,690

TOTAL COMPREHENSIVE INCOME
 
$
2,029

 
4,633

 
12,114

 
10,280


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


4

Table of Contents



LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED CONDENSED 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
 
Total Shareholders'
Equity
Balance at December 31, 2014
 
9,311,318

 
$
67,181

 
69,394

 
(11,665
)
 
785

 
125,695

Net income
 
 

 
 

 
8,590

 
 

 
 

 
8,590

Other comprehensive income, net of taxes
 
 

 
 

 
 

 
 

 
1,690

 
1,690

Dividend Reinvestment and Stock Purchase Plan
 
18,395

 
289

 
 

 
 

 
 

 
289

Acquisition of BNB Bancorp, Inc
 
560,132

 
9,063

 
 
 
 
 
 
 
9,063

Exercise of stock options
 
13,449

 
152

 


 


 
 

 
152

Excess tax benefit on exercise of stock options
 
 
 
13

 
 
 
 
 
 
 
13

Compensation expense relating to stock options
 
 

 
13

 
 

 
 

 
 

 
13

Common stock dividends, $0.48 per share
 
 

 
 

 
(4,654
)
 
 

 
 

 
(4,654
)
Balance at September 30, 2015
 
9,903,294

 
$
76,711

 
73,330

 
(11,665
)
 
2,475

 
140,851

 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
 
9,925,547

 
$
76,908

 
74,629

 
(11,665
)
 
236

 
140,108

Net income
 
 

 
 

 
8,828

 
 

 
 

 
8,828

Other comprehensive income, net of taxes
 
 

 
 

 
 

 
 

 
3,286

 
3,286

Dividend Reinvestment and Stock Purchase Plan
 
16,758

 
282

 
 

 
 

 
 

 
282

Repurchase of stock warrants
 
 
 
(1,545
)
 
 
 
 
 
 
 
(1,545
)
Exercise of stock options
 
51,390

 
592

 
 

 
 

 
 

 
592

Excess tax benefit on exercise of stock options
 
 
 
58

 
 
 
 
 
 
 
58

Compensation expense relating to stock options
 
 
 
4

 
 
 
 
 
 
 
4

Compensation expense relating to restricted stock
 
 
 
68

 
 
 
 
 
 
 
68

Common stock dividends, $0.48 per share
 
 

 
 

 
(4,775
)
 
 

 
 

 
(4,775
)
Balance at September 30, 2016
 
9,993,695

 
$
76,367

 
78,682

 
(11,665
)
 
3,522

 
146,906


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


5

Table of Contents



LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
 
Nine Months Ended 
 September 30,
 
 
2016
 
2015
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
Net income
 
$
8,828

 
8,590

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

 
 

Depreciation, amortization, and accretion
 
2,672

 
2,108

Provision for loan losses
 
858

 
986

Increase in cash surrender value of bank owned life insurance
 
(553
)
 
(470
)
Realized gain from sales of securities available-for-sale
 
(957
)
 
(332
)
Realized loss from sales of premises and equipment
 
35

 
(1
)
Realized loss from sales and write-downs of other real estate owned and repossessed assets
 
537

 
146

Origination of mortgage loans for sale
 
(7,853
)
 
(5,237
)
Realized gains from sales of loans
 
(175
)
 
(288
)
Proceeds from sales of mortgage loans
 
7,955

 
5,291

Penalty for prepayment of long-term debt
 
251

 

Compensation expense related to stock options
 
4

 
13

Compensation expense related to restricted stock
 
68

 

Changes in:
 
 

 
 

Accrued income receivable
 
(1,208
)
 
(1,103
)
Other assets
 
1,494

 
(1,789
)
Other liabilities
 
(1,025
)
 
776

TOTAL ADJUSTMENTS
 
2,103

 
100

NET CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
 
10,931

 
8,690

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 

 
 

Proceeds from sales of investment securities available-for-sale
 
62,252

 
54,955

Proceeds from maturities and calls of investment securities:
 
 

 
 

Available-for-sale
 
41,157

 
19,658

Held-to-maturity
 
5,306

 
1,574

Purchases of investment securities:
 
 

 
 

Available-for-sale
 
(67,139
)
 
(89,961
)
Held-to-maturity
 
(24,710
)
 
(3,413
)
Proceeds from sale of impaired loans
 

 
4,559

Net increase in loans
 
(40,908
)
 
(34,281
)
Purchase of bank owned life insurance
 
(4,000
)
 

Proceeds from sale of other real estate owned and repossessed assets
 
253

 
114

Additions to other real estate owned
 
(182
)
 
(20
)
Purchases of premises and equipment
 
(5,234
)
 
(444
)
Proceeds from sale of premises and equipment
 
61

 
22

Net cash acquired from acquisition
 

 
8,993

NET CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
 
(33,144
)
 
(38,244
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 

 
 

Net increase in deposits
 
71,761

 
58,175

Net decrease in short-term borrowings
 
(20,398
)
 
(1,714
)
Principal payments on long-term debt
 
(5,285
)
 
(5,341
)
Penalty for prepayment of long-term debt
 
(251
)
 

Proceeds from issuance of common stock
 
38

 
46

Repurchase of stock warrants
 
(1,545
)
 

Proceeds and excess tax benefit from exercise of stock options
 
650

 
165

Cash dividends paid on common stock
 
(4,531
)
 
(4,411
)
NET CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
 
40,439

 
46,920

NET CHANGE IN CASH AND CASH EQUIVALENTS
 
18,226

 
17,366

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
 
14,987

 
15,845

CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
33,213

 
33,211

SUPPLEMENTAL CASH FLOW INFORMATION:
 
 

 
 

Interest paid
 
$
2,680

 
2,490

Income taxes paid
 
3,330

 
3,470

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES:
 
 

 
 

Transfer from loans to other real estate owned and repossessed assets
 
32

 
79


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

6

Table of Contents



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

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

The unaudited interim consolidated condensed 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").  Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations.  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 condensed balance sheet as of December 31, 2015 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.

LCNB adopted ASU No. 2015-07, "Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)" during the first quarter of 2016. ASU No. 2015-07 applies to entities that measure an investment's fair value using the net asset value per share, or an equivalent, as a practical expedient. It eliminates the requirement to classify such investments within the fair value hierarchy. The amendments are to be applied retrospectively to all periods presented. LCNB measures the fair value of certain mutual fund investments using the net asset value per share practical expedient and disclosures concerning these investments in Note 15 - Fair Value Measurements have been changed to comply with the new guidance. Adoption did not have an impact on LCNB's results of operations or financial position.

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, 2016 are not necessarily indicative of the results to be expected for the full year ending December 31, 2016.  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 2015 Annual Report on Form 10-K filed with the SEC.


Note 2 – Acquisitions

On December 29, 2014, LCNB and BNB Bancorp, Inc. (“BNB”) entered into an Agreement and Plan of Merger (“Merger Agreement”) pursuant to which BNB was acquired by LCNB on April 30, 2015. Immediately following the merger of BNB into LCNB, Brookville National Bank ("Brookville"), a wholly-owned subsidiary of BNB, was merged into LCNB National Bank. Brookville operated a main office and a branch office, both in Brookville, Ohio.  These offices became branches of the Bank after the merger.

Under the terms of the Merger Agreement, the shareholders of BNB common stock received, for each share of BNB common stock, (i) $15.75 in cash and (ii) 2.005 LCNB common shares.



7

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

Note 2 – Acquisitions (continued)


The merger with BNB 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:
 
Common shares issued
$
9,063

Cash paid to shareholders
4,403

    Total consideration paid
13,466

 
 
Identifiable Assets Acquired:
 
Cash and cash equivalents
13,396

Investment securities
58,239

Federal Reserve Bank stock
130

Loans
34,661

Premises and equipment
2,311

Core deposit intangible
1,418

Other assets
532

Total identifiable assets acquired
110,687

 
 
Liabilities Assumed:
 
Deposits
99,133

Deferred income taxes
576

Other liabilities
57

Total liabilities assumed
99,766

 
 
Total Identifiable Net Assets Acquired
10,921

 
 
Goodwill resulting from merger
$
2,545


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 represent 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 nine years using the straight-line method.

Direct costs related to the acquisition were expensed as incurred and are recorded as a merger-related expense in the consolidated condensed statements of income.  

8

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




Note 3 - Investment Securities
 
The amortized cost and estimated fair value of investment securities at September 30, 2016 and December 31, 2015 are summarized as follows (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
September 30, 2016
 
 
 
 
 
 
 
Available-for-Sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
44,892

 
1,019

 

 
45,911

U.S. Agency notes
107,819

 
1,174

 
30

 
108,963

U.S. Agency mortgage-backed securities
49,753

 
606

 
37

 
50,322

Municipal securities:
 

 
 

 
 

 
 

Non-taxable
115,493

 
2,227

 
44

 
117,676

Taxable
19,673

 
599

 
2

 
20,270

Mutual funds
2,517

 
2

 
11

 
2,508

Trust preferred securities
49

 

 

 
49

Equity securities
632

 
67

 
7

 
692

 
$
340,828

 
$
5,694

 
131

 
346,391

 
 
 
 
 
 
 
 
Held-to-Maturity:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
Non-taxable
31,965

 
821

 
23

 
32,763

Taxable
10,072

 
44

 

 
10,116

 
$
42,037

 
865

 
23

 
42,879

 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
 
Available-for-Sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
72,672

 
309

 
135

 
72,846

U.S. Agency notes
140,876

 
164

 
1,151

 
139,889

U.S. Agency mortgage-backed securities
29,608

 
174

 
404

 
29,378

Certificates of deposit
248

 
1

 

 
249

Municipal securities:
 

 
 

 
 

 
 

Non-taxable
103,900

 
1,713

 
134

 
105,479

Taxable
26,738

 
337

 
134

 
26,941

Mutual funds
2,517

 

 
51

 
2,466

Trust preferred securities
49

 
1

 

 
50

Equity securities
659

 
40

 
19

 
680

 
$
377,267

 
2,739

 
2,028

 
377,978

 
 
 
 
 
 
 
 
Held-to-Maturity:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
Non-taxable
22,233

 
95

 
97

 
22,231

Taxable
400

 

 
1

 
399

 
$
22,633

 
95

 
98

 
22,630


9

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

Note 3 - Investment Securities (continued)


Information concerning investment securities with gross unrealized losses at September 30, 2016 and December 31, 2015, 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, 2016
 
 
 
 
 
 
 
Available-for-Sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
4,008

 

 
$

 

U.S. Agency notes
11,891

 
30

 

 

U.S. Agency mortgage-backed securities
5,164

 
11

 
3,761

 
26

Municipal securities:
 

 
 

 
 
 
 
Non-taxable
6,926

 
41

 
1,602

 
3

Taxable
501

 

 
450

 
2

Mutual funds

 

 
272

 
11

Trust preferred securities
49

 

 

 

Equity securities
81

 
7

 

 

 
$
28,620

 
89

 
$
6,085

 
42

 
 
 
 
 
 
 
 
Held-to-Maturity:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
  Non-taxable
$

 

 
2,641

 
23

  Taxable

 

 

 

 
$

 

 
$
2,641

 
23

 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
 
Available-for-Sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
32,854

 
75

 
$
4,846

 
60

U.S. Agency notes
104,053

 
1,000

 
9,869

 
151

U.S. Agency mortgage-backed securities
19,190

 
256

 
4,068

 
148

Municipal securities:
 

 
 

 
 

 
 
Non-taxable
13,124

 
74

 
7,037

 
60

Taxable
15,601

 
114

 
880

 
20

Mutual funds
1,215

 
17

 
268

 
34

Trust preferred securities

 

 

 

Equity securities
248

 
12

 
73

 
7

 
$
186,285

 
1,548

 
$
27,041

 
480

 
 
 
 
 
 
 
 
Held-to-Maturity:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
  Non-taxable
$
832

 
3

 
$
3,426

 
94

  Taxable
399

 
1

 

 

 
$
1,231

 
4

 
$
3,426

 
94



10

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

Note 3 - Investment Securities (continued)


Management has determined that the unrealized losses at September 30, 2016 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, 2016 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
$
27,119

 
27,161

 
3,640

 
3,643

Due from one to five years
120,742

 
122,761

 
4,154

 
4,159

Due from five to ten years
135,686

 
138,587

 
11,073

 
11,297

Due after ten years
4,330

 
4,311

 
23,170

 
23,780

 
287,877

 
292,820

 
42,037

 
42,879

U.S. Agency mortgage-backed securities
49,753

 
50,322

 

 

Mutual funds
2,517

 
2,508

 

 

Trust preferred securities
49

 
49

 

 

Equity securities
632

 
692

 

 

 
$
340,828

 
346,391

 
42,037

 
42,879


Investment securities with a market value of $195,448,000 and $215,952,000 at September 30, 2016 and December 31, 2015, respectively, were pledged to secure public deposits and for other purposes required as permitted by law.

Certain information concerning the sale of investment securities available-for-sale for the three and nine months ended September 30, 2016 and 2015 was as follows (in thousands):
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Proceeds from sales
$
25,723

 

 
$
62,252

 
54,955

Gross realized gains
307

 

 
978

 
345

Gross realized losses

 

 
21

 
13


Realized gains or losses from the sale of securities are computed using the specific identification method.

11

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




Note 4 - Loans
 
Major classifications of loans at September 30, 2016 and December 31, 2015 are as follows (in thousands):
 
September 30, 2016
 
December 31, 2015
Commercial and industrial
$
40,097

 
45,275

Commercial, secured by real estate
467,512

 
419,633

Residential real estate
268,574

 
273,139

Consumer
18,752

 
18,510

Agricultural
15,872

 
13,479

Other loans, including deposit overdrafts
619

 
665

 
811,426

 
770,701

Deferred net origination costs (fees)
236

 
237

 
811,662

 
770,938

Less allowance for loan losses
3,798

 
3,129

Loans, net
$
807,864

 
767,809


All advances from the Federal Home Loan Bank ("FHLB") of Cincinnati are secured by a blanket pledge of LCNB's 1-4 family first lien mortgage loans in the amount of approximately $228 million and $231 million at September 30, 2016 and December 31, 2015, respectively.  Additionally, LCNB is required to hold minimum levels of FHLB stock, based on the outstanding borrowings.

Loans acquired through mergers 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 Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("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.
 













12

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

Note 4 – Loans (continued)


Non-accrual, past-due, and accruing restructured loans as of September 30, 2016 and December 31, 2015 are as follows (in thousands):
 
September 30, 2016
 
December 31, 2015
Non-accrual loans:
 
 
 
Commercial and industrial
$
182

 

Commercial, secured by real estate
2,744

 
876

Residential real estate
1,309

 
799

Consumer

 

Agricultural
384

 
48

Total non-accrual loans
4,619

 
1,723

Past-due 90 days or more and still accruing
20

 
559

Total non-accrual and past-due 90 days or more and still accruing
4,639

 
2,282

Accruing restructured loans
13,598

 
13,723

Total
$
18,237

 
16,005



13

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

Note 4 – Loans (continued)


The allowance for loan losses for the three and nine months ended September 30, 2016 and 2015 are as follows (in thousands):
 
Commercial
& Industrial
 
Commercial, Secured by
Real Estate
 
Residential
Real Estate
 
Consumer
 
Agricultural
 
Other
 
Total
Three Months Ended September 30, 2016
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, beginning of period
$
273

 
2,071

 
885

 
80

 
62

 
2

 
3,373

Provision charged to expenses
162

 
193

 
(46
)
 
36

 
6

 
21

 
372

Losses charged off

 
(19
)
 
(21
)
 
(30
)
 

 
(33
)
 
(103
)
Recoveries
12

 
80

 
43

 
9

 

 
12

 
156

Balance, end of period
$
447

 
2,325

 
861

 
95

 
68

 
2

 
3,798

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2016
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, beginning of year
$
244

 
1,908

 
854

 
54

 
66

 
3

 
3,129

Provision charged to expenses
236

 
478

 
19

 
85

 
2

 
38

 
858

Losses charged off
(49
)
 
(159
)
 
(63
)
 
(83
)
 

 
(75
)
 
(429
)
Recoveries
16

 
98

 
51

 
39

 

 
36

 
240

Balance, end of period
$
447

 
2,325

 
861

 
95

 
68

 
2

 
3,798

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2015
Allowance for loan losses:
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance, beginning of period
$
162

 
1,655

 
914

 
62

 
83

 
3

 
2,879

Provision charged to expenses
167

 
97

 
(60
)
 
14

 
9

 
13

 
240

Losses charged off
(89
)
 
(29
)
 
(46
)
 
(20
)
 

 
(26
)
 
(210
)
Recoveries
3

 

 
23

 
12

 

 
11

 
49

Balance, end of period
$
243

 
1,723

 
831

 
68

 
92

 
1

 
2,958

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2015
Allowance for loan losses:
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance, beginning of year
$
129

 
1,990

 
926

 
63

 
11

 
2

 
3,121

Provision charged to expenses
209

 
612

 
57

 
1

 
81

 
26

 
986

Losses charged off
(100
)
 
(975
)
 
(243
)
 
(49
)
 
(67
)
 
(52
)
 
(1,486
)
Recoveries
5

 
96

 
91

 
53

 
67

 
25

 
337

Balance, end of period
$
243

 
1,723

 
831

 
68

 
92

 
1

 
2,958




14

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED 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, 2016 and December 31, 2015 are as follows (in thousands):
 
Commercial
& Industrial
 
Commercial, Secured by
Real Estate
 
Residential
Real Estate
 
Consumer
 
Agricultural
 
Other
 
Total
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
171

 
183

 
96

 
14

 

 

 
464

Collectively evaluated for impairment
276

 
1,846

 
765

 
81

 
68

 
2

 
3,038

Acquired credit impaired loans

 
296

 

 

 

 

 
296

Balance, end of period
$
447

 
2,325

 
861

 
95

 
68

 
2

 
3,798

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
527

 
12,736

 
1,675

 
57

 
384

 

 
15,379

Collectively evaluated for impairment
38,260

 
448,252

 
264,726

 
18,767

 
15,495

 
130

 
785,630

Acquired credit impaired loans
1,325

 
6,181

 
2,640

 
18

 

 
489

 
10,653

Balance, end of period
$
40,112

 
467,169

 
269,041

 
18,842

 
15,879

 
619

 
811,662

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
9

 
306

 
48

 

 

 

 
363

Collectively evaluated for impairment
235

 
1,602

 
806

 
54

 
66

 
3

 
2,766

Acquired credit impaired loans

 

 

 

 

 

 

Balance, end of period
$
244

 
1,908

 
854

 
54

 
66

 
3

 
3,129

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
370

 
12,351

 
1,541

 
56

 

 

 
14,318

Collectively evaluated for impairment
43,726

 
399,092

 
269,001

 
18,516

 
13,438

 
179

 
743,952

Acquired credit impaired loans
1,191

 
7,877

 
3,039

 
27

 
48

 
486

 
12,668

Balance, end of period
$
45,287

 
419,320

 
273,581

 
18,599

 
13,486

 
665

 
770,938



15

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED 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 adjustment periods ranging from one month to 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% 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 generally 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 agricultural related collateral.

16

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED 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, 2016 and December 31, 2015 is as follows (in thousands):
 
Pass
 
OAEM
 
Substandard
 
Doubtful
 
Total
September 30, 2016
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
39,237

 
318

 
557

 

 
40,112

Commercial, secured by real estate
438,732

 
1,400

 
27,037

 

 
467,169

Residential real estate
263,583

 
518

 
4,940

 

 
269,041

Consumer
18,779

 

 
63

 

 
18,842

Agricultural
14,331

 

 
1,548

 

 
15,879

Other
619

 

 

 

 
619

Total
$
775,281

 
2,236

 
34,145

 

 
811,662

 
 
 
 
 
 
 
 
 
 
December 31, 2015
 

 
 

 
 

 
 

 
 

Commercial & industrial
$
44,596

 

 
691

 

 
45,287

Commercial, secured by real estate
397,938

 
9,316

 
12,066

 

 
419,320

Residential real estate
267,567

 
1,935

 
4,079

 

 
273,581

Consumer
18,528

 

 
71

 

 
18,599

Agricultural
12,246

 
850

 
390

 

 
13,486

Other
665

 

 

 

 
665

Total
$
741,540

 
12,101

 
17,297

 

 
770,938















17

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

Note 4 – Loans (continued)


A loan portfolio aging analysis at September 30, 2016 and December 31, 2015 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, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
$

 

 

 

 
40,112

 
40,112

 

Commercial, secured by real estate
266

 
1,217

 
278

 
1,761

 
465,408

 
467,169

 

Residential real estate
587

 
109

 
1,086

 
1,782

 
267,259

 
269,041

 
19

Consumer
50

 
4

 
1

 
55

 
18,787

 
18,842

 
1

Agricultural

 

 

 

 
15,879

 
15,879

 

Other
65

 

 

 
65

 
554

 
619

 

Total
$
968

 
1,330

 
1,365

 
3,663

 
807,999

 
811,662

 
20

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial & industrial
$

 

 

 

 
45,287

 
45,287

 

Commercial, secured by real estate
73

 
81

 
876

 
1,030

 
418,290

 
419,320

 

Residential real estate
777

 
198

 
1,124

 
2,099

 
271,482

 
273,581

 
516

Consumer
62

 
7

 
43

 
112

 
18,487

 
18,599

 
43

Agricultural

 

 

 

 
13,486

 
13,486

 

Other
109

 

 

 
109

 
556

 
665

 

Total
$
1,021

 
286

 
2,043

 
3,350

 
767,588

 
770,938

 
559































18

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

Note 4 – Loans (continued)


Impaired loans, including acquired credit impaired loans, at September 30, 2016 and December 31, 2015 are as follows (in thousands):
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
September 30, 2016
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
Commercial & industrial
$
1,337

 
1,599

 

Commercial, secured by real estate
15,289

 
16,629

 

Residential real estate
3,624

 
4,784

 

Consumer
28

 
36

 

Agricultural
384

 
384

 

Other
489

 
665

 

Total
$
21,151

 
24,097

 

 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

Commercial & industrial
$
515

 
515

 
171

Commercial, secured by real estate
3,628

 
3,999

 
479

Residential real estate
691

 
762

 
96

Consumer
47

 
47

 
14

Agricultural

 

 

Other

 

 

Total
$
4,881

 
5,323

 
760

 
 
 
 
 
 
Total:
 

 
 

 
 

Commercial & industrial
$
1,852

 
2,114

 
171

Commercial, secured by real estate
18,917

 
20,628

 
479

Residential real estate
4,315

 
5,546

 
96

Consumer
75

 
83

 
14

Agricultural
384

 
384

 

Other
489

 
665

 

Total
$
26,032

 
29,420

 
760

 
 
 
 
 
 
December 31, 2015
 

 
 

 
 

With no related allowance recorded:
 

 
 

 
 

Commercial & industrial
$
1,205

 
1,500

 

Commercial, secured by real estate
16,345

 
18,335

 

Residential real estate
3,734

 
5,055

 

Consumer
81

 
109

 

Agricultural
48

 
151

 

Other
486

 
701

 

Total
$
21,899

 
25,851

 

 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

Commercial & industrial
$
356

 
356

 
9

Commercial, secured by real estate
3,883

 
4,014

 
306

Residential real estate
846

 
958

 
48

Consumer
2

 
1

 

Agricultural

 

 

Other

 

 

Total
$
5,087

 
5,329

 
363

 
 
 
 
 
 
Total:
 

 
 

 
 

Commercial & industrial
$
1,561

 
1,856

 
9

Commercial, secured by real estate
20,228

 
22,349

 
306

Residential real estate
4,580

 
6,013

 
48

Consumer
83

 
110

 

Agricultural
48


151



Other
486


701



Total
$
26,986

 
31,180

 
363


19

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED 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, 2016 and 2015 (in thousands):
 
2016
 
2015
 
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
Three Months Ended September 30,
 
 
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
 
 
Commercial & industrial
$
1,356

 
34

 
1,609

 
34

Commercial, secured by real estate
15,594

 
236

 
18,841

 
270

Residential real estate
3,769

 
113

 
4,164

 
124

Consumer
29

 
7

 
110

 
7

Agricultural
384

 

 
110

 
11

Other
480

 
18

 
516

 
19

Total
$
21,612

 
408

 
25,350

 
465

 
 
 
 
 
 
 
 
With an allowance recorded:
 
 
 
 
 
 
 
Commercial & industrial
$
476

 
5

 
382

 
6

Commercial, secured by real estate
3,383

 
41

 
3,994

 
29

Residential real estate
695

 
8

 
808

 
10

Consumer
45

 
1

 

 

Agricultural

 

 

 

Other

 

 

 

Total
$
4,599

 
55

 
5,184

 
45

 
 
 
 
 
 
 
 
Total:
 
 
 
 
 
 
 
Commercial & industrial
$
1,832

 
39

 
1,991

 
40

Commercial, secured by real estate
18,977

 
277

 
22,835

 
299

Residential real estate
4,464

 
121

 
4,972

 
134

Consumer
74

 
8

 
110

 
7

Agricultural
384

 

 
110

 
11

Other
480

 
18

 
516

 
19

Total
$
26,211

 
463

 
30,534

 
510

 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
 
 
Commercial & industrial
$
1,167

 
89

 
1,437

 
175

Commercial, secured by real estate
16,654

 
897

 
19,941

 
1,901

Residential real estate
3,809

 
306

 
4,295

 
364

Consumer
41

 
22

 
119

 
15

Agricultural
403

 
135

 
107

 
479

Other
488

 
58

 
515

 
58

Total
$
22,562

 
1,507

 
26,414

 
2,992

 
 
 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

 
 

Commercial & industrial
$
400

 
15

 
389

 
17

Commercial, secured by real estate
2,960

 
82

 
3,977

 
85

Residential real estate
680

 
24

 
825

 
29

Consumer
43

 
2

 

 

Agricultural

 

 

 

Other

 

 

 

Total
$
4,083

 
123

 
5,191

 
131

 
 
 
 
 
 
 
 
Total:
 

 
 

 
 

 
 

Commercial & industrial
$
1,567

 
104

 
1,826

 
192

Commercial, secured by real estate
19,614

 
979

 
23,918

 
1,986

Residential real estate
4,489

 
330

 
5,120

 
393

Consumer
84

 
24

 
119

 
15

Agricultural
403

 
135

 
107

 
479

Other
488

 
58

 
515

 
58

Total
$
26,645

 
1,630

 
31,605

 
3,123


20

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

Note 4 – Loans (continued)


Of the interest income recognized on impaired loans during the nine months ended September 30, 2016 and 2015, approximately $48,000 and $96,000, respectively, were recognized on a cash basis.

Loan modifications that were classified as troubled debt restructurings during the three and nine months ended September 30, 2016 and 2015 are as follows (dollars in thousands):
 
2016
 
2015
 
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

 
304

 
304

 

 

 

Residential real estate
1

 
27

 
27

 

 

 

Consumer
1

 
11

 
11

 
1

 
2

 
2

Total
3

 
$
342

 
342

 
1

 
$
2

 
2

 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
 
 
 

 
 

Commercial & industrial

 
$

 

 
1

 
$
72

 
74

Commercial, secured by real estate
2

 
$
603

 
676

 

 

 

Residential real estate
3

 
72

 
72

 
4

 
137

 
137

Consumer
3

 
38

 
38

 
1

 
2

 
2

Total
8

 
$
713

 
786

 
6

 
$
211

 
213


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.

There were no troubled debt restructurings that subsequently defaulted within twelve months of the restructuring date for the nine months ended September 30, 2016 and 2015 and that remained in default at period end.

21

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




Note 5 - Acquired Credit Impaired Loans

The following table provides at September 30, 2016 and December 31, 2015 the major classifications of acquired credit impaired loans that are accounted for in accordance with FASB ASC 310-30 (in thousands):
 
September 30, 2016
 
December 31, 2015
Commercial & industrial
$
1,325

 
1,191

Commercial, secured by real estate
6,181

 
7,877

Residential real estate
2,640

 
3,039

Consumer
18

 
27

Agricultural

 
48

Other loans, including deposit overdrafts
489

 
486

 
10,653

 
12,668

Less allowance for loan losses
296

 

Loans, net
$
10,357

 
12,668


The following table provides the outstanding balance and related carrying amount for acquired credit impaired loans at the dates indicated (in thousands):
 
September 30, 2016
 
December 31, 2015
Outstanding balance
$
13,851

 
16,507

Carrying amount
10,357

 
12,668


Activity during the nine months ended September 30, 2016 and 2015 for the accretable discount related to acquired credit impaired loans is as follows (in thousands):
 
2016
 
2015
Accretable discount at beginning of year
$
1,503

 
2,674

Accretable discount acquired during period

 
413

Reclass from nonaccretable discount to accretable discount
338

 
957

Less disposals
(3
)
 
(850
)
Less accretion
(579
)
 
(1,540
)
Accretable discount at end of period
$
1,259

 
1,654



22

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED 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 are included in "other assets" in the consolidated condensed balance sheets.  Changes in other real estate owned are as follows (in thousands):
 
Nine Months Ended September 30,
 
2016
 
2015
Balance, beginning of year
$
846

 
1,370

Additions
214

 
99

Reductions due to sales
(214
)
 
(105
)
Reductions due to valuation write downs
(576
)
 
(156
)
Balance, end of period
$
270

 
1,208


Other real estate owned at September 30, 2016 and December 31, 2015 consisted of (dollars in thousands):
 
September 30, 2016
 
December 31, 2015
Commercial real estate
$
270

 
$
846

Residential real estate

 

 
$
270

 
$
846


The total recorded investment in residential consumer mortgage loans secured by residential real estate that was in the process of foreclosure at September 30, 2016 was $509,000


Note 7 - Affordable Housing Tax Credit Limited Partnership

LCNB is a limited partner in a limited partnership that sponsors affordable housing projects utilizing the Low Income Housing Tax Credit (LIHTC) pursuant to Section 42 of the Internal Revenue Code. The purpose of this investment is to achieve a satisfactory return on capital, to facilitate the sale of additional affordable housing product offerings, and to assist in achieving goals associated with the Community Reinvestment Act. The primary activities of the limited partnership include the identification, development, and operation of multi-family housing that is leased to qualifying residential tenants.

The following table presents the balances of LCNB's affordable housing tax credit investment and related unfunded commitment at September 30, 2016 and December 31, 2015 (in thousands):
 
September 30,
2016
 
December 31,
2015
Affordable housing tax credit investment
$
1,000

 
1,000

Less amortization
74

 
12

Net affordable housing tax credit investment
$
926

 
988

 
 
 
 
Unfunded commitment
$
838

 
907


LCNB expects to fund the unfunded commitment over 9.25 years.





23

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

Note 7 – Affordable Housing Tax Credit Limited Partnership (continued)

The following table presents other information relating to LCNB's affordable housing tax credit investment for the periods indicated (in thousands):
 
Nine Months ended September 30,
 
2016
 
2015
Tax credits and other tax benefits recognized
$
83

 

Tax credit amortization expense included in provision for income taxes
62

 



Note 8 – Short-Term Borrowings

Short-term borrowings at September 30, 2016 and December 31, 2015 are as follows (dollars in thousands):

 
September 30, 2016
 
December 31, 2015
 
Amount
 
Rate

 
Amount
 
Rate
Line of credit
$

 
%
 
$
13,187

 
1.00
%
FHLB short-term advance

 
%
 
10,000

 
0.35
%
Repurchase agreements
16,989

 
0.10
%
 
14,200

 
0.10
%
 
$
16,989

 
0.10
%
 
$
37,387

 
0.48
%

Repurchase agreements are an option customers may use in managing their cash positions and mature the next business day after issuance. Repurchase agreements at September 30, 2016 and December 31, 2015 were fully secured by U.S. Agency notes and such collateral securities were held by the Federal Reserve Bank.


Note 9 – 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,
 
2016
 
2015
 
2016
 
2015
Statutory tax rate
34.2
 %
 
34.0
 %
 
34.2
 %
 
34.0
 %
Increase (decrease) resulting from:
 

 
 

 
 

 
 

Tax exempt interest
(7.0
)%
 
(6.8
)%
 
(6.6
)%
 
(5.9
)%
Tax exempt income on bank owned life insurance
(1.7
)%
 
(1.5
)%
 
(1.6
)%
 
(1.4
)%
Other, net
0.1
 %
 
0.2
 %
 
 %
 
0.5
 %
Effective tax rate
25.6
 %
 
25.9
 %
 
26.0
 %
 
27.2
 %


Note 10 - 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.



24

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

Note 10 – Commitments and Contingent Liabilities (continued)


The Bounce Protection product, a customer deposit overdraft program, 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.  

Financial instruments whose contract amounts represent off-balance-sheet credit risk at September 30, 2016 and December 31, 2015 are as follows (in thousands):
 
September 30, 2016
 
December 31,
2015
Commitments to extend credit:
 
 
 
Commercial loans
$
9,344

 
8,160

Other loans
 

 
 

Fixed rate
8,126

 
2,293

Adjustable rate
1,908

 
1,362

Unused lines of credit:
 

 
 

Fixed rate
6,430

 
6,378

Adjustable rate
89,843

 
90,153

Unused overdraft protection amounts on demand and NOW accounts
17,372

 
10,057

Standby letters of credit
357

 
457

 
$
133,380

 
118,860


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, 2016 totaled approximately $7,390,000, which includes estimated remaining costs for construction of a new Operations Center in Lebanon, Ohio.

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.

25

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




Note 11 – Accumulated Other Comprehensive Income
 
Changes in accumulated other comprehensive income for the nine months ended September 30, 2016 and 2015 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, 2016
 
 
 
 
 
Balance at beginning of period
$
469

 
(233
)
 
236

Before reclassifications
3,835

 
83

 
3,918

Reclassifications
(632
)
 

 
(632
)
Balance at end of period
$
3,672

 
(150
)
 
3,522

 
 
 
 
 
 
September 30, 2015
 

 
 

 
 

Balance at beginning of period
$
1,126

 
(341
)
 
785

Before reclassifications
1,823

 
86

 
1,909

Reclassifications
(219
)
 

 
(219
)
Balance at end of period
$
2,730

 
(255
)
 
2,475


Reclassifications out of accumulated other comprehensive income during the three and nine months ended September 30, 2016 and 2015 and the affected line items in the consolidated condensed statements of income are as follows (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
Affected Line Item in the Consolidated Condensed Statements of Income
 
2016
 
2015
 
2016
 
2015
 
Realized gain on sale of securities
$
307

 

 
$
957

 
332

 
Net gain on sales of securities
Less provision for income taxes
104

 

 
325

 
113

 
Provision for income taxes
Reclassification adjustment, net of taxes
$
203

 

 
$
632

 
219

 
 


Note 12 – 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 hired before this date who received a benefit reduction under certain amendments to the defined benefit retirement plan receive an automatic contribution of 5% or 7% of their annual compensation, depending on the sum of an employee's age and vesting service, into their defined contribution plans (401(k) plans), regardless of the contributions made by the employees.  These contributions are made annually and these employees do not receive any employer matches to their 401(k) contributions.

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.  


26

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


Note 12 – Retirement Plans (continued)


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 condensed statements of income for the three and nine-month periods ended September 30, 2016 and 2015 are as follows (in thousands):
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2016
 
2015
 
2016
 
2015
Qualified noncontributory defined benefit retirement plan
$
272

 
220

 
$
712

 
763

401(k) plan
81

 
86

 
241

 
263


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, 2016 and 2015 are summarized as follows (in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2016
 
2015
 
2016
 
2015
Service cost
 
$
10

 
10

 
$
30

 
29

Interest cost
 
20

 
17

 
58

 
51

Amortization of unrecognized net loss
 
42

 
43

 
126

 
128

Net periodic pension cost
 
$
72

 
70

 
$
214

 
208


Amounts recognized in accumulated other comprehensive income, net of tax, at September 30, 2016 and December 31, 2015 for the nonqualified defined benefit retirement plan consists of (in thousands):
 
September 30, 2016
 
December 31,
2015
Net actuarial loss
$
150

 
233



Note 13 - Stock Based Compensation
 
LCNB established an Ownership Incentive Plan (the "2002 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 2002 Plan provided for the issuance of up to 200,000 shares. The 2002 Plan expired on April 16, 2012. Any outstanding unexercised options, however, continue to be exercisable in accordance with their terms.

The 2015 Ownership Incentive Plan (the "2015 Plan") was ratified by LCNB's shareholders at the annual meeting on April 28, 2015 and allows for stock-based awards to eligible employees, as determined by the Compensation Committee of the Board of Directors. Awards may be made in the form of stock options, appreciation rights, restricted shares, and/or restricted share units. The 2015 Plan provides for the issuance of up to 450,000 shares. The 2015 Plan will terminate on April 28, 2025 and is subject to earlier termination by the Compensation Committee.

Stock-based awards may be in the form of treasury shares or new shares.




27

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


Note 13 – Stock Based Compensation (continued)

LCNB has not granted stock option awards since 2012. Options granted to date under the 2002 Plan vest ratably over a five-year period and expire ten years after the date of grant. Stock options outstanding at September 30, 2016 were 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
 
4,356

 
$
9.00

 
2.3
 
4,356

 
$
9.00

 
2.3
$11.00 - $12.99
 
17,797

 
12.13

 
4.1
 
16,052

 
12.08

 
3.9
$17.00 - $18.99
 
2,516

 
17.88

 
0.3
 
2,516

 
17.88

 
0.3
 
 
24,669

 
12.17

 
3.4
 
22,924

 
12.13

 
3.2

The following table summarizes stock option activity for the periods indicated:
 
2016
 
2015
 
Options
 
Weighted Average Exercise
Price
 
Options
 
Weighted Average Exercise
Price
Outstanding, January 1,
83,861

 
$
12.39

 
99,810

 
$
12.16

Granted

 

 

 

Exercised
(51,390
)
 
11.53

 
(13,449
)
 
11.31

Expired
(7,802
)
 
18.76

 
(2,500
)
 
9.00

Outstanding, September 30,
24,669

 
12.17

 
83,861

 
12.39

Exercisable, September 30,
22,924

 
12.13

 
75,072

 
12.40


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, 2016 that were "in the money" (market price greater than exercise price) was $149,000.  The aggregate intrinsic value at that date for only the options that were exercisable was $140,000.  The aggregate intrinsic value for options outstanding at September 30, 2015 that were in the money was $348,000 and the aggregate intrinsic value at that date for only the options that were exercisable was $313,000.  The intrinsic value changes based upon fluctuations in the market value of LCNB's common stock.

Total expense related to options included in salaries and employee benefits for the three and nine months ended September 30, 2016 was $2,000 and $4,000, respectively. The related tax benefit for the three and nine months ended September 30, 2016 was $0 and $1,000, respectively. Total expense related to options included in salaries and employee benefits for the three and nine months ended September 30, 2015 was $3,000 and $13,000, respectively. The related tax benefit for the three and nine months ended September 30, 2015 was $1,000 and $4,000, respectively. Unrecognized compensation cost related to option awards to be recognized through the first quarter of 2017 is approximately $2,000.












28

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


Note 13 – Stock Based Compensation (continued)

Restricted stock awards granted under the 2015 Plan were as follows:
 
2016
 
2015
 
 
 
Shares
 
Weighted Average Grant Date Fair Value
 
 
 
Shares
 
Weighted Average Grant Date Fair Value
Outstanding, January 1,
16,038

 
$
15.47

 

 
$

Granted

 

 

 

Vested
(5,255
)
 
15.47

 

 

Forfeited

 

 

 

Outstanding, September 30,
10,783

 
$
15.47

 

 
$


Total expense related to restricted stock awards included in salaries and wages in the consolidated condensed statements of income for the three and nine months ended September 30, 2016 was $23,000 and $68,000, respectively. The related tax benefit for the three and nine months end September 30, 2016 was $8,000 and $23,000, respectively. Unrecognized compensation expense for restricted stock awards was $90,000 at September 30, 2016 and is expected to be recognized over a period of 4.25 years.


Note 14 - 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, 2016 and 2015 (dollars in thousands, except share and per share data):
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2016
 
2015
 
2016
 
2015
Net income
$
2,896

 
2,633

 
$
8,828

 
8,590

Weighted average number of shares outstanding used in the calculation of basic earnings per common share
9,962,571

 
9,898,233

 
9,930,182

 
9,637,344

Add dilutive effect of:
 

 
 

 
 

 
 

Stock options
10,052

 
16,219

 
15,360

 
17,199

Stock warrants

 
91,336

 
22,093

 
88,296

Restricted shares
4,969

 

 
6,684

 

Adjusted weighted average number of shares outstanding used in the calculation of diluted earnings per common share
9,977,592

 
10,005,788

 
9,974,319

 
9,742,839

Earnings per common share:
 

 
 

 
 

 
 

Basic
$
0.29

 
0.26

 
$
0.89

 
0.89

Diluted
0.29

 
0.26

 
0.88

 
0.88


Options to purchase 2,516 and 12,962 shares of common stock at a weighted average price of $17.88 and $18.41 per share were outstanding at September 30, 2016 and 2015, 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.

29

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




Note 15 - 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.

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 three mutual funds that are not priced by the pricing service. Market quotations (level 1) are used to determine fair values for the trust preferred securities, equity securities, and a publicly traded mutual fund. Investments in two mutual funds that are measured at fair value using net asset values ("NAV") per share as a practical expedient are not required to be classified in the fair value hierarchy.  These funds can be redeemed at any time at their current NAVs. 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.


30

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

Note 15 - 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, 2016 and December 31, 2015 (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, 2016
 
 
 
 
 
 
 
 
Recurring fair value measurements:
 
 
 
 
 
 
 
 
 
Investment securities available-for-sale:
 
 
 
 
 
 
 
 
 
     U.S. Treasury notes
 
$
45,911

 
45,911

 

 

 
     U.S. Agency notes
 
108,963

 

 
108,963

 

 
     U.S. Agency mortgage-backed securities
 
50,322

 

 
50,322

 

 
     Certificates of deposit with other banks
 

 

 

 

 
     Municipal securities:
 
 

 
 

 
 

 
 

 
          Non-taxable
 
117,676

 

 
117,676

 

 
          Taxable
 
20,270

 

 
20,270

 

 
     Mutual funds
 
1,000

 

 
1,000

 

 
     Mutual funds measured at net asset value (a)
 
1,508

 
 
 
 
 
 
 
     Trust preferred securities
 
49

 
49

 

 

 
     Equity securities
 
692

 
692

 

 

 
          Total recurring fair value measurements
 
$
346,391

 
46,652

 
298,231

 

 
 
 
 
 
 
 
 
 
 
Nonrecurring fair value measurements:
 
 

 
 

 
 
 
 

 
Impaired loans
 
$
4,121

 

 

 
4,121

 
Other real estate owned and repossessed assets
 
270

 

 

 
270

 
     Total nonrecurring fair value measurements
 
$
4,391

 

 

 
4,391

 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 

 
 

Recurring fair value measurements:
 
 

 
 

 
 

 
 

 
Investment securities available-for-sale:
 
 

 
 

 
 

 
 

 
     U.S. Treasury notes
 
$
72,846

 
72,846

 

 

 
     U.S. Agency notes
 
139,889

 

 
139,889

 

 
     U.S. Agency mortgage-backed securities
 
29,378

 

 
29,378

 

 
     Certificates of deposit with other banks
 
249

 

 
249

 

 
     Municipal securities:
 
 

 
 

 
 

 
 

 
          Non-taxable
 
105,479

 

 
105,479

 

 
          Taxable
 
26,941

 

 
26,941

 

 
     Mutual funds
 
1,018

 
18

 
1,000

 

 
     Mutual funds measured at net asset value (a)
 
1,448

 
 
 
 
 
 
 
     Trust preferred securities
 
50

 
50

 

 

 
     Equity securities
 
680

 
680

 

 

 
          Total recurring fair value measurements
 
$
377,978

 
73,594

 
302,936

 

 
 
 
 
 
 
 
 
 
 
Nonrecurring fair value measurements:
 
 

 
 

 
 

 
 

 
Impaired loans
 
$
4,722

 

 

 
4,722

 
Other real estate owned and repossessed assets
 
846

 

 

 
846

 
     Total nonrecurring fair value measurements
 
$
5,568

 

 

 
5,568

 
 
 
 
 
 
 
 
 
 
(a)
In accordance with Subtopic 820-10, certain investments that are measured at fair value using the net asset value per share practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the Consolidated Condensed Balance Sheets.

31

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

Note 15 - Fair Value Measurements (continued)

The following table presents quantitative information about unobservable inputs used in nonrecurring level 3 fair value measurements at September 30, 2016 and December 31, 2015 (dollars in thousands):
 
 
 
 
 
 
 
 
Range
 
 
Fair Value
 
Valuation Technique
 
Unobservable Inputs
 
High
 
Low
 
Weighted Average
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans
 
$
4,121

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

 
Discounted cash flows
 
Discount rate
 
8.25
%
 
4.45
%
 
5.48
%
Other real estate owned
 
270

 
Estimated sales price
 
Adjustments for comparable properties, discounts to reflect current market conditions
 
Not applicable
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans
 
$
4,722

 
Estimated sales price
 
Adjustments for comparable properties, discounts to reflect current market conditions
 
Not applicable
 
 
 
 
Discounted cash flows
 
Discount rate
 
11.00
%
 
4.00
%
 
5.27
%
Other real estate owned
 
846

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

32

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

Note 15 - Fair Value Measurements (continued)

Carrying amounts and estimated fair values of financial instruments as of September 30, 2016 and December 31, 2015 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, 2016
 
 
 
 
 
 
 
 
 
 
FINANCIAL ASSETS:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
33,213

 
33,213

 
33,213

 

 

Investment securities, held-to-maturity
 
42,037

 
42,879

 

 

 
42,879

Federal Reserve Bank stock
 
2,732

 
2,732

 
2,732

 

 

Federal Home Loan Bank stock
 
3,638

 
3,638

 
3,638

 

 

Loans, net
 
807,864

 
800,499

 

 

 
800,499

  Accrued interest receivable
 
4,449

 
4,449

 

 
4,449

 

 
 
 
 
 
 
 
 
 
 
 
FINANCIAL LIABILITIES:
 
 

 
 

 
 
 
 
 
 
Deposits
 
1,158,921

 
1,161,419

 
940,294

 
221,125

 

Short-term borrowings
 
16,989

 
16,989

 
16,989

 

 

Long-term debt
 
662

 
681

 

 
681

 

  Accrued interest payable
 
282

 
282

 

 
282

 

 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
 
 
 
 
FINANCIAL ASSETS:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
14,987

 
14,987

 
14,987

 

 

Investment securities, held-to-maturity
 
22,633

 
22,630

 

 

 
22,630

Federal Reserve Bank stock
 
2,732

 
2,732

 
2,732

 

 

Federal Home Loan Bank stock
 
3,638

 
3,638

 
3,638

 

 

Loans, net
 
767,809

 
761,388

 

 

 
761,388

  Accrued interest receivable
 
3,380

 
3,380

 

 
3,380

 

 
 
 
 
 
 
 
 
 
 
 
FINANCIAL LIABILITIES:
 
 

 
 

 
 
 
 
 
 
Deposits
 
1,087,160

 
1,087,914

 
869,940

 
217,974

 

Short-term borrowings
 
37,387

 
37,387

 
37,387

 

 

Long-term debt
 
5,947

 
6,290

 

 
6,290

 

Accrued interest payable
 
345

 
345

 

 
345

 











33

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

Note 15 - Fair Value Measurements (continued)

The fair values of off-balance-sheet financial instruments such as loan commitments and letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements. The fair values of such instruments were not material at September 30, 2016 and December 31, 2015.

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.

Investment securities, held-to-maturity
Fair values for investment securities, held-to-maturity are based on quoted market prices for similar securities and/or discounted cash flow analysis or other methods.  

Federal Home Loan Bank stock and Federal Reserve Bank stock
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.

Accrued interest receivable and Accrued interest payable
Carrying amount approximates fair value.


Note 16 – Recent Accounting Pronouncements
 
From time to time the FASB issues an Accounting Standards Update ("ASU") to communicate changes to Generally Accepted Accounting Principles. The following information provides brief summaries of newly issued but not yet effective ASUs that could have an effect on LCNB’s financial position or results of operations:








34

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

Note 16 – Recent Accounting Pronouncements (continued)

ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)"
ASU No. 2014-09 was issued in May 2014 and supersedes 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.

Guidance in ASU No. 2014-09 has been clarified by the following ASUs:
ASU No. 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)"
ASU No. 2016-10, "Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing"
ASU No. 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow Scope Improvements and Practical Expedients"

As extended by ASU No. 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date," ASU No. 2014-09 and the clarifying ASUs are effective for public companies for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Transitional guidance is included in the updates. Earlier adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. Since LCNB's products are substantially financial in nature, adoption of ASU No. 2014-09 and the clarifying ASUs are 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.

ASU No. 2016-01, "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities"
ASU No. 2016-01 was issued in January 2016 and applies to all entities that hold financial assets or owe financial liabilities. It makes targeted changes to generally accepted accounting principles for public companies as follows:
1.
Requires most equity investments to be measured at fair value with changes in fair value recognized in net income.
2.
Simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value.
3.
Eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet.
4.
Requires use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes.
5.
Requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments.
6.
Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements.
7.
Clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets.


35

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

Note 16 – Recent Accounting Pronouncements (continued)

For public business entities, the new guidance is effective for annual reporting periods, and interim reporting periods within those annual periods, beginning after December 15, 2017. Adoption of ASU No. 2016-01 is not expected to have a material impact on LCNB's results of operations or financial position.

ASU No. 2016-02, "Leases (Topic 842)"
ASU No. 2016-02 was issued in February 2016 and requires a lessee to recognize in the statement of financial position a liability to make lease payments ("the lease liability") and a right-of-use asset representing its right to use the underlying asset for the lease term, initially measured at the present value of the lease payments. When measuring assets and liabilities arising from a lease, the lessee should include payments to be made in optional periods only if the lessee is reasonably certain, as defined, to exercise an option to the lease or not to exercise an option to terminate the lease. Optional payments to purchase the underlying asset should be included if the lessee is reasonably certain it will exercise the purchase option. Most variable lease payments should be excluded except for those that depend on an index or a rate or are in substance fixed payments.

A lessee shall classify a lease as a finance lease if it meets any of five listed criteria:
1.
The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
2.
The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
3.
The lease term is for the major part of the remaining economic life of the underlying asset.
4.
The present value of the sum of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the underlying asset.
5.
The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

For finance leases, a lessee shall recognize in the statement of comprehensive income interest on the lease liability separately from amortization of the right-of-use asset. Amortization of the right-of-use asset shall be on a straight-line basis, unless another basis is more representative of the pattern in which the lessee expects to consume the right-of-use asset’s future economic benefits. If the lease does not meet any of the five criteria, the lessee shall classify it as an operating lease and shall recognize a single lease cost on a straight-line basis over the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term.

The amendments in this update are to be applied using a modified retrospective approach, as defined, and are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2018. Early application is permitted. LCNB management is currently evaluating the financial statement impact of adopting the new guidance.

ASU No. 2016-05, "Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships (a consensus of the Emerging Issues Task Force)"
ASU No. 2016-05 was issued in March 2016 and applies to reporting entities for which there is a change in a counterparty to a derivative instrument that has been designated a hedging instrument under Topic 815, "Derivatives and Hedging." The amendments in this update clarify that a change in a counterparty to such a derivative instrument does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria under applicable guidance continue to be met. The amendments in ASU No. 2016-05 are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2016. LCNB does not currently have any investments in derivative instruments that have been designated as hedging instruments and adoption of ASU No. 2016-05 is not expected to have an impact on LCNB's results of operations or financial position.







36

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

Note 16 – Recent Accounting Pronouncements (continued)

ASU No. 2016-06 , "Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments (a consensus of the Emerging Issues Task Force)"
ASU No. 2016-06 was issued in March 2016 and clarifies what steps are required when assessing whether the economic characteristics and risks of call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to the economic characteristics and risks of their debt hosts, which is one of the criteria for bifurcating an embedded derivative. An entity performing the assessment under the amendments in this update is required to assess the
embedded call (put) options solely in accordance with the four-step decision sequence. The four-step decision sequence requires an entity to consider whether (1) the payoff is adjusted based on changes in an index, (2) the payoff is indexed to an underlying other than interest rates or credit risk, (3) the debt involves a substantial premium or discount, and (4) the call (put) option is contingently exercisable. The amendments in ASU No. 2016-06 are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2016. LCNB does not currently have any investments in debt instruments containing such call (put) options and adoption of ASU No. 2016-06 is not expected to have an impact on LCNB's results of operations or financial position.

ASU No. 2016-09, "Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting"
ASU No. 2016-09 was issued in March 2016 and affects all entities that issue share-based payment awards to their employees. The new guidance involves several aspects of the accounting for share-based payment transactions, including income tax
consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Under ASU No. 2016-09, any excess tax benefits or tax deficiencies should be recognized as income tax expense or benefit in the income statement. Excess tax benefits are to be classified as an operating activity in the statement of cash flows. In accruing compensation cost, an entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest, as required under current guidance, or account for forfeitures when they occur. For an award to qualify for equity classification, an entity cannot partially settle the award in excess of the employer's maximum statutory withholding requirements. Such cash paid by an employer when directly withholding shares for tax withholding purposes should be classified as a financing activity in the statement of cash flows. The amendments in ASU No. 2016-09 are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. Adoption of ASU No. 2016-07 is not expected to have a material impact on LCNB's results of operations or financial position.

ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments"
ASU No. 2016-13 was issued in June 2016 and, once effective, will significantly change current guidance for recognizing impairment of financial instruments. Current guidance requires an "incurred loss" methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. ASU No. 2016-13 replaces the incurred loss impairment methodology with a new methodology that reflects expected credit losses over the lives of the loans and requires consideration of a broader range of information to inform credit loss estimates. The ASU requires an organization to estimate all expected credit losses for financial assets measured at amortized cost, including loans and held-to-maturity debt securities, based on historical experience, current conditions, and reasonable and supportable forecasts. Additional disclosures are required.

ASU No. 2016-13 also amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. Under the new guidance, entities will determine whether all or a portion of the unrealized loss on an available-for-sale debt security is a credit loss. Any credit loss will be recognized as an allowance for credit losses on available-for-sale debt securities rather than as a direct reduction of the amortized cost basis of the investment, as is currently required. As a result, entities will recognize improvements to estimated credit losses on available-for-sale debt securities immediately in earnings rather than as interest income over time, as currently required.

ASU No. 2016-13 eliminates the current accounting model for purchased credit impaired loans and debt securities. Instead, purchased financial assets with credit deterioration will be recorded gross of estimated credit losses as of the date of acquisition and the estimated credit losses amounts will be added to the allowance for credit losses. Thereafter, entities will account for additional impairment of such purchased assets using the models listed above.
 

37

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

Note 16 – Recent Accounting Pronouncements (continued)

ASU No. 2016-13 will take effect for U.S. Securities and Exchange Commission (SEC) filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. LCNB management is currently evaluating the financial statement impact of adopting the new guidance.

ASU No. 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Paymnents"
ASU No. 2016-15 was issued in August 2016 and applies to all entities required to present a statement of cash flows in their financial reports. The guidance in this ASU addresses eight cash flow classification issues that have been creating diversity in practice. One of the issues is the classification of cash payments for debt prepayment or debt extinguishment costs, which are to be classified as cash outflows from financing activities under the new guidance. LCNB incurred a prepayment penalty during January 2016 upon the early payment in full of a FHLB advance and classified such penalty as a cash outflow from operating activities in its consolidated condensed statements of cash flows. Management early adopted ASU No. 2016-15 during the third quarter 2016 and reclassified the penalty as a cash outflow from financing activities.

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 statements made in this document regarding LCNB’s financial condition, results of operations, plans, objectives, future performance and business, are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. These forward-looking statements are identified by the fact they are not historical facts and include words such as “anticipate”, “could”, “may”, “feel”, “expect”, “believe”, “plan”, and similar expressions.

These forward-looking statements reflect management's current expectations based on all information available to management and its knowledge of LCNB’s business and operations. Additionally, LCNB’s financial condition, results of operations, plans, objectives, future performance and business are subject to risks and uncertainties that may cause actual results to differ materially. These factors include, but are not limited to:

1.
the success, impact, and timing of the implementation of LCNB’s business strategies;
2.
LCNB may incur increased charge-offs in the future;
3.
LCNB may face competitive loss of customers;
4.
changes in the interest rate environment may have results on LCNB’s operations materially different from those anticipated by LCNB’s market risk management functions;
5.
changes in general economic conditions and increased competition could adversely affect LCNB’s operating results;
6.
changes in other regulations and government policies affecting bank holding companies and their subsidiaries, including changes in monetary policies, could negatively impact LCNB’s operating results;
7.
LCNB may experience difficulties growing loan and deposit balances;
8.
the current economic environment poses significant challenges for us and could adversely affect our financial condition and results of operations;
9.
deterioration in the financial condition of the U.S. banking system may impact the valuations of investments LCNB has made in the securities of other financial institutions resulting in either actual losses or other than temporary impairments on such investments; and
10.
the effects of the Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and the regulations promulgated and to be promulgated thereunder, which may subject LCNB and its subsidiaries to a variety of new and more stringent legal and regulatory requirements which adversely affect their respective businesses. 

Forward-looking statements made herein reflect management's expectations as of the date such statements are made. Such information is provided to assist shareholders and potential investors in understanding current and anticipated financial operations of LCNB and is included pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. LCNB undertakes no obligation to update any forward-looking statement to reflect events or circumstances that arise after the date such statements are made. 
 
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.


39

Table of Contents

LCNB CORP. AND SUBSIDIARIES

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




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.

Accounting for Intangibles.  LCNB’s intangible assets at September 30, 2016 are composed primarily of goodwill and core deposit intangibles related to acquisitions of other financial institutions. 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 acquisition of Eaton National Bank & Trust Co.  Goodwill is not subject to amortization, but is reviewed annually for impairment.  Core deposit intangibles are being amortized on a straight line basis over their respective estimated weighted average lives.  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 and nine months ended September 30, 2016 was $2,896,000 (total basic and diluted earnings per share of $0.29) and $8,828,000 (total basic and diluted earnings per share of $0.89 and $0.88), respectively.  This compares to net income of $2,633,000 (total basic and diluted earnings per share of $0.26) and $8,590,000 (total basic and diluted earnings per share of $0.89 and $0.88, respectively) for the same three- and nine-month periods in 2015. Results for the first nine months of 2016 were significantly affected by the acquisition of BNB Bancorp, Inc. ("BNB") on April 30, 2015. In addition, LCNB sold impaired loans with a carrying value of approximately $4.5 million during the second quarter of 2015, resulting in a net gain from sale of loans of $181,000.

Net income for the nine months ended September 30, 2016 included several one-time charges. The first of which was a $251,000 penalty incurred during the first quarter for the early payoff of a now high-rate Federal Home Loan Bank ("FHLB") borrowing, which will decrease future interest expense. The second was write-downs totaling $576,000 recognized during the second and third quarters for a commercial other real estate owned property.

Organic loan growth during the nine-month period in 2016 was $40.7 million, which significantly contributed to increases in
net interest income of $513,000 and $482,000 for the three and nine months ended September 30, 2016, respectively, as
compared to the same periods in 2015.





40

Table of Contents

LCNB CORP. AND SUBSIDIARIES

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




The provision for loan losses for the three months ended September 30, 2016 was $132,000 greater than the comparable period
in 2015. The provision for the nine-month period of 2016 was $128,000 less than the comparable period in 2015. Net loan
charge-offs for the nine months ended September 30, 2016 and 2015 totaled $189,000 and $1,149,000, respectively. The
2015 balance includes charge-offs recognized as a result of the impaired loan sale mentioned above.

Non-accrual loans and loans past due 90 days or more and still accruing interest increased $2,357,000, from $2,282,000 or 0.30% of total loans at December 31, 2015, to $4,639,000 or 0.57% of total loans at September 30, 2016, primarily due to two loans to the same borrower totaling $1,307,000 that were newly classified as non-accrual during the first quarter 2016 and two loans to the same borrower totaling $1,217,000 that were newly classified as non-accrual during the third quarter 2016. These four loans were classified as impaired at September 30, 2016 and reviewed to determine if specific allowance for loan loss allocations were needed.

Loans with a credit quality indicator of substandard increased $16,848,000, from $17,297,000 at December 31, 2015 to $34,145,000 at September 30, 2016. Commercial, secured by real estate loans classified as substandard at September 30, 2016 included seven loans totaling $12,276,000 that were not classified as substandard at December 31, 2015.

Other real estate owned (which includes property acquired through foreclosure or deed-in-lieu of foreclosure) decreased from $846,000 at December 31, 2015 to $270,000 at September 30, 2016 due to write-downs totaling $576,000 recognized on commercial property.

Non-interest income for the three and nine months ended September 30, 2016 was $460,000 and $715,000 greater
than the comparable periods in 2015, respectively, primarily due to increases in gains from sales of investment securities, reflecting a higher volume of securities sales.

Non-interest expense for the three and nine months ended September 30, 2016 was $505,000 and $1,190,000 greater than the comparable periods in 2015, respectively. The increase for the quarter was largely due to increases in salaries and employee
benefits. The increase for the nine-month period was primarily due to increases in salaries and employee benefits, increases in
other real estate owned expenses, and a $251,000 penalty for the early payoff of a $5 million FHLB advance recognized during the first quarter 2016. The FHLB advance had an interest rate of 5.25% and was paid off to reduce interest expense on long-term debt. Salaries and employee benefits increased primarily due to salary and wage increases, employees retained from the BNB acquisition, and an increase in the number of employees in addition to the acquisition. Other real estate owned expenses increased primarily due to the $576,000 of write-downs recognized during the second and third quarters of 2016 as discussed previously. These increases were partially offset by the absence of merger-related expenses during the 2016 period.



41

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, 2016 vs. 2015
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, 2016 and 2015, 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,
 
 
2016
 
2015
 
 
Average
Outstanding
Balance
 
Interest
Earned/
Paid
 
Average
Yield/
Rate
 
Average
Outstanding
Balance
 
Interest
Earned/
Paid
 
Average
Yield/
Rate
 
 
 
 
(Dollars in thousands)
 
 
 
 
Loans (1)
 
$
800,729

 
8,876

 
4.41
%
 
$
760,159

 
8,540

 
4.46
%
Federal funds sold
 

 

 
%
 

 

 
%
Interest-bearing demand deposits
 
14,883

 
18

 
0.48
%
 
15,257

 
7

 
0.18
%
Federal Reserve Bank stock
 
2,732

 

 
%
 
2,476

 

 
%
Federal Home Loan Bank stock
 
3,638

 
36

 
3.94
%
 
3,638

 
36

 
3.93
%
Investment securities:
 
 
 
 
 
 
 
 
 
 
 
 
Taxable
 
245,863

 
1,152

 
1.86
%
 
259,090

 
1,094

 
1.68
%
Non-taxable (2)
 
144,387

 
1,236

 
3.41
%
 
120,149

 
1,109

 
3.66
%
Total earnings assets
 
1,212,232

 
11,318

 
3.71
%
 
1,160,769

 
10,786

 
3.69
%
Non-earning assets
 
114,682

 
 

 
 

 
109,287

 
 

 
 

Allowance for loan losses
 
(3,382
)
 
 

 
 

 
(2,885
)
 
 

 
 

Total assets
 
$
1,323,532

 
 

 
 

 
$
1,267,171

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Savings deposits
 
$
668,007

 
167

 
0.10
%
 
$
637,331

 
143

 
0.09
%
IRA and time certificates
 
217,125

 
705

 
1.29
%
 
225,506

 
691

 
1.22
%
Short-term borrowings
 
16,328

 
8

 
0.19
%
 
13,450

 
5

 
0.15
%
Long-term debt
 
684

 
5

 
2.91
%
 
6,040

 
73

 
4.80
%
Total interest-bearing liabilities
 
902,144

 
885

 
0.39
%
 
882,327

 
912

 
0.41
%
Demand deposits
 
262,849

 
 

 
 

 
236,893

 
 

 
 

Other liabilities
 
11,168

 
 

 
 

 
8,919

 
 

 
 

Capital
 
147,371

 
 

 
 

 
139,032

 
 

 
 

Total liabilities and capital
 
$
1,323,532

 
 

 
 

 
$
1,267,171

 
 

 
 

Net interest rate spread (3)
 
 

 
 

 
3.32
%
 
 

 
 

 
3.28
%
Net interest income and net interest margin on a taxable-equivalent basis (4)
 
 

 
10,433

 
3.42
%
 
 

 
9,874

 
3.37
%
Ratio of interest-earning assets to interest-bearing liabilities
 
134.37
%
 
 

 
 

 
131.56
%
 
 

 
 

(1)Includes non-accrual 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 34.2% for 2016 and 34.0% for
2015.
(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.




42

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, 2016 as compared to the same period in 2015.  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, 2016 vs. 2015
Increase (decrease) due to:
 
 
Volume
 
Rate
 
Total
 
 
(In thousands)
Interest-earning Assets:
 
 
 
 
 
 
Loans
 
$
451

 
(115
)
 
336

Federal funds sold
 

 

 

Interest-bearing demand deposits
 

 
11

 
11

Federal Reserve Bank stock
 

 

 

Federal Home Loan Bank stock
 

 

 

Investment securities:
 
 
 
 
 
 

Taxable
 
(58
)
 
116

 
58

Non-taxable
 
212

 
(85
)
 
127

Total interest income
 
605

 
(73
)
 
532

Interest-bearing Liabilities:
 
 

 
 

 
 

Savings deposits
 
7

 
17

 
24

IRA and time certificates
 
(26
)
 
40

 
14

Short-term borrowings
 
1

 
2

 
3

Long-term debt
 
(47
)
 
(21
)
 
(68
)
Total interest expense
 
(65
)
 
38

 
(27
)
Net interest income
 
$
670

 
(111
)
 
559


Net interest income on a fully tax-equivalent basis for the three months ended September 30, 2016 totaled $10,433,000, an increase of $559,000 over the comparable period in 2015.  Total interest income increased $532,000 and total interest expense decreased $27,000.

The increase in total interest income was due primarily to a $51.5 million increase in average total earning assets. Average loans increased $40.6 million and average non-taxable investment securities increased $24.2 million, partially offset by a $13.2 million decrease in taxable investment securities. Slightly offsetting this net increase was a 5 basis point (a basis point equals 0.01%) decrease in the average rate earned on loans and a 25 basis point decrease in the average rate earned on non-taxable investment securities, partially offset by an 18 basis point increase in the average rate earned on taxable investment securities.

The decrease in total interest expense was due primarily to a $5.4 million decrease in average long-term debt and a 189 basis point decrease in the average rate paid on average long-term debt. Both decreases were due to the early payment in full during January 2016 of a $5.0 million FHLB advance bearing an interest rate of 5.25%. The advance was paid off to reduce future interest expense. These decreases were partially offset by increases in the average rates paid on savings deposits and IRA and time certificates.


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, 2016 vs. 2015
The following table presents, for the nine months ended September 30, 2016 and 2015, 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.
 
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
 
Average
Outstanding
Balance
 
Interest
Earned/
Paid
 
Average
Yield/
Rate
 
Average
Outstanding
Balance
 
Interest
Earned/
Paid
 
Average
Yield/
Rate
 
 
 
 
(Dollars in thousands)
 
 
 
 
Loans (1)
 
$
785,807

 
26,395

 
4.49
%
 
$
732,600

 
26,572

 
4.85
%
Federal funds sold
 

 

 
%
 
604

 
1

 
0.22
%
Interest-bearing demand deposits
 
12,632

 
45

 
0.48
%
 
12,756

 
21

 
0.22
%
Federal Reserve Bank stock
 
2,732

 
82

 
4.01
%
 
2,421

 
74

 
4.09
%
Federal Home Loan Bank stock
 
3,638

 
109

 
4.00
%
 
3,638

 
109

 
4.01
%
Investment securities:
 
 
 
 
 
 
 
 

 
 

 
 

Taxable
 
250,354

 
3,528

 
1.88
%
 
236,412

 
2,983

 
1.69
%
Non-taxable (2)
 
137,417

 
3,594

 
3.49
%
 
110,920

 
3,162

 
3.81
%
Total earnings assets
 
1,192,580

 
33,753

 
3.78
%
 
1,099,351

 
32,922

 
4.00
%
Non-earning assets
 
112,246

 
 

 
 
 
108,431

 
 

 
 

Allowance for loan losses
 
(3,206
)
 
 

 
 
 
(2,873
)
 
 

 
 

Total assets
 
$
1,301,620

 
 

 
 
 
$
1,204,909

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Savings deposits
 
$
655,999

 
499

 
0.10
%
 
$
599,371

 
397

 
0.09
%
IRA and time certificates
 
217,329

 
2,066

 
1.27
%
 
219,720

 
1,790

 
1.09
%
Short-term borrowings
 
17,128

 
30

 
0.23
%
 
13,358

 
13

 
0.13
%
Long-term debt
 
895

 
22

 
3.28
%
 
6,247

 
222

 
4.75
%
Total interest-bearing liabilities
 
891,351

 
2,617

 
0.39
%
 
838,696

 
2,422

 
0.39
%
Demand deposits
 
255,314

 
 

 
 

 
223,788

 
 

 
 

Other liabilities
 
10,277

 
 

 
 

 
8,169

 
 

 
 

Capital
 
144,678

 
 

 
 

 
134,256

 
 

 
 

Total liabilities and capital
 
$
1,301,620

 
 

 
 

 
$
1,204,909

 
 

 
 

Net interest rate spread (3)
 
 

 
 

 
3.39
%
 
 

 
 

 
3.61
%
Net interest income and net interest margin on a taxable-equivalent basis (4)
 
 

 
31,136

 
3.49
%
 
 

 
30,500

 
3.71
%
Ratio of interest-earning assets to interest-bearing liabilities
 
133.79
%
 
 

 
 

 
131.08
%
 
 

 
 

(1)Includes non-accrual 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 of 34.2% for 2016 and 34.0% for
2015.
(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.





44

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 nine months ended September 30, 2016 as compared to the same period in 2015.  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.
 
 
Nine Months Ended
September 30, 2016 vs. 2015
Increase (decrease) due to:
 
 
Volume
 
Rate
 
Total
 
 
(In thousands)
Interest-earning Assets:
 
 
 
 
 
 
Loans
 
$
1,859

 
(2,036
)
 
(177
)
Federal funds sold
 
(1
)
 

 
(1
)
Interest-bearing demand deposits
 

 
24

 
24

Federal Reserve Bank stock
 
9

 
(1
)
 
8

Federal Home Loan Bank stock
 

 

 

Investment securities:
 
 
 
 
 
 

Taxable
 
183

 
362

 
545

Non-taxable
 
709

 
(277
)
 
432

Total interest income
 
2,759

 
(1,928
)
 
831

Interest-bearing Liabilities:
 
 

 
 

 
 

Savings deposits
 
40

 
62

 
102

IRA and time certificates
 
(20
)
 
296

 
276

Short-term borrowings
 
4

 
13

 
17

Long-term debt
 
(147
)
 
(53
)
 
(200
)
Total interest expense
 
(123
)
 
318

 
195

Net interest income
 
$
2,882

 
(2,246
)
 
636


Net interest income on a fully tax-equivalent basis for the nine months ended September 30, 2016 totaled $31,136,000, an increase of $636,000 over the comparable period in 2015.  Total interest income increased $831,000, partially offset by an increase in total interest expense of $195,000.

The increase in total interest income was due primarily to a $93.2 million increase in average total earning assets, partially offset by a 22 basis point decrease in the average rate earned on earning assets.  Included in the average rate for 2015 was non-accrual interest recognized as a result of the impaired loan sale. The increase in average total earning assets was due to a $53.2 million increase in average loans and to a $40.4 million increase in average total investment securities. The increase in average loans was partially due to the acquisition of BNB and partially due to organic loan growth.

The increase in total interest expense was primarily due to an 18 basis point increase in the average rate paid on IRA and time certificates, partially offset by a combination of a 147 basis point decrease in the average rate paid on long-term debt and a $5.4 million decrease in average long-term debt. Average long-term debt and the rate associated with that debt decreased due to the payment in full during January 2016 of a $5.0 million advance from the FHLB of Cincinnati that had an interest rate of 5.25%.











45

Table of Contents

LCNB CORP. AND SUBSIDIARIES

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




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, 2016 were $372,000 and $858,000, respectively, as compared to $240,000 and $986,000 for the same periods in 2015. Net recoveries for the three months ended September 30, 2016 was $53,000 and net charge-offs for the nine months ended September 30, 2016 was $189,000. This compares to net charge-offs of $161,000 and $1,149,000 for the three and nine months ended September 30, 2015, respectively. Net charge-offs and the provision for loan losses had elevated balances during the nine-month period in 2015 due to the sale of impaired loans during the second quarter of that year.

Non-Interest Income

Three Months Ended September 30, 2016 vs. 2015
Total non-interest income for the third quarter of 2016 was $460,000 greater than for the third quarter of 2015 primarily due to $307,000 in net gains from sales of securities (no securities were sold during the third quarter of 2015) and to a $117,000 increase in trust income reflecting an increase in the volume of brokerage sales during the third quarter of 2016.

Nine Months Ended September 30, 2016 vs. 2015
Total non-interest income for the first nine months of 2016 was $715,000 greater than for the first nine months of 2015 primarily due to a $625,000 increase in net gains from sales of securities, partially offset by a $113,000 decrease in gains from sales of loans. Net gains from sales of securities increased due to a greater volume of sales during 2016. The decrease in gains from sales of loans reflects the absence during 2016 of net gains totaling $181,000 recognized on impaired loans sold during the second quarter of 2015.

Non-Interest Expense

Three Months Ended September 30, 2016 vs. 2015
Non-interest expense for the third quarter of 2016 was $505,000 greater than for the third quarter of 2015 primarily due to a $302,000 increase in salaries and employee benefits and a $237,000 increase in other non-interest expense. Salaries and employee benefits increased primarily due to salary and wage increases and an increase in the number of employees. The increase in other non-interest expense includes a $98,000 increase in fraudulent check and checkcard losses, and a $110,000 increase in fees paid for contracted services.

Nine Months Ended September 30, 2016 vs. 2015
Non-interest expense for the first nine months of 2016 was $1,190,000 greater than for the first nine months of 2015 primarily due to a $726,000 increase in salaries and employee benefits, a $364,000 increase in other real estate owned expense, and a $759,000 increase in other non-interest expense. Salaries and employee benefits increased primarily due to salary and wage increases, employees retained from the BNB acquisition, and an increase in the number of employees outside of the acquisition. The increase in other real estate owned expense was primarily due to writedowns during 2016 totaling $576,000 on a commercial other real estate owned property. The increase in other non-interest expense included a $251,000 penalty incurred on the early payoff during the first quarter of 2016 of the FHLB advance mentioned earlier, a $161,000 increase in fraudulent check and checkcard losses, and a $122,000 increase in fees paid for contracted services.

Income Taxes
LCNB's effective tax rates for the nine months ended September 30, 2016 and 2015 were 26.0% and 27.2%, 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.

Financial Condition
Interest-bearing demand deposits, a component of total cash and cash equivalents in the asset section of the balance sheet, was $15.3 million greater at September 30, 2016 than at December 31, 2015 because of a $38.3 million increase in public fund deposits. Public fund deposits can be relatively volatile due to seasonal tax collections and the financial needs of the local entities. Historically, public fund deposits tend to be at their lowest balances at year-ends. Not including public fund deposits, the remaining increase was predominately in short-term noninterest-bearing deposits and savings deposits products.
Available-for-sale investment securities at September 30, 2016 were $31.6 million less than at December 31, 2015 and held-to-maturity investment securities were $19.4 million greater at September 30, 2016 than at December 31, 2015. Investment securities in the held-to-maturity category increased due to municipal securities purchased from various governmental entities within LCNB's marketing area. Investment securities in the available-for-sale category decreased because a portion of the cash received from sales, maturities, and calls was used to fund loan growth and the purchase of the local held-to-maturity municipal securities.

Net loans at September 30, 2016 were $40.1 million greater than at December 31, 2015. Commercial real estate loans increased by $47.9 million and agricultural loans increased by $2.4 million, partially offset by a $4.6 million decrease in residential real estate loans and a $5.2 million decrease in commercial and industrial loans.

Net premises and equipment at September 30, 2016 was $4.2 million greater than at December 31, 2015 primarily due to land and construction costs paid during the first nine months of 2016 for the new Operations Center.

Bank owned life insurance at September 30, 2016 was $4.6 million greater than at December 31, 2015 primarily due to the purchase of $4.0 million of new policies during the first quarter of 2016.

Total deposits at September 30, 2016 were $71.8 million greater than at December 31, 2015. Included in this increase was a $38.3 million increase in public fund deposits by local government entities.

The increase in public fund deposits contributed to the $15.3 million increase in interest-bearing demand deposits, a component of total cash and cash equivalents in the asset section of the balance sheet, between December 31, 2015 and September 30, 2016 and the $20.4 million decrease in short-term borrowings between the same two dates.

Long-term debt at September 30, 2016 was $5.3 million less than at December 31, 2015 primarily due to the early payment in full of a $5.0 million advance from the FHLB during January 2016. The advance had an interest rate of 5.25% and its payment will reduce future interest expense.

Shareholders' equity at September 30, 2016 was $6.8 million greater than at December 31, 2015, primarily due to earnings retained and an increase in accumulated other comprehensive income, net of taxes, resulting from market driven increases in the market value of investments securities. Partially offsetting these increases was a $1.3 million decrease in common shares primarily resulting from the repurchase and cancellation of all outstanding warrants.

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). Common Equity Tier 1 Capital is the sum of common stock, related surplus, and retained earnings net of treasury stock, accumulated other comprehensive income, and other adjustments. These three 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.
For various regulatory purposes, financial institutions are classified into categories based upon capital adequacy:
 
 
Minimum Requirement
 
To Be Considered
Well-Capitalized
Ratio of Common Equity Tier 1 Capital to risk-weighted assets
 
4.5
%
 
6.5
%
Ratio of Tier 1 Capital to risk-weighted assets
 
6.0
%
 
8.0
%
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)
 
4.0
%
 
5.0
%
 




46

Table of Contents

LCNB CORP. AND SUBSIDIARIES

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




A new rule requiring a Capital Conservation Buffer began phase-in on January 1, 2016. Under the fully-implemented rule, a financial institution will need to maintain a Capital Conservation Buffer composed of Common Equity Tier 1 Capital of at least 2.5% above its minimum risk-weighted capital requirements to avoid limitations on its ability to make capital distributions, including dividend payments to shareholders and certain discretionary bonus payments to executive officers. A financial institution with a buffer below 2.5% will be subject to increasingly stringent limitations on capital distributions as the buffer approaches zero.

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, 2016
 
December 31,
2015
Regulatory Capital:
 
 
Shareholders' equity
 
$
146,906

 
140,108

Goodwill and other intangibles
 
(32,790
)
 
(32,146
)
Accumulated other comprehensive (income) loss
 
(3,522
)
 
(256
)
Tier 1 risk-based capital
 
110,594

 
107,706

Eligible allowance for loan losses
 
3,798

 
3,129

Total risk-based capital
 
$
114,392

 
110,835

Capital ratios:
 
 

 
 

Common Equity Tier 1 Capital to risk-weighted assets
 
12.92
%
 
13.46
%
Tier 1 Capital to risk-weighted assets
 
12.92
%
 
13.46
%
Total Capital to risk-weighted assets
 
13.36
%
 
13.85
%
Leverage
 
8.61
%
 
8.62
%

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, 2016, LCNB's liquid assets amounted to $379.6 million or 28.5% of total assets.  This compares to liquid assets totaling $393.0 million, or 30.7% of total assets, at December 31, 2015.

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, 2016 were "core" deposits, compared to 84.3% of deposits at December 31, 2015. 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.





47

Table of Contents

LCNB CORP. AND SUBSIDIARIES

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




Secondary sources of liquidity include LCNB's ability to sell loan participations, borrow funds from the FHLB, 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.


48

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, 2016 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
 
$
44,287

 
3,257

 
7.94
%
Up 200
 
43,134

 
2,104

 
5.13
%
Up 100
 
42,039

 
1,009

 
2.46
%
Base
 
41,030

 

 
%

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, 2016 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
 
$
145,353

 
(3,864
)
 
(2.59
)%
Up 200
 
146,149

 
(3,068
)
 
(2.06
)%
Up 100
 
146,831

 
(2,386
)
 
(1.60
)%
Base
 
149,217

 

 
 %

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.


49

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, 2016, 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.

50

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
 

51

Table of Contents



LCNB CORP. AND SUBSIDIARIES
Item 6.
Exhibits

Exhibit No.
Exhibit Description
2.1
Agreement and Plan of Merger dated as of December 29, 2014 by and between LCNB Corp. and BNB Bancorp, Inc. - incorporated by reference to the Registrant's Current Report on Form 8-K filed on January 2, 2015, 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
LCNB Corp. 2015 Ownership Incentive Plan - incorporated by reference to Registrant's Form DEF 14A Proxy Statement pursuant to Section 14(a), dated March 13, 2015, Exhibit A (001-35292)
 
 
10.3
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.
 
 
10.4
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.
 
 
10.5
Form of Restricted Share Grant Agreement under the LCNB Corp. 2015 Ownership Incentive Plan - incorporated by reference to the Registrant's Form 10-K for the fiscal year ended December 31, 2015, Exhibit 10.7
 
 
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, 2016 is formatted in Extensible Business Reporting Language:  (i) the Consolidated Condensed Balance Sheets, (ii) the Consolidated Condensed Statements of Income, (iii) the Consolidated Condensed Statements of Comprehensive Income, (iv) the Consolidated Condensed Statements of Shareholders' Equity, (v) the Consolidated Condensed Statements of Cash Flows, and (vi) the Notes to Consolidated Condensed Financial Statements.

52

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 8, 2016
/s/ Steve P. Foster
 
 
Steve P. Foster
 
 
Chief Executive Officer and President
 
 
 
 
November 8, 2016
/s/ Robert C. Haines, II
 
 
Robert C. Haines, II
 
 
Executive Vice President and Chief Financial Officer

53