Converted by EDGARwiz

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.   20549


FORM 10-Q


(Mark One)


(  X  )

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934


For the quarterly period ended September 30, 2009


(      )

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934


For the transition period from ______________  to  ______________


Commission File Number  000-26121


LCNB Corp.

(Exact name of registrant as specified in its charter)


Ohio

 31-1626393

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification Number)


2 North Broadway, Lebanon, Ohio   45036

(Address of principal executive offices, including Zip Code)


(513) 932-1414

(Registrant's telephone number, including area code)


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

                                                 [X] Yes         [  ] No


Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

                                                 [  ] Yes         [  ] No


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

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


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

                                                 [  ] Yes         [X] No


The number of shares outstanding of the issuer's common stock, without par value, as of November 5, 2009 was 6,687,232 shares.









LCNB CORP. AND SUBSIDIARIES


INDEX


PART I – FINANCIAL INFORMATION

2


Item 1.  Financial Statements

2


CONSOLIDATED BALANCE SHEETS

2


CONSOLIDATED STATEMENTS OF INCOME

3


CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

4


CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

5


CONSOLIDATED STATEMENTS OF CASH FLOWS

6


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

27


Item 2. Management's Discussion and Analysis of Financial Condition and Results of  Operations  28


Item 3.  Quantitative and Qualitative Disclosures about Market Risks

39


Item 4.  Controls and Procedures

40


PART II.  OTHER INFORMATION

41


Item 1.     Legal Proceedings

41


Item 1A.  Risk Factors

41


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

41


Item 3.     Defaults Upon Senior Securities

41


Item 4.     Submission of Matters to a Vote of Security Holders

41


Item 5.     Other Information

41


Item 6.     Exhibits

42


SIGNATURES

44




1






PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements


 

LCNB CORP. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

(Dollars in thousands)

        
     

September 30,

 

December 31,

     

2009

 

2008

     

(Unaudited)

  

ASSETS:

    
 

Cash and due from banks

$

22,161

 

11,278

 

Federal funds sold and interest-bearing demand deposits

 

8,811

 

6,742

  

Total cash and cash equivalents

 

30,972

 

18,020

        
 

Investment securities:

    
 

  

Available-for-sale, at fair value

 

201,614

 

136,244

 

  

Held-to-maturity, at cost

 

12,156

 

-

 

Federal Reserve Bank and Federal Home Loan Bank stock, at cost

 

3,031

 

 3,028

 

Loans, net

 

457,199

 

451,343

 

Premises and equipment, net

 

15,976

 

15,582

 

Goodwill

 

5,915

 

5,915

 

Other intangible assets, net

 

919

 

  807

 

Bank owned life insurance

 

13,964

 

            13,485

 

Other assets

 

8,060

 

           5,307

   

TOTAL ASSETS

$

749,806

 

          649,731

        

LIABILITIES:

    
 

Deposits –

    
  

Noninterest-bearing

$

81,815

 

82,645

  

Interest-bearing

 

557,266

 

494,977

   

Total deposits

 

639,081

 

          577,622

 

Short-term borrowings

 

317

 

           2,206

 

Long-term debt

 

25,309

 

               5,000

 

Accrued interest and other liabilities

 

5,934

 

6,787

   

TOTAL LIABILITIES

 

670,641

 

          591,615

        

SHAREHOLDERS’ EQUITY:

    
 

Preferred shares – no par value, authorized 1,000,000 shares,

    
  

13,400 shares issued at September 30, 2009

 

12,929

 

-

 

Common shares – no par value, authorized 8,000,000 shares, issued

    
  

7,445,514 shares at September 30, 2009 and December 31, 2008

 

11,068

 

11,068

 

Surplus

 

15,398

 

14,792

 

Retained earnings

 

48,306

 

            46,584

 

Treasury shares at cost, 758,282 shares at September 30, 2009 and

    
  

December 31, 2008

 

(11,737)

 

(11,737)

 

Accumulated other comprehensive income (loss), net of taxes

 

3,201

 

 (2,591)

   

TOTAL SHAREHOLDERS’ EQUITY

 

79,165

 

            58,116

        
   

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

$

749,806

 

          649,731

        

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




2








LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share data)

(Unaudited)

        
    

Three Months Ended

 

Nine Months Ended

    

September 30,

 

September 30,

     

2009

 

2008

 

2009

 

2008

INTEREST INCOME:

        
 

Interest and fees on loans

$

6,884

 

7,115

 

20,580

 

21,850

 

Dividends on Federal Reserve Bank

        
  

and Federal Home Loan Bank stock

 

26

 

28

 

101

 

106

 

Interest on investment securities –

        
  

Taxable

 

1,050

 

784

 

3,183

 

1,806

  

Non-taxable

 

795

 

530

 

2,129

 

    1,459

 

Other short-term investments

 

13

 

151

 

41

 

466

   

TOTAL INTEREST INCOME

 

8,768

 

8,608

 

26,034

 

25,687

            

INTEREST EXPENSE:

        
 

Interest on deposits

 

2,278

 

3,220

 

7,269

 

9,996

 

Interest on short-term borrowings

 

-

 

4

 

-

 

 12

 

Interest on long-term debt

 

177

 

66

 

440

 

 197

   

TOTAL INTEREST EXPENSE

 

2,455

 

3,290

 

7,709

 

10,205

   

NET INTEREST INCOME

 

6,313

 

5,318

 

18,325

 

15,482

 

PROVISION FOR LOAN LOSSES

 

664

 

 188

 

970

 

322

            
   

NET INTEREST INCOME AFTER

        
   

  PROVISION FOR LOAN LOSSES

 

5,649

 

5,130

 

17,355

 

15,160

            

NON-INTEREST INCOME:

        
 

Trust income

 

451

 

443

 

1,365

 

1,421

 

Service charges and fees

 

1,018

 

1,169

 

2,956

 

3,193

 

Net gain on sales of securities

 

60

 

-

 

60

 

-

 

Insurance agency income

 

402

 

421

 

1,160

 

1,281

 

Bank owned life insurance income

 

162

 

135

 

478

 

397

 

Gains from sales of mortgage loans

 

46

 

2

 

377

 

9

 

Other operating income

 

37

 

33

 

121

 

129

   

TOTAL NON-INTEREST INCOME

 

2,176

 

2,203

 

6,517

 

6,430

            

NON-INTEREST EXPENSE:

        
 

Salaries and wages

 

2,378

 

2,259

 

7,102

 

6,704

 

Pension and other employee benefits

 

503

 

601

 

1,779

 

1,803

 

Equipment expenses

 

262

 

243

 

749

 

718

 

Occupancy expense, net

 

418

 

416

 

1,280

 

1,235

 

State franchise tax

 

152

 

158

 

470

 

489

 

Marketing

 

112

 

119

 

353

 

330

 

Intangible amortization

 

28

 

44

 

83

 

287

 

FDIC premiums

 

317

 

21

 

926

 

52

 

Write-off of pension asset

 

-

 

-

 

722

 

-

 

Other non-interest expense

 

1,024

 

1,067

 

3,414

 

3,357

   

TOTAL NON-INTEREST EXPENSE

 

5,194

 

4,928

 

16,878

 

14,975

   

INCOME BEFORE INCOME TAXES

 

2,631

 

2,405

 

6,994

 

6,615

PROVISION FOR INCOME TAXES

 

588

 

611

 

1,548

 

1,679

   

NET INCOME

 

2,043

 

1,794

 

5,446

 

4,936

PREFERRED STOCK DIVIDENDS AND

  DISCOUNT ACCRETION

 


206

 


-

 


514

 


-

   

NET INCOME AVAILABLE TO

COMMON SHAREHOLDERS

$


1,837

 


1,794

 


4,932

 


4,936

            

Dividends declared per common share

$

0.16

 

0.16

 

0.48 

 

0.48

            

Earnings per common share:

        
 

Basic

$

0.27

 

0.27

 

0.74

 

0.74

 

Diluted

 

0.27

 

0.27

 

0.74

 

0.74

          

Average common shares outstanding:

        
 

Basic

 

6,687,232

 

6,687,232

 

6,687,232

 

6,687,232

 

Diluted

 

6,707,746

 

6,687,232

 

6,693,032

 

6,687,232

          

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

  




3








LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

             
     

Three Months Ended

 

Nine Months Ended

     

September 30,

 

September 30,

      

2009

 

2008

 

2009

 

2008

         

Net Income

$

2,043

 

1,794

 

5,446

 

4,936

         

Other comprehensive income (loss):

        
         
 

Net unrealized gain on available-for-sale securities (net of taxes of $1,194 and $340 for the three months ended September 30, 2009 and 2008, respectively, and $1,440 and $127 for the nine months ended September 30, 2009 and 2008, respectively)

 

2,310

 

661

 

2,795

 

246

           
 

Reclassification adjustment for  net realized gain on sale of available-for-sale securities included in net income (net of taxes of $20)

 



(40)

   



(40)

  
           
 

Reversal of pension plan unrecognized net loss

 (net of taxes of $1,564)

 

-

 

-

 

3,037

 

-

          
 

Recognition of pension plan net actuarial loss (net of taxes of $10 and $31 for the three and nine months ended September 30, 2008, respectively)

 



-

 



        20

 



-

 



        60

          
  

TOTAL COMPREHENSIVE INCOME

$

4,313

 

2,475

 

11,238

 

 5,242

 

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




4








   

LCNB CORP. AND SUBSIDIARIES

   

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

   

(Dollars in thousands, except per share amounts)

   

(Unaudited)

                
                
            

Accumulated

 
 

Common

          

Other

Total

 

Shares

 

Preferred

 

Common

   

Retained

 

Treasury

Comprehensive

Shareholders’

 

Outstanding

 

Stock

 

Stock

 

Surplus

 

Earnings

 

Shares

Income (Loss)

Equity

Balance January 1, 2009

6,687,232

$

  

11,068

 

14,792

 

46,584 

 

(11,737)

 

 (2,591)

 

58,116 

Net income

        

5,446

     

5,446

Issuance of preferred stock and related warrants

  

12,817

   

583

       

13,400

Net unrealized gain on available-for-sale

  securities, net of tax

            

2,755

 

2,755

Reversal of pension plan unrecognized net

  loss, net of tax

            

3,037

 

3,037

Compensation expense relating to stock options

      

23

       

23

Preferred stock dividends and discount

  accretion

  

112

     

(514)

     

(402)

Common stock dividends, $0.48 per share

        

(3,210)

     

(3,210)

Balance September 30, 2009

6,687,232

$

12,929

 

11,068

 

15,398

 

48,306

 

(11,737)

 

3,201

 

79,165

                

Balance January 1, 2008

6,687,232

$

-

 

11,068

 

14,761

 

44,261 

 

(11,737)

 

  (1,825)

 

56,528

Net income

        

4,936 

     

4,936

Net unrealized gain (loss) on available-for-sale

  securities, net of tax

            


246

 


246

Change in pension plan unrecognized net loss,

  net of tax

            


60

 


60

Compensation expense relating to stock options

      

23

       

23

Common stock dividends, $0.48 per share

        

(3,210)

     

(3,210)

Balance September 30, 2008

6,687,232

$

-

 

11,068

 

14,784

 

45,987 

 

(11,737)

 

(1,519)

 

58,583 

                
   

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




5








LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)

         
       

Nine Months Ended

       

September 30,

       

2009

 

2008

CASH FLOWS FROM OPERATING ACTIVITIES:

    
 

Net income

$

5,446

 

4,936

 

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

    
   

Depreciation, amortization, and accretion

 

1,734

 

      1,593

   

Provision for loan losses

 

970

 

           322

   

Federal Home Loan Bank stock dividends

 

-

 

(82)

   

Increase in cash surrender value of bank owned life insurance

 

(478)

 

    (397)

   

Realized loss (gain) on sales of securities available for sale

 

(60)

 

-

   

Realized loss (gain) on sale of premises and equipment

 

(17)

 

(3)

   

Origination of mortgage loans for sale

 

(26,033)

 

 (814)

   

Realized gains from sales of mortgage loans

 

(377)

 

 (9)

   

Proceeds from sales of mortgage loans

 

26,151

 

    814

   

Compensation expense related to stock options

 

23

 

            23

   

Increase (decrease) due to changes in assets and liabilities:

    
   

     Income receivable

 

(945)

 

          (730)

   

     Other assets

 

(1,139)

 

    (178)

   

     Other liabilities

 

2,414

 

        148

     

NET CASH FLOWS FROM OPERATING ACTIVITIES

 

7,689

 

      5,623

          

CASH FLOWS FROM INVESTING ACTIVITIES:

    
 

Proceeds from sales of securities available for sale

 

210

 

-

 

Proceeds from maturities and calls of investment securities

 

46,656

 

    24,780

 

Purchases of investment securities

 

(120,659)

 

(73,742)

 

Purchase of Federal Reserve Bank stock

 

(3)

 

(215)

 

Net (increase) decrease in loans

 

(9,435)

 

(3,886)

 

Proceeds from sale of other real estate owned

 

-

 

           877

 

Additions to other real estate owned

 

-

 

          (37)

 

Proceeds from sale of repossessed assets

 

72

 

-

 

Purchases of premises and equipment

 

(1,263)

 

(1,228)

 

Proceeds from sales of premises and equipment

 

18

 

              3

     

NET CASH FLOWS FROM INVESTING ACTIVITIES

 

(84,404)

 

(53,448)

          

CASH FLOWS FROM FINANCING ACTIVITIES:

    
 

Net increase (decrease) in deposits

 

61,459

 

     60,258

 

Net increase (decrease) in short-term borrowings

 

(1,889)

 

   186

 

Proceeds from long-term debt

 

21,000

 

        -

 

Principal payments on long-term debt

 

(691)

 

-

 

Proceeds from issuance of preferred stock

 

13,400

 

-

 

Cash dividends paid on common stock

 

(3,210)

 

(3,210)

 

Cash dividends paid on preferred stock

 

(402)

 

-

     

NET CASH FLOWS FROM FINANCING ACTIVITIES

 

89,667

 

57,234

          
     

NET CHANGE IN CASH AND CASH EQUIVALENTS

 

12,952

 

  9,409

       

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

 

18,020

 

  31,190

       

CASH AND CASH EQUIVALENTS AT END OF PERIOD

$

30,972

 

   40,599

          

SUPPLEMENTAL CASH FLOW INFORMATION:

    

  CASH PAID DURING THE YEAR FOR:

    
 

Interest

$

7,813

 

      10,315

 

Income taxes

 

1,560

 

    1,750

      

  SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES:

    
 

Transfer from loans to other real estate owned and repossessed assets

 

2,392

 

-

      
          

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



6






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



Note 1 - Basis of Presentation

Substantially all of the assets, liabilities and operations of LCNB Corp. ("LCNB") are attributable to its wholly-owned subsidiaries, LCNB National Bank (the "Bank") and Dakin Insurance Agency, Inc. ("Dakin").  The accompanying unaudited consolidated financial statements include the accounts of LCNB, the Bank, and Dakin.


The unaudited interim consolidated financial statements, which have been reviewed by J.D. Cloud & Co. L.L.P., LCNB’s independent registered public accounting firm, in accordance with standards established by the Public Company Accounting Oversight Board, as indicated by their report included herein and which does not express an opinion on those statements, have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and the rules and regulations of the Securities and Exchange Commission (the “SEC”).  Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  In the opinion of management, the unaudited interim consolidated financial statements include all adjustments (consisting of normal, recurring accruals) considered necessary for a fair presentation of financial position, results of operations, and cash flows for the interim periods, as required by Regulation S-X, Rule 10-01.


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


The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.


Management has reviewed and evaluated transactions and events for subsequent event accounting and disclosure purposes through November 5, 2009, the date the financial statements were issued.


Results of operations for the three and nine months ended September 30, 2009 are not necessarily indicative of the results to be expected for the full year ending December 31, 2009.  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 2008 Form 10-K filed with the SEC.



7






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 2 - Investment Securities

The amortized cost and estimated fair value of available-for-sale investment securities at September 30, 2009 and December 31, 2008 are summarized as follows (in thousands):


 

September 30, 2009

 
  

Amortized

Cost

 

Unrealized

Gains

 

Unrealized

Losses

 

Fair

Value

 

U.S. Treasury notes

$

5,313

 

63

 

-

 

5,376

 

U.S. Agency notes

 

45,479

 

362

 

65

 

45,776

 

U.S. Agency mortgage-backed securities

 

51,936

 

1,308

 

73

 

53,171

 

Corporate securities

 

7,413

 

198

 

-

 

7,611

 

Municipal securities:

         

     Non-taxable

 

75,945

 

2,730

 

2

 

78,673

 

     Taxable

 

9,755

 

276

 

-

 

10,031

 

Trust preferred securities

 

348

 

48

 

-

 

396

 

Other debt securities

 

536

 

3

 

-

 

539

 

Marketable equity securities

 

39

 

2

 

-

 

41

 
 

$

196,764

 

4,990

 

140

 

201,614

 


 

December 31, 2008

  

Amortized

Cost

 

Unrealized

Gains

 

Unrealized

Losses

 

Fair

Value

 
          

U.S. Agency notes

$

44,264

 

372

 

-

 

44,636

 

U.S. Agency mortgage-backed securities

 

32,310

 

491

 

33

 

32,768

 

Corporate securities

 

1,010

 

4

 

1

 

1,013

 

Municipal securities:

         

     Non-taxable

 

53,821

 

430

 

627

 

53,624

 

     Taxable

 

3,605

 

46

 

4

 

3,647

 

Other debt securities

 

521

 

-

 

9

 

512

 

Marketable equity securities

 

37

 

7

 

-

 

44

 
 

$

135,568

 

1,350

 

674

 

136,244

 


The fair value of held-to-maturity investment securities, consisting of non-taxable and taxable municipal securities, approximates amortized cost at September 30, 2009.



8






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 2 - Investment Securities (continued)

Information concerning securities with gross unrealized losses at September 30, 2009, aggregated by length of time that individual securities have been in a continuous loss position, is as follows (in thousands):


  

Less than Twelve Months

 

Twelve Months or Greater

  

Fair

Value

 

Unrealized

Losses

 

Fair

Value

 

Unrealized

Losses

         

U.S. Agency notes

$

10,992

 

65

 

-

 

-

U.S. Agency mortgage-

   backed securities

 


9,985

 


72

 


42

 


1

Corporate securities

 

250

 

-

 

-

 

-

Municipal securities:

        

     Non-taxable

 

-

 

-

 

438

 

2

     Taxable

 

200

 

-

 

-

 

-

Marketable equity securities

 

41

 

-

 

-

 

-

 

$

21,468

 

137

 

480

 

3


The unrealized losses at September 30, 2009 are primarily due to increases in market interest rates. 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 maturity, LCNB does not consider these investments to be other-than-temporarily impaired at September 30, 2009.


Accumulated other comprehensive income at September 30, 2009 consisted solely of the net unrealized gain on available-for-sale investment securities.



9






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 3 - Loans

Major classifications of loans at September 30, 2009 and December 31, 2008 are as follows (in thousands):


   

September 30,

 

December 31,

    

2009

   

2008

 
         

Commercial and industrial

$

 

43,707

   

38,724

 

Commercial, secured by real estate

  

181,286

   

174,493

 

Residential real estate

  

193,695

   

194,039

 

Consumer

  

27,863

   

33,369

 

Agricultural

  

3,348

   

3,216

 

Other loans, including deposit overdrafts

  

9,477

   

9,203

 
    

459,376

   

453,044

 

Deferred net origination costs

  

622

   

767

 
    

459,998

   

453,811

 

Less allowance for loan losses

  

2,799

   

   2,468

 
 

Loans, net

$

 

457,199

   

451,343

 


Changes in the allowance for loan losses for the nine months ended September 30, 2009 and 2008 were as follows (in thousands):


   

Nine Months Ended

   

September 30,

   

2009

  

2008

Balance, beginning of period

$

2,468

  

2,468

Provision for loan losses

 

970

  

322

Charge-offs

 

(910)

  

(646)

Recoveries

 

271

  

324

 

Balance, end of period

$

2,799

  

2,468


Charge-offs for the nine months ended September 30, 2009 included charge-offs on three commercial real estate loans totaling $352,000.  The balance of charge-offs during this period consisted primarily of residential second mortgage loans, consumer loans, and checking and NOW account overdrafts.  Charge-offs for the nine months ended September 30, 2008 consisted primarily of consumer loans and checking and NOW account overdrafts.  



10






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 3 - Loans (continued)

Non-accrual, past-due, and restructured loans as of September 30, 2009 and December 31, 2008 were as follows (in thousands):


   

September 30,

 

December 31,

    

2009

   

2008

 

Non-accrual loans

$

 

1,445

   

2,281

 

Past-due 90 days or more and still accruing

  

336

   

   806

 

Restructured loans

  

2,468

   

332

 
 

Total

$

 

4,249

   

  3,419

 

Percent to total loans

  

0.92%

   

0.75%

 


Non-accrual loans at September 30, 2009 consisted of three commercial real estate loans totaling $789,000 and four residential real estate loans totaling $656,000.  Included in the commercial real estate non-accrual loans at September 30, 2009 were two loans totaling $647,000 that had been classified as past-due 90 days or more and still accruing interest at December 31, 2008, when their total balance outstanding was $670,000.  Non-accrual loans at December 31, 2008 included a commercial real estate loan with a balance of $2,149,000.  The borrower was unsuccessful in its efforts to sell the property and LCNB accepted a deed in lieu of foreclosure during the third quarter 2009.  The remaining balance of non-accrual loans at December 31, 2008 consisted primarily of residential real estate mortgage loans.  


Loans past-due 90 days or more and still accruing interest at September 30, 2009 were primarily composed of consumer and residential mortgage loans.  Loans past-due 90 days or more and still accruing interest at December 31, 2008 were primarily composed of the two commercial real estate loans mentioned previously and consumer and residential mortgage loans.


The increase in restructured loans is due to a commercial real estate loan which was restructured during the first quarter 2009.  Its balance at September 30, 2009 was $2,162,000.  Restructured loans at September 30, 2009 and December 31, 2008 also include a commercial real estate loan in the amount of $306,000 and $310,000, respectively.





11






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 3 - Loans (continued)

The following is a summary of information pertaining to loans considered to be impaired at September 30, 2009 and December 31, 2008 (in thousands):


  

September 30,

 

December 31,

   

2009

   

2008

 
         

Impaired loans without a valuation allowance

$

 

1,297

   

2,451

 

Impaired loans with a valuation allowance

  

5,330

   

3,121

 

Total impaired loans

  

6,627

   

5,572

 
         

Valuation allowance related to impaired loans

$

 

1,092

   

630

 


Other real estate owned (which includes property acquired through foreclosure or deed-in-lieu of foreclosure and also includes property deemed to be in-substance foreclosed) and other repossessed assets, which are included in “other assets” in the consolidated balance sheets, totaled approximately $2,424,000 at September 30, 2009, compared to $89,000 at December 31, 2008.  Other real estate owned increased due to the transfer of three commercial real estate properties into this category during the third quarter 2009.


Loans sold to and serviced for others are not included in the accompanying balance sheets.  The unpaid principal balances of those loans at September 30, 2009 and December 31, 2008 were $57,111,000 and $37,783,000, respectively.  Loans sold to the Federal Home Loan Mortgage Corporation during the three and nine months ended September 30, 2009 totaled $2,481,000 and $26,033,000, respectively, and $81,000 and $814,000 during the three and nine months ended September 30, 2008, respectively.  The increase in the amount of mortgage loans sold is primarily due to an increase in the number of refinanced loans because of the general decline in market interest rates for residential mortgage loans during the first nine months of 2009.




12






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 4 – Borrowings

Funds borrowed from the Federal Home Loan Bank of Cincinnati at September 30, 2009 and December 31, 2008 are as follows (thousands):


 

Current

   
 

Interest

September 30,

 

December 31,

 

Rate

 

2009

   

2008

 
         

Fixed Rate Advances, due at maturity:

        

  Advance due February 2011

2.10%

$

5,000

   

-

 

  Advance due July 2012

1.99%

 

6,000

   

-

 

  Advance due March 2017

5.25%

 

5,000

   

5,000

 
         

Fixed Rate Advances, with monthly

  principal and interest payments:

        

    Advance due March 2014

2.45%

 

4,527

   

-

 

    Advance due March 2019

2.82%

 

4,782

   

-

 
  

$

25,309

   

5,000

 


All advances from the Federal Home Loan Bank of Cincinnati are secured by a blanket pledge of LCNB’s 1-4 family first lien mortgage loans.


Short-term borrowings at September 30, 2009 and December 31, 2008 consisted of U.S. Treasury demand note borrowings of approximately $317,000 and $2,206,000, respectively.  The U.S. Treasury was not charging interest at September 30, 2009 or December 31, 2008.



Note 5 - 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 included 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.




13






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 5 - Commitments and Contingent Liabilities (continued)

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, 2009 and December 31, 2008 were as follows (in thousands):


   

September 30,

 

 December 31,

    

2009

   

2008

 
 

Commitments to extend credit:

        
 

  Commercial loans

$

 

4,461

   

4,376

 
 

  Other loans

        
 

     Fixed rate

  

519

   

1,033

 
 

     Adjustable rate

  

604

   

  302

 
 

Unused lines of credit:

        
 

     Fixed rate

  

5,267

   

2,807

 
 

     Adjustable rate

  

66,764

   

70,647

 
 

Unused overdraft protection amounts on

        
 

  demand and NOW accounts

  

10,253

   

 10,408

 
 

Standby letters of credit

  

7,257

   

8,138

 
  

$

 

95,125

   

97,711

 


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 in 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.  At September 30, 2009 and December 31, 2008, outstanding guarantees of $1.7 million and $1.8 million, respectively, were issued to developers and contractors.  These guarantees generally are fully secured and have varying maturities.  In addition, LCNB has a participation in a letter of credit securing payment of principal and interest on a bond issue.  The participation amount at September 30, 2009 and December 31, 2008 was approximately $5.5 million and $6.3 million, respectively.  The agreement has a final maturity date of January, 2012.


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; property, plant and equipment; residential realty; and income-producing commercial properties.




14






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 5 – Commitments and Contingent Liabilities (continued)

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


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



Note 6 – Regulatory Capital

On January 9, 2009, LCNB received $13.4 million of new equity capital from the U.S. Treasury Department’s Capital Purchase Program (CPP) established under the Emergency Economic Stabilization Act of 2008.  The investment by the U.S. Treasury Department is comprised of $13.4 million in preferred shares, with a warrant to purchase 217,063 common shares of LCNB at an exercise price of $9.26, with a term of ten years.  LCNB allocated $583,000 of the proceeds from the preferred stock issuance to the warrants.  The resulting discount in the preferred stock is being amortized over five years and is being reported as an adjustment to preferred stock dividends.  


The preferred shares pay a dividend of 5% per year for the first five years and will pay 9% thereafter. LCNB may repay the U.S. Treasury Department amounts previously received at any time without penalty, subject to consultation with the Office of the Comptroller of the Currency, LCNB’s primary regulator.  The minimum redemption amount is 25% of the issue price, or $3,350,000 for LCNB.  LCNB may repurchase the warrant at fair market value, as defined in the Securities Purchase Agreement, if it redeems the preferred stock in full.  If the warrant is not repurchased at the time the preferred stock is redeemed, the U.S. Treasury Department will attempt to sell the warrant in the secondary market.


Participation in the CPP is voluntary and requires participating institutions to comply with a number of restrictions and provisions, including, but not limited to, restrictions on compensation of certain executive officers and limitations on stock repurchase activities and dividend payments.  Generally, LCNB will be unable to increase dividends to common shareholders or repurchase common shares without U.S. Treasury Department permission for a period of three years from the date of participation unless the preferred securities are no longer held by the U.S. Treasury Department.  Additionally, no dividends may be paid on common stock unless and until all accrued and unpaid dividends for all past dividend periods owed to the U.S. Treasury Department on the preferred shares are fully paid.  For more information regarding the terms of agreement between LCNB and the U.S. Treasury Department under the CPP and the securities issued by LCNB to the Treasury thereunder, please see the Current Report on Form 8-K filed by LCNB with the SEC on January 9, 2009, which is hereby, along with exhibits thereto, incorporated by reference.


On October 21, 2009, LCNB redeemed all 13,400 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A.  See “Notes to Consolidated Financial Statements, Note 11 - Subsequent Event” of this report for additional information pertaining to the redemption of the preferred shares.



15






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 6 – Regulatory Capital (continued)

The Bank and LCNB are required by regulators to meet certain minimum levels of capital adequacy. These are expressed in the form of certain ratios. Capital is separated into Tier 1 capital (essentially shareholders' equity less goodwill and other intangibles) and Tier 2 capital (essentially the allowance for loan losses limited to 1.25% of risk-weighted assets). The first two ratios, which are based on the degree of credit risk in LCNB's assets, provide for weighing assets based on assigned risk factors and include off-balance sheet items such as stand-by letters of credit. The ratio of Tier 1 capital to risk-weighted assets must be at least 4.0% and the ratio of Total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8.0%.  The capital leverage ratio supplements the risk-based capital guidelines. Banks are required to maintain a minimum ratio of Tier 1 capital to adjusted quarterly average total assets of 3.0%.


For various regulatory purposes, financial institutions are classified into categories based upon capital adequacy.  The highest "well-capitalized" category requires capital ratios of at least 10% for total risk-based, 6% for Tier 1 risk-based, and 5% for leverage.  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):


    

At

 

At

    

September 30,

 

December 31,

     

2009

   

2008

 
           

Regulatory Capital:

        
 

Shareholders' equity

$

 

79,165 

   

58,116 

 
 

Goodwill and other intangibles

  

(6,534)

   

(6,600)

 
 

Accumulated other comprehensive (income) loss

  

(3,201)

   

  2,591 

 
  

Tier 1 risk-based capital

  

69,430 

   

54,107 

 
           

Eligible allowance for loan losses

  

2,799 

   

2,468 

 
  

Total risk-based capital

$

 

72,229 

   

56,575 

 
           

Capital ratios:

        
 

Total risk-based (required 8.00%)

  

15.08%

   

12.61%

 
 

Tier 1 risk-based (required 4.00%)

  

14.50%

   

12.06%

 
 

Leverage (required 3.00%)

  

9.48%

   

8.19%

 



16






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 7 – Employee Benefits

Effective January 1, 2009, LCNB redesigned its qualified noncontributory defined benefit retirement plan and merged its single-employer plan into a multiple-employer plan, which is accounted for as a multi-employer plan because assets contributed by an employer are not segregated in a separate account or restricted to provide benefits only to employees of that employer.  Accordingly, the assets and obligations of the single-employer plan were transferred to the multiple-employer plan in January 2009.  At that time, the pension plan related balance sheet accounts were adjusted resulting in an approximate $3.0 million increase in other comprehensive income, which is included in shareholders’ equity, and a $722,000 charge to non-interest expense in the consolidated statements of income.  Employees hired on or after January 1, 2009 are not eligible to participate in this plan.  


Effective February 1, 2009, LCNB amended the plan to reduce benefits for those whose age plus vesting service equaled less than 65 at that date.  Also effective February 1, 2009, an enhanced 401-K plan was made available to those hired on or after January 1, 2009 and to those who received benefit reductions from the amendments to the noncontributory defined benefit retirement plan.  Employees hired on or after January 1, 2009 will receive a 50% employer match on their contributions into the 401-K plan, up to a maximum LCNB contribution of 3% of each individual employee’s annual compensation.  Employees who received a benefit reduction under the retirement plan amendments will receive an automatic contribution of 5% or 7% of annual compensation, depending on the sum of an employee’s age and vesting service, into the 401-K plan, regardless of the contributions made by the employees.  This contribution will be made annually and these employees will not receive any employer matches to their 401-K contributions.


Funding and administrative costs of the qualified noncontributory defined benefit retirement plan charged to pension and other employee benefits in the consolidated statements of income for the three and nine months ended September 30, 2009 were $10,000 and $82,000, respectively.  Employer expense incurred in connection with the 401-K plan during the three and nine months ended September 30, 2009 was $58,000 and $170,000 respectively.  


The components of net periodic pension cost of the qualified noncontributory defined benefit retirement plan for the three and nine months ended September 30, 2008 are summarized as follows (in thousands):


 

For the Three Months

 

For the Nine Months

 

Ended September 30,

2008

 

Ended September 30,

2008

        

Service cost

$

186 

   

559 

 

Interest cost

 

140 

   

420 

 

Expected return on plan assets

 

(132)

   

  (396)

 

Amortization of net loss

 

30 

   

91 

 

     Net periodic pension cost

 

224 

   

674 

 




17






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 7 – Employee Benefits (continued)

Effective February 1, 2009, LCNB established a nonqualified defined benefit retirement plan for certain highly compensated employees.  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, 2009 are summarized as follows (in thousands):


 

For the Three Months

 

For the Nine Months

 

Ended September 30,

2009

 

Ended September 30,

2009

        

Service cost

$

41

   

108

 

Interest cost

 

7

   

19

 

Prior service cost

 

12

   

32

 

     Net periodic pension cost

 

60

   

159

 



Note 8 - Stock Options

Under the Ownership Incentive Plan (the "Plan"), LCNB may grant stock-based awards to eligible employees.  The awards may be in the form of stock options, share awards, and/or appreciation rights. The Plan provides for the issuance of up to 200,000 common shares.  As of September 30, 2009, only stock options have been granted under the Plan.  Options granted to date vest ratably over a five year period and expire ten years after the date of grant.  Stock options outstanding at September 30, 2009 were as follows:


 

Outstanding

 

Exercisable

 

Expiration

Date

Number

Weighted Average Exercise Price

 

Number

Weighted Average Exercise Price

Number Exercised

            

Feb 2013

11,056

$

13.09

  

11,056

$

13.09

 

-

 

Jan 2014

8,108

 

17.66

  

8,108

 

17.66

 

-

 

Jan 2016

7,934

 

18.95

  

4,760

 

18.95

 

-

 

Feb 2017

8,116

 

17.88

  

3,246

 

17.88

 

-

 

Feb 2018

13,918

 

12.55

  

2,784

 

12.55

 

-

 

Jan 2019

29,110

 

9.00

  

-

 

-

 

-

 
 

78,242

$

13.04

  

29,954

$

15.73

 

-

 





18






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 8 - Stock Options (continued)

The following table summarizes stock option activity for the periods indicated:


  

Nine Months ended September 30,

 
  

2009

 

2008

 
  

Options

 

Weighted Average Exercise Price

 

Options

 

Weighted Average Exercise Price

 
          

Outstanding, January 1,

 

49,132

 

$ 15.43

 

35,214

 

$ 16.57

 

Granted

 

29,110

 

9.00

 

13,918

 

12.55

 

Exercised

 

-

 

-

 

-

 

-

 

Outstanding, September 30,

 

78,242

 

$ 13.04

 

49,132

 

$ 15.43

 

Exercisable,  September 30,

 

29,954

 

$ 15.73

 

22,339

 

$ 15.60

 


At September 30, 2009, 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 that date and that were “in the money” (market price greater than exercise price) was approximately $58,000.  There was no aggregate intrinsic value at that date for only the options that were exercisable.  The intrinsic value changes based on changes in the market price of the Company’s stock.


The estimated weighted-average fair value of the options granted in the first quarter of 2009 and 2008 was $1.89 and $2.27 per option, respectively.  The fair value was estimated at the dates of grant using the Black-Scholes option-pricing model and the following assumptions:


 

2009

2008

 

Risk-free interest rate

3.49%

3.56%

 

Average dividend yield

4.04%

3.77%

 

Volatility factor of the expected market

   

  price of LCNB’s common stock

27.54%

22.72%

 

Average life in years

9.0

8.2

 



Total expense related to options included in salaries and wages in the consolidated statements of income for the three and nine months ended September 30, 2009 were $9,000 and $24,000, respectively and $8,000 and $23,000 for the three and nine months ended September 30, 2008, respectively.  





19






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 9 - 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 and warrants.  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 were as follows (dollars in thousands, except share and per share data):


  

For the Three Months

 

For the Nine Months

  

Ended September 30,

 

Ended September 30,

  

2009

 

2008

 

2009

 

2008

         

Net income available to common shareholders


$


1,837

 


1,794

 


4,932

 


4,936

         

Weighted average number of shares outstanding used in the calculation of basic earnings per common share

 



6,687,232

 



6,687,232

 



6,687,232

 



6,687,232

         

Add dilutive effect of warrants

 

20,514

 

 -

 

5,800

 

-

         

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

 



6,707,746

 



6,687,232

 



6,693,032

 



6,687,232

         

Basic earnings per common share

$

0.27

 

0.27

 

0.74

 

0.74

         

Diluted earnings per common share

$

0.27

 

0.27

 

0.74

 

0.74



Note 10 - Fair Value of Financial Instruments

The inputs to valuation techniques used to measure fair value are assigned to one of three broad input 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; and


·

Level 3 - inputs that are unobservable for the asset or liability.


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.   



20






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 10 - Fair Value Measurements (continued)

The majority of LCNB’s 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 and corporate securities 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, approximately $539,000 is invested in a mutual fund.  LCNB uses the fair value estimate provided by the mutual fund company, which uses market quotations when such quotes are available and good faith judgment when market quotations are not available.  Because LCNB does not know the portion of the mutual fund valued using market quotations and the portion valued using good faith judgment, the entire investment in the mutual fund has been classified as a level 3 input.  Additionally, Dakin owns stock in an insurance company and LCNB Corp. owns trust preferred securities in various financial institutions. Market quotations (level 1) are used to determine fair value for these investments.  


The following table summarizes the valuation of LCNB’s financial assets and liabilities measured on a recurring basis by the input levels defined by the fair value hierarchy as of September 30, 2009 and December 31, 2008 (000’s):


  

Fair Value Measurements at

Reporting Date 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, 2009

             

Available-for-sale  

  securities



$


201,614

  


13,424

  


187,651

  


539

 
              

December 31, 2008

             

Available-for-sale

  securities

 


$


136,244

  


1,057

  


132,731

  


2,456

 






21






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 10 - Fair Value Measurements (continued)

The following table is a reconciliation of the beginning and ending balances of recurring fair value measurements that use significant unobservable inputs (level 3) for the three and nine months ended September 30, 2009 and 2008 (000’s):


  

For the Three Months

 

For the Nine Months

  

Ended September 30,

 

Ended September 30,

  

2009

 

2008

 

2009

 

2008

         

Beginning balance

$

526

 

2,087

 

2,456

 

1,592

Purchases

 

-

 

-

 

-

 

500

Tax-exempt municipal securities reclassified

  as held-to-maturity

 


-

 


-

 


(1,944)

 


-

Dividends reinvested

 

5

 

5

 

15

 

16

Net change in unrealized gains (losses)

  included in other comprehensive income

 


8

 


1

 


12

 


(15)

Ending balance

$

539

 

2,093

 

539

 

2,093


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.  When the fair value of the collateral is based on an observable market price or current appraised value, the inputs are considered to be level 2.  When an appraised value is not available and there is not an observable market price, 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.  The inputs for a valuation based on current appraised value are considered to be level 2.




22






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 10 - Fair Value Measurements (continued)

The following table summarizes the valuation of LCNB’s assets measured on a nonrecurring basis by the input levels defined by the fair value hierarchy as of September 30, 2009 and December 31, 2008 (000’s):


  

Fair Value Measurements at

Reporting Date 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, 2009

             

Impaired loans

 

$

5,535

  

-

  

-

  

5,535

 

Other real estate owned

  

2,424

  

-

  

2,424

  

-

 

Totals

 

$

7,959

     

2,424

  

5,535

 
              

December 31, 2008

             

Impaired loans

 

$

2,491

  

-

  

-

  

2,491

 

Other real estate owned

  

39

  

-

  

39

  

-

 

Repossessed assets

  

50

  

-

  

50

  

-

 

Totals

 

$

2,580

  

-

  

89

  

2,491

 


Carrying amounts and estimated fair values of financial instruments as of September 30, 2009 and December 31, 2008 were as follows (000’s):


  

September 30, 2009

 

December 31, 2008

  

Carrying

 

Fair

 

Carrying

 

Fair

  

Amount

 

Value

 

Amount

 

Value

         

FINANCIAL ASSETS:

        

  Cash and cash equivalents

$

30,972

 

30,972

 

18,020

 

18,020

  Securities available for sale

 

201,614

 

201,614

 

136,244

 

136,244

  Securities held to maturity

 

12,156

 

12,156

 

-

 

-

  Federal Reserve Bank and

    Federal Home Loan Bank stock

 


3,031

 


3,031

 


3,028

 


3,028

  Loans, net

 

457,199

 

470,428

 

451,343

 

465,201

         

FINANCIAL LIABILITIES:

        

  Deposits

 

639,081

 

642,789

 

577,622

 

581,536

  Short-term borrowings

 

317

 

317

 

2,206

 

2,206

  Long-term debt

 

25,309

 

26,665

 

5,000

 

5,493




23






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 10 - Fair Value Measurements (continued)

The fair value of off-balance-sheet financial instruments at September 30, 2009 and December 31, 2008 was not material.


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

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


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.


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.


Borrowings

The carrying amounts of federal funds purchased 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.




24






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 11 – Subsequent Event

On October 21, 2009, LCNB entered into a repurchase agreement with the U.S. Department of the Treasury (the “Treasury Department”) pursuant to which LCNB redeemed all 13,400 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A, sold to the Treasury Department on January 9, 2009 in connection with the Treasury Department’s Capital Purchase Program (CPP).  Under the CPP, the Treasury Department also received a warrant to purchase 217,063 shares of the Company’s common stock with an exercise price of $9.26 per share.


In connection with this redemption, LCNB paid approximately $13.5 million to the Treasury Department, which includes the original investment amount of $13.4 million plus accrued and unpaid dividends of approximately $123,000.


As a result of the redemption, LCNB Corp. recorded a reduction in retained earnings of approximately $463,000 in the fourth quarter of 2009 associated with accelerated discount accretion related to the difference between the amount at which the Preferred Stock sale was initially recorded and its redemption price. The Preferred Stock dividend and the acceleration of the accretion will reduce the fourth quarter’s net income available to common shareholders and earnings per common share.


The funds for the redemption were obtained, in part, through the sale of approximately $10.9 million of available-for-sale investment securities at a total net loss of $74,000.  All securities sold had an unrealized gain at September 30, 2009.


LCNB Corp. exceeded all regulatory requirements to be classified as “well capitalized” before accepting the CPP investment and will exceed the regulatory requirements after the redemption.


LCNB Corp. does not intend to negotiate the repurchase of the warrant issued to the Treasury Department as part of the CPP.  Instead, pursuant to the terms of the repurchase agreement, the warrant has been cancelled and LCNB has issued a substitute warrant to the Treasury Department with the same terms as the original warrant, except that Section 13(H) of the original warrant, which dealt with the reduction of shares subject to the warrant in the event that LCNB raised $13.4 million in a qualified stock offering prior to December 31, 2009, has been removed.  A copy of the repurchase agreement was filed by LCNB as Exhibit 10.1 to its Current Report on Form 8-K dated October 21, 2009, and a copy of the substitute warrant is included as an exhibit to this report.  Both documents are incorporated by reference into this Note 11, and the foregoing summary of certain provisions of these documents is qualified in its entirety by reference thereto.




25






LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)



Note 12 – Recent Accounting Pronouncements

Statement of Financial Accounting Standards (“SFAS”) No. 166, “Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140” and SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” were issued by the Financial Accounting Standards Board (the “FASB”) on June 12, 2009.  Both standards will be effective for LCNB on January 1, 2010.


SFAS No. 166 requires more information about transfers of financial assets, including securitization transactions and the continued risk exposures related to such transfers.  It eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures.


SFAS No. 167 changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting or similar rights should be consolidated.  The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance.  Additional disclosures are also required.


LCNB management does not anticipate that adoption of SFAS No. 166 and No. 167 will have a material effect on LCNB’s consolidated financial statements.


Accounting Standards Update No. 2009-05, “Measuring Liabilities at Fair Value” was issued by the FASB in August 2009.  For those entities that elect to value liabilities at fair value, this release provides guidance for measuring the fair value of liabilities and classifying the inputs as level 1, level 2, or level 3. It is effective for the first reporting period, including interim periods, after issuance.  LCNB does not currently value any of its liabilities at fair value and does not anticipate that adoption of this update will have a material effect on its consolidated financial statements.




26






REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the Board of Directors and Shareholders

LCNB Corp. and subsidiaries

Lebanon, Ohio



We have reviewed the accompanying consolidated balance sheet of LCNB Corp. and subsidiaries as of September 30, 2009, and the related consolidated statements of income and comprehensive income for each of the three-month and nine-month periods ended September 30, 2009 and 2008, and the related consolidated statements of shareholders’ equity and cash flows for each of the nine-month periods ended September 30, 2009 and 2008.  These interim financial statements are the responsibility of the Company's management.


We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.


Based on our reviews, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements for them to be in conformity with U.S. generally accepted accounting principles.


We previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of LCNB Corp. and subsidiaries as of December 31, 2008, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for the year then ended (not presented herein), and in our report dated February 27, 2009, we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2008, is fairly stated in all material respects, in relation to the consolidated balance sheet from which it has been derived.





/s/ J.D. Cloud & Co. L.L.P.



Cincinnati, Ohio

November 5, 2009



27






LCNB CORP. AND SUBSIDIARIES


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

Forward Looking Statements

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



Results of Operations

LCNB’s net income available to common shareholders was $1,837,000 or $0.27 basic and diluted earnings per common share and $4,932,000 or $0.74 basic and diluted earnings per common share for the three and nine-month periods ended September 30, 2009, respectively.  Net income available to common shareholders was $1,794,000 or $0.27 basic and diluted earnings per common share and $4,936,000 or $0.74 basic and diluted earnings per common share for the comparable periods in 2008.  Affecting net income to common shareholders and earnings per common share for the three and nine month periods was an increase in net interest income, offset by increases in the provision for loan losses and non-interest expense.  Negatively affecting net income available to common shareholders during 2009 were preferred stock dividends paid and related discount accretion recorded in connection with the preferred shares and warrant issued under the Capital Purchase Program (the “CPP”) on January 9, 2009.


Net interest income grew during the three and nine month periods of 2009 compared to 2008 primarily because of growth in interest earning assets and a general market decline in deposit interest rates.  Non-interest expense during the three and nine periods of 2009 was influenced by industry-wide increases in FDIC deposit insurance premiums, an industry-wide special assessment levied by the FDIC, and a pension-related charge recognized by LCNB during the first quarter 2009.  


Current economic conditions have contributed to an increase in loan delinquencies, but LCNB’s loan portfolio continues to benefit from responsible underwriting and lending practices.  Net charge-offs for the first nine months of 2009 and 2008 totaled $639,000 and $322,000, respectively.  Non-accrual loans and loans past due 90 days or more and still accruing interest totaled $1,781,000 or 0.39% of total loans at September 30, 2009, compared to $3,087,000 or 0.68% of total loans at December 31, 2008.  Other real estate owned and other repossessed assets totaled approximately $2,424,000 at September 30, 2009, compared to $89,000 at December 31, 2008.  Non-accrual loans and loans past due 90 days or more decreased and other real estate owned increased largely due to the transfer of commercial real estate property into the other real estate owned category.







28






LCNB CORP. AND SUBSIDIARIES


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

Operations (continued)


LCNB’s net income was $2,043,000 for the three months ended September 30, 2009, compared to $1,794,000 for the three months ended September 30, 2008.  The return on average assets (ROAA) for the third quarter 2009 was 1.09% and the return on average total equity (ROAE) was 10.46%, compared with an ROAA of 1.09% and an ROAE of 12.27% for the third quarter of 2008.  LCNB’s net income was $5,446,000 during the first nine months of 2009 compared to $4,936,000 for the first nine months of 2008.  The ROAA and ROAE for the first nine months of 2009 were 1.02% and 9.54%, respectively.  The comparable ratios for the first nine months of 2008 were 1.05% and 11.38%, respectively.  The decrease in ROAE during the 2009 periods is primarily due to the addition of preferred stock to equity on January 9, 2009.




[Remainder of this page intentionally left blank]



29






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, 2009 vs. 2008.

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, 2009 and 2008, 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,

 

2009

 

2008

  

Average

 

Interest

 

Average

 

Average

 

Interest

 

Average

  

Outstanding

 

Earned/

 

Yield/

 

Outstanding

 

Earned/

 

Yield/

  

Balance

 

Paid

 

Rate

 

Balance

 

Paid

 

Rate

  

(Dollars in thousands)

    
             

Loans (1)

$

457,372

$

6,884

 

5.97%

$

443,602

$

7,115

 

6.36%

Federal funds sold and interest-

  bearing demand deposits

 


20,014

 


13

 


0.26%

 


24,201

 


126

 


2.07%

Interest-bearing deposits in banks

 

-

 

-

 

-%

 

3,913

 

25

 

2.53%

Federal Reserve Bank stock

 

940

 

-

 

-%

 

938

 

 -

 

    -%

Federal Home Loan Bank stock

 

2,091

 

26

 

4.93%

 

2,063

 

28

 

5.38%

Investment securities:

            
 

Taxable

 

112,375

 

1,050

 

3.71%

 

74,410

 

784

 

4.18%

 

Non-taxable (2)

 

86,662

 

1,205

 

5.52%

 

53,130

 

803

 

6.00%

 

Total earnings assets

 

679,454

 

9,178

 

5.36%

 

602,257

 

8,881

 

5.85%

Non-earning assets

 

64,019

     

54,005

    

Allowance for loan losses

 

(2,678)

     

(2,473)

    
 

Total assets

$

740,795

    

$

653,789

    
             

Interest-bearing deposits

$

548,512

 

2,278

 

1.65%

$

501,341

 

3,220

 

2.55%

Short-term borrowings

 

599

 

-

 

-%

 

725

 

4

 

2.19%

Long-term debt

 

23,929

 

177

 

2.93%

 

   5,000

 

66

 

5.24%

 

Total interest-bearing liabilities

 

573,040

 

2,455

 

1.70%

 

507,066

 

3,290

 

2.57%

Demand deposits

 

84,927

     

83,443

    

Other liabilities

 

5,342

     

5,312

    

Capital

 

77,486

     

57,968

    
 

Total liabilities and capital

$

740,795

    

$

653,789

    
             

Net interest rate spread (3)

     

3.66%

     

3.28%

             

Net interest income and net interest margin

  on a taxable-equivalent basis (4)

  


$


6,723

 


3.93%

  


$


5,591

 


3.68%

             

Ratio of interest-earning assets to

  interest-bearing liabilities

 


118.57%

     


118.77%

    
             

(1)

Includes nonaccrual loans, if any.

(2)

Income from tax-exempt securities is included in interest income on a taxable-equivalent basis.  Interest income has been divided by a factor comprised of the complement of the incremental tax rate of 34%.

(3)

The net interest spread is the difference between the average rate on total interest-earning assets and interest-bearing liabilities.

(4)

The net interest margin is the taxable-equivalent net interest income divided by average interest-earning assets.



30






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, 2009 as compared to the same period in 2008.  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, 2009 vs. 2008

      

Increase (decrease) due to:

      

Volume

 

Rate

 

Total

      

(In thousands)

Interest-earning Assets:

      
 

Loans

 

$

216

 

(447)

 

(231)

 

Federal funds sold and interest-bearing

  demand deposits

 

(19)

 

(94)

 

(113)

 

Interest-bearing deposits in banks

 

(25)

 

-

 

(25)

 

Federal Reserve Bank stock

 

-

 

-

 

-

 

Federal Home Loan Bank stock

 

-

 

(2)

 

(2)

 

Investment securities:

      
  

Taxable

 

363

 

(97)

 

266

  

Nontaxable

 

471

 

(69)

 

402

   

Total interest income

 

1,006

 

(709)

 

297

           

Interest-bearing Liabilities:

      
 

Deposits

 

280

 

(1,222)

 

(942)

 

Short-term borrowings

 

(1)

 

(3)

 

(4)

 

Long-term debt

 

151

 

(40)

 

111

   

Total interest expense

 

430

 

(1,265)

 

(835)

    

Net interest income

$

576

 

556

 

1,132


Net interest income on a fully tax-equivalent basis for the three months ended September 30, 2009 totaled $6,723,000, an increase of $1,132,000 from the comparable period in 2008.  Total interest income increased $297,000 and total interest expense decreased $835,000.  


The increase in total interest income was due to a $77.2 million increase in average earning assets, partially offset by a 49 basis point (one basis point equals 0.01%) decrease in the average rate earned on earning assets.  The increase in interest earning assets was primarily due to a $71.5 million increase in average investment securities and a $13.8 million increase in the loan portfolio.  The decrease in the average rate earned on earning assets was primarily due to general decreases in market interest rates.



31






LCNB CORP. AND SUBSIDIARIES


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

Operations (continued)


The decrease in total interest expense was primarily due to an 87 basis point decrease in the average rate paid, partially offset by a $66.0 million increase in average interest-bearing liabilities.  The decrease in the average rate paid on interest-bearing liabilities was primarily due to general decreases in market interest rates.  The increase in average interest-bearing liabilities was due to average interest-bearing deposits, which increased $47.2 million, and average long-term borrowings, which increased $18.9 million due to additional borrowings from the Federal Home Loan Bank of Cincinnati during the first and third quarters of 2009.  


Nine Months Ended September 30, 2009 vs. 2008.

The following table presents, for the nine months ended September 30, 2009 and 2008, average balances for interest-earning assets and interest-bearing liabilities, the income or expense related to each item, and the resultant average yields earned or rates paid.


 

Nine Months Ended September 30,

 

2009

 

2008

  

Average

 

Interest

 

Average

 

Average

 

Interest

 

Average

 

Outstanding

 

Earned/

 

Yield/

 

Outstanding

 

Earned/

 

Yield/

  

Balance

 

Paid

 

Rate

 

Balance

 

Paid

 

Rate

  

(Dollars in thousands)

    
             

Loans (1)

$

452,047

$

20,580

 

6.09%

$

445,882

$

21,850

 

6.55%

Federal funds sold and interest-

  bearing demand deposits

 


21,107

 


41

 


0.26%

 


24,248

 


428

 


2.36%

Interest-bearing deposits in banks

 

-

 

-

 

-%

 

2,044

 

38

 

2.48%

Federal Reserve Bank stock

 

939

 

28

 

3.99%

 

850

 

24

 

3.77%

Federal Home Loan Bank stock

 

2,091

 

73

 

4.67%

 

2,036

 

82

 

5.38%

Investment securities:

            
 

Taxable

 

106,067

 

3,183

 

4.01%

 

55,156

 

1,806

 

4.37%

 

Non-taxable (2)

 

76,217

 

3,226

 

5.66%

 

48,957

 

2,211

 

6.03%

 

Total earnings assets

 

658,468

 

27,131

 

5.51%

 

579,173

 

26,439

 

6.10%

Non-earning assets

 

60,313

     

52,829

    

Allowance for loan losses

 

(2,555)

     

(2,472)

    
 

Total assets

$

716,226

    

$

629,530

    
             

Interest-bearing deposits

$

531,461

 

7,269

 

1.83%

$

478,511

 

9,996

 

2.79%

Short-term borrowings

 

718

 

-

 

-%

 

726

 

12

 

2.21%

Long-term debt

 

18,665

 

440

 

3.15%

 

5,000

 

197

 

5.26%

 

Total interest-bearing liabilities

550,844

 

7,709

 

1.87%

 

484,237

 

10,205

 

2.82%

Demand deposits

 

84,672

     

82,472

    

Other liabilities

 

4,413

     

4,882

    

Capital

 

76,297

     

57,939

    
 

Total liabilities and capital

$

716,226

    

$

629,530

    
             

Net interest rate spread (3)

     

3.64%

     

3.28%

             

Net interest income and net interest margin

  on a taxable-equivalent basis (4)

 


$


19,422

 


3.94%

  


$


16,234

 


3.74%

             

Ratio of interest-earning assets to

  interest-bearing liabilities

 


119.54%

     


119.61%

    
             


(1)

Includes nonaccrual loans, if any.  Income from tax-exempt loans is included in interest income on a tax-equivalent basis, using an incremental rate of 34%.

(2)

Income from tax-exempt securities is included in interest income on a taxable-equivalent basis.  Interest income has been divided by a factor comprised of the complement of the incremental tax rate of 34%.

(3)

The net interest spread is the difference between the average rate on total interest-earning assets and interest-bearing liabilities.

(4)

The net interest margin is the taxable-equivalent net interest income divided by average interest-earning assets.



32






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, 2009 as compared to the same period in 2008.  


      

 Nine Months Ended

      

September 30, 2009 vs. 2008

      

Increase (decrease) due to:

      

Volume

 

Rate

 

Total

      

(In thousands)

Interest-earning Assets:

      
 

Loans

 

$

299

 

(1,569)

 

(1,270)

 

Federal funds sold and interest-bearing

  demand deposits

 

(49)

 

(338)

 

(387)

 

Interest-bearing deposits in banks

 

(38)

 

-

 

(38)

 

Federal Reserve Bank stock

 

3

 

1

 

4

 

Federal Home Loan Bank stock

 

2

 

(11)

 

(9)

 

Investment securities:

      
  

Taxable

 

1,539

 

(162)

 

1,377

  

Nontaxable

 

1,162

 

(147)

 

1,015

   

Total interest income

 

2,918

 

(2,226)

 

692

           

Interest-bearing Liabilities:

      
 

Deposits

 

1,013

 

(3,740)

 

(2,727)

 

Short-term borrowings

 

-

 

(12)

 

(12)

 

Long-term debt

 

350

 

(107)

 

243

   

Total interest expense

 

1,363

 

(3,859)

 

(2,496)

    

Net interest income

$

1,555

 

1,633

 

3,188


Net interest income on a fully tax-equivalent basis for the first nine months of 2009 totaled $19,422,000, a $3,188,000 increase from the first nine months of 2008.  Total interest income increased $692,000 and total interest expense decreased $2,496,000.


The increase in total interest income was primarily due to a $79.3 million increase in average total earning assets, partially offset by a 59 basis point decrease in the average rate earned on earning assets.  The increase in average earning assets was primarily due to a $78.2 million increase in average investment securities.  The decrease in the average rate earned on earning assets was primarily due to general decreases in market interest rates.



33






LCNB CORP. AND SUBSIDIARIES


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

Operations (continued)


The decrease in total interest expense was due primarily to a 95 basis point decrease in the average rate paid on interest-bearing liabilities, partially offset by a $66.6 million increase in average interest-bearing liabilities.  The increase in average interest-bearing liabilities was primarily due to a $53.0 million increase in average interest-bearing deposits and a $13.7 million increase in average long term debt due to additional borrowings from the Federal Home Loan Bank of Cincinnati during the first and third quarters of 2009.



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 months ended September 30, 2009 and 2008 was $664,000 and $188,000, respectively, and $970,000 and $322,000 for the nine months ended September 30, 2009 and 2008, respectively.  The increase in the provision for loan losses reflects an increase in non-accrual and delinquent loans, the net charge-off trend, and the current economic conditions.



Non -Interest Income


Three Months Ended September 30, 2009 vs. 2008.

Non-interest income for the third quarter of 2009 was $27,000 less than for the same period in 2008. Service charges and fees decreased $151,000 primarily due to fewer overdraft fees on checking and NOW accounts.  This decrease was partially offset by a $60,000 increase in gains on sales of securities and a $44,000 increase in gains from sales of mortgage loans.  


Gains from sales of mortgage loans increased due to a higher volume of sales to the Federal Home Loan Mortgage Corporation during the 2009 period.  Loan sales during the third quarter 2009 totaled $2,481,000 compared to $81,000 in sales during the third quarter 2008.  The increase in the amount of mortgage loans sold is primarily due to an increase in the number of loans being refinanced, reflecting a general decline in market interest rates for residential mortgage loans during the first nine months of 2009.


Nine Months Ended September 30, 2009 vs. 2008.

Non-interest income for the first nine months of 2009 was $87,000 greater than for the same period in 2008.  Gains from sales of mortgage loans increased $368,000, partially offset by a $237,000 decrease in service charges and fees and a $121,000 decrease in insurance agency income.  Loan sales for the first nine months of 2009 totaled $26,033,000, compared to $814,000 of loans sold for the first nine months of 2008.  Service charges and fees decreased primarily due to fewer overdraft fees on checking and NOW accounts and insurance agency income decreased due to a $64,000 decrease in contingency commissions and a general decline in commission income due to market factors.  Contingency commissions are profit-sharing arrangements on property and casualty policies between the originating agency and the carrier and are generally based on underwriting results and written premiums.  As such, the amount received each year can vary significantly depending on loss experience.



34







LCNB CORP. AND SUBSIDIARIES


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

Operations (continued)


Non-Interest Expense


Three Months Ended September 30, 2009 vs. 2008.

Total non-interest expense increased $266,000 during the third quarter 2009 as compared to the third quarter 2008 primarily due to a $296,000 increase in FDIC premiums reflecting an industry-wide increase in quarterly premiums.  Salaries and wages increased $119,000 primarily due to additional employees, partially due to the opening of the Centerville office in September 2008, and annual salary and wage increases.  


These expense increases were partially offset by a $98,000 decrease in pension and other employee benefits primarily due to lower pension expense.  


Nine Months Ended September 30, 2009 vs. 2008.

Total non-interest expense increased $1,903,000 during the first nine months of 2009 as compared to the first nine months of 2008 primarily due to an $874,000 increase in FDIC premiums and a $722,000 write-off of a pension asset during the first quarter 2009.  The increase in FDIC premiums includes an approximate $325,000 expense recognized for an industry-wide special assessment levied by the FDIC as of June 30, 2009.  The balance of the increase reflects industry-wide increases in quarterly premiums. The write-off of the pension asset is related to the redesign during the first quarter 2009 of LCNB’s retirement program.  The plans were redesigned to provide competitive benefits to employees and provide more predictable and lower retirement plan costs over the long term.  Because of the redesign, pension plan related balance sheet accounts were adjusted resulting in an approximate $3.0 million after tax increase in other comprehensive income, which is a component of shareholders’ equity, and the $722,000 charge to non-interest expense.  


The remainder of the increase in total non-interest expense is due to a $398,000 increase in salaries and wages primarily for the same reasons discussed above, partially offset by a $204,000 decrease in intangible amortization.  The decrease in the intangible amortization is primarily due to the amortization in full during 2008 of an intangible asset related to the purchase of three offices from another bank in 1997.    



Income Taxes

LCNB’s effective tax rates for the nine months ended September 30, 2009 and 2008 were 22.1% and 25.4%, 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

Total assets at September 30, 2009 were $100.1 million greater than at December 31, 2008.  The growth in total assets were primarily funded by a $61.5 million increase in total deposits, a $20.3 million increase in long-term debt, and $13.4 million received from the sale of preferred stock to the U.S. Treasury Department under the CPP.  



35






LCNB CORP. AND SUBSIDIARIES


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

Operations (continued)


Net loans at September 30, 2009 were $5,856,000 greater than at December 31, 2008.  Commercial and industrial loans were $4,983,000 greater at September 30, 2009 and commercial real estate loans were $6,793,000 greater.  During the same period, residential real estate loans decreased $344,000 and consumer loans decreased $5,506,000.  Residential real estate loans decreased primarily because new loans originated were sold to FHLMC.  New residential real estate loans sold during the nine months ended September 30, 2009 totaled $26,033,000.  Consumer loans decreased primarily due to weak demand.


The investment securities portfolio at September 30, 2009 was $77.5 million greater than at December 31, 2008.  Most of the growth was in U. S. Agency mortgage-backed securities, which increased $20.4 million and municipal securities, which increased $43.6 million.  


The $20.3 million increase in long-term debt is due to new borrowings from the Federal Home Loan Bank of Cincinnati during the first and third quarters of 2009.  Of the $61.5 million increase in total deposits, approximately $29.8 million was due to increases in public fund deposits by local governmental entities. LCNB has also been receiving a higher than normal increase in deposits due, in part, to the volatility of current economic conditions.  Most of the deposit growth has been in liquid NOW account, money fund deposit account, and regular savings account products.  


On January 9, 2009, LCNB received $13.4 million of new capital from the U.S. Treasury Department under the CPP and issued 13,400 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A and a warrant to the U.S. Treasury Department for the purchase of 217,063 common shares of LCNB stock at an exercise price of $9.26.  LCNB allocated $583,000 of the proceeds from the preferred stock issuance to the warrants.  The resulting discount in the preferred stock is being amortized over five years and is being reported as an adjustment to preferred stock dividends.  The issuance of preferred stock significantly increased LCNB’s capital and liquidity levels. The preferred stock pays a cumulative dividend of 5% per annum for the first five years and 9% per annum thereafter if not redeemed first.  For more information regarding the terms of agreement between LCNB and the U.S. Treasury Department under the CPP and the securities issued by LCNB to the U.S. Treasury Department thereunder, please see the Current Report on Form 8-K filed by LCNB with the SEC on January 9, 2009 which is hereby, along with exhibits thereto, incorporated by reference.


On October 21, 2009, LCNB redeemed all 13,400 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A.  See “Notes to Consolidated Financial Statements, Note 11 – Subsequent Event” for additional information pertaining to the redemption of the preferred shares.


Other assets at September 30, 2009 were $2.8 million greater than at December 31, 2008 primarily due to the transfer of three commercial real estate properties totaling $2.4 million from the loan portfolio into other real estate owned during the third quarter 2009.





36






LCNB CORP. AND SUBSIDIARIES


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

Operations (continued)


Liquidity

On October 21, 2009, LCNB redeemed all 13,400 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A.  See “Notes to Consolidated Financial Statements, Note 11 – Subsequent Event” for additional information pertaining to the redemption of the preferred shares.


LCNB depends on dividends from its subsidiaries 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, as defined, 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, would be 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 without needing to request 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, interest-bearing deposits in other banks, and securities available for sale.  At September 30, 2009, LCNB’s liquid assets amounted to $232.6 million or 31.0% of total assets, an increase from $154.3 million or 23.7% of total assets at December 31, 2008. Most of this growth was due to growth in investment securities available for sale.


Liquidity is also provided by access to core funding sources, primarily core depositors in the bank’s market area.  Approximately 76.5% of total deposits at September 30, 2009 were “core” deposits, compared to 79.6% of deposits at December 31, 2008.  Core deposits, for this purpose, are defined as total deposits less public funds and certificates of deposit greater than $100,000.  The percentage of core deposits to total deposits decreased because of the growth in public fund deposits discussed above in relation to total growth in deposits.    


Secondary sources of liquidity include LCNB’s ability to sell loan participations, borrow funds from the Federal Home Loan Bank, purchase federal funds, 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.




37






LCNB CORP. AND SUBSIDIARIES


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

Operations (continued)


Recent Accounting Pronouncements

Statement of Financial Accounting Standards (“SFAS”) No. 166, “Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140” and SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” were issued by the Financial Accounting Standards Board (the “FASB”) on June 12, 2009.  Both standards will be effective for LCNB on January 1, 2010.


SFAS No. 166 requires more information about transfers of financial assets, including securitization transactions and the continued risk exposures related to such transfers.  It eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures.


SFAS No. 167 changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting or similar rights should be consolidated.  The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance.  Additional disclosures are also required.

LCNB management does not anticipate that adoption of SFAS No. 166 and No. 167 will have a material effect on LCNB’s consolidated financial statements.

Accounting Standards Update No. 2009-05, “Measuring Liabilities at Fair Value” was issued by the FASB in August 2009.  For those entities that elect to value liabilities at fair value, this release provides guidance for measuring the fair value of liabilities and classifying the inputs as level 1, level 2, or level 3.  It is effective for the first reporting period, including interim periods, after issuance.  LCNB does not currently value any of its liabilities at fair value and does not anticipate that adoption of this update will have a material effect on its consolidated financial statements.




38






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 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 the down 300 basis points scenario 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, 2009 IRSA indicates that an increase in interest rates would have a positive effect on net interest income (“NII”), and a decrease in rates would have a negative effect on NII. The changes in NII for all rate assumptions are within LCNB’s acceptable ranges.  



Rate Shock Scenario in Basis Points

 



Amount

$ Change in

Net Interest

Income

% Change in

Net Interest

Income

  

(Dollars in thousands)

Up 300

$

28,067

889

3.27%

Up 200

 

27,789

611

2.25%

Up 100

 

27,411

233

0.86%

Base

 

27,178

-

-%

Down 100

 

26,970

(208)

-0.77%

Down 200

 

26,832

(346)

-1.27%


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, 2009 EVE analysis indicates that an increase in interest rates would have a negative effect on the EVE and a decrease in rates would have a positive 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

$

75,554

(21,368)

-22.05%

Up 200

 

83,069

(13,853)

-14.29%

Up 100

 

89,816

(7,106)

-7.33%

Base

 

96,922

-

-%

Down 100

 

102,349

5,427

5.60%

Down 200

 

108,518

11,596

11.96%



39






LCNB CORP. AND SUBSIDIARIES



Item 3.  Quantitative and Qualitative Disclosures about Market Risks (continued)


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.  



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, 2009, 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.


40






PART II.  OTHER INFORMATION

LCNB CORP. AND SUBSIDIARIES



Item 1.     Legal Proceedings

Not applicable


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, except as previously disclosed in the Current Report on Form 8-K filed on January 9, 2009.


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


During the period of this report, LCNB was unable to increase dividends to common shareholders without U.S. Treasury Department permission for a period of three years from the date of participation in the CPP unless the preferred securities are no longer held by the U.S. Treasury Department.  Additionally, no dividends were permitted to be paid on common stock unless and until all accrued and unpaid dividends for all past dividend periods owed to the U.S. Treasury Department on the preferred shares are fully paid. On October 21, 2009, LCNB redeemed all 13,400 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A.  See “Notes to Consolidated Financial Statements, Note 11 - Subsequent Event” of this report for additional information pertaining to the redemption of the preferred shares.


LCNB depends on dividends from its subsidiaries 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, as defined, 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, would be 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.  


Item 3.     Defaults Upon Senior Securities

Not applicable


Item 4.     Submission of Matters to a Vote of Security Holders  

None


Item 5.     Other Information

Not applicable



41






LCNB CORP. AND SUBSIDIARIES



Item 6.     Exhibits

Exhibit No.

Exhibit Description

 

3.1

 

Amended and Restated Articles of Incorporation of LCNB Corp. – incorporated by reference to Form 10-K for the fiscal year ended December 30, 2008, Exhibit 3.1.

    
 

3.2

 

Code of Regulations of LCNB Corp. – incorporated by reference to Form 10-Q for the quarterly period ended March 31, 2005, Exhibit 3(ii).

    
 

4.1

 

Warrant to Purchase Shares of Common Stock of the Registrant, dated January 9, 2009 – incorporated by reference to the Registrant’s Current Report on Form 8-K filed on January 9, 2009, Exhibit 4.1.

    
 

4.2

 

Letter Agreement, dated as of January 9, 2009 between the Registrant and the U.S. Department of the Treasury, which includes the Securities Purchase Agreement – Standard Terms – incorporated by reference to the Registrant’s Current Report on Form 8-K filed on January 9, 2009, Exhibit 10.1.

    
 

4.3

 

Substitute Warrant to Purchase Shares of Common Stock of the Registrant, dated January 9, 2009.

    
 

4.4

 

Repurchase Letter Agreement, dated as of October 21, 2009 between the Registrant and the U.S. Department of the Treasury – incorporated by reference to the Registrant’s Current Report on Form 8-K filed on October 21, 2009, Exhibit 10.1.

    
 

10.1

 

LCNB Corp. Ownership Incentive Plan – incorporated by reference to Registrant’s Form DEF 14A Proxy Statement pursuant to Section 14(a), dated March 15, 2002, Exhibit A (000-26121).

    
 

10.2

 

Form of Option Grant Agreement under the LCNB Corp. Ownership Incentive Plan – incorporated by reference to Form 10-K for the fiscal year ended December 31, 2005, Exhibit 10.2.

    
 

10.3

 

Letter Agreement, dated as of January 9, 2009 between the Registrant and the U.S. Department of the Treasury, which includes the Securities Purchase Agreement – Standard Terms – incorporated by reference to the Registrant’s Current Report on Form 8-K filed on January 9, 2009, Exhibit 10.1.

    
 

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

 

Repurchase Letter Agreement, dated as of October 21, 2009 between the Registrant and the U.S. Department of the Treasury – incorporated by reference to the Registrant’s Current Report on Form 8-K filed on October 21, 2009, Exhibit 10.1.



42






LCNB CORP. AND SUBSIDIARIES



Item 6.     Exhibits (continued)

Exhibit No.

Exhibit Description

 

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.


43






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 5, 2009

/s/ Stephen P. Wilson                                             

Stephen P. Wilson, Chief Executive Officer and

Chairman of the Board of Directors



November 5, 2009

/s/Robert C. Haines, II                                            

Robert C. Haines, II, Executive Vice President

and Chief Financial Officer





44