LCNB CORP - Quarter Report: 2005 June (Form 10-Q)

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 June 30, 2005

 (      )

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.

Yes   X  No   

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes   X  No   

The number of shares outstanding of the issuer's common stock, without par value, as of July 29, 2005 was 3,305,508 shares.

LCNB Corp.

INDEX

Page No.

Part I - Financial Information

Item 1.  Financial Statements

Consolidated Balance Sheets -

June 30, 2005, and December 31, 2004

1

Consolidated Statements of Income -

Three and Six Months Ended June 30, 2005 and 2004

2

Consolidated Statements of Comprehensive Income -

Three and Six Months Ended June 30, 2005 and 2004

3

Consolidated Statements of Stockholders' Equity -

Six Months Ended June 30, 2005 and 2004

4

Consolidated Statements of Cash Flows -

Six Months Ended June 30, 2005 and 2004

5

Notes to Consolidated Financial Statements

6-12

Independent Accountants' Review Report

13

Item 2.  Management's Discussion and Analysis of Financial

Condition and Results of Operations

14-27

Item 3.  Quantitative and Qualitative Disclosures about

Market Risks

28

Item 4  Controls and Procedures

29

Part II - Other Information

Item 1  Legal Proceedings

30

Item 2  Changes in Securities and Use of Proceeds

30-31

Item 3  Defaults by the Company on its Senior Securities

31

Item 4  Submission of Matters to a Vote of Security Holders

31-32

Item 5  Other Information

32

Item 6  Exhibits

32

Signatures

33

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LCNB Corp. and Subsidiaries

Notes to the 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, Lebanon Citizens National Bank ("Lebanon Citizens") and Dakin Insurance Agency, Inc. ("Dakin").  The accompanying unaudited consolidated financial statements include the accounts of LCNB, Lebanon Citizens, and Dakin.

The statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and the instructions to Form 10-Q.  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 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.

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

Results of operations for the three and six months ended June 30, 2005 are not necessarily indicative of the results to be expected for the full year ending December 31, 2005.  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 2004 Form 10-K filed with the Securities and Exchange Commission.

The financial information presented on pages one through twelve of this Form 10-Q has been subject to a review by J.D. Cloud & Co., L.L.P., LCNB's independent registered public accounting firm, as described in their report contained herein.

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LCNB Corp. and Subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(Continued)

Note 2 - Earnings Per Share

Basic earnings per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period.  Diluted earnings per share is adjusted for the dilutive effects of stock options.  The diluted average number of common shares outstanding has been increased for the assumed exercise of stock options with proceeds used to purchase treasury shares at the average market price for the period.  The computations were as follows for the three and six months ended June 30 (thousands, except share and per share data):

Note 3 -  Investment Securities

The amortized cost and estimated market value of available-for-sale investment securities at June 30, 2005 and December 31, 2004 are summarized as follows (thousands):

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LCNB Corp. and Subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(Continued)

Note 3 – Investment Securities (continued)

The decline in fair values is primarily due to increases in market interest rates.  Unrealized losses on securities at June 30, 2005 and December 31, 2004 have not been recognized into income because management has the intent and ability to hold the securities for a period of time sufficient to allow for any anticipated recovery in fair values.  Therefore, no individual declines are deemed to be other than temporary.

Note 4 - Loans

Major classifications of loans at June 30, 2005 and December 31, 2004 are as follows (thousands):

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LCNB Corp. and Subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(Continued)

Note 4 - Loans (continued)

Mortgage loans sold to and serviced for the Federal Home Loan Mortgage Corporation ("FHLMC") are not included in the accompanying balance sheets.  The unpaid principal balances of those loans at June 30, 2005 and December 31, 2004 were $46,087,000 and $46,345,000, respectively.  Loans sold to the FHLMC during the three and six months ended June 30, 2005 totaled $2,068,000 and $2,796,000, respectively, and $1,086,000 and $1,665,000 during the three and six months ended June 30, 2004, respectively.

Changes in the allowance for loan losses for the six months ended June 30, 2005 and 2004 were as follows (thousands):

Charge-offs for the six months ended June 30, 2005 consisted primarily of consumer loans and checking and NOW account overdrafts.  Charge-offs for the six months ended June 30, 2004 included a $107,000 partial charge-off for a commercial loan.  The balance of charge-offs for the 2004 period was primarily for consumer loans.  LCNB charges off checking and NOW account overdrafts when considered uncollectible, but no later than 60 days from the date first overdrawn.  Prior to 2005, overdrafts considered uncollectible were netted against service charges and fees in non-interest income.

Non-accrual, past-due, and restructured loans as of June 30, 2005 and December 31, 2004 were as follows (thousands):

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LCNB Corp. and Subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(Continued)

Note 4 - Loans (continued)

Non-accrual loans at June 30, 2005 consist of one residential real estate mortgage loan.  Loans past-due 90 days or more and still accruing interest at June 30, 2005 consisted of consumer loans.  Consumer loans totaling $104,000 and residential mortgage loans totaling $61,000 comprised the loans classified as past-due 90 days or more and still accruing at December 31, 2004.  The restructured loan at both dates is a commercial loan secured by a combination of mortgages and other collateral.    

Note 5 – Other Borrowings

At June 30, 2005 and December 31, 2004, accrued interest and other liabilities included U.S. Treasury demand note borrowings of approximately $729,000 and $1,269,000, respectively.

Note 6 - 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.

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 June 30, 2005 and December 31, 2004 were as follows (thousands):

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.  Commitments 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 June 30, 2005 and December 31, 2004, outstanding guarantees of $1,860,000 and $1,983,000, 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 June 30, 2005 and December 31, 2004 was approximately $4.2 million.  The letter of credit will expire on July 15, 2009.  It is secured by an assignment of rents and the underlying real property.

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LCNB Corp. and Subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(Continued)

Note 6 - Commitments and Contingent Liabilities (continued)

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.

At June 30, 2005, LCNB is committed under various contracts to expend approximately $80,000 to complete certain building and office renovation projects and computer upgrades.

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 7 - Stock Options

LCNB established an Ownership Incentive Plan (the "Plan") during 2002 that allows for 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 100,000 shares.  Stock options for 4,054 shares with an exercise price of $35.315 were granted to key executive officers of LCNB during the first quarter, 2004.  No stock options were granted during the first or second quarters, 2005.  At June 30, 2005, 9,582 stock options with a weighted average exercise price of $30.05 were outstanding.  The options expire in 2013 and 2014.  No options have been exercised as of June 30, 2005.

Effective January 1, 2005, LCNB adopted the fair value method of accounting for stock options as described in Statement of  Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123 (revised)”).  SFAS No. 123 (revised) generally requires an entity to recognize expense for the grant-date fair value of share-based compensation, where the original SFAS No. 123, Accounting for Stock-Based Compensation, encouraged but did not require an entity to recognize expense for such transactions.  The estimated cost of share-based compensation is to be recognized over the period during which an employee is required to provide service in exchange for the award, usually the vesting period or five years.  Compensation expense recognized in the consolidated statements of income for all stock options granted prior to January 1, 2005 is determined using the modified prospective approach as allowed by SFAS No. 123 (revised).  Total expense related to options included in salaries and wages in the consolidated statements of income for the three and six months ended June 30, 2005 were $2,000 and $4,000, respectively.

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LCNB Corp. and Subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(Continued)

Note 7 - Stock Options (continued)

Prior to January 1, 2005, LCNB accounted for stock options under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25), and related Interpretations.  Under APB No. 25, no stock-based employee compensation cost was reflected in net income, as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant.  If LCNB had applied the fair value recognition provisions of SFAS 123 (revised) for the three and six months ended June 30, 2004, the pro-forma effect  on net income and basic and diluted earnings per share would not have been material.

Note 8 – Employee Benefits

LCNB has a noncontributory defined benefit retirement plan that covers all regular full-time employees.  The components of net periodic pension cost for the three and six months ended June 30, 2005 and 2004, are summarized as follows (thousands):

LCNB previously disclosed in its consolidated financial statements for the year ended December 31, 2004, that it expected to contribute $650,000 to its pension plan in 2005.  As of June 30, 2005, no contributions have been made.

Note 9 – Recent Accounting Pronouncements

Statement of Financial Accounting Standards (“SFAS”) No. 154, Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3, was issued in May, 2005.  It primarily applies to voluntary changes in accounting principles, but it also includes changes in accounting estimates and corrections of errors in previously issued financial statements.  SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.

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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 June 30, 2005, and the related consolidated statements of income and comprehensive income for each of the three-month and six-month periods ended June 30, 2005 and 2004, and the related consolidated statements of shareholders’ equity and cash flows for each of the six-month periods ended June 30, 2005 and 2004.  These financial statements are the responsibility of the Company's management.

We conducted our review 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 review, 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, 2004 (presented herein), and the related consolidated statements of income, shareholders' equity, and cash flows for the year then ended (not presented herein), and in our report dated February 14, 2005, 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, 2004, is fairly stated in all material respects.

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

Cincinnati, Ohio

July 26, 2005

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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, including regulatory policy changes, interest rate fluctuations, loan demand, loan delinquencies and losses, and other risks.  Actual strategies and results in future time periods may differ materially from those currently expected.  Such forward-looking statements represent management's judgment as of the current date.  The Company disclaims, however, any intent or obligation to update such forward-looking statements.

Results of Operations

LCNB earned $1,692,000 or $0.51 per share for the three months ended June 30, 2005, compared to $1,556,000 or $0.46 per share for the three months ended June 30, 2004.  The return on average assets (ROAA) for the second quarter, 2005 was 1.26% and the return on average equity (ROAE) was 13.01%, compared with an ROAA of 1.24% and an ROAE of 11.89% for the second quarter of 2004.  The increase in net income for the second quarter, 2005 is primarily attributable to increased net interest income, a decreased provision for loan losses, and increased non-interest income.  These items were partially offset by an increase in non-interest expense.

LCNB earned $3,098,000 or $0.93 per share during the first six months of 2005 compared to $3,218,000 or $0.96 per share for the first six months of 2004.  Earnings for the first half of 2004 included $350,000 in after-tax gains, or $530,000 on a before-tax basis, from first quarter sales of investment securities totaling $11.4 million and credit card receivables totaling approximately $2.5 million.  No investment securities were sold during the first six months of 2005.  The ROAA and ROAE for the first six months of 2005 were 1.18% and 11.92%, respectively.  The comparable ratios for the first six months of 2004 were 1.28% and 12.25%, respectively.  Net interest income for the first half of 2005 was greater than that of the comparable period in 2004, as was non-interest income (excluding the effects of the 2004 gains from sales of investment securities and credit card receivables from the comparison).  These increases in income were partially offset by an increase in non-interest expense.   

Net Interest Income

Three Months Ended June 30, 2005 vs. 2004.

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 June 30, 2005 and 2004, 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.

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LCNB Corp. and Subsidiaries

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

Operations (continued)

(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.

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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 June 30, 2005 as compared to the comparable period in 2004.  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.

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LCNB Corp. and Subsidiaries

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

Operations (continued)

Net interest income on a fully tax-equivalent basis for the three months ended June 30, 2005 totaled $4,883,000, an increase of $103,000 from the comparable period in 2004.  Total interest income increased $564,000 and was partially offset by an increase in total interest expense of $461,000.  

The increase in total interest income was primarily due to a $22.8 million increase in average interest earning assets, from $474.3 million for the three months ended June 30, 2004 to $497.1 million for the same period in 2005.  Most of the increase in interest earning assets was from loan growth, which increased by $23.3 million on an average basis.  In addition, federal funds sold and interest-bearing demand deposits increased $8.7 million on an average basis.  These increases were partially offset by a $9.2 million decrease in average investment securities.  A secondary factor for the increase in total interest income was a 20 basis point (one basis point equals 0.01%) increase in the average rate earned on earning assets, from 5.52% for the second quarter of 2004 to 5.72% for the second quarter of 2005.

The increase in total interest expense was primarily due to a 31 basis point increase in the average rate paid and secondarily due to a $31.4 million increase in average interest-bearing liabilities.  Average interest-bearing deposits increased $33.4 million, while average long-term debt decreased $2.1 million.  The decrease in long-term debt was due to the maturity of a $2.0 million Federal Home Loan Bank advance in December, 2004.

The net interest margin narrowed 10 basis points in the second quarter, 2005 compared to the second quarter, 2004. The tighter margin reflects highly competitive market pricing conditions for deposits.  The average rate paid for deposits during the second quarter, 2005 was 32 basis points greater than the average rate paid during the second quarter, 2004.  Comparing the same periods, the average yield earned on interest earning assets increased by only 20 basis points.   Net interest income for the second quarter, 2005 was greater than the comparable period in 2004 primarily due to the loan growth discussed above.

Six Months Ended June 30, 2005 vs. 2004.

The following table presents, for the six months ended June 30, 2005 and 2004, 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.

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LCNB Corp. and Subsidiaries

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

Operations (continued)

(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.

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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 six months ended June 30, 2005 as compared to the comparable period in 2004.  

Net interest income on a fully tax-equivalent basis for the first half of 2005 totaled $9,710,000, an increase of $178,000 from the first half of 2004.  Total interest income increased $752,000 and was partially offset by an increase in total interest expense of $574,000.

The increase in total interest income was primarily due to a $13.0 million increase in average total earning assets and secondarily to a 17 basis point increase in the average rate earned on earning assets, from 5.56% for the first half of 2004 to 5.73% for the first half of 2005.  Most of the increase in average earning assets was due to a $21.9 million increase in average loans.  Federal funds sold and interest-bearing demand deposits also grew by $4.7 million on an average basis.  These increases were partially offset by a $13.7 million decrease in average investment securities.

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LCNB Corp. and Subsidiaries

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

Operations (continued)

The increase in total interest expense was primarily due to a 20 basis point increase in the average rate paid, and secondarily to a $20.1 million increase in average interest-bearing liabilities.  Average interest-bearing deposits increased $22.1 million and average long-term debt decreased $2.1 million.  As discussed in the previous section, the decrease in long-term debt was due to the maturity of a $2.0 million Federal Home Loan Bank advance in December, 2004.

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 credit losses at a level considered appropriate in relation to the risk of losses inherent in the portfolio.  The total loan loss provision and the other changes in the allowance for loan losses are shown below.  

Charge-offs for the six months ended June 30, 2005 consisted primarily of consumer loans and checking and NOW account overdrafts.  Charge-offs for the three and six months ended June 30, 2004 included a $107,000 partial charge-off for a commercial loan.  The balance of charge-offs for the 2004 period was primarily for consumer loans.  LCNB charges off checking and NOW account overdrafts when considered uncollectible, but no later than 60 days from the date first overdrawn.  Prior to 2005, overdrafts considered uncollectible were netted against service charges and fees in non-interest income.

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LCNB Corp. and Subsidiaries

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

Operations (continued)

The following table sets forth information regarding the past due, non-accrual and renegotiated loans of the Bank at the dates indicated:

Non-accrual loans at June 30, 2005 consisted of one residential real estate mortgage loan.  Loans that were past-due 90 days or more and were still accruing at June 30, 2005 consisted of consumer loans.  Loans classified as past-due 90 days or more and still accruing at December 31, 2004 consisted of consumer loans totaling $104,000 and residential mortgage loans totaling $61,000.  The restructured loan at both dates is a commercial loan secured by a combination of mortgages and other collateral.    

Non -Interest Income

Three Months Ended June 30, 2005 vs. 2004.

Total non-interest income for the second quarter of 2005 was $249,000, or 14.0%, greater than the second quarter of 2004 primarily due to earnings from bank-owned life insurance, increased service charges and fees, and increased trust income.  LCNB did not hold bank-owned life insurance during the first half of 2004.  Service charges and fees increased primarily due to an increase in check card income and an increase in the number of non-sufficient fund charges.    Check card income grew because a greater number of cards were outstanding and because of the increasing popularity of check cards as a retail payment method.  The increase in trust income was due to brokerage fees, which increased primarily due to new business.  Brokerage accounts at June 30, 2005 totaled $30.9 million, a 75.2% increase from $17.7 million at June 30, 2004.  Brokerage accounts are offered through a partnership with UVEST Investment Services, Inc.

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LCNB Corp. and Subsidiaries

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

Operations (continued)

Six Months Ended June 30, 2005 vs. 2004.

Total non-interest income for the first six months of 2005 was $316,000, or 9.2%, more than that of the comparable period in 2004, excluding the investment security and credit card gains of $530,000 recognized during the first quarter, 2004.  The increase was primarily due to earnings from bank-owned life insurance and increased service charges and fees.  Service charges and fees increased due to substantially the same reasons mentioned above.  Despite the increase in trust income for the second quarter, 2005, the first half of 2005 does not show a similar increase because of the absence of certain non-recurring executor and account termination fees recognized during the first quarter, 2004.

Non-Interest Expense

Three Months Ended June 30, 2005 vs. 2004.

Total non-interest expense increased $286,000, or 7.2%, during the second quarter, 2005 compared to the second quarter, 2004, primarily due to increases in salaries and wages, pension and other employee benefits, and marketing expenses.  Salaries and wages increased $142,000, or 8.2%, primarily due to routine salary and wage increases and to additional staffing required by the respective openings of the Fairfield Office during the fourth quarter, 2004 and the Lebanon High School Warrior Office during the first quarter, 2005.  Pension and other employee benefits increased primarily due to increased pension and health insurance expenses.

Six Months Ended June 30, 2005 vs. 2004.

Total non-interest expense increased $331,000, or 4.0%, during the first half, 2005 compared to the first half of 2004 primarily due to increases in salaries and wages and pension and other employee benefits, for substantially the same reasons discussed above.  Also contributing on a smaller scale were increases in equipment, occupancy, marketing, and state franchise tax expenses.  Equipment expenses increased due to increased phone equipment rental costs caused by additional equipment and upgrades, primarily for the Fairfield and Lebanon High School Warrior Offices, and to increased maintenance contract costs.  These increases were partially offset by a decrease in depreciation expense for furniture and equipment.  Increased expenditures for utilities, additional rent expense for the Fairfield Office and additional depreciation expense for buildings and premises contributed to the increase in occupancy expenses.  The additional depreciation expense was primarily caused by the new Loveland Office, which opened during the second quarter, 2005.  

Income Taxes

LCNB’s effective tax rates for the six months ended June 30, 2005 and 2004 were 24.8% and 26.9%, respectively.  The difference between the statutory rate of 34.0% and the effective tax rate is primarily due to tax-exempt interest income and, for the 2005 period, tax-exempt earnings from bank-owned life insurance.

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LCNB Corp. and Subsidiaries

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

Operations (continued)

Financial Condition

Loans at June 30, 2005 were approximately $11.9 million greater than at December 31, 2004.  Commercial loans secured by real estate comprised $7.7 million of the increase and residential real estate mortgage loans comprised another $2.9 million of the increase.  

Securities available for sale at June 30, 2005 were approximately $27.6 million greater than at December 31, 2004.  Approximately $25.6 million of the increase was in U.S. Agency notes, primarily Federal Home Loan Mortgage Corporation and Federal National Mortgage Association securities.

The increase in loans and securities were financed largely by a $21.6 million increase in total deposits and by a $26.6 million decrease in federal funds sold and interest bearing demand deposits.  NOW and money fund investment accounts grew a combined $25.7 million while savings deposits declined by $10.3 million.  The balance of the increase was in demand deposit accounts and IRA certificates of deposit.

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LCNB Corp. and Subsidiaries

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

Operations (continued)

The following table highlights the changes in the balance sheet. The analysis uses quarterly averages to give a better indication of balance sheet trends.