LCNB CORP - Quarter Report: 2009 September (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 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.

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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

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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

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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

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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

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			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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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.

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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 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

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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.  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.

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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.

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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

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.