LCNB CORP - Quarter Report: 2009 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, 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 August 3, 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

25

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations    26

Item 3.  Quantitative and Qualitative Disclosures about Market Risks

35

Item 4.  Controls and Procedures

36

PART II.  OTHER INFORMATION

37

Item 1.     Legal Proceedings

37

Item 1A.  Risk Factors

37

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

37

Item 3.     Defaults Upon Senior Securities

37

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

38

Item 5.     Other Information

38

Item 6.     Exhibits

39

SIGNATURES

40

1

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PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements

	LCNB CORP. AND SUBSIDIARIES
	CONSOLIDATED BALANCE SHEETS
	(Dollars in thousands)
							June 30,				December 31,
							2009				2008
							(Unaudited)
ASSETS:
	Cash and due from banks					$		22,978			11,278
	Federal funds sold and interest-bearing demand deposits							4,973			6,742
		Total cash and cash equivalents						27,951			18,020
	Investment securities:
		Available-for-sale, at fair value						185,338			136,244
		Held-to-maturity, at cost						6,071			-
	Federal Reserve Bank and Federal Home Loan Bank stock, at cost							3,031			3,028
	Loans, net							451,951			451,343
	Premises and equipment, net							15,962			15,582
	Goodwill							5,915			5,915
	Other intangible assets, net							947			807
	Bank owned life insurance							13,802			13,485
	Other assets							5,240			5,307
				TOTAL ASSETS		$		716,208			649,731
LIABILITIES:
	Deposits –
		Noninterest-bearing				$		82,198			82,645
		Interest-bearing						532,790			494,977
			Total deposits					614,988			577,622
	Short-term borrowings							1,087			2,206
	Long-term debt							19,656			5,000
	Accrued interest and other liabilities							4,395			6,787
				TOTAL LIABILITIES				640,126			591,615
SHAREHOLDERS’ EQUITY:
	Preferred shares – no par value, authorized 1,000,000 shares,
		13,400 shares issued at June 30, 2009						12,890			-
	Common shares – no par value, authorized 8,000,000 shares,
		issued 7,445,514 shares at June 30, 2009 and December 31, 2008						11,068			11,068
	Surplus							15,390			14,792
	Retained earnings							47,540			46,584
	Treasury shares at cost, 758,282 shares at June 30, 2009 and
		December 31, 2008						(11,737)			(11,737)
	Accumulated other comprehensive income (loss), net of taxes							931			(2,591)
				TOTAL SHAREHOLDERS’ EQUITY				76,082			58,116
				TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$		716,208			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				Six Months Ended
					June 30,				June 30,
					2009		2008		2009		2008
INTEREST INCOME:
	Interest and fees on loans			$	6,820		7,211		13,696		14,735
	Dividends on Federal Reserve Bank
		and Federal Home Loan Bank stock			51		52		75		78
	Interest on investment securities –
		Taxable			1,062		554		2,133		1,022
		Non-taxable			710		483		1,334		929
	Other short-term investments				16		164		28		315
			TOTAL INTEREST INCOME		8,659		8,464		17,266		17,079
INTEREST EXPENSE:
	Interest on deposits				2,370		3,214		4,991		6,776
	Interest on short-term borrowings				-		4		-		8
	Interest on long-term debt				156		66		263		131
			TOTAL INTEREST EXPENSE		2,526		3,284		5,254		6,915
			NET INTEREST INCOME		6,133		5,180		12,012		10,164
	PROVISION FOR LOAN LOSSES				208		51		306		134
			NET INTEREST INCOME AFTER
			PROVISION FOR LOAN LOSSES		5,925		5,129		11,706		10,030
NON-INTEREST INCOME:
	Trust income				433		493		914		978
	Service charges and fees				1,003		1,064		1,938		2,024
	Insurance agency income				392		444		758		860
	Bank owned life insurance income				158		132		316		262
	Gains from sales of mortgage loans				194		-		331		7
	Other operating income				31		31		84		96
			TOTAL NON-INTEREST INCOME		2,211		2,164		4,341		4,227
NON-INTEREST EXPENSE:
	Salaries and wages				2,372		2,230		4,724		4,445
	Pension and other employee benefits				614		584		1,276		1,202
	Equipment expenses				243		243		487		475
	Occupancy expense, net				380		417		862		819
	State franchise tax				156		165		318		331
	Marketing				128		109		241		211
	Intangible amortization				27		121		55		243
	FDIC premiums				584		15		609		31
	Write-off of pension asset				-		-		722		-
	Other non-interest expense				1,263		1,118		2,390		2,290
			TOTAL NON-INTEREST EXPENSE		5,767		5,002		11,684		10,047
			INCOME BEFORE INCOME TAXES		2,369		2,291		4,363		4,210
PROVISION FOR INCOME TAXES					529		593		960		1,068
			NET INCOME		1,840		1,698		3,403		3,142
PREFERRED STOCK DIVIDENDS AND   DISCOUNT ACCRETION					206		-		308		-
			NET INCOME AVAILABLE TO COMMON SHAREHOLDERS	$	1,634		1,698		3,095		3,142
Dividends declared per common share				$	0.16		0.16		0.32		0.32
Earnings per common share:
	Basic			$	0.24		0.25		0.46		0.47
	Diluted				0.24		0.25		0.46		0.47
Average common shares outstanding:
	Basic				6,687,232		6,687,232		6,687,232		6,687,232
	Diluted				6,693,084		6,687,232		6,687,232		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					Six Months Ended
								June 30,					June 30,
								2009			2008		2009		2008
Net Income							$	1,840			1,698		3,403		3,142
Other comprehensive income (loss):
	Net unrealized gain (loss) on available-for-sale securities (net of taxes of $299 and $525 for the three months ended June 30, 2009 and 2008, respectively, and $246 and $213 for the six months ended June 30, 2009 and 2008, respectively)							587			(1,020)		485		(415)
	Reversal of pension plan unrecognized net loss  (net of taxes of $1,564)							-			-		3,037		-
	Recognition of pension plan net loss (net of taxes of $11 and $21 for the three and six months ended June 30, 2008, respectively)							-			21		-		40
		TOTAL COMPREHENSIVE INCOME					$	2,427			699		6,925		2,767
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												3,403						3,403
Issuance of preferred stock and related warrants						12,817				583								13,400
Net unrealized gain on available-for-sale   securities, net of tax																485		485
Reversal of pension plan unrecognized net   loss, net of tax																3,037		3,037
Compensation expense relating to stock options										15								15
Preferred stock dividends and discount   accretion						73						(308)						(235)
Common stock dividends, $0.32 per share												(2,139)						(2,139)
Balance June 30, 2009				6,687,232	$	12,890		11,068		15,390		47,540		(11,737)		931		76,082
Balance January 1, 2008				6,687,232	$	-		11,068		14,761		44,261		(11,737)		(1,825)		56,528
Net income												3,142						3,142
Net unrealized loss on available-for-sale   securities, net of tax																(415)		(415)
Change in pension plan unrecognized net loss,   net of tax																40		40
Compensation expense relating to stock   options										15								15
Common stock dividends, $0.32 per share												(2,140)						(2,140)
Balance June 30, 2008				6,687,232	$	-		11,068		14,776		45,263		(11,737)		(2,200)		57,170
			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)
									Six Months Ended
									June 30,
									2009		2008
CASH FLOWS FROM OPERATING ACTIVITIES:
		Net income						$	3,403		3,142
		Adjustments to reconcile net income to net cash flows from operating activities-
				Depreciation, amortization, and accretion					1,050		1,119
				Provision for loan losses					306		134
				Federal Home Loan Bank stock dividends					-		(54)
				Increase in cash surrender value of bank owned life insurance					(316)		(262)
				Origination of mortgage loans for sale					(23,552)		(733)
				Realized gains from sales of mortgage loans					(331)		(7)
				Proceeds from sales of mortgage loans					23,650		732
				Compensation expense related to stock options					15		15
				Increase (decrease) due to changes in assets and liabilities:
				Income receivable					(342)		(99)
				Other assets					(1,325)		(89)
				Other liabilities					2,044		(341)
						NET CASH FLOWS FROM OPERATING ACTIVITIES			4,602		3,557
CASH FLOWS FROM INVESTING ACTIVITIES:
		Proceeds from maturities and calls of investment securities							41,495		15,906
		Purchases of investment securities							(96,165)		(31,501)
		Purchase of Federal Reserve Bank stock							(3)		(215)
		Net (increase) decrease in loans							(1,076)		87
		Proceeds from sale of other real estate acquired through foreclosure							-		877
		Additions to other real estate acquired through foreclosure							-		(37)
		Proceeds from sale of repossessed assets							72		-
		Purchases of premises and equipment							(941)		(380)
		Proceeds from sales of premises and equipment							18		2
						NET CASH FLOWS FROM INVESTING ACTIVITIES			(56,600)		(15,261)
CASH FLOWS FROM FINANCING ACTIVITIES:
		Net increase (decrease) in deposits							37,366		30,774
		Net increase (decrease) in short-term borrowings							(1,119)		388
		Proceeds from long-term debt							15,000		-
		Principal payments on long-term debt							(344)		-
		Proceeds from issuance of preferred stock							13,400		-
		Cash dividends paid on common stock							(2,139)		(2,140)
		Cash dividends paid on preferred stock							(235)		-
						NET CASH FLOWS FROM FINANCING ACTIVITIES			61,929		29,022
						NET CHANGE IN CASH AND CASH EQUIVALENTS			9,931		17,318
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD									18,020		31,190
CASH AND CASH EQUIVALENTS AT END OF PERIOD								$	27,951		48,508
SUPPLEMENTAL CASH FLOW INFORMATION:
CASH PAID DURING THE YEAR FOR:
		Interest						$	5,366		7,011
		Income taxes							900		1,100
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 August 3, 2009, the date the financial statements were issued.

Results of operations for the three and six months ended June 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 June 30, 2009 and December 31, 2008 are summarized as follows (in thousands):

 

	June 30, 2009
		Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
U.S. Treasury notes	$	5,350		33		-		5,383
U.S. Agency notes		31,892		399		49		32,242
U.S. Agency mortgage-backed securities		55,587		1,028		284		56,331
Corporate securities		7,425		125		14		7,536
Municipal securities:
Non-taxable		76,741		809		839		76,711
Taxable		5,866		145		3		6,008
Trust preferred securities		497		70		-		567
Other debt securities		531		-		5		526
Marketable equity securities		38		-		4		34
	$	183,927		2,609		1,198		185,338

	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 municipal securities, approximates amortized cost at June 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 June 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	$	10,353		49		-		-
U.S. Agency mortgage-    backed securities		19,276		283		47		1
Corporate securities		1,020		14		-		-
Municipal securities:
Non-taxable		30,464		795		763		44
Taxable		658		3		-		-
Other debt securities		-		-		526		5
Marketable equity securities		34		4		-		-
	$	61,805		1,148		1,336		50

The unrealized losses 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 June 30, 2009.

9

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 3 - Loans

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

			June 30,		December 31,
			2009			2008
Commercial and industrial		$	42,149				38,724
Commercial, secured by real estate			178,349				174,493
Residential real estate			191,614				194,039
Consumer			29,206				33,369
Agricultural			3,120				3,216
Other loans, including deposit overdrafts			9,474				9,203
			453,912				453,044
Deferred net origination costs			639				767
			454,551				453,811
Less allowance for loan losses			2,600				2,468
	Loans, net	$	451,951				451,343

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

			Six Months Ended
			June 30,
			2009			2008
Balance, beginning of period		$	2,468			2,468
Provision for loan losses			306			134
Charge-offs			(393)			(363)
Recoveries			219			229
	Balance, end of period	$	2,600			2,468

Charge-offs for the six months ended June 30, 2009 and 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 June 30, 2009 and December 31, 2008 were as follows (in thousands):

			June 30,		December 31,
			2009			2008
Non-accrual loans		$	3,550			2,281
Past-due 90 days or more and still accruing			558			806
Restructured loans			2,477			332
	Total	$	6,585			3,419
Percent to total loans			1.45%			0.75%

Non-accrual loans at June 30, 2009 consisted primarily of five commercial real estate loans.  One of the loans was also included in non-accrual loans at December 31, 2008.  Its balance was $2,063,000 and $2,149,000 at June 30, 2009 and December 31, 2008, respectively.  The balance decreased because the borrower entered into a third party short-term lease agreement during the fourth quarter 2008 whereby substantially all of the lease payment proceeds are remitted to LCNB.  The borrower is continuing efforts to sell the property.  Non-accrual loans at June 30, 2009 also included two commercial real estate loans totaling $652,000 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.  The remaining balance of non-accrual loans at June 30, 2009 and December 31, 2008 consisted primarily of residential real estate mortgage loans.  

Loans past-due 90 days or more and still accruing interest at June 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 restructured during the first quarter 2009.  Its balance at June 30, 2009 was $2,170,000.  Restructured loans at June 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 June 30, 2009 and December 31, 2008 (in thousands):

		June 30,		December 31,
		2009		2008
Impaired loans without a valuation allowance	$	1,489			2,451
Impaired loans with a valuation allowance		5,873			3,121
Total impaired loans		7,362			5,572
Valuation allowance related to impaired loans	$	849			630

Loans sold to and serviced for others are not included in the accompanying balance sheets.  The unpaid principal balances of those loans at June 30, 2009 and December 31, 2008 were $57,027,000 and $37,783,000, respectively.  Loans sold to the Federal Home Loan Mortgage Corporation during the three and six months ended June 30, 2009 totaled $13,518,000 and $23,552,000, respectively, and $90,000 and $733,000 during the three and six months ended June 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 half of 2009.

Note 4 – Borrowings

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

	Current
	Interest	June 30,				December 31,
	Rate		2009				2008
Fixed Rate Advances, due at maturity:
Advance due February 2011	2.10%	$	5,000				-
Advance due March 2017	5.25%		5,000				5,000
Fixed Rate Advances, with monthly   principal and interest payments:
Advance due February 2014	2.45%		4,764				-
Advance due February 2019	2.82%		4,892				-
		$	19,656				5,000

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 4 – Borrowings (continued)

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.

An additional $6.0 million was borrowed from the Federal Home Loan Bank of Cincinnati during July 2009.  The new advance has a three-year maturity and a fixed interest rate of 1.99%.

Short-term borrowings at June 30, 2009 and December 31, 2008 consisted of U.S. Treasury demand note borrowings of approximately $1,087,000 and $2,206,000, respectively.  The U.S. Treasury was not charging interest at June 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.

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

			June 30,			December 31,
			2009				2008
	Commitments to extend credit:
	Commercial loans	$	4,381				4,376
	Other loans
	Fixed rate		5,685				1,033
	Adjustable rate		1,152				302
	Unused lines of credit:
	Fixed rate		2,842				2,807
	Adjustable rate		70,667				70,647
	Unused overdraft protection amounts on
	Demand and NOW accounts		10,318				10,408
	Standby letters of credit		8,082				8,138
		$	103,127				97,711

13

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 5 – Commitments and Contingent Liabilities (continued)

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 June 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 June 30, 2009 and December 31, 2008 was approximately $6.3 million.  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.

Material commitments for capital expenditures outstanding as of June 30, 2009 totaled approximately $290,000 and related primarily to the construction of a new branch facility in South Lebanon, Ohio.

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

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

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.  

14

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 6 – Regulatory Capital (continued)

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.

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

15

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 6 – Regulatory Capital (continued)

				At			At
				June 30,		December 31,
				2009			2008
Regulatory Capital:
	Shareholders' equity		$	76,082			58,116
	Goodwill and other intangibles			(6,561)			(6,600)
	Accumulated other comprehensive (income) loss			(870)			2,591
		Tier 1 risk-based capital		68,651			54,107
Eligible allowance for loan losses				2,600			2,468
		Total risk-based capital	$	71,251			56,575
Capital ratios:
	Total risk-based (required 8.00%)			15.15%			12.61%
	Tier 1 risk-based (required 4.00%)			14.60%			12.06%
	Leverage (required 3.00%)			9.70%			8.19%

Note 7 – Employee Benefits

Effective January 1, 2009, LCNB redesigned its 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, in accordance with SFAS No. 87, “Employers’ Accounting for Pensions,” 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.  

16

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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 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.

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.  

Funding and administrative costs of the noncontributory defined benefit retirement plan charged to pension and other employee benefits in the consolidated statements of income for the three and six months ended June 30, 2009 were $40,000 and $72,000, respectively.  Matching contributions to the 401-K plan during the three and six months ended June 30, 2009 were $3,000 and $6,000 respectively.  Expense recognized during the three and six months ended June 30, 2009 for the nonqualified defined benefit retirement plan was $127,000 and $244,000, respectively.

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

	For the Three Months				For the Six Months
	Ended June 30, 2008				Ended June 30, 2008
Service cost	$	186				373
Interest cost		140				280
Expected return on plan assets		(133)				(264)
Amortization of net loss		32				61
Net periodic pension cost		225				450

17

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

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 June 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 June 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		-

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

		Six Months ended June 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, June 30,		78,242		$ 13.04		49,132		$ 15.43
Exercisable,  June 30,		29,954		$ 15.73		22,339		$ 15.60

At June 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 $25,000.  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 value of the Company’s stock.

18

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 8 - Stock Options (continued)

The estimated weighted-average fair value of the options granted in the first quarter of 2009 and 2008 were $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 six months ended June 30, 2009 were $9,000 and $15,000, respectively and $7,000 and $15,000 for the three and six months ended June 30, 2008, respectively.  

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 (in thousands, except share and per share data):

						For the Three Months										For the Six Months
							Ended June 30,										Ended June 30,
					2009				2008					2009					2008
Net income available to common shareholders		$			1,634				1,698					3,095					3,142
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					5,852				-					-					-
Adjusted weighted average number of shares outstanding used in the calculation of diluted earnings per common share					6,693,084				6,687,232					6,687,232					6,687,232
Basic earnings per common share		$			0.24				0.25					0.46					0.47
Diluted earnings per common share		$			0.24				0.25					0.46					0.47

19

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 10 - Fair Value of Financial Instruments

The fair value hierarchy requires an entity to prioritize the inputs to valuation techniques used to measure fair value.  The three broad input levels are:

·

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.   

The majority of LCNB’s financial debt securities are classified as available-for-sale.  The securities are reported at fair value with unrealized holding gains and losses reported net of income taxes in accumulated other comprehensive income.  

LCNB utilizes a pricing service for determining the fair values of most of its investment securities.  Fair value for Corporate Securities is 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 $526,000 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 at a level 3 input level.  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.  

20

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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 financial assets and liabilities measured on a recurring basis by the input levels defined by the fair value hierarchy as of June 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)
June 30, 2009
Available-for-sale     securities		$	185,338			13,266			171,546			526
December 31, 2008
Available-for-sale   Securities		$	136,244			1,057			132,731			2,456

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 six months ended June 30, 2009 and 2008 (000’s):

						For the Three Months										For the Six Months
							Ended June 30,										Ended June 30,
					2009				2008					2009					2008
Beginning balance		$			523				2,092					2,456					1,592
Purchases																			500
Tax-exempt municipal securities reclassified   as  held-to-maturity														(1,944)					-
Dividends reinvested					5				6					10					11
Net change in unrealized gains (losses)   included in other comprehensive incom					(2)				(11)					4					(16)
Ending balance		$			526				2,087					526					2,087

21

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 10 - Fair Value Measurements (continued)

Assets that may be recorded at fair value on a nonrecurring basis include impaired loans, real estate acquired through foreclosure, 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 valuation is considered a level 2 fair value.  When an appraised value is not available and there is not an observable market price, the resulting valuation is considered a level 3 fair value.  

Real estate acquired through foreclosure 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.  A valuation based on current appraised value is considered a level 2 fair value.

The following table presents LCNB’s impaired loans, real estate acquired through foreclosure, and repossessed assets measured at fair value on a nonrecurring basis as of June 30, 2009 and December 31, 2008 by the level in the fair value hierarchy within which those measurements fall (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)
June 30, 2009
Impaired loans		$	5,025			-			-			5,025
Real estate acquired   through foreclosure			39			-			39			-
Totals		$	5,064			-			39			5,025
December 31, 2008
Impaired loans		$	2,491			-			-			2,491
Real estate acquired   through foreclosure			39			-			39			-
Repossessed assets			50			-			50			-
Totals		$	2,580			-			89			2,491

22

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 10 - Fair Value Measurements (continued)

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

		June 30, 2009				December 31, 2008
		Carrying		Fair		Carrying		Fair
		Amount		Value		Amount		Value
FINANCIAL ASSETS:
Cash and cash equivalents	$	27,951		27,951		18,020		18,020
Securities available for sale		185,338		185,338		136,244		136,244
Securities held to maturity		6,071		6,071		-		-
Federal Reserve Bank and     Federal Home Loan Bank stock		3,031		3,031		3,028		3,028
Loans, net		451,951		464,969		451,343		465,201
FINANCIAL LIABILITIES:
Deposits		614,988		619,090		577,622		581,536
Short-term borrowings		1,087		1,087		2,206		2,206
Long-term debt		19,656		21,061		5,000		5,493

The fair value of off-balance-sheet financial instruments at June 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.

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.

23

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 10 - Fair Value Measurements (continued)

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.

Note 11 – Recent Accounting Pronouncements

Statement of Financial Accounting Standards (“SFAS”) No. 166, “Accounting for Transfers of Financial Assets” and SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” were issued by the Financial Accounting Standards Board on June 12, 2009.  Both standards will be effective at the start of a company’s first fiscal year beginning after November 15, 2009.

SFAS No. 166 is a revision to SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.”  It 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.

24

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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, 2009, and the related consolidated statements of income and comprehensive income for each of the three-month and six-month periods ended June 30, 2009 and 2008, and the related consolidated statements of shareholders’ equity and cash flows for each of the six-month periods ended June 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

August 3, 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 $1,624,000 or $0.24 basic and diluted earnings per common share and $3,095,000 or $0.46 basic and diluted earnings per common share for the three and six-month periods ended June 30, 2009, respectively.  Net income available to common shareholders was $1,698,000 or $0.25 basic and diluted earnings per common share and $3,142,000 or $0.47 basic and diluted earnings per common share for the comparable periods in 2008.  The decline in net income to common shareholders and earnings per common share were due, in part, to preferred stock dividends paid and related discount accretion recorded in connection with the preferred shares and warrant issued under the Captal Purchase Program (the “CPP”) on January 9, 2009.

LCNB’s net income was $1,840,000 for the three months ended June 30, 2009, compared to $1,698,000 for the three months ended June 30, 2008.  The return on average assets (ROAA) for the second quarter, 2009 was 1.03% and the return on average total equity (ROAE) was 9.64%, compared with an ROAA of 1.08% and an ROAE of 11.71% for the second quarter of 2008.  LCNB’s net income was $3,403,000 during the first six months of 2009 compared to $3,142,000 for the first six months of 2008.  The ROAA and ROAE for the first six months of 2009 were 0.98% and 9.07%, respectively.  The comparable ratios for the first six months of 2008 were 1.02% and 10.91%, respectively.  

The increase in net income for each of the three and six months periods ended June 30, 2009 compared to 2008 was primarily attributed to an increase in net interest income, partially offset by increases in non-interest expense and the provision for loan losses.  Net interest income grew during the three and six month periods of 2009 primarily because of growth in interest earning assets and a general market decline in interest rates.  Non-interest expenses during 2009 were influenced by standard 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.  

26

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LCNB CORP. AND SUBSIDIARIES

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

Operations (continued)

While not immune from the effects of weakening economic conditions, LCNB’s earnings reflect continued strong asset quality resulting from responsible underwriting and lending practices.  Consequently, net charge-offs for the first half of 2009 and 2008 totaled $174,000 and $134,000, respectively.  Non-accrual loans and loans past due 90 days or more and still accruing interest totaled $4,108,000 or 0.90% of total loans at June 30, 2009, compared to $3,087,000 or 0.68% of total loans at December 31, 2008.

Net Interest Income

Three Months Ended June 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 June 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 June 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)		$	448,623	$	6,820		6.10%	$	448,092		$	7,211		6.45%
Federal funds sold and interest-   bearing demand deposits			24,113		16		0.27%		29,025			151		2.09%
Interest-bearing deposits in banks			-		-		-%		2,198			13		2.37%
Federal Reserve Bank stock			940		28		11.95%		890			24		10.82%
Federal Home Loan Bank stock			2,091		23		4.41%		2,036			28		5.52%
Investment securities:
	Taxable		109,623		1,062		3.89%		49,541			554		4.49%
	Non-taxable (2)		70,827		1,076		6.09%		48,750			732		6.02%
	Total earnings assets		656,217		9,025		5.52%		580,532			8,713		6.02%
Non-earning assets			61,882						50,929
Allowance for loan losses			(2,507)						(2,477)
	Total assets	$	715,592					$	628,984
Interest-bearing deposits		$	529,517		2,370		1.80%	$	477,268			3,214		2.70%
Short-term borrowings			810		-		-%		927			4		1.73%
Long-term debt			19,771		156		3.16%		5,000			66		5.29%
	Total interest-bearing liabilities		550,098		2,526		1.84%		483,195			3,284		2.73%
Demand deposits			84,948						83,084
Other liabilities			3,967						4,500
Capital			76,579						58,205
	Total liabilities and capital	$	715,592					$	628,984
Net interest rate spread (3)							3.68%							3.29%
Net interest income and net   interest margin on a taxable-   equivalent basis (4)				$	6,499		3.97%				$	5,429		3.75%
Ratio of interest-earning assets to   interest-bearing liabilities			119.29%						120.14%

(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.