LCNB CORP - Quarter Report: 2011 September (Form 10-Q)

form10q.htm

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, 2011

o	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 incorporation or organization)		(I.R.S. Employer Identification Number)

2 North Broadway, Lebanon, Ohio 45036

(Address of principal executive offices, including Zip Code)

(513) 932-1414

(Registrant's telephone number, including area code)

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

x Yes o 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).

x Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

	Large accelerated filer o	Accelerated filer x
	Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company o

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

o Yes x No

The number of shares outstanding of the issuer's common stock, without par value, as of November 8, 2011 was 6,697,982 shares.

LCNB CORP. AND SUBSIDIARIES

INDEX

PART I – FINANCIAL INFORMATION	2

Item 1. Financial Statements	2


CONSOLIDATED BALANCE SHEETS	2

CONSOLIDATED STATEMENTS OF INCOME	3

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME	4

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY	5

CONSOLIDATED STATEMENTS OF CASH FLOWS	6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS	7

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	35

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	36

Item 3. Quantitative and Qualitative Disclosures about Market Risks	46

Item 4. Controls and Procedures	47

PART II. OTHER INFORMATION	48

Item 1. Legal Proceedings	48

Item 1A. Risk Factors	48

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	48

Item 3. Defaults Upon Senior Securities	48

Item 4. (Removed and Reserved)	48

Item 5. Other Information	48

Item 6. Exhibits	49

SIGNATURES	50

Index

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

	September 30,			December 31,
	2011			2010
	(Unaudited)
ASSETS:
Cash and due from banks	$	17,577			10,817
Interest-bearing demand deposits		15,080			182
Total cash and cash equivalents		32,657			10,999
Investment securities:
Available-for-sale, at fair value		268,017			235,882
Held-to-maturity, at cost		11,133			12,141
Federal Reserve Bank stock, at cost		941			939
Federal Home Loan Bank stock, at cost		2,091			2,091
Loans, net		446,295			452,350
Premises and equipment, net		17,496			16,017
Goodwill		5,915			5,915
Bank owned life insurance		14,689			14,242
Other assets		9,325			9,558
TOTAL ASSETS	$	808,559			760,134

LIABILITIES:
Deposits:
Noninterest-bearing	$	102,348			98,994
Interest-bearing		587,349			539,545
Total deposits		689,697			638,539
Short-term borrowings		12,386			21,691
Long-term debt		21,718			23,120
Accrued interest and other liabilities		7,298			6,077
TOTAL LIABILITIES		731,099			689,427

SHAREHOLDERS’ EQUITY:
Preferred shares – no par value, authorized 1,000,000 shares, none outstanding		-			-
Common shares – no par value, authorized 12,000,000 shares,issued 7,453,173 shares at September 30, 2011 and 7,445,514 shares at December 31, 2010		11,081			11,068
Surplus		15,566			15,447
Retained earnings		56,995			54,045
Treasury shares at cost, 755,771 shares at September 30, 2011 and December 31, 2010		(11,698	)		(11,698	)
Accumulated other comprehensive income, net of taxes		5,516			1,845
TOTAL SHAREHOLDERS’ EQUITY		77,460			70,707

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	808,559			760,134

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

Index

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,
	2011		2010		2011		2010
INTEREST INCOME:
Interest and fees on loans	$	6,294		6,748		19,289		20,379
Interest on investment securities –
Taxable		1,036		913		2,826		2,725
Non-taxable		619		773		1,966		2,364
Other investments		27		38		124		138
TOTAL INTEREST INCOME		7,976		8,472		24,205		25,606

INTEREST EXPENSE:
Interest on deposits		1,371		1,902		4,454		5,806
Interest on short-term borrowings		6		6		23		19
Interest on long-term debt		160		173		499		523
TOTAL INTEREST EXPENSE		1,537		2,081		4,976		6,348
NET INTEREST INCOME		6,439		6,391		19,229		19,258
PROVISION FOR LOAN LOSSES		588		268		1,476		987

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		5,851		6,123		17,753		18,271

NON-INTEREST INCOME:
Trust income		553		479		1,572		1,389
Service charges and fees on deposit accounts		957		1,009		2,810		2,940
Net gain on sales of securities		273		48		692		176
Bank owned life insurance income		153		148		447		1,245
Gains from sales of mortgage loans		35		195		92		243
Other operating income		79		49		224		202
TOTAL NON-INTEREST INCOME		2,050		1,928		5,837		6,195

NON-INTEREST EXPENSE:
Salaries and employee benefits		2,983		2,861		8,990		8,400
Equipment expenses		288		222		745		646
Occupancy expense, net		443		456		1,305		1,421
State franchise tax		190		173		582		528
Marketing		145		118		370		320
Intangible amortization		15		15		43		43
FDIC insurance premiums		95		269		563		716
Other non-interest expense		1,294		1,426		3,984		3,891
TOTAL NON-INTEREST EXPENSE		5,453		5,540		16,582		15,965
INCOME BEFORE INCOME TAXES		2,448		2,511		7,008		8,501
PROVISION FOR INCOME TAXES		581		561		1,640		1,725
INCOME FROM CONTINUING OPERATIONS		1,867		1,950		5,368		6,776
INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAX		-		39		793		177
NET INCOME	$	1,867		1,989		6,161		6,953

Dividends declared per common share	$	0.16		0.16		0.48		0.48

Basic earnings per common share:
Continuing operations	$	0.28		0.30		0.80		1.02
Discontinued operations		-		-		0.12		0.02

Diluted earnings per common share:
Continuing operations	$	0.28		0.30		0.80		1.02
Discontinued operations		-		-		0.12		0.02

Weighted average common shares outstanding:
Basic		6,690,963		6,687,232		6,690,157		6,687,232
Diluted		6,750,807		6,740,884		6,746,568		6,737,965

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

Index

LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2011			2010			2011			2010

Net Income	$	1,867			1,989			6,161			6,953

Other comprehensive income:

Net unrealized gain on available-for-sale securities (net of taxes of $1,348 and $719 for the three months ended September 30, 2011 and 2010, respectively, and $2,054 and $1,554 for the nine months ended September 30, 2011 and 2010, respectively)		2,618			1,396			3,969			3,017

Reclassification adjustment for net realized gain on sale of available-for-sale securities included in net income (net of taxes of $92 and $17 for the three months ended September 30, 2011 and 2010, respectively, and $235 and $61 for the nine months ended September 30, 2011 and 2010, respectively)		(181	)		(31	)		(457	)		(115	)

Change in nonqualified pension plan unrecognized net loss (net of taxes of $3 and $9 for the three and nine months ended September 30, 2011, respectively)		5			-			17			-

Reclassification adjustment for recognition of nonqualified pension plan net loss (net of taxes of $3 and $7 for the three and nine months ended September 30, 2011, respectively)		(5	)		-			(13	)		-

Nonqualified pension plan curtailment (net of taxes of $80)		-			-			155			-

TOTAL COMPREHENSIVE INCOME	$	4,304			3,354			9,832			9,855

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

Index

LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Dollars in thousands, except per share amounts)

(Unaudited)

	Common Shares Outstanding		Common Stock		Surplus		Retained Earnings			Treasury Shares			Accumulated Other Comprehensive Income			Total Shareholders’ Equity

Balance January 1, 2010		6,687,232	$	11,068		15,407		48,962			(11,737	)		1,915			65,615
Net income								6,953									6,953
Net unrealized gain on available-for-sale securities, net of taxes														3,017			3,017
Reclassification adjustment for net realized gain on sale of available-for-sale securities included in net income, net of taxes														(115	)		(115	)
Compensation expense relating to stock options						30											30
Common stock dividends, $0.48 per share								(3,210	)								(3,210	)
Balance September 30, 2010		6,687,232		11,068		15,437		52,705			(11,737	)		4,817			72,290

Balance January 1, 2011		6,689,743	$	11,068		15,447		54,045			(11,698	)		1,845			70,707
Net income								6,161									6,161
Net unrealized gain on available-for-sale securities, net of taxes														3,969			3,969
Reclassification adjustment for net realized gain on sale of available-for-sale securities included in net income, net of taxes														(457	)		(457	)
Change in nonqualified pension plan unrecognized net gain (loss), net of taxes														17			17
Reclassification adjustment for recognition of nonqualified pension plan net gain, net of taxes														(13	)		(13	)
Nonqualified pension plan curtailment entry, net of taxes														155			155
Dividend Reinvestment and Stock Purchase Plan		7,659		13		84											97
Compensation expense relating to stock options						35											35
Common stock dividends, $0.48 per share								(3,211	)								(3,211	)
Balance September 30, 2011		6,697,402		11,081		15,566		56,995			(11,698	)		5,516			77,460

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

Index

LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)

	Nine Months Ended
	September 30,
	2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	6,161			6,953
Adjustments to reconcile net income to net cash flows from operating activities:
Depreciation, amortization, and accretion		2,137			2,007
Provision for loan losses		1,476			987
Curtailment charge for nonqualified defined benefit retirement plan		191			-
Increase in cash surrender value of bank owned life insurance		(447	)		(453	)
Bank owned life insurance death benefits in excess of cash surrender value		-			(792	)
Realized (gain) loss on sales of securities available-for-sale		(692	)		(176	)
Realized (gain) loss on sales of premises and equipment		(6	)		16
Realized gain from sale of insurance agency		(1,503	)		-
Realized gain from sale of repossessed assets		(48	)		(18	)
Origination of mortgage loans for sale		(4,871	)		(12,512	)
Realized gains from sales of mortgage loans		(92	)		(243	)
Proceeds from sales of mortgage loans		4,911			12,624
Compensation expense related to stock options		35			30
Partial charge-off of other real estate owned		-			389
Changes in:
Accrued income receivable		(458	)		(366	)
Other assets		31			(63	)
Other liabilities		(119	)		111
NET CASH FLOWS FROM OPERATING ACTIVITIES		6,706			8,494

CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of investment securities available-for-sale		28,470			12,591
Proceeds from maturities and calls of investment securities:
Available-for-sale		43,123			46,839
Held-to-maturity		3,658			3,989
Purchases of investment securities:
Available-for-sale		(98,750	)		(77,025	)
Held-to-maturity		(2,650	)		(3,435	)
Purchase of Federal Reserve Bank stock		(2	)		-
Proceeds from redemption of Federal Reserve Bank stock		-			1
Net (increase) decrease in loans		4,255			1
Proceeds from bank owned life insurance death benefits		-			1,269
Proceeds from sale of repossessed assets		295			137
Purchases of premises and equipment		(2,323	)		(919	)
Proceeds from sales of premises and equipment		16			16
Proceeds from sale of insurance agency, net of cash disposed		1,523			-
NET CASH FLOWS FROM INVESTING ACTIVITIES		(22,385	)		(16,536	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits		51,158			48,216
Net increase (decrease) in short-term borrowings		(9,305	)		(7,468	)
Proceeds from long-term debt		5,000			-
Principal payments on long-term debt		(6,402	)		(1,493	)
Issuance of common stock		97			-
Cash dividends paid on common stock		(3,211	)		(3,210	)
NET CASH FLOWS FROM FINANCING ACTIVITIES		37,337			36,045

NET CHANGE IN CASH AND CASH EQUIVALENTS		21,658			28,003
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		10,999			12,626
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	32,657			40,629

SUPPLEMENTAL CASH FLOW INFORMATION:
CASH PAID DURING THE YEAR FOR:
Interest	$	5,096			6,385
Income taxes		2,844			2,331

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES:
Transfer from loans to other real estate owned and repossessed assets		229			170

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

Index

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 subsidiary, LCNB National Bank (the "Bank"). The accompanying unaudited consolidated financial statements include the accounts of LCNB and the Bank. LCNB completed the sale of its subsidiary, Dakin Insurance Agency, Inc. (“Dakin”) on March 23, 2011. The financial results of Dakin are included as income from discontinued operations, net of tax, in the accompanying unaudited consolidated financial statements through the date of sale.

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.

Results of operations for the three and nine months ended September 30, 2011 are not necessarily indicative of the results to be expected for the full year ending December 31, 2011. 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 2010 Annual Report on Form 10-K filed with the SEC.

Index

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, 2011 and December 31, 2010 are summarized as follows (in thousands):

	September 30, 2011
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
U.S. Treasury notes	$	17,437		115		33		17,519
U.S. Agency notes		102,302		1,807		9		104,100
U.S. Agency mortgage-backed securities		46,139		1,615		82		47,672
Corporate securities		6,361		23		25		6,359
Municipal securities:
Non-taxable		63,305		4,005		11		67,299
Taxable		21,581		851		32		22,400
Mutual funds		1,588		28		-		1,616
Trust preferred securities		549		45		19		575
Equity securities		476		17		16		477
	$	259,738		8,506		227		268,017

	December 31, 2010
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value

U.S. Treasury notes	$	19,724		16		155		19,585
U.S. Agency notes		83,600		107		845		82,862
U.S. Agency mortgage-backed securities		31,786		1,364		56		33,094
Corporate securities		2,012		13		-		2,025
Municipal securities:
Non-taxable		71,902		2,642		116		74,428
Taxable		22,049		302		383		21,968
Mutual fund		1,063		-		10		1,053
Trust preferred securities		549		57		2		604
Equity securities		249		18		4		263
	$	232,934		4,519		1,571		235,882

The fair value of held-to-maturity investment securities, consisting of taxable and non-taxable municipal securities, approximates amortized cost at September 30, 2011 and December 31, 2010.

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 2 - Investment Securities (continued)

Substantially all securities in unrealized loss positions at September 30, 2011 have been in a loss position less than twelve months. Management has determined that the unrealized losses at September 30, 2011 are primarily due to fluctuations in market interest rates and do not reflect credit quality deterioration of the securities. Because LCNB does not have the intent to sell the investments and it is more likely than not that LCNB will not be required to sell the investments before recovery of their amortized cost bases, which may be at maturity, LCNB does not consider these investments to be other-than-temporarily impaired.

Note 3 - Loans

Major classifications of loans at September 30, 2011 and December 31, 2010 are as follows (in thousands):

	September 30,		December 31,
	2011		2010

Commercial and industrial	$	32,156		36,122
Commercial, secured by real estate		204,174		196,136
Residential real estate		183,878		190,277
Consumer		16,047		19,691
Agricultural		3,245		2,966
Other loans, including deposit overdrafts		9,759		9,413
		449,259		454,605
Deferred net origination costs		277		386
		449,536		454,991
Less allowance for loan losses		3,241		2,641
Loans, net	$	446,295		452,350

Index

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, 2011 and December 31, 2010 were as follows (dollars in thousands):

	September 30,			December 31,
	2011			2010
Non-accrual loans	$	3,120			3,761
Past-due 90 days or more and still accruing		667			300
Restructured loans		9,605			9,088
Total	$	13,392			13,149
Percent to total loans		2.98	%		2.89	%

Non-accrual loans at September 30, 2011 decreased from the balance at December 31, 2010 primarily due to the receipt of a $594,000 guarantee payment on a Small Business Administration loan during the first quarter 2011. Restructured loans at September 30, 2011 increased from the balance at December 31, 2010 primarily due to the modification of two commercial real estate loans to the same borrower totaling $626,000 during the first quarter 2011.

Loans sold to and serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of those loans at September 30, 2011 and December 31, 2010 were $67,956,000 and $70,705,000, respectively. Loans sold to the Federal Home Loan Mortgage Corporation during the three and nine months ended September 30, 2011 totaled $2,173,000 and $4,871,000, respectively, and $9,958,000 and $12,512,000 during the three and nine months ended September 30, 2010, respectively.

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 3 – Loans (continued)

The allowance for loan losses and recorded investment in loans for the nine months ended September 30 were as follows (in thousands):

	Commercial & Industrial			Commercial, Secured by Real Estate			Residential Real Estate			Consumer			Agricultural		Other			Unallocated		Total
September 30, 2011
Allowance for loan losses:
Balance, beginning of year	$	305			1,625			459			246			-		6			-		2,641
Provision charged to expenses		499			409			501			36			-		31			-		1,476
Losses charged off		(251	)		(203	)		(371	)		(183	)		-		(100	)		-		(1,108	)
Recoveries		-			30			28			105			-		69			-		232
Balance, end of period	$	553			1,861			617			204			-		6			-		3,241

Ending balance: individually evaluated for impairment	$	337			303			93			-			-		-			-		733
Ending balance: collectively evaluated for impairment		216			1,558			524			204			-		6			-		2,508

Loans:
Ending balance	$	32,156			204,174			183,878			16,047			3,245		9,759			-		449,259
Ending balance: individually evaluated for impairment		904			11,621			596			10			-		-			-		13,131
Ending balance: collectively evaluated for impairment		31,252			192,553			183,282			16,037			3,245		9,759			-		436,128

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 3 – Loans (continued)

	Commercial & Industrial			Commercial, Secured by Real Estate			Residential Real Estate			Consumer			Agricultural		Other			Unallocated			Total
September 30, 2010
Allowance for loan losses:
Balance, beginning of year	$	546			1,628			491			313			-		9			11			2,998
Provision charged to expenses		(30	)		720			96			179			-		33			(11	)		987
Losses charged off		(289	)		(1,011	)		(111	)		(343	)		-		(109	)		-			(1,863	)
Recoveries		6			-			1			88			-		73			-			168
Balance, end of period	$	233			1,337			477			237			-		6			-			2,290

Ending balance: individually evaluated for impairment	$	-			210			-			-			-		-			-			210
Ending balance: collectively evaluated for impairment		233			1,127			477			237			-		6			-			2,080

Loans:
Ending balance	$	35,853			193,422			194,703			21,384			3,191		9,415			-			457,968
Ending balance: individually evaluated for impairment		947			10,712			533			-			-		-			-			12,192
Ending balance: collectively evaluated for impairment		34,906			182,710			194,170			21,384			3,191		9,415			-			445,776

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 3 – Loans (continued)

LCNB uses a risk-rating system to quantify loan quality. A loan is assigned to a risk category based on relevant information about the ability of the borrower to service the debt including, but not limited to, current financial information, historical payment experience, credit documentation, public information, and current economic trends. The categories used are:

Pass – loans categorized in this category are higher quality loans that do not fit any of the other categories described below.

Other Assets Especially Mentioned (OAEM) - loans in this category are currently protected but are potentially weak. These loans constitute a risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitute an undue risk in light of the circumstances surrounding a specific asset.

Substandard – loans in this category are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the possibility that LCNB will sustain some loss if the deficiencies are not corrected.

Doubtful – loans classified in this category have all the weaknesses inherent in loans classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 3 – Loans (continued)

An analysis of LCNB’s loan portfolio by credit quality indicators at September 30, 2011 and December 31, 2010 is as follows (in thousands):

	No Grade		Pass		OAEM		Substandard		Doubtful		Total
September 30, 2011
Commercial & industrial	$	1,094		26,975		1,101		2,408		578		32,156
Commercial, secured by real estate		2,831		189,346		1,292		8,592		2,113		204,174
Residential real estate		18,404		161,527		1,569		2,296		82		183,878
Consumer		405		15,504		-		117		21		16,047
Agricultural		373		1,472		-		1,400		-		3,245
Other		192		9,567		-		-		-		9,759
Total	$	23,299		404,391		3,962		14,813		2,794		449,259

December 31, 2010
Commercial & industrial	$	1,299		32,421		1,177		1,225		-		36,122
Commercial, secured by real estate		2,053		179,710		4,897		8,574		902		196,136
Residential real estate		17,346		170,900		264		1,702		65		190,277
Consumer		394		19,144		-		72		81		19,691
Agricultural		247		2,719		-		-		-		2,966
Other		116		9,297		-		-		-		9,413
Total	$	21,455		414,191		6,338		11,573		1,048		454,605

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 3 – Loans (continued)

A loan portfolio aging analysis at September 30, 2011 and December 31, 2010 is as follows (in thousands):

	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans Greater Than 90 Days and Accruing

September 30, 2011
Commercial & industrial	$	-		-		578		578		31,578		32,156		578
Commercial, secured by real estate		-		110		2,113		2,223		201,951		204,174		-
Residential real estate		440		108		887		1,435		182,443		183,878		80
Consumer		118		102		9		229		15,818		16,047		9
Agricultural		-		-		-		-		3,245		3,245		-
Other		192		-		-		192		9,567		9,759		-
Total	$	750		320		3,587		4,657		444,602		449,259		667

December 31, 2010
Commercial & industrial	$	138		-		595		733		35,389		36,122		1
Commercial, secured by real estate		753		-		1,766		2,519		193,617		196,136		114
Residential real estate		482		36		698		1,216		189,061		190,277		110
Consumer		231		54		76		361		19,330		19,691		75
Agricultural		-		-		-		-		2,966		2,966		-
Other		5		-		-		5		9,408		9,413		-
Total	$	1,609		90		3,135		4,834		449,771		454,605		300

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 3 – Loans (continued)

Impaired loans at September 30, 2011 and December 31, 2010 were as follows (in thousands):

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
September 30, 2011
With no related allowance recorded:
Commercial & industrial	$	-		-		-		-		-
Commercial, secured by real estate		6,897		6,897		-		7,009		216
Residential real estate		332		332		-		332		-
Consumer		1		1		-		1		-
Total		7,230		7,230		-		7,342		216

With an allowance recorded:
Commercial & industrial		567		904		337		1,181		44
Commercial, secured by real estate		4,421		4,724		303		4,943		117
Residential real estate		172		264		92		255		-
Consumer		8		9		1		5		-
Total		5,168		5,901		733		6,384		161

Total:
Commercial & industrial		567		904		337		1,181		44
Commercial, secured by real estate		11,318		11,621		303		11,952		333
Residential real estate		504		596		92		587		-
Consumer		9		10		1		6		-
Total	$	12,398		13,131		733		13,726		377

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 3 – Loans (continued)

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
December 31, 2010
With no related allowance recorded:
Commercial & industrial	$	594		594		-		751		9
Commercial, secured by real estate		8,350		8,350		-		9,058		372
Residential real estate		533		533		-		534		-
Total		9,477		9,477		-		10,343		381

With an allowance recorded:
Commercial & industrial		356		476		120		693		29
Commercial, secured by real estate		2,974		3,150		176		3,403		142
Residential real estate		-		-		-		-		-
Total	$	3,330		3,626		296		4,096		171

Total:
Commercial & industrial	$	950		1,070		120		1,444		38
Commercial, secured by real estate		11,324		11,500		176		12,461		514
Residential real estate		533		533		-		534		-
Total	$	12,807		13,103		296		14,439		552

Non-accrual loans at September 30, 2011 and December 31, 2010 were as follows (in thousands):

	September 30, 2011		December 31, 2010

Commercial and industrial	$	-		595
Commercial, secured by real estate		2,113		2,377
Residential real estate		1,007		789
		3,120		3,761

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 3 – Loans (continued)

Loan modifications that were classified as troubled debt restructurings during the three and nine months ended September 30, 2011 and 2010 were as follows (dollars in thousands):

	Three Months Ended September 30,								Nine Months Ended September 30,
	2011				2010				2011				2010
	Number of Loans		Balance at Modification		Number of Loans		Balance at Modification		Number of Loans		Balance at Modification		Number of Loans		Balance at Modification

Commercial and industrial		-	$	-		-	$	-		1	$	204		-	$	-
Commercial, secured by real estate		2		626		1		1,170		2		626		2		3,505
Residential real estate		-		-		-		-		5		64		-		-
Consumer		-		-		-		-		3		11		-		-
		2	$	626		1	$	1,170		11	$	905		2	$	3,505

Each restructured loan is separately negotiated with the borrower and includes terms and conditions that reflect the borrower’s ability to pay the debt as modified. Modifications may include interest only payments for a period of time, temporary or permanent reduction of the loan’s interest rate, or extensions of the maturity date.

LCNB is not committed to lend additional funds to borrowers whose loan terms were modified in a troubled debt restructuring.

Troubled debt restructurings that subsequently defaulted within twelve months of the restructuring date were as follows (dollars in thousands):

	Three Months Ended September 30,								Nine Months Ended September 30,
	2011				2010				2011				2010
	Number of Loans		Recorded Balance		Number of Loans		Recorded Balance		Number of Loans		Recorded Balance		Number of Loans		Recorded Balance

Commercial and industrial		-	$	-		-	$	-		-	$	-		1	$	595
Commercial, secured by real estate		-		-		-		-		-		-		1		750
		-	$	-		-	$	-		-	$	-		2	$	1,345

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 3 – Loans (continued)

As a result of adopting the amendments in Accounting Standards Update No. 2011-02, “Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring,” LCNB reassessed all restructurings that occurred on or after the beginning of the current fiscal year (January 1, 2011) for identification as troubled debt restructurings. LCNB identified as troubled debt restructurings certain receivables for which the allowance for credit losses had previously been measured under a general allowance for credit losses methodology. Upon identifying those receivables as troubled debt restructurings, LCNB identified them as impaired under the guidance in Section 310-10-35. The amendments in Accounting Standards Update No. 2011-02 require prospective application of the impairment measurement guidance in Section 310-10-35 for those receivables newly identified as impaired. At the end of the first interim period of adoption (September 30, 2011), the recorded investment in receivables for which the allowance for credit losses was previously measured under a general allowance for credit losses methodology and are now impaired under Section 310-10-35 was $192,000 and the allowance for credit losses associated with those receivables, on the basis of a current evaluation of loss, was $1,000.

Note 4 – Other Real Estate Owned

Other real estate owned includes property acquired through foreclosure or deed-in-lieu of foreclosure and also includes property deemed to be in-substance foreclosed and are included in “other assets” in the consolidated balance sheets. Changes in other real estate owned were as follows (in thousands):

	Nine Months Ended September 30,
	2011		2010
Balance, beginning of year	$	2,088		2,424
Additions		-		104
Reductions due to valuation write downs		-		(389	)
Balance, end of period	$	2,088		2,139

Other real estate owned at September 30, 2011 consisted of two commercial properties and one single-family residential home. Other real estate owned at September 30, 2010 consisted of two commercial properties and two single-family residential homes. Additions for the 2010 period consisted of one single family residential home.

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 5 – Borrowings

Funds borrowed from the Federal Home Loan Bank of Cincinnati at September 30, 2011 and December 31, 2010 were as follows (dollars in thousands):

	Current Interest Rate			September 30, 2011		December 31, 2010

Fixed Rate Advances, due at maturity:
Advance due February 2011		2.10	%	$	-		5,000
Advance due August 2012		1.99	%		6,000		6,000
Advance due January 2015		2.00	%		5,000		-
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	%		2,576		3,319
Advance due March 2019		2.82	%		3,142		3,801
				$	21,718		23,120

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 in the amount of approximately $143 million and $148 million at September 30, 2011 and December 31, 2010, respectively. Additionally, LCNB was required to hold minimum levels of FHLB stock, based on the outstanding borrowings.

Short-term borrowings at September 30, 2011 and December 31, 2010 are as follows (dollars in thousands):

	September 30, 2011					December 31, 2010
	Amount		Rate			Amount		Rate
U.S. Treasury demand note	$	1,038		-	%	$	1,295		-	%
Federal funds purchased		-		-	%		7,000		0.50	%
Line of credit		-		-	%		3,026		1.00	%
Repurchase agreements		11,348		0.15	%		10,370		0.30	%
	$	12,386		0.14	%	$	21,691		0.44	%

Note 6 - Commitments and Contingent Liabilities

LCNB is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments included commitments to extend credit. They involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. Exposure to credit loss in the event of nonperformance by the other parties to financial instruments for commitments to extend credit is represented by the contract amount of those instruments.

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 6 – Commitments and Contingent Liabilities (continued)

LCNB offers the Bounce Protection product, a customer deposit overdraft program, which is offered as a service and does not constitute a contract between the customer and LCNB.

LCNB uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Financial instruments whose contract amounts represent off-balance-sheet credit risk at September 30, 2011 and December 31, 2010 were as follows (in thousands):

	September 30,		December 31,
	2011		2010
Commitments to extend credit:
Commercial loans	$	8,206		1,856
Other loans
Fixed rate		2,683		1,200
Adjustable rate		1,334		480
Unused lines of credit:
Fixed rate		2,846		1,773
Adjustable rate		51,217		67,038
Unused Bounce Protection amounts on demand and NOW accounts		9,920		10,031
Standby letters of credit		5,653		6,528
	$	81,859		88,906

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, 2011 and December 31, 2010, outstanding guarantees of approximately $624,000 and $998,000, respectively, were issued to developers and contractors. These guarantees generally are fully secured and have varying maturities. In addition, LCNB has a participation in four letters of credit securing payment of principal and interest on a bond issue. The participation amounts at September 30, 2011 and December 31, 2010 totaled approximately $5.0 million and $5.5 million, respectively. The letters of credit have a final maturity date of July 15, 2014, as extended.

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.

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 6 – Commitments and Contingent Liabilities (continued)

Capital expenditures include the construction or acquisition of new office buildings, improvements to LCNB’s 26 offices, purchases of furniture and equipment, and additions or improvements to LCNB’s information technology system. Material commitments for capital expenditures outstanding as of September 30, 2011 totaled approximately $202,000.

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

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

Note 7 – Regulatory Capital

The Bank and LCNB are required by regulators to meet certain minimum levels of capital adequacy. These are expressed in the form of certain ratios. Capital is separated into Tier 1 capital (essentially shareholders' equity less goodwill and other intangibles) and Tier 2 capital (essentially the allowance for loan losses limited to 1.25% of risk-weighted assets). 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 loan commitments and 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.

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 7 – Regulatory Capital (continued)

A summary of the regulatory capital and capital ratios of LCNB follows (dollars in thousands):

	At			At
	September 30,			December 31,
	2011			2010

Regulatory Capital:
Shareholders' equity	$	77,460			70,707
Goodwill and other intangibles		(6,086	)		(6,413	)
Accumulated other comprehensive (income) loss		(5,515	)		(1,845	)
Tier 1 risk-based capital		65,859			62,449

Eligible allowance for loan losses		3,241			2,641
Total risk-based capital	$	69,100			65,090

Capital ratios:
Total risk-based (required 8.00%)		14.57	%		13.82	%
Tier 1 risk-based (required 4.00%)		13.89	%		13.26	%
Leverage (required 3.00%)		8.31	%		8.12	%

Note 8 – Employee Benefits

LCNB participates in a noncontributory defined benefit retirement multi-employer plan that covers substantially all regular full-time employees hired before January 1, 2009.

Employees of LCNB also participate in a defined contribution retirement plan. Employees hired on or after January 1, 2009 receive a 50% employer match on their contributions into the 401(k) plan, up to a maximum LCNB contribution of 3% of each individual employee’s annual compensation. Employees hired before January 1, 2009 who received a benefit reduction under certain amendments to the defined benefit retirement plan 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 is made annually and these employees do not receive any employer matches to their 401(k) contributions.

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 8 – Employee Benefits (continued)

Funding and administrative costs of the qualified noncontributory defined benefit retirement plan and 401(k) plan charged to salaries and employee benefits in the consolidated statements of income for the three and nine-month periods ended September 30, 2011 and 2010 were as follows (in thousands):

	For the Three Months				For the Nine Months
	Ended September 30,				Ended September 30,
	2011		2010		2011		2010

Qualified noncontributory defined benefit retirement plan	$	198		71		456		192

401(k) plan		75		76		232		229

Certain highly compensated employees participate in a nonqualified defined benefit retirement plan. The nonqualified plan ensures that participants receive the full amount of benefits to which they would have been entitled under the noncontributory defined benefit retirement plan in the absence of limits on benefit levels imposed by certain sections of the Internal Revenue Code.

The components of net periodic pension cost of the nonqualified defined benefit retirement plan for the three and nine months ended September 30, 2011 and 2010 are summarized as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Service cost	$	23			44			89			131
Interest cost		9			8			26			24
Amortization of unrecognized prior service cost		7			12			25			36
Amortization of unrecognized net gain		(8	)		(1	)		(20	)		(1	)
Net periodic pension cost	$	31			63			120			190

Amounts recognized in accumulated other comprehensive income, net of deferred federal income taxes, at September 30, 2011 and December 31, 2010 for the nonqualified defined benefit retirement plan consists of (in thousands):

	September 30,			December 31,
	2011			2010
Net actuarial gain	$	(103	)		(117	)
Past service cost		63			225
Total net accumulated other comprehensive (income) loss	$	(50	)		108

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 9 - Stock Based Compensation

LCNB established an Ownership Incentive Plan (the "Plan") during 2002 that allows for stock-based awards to eligible employees, as determined by the Board of Directors. 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 shares.

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, 2011 were as follows:

		Outstanding Stock Options						Exercisable Stock Options
Exercise Price Range		Number		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)		Number		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)

$	9.00 - $10.99		29,110	$	9.00		6.5		13,891	$	9.00		5.6
$	11.00 - $12.99		59,799		11.89		7.3		18,918		12.08		4.4
$	13.00 - $14.99		11,056		13.09		1.3		11,056		13.09		1.3
$	17.00 - $18.99		24,158		18.16		3.4		22,844		18.17		3.3
			124,123		12.54		5.8		66,709		13.69		3.8

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

	2011				2010
	Options		Weighted Average Exercise Price		Options		Weighted Average Exercise Price
Outstanding, January 1		99,040	$	12.71		78,242	$	13.04
Granted		25,083		11.85		20,798		11.50
Exercised		-		-		-		-
Outstanding, September 30		124,123		12.54		99,040		12.71
Exercisable, September 30		66,709		13.69		41,770		14.78

The aggregate intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) for options outstanding at September 30, 2011 that were “in the money” (market price greater than exercise price) was $217,000. The aggregate intrinsic value at that date for only the options that were exercisable was $87,000. The intrinsic value changes based on changes in the market value of LCNB’s stock.

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 9 - Stock Based Compensation (continued)

The fair value of options granted is estimated at the date of grant using the Black-Scholes option-pricing model. The following table shows the estimated weighted-average fair value and the assumptions used in calculating that value for options granted during the nine month periods ended September 30:

	2011			2010
Estimated weighted-average fair value of options granted	$	2.09			2.27
Risk-free interest rate		2.84	%		3.34	%
Average dividend yield		4.43	%		4.31	%
Volatility factor of the expected market price of LCNB's common stock		27.37	%		28.32	%
Average life in years		6.5			7.0

Total expense related to options included in salaries and employee benefits in the consolidated statements of income for the three and nine months ended September 30, 2011 were $13,000 and $35,000, respectively, and $11,000 and $30,000 for the three and nine months ended September 30, 2010, respectively.

A total of 2,511 restricted shares were granted to an executive officer in February 2010 and vested in November 2010. Until they vested, they were restricted from sale, transfer, or assignment in accordance with the terms of the agreement under which they were issued. At the date of vesting, the shares were issued from treasury stock and, therefore, did not affect the number of securities remaining available for future issuance in the table above. No restricted shares were granted prior to February 2010 or during the first nine months of 2011.

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 10 - 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, warrant, and restricted stock. The diluted average number of common shares outstanding has been increased for the assumed exercise of stock options, warrant, and restricted stock with proceeds used to purchase treasury shares at the average market price for the period. The computations were as follows for the three and nine months ended September 30, 2011 and 2010 (dollars in thousands, except share and per share data):

	For the Three Months				For the Nine Months
	Ended September 30,				Ended September 30,
	2011		2010		2011		2010

Income from continuing operations	$	1,867		1,950		5,368		6,776
Income from discontinued operations, net of tax		-		39		793		177
Net income	$	1,867		1,989		6,161		6,953

Weighted average number of shares outstanding used in the calculation of basic earnings per common share		6,690,963		6,687,232		6,690,157		6,687,232

Add dilutive effect of:
Stock options		5,003		3,435		4,426		3,029
Restricted stock		-		2,511		-		2,033
Stock warrant		54,841		47,706		51,985		45,671
		59,844		53,652		56,411		50,733

Adjusted weighted average number of shares outstanding used in the calculation of diluted earnings per common share		6,750,807		6,740,884		6,746,568		6,737,965

Basic earnings per common share:
Continuing operations	$	0.28		0.30		0.80		1.02
Discontinued operations		-		-		0.12		0.02

Diluted earnings per common share:
Continuing operations	$	0.28		0.30		0.80		1.02
Discontinued operations		-		-		0.12		0.02

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 11 - Fair Value of Financial Instruments

The inputs to valuation techniques used to measure fair value are assigned to one of three broad levels:

Level 1 – quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the reporting date.

Level 2 – inputs other than quoted prices included within level 1 that are observable for the asset or liability either directly or indirectly. Level 2 inputs may include quoted prices for similar assets in active markets, quoted prices for identical assets or liabilities in markets that are not active, inputs other than quoted prices (such as interest rates or yield curves) that are observable for the asset or liability, and inputs that are derived from or corroborated by observable market data.

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

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

LCNB utilizes a pricing service for determining the fair values of most of its investment securities. Fair value for U.S. Treasury notes 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. The investments in mutual funds are considered to have level 3 inputs because LCNB does not have precise information about the methods used by the mutual fund companies to assign fair values or full information on the investments made by the funds. Additionally, LCNB Corp. owns trust preferred securities in various financial institutions and equity securities in non-financial companies. Market quotations (level 1) are used to determine fair values for these investments.

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 11 - Fair Value Measurements (continued)

The following table summarizes the valuation of LCNB’s available-for-sale securities by input levels as of September 30, 2011 and December 31, 2010 (in thousands):

			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, 2011
Available-for-sale securities:
U.S. Treasury notes	$	17,519		17,519		-		-
U.S. Agency notes		104,100		-		104,100		-
U.S. Agency mortgage- backed securities		47,672		-		47,672		-
Corporate securities		6,359		6,359		-		-
Municipal securities:
Non-taxable		67,299		-		67,299		-
Taxable		22,400		-		22,400		-
Mutual funds		1,616		-		-		1,616
Trust preferred securities		575		575		-		-
Equity securities		477		477		-		-
Totals	$	268,017		24,930		241,471		1,616

December 31, 2010
Available-for-sale securities:
U.S. Treasury notes	$	19,585		19,585		-		-
U.S. Agency notes		82,862		-		82,862		-
U.S. Agency mortgage- backed securities		33,094		-		33,094		-
Corporate securities		2,025		2,025		-		-
Municipal securities:
Non-taxable		74,428		-		74,428		-
Taxable		21,968		-		21,968		-
Mutual fund		1,053		-		-		1,053
Trust preferred securities		604		604		-		-
Equity securities		263		263		-		-
Totals	$	235,882		22,477		212,352		1,053

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 11- Fair Value of Financial Instruments (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 nine months ended September 30, 2011 and 2010 (in thousands):

	Nine Months Ended September 30,
	2011		2010
	Mutual Funds		Total		Mutual Funds		Equity Securities
Beginning balance	$	1,053		561		538		23
Purchases		500		-		-		-
Dividends reinvested		25		14		14		-
Net change in unrealized gains (losses) included in other comprehensive income		38		18		18		-
Ending balance	$	1,616		593		570		23

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 and 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.

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 11- Fair Value of Financial Instruments (continued)

The table below presents LCNB’s impaired loans, other real estate owned, and repossessed assets measured at fair value on a nonrecurring basis as of September 30, 2011 and December 31, 2010 by the level in the fair value hierarchy within which the inputs for these measurements fall (in thousands):

			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, 2011
Impaired loans	$	5,168		-		1,167		4,001
Other real estate owned		2,088		-		2,088		-
Repossessed assets		8		-		-		8
Totals	$	7,264		-		3,255		4,009

December 31, 2010
Impaired loans	$	4,080		-		1,430		2,650
Other real estate owned		2,088		-		2,088		-
Repossessed assets		26		-		-		26
Totals	$	6,194		-		3,518		2,676

Carrying amounts and estimated fair values of financial instruments as of September 30, 2011 and December 31, 2010 were as follows (in thousands):

	September 30, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value

FINANCIAL ASSETS:
Cash and cash equivalents	$	32,657		32,657		10,999		10,999
Investment securities:
Available-for-sale		268,017		268,017		235,882		235,882
Held-to-maturity		11,133		11,133		12,141		12,141
Federal Reserve Bank stock		941		941		939		939
Federal Home Loan Bank stock		2,091		2,091		2,091		2,091
Loans, net		446,295		459,453		452,350		465,053

FINANCIAL LIABILITIES:
Deposits		689,697		695,965		638,539		642,734
Short-term borrowings		12,386		12,386		21,691		21,691
Long-term debt		21,718		22,986		23,120		24,217

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 11- Fair Value of Financial Instruments (continued)

The fair value of off-balance-sheet financial instruments at September 30, 2011 and December 31, 2010 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 LCNB. The following methods and assumptions were used to estimate the fair value of certain financial instruments:

Cash and cash equivalents

The carrying amounts presented are deemed to approximate fair value.

Investment securities

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 or other methods. 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.

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, repurchase agreements, and U.S. Treasury demand note borrowings are deemed to approximate fair value of short-term borrowings. For long-term debt, fair values are estimated based on the discounted value of expected net cash flows using current interest rates.

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 12 – Discontinued Operations

LCNB sold its insurance agency subsidiary on March 23, 2011 and therefore its financial results are reported in the income statements as income from discontinued operations, net of taxes. Income from discontinued operations for the nine months ended September 30, 2011 include the gain recognized from the sale less certain related closing costs, taxes, and a curtailment expense recognized in LCNB’s nonqualified defined benefit retirement plan due to the sale. The following table summarizes income from discontinued operations for the periods indicated (in thousands):

	For the Three Months					For the Nine Months
	Ended September 30,					Ended September 30,
	2011		2010			2011			2010

Dakin Insurance Agency financial results:
Revenue	$	-		380			381			1,225
Non-interest expenses		-		322			301			957
Income from operations before income taxes		-		58			80			268
Gain from sale of insurance agency		-		-			1,503			-
Closing costs related to sale		-		-			(60	)		-
Curtailment expense on nonqualified defined benefit retirement plan		-		-			(191	)		-
Provision for income taxes		-		(19	)		(539	)		(91	)
Total income (loss) from discontinued operations, net of tax	$	-		39			793			177

Note 13 – Recent Accounting Pronouncements

Accounting Standards Update No. 2011-04, “Fair Value Measurement (ASC Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs,” was issued by the Financial Accounting Standards Board (the “FASB”) in May 2011. The update does not extend the use of fair value accounting, but provides guidance on how it should be applied where its use is already required or permitted by other standards within IFRS or U.S. GAAP. It supersedes most of the guidance in ASC Topic 820, although many of the changes are clarifications of existing guidance or wording changes to align with IFRS 13. Changes to current guidance include:

Clarification on using premiums and discounts in calculating fair value when level 2 or 3 inputs are used,

An expansion of disclosures about fair value measurements, and

The categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position, but for which the fair value is required to be disclosed.

The amendments in the update must be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after Dec. 15, 2011. Early application by public entities is not permitted. The required disclosures will be included in LCNB’s financial statements beginning January 1, 2012.

Index

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 13 – Recent Accounting Pronouncements (continued)

Accounting Standards Update No. 2011-05, “Comprehensive Income (ASC Topic 220): Presentation of Comprehensive Income,” was issued by the FASB in June 2011. The update eliminates the option to present the components of other comprehensive income as part of the statement of shareholders’ equity. Instead, a company is required to report comprehensive income in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. The amendments in the update are effective for public companies during the interim and annual periods beginning after Dec. 15, 2011 with early adoption permitted. LCNB’s presentation of the Consolidated Statements of Comprehensive Income already complies with the requirements of the update.

Accounting Standards Update No. 2011-08, “Intangibles – Goodwill and Other (ASC Topic 350): Testing Goodwill for Impairment,” was issued by the FASB in September 2011. The update simplifies the goodwill impairment test by allowing companies an option to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under that option, a company no longer will be required to calculate the fair value of a reporting unit unless the company determines, based on that qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. A company has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test. The company may resume performing the qualitative assessment in any subsequent period. The guidance includes examples of the types of events and circumstances to consider in conducting the qualitative assessment. The update also eliminates the provision allowing a company to carry forward its detailed calculation of a reporting unit’s fair value from a prior year. The amendments in the update will be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. LCNB management does not anticipate that adoption of this update will have a material effect on its consolidated financial statements.

Accounting Standards Update No. 2011-09, “Compensation-Retirement Benefits-Multiemployer Plans (ASC Subtopic 715-80): Disclosures about an Employer’s Participation in a Multiemployer Plan,” was issued by the FASB in September 2011. The update requires companies to provide enhanced disclosures relating to participation in multiemployer pension plans, including:

The amount of contributions made to each significant plan and to all plans in the aggregate,

An indication of whether the company’s contributions represent more than 5% of total contributions to the plan,

An indication of which plans are subject to a funding improvement plan,

Information about the funded status of the plan, and

A description of the nature and effect of any changes affecting comparability between for each period in which an income statement is presented.

For public companies, the amendments in the update are effective for annual periods ending after December 15, 2011. The required disclosures will be included in LCNB’s financial statements for the year ended December 31, 2011.

Index

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, 2011, and the related consolidated statements of income and comprehensive income for each of the three-month and nine-month periods ended September 30, 2011 and 2010, and the related consolidated statements of shareholders’ equity and cash flows for each of the nine-month periods ended September 30, 2011 and 2010. 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 have 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, 2010, 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 March 1, 2011, 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, 2010, 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 8, 2011

Index

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

Net income for the three and nine months ended September 30, 2011 was $1,867,000 (total basic and diluted earnings per common share of $0.28) and $6,161,000 (total basic and diluted earnings per common share of $0.92), respectively. This compares to $1,989,000 (total basic and diluted earnings per common share of $0.30) and $6,953,000 (total basic and diluted earnings per common share of $1.04) for the same three and nine-month periods in 2010.

Net income from continuing operations for the three and nine months ended September 30, 2011 was $1,867,000 and $5,368,000, respectively. This compares to $1,950,000 and $6,776,000 for the comparable periods in 2010. Net income from discontinued operations, net of taxes, for the nine months ended September 30, 2011 was $793,000, which is a $616,000 increase from the same period in 2010. This increase was caused by the sale of LCNB’s insurance agency subsidiary, Dakin Insurance Agency, Inc., during the first quarter 2011 and reflects the gain recognized on the sale less certain related closing costs, taxes, and a curtailment expense recognized in LCNB’s nonqualified defined benefit retirement plan due to the sale.

Net loan charge-offs for the first nine months of 2011 and 2010 totaled $876,000 and $1,695,000, respectively. Non-accrual loans and loans past due 90 days or more and still accruing interest totaled $3,787,000 or 0.84% of total loans at September 30, 2011, compared to $4,061,000 or 0.89% of total loans at December 31, 2010. The decrease was primarily due to the receipt of a guarantee payment on a Small Business Administration loan that had been classified as non-accrual at December 31, 2010. 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 totaled approximately $2,095,000 at September 30, 2011 and $2,114,000 at December 31, 2010. The decrease is due to the sale of other repossessed assets during 2011.

Index

LCNB CORP. AND SUBSIDIARIES

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

Net interest income for the three months ended September 30, 2011 increased $48,000 over the comparative period in 2010 primarily due to an increase in average interest earning assets, partially offset by a decrease in the net interest margin. Net interest income for the nine months ended September 30, 2011 decreased $29,000 from the comparative period in 2010 primarily due to a decrease in the net interest margin, partially offset by an increase in interest earning assets.

Non-interest income for the three months ended September 30, 2011 was $122,000 greater than the comparable period in 2010 primarily due to an increase in net gains from the sale of investment securities, partially offset by a decrease in net gains from the sale of mortgage loans. Non-interest income for the nine-month period in 2011 was $358,000 less than the comparative period in 2010 primarily due to the absence in 2011 of death benefits received from bank owned life insurance during the second quarter 2010 and a decrease in net gains from the sale of mortgage loans. These decreases were partially offset by an increase in net gains from the sale of investment securities.

Non-interest expense for the three months ended September 30, 2011 decreased $87,000 compared to the same period in 2010 primarily due to decreases in FDIC insurance premiums and foreclosed real estate write downs and holding costs, partially offset by an increase in employee salaries and benefits. Non-interest expense for the first nine months of 2011 was $617,000 greater than the comparable period in 2010 primarily due to increases in employee salaries and benefits, partially offset by decreases in FDIC insurance premiums and on foreclosed real estate write downs and holding costs.

Index

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, 2011 vs. 2010.

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, 2011 and 2010, 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,
	2011								2010
	Average			Interest		Average			Average			Interest		Average
	Outstanding			Earned/		Yield/			Outstanding			Earned/		Yield/
	Balance			Paid		Rate			Balance			Paid		Rate
	(Dollars in thousands)
Loans (1)	$	454,192			6,294		5.50	%		458,952			6,748		5.83	%
Interest-bearing demand deposits		10,641			6		0.22	%		25,698			15		0.23	%
Federal Reserve Bank stock		941			-		-	%		939			-		-	%
Federal Home Loan Bank stock		2,091			21		3.98	%		2,091			23		4.36	%
Investment securities:
Taxable		198,189			1,036		2.07	%		138,480			913		2.62	%
Non-taxable (2)		76,550			938		4.86	%		85,871			1,171		5.41	%
Total earnings assets		742,604			8,295		4.43	%		712,031			8,870		4.94	%
Non-earning assets		65,271								68,050
Allowance for loan losses		(3,030	)							(3,017	)
Total assets	$	804,845								777,064

Interest-bearing deposits	$	586,380			1,371		0.93	%		574,853			1,902		1.31	%
Short-term borrowings		12,050			6		0.20	%		6,379			6		0.37	%
Long-term debt		21,834			160		2.91	%		23,584			173		2.91	%
Total interest-bearing liabilities		620,264			1,537		0.98	%		604,816			2,081		1.37	%
Demand deposits		101,513								94,094
Other liabilities		6,725								6,527
Capital		76,343								71,627
Total liabilities and capital	$	804,845								777,064

Net interest rate spread (3)							3.45	%							3.57	%

Net interest income and net interest margin on a taxable- equivalent basis (4)					6,758		3.61	%					6,789		3.78	%

Ratio of interest-earning assets to interest-bearing liabilities		119.72	%							117.73	%

(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.

Index

LCNB CORP. AND SUBSIDIARIES

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

The following table presents the changes in taxable-equivalent basis interest income and expense for each major category of interest-earning assets and interest-bearing liabilities and the amount of change attributable to volume and rate changes for the three months ended September 30, 2011 as compared to the same period in 2010. Changes not solely attributable to rate or volume have been allocated to volume and rate changes in proportion to the relationship of absolute dollar amounts of the changes in each.

	Three Months Ended
	September 30, 2011 vs. 2010
	Increase (decrease) due to:
	Volume			Rate			Total
	(In thousands)
Interest-earning Assets:
Loans	$	(69	)		(385	)		(454	)
Interest-bearing demand deposits		(9	)		-			(9	)
Federal Reserve Bank stock		-			-			-
Federal Home Loan Bank stock		-			(2	)		(2	)
Investment securities:
Taxable		339			(216	)		123
Nontaxable		(120	)		(113	)		(233	)
Total interest income		141			(716	)		(575	)

Interest-bearing Liabilities:
Deposits		37			(568	)		(531	)
Short-term borrowings		4			(4	)		-
Long-term debt		(13	)		-			(13	)
Total interest expense		28			(572	)		(544	)
Net interest income	$	113			(144	)		(31	)

Net interest income on a fully tax-equivalent basis for the three months ended September 30, 2011 totaled $6,758,000, a decrease of $31,000 from the comparable period in 2010. The decrease resulted from a decrease in total interest income of $575,000, largely offset by a decrease in total interest expense of $544,000.

The decrease in total interest income was due to a 51 basis point (one basis point equals 0.01%) decrease in the average rate earned on earning assets, partially offset by the effect of a $30.6 million increase in average earning assets. The increase in interest earning assets was due to a $59.7 million increase in average taxable investment securities. The decrease in the average rate earned on earning assets was primarily due to general decreases in market interest rates.

Index

LCNB CORP. AND SUBSIDIARIES

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

The decrease in total interest expense was primarily due to a 39 basis point decrease in the average rate paid, slightly offset by the effect of a $15.4 million increase in average interest-bearing liabilities. The decrease in the average rate paid on interest-bearing liabilities was primarily due to general decreases in market interest rates. The increase in average interest-bearing liabilities was due to a $11.5 million increase in average interest-bearing deposits primarily resulting from an increase in public funds and continuing consumer trends and a $5.7 million increase in average short-term borrowings.

Nine Months Ended September 30, 2011 vs. 2010.

The following table presents, for the nine months ended September 30, 2011 and 2010, average balances for interest-earning assets and interest-bearing liabilities, the income or expense related to each item, and the resultant average yields earned or rates paid.

	Nine Months Ended September 30,
	2011								2010
	Average			Interest		Average			Average			Interest		Average
	Outstanding			Earned/		Yield/			Outstanding			Earned/		Yield/
	Balance			Paid		Rate			Balance			Paid		Rate
						(Dollars in thousands)

Loans (1)	$	457,663			19,289		5.64	%		459,015			20,379		5.94	%
Interest-bearing demand deposits		15,878			28		0.24	%		22,649			40		0.24	%
Federal Reserve Bank stock		940			28		3.98	%		939			28		3.99	%
Federal Home Loan Bank stock		2,091			68		4.35	%		2,091			70		4.48	%
Investment securities:
Taxable		171,186			2,826		2.21	%		125,551			2,725		2.90	%
Non-taxable (2)		78,773			2,979		5.06	%		85,184			3,582		5.62	%
Total earnings assets		726,531			25,218		4.64	%		695,429			26,824		5.16	%
Non-earning assets		65,978								67,471
Allowance for loan losses		(2,861	)							(3,013	)
Total assets	$	789,648								759,887

Interest-bearing deposits	$	575,168			4,454		1.04	%		560,948			5,806		1.38	%
Short-term borrowings		12,263			23		0.25	%		6,558			19		0.39	%
Long-term debt		23,152			499		2.88	%		24,025			523		2.91	%
Total interest-bearing liabilities		610,583			4,976		1.09	%		591,531			6,348		1.43	%
Demand deposits		100,077								93,633
Other liabilities		5,602								5,625
Capital		73,386								69,098
Total liabilities and capital	$	789,648								759,887

Net interest rate spread (3)							3.55	%							3.73	%

Net interest income and net interest margin on a taxable- equivalent basis (4)					20,242		3.73	%					20,476		3.94	%

Ratio of interest-earning assets to interest-bearing liabilities		118.99	%							117.56	%

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

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

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

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

Index

LCNB CORP. AND SUBSIDIARIES

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

	Nine Months Ended
	September 30, 2011 vs. 2010
	Increase (decrease) due to:
	Volume			Rate			Total
	(In thousands)
Interest-earning Assets:
Loans	$	(60	)		(1,030	)		(1,090	)
Interest-bearing demand deposits		(12	)		-			(12	)
Federal Reserve Bank stock		-			-			-
Federal Home Loan Bank stock		-			(2	)		(2	)
Investment securities:
Taxable		848			(747	)		101
Nontaxable		(258	)		(345	)		(603	)
Total interest income		518			(2,124	)		(1,606	)

Interest-bearing Liabilities:
Deposits		144			(1,496	)		(1,352	)
Short-term borrowings		12			(8	)		4
Long-term debt		(19	)		(5	)		(24	)
Total interest expense		137			(1,509	)		(1,372	)
Net interest income	$	381			(615	)		(234	)

Net interest income on a fully tax-equivalent basis for the first nine months of 2011 totaled $20,242,000, a $234,000 decrease from the first nine months of 2010. The decrease resulted from a decrease in total interest income of $1,606,000, largely offset by a $1,372,000 decrease in total interest expense.

The decrease in total interest income was due to a 52 basis point decrease in the average rate earned on earning assets, partially offset by the effect of a $31.1 million increase in average total earning assets. The increase in average earning assets was due to a $45.6 million increase in average taxable investment securities. The decrease in the average rate earned on earning assets was primarily due to general decreases in market interest rates.

Index

LCNB CORP. AND SUBSIDIARIES

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

The decrease in total interest expense was due primarily to a 34 basis point decrease in the average rate paid on interest-bearing liabilities, partially offset by the effect of a $19.1 million increase in average interest-bearing liabilities. The increase in average interest-bearing liabilities was due to a $14.2 million increase in average interest-bearing deposits primarily resulting from an increase in public funds and continuing consumer trends and a $5.7 million increase in average short-term borrowings. The decrease in the average rate paid also reflects a general decrease in market rates.

Provision and Allowance For Loan Losses

The total provision for loan losses is determined based upon management's evaluation as to the amount needed to maintain the allowance for loan losses at a level considered appropriate in relation to the risk of losses inherent in the portfolio. In addition to historic charge-off percentages, factors taken into consideration to determine the adequacy of the allowance for loan losses include the nature, volume, and consistency of the loan portfolio, overall portfolio quality, a review of specific problem loans, and current economic conditions that may affect borrowers’ ability to pay. The provision for loan losses for the three months ended September 30, 2011 and 2010 was $588,000 and $268,000, respectively, and $1,476,000 and $987,000 for the nine months ended September 30, 2011 and 2010, respectively. The increase in the provision for the three and nine-month periods in 2011 reflects an increase in impaired loans, the net charge-off trend, and current economic conditions.

Non-Interest Income

Three Months Ended September 30, 2011 vs. 2010.

Non-interest income for the third quarter of 2011 was $122,000 greater than for the comparable period in 2010. Trust income increased $74,000 primarily due to executor fees received during the third quarter 2011 and net gains on sale of securities increased $225,000 primarily due to the volume of securities sold. These increases were partially offset by a $160,000 decrease in gains from sales of mortgage loans during the third quarter 2011 resulting from a decrease in the volume of loans sold.

Nine Months Ended September 30, 2011 vs. 2010.

Non-interest income for the first nine months of 2011 was $358,000 less than for the comparable period in 2010. The decrease was due to a $798,000 decrease in bank owned life insurance income primarily due to the absence in 2011 of death benefits received during the second quarter 2010. In addition, gains from sales of mortgage loans decreased $151,000 due to a decrease in the volume of loans sold. Partially offsetting these decreases were a $516,000 increase in net gains on sales of securities and a $183,000 increase in trust income. Gains from sales of securities increased due to a greater volume of sales. Trust income increased primarily due to executor fees received and a change in the mix of trust assets.

Index

LCNB CORP. AND SUBSIDIARIES

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

Non-Interest Expense

Three Months Ended September 30, 2011 vs. 2010.

Total non-interest expense decreased $87,000 during the third quarter 2011 as compared to the third quarter 2010 primarily due to a $174,000 decrease in FDIC insurance premiums expense and a $132,000 decrease in other non-interest expense. The decrease in FDIC insurance premiums is primarily due to the implementation of a new assessment base that uses total assets and tier one capital as opposed to deposits. The decrease in other non-interest expense is primarily due to decreased write downs and holding costs for foreclosed property. These decreases were partially offset by a $122,000 or 4.3% increase in salaries and employee benefits. In addition to routine salary and wage increases, this increase also reflects increases in pension expense and health insurance costs. In addition, equipment expenses increased $66,000 primarily due to increased depreciation expense relating to ATM and computer equipment replacements.

Nine Months Ended September 30, 2011 vs. 2010.

Total non-interest expense increased $617,000 during the first nine months of 2011 as compared to the same period in 2010 primarily due to a $590,000 increase in salaries and employee benefits, a $99,000 increase in equipment expenses, and a $93,000 increase in other non-interest expense. Salaries and employee benefits and equipment expenses increased due to the same reasons described above. Other non-interest expense for the first nine months of 2011 includes a $56,000 loss, net of recoveries received during the second quarter 2011, recognized on a standby letter of credit, $52,000 in environmental remediation costs for the lot on which LCNB’s new Lebanon Drive-Up facility is located, $50,000 in NASDAQ® application fees, and other smaller miscellaneous increases. These increases were partially offset by decreased write downs and holding costs for foreclosed property.

Income Taxes

LCNB’s effective tax rates for continuing operations for the nine months ended September 30, 2011 and 2010 were 23.4% and 20.3%, respectively. The difference between the statutory rate of 34.0% and the effective tax rate is primarily due to tax-exempt interest income from municipal securities and tax-exempt earnings from bank owned life insurance.

Financial Condition

Total assets at September 30, 2011 were $48.4 million greater than at December 31, 2010. The increase in total assets is primarily due to a $21.7 million increase in cash and cash equivalents and a $32.1 million increase in available-for-sale investment securities. Most of the growth in available-for-sale investment securities was in U.S. Agency notes, which increased $21.2 million, and U.S. Agency mortgage-backed securities, which increased $14.6 million.

Index

LCNB CORP. AND SUBSIDIARIES

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

Net loans at September 30, 2011 were $6.1 million less than at December 31, 2010. This decrease was composed of a $5.5 million decrease in gross loans and a $600,000 increase in the allowance for loan losses. Consumer loans decreased $3.6 million due to weak demand for new loans, commercial and industrial loans decreased $4.0 million, and residential real estate loans decreased $6.4 million largely because the majority of loans originated during the first nine months of 2011 were sold to the Federal Home Loan Mortgage Corporation. Residential mortgage loans sold during the nine-month period totaled $4.9 million. These decreases were partially offset by an $8.0 increase in commercial real estate loans.

Total deposits were $51.2 million greater at September 30, 2011 than at December 31, 2010, primarily due to a $51.4 million increase in public fund deposits by local government entities. Public fund deposits can be relatively volatile due to seasonal tax collections and the financial needs of the local entities. LCNB believes that much of the increase at September 30, 2011 was due to seasonal property and other tax receipts. The deposit growth was used to reduce short-term borrowings, which decreased $9.3 million, fund growth in the investment portfolio, and enhance LCNB’s liquidity position for anticipated future needs.

Liquidity

LCNB depends on dividends from its subsidiaries for the majority of its liquid assets, including the cash needed to pay dividends to its shareholders. National banking law limits the amount of dividends the Bank may pay to the sum of retained net income, as defined, for the current year plus retained net income for the previous two years. Prior approval from the Office of the Comptroller of the Currency, the Bank’s primary regulator, is necessary for the Bank to pay dividends in excess of this amount. In addition, dividend payments may not reduce capital levels below minimum regulatory guidelines. Management believes the Bank will be able to pay anticipated dividends to LCNB without needing to request approval.

Liquidity is the ability to have funds available at all times to meet the commitments of LCNB. Asset liquidity is provided by cash and assets which are readily marketable or pledgeable or which will mature in the near future. Liquid assets include cash and cash equivalents and securities available for sale. At September 30, 2011, LCNB’s liquid assets amounted to $300.7 million or 37.2% of total assets, an increase from $246.9 million or 32.5% of total assets at December 31, 2010.

Liquidity is also provided by access to core funding sources, primarily core depositors in LCNB’s market area. Approximately 75.4% of total deposits at September 30, 2011 were “core” deposits, compared to 81.8% of deposits at December 31, 2010. Core deposits, for this purpose, are defined as total deposits less public funds and certificates of deposit greater than $100,000. The percentage of core deposits to total deposits decreased because of the growth in public fund deposits discussed above in relation to total growth in deposits.

Secondary sources of liquidity include LCNB’s ability to sell loan participations, borrow funds from the Federal Home Loan Bank, purchase federal funds, issue repurchase agreements, or use a line of credit established with another bank.

Index

LCNB CORP. AND SUBSIDIARIES

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

Management closely monitors the level of liquid assets available to meet ongoing funding needs. It is management’s intent to maintain adequate liquidity so that sufficient funds are readily available at a reasonable cost. LCNB experienced no liquidity or operational problems as a result of the current liquidity levels.

Index

LCNB CORP. AND SUBSIDIARIES

Item 3. Quantitative and Qualitative Disclosures about Market Risks

Market risk for LCNB is primarily interest rate risk. LCNB attempts to mitigate this risk through asset/liability management strategies designed to decrease the vulnerability of its earnings to material and prolonged changes in interest rates. LCNB does not use derivatives such as interest rate swaps, caps, or floors to hedge this risk. LCNB has not entered into any market risk instruments for trading purposes.

LCNB's Asset and Liability Management Committee ("ALCO") primarily uses a combination of Interest Rate Sensitivity Analysis (“IRSA”) and Economic Value of Equity (“EVE”) analysis for measuring and managing interest rate risk. IRSA is used to estimate the effect on net interest income during a one-year period of instantaneous and sustained movements in interest rates, also called interest rate shocks, of 100, 200, and 300 basis points. Management considers the results of the down 200 and down 300 basis point scenarios to not be meaningful in the current interest rate environment. The base projection uses a current interest rate scenario. As shown below, the September 30, 2011 IRSA indicates that an increase in interest rates would have a positive effect on net interest income (“NII”) and a decrease in interest rates would have a negative effect on NII. The changes in NII for all rate assumptions are within LCNB’s acceptable ranges.

Rate Shock Scenario in Basis Points	Amount		$ Change in NII			% Change in NII
	(Dollars in thousands)
Up 300	$	26,723		1,208			4.73	%
Up 200		26,295		780			3.06	%
Up 100		25,861		346			1.36	%
Base		25,515		-			-	%
Down 100		25,257		(258	)		-1.01	%

IRSA shows the effect on NII during a one-year period only. A more long-range model is the EVE analysis, which shows the estimated present value of future cash inflows from interest-earning assets less the present value of future cash outflows for interest-bearing liabilities for the same rate shocks. As shown below, the September 30, 2011 EVE analysis indicates that an increase in interest rates would have a negative effect on the EVE and a decrease in rates would have a positive effect on the EVE. The changes in EVE for the up 300 basis points scenario is slightly outside LCNB’s policy range of a 25% change, but management has determined the changes are acceptable in the current economic environment.

Rate Shock Scenario in Basis Points	Amount		$ Change in EVE			% Change in EVE
	(Dollars in thousands)
Up 300	$	63,494		(23,318	)		-26.86	%
Up 200		70,703		(16,109	)		-18.56	%
Up 100		78,608		(8,204	)		-9.45	%
Base		86,812		-			-	%
Down 100		94,820		8,008			9.22	%

Index

LCNB CORP. AND SUBSIDIARIES

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

The IRSA and EVE simulations discussed above are not projections of future income or equity and should not be relied on as being indicative of future operating results. Assumptions used, including the nature and timing of interest rate levels, yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment or replacement of asset and liability cash flows, are inherently uncertain and, as a result, the models cannot precisely measure future net interest income or equity. Furthermore, the models do not reflect actions that borrowers, depositors, and management may take in response to changing economic conditions and interest rate levels.

Item 4. Controls and Procedures

a) Disclosure controls and procedures. The Chief Executive Officer and the Chief Financial Officer have carried out an evaluation of the effectiveness of LCNB's disclosure controls and procedures that ensure that information relating to LCNB required to be disclosed by LCNB in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that such information is accumulated and communicated to LCNB’s management, including its principal executive officer and principal financial officer, as appropriate, in order to allow timely decisions to be made regarding required disclosures. Based upon this evaluation, these officers have concluded, that as of September 30, 2011, LCNB's disclosure controls and procedures were effective.

b) Changes in internal control over financial reporting. During the period covered by this report, there were no changes in LCNB's internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, LCNB's internal control over financial reporting.

Index

PART II. OTHER INFORMATION

LCNB CORP. AND SUBSIDIARIES

Item 1. Legal Proceedings

Not applicable

Item 1A. Risk Factors

The Dodd-Frank Act directs the Federal Reserve to set interchange rates in electronic debit card transactions involving issuers with more than $10 billion in assets. On June 29, 2011, the Federal Reserve issued a final rule, which goes into effect on October 1, 2011, setting the maximum interchange fee an issuer may receive at the sum of 21 cents per transaction plus five basis points multiplied by the value of the transaction. The Federal Reserve also issued an interim final rule that allows for an upward adjustment of at most one cent to an issuer’s debit card interchange fee if the issuer develops and implements policies and procedures to achieve the fraud prevention standards detailed in the interim final rule. Although institutions with $10 billion or less in total assets will be exempt from the new rules, many within the financial institutions industry believe that smaller institutions will need to match the pricing of those institutions with assets greater than $10 billion or lose business to the larger institutions. The effect of the new rules on LCNB’s income statement cannot be predicted at this time.

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

During the period of this report, LCNB did not sell any of its securities that were not registered under the Securities Act.

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

Item 3. Defaults Upon Senior Securities

Not applicable

Item 4. (Removed and Reserved)

Item 5. Other Information

Not applicable

Index

LCNB CORP. AND SUBSIDIARIES

Item 6. Exhibits

Exhibit No.	Exhibit Description
3.1	Amended and Restated Articles of Incorporation of LCNB Corp., as amended – incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2010, Exhibit 3.1.

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

31.1	Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.

31.2	Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.

32	Certification of Chief Executive Officer and Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.

101	The following financial information from LCNB Corp.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011 is formatted in Extensible Business Reporting Language: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to Consolidated Financial Statements, tagged as blocks of text.

Index

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	LCNB Corp.

November 8, 2011	By:	/s/ Stephen P. Wilson
		Stephen P. Wilson, Chief Executive Officer and
		Chairman of the Board of Directors


November 8, 2011	By:	/s/Robert C. Haines, II
		Robert C. Haines, II, Executive Vice President
		and Chief Financial Officer