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LCNB CORP - Quarter Report: 2013 March (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 March 31, 2013

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

2 North Broadway, Lebanon, Ohio   45036
(Address of principal executive offices, including Zip Code)

(513) 932-1414
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes         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 May 6, 2013 was 7,625,920 shares.
 


 
 

 
 
LCNB CORP. AND SUBSIDIARIES
FOR THE THREE MONTHS ENDED MARCH 31, 2013
 
Table of Contents
 
   
PART I – FINANCIAL INFORMATION
3
   
3
   
3
4
5
6
7
8
35
   
36
   
41
   
42
   
PART II -- OTHER INFORMATION
43
   
43
   
Item 1A.  Risk Factors
43
   
43
   
43
   
43
   
43
   
Item 6. Exhibits
44
   
45
 

PART I – FINANCIAL INFORMATION
 
Item 1.  Financial Statements
LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)

   
March 31,
   
December 31,
 
   
2013
   
2012
 
   
(Unaudited)
       
ASSETS:
           
Cash and due from banks
  $ 24,500       11,260  
Interest-bearing demand deposits
    3,813       2,215  
Total cash and cash equivalents
    28,313       13,475  
                 
Investment securities:
               
Available-for-sale, at fair value
    277,559       258,506  
Held-to-maturity, at cost
    22,831       15,424  
Federal Reserve Bank stock, at cost
    1,106       949  
Federal Home Loan Bank stock, at cost
    2,854       2,091  
Loans, net
    546,263       450,346  
Premises and equipment, net
    20,156       16,564  
Goodwill
    14,319       5,915  
Bank owned life insurance
    20,774       16,915  
Other assets
    12,229       8,452  
TOTAL ASSETS
  $ 946,404       788,637  
                 
LIABILITIES:
               
Deposits:
               
Noninterest-bearing
  $ 158,648       133,848  
Interest-bearing
    662,222       537,623  
Total deposits
    820,870       671,471  
Short-term borrowings
    11,609       13,756  
Long-term debt
    13,128       13,705  
Accrued interest and other liabilities
    6,593       7,699  
TOTAL LIABILITIES
    852,200       706,631  
                 
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 8,379,387 and 7,485,527 shares at March 31, 2013 and December 31, 2012, respectively
    39,517       27,107  
Retained earnings
    62,352       61,843  
Treasury shares at cost, 753,627 shares at  March 31, 2013 and December 31, 2012
    (11,665 )     (11,665 )
Accumulated other comprehensive income, net of taxes
    4,000       4,721  
TOTAL SHAREHOLDERS' EQUITY
    94,204       82,006  
                 
TOTAL LIABILITES AND SHAREHOLDERS' EQUITY
  $ 946,404       788,637  

The accompanying notes to consolidated financial statements are an integral part of these statements.
 
 
LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
(Unaudited)

     
Three Months Ended
 
     
March 31,
 
     
2013
     
2012
 
INTEREST INCOME:
               
Interest and fees on loans
 
$
6,580
     
6,208
 
Interest on investment securities:
               
Taxable
   
834
     
887
 
Non-taxable
   
623
     
606
 
Other investments
   
39
     
30
 
TOTAL INTEREST INCOME
   
8,076
     
7,731
 
                 
INTEREST EXPENSE:
               
Interest on deposits
   
983
     
1,165
 
Interest on short-term borrowings
   
3
     
3
 
Interest on long-term debt
   
112
     
154
 
TOTAL INTEREST EXPENSE
   
1,098
     
1,322
 
NET INTEREST INCOME
   
6,978
     
6,409
 
PROVISION FOR LOAN LOSSES
   
149
     
215
 
                 
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
   
6,829
     
6,194
 
                 
NON-INTEREST INCOME:
               
Trust income
   
575
     
766
 
Service charges and fees on deposit accounts
   
979
     
878
 
Net gain on sales of securities
   
587
     
380
 
Bank owned life insurance income
   
172
     
148
 
Gains from sales of mortgage loans
   
129
     
107
 
Other operating income
   
65
     
57
 
TOTAL NON-INTEREST INCOME
   
2,507
     
2,336
 
                 
NON-INTEREST EXPENSE:
               
Salaries and employee benefits
   
3,294
     
2,982
 
Equipment expenses
   
292
     
262
 
Occupancy expense, net
   
506
     
407
 
State franchise tax
   
216
     
206
 
Marketing
   
144
     
111
 
FDIC premiums
   
128
     
111
 
Other non-interest expense
   
2,511
     
1,369
 
TOTAL NON-INTEREST EXPENSE
   
7,091
     
5,448
 
INCOME BEFORE INCOME TAXES
   
2,245
     
3,082
 
PROVISION FOR INCOME TAXES
   
517
     
805
 
NET INCOME
 
$
1,728
     
2,277
 
                 
Dividends declared per common share
 
$
0.16
     
0.16
 
                 
Earnings per common share:
               
Basic
 
$
0.23
     
0.34
 
Diluted
   
0.23
     
0.34
 
                 
Weighted average common shares outstanding:
               
Basic
   
7,513,101
     
6,706,295
 
Diluted
   
7,610,626
     
6,773,451
 

The accompanying notes to consolidated financial statements are an integral part of these statements.
 
 
LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
 
   
Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
             
Net income
  $ 1,728       2,277  
                 
Other comprehensive income:
               
                 
Net unrealized gain (loss) on available-for-sale securities (net of taxes of $176 and $259 for the three months ended March 31, 2013 and 2012, respectively)
    (342 )     (505 )
                 
Reclassification adjustment for net realized gain on sales of available-for-sale securities included in net income, net of taxes
    (387 )     (251 )
                 
Change in nonqualified pension plan unrecognized net loss and unrecognized prior service cost (net of taxes of $5 and $5 for the three months ended March 31, 2013 and 2012, respectively)
    8       7  
                 
Total comprehensive income
  $ 1,007       1,528  

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

LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Dollars in thousands, except per share amounts)
(Unaudited)
 
                           
Accumulated
       
   
Common
                     
Other
   
Total
 
   
Shares
   
Common
   
Retained
   
Treasury
   
Comprehensive
   
Shareholders'
 
   
Outstanding
   
Stock
   
Earnings
   
Shares
   
Income (Loss)
   
Equity
 
                                     
Balance December 31, 2011
    6,704,723     $ 26,753       57,877       (11,698 )     5,028       77,960  
Net income
                    2,277                       2,277  
Net unrealized gain (loss) on available-for- sale securities, net of taxes
                                    (505 )     (505 )
Reclassification adjustment for net realized gain on sales of available-for-sale securities included in net income, net of taxes
                                    (251 )     (251 )
Change in nonqualified pension plan unrecognized net gain and unrecognized prior service cost, net of taxes
                                    7       7  
Dividend Reinvestment and Stock Purchase Plan
    6,968       89                               89  
Compensation expense relating to stock options
            9                               9  
Common stock dividends, $0.16 per share
                    (1,073 )                     (1,073 )
Balance March 31, 2012
    6,711,691       26,851       59,081       (11,698 )     4,279       78,513  
                                                 
Balance December 31, 2012
    6,731,900     $ 27,107       61,843       (11,665 )     4,721       82,006  
Net income
                    1,728                       1,728  
Net unrealized gain (loss) on available-for- sale securities, net of tax
                                    (342 )     (342 )
Reclassification adjustment for net realized gain on sales of available-for-sale securities included in net income, net of taxes
                                    (387 )     (387 )
Change in nonqualified pension plan unrecognized net gain and unrecognized prior service cost, net of taxes
                                      8         8  
Dividend Reinvestment and Stock Purchase Plan
    5,049       80                               80  
Acquisition of First Capital Bancshares, Inc.
    888,811       12,321                               12,321  
Compensation expense relating to stock options
            9                               9  
Common stock dividends, $0.16 per share
                    (1,219 )                     (1,219 )
Balance March 31, 2013
    7,625,760       39,517       62,352       (11,665 )     4,000       94,204  

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

LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
   
Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 1,728       2,277  
Adjustments to reconcile net income to net cash flows from operating activities:
               
Depreciation, amortization and accretion
    740       775  
Provision for loan losses
    149       215  
Increase in cash surrender value of bank owned life insurance
    (172 )     (148 )
Realized gain from sales of securities available-for-sale
    (587 )     (380 )
Realized (gain) loss from sales and write-downs of other real estate owned and repossessed assets
    (230 )      81  
Origination of mortgage loans for sale
    (7,175 )     (5,866 )
Realized gains from sales of mortgage loans
    (129 )     (107 )
Proceeds from sales of mortgage loans
    7,241       5,914  
Compensation expense related to stock options
    9       9  
(Increase) decrease due to changes in assets and liabilities:
               
Accrued income receivable
    (671 )     (578 )
Other assets
    (53 )     144  
Other liabilities
    (928 )     (178 )
TOTAL ADJUSTMENTS
    (1,806 )     (119 )
NET CASH FLOWS FROM OPERATING ACTIVITIES
    (78 )     2,158  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Proceeds from sales of investment securities available-for-sale
    23,337       29,944  
Proceeds from maturities and calls of investment securities:
               
Available-for-sale
    5,059       5,514  
Held-to-maturity
    1,353       413  
Purchases of investment securities:
               
Available-for-sale
    (26,725 )     (34,944 )
Held-to-maturity
    (8,376 )     (131 )
Purchase of Federal Reserve Bank stock
    -       (8 )
Net decrease in loans
    2,865       3,458  
Proceeds from sale of other real estate owned and repossessed assets
    865       14  
Purchases of premises and equipment
    (204 )     (47 )
Net cash acquired from acquisition
    9,771       -  
NET CASH FLOWS FROM INVESTING ACTIVITIES
    7,945       4,213  
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net increase in deposits
    12,626       12,004  
Net decrease in short-term borrowings
    (2,147 )     (11,006 )
Principal payments on long-term debt
    (2,369 )     (642 )
Proceeds from issuance of common stock
    11       15  
Cash dividends paid on common stock
    (1,150 )     (999 )
NET CASH FLOWS FROM FINANCING ACTIVITIES
    6,971       (628 )
                 
NET CHANGE IN CASH AND CASH EQUIVALENTS
    14,838       5,743  
                 
CASH AND CASH EQUIVALENTS AT BEGINNING OF  PERIOD
    13,475       19,535  
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 28,313       25,278  
                 
SUPPLEMENTAL CASH FLOW INFORMATION:
               
CASH PAID DURING THE YEAR FOR:
               
Interest
  $ 1,171       1,361  
Income taxes
    440       -  
                 
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES:
               
Transfer from loans to other real estate owned and repossessed assets
    6       543  
 
The accompanying notes to consolidated financial statements are an integral part of these statements.
 
 
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" or the “Company”) 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.

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 months ended March 31, 2013 are not necessarily indicative of the results to be expected for the full year ending December 31, 2013.  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 2012 Annual Report on Form 10-K filed with the SEC.

Note 2 – Acquisition
On October 9, 2012, LCNB and First Capital Bancshares, Inc. (“First Capital”) entered into an Agreement and Plan of Merger (“Merger Agreement”) pursuant to which First Capital was merged into LCNB on January 11, 2013 in a stock and cash transaction valued at approximately $20.2 million.  Immediately following the merger of First Capital into LCNB, Citizens National Bank (“Citizens”), a wholly-owned subsidiary of First Capital, was merged into LCNB National Bank.  Citizens operated six full–service branches with a main office and two other facilities in Chillicothe, Ohio and one branch in each of Frankfort, Ohio, Clarksburg, Ohio, and Washington Court House, Ohio.  These offices became branches of the Bank after the merger.
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 2 – Acquisition (continued)
Under the terms of the Merger Agreement, each shareholder of First Capital common stock was entitled to elect to receive, for each share of First Capital Common Stock, (i) $30.76 in cash, (ii) 2.329 common shares of LCNB (subject to an adjustment based upon the average closing price of LCNB common shares for the 25 trading days prior to the effective date of the merger), or (iii) a combination of cash and LCNB common stock.  A First Capital shareholder’s election to receive cash or stock was subject to allocation procedures that ensured that no more than 50% and no less than 40% of the outstanding First Capital shares were exchanged for cash and that no more than 60% and no less than 50% of the outstanding First Capital shares were exchanged for LCNB common shares.

The merger with First Capital was accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration paid were recorded at their estimated fair values as of the merger date, as summarized in the following table (in thousands):

Consideration Paid:
     
Common shares issued (888,811)
  $ 12,354  
Cash paid to shareholders
    7,828  
Total value of consideration paid
    20,182  
         
Identifiable Assets Acquired:
       
Cash and cash equivalents
    17,632  
Investment securities:
       
Available-for-sale
    21,606  
Held-to-maturity
    384  
Federal Reserve Bank stock
    157  
Federal Home Loan Bank stock
    763  
Loans, net
    98,899  
Premises and equipment, net
    3,729  
Bank owned life insurance
    3,687  
Core deposit intangible
    2,574  
Other real estate owned
    127  
Deferred income taxes
    504  
Other assets
    1,150  
Total identifiable assets acquired
    151,212  
         
Liabilities Assumed:
       
Deposits
    136,823  
Long-term debt
    1,792  
Other liabilities
    819  
Total liabilities assumed
    139,434  
         
Total Identifiable Net Assets Acquired
    11,778  
         
Goodwill resulting from merger
  $ 8,404  
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 2 – Acquisition (continued)
The amount of goodwill recorded reflects LCNB’s entrance into a new market and related synergies that are expected to result from the acquisition and represents the excess purchase price over the estimated fair value of the net assets acquired.  The goodwill will not be amortizable and is not deductible for tax purposes.  The core deposit intangible will be amortized over nine years using the straight-line method.

The following table details the acquired loans that are accounted for in accordance with FASB ASC 310-30 (in thousands):

Contractually required principal at acquisition
  $ 103,456  
Contractual cash flows not expected to be collected (nonaccretable difference)
    (3,409 )
Expected cash flows at acquisition
    100,047  
Interest component of expected cash flows (accretable discount)
    (1,148 )
Fair value of acquired loans
  $ 98,899  

In accordance with U.S. GAAP, there was no carryover of the allowance for loan losses that had been previously recorded by Citizens.

Direct costs related to the acquisition were expensed as incurred and are recorded in other non-interest expense in the consolidated statements of income.  During the first quarter 2013 LCNB incurred $1,055,000 in merger and acquisition integration expenses related to the transaction, including $496,000 in merger related costs and $559,000 for converting Citizens data processing system to LCNB’s system.

The results of operations are included in the consolidated income statement from the date of the merger.  The estimated amount of Citizens revenue and net income, excluding merger and data conversion costs, included in LCNB’s consolidated income statement for the first quarter 2013 was $1,260,000 and $393,000 respectively.

The following table presents unaudited pro forma information as if the merger with First Capital had occurred on January 1, 2012 (in thousands).  This pro forma information gives effect to certain adjustments, including purchase accounting fair value adjustments, amortization of the core deposit intangible, and related income tax effects.  It does not include merger and data conversion costs.  The pro forma information does not necessarily reflect the results of operations that would have occurred had the merger with First Capital occurred in 2012.  In particular, expected operational cost savings are not reflected in the pro forma amounts.

   
Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
             
Total revenue
  $ 9,688       10,466  
Net income
    2,115       2,555  
                 
Basic earnings per common share
    0.28       0.34  
Diluted earnings per common share
    0.27       0.33  
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 3 - Investment Securities
The amortized cost and fair value of available-for-sale investment securities at March 31, 2013 and December 31, 2012 are summarized as follows (in thousands):

   
March 31, 2013
 
   
Amortized
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
U.S. Treasury notes
  $ 19,447       246       -       19,693  
U.S. Agency notes
    100,668       1,021       190       101,499  
U.S. Agency mortgage-backed securities
    53,116       1,166       126       54,156  
Certificates of deposit with other banks
    1,494       15       -       1,509  
Municipal securities:
                               
Non-taxable
    75,766       3,157       179       78,744  
Taxable
    16,684       919       11       17,592  
Mutual funds
    2,201       22       -       2,223  
Trust preferred securities
    149       3       4       148  
Equity securities
    1,751       261       17       1,995  
    $ 271,276       6,810       527       277,559  

   
December 31, 2012
 
   
Amortized
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
                         
U.S. Treasury notes
  $ 18,462       224       -       18,686  
U.S. Agency notes
    89,372       1,364       130       90,606  
U.S. Agency mortgage-backed securities
    51,121       1,444       24       52,541  
Corporate securities
    3,032       35       -       3,067  
Municipal securities:
                               
Non-taxable
    70,504       3,497       119       73,882  
Taxable
    14,851       993       3       15,841  
Mutual fund
    2,138       30       -       2,168  
Trust preferred securities
    250       2       7       245  
Equity securities
    1,390       106       26       1,470  
    $ 251,120       7,695       309       258,506  

The fair value of held-to-maturity investment securities, consisting of non-taxable and taxable municipal securities, approximates amortized cost at March 31, 2013 and December 31, 2012.
 

LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 3 - Investment Securities (continued)
Information concerning securities with gross unrealized losses at March 31, 2013, aggregated by length of time that individual securities have been in a continuous loss position, is as follows (in thousands):

   
Less than Twelve Months
   
Twelve Months or More
 
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
 
                         
U.S. Agency notes
  $ 23,040       190       -       -  
U.S. Agency mortgage-backed securities
     11,255        126        -        -  
Municipal securities:
                               
Non-taxable
    13,130       178       453       1  
Taxable
    1,922       11       -       -  
Mutual funds
    57       -       -       -  
Trust preferred securities
    47       3       49       1  
Equity securities
    111       3       101       14  
    $ 49,562       511       603       16  

Management has determined that the unrealized losses at March 31, 2013 are primarily due to fluctuations in market interest rates and do not reflect credit quality deterioration of the securities.   Because the Company does not have the intent to sell the investments and it is more likely than not that the Company will not be required to sell the investments before recovery of their amortized cost bases, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired.
 
Note 4 - Loans
Major classifications of loans at March 31, 2013 and December 31, 2012 are as follows (in thousands):

   
March 31,
 
December 31,
     
2013
     
2012
 
                 
Commercial and industrial
 
$
35,452
     
26,236
 
Commercial, secured by real estate
   
283,144
     
230,256
 
Residential real estate
   
214,282
     
183,132
 
Consumer
   
13,860
     
10,554
 
Agricultural
   
1,805
     
1,668
 
Other loans, including deposit overdrafts
   
1,146
     
1,875
 
     
549,689
     
453,721
 
Deferred net origination (fees) costs
   
(22)
     
62
 
     
549,667
     
453,783
 
Less allowance for loan losses
   
3,404
     
3,437
 
Loans, net
 
$
546,263
     
450,346
 
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 4 – Loans (continued)
Non-accrual, past-due, and accruing restructured loans as of March 31, 2013 and December 31, 2012 are as follows (in thousands):

   
March 31,
   
December 31,
 
   
2013
   
2012
 
             
Non-accrual loans:
           
Commercial and industrial
  $ 181       264  
Commercial, secured by real estate
    1,414       788  
Residential real estate
    1,578       1,231  
Total non-accrual loans
    3,173       2,283  
Past-due 90 days or more and still accruing
    180       128  
Total non-accrual and past-due 90 days or more and still accruing
    3,353       2,411  
Accruing restructured loans
    13,693       13,343  
Total
  $ 17,046       15,754  
                 
Percentage of total non-accrual and past-due 90 days or more and still accruing to total loans
    0.61 %     0.53 %
                 
Percentage of total non-accrual, past-due 90 days or more and still accruing, and accruing restructured loans to total loans
    3.10 %     3.47 %

Loans sold to and serviced for the Federal Home Loan Mortgage Corporation and other investors are not included in the accompanying consolidated balance sheets. The unpaid principal balances of those loans at March 31, 2013 and December 31, 2012 were $87,710,000 and $71,568,000, respectively.  Loans sold during the three months ended March 31, 2013 and 2012 totaled $7,175,000 and $5,866,000, respectively.
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 4 – Loans (continued)
The allowance for loan losses and recorded investment in loans for the three months ended March 31 are as follows (in thousands):

   
Commercial
& Industrial
   
Commercial
Real Estate
   
Residential
Real Estate
   
Consumer
   
Agricultural
   
Other
   
Total
 
2013
                                         
Allowance for loan losses:
                                         
Balance, beginning of year
  $ 320       2,296       712       108       -       1       3,437  
Provision charged to expenses
    20       87       14       22       -       6       149  
Losses charged off
    (83 )     (30 )     (27 )     (63 )     -       (16 )     (219 )
Recoveries
    -       -       5       23       -       9       37  
Balance, end of period
  $ 257       2,353       704       90       -       -       3,404  
                                                         
Individually evaluated for impairment
  $ 71       657       157       -       -       -       885  
Collectively evaluated for impairment
    186       1,696       547       90       -       -       2,519  
Balance, end of period
  $ 257       2,353       704       90       -       -       3,404  
                                                         
Loans:
                                                       
Individually evaluated for impairment
  $ 181       14,006       1,294       7       -       -       15,488  
Collectively evaluated for impairment
    35,234       268,838       213,190       13,966       1,805       1,146       534,179  
Balance, end of period
  $ 35,415       282,844       214,484       13,973       1,805       1,146       549,667  
                                                         
2012
                                                       
Allowance for loan losses:
                                                       
Balance, beginning of year
  $ 162       1,941       656       166       -       6       2,931  
Provision charged to expenses
    7       61       155       (6 )     -       (2 )     215  
Losses charged off
    -       (205 )     (117 )     (46 )     -       (20 )     (388 )
Recoveries
    -       70       7       38       -       17       132  
Balance, end of period
  $ 169       1,867       701       152       -       1       2,890  
                                                         
Individually evaluated for impairment
  $ -       263       150       -       -       -       413  
Collectively evaluated for impairment
    169       1,604       551       152       -       1       2,477  
Balance, end of period
  $ 169       1,867       701       152       -       1       2,890  
                                                         
Loans:
                                                       
Individually evaluated for impairment
  $ 2,922       13,900       629       9       -       -       17,460  
Collectively evaluated for impairment
    27,735       204,602       186,378       13,375       2,357       5,074       439,521  
Balance, end of period
  $ 30,657       218,502       187,007       13,384       2,357       5,074       456,981  
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 4 – Loans (continued)
The Company 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 the Company 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.
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 4 – Loans (continued)
An analysis of the Company’s loan portfolio by credit quality indicators at March 31, 2013 and December 31, 2012 is as follows (in thousands):

   
Pass
   
OAEM
   
Substandard
   
Doubtful
   
Total
 
March 31, 2013
                             
Commercial & industrial
  $ 31,083       1,793       2,358       181       35,415  
Commercial, secured by real estate
    262,682       1,797       18,365       -       282,844  
Residential real estate
    206,546       2,322       5,616       -       214,484  
Consumer
    13,931       -       42       -       13,973  
Agricultural
    1,771       -       34       -       1,805  
Other
    1,146       -       -       -       1,146  
Total
  $ 517,159       5,912       26,415       181       549,667  
                                         
December 31, 2012
                                       
Commercial & industrial
  $ 22,965       1,804       1,177       264       26,210  
Commercial, secured by real estate
    218,246       2,653       9,022       107       230,028  
Residential real estate
    172,589       2,353       8,130       298       183,370  
Consumer
    10,549       -       62       20       10,631  
Agricultural
    1,665       -       3       -       1,668  
Other
    1,876       -       -       -       1,876  
Total
  $ 427,890       6,810       18,394       689       453,783  
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 4 – Loans (continued)
A loan portfolio aging analysis at March 31, 2013 and December 31, 2012 is as follows (in thousands):

   
30-59 Days
Past Due
   
60-89 Days
Past Due
   
Greater Than
90 Days
Past Due
   
Total
Past Due
   
Current
   
Total Loans
Receivable
   
Total Loans
Greater Than
90 Days and
Accruing
 
                                           
March 31, 2013
                                         
Commercial & industrial
  $ -       -       181       181       35,234       35,415       -  
Commercial, secured by real estate
    378       -       1,301       1,679       281,165       282,844       127  
Residential real estate
    945       223       1,376       2,544       211,940       214,484       49  
Consumer
    60       11       4       75       13,898       13,973       4  
Agricultural
    -       -       -       -       1,805       1,805       -  
Other
    63       -       -       63       1,083       1,146       -  
Total
  $ 1,446       234       2,862       4,542       545,125       549,667       180  
                                                         
December 31, 2012
                                                       
Commercial & industrial
  $ -       1       264       265       25,945       26,210       -  
Commercial, secured by real estate
    346       79       788       1,213       228,815       230,028       -  
Residential real estate
    791       212       1,172       2,175       181,195       183,370       103  
Consumer
    61       57       25       143       10,488       10,631       25  
Agricultural
    -       -       -       -       1,668       1,668       -  
Other
    72       -       -       72       1,804       1,876       -  
Total
  $ 1,270       349       2,249       3,868       449,915       453,783       128  
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 4 – Loans (continued)
Impaired loans at March 31, 2013 and December 31, 2012 are as follows (in thousands):

   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
March 31, 2013
                             
With no related allowance recorded:
                             
Commercial & industrial
  $ -       -       -       -       -  
Commercial real estate
    9,480       9,875       -       9,516       89  
Residential real estate
    534       727       -       591       3  
Consumer
    -       -       -       3       -  
Total
  $ 10,014       10,602       -       10,110       92  
                                         
With an allowance recorded:
                                       
Commercial & industrial
  $ 181       249       71       202       -  
Commercial real estate
    4,526       4,654       657       4,548       32  
Residential real estate
    760       786       157       764       3  
Consumer
    7       7       -       7       -  
Total
  $ 5,474       5,696       885       5,521       35  
                                         
Total:
                                       
Commercial & industrial
  $ 181       249       71       202       -  
Commercial real estate
    14,006       14,529       657       14,064       121  
Residential real estate
    1,294       1,513       157       1,355       6  
Consumer
    7       7       -       10       -  
Total
  $ 15,488       16,298       885       15,631       127  
                                         
December 31, 2012
                                       
With no related allowance recorded:
                                       
Commercial & industrial
  $ -       -       -       975       43  
Commercial real estate
    9,541       9,936       -       9,310       350  
Residential real estate
    417       417       -       397       5  
Consumer
    20       20       -       23       2  
Total
  $ 9,978       10,373       -       10,705       400  
                                         
With an allowance recorded:
                                       
Commercial & industrial
  $ 264       822       159       374       -  
Commercial real estate
    4,258       4,360       660       4,765       171  
Residential real estate
    658       853       85       707       2  
Consumer
    -       -       -       4       -  
Total
  $ 5,180       6,035       904       5,850       173  
                                         
Total:
                                       
Commercial & industrial
  $ 264       822       159       1,349       43  
Commercial real estate
    13,799       14,296       660       14,075       521  
Residential real estate
    1,075       1,270       85       1,104       7  
Consumer
    20       20       -       27       2  
Total
  $ 15,158       16,408       904       16,555       573  
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 4 – Loans (continued)
One residential real estate loan was modified and classified as a troubled debt restructuring in each of the three-month periods ended March 31, 2013 and 2012 with a balance of $80,000 and $30,000, respectively, at the date of modification.

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, capitalization of delinquent interest, 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.

A restructured automobile loan with a balance of $13,000 was charged off during the first quarter 2013, which was within twelve months of the loan’s modification date.  There were no other troubled debt restructurings that subsequently defaulted within twelve months of the restructuring date for the three months ended March 31, 2013 and 2012.

Note 5 – 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 are as follows (in thousands):
 
   
Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
Balance, beginning of period
  $ 2,189       1,619  
Additions
    -       543  
Addition due to merger
    127       -  
Reductions due to sales
    (612 )     -  
Reductions due to valuation write-downs
    (17 )     (76 )
Balance, end of period
  $ 1,687       2,086  
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 5 – Other Real Estate Owned (continued)
Other real estate owned at March 31, 2013 and December 31, 2012 consisted of (dollars in thousands):
 
   
March 31, 2013
   
December 31, 2012
 
   
Number
   
Amount
   
Number
   
Amount
 
                         
Commercial, secured by real estate
     2     $ 1,443        2     $ 1,875  
Residential real estate
    5       244       8       314  
      7     $ 1,687       10     $ 2,189  
 
Note 6 – Premises and Equipment
Premises and equipment at March 31, 2013 and December 31, 2012 are summarized as follows (in thousands):

   
March 31,
   
December 31,
 
   
2013
   
2012
 
             
Land
  $ 5,315       4,708  
Buildings
    18,467       15,616  
Equipment
    11,672       11,280  
Construction in progress
    84       -  
Total
    35,538       31,604  
Less accumulated depreciation
    15,382       15,040  
Premises and equipment, net
  $ 20,156       16,564  

Depreciation charged to expense was $341,000 and $299,000 for the three months endeded March 31, 2013 and 2012, respectively.
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 7 – Borrowings
Funds borrowed from the Federal Home Loan Bank of Cincinnati at March 31, 2013 and December 31, 2012 are as follows (dollars in thousands):

   
Current
             
   
Interest
   
March 31,
   
December 31,
 
   
Rate
   
2013
   
2012
 
                   
Fixed Rate Advances, due at maturity:
                 
Advance due January 2015
    2.00 %   $ 5,000       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 %     1,050       1,308  
Advance due March 2019
    2.82 %     2,078       2,397  
            $ 13,128       13,705  

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 $179 million and $142 million at March 31, 2013 and December 31, 2012, respectively.  Additionally, LCNB is required to hold minimum levels of FHLB stock, based on the outstanding borrowings.

Short-term borrowings at March 31, 2013 and December 31, 2012 are as follows (dollars in thousands):

   
March 31, 2013
   
December 31, 2012
 
   
Amount
   
Rate
   
Amount
   
Rate
 
Line of credit
  $ -       - %   $ 2,661       0.75 %
Repurchase agreements
    11,609       0.10 %     11,095       0.10 %
    $ 11,609       0.10 %   $ 13,756       0.23 %
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 8 – Income Taxes
A reconciliation between the statutory income tax and the Company's effective tax rate is as follows:

   
For the three months ended
March 31,
 
   
2013
   
2012
 
             
Statutory tax rate
    34.0 %     34.0 %
Increase (decrease) resulting from -
               
Tax exempt interest
    (9.1 )%     (6.4 )%
Tax exempt income on bank owned life insurance
    (2.6 )%     (1.6 )%
Other, net
    0.7 %     0.1 %
Effective tax rate
    23.0 %     26.1 %

Note 9 - 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 include commitments to extend credit.  They involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.  Exposure to credit loss in the event of nonperformance by the other parties to financial instruments for commitments to extend credit is represented by the contract amount of those instruments.

LCNB 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 CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 9 - Commitments and Contingent Liabilities (continued)
LCNB uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.  Financial instruments whose contract amounts represent off-balance-sheet credit risk at March 31, 2013 and December 31, 2012 are as follows (in thousands):

      March 31,       December 31,  
     
2013
     
2012
 
         
Commitments to extend credit:
           
 
 
Commercial loans
 
$
15,170
     
13,625
 
Other loans:
               
Fixed rate
   
3,039
     
4,602
 
Adjustable rate
   
2,340
     
1,238
 
Unused lines of credit:
               
Fixed rate
   
3,869
     
3,368
 
Adjustable rate
   
63,375
     
45,199
 
Unused overdraft protection amounts on demand and NOW accounts
   
9,556
     
9,665
 
Standby letters of credit
   
5,375
     
5,109
 
   
$
102,724
     
82,806
 

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 March 31, 2013 and December 31, 2012, outstanding guarantees of approximately $346,000 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 March 31, 2013 and December 31, 2012 totaled approximately $5.0 million and $4.8 million, respectively.  The letters of credit have a final maturity date of July 15, 2015, 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.

Capital expenditures include the construction or acquisition of new office buildings, improvements to LCNB’s offices, purchases of furniture and equipment, and additions or improvements to LCNB’s information technology system.
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 9 - Commitments and Contingent Liabilities (continued)
Management believes that LCNB has sufficient liquidity to fund its lending and capital expenditure commitments.

LCNB and its subsidiary 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 10 – 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 capital leverage ratio supplements the risk-based capital guidelines.

For various regulatory purposes, financial institutions are classified into categories based upon capital adequacy.

   
Minimum
Requirement
   
To Be Considered
Well-Capitalized
 
Ratio of tier 1 capital to risk-weighted assets
    4.0 %     6.0 %
Ratio of total capital (tier 1 capital plus tier 2 capital) to risk-weighted assets
    8.0 %     10.0 %
Leverage ratio (tier 1 capital to adjusted quarterly average total assets)
    3.0 %     5.0 %

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.
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 10 – Regulatory Capital (continued)
A summary of the regulatory capital and capital ratios of LCNB follows (dollars in thousands):

     
At
     
At
 
     
March 31,
     
December 31,
 
     
2013
     
2012
 
     
Regulatory Capital:
               
Shareholders' equity
 
$
94,204
     
82,006
 
Goodwill and other intangibles
   
(16,924)
     
(6,019)
 
Accumulated other comprehensive income
   
(4,000)
     
(4,721)
 
Tier 1 risk-based capital
   
73,280
     
71,266
 
                 
Eligible allowance for loan losses
   
3,404
     
3,437
 
Total risk-based capital
 
$
76,684
     
74,703
 
                 
Capital ratios:
               
Total risk-based (8% required)
   
13.40%
     
15.86%
 
Tier 1 risk-based (4% required)
   
12.80%
     
15.13%
 
Leverage (3% required)
   
8.13%
     
8.98%
 

Note 11 – Accumulated Other Comprehensive Income
Changes in accumulated other comprehensive income for the three months ended March 31, 2013 and 2012 are as follows (in thousands):
 
   
Unrealized
Gains and
Losses on
Available-
for-Sale
Securities
   
Changes in
Pension
Plan Assets
and Benefit
Obligations
   
 
 
 
Total
 
                   
2013
                 
Balance at beginning of period
  $ 4,875       (154 )     4,721  
Before reclassifications
    (342 )     8       (334 )
Reclassifications
    (387 )     -       (387 )
Balance at end of period
    4,146       (146 )     4,000  
                         
2012
                       
Balance at beginning of period
    5,180       (152 )     5,028  
Before reclassifications
    (505 )     7       (498 )
Reclassifications
    (251 )     -       (251 )
Balance at end of period
    4,424       (145 )     4,279  
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 11 – Accumulated Other Comprehensive Income (continued)
Reclassifications out of accumulated other comprehensive income during the three months ended March 31, 2013 and 2012 and the affected line items in the consolidated statements of income are as follows (in thousands):

   
Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
Realized gain on sale of securities
  $ 587       380  
Provision for income taxes
    200       129  
Reclassification adjustment, net of taxes
  $ 387       251  

Note 12 – Retirement Plans
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.

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-month periods ended March 31, 2013 and 2012 are as follows (in thousands):

   
Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
             
Qualified noncontributory defined benefit retirement plan
  $ 31       142  
                 
401(k) plan
    79       36  

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.
 

LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 12 – Retirement Plans (continued)
The components of net periodic pension cost of the nonqualified defined benefit retirement plan for the three months ended March 31, 2013 and 2012 are summarized as follows (in thousands):

   
Three Months Ended
March 31,
 
   
2013
   
2012
 
Service cost
  $ 18       22  
Interest cost
    11       11  
Amortization of unrecognized net (gain)/loss
    6       5  
Amortization of unrecognized prior service cost
    7       7  
Net periodic pension cost
  $ 42       45  

Amounts recognized in accumulated other comprehensive income, net of deferred federal income taxes, at March 31, 2013 and December 31, 2012 for the nonqualified defined benefit retirement plan consists of (in thousands):

   
March 31,
   
December 31,
 
   
2013
   
2012
 
Net actuarial loss
  $ 121       125  
Past service cost
    24       29  
    $ 145       154  

Citizens National Bank had a qualified noncontributory defined benefit pension plan which covered employees hired before May 1, 2005.  LCNB assumed this plan at the time of the merger.
 
 
-27-

 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 13 - 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 March 31, 2013 are 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       25,360     $ 9.00       5.8       20,285     $ 9.00       5.8  
$ 11.00 - $12.99       65,708       12.04       7.3       33,716       12.04       6.7  
$ 17.00 - $18.99       19,518       18.15       2.5       19,518       18.15       2.5  
          110,586       12.42       6.1       73,519       12.82       5.3  

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

   
2013
   
2012
 
   
 
 
Options
   
Weighted
Average
Exercise
Price
   
 
 
Options
   
Weighted
Average
Exercise
Price
 
Outstanding, January 1
    110,586     $ 12.42       124,123     $ 12.54  
Granted
    -       -       14,491       12.60  
Exercised
    -       -       -       -  
Outstanding, March 31
    110,586       12.42       138,614       12.55  
Exercisable, March 31
    73,519       12.82       83,337       13.25  

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 March 31, 2013 that were “in the money” (market price greater than exercise price) was $499,000.  The aggregate intrinsic value at that date for only the options that were exercisable was $312,000.  The aggregate intrinsic value for options outstanding at March 31, 2012 that were in the money was $216,000 and the aggregate intrinsic value at that date for only the options that were exercisable was $119,000.  The intrinsic value changes based on changes in the market value of the Company’s stock.

Total expense related to options included in salaries and wages in the consolidated statements of income for each of the three months ended March 31, 2013 and 2012 was $9,000.
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 14 - 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 are as follows for the three months ended March 31, 2013 and 2012 (dollars in thousands, except share and per share data):

   
For the Three Months
 
   
Ended March 31,
 
   
2013
   
2012
 
             
Net income
  $ 1,728       2,277  
                 
Weighted average number of shares outstanding used in the calculation of basic earnings per common share
     7,513,101        6,706,295  
                 
Add dilutive effect of:
               
Stock options
    14,312       7,103  
Stock warrant
    83,213       60,053  
Adjusted weighted average number of shares outstanding used in the calculation of diluted earnings per common share
     7,610,626        6,773,451  
                 
Earnings per common share:
               
Basic
  $ 0.23       0.34  
Diluted
    0.23       0.34  
                 
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 15 - Fair Value Measurements
LCNB measures certain assets at fair value using various valuation techniques and assumptions, depending on the nature of the asset.  Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.

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 investment securities are classified as available-for-sale. The securities are reported at fair value on a recurring basis with unrealized holding gains and losses reported net of income taxes in accumulated other comprehensive income.

LCNB utilizes a pricing service for determining the fair values of most of its investment securities.  Fair value for U.S. Treasury Notes and corporate securities are determined based on market quotations (level 1).  Fair value for most of the other investment securities is calculated using the discounted cash flow method for each security.  The discount rates for these cash flows are estimated by the pricing service using rates observed in the market (level 2).  Cash flow streams are dependent on estimated prepayment speeds and the overall structure of the securities given existing market conditions.  In addition, the Company has invested in two mutual funds that invest in debt securities or loans that qualify for credit under the Community Reinvestment Act.  The investment in one of the mutual funds is considered to have level 1 inputs because it is publically traded in an active market and it publishes a daily net asset value.  The investment in the other mutual fund is considered to have level 2 inputs because, although its shares are not traded in an active market, an investor can have its interest in the fund redeemed for the balance of its capital account at any quarter-end assuming the fund is given a 60 day notice.  The investment in this fund is carried at cost and approximates fair value.  A third mutual fund invests in U.S. Government securities.  It is considered to have level 1 inputs because it is publically traded in an active market and it publishes a daily net asset value.  Additionally, LCNB owns trust preferred securities in various financial institutions and equity securities in various financial and non-financial companies.  Market quotations (level 1) are used to determine fair value for these investments.
 

LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 15 - Fair Value Measurements (continued)
Assets that may be recorded at fair value on a nonrecurring basis include impaired loans, other real estate owned, and other repossessed assets.  A loan is considered impaired when management believes it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement.  Impaired loans are carried at the present value of estimated future cash flows using the loan’s existing rate or the fair value of collateral if the loan is collateral dependent, if this value is less than the loan balance.  When the fair value of the collateral is based on an observable market price or current appraised value, the inputs are considered to be level 2.  When an appraised value is not available and there is not an observable market price, the inputs are considered to be level 3.

Other real estate owned is adjusted to fair value upon transfer of the loan to foreclosed assets, usually based on an appraisal of the property.  Subsequently, foreclosed assets are carried at the lower of carrying value or fair value.  The inputs for a valuation based on current appraised value are considered to be level 2.
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 15 - Fair Value Measurements (continued)
The following table summarizes the valuation of LCNB’s assets recorded at fair value by input levels as of March 31, 2013 and December 31, 2012 (in thousands):

     
Fair Value Measurements at the End of
the Reporting Period 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)
   
 
 
Total
Gains
(Losses)
 
March 31, 2013
                             
Recurring fair value measurements:
                             
Investment securities available-for-sale:
                             
U.S. Treasury notes
  $ 19,693       19,693       -       -       -  
U.S. Agency notes
    101,499       -       101,499       -       -  
U.S. Agency mortgage-backed securities
    54,156       -       54,156       -       -  
Certificates of deposit with other banks
    1,509       -       1,509       -          
Municipal securities:
                                       
Non-taxable
    78,744       -       78,744       -       -  
Taxable
    17,592       -       17,592       -       -  
Mutual funds
    2,223       1,223       1,000       -       -  
Trust preferred securities
    148       148       -       -       -  
Equity securities
    1,995       1,995       -       -       -  
Total recurring fair value measurements
  $ 277,559       23,059       254,500       -       -  
                                         
Nonrecurring fair value measurements:
                                       
Impaired loans
  $ 4,589       -       707       3,882       -  
Other real estate owned and repossessed assets (a)
    1,687        -        1,687        -        230  
Total nonrecurring fair value measurements
  $ 6,276       -       2,394       3,882       230  
                                         
December 31, 2012
                                       
Recurring fair value measurement:
                                       
Investment securities available-for-sale:
                                       
U.S. Treasury notes
  $ 18,686       18,686       -       -       -  
U.S. Agency notes
    90,606       -       90,606       -       -  
U.S. Agency mortgage-backed securities
    52,541       -       52,541       -       -  
Corporate securities
    3,067       3,067       -       -       -  
Municipal securities:
                                       
Non-taxable
    73,882       -       73,882       -       -  
Taxable
    15,841       -       15,841       -       -  
Mutual funds
    2,168       1,168       1,000       -       -  
Trust preferred securities
    245       245       -       -       -  
Equity securities
    1,470       1,470       -       -       -  
Total recurring fair value measurements
  $ 258,506       24,636       233,870       -       -  
                                         
Nonrecurring fair value measurements:
                                       
Impaired loans
  $ 4,276       -       161       4,115       -  
Other real estate owned and repossessed assets (b)
    2,189        -        2,189        -       (295 )
Total nonrecurring fair value measurements
  $ 6,465       -       2,350       4,115       (295 )
 
(a)
Two other real estate owned properties with a total carrying amount of $173,000 were written down to their combined fair value of $156,000, resulting in an impairment charge of $17,000.  Four other real estate owned properties with a total carrying amount of $612,000 were sold for a combined total of $857,000, resulting in a net gain of $245,000.    A repossessed asset with a carrying value of $6,000 was sold for $8,000, resulting in a net gain of $2,000.  The write-downs, losses, and gains were included in other non-interest expense for the period.
(b)
Eight other real estate owned properties with a total carrying amount of $1,809,000 were written down to their combined fair value of $1,525,000, resulting in an impairment charge of $284,000.  Another property was sold at a loss of $8,000.  Repossessed assets with a carrying value of $23,000 were sold for a combined total of $20,000, resulting in a net loss of $3,000.  The write-downs and losses were included in other non-interest expense for the period.
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 15 - Fair Value Measurements (continued)
Carrying amounts and estimated fair values of financial instruments as of March 31, 2013 and December 31, 2012 are as follows (in thousands):

   
March 31, 2013
   
December 31, 2012
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
   
Amount
   
Value
   
Amount
   
Value
 
                         
FINANCIAL ASSETS:
                       
Cash and cash equivalents
    28,313       28,313       13,475       13,475  
Investment securities:
                               
Available-for-sale
    277,559       277,559       258,506       258,506  
Held-to-maturity
    22,831       22,831       15,424       15,424  
Federal Reserve Bank stock
    1,106       1,106       949       949  
Federal Home Loan Bank stock
    2,854       2,854       2,091       2,091  
Loans, net
    546,263       554,993       450,346       453,060  
                                 
FINANCIAL LIABILITIES:
                               
Deposits
    820,870       825,318       671,471       675,964  
Short-term borrowings
    11,609       11,609       13,756       13,756  
Long-term debt
    13,128       14,066       13,705       14,724  

The fair value of off-balance-sheet financial instruments at March 31, 2013 and December 31, 2012 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.  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.  These current rates approximate market rates.
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

Note 15 - Fair Value Measurements (continued)
Deposits
The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date.  The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities, which approximates market rates.

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.

The following table summarizes the categorization by input level as of March 31, 2013 and December 31, 2012 of LCNB’s financial assets and liabilities not recorded at fair value but for which fair value is disclosed (in thousands):

     
Fair Value Measurements at the End of
the Reporting Period 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)
 
March 31, 2013
                       
Assets:
                       
Loans, net
  $ 550,404       -       550,404       -  
Investment securities, non-taxable, held-to-maturity
     22,831        -        -        22,831  
Federal Reserve Bank stock
    1,106       1,106       -       -  
Federal Home Loan Bank stock
    2,854       2,854       -       -  
                                 
Liabilities:
                               
Deposits
    825,318       -       825,318       -  
Long-term debt
    14,066       -       14,066       -  
                                 
December 31, 2012
                               
Assets:
                               
Loans, net
  $ 448,784       -       448,784       -  
Investment securities, non-taxable, held-to-maturity
     15,424        -        -        15,424  
Federal Reserve Bank stock
    949       949       -       -  
Federal Home Loan Bank stock
    2,091       2,091       -       -  
                                 
Liabilities:
                               
Deposits
    675,964       -       675,964       -  
Long-term debt
    14,724       -       14,724       -  
 
 
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Shareholders
LCNB Corp.
Lebanon, Ohio
 
We have reviewed the accompanying consolidated balance sheet of LCNB Corp. and subsidiaries (“LCNB”) as of March 31, 2013, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for the three-month periods ended March 31, 2013 and 2012.  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 as of December 31, 2012, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for the year then ended (not presented herein), and in our report dated February 25, 2013, 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, 2012, 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
May 6, 2013
 

LCNB CORP. AND SUBSIDIARIES

Item 2.

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 months ended March 31, 2013 was $1,728,000 (total basic and diluted earnings per share of $0.23).  This compares to net income of $2,277,000 (total basic and diluted earnings per share of $0.34) for the same three month period in 2012.

On January 11, 2013, First Capital Bancshares, Inc. (“First Capital”), a one-bank holding company located in Chillicothe, Ohio, merged into LCNB.  Immediately following this merger, Citizens National Bank (“Citizens”), a wholly-owned subsidiary of First Capital, was merged into LCNB National Bank.  The acquisition was accounted for using the acquisition method in accordance with applicable accounting guidance.  Accordingly, assets acquired and liabilities assumed were measured at their fair values as of the date of the transaction.  The excess of the estimated fair value of LCNB common shares issued and cash paid to First Capital shareholders over the net fair values of the assets acquired and liabilities assumed was recorded as goodwill, which approximated $8.4 million.  The results of operations are included in the consolidated income statement from the date of the merger. Expenses for the first quarter 2013 include expenditures totaling about $1,055,000 for costs associated with the merger and converting Citizens’ data processing system to LCNB’s system.

Net interest income for the first quarter 2013 was $569,000 greater than results for the first quarter 2012 primarily due to the increased volume of average interest earning assets provided by the merger, partially offset by a decrease in the net interest margin.

The provision for loan losses for the first quarter 2013 was $66,000 less than for the same period in 2012.  Net loan charge-offs for the first quarter 2013 and 2012 totaled $182,000 and $256,000, respectively.  Non-accrual loans and loans past due 90 days or more and still accruing interest totaled $3,353,000 or 0.61% of total loans at March 31, 2013, compared to $2,411,000 or 0.53% of total loans at December 31, 2012.  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 decreased from $2,189,000 at December 31, 2012 to $1,687,000 at March 31, 2013 primarily due to the sale of commercial real estate property during the quarter.
 
 
LCNB CORP. AND SUBSIDIARIES

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

Non-interest income for the first quarter 2013 was $171,000 greater than the comparable period in 2012 primarily due to increases in service charges and fees on deposit accounts primarily resulting from the merger and gains recognized on the sale of investment securities.  The increases were partially offset by a decrease in trust income due to the absence of one-time fees recognized in 2012.

Non-interest expense for the first quarter 2013 was $1,643,000 more than the comparable period in 2012 primarily due the recognition of $1,055,000 in costs related to the merger with Citizens.   Salaries and employee benefits, as well as a variety of other expense items, increased significantly due to the increased number of employees and offices resulting from the merger.  These expense increases were partially offset by a gain recognized on the sale of other real estate owned property during the quarter.

Net Interest Income
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 March 31, 2013 and 2012, 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.

   
Three Months Ended March 31,
 
   
2013
   
2012
 
   
Average
   
Interest
   
Average
   
Average
   
Interest
   
Average
 
   
Outstanding
   
Earned/
   
Yield/
   
Outstanding
   
Earned/
   
Yield/
 
   
Balance
   
Paid
   
Rate
   
Balance
   
Paid
   
Rate
 
   
(Dollars in thousands)
 
                                     
Loans (1)
  $ 536,518       6,580       4.97 %   $ 461,079       6,208       5.42 %
Federal funds sold
    3,115       1       0.13 %     -       -       - %
Interest-bearing demand deposits
    13,166       7       0.22 %     15,202       6       0.16 %
Federal Reserve Bank stock
    1,104       -       - %     941       -       - %
Federal Home Loan Bank stock
    2,743       31       4.58 %     2,091       24       4.62 %
Investment securities:
                                               
Taxable
    188,749       834       1.79 %     174,323       887       2.05 %
Non-taxable (2)
    93,033       944       4.12 %     79,742       918       4.63 %
Total interest-earning assets
    838,428       8,397       4.06 %     733,378       8,043       4.41 %
Non-earning assets
    89,527                       65,168                  
Allowance for loan losses
    (3,349 )                     (2,816 )                
Total assets
  $ 924,606                     $ 795,730                  
                                                 
Interest-bearing deposits
  $ 645,950       983       0.62 %     570,980       1,165       0.82 %
Short-term borrowings
    11,623       3       0.10 %     10,917       3       0.11 %
Long-term debt
    13,396       112       3.39 %     21,044       154       2.94 %
Total interest-bearing liabilities
    670,969       1,098       0.66 %     602,941       1,322       0.88 %
Demand deposits
    153,026                       106,985                  
Other liabilities
    7,276                       6,541                  
Capital
    93,335                       79,263                  
Total liabilities and capital
  $ 924,606                     $ 795,730                  
                                                 
Net interest rate spread (3)
                    3.40 %                     3.53 %
                                                 
Net interest income and net interest margin on a tax-equivalent basis (4)
            7,299       3.53 %             6,721       3.69 %
                                                 
Ratio of interest-earning assets to interest-bearing liabilities
    124.96 %                     121.63 %                
 
(1)
Includes nonaccrual loans if any.
(2)
Income from tax-exempt securities is included in interest income on a tax-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 rate spread is the difference between the average rate on total interest-earning assets and interest-bearing liabilities.
(4)
The net interest margin is the tax-equivalent net interest income divided by average interest-earning assets.
 
 
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 tax-equivalent 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 March 31, 2013 as compared to the same period in 2012.  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
 
   
March 31,
 
   
2013 vs. 2012
 
   
Increase (decrease) due to:
 
   
Volume
   
Rate
   
Total
 
   
(In thousands)
 
Interest-earning Assets:
                 
Loans
  $ 957       (585 )     372  
Federal funds sold
    1       -       1  
Interest-bearing demand deposits
    (1 )     2       1  
Federal Reserve Bank stock
    -       -       -  
Federal Home Loan Bank stock
    7       -       7  
Investment securities:
                       
Taxable
    70       (123 )     (53 )
Nontaxable
    142       (116 )     26  
Total interest income
    1,176       (822 )     354  
                         
Interest-bearing Liabilities:
                       
Deposits
    140       (322 )     (182 )
Short-term borrowings
    -       -       -  
Long-term debt
    (62 )     20       (42 )
Total interest expense
    78       (302 )     (224 )
Net interest income
  $ 1,098       (520 )     578  

Net interest income on a tax-equivalent basis for the three months ended March 31, 2013 totaled $7,299,000, an increase of $578,000 from the comparable period in 2012.  Total tax-equivalent interest income increased $354,000 and total interest expense declined $224,000.

The increase in total interest income was primarily due to a $105.1 million increase in average total earning assets, partially offset by a 35 basis point (a basis point equals 0.01%) decrease in the average rate earned on earning assets.  The increase in average interest earning assets was primarily due to interest-earning assets acquired through the merger with First Capital.  The decrease in the average rate earned reflects a general decrease in market rates.

The decrease in total interest expense was primarily due to a 22 basis point decrease in the average rate paid on interest-bearing liabilities, partially offset by a $68.0 million increase in average interest-bearing liabilities.  The increase in average interest-bearing liabilities was primarily due to a $75.0 million increase in average interest-bearing deposits primarily due to the merger, partially offset by a $7.6 million decrease in average long-term debt.  Long-term debt decreased because of the payment in full of a $6.0 million Federal Home Loan Bank advance in August 2012.  The decrease in the average rate paid on deposits also reflects a general decrease in market rates.
 
 
LCNB CORP. AND SUBSIDIARIES

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

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 March 31, 2013 and 2012 was $149,000 and $215,000, respectively.  The decrease in the provision reflects a decrease in net charge-offs coupled with relatively stable regional market conditions.

The fair value of loans acquired through the merger was estimated by discounting at current rates the cash flows expected to be received on Citizens’ loan portfolio.  Since the estimation of cash flows recognized the probability that LCNB would not be able to collect all contractually required principal and interest payments, Citizens’ allowance for loan losses was not carried forward.

Non-Interest Income
Total non-interest income for the first quarter 2013 was $171,000 greater than for the first quarter 2012 primarily due to a $101,000 increase in service charges and fees on deposit accounts and a $207,000 increase in gains from sales of securities.  Service charges and fees on deposit accounts increased primarily due to a greater number of deposit accounts resulting from the merger.  The results also reflect a continuing downward trend in overdraft fee income and a continuing upward trend in check card fee income. Gains from sales of securities increased due to the sale of $22.8 million in securities in 2013, the fair values of which had benefited from the continuing decline in general market rates.  Approximately $29.6 million of securities with relatively lower unrealized gains were sold during the 2012 period.  Partially offsetting these increases was a $191,000 decrease in trust income primarily due to the absence of one-time estate fees recognized during the first quarter 2012.

Non-Interest Expense
Non-interest expense for the first quarter 2013 was $1,643,000 greater than for the first quarter 2012 due primarily to a $312,000 increase in salaries and employee benefits and a $1,142,000 increase in other non-interest expense.  The increase in salaries and employee benefits primarily reflects the additional staff needed to operate the six additional offices LCNB acquired as a result of the merger.  Other non-interest expense for the first quarter 2013 includes $1,055,000 in costs related to the merger and converting Citizens’ data processing system to LCNB’s system.  Partially offsetting the merger related costs in other non-interest expense for the 2013 period was a $274,000 decrease in net costs related to other real estate owned including a gain recognized in 2013 on the sale of commercial real estate property and a decrease in impairment write-downs.

Income Taxes
LCNB’s effective tax rates for continuing operations for the three months ended March 31, 2013 and 2012 were 23.0% and 26.1%, 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 income from bank owned life insurance.
 
 
LCNB CORP. AND SUBSIDIARIES

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

Financial Condition
The carrying values of loans, securities available-for-sale, premises and equipment, and deposits were greatly influenced by the merger.  See Note 2 to the Financial Statements for a description of the merger and a summary of the fair values of First Capital’s assets and liabilities added to LCNB’s consolidated balance sheet.

In addition to the merger, a $27.9 million increase in public fund deposits by local government entities was a secondary reason for the increase in total deposits.  Public fund deposits can be relatively volatile due to seasonal tax collections and the financial needs of the local entities.

Common stock in the shareholders’ equity section of the consolidated balance sheet at March 31, 2013 was $12.4 million greater than the balance shown for December 31, 2012 due to the merger.  LCNB issued 888,811 shares of stock, valued at $12.4 million on the date of the merger, and paid approximately $7.8 million in cash to effect the merger.

Liquidity
LCNB depends on dividends from its subsidiary 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, interest-bearing deposits in other banks, and securities available for sale.  At March 31, 2013, LCNB’s liquid assets amounted to $305.9 million or 32.3% of total assets.  Liquid assets at December 31, 2012 totaled $272.0 million, or 34.5% of total assets.

Liquidity is also provided by access to core funding sources, primarily core deposits in the bank’s market area.  Approximately 82.5% of total deposits at March 31, 2013 were core deposits, compared to 83.6% of deposits at December 31, 2012.  Core deposits, for this purpose, are defined as total deposits less public funds and certificates of deposit equal to or 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.

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.
 
 
LCNB CORP. AND SUBSIDIARIES

Item 3.
 
Market risk for LCNB is primarily interest rate risk.  LCNB attempts to mitigate this risk through asset/liability management strategies designed to decrease the vulnerability of its earnings to material and prolonged changes in interest rates.  LCNB does not use derivatives such as interest rate swaps, caps, or floors to hedge this risk.  LCNB has not entered into any market risk instruments for trading purposes.

The Bank's Asset and Liability Management Committee ("ALCO") primarily uses a combination of Interest Rate Sensitivity Analysis (“IRSA”) and Economic Value of Equity (“EVE”) analysis for measuring and managing interest rate risk.  IRSA is used to estimate the effect on net interest income during a one-year period of instantaneous and sustained movements in interest rates, also called interest rate shocks, of 100, 200, and 300 basis points.  Management considers the results of any significant downward scenarios to not be meaningful in the current interest rate environment.  The base projection uses a current interest rate scenario.  As shown below, the March 31, 2013 IRSA indicates that an increase in interest rates at all shock levels would have a positive effect on net interest income (“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
  $ 31,527       2,051       6.96 %
Up 200
    30,820       1,344       4.56 %
Up 100
    30,134       658       2.23 %
Base
    29,476       -       - %

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 March 31, 2013 EVE analysis indicates that an increase in interest rates would have a negative effect on the EVE.  The changes in the EVE for all rate assumptions are within LCNB’s acceptable ranges.

Rate Shock Scenario in
Basis Points
 
Amount
   
$ Change in
EVE
   
% Change in
EVE
 
   
(Dollars in thousands)
 
Up 300
  $ 90,504       (8,258 )     (8.36 )%
Up 200
    92,756       (6,006 )     (6.08 )%
Up 100
    95,579       (3,183 )     (3.22 )%
Base
    98,762       -       - %
 
 
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.

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 March 31, 2013, 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.
 
 
LCNB CORP. AND SUBSIDIARIES
 
PART II -- OTHER INFORMATION
 
Item 1.

Not Applicable

Item 1A.

No material changes

Item 2.

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.

Not Applicable

Item 4.

Not Applicable

Item 5.

Not Applicable
 
 
LCNB CORP. AND SUBSIDIARIES

Item 6.
 
Exhibit No.
Exhibit Description
2
Agreement and Plan of Merger dated as of October 9, 2012 by and between LCNB Corp. and First Capital Bancshares, Inc.  – incorporated by reference to the Registrant’s Form 8-K filed on October 9, 2012, Exhibit 2.1.
   
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).
   
10.1
LCNB Corp. Ownership Incentive Plan – incorporated by reference to Registrant’s Form DEF 14A Proxy Statement pursuant to Section 14(a), dated March 15, 2002, Exhibit A (000-26121).
   
10.2
Form of Option Grant Agreement under the LCNB Corp. Ownership Incentive Plan – incorporated by reference to the Registrant’s Form 10-K for the fiscal year ended December 31, 2005, Exhibit 10.2.
   
10.3
Nonqualified Executive Retirement Plan – incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the period ended June 30, 2009, Exhibit 10.4.
   
Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
   
Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
   
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 March 31, 2013 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.
 
 
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.
 
     
May 6, 2013
 /s/ Stephen P. Wilson
 
 
Stephen P. Wilson, CEO &
 
 
Chairman of the Board of Directors
 
     
May 6, 2013
 /s/ Robert C. Haines, II
 
 
Robert C. Haines, II, Executive Vice President
 
 
and Chief Financial Officer
 
 
 
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