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LCNB CORP - Quarter Report: 2014 March (Form 10-Q)


 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.   20549

FORM 10-Q

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2014
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                                                        to                                                      

Commission File Number 000-26121
LCNB Corp.
(Exact name of registrant as specified in its charter)
Ohio
 
 31-1626393
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes         ¨ 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         ¨ 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).
¨ Yes         x No
The number of shares outstanding of the issuer's common stock, without par value, as of May 8, 2014 was 9,292,626 shares.
 
 
 
 
 


Table of Contents



LCNB CORP. AND SUBSIDIARIES

TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

1

Table of Contents



PART I – FINANCIAL INFORMATION
 
Item 1.
Financial Statements

LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)

 
 
March 31, 2014
 
December 31,
2013
 
 
(Unaudited)
 
ASSETS:
 
 
 
 
Cash and due from banks
 
$
20,238

 
10,410

Interest-bearing demand deposits
 
13,185

 
4,278

Total cash and cash equivalents
 
33,423

 
14,688

Investment securities:
 
 

 
 

Available-for-sale, at fair value
 
310,063

 
258,241

Held-to-maturity, at cost
 
16,467

 
16,323

Federal Reserve Bank stock, at cost
 
1,603

 
1,603

Federal Home Loan Bank stock, at cost
 
3,638

 
2,854

Loans, net
 
681,826

 
570,766

Premises and equipment, net
 
21,042

 
19,897

Goodwill
 
27,424

 
14,186

Bank owned life insurance
 
21,437

 
21,280

Other assets
 
16,585

 
12,500

TOTAL ASSETS
 
$
1,133,508

 
932,338

LIABILITIES:
 
 

 
 

Deposits:
 
 

 
 

Noninterest-bearing
 
$
196,007

 
164,912

Interest-bearing
 
788,507

 
620,849

Total deposits
 
984,514

 
785,761

Short-term borrowings
 
11,215

 
8,655

Long-term debt
 
11,580

 
12,102

Accrued interest and other liabilities
 
6,438

 
6,947

TOTAL LIABILITIES
 
1,013,747

 
813,465

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 10,045,853 and 10,041,163 shares at March 31, 2014 and December 31, 2013, respectively
 
66,874

 
66,785

Retained earnings
 
65,313

 
65,475

Treasury shares at cost, 753,627 shares at March 31, 2014 and December 31, 2013
 
(11,665
)
 
(11,665
)
Accumulated other comprehensive loss, net of taxes
 
(761
)
 
(1,722
)
TOTAL SHAREHOLDERS' EQUITY
 
119,761

 
118,873

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
 
$
1,133,508

 
932,338


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

The consolidated balance sheet as of December 31, 2013 has been derived from the audited consolidated balance sheet as of that day.

2

Table of Contents



LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
(Unaudited)
 
 
Three Months Ended 
 March 31,
 
 
2014
 
2013
INTEREST INCOME:
 
 
 
 
Interest and fees on loans
 
7,696

 
6,580

Interest on investment securities –
 
 

 
 

Taxable
 
891

 
834

Non-taxable
 
646

 
623

Other short-term investments
 
45

 
39

TOTAL INTEREST INCOME
 
9,278

 
8,076

INTEREST EXPENSE:
 
 

 
 

Interest on deposits
 
809

 
983

Interest on short-term borrowings
 
3

 
3

Interest on long-term debt
 
103

 
112

TOTAL INTEREST EXPENSE
 
915

 
1,098

NET INTEREST INCOME
 
8,363

 
6,978

PROVISION FOR LOAN LOSSES
 
81

 
149

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
 
8,282

 
6,829

NON-INTEREST INCOME:
 
 

 
 

Trust income
 
655

 
575

Service charges and fees on deposit accounts
 
1,122

 
979

Net gain (loss) on sales of securities
 
(4
)
 
587

Bank owned life insurance income
 
172

 
172

Gains from sales of mortgage loans
 
15

 
129

Other operating income
 
117

 
65

TOTAL NON-INTEREST INCOME
 
2,077

 
2,507

NON-INTEREST EXPENSE:
 
 

 
 

Salaries and employee benefits
 
3,918

 
3,294

Equipment expenses
 
294

 
292

Occupancy expense, net
 
651

 
506

State franchise tax
 
244

 
216

Marketing
 
132

 
144

FDIC insurance premiums
 
149

 
128

Merger-related expenses
 
1,292

 
1,055

Other non-interest expense
 
1,992

 
1,456

TOTAL NON-INTEREST EXPENSE
 
8,672

 
7,091

INCOME BEFORE INCOME TAXES
 
1,687

 
2,245

PROVISION FOR INCOME TAXES
 
364

 
517

NET INCOME
 
1,323

 
1,728

Dividends declared per common share
 
0.16

 
0.16

Earnings per common share:
 
 

 
 

Basic
 
0.14

 
0.23

Diluted
 
0.14

 
0.23

Weighted average common shares outstanding:
 
 

 
 

Basic
 
9,288,400

 
7,513,101

Diluted
 
9,413,049

 
7,610,626


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

3

Table of Contents



LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)

 
 
Three Months Ended 
 March 31,
 
 
2014
 
2013
Net income
 
1,323

 
1,728

Other comprehensive income:
 
 

 
 

Net unrealized gain (loss) on available-for-sale securities (net of taxes of $493 and $176 for the three months ended March 31, 2014 and 2013, respectively)
 
956

 
(342
)
Reclassification adjustment for net realized (gain) loss on sale of available-for-sale securities included in net income (net of taxes of $1 and $200 for the three months ended March 31, 2014 and 2013, respectively)
 
3

 
(387
)
Change in nonqualified pension plan unrecognized net loss and unrecognized prior service cost (net of taxes of $1 and $5 for the three months ended March 31, 2014 and 2013, respectively)
 
2

 
8

TOTAL COMPREHENSIVE INCOME
 
2,284

 
1,007


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


4

Table of Contents



CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Dollars in thousands, except per share amounts)
(Unaudited)

 
 
Common Shares Outstanding
 
Common Stock
 
Retained
Earnings
 
Treasury
Shares
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total Shareholders'
Equity
Balance at December 31, 2012
 
6,731,900

 
$
27,107

 
61,843

 
(11,665
)
 
4,721

 
82,006

Net income
 
 

 
 

 
1,728

 
 

 
 

 
1,728

Net unrealized loss on available-for-sale securities, net of taxes
 
 

 
 

 
 

 
 

 
(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 loss 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 at March 31, 2013
 
7,625,760

 
$
39,517

 
62,352

 
(11,665
)
 
4,000

 
94,204

 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2013
 
9,287,536

 
$
66,785

 
65,475

 
(11,665
)
 
(1,722
)
 
118,873

Net income
 
 

 
 

 
1,323

 
 

 
 

 
1,323

Net unrealized gain on available-for-sale securities, net of taxes
 
 

 
 

 
 

 
 

 
956

 
956

Reclassification adjustment for net realized loss on sales of available-for-sale securities included in net income, net of taxes
 
 

 
 

 
 

 
 

 
3

 
3

Change in nonqualified pension plan unrecognized net loss and unrecognized prior service cost, net of taxes
 
 

 
 

 
 

 
 

 
2

 
2

Dividend Reinvestment and Stock Purchase Plan
 
4,690

 
82

 
 

 
 

 
 

 
82

Compensation expense relating to stock options
 
 
 
7

 
 
 
 
 
 
 
7

Common stock dividends, $0.16 per share
 
 

 
 

 
(1,485
)
 
 

 
 

 
(1,485
)
Balance at March 31, 2014
 
9,292,226

 
$
66,874

 
65,313

 
(11,665
)
 
(761
)
 
119,761


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


5

Table of Contents



LCNB CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
 
Three Months Ended 
 March 31,
 
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
Net income
 
$
1,323

 
1,728

Adjustments to reconcile net income to net cash flows from operating activities:
 
 

 
 

Depreciation, amortization, and accretion
 
775

 
740

Provision for loan losses
 
81

 
149

Increase in cash surrender value of bank owned life insurance
 
(172
)
 
(172
)
Realized (gain) loss from sales of securities available-for-sale
 
4

 
(587
)
Realized (gain) loss from sales of premises and equipment
 
(5
)
 

Realized (gain) loss from sales and write-downs of other real estate owned and repossessed assets
 
19

 
(230
)
Origination of mortgage loans for sale
 
(610
)
 
(7,175
)
Realized gains from sales of mortgage loans
 
(15
)
 
(129
)
Proceeds from sales of mortgage loans
 
620

 
7,241

Compensation expense related to stock options
 
7

 
9

Changes in:
 
 

 
 

Accrued income receivable
 
(599
)
 
(671
)
Other assets
 
309

 
(53
)
Other liabilities
 
(767
)
 
(928
)
TOTAL ADJUSTMENTS
 
(353
)
 
(1,806
)
NET CASH FLOWS FROM OPERATING ACTIVITIES
 
970

 
(78
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 

 
 

Proceeds from sales of investment securities available-for-sale
 
26,071

 
23,337

Proceeds from maturities and calls of investment securities:
 
 

 
 

Available-for-sale
 
7,795

 
5,059

Held-to-maturity
 
562

 
1,353

Purchases of investment securities:
 
 

 
 

Available-for-sale
 
(48,672
)
 
(26,725
)
Held-to-maturity
 
(706
)
 
(8,376
)
Proceeds from redemption of Federal Reserve Bank stock
 
41

 

Net (increase) decrease in loans
 
4,749

 
2,865

Proceeds from redemption of bank owned life insurance
 
3,633

 

Proceeds from sale of other real estate owned and repossessed assets
 
137

 
865

Additions to other real estate owned
 
(17
)
 

Purchases of premises and equipment
 
(178
)
 
(204
)
Proceeds from sale of premises and equipment
 
6

 

Net cash acquired from (paid for) acquisition
 
(9,115
)
 
9,771

NET CASH FLOWS FROM INVESTING ACTIVITIES
 
(15,694
)
 
7,945

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 

 
 

Net increase (decrease) in deposits
 
33,475

 
12,626

Net increase (decrease) in short-term borrowings
 
1,909

 
(2,147
)
Principal payments on long-term debt
 
(522
)
 
(2,369
)
Proceeds from issuance of common stock
 
11

 
11

Cash dividends paid on common stock
 
(1,414
)
 
(1,150
)
NET CASH FLOWS FROM FINANCING ACTIVITIES
 
33,459

 
6,971

NET CHANGE IN CASH AND CASH EQUIVALENTS
 
18,735

 
14,838

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
 
14,688

 
13,475

CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
33,423

 
28,313

SUPPLEMENTAL CASH FLOW INFORMATION:
 
 

 
 

Interest paid
 
$
784

 
1,171

Income taxes paid
 

 
440

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES:
 
 

 
 

Transfer from loans to other real estate owned and repossessed assets
 
213

 
6


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

6

Table of Contents



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 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.

The consolidated balance sheet as of December 31, 2013 has been derived from the audited consolidated balance sheet as of that day.

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, 2014 are not necessarily indicative of the results to be expected for the full year ending December 31, 2014.  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 2013 Annual Report on Form 10-K filed with the SEC.

Note 2 – Acquisitions
 
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 of Chillicothe ("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.

On October 28, 2013, LCNB and Colonial Banc Corp. (“Colonial”) entered into a Stock Purchase Agreement (“Purchase Agreement”) pursuant to which LCNB purchased from Colonial on January 24, 2014 all of the issued and outstanding shares of Eaton National Bank & Trust Co. ("ENB") in a cash transaction valued at $24.75 million. Immediately following the acquisition, ENB was merged into the Bank.  ENB operated five full–service branches with a main office and another facility in Eaton, Ohio and branch offices in each of West Alexandria, Ohio, New Paris, Ohio, and Lewisburg, Ohio.  These offices became branches of the Bank after the merger.



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Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 2 – Acquisitions (continued)


The merger with ENB 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:
 
Cash paid to shareholder
$
24,750

 
 

Identifiable Assets Acquired:
 

Cash and cash equivalents
15,635

Investment securities:
 

Available-for-sale
35,859

Federal Reserve Bank stock
41

Federal Home Loan Bank stock
784

Loans
116,133

Premises and equipment
1,314

Bank owned life insurance
3,618

Core deposit intangible
2,466

Other real estate owned
262

Other assets
1,645

Total identifiable assets acquired
177,757

 
 

Liabilities Assumed:
 

Deposits
165,335

Short-term borrowings
651

Other liabilities
259

Total liabilities assumed
166,245

 
 

Total Identifiable Net Assets Acquired
11,512

 
 

Goodwill resulting from merger
$
13,238


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 on LCNB's financial records, but is deductible for tax purposes.  The core deposit intangible will be amortized over eight years using the straight-line method.

Prior to the end of the one-year measurement period for finalizing the purchase allocation, if information becomes available which would indicated adjustments to the purchase price allocation, such adjustments will be included in the purchase price retrospectively.

Direct costs related to the acquisition were expensed as incurred and are recorded in merger-related expense in the consolidated statements of income.  
 
The results of operations are included in the consolidated statement of income from the date of the merger.  The estimated amount of ENB revenue (net interest income plus non-interest income) and net income, excluding merger and data conversion costs, included in LCNB's consolidated statement of income for the three months ended March 31, 2014 were as follows (in thousands):
Total revenue
$
1,139

Net income
371


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Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 2 – Acquisitions (continued)



The following table presents unaudited pro forma information as if the merger with ENB had occurred on January 1, 2013 (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 ENB occurred in 2013.  In particular, expected operational cost savings are not reflected in the pro forma amounts.
 
 
Three Months Ended
March 31,
 
 
2014
 
2013
Total revenue
 
$
10,935

 
11,756

Net income
 
2,331

 
2,306

Basic earnings per common share
 
0.25

 
0.25

Diluted earnings per common share
 
0.25

 
0.25



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


Note 3 - Investment Securities
 
The amortized cost and estimated fair value of available-for-sale investment securities at March 31, 2014 and December 31, 2013 are summarized as follows (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
March 31, 2014
 
 
 
 
 
 
 
Available-for-Sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
35,477

 
1

 
306

 
35,172

U.S. Agency notes
125,001

 
152

 
2,692

 
122,461

U.S. Agency mortgage-backed securities
44,041

 
496

 
708

 
43,829

Certificates of deposit
3,079

 
16

 

 
3,095

Municipal securities:
 

 
 

 
 

 
 

Non-taxable
83,108

 
2,136

 
758

 
84,486

Taxable
16,439

 
533

 
141

 
16,831

Mutual funds
2,427

 

 
32

 
2,395

Trust preferred securities
50

 

 

 
50

Equity securities
1,474

 
308

 
38

 
1,744

 
$
311,096

 
3,642

 
4,675

 
310,063

 
 
 
 
 
 
 
 
Investment Securities Held-to-Maturity:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
Non-taxable
16,067

 
117

 
258

 
15,926

Taxable
400

 

 

 
400

 
$
16,467

 
117

 
258

 
16,326

 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
Available-for-Sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
13,184

 

 
290

 
12,894

U.S. Agency notes
110,248

 
141

 
3,714

 
106,675

U.S. Agency mortgage-backed securities
40,602

 
555

 
848

 
40,309

Certificates of deposit
1,492

 
9

 

 
1,501

Municipal securities:
 

 
 

 
 

 
 

Non-taxable
74,185

 
2,116

 
968

 
75,333

Taxable
17,020

 
503

 
214

 
17,309

Mutual funds
2,419

 

 
39

 
2,380

Trust preferred securities
149

 
4

 
6

 
147

Equity securities
1,429

 
329

 
65

 
1,693

 
$
260,728

 
3,657

 
6,144

 
258,241

 
 
 
 
 
 
 
 
Investment Securities Held-to-Maturity:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
Non-taxable
15,923

 
159

 
285

 
15,797

Taxable
400

 

 
1

 
399

 
$
16,323

 
159

 
286

 
16,196


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Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 3 - Investment Securities (continued)



Information concerning available-for-sale investment securities with gross unrealized losses at March 31, 2014 and December 31, 2013, aggregated by length of time that individual securities have been in a continuous loss position, is as follows (dollars in thousands):
 
Less than Twelve Months
 
Twelve Months or Greater
 
Number
 
Fair
Value
 
Unrealized
Losses
 
Number
 
Fair
Value
 
Unrealized
Losses
March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
Investment Securities Available-for-Sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury notes
7

 
$
32,219

 
306

 

 
$

 

U.S. Agency notes
26

 
100,721

 
2,042

 
2

 
9,803

 
650

U.S. Agency mortgage-backed securities
9

 
21,554

 
454

 
19

 
4,974

 
254

Municipal securities:
 
 
 

 
 

 
 
 
 
 
 
Non-taxable
23

 
9,062

 
182

 
32

 
13,994

 
576

Taxable
7

 
4,032

 
135

 
5

 
1,254

 
6

Mutual funds
2

 
1,395

 
32

 

 

 

Trust preferred securities

 

 

 
1

 
49

 

Equity securities
8

 
353

 
23

 
3

 
99

 
15

 
82

 
$
169,336

 
3,174

 
62

 
$
30,173

 
1,501

 
 
 
 
 
 
 
 
 
 
 
 
Investment Securities Held-to-Maturity:
 
 
 
 
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
 
 
 
 
  Non-taxable
8

 
$
4,977

 
258

 

 
$

 

  Taxable

 

 

 

 

 

 
8

 
$
4,977

 
258

 

 
$

 

 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
Investment Securities Available-for-Sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury notes
3

 
$
12,894

 
290

 

 
$

 

U.S. Agency notes
25

 
89,080

 
2,880

 
2

 
9,636

 
834

U.S. Agency mortgage-backed securities
9

 
17,557

 
575

 
19

 
5,130

 
273

Municipal securities:
 
 
 

 
 

 
 
 
 

 
 
Non-taxable
37

 
15,641

 
398

 
24

 
10,751

 
570

Taxable
9

 
4,903

 
202

 
5

 
1,252

 
12

Mutual funds
2

 
1,380

 
39

 

 

 

Trust preferred securities

 

 

 
2

 
93

 
6

Equity securities
6

 
300

 
44

 
3

 
93

 
21

 
91

 
$
141,755

 
4,428

 
55

 
$
26,955

 
1,716

 
 
 
 
 
 
 
 
 
 
 
 
Investment Securities Held-to-Maturity:
 
 
 
 
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
 
 
 
 
  Non-taxable
6

 
$
4,890

 
285

 

 
$

 

  Taxable
1

 
399

 
1

 

 

 

 
7

 
$
5,289

 
286

 

 
$

 



11

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 3 - Investment Securities (continued)


Management has determined that the unrealized losses at March 31, 2014 are primarily due to fluctuations in market interest rates and do not reflect credit quality deterioration of the securities.   Because LCNB does not have the intent to sell the investments and it is more likely than not that LCNB will not be required to sell the investments before recovery of their amortized cost bases, which may be at maturity, LCNB does not consider these investments to be other-than-temporarily impaired.

Contractual maturities of investment securities at March 31, 2014 were as follows (in thousands).  Actual maturities may differ from contractual maturities when issuers have the right to call or prepay obligations.
 
Available-for-Sale
 
Held-to-Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Due within one year
$
16,162

 
16,294

 
2,145

 
2,151

Due from one to five years
119,445

 
120,461

 
4,229

 
4,228

Due from five to ten years
117,716

 
115,829

 
6,383

 
6,169

Due after ten years
9,781

 
9,461

 
3,710

 
3,778

 
263,104

 
262,045

 
16,467

 
16,326

U.S. Agency mortgage-backed securities
44,041

 
43,829

 

 

Mutual funds
2,427

 
2,395

 

 

Trust preferred securities
50

 
50

 

 

Equity securities
1,474

 
1,744

 

 

 
$
311,096

 
310,063

 
16,467

 
16,326


Note 4 - Loans
 
Major classifications of loans at March 31, 2014 and December 31, 2013 are as follows (in thousands):
 
March 31, 2014
 
December 31, 2013
 
Acquired Credit Impaired
 
Other
 
Total
 
Acquired Credit Impaired
 
Other
 
Total
Commercial and industrial
$
1,803

 
38,329

 
40,132

 
332

 
29,005

 
29,337

Commercial, secured by real estate
11,723

 
364,387

 
376,110

 
4,363

 
309,889

 
314,252

Residential real estate
6,116

 
232,122

 
238,238

 
1,332

 
214,255

 
215,587

Consumer
218

 
20,779

 
20,997

 

 
12,643

 
12,643

Agricultural
243

 
7,639

 
7,882

 

 
2,472

 
2,472

Other loans, including deposit overdrafts

 
1,922

 
1,922

 

 
91

 
91

 
20,103

 
665,178

 
685,281

 
6,027

 
568,355

 
574,382

Deferred net origination costs (fees)

 
(85
)
 
(85
)
 

 
(28
)
 
(28
)
 
20,103

 
665,093

 
685,196

 
6,027

 
568,327

 
574,354

Less allowance for loan losses

 
3,370

 
3,370

 

 
3,588

 
3,588

Loans, net
$
20,103

 
661,723

 
681,826

 
6,027

 
564,739

 
570,766



Loans acquired from the mergers with First Capital and ENB are recorded at fair value with no carryover of the acquired entity's previously established allowance for loan losses.  The excess of expected cash flows over the estimated fair value of acquired loans is recognized as interest income over the remaining contractual lives of the loans using the level yield method.
Subsequent decreases in expected cash flows will require additions to the allowance for loan losses.  Subsequent improvements in expected cash flows result in the recognition of additional interest income over the then-remaining contractual lives of the loans.

12

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)



Impaired loans acquired are accounted for under FASB ASC 310-30.  Factors considered in evaluating whether an acquired loan was impaired include delinquency status and history, updated borrower credit status, collateral information, and updated loan-to-value information.  The difference between contractually required payments at the time of acquisition and the cash flows expected to be collected is referred to as the nonaccretable difference.  The interest component of the cash flows expected to be collected is referred to as the accretable yield and is recognized as interest income over the remaining contractual life of the loan using the level yield method.   Subsequent decreases in expected cash flows will require additions to the allowance for loan losses.  Subsequent improvements in expected cash flows will result in a reclassification from the nonaccretable difference to the accretable yield.
 
The following table provides certain information at the acquisition date on loans acquired from ENB, not including loans considered to be impaired (in thousands):
Contractually required principal at acquisition
$
102,731

Less fair value adjustment
1,347

Fair value of acquired loans
$
101,384

 
 

Contractual cash flows not expected to be collected
$
1,702

The following table provides details on acquired credit impaired loans obtained through the merger with ENB that are accounted for in accordance with FASB ASC 310-30 (in thousands):
Contractually required principal at acquisition
$
23,233

Contractual cash flows not expected to be collected (nonaccretable difference)
(5,930
)
Expected cash flows at acquisition
17,303

Interest component of expected cash flows (accretable discount)
(2,153
)
Fair value of acquired impaired loans
$
15,150


The following table provides the outstanding balance and related carrying amount for acquired credit impaired loans at the dates indicated (in thousands):
 
March 31,
2014
 
December 31,
2013
Outstanding balance
$
30,015

 
8,220

Carrying amount
20,103

 
6,027


Activity during 2014 for the accretable discount related to acquired credit impaired loans is as follows (in thousands):
Accretable discount at December 31, 2013
$
1,107

Accretable discount acquired during period
2,153

Less transferred to other real estate owned
(61
)
Less accretion
(47
)
Accretable discount at March 31, 2014
$
3,152


13

Table of Contents
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, 2014 and December 31, 2013 are as follows (in thousands):
 
March 31, 2014
 
December 31, 2013
 
Acquired Credit Impaired
 
Other
 
Total
 
Acquired Credit Impaired
 
Other
 
Total
Non-accrual loans:
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
318

 

 
318

 

 
144

 
144

Commercial, secured by real estate
1,483

 
2,200

 
3,683

 
370

 
1,048

 
1,418

Residential real estate
227

 
1,146

 
1,373

 
143

 
1,256

 
1,399

Total non-accrual loans
2,028

 
3,346

 
5,374

 
513

 
2,448

 
2,961

Past-due 90 days or more and still accruing

 
825

 
825

 

 
250

 
250

Total non-accrual and past-due 90 days or more and still accruing
2,028

 
4,171

 
6,199

 
513

 
2,698

 
3,211

Accruing restructured loans
680

 
13,559

 
14,239

 
670

 
14,481

 
15,151

Total
$
2,708

 
17,730

 
20,438

 
1,183

 
17,179

 
18,362

Percentage of total non-accrual loans and loans past-due 90 days or more and still accruing to total loans
 
 
 
 
0.90
%
 
 
 


 
0.56
%
Percentage of total non-accrual loans, loans past-due 90 days or more and still accruing, and accruing restructured loans to total loans
 
 
 
 
2.98
%
 
 
 


 
3.20
%

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, 2014 and December 31, 2013 are $133,504,000 and $90,343,000, respectively.  Loans sold during the three months ended March 31, 2014 and 2013 totaled $610,000 and $7,175,000, respectively.

14

Table of Contents
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, 2014 and 2013 are as follows (in thousands):
 
Commercial
& Industrial
 
Commercial, Secured by
Real Estate
 
Residential
Real Estate
 
Consumer
 
Agricultural
 
Other
 
Total
March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, beginning of year
$
175

 
2,520

 
826

 
66

 

 
1

 
3,588

Provision charged to expenses
(109
)
 
213

 
(25
)
 
(3
)
 

 
5

 
81

Losses charged off:
 
 
 
 
 
 
 
 
 
 
 
 
 
  Other loans

 
(203
)
 
(119
)
 
(23
)
 

 
(18
)
 
(363
)
Recoveries
6

 

 
21

 
24

 

 
13

 
64

Balance, end of period
$
72

 
2,530

 
703

 
64

 

 
1

 
3,370

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$

 
648

 
167

 

 

 

 
815

Collectively evaluated for impairment
72

 
1,882

 
536

 
64

 

 
1

 
2,555

Acquired credit impaired loans

 

 

 

 

 

 

Balance, end of period
$
72

 
2,530

 
703

 
64

 

 
1

 
3,370

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
164

 
14,448

 
1,977

 
17

 

 

 
16,606

Collectively evaluated for impairment
38,123

 
349,549

 
230,410

 
20,844

 
7,639

 
1,922

 
648,487

Acquired credit impaired loans
1,803

 
11,723

 
6,116

 
218

 
243

 

 
20,103

Balance, end of period
$
40,090

 
375,720

 
238,503

 
21,079

 
7,882

 
1,922

 
685,196

 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 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




15

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)


Commercial and Industrial Loans. LCNB’s commercial and industrial loan portfolio consists of loans for various purposes, including loans to fund working capital requirements (such as inventory and receivables financing) and purchases of machinery and equipment.  LCNB offers a variety of commercial and industrial loan arrangements, including term loans, balloon loans, and line of credit.  Most commercial and industrial loans have a variable rate, with adjustments occurring monthly, annually, every three years, or every five years.  Adjustments are generally based on a publicly available index rate plus a margin.  The margin varies based on the terms and collateral securing the loan.  Commercial and industrial loans are offered to businesses and professionals for short and medium terms on both a collateralized and uncollateralized basis. Commercial and industrial loans typically are underwritten on the basis of the borrower’s ability to make repayment from the cash flow of the business.  Collateral, when obtained, may include liens on furniture, fixtures, equipment, inventory, receivables, or other assets.  As a result, such loans involve complexities, variables, and risks that require thorough underwriting and more robust servicing than other types of loans.

Commercial, Secured by Real Estate Loans.  Commercial real estate loans include loans secured by a variety of commercial, retail, and office buildings, religious facilities, multifamily (more than two-family) residential properties, construction and land development loans, and other land loans. Commercial real estate loan products generally amortize over five to twenty-five years and are payable in monthly principal and interest installments.  Some have balloon payments due within one to ten years after the origination date.  Many have adjustable interest rates with adjustment periods ranging from one to ten years, some of which are subject to established “floor” interest rates.

Commercial real estate loans are underwritten based on the ability of the property, in the case of income producing property, or the borrower’s business to generate sufficient cash flow to amortize the debt. Secondary emphasis is placed upon global debt service, collateral value, financial strength of any guarantors, and other factors. Commercial real estate loans are generally originated with a 75 percent maximum loan to appraised value ratio.

Residential Real Estate Loans.  Residential real estate loans include loans secured by first or second mortgage liens on one-to-two family residential property.  Home equity lines of credit and mortgage loans secured by owner-occupied agricultural property are included in this category.  First and second mortgage loans are generally amortized over five to thirty years with monthly principal and interest payments.  Home equity lines of credit generally have a five year draw period with interest only payments followed by a repayment period with monthly payments based on the amount outstanding.  LCNB offers both fixed and adjustable rate mortgage loans.  Adjustable rate loans are available with adjustment periods ranging between one to ten years and adjust according to an established index plus a margin, subject to certain floor and ceiling rates.  Home equity lines of credit have a variable rate based on the Wall Street Journal prime rate plus a margin.

LCNB does not originate reverse mortgage loans or residential real estate loans generally considered to be “subprime.”

Residential real estate loans are underwritten primarily based on the borrower’s ability to repay, prior credit history, and the value of the collateral.  LCNB requires private mortgage insurance for first mortgage loans that have a loan to appraised value ratio of greater than 80%.
Consumer Loans.  LCNB’s portfolio of consumer loans generally includes secured and unsecured loans to individuals for household, family and other personal expenditures.  Secured loans include loans to fund the purchase of automobiles, recreational vehicles, boats, and similar acquisitions. Consumer loans made by LCNB generally have fixed rates and terms ranging up to 72 months, depending upon the nature of the collateral, size of the loan, and other relevant factors.

Consumer loans generally have higher interest rates, but pose additional risks of collectability and loss when compared to certain other types of loans. Collateral, if present, is generally subject to damage, wear, and depreciation.  The borrower’s ability to repay is of primary importance in the underwriting of consumer loans.

Agricultural Loans.  LCNB’s portfolio of agricultural loans includes loans for financing agricultural production or for financing the purchase of equipment used in the production of agricultural products.  LCNB’s agricultural loans are generally secured by farm machinery, livestock, crops, vehicles, or other agri-related collateral.

16

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)



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

Pass – loans categorized in this category are higher quality loans that do not fit any of the other categories described below.
Other Assets Especially Mentioned (OAEM) - loans in this category are currently protected but are potentially weak.  These loans constitute a risk but not to the point of justifying a classification of substandard.  The credit risk may be relatively minor yet constitute an undue risk in light of the circumstances surrounding a specific asset.
Substandard – loans in this category are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any.  Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the possibility that LCNB will sustain some loss if the deficiencies are not corrected.
Doubtful – loans classified in this category have all the weaknesses inherent in loans classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
 

17

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)


A breakdown of the loan portfolio by credit quality indicators at March 31, 2014 and December 31, 2013 is as follows (in thousands):
 
Pass
 
OAEM
 
Substandard
 
Doubtful
 
Total
March 31, 2014
 
 
 
 
 
 
 
 
 
Acquired credit impaired:














Commercial & industrial
$

 

 
1,803

 


1,803

Commercial, secured by real estate

 
756

 
10,967

 


11,723

Residential real estate

 

 
6,116

 


6,116

Consumer

 

 
218

 

 
218

Agricultural

 

 
243

 

 
243

Total
$


756


19,347




20,103

 
 
 
 
 
 
 
 
 
 
Other:
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
36,984

 
30

 
1,273

 


38,287

Commercial, secured by real estate
349,285

 
3,217

 
11,495

 


363,997

Residential real estate
227,881

 
336

 
4,170

 


232,387

Consumer
20,798

 

 
63

 


20,861

Agricultural
7,450

 

 
189

 


7,639

Other
1,922

 

 

 


1,922

Total
$
644,320

 
3,583

 
17,190

 

 
665,093

 
 
 
 
 
 
 
 
 
 
Total:
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
36,984

 
30

 
3,076

 

 
40,090

Commercial, secured by real estate
349,285

 
3,973

 
22,462

 

 
375,720

Residential real estate
227,881

 
336

 
10,286

 

 
238,503

Consumer
20,798

 

 
281

 

 
21,079

Agricultural
7,450

 

 
432

 

 
7,882

Other
1,922

 

 

 

 
1,922

Total
$
644,320

 
4,339

 
36,537

 

 
685,196

 
 
 
 
 
 
 
 
 
 
December 31, 2013
 

 
 

 
 

 
 

 
 

Acquired credit impaired:
 
 
 
 
 
 
 
 
 
Commercial & industrial
$

 

 
332

 

 
332

Commercial, secured by real estate

 
761

 
3,602

 

 
4,363

Residential real estate

 

 
1,332

 

 
1,332

Total
$

 
761

 
5,266

 

 
6,027

 
 
 
 
 
 
 
 
 
 
Other:
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
27,563

 
44

 
1,367

 

 
28,974

Commercial, secured by real estate
295,189

 
3,206

 
11,155

 

 
309,550

Residential real estate
208,881

 
1,136

 
4,493

 

 
214,510

Consumer
12,681

 

 
49

 

 
12,730

Agricultural
2,472

 

 

 

 
2,472

Other
91

 

 

 

 
91

Total
$
546,877

 
4,386

 
17,064

 

 
568,327

 
 
 
 
 
 
 
 
 
 
Total:
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
27,563

 
44

 
1,699

 

 
29,306

Commercial, secured by real estate
295,189

 
3,967

 
14,757

 

 
313,913

Residential real estate
208,881

 
1,136

 
5,825

 

 
215,842

Consumer
12,681

 

 
49

 

 
12,730

Agricultural
2,472

 

 

 

 
2,472

Other
91

 

 

 

 
91

Total
$
546,877

 
5,147

 
22,330

 

 
574,354


18

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)



A loan portfolio aging analysis at March 31, 2014 and December 31, 2013 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, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquired credit impaired:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
288

 
302

 

 
590

 
1,213

 
1,803

 

Commercial, secured by real estate
2,301

 
878

 
421

 
3,600

 
8,123

 
11,723

 

Residential real estate
337

 
40

 
168

 
545

 
5,571

 
6,116

 

Consumer
23

 
9

 

 
32

 
186

 
218

 

Agricultural
231

 

 

 
231

 
12

 
243

 

Total
$
3,180

 
1,229

 
589

 
4,998

 
15,105

 
20,103

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
$

 

 
800

 
800

 
37,487

 
38,287

 
800

Commercial, secured by real estate
307

 

 
2,006

 
2,313

 
361,684

 
363,997

 

Residential real estate
702

 
72

 
890

 
1,664

 
230,723

 
232,387

 
18

Consumer
75

 
27

 
7

 
109

 
20,752

 
20,861

 
7

Agricultural
83

 

 

 
83

 
7,556

 
7,639

 

Other
57

 

 

 
57

 
1,865

 
1,922

 

Total
$
1,224

 
99

 
3,703

 
5,026

 
660,067

 
665,093

 
825

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
288

 
302

 
800

 
1,390

 
38,700

 
40,090

 
800

Commercial, secured by real estate
2,608

 
878

 
2,427

 
5,913

 
369,807

 
375,720

 

Residential real estate
1,039

 
112

 
1,058

 
2,209

 
236,294

 
238,503

 
18

Consumer
98

 
36

 
7

 
141

 
20,938

 
21,079

 
7

Agricultural
314

 

 

 
314

 
7,568

 
7,882

 

Other
57

 

 

 
57

 
1,865

 
1,922

 

Total
$
4,404

 
1,328

 
4,292

 
10,024

 
675,172

 
685,196

 
825

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 

 
 

 
 

 
 

 
 

 
 

 
 

Acquired credit impaired:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
273

 

 

 
273

 
59

 
332

 

Commercial, secured by real estate
729

 

 
126

 
855

 
3,508

 
4,363

 

Residential real estate

 
41

 
143

 
184

 
1,148

 
1,332

 

Total
$
1,002

 
41

 
269

 
1,312

 
4,715

 
6,027

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
4

 

 
144

 
148

 
28,826

 
28,974

 

Commercial, secured by real estate
222

 
582

 
1,048

 
1,852

 
307,698

 
309,550

 

Residential real estate
1,131

 
258

 
1,461

 
2,850

 
211,660

 
214,510

 
236

Consumer
38

 
35

 
13

 
86

 
12,644

 
12,730

 
14

Agricultural

 

 

 

 
2,472

 
2,472

 

Other
91

 

 

 
91

 

 
91

 

Total
$
1,486

 
875

 
2,666

 
5,027

 
563,300

 
568,327

 
250

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
277

 

 
144

 
421

 
28,885

 
29,306

 

Commercial, secured by real estate
951

 
582

 
1,174

 
2,707

 
311,206

 
313,913

 

Residential real estate
1,131

 
299

 
1,604

 
3,034

 
212,808

 
215,842

 
236

Consumer
38

 
35

 
13

 
86

 
12,644

 
12,730

 
14

Agricultural

 

 

 

 
2,472

 
2,472

 

Other
91

 

 

 
91

 

 
91

 

Total
$
2,488

 
916

 
2,935

 
6,339

 
568,015

 
574,354

 
250



19

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)


 
Impaired loans, excluding acquired credit impaired loans, at March 31, 2014 and December 31, 2013 are as follows (in thousands):
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
March 31, 2014
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
Commercial & industrial
$
164

 
269

 

Commercial, secured by real estate
10,483

 
10,506

 

Residential real estate
798

 
909

 

Consumer

 

 

Total
$
11,445

 
11,684

 

 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

Commercial & industrial
$

 

 

Commercial, secured by real estate
3,965

 
4,159

 
648

Residential real estate
1,179

 
1,434

 
167

Consumer
17

 
17

 

Total
$
5,161

 
5,610

 
815

 
 
 
 
 
 
Total:
 

 
 

 
 

Commercial & industrial
$
164

 
269

 

Commercial, secured by real estate
14,448

 
14,665

 
648

Residential real estate
1,977

 
2,343

 
167

Consumer
17

 
17

 

Total
$
16,606

 
17,294

 
815

 
 
 
 
 
 
December 31, 2013
 

 
 

 
 

With no related allowance recorded:
 

 
 

 
 

Commercial & industrial
$

 

 

Commercial, secured by real estate
6,797

 
6,810

 

Residential real estate
487

 
763

 

Consumer

 

 

Total
$
7,284

 
7,573

 

 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

Commercial & industrial
$
165

 
270

 
2

Commercial, secured by real estate
7,725

 
7,725

 
760

Residential real estate
1,645

 
1,663

 
270

Consumer
27

 
27

 

Total
$
9,562

 
9,685

 
1,032

 
 
 
 
 
 
Total:
 

 
 

 
 

Commercial & industrial
$
165

 
270

 
2

Commercial, secured by real estate
14,522

 
14,535

 
760

Residential real estate
2,132

 
2,426

 
270

Consumer
27

 
27

 

Total
$
16,846

 
17,258

 
1,032


20

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 4 – Loans (continued)



The following presents information related to the average recorded investment and interest income recognized on impaired loans, excluding acquired credit impaired loans, for the three months ended March 31, 2014 and 2013 (in thousands):
 
Three Months Ended 
 March 31, 2014
 
Three Months Ended 
 March 31, 2013
 
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
With no related allowance recorded:
 
 
 
 
 
 
 
Commercial & industrial
$
164

 

 

 

Commercial, secured by real estate
10,587

 
82

 
9,516

 
89

Residential real estate
845

 
9

 
591

 
3

Consumer
3

 

 
3

 

Total
$
11,599

 
91

 
10,110

 
92

 
 
 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

 
 

Commercial & industrial
$

 

 
202

 

Commercial, secured by real estate
4,076

 
27

 
4,548

 
32

Residential real estate
1,191

 
11

 
764

 
3

Consumer
17

 

 
7

 

Total
$
5,284

 
38

 
5,521

 
35

 
 
 
 
 
 
 
 
Total:
 

 
 

 
 

 
 

Commercial & industrial
$
164

 

 
202

 

Commercial, secured by real estate
14,663

 
109

 
14,064

 
121

Residential real estate
2,036

 
20

 
1,355

 
6

Consumer
20

 

 
10

 

Total
$
16,883

 
129

 
15,631

 
127


Loan modifications that were classified as troubled debt restructurings during the three months ended March 31, 2014 and 2013 are as follows (dollars in thousands):
 
Three Months Ended 
 March 31, 2014
 
Three Months Ended 
 March 31, 2013
 
Number
of Loans
 
Balance at Modification
 
Number
of Loans
 
Balance at Modification
Commercial and industrial
1

 
$
10

 

 
$

Residential real estate

 

 
1

 
80

Consumer
1

 
2

 

 

Total
2

 
$
12

 
1

 
$
80


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, 2014 and 2013.


21

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


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,
 
2014
 
2013
Balance, beginning of year
$
1,463

 
2,189

Additions
230

 

Additions due to merger
262

 
127

Reductions due to sales
(151
)
 
(612
)
Reductions due to valuation write downs
(5
)
 
(17
)
Balance, end of period
$
1,799

 
1,687


Other real estate owned at March 31, 2014 and December 31, 2013 consisted of (dollars in thousands):
 
March 31, 2014
 
December 31, 2013
 
Number
 
Balance
 
Number
 
Balance
Commercial real estate
3

 
$
1,649

 
2

 
$
1,415

Residential real estate
3

 
150

 
2

 
48

 
6

 
$
1,799

 
4

 
$
1,463

 
Note 6 – Premises and Equipment
 
Premises and equipment at March 31, 2014 and December 31, 2013 are summarized as follows (in thousands):
 
March 31,
2014
 
December 31,
2013
Land
$
5,622

 
5,354

Buildings
19,637

 
18,778

Equipment
12,490

 
12,172

Construction in progress
48

 

Total
37,797

 
36,304

Less accumulated depreciation
16,755

 
16,407

Premises and equipment, net
$
21,042

 
19,897


Depreciation charged to expense was $347,000 and $341,000 for the three months ended March 31, 2014 and 2013, respectively.


22

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


Note 7 – Borrowings
 
Funds borrowed from the Federal Home Loan Bank of Cincinnati ("FHLB") at March 31, 2014 and December 31, 2013 are as follows (dollars in thousands):
 
Interest
Rate
 
March 31,
2014
 
December 31,
2013
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
%
 

 
265

Advance due March 2019
2.82
%
 
1,580

 
1,837

 
 

 
$
11,580

 
12,102


All advances from the FHLB are secured by a blanket pledge of LCNB's 1-4 family first lien mortgage loans in the amount of approximately $199 million and $183 million at March 31, 2014 and December 31, 2013, respectively.  Additionally, LCNB is required to hold minimum levels of FHLB stock, based on the outstanding borrowings.

Short-term borrowings at March 31, 2014 and December 31, 2013 are as follows (dollars in thousands):
 
March 31, 2014
 
December 31, 2013
 
Amount
 
Rate
 
Amount
 
Rate
Repurchase agreements
$
11,215

 
0.10
%
 
$
8,655

 
0.10
%
 
$
11,215

 
0.10
%
 
$
8,655

 
0.10
%
Note 8 – Income Taxes
 
A reconciliation between the statutory income tax and LCNB's effective tax rate on income from continuing operations follows:
 
 
For the three months ended
March 31,
 
 
2014
 
2013
Statutory tax rate
 
34.0
 %
 
34.0
 %
Increase (decrease) resulting from:
 
 

 
 

Tax exempt interest
 
(12.7
)%
 
(9.1
)%
Tax exempt income on bank owned life insurance
 
(3.5
)%
 
(2.6
)%
Other, net
 
3.8
 %
 
0.7
 %
Effective tax rate
 
21.6
 %
 
23.0
 %

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 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 uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.  

23

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 9 – Commitments and Contingent Liabilities (continued)



Financial instruments whose contract amounts represent off-balance-sheet credit risk at March 31, 2014 and December 31, 2013 are as follows (in thousands):
 
March 31,
2014
 
December 31,
2013
Commitments to extend credit:
 
 
 
Commercial loans
$
8,738

 
9,316

Other loans
 

 
 

Fixed rate
1,790

 
852

Adjustable rate
3,230

 
1,653

Unused lines of credit:
 

 
 

Fixed rate
3,296

 
3,404

Adjustable rate
72,820

 
60,236

Unused overdraft protection amounts on demand and NOW accounts
10,647

 
9,494

Standby letters of credit
590

 
365

 
$
101,111

 
85,320


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 on 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.  These guarantees generally are fully secured and have varying maturities.  

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. Commitments outstanding for capital expenditures as of March 31, 2014 totaled approximately $90,000.

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 leverage ratio supplements the risk-based capital guidelines.

24

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 10 – Regulatory Capital (continued)


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.
 
A summary of the regulatory capital and capital ratios of LCNB follows (dollars in thousands):
 
 
March 31,
2014
 
December 31,
2013
Regulatory Capital:
 
 
Shareholders' equity
 
$
119,761

 
118,873

Goodwill and other intangibles
 
(32,129
)
 
(16,532
)
Accumulated other comprehensive (income) loss
 
761

 
1,722

Tier 1 risk-based capital
 
88,393

 
104,063

Eligible allowance for loan losses
 
3,370

 
3,588

Total risk-based capital
 
$
91,763

 
107,651

Capital ratios:
 
 

 
 

Total risk-based
 
13.08
%
 
18.65
%
Tier 1 risk-based
 
12.60
%
 
18.03
%
Leverage
 
8.49
%
 
11.10
%

Capital ratios at March 31, 2014 are less than the ratios at December 31, 2013 due to additional assets obtained through the merger with ENB.

25

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


Note 11 – Accumulated Other Comprehensive Income
 
Changes in accumulated other comprehensive income for the three months ended March 31, 2014 and 2013 are as follows (in thousands):
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Changes in Pension Plan Assets and Benefit Obligations
 
Total
March 31, 2014
 
 
 
 
 
Balance at beginning of period
$
(1,641
)
 
(81
)
 
(1,722
)
Before reclassifications
956

 
2

 
958

Reclassifications
3

 

 
3

Balance at end of period
$
(682
)
 
(79
)
 
(761
)
 
 
 
 
 
 
March 31, 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


Reclassifications out of accumulated other comprehensive income during the three months ended March 31, 2014 and 2013 and the affected line items in the consolidated statements of income are as follows (in thousands):
 
 
Three Months Ended
March 31,
 
 
2014
 
2013
Realized gain (loss) on sale of securities
 
(4
)
 
587

Less provision for income taxes
 
(1
)
 
200

Reclassification adjustment, net of taxes
 
(3
)
 
387



26

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


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 pension and other employee benefits in the consolidated statements of income for the three-month periods ended March 31, 2014 and 2013 are as follows (in thousands):
 
 
For the Three Months
Ended March 31,
 
 
2014
 
2013
Qualified noncontributory defined benefit retirement plan
 
207

 
31

401(k) plan
 
78

 
79


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

The components of net periodic pension cost of the nonqualified defined benefit retirement plan for the three months ended March 31, 2014 and 2013 are summarized as follows (in thousands):
 
 
 
Three Months Ended
March 31,
 
 
 
2014
 
2013
Service cost
 
 
17

 
18

Interest cost
 
 
15

 
11

Amortization of unrecognized net (gain) loss
 
 

 
6

Amortization of unrecognized prior service cost
 
 
4

 
7

Net periodic pension cost
 
 
36

 
42


Amounts recognized in accumulated other comprehensive income, net of tax, at March 31, 2014 and December 31, 2013 for the nonqualified defined benefit retirement plan consists of (in thousands):
 
March 31,
2014
 
December 31,
2013
Net actuarial loss
$
70

 
70

Past service cost
8

 
10

 
$
78

 
80





27

Table of Contents
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 allowed for stock-based awards to eligible employees, as determined by the Board of Directors.  The awards were made in the form of stock options, share awards, and/or appreciation rights.  The Plan provided for the issuance of up to 200,000 shares. The plan expired on April 16, 2012. Any outstanding unexercized options, however, continue to be exercisable in accordance with their terms.

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, 2014 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
23,494

 
$
9.00

 
4.8
 
23,494

 
$
9.00

 
4.8
$11.00 - $12.99
63,354

 
12.05

 
6.3
 
42,249

 
12.02

 
5.9
$17.00 - $18.99
12,962

 
18.41

 
2.4
 
12,962

 
18.41

 
2.4
 
99,810

 
12.16

 
5.4
 
78,705

 
12.17

 
5.0

The following table summarizes stock option activity for the periods indicated:
 
2014
 
2013
 
Options
 
Weighted Average Exercise
Price
 
Options
 
Weighted Average Exercise
Price
Outstanding, January 1
104,966

 
$
12.43

 
110,586

 
$
12.42

Granted

 

 

 

Exercised

 

 

 

Expired
(5,156
)
 
17.66

 

 

Outstanding, March 31
99,810

 
12.16

 
110,586

 
12.42

Exercisable, March 31
78,705

 
12.17

 
73,519

 
12.82


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, 2014 that were "in the money" (market price greater than exercise price) was $528,000.  The aggregate intrinsic value at that date for only the options that were exercisable was $418,000.  The aggregate intrinsic value for options outstanding at March 31, 2013 that were in the money was $499,000 and the aggregate intrinsic value at that date for only the options that were exercisable was $312,000.  The intrinsic value changes based upon fluctuations in the market value of LCNB's stock.

Total expense related to options included in salaries and employee benefits in the consolidated statements of income for the three months ended March 31, 2014 and 2013 was $7,000 and $9,000, respectively.


28

Table of Contents
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, warrants, and restricted stock.  The diluted average number of common shares outstanding has been increased for the assumed exercise of stock options, warrants, 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, 2014 and 2013 (dollars in thousands, except share and per share data):
 
 
For the Three Months
Ended March 31,
 
 
2014
 
2013
Net income
 
1,323

 
1,728

Weighted average number of shares outstanding used in the calculation of basic earnings per common share
 
9,288,400

 
7,513,101

Add dilutive effect of:
 
 

 
 

Stock options
 
21,769

 
14,312

Stock warrants
 
102,880

 
83,213

Adjusted weighted average number of shares outstanding used in the calculation of diluted earnings per common share
 
9,413,049

 
7,610,626

Earnings per common share:
 
 

 
 

Basic
 
0.14

 
0.23

Diluted
 
0.14

 
0.23


Options to purchase 18,118 and 19,518 shares of common stock at a weighted average price of $18.19 and $18.15 per share were outstanding at March 31, 2014 and 2013, respectively, but were not included in the computation of diluted earnings per common share because the exercise prices of the options were greater than the average market price of the common shares.

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


29

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 15 - Fair Value Measurements (continued)


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, LCNB 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 publicly 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 fair value, which approximates cost.  Additionally, LCNB owns trust preferred securities in various financial institutions, equity securities in various financial and non-financial companies, and a mutual fund that invests primarily in floating rate loans.   Market quotations (level 1) are used to determine fair values for these investments. The investment in the mutual fund is considered to have level 1 inputs because it is publicly traded in an active market and it publishes a daily net asset value.
 
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.


30

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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, 2014 and December 31, 2013 (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, 2014
 
 
 
 
 
 
 
 
 
 
Recurring fair value measurements:
 
 
 
 
 
 
 
 
 
 
Investment securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
U.S. Treasury notes
 
$
35,172

 
35,172

 

 

 
 
U.S. Agency notes
 
122,461

 

 
122,461

 

 
 
U.S. Agency mortgage-backed securities
 
43,829

 

 
43,829

 

 
 
Certificates of deposit with other banks
 
3,095

 

 
3,095

 

 
 
Municipal securities:
 
 

 
 

 
 

 
 

 
 
Non-taxable
 
84,486

 

 
84,486

 

 
 
Taxable
 
16,831

 

 
16,831

 

 
 
Mutual funds
 
2,395

 
1,395

 
1,000

 

 
 
Trust preferred securities
 
50

 
50

 

 

 
 
Equity securities
 
1,744

 
1,744

 

 

 
 
Total recurring fair value measurements
 
$
310,063

 
38,361

 
271,702

 

 
 
Nonrecurring fair value measurements:
 
 

 
 

 
 
 
 

 
 
Impaired loans
 
$
4,345

 

 
349

 
3,996

 

Other real estate owned and repossessed assets (a)
 
1,799

 

 
1,799

 

 
(19
)
Total nonrecurring fair value measurements
 
$
6,144

 

 
2,148

 
3,996

 
(19
)
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 

 
 

 
 

 
 

 
 

Recurring fair value measurements:
 
 

 
 

 
 

 
 

 
 

Investment securities available-for-sale:
 
 

 
 

 
 

 
 

 
 

U.S. Treasury notes
 
$
12,894

 
12,894

 

 

 
 

U.S. Agency notes
 
106,675

 

 
106,675

 

 
 

U.S. Agency mortgage-backed securities
 
40,309

 

 
40,309

 

 
 

Certificates of deposit with other banks
 
1,501

 

 
1,501

 

 
 
Municipal securities:
 
 

 
 

 
 

 
 

 
 

Non-taxable
 
75,333

 

 
75,333

 

 
 

Taxable
 
17,309

 

 
17,309

 

 
 

Mutual funds
 
2,380

 
1,380

 
1,000

 

 
 

Trust preferred securities
 
147

 
147

 

 

 
 

Equity securities
 
1,693

 
1,693

 

 

 
 

Total recurring fair value measurements
 
$
258,241

 
16,114

 
242,127

 

 
 

Nonrecurring fair value measurements:
 
 

 
 

 
 

 
 

 
 

Impaired loans
 
$
8,530

 

 
773

 
7,757

 

Other real estate owned and repossessed assets (b)
 
1,463

 

 
1,463

 

 
178

Total nonrecurring fair value measurements
 
$
9,993

 

 
2,236

 
7,757

 
178

(a)
One other real estate owned property with a total carrying amount of $99,000 was written down to its fair value of $94,000, resulting in an impairment charge of $5,000.  Two other real estate owned properties with a total carrying amount of $150,000 were sold for a combined total of $136,000, resulting in a net loss of $14,000.    The write-downs and losses,were included in other non-interest expense for the period.
(b)
Seven other real estate owned properties with a total carrying amount of $404,000 were written down to their combined fair value of $328,000, resulting in an impairment charge of $76,000Twelve properties were sold for a combined net gain of $256,000.  The write-downs and net gain were included in other real estate owned expense for the period. A repossessed asset was sold for a loss of $2,000, which was included in other non-interest expense for the period.

31

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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, 2014 and December 31, 2013 are as follows (in thousands):
 
 
March 31, 2014
 
December 31, 2013
 
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
FINANCIAL ASSETS:
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
33,423

 
33,423

 
14,688

 
14,688

Investment securities:
 
 

 
 

 
 

 
 

Available-for-sale
 
310,063

 
310,063

 
258,241

 
258,241

Held-to-maturity
 
16,467

 
16,326

 
16,323

 
16,196

Federal Reserve Bank stock
 
1,603

 
1,603

 
1,603

 
1,603

Federal Home Loan Bank stock
 
3,638

 
3,638

 
2,854

 
2,854

Loans, net
 
681,826

 
685,250

 
570,766

 
573,163

 
 
 
 
 
 
 
 
 
FINANCIAL LIABILITIES:
 
 

 
 

 
 

 
 

Deposits
 
984,514

 
986,967

 
785,761

 
788,096

Short-term borrowings
 
11,215

 
11,215

 
8,655

 
8,655

Long-term debt
 
11,580

 
12,307

 
12,102

 
12,842


The fair value of off-balance-sheet financial instruments at March 31, 2014 and December 31, 2013 was not material.

Fair values of financial instruments are based on various assumptions, including the discount rate and estimates of future cash flows. Therefore, the fair values presented may not represent amounts that could be realized in actual transactions.  In addition, because the required disclosures exclude certain financial instruments and all nonfinancial instruments, any aggregation of the fair value amounts presented would not represent the underlying value of LCNB.  The following methods and assumptions were used to estimate the fair value of certain financial instruments:

Cash and cash equivalents
The carrying amounts presented are deemed to approximate fair value.

Investment securities
Fair values for securities, excluding Federal Home Loan Bank and Federal Reserve Bank stock, are based on quoted market prices, if available.  If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities and/or discounted cash flow analyses or other methods.  The carrying value of Federal Home Loan Bank and Federal Reserve Bank stock approximates fair value based on the respective redemptive provisions.

Loans
Fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, incorporating assumptions of current and projected prepayment speeds.  These current rates approximate market rates.

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.


32

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LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 15 - Fair Value Measurements (continued)


The following table summarizes the categorization by input level as of March 31, 2014 and December 31, 2013 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, 2014
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Loans, net
 
$
680,905

 

 
680,905

 

Investment securities, non-taxable, held-to-maturity
 
16,326

 

 

 
16,326

Federal Reserve Bank stock
 
1,603

 
1,603

 

 

Federal Home Loan Bank stock
 
3,638

 
3,638

 

 

Liabilities:
 
 

 
 
 
 

 
 

Deposits
 
986,967

 

 
986,967

 

Long-term debt
 
12,307

 

 
12,307

 

 
 
 
 
 
 
 
 
 
December 31, 2013
 
 

 
 

 
 

 
 

Assets:
 
 

 
 

 
 

 
 

Loans, net
 
$
564,633

 

 
564,633

 

Investment securities, non-taxable, held-to-maturity
 
16,196

 

 

 
16,196

Federal Reserve Bank stock
 
1,603

 
1,603

 

 

Federal Home Loan Bank stock
 
2,854

 
2,854

 

 

Liabilities:
 
 

 
 
 
 

 
 

Deposits
 
788,096

 

 
788,096

 

Long-term debt
 
12,842

 

 
12,842

 


33

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


Note 16 – Recent Accounting Pronouncements
 
Financial Accounting Standards Board Accounting Standards Update ("ASU") No. 2013-04, "Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date"
ASU No. 2013-04 was issued in February 2013 and requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date as the sum of (a) the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and (b) any additional amount the reporting entity expects to pay on behalf of its co-obligors.  The entity is also required to disclose information about the obligation, including its nature and amount.  ASU No. 2013-04 is effective for public companies for fiscal years, and interim periods within those years, beginning after December 15, 2013.  The ASU is effective for nonpublic companies for fiscal years, and interim periods within those years, beginning after December 15, 2014.  The adoption of this guidance did not have a material impact on LCNB's results of operations or financial position.

ASU No. 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists”
ASU No. 2013-11 was issued in July 2013 and requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. No new recurring disclosures are required. ASU No. 2013-11 is effective for public companies for fiscal years, and interim periods within those years, beginning after December 15, 2013 and is to be applied prospectively to all unrecognized tax benefits that exist at the effective date. The adoption of ASU No. 2013-11 did not have a material impact on LCNB’s results of operations or financial position.

ASU No. 2014-02, "Investments-Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force)"
ASU No. 2114-02 was issued in January 2014 and provides guidance on accounting for investments in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for low-income housing tax credits. Entities are permitted to make an accounting policy election to account for such investments using the proportional amortization method, as defined, if certain enumerated conditions are met. Under the proportional amortization method, an investor amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). Investments not accounted for using the proportional amortization method should be accounted for as an equity method investment or a cost method investment in accordance with Subtopic 970-323. ASU No. 2014-022 is effective for public companies for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2014 and is to be applied retrospectively to all periods presented. LCNB currently does not have any investments in qualified affordable housing projects and adoption of ASU No. 2014-02 is not expected to have a material impact on LCNB's results of operations or financial position.

ASU No. 2014-04, "Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force)"
ASU No. 2014-04 was issued in January 2014 and clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor through completion of a deed in lieu of foreclosure or through a similar legal agreement. In addition, the update requires interim and annual disclosure of both the amount of foreclosed residential real estate properties held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate properties that are in the process of foreclosure. ASU No. 2014-04 is effective for public companies for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. Adoption of ASU No. 2014-04 is not expected to have a material impact on LCNB's results of operations or financial position.

34

Table of Contents
LCNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Note 16 – Recent Accounting Pronouncements (continued)

ASU No. 2014-08, "Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity"
ASU No. 2014-08 was issued in April 2014 and changes the criteria for reporting discontinued operations and provides for expanded disclosures in this area. The new guidance provides that only disposals representing a strategic shift in operations should be presented as discontinued operations and that theses strategic shifts should have a major effect on an organization's operations and financial results. ASU No. 2014-08 is effective for public companies with calendar year-ends in the first quarter of 2015.




Table of Contents



LCNB CORP. AND SUBSIDIARIES

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

Forward Looking Statements
Certain matters disclosed herein may be deemed to be forward-looking statements that involve risks and uncertainties.  Forward looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualifying words and their derivatives such as "expects," "anticipates," "believes," "estimates," "plans," "projects," or other statements concerning opinions or judgments of LCNB and its management about future events.   Factors that could influence the accuracy of such forward looking statements include, but are not limited to, regulatory policy changes, interest rate fluctuations, loan demand, loan delinquencies and losses, general economic conditions and other risks.  Such forward-looking statements represent management's judgment as of the current date.  Actual strategies and results in future time periods may differ materially from those currently expected.  LCNB disclaims, however, any intent or obligation to update such forward-looking statements.  LCNB intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.
 
Critical Accounting Policies

Allowance for Loan Losses.  The allowance for loan losses is established through a provision for loan losses charged to expense.  Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely.  Subsequent recoveries, if any, are credited to the allowance.  The allowance is an amount that management believes will be adequate to absorb inherent losses in the loan portfolio, based on evaluations of the collectability of loans and prior loan loss experience.  The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers' ability to pay.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of specific and general components.  The specific component relates to loans that are classified as doubtful, substandard, or special mention.  For such loans an allowance is established when the discounted cash flows or collateral value is lower than the carrying value of that loan.  The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors, which include trends in underperforming loans, trends in the volume and terms of loans, economic trends and conditions, concentrations of credit, trends in the quality of loans, and borrower financial statement exceptions.

Based on its evaluations, management believes that the allowance for loan losses will be adequate to absorb estimated losses inherent in the current loan portfolio.

Acquired Credit Impaired Loans. LCNB accounts for acquisitions using the acquisition method of accounting, which requires that assets acquired and liabilities assumed be measured at their fair values at the acquisition date. Acquired loans are reviewed to determine if there is evidence of deterioration in credit quality since inception and if it is probable that LCNB will be unable to collect all amounts due under the contractual loan agreements. The analysis includes expected prepayments and estimated cash flows including principal and interest payments at the date of acquisition. The amount in excess of the estimated future cash flows is not accreted into earnings. The amount in excess of the estimated future cash flows over the book value of the loan is accreted into interest income over the remaining life of the loan (accretable yield). LCNB records these loans on the acquisition date at their net realizable value. Thus, an allowance for estimated future losses is not established on the acquisition date. Subsequent to the date of acquisition, expected future cash flows on loans acquired are updated and any losses or reductions in estimated cash flows which arise subsequent to the date of acquisition are reflected as a charge through the provision for loan losses. An increase in the expected cash flows adjusts the level of the accretable yield recognized on a prospective basis over the remaining life of the loan. Due to the number, size, and complexity of loans within the acquired loan portfolio, there is always a possibility of inherent undetected losses.


36

Table of Contents

LCNB CORP. AND SUBSIDIARIES

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




Accounting for Intangibles.  LCNB’s intangible assets at March 31, 2014 are composed primarily of goodwill and core deposit intangibles related to the acquisitions of Sycamore during the fourth quarter 2007, First Capital during the first quarter 2013, and ENB during the first quarter 2014. It also includes mortgage servicing rights recorded from sales of mortgage loans to the Federal Home Loan Mortgage Corporation and mortgage servicing rights acquired through the merger with ENB.  Goodwill is not subject to amortization, but is reviewed annually for impairment.  The core deposit intangible for Sycamore was amortized on a straight line basis over six years.  The core deposit intangible for First Capital is being amortized on a straight line basis over nine years and the core deposit intangible for ENB is being amortized on a straight line basis over eight years. Mortgage servicing rights are capitalized by allocating the total cost of loans between mortgage servicing rights and the loans based on their estimated fair values.  Capitalized mortgage servicing rights are amortized to loan servicing income in proportion to and over the period of estimated servicing income, subject to periodic review for impairment.

Results of Operations
Net income for the three months ended March 31, 2014 was $1,323,000 (total basic and diluted earnings per common share of $0.14).  This compares to net income of $1,728,000 (total basic and diluted earnings per common share of $0.23) for the same three month period in 2013.  Results for 2014 were significantly affected by the completion of a merger with Eaton National Bank & Trust Co. (“ENB”) on January 24, 2014 and the issuance of 1,642,857 new shares of voting common stock during the fourth quarter 2013. Results for 2013 were significantly affected by the completion of a merger with First Capital Bancshares, Inc. ("First Capital") and its subsidiary, Citizens National Bank of Chillicothe ("Citizens") on January 11, 2013.

Net interest income for the three months ended March 31, 2014 was $1,385,000 greater than results for the comparative period in 2013 primarily due to the increased volume of average interest earning assets provided by the merger with ENB and by an increase in the net interest margin.

The provision for loan losses for the first quarter 2014 was $68,000 less than for the same period in 2013. Net loan charge-offs for the first quarter 2014 and 2013 totaled $299,000 and $182,000, respectively. 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 increased from $1,463,000 at December 31, 2013 to $1,799,000 at March 31, 2014 primarily due to a foreclosure and property obtained through the ENB acquisition.

Non-interest income for the first quarter 2014 was $430,000 less than the comparable period in 2013 due to a combined $705,000 decrease in gains from sales of investment securities and mortgage loans, partially offset by increases in trust income and service charges and fees on deposit accounts. The decrease in gains from sales of investment securities and mortgage loans was due to lower sales volumes during the 2014 period.

Non-interest expense for the first quarter 2014 was $1,581,000 more than the comparable period in 2013. 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. Also contributing to the increase in non-interest expense were increases in other real estate owned expenses and merger-related expenses.

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, 2014 and 2013, average balances for interest-earning assets and interest-bearing liabilities, the income or expense related to each item, and the resulting average yields earned or rates paid.


37

Table of Contents

LCNB CORP. AND SUBSIDIARIES

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




 
 
Three Months Ended March 31,
 
 
2014
 
2013
 
 
Average
Outstanding
Balance
 
Interest
Earned/
Paid
 
Average
Yield/
Rate
 
Average
Outstanding
Balance
 
Interest
Earned/
Paid
 
Average
Yield/
Rate
 
 
 
 
(Dollars in thousands)
 
 
 
 
Loans (1)
 
$
647,535

 
7,696

 
4.82
%
 
$
536,518

 
6,580

 
4.97
%
Federal funds sold
 

 

 
%
 
3,115

 
1

 
0.13
%
Interest-bearing demand deposits
 
13,892

 
8

 
0.23
%
 
13,166

 
7

 
0.22
%
Federal Reserve Bank stock
 
1,603

 

 
%
 
1,104

 

 
%
Federal Home Loan Bank stock
 
3,368

 
37

 
4.46
%
 
2,743

 
31

 
4.58
%
Investment securities:
 
 

 
 

 
 

 
 

 
 

 
 

Taxable
 
199,723

 
891

 
1.81
%
 
188,749

 
834

 
1.79
%
Non-taxable (2)
 
98,097

 
979

 
4.05
%
 
93,033

 
944

 
4.12
%
Total earnings assets
 
964,218

 
9,611

 
4.04
%
 
838,428

 
8,397

 
4.06
%
Non-earning assets
 
110,352

 
 

 
 

 
89,527

 
 

 
 

Allowance for loan losses
 
(3,372
)
 
 

 
 

 
(3,349
)
 
 

 
 

Total assets
 
$
1,071,198

 
 

 
 

 
$
924,606

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
$
736,604

 
809

 
0.45
%
 
$
645,950

 
983

 
0.62
%
Short-term borrowings
 
10,814

 
3

 
0.11
%
 
11,623

 
3

 
0.10
%
Long-term debt
 
11,821

 
103

 
3.53
%
 
13,396

 
112

 
3.39
%
Total interest-bearing liabilities
 
759,239

 
915

 
0.49
%
 
670,969

 
1,098

 
0.66
%
Demand deposits
 
185,447

 
 

 
 

 
153,026

 
 

 
 

Other liabilities
 
6,553

 
 

 
 

 
7,276

 
 

 
 

Capital
 
119,959

 
 

 
 

 
93,335

 
 

 
 

Total liabilities and capital
 
$
1,071,198

 
 

 
 

 
$
924,606

 
 

 
 

Net interest rate spread (3)
 
 

 
 

 
3.55
%
 
 

 
 

 
3.40
%
Net interest income and net interest margin on a taxable-equivalent basis (4)
 
 

 
8,696

 
3.66
%
 
 

 
7,299

 
3.53
%
Ratio of interest-earning assets to interest-bearing liabilities
 
127.00
%
 
 

 
 

 
124.96
%
 
 

 
 

(1)
Includes nonaccrual loans, if any.
(2)
Income from tax-exempt securities is included in interest income on a taxable-equivalent basis.  Interest income has been divided by a factor comprised of the complement of the incremental tax rate of 34%.
(3)
The net interest spread is the difference between the average rate on total interest-earning assets and interest-bearing liabilities.
(4)
The net interest margin is the taxable-equivalent net interest income divided by average interest-earning assets.

The following table presents the changes in taxable-equivalent basis interest income and expense for each major category of interest-earning assets and interest-bearing liabilities and the amount of change attributable to volume and rate changes for the three months ended March 31, 2014 as compared to the same period in 2013.  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.


38

Table of Contents

LCNB CORP. AND SUBSIDIARIES

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




 
 
Three Months Ended
March 31, 2014 vs. 2013
Increase (decrease) due to:
 
 
Volume
 
Rate
 
Total
 
 
(In thousands)
Interest-earning Assets:
 
 
 
 
 
 
Loans
 
$
1,325

 
(209
)
 
1,116

Federal funds sold
 
(1
)
 

 
(1
)
Interest-bearing demand deposits
 

 
1

 
1

Federal Reserve Bank stock
 

 

 

Federal Home Loan Bank stock
 
7

 
(1
)
 
6

Investment securities:
 
 

 
 

 
 

Taxable
 
49

 
8

 
57

Non-taxable
 
51

 
(16
)
 
35

Total interest income
 
1,431

 
(217
)
 
1,214

Interest-bearing Liabilities:
 
 

 
 

 
 

Deposits
 
125

 
(299
)
 
(174
)
Short-term borrowings
 

 

 

Long-term debt
 
(14
)
 
5

 
(9
)
Total interest expense
 
111

 
(294
)
 
(183
)
Net interest income
 
$
1,320

 
77

 
1,397


Net interest income on a fully tax-equivalent basis for the three months ended March 31, 2014 totaled $8,696,000, an increase of $1,397,000 over the comparable period in 2013.  Total interest income increased $1,214,000 and total interest expense decreased $183,000.

The increase in total interest income was primarily due to a $125.8 million increase in average total earning assets, slightly offset by a 2 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 ENB.  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 17 basis point decrease in the average rate paid on interest-bearing liabilities, partially offset by an $88.3 million increase in average interest-bearing liabilities.  The increase in average interest-bearing liabilities was primarily due to an $90.7 million increase in average interest-bearing deposits primarily due to the merger.  The decrease in the average rate paid on interest-bearing liabilities also reflects a general decrease in market rates.

Provision and Allowance For Loan Losses
The total provision for loan losses is determined based upon management's evaluation as to the amount needed to maintain the allowance for loan losses at a level considered appropriate in relation to the risk of losses inherent in the portfolio.  In addition to historic charge-off percentages, factors taken into consideration to determine the adequacy of the allowance for loan losses include the nature, volume, and consistency of the loan portfolio, overall portfolio quality, a review of specific problem loans, and current economic conditions that may affect borrowers' ability to pay.  The provision for loan losses for the three months ended March 31, 2014 and 2013 was $81,000 and $149,000, respectively.  The decrease in the provision reflects stabilization in the credit quality of the loan portfolio in part due to relatively stable regional market conditions.

The fair value of loans acquired through the merger with ENB was estimated by discounting at current rates the cash flows expected to be received on ENB's 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, ENB's allowance for loan losses was not carried forward.


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LCNB CORP. AND SUBSIDIARIES

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




Non-Interest Income
Total non-interest income for the first quarter 2014 was $430,000 less than for the first quarter 2013 primarily due to a $591,000 decrease in net gains on sales of investment securities and a $114,000 decrease in net gains from sales of mortgage loans. The decreases reflect declines in the volume of investment securities and loans sold.

These decreases were partially offset by a $143,000 increase in service charges and fees on deposit accounts and an $80,000 increase in trust income.  Service charges and fees on deposit accounts increased primarily due to a greater number of deposit accounts resulting from the merger with ENB.  Trust income increased primarily due to an increase in the fair value of trust assets and brokerage accounts managed along with fee adjustments that became effective July 1, 2013.

Non-Interest Expense
Non-interest expense for the first quarter 2014 was $1,581,000 greater than for the first quarter 2013 primarily due to a $624,000 increase in salaries and employee benefits, a $145,000 increase in net occupancy expense, and a $237,000 increase in merger-related expenses, and a $536,000 increase in other non-interest expense.  The increase in salaries and employee benefits reflects the additional staff needed to operate the five offices LCNB acquired as a result of the merger with ENB.  Net occupancy expense increased due to increased costs for the additional offices and to greater snow removal costs required for the 2014 period. Included in the other non-interest expense increase was a $247,000 increase in other real estate owned expenses, reflecting the absence of a $245,000 net gain recognized on the sale of property during the first quarter 2013.

Income Taxes
LCNB's effective tax rates for the three months ended March 31, 2014 and 2013 were 21.6% and 23.0%, respectively.  The difference between the statutory rate of 34.0% and the effective tax rate is primarily due to tax-exempt interest income from municipal securities and tax-exempt earnings from bank owned life insurance.

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

Liquidity
LCNB depends on dividends from its subsidiaries for the majority of its liquid assets, including the cash needed to pay dividends to its shareholders.  National banking law limits the amount of dividends the Bank may pay to the sum of retained net income 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 Corp. without needing to request approval.  The Bank is not aware of any reasons why it would not receive such approval.

Liquidity is the ability to have funds available at all times to meet the commitments of LCNB.  Asset liquidity is provided by cash and assets which are readily marketable or pledgeable or which will mature in the near future. Liquid assets include cash and cash equivalents and securities available for sale.  At March 31, 2014, LCNB's liquid assets amounted to $343.5 million or 30.3% of total assets.  This compares to liquid assets totaling $272.9 million or 29.3% of total assets at December 31, 2013.

Liquidity is also provided by access to core funding sources, primarily core depositors in LCNB's market area.  Approximately 82.7% of total deposits at March 31, 2014 were "core" deposits, compared to 83.9% of deposits at December 31, 2013. Core deposits, for this purpose, are defined as total deposits less public funds and certificates of deposit greater than $100,000. The percentage of core deposits to total deposits decreased because of the growth in public fund deposits discussed above in relation to total growth in deposits.

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

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.


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LCNB CORP. AND SUBSIDIARIES
Item 3.
Quantitative and Qualitative Disclosures about Market Risks

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

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, 2014 IRSA indicates that an increase in interest rates 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
 
$
39,284

 
2,907

 
7.99
%
Up 200
 
38,289

 
1,912

 
5.26
%
Up 100
 
37,323

 
946

 
2.60
%
Base
 
36,377

 

 
%

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, 2014 EVE analysis indicates that an increase in interest rates would have a negative effect on the EVE.  The changes in 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
 
$
115,096

 
(6,419
)
 
(5.28
)%
Up 200
 
116,464

 
(5,051
)
 
(4.16
)%
Up 100
 
118,551

 
(2,964
)
 
(2.44
)%
Base
 
121,515

 

 
 %

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.


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LCNB CORP. AND SUBSIDIARIES
Item 4.
Controls and Procedures

a)  Disclosure controls and procedures.  The Chief Executive Officer and the Chief Financial Officer have carried out an evaluation of the effectiveness of LCNB's disclosure controls and procedures that ensure that information relating to LCNB required to be disclosed by LCNB in the reports that it files or submits under the Securities and 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, 2014, 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.

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PART II.  OTHER INFORMATION

LCNB CORP. AND SUBSIDIARIES
 
Item 1.
Legal Proceedings

None

Item 1A.
Risk Factors

No material changes

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

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

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

Item 3.
Defaults Upon Senior Securities

None

Item 4.
Mine Safety Disclosures

Not applicable

Item 5.
Other Information

None
 

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LCNB CORP. AND SUBSIDIARIES
Item 6.
Exhibits

Exhibit No.
Exhibit Description
2
Stock Purchase Agreement dated as of October 28, 2013 by and between LCNB Corp. and Colonial Banc Corp.  – incorporated by reference to the Registrant's Form 8-K filed on October 28, 2013, 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.
 
 
31.1
Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
31.2
Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
32
Certification of Chief Executive Officer and Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
101
The following financial information from LCNB Corp.'s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014 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.

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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 9, 2014
/s/ Stephen P. Wilson
 
 
Stephen P. Wilson, Chief Executive Officer and
 
 
Chairman of the Board of Directors
 
 
 
 
May 9, 2014
/s/ Robert C. Haines, II
 
 
Robert C. Haines, II, Executive Vice President
 
 
and Chief Financial Officer
 

45