Introduction

The following is management's discussion and analysis of the consolidated financial condition and consolidated results of operations of LCNB. It is intended to amplify certain financial information regarding LCNB and should be read in conjunction with the Consolidated Financial Statements and related Notes and the Financial Highlights contained in the 2008 Annual Report to Shareholders.

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 the Company 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.

Acquisitions

At the close of business on December 20, 2007, LCNB acquired Sycamore in a stock and cash transaction valued at approximately $9.6 million. Sycamore operated two full-service branches in Cincinnati, Ohio, which became branches of the Bank. As of December 20, 2007, Sycamore had total assets of $48.9 million, total loans, net of the related allowance for loan losses, of $42.8 million, and total deposits of $44.4 million.

Under the terms of the affiliation agreement, each share of Sycamore common stock was exchanged for, at the election of each shareholder, $33.75 in cash, 2.444 shares of LCNB common stock, or a combination of cash and shares. A Sycamore shareholder's election to receive cash or stock was subject to allocation procedures that ensured that, in the aggregate, 50% of the shares of Sycamore common stock were exchanged for cash and 50% were exchanged for stock.

The transaction, which was accounted for under the purchase accounting method, included the recognition of approximately $343,000 of core deposit intangibles and goodwill of $5,915,000, as adjusted in 2008. The goodwill represents the excess of the purchase price over the fair value of identifiable net assets, including the core deposit intangible. The core deposit intangible is being amortized on a straight-line basis over 6 years. Goodwill is not amortized, but is instead subject to an annual review for impairment. Sycamore's results of operations are included in the consolidated financial results of LCNB from the acquisition date.

On May 31, 2006, Dakin purchased the existing book of business of Altemeier Oliver & Company Agency, Inc. ("AOC"), an independent insurance agency located in Blue Ash, Ohio. The acquisition of AOC was accounted for using the purchase accounting method and the results of operations of AOC have been included in the consolidated financial statements of LCNB since the acquisition date. The acquired assets consisted solely of a customer list intangible asset. This intangible asset is being amortized on a straight-line basis over a ten year period.

Overview

LCNB earned $6,603,000 in 2008, compared to $5,954,000 in 2007 and $6,514,000 in 2006. Basic and diluted earnings per share for 2008, 2007, and 2006 were $0.99, $0.94, and $1.00, respectively.

Net interest income for 2008, 2007, and 2006 was $20,929,000, $18,153,000, and $18,315,000, respectively. Net interest income for 2008 was $2,776,000 greater than for 2007 primarily due to additional loans and deposits from the Sycamore National Bank acquisition in late 2007 and organic growth. Also contributing to the increase in net interest income was a decrease in average rates paid on interest-bearing liabilities, primarily deposits, partially offset by a decrease in average rates earned on interest-earning assets. Net interest income for 2007 was $162,000 lower than net interest income for 2006 primarily due an increase in average rates paid on interest-bearing liabilities, partially offset by an increase in average rates earned on interest-earning assets.

Total non-interest income grew from $8,346,000 in 2007 to $8,453,000 in 2008 and remained virtually the same from 2006 to 2007. Primary contributors to the 2008 increase were check card income and income from bank owned life insurance.

Total non-interest expense also increased annually from 2006 to 2008. Total non-interest expense for 2006 was $17,838,000, $18,344,000 for 2007, and $19,934,000 for 2008. These increases were largely due to increased salaries and benefits resulting from routine salary and wage increases and an increase in the number of employees.

Net Interest Income

The amount of net interest income earned by LCNB is influenced by the dollar amount ("volume") and mix of interest earning assets and interest bearing liabilities and the rates earned or paid on each. The following table presents, for the years indicated, the distribution of average assets, liabilities and shareholders' equity, as well as the total dollar amounts of interest income from average interest earning assets and the resultant yields on a taxable equivalent basis, and the dollar amounts of interest expense and average interest-bearing liabilities and the resultant rates paid.

                                                                             Years ended December 31,
                                                   2008                                  2007                                2006
                                       Average       Interest   Average      Average      Interest   Average      Average      Interest Average
                                     Outstanding     Earned/    Yield/     Outstanding    Earned/    Yield/     Outstanding    Earned/  Yield/
                                       Balance         Paid      Rate        Balance        Paid      Rate        Balance        Paid    Rate
                                                                              (Dollars in thousands)

Loans (1)                            $   447,751   $   29,024     6.48%   $   394,760   $   27,066     6.86%   $  375,247    $   25,284   6.74%
Federal funds sold and interest-          23,527          491     2.09%       13,175           654     4.96%        8,961           458   5.11%
 bearing demand deposits
Interest-bearing deposits in banks         1,530           38     2.48%            -             -        -%             -            -      -%
Federal Reserve Bank Stock                   872           52     5.96%          650            39     6.00%          647            39   6.03%
Federal Home Loan Bank Stock               2,050          108     5.27%        1,852           124     6.70%        2,590           150   5.79%
Investment securities:
 Taxable                                  62,082        2,642     4.26%       49,838         2,229     4.47%       65,413         2,650   4.05%
 Nontaxable (2)                           50,016        3,023     6.04%       46,939         2,847     6.07%       50,271         2,980   5.93%
   Total earning assets                  587,828       35,378     6.02%      507,214        32,959     6.50%      503,129        31,561   6.27%

Non-earning assets                        52,746                              44,928                               44,588
Allowance for loan losses                (2,474)                              (2,068)                              (2,079)
   Total assets                      $   638,100                          $  550,074                            $ 545,638

Savings deposits                     $    83,403          863     1.03%   $   79,510           827     1.04%    $  93,670         1,016   1.08%
NOW and money fund                       164,485        2,941     1.79%      119,211         3,197     2.68%      116,115         2,869   2.47%
IRA and time certificates                238,166        9,341     3.92%      208,361         9,421     4.52%      198,536         8,228   4.14%
Short-term borrowings                        863           13     1.51%        3,373           181     5.37%        1,814            90   4.96%
Long-term debt                             5,000          263     5.26%        4,041           212     5.25%          528            30   5.68%
   Total interest-bearing                491,917       13,421     2.73%      414,496        13,838     3.34%      410,663        12,233   2.98%
    liabilities

Demand deposits                           83,009                              80,221                               79,741
Other liabilities                          5,012                               3,189                                3,026
Capital                                   58,162                              52,168                               52,208
   Total liabilities and capital     $   638,100                          $  550,074                            $ 545,638

Net interest rate spread  (3)                                     3.29%                                3.16%                              3.29%

Net interest income and net                        $   21,957     3.74%                 $   19,121     3.77%                 $   19,328   3.84%
  interest margin on a tax
 equivalent basis (4)

Ratio of interest-earning assets to 119.50% 122.37% 122.52% interest-bearing liabilities

Includes non-accrual loans if any. Income from tax-exempt loans is included in interest income on a taxable equivalent basis, using an incremental rate of 34%.

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%.

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

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

The following table presents the changes in 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 years indicated. 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.

                                           For the years ended December 31,
                                   2008 vs. 2007                       2007 vs. 2006
                             Increase (decrease) due to         Increase (decrease) due to
                           Volume        Rate       Total      Volume        Rate      Total
                                                    (In thousands)
Interest income
 attributable to:
  Loans(1)              $    3,492       (1,534)     1,958      1,332         450      1,782
  Federal funds sold           342         (505)     (163)        210          (14)      196
and
  interest-bearing
demand
  deposits
  Interest-bearing              38             -        38            -           -         -
deposits
   in banks
  Federal Reserve               13             -        13            -           -         -
Bank
   stock
  Federal Home Loan             12          (28)      (16)         (47)        21        (26)
  Bank stock
  Investment
securities:
  Taxable                      525         (112)       413        (677)       256       (421)
  Nontaxable(2)                186          (10)       176        (201)        68       (133)
   Total interest            4,608       (2,189)     2,419         617        781      1,398
income

Interest expense
 attributable to:
  Savings deposits              40           (4)        36        (149)        (40)     (189)
  NOW and money fund           999       (1,255)     (256)          78         250       328
  IRA and time               1,255       (1,335)      (80)         420         773     1,193
certificates
  Short-term                  (85)          (83)     (168)          83           8        91
borrowings
  Long-term debt                50             1        51         184          (2)      182
   Total interest            2,259       (2,676)     (417)         616         989     1,605
expense

   Net interest         $    2,349           487     2,836           1        (208)     (207)
income

Non-accrual loans, if any, are included in average loan balances.

Change in interest income from nontaxable loans and investment securities is computed based on interest income determined on a taxable equivalent yield basis. Interest income has been divided by a factor comprised of the complement of the incremental tax rate of 34%.

2008 vs. 2007. Taxable equivalent interest income increased $2,419,000 due to an $80.6 million increase in total average interest-earning assets primarily due to loans obtained in the Sycamore National Bank acquisition and organic growth.
The loan portfolio grew $53.0 million on an average basis and average investment securities increased $15.3 million. This increase was partially offset by a 48 basis point (a basis point equals 0.01%) decrease in the average rate earned on interest-earning assets, primarily due to general decreases in market rates.

Interest expense decreased $417,000 primarily due to a 61 basis point decrease in the average rate paid on interest-bearing liabilities, partially offset by a $77.4 million increase in average interest-bearing liabilities, primarily deposits. The decrease in average rates paid is primarily due to general decreases in market rates.

The net interest margin, on a taxable equivalent basis, was relatively stable - decreasing slightly from 3.77% for 2007 to 3.74% for 2008.

2007 vs. 2006. Taxable equivalent interest income increased $1,398,000 due to a 23 basis point increase in the average rate earned on interest-earning assets and to a $4.1 million increase in total average interest-earning assets. The increase in average rates earned was primarily due to general increases in market rates. The increase in average interest-earning assets occurred primarily in the loan portfolio, which grew $19.5 million on an average basis, and in federal funds sold and interest-bearing demand deposits, which grew $4.2 million on an average basis. Growth in these assets was partially offset by an $18.9 million decrease in average taxable and nontaxable investment securities.
The movement in loans and investment securities reflects management's decision to reinvest most maturing investment securities into higher rate loans.

Interest expense increased $1,605,000 primarily due to a 36 basis point increase in the average rate paid on interest-bearing liabilities and secondarily to a $3.8 million increase in average interest-bearing liabilities. The increase in average rates paid is primarily due to general increases in market rates.

The net interest margin, on a taxable equivalent basis, decreased from 3.84% for 2006 to 3.77% for 2007. Even though the average rate earned on interest-earning assets increased 23 basis points, this increase was offset by the 36 basis point increase in the average rate paid on interest-bearing liabilities.

Provisions and Allowance for Loan Losses

The provision for loan losses is determined by management based upon its evaluation of the amount needed to maintain the allowance for loan losses at a level considered appropriate in relation to the estimated 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 following table presents the total loan loss provision and the other changes in the allowance for loan losses for the years 2004 through 2008.

                                     2008    2007    2006    2005    2004
                                            (Dollars in thousands)

Balance - Beginning of year        $ 2,468   2,050   2,150   2,150   2,150

Allowance related to Sycamore            -     453       -       -       -
 acquisition
                                     2,468   2,503   2,150   2,150   2,150

Loans charged off:
 Commercial and industrial              73      81       -       -     126
 Commercial, secured by                  -       -      34       -       -
  real estate
 Residential real estate               129      71      62      14      32
 Consumer, excluding credit card       617     231     236     395     446
 Agricultural                            -       -       -       -       -
 Credit Card                             -               -       -      10
 Other loans, including                228     305     308     335       -
  deposit overdrafts
   Total loans charged off           1,047     688     640     744     614

Recoveries:
 Commercial and industrial              40      17       -      19       -
 Commercial, secured by                  -       -       -       -       -
  real estate
 Residential real estate                20       2       3       9       -
 Consumer, excluding credit card       201     142     186     175     124
 Agricultural                            -       -       -       -       -
 Credit Card                             1       3       3      11       1
 Other loans, including                165     223     205     192       -
  deposit overdrafts
   Total recoveries                    427     387     397     406     125
    Net charge offs                    620     301     243     338     489

Provision charged to operations        620     266     143     338     489
    Balance - End of year          $ 2,468   2,468   2,050   2,150   2,150

Ratio of net charge-offs during      0.14%   0.08%   0.06%   0.10%   0.15%
 the period to average loans
 outstanding

Ratio of allowance for loan losses   0.54%   0.55%   0.53%   0.60%   0.64%
 to total loans at year-end

Of the $73,000 charged off during 2008 in the commercial and industrial loan category, approximately $53,000 was due to one loan. Of the $129,000 charged off during 2008 in the residential real estate loan category, approximately $119,000 was due to two loans. The increase in consumer loan charge-offs during 2008 reflect a greater number of delinquent loans, primarily due to deteriorating economic conditions. Of the $81,000 charged-off in the commercial and industrial loan category during 2007, approximately $76,000 was due to two loans. The commercial and industrial loan charge-off of $126,000 during 2004 is due to one company that had filed bankruptcy. Consumer loan charge-offs in 2004 included $41,000 that was due to a yacht that was subsequently repossessed and sold that same year. The balance of increased consumer loan charge-offs during 2004 are due to a greater number of troubled loans.

Charge-offs and recoveries classified as "Other" during 2005, 2006, 2007, and 2008 represent charge-offs and recoveries on checking and NOW account overdrafts. LCNB charges off such overdrafts when considered uncollectible, but no later than 60 days from the date first overdrawn. Prior to 2005, overdrafts considered uncollectible were netted against service charges and fees in non-interest income.

For additional discussion regarding changes in the components of the allowance for loan losses, see Item 1. Business, Statistical Information, Components of the Allowance for Loan Losses.

Non-Interest Income

2008 vs. 2007. Total non-interest income for 2008 was $107,000 greater than 2007. Service charges and fees increased $151,000, primarily due to increases in checkcard income. The increase reflects a greater number of cards outstanding during 2008 and the increasing popularity of checkcards as a retail payment method. In addition, income from bank owned life insurance increased $62,000. These increases were partially offset by a $29,000 decrease in trust income and a $36,000 decrease in gains from sales of mortgage loans. Trust income decreased primarily due to weakening market conditions and the decrease in gains from sales of loans reflects a lower volume of sales. Approximately $971,000 of residential mortgage loans were sold during 2008, compared to $2,796,000 sold during 2007.

2007 vs. 2006. Total non-interest income for 2007 was $1,000 greater than 2006.
Small decreases in trust income and insurance agency income were offset by an increase in other operating income. Service charges and fees were the same in total, but the mix of fees changed. A continuing decrease in overdraft fees was offset by a continuing increase in checkcard income.

Non-Interest Expense

2008 vs. 2007. Total non-interest expense increased $1,590,000 during 2008 compared with 2007. Contributing to the increase were a $848,000 increase in salaries and wages, a $308,000 increase in pension and other employee benefits, a $146,000 increase in occupancy expense, and a $421,000 increase in other non-interest expense. These increases were partially offset by a $259,000 decrease in intangible amortization.

Salaries and wages increased due to additional employees, primarily from the Sycamore acquisition and the opening of the Centerville Office in September 2008, and routine salary and wage increases. Pension and other employee benefits increased due to increased pension costs, increased health insurance costs, and increased payroll taxes. The increase in occupancy expense is primarily due to increased maintenance and repair costs, utilities expense, depreciation expense, and rent expense for the Bridgetown office obtained as part of the Sycamore National Bank acquisition. These increases partially reflect an increased number of offices maintained by LCNB. The increase in other non-interest expense is due to increases in printing and office supplies, postage, and a variety of other operating expenses.

Intangible amortization decreased due to the amortization in full the third quarter of 2008 of intangible assets related to the purchase of three offices from another bank in 1997. This decrease was partially offset by amortization of the core deposit intangible resulting from the Sycamore National Bank acquisition in December 2007.

2007 vs. 2006. Total non-interest expense increased $506,000 during 2007 compared with 2006. Contributing to the increase were a $180,000 increase in salaries and wages, a $122,000 increase in pension and other employee benefits, a $136,000 increase in occupancy expense, and a $100,000 increase in telephone expense.

Salaries and wages increased due to additional employees, primarily from the Sycamore acquisition and the opening of the Centerville office in September 2008, and routine salary and wage increases. Pension and other employee benefits increased primarily due to increased pension costs. The increase in occupancy expense is primarily due to increased maintenance and repair costs, rent expense for the land at the new Oakwood office (opened May, 2007), and real estate taxes for the Oakwood office. Telephone expense increased due to increased network costs and a system upgrade.

Income Taxes

LCNB's effective tax rates for the years ended December 31, 2008, 2007, and 2006 were 25.2%, 24.9%, and 24.9%, respectively. The difference between the statutory rate of 34.0% and the effective tax rate is primarily due to tax-exempt interest income and tax-exempt earnings from bank owned life insurance.

Assets

Net loans grew $6.9 million during 2008. Commercial real estate loans increased $15.1 million while consumer loans decreased $10.0 million, reflecting a lower demand for consumer loans due to economic conditions during 2008.

Investment securities available for sale increased $48.8 million during 2008.
With a decreased demand for loans, management invested much of the deposit growth experienced during 2008 in investment securities.

Net premises and equipment was $1.4 million higher at December 31, 2008 than at December 31, 2007, primarily due to the purchase of land for a new South Lebanon office and the completion of construction on the Centerville office. The rest of the increase represents information technology upgrades and miscellaneous furniture and equipment purchases.

Deposits

Total deposits at December 31, 2008 were $41.7 million greater than at December 31, 2007. Of this increase, approximately $17.8 million was due to increases in public fund deposits by local governmental entities. LCNB has also been receiving a higher than normal volume of deposits withdrawn from other banks due, in part, to the volatility of current economic conditions.

Liquidity

Liquidity is the ability to have funds available at all times to meet the commitments of LCNB. These commitments may include paying dividends to shareholders, funding new loans for borrowers, funding withdrawals by depositors, paying general and administrative expenses, and funding capital expenditures. Sources of liquidity include growth in deposits, principal payments received on loans, proceeds from the sale of loans, the sale or maturation of investment securities, cash generated by operating activities, and the ability to borrow funds. Management closely monitors the level of liquid assets available to meet ongoing funding requirements. 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 during the past year as a result of current liquidity levels.

The liquidity of LCNB is enhanced by the fact that 79.6% of total deposits at December 31, 2008 were "core" deposits. Core deposits, for this purpose, are . . .