Executive Summary

LSB Financial Corp. (the "Company" or "LSB Financial") is an Indiana corporation which was organized in 1994 by Lafayette Savings Bank, FSB ("Lafayette Savings") for the purpose of becoming a thrift institution holding company. Lafayette Savings is a federally chartered stock savings bank headquartered in Lafayette, Indiana. References in this Form 10-Q to "we," "us," and "our" refer to LSB Financial and/or Lafayette Savings as the context requires.

Lafayette Savings has been, and intends to continue to be, a community-oriented financial institution. Our principal business consists of attracting retail deposits from the general public and investing those funds primarily in permanent first mortgage loans secured by owner-occupied, one- to four-family residences and, to a lesser extent, non-owner occupied one- to four-family residential, commercial real estate, multi-family, construction and development, consumer and commercial business loans. Our revenues are derived principally from interest on mortgage and other loans and interest on securities.

We have an experienced and committed staff and enjoy a good reputation for serving the people of the community and understanding their financial needs and for finding a way to meet those needs. We contribute time and money to improve the quality of life in our market area and many of our employees volunteer for local non-profit agencies. We believe this sets us apart from the other 19 banks and credit unions that compete with us. We also believe that operating independently under the same name for 140 years is a benefit to us-especially as acquisitions and consolidations of local financial institutions continue. Focusing time and resources on acquiring customers who may be feeling disenfranchised by their no-longer-local bank has proved to be a successful strategy.

Tippecanoe County and the eight surrounding counties comprise Lafayette Savings' primary market area. In this period of extraordinary economic times, we find ourselves in a community that to some extent has been sheltered from the worst effects of the slowdown. The greater Lafayette area enjoys diverse employment including several major manufacturers; a strong education sector with Purdue University and a large local campus of Ivy Tech Community College; government offices of Lafayette, West Lafayette and Tippecanoe County and a growing high-tech presence with the Purdue Research Park and the growth of a new medical corridor

spurred by the building of two new hospitals. However the area isn't immune to the effects of the recession. The Tippecanoe County unemployment rate for March 2009 was 8.5%, compared to 10.6% for Indiana and 9.0% for the U.S. There were temporary layoffs announced by Caterpillar, and Wabash National indicated it may be looking for a buyer. However, a recent national report on the "Best Cities for Jobs" by the Praxis Strategy Group characterized the Lafayette area as "this year's shooting star" having moved from a ranking of 287 in 2008 to 85 this year. It noted the "significant investment in infrastructure and advanced infrasystems, enabling them (rising stars) to create jobs in higher-value, innovation-generating economic activities." Purdue University employs almost 15,000 people and has enrollment at the West Lafayette campus of over 40,000. The University's new construction in 2008 provided capital investments of over $242 million, thanks in part to their successful fundraising campaign which raised over $7 billion. The success of the Purdue Research Park in attracting high-tech companies to the Lafayette area is seen in the 52 buildings with 1.3 million square feet owned or leased by 160 companies employing 3,100 people. Its 195,000 square feet of incubator space makes it the largest institutionally operated incubator program in the nation. A 121 turbine wind farm being established in adjacent White County is expected to boost Tippecanoe County's economy by at least $20 million a year according to Greater Lafayette Commerce. Some examples of new manufacturing growth include Federal Express which announced it will build a distribution center in Lafayette in 2009, EDS Indiana Technical Resource Center leasing 13,000 square feet in Purdue Research Park and hiring 92 people with additional growth planned for 45,000 square feet occupied in 2009 and 200 employees hired by 2010. TRW plans to expand its operations with a new $29 million facility in south Lafayette that will employ 200 people. Subaru of Indiana increased its national sales by 3% in 2008, the only major auto manufacturer to do so.

The community is making progress working through the effects of the overbuilding of one- to four-family housing when housing starts increased from a somewhat typical 858 starts in 2001 to 1,219 in 2004. New construction has dropped every year since, to 448 in 2008. Many of the houses which had been sold to marginally qualified borrowers reappeared on the market as foreclosed properties, further slowing the need for new housing. While this increase in foreclosed properties and distressed housing sales has been a drag on the economy, this was due more to aggressive marketing of houses to people who couldn't afford them rather than because of increased levels of unemployment. In addition, unlike in other parts of the country, housing values in the Metropolitan Statistical Area of which Tippecanoe County is a part have increased by 2.88% over the last 12 months according to a report from the Office of Federal Housing Enterprise Oversight.

We continue to work with borrowers who have fallen substantially behind on their loans. The majority of our delinquent loans are secured by real estate and we believe we have sufficient reserves to cover probable losses. The challenge is to get delinquent borrowers back on a workable payment schedule or to get control of their properties through an overburdened court system. We acquired 11 properties in the first quarter of 2009 through foreclosure or deeds-in-lieu of foreclosure.

Our primary source of income is net interest income, which is the difference between the interest income earned on our loan and investment portfolio and the interest expense incurred on deposits and borrowings. Our net interest income depends on the balance of our loan and investment portfolios and the size of our net interest margin - the difference between the income

generated from loans and the cost of funding. Our net interest income also depends on the shape of the yield curve. Since January 2007, the Federal Reserve has lowered short-term rates from around 5.0% to almost zero while long-term rates which had also been near 5.0% fell to under 3.0%. Because deposits are generally tied to shorter-term market rates and loans are generally tied to longer-term rates this would typically be viewed as a positive step. In reality, loans-especially those immediately repriceable to prime-fell immediately while deposits generally stayed high due to a demand for liquidity, especially by big banks whose presence in the deposit markets was ubiquitous. We have started to see deposit rates gradually respond to the lower market rates as banks are less concerned about the loss of liquidity. Overall loan rates are expected to stay low.

Rate changes can typically be expected to have an impact on interest income. Falling rates generally increase borrower preference for fixed rate products, which we typically sell on the secondary market, and existing adjustable rate loans can be expected to reprice to lower rates, which could be expected to have a negative impact on our interest income. Also any new loans put on the books will be at comparatively low rates. Because the government is working to push long-term rates to fall further to help ease the housing crisis, we are seeing a return to a high volume of refinancing.

We consider expected changes in interest rates when structuring our interest-earning assets and our interest-bearing liabilities. If rates are expected to increase we try to book shorter-term assets that will reprice relatively quickly to higher rates over time, and book longer-term liabilities that will remain for a longer time at lower rates. Conversely, if rates are expected to fall, we intend to structure our balance sheet such that loans will reprice more slowly to lower rates and deposits will reprice more quickly. We currently offer a three-year and a five-year certificate of deposit that allows depositors one opportunity to have their rate adjusted to the market rate at a future date to encourage them to choose longer-term deposit products. However, since we are not able to predict market interest rate fluctuations, our asset/liability management strategy may not prevent interest rate changes from having an adverse effect on our results of operations and financial condition.

Our results of operations may also be affected by general and local competitive conditions, particularly those with respect to changes in market interest rates, government policies and actions of regulatory authorities.

The level of turmoil in the financial services industry does present unusual risks and challenges for the Company, as described in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Possible Implications of Current Events" in the Annual Report to Shareholders filed as Exhibit 13 to the Company's Form 10-K for the year ended December 31, 2008.

Critical Accounting Policies

Generally accepted accounting principles are complex and require management to apply significant judgments to various accounting, reporting and disclosure matters. Management of LSB Financial must use assumptions and estimates to apply these principles where actual measurement is not possible or practical. For a complete discussion of LSB Financial's significant accounting policies, see Note 1 to the Consolidated Financial Statements as of

March 31, 2009. Certain policies are considered critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such estimates may have a significant impact on the financial statements. Management has reviewed the application of these policies with the Audit Committee of LSB Financial's Board of Directors. These policies include the following:

Allowance for Loan Losses

The allowance for loan losses represents management's estimate of probable losses inherent in Lafayette Savings' loan portfolios. In determining the appropriate amount of the allowance for loan losses, management makes numerous assumptions, estimates and assessments.

The strategy also emphasizes diversification on an industry and customer level, regular credit quality reviews and quarterly management reviews of large credit exposures and loans experiencing deterioration of credit quality.

Lafayette Savings' allowance consists of three components: probable losses estimated from individual reviews of specific loans, probable losses estimated from historical loss rates, and probable losses resulting from economic or other deterioration above and beyond what is reflected in the first two components of the allowance.

Larger commercial loans that exhibit probable or observed credit weaknesses are subject to individual review. Where appropriate, reserves are allocated to individual loans based on management's estimate of the borrower's ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to Lafayette Savings. Included in the review of individual loans are those that are impaired as provided in SFAS No. 114, Accounting by Creditors for Impairment of a Loan. Any allowances for impaired loans are determined by the present value of expected future cash flows discounted at the loan's effective interest rate or fair value of the underlying collateral. Historical loss rates are applied to other commercial loans not subject to specific reserve allocations.

Homogenous smaller balance loans, such as consumer installment and residential mortgage loans are not individually risk graded. Reserves are established for each pool of loans based on the expected net charge-offs for one year. Loss rates are based on the average net charge-off history by loan category.

Historical loss rates for commercial and consumer loans may be adjusted for significant factors that, in management's judgment, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs and nonaccrual loans), changes in mix, asset quality trends, risk management and loan administration, changes in the internal lending policies and credit standards, collection practices and examination results from bank regulatory agencies and Lafayette Savings' internal loan review.

Allowances on individual loans are reviewed quarterly and historical loss rates are reviewed annually and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience.

Lafayette Savings' primary market area for lending is Tippecanoe County, Indiana. When evaluating the adequacy of allowance, consideration is given to this regional geographic concentration and the closely associated effect of changing economic conditions on Lafayette Savings' customers.

Mortgage Servicing Rights

Mortgage servicing rights (MSRs) associated with loans originated and sold, where servicing is retained, are capitalized and included in other intangible assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value.

Financial Condition

Comparison of Financial Condition at March 31, 2009 and December 31, 2008

Our total assets increased $10.6 million, or 2.83%, during the three months from December 31, 2008 to March 31, 2009. Primary components of this increase were a $15.0 million increase in short-term investments and cash and due from banks partially offset by a $4.1 million decrease in net loans receivable including loans held for sale. Management attributes the increase in short-term investments to a $17.1 million increase in deposits from December 31, 2008 to March 31, 2009 which we moved to short-term investments in expectation of future funding needs or repayments of Federal Home Loan Bank advances or maturing brokered deposits. The decrease in net loans was generally due to the increase in borrowers refinancing their mortgages to lower rate fixed rate mortgages which we typically sell on the secondary market. The increase in deposits was generally due to a decision by bank customers to move funds to the safety of a bank offering FDIC deposit insurance coverage rather than leave them in more risky investments. We reduced Federal Home Loan Bank advances by $7.0 million from December 31, 2008 to March 31, 2009.

Non-performing assets, which include non-accruing loans, accruing loans 90 days past due and foreclosed assets, increased from $9.4 million at December 31, 2008 to $12.9 million at March 31, 2009. Non-performing assets at March 31, 2009 consisted of $8.0 million of loans on residential real estate, $2.2 million on land or commercial real estate loans, $19,000 on consumer loans and $683,000 on commercial business loans. Foreclosed assets consisted of $1.7 million of residential property and $220,000 of commercial real estate. At March 31, 2009, our allowance for losses equaled 1.20% of total loans (including loans held for sale) compared to 1.12% at December 31, 2008. The allowance for loan losses at March 31, 2009 totaled 30.45% of nonperforming assets compared to 39.38% at December 31, 2008, and 35.71% of non-performing loans at March 31, 2009 compared to 46.35% at December 31, 2008. Our non-performing assets equaled 3.36% of total assets at March 31, 2009 compared to 2.52% at December 31, 2008.

When a non-performing loan is added to our classified loan list, an impairment analysis is completed to determine expected losses upon final disposition of the property. An adjustment to loan loss reserves is made at that time for any anticipated losses. This analysis is updated quarterly thereafter. Because of the large number of foreclosures the court systems frequently have backlogs in scheduling loan hearings. It may take up to two years to move a foreclosed property through the system to the point where we can obtain title to and dispose of it. We attempt to acquire properties through deeds-in-lieu of foreclosure if there are no other liens on the properties. In 2008, we acquired 25 properties through deeds-in-lieu of foreclosure and an additional 9 properties through foreclosure. In the first quarter of 2009 we acquired 2 properties through deeds-in-lieu of foreclosure and an additional 9 properties through foreclosure. As a result, $351 was charged against loan loss reserves for these properties in 2009 to reduce the carrying value of the property to the estimated realizable value. Although we believe we use the best information available to determine the adequacy of our allowance for loan losses, future adjustments to the allowance may be necessary, and net income could be significantly affected if circumstances and/or economic conditions cause substantial changes in the estimates we use in making the determinations about the levels of the allowance for losses. Additionally, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses. These agencies may require the recognition of additions to the allowance based upon their judgments of information available at the time of their examination.

Shareholders' equity increased from $34.1 million at December 31, 2008 to $34.2 million at March 31, 2009, an increase of $123,000, or 0.36%, primarily as a result of net income of $302,000, partially offset by our payment of $193,000 of dividends on common stock. Shareholders' equity to total assets was 8.92% at March 31, 2009 compared to 9.14% at December 31, 2008.

Average Balances, Interest Rates and Yields

The following table presents for the periods indicated the total dollar amount
of interest income earned on average interest-earning assets and the resultant
yields on such assets, as well as the interest expense paid on average
interest-bearing liabilities, and the rates paid on such liabilities. No tax
equivalent adjustments were made. All average balances are monthly average
balances. Non-accruing loans have been included in the table as loans carrying a
zero yield.

                                               Three months ended                                            Three months ended
                                                 March 31, 2009                                                March 31, 2008
                                  Average
                                Outstanding          Interest                             Average Outstanding          Interest
                                  Balance          Earned/ Paid        Yield/ Rate              Balance               Earned/Paid        Yield/ Rate

     Interest-Earning
     Assets:
     Loans receivable(1)      $       324,078               4,856              5.99 %   $               300,871               5,204              6.92 %
     Other investments                 33,532                 117              1.40                      26,462                 217              3.28
     Total interest-earning
     assets                           357,610               4,973              5.56                     327,333               5,421              6.62

     Savings deposits         $        23,889                  61              1.02     $                20,807                  55              1.06
     Demand and NOW
     deposits                          63,431                 112              0.71                      60,522                 140              0.93
     Time deposits                    182,574               1,641              3.60                     155,968               1,754              4.50
     Borrowings                        71,500                 771              4.31                      75,589                 929              4.92
     Total interest-bearing
     liabilities                      341,394               2,585              3.03                     312,886               2,878              3.68

     Net interest income                          $         2,388                                                   $         2,543
     Net interest rate
     spread                                                                    2.53 %                                                            2.95 %
     Net earning assets       $        16,216                                           $                14,447
     Net yield on average
     interest-earning
     assets                                                                    2.67 %                                                            3.11 %
     Average
     interest-earning
     assets to average
     interest-bearing
     liabilities                         1.05 x                                                            1.05 x

Results of Operations

Comparison of Operating Results the Quarter Ended March 31, 2009 and March 31, 2008

General. Net income for the three months ended March 31, 2009 was $302,000, a decrease of $213,000, or 41.36%, over the three months ended March 31, 2008. The decrease was primarily due to a $319,000 increase in the allowance for loan losses and a $156,000 decrease in net interest income and a $214,000 increase in non-interest expenses, partially offset by a $354,000 increase in non-interest income, and a $122,000 decrease in taxes on income.

Net Interest Income. Net interest income for the three months ended March 31, 2009 decreased $156,000, or 6.13%, over the same period in 2008. This decrease was due to a 44 basis point decrease in our net interest margin (net interest income divided by average interest-earning assets) from 3.11% for the three months ended March 31, 2008 to 2.67% for the three months ended March 31, 2009 offset by a $1.8 million increase in net interest-earning assets. The decrease in net interest margin is primarily due to the 106 basis point decrease in the average rate on interest-earning assets from 6.62% for the three months ended March 31, 2008 to 5.56% for the three months ended March 31, 2009 offset by a 65 basis point decrease in the average rate on interest-bearing liabilities from 3.68% to 3.03% for the same respective periods.

Interest income on loans decreased $348,000, or 6.69%, for the three months ended March 31, 2009 compared to the same three months in 2008. The average rate on loans fell from 6.92% to 5.99% partly due to the aggressive rate cuts by the Federal Reserve starting in 2007 which left prime rates at 3.25% at March 31, 2009 compared to 5.25% in March 2008. The effect on rates tied to prime was immediate but all variable rates repriced downward during the period. The average balance of loans increased by $23.2 million due to tighter credit at some of the larger banks which brought us the opportunity to consider new lending relationships.

Interest earned on other investments and Federal Home Loan Bank stock decreased by $100,000, or 46.08%, for the three months ended March 31, 2009 compared to the same period in 2008. This was the result of a 188 basis point decrease in the average yield on other investments and Federal Home Loan Bank stock offset by a $7.1 million increase in average balances. Much of the $17.1 million increase in deposits received in the first quarter was moved into low-rate, short-term investments in expectation of the opportunity to replace brokered deposits with local deposits and reduce the level of Federal Home Loan Bank advances and to fund growth.

Interest expense for the three months ended March 31, 2009 decreased $292,000, or 10.15%, over the same period in 2008 due to a $158,000 decrease in interest expense on Federal Home Loan Bank advances and a $134,000 decrease in interest on deposits. The decrease in interest expense on Federal Home Loan Bank advances was due to a $4.1 million decrease in the average balance along with a 60 basis point decrease in the average rate. The decrease in interest on deposits was due to a decrease in the average rate paid on deposits from 3.28% for the first three months of 2008 to 2.69% for the first three months of 2009, offset by a $32.6 million increase in average deposits. The decrease in rates was due to generally lower interest rates in the economy.

Provision for Loan Losses. The evaluation of the level of loan loss reserves is an ongoing process that includes closely monitoring loan delinquencies. The following chart shows delinquent loans as well as a breakdown of non-performing assets.

                                            03/31/09       12/31/08      03/31/08

          Loans delinquent 30-59 days       $     721     $    1,483     $     542
          Loans delinquent 60-89 days           3,758          3,187         1,260
          Total delinquencies                   4,479          4,670         1,802

          Accruing loans past due 90 days         656              0         1,669
          Non-accruing loans                   10,320          7,976         6,592
          Total non-performing loans           10,976          7,976         8,261
          OREO                                  1,897          1,412         3,292
          Total non-performing assets       $  12,873     $    9,388     $  11,553

The accrual of interest income is discontinued when a loan becomes 90 days and three payments past due. Loans 90 days past due but not yet three payments past due will continue to accrue interest as long as it has been determined that the loan is well secured and in the process of collection. Troubled debt restructurings are considered non-accruing loans until sufficient time has passed for them to establish a pattern of compliance with the terms of the restructure. Delinquent loans, non-performing loans and other real estate owned ("OREO") properties all showed improvement compared to the prior quarter and the prior year, reflecting the efforts of the staff and the condition of the local economy.

The increase in non-performing loans at March 31, 2009 compared to December 31, 2008 was generally due to a number of properties moving into non-performing status because factors including the deterioration in the borrower's situation due to loss of employment or in some cases due to the postponement or inability . . .