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 over 140 years is a benefit to us-especially as local offices of large banks have less local authority than was once seen. 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. Lafayette is the county seat of Tippecanoe County and West Lafayette is the home of Purdue University. The Greater Lafayette area enjoys diverse employment including major manufacturers such as Subaru/Toyota, Caterpillar, and Wabash National; 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; 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 June 2009 was 10.3%, compared to 10.7% for Indiana and 9.7% for the U.S. Pending temporary layoffs announced by Caterpillar and new layoffs by Wabash National last quarter contributed to the increase in the unemployment rate this quarter. Wabash National has just announced that it has entered into a securities purchase agreement with Trailer Investments, LLC, pursuant to which Trailer Investments will invest $35 million in Wabash National. Non-manufacturing sectors of the economy have fared better. 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. The Purdue Research Park has more than 3,700 employees earning an average annual wage of $54,000. With the addition of the two new buildings in May, 2009, the Purdue Research Park of West Lafayette has about 364,000 square feet of incubation space, making it the largest business incubator complex in the state.

Despite the foreclosed properties and sales of distressed housing, the Federal Housing Finance Agency housing values in the Metropolitan Statistical Area in which Tippecanoe County is located for the first quarter show that Tippecanoe County is faring well in home sales with prices over the last year decreasing only 0.19%. In addition the Indiana Association of Realtors reported that sales of existing single-family homes increased by 11.9% this June over June, 2008.

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 incurred 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 second quarter of 2009 through foreclosure or deeds-in-lieu of foreclosure and also sold 11 properties in the same period.

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 investments 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 become less concerned about the loss of liquidity. Overall short term loan rates are expected to stay low while longer term rates may rise somewhat.

Rate changes can 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. For example, in June, our variable rate loans which are tied to the three-year Treasury rate repriced almost 2.0% lower. The average rate on 30-year conventional mortgages increased 81 basis points from March 31, 2009 to June 30, 2009 based on the Freddie Mac index. This can be expected to slow the number of loans being refinanced.

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, 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.

In addition, on June 17, 2009, the Obama Administration published a comprehensive regulatory reform plan that is intended to modernize and protect the integrity of the United States financial system. The President's plan contains several elements that would have a direct effect on the Company and Lafayette Savings. Under the reform plan, the federal thrift charter and the Office of Thrift Supervision would be eliminated and all companies that control an insured depository institution must register as a bank holding company. Draft legislation would require Lafayette Savings to become a national bank or adopt a state charter. Registration as a bank holding company would represent a significant change, as there currently exist significant differences between savings and loan holding company and bank holding company supervision and regulation. For example, the Federal Reserve imposes leverage and risk-based capital requirements on bank holding companies whereas the Office of Thrift Supervision does not impose any capital requirements on savings and loan holding companies. If implemented, the foregoing regulatory reforms may have a material impact on our operations. However, at this time, we cannot determine the likelihood that the proposed regulatory reform will be adopted in the form proposed by the Obama Administration or the specific impact that any adopted legislation will have on the Company or Lafayette Savings.

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 December 31, 2008 included in the Annual Report to Shareholders filed as Exhibit 13 to the Company's Form 10-K for the year ended December 31, 2008. 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. See Note 6 - Disclosures About Fair Value of Assets and Liabilities to the Consolidated Financial Statements as of June 30, 2009. 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. For purposes of measuring impairment, the servicing rights are compared to a valuation prepared based on a discounted cash flow methodology, utilizing current prepayment speeds and discount rates. Impairment, if any, is recognized through a valuation allowance and is recorded as amortization of intangible assets.

Financial Condition

Comparison of Financial Condition at June 30, 2009 and December 31, 2008

Our total assets increased $2.5 million, or 0.68%, during the six months from December 31, 2008 to June 30, 2009. Primary components of this increase were a $9.3 million increase in short term investments offset by a $5.4 million decrease in net loans receivable including loans held for sale and a $1.6 million decrease in other assets due primarily to a $1.8 million decrease in account transfers in the process of settlement. Management attributes the increase in short-term investments to a $22.4 million increase in deposits from December 31, 2008 to June 30, 2009, part of which we moved to short-term investments in expectation of repayments of maturing Federal Home Loan Bank advances or maturing brokered deposits. We reduced Federal Home Loan Bank advances by $21.0 million from December 31, 2008 to June 30, 2009. The decrease in net loans was generally due to the increase in the number of borrowers interested in 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, as well as the increased security offered by the Company's participation in the FDIC's Temporary Liquidity Guarantee Program, ("TLGP"). The Company's participation in the TLGP allows noninterest bearing transaction accounts to receive unlimited insurance coverage until December 31, 2009. The FDIC has proposed a possible extension of the unlimited insurance protection for noninterest bearing accounts beyond the current termination date of December 31, 2009, for a possible cost of 25 basis point per $100 of insured deposits.

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 $12.3 million at June 30, 2009. Non-performing loans and accruing loans 90 days past due totaled $10.8 million at June 30, 2009 and consisted of $6.6 million, or 60.63%, of one- to four-family or multi-family residential real estate loans, $3.7 million, or 33.77%, of loans on land or commercial property, $598,000, or 5.52%, of commercial business loans and $9,000, or 0.08%, of consumer loans. Non-performing assets also include $1.5 million in foreclosed assets. At June 30, 2009, our allowance for loan losses equaled 1.27% of total loans (including loans held for sale) compared to 1.12% at December 31, 2008. The allowance for loan losses at June 30, 2009 totaled 33.20% of non-performing assets compared to 39.38% at December 31, 2008, and 37.71% of non-performing loans at June 30, 2009 compared to 46.35% at December 31, 2008. Our non-performing assets equaled 3.28% of total assets at June 30, 2009 compared to 2.52% at December 31, 2008. Non-performing loans totaling $583,000 were charged off in the first six months of 2009, offset by recoveries of $13,000.

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. 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 8 properties through foreclosure. In the second quarter of 2009 we acquired 3 properties through deeds-in-lieu of foreclosure and an additional 8 properties through foreclosure. As a result, $147,000 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 $34.3 million at June 30, 2009, an increase of $256,000, or 0.75%, primarily as a result of net income of $614,000, partially offset by our payment of $388,000 of dividends on common stock. Shareholders' equity to total assets was 9.14% at June 30, 2009 and at December 31, 2008.

Average Balances, Interest Rates and Yields

The following two tables present, 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 June 30, 2009                             Three months ended June 30, 2008
                       Average                                                     Average
                     Outstanding             Interest                            Outstanding              Interest
                       Balance             Earned/ Paid        Yield/Rate          Balance              Earned/Paid         Yield/Rate

Interest-Earning
Assets:
Loans
receivable(1)      $        324,704                 4,911             6.05 %   $        305,854                  5,153             6.74 %
Other
investments                  36,657                   148             1.61               25,128                    221             3.52
Total
interest-earning
assets                      361,361                 5,059             5.60              330,981                  5,374             6.49

Savings deposits   $         26,728                    69             1.03     $         21,969                     54             0.98
Demand and NOW
deposits                     72,097                   142             0.79               62,651                    127             0.81
Time deposits               178,522                 1,567             3.51              154,872                  1,686             4.35
Borrowings                   66,000                   745             4.52               75,923                    907             4.78
Total
interest-bearing
liabilities                 343,348                 2,523             2.94              315,414                  2,774             3.52

Net interest
income                                    $         2,536                                             $          2,600
Net interest
rate spread                                                           2.66 %                                                       2.95 %
Net earning
assets             $         18,013                                            $         15,567
Net yield on
average
interest-earning
assets                                                                2.81 %                                                       3.11 %
Average
interest-earning
assets to
average
interest-bearing
liabilities                    1.05 x                                                      1.05 x


_________________

                               Six months endedJune 30, 2009                              Six months endedJune 30, 2008
                       Average                                                    Average
                     Outstanding             Interest                           Outstanding             Interest
                       Balance             Earned/Paid        Yield/Rate          Balance             Earned/Paid        Yield/Rate

Interest-Earning
Assets:
Loans
receivable(1)      $        324,391                9,766             6.02 %   $        303,362               10,356             6.83 %
Other
investments                  35,072                  266             1.52               25,795                  439             3.40
Total
interest-earning
assets                      359,463               10,032             5.58              329,157               10,795             6.56

Savings deposits   $         25,309                  130             1.03     $         21,388                  109             1.02
Demand and NOW
deposits                     67,764                  254             0.75               61,586                  266             0.86
Time deposits               180,548                3,209             3.55              155,420                3,441             4.43
Borrowings                   68,750                1,516             4.41               75,753                1,836             4.85
Total
interest-bearing
liabilities                 342,371                5,109             2.98              314,147                5,652             3.60

Net interest
income                                    $        4,923                                             $        5,143
Net interest
rate spread                                                          2.60 %                                                     2.96 %
Net earning
assets             $         18,013                                           $         15,567
Net yield on
average
interest-earning
assets                                                               2.74 %                                                     3.12 %
Average
interest-earning
assets
to average
interest-bearing
liabilities                    1.05 x                                                     1.05 x


_________________

Results of Operations

Comparison of Operating Results for the Six Months and the Quarter Ended June 30, 2009 and June 30, 2008

General. Net income for the six months ended June 30, 2009 was $614,000, a decrease of $423,000, or 40.79%, over the six months ended June 30, 2008. Net income for the quarter ended June 30, 2009 was $312,000, a decrease of $209,000, or 40.12%, over the comparable quarter in 2008. The decrease for the six month period was primarily due to a $221,000, or 4.30%, decrease in net interest income, a $458,000, or 91.60%, increase in the provision for loan losses, a $360,000, or 15.18%, increase in salaries and benefits, a $270,000 increase in FDIC insurance premiums, a $123,000 decrease in service charges and fees and a $138,000 decrease in other income, partially offset by a $949,000 increase in gain on sales of loans and a $242,000 decrease in taxes on income. The decrease for the three month period was primarily due to a $64,000 or 2.46% decrease in net interest income, a $139,000, or 55.60%, increase in the provision for loan losses, a $235,000, or 20.52%, increase in salaries and benefits, a $170,000 increase in FDIC insurance premiums, a $63,000 decrease in service charges and fees and a $103,000 decrease in other income, partially offset by a $443,000 increase in gain on sales of loans and a $120,000 decrease in taxes on income. The increase in FDIC insurance premiums is primarily due to a special assessment by the FDIC that cost the Company an additional $171,000. The FDIC has authority to impose additional special assessments of up to 5 basis points on assets minus Tier 1 capital each quarter of this year after June 30, 2009 as deemed necessary. The latest possible date for the additional special assessment would be December 31, 2009, with collection on March 30, 2010.

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