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LCNB > SEC Filings for LCNB > Form 10-K on 6-Mar-2014All Recent SEC Filings

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Form 10-K for LCNB CORP


6-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

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 2013 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.

Overview

Net income for 2013 was $8,780,000 (basic and diluted earnings per share of $1.12 and $1.10, respectively), compared to $8,270,000 (basic and diluted earnings per share of $1.23 and $1.22) in 2012 and $8,115,000 (total basic and diluted earnings per share of $1.21 and $1.20) in 2011.

The following items significantly affected earnings for the years indicated:
The completion of a merger with First Capital Bancshares, Inc. and its subsidiary, Citizens National Bank of Chillicothe, on January 11, 2013.

The provision for loan losses has declined significantly over the years presented.

Gains from sales of securities were significantly greater in 2012 when compared to 2013 and 2011.

Other real estate owned expense was significantly less in 2013 as compared to 2012 and 2011 because of decreases in valuation write-downs and a gain recognized during the first quarter 2013 on the sale of commercial real estate property.

Income from discontinued operations, net of tax, for 2011 includes a gain from the sale of Dakin Insurance Agency.

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 years indicated, 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.

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Table of Contents
                          LCNB CORP. AND SUBSIDIARIES

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)


                                                                                            Years ended December 31,
                                                       2013                                          2012                                           2011
                                        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)                           $      555,602       27,325         4.92 %   $      457,519         23,585         5.15 %   $      458,049     $   25,502         5.57 %
Federal funds sold                             768            1         0.13 %                -              -            - %                -              -            - %
Interest-bearing demand deposits             9,908           24         0.24 %           11,031             25         0.23 %           13,296             32         0.24 %
Federal Reserve Bank stock                   1,436           86         5.99 %              947             57         6.02 %              940             56         5.96 %
Federal Home  Loan Bank stock                2,826          119         4.21 %            2,091             93         4.45 %            2,091             89         4.26 %
Investment securities:
Taxable                                    192,983        3,369         1.75 %          192,284          3,737         1.94 %          176,922          3,843         2.17 %
Non-taxable (2)                             98,567        3,898         3.95 %           83,342          3,698         4.44 %           78,917          3,895         4.94 %
Total earning assets                       862,090       34,822         4.04 %          747,214         31,195         4.17 %          730,215         33,417         4.58 %
Non-earning assets                          85,970                                       63,760                                         64,735
Allowance for loan losses                   (3,401 )                                     (2,877 )                                       (2,936 )
Total assets                        $      944,659                               $      808,097                                 $      792,014

Savings deposits                    $      169,288          184         0.11 %   $      138,656            265         0.19 %   $      122,987            452         0.37 %
NOW and money fund                         284,977          223         0.08 %          244,225            347         0.14 %          232,418            667         0.29 %
IRA and time certificates                  197,302        3,195         1.62 %          191,129          3,705         1.94 %          219,174          4,583         2.09 %
Short-term borrowings                       16,912           25         0.15 %           12,648             16         0.13 %           12,415             28         0.23 %
Long-term debt                              12,768          438         3.43 %           18,219            556         3.05 %           22,733            657         2.89 %
Total interest-bearing liabilities         681,247        4,065         0.60 %          604,877          4,889         0.81 %          609,727          6,387         1.05 %
Demand deposits                            160,470                                      115,087                                        101,781
Other liabilities                            5,593                                        7,188                                          5,964
Capital                                     97,349                                       80,945                                         74,542
Total  liabilities  and capital     $      944,659                               $      808,097                                 $      792,014
Net interest rate spread (3)                                            3.44 %                                         3.36 %                                         3.53 %
Net interest income and net
interest margin on a tax equivalent
basis (4)                                                30,757         3.57 %                      $   26,306         3.52 %                      $   27,030         3.70 %
Ratio of interest-earning assets to
interest-bearing liabilities                126.55 %                                     123.53 %                                       119.76 %

(1) Includes non-accrual 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.

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Table of Contents
LCNB CORP. AND SUBSIDIARIES

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

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,
                                    2013 vs. 2012                             2012 vs. 2011
                              Increase (decrease) due to                Increase (decrease) due to
                          Volume           Rate        Total        Volume          Rate        Total
                                                        (In thousands)
Interest income
attributable to:
Loans (1)              $    4,865         (1,125 )      3,740          (29 )       (1,888 )     (1,917 )
Federal funds sold              1              -            1            -              -            -
Interest-bearing
demand deposits                (3 )            2           (1 )         (5 )           (2 )         (7 )
Federal Reserve Bank
stock                          29              -           29            -              1            1
Federal Home Loan Bank
stock                          31             (5 )         26            -              4            4
Investment securities:
Taxable                        14           (382 )       (368 )        318           (424 )       (106 )
Non-taxable (2)               630           (430 )        200          211           (408 )       (197 )
Total interest income       5,567         (1,940 )      3,627          495         (2,717 )     (2,222 )
Interest expense
attributable to:
Savings deposits               50           (131 )        (81 )         52           (239 )       (187 )
NOW and money fund             51           (175 )       (124 )         32           (352 )       (320 )
IRA and time
certificates                  116           (626 )       (510 )       (559 )         (319 )       (878 )
Short-term borrowings           6              3            9            1            (13 )        (12 )
Long-term debt               (181 )           63         (118 )       (136 )           35         (101 )
Total interest expense         42           (866 )       (824 )       (610 )         (888 )     (1,498 )
Net interest income    $    5,525         (1,074 )      4,451        1,105         (1,829 )       (724 )

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

(2) Change in interest income from non-taxable 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%.

2013 vs. 2012. Net interest income on a fully tax-equivalent basis for 2013 totaled $30,757,000, an increase of $4,451,000 from 2012. The increase resulted from an increase in total taxable-equivalent interest income of $3,627,000 and a decrease in total interest expense of $824,000.

The increase in taxable-equivalent interest income was due to a $114.9 million increase in total average interest-earning assets, partially offset by a 13 basis point (a basis point equals 0.01%) decrease in the average rate earned on interest-earning assets. The increase in total average interest-earning assets reflects an increase of $98.1 million in average loans, primarily from the First Capital merger, and a $15.2 million in non-taxable investment securities. The decrease in the average rate earned was primarily due to general decreases in market rates.

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Table of Contents
LCNB CORP. AND SUBSIDIARIES

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

Interest expense decreased primarily due to a 21 basis point decrease in the average rate paid on interest-bearing liabilities, partially offset by a $76.4 million increase in total average interest-bearing liabilities. Deposit accounts
(savings deposits, NOW and money fund deposits, and IRA and time certificates)
grew a combined total of $77.6 million on an average basis and average short-term borrowings increased $4.3 million, while average long-term debt decreased $5.5 million. The growth in deposits was primarily due to the First Capital merger and the decrease in long-term debt reflects the payment in full of a $6.0 million Federal Home Loan Bank advance in August 2012. The decrease in average rates paid was primarily due to general decreases in market rates.

The net interest margin, on a taxable-equivalent basis, increased from 3.52% for 2012 to 3.57% for 2013, the net effect of declines in both yields on earning assets and rates paid on liabilities, as indicated above.

2012 vs. 2011. Net interest income on a fully tax-equivalent basis for 2012 totaled $26,306,000, a decrease of $724,000 from 2011. The decrease resulted from a decrease in total taxable-equivalent interest income of $2,222,000, partially offset by a decrease in total interest expense of $1,498,000.

The decrease in taxable-equivalent interest income was due to a 41 basis point decrease in the average rate earned on interest-earning assets, partially offset by a $17.0 million increase in total average interest-earning assets. The decrease in average rates earned was primarily due to general decreases in market rates. The increase in average interest-earning assets occurred primarily in the investment securities portfolio, which grew $19.8 million on an average basis.

Interest expense decreased primarily due to a 24 basis point decrease in the average rate paid on interest-bearing liabilities and to a $4.9 million decrease in total average interest-bearing liabilities. Savings deposits and NOW and money fund deposits grew a combined total of $27.5 million on an average basis, while average IRA and time certificates decreased $28.0 million. Average long-term debt decreased $4.5 million due to the payment in full of a $6.0 million Federal Home Loan Bank advance in August 2012. The decrease in average rates paid was primarily due to general decreases in market rates.

The net interest margin, on a taxable-equivalent basis, decreased from 3.70% for 2011 to 3.52% for 2012 primarily due to the limited loan growth during 2012 and low market interest rates. With weak demand for loans and the sale of most residential real estate mortgage loans originated to the Federal Home Loan Mortgage Corporation, deposit growth was largely invested in the investment securities portfolio, which usually pays lower interest rates than the loan portfolio.

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Table of Contents
                          LCNB CORP. AND SUBSIDIARIES

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)


Provisions and Allowance for Loan Losses

The following table presents the total loan loss provision and the other changes
in the allowance for loan losses for the years 2009 through 2013:
                                    2013          2012         2011         2010         2009
                                                     (Dollars in thousands)
Balance - Beginning of year      $   3,437        2,931        2,641        2,998        2,468

Loans charged off:
Commercial and industrial              119          159          581          289           36
Commercial, secured by real
estate                                  58          234          598        1,105          352
Residential real estate                244          486          512          331          152
Consumer                               181          134          252          422          490
Other loans, including deposit
overdrafts                              67           85          127          144          178
Total loans charged off                669        1,098        2,070        2,291        1,208

Recoveries:
Commercial and industrial                4            -            -           35            2
Commercial, secured by real
estate                                  26           71           30            -            -
Residential real estate                 31            7           31            2            3
Consumer                               127          123          122          120          203
Other loans, including deposit
overdrafts                              44           52           88           97          130
Total recoveries                       232          253          271          254          338
Net charge offs                        437          845        1,799        2,037          870

Provision charged to operations        588        1,351        2,089        1,680        1,400
Balance - End of year            $   3,588        3,437        2,931        2,641        2,998

Ratio of net charge-offs during
the period to average loans
outstanding                           0.08 %       0.18 %       0.39 %       0.44 %       0.19 %

Ratio of allowance for loan
losses to total loans at
year-end                              0.62 %       0.76 %       0.64 %       0.58 %       0.65 %

The $581,000 of charge-offs in the commercial and industrial loan category for 2011 is comprised of a $251,000 charge-off connected to a retail business that ceased operations during that year and the remaining $330,000 is due to one borrower. Commercial real estate charge-offs for 2011 consisted of loans to five different borrowers.

Of the $1,105,000 in commercial real estate loan charge-offs during 2010, $421,000 was due to four loans while $684,000 was due to two loans made to the same borrower. Commercial and industrial loan charge-offs of $289,000 during 2010 included one charge-off of $281,000 relating to a business that ceased operations during that year.

Charge-offs and recoveries classified as "Other" 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.

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Table of Contents
LCNB CORP. AND SUBSIDIARIES

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

LCNB continuously reviews the loan portfolio for credit risk through the use of its lending and loan review functions. Independent loan reviews analyze specific loans, providing validation that credit risks are appropriately identified and reported to the Loan Committee and Board of Directors. In addition, the Board of Directors' Audit Committee receives loan review reports throughout each year. New credits meeting specific criteria are analyzed prior to origination and are reviewed by the Loan Committee and Board of Directors.
Inputs from all of the Bank's credit risk identification processes are used by management to analyze and validate the adequacy and methodology of the allowance quarterly. The analysis includes two basic components: specific allocations for individual loans and general loss allocations for pools of loans based on average historic loss ratios for the thirty-six preceding months adjusted for identified economic and other risk factors. Due to the number, size, and complexity of loans within the loan portfolio, there is always a possibility of inherent undetected losses.

The following table presents the components of the allowance for loan losses on the dates specified:

                                                       At December 31,
                                      2013                  2012                  2011
                                Amount    Percent     Amount    Percent     Amount    Percent
                                                   (Dollars in thousands)
Specific allocations           $ 1,032      28.8 %   $   904      26.3 %       399      13.6 %
General allocations:
Historical loss                    982      27.4 %     1,399      40.7 %     1,381      47.3 %
Adjustments to historical loss   1,574      43.8 %     1,134      33.0 %     1,151      39.1 %
Total                          $ 3,588     100.0 %   $ 3,437     100.0 %   $ 2,931     100.0 %

The increase in the adjustments to historical loss category from December 31, 2012 to December 31, 2013 primarily reflects risk factors identified in the commercial, secured by real estate loan portfolio. The increase in the specific allocation from December 31, 2011 to December 31, 2012 was primarily due to one commercial real estate loan where a borrower was continuing to experience financial difficulty, although the loan was current under the terms of a troubled debt restructuring modification.

Non-Interest Income

2013 vs. 2012. Total non-interest income for 2013 was $41,000 greater than for 2012 primarily due to increases in trust income, service charges and fees on deposit accounts, and smaller increases in several different line items. Trust income increased $201,000 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. Service charges and fees on deposit accounts increased $550,000 primarily due to a greater number of deposit accounts resulting from the merger. These favorable increases were largely offset by a $793,000 decrease in net gains from sales of securities primarily due a lower volume of securities sold.

2012 vs. 2011. Total non-interest income for 2012 was $1,285,000 greater than for 2011. Net gains on sales of securities increased $905,000 due to a greater volume of sales during 2012. LCNB sold about $88.7 million of securities during 2012, compared to $35.8 million of securities sold during 2011. Gains from sales of mortgage loans during 2012 were $329,000 more than in 2011 primarily due to an increase in the volume of loans sold. Loans sold during 2012 totaled $28.1 million, compared to $9.4 million in sales during 2011. Trust income increased $218,000 primarily due to executor fees recognized during the first quarter 2012 and to an increase in brokerage income due to an increase in the volume of new accounts. These favorable items were partially offset by a $134,000 decrease in service charges and fees on deposit accounts primarily due to a downward trend in overdraft fees, partially offset by an increase in check card fee income.

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Table of Contents
LCNB CORP. AND SUBSIDIARIES

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

Non-Interest Expense

2013 vs. 2012. Total non-interest expense was $4,530,000 greater in 2013 than in 2012 primarily due to a $1,354,000 increase in merger related expenses (consisting primarily of professional fees, data system conversion costs, and employee severance payments) for the First Capital and Eaton National Banks acquisitions, a $1,873,000 increase in salaries and employee benefits, a $371,000 increase in occupancy expenses, and a $901,000 increase in other non-interest expenses. Salaries and employee benefits and occupancy expenses, as well as a variety of other expense items, increased due to the increased number of employees and offices resulting from the First Capital merger. The increase in other non-interest expenses includes $277,000 in amortization for the Citizens National Bank core deposit intangible. The remainder of the increase in other non-interest expenses is due primarily to increased operating expenses resulting from the First Capital merger.

These expense increases were partially offset by a $520,000 decrease in other real estate owned expenses, reflecting decreased valuation writedowns and a gain recognized on the sale of commercial property in the first quarter 2013.

2012 vs. 2011. Total non-interest expense was $167,000 less in 2012 as compared to 2011 primarily due to a $129,000 decrease in salaries and employee benefits, a $140,000 decrease in FDIC premiums, and a $266,000 decrease in other non-interest expenses.
Salaries and employee benefits decreased primarily due to decreased expense for LCNB's qualified noncontributory defined benefit retirement plan. LCNB's minimum funding requirements for its qualified noncontributory defined benefit retirement plan for the plan year July 1, 2012 through June 30, 2013 was significantly less than the previous fiscal year due to an interest rate stabilization provision included in the "Moving Ahead for Progress in the 21st Century Act." Although LCNB management elected to contribute an amount that would have been required absent the stabilization provision, accounting guidance allows expensing only the required contribution. Consequently, LCNB charged a $694,000 difference to a prepaid account, which is included with other assets in the Consolidated Balance Sheets at December 31, 2012.

FDIC premiums decreased primarily due to implementation of a new assessment base, effective April 1, 2011, that uses total assets and tier one capital as opposed to deposits. The decrease in other non-interest expenses is primarily due to the absence during the 2012 period of the following costs paid during 2011: a $56,000 loss recognized on a standby letter of credit, $59,000 in environmental remediation costs for the lot on which LCNB's new Lebanon Drive-Up facility is located, and $50,000 in NASDAQ application fees.

These favorable items were partially offset by a $140,000 increase in other real estate owned expenses primarily due to the recognition of impairment charges on property currently held for sale.

Income Taxes

LCNB's effective tax rates for the years ended December 31, 2013, 2012, and 2011 were 25.1%, 25.3%, and 23.2%, 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

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