Edgar Filing: LCNB CORP

form10k.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2012

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE

ACT OF 1934

For the transition period from _______________________ to ______________________

Commission File Number 000-26121

LCNB Corp.

(Exact name of registrant as specified in its charter)

Ohio		31-1626393
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

2 North Broadway, Lebanon, Ohio 45036

(Address of principal executive offices, including Zip Code)

(513) 932-1414

(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Exchange Act:

Title of Each Class		Name of each exchange on which registered
None		None

Securities registered pursuant to 12(g) of the Exchange Act:

COMMON STOCK, NO PAR VALUE

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.o Yes x No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.o Yes x No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

o Large accelerated filer	xAccelerated filer
o Non-accelerated filer (Do not check if a smaller reporting company)	o Smaller reporting company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). o Yes x No

The aggregate market value of the registrant’s outstanding voting common stock held by nonaffiliates on June 30, 2012, determined using a per share closing price on that date of $13.33 as quoted on the NASDAQ Capital Market, was $85,277,689.

As of February 25, 2013, 7,620,914 common shares were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement included in the Notice of Annual Meeting of Shareholders to be held April 23, 2013, which Proxy Statement will be mailed to shareholders within 120 days from the end of the fiscal year ended December 31, 2012 are incorporated by reference into Part III.

LCNB CORP.

For the Year Ended December 31, 2012

TABLE OF CONTENTS

PART I	4
Item 1. Business	4
Item 1A. Risk Factors	22
Item 1B. Unresolved Staff Comments	28
Item 2. Properties	29
Item 3. Legal Proceedings	31
Item 4. Mine Safety Disclosures	31

PART II	32
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.	32
Item 6. Selected Financial Data	35
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations	37
Item 7A. Quantitative and Qualitative Disclosures About Market Risk	52
Item 8. Financial Statements and Supplementary Data	53
REPORT OF MANAGEMENT’S ASSESSMENT OF INTERNAL CONTROL OVER FINANCIAL REPORTING	53
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	54
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	57
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures	109
Item 9A. Controls and Procedures	109
Item 9B. Other Information	109

PART III	110
Item 10. Directors, Executive Officers and Corporate Governance	110
Item 11. Executive Compensation	110
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.	110
Item 13. Certain Relationships and Related Transactions, and Director Independence	110
Item 14. Principal Accounting Fees and Services	110

PART IV	111
Item 15. Exhibits, Financial Statement Schedules	111

SIGNATURES	113

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PART I

Item 1. Business

FORWARD-LOOKING STATEMENTS

Certain matters disclosed herein may be deemed to be forward-looking statements that involve risks and uncertainties. Forward looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualifying words and their derivatives such as “expects,” “anticipates,” “believes,” “estimates,” “plans,” “projects,” or other statements concerning opinions or judgments of LCNB Corp. 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 Corp. disclaims, however, any intent or obligation to update such forward-looking statements. LCNB Corp. 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.

DESCRIPTION OF LCNB CORP.'S BUSINESS

General Description

LCNB Corp., an Ohio corporation formed in December, 1998, is a financial holding company headquartered in Lebanon, Ohio. Substantially all of the assets, liabilities and operations of LCNB Corp. are attributable to its wholly-owned subsidiary, LCNB National Bank (the "Bank"). LCNB Corp. and its subsidiary are herein collectively referred to as “LCNB.”

The predecessor of LCNB Corp., the Bank, was formed as a national banking association in 1877. On May 19, 1999, the Bank became a wholly-owned subsidiary of LCNB Corp. The Bank's main office is located in Warren County, Ohio and 24 branch offices are located in Warren, Butler, Clinton, Clermont, Hamilton, and Montgomery Counties, Ohio. In addition, the Bank operates 31 automated teller machines ("ATMs") in its market area.

On January 11, 2013, LCNB consummated a merger with First Capital Bancshares, Inc. (“First Capital”) in a stock and cash transaction valued at approximately $20.2 million. Immediately following the merger of First Capital into LCNB, Citizens National Bank (“Citizens”), a wholly-owned subsidiary of First Capital, was merged into LCNB National Bank. At that time, Citizens’ six full–service offices became offices of LCNB. Three of these offices are located in Chillicothe, Ohio and one office is located in each of Frankfort, Ohio, Clarksburg, Ohio, and Washington Court House, Ohio.

The Bank is a full service community bank offering a wide range of commercial and personal banking services. Deposit services include checking accounts, NOW accounts, savings accounts, Christmas and vacation club accounts, money market deposit accounts, Classic 50 accounts (a senior citizen program), individual retirement accounts, and certificates of deposit. Deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund, which is administered by the Federal Deposit Insurance Corporation (the “FDIC”).

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Loan products offered include commercial and industrial loans, commercial and residential real estate loans, construction loans, various types of consumer loans, and Small Business Administration loans. The Bank's residential mortgage lending activities consist primarily of loans for purchasing or refinancing personal residences, home equity lines of credit, and loans for commercial or consumer purposes secured by residential mortgages. Most fixed-rate residential real estate loans are sold to the Federal Home Loan Mortgage Corporation with servicing retained. Consumer lending activities include automobile, boat, home improvement and personal loans. The Bank also offers indirect financing through various automotive, boat, and lawn and garden dealers.

The Trust and Investment Management Division of the Bank performs complete trust administrative functions and offers agency and trust services, retirement savings products, and mutual fund investment products to individuals, partnerships, corporations, institutions and municipalities.

Security brokerage services are offered by the Bank through arrangements with LPL Financial LLC, a registered broker/dealer. Licensed brokers offer a full range of investment services and products, including financial needs analysis, mutual funds, securities trading, annuities, and life insurance.

Other services offered include safe deposit boxes, night depositories, travelers' checks, money orders, cashier's checks, bank-by-mail, ATMs, cash and transaction services, debit cards, wire transfers, electronic funds transfer, utility bill collections, notary public service, personal computer based cash management services, 24 hour telephone banking, PC Internet banking, mobile banking, and other services tailored for both individuals and businesses.

The Bank is not dependent upon any one significant customer or specific industry. Business is not seasonal to any material degree.

The address of the main office of the Bank is 2 North Broadway, Lebanon, Ohio 45036; telephone (513) 932-1414.

Market Area

LCNB’s primary market area consists of Warren, Butler, and Clinton Counties and portions of Hamilton, Clermont, and Montgomery Counties in Southwestern Ohio. Certain demographic information for Warren, Butler, Clinton, Hamilton, and Montgomery Counties are as follows:

	Warren			Butler			Clinton			Hamilton			Montgomery
Population, 2000 census		158,383			332,807			40,543			845,303			559,062
Population, 2010 census		212,693			368,130			42,040			802,374			535,153
Percentage increase/decrease in population		34.3	%		10.6	%		3.0	%		-5.1	%		-4.3	%
Estimated percentage of persons below poverty level		5.9	%		12.8	%		14.0	%		15.4	%		15.7	%
Estimated median household income	$	71,274		$	54,788		$	46,261		$	48,234		$	43,965
Median age		37.0			35.7			37.7			36.9			38.7
Unemployment rate:
December 2012		5.6	%		6.0	%		9.7	%		6.2	%		7.0	%
December 2011		7.0	%		7.9	%		11.1	%		7.5	%		8.5	%
December 2010		8.4	%		8.8	%		15.0	%		8.5	%		10.1	%

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Once primarily a rural county (its population according to the 1950 census was only 38,505), Warren County experienced significant growth during the latter half of the twentieth century and into the twenty-first century. Many people who now live in Warren County are employed by companies located in the Cincinnati and Dayton metropolitan areas. People employed within Warren County usually work in the trade, transportation, and utilities sector, the manufacturing sector, the professional and businesses services sector, and the leisure and hospitality sector. A sizable tourist industry that includes King’s Island and the Ohio Renaissance Festival provides a number of temporary summer jobs. Not including local government entities and school districts, which are significant sources of employment, the top five major employers in Warren County are Macy’s Credit and Customer Service, Procter and Gamble’s Mason Business Center, Atrium Medical Center (a hospital), WellPoint (health insurance), and Luxottica.

Butler County was historically a rural area with the exception of three urban centers. Hamilton and Middletown were both manufacturing centers. As is true with many manufacturing communities in the Midwest, many of the manufacturing companies in Hamilton and Middletown have either closed or greatly diminished their workforces and these jobs have been largely replaced with lower-paying service oriented jobs. Oxford is the home of Miami University and Oxford’s businesses primarily serve the college students.

Most of the growth in Butler County has occurred in West Chester, Liberty, and Fairfield Townships. Many of the people living in these townships are employed by companies located in the Cincinnati metropolitan area. People employed within Butler County usually work in the trade, transportation, and utilities sectors, the manufacturing sector, the education and health services sectors, the professional and business services sectors, and the leisure and hospitality sector. Not including local government entities and school districts, the top five major employers in Butler County are Miami University, AK Steel, Cincinnati Financial Corp. (insurance), GE Aviation, and Fort Hamilton Hospital. In addition to Fort Hamilton Hospital, Mercy Hospital Fairfield, McCullough-Hyde Memorial Hospital, West Chester Hospital, and Bethesda Butler County TriHealth Hospital are located in Butler County and collectively are a significant source of health-related employment.

Clinton County remains mostly rural. Wilmington, with a 2010 census population of 12,520, is the largest city. The next largest is Blanchester, with a 2010 census population of 4,243. The unemployment rates at December 2010, 2011, and 2012 are unusually high, even for the current economy, because of the loss of a dominant employer. DHL, an overnight shipping company, owned the Wilmington Air Park, a decommissioned air force base, and maintained hub operations at this location. In 2008, Wilmington Air Park discontinued operations, resulting in the direct loss of approximately 8,000 jobs, not including job losses sustained by other businesses dependent on the air park operations. Certain services subcontracted to ABX Air and ASTAR Air Cargo continue, but with greatly diminished work forces.

Hamilton County’s economics are dominated by Cincinnati. Fortune 500 companies with their headquarters in Hamilton County include American Financial Group, Federated Department Stores, Fifth Third Bank, The Kroger Company, The Procter & Gamble Company, and Western & Southern Financial Group. The five largest employers are The Kroger Company, The University of Cincinnati, The Procter & Gamble Company, Cincinnati Children’s Hospital Medical Center, and the Health Alliance of Greater Cincinnati.

LCNB’s two offices in Montgomery County are located in the communities of Oakwood and Centerville. Similar to Cincinnati and Hamilton County, Dayton is the largest city in Montgomery County and dominates the economic demographics of the county. The largest employer of Montgomery County residents is Wright Patterson Air Force Base, which is actually located in Greene County. Large employers located in Montgomery County include Premier Health Partners, Kettering Health Network, LexisNexis, and Honda of America.

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LCNB’s market area includes a portion of Clermont County primarily because of a branch office located in Goshen, Ohio. Goshen is a suburb of Cincinnati and many of its residents work in Hamilton County. Goshen’s economic demographics are similar to Hamilton County’s demographics.

Competition

The Bank faces strong competition both in making loans and attracting deposits. The deregulation of the banking industry and the wide spread enactment of state laws that permit multi-bank holding companies as well as the availability of nationwide interstate banking has created a highly competitive environment for financial services providers. The Bank competes with other national and state banks, savings and loan associations, credit unions, finance companies, mortgage brokerage firms, realty companies with captive mortgage brokerage firms, mutual funds, insurance companies, brokerage and investment banking companies, and other financial intermediaries operating in its market and elsewhere, many of whom have substantially larger financial and managerial resources.

The Bank seeks to minimize the competitive effect of other financial institutions through a community banking approach that emphasizes direct customer access to the Bank's President and other officers in an environment conducive to friendly, informed, and courteous personal services. Management believes that the Bank is well positioned to compete successfully in its primary market area. Competition among financial institutions is based upon interest rates offered on deposit accounts, interest rates charged on loans and other credit and service charges, the quality and scope of the services rendered, the convenience of the banking facilities, and, in the case of loans to commercial borrowers, relative lending limits.

Management believes the commitment of the Bank to personal service, innovation, and involvement in the communities and primary market areas it serves, as well as its commitment to quality community banking service, are factors that contribute to its competitive advantage.

Supervision and Regulation

LCNB Corp., as a financial holding company, is regulated under the Bank Holding Company Act of 1956, as amended (the "Act"), and is subject to the supervision and examination of the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). The Act requires the prior approval of the Federal Reserve Board for a bank or financial holding company to acquire or hold more than a 5% voting interest in any bank and restricts interstate banking activities.

On September 29, 1994, the Act was amended by the Interstate Banking and Branch Efficiency Act of 1994, which authorizes interstate bank acquisitions anywhere in the country, effective one year after the date of enactment, and interstate branching by acquisition and consolidation, effective June 1, 1997, in those states that have not opted out by that date.

The Bank is subject to the provisions of the National Bank Act. The Bank is subject to primary supervision, regulation and examination by the Office of the Comptroller of the Currency (the "OCC"). The Bank is also subject to the rules and regulations of the Board of Governors of the Federal Reserve System and the FDIC. Under the Bank Holding Company Act of 1956, as amended, and under Regulations of the Federal Reserve Board pursuant thereto, a bank or financial holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with the extension of credit.

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LCNB Corp. and the Bank are subject to an extensive array of banking laws and regulations that are intended primarily for the protection of the customers and depositors of LCNB's subsidiary. These laws and regulations govern such areas as permissible activities, loans and investments, and rates of interest that can be charged on loans and reserves. LCNB and the Bank also are subject to general U.S. federal laws and regulations and to the laws and regulations of the State of Ohio. Set forth below are brief descriptions of selected laws and regulations applicable to LCNB and the Bank.

The Financial Reform, Recovery and Enforcement Act of 1989 ("FIRREA") provides that a holding company and its controlled insured depository institutions are liable for any loss incurred by the FDIC in connection with the default of any FDIC assisted transaction involving an affiliated insured bank or savings association.

The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and several other federal banking statutes. Among its many reforms, FDICIA, as amended:

Required regulatory agencies to take "prompt corrective action" with financial institutions that do not meet minimum capital requirements;

Established five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized;

Imposed significant restrictions on the operations of a financial institution that is not rated well-capitalized or adequately capitalized;

Prohibited a depository institution from making any capital distributions, including payments of dividends or paying any management fee to its holding company, if the institution would be undercapitalized as a result;

Implemented a risk-based premium system;

Required an audit committee to be comprised of outside directors;

Required a financial institution with more than $1 billion in total assets to issue annual, audited financial statements prepared in conformity with U.S. generally accepted accounting principles; and

Required a financial institution with more than $1 billion in total assets to document, evaluate, and report on the effectiveness of the entity's internal control system and required an independent public accountant to attest to management's assertions concerning the bank's internal control system.

The members of an audit committee for banks with more than $1 billion in total assets must be independent of management. Only a majority, rather than all, of the members of an audit committee for banks with total assets between $500 million and $1 billion must be independent. Financial institutions that are public companies, such as LCNB, are not relieved from their SOX internal control reporting and attestation requirements or their audit committee independence requirements by the provisions of FDICIA.

At December 31, 2012, the Bank was well capitalized based on FDICIA's guidelines.

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The Gramm-Leach-Bliley Act, which amended the Bank Holding Company Act of 1956 and other banking related laws, was signed into law on November 12, 1999. The Gramm-Leach-Bliley Act repealed certain sections of the Glass-Steagall Act and substantially eliminated the barriers separating the banking, insurance, and securities industries. Effective March 11, 2000, qualifying bank holding companies could elect to become financial holding companies. Financial holding companies have expanded investment powers, including affiliating with securities and insurance firms and engaging in other activities that are "financial in nature or incidental to such financial activity" or "complementary to a financial activity." The Gramm-Leach-Bliley Act defines "financial in nature" to include:

securities underwriting, dealing, and market making;

sponsoring mutual funds and investment companies;

insurance underwriting and agency;

merchant banking activities; and

other activities that the Federal Reserve Board, in consultation with and subject to the approval of the U.S. Department of the Treasury (the “Treasury Department”), determines are financial in nature.

Financial holding companies may commence the activities listed above or acquire a company engaged in any of those activities without additional approval from the Federal Reserve. Notice of the commencement or acquisition must be provided to the Federal Reserve within thirty days of the start of the activity. Sixty days advance notice is required before the start of any activity that is "complementary to a financial activity."

The Sarbanes-Oxley Act of 2002 ("SOX") became effective on July 30, 2002. The purpose of SOX is to strengthen accounting oversight and corporate accountability by enhancing disclosure requirements, increasing accounting and auditor regulation, creating new federal crimes, and increasing penalties for existing federal crimes. SOX directly impacts publicly traded companies, certified public accounting firms auditing public companies, attorneys who work for public companies or have public companies as clients, brokerage firms, investment bankers, and financial analysts who work for brokerage firms or investment bankers. Key provisions affecting LCNB include:

Certification of financial reports by the chief executive officer ("CEO") and the chief financial officer ("CFO"), who are responsible for designing and monitoring internal controls to ensure that material information relating to the issuer and its consolidated subsidiaries is made known to the certifying officers by others within the company;

Inclusion of an internal control report in annual reports that include management's assessment of the effectiveness of a company's internal control over financial reporting and a report by the company's independent registered public accounting firm attesting to the effectiveness of internal control over financial reporting;

Accelerated reporting of stock trades on Form 4 by directors and executive officers;

Disgorgement requirements of incentive pay or stock-based compensation profits received within twelve months of the release of financial statements if the company is later required to restate those financial statements due to material noncompliance with any financial reporting requirement that resulted from misconduct;

Disclosure in a company's periodic reports stating if it has adopted a code of ethics for its CFO and principal accounting officer or controller and, if such code of ethics has been implemented, immediate disclosure of any change in or waiver of the code of ethics;

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Disclosure in a company's periodic reports stating if at least one member of the audit committee is a "financial expert," as that term is defined by the Securities and Exchange Commission (the "SEC"); and

Implementation of new duties and responsibilities for a company's audit committee, including independence requirements, the direct responsibility to appoint the outside auditing firm and to provide oversight of the auditing firm's work, and a requirement to establish procedures for the receipt, retention, and treatment of complaints from a company's employees regarding questionable accounting, internal control, or auditing matters.

In addition, the SEC adopted final rules on September 5, 2002, which rules were amended in December, 2005, requiring accelerated filing of quarterly and annual reports. Under the amended rules, “large accelerated filers” includes companies with a market capitalization of $700 million or more and “accelerated filers” includes companies with a market capitalization between $75 million and $700 million. Large accelerated filers are required to file their annual reports within 60 days of year-end and quarterly reports within 40 days. Accelerated filers are required to file their annual and quarterly reports within 75 days and 40 days, respectively. These new accelerated filing deadlines were effective for fiscal years ending on or after December 15, 2005. Under the amended rules, LCNB is considered an accelerated filer.

The Federal Deposit Insurance Reform Act of 2005 and the Federal Deposit Insurance Reform Conforming Amendments Act of 2005 (collectively, the “Deposit Insurance Reform Acts”) were both signed into law during February, 2006. The provisions of the Deposit Insurance Reform Acts included:

Merging the Bank Insurance Fund and the Savings Association Insurance Fund into a new fund called the Deposit Insurance Fund, effective March 31, 2006;

Increasing insurance coverage for retirement accounts from $100,000 to $250,000, effective April 1, 2006;

Adjusting deposit insurance levels of $100,000 for non-retirement accounts and $250,000 for retirement accounts every five years based on an inflation index;

Eliminating a 1.25% hard target Designated Reserve Ratio, as defined, and giving the FDIC discretion to set the Designated Reserve Ratio within a range of 1.15% to 1.50% for any given year;

Eliminating certain restrictions on premium rates the FDIC charges covered institutions and establishing a risk-based premium system; and

Providing for a one-time credit for institutions that paid premiums to the Bank Insurance Fund or the Savings Association Insurance Fund prior to December 31, 1996.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) became effective on July 21, 2010. The Dodd-Frank Act includes provisions that specifically affect financial institutions and other entities providing financial services and other corporate governance and compensation provisions that will affect most public companies.

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The Dodd-Frank Act established a new independent regulatory body within the Federal Reserve System known as the Bureau of Consumer Financial Protection (the “Bureau”). The Bureau has assumed responsibility for most consumer protection laws and has broad authority, with certain exceptions, to regulate financial products offered by banks and non-banks. The Bureau has authority to supervise, examine, and take enforcement actions with respect to depository institutions with more than $10 billion in assets, non-bank mortgage industry participants, and other Bureau-designated non-bank providers of consumer financial services. The primary regulator for depository institutions with $10 billion or less in assets will continue to have primary examination and enforcement authority for these institutions. The regulations enforced, however, will be the regulations written by the Bureau.

The Dodd-Frank Act directs federal bank regulators to develop new capital requirements for holding companies and depository institutions that address activities that pose risk to the financial system, such as significant activities in higher risk areas, or concentrations in assets whose reported values are based on models.

The Dodd-Frank Act permanently raised the FDIC maximum deposit insurance amount to $250,000. In addition, the Dodd-Frank Act places a floor on the FDIC’s reserve ratio at 1.35% of estimated insured deposits or the comparable percentage of the assessment base.

The Dodd-Frank Act provided for temporary unlimited deposit insurance for non-interest bearing transaction accounts. With several important differences, the unlimited coverage was similar to coverage provided by the FDIC’s Transaction Account Guarantee Program (the “TAGP”), which expired December 31, 2010, as extended. The Dodd-Frank Act coverage was in effect from January 1, 2011 to December 31, 2012. All insured institutions had unlimited coverage for non-interest bearing transactions under Dodd-Frank; financial institutions could opt-out of the TAGP. Only non-interest bearing transaction accounts and accounts commonly known as Interest on Lawyers Trust Accounts (“IOLTAs”) were covered under the Dodd-Frank provisions. Under TAGP, low-interest NOW accounts were included.

On November 9, 2010, the FDIC issued a final rule implementing Section 343 of the Dodd-Frank Act providing for unlimited insurance coverage of noninterest-bearing transaction accounts and Interest on Lawyers Trust Accounts beginning on December 31, 2010 and ending on December 31, 2012. The extended coverage was available to all depositors including consumer, businesses, and government entities. Money market deposit accounts and NOW accounts were not eligible for the unlimited coverage, even if no interest was paid on the accounts.

General corporate governance provisions included in the Dodd-Frank Act include expanding executive compensation disclosures to be included in the annual proxy statement, requiring non-binding shareholder advisory votes on executive compensation at annual meetings, enhancing independence requirements for compensation committee members and any advisors used by the compensation committee, and requiring the adoption of certain compensation policies including the recovery of executive compensation in the event of a financial statement restatement.

LCNB and the Bank are also subject to the state banking laws of Ohio. Ohio adopted nationwide reciprocal interstate banking effective October, 1988.

Noncompliance with laws and regulations by bank holding companies and banks can lead to monetary penalties and/or an increased level of supervision or a combination of these two items. Management is not aware of any current significant instances of noncompliance with laws and regulations and does not anticipate any problems maintaining compliance on a prospective basis. Recent regulatory inspections and examinations of LCNB and the Bank have not disclosed any significant instances of noncompliance.

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The earnings and growth of LCNB are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government and its agencies, particularly the Federal Reserve Board. Its policies influence the amount of bank loans and deposits and the interest rates charged and paid thereon and thus have an effect on earnings. The nature of future monetary policies and the effect of such policies on the future business and earnings of LCNB and the Bank cannot be predicted.

A substantial portion of LCNB's cash revenues is derived from dividends paid by the Bank. These dividends are subject to various legal and regulatory restrictions. Generally, dividends are limited to the aggregate of current year retained net income, as defined, plus the retained net income of the two prior years. In addition, dividend payments may not reduce capital levels below minimum regulatory guidelines.

Employees

As of December 31, 2012, LCNB employed 217 full-time equivalent employees. LCNB is not a party to any collective bargaining agreement. Management considers its relationship with its employees to be very good. Employee benefit programs are considered by management to be competitive with benefit programs provided by other financial institutions and major employers within LCNB’s market area.

Divestitures

In March 2011, LCNB Corp. sold Dakin Insurance Agency Inc. (“Dakin”) to an independent insurance agency and therefore its financial results are reported in the income statements as income from discontinued operations, net of tax.

Availability of Financial Information

LCNB files unaudited quarterly financial reports on Form 10-Q, annual financial reports on Form 10-K, current reports on Form 8-K, and amendments to these reports are filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 with the SEC. Copies of these reports are available free of charge in the shareholder information section of the Bank's website, www.lcnb.com, as soon as reasonably practicable after they are electronically filed or furnished to the SEC, or by writing to:

Robert C. Haines II

Executive Vice President, CFO

LCNB Corp.

2 N. Broadway

P.O. Box 59

Lebanon, Ohio 45036

Financial reports and other materials filed by LCNB with the SEC may also be read and copied at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained from the SEC by calling 1-800-SEC-0330. The SEC also maintains an internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding registrants that file reports electronically, as LCNB does.

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FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES

LCNB and its subsidiary do not have any offices located in foreign countries and have no foreign assets, liabilities or related income and expense for the years presented.

STATISTICAL INFORMATION

The following tables and certain tables appearing in Item 7, Management's Discussion and Analysis present additional statistical information about LCNB Corp. and its operations and financial condition. They should be read in conjunction with the consolidated financial statements and related notes and the discussion included in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and Item 7A, Quantitative and Qualitative Disclosures about Market Risk.

Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and Interest Differential

The table presenting an average balance sheet, interest income and expense, and the resultant average yield for average interest-earning assets and average interest-bearing liabilities is included in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.

The table analyzing changes in interest income and expense by volume and rate is included in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.

Investment Portfolio

The following table presents the carrying values of securities for the years indicated:

	At December 31,
	2012		2011		2010
	(Dollars in thousands)
Securities available-for-sale:
U.S. Treasury notes	$	18,686		17,550		19,585
U.S. Agency notes		90,606		82,927		82,862
U.S. Agency mortgage-backed securities		52,541		52,287		33,094
Corporate securities		3,067		6,365		2,025
Municipal securities		89,723		91,610		96,396
Mutual funds		2,168		2,125		1,053
Trust preferred securities		245		564		604
Equity securities		1,470		578		263
Total securities available-for-sale		258,506		254,006		235,882

Securities held-to-maturity:
Municipal securities		15,424		10,734		12,141

Federal Reserve Bank stock		949		940		939
Federal Home Loan Bank stock		2,091		2,091		2,091
Total securities	$	276,970		267,771		251,053

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Contractual maturities of securities at December 31, 2012, were as follows. Actual maturities may differ from contractual maturities when issuers have the right to call or prepay obligations.

	Available-for-Sale							Held-to-Maturity
	Amortized		Fair					Amortized		Fair
	Cost		Value		Yield			Cost		Value		Yield
	(Dollars in thousands)

U.S. Treasury notes:
Five to ten years	$	18,462		18,686		1.10	%		-		-		-	%
Total U.S. Treasury notes		18,462		18,686		1.10	%		-		-		-	%

U.S. Agency notes:
One to five years		31,264		32,239		1.58	%		-		-		-	%
Five to ten years		58,108		58,367		1.39	%		-		-		-	%
Total U.S. Agency notes		89,372		90,606		1.46	%		-		-		-	%

Corporate securities:
Within one year		1,000		1,000		2.21	%		-		-		-	%
One to five years		2,032		2,067		1.23	%		-		-		-	%
Total corporate securities		3,032		3,067		1.56	%		-		-		-	%

Municipal securities (1):
Within one year		7,023		7,091		2.35	%		6,701		6,701		1.67	%
One to five years		38,204		40,325		3.80	%		985		985		3.90	%
Five to ten years		30,206		32,167		4.04	%		3,928		3,928		6.56	%
After ten years		9,922		10,140		3.94	%		3,810		3,810		8.62	%
Total Municipal securities		85,355		89,723		3.78	%		15,424		15,424		4.77	%

U.S. Agency mortgage-backed securities		51,121		52,541		2.41	%		-		-		-	%
Mutual Funds		2,138		2,168		2.48	%		-		-		-	%
Trust preferred securities		250		245		8.13	%		-		-		-	%
Equity securities		1,390		1,470		3.96	%		-		-		-	%

Totals	$	251,120		258,506		2.50	%		15,424		15,424		4.77	%

(1)

Yields on tax-exempt obligations are computed on a taxable-equivalent basis based upon a 34% statutory Federal income tax rate.

Excluding holdings in U.S. Treasury securities and U.S. Government Agencies, there were no investments in securities of any issuer that exceeded 10% of LCNB's consolidated shareholders' equity at December 31, 2012.

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Loan Portfolio

Administration of the lending function is the responsibility of the Chief Lending Officer and certain senior lenders. Such lenders perform their lending duties subject to oversight and policy direction from the Board of Directors and the Loan Committee. The Loan Committee consists of LCNB’s Chief Executive Officer, President, Chief Financial Officer, Cashier, Chief Lending Officer, Chief Credit Officer, Loan Operations Officer, Loan Review Officer, Credit Analysis Officer, and the officers in charge of commercial, consumer, and real estate loans.

Employees authorized to accept loan applications have various, designated lending limits for the approval of loans. A loan application for an amount outside a particular employee’s lending limit needs to be approved by an employee with a lending limit sufficient for that loan. Residential and commercial real estate loans of any amount require the approval of two of the following designated officers: Chief Executive Officer, President, Chief Lending Officer, Chief Credit Officer, and the officers in charge of commercial and consumer lending. Any loan in excess of $2.0 million needs the approval of the Board of Directors.

Interest rates charged by LCNB vary with degree of risk, type of loan, amount, complexity, repricing frequency and other relevant factors associated with the loan.

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The following table summarizes the distribution of the loan portfolio for the years indicated:

	At December 31,
	2012					2011					2010					2009					2008
	Amount		%			Amount		%			Amount		%			Amount		%			Amount		%
	(Dollars in thousands)
Commercial and industrial	$	26,236		5.8	%		30,990		6.7	%		36,122		7.9	%		42,807		9.3	%		38,724		8.6	%
Commercial, secured by real estate		230,256		50.7	%		219,188		47.6	%		196,136		43.1	%		185,024		40.2	%		174,493		38.5	%
Residential real estate		183,132		40.4	%		186,904		40.5	%		190,277		41.9	%		193,293		42.0	%		194,039		42.8	%
Consumer		10,554		2.3	%		14,562		3.2	%		19,691		4.3	%		26,185		5.7	%		33,369		7.4	%
Agricultural		1,668		0.4	%		2,835		0.6	%		2,966		0.7	%		3,125		0.7	%		3,216		0.7	%
Other loans, including deposit overdrafts		1,875		0.4	%		6,554		1.4	%		9,413		2.1	%		9,422		2.1	%		9,203		2.0	%
		453,721		100.0	%		461,033		100.0	%		454,605		100.0	%		459,856		100.0	%		453,044		100.0	%
Deferred origination costs, net		62					229					386					560					767
Total loans		453,783					461,262					454,991					460,416					453,811
Less allowance for loan losses		3,437					2,931					2,641					2,998					2,468
Loans, net	$	450,346					458,331					452,350					457,418					451,343

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

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

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

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

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

Residential real estate loans are underwritten primarily based on the borrower’s ability to repay, prior credit history, and the value of the collateral. LCNB requires private mortgage insurance for first mortgage loans that have a loan to appraised value ratio of greater than 80%.

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Consumer Loans. LCNB’s portfolio of consumer loans generally includes secured and unsecured loans to individuals for household, family and other personal expenditures. Secured loans include loans to fund the purchase of automobiles, recreational vehicles, boats, and similar acquisitions. Consumer loans made by LCNB generally have fixed rates and terms ranging up to 72 months, depending upon the nature of the collateral, size of the loan, and other relevant factors.

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

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

As of December 31, 2012, there were no concentrations of loans exceeding 10% of total loans that are not already disclosed as a category of loans in the above table.

The following table summarizes the commercial and agricultural loan maturities and sensitivities to interest rate change at December 31, 2012:

	(Dollars in thousands)

Maturing in one year or less	$	18,150
Maturing after one year, but within five years		35,077
Maturing beyond five years		204,933
Total commercial and agricultural loans	$	258,160

Loans maturing beyond one year:
Fixed rate	$	68,152
Variable rate		171,858
Total	$	240,010

Risk Elements

The following table summarizes non-accrual, past-due, and accruing restructured loans for the dates indicated:

	At December 31,
	2012			2011			2010			2009			2008
	(Dollars in thousands)

Non-accrual loans	$	2,283			3,668			3,761			2,939			2,281
Past-due 90 days or more and still accruing		128			39			300			924			806
Accruing restructured loans		13,343			14,739			9,088			7,173			332
Total	$	15,754			18,446			13,149			11,036			3,419
Percent to total loans		3.47	%		4.00	%		2.89	%		2.40	%		0.75	%

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LCNB is not committed to lend additional funds to debtors whose loans have been modified to provide a reduction or deferral of principal or interest because of deterioration in the financial position of the borrower.

At December 31, 2012, there were no material additional loans not already disclosed as non-accrual, accruing restructured, or accruing past due 90 days or more where known information about possible credit problems of the borrowers causes management to have serious doubts as to the ability of such borrowers to comply with present loan repayment terms.

Summary of Loan Loss Experience

The table summarizing the activity related to the allowance for loan losses is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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Allocation of the Allowance for Loan Losses

The following table presents the allocation of the allowance for loan loss:

	At December 31,
	2012					2011					2010					2009					2008
	Amount		Percent of Loans in Each Category to Total Loans			Amount		Percent of Loans in Each Category to Total Loans			Amount		Percent of Loans in Each Category to Total Loans			Amount		Percent of Loans in Each Category to Total Loans			Amount		Percent of Loans in Each Category to Total Loans
	(Dollars in thousands)

Commercial and industrial	$	320		5.8	%		162		6.7	%		305		7.9	%		546		9.3	%		369		8.6	%
Commercial, secured by real estate		2,296		50.7	%		1,941		47.6	%		1,625		43.1	%		1,628		40.2	%		1,182		38.5	%
Residential real estate		712		40.4	%		656		40.5	%		459		41.9	%		491		42.0	%		471		42.8	%
Consumer		108		2.3	%		166		3.2	%		246		4.3	%		313		5.7	%		429		7.4	%
Agricultural		-		0.4	%		-		0.6	%		-		0.7	%		-		0.7	%		-		0.7	%
Other loans, including deposit overdrafts		1		0.4	%		6		1.4	%		6		2.1	%		9		2.1	%		13		2.0	%
Unallocated		-		-	%		-		-	%		-		-	%		11		-	%		4		-	%
Total	$	3,437		100.0	%		2,931		100.0	%		2,641		100.0	%		2,998		100.0	%		2,468		100.0	%

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Deposits

The statistical information regarding average amounts and average rates paid for the deposit categories is included in the "Distribution of Assets, Liabilities and Shareholders' Equity" table included in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following table presents the contractual maturity of time deposits of $100,000 or more at December 31, 2012:

	(Dollars in thousands)

Maturity within 3 months	$	5,480
After 3 but within 6 months		9,549
After 6 but within 12 months		12,295
After 12 months		37,157
	$	64,481

Return on Equity and Assets

The statistical information regarding the return on assets, return on equity, dividend payout ratio, and equity to assets ratio is presented in Item 6, Selected Financial Data.

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Item 1A. Risk Factors

There are risks inherent in LCNB’s operations, many beyond management’s control, which may adversely affect its financial condition and results from operations and should be considered in evaluating the company. Credit, market, operational, liquidity, interest rate and other risks are described elsewhere in this report. Other risk factors may include the items described below.

New capital requirements could adversely affect LCNB’s capital ratios

The Dodd-Frank Act directs federal bank regulators to develop new capital requirements for holding companies and depository institutions that address activities that pose risk to the financial system, such as significant activities in higher-risk areas, or concentrations in assets whose reported values are based on models.

During June 2012, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation issued three proposed rules that would significantly revise current regulatory capital requirements for financial institutions. Among other items, the proposals, if adopted, would:

Introduce a new requirement that common equity Tier 1 capital be at least 4.5% of risk-weighted assets;

Increase the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6%;

Introduce a new requirement to maintain a capital conservation buffer in excess of other minimum risk-based capital ratios of at least 2.5% of risk-weighted assets;

Revise capital definitions and risk-weighting categories for various assets; and

Revise the prompt corrective action framework by increasing category thresholds to reflect the new requirements.

Financial institutions not meeting the 2.5% capital conservation buffer would be subject to limits on capital distributions, including dividend payments to shareholders and treasury share purchases, and would also be limited in awarding certain discretionary bonus payments to executive officers.

If issued as proposed, the new requirements would have phased in starting in 2013 with full implementation in 2019. During November 2012, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation announced that, in light of the volume of comments received and the wide range of views expressed during the comment period, the three agencies did not expect that any of the proposed rules would become effective on January 1, 2013. The exact nature of the final requirements, the timing of implementation, or their impact on LCNB cannot be predicted at this time.

LCNB’s financial results may be adversely affected by current economic conditions and resulting government legislation.

The United States economy was in an economic recession during much of 2008 and 2009, which reduced business activity across a wide range of industries and regions. Economic conditions have slowly improved since then, but many government entities and businesses are still experiencing financial difficulties and unemployment remains at historically elevated levels. A direct consequence has been increased loan delinquencies and charge-offs.

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In response, the United States government has established and may continue to establish a variety of new programs and policies designed to mitigate the effects of the recession, stimulate the economy, and reduce the likelihood of future downturns. The nature of future laws and regulations and their effect on LCNB’s operations cannot be predicted.

LCNB’s earnings are significantly affected by market interest rates.

Fluctuations in interest rates may negatively impact LCNB’s profitability. A primary source of income from operations is net interest income, which is equal to the difference between interest income earned on loans and investment securities and the interest paid for deposits and other borrowings. These rates are highly sensitive to many factors beyond LCNB’s control, including general economic conditions, the slope of the yield curve (that is, the relationship between short and long-term interest rates), and the monetary and fiscal policies of the United States Federal government. LCNB expects the current level of interest rates and the current slope of the yield curve will cause further downward pressure on its net interest margin.

Increases in general interest rates could have a negative impact on LCNB’s results of operations by reducing the ability of borrowers to repay their current loan obligations. Some residential real estate mortgage loans, most home equity line of credit loans, and many of LCNB’s commercial loans have adjustable rates. Borrower inability to make scheduled loan payments due to a higher loan cost could result in increased loan defaults, foreclosures, and write-offs and may necessitate additions to the allowance for loan losses. In addition, increases in the general level of interest rates may decrease the demand for new consumer and commercial loans, thus limiting LCNB’s growth and profitability. A general increase in interest rates may also result in deposit disintermediation, which is the flow of deposits away from banks and other depository institutions into direct investments that have the potential for higher rates of return, such as stocks, bonds, and mutual funds. If this occurs, LCNB may have to rely more heavily on borrowings as a source of funds in the future, which could negatively impact its net interest margin.

Gains from sales of mortgage loans may experience significant volatility.

Gains from sales of mortgage loans are highly influenced by the level and direction of mortgage interest rates, real estate activity, and refinancing activity. Current historically low market interest rates created a refinancing demand for residential fixed-rate mortgage loans. The increased volume of refinancing activity increased gains from sales of mortgage loans as LCNB sold most of these loans to the Federal Home Loan Mortgage Corporation. An increase in market interest rates may decrease the demand for refinanced loans and decrease the gains from sales of mortgage loans recognized in LCNB’s consolidated statements of income. Gains from sales of mortgage loans may also be impacted by changes in LCNB’s strategy to manage its residential mortgage portfolio. For example, LCNB may occasionally change the proportion of loan originations that are sold in the secondary market and instead add a greater proportion to its loan portfolio.

Increasing regulation of interchange reimbursement fees may affect LCNB’s earnings.

The Federal Reserve enacted a rule, effective October 1, 2011, setting the maximum interchange fee an electronic debit card issuer with more than $10 billion in assets may receive at the sum of 21 cents per transaction plus five basis points multiplied by the value of the transaction. The Federal Reserve also issued a rule that allows for an upward adjustment of at most one cent to an issuer’s debit card interchange fee if the issuer develops and implements policies and procedures to achieve the fraud prevention standards detailed in the interim final rule. Although institutions with less than $10 billion in assets, including LCNB, are exempt from the new rules, many within the financial institutions industry believe that smaller institutions will need to match the pricing of those institutions with assets greater than $10 billion or lose business to the larger institutions.

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Banking competition in Southwestern Ohio is intense.

LCNB faces strong competition for deposits, loans, trust accounts, and other services from other banks, savings banks, credit unions, mortgage brokers, and other financial institutions. Many of LCNB’s competitors include major financial institutions that have been in business for many years and have established customer bases, numerous branches, and substantially higher regulatory lending limits. Competitors in the Southwestern Ohio area include U.S. Bank, PNC Bank, Fifth Third Bank, Chase, KeyBank, Park National Bank, Huntington National Bank, and First Financial Bank. In addition, credit unions are growing larger due to more flexible membership requirement regulations and are offering more financial services than they legally could in the past.

LCNB also competes with numerous real estate brokerage firms, some owned by realty companies, for residential real estate mortgage loans. Incentives offered by captive finance companies owned by the major automobile companies, primarily Ally Bank (formerly General Motors Acceptance Corporation) and Ford Motor Credit Company, have limited the banking industry’s opportunities for growth in the new automobile loan market. The banking industry now competes with brokerage firms and mutual fund companies for funds that would have historically been held as bank deposits. Technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of these competitors have fewer regulatory constraints and may have lower cost structures.

If LCNB is unable to attract and retain loan, deposit, brokerage, and trust customers, its growth and profitability levels may be negatively impacted.

Economic conditions in Southwestern Ohio could adversely affect LCNB’s financial condition and results of operations.

LCNB has 31 offices located in Warren, Butler, Clinton, Clermont, Hamilton, Fayette, Ross, and Montgomery Counties in Southern Ohio. As a result of this geographic concentration, LCNB’s results are heavily influenced by economic conditions in this area. A further deterioration in economic conditions or a natural or manmade disaster in Southwestern Ohio or Ohio in general could have a material adverse impact on the ability of borrowers to make scheduled loan payments, the fair value of underlying loan collateral, the ability of depositors to maintain or add to deposit balances, the demand for trust and brokerage services, and the demand for other products and services offered by LCNB.

The allowance for loan losses may be inadequate.

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, the fair value of any underlying collateral, borrowers’ cash flows, and current economic conditions that may affect borrowers’ ability to make payments. Increases in the allowance result in an expense for the period. By its nature, the evaluation is imprecise and requires significant judgment. Actual results may vary significantly from management’s assumptions. If, as a result of general economic conditions or a decrease in asset quality, management determines that additional increases in the allowance for loan losses are necessary, LCNB will incur additional expenses.

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LCNB’s loan portfolio includes a substantial amount of commercial and industrial loans and commercial real estate loans, which may have more risks than residential or consumer loans.

LCNB’s commercial and industrial and commercial real estate loans comprise a substantial portion of its total loan portfolio. These loans generally carry larger loan balances and involve a greater degree of financial and credit risk than home equity, residential mortgage, or consumer loans. The increased financial and credit risk associated with these types of loans is a result of several factors, including the concentration of principal in a limited number of loans, the size of loan balances, the effects of general economic conditions on income-producing properties, and the increased difficulty of evaluating and monitoring these types of loans.

The repayment of loans secured by commercial real estate is often dependent upon the successful operation, development, or sale of the related real estate or commercial business and may, therefore, be subject to adverse conditions in the real estate market or economy. If the cash flow from operations is reduced, the borrower’s ability to repay the loan may be impaired. In such cases, LCNB may take one or more actions to protect its financial interest in the loan. Such actions may include foreclosure on the real estate securing the loan, taking possession of other collateral that may have been pledged as security for the loan, or modifying the terms of the loan. If foreclosed on, commercial real estate is often unique and may not be as salable as a residential home.

The fair value of LCNB’s investments could decline.

Most of LCNB’s investment securities portfolio is designated as available-for-sale. Accordingly, unrealized gains and losses, net of tax, in the estimated fair value of the available-for-sale portfolio is recorded as other comprehensive income, a separate component of shareholders’ equity. The fair value of LCNB’s investment portfolio may decline, causing a corresponding decline in shareholders’ equity. Management believes that several factors will affect the fair values of the investment portfolio including, but not limited to, changes in interest rates or expectations of changes, the degree of volatility in the securities markets, inflation rates or expectations of inflation, and the slope of the interest rate yield curve. These and other factors may impact specific categories of the portfolio differently and the effect any of these factors may have on any specific category of the portfolio cannot be predicted.

Approximately 38% of LCNB’s investment securities portfolio at December 31, 2012 was composed of municipal securities. Many state and local governmental authorities have experienced deterioration of financial condition in recent years due to declining tax revenues, increased demand for services, and various other factors. To the extent LCNB has any municipal securities in its portfolio from issuers who are experiencing deterioration of financial condition or who may experience future deterioration of financial condition, the value of such securities may decline and could result in other-than-temporary impairment charges, which could have an adverse effect on LCNB’s financial condition and results of operations. Additionally, a general, industry-wide decline in the fair value of municipal securities could significantly affect LCNB’s financial condition and results of operations.

Changes in income tax laws or interpretations or in accounting standards could materially affect LCNB’s financial condition or results of operations.

Changes in income tax laws could be enacted, or interpretations of existing income tax laws could change, causing an adverse effect to LCNB’s financial condition or results of operations. Similarly, new accounting standards may be issued by the Financial Accounting Standards Board (the “FASB”) or existing standards revised, changing the methods for preparing financial statements. These changes are not within LCNB’s control and may significantly impact its reported financial condition and results of operations. FASB is currently working on various projects, including accounting for impaired financial instruments and accounting for leases.

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LCNB is subject to environmental liability risk associated with lending activities.

A significant portion of the Bank’s loan portfolio is secured by real property. During the ordinary course of business, the Bank may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Bank may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require the Bank to incur substantial expenses and may materially reduce the affected property’s value or limit the Bank’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase the Bank’s exposure to environmental liability. Although the Bank has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on LCNB’s financial condition and results of operations.

The banking industry is highly regulated.

LCNB is subject to regulation, supervision, and examination by the Federal Reserve Board and the Bank is subject to regulation, supervision, and examination by the OCC. LCNB and the Bank are also subject to regulation and examination by the FDIC as the deposit insurer. The Bureau of Consumer Financial Protection is responsible for most consumer protection laws and has broad authority, with certain exceptions, to regulate financial products offered by banks. Federal and state laws and regulations govern numerous matters including, but not limited to, changes in the ownership or control of banks, maintenance of adequate capital, permissible business operations, maintenance of deposit insurance, protection of customer financial privacy, the level of reserves held against deposits, restrictions on dividend payments, the making of loans, and the acceptance of deposits. See the previous section titled “Supervision and Regulation” for more information on this subject.

Federal regulators may initiate various enforcement actions against a financial institution that violates laws or regulations or that operates in an unsafe or unsound manner. These enforcement actions may include, but are not limited to, the assessment of civil money penalties, the issuance of cease-and-desist or removal orders, and the imposition of written agreements.

Proposals to change the laws governing financial institutions are periodically introduced in Congress and proposals to change regulations are periodically considered by the regulatory bodies. Such future legislation and/or changes in regulations could increase or decrease the cost of doing business, limit or expand permissible activities, or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. The likelihood of any major changes in the future and their effects are impossible to determine.

FDIC deposit insurance assessments may materially increase in the future.

Bank and thrift failures during 2009 and 2008 coupled with deteriorating economic conditions significantly decreased the deposit insurance fund’s reserve ratio. The FDIC developed and implemented a restoration plan that included a special assessment on all member financial institutions in early 2009, followed by a required prepayment in December 2009 of premiums relating to the period for 2010 through 2012. The FDIC implemented a new assessment base during 2011 that uses total assets and tier one capital as opposed to deposits. LCNB’s premiums decreased under the new assessment base, but the likelihood of future rate increases and the imposition of additional special assessments are indeterminable.

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The FDIC may borrow up to $100 billion from the U.S. Treasury. Although no borrowings were outstanding at December 31, 2012, LCNB cannot predict if the FDIC will borrow funds in the future. The source for repaying any future borrowings will be the premiums paid by financial institutions, which may necessitate additional rate increases or special assessments.

Future growth and expansion opportunities may contain risks.

From time to time LCNB may seek to acquire other financial institutions or parts of those institutions or may engage in de novo branch expansion. It may also consider and enter into new lines of business or offer new products or services. Such activities involve a number of risks, which may include potential inaccuracies in estimates and judgments used to evaluate the expansion opportunity, diversion of management and employee attention, lack of experience in a new market or product or service, and difficulties in integrating a future acquisition or introducing a new product or service. There is no assurance that such growth or expansion activities will be successful or that they will achieve desired profitability levels.

LCNB’s controls and procedures may fail or be circumvented.

Management regularly reviews and updates LCNB’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of LCNB’s controls and procedures or failure to comply with regulations related to its controls and procedures could have a material adverse effect on LCNB’s business, results of operations, and financial condition.

LCNB’s information systems may experience an interruption or breach in security.

LCNB relies heavily on communications and information systems to conduct its business. Any failure, interruption, or breach in security of these systems could result in failures or disruptions in LCNB’s customer relationship management, general ledger, deposit, loan, and other systems. While LCNB has policies and procedures designed to prevent or limit the effect of the failure, interruption, or security breach of its information systems, there can be no assurance that any such occurrences will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions, or security breaches of LCNB’s information systems could damage LCNB’s reputation, result in a loss of customer business, subject LCNB to additional regulatory scrutiny, or expose LCNB to civil litigation and possible financial liability, any of which could have a material adverse effect on its financial condition and results of operations.

Risk factors related to LCNB’s trust business.

Competition for trust business is intense. Competitors include other commercial bank and trust companies, brokerage firms, investment advisory firms, mutual fund companies, accountants, and attorneys.

LCNB’s trust business is directly affected by conditions in the debt and equity securities markets. The debt and equity securities markets are affected by, among other factors, domestic and foreign economic conditions and the monetary and fiscal policies of the United States Federal government, all of which are beyond LCNB’s control. Changes in economic conditions may directly affect the economic performance of the trust accounts in which clients’ assets are invested. A decline in the fair value of the trust accounts caused by a decline in general economic conditions directly affects LCNB’s trust fee income because such fees are primarily based on the fair value of the trust accounts. In addition, a sustained decrease in the performance of the trust accounts or a lack of sustained growth may encourage clients to seek alternative investment options.

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The management of trust accounts is subject to the risk of mistaken distributions, poor investment choices, and miscellaneous other incorrect decisions. Such mistakes may give rise to surcharge actions by beneficiaries, with damages substantially in excess of the fees earned from management of the accounts.

LCNB’s ability to pay cash dividends is limited.

LCNB is dependent upon the earnings of the Bank for funds to pay dividends on its common shares. The payment of dividends by LCNB and the Bank is subject to certain regulatory restrictions. As a result, any payment of dividends in the future will be dependent, in large part, on the ability of LCNB and the Bank to satisfy these regulatory restrictions and on the Bank’s earnings, capital levels, financial condition, and other factors. Although LCNB’s financial earnings and financial condition have allowed it to declare and pay periodic cash dividends to shareholders, there can be no assurance that the current dividend policy or the amount of dividend distributions will continue in the future.

Item 1B. Unresolved Staff Comments

Not applicable

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Item 2. Properties

The Bank conducts its business from the following offices:

	Name of Office	Address

1.	Main Office	2 North Broadway Lebanon, Ohio 45036	Owned

2.	Auto Bank	Silver and Mechanic Streets Lebanon, Ohio 45036	Owned

3.	Centerville Office	9605 Dayton-Lebanon Pike Centerville, Ohio 45458	Owned

4.	Colerain Township Office	3209 West Galbraith Road Cincinnati, Ohio 45239	Owned

5.	Columbus Avenue Office	730 Columbus Avenue Lebanon, Ohio 45036	Owned

6.	Fairfield Office	765 Nilles Road Fairfield, Ohio 45014	Leased

7.	Goshen Office	6726 Dick Flynn Blvd. Goshen, Ohio 45122	Owned

8.	Hamilton Office	794 NW Washington Blvd. Hamilton, Ohio 45013	Owned

9.	Hunter Office	3878 State Route 122 Franklin, Ohio 45005	Owned

10.	Loveland Office	500 Loveland-Madeira Road Loveland, OH 45140	Owned

11.	Maineville Office	7795 South State Route 48 Maineville, Ohio 45039	Owned

12.	Mason/West Chester Office	1050 Reading Road Mason, Ohio 45040	Owned

13.	Mason Christian Village Office	Mason Christian Village 411 Western Row Road Mason, Ohio 45040	Leased

14.	Middletown Office	4441 Marie Drive Middletown, Ohio 45044	Owned

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	Name of Office	Address

15.	Monroe Office	101 Clarence F. Warner Drive Monroe, Ohio 45050	Owned

16.	Oakwood Office	2705 Far Hills Avenue Oakwood, Ohio 45419	(2)

17.	Okeana Office	6225 Cincinnati-Brookville Road Okeana, Ohio 45053	Owned

18.	Otterbein Office	Otterbein Retirement Community State Route 741 Lebanon, Ohio 45036	Leased

19.	Oxford Office (1)	30 West Park Place Oxford, Ohio 45056	(2)

20.	Rochester/Morrow Office	Route 22-3 at 123 Morrow, Ohio 45152	Owned

21.	South Lebanon Office	603 Corwin Nixon Blvd. South Lebanon, Ohio 45065	Owned

22.	Springboro/Franklin Office	525 West Central Avenue Springboro, Ohio 45066	Owned

23.	Warrior Office	Lebanon High School 1916 Drake Road Lebanon, Ohio 45036	Leased

24.	Waynesville Office	9 North Main Street Waynesville, Ohio 45068	Owned

25.	Wilmington Office	1243 Rombach Avenue Wilmington, Ohio 45177	Owned

(1)

Excess space in this office is leased to third parties.

(2)

The Bank owns the Oakwood and Oxford office buildings and leases the land.

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On January 11, 2013, First Capital merged into LCNB Corp. and First Capital’s wholly owned subsidiary, Citizens National Bank, merged into LCNB National Bank. At that time, the following locations became offices of LCNB:

	Name of Office	Address

1.	Chillicothe Office	33 West Main Street Chillicothe, Ohio 45601	Owned

2.	Frankfort Office	Springfield and Main Streets Frankfort, Ohio 45628	Owned

3.	Western Avenue Office	1006 Western Avenue Chillicothe, Ohio 45601	Owned

4.	Bridge Street Office	1240 North Bridge Street Chillicothe, Ohio 45601	Owned

5.	Washington Court House Office	100 Crossings Drive Washington Court House, Ohio 43160	(1)

6.	Clarksburg Office	10820 Main Street Clarksburg, Ohio 43115	Owned

(1)

The Bank owns the Washington Court House office building and leases the land.

Item 3. Legal Proceedings

Except for routine litigation incidental to its businesses, LCNB is not a party to any material pending legal proceedings and none of its property is the subject of any such proceedings.

Item 4. Mine Safety Disclosures

Not Applicable

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PART II

Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.

LCNB had approximately 654 registered holders of its common stock as of December 31, 2012. The number of shareholders includes banks and brokers who act as nominees, each of whom may represent more than one shareholder. On September 8, 2011, LCNB’s stock began trading on the NASDAQ Capital Market exchange under the symbol “LCNB.” Before that date, it traded on the NASDAQ Over-The-Counter Bulletin Board, also under the symbol "LCNB." Trade prices for shares of LCNB Common Stock are set forth below. Prior to its listing on the NASDAQ Capital Market exchange, trade prices for shares of LCNB common stock were reported through registered securities dealers and trades could have occurred during those periods without the knowledge of LCNB. The trade prices shown below are interdealer without retail markups, markdowns, or commissions.

	2012				2011
	High		Low		High		Low

First Quarter	$	13.44		12.34		12.25		11.56
Second Quarter		14.49		12.80		13.00		11.70
Third Quarter		13.75		12.84		14.22		11.85
Fourth Quarter		14.49		13.10		13.70		12.22

The following table presents cash dividends per share declared and paid in the periods shown.

	2012		2011

First Quarter	$	0.16		0.16
Second Quarter		0.16		0.16
Third Quarter		0.16		0.16
Fourth Quarter		0.16		0.16
Total	$	0.64		0.64

It is expected that LCNB will continue to pay dividends on a similar schedule, to the extent permitted by business and other factors beyond management's control.

LCNB depends on dividends from the Bank for the majority of its liquid assets, including the cash needed to pay dividends to its shareholders. National banking law limits the amount of dividends the Bank may pay to the sum of retained net income, as defined, for the current year plus retained net income for the previous two years. Prior approval from the OCC, the Bank’s primary regulator, would be necessary for the Bank to pay dividends in excess of this amount. In addition, dividend payments may not reduce capital levels below minimum regulatory guidelines. Management believes the Bank will be able to pay anticipated ordinary dividends to LCNB without needing to request approval.

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

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On April 17, 2001, LCNB's Board of Directors authorized three separate stock repurchase programs, two of which continue to be in effect – the “Market Repurchase Program and the “Private Sale Repurchase Program.” Any shares purchased will be held for future corporate purposes.

Under the Market Repurchase Program, LCNB was originally authorized to purchase up to 200,000 shares of its stock through market transactions with a selected stockbroker. On November 14, 2005, the Board of Directors extended the Market Repurchase Program by increasing the shares authorized for repurchase to 400,000 total shares. Through December 31, 2012, 290,444 shares have been purchased under this program. No shares were purchased under the Market Repurchase Program during 2012.

The Private Sale Repurchase Program is available to shareholders who wish to sell large blocks of stock at one time. Because LCNB's stock is not widely traded, a shareholder releasing large blocks may not be able to readily sell all shares through normal procedures. Purchases of blocks will be considered on a case-by-case basis and will be made at prevailing market prices. There is no limit to the number of shares that may be purchased under this program. A total of 466,018 shares have been purchased under this program since its inception through December 31, 2012. No shares were purchased under the Private Sale Repurchase Program during 2012.

LCNB established an Ownership Incentive Plan during 2002 that allows for the issuance of up to 200,000 shares of stock-based awards to eligible employees, as determined by the Board of Directors. The awards may be in the form of stock options, share awards, and/or appreciation rights. The following table shows information relating to stock options outstanding at December 31, 2012:

Plan Category	Number of Securities to be Issued upon Exercise of Outstanding Options			Weighted Average Exercise Price of Outstanding Options	Number of Securities Remaining Available for Future Issuance
Equity compensation plans approved by security holders		110,586	$	12.42	87,270
Equity compensation plans not approved by security holders		-		-	-
Total		110,586	$	12.42	87,270

A total of 2,511 restricted shares were granted to an executive officer in February 2010 and vested in November 2010. Until they vested, they were restricted from sale, transfer, or assignment in accordance with the terms of the agreement under which they were issued. At the date of vesting, the shares were issued from treasury stock and, therefore, did not affect the number of securities remaining available for future issuance in the table above. No restricted shares were granted prior to February 2010 or during 2011 or 2012.

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The graph below provides an indicator of cumulative total shareholder returns for LCNB as compared with the NASDAQ Composite, the SNL Midwest OTC-BB and Pink Sheet Banks, and the SNL Midwest Bank indexes. This graph covers the period from December 31, 2007 through December 31, 2012. The cumulative total shareholder returns included in the graph reflect the returns for the shares of common stock of LCNB. The information provided in the graph assumes that $100 was invested on December 31, 2007 in LCNB common stock, the NASDAQ Composite, the SNL Midwest OTC-BB and Pink Sheet Banks, and the SNL Midwest Bank Index and that all dividends were reinvested.

LCNB Corp.

	Period Ending
Index	12/31/07		12/31/08		12/31/09		12/31/10		12/31/11		12/31/12
LCNB Corp.		100.00		83.09		103.45		124.18		141.76		157.27
NASDAQ Composite		100.00		60.02		87.24		103.08		102.26		120.42
SNL Midwest OTC-BB and Pink Banks Index		100.00		74.53		63.59		67.50		66.87		77.21
SNL Midwest Bank		100.00		65.79		55.75		69.23		65.39		78.71

Source : SNL Financial LC, Charlottesville, VA

www.snl.com

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Item 6. Selected Financial Data

The following represents selected consolidated financial data of LCNB for the years ended December 31, 2008 through 2012 and are derived from LCNB's consolidated financial statements. Certain prior year data presented in this table have been reclassified to conform with the current year presentation. This data should be read in conjunction with the consolidated financial statements and the notes thereto included in Item 8 of this Form 10-K and Management's Discussion and Analysis of Financial Condition and Results of Operations and Quantitative and Qualitative Disclosures about Market Risk included in Items 7 and 7A, respectively, of this Form 10-K, and are qualified in their entirety thereby and by other detailed information elsewhere in this Form 10-K.

		For the Years Ended December 31,
		2012		2011		2010		2009		2008
		(Dollars in thousands, except ratios and per share data)
Income Statement:
Interest income	$	29,938		32,093		34,031		34,898		34,398
Interest expense		4,889		6,387		8,334		10,060		13,421
Net interest income		25,049		25,706		25,697		24,838		20,977
Provision for loan losses		1,351		2,089		1,680		1,400		620
Net interest income after provision for loan losses		23,698		23,617		24,017		23,438		20,357
Non-interest income		9,049		7,764		8,887		7,180		6,759
Non-interest expenses		21,682		21,849		21,277		20,686		18,555
Income before income taxes		11,065		9,532		11,627		9,932		8,561
Provision for income taxes		2,795		2,210		2,494		2,245		2,134
Net income from continuing operations		8,270		7,322		9,133		7,687		6,427
Income from discontinued operations, net of tax		-		793		240		79		176
Net income		8,270		8,115		9,373		7,766		6,603
Preferred stock dividends and discount accretion		-		-		-		1,108		-
Net income available to common shareholders		8,270		8,115		9,373		6,658		6,603

Dividends per common share	$	0.64		0.64		0.64		0.64		0.64
Basic earnings per common share:
Continuing operations		1.23		1.09		1.37		0.99		0.96
Discontinued operations		-		0.12		0.03		0.01		0.03
Diluted earnings per common share:
Continuing operations		1.22		1.08		1.36		0.98		0.96
Discontinued operations		-		0.12		0.03		0.01		0.03

Balance Sheet:
Securities	$	276,970		267,771		251,053		217,639		139,272
Loans, net		450,346		458,331		452,350		457,418		451,343
Total assets		788,637		791,570		760,134		734,409		649,731
Total deposits		671,471		663,562		638,539		624,179		577,622
Short-term borrowings		13,756		21,596		21,691		14,265		2,206
Long-term debt		13,705		21,373		23,120		24,960		5,000
Total shareholders' equity		82,006		77,960		70,707		65,615		58,116

Selected Financial Ratios and Other Data:
Return on average assets		1.02	%	1.02	%	1.22	%	1.07	%	1.03	%
Return on average equity		10.22	%	10.89	%	13.36	%	10.43	%	11.35	%
Equity-to-assets ratio		10.40	%	9.85	%	9.30	%	8.93	%	8.94	%
Dividend payout ratio		52.03	%	52.89	%	45.71	%	64.39	%	64.65	%
Net interest margin, fully taxable equivalent		3.52	%	3.70	%	3.89	%	3.96	%	3.74	%

Dakin was sold during the first quarter 2011 and therefore the net gain on the sale and Dakin’s financial operating results are reported in the income statements as income from discontinued operations, net of tax.

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LCNB CORP. AND SUBSIDIARIES

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 2012 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 2012 was $8,270,000, compared to $8,115,000 in 2011 and $9,373,000 in 2010. Total basic earnings per common share for 2012, 2011, and 2010 were $1.23, $1.21, and $1.40, respectively. Total diluted earnings per common share for 2012, 2011, and 2010 were $1.22, $1.20, and $1.39, respectively.

The following items significantly affected earnings for the years indicated:

Gains from sales of securities were significantly greater in 2012 when compared to 2011 and 2010.

Gains from sales of mortgage loans were greater in 2012 and 2010 as compared to 2011 due to higher volumes of residential mortgage loan refinancings.

Bank owned life insurance income was greater during 2010 due to death benefits received. No death benefits were received during 2012 or 2011.

FDIC premiums for 2012 and 2011 were less than for 2010 due to a change in the assessment base.

Other real estate owned expense was greater during 2012 and 2010 as compared to 2011 because of valuation write-downs and related increases in holding costs. Other real estate owned expense for 2011 included a loss recognized on the sale of commercial property.

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

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LCNB CORP. AND SUBSIDIARIES

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

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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LCNB CORP. AND SUBSIDIARIES

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

	Years ended December 31,
	2012								2011								2010
	Average Outstanding Balance			Interest Earned/ Paid		Average Yield/ Rate			Average Outstanding Balance			Interest Earned/ Paid		Average Yield/ Rate			Average Outstanding Balance			Interest Earned/ Paid		Average Yield/ Rate

	(Dollars in thousands)

Loans (1)	$	457,519			23,585		5.15	%	$	458,049		$	25,502		5.57	%	$	458,708		$	27,020		5.89	%
Interest-bearing demand deposits		11,031			25		0.23	%		13,296			32		0.24	%		20,876			51		0.24	%
Federal Reserve Bank Stock		947			57		6.02	%		940			56		5.96	%		940			56		5.96	%
Federal Home Loan Bank Stock		2,091			93		4.45	%		2,091			89		4.26	%		2,091			92		4.40	%
Investment securities:
Taxable		192,284			3,737		1.94	%		176,922			3,843		2.17	%		133,556			3,686		2.76	%
Nontaxable (2)		83,342			3,698		4.44	%		78,917			3,895		4.94	%		85,718			4,736		5.53	%
Total earning assets		747,214			31,195		4.17	%		730,215			33,417		4.58	%		701,889			35,641		5.08	%

Non-earning assets		63,760								64,735								66,489
Allowance for loan losses		(2,877	)							(2,936	)							(2,815	)
Total assets	$	808,097							$	792,014							$	765,563

Savings deposits	$	138,656			265		0.19	%	$	122,987			452		0.37	%	$	108,734			653		0.60	%
NOW and money fund		244,225			347		0.14	%		232,418			667		0.29	%		221,926			1,282		0.58	%
IRA and time certificates		191,129			3,705		1.94	%		219,174			4,583		2.09	%		231,971			5,678		2.45	%
Short-term borrowings		12,648			16		0.13	%		12,415			28		0.23	%		7,606			27		0.35	%
Long-term debt		18,219			556		3.05	%		22,733			657		2.89	%		23,826			694		2.91	%
Total interest-bearing liabilities		604,877			4,889		0.81	%		609,727			6,387		1.05	%		594,063			8,334		1.40	%

Demand deposits		115,087								101,781								95,273
Other liabilities		7,188								5,964								6,059
Capital		80,945								74,542								70,168
Total liabilities and capital	$	808,097							$	792,014							$	765,563

Net interest rate spread (3)							3.37	%							3.53	%							3.68	%

Net interest income and net interest margin on a tax equivalent basis (4)					26,306		3.52	%				$	27,030		3.70	%				$	27,307		3.89	%

Ratio of interest-earning assets to interest-bearing liabilities		123.53	%							119.76	%							118.15	%

(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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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,
	2012 vs. 2011									2011 vs. 2010
	Increase (decrease) due to									Increase (decrease) due to
	Volume			Rate			Total			Volume			Rate			Total
	(In thousands)
Interest income attributable to:
Loans (1)	$	(29	)		(1,888	)		(1,917	)		(39	)		(1,479	)		(1,518	)
Interest-bearing demand deposits		(5	)		(2	)		(7	)		(18	)		(1	)		(19	)
Federal Reserve Bank stock		-			1			1			-			-			-
Federal Home Loan Bank stock		-			4			4			-			(3	)		(3	)
Investment securities:
Taxable		318			(424	)		(106	)		1,043			(886	)		157
Nontaxable (2)		211			(408	)		(197	)		(359	)		(482	)		(841	)
Total interest income		495			(2,717	)		(2,222	)		627			(2,851	)		(2,224	)

Interest expense attributable to:
Savings deposits		52			(239	)		(187	)		77			(278	)		(201	)
NOW and money fund		32			(352	)		(320	)		58			(673	)		(615	)
IRA and time certificates		(559	)		(319	)		(878	)		(301	)		(794	)		(1,095	)
Short-term borrowings		1			(13	)		(12	)		13			(12	)		1
Long-term debt		(136	)		35			(101	)		(32	)		(5	)		(37	)
Total interest expense		(610	)		(888	)		(1,498	)		(185	)		(1,762	)		(1,947	)

Net interest income	$	1,105			(1,829	)		(724	)		812			(1,089	)		(277	)

(1)

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

(2)

Change in interest income from nontaxable 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%.

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LCNB CORP. AND SUBSIDIARIES

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

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 (a basis point equals 0.01%) 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 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.

2011 vs. 2010. Net interest income on a fully tax-equivalent basis for 2011 totaled $27,030,000, a decrease of $277,000 from 2010. The decrease resulted from a decrease in total taxable-equivalent interest income of $2,224,000, largely offset by a decrease in total interest expense of $1,947,000.

The decrease in taxable-equivalent interest income was due to a 50 basis point decrease in the average rate earned on interest-earning assets, partially offset by a $28.3 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 taxable investment securities portfolio, which grew $43.4 million on an average basis.

Interest expense decreased primarily due to a 35 basis point decrease in the average rate paid on interest-bearing liabilities. A secondary factor was a $12.8 million decrease in average IRA and time certificate balances, partially offset by increases in average balances of other deposit account categories and average short-term borrowings. 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 3.89% for 2010 to 3.70% for 2011 primarily due to the limited loan growth during 2011 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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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 2008 through 2012:

	2012			2011			2010			2009			2008
	(Dollars in thousands)

Balance – Beginning of year		2,931			2,641			2,998			2,468			2,468

Loans charged off:
Commercial and industrial		159			581			289			36			73
Commercial, secured by real estate		234			598			1,105			352			-
Residential real estate		486			512			331			152			129
Consumer		134			252			422			490			617
Agricultural		-			-			-			-			-
Other loans, including deposit overdrafts		85			127			144			178			228
Total loans charged off		1,098			2,070			2,291			1,208			1,047

Recoveries:
Commercial and industrial		-			-			35			2			40
Commercial, secured by real estate		71			30			-			-			-
Residential real estate		7			31			2			3			20
Consumer, excluding credit card		123			122			120			203			201
Agricultural		-			-			-			-			-
Credit Card		-			-			-			-			1
Other loans, including deposit overdrafts		52			88			97			130			165
Total recoveries		253			271			254			338			427
Net charge offs		845			1,799			2,037			870			620

Provision charged to operations		1,351			2,089			1,680			1,400			620
Balance - End of year	$	3,437			2,931			2,641			2,998			2,468

Ratio of net charge-offs during the period to average loans outstanding		0.18	%		0.39	%		0.44	%		0.19	%		0.14	%

Ratio of allowance for loan losses to total loans at year-end		0.76	%		0.64	%		0.58	%		0.65	%		0.54	%

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LCNB CORP. AND SUBSIDIARIES

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

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.

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 multiple times throughout each year. Specific new credits 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 possible imprecision of management’s assumptions in the evaluation of loans can result in the allowance also having an unallocated component.

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

	At December 31,
	2012					2011					2010
	Amount		Percent			Amount		Percent			Amount		Percent
	(Dollars in thousands)
Specific allocations	$	904		26.3	%		399		13.6	%		296		11.2	%
General allocations:
Historical loss		1,399		40.7	%		1,381		47.3	%		975		36.9	%
Adjustments to historical loss		1,134		33.0	%		1,151		39.1	%		1,370		51.9	%
Total	$	3,437		100.0	%		2,931		100.0	%		2,641		100.0	%

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

The increase in the specific allocation from December 31, 2011 to December 31, 2012 is primarily due to one commercial real estate loan where the borrower is continuing to experience financial difficulty, although the loan is current under the terms of a troubled debt restructuring modification. The increase in the general historical loss allocation from December 31, 2010 to December 31, 2011 is primarily due to increases in net charge-offs during the historic look-back period.

Non-Interest Income

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.

2011 vs. 2010. Total non-interest income for 2011 was $1,123,000 less than for 2010. Bank owned life insurance income decreased in 2011 by $793,000 primarily due to the absence during 2011 of death benefits received in 2010. Gains from sales of mortgage loans were $319,000 less primarily due to a decrease in the volume of loans sold. Loans sold during 2011 totaled $9.4 million, compared to $24.2 million in sales during 2010. Lower interest rates fueled a demand for loan refinancings during 2010. Service charges and fees on deposit accounts decreased $165,000 primarily due to a downward trend in overdraft fees, partially offset by an increase in check card fee income. These unfavorable items were partially offset by a $202,000 increase in trust income that was primarily due to executor fees received and a change in the mix of trust assets.

Non-Interest Expense

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 $187,000 decrease in other non-interest expenses.

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

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.

2011 vs. 2010. Total non-interest expense was $572,000 greater in 2011 as compared to 2010 primarily due to a $472,000 increase in salaries and employee benefits, a $149,000 increase in equipment expenses, a $109,000 increase in computer maintenance and supplies, and a $399,000 increase in other non-interest expenses. While salaries were held to a less than 4% increase, health care costs and pension costs contributed to the balance of the increase in salaries and employee benefits. Equipment expenses increased primarily due to increased depreciation caused by ATM and computer hardware replacements. The increase in other non-interest expenses resulted from the one-time costs detailed in the 2012 vs. 2011 other non-interest expense comparison above and other smaller miscellaneous costs. Partially offsetting these increases were a $413,000 decrease in FDIC premiums, a $156,000 decrease in other real estate owned expense, and a $114,000 decrease in occupancy expense. FDIC premiums decreased primarily due to implementation of a new assessment base that uses total assets and tier one capital as opposed to deposits. Other real estate owned expense decreased due to a decrease in valuation write-downs.

Income Taxes

LCNB's effective tax rates for the years ended December 31, 2012, 2011, and 2010 were 25.3%, 23.2%, and 21.4%, 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.

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

Assets

Net loans decreased $8.0 million during 2012. The commercial real estate loan portfolio, which increased $11.1 million, was the only category that experienced growth during 2012. Commercial and industrial loans decreased $4.8 million and consumer loans decreased $4.0 million, reflecting lower demand due to economic conditions during 2012. Residential real estate loans decreased $3.8 million, which does not reflect $28.1 million of residential real estate loans that were originated and sold to the Federal Home Loan Mortgage Corporation during 2012.

Investment securities available-for-sale increased $4.5 million during 2012. U.S. Agency notes increased $7.7 million, non-taxable municipal securities increased $4.2 million, and U.S. Treasury notes increased $1.1 million. These increases were partially offset by a $6.1 million decrease in taxable municipal securities.

Investment securities held-to-maturity increased $4.7 million primarily due to the purchase of non-taxable municipal securities. Securities placed in the held-to-maturity category are securities purchased from local municipalities.

Bank owned life insurance increased $2.1 million due to the purchase of $1.5 million in new policies and earnings on existing policies.

Deposits

Total deposits at December 31, 2012 were $7.9 million greater than at December 31, 2011. The growth was in the liquid deposit products – checking, NOW, and savings accounts. These types of instruments increased a total of $44.6 million, while IRA and time certificate accounts decreased $30.2 million and money fund deposit accounts decreased $6.5 million. Of the $30.2 million decrease in IRA and time certificate accounts, $13.6 million of the decrease was due to public fund time deposit accounts. Approximately $12.2 million of the decrease in public fund time deposit accounts was reinvested in other financial institutions through LCNB’s membership in the Certificate of Deposit Account Registry Service (CDARS). CDARS is a program that allows customers to spread large time deposits among various financial institutions, usually to stay below FDIC insurance limits at any given bank.

Long-Term Debt

Long-term debt decreased $7.7 million primarily because of the payment in full of a $6.0 million advance from the Federal Home Loan Bank of Cincinnati in August 2012.

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

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 83.6% of total deposits at December 31, 2012 were "core" deposits. Core deposits, for this purpose, are defined as total deposits less public funds and certificates of deposit greater than $100,000.

Liquid assets include cash, federal funds sold and securities available-for-sale. Except for investments in the stock of the Federal Reserve Bank and the Federal Home Loan Bank of Cincinnati (“FHLB”) and certain local municipal securities, all of LCNB's investment portfolio is classified as "available-for-sale" and can be readily sold to meet liquidity needs, subject to certain pledging commitments for public funds, repurchase agreements, and other requirements. At December 31, 2012, LCNB's liquid assets amounted to $272.0 million or 34.5% of total assets, a slight decrease from $273.5 million or 34.6% of total assets at December 31, 2011.

An additional source of funding is borrowings from the FHLB. Long-term advances totaling $13.7 million were outstanding at December 31, 2012. LCNB is approved to borrow up to $39.4 million in short-term advances through the FHLB’s Cash Management Advance program. Total remaining available borrowing capacity, including short-term advances, with the FHLB at December 31, 2012 was approximately $31.8 million. One of the factors limiting availability of FHLB borrowings is a bank’s ownership of FHLB stock. LCNB could increase its available borrowing capacity by purchasing more FHLB stock.

Besides the short-term FHLB advances, short-term borrowings may include repurchase agreements, federal funds purchased, and advances from a line of credit with another financial institution. At December 31, 2012, LCNB could borrow up to $20 million through the line of credit and up to $17 million under federal funds arrangements with two other financial institutions. Short-term borrowings at December 31, 2012 included $2.7 million from the line of credit and $11.1 million in repurchase agreements.

Commitments to extend credit at December 31, 2012 totaled $77.7 million and standby letters of credit totaled $5.1 million and are more fully described in Note 11 to LCNB's Financial Statements. Since many commitments to extend credit may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

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

The following table provides information concerning LCNB's contractual obligations at December 31, 2012:

			Payments due by period
					Over 1		Over 3
			1 year		through 3		through 5		More than
	Total		or less		years		years		5 years
	(In thousands)

Short-term borrowings	$	13,756		13,756		-		-		-
Long-term debt obligations		13,705		1,603		6,155		5,644		303
Operating lease obligations		5,485		349		601		475		4,060
Commitments to purchase municipal securities to be issued in January 2013		2,729		2,729		-		-		-
Estimated pension plan contribution for 2013		125		125		-		-		-
Certificates of deposit:
$100,000 and over		64,481		27,324		22,431		4,083		10,643
Other time certificates		114,299		53,545		44,990		9,768		5,996
Total	$	214,580		97,828		74,330		19,326		23,096

The following table provides information concerning LCNB's commitments at December 31, 2012:

			Amount of Commitment Expiration Per Period
	Total Amounts Committed		1 year or less		Over 1 through 3 years		Over 3 through 5 years		More than 5 years
	(In thousands)

Commitments to extend credit	$	19,465		19,465		-		-		-
Unused lines of credit		58,232		25,804		11,059		10,807		10,562
Standby letters of credit		5,109		346		4,763		-		-
Total	$	82,806		45,615		15,822		10,807		10,562

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

Capital Resources

LCNB and the Bank are required by banking regulators to meet certain minimum levels of capital adequacy. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on LCNB's and the Bank's financial statements. These minimum levels are expressed in the form of certain ratios. Capital is separated into Tier 1 capital (essentially shareholders' equity less goodwill and other intangibles) and Tier 2 capital (essentially the allowance for loan losses limited to 1.25% of risk-weighted assets). The first two ratios, which are based on the degree of credit risk in the Bank's assets, provide for weighting assets based on assigned risk factors and include off-balance sheet items such as loan commitments and stand-by letters of credit. The ratio of Tier 1 capital to risk-weighted assets must be at least 4.00% and the ratio of total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8.00%. The capital leverage ratio supplements the risk-based capital guidelines. Banks are required to maintain a minimum ratio of Tier 1 capital to adjusted quarterly average total assets of 3.00%. A table summarizing the regulatory capital of LCNB and the Bank at December 31, 2012 and 2011 is included in Note 12, "Regulatory Matters", of the 2012 Annual Report to Shareholders.

The FDIC, the insurer of deposits in financial institutions, has adopted a risk-based insurance premium system based in part on an institution's capital adequacy. Under this system, a depository institution is required to pay successively higher premiums depending on its capital levels and its supervisory rating by its primary regulator. It is management's intention to maintain sufficient capital to permit the Bank to maintain a "well capitalized" designation (the FDIC's highest rating).

On April 17, 2001, LCNB's Board of Directors authorized three separate stock repurchase programs, two of which continue to be in effect – the “Market Repurchase Program” and the “Private Sale Repurchase Program.” Any shares purchased will be held for future corporate purposes.

Under the Market Repurchase Program, LCNB was originally authorized to purchase up to 200,000 shares of its stock, as restated for a 100% stock dividend issued in May, 2007, through market transactions with a selected stockbroker. On November 14, 2005, the Board of Directors extended the Market Repurchase Program by increasing the shares authorized for repurchase to 400,000 total shares, as restated for the stock dividend. Through December 31, 2012, 290,444 shares, as restated for the stock dividend, had been purchased under this program. No shares were purchased under this program during 2012.

The Private Sale Repurchase Program is available to shareholders who wish to sell large blocks of stock at one time. Because LCNB's stock is not widely traded, a shareholder releasing large blocks may not be able to readily sell all shares through normal procedures. Purchases of blocks will be considered on a case-by-case basis and will be made at prevailing market prices. A total of 466,018 shares, as restated for the stock dividend, had been purchased under this program at December 31, 2012. No shares were purchased under this program during 2012.

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

LCNB established an Ownership Incentive Plan during 2002 that allows for stock-based awards to eligible employees. The awards may be in the form of stock options, share awards, and/or appreciation rights. The plan provides for the issuance of up to 200,000 shares, as restated for the stock dividend. The following table provides the stock options granted to key executive officers of LCNB for the years indicated:

Year	Options Granted
2008		13,918
2009		29,110
2010		20,798
2011		25,083
2012		14,491

The exercise price for stock options granted shall not be less than the fair market value of the stock on the date of grant. Options vest ratably over a five-year period and the maximum term for each grant will be specified by the Board of Directors, but cannot be greater than ten years from the date of grant. In the event of an optionee's death or incapacity, all outstanding options held by that optionee shall immediately vest and be exercisable.

On January 9, 2009, LCNB issued 13,400 shares of Fixed Rate Cumulative Preferred Stock, Series A and a warrant for the purchase of 217,063 common shares of LCNB stock at an exercise price of $9.26 per share to the U.S. Treasury Department. LCNB allocated $583,000 of the proceeds from the preferred stock issuance to the warrant. The warrant carries a ten year term and was 100% vested at grant. On October 21, 2009, LCNB redeemed the preferred stock that had been issued under the Capital Purchase Program agreement, but did not redeem the warrant. The Treasury Department sold the warrant to an investor during the fourth quarter 2011.

Critical Accounting Policies

Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance. The allowance is an amount that management believes will be adequate to absorb inherent losses in the loan portfolio, based on evaluations of the collectability of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers' ability to pay. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

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

The allowance consists of specific and general components. The specific component relates to loans that are classified as doubtful, substandard, or special mention. For such loans an allowance is established when the discounted cash flows or collateral value is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors, which include trends in underperforming loans, trends in the volume and terms of loans, economic trends and conditions, concentrations of credit, trends in the quality of loans, and borrower financial statement exceptions.

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

Accounting for Intangibles. LCNB’s intangible assets at December 31, 2012 are composed primarily of goodwill and a core deposit intangible related to the acquisition of Sycamore during the fourth quarter 2007 and mortgage servicing rights recorded from sales of mortgage loans to the Federal Home Loan Mortgage Corporation. Goodwill is not subject to amortization, but is reviewed annually for impairment. The core deposit intangible is being amortized on a straight line basis over six years. Mortgage servicing rights are capitalized by allocating the total cost of loans between mortgage servicing rights and the loans based on their estimated fair values. Capitalized mortgage servicing rights are amortized to loan servicing income in proportion to and over the period of estimated servicing income, subject to periodic review for impairment.

Fair Value Accounting for Investment Securities. Securities classified as available-for-sale are carried at estimated fair value. Unrealized gains and losses, net of taxes, are reported as accumulated other comprehensive income or loss in shareholders’ equity. Fair value is estimated using market quotations for U.S. Treasury and corporate securities and equity investments. Fair value for the majority of the remaining available-for-sale securities is estimated using the discounted cash flow method for each security with discount rates based on rates observed in the market.

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QUARTERLY FINANCIAL DATA (UNAUDITED)

(Dollars in thousands, except per share data)

	Three Months Ended
	March 31		June 30			Sep. 30		Dec. 31

2012
Interest income	$	7,731		7,571			7,404		7,232
Interest expense		1,322		1,272			1,190		1,105
Net interest income		6,409		6,299			6,214		6,127
Provision for loan losses		215		91			436		609
Net interest income after provision		6,194		6,208			5,778		5,518
Total non-interest income		2,336		1,755			2,205		2,753
Total non-interest expenses		5,448		5,330			5,564		5,340
Income before income taxes		3,082		2,633			2,419		2,931
Provision for income taxes		805		646			572		772
Net income from continuing operations		2,277		1,987			1,847		2,159
Income (loss) from discontinued operations, net of tax		-		-			-		-
Net income	$	2,277		1,987			1,847		2,159

Basic earnings per common share:
Continuing operations	$	0.34		0.30			0.27		0.32
Discontinued operations		-		-			-		-
Diluted earnings per common share:
Continuing operations		0.34		0.29			0.27		0.32
Discontinued operations		-		-			-		-


2011
Interest income	$	8,130		8,099			7,976		7,888
Interest expense		1,772		1,667			1,537		1,411
Net interest income		6,358		6,432			6,439		6,477
Provision for loan losses		664		224			588		613
Net interest income after provision		5,694		6,208			5,851		5,864
Total non-interest income		1,915		1,835			2,033		1,981
Total non-interest expenses		5,785		5,307			5,436		5,321
Income before income taxes		1,824		2,736			2,448		2,524
Provision for income taxes		346		713			581		570
Net income from continuing operations		1,478		2,023			1,867		1,954
Income (loss) from discontinued operations, net of tax		824		(31	)		-		-
Net income	$	2,302		1,992			1,867		1,954

Basic earnings per common share:
Continuing operations	$	0.22		0.30			0.28		0.29
Discontinued operations		0.12		-			-		-
Diluted earnings per common share:
Continuing operations		0.22		0.30			0.28		0.28
Discontinued operations		0.12		-			-		-

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

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

The Bank's Asset and Liability Management Committee ("ALCO") primarily uses a combination of Interest Rate Sensitivity Analysis (IRSA) and Economic Value of Equity (EVE) analysis for measuring and managing interest rate risk. The IRSA model is used to estimate the effect on net interest income during a one-year period of instantaneous and sustained movements in interest rates, also called interest rate shocks, of 100, 200, and 300 basis points. Management considers the results of any significant downward scenarios to not be meaningful in the current interest rate environment. The base projection uses a current interest rate scenario. As shown below, the December 31, 2012 IRSA indicates that an increase in interest rates at all shock levels will have a positive effect on net interest income. The changes in net interest income for all rate assumptions are within LCNB’s acceptable ranges.

Rate Shock Scenario in Basis Points	Amount (In thousands)		$ Change in Net Interest Income		% Change in Net Interest Income
Up 300	$	25,904		1,634		6.73	%
Up 200		25,359		1,089		4.49	%
Up 100		24,807		537		2.21	%
Base		24,270		-		-	%

IRSA shows the effect on net interest income during a one-year period only. A more long-range model is the EVE analysis, which shows the estimated present value of future cash inflows from interest-earning assets less the present value of future cash outflows for interest-bearing liabilities for the same rate shocks. As shown below, the December 31, 2012 EVE analysis indicates that an increase in interest rates would have a negative effect on the EVE. The changes in the EVE for all rate assumptions are within LCNB’s acceptable ranges.

Rate Shock Scenario in Basis Points	Amount (In thousands)		$ Change in EVE			% Change in EVE
Up 300	$	80,130		(1,374	)		(1.69	)%
Up 200		81,217		(287	)		(0.35	)%
Up 100		81,449		(55	)		(0.07	)%
Base		81,504		-			-	%

The IRSA and EVE simulations discussed above are not projections of future income or equity and should not be relied on as being indicative of future operating results. Assumptions used, including the nature and timing of interest rate levels, yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment or replacement of asset and liability cash flows, are inherently uncertain and, as a result, the models cannot precisely measure future net interest income or equity. Furthermore, the models do not reflect actions that borrowers, depositors, and management may take in response to changing economic conditions and interest rate levels.

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Item 8. Financial Statements and Supplementary Data

REPORT OF MANAGEMENT’S ASSESSMENT OF INTERNAL CONTROL OVER FINANCIAL REPORTING

LCNB Corp. (“LCNB”) is responsible for the preparation, integrity, and fair presentation of the consolidated financial statements included in this annual report. Management of LCNB and its subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15f. LCNB’s internal control over financial reporting is a process designed under the supervision of LCNB’s Chief Executive Officer and the Chief Financial Officer. The purpose is to provide reasonable assurance to the Board of Directors regarding the reliability of financial reporting and the preparation of LCNB’s financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

Management maintains internal controls over financial reporting. The internal controls contain control processes and actions are taken to correct deficiencies as they are identified. The internal controls are evaluated on an ongoing basis by LCNB’s Management and Audit Committee. Even effective internal controls, no matter how well designed, have inherent limitations – including the possibility of circumvention or overriding of controls – and therefore can provide only reasonable assurance with respect to financial statement preparation. Also, because of changes in conditions, internal control effectiveness may vary over time.

Management assessed LCNB’s internal controls as of December 31, 2012, in relation to criteria for effective internal control over financial reporting described in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on this assessment, management believes that, as of December 31, 2012, LCNB’s internal control over financial reporting met the criteria.

J.D. Cloud & Co. L.L.P., an independent registered public accounting firm, has issued an attestation report on the effectiveness of LCNB’s internal control over financial reporting as of December 31, 2012.

Submitted by:

LCNB Corp.

/s/ Stephen P. Wilson		/s/ Robert C. Haines II
Stephen P. Wilson		Robert C. Haines II
Chief Executive Officer &		Executive Vice President &
Chairman of the Board of Directors		Chief Financial Officer
February 25, 2013		February 25, 2013

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

LCNB Corp.

Lebanon, Ohio

We have audited LCNB Corp. and subsidiaries’ (LCNB) internal control over financial reporting as of December 31, 2012, based on criteria established in “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). LCNB’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying “Report of Management’s Assessment of Internal Control over Financial Reporting.” Our responsibility is to express an opinion on LCNB’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, LCNB maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

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We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2012 and 2011 and the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2012 of LCNB, and our report dated February 25, 2013 expressed an unqualified opinion.

	/s/ J.D. Cloud & Co. L.L.P.
	Certified Public Accountant

Cincinnati, Ohio
February 25, 2013

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

LCNB Corp.

Lebanon, Ohio

We have audited the accompanying consolidated balance sheets of LCNB Corp. and subsidiaries (LCNB) as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2012. LCNB’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of LCNB as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), LCNB’s internal control over financial reporting as of December 31, 2012, based on criteria established in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 25, 2013 expressed an unqualified opinion.

	/s/ J.D. Cloud & Co. L.L.P.
	Certified Public Accountants

Cincinnati, Ohio
February 25, 2013

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FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

At December 31,

(Dollars in thousands)

		2012	2011
ASSETS:
Cash and due from banks	$	11,260	12,449
Interest-bearing demand deposits		2,215	7,086
Total cash and cash equivalents		13,475	19,535

Investment securities:
Available-for-sale, at fair value		258,506	254,006
Held-to-maturity, at cost		15,424	10,734
Federal Reserve Bank stock, at cost		949	940
Federal Home Loan Bank stock, at cost		2,091	2,091
Loans, net		450,346	458,331
Premises and equipment, net		16,564	17,346
Goodwill		5,915	5,915
Bank owned life insurance		16,915	14,837
Other assets		8,452	7,835
TOTAL ASSETS	$	788,637	791,570

LIABILITIES:
Deposits:
Noninterest-bearing	$	133,848	106,793
Interest-bearing		537,623	556,769
Total deposits		671,471	663,562
Short-term borrowings		13,756	21,596
Long-term debt		13,705	21,373
Accrued interest and other liabilities		7,699	7,079
TOTAL LIABILITIES		706,631	713,610

SHAREHOLDERS' EQUITY:
Preferred shares - no par value, authorized 1,000,000 shares, none outstanding		-	-
Common shares - no par value, authorized 12,000,000 shares, issued 7,485,527 and 7,460,494 shares at December 31, 2012 and 2011, respectively		27,107	26,753
Retained earnings		61,843	57,877
Treasury shares at cost, 753,627 and 755,771 shares at December 31, 2012 and 2011, respectively		(11,665)	(11,698)
Accumulated other comprehensive income, net of taxes		4,721	5,028
TOTAL SHAREHOLDERS' EQUITY		82,006	77,960

TOTAL LIABILITES AND SHAREHOLDERS' EQUITY	$	788,637	791,570

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

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LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

For the years ended December 31,

(Dollars in thousands, except per share data)

	2012		2011		2010
INTEREST INCOME:
Interest and fees on loans	$	23,585		25,502		27,020
Interest on investment securities:
Taxable		3,737		3,843		3,686
Non-taxable		2,441		2,571		3,126
Other investments		175		177		199
TOTAL INTEREST INCOME		29,938		32,093		34,031

INTEREST EXPENSE:
Interest on deposits		4,317		5,702		7,613
Interest on short-term borrowings		16		28		27
Interest on long-term debt		556		657		694
TOTAL INTEREST EXPENSE		4,889		6,387		8,334
NET INTEREST INCOME		25,049		25,706		25,697
PROVISION FOR LOAN LOSSES		1,351		2,089		1,680

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		23,698		23,617		24,017

NON-INTEREST INCOME:
Trust income		2,317		2,099		1,897
Service charges and fees on deposit accounts		3,605		3,739		3,904
Net gain on sales of securities		1,853		948		948
Bank owned life insurance income		578		596		1,389
Gains from sales of mortgage loans		506		177		496
Other operating income		190		205		253
TOTAL NON-INTEREST INCOME		9,049		7,764		8,887

NON-INTEREST EXPENSE:
Salaries and employee benefits		11,614		11,743		11,271
Equipment expenses		1,100		1,038		889
Occupancy expense, net		1,671		1,761		1,875
State franchise tax		790		764		703
Marketing		526		480		448
FDIC premiums		405		545		958
ATM expense		620		553		513
Computer maintenance and supplies		524		565		456
Telephone expense		465		407		414
Contracted services		441		420		370
Other real estate owned		490		350		506
Other non-interest expense		3,036		3,223		2,874
TOTAL NON-INTEREST EXPENSE		21,682		21,849		21,277

INCOME BEFORE INCOME TAXES		11,065		9,532		11,627
PROVISION FOR INCOME TAXES		2,795		2,210		2,494
NET INCOME FROM CONTINUING OPERATIONS		8,270		7,322		9,133
INCOME FROM DISCONTINUED OPERATIONS, NET OF TAX		-		793		240
NET INCOME	$	8,270		8,115		9,373

Basic earnings per common share:
Continuing Operations	$	1.23		1.09		1.37
Discontinued Operations		-		0.12		0.03

Diluted earnings per common share:
Continuing operations		1.22		1.08		1.36
Discontinued operations		-		0.12		0.03

Weighted average shares outstanding:
Basic		6,717,357		6,692,385		6,687,500
Diluted		6,802,475		6,751,599		6,736,622

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

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LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

For the years ended December 31,

(Dollars in thousands)

	2012			2011			2010

Net income	$	8,270			8,115			9,373

Other comprehensive income (loss):

Net unrealized gain on available-for-sale securities (net of taxes of $473, $1,994, and $231 for 2012, 2011, and 2010, respectively)		918			3,852			448

Change in nonqualified pension plan unrecognized net gain (loss) and unrecognized prior service cost (net of taxes of $1, $102, and $55 for 2012, 2011, and 2010, respectively)		(2	)		(199	)		107

Nonqualified pension plan curtailment (net of taxes of $80)		-			155			-

Reclassification adjustment for:

Net realized gain on sale of available-for-sale securities included in net income (net of taxes of $630, $323, and $323 for 2012, 2011 and 2010, respectively)		(1,223	)		(625	)		(625	)

TOTAL COMPREHENSIVE INCOME	$	7,963			11,298			9,303


SUPPLEMENTAL INFORMATION:
COMPONENTS OF ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX, AS OF YEAR-END:
Net unrealized gain on securities available-for-sale	$	4,875			5,180			1,953
Net unfunded liability for nonqualified pension plan		(154	)		(152	)		(108	)
Balance at year-end	$	4,721			5,028			1,845

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

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LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the years ended December 31,

(Dollars in thousands)

												Accumulated
	Common											Other			Total
	Shares		Common			Retained			Treasury			Comprehensive			Shareholders'
	Outstanding		Shares			Earnings			Shares			Income (Loss)			Equity

Balance, December 31, 2009		6,687,232	$	26,475			48,962			(11,737	)		1,915			65,615

Net income							9,373									9,373
Net unrealized gain on available-for-sale securities, net of tax													448			448
Reclassification adjustment for net realized gain on sale of available-for-sale securities included in net income, net of taxes													(625	)		(625	)
Change in nonqualified pension plan unrecognized net loss and unrecognized prior service cost, net of taxes													107			107
Compensation expense relating to stock options				40												40
Restricted stock awards		2,511					(10	)		39						29
Common stock dividends, $0.64 per share							(4,280	)								(4,280	)
Balance, December 31, 2010		6,689,743	$	26,515			54,045			(11,698	)		1,845			70,707

Net income							8,115									8,115
Net unrealized gain on available-for-sale securities, net of tax													3,852			3,852
Reclassification adjustment for net realized gain on sale of available-for-sale securities included in net income, net of taxes													(625	)		(625	)
Change in nonqualified pension plan unrecognized net loss and unrecognized prior service cost, net of taxes													(199	)		(199	)
Nonqualified pension plan curtailment, net of taxes													155			155
Dividend Reinvestment and Stock Purchase Plan		14,980		193												193
Compensation expense relating to stock options				45												45
Common stock dividends, $0.64 per share							(4,283	)								(4,283	)
Balance, December 31, 2011		6,704,723	$	26,753			57,877			(11,698	)		5,028			77,960

Net income							8,270									8,270
Net unrealized gain on available-for-sale securities, net of tax													918			918
Reclassification adjustment for net realized gain on sale of available-for-sale securities included in net income, net of taxes													(1,223	)		(1,223	)
Change in nonqualified pension plan unrecognized net loss and unrecognized prior service cost, net of taxes													(2	)		(2	)
Reclassification adjustment for recognition of pension plan net (gain) loss, net of taxes
Dividend Reinvestment and Stock Purchase Plan		25,033		332												332
Exercise of stock options		2,144					(5	)		33						28
Excess tax expense on exercise and forfeiture of stock options				(19	)											(19	)
Compensation expense relating to stock options				41												41
Common stock dividends, $0.64 per share							(4,299	)								(4,299	)
Balance, December 31, 2012		6,731,900		27,107			61,843			(11,665	)		4,721			82,006

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

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LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the years ended December 31,

(Dollars in thousands)

	2012			2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	8,270			8,115			9,373
Adjustments to reconcile net income to net cash flows from operating activities-
Depreciation, amortization and accretion		3,072			2,978			2,814
Provision for loan losses		1,351			2,089			1,680
Deferred income tax provision (benefit)		31			(231	)		(112	)
Curtailment charge for nonqualified defined benefit retirement plan		-			191			-
Increase in cash surrender value of bank owned life insurance		(578	)		(596	)		(597	)
Bank owned life insurance death benefits in excess of cash surrender value		-			-			(792	)
Realized gain on sales of securities available-for-sale		(1,853	)		(948	)		(948	)
Realized (gain) loss on sale of premises and equipment		(10	)		50			16
Realized gain from sale of insurance agency		-			(1,503	)		-
Realized loss from sale and write-downs of other real estate owned and repossessed assets		295			137			371
Origination of mortgage loans for sale		(28,084	)		(9,352	)		(24,200	)
Realized gains from sales of mortgage loans		(506	)		(177	)		(496	)
Proceeds from sales of mortgage loans		28,307			9,430			24,438
Compensation expense related to stock options		41			45			40
Excess tax expense on exercise and forfeiture of stock options		(19	)		-			-
Increase (decrease) due to changes in assets and liabilities:
Income receivable		236			267			275
Other assets		(307	)		324			913
Other liabilities		743			(162	)		1,025
TOTAL ADJUSTMENTS		2,719			2,542			4,427

NET CASH FLOWS FROM OPERATING ACTIVITIES		10,989			10,657			13,800

CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of investment securities available-for-sale		90,573			36,769			53,365
Proceeds from maturities and calls of investment securities:
Available-for-sale		37,669			61,424			63,203
Held-to-maturity		2,648			6,521			5,474
Purchases of investment securities:
Available-for-sale		(132,836	)		(111,914	)		(151,589	)
Held-to-maturity		(7,338	)		(5,114	)		(4,582	)
Proceeds from redemption of Federal Reserve Bank stock		-			-			1
Purchase of Federal Reserve Bank stock		(9	)		(1	)		-
Net (increase) decrease in loans		5,729			(8,438	)		3,003
Purchase of bank owned life insurance		(1,500	)		-			-
Proceeds from bank owned life insurance death benefits		-			-			1,269
Proceeds from sales of other real estate owned and repossessed assets		33			580			194
Additions to other real estate owned		(16	)		-			-
Purchases of premises and equipment		(478	)		(2,578	)		(1,447	)
Proceeds from sales of premises and equipment		14			16			16
Proceeds from sale of insurance agency, net of cash disposed		-			1,523			-
NET CASH FLOWS FROM INVESTING ACTIVITIES		(5,511	)		(21,212	)		(31,093	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		7,909			25,023			14,360
Net increase (decrease) in short-term borrowings		(7,840	)		(95	)		7,426
Proceeds from long-term debt		-			5,000			-
Principal payments on long-term debt		(7,668	)		(6,747	)		(1,840	)
Proceeds from issuance of common stock		49			193			-
Exercise of stock options		28			-			-
Cash dividends paid on common stock		(4,016	)		(4,283	)		(4,280	)
NET CASH FLOWS FROM FINANCING ACTIVITIES		(11,538	)		19,091			15,666

NET CHANGE IN CASH AND CASH EQUIVALENTS		(6,060	)		8,536			(1,627	)

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR		19,535			10,999			12,626

CASH AND CASH EQUIVALENTS AT END OF YEAR	$	13,475			19,535			10,999

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LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

For the years ended December 31,

(Dollars in thousands)

	2012		2011		2010
SUPPLEMENTAL CASH FLOW INFORMATION:
CASH PAID DURING THE YEAR FOR:
Interest	$	4,967		6,489		8,378
Income taxes		2,165		3,634		2,471

SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING ACTIVITY:
Transfer from loans to other real estate owned and repossessed assets		859		245		183

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

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

NOTE 1 -

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

LCNB Corp. (the "Company" or “LCNB”), an Ohio corporation formed in December 1998, is a financial holding company whose principal activity is the ownership of LCNB National Bank (the "Bank"). The Bank was founded in 1877 and provides full banking services, including trust and brokerage services, to customers primarily in the Southwestern Ohio area of Warren, Butler, and Clinton Counties and portions of Clermont, Hamilton, and Montgomery Counties. LCNB completed the sale of its other operating subsidiary, Dakin Insurance Agency, Inc. (“Dakin”) on March 23, 2011.

BASIS OF PRESENTATION

The consolidated financial statements include the accounts of the Company and its subsidiaries. Significant intercompany accounts and transactions are eliminated in consolidation. The accounting and reporting policies of the Company conform with U.S. generally accepted accounting principles and with general practices in the banking industry. The financial results of Dakin are included as income from discontinued operations, net of tax, in the consolidated financial statements through the date of sale.

Certain prior period data presented in the financial statements have been reclassified to conform with the current year presentation.

USE OF ESTIMATES

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

CASH AND CASH EQUIVALENTS

For purposes of reporting cash flows, cash and cash equivalents include cash, balances due from banks, federal funds sold, and interest-bearing demand deposits with original maturities of three months or less. Deposits with other banks routinely have balances greater than FDIC insured limits. Management considers the risk of loss to be very low with respect to such deposits.

INVESTMENT SECURITIES

Certain municipal debt securities that management has the positive intent and ability to hold to maturity are classified as “held-to-maturity” and recorded at amortized cost. Securities not classified as held-to-maturity are classified as “available-for-sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income, a separate component of shareholders’ equity. Amortization of premiums and accretion of discounts are recognized as adjustments to interest income using the level-yield method. Realized gains or losses from the sale of securities are recorded on the trade date and are computed using the specific identification method.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 1 -

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Declines in the fair value of securities below their cost that are deemed to be other-than-temporarily impaired and for which the Company does not intend to sell the securities and it is not more likely than not that the securities will be sold before the anticipated recovery of the impairment are separated into losses related to credit factors and losses related to other factors. The losses related to credit factors are recognized in earnings and losses related to other factors are recognized in other comprehensive income. In estimating other than temporary impairment losses, management considers the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

Federal Home Loan Bank ("FHLB") stock is an equity interest in the Federal Home Loan Bank of Cincinnati. It can be sold only at its par value of $100 per share and only to the FHLB or to another member institution. In addition, the equity ownership rights are more limited than would be the case for a public company because of the oversight role exercised by the Federal Housing Finance Agency in the process of budgeting and approving dividends. Federal Reserve Bank stock is similarly restricted in marketability and value. Both investments are carried at cost, which is their par value.

FHLB and Federal Reserve Bank stock are both subject to minimum ownership requirements by member banks. The required investments in common stock are based on predetermined formulae.

LOANS

The Company’s loan portfolio includes most types of residential and commercial real estate loans, consumer loans, commercial and industrial loans, agricultural loans and other types of loans. Most of the properties collateralizing the loan portfolio are located within the Company’s market area.

Loans are stated at the principal amount outstanding, net of unearned income, deferred origination fees and costs, and the allowance for loan losses. Interest income is accrued on the unpaid principal balance. The delinquency status of a loan is based on contractual terms and not on how recently payments have been received. Generally, a loan is placed on non-accrual status when it is classified as impaired or there is an indication that the borrower’s cash flow may not be sufficient to make payments as they come due, unless the loan is well secured and in the process of collection. Subsequent cash receipts on non-accrual loans are recorded as a reduction of principal and interest income is recorded once principal recovery is reasonably assured. The current year's accrued interest on loans placed on non-accrual status is charged against earnings. Previous years' accrued interest is charged against the allowance for loan losses.

Loan origination fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment of loan yields. These amounts are being amortized over the lives of the related loans.

In the ordinary course of business, the Company enters into off-balance sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded. The credit risk associated with these commitments is evaluated in a manner similar to the allowance for loan losses.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 1 -

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Consumer loans are charged off when they reach 120 days past due. Subsequent recoveries, if any, are credited to the allowance.

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. Current methodology used by management to estimate the allowance takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, historic categorical trends, current delinquency levels as related to historical levels, portfolio growth rates, changes in composition of the portfolio, the current economic environment, as well as current allowance adequacy in relation to the portfolio. Management is cognizant that reliance on historical information coupled with the cyclical nature of the economy, including credit cycles, affects the allowance. Management considers all of these factors prior to making any adjustments to the allowance due the subjectivity and imprecision involved in allocation methodology. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific and general components. The specific component relates to loans that are specifically reviewed for impairment. For such loans, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers loans not specifically reviewed for impairment and homogeneous loan pools, such as residential real estate and consumer loans. The general component is measured for each loan category separately based on each category’s average of historical loss experience over a thirty-six month period, adjusted for qualitative factors. Such qualitative factors may include current economic conditions if different from the three-year historical loss period, trends in underperforming loans, trends in volume and terms of loan categories, concentrations of credit, and trends in loan quality.

A loan is considered impaired when management believes, based on current information and events, it is probable that the Bank will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the loan agreement. An impaired loan is measured by the present value of expected future cash flows using the loan's effective interest rate. An impaired collateral-dependent loan may be measured based on collateral value. Smaller-balance homogenous loans, including residential mortgage and consumer installment loans, that are not evaluated individually are collectively evaluated for impairment.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 1 -

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

PREMISES AND EQUIPMENT

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on both the straight-line and accelerated methods over the estimated useful lives of the assets, generally 15 to 40 years for premises and 3 to 10 years for equipment. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. Costs incurred for maintenance and repairs are expensed currently.

OTHER REAL ESTATE OWNED

Other real estate owned includes properties acquired through foreclosure or deed in lieu of foreclosure. Such property is held for sale and is initially recorded at fair value, less costs to sell, establishing a new cost basis. Fair value is primarily based on a property appraisal obtained at the time of transfer and any periodic updates that may be obtained thereafter. The allowance for loan losses is charged for any write down of the loan’s carrying value to fair value at the date of acquisition. Any subsequent reductions in fair value and expenses incurred from holding other real estate owned are charged to other non-interest expense. Costs, excluding interest, relating to the improvement of other real estate owned are capitalized. Gains and losses from the sale of other real estate owned are included in other non-interest expense.

Other real estate owned also includes in-substance foreclosed properties, which are properties that the Company has taken physical control of, regardless of whether formal foreclosure proceedings have occurred.

GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill is the excess of the purchase price over the fair value of the net identifiable assets acquired in a business combination. Goodwill is not amortized, but is instead subject to an annual review for impairment.

Mortgage servicing rights on originated mortgage loans that have been sold are initially recorded at their estimated fair values. Mortgage servicing rights are amortized to loan servicing income in proportion to and over the period of estimated servicing income. Such assets are periodically evaluated as to the recoverability of their carrying value.

The Company’s other intangible asset relates to core deposits acquired from the Sycamore National Bank acquisition consummated in 2007. This intangible asset is amortized on a straight-line basis over its estimated useful life. Management evaluates whether events or circumstances have occurred that indicate the remaining useful life or carrying value of the amortizing intangible should be revised.

BANK OWNED LIFE INSURANCE

The Company has purchased life insurance policies on certain officers of the Company. The Company is the beneficiary of these policies and has recorded the estimated cash surrender value in other assets in the consolidated balance sheets. Income on the policies, based on the increase in cash surrender value and any incremental death benefits, is included in other non-interest income in the consolidated statements of income.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 1 -

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

FAIR VALUE MEASUREMENTS

Accounting guidance establishes a fair value hierarchy to prioritize the inputs to valuation techniques used to measure fair value. A financial instrument’s level within the hierarchy is based on the lowest level of input that is significant to the fair value measurement. The three broad input levels are:

Level 1 – quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the reporting date;

Level 2 – inputs other than quoted prices included within level 1 that are observable for the asset or liability either directly or indirectly; and

Level 3 - inputs that are unobservable for the asset or liability.

Level 2 inputs may include quoted prices for similar assets in active markets, quoted prices for identical assets or liabilities in markets that are not active, inputs other than quoted prices (such as interest rates or yield curves) that are observable for the asset or liability, and inputs that are derived from or corroborated by observable market data.

Accounting guidance permits, but does not require, companies to measure many financial instruments and certain other items at fair value. The decision to elect the fair value option is made individually for each instrument and is irrevocable once made. Changes in fair value for the selected instruments are recorded in earnings. The Company did not select any financial instruments for the fair value election in 2012 or 2011.

ADVERTISING EXPENSE

Advertising costs are expensed as incurred and are recorded as a marketing expense, a component of non-interest expense.

PENSION PLAN

Eligible employees of the Company hired before 2009 participate in a multiple-employer qualified noncontributory defined benefit retirement plan. This plan is accounted for as a multi-employer plan because assets contributed by an employer are not segregated in a separate account or restricted to provide benefits only to employees of that employer.

STOCK OPTIONS

The cost of employee services received in exchange for stock option grants is the grant-date fair value of the award estimated using an option-pricing model. This estimated cost is recognized over the period the employee is required to provide services in exchange for the award, usually the vesting period. The Company uses a Black-Scholes pricing model and related assumptions for estimating the fair value of stock option grants and a five-year vesting period.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 1 -

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

INCOME TAXES

Deferred income taxes are determined using the liability method of accounting. Under this method, the net deferred tax asset or liability is determined based on the tax effects of temporary differences between the book and tax basis of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.

Management analyzes material tax positions taken in any income tax return for any tax jurisdiction and determines the likelihood of the positions being sustained in a tax examination. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

EARNINGS PER SHARE

Basic earnings per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is adjusted for the dilutive effects of stock options and warrants. The diluted average number of common shares outstanding has been increased for the assumed exercise of stock options and warrants with the proceeds used to purchase treasury shares at the average market price for the period.

RECENT ACCOUNTING PRONOUNCEMENTS

In July 2012, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2012-02, “Testing Indefinite-Lived Intangible Assets for Impairment.” The provisions of ASU No. 2012-02 permit an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform a quantitative impairment test, as is currently required by GAAP. ASU No. 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. As LCNB does not have any indefinite-lived intangible assets, other than goodwill, the adoption of ASU No. 2012-02 is expected to have no impact on its consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 1 -

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

In October 2012, the FASB issued ASU No. 2012-06, “Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution.” When a reporting entity recognizes an indemnification asset (as a result of a loss-sharing agreement with the FDIC or National Credit Union Administration) and a subsequent change in the cash flows expected to be collected on the indemnification asset occurs (as a result of a change in cash flows expected to be collected on the assets subject to indemnification), the reporting entity should subsequently account for the change in the measurement of the indemnification asset on the same basis as the change in the assets subject to indemnification. Any amortization of changes in value should be limited to the lesser of the term of the indemnification agreement or the remaining life of the indemnified assets. This ASU is effective for fiscal years beginning on or after December 15, 2012 and will be applied prospectively to new indemnification assets acquired and to changes in expected cash flows of existing indemnification assets occurring on or after the date of adoption. As LCNB has not participated in any government-assisted acquisitions of other financial institutions, the adoption of ASU No. 2012-06 is expected to have no impact on its consolidated financial statements.

On February 5, 2013, the FASB issued ASU No. 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The provisions of this update require public and non-public companies to present information about reclassification adjustments from accumulated other comprehensive income in their annual financial statements in a single note or on the face of the financial statements. Public companies, such as LCNB, must also provide this information in their interim financial statements. This standard is effective prospectively for public companies for annual and interim reporting periods beginning after December 15, 2012.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 2 -

INVESTMENT SECURITIES

The amortized cost and fair value of available-for-sale investment securities at December 31 are summarized as follows (in thousands):

	2012
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value

U.S. Treasury notes	$	18,462		224		-		18,686
U.S. Agency notes		89,372		1,364		130		90,606
U.S. Agency mortgage-backed securities		51,121		1,444		24		52,541
Corporate securities		3,032		35		-		3,067
Municipal securities:
Non-taxable		70,504		3,497		119		73,882
Taxable		14,851		993		3		15,841
Mutual funds		2,138		30		-		2,168
Trust preferred securities		250		2		7		245
Equity securities		1,390		106		26		1,470
	$	251,120		7,695		309		258,506

	2011
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value

U.S. Treasury notes	$	17,385		165		-		17,550
U.S. Agency notes		81,415		1,517		5		82,927
U.S. Agency mortgage-backed securities		50,923		1,475		111		52,287
Corporate securities		6,334		47		16		6,365
Municipal securities:
Non-taxable		65,896		3,827		20		69,703
Taxable		21,027		894		14		21,907
Mutual funds		2,103		22		-		2,125
Trust preferred securities		549		37		22		564
Equity securities		526		57		5		578
	$	246,158		8,041		193		254,006

The fair value of held-to-maturity investment securities, consisting of non-taxable and taxable municipal securities, approximates amortized cost at December 31, 2012 and 2011.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 2 -

INVESTMENT SECURITIES (Continued)

Information concerning securities with gross unrealized losses at December 31, 2012, aggregated by length of time that individual securities have been in a continuous loss position, is as follows (in thousands):

	Less than Twelve Months				Twelve Months or More
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses

U.S. Agency notes	$	13,471		130		-		-
U.S. Agency mortgage-backed securities		4,862		24		-		-
Municipal securities:
Non-taxable		9,903		118		456		1
Taxable		497		3		-		-
Trust preferred securities		144		6		48		1
Equity securities		314		13		51		13
	$	29,191		294		555		15

Management has determined that the unrealized losses at December 31, 2012 are primarily due to fluctuations in market interest rates and do not reflect credit quality deterioration of the securities. Because the Company does not have the intent to sell the investments and it is more likely than not that the Company will not be required to sell the investments before recovery of their amortized cost, the Company does not consider these investments to be other-than-temporarily impaired.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 2 -

INVESTMENT SECURITIES (Continued)

Contractual maturities of investment securities at December 31, 2012 were as follows (in thousands). Actual maturities may differ from contractual maturities when issuers have the right to call or prepay obligations.

	Available-for-Sale				Held-to-Maturity
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value

Due within one year	$	8,023		8,091		6,701		6,701
Due from one to five years		71,500		74,631		985		985
Due from five to ten years		106,776		109,220		3,928		3,928
Due after ten years		9,922		10,140		3,810		3,810
		196,221		202,082		15,424		15,424
U.S. Agency mortgage-backed securities		51,121		52,541		-		-
Mutual funds		2,138		2,168		-		-
Trust preferred securities		250		245		-		-
Equity securities		1,390		1,470		-		-
	$	251,120		258,506		15,424		15,424

Investment securities with a market value of $158,287,000 and $157,534,000 at December 31, 2012 and 2011, respectively, were pledged to secure public deposits and for other purposes required or permitted by law.

Certain information concerning the sale of investment securities available-for-sale for the years ended December 31 was as follows (in thousands):

	2012		2011		2010

Proceeds from sales	$	90,573		36,769		53,365
Gross realized gains		1,860		949		948
Gross realized losses		7		1		-

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 3 -

LOANS

Major classifications of loans at December 31 were as follows (in thousands):

	2012		2011

Commercial and industrial	$	26,236		30,990
Commercial, secured by real estate		230,256		219,188
Residential real estate		183,132		186,904
Consumer		10,554		14,562
Agricultural		1,668		2,835
Other loans, including deposit overdrafts		1,875		6,554
		453,721		461,033
Deferred origination costs, net		62		229
		453,783		461,262
Less allowance for loan losses		3,437		2,931
Loans-net	$	450,346		458,331

Non-accrual, past-due, and accruing restructured loans at December 31 were as follows (in thousands):

	2012			2011

Non-accrual loans:
Commercial and industrial	$	264			495
Commercial, secured by real estate		788			1,950
Residential real estate		1,231			1,223
Total non-accrual loans		2,283			3,668
Past-due 90 days or more and still accruing		128			39
Total non-accrual and past-due 90 days or more and still accruing		2,411			3,707
Accruing restructured loans		13,343			14,739
Total	$	15,754			18,446

Percentage of total non-accrual and past-due 90 days or more and still accruing to total loans		0.53	%		0.80	%

Percentage of total non-accrual, past-due 90 days or more and still accruing, and accruing restructured loans to total loans		3.47	%		4.00	%

Interest income that would have been recorded during 2012 and 2011 if loans on non-accrual status at December 31, 2012 and 2011 had been current and in accordance with their original terms was approximately $235,000 and $335,000, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 3 -

LOANS (Continued)

The Company is not committed to lend additional funds to debtors whose loans have been modified to provide a reduction or deferral of principal or interest because of deterioration in the financial position of the borrower.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 3 -

LOANS (Continued)

The allowance for loan losses and recorded investment in loans for the years ended December 31 were as follows (in thousands):

	Commercial & Industrial			Commercial, Secured by Real Estate			Residential Real Estate			Consumer			Agricultural		Other			Unallocated		Total
December 31, 2012
Allowance for loan losses:
Balance, beginning of year	$	162			1,941			656			166			-		6			-		2,931
Change in classification		18			(18	)		-			-			-		-			-		-
Provision charged to expenses		299			536			535			(47	)		-		28			-		1,351
Losses charged off		(159	)		(234	)		(486	)		(134	)		-		(85	)		-		(1,098	)
Recoveries		-			71			7			123			-		52			-		253
Balance, end of year	$	320			2,296			712			108			-		1			-		3,437

Individually evaluated for impairment	$	159			607			138			-			-		-			-		904
Collectively evaluated for impairment		161			1,689			574			108			-		1			-		2,533
Balance, end of year	$	320			2,296			712			108			-		1			-		3,437

Loans:
Individually evaluated for impairment	$	264			9,851			5,023			7			-		-			-		15,145
Collectively evaluated for impairment		25,946			220,177			178,347			10,624			1,668		1,876			-		438,638
Balance, end of year	$	26,210			230,028			183,370			10,631			1,668		1,876			-		453,783

December 31, 2011
Allowance for loan losses:
Balance, beginning of year	$	305			1,625			459			246			-		6			-		2,641
Provision charged to expenses		438			884			678			50			-		39			-		2,089
Losses charged off		(581	)		(598	)		(512	)		(252	)		-		(127	)		-		(2,070	)
Recoveries		-			30			31			122			-		88			-		271
Balance, end of year	$	162			1,941			656			166			-		6			-		2,931

Individually evaluated for impairment	$	-			257			142			-			-		-			-		399
Collectively evaluated for impairment		162			1,684			514			166			-		6			-		2,532
Balance, end of year	$	162			1,941			656			166			-		6			-		2,931

Loans:
Individually evaluated for impairment	$	3,058			14,493			596			10			-		-			-		18,157
Collectively evaluated for impairment		27,915			204,569			186,552			14,680			2,835		6,554			-		443,105
Balance, end of year	$	30,973			219,062			187,148			14,690			2,835		6,554			-		461,262

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 3 -

LOANS (Continued)

	Commercial & Industrial			Commercial, Secured by Real Estate			Residential Real Estate			Consumer			Agricultural		Other			Unallocated			Total
December 31, 2010
Allowance for loan losses:
Balance, beginning of year	$	546			1,628			491			313			-		9			11			2,998
Provision charged to expenses		13			1,102			297			235			-		44			(11	)		1,680
Losses charged off		(289	)		(1,105	)		(331	)		(422	)		-		(144	)		-			(2,291	)
Recoveries		35			-			2			120			-		97			-			254
Balance, end of year	$	305			1,625			459			246			-		6			-			2,641

Individually evaluated for impairment	$	120			176			-			-			-		-			-			296
Collectively evaluated for impairment		185			1,449			459			246			-		6			-			2,345
Balance, end of year	$	305			1,625			459			246			-		6			-			2,641

Loans:
Individually evaluated for impairment	$	1,370			11,197			533			-			-		-			-			13,100
Collectively evaluated for impairment		34,739			184,865			189,996			19,912			2,966		9,413			-			441,891
Balance, end of year	$	36,109			196,062			190,529			19,912			2,966		9,413			-			454,991

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 3 -

LOANS (Continued)

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

Pass – loans categorized in this category are higher quality loans that do not fit any of the other categories described below.

Other Assets Especially Mentioned (OAEM) - loans in this category are currently protected but are potentially weak. These loans constitute a risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitute an undue risk in light of the circumstances surrounding a specific asset.

Substandard – loans in this category are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful – loans classified in this category have all the weaknesses inherent in loans classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 3 -

LOANS (Continued)

An analysis of the Company’s loan portfolio by credit quality indicators at December 31is as follows (in thousands):

	Pass		OAEM		Substandard		Doubtful		Total
December 31, 2012
Commercial & industrial	$	22,965		1,804		1,177		264		26,210
Commercial, secured by real estate		218,246		2,653		9,022		107		230,028
Residential real estate		172,589		2,353		8,130		298		183,370
Consumer		10,549		-		62		20		10,631
Agricultural		1,665		-		3		-		1,668
Other		1,876		-		-		-		1,876
Total	$	427,890		6,810		18,394		689		453,783

December 31, 2011
Commercial & industrial	$	26,099		1,700		2,804		370		30,973
Commercial, secured by real estate		206,728		2,133		9,633		568		219,062
Residential real estate		182,409		1,681		2,682		376		187,148
Consumer		14,601		-		50		39		14,690
Agricultural		1,430		-		1,405		-		2,835
Other		6,554		-		-		-		6,554
Total	$	437,821		5,514		16,574		1,353		461,262

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Table of Contents

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 3 -

LOANS (Continued)

A loan portfolio aging analysis at December 31 is as follows (in thousands):

	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans Greater Than 90 Days and Accruing

December 31, 2012
Commercial & industrial	$	-		1		264		265		25,945		26,210		-
Commercial, secured by real estate		346		79		788		1,213		228,815		230,028		-
Residential real estate		791		212		1,172		2,175		181,195		183,370		103
Consumer		61		57		25		143		10,488		10,631		25
Agricultural		-		-		-		-		1,668		1,668		-
Other		72		-		-		72		1,804		1,876		-
Total	$	1,270		349		2,249		3,868		449,915		453,783		128

December 31, 2011
Commercial & industrial	$	2		-		495		497		30,476		30,973		-
Commercial, secured by real estate		-		83		1,769		1,852		217,210		219,062		-
Residential real estate		1,132		22		1,202		2,356		184,792		187,148		-
Consumer		82		37		39		158		14,532		14,690		39
Agricultural		-		-		-		-		2,835		2,835		-
Other		59		-		-		59		6,495		6,554		-
Total	$	1,275		142		3,505		4,922		456,340		461,262		39

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Table of Contents

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 3 -

LOANS (Continued)

Impaired loans for the years ended December 31 were as follows (in thousands):

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
December 31, 2012
With no related allowance recorded:
Commercial & industrial	$	-		-		-		975		43
Commercial, secured by real estate		9,541		9,936		-		9,310		350
Residential real estate		417		417		-		397		5
Consumer		20		20		-		23		2
Total	$	9,978		10,373		-		10,705		400

With an allowance recorded:
Commercial & industrial	$	264		822		159		374		-
Commercial, secured by real estate		4,258		4,360		660		4,765		171
Residential real estate		658		853		85		707		2
Consumer		-		-		-		4		-
Total	$	5,180		6,035		904		5,850		173

Total:
Commercial & industrial	$	264		822		159		1,349		43
Commercial, secured by real estate		13,799		14,296		660		14,075		521
Residential real estate		1,075		1,270		85		1,104		7
Consumer		20		20		-		27		2
Total	$	15,158		16,408		904		16,555		573

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Table of Contents

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 3 -

LOANS (Continued)

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
December 31, 2011
With no related allowance recorded:
Commercial & industrial	$	2,881		3,211		-		3,015		139
Commercial, secured by real estate		12,373		12,587		-		12,686		529
Residential real estate		332		332		-		332		-
Consumer		8		8		-		5		1
Total	$	15,594		16,138		-		16,038		669

With an allowance recorded:
Commercial & industrial	$	177		177		-		330		14
Commercial, secured by real estate		2,120		3,136		257		2,514		67
Residential real estate		264		264		142		257		-
Consumer		2		2		-		1		-
Total	$	2,563		3,579		399		3,102		81

Total:
Commercial & industrial	$	3,058		3,388		-		3,345		153
Commercial, secured by real estate		14,493		15,723		257		15,200		596
Residential real estate		596		596		142		589		-
Consumer		10		10		-		6		1
Total	$	18,157		19,717		399		19,140		750

Of the $750,000 of interest income recognized on impaired loans during 2011, $8,000 was recognized on a cash basis. During 2010, the Company recognized approximately $552,000 of interest income on impaired loans, none of which was recognized on a cash basis. The Company continued to accrue interest on certain loans classified as impaired during 2012, 2011, and 2010 because they were restructured or considered well secured and in the process of collection.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 3 -

LOANS (Continued)

Loan modifications that were classified as troubled debt restructurings during the years ended December 31 were as follows (dollars in thousands):

	2012				2011
	Number of Loans		Balance at Modification		Number of Loans		Balance at Modification

Commercial and industrial		-	$	-		5	$	2,718
Commercial, secured by real estate		-		-		4		3,048
Residential real estate		6		449		6		477
Consumer		2		20		3		11
		8	$	469		18	$	6,254

Each restructured loan is separately negotiated with the borrower and includes terms and conditions that reflect the borrower’s ability to pay the debt as modified. Modifications may include interest only payments for a period of time, temporary or permanent reduction of the loan’s interest rate, capitalization of delinquent interest, or extensions of the maturity date.

LCNB is not committed to lend additional funds to borrowers whose loan terms were modified in a troubled debt restructuring.

Troubled debt restructurings that subsequently defaulted within twelve months of the restructuring date during the years ended December 31, 2012 and 2011 were not material.

Approximately $200,000 of impaired loans without a valuation allowance and $258,000 of impaired loans with a valuation allowance at December 31, 2012 consisted of loans that were modified during 2012 and were determined to be troubled debt restructurings. Approximately $5,358,000 of impaired loans without a valuation allowance and $832,000 of impaired loans with a valuation allowance at December 31, 2011 consisted of loans that were modified during 2011 and were determined to be troubled debt restructurings.

Mortgage loans sold to and serviced for the Federal Home Loan Mortgage Corporation and other investors are not included in the accompanying consolidated balance sheets. The unpaid principal balances of those loans at December 31, 2012, 2011 and 2010 were approximately $71,568,000, $67,410,000, and $70,705,000 respectively.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 3 -

LOANS (Continued)

Mortgage servicing right assets are included in other assets in the consolidated balance sheets. Amortization of mortgage servicing rights is an adjustment to loan servicing income, which is included with other operating income in the consolidated statements of income. Activity in the mortgage servicing rights portfolio during the years ended December 31 was as follows (in thousands):

	2012			2011			2010
Balance, beginning of year	$	418			474			327
Amount capitalized to mortgage servicing rights		283			99			258
Amortization of mortgage servicing rights		(226	)		(155	)		(111	)
Balance, end of year	$	475			418			474

NOTE 4 –

OTHER REAL ESTATE OWNED

Other real estate owned includes property acquired through foreclosure or deed-in-lieu of foreclosure and also includes property deemed to be in-substance foreclosed and are included in “other assets” in the consolidated balance sheets. Changes in other real estate owned were as follows (in thousands):

	2012			2011
Balance, beginning of year	$	1,619			2,088
Additions		875			-
Reductions due to sales		(21	)		(469	)
Reductions due to valuation write downs		(284	)		-
Balance, end of year	$	2,189			1,619

Other real estate owned at December 31 consisted of (dollars in thousands):

	2012				2011
	Number		Amount		Number		Amount

Commercial real estate		2	$	1,875		1	$	1,579
Residential real estate		8		314		1		40
		10	$	2,189		2	$	1,619

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 5 -

PREMISES AND EQUIPMENT

Premises and equipment at December 31 are summarized as follows (in thousands):

	2012		2011

Land	$	4,708		4,708
Buildings		15,616		15,488
Equipment		11,280		11,528
Construction in progress		-		8
Total		31,604		31,732
Less accumulated depreciation		15,040		14,386
Premises and equipment, net	$	16,564		17,346

Depreciation charged to expense was $1,256,000 in 2012, $1,182,000 in 2011, and $1,056,000 in 2010.

NOTE 6 -

LEASES

Some of the Bank's branches, telephone equipment, and other equipment are leased under agreements expiring at various dates through 2050. These leases are accounted for as operating leases. The leases generally provide for renewal options and most require periodic changes in rental amounts based on various indices. Minimum annual rentals for each of the years 2013 through 2017 and thereafter for non-cancelable leases having terms in excess of one year are as follows (in thousands):

2013	$	349
2014		318
2015		283
2016		244
2017		231
Thereafter		4,060
Total	$	5,485

Rental expense for all leased branches and equipment was approximately $451,000 in 2012, $453,000 in 2011, and $448,000 in 2010.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 7 -

GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill relating to the acquisition of Sycamore was $5,915,000 at December 31, 2012 and 2011.

Other intangible assets included in other assets in the consolidated balance sheets at December 31, 2012 and 2011 were as follows (in thousands):

	Gross Intangible Assets		Accumulated Amortization		Net Intangible Assets

December 31, 2012:
Core deposit intangible	$	343		286		57
Mortgage servicing rights		1,453		978		475
Total	$	1,796		1,264		532

December 31, 2011:
Core deposit intangible	$	343	229	114
Mortgage servicing rights		1,169	751	418
Other intangibles		89	89	-
Total	$	1,601	1,069	532

The estimated aggregate future amortization expense for each of the next five years for intangible assets remaining as of December 31, 2012 is as follows (in thousands):

2013	$	178
2014		99
2015		82
2016		68
2017		54

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Table of Contents

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 8 -

CERTIFICATES OF DEPOSIT

Contractual maturities of time deposits at December 31, 2012 were as follows (in thousands):

	Certificates
	Equal to or		All Other
	Over $100,000		Certificates		Total

2013	$	27,324		53,545		80,869
2014		16,037		29,704		45,741
2015		6,394		15,286		21,680
2016		3,261		5,835		9,096
2017		822		3,933		4,755
Thereafter		10,643		5,996		16,639
	$	64,481		114,299		178,780

NOTE 9 -

BORROWINGS

Funds borrowed from the FHLB at December 31 are as follows (in thousands):

	Current
	Interest
	Rate			2012		2011

Fixed Rate Advances, due at maturity:
Advance due August 2012		1.99	%	$	-		6,000
Advance due January 2015		2.00	%		5,000		5,000
Advance due March 2017		5.25	%		5,000		5,000

Fixed Rate Advances, with monthly principal and interest payments:
Advance due March 2014		2.45	%		1,308		2,326
Advance due March 2019		2.82	%		2,397		3,047
				$	13,705		21,373

All advances from the FHLB are secured by a blanket pledge of the Company’s 1-4 family first lien mortgage loans in the amount of approximately $142 million and $147 million at December 31, 2012 and 2011, respectively. Additionally, the Company was required to hold minimum levels of FHLB stock, based on the outstanding borrowings. Total remaining borrowing capacity, including short-term borrowing arrangements, at December 31, 2012 was approximately $31.8 million. One of the factors limiting remaining borrowing capacity is ownership of FHLB stock. The Company could increase its remaining borrowing capacity by purchasing additional FHLB stock.

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Table of Contents

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 9 -

BORROWINGS (continued)

Short-term borrowings at December 31 are as follows (in thousands):

	2012					2011
	Amount		Rate			Amount		Rate
Line of credit	$	2,661		0.75	%	$	-		-	%
FHLB short-term advance		-					12,000		0.04	%
Repurchase agreements		11,095		0.10	%		9,596		0.10	%
	$	13,756		0.23	%	$	21,596		0.07	%

At December 31, 2012, the Company had short-term borrowing arrangements with three financial institutions and the Federal Home Loan Bank of Cincinnati. The first arrangement provides that the Company can borrow up to $7 million in federal funds at the interest rate in effect at the time of the borrowing. The second arrangement provides that the Company can borrow up to $10 million in federal funds at the interest rate in effect at the time of the borrowing. The third arrangement is a short-term line of credit for a maximum amount of $20 million at an interest rate equal to the lending institution’s federal funds rate plus a spread of 50 basis points.

Under the terms of the Cash Management Advance program with the Federal Home Loan Bank of Cincinnati, the Company can borrow up to $39.4 million in short-term advances, subject to total remaining borrowing capacity limitations. The Company has the option of selecting a variable rate of interest for up to 90 days or a fixed rate of interest for up to 30 days. The interest rate on the Cash Management Advance program is the published rate in effect at the time of the advance. This agreement expires on August 29, 2013.

Repurchase agreements are an option customers may use in managing their cash positions. The repurchase agreements mature the next business day after issuance. They are secured by U.S. Treasury, U.S. Agency, or government guaranteed mortgage-backed securities and such collateral securities are held by the Federal Reserve Bank. The maximum amount of outstanding agreements at any month-end during 2012 and 2011 totaled $13,142,000 and $12,402,000, respectively. The average balance during 2012 and 2011 was $11,390,000 and $11,029,000, respectively.

As of December 31, 2012 and 2011, approximately $1.7 million and $1.6 million, respectively, of the repurchase agreements outstanding were held by a company owned by a member of the Company’s Board of Directors.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 10 -

INCOME TAXES

The provision for federal income taxes consists of (in thousands):

	2012		2011			2010

Income taxes currently payable	$	2,764		2,441			2,564
Deferred income tax provision (benefit)		31		(231	)		(70	)
Provision for income taxes	$	2,795		2,210			2,494

A reconciliation between the statutory income tax and the Company's effective tax rate follows:

	2012			2011			2010

Statutory tax rate		34.0	%		34.0	%		34.0	%
Increase (decrease) resulting from -
Tax exempt interest		(7.2	)%		(7.7	)%		(8.6	)%
Tax exempt income on bank owned life insurance		(1.8	)%		(1.9	)%		(4.1	)%
Other – net		0.3	%		(1.2	)%		0.1	%
Effective tax rate		25.3	%		23.2	%		21.4	%

Deferred tax assets and liabilities at December 31 consist of the following (in thousands):

	2012			2011
Deferred tax assets:
Allowance for loan losses	$	1,169			997
Write-down of other real estate owned		185			89
Pension and deferred compensation		1,189			1,232
Other		23			-
		2,566			2,318

Deferred tax liabilities:
Depreciation of premises and equipment		(987	)		(796	)
Unrealized gains on securities available-for-sale		(2,511	)		(2,668	)
Amortization of intangibles		(181	)		(89	)
Deferred loan fees		(5	)		(9	)
FHLB stock dividends		(267	)		(267	)
		(3,951	)		(3,829	)
Net deferred tax liability	$	(1,385	)		(1,511	)

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Table of Contents

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 10 -

INCOME TAXES (continued)

As of December 31, 2012 and 2011 there were no unrecognized tax benefits and the Company does not anticipate the total amount of unrecognized tax benefits will significantly change within the next twelve months. There were no amounts recognized for interest and penalties in the consolidated statements of income for the three-year period ended December 31, 2012.

The Company is no longer subject to examination by federal tax authorities for years before 2009.

NOTE 11 -

COMMITMENTS AND CONTINGENT LIABILITIES

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. They involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contract amount of those instruments.

The Company offers the Bounce Protection product, a customer deposit overdraft program, which is offered as a service and does not constitute a contract between the customer and LCNB.

The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Financial instruments whose contract amounts represent off-balance-sheet credit risk at December 31 were as follows (in thousands):

	2012		2011
Commitments to extend credit:
Commercial loans	$	13,625		3,227
Other loans:
Fixed rate		4,602		1,391
Adjustable rate		1,238		2,099
Unused lines of credit:
Fixed rate		3,368		3,883
Adjustable rate		45,199		55,274
Unused overdraft protection amounts on demand and NOW accounts		9,665		9,810
Standby letters of credit		5,109		5,575
	$	82,806		81,259

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Table of Contents

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 11 -

COMMITMENTS AND CONTINGENT LIABILITIES (continued)

Standby letters of credit at December 31, 2012 include a letter of credit in the amount of $80,000 to a company of which a member of LCNB’s Board of Directors is a partner.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract or agreement. Unused lines of credit include amounts not drawn on line of credit loans. Commitments to extend credit and unused lines of credit generally have fixed expiration dates or other termination clauses.

Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. At December 31, 2012 and 2011, outstanding guarantees of approximately $346,000 and $546,000, respectively, were issued to various types of businesses. These guarantees generally are fully secured and have varying maturities. In addition, the Company has a participation in four letters of credit securing payment of principal and interest on a bond issue. The participation amounts at December 31, 2012 and 2011 totaled approximately $4.8 million and $5.0 million, respectively. The letters of credit have a final maturity date of July 15, 2015, as extended.

The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company, is based on management’s credit evaluation of the borrower. Collateral held varies, but may include accounts receivable; inventory; property, plant and equipment; residential realty; and income-producing commercial properties.

The Company and its subsidiaries are parties to various claims and proceedings arising in the normal course of business. Management, after consultation with legal counsel, believes that the liabilities, if any, arising from such proceedings and claims will not be material to the consolidated financial position or results of operations.

NOTE 12 -

REGULATORY MATTERS

The Federal Reserve Act requires depository institutions to maintain cash reserves with the Federal Reserve Bank. In 2012 and 2011, the Bank maintained average reserve balances of $10,658,000 and $9,348,000, respectively. The reserve balances at December 31, 2012 and 2011 were $6,438,000 and $4,371,000, respectively.

The principal source of income and funds for LCNB Corp. is dividends paid by the Bank. The payment of dividends is subject to restriction by regulatory authorities. For 2012, the restrictions generally limit dividends to the aggregate of net income for the year 2012 plus the net earnings retained for 2011 and 2010. In addition, dividend payments may not reduce capital levels below minimum regulatory guidelines. At December 31, 2012, approximately $10,517,000 of the Bank’s earnings retained was available for dividends in 2013 under this guideline. Dividends in excess of these limitations would require the prior approval of the Comptroller of the Currency.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 12 -

REGULATORY MATTERS (continued)

The Company (consolidated) and the Bank must meet certain minimum capital requirements set by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company's and Bank's financial statements. The Company’s and Bank’s capital amounts and classification are also subject to qualitative judgments by regulators about components, risk weightings, and other factors. For various regulatory purposes, institutions are classified into categories based upon capital adequacy.

Minimum capital requirements and capital levels needed to be considered well-capitalized at December 31, 2012 and 2011 are:

	Minimum Requirement	To Be Considered Well-Capitalized
Ratio of tier 1 capital to risk-weighted assets	4.0%	6.0%
Ratio of total capital (tier 1 capital plus tier 2 capital) to risk-weighted assets	8.0%	10.0%
Leverage ratio (tier 1 capital to adjusted quarterly average total assets)	3.0%	5.0%

As of the most recent notification from their regulators, the Company and Bank were categorized as "well-capitalized" under the regulatory framework for prompt corrective action. Management believes that no conditions or events have occurred since the last notification that would change the Bank's category.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 12 -

REGULATORY MATTERS (continued)

A summary of the regulatory capital of the Consolidated Company and Bank at December 31 follows (dollars in thousands):

	2012						2011
	Consolidated						Consolidated
	Company			Bank			Company			Bank

Regulatory Capital:
Shareholders' equity	$	82,006			76,999			77,960			72,897
Goodwill and other intangible assets		(6,019	)		(6,019	)		(6,071	)		(6,071	)
Accumulated other comprehensive income		(4,721	)		(4,672	)		(5,028	)		(4,974	)
Tier 1 risk-based capital		71,266			66,308			66,861			61,852
Eligible allowance for loan losses		3,437			3,437			2,931			2,931
Total risk-based capital	$	74,703			69,745			69,792			64,783

Capital Ratios:
Total risk-based		15.86	%		14.86	%		14.54	%		13.55	%
Tier 1 risk-based		15.13	%		14.13	%		13.93	%		12.94	%
Leverage		8.98	%		8.40	%		8.51	%		7.90	%

LCNB Corp. filed a Registration Statement on Form S-3 with the SEC on July 27, 2011 to register 400,000 shares for use in its Amended and Restated Dividend Reinvestment and Stock Purchase Plan (the “Amended Plan”). Formerly LCNB purchased the shares needed for its Dividend and Stock Purchase Plan in the secondary market. Under the Amended Plan, LCNB has the option of purchasing shares in the secondary market, using treasury shares, or issuing new shares.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 13 -

RETIREMENT PLANS

Prior to January 1, 2009, the Company had a single-employer qualified noncontributory defined benefit retirement plan that covered substantially all regular full-time employees. Effective January 1, 2009, the Company redesigned the plan and merged it into a multiple-employer plan, which is accounted for as a multi-employer plan because assets contributed by an employer are not segregated in a separate account or restricted to provide benefits only to employees of that employer. Employees hired on or after January 1, 2009 are not eligible to participate in this plan.

Effective February 1, 2009, the Company amended the plan to reduce benefits for those whose age plus vesting service equaled less than 65 at that date. Also effective February 1, 2009, an enhanced 401(k) plan was made available to those hired on or after January 1, 2009 and to those who received benefit reductions from the amendments to the noncontributory defined benefit retirement plan. Employees hired on or after January 1, 2009 receive a 50% employer match on their contributions into the 401(k) plan, up to a maximum company contribution of 3% of each individual employee’s annual compensation. Employees who received a benefit reduction under the retirement plan amendments receive an automatic contribution of 5% or 7% of annual compensation, depending on the sum of an employee’s age and vesting service, into the 401(k) plan, regardless of the contributions made by the employees. This contribution is made annually and these employees will not receive any employer matches to their 401(k) contributions.

Certain information pertaining to the qualified noncontributory defined benefit retirement plan is as follows:

Legal name		Pentegra Defined Benefit Plan for Financial Institutions
Plan’s employer identification number		13-5645888
Plan number		333

The plan is at least 80% funded as of July 1, 2012 and 2011. A funding improvement or rehabilitation plan has not been implemented, nor has a surcharge been paid to the plan.

Funding and administrative costs of the qualified noncontributory defined benefit retirement plan and 401(k) plan charged to salaries and employee benefits in the consolidated statements of income for the years ended December 31 were as follows (in thousands):

	2012		2011		2010

Qualified noncontributory defined benefit retirement plan	$	355		543		360

401(k) plan		275		290		277

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Table of Contents

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 13 -

RETIREMENT PLANS (Continued)

The Company expects to contribute $125,000 to the qualified noncontributory defined benefit retirement plan in 2013. The Company expects to contribute $249,000 to the 401(k) plan in 2013. The Company’s contributions to the qualified noncontributory defined benefit retirement plan do not represent more than 5% of total contributions to the plan.

The Bank has a benefit plan which permits eligible officers to defer a portion of their compensation. The deferred compensation balance, which accrues interest at 8% annually, is distributable in cash after retirement or termination of employment. The amount of such deferred compensation liability at December 31, 2012 and 2011 was $2,442,000 and $2,248,000, respectively.

The Bank also has a supplemental income plan which provides a covered employee an amount based on a percentage of average compensation, payable annually for ten years upon retirement. The projected benefit obligation included in other liabilities for this supplemental income plan at December 31, 2012 and 2011 is $476,000 and $436,000, respectively. The discount rate used to determine the present value of the obligation was 4.50% and 5.25% in 2012 and 2011, respectively. The service cost associated with this plan was $20,000 for 2012, $20,000 for 2011, and $18,000 for 2010. Interest costs were $20,000, $21,000, and $19,000 for 2012, 2011, and 2010, respectively.

The deferred compensation plan and the supplemental income plan are both nonqualified and unfunded. Participation in each plan is limited to a select group of management.

Effective February 1, 2009, the Company established a nonqualified defined benefit retirement plan, which is also unfunded, for certain highly compensated employees. The nonqualified plan ensures that participants receive the full amount of benefits to which they would have been entitled under the noncontributory defined benefit retirement plan in the absence of limits on benefit levels imposed by certain sections of the Internal Revenue Code.

The components of net periodic pension cost of the nonqualified defined benefit retirement plan for the years ended December 31 are summarized as follows (in thousands):

	2012		2011			2010
Service cost	$	89		111			174
Interest cost		43		35			32
Amortization of unrecognized (gain) loss		20		(28	)		(1	)
Amortization of unrecognized prior service cost		29		32			48
Net periodic pension cost	$	181		150			253

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 13 -

RETIREMENT PLANS (Continued)

A reconciliation of changes in the projected benefit obligation of the nonqualified defined benefit retirement plan at December 31 follows (in thousands):

	2012		2011			2010
Projected benefit obligation at beginning of year	$	969		636			544
Service cost		89		111			174
Interest cost		43		35			32
Actuarial (gain) or loss		52		305			(114	)
Settlements		-		(74	)		-
Curtailment		-		(44	)		-
Projected benefit obligation at end of year	$	1,153		969			636

Amounts recognized in other liabilities in the consolidated balance sheets for the nonqualified defined benefit retirement plan at December 31, 2012 and 2011 were $1,153,000 and $969,000, respectively.

The accumulated benefit obligation for the nonqualified defined benefit retirement plan at December 31, 2012 and 2011 was $854,000 and $609,000, respectively.

Amounts recognized in accumulated other comprehensive income at December 31 for the nonqualified defined benefit retirement plan consists of (in thousands):

	2012		2011		2010
Net actuarial (gain)/loss	$	125		103		(117	)
Past service cost		29		49		225
	$	154		152		108

The estimated amounts that will be amortized from accumulated other comprehensive income into net periodic benefit cost during 2013 for the nonqualified defined benefit retirement plan are (in thousands):

Net actuarial loss	$	25
Past service cost		29
	$	54

The measurement date used to determine the current year’s benefit obligation for the nonqualified defined benefit retirement plan was December 31, 2012.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 13 -

RETIREMENT PLANS (Continued)

Key weighted-average assumptions used to determine the benefit obligation and net periodic pension costs for the nonqualified defined benefit retirement plan for the years ended December 31 were as follows:

	2012			2011			2010
Benefit obligation:
Discount rate		4.05	%		4.40	%		5.54	%
Salary increase rate		3.00	%		3.00	%		3.00	%

Net periodic pension cost:
Discount rate		4.40	%		5.54	%		5.92	%
Salary increase rate		3.00	%		3.00	%		4.00	%
Amortization period in years		2.98			6.92/3.48			7.90

The nonqualified defined benefit retirement plan is not funded. Therefore no contributions will be made in 2012. Estimated future benefit payments reflecting expected future service for the years ended after December 31, 2012 are (in thousands):

2013			15
2014			15
2015			54
2016			59
2017			112
2018-2022			559

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 14 -

STOCK BASED COMPENSATION

The Company established an Ownership Incentive Plan (the "Plan") during 2002 that allows for stock-based awards to eligible employees, as determined by the Board of Directors. The awards may be in the form of stock options, share awards, and/or appreciation rights. The Plan provides for the issuance of up to 200,000 shares.

Options granted to date vest ratably over a five year period and expire ten years after the date of grant. Stock options outstanding at December 31, 2012 were as follows:

		Outstanding Stock Options						Exercisable Stock Options
Exercise Price Range		Number		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)		Number		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)

$	9.00 - $10.99		25,360	$	9.00		6.1		15,214	$	9.00		6.1
$	11.00 - $12.99		65,708		12.04		7.6		20,577		12.03		6.5
$	13.00 - $14.99		-		-		-		-		-		-
$	17.00 - $18.99		19,518		18.15		2.7		19,518		18.15		2.7
			110,586		12.42		6.4		55,309		13.36		5.0

The following table summarizes stock option activity for the years indicated:

	Year ended December 31,
	2012					2011				2010
	Options			Weighted Average Exercise Price		Options		Weighted Average Exercise Price		Options		Weighted Average Exercise Price
Outstanding, beginning of year		124,123		$	12.54		99,040	$	12.71		78,242	$	13.04
Granted		14,491			12.60		25,083		11.85		20,798		11.50
Exercised or cancelled		(8,676	)		13.09		-		-		-		-
Expired		(19,352	)		13.01		-		-		-		-
Outstanding, end of year		110,586			12.42		124,123		12.54		99,040		12.71
Exercisable, end of year		55,309			13.36		66,709		13.69		41,770		14.78

During 2012, the Company received cash of $28,000 in connection with the exercise of 2,144 stock options. The Company also paid approximately $6,000 to certain option holders in connection with the cancellation of 6,532 options.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 14 -

STOCK BASED COMPENSATION (continued)

The aggregate intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) for options outstanding at December 31, 2012 that were “in the money” (market price greater than exercise price) was $228,000. The aggregate intrinsic value at that date for only the options that were exercisable was $106,000. The aggregate intrinsic value for options outstanding at December 31, 2011 that were in the money was $178,000 and the aggregate intrinsic value at that date for only the options that were exercisable was $71,000. The intrinsic value changes based on changes in the market value of the Company’s stock.

The fair value of options granted is estimated at the date of grant using the Black-Scholes option-pricing model. The following table shows the estimated weighted-average fair value of options granted and the assumptions used in calculating that value for the years indicated:

	2012			2011			2010
Estimated weighted-average fair value of options granted	$	2.80			2.09			2.27
Risk-free interest rate		0.84	%		2.84	%		3.34	%
Average dividend	$	0.64		$	0.64		$	0.57
Volatility factor of the expected market price of the Company's common stock		39.56	%		27.37	%		28.32	%
Average life in years		6.5			6.5			7.0

Total expense related to options included in salaries and wages in the consolidated statements of income for the years ended December 31, 2012, 2011, and 2010 was $41,000, $45,000, and $40,000, respectively. Total compensation cost related to option awards to be recognized ratably through the first quarter of 2017 is approximately $88,000.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 15 -

EARNINGS PER SHARE

Earnings per share for the years ended December 31 were calculated as follows (in thousands, except share and per share data):

	2012		2011		2010

Net income from continuing operations	$	8,270		7,322		9,133
Income from discontinued operations, net of taxes		-		793		240
Net income	$	8,270		8,115		9,373

Weighted average number of shares outstanding used in the calculation of basic earnings per common share		6,717,357		6,692,385		6,687,500

Add dilutive effect of:
Stock options		19,205		4,792		3,288
Stock warrant		65,913		54,422		45,834

Adjusted weighted average number of shares outstanding used in the calculation of diluted earnings per common share		6,802,475		6,751,599		6,736,622

Basic earnings per common share:
Continuing operations	$	1.23		1.09		1.37
Discontinued operations		-		0.12		0.03
Diluted earnings per common share:
Continuing operations		1.22		1.08		1.36
Discontinued operations		-		0.12		0.03

NOTE 16 -

RELATED PARTY TRANSACTIONS

The Company has entered into related party transactions with various directors and executive officers. Management believes these transactions do not involve more than a normal risk of collectability or present other unfavorable features. The following table provides of summary of the loan activity for these officers and directors for the years ended December 31 (in thousands):

	2012			2011

Beginning balances	$	712			911
Additions		889			152
Reductions		(493	)		(351	)
Ending Balance	$	1,108			712

Deposits from executive officers, directors and related interests of such persons held by the Company at December 31, 2012 and 2011 amounted to $5,527,000 and $4,943,000, respectively.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 17 -

FAIR VALUE OF FINANCIAL INSTRUMENTS

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

The Company utilizes a pricing service for determining the fair values of most of its investment securities. Fair value for U.S. Treasury Notes and corporate securities are determined based on market quotations (level 1). Fair value for most of the other investment securities is calculated using the discounted cash flow method for each security. The discount rates for these cash flows are estimated by the pricing service using rates observed in the market (level 2). Cash flow streams are dependent on estimated prepayment speeds and the overall structure of the securities given existing market conditions. In addition, the Company has invested in two mutual funds that invest in debt securities or loans that qualify for credit under the Community Reinvestment Act. The investment in one of the mutual funds is considered to have level 1 inputs because it is publically traded in an active market and it publishes a daily net asset value. The investment in the other mutual fund is considered to have level 2 inputs because, although its shares are not traded in an active market, an investor can have its interest in the fund redeemed for the balance of its capital account at any quarter-end assuming the fund is given a 60 day notice. The investment in this Fund is carried at cost and approximates fair value. Additionally, LCNB Corp. owns trust preferred securities in various financial institutions and equity securities in non-financial companies. Market quotations (level 1) are used to determine fair value for these investments.

Assets that may be recorded at fair value on a nonrecurring basis include impaired loans, other real estate owned, and other repossessed assets. A loan is considered impaired when management believes it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. Impaired loans are carried at the present value of estimated future cash flows using the loan’s existing rate or the fair value of collateral if the loan is collateral dependent, if this value is less than the loan balance. When the fair value of the collateral is based on an observable market price or current appraised value, the inputs are considered to be level 2. When an appraised value is not available and there is not an observable market price, the inputs are considered to be level 3.

Other real estate owned is adjusted to fair value upon transfer of the loan to foreclosed assets, usually based on an appraisal of the property. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. The inputs for a valuation based on current appraised value are considered to be level 2.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 17 -

FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)

The following table summarizes the valuation of LCNB’s assets recorded at fair value by input levels as of December 31 (in thousands):

			Fair Value Measurements at the End of the Reporting Period Using
	Fair Value Measurements		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Gains (Losses)
December 31, 2012
Recurring fair value measurements:
Investment securities available-for-sale:
U.S. Treasury notes	$	18,686		18,686		-		-
U.S. Agency notes		90,606		-		90,606		-
U.S. Agency mortgage-backed securities		52,541		-		52,541		-
Corporate securities		3,067		3,067		-		-
Municipal securities:
Non-taxable		73,882		-		73,882		-
Taxable		15,841		-		15,841		-
Mutual funds		2,168		1,168		1,000		-
Trust preferred securities		245		245		-		-
Equity securities		1,470		1,470		-		-
Total recurring fair value measurements	$	258,506		24,636		233,870		-

Nonrecurring fair value measurements:
Impaired loans	$	4,276		-		161		4,115		-
Other real estate owned and repossessed assets (a) (b)		2,189		-		2,189		-		(295	)
Total nonrecurring fair value measurements	$	6,465		-		2,350		4,115		(295	)

December 31, 2011
Recurring fair value measurement:
Investment securities available-for-sale:
U.S. Treasury notes	$	17,550		17,550		-		-
U.S. Agency notes		82,927		-		82,927		-
U.S. Agency mortgage-backed securities		52,287		-		52,287		-
Corporate securities		6,365		4,152		2,213		-
Municipal securities:
Non-taxable		69,703		-		69,703		-
Taxable		21,907		-		21,907		-
Mutual funds		2,125		1,125		1,000		-
Trust preferred securities		564		564		-		-
Equity securities		578		578		-		-
Total recurring fair value measurements	$	254,006		23,969		230,037		-

Nonrecurring fair value measurements:
Impaired loans	$	2,563		-		1,300		1,263		-
Other real estate owned and repossessed assets (c)		1,642		-		1,619		23		31
Total nonrecurring fair value measurements	$	4,205		-		2,919		1,286		31

(a)

Eight other real estate owned properties with a total carrying amount of $1,809,000 were written down to their combined fair value of $1,525,000, resulting in an impairment charge of $284,000. Another property was sold at a loss of $8,000. The write-downs and loss were included in other non-interest expense for the period.

(b)	Repossessed assets with a carrying value of $23,000 were sold for a combined total of $20,000, resulting in a net loss of $3,000, which was included in other non-interest expense for the period.

(c)	Repossessed assets with a carrying value of $117,000 were sold for a combined total of $148,000, resulting in a net gain of $31,000, which was included in other non-interest expense for the period.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 17 -

FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)

The following table is a reconciliation of the beginning and ending balances of recurring fair value measurements that use significant unobservable inputs (level 3) for the years ended December 31 (in thousands):

	2012		2011

Beginning balance	$	-		1,053
Dividends reinvested		-		40
Net change in unrealized gains (losses) included in other comprehensive income		-		32
Transfers out of level 3		-		(1,125	)
Ending balance	$	-		-

The inputs for an investment in a mutual fund were transferred out of level 3 into level 1 during the fourth quarter 2011 based on an analysis of the fund’s investments and the net asset value published by the fund.

Carrying amounts and estimated fair values of financial instruments as of December 31 were as follows (in thousands):

	2012				2011
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value

FINANCIAL ASSETS:
Cash and cash equivalents	$	13,475		13,475		19,535		19,535
Investment securities:
Available-for-sale		258,506		258,506		254,006		254,006
Held-to-maturity		15,424		15,424		10,734		10,734
Federal Reserve Bank stock		949		949		940		940
Federal Home Loan Bank stock		2,091		2,091		2,091		2,091
Loans, net		450,346		453,060		458,331		470,846

FINANCIAL LIABILITIES:
Deposits		671,471		675,964		663,562		669,383
Short-term borrowings		13,756		13,756		21,596		21,596
Long-term debt		13,705		14,724		21,373		22,570

The fair value of off-balance-sheet financial instruments at December 31, 2012 and 201 was not material.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 17 -

FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)

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

Cash and cash equivalents

The carrying amounts presented are deemed to approximate fair value.

Investment securities

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

Loans

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

Deposits

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.

Borrowings

The carrying amounts of federal funds purchased, repurchase agreements, and U.S. Treasury demand note borrowings are deemed to approximate fair value of short-term borrowings. For long-term debt, fair values are estimated based on the discounted value of expected net cash flows using current interest rates.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 17 -

FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)

The following table summarizes the categorization by input level of the Company’s financial assets and liabilities not recorded at fair value but for which fair value is disclosed at December 31 (in thousands):

			Fair Value Measurements at the End of the Reporting Period Using
	Fair Value Measurements		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2012
Assets:
Loans, net		448,784		-		448,784		-
Investment securities, non-taxable, held-to-maturity		15,424		-		-		15,424
Federal Reserve Bank stock		949		949		-		-
Federal Home Loan Bank stock		2,091		2,091		-		-

Liabilities:
Deposits		675,964		-		675,964		-
Long-term debt		14,724		-		14,724		-

December 31, 2011
Assets:
Loans, net	$	468,283		-		468,283		-
Investment securities, non-taxable, held-to-maturity		10,734		-		-		10,734
Federal Reserve Bank stock		940		940		-		-
Federal Home Loan Bank stock		2,091		2,091		-		-

Liabilities:
Deposits		669,383		-		669,383		-
Long-term debt		22,570		-		22,570		-

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 18 –

DISCONTINUED OPERATIONS

LCNB sold its insurance agency subsidiary on March 23, 2011 and therefore its financial results are reported in the income statements as income from discontinued operations, net of taxes. Income from discontinued operations for 2011 include the gain recognized from the sale less certain related closing costs, taxes, and a curtailment expense recognized in LCNB’s nonqualified defined benefit retirement plan due to the sale. The following table summarizes income from discontinued operations for the years indicated (in thousands):

	2011			2010

Revenue	$	381			1,685
Non-interest expenses		301			1,322
Income from operations before income taxes		80			363
Gain from sale of insurance agency		1,503			-
Closing costs related to sale		(60	)		-
Curtailment expense on nonqualified defined benefit retirement plan		(191	)		-
Provision for income taxes		(539	)		(123	)
Net income	$	793			240

NOTE 19 –

ACQUISITION

On October 9, 2012, LCNB and First Capital Bancshares, Inc. (“First Capital”) entered into an Agreement and Plan of Merger (“Merger Agreement”) pursuant to which First Capital was merged into LCNB on January 11, 2013 in a stock and cash transaction valued at approximately $20.2 million. Immediately following the merger of First Capital into LCNB, Citizens National Bank (“Citizens”), a wholly-owned subsidiary of First Capital, was merged into LCNB National Bank. Citizens operated six full–service branches with a main office and two other facilities in Chillicothe, Ohio and one branch in each of Frankfort, Ohio, Clarksburg, Ohio, and Washington Court House, Ohio. These offices became branches of LCNB after the merger.

Under the terms of the Merger Agreement, the shareholders of First Capital common stock was entitled to elect to receive, for each share of First Capital Common Stock, (i) $30.76 in cash, (ii) 2.329 common shares of LCNB (subject to an adjustment based upon the average closing price of LCNB common shares for the 25 trading days prior to the effective date of the merger), or (iii) a combination of cash and LCNB common stock. A First Capital shareholder’s election to receive cash or stock was subject to allocation procedures that ensured that no more than 50% and no less than 40% of the outstanding First Capital shares were exchanged for cash and that no more than 60% and no less than 50% of the outstanding First Capital shares were exchanged for LCNB common shares. LCNB issued 888,811 shares of stock, valued at $12.4 million on the date of the merger, and paid approximately $7.8 million in cash to effect the merger. At closing, the Company paid a successful effort fee of $250,000 to an investment banking firm in connection with the consummation of merger which was expensed in 2013.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 19 –

ACQUISITION (continued)

The acquisition will be accounted for in accordance with applicable accounting guidance. Accordingly, the assets and liabilities of First Capital will be recorded at estimated fair values at the acquisition date. The excess of the estimated fair value of LCNB common shares issued and the cash proceeds paid over the net fair values of the assets acquired, including identifiable intangible assets, and liabilities assumed will be recorded as goodwill. The results of operations will be included in the consolidated income statement from the date of the acquisition. Goodwill will be subject to an annual test for impairment and the amount impaired, if any, will be charged to expense at the time of impairment.

The estimated fair values of the assets and liabilities have not yet been determined. The recorded amounts reflected on the historic financial records of First Capital as of the acquisition date include total assets of approximately $152 million, consisting primarily of net loans of $103 million and investments of $23 million. Recorded liabilities totaling approximately $137 million consisted primarily of deposits totaling $135 million.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 20 -

PARENT COMPANY FINANCIAL INFORMATION

Condensed financial information for LCNB Corp., parent company only, follows (in thousands):

Condensed Balance Sheets:
December 31,
	2012		2011
Assets:
Cash on deposit with subsidiary	$	3,328		1,292
Investment securities available-for-sale, at fair value		1,715		4,211
Investment in subsidiary		76,998		72,897
Other assets		10		29
Total assets	$	82,051		78,429

Liabilities	$	45		470

Shareholders' equity		82,006		77,959
Total liabilities and shareholders' equity	$	82,051		78,429

Condensed Statements of Income
Year ended December 31,	2012			2011			2010

Income:
Dividends from subsidiaries	$	3,800			6,893			4,100
Interest and dividends		110			63			38
Gain from sale of Dakin Insurance Agency		-			1,503			-
Net gain/(loss) on sales of securities		63			10			-
Total income		3973			8,469			4,138

Total expenses		107			181			44

Income before income tax expense/benefit and equity in undistributed income of subsidiaries		3,866			8,288			4,094
Income tax (expense) benefit		(1	)		(444	)		2
Equity in undistributed income of subsidiaries		4,405			271			5,277
Net income	$	8,270			8,115			9,373

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Continued)

NOTE 20 -

PARENT COMPANY FINANCIAL INFORMATION (continued)

Condensed Statements of Cash Flows
Year ended December 31,	2012			2011			2010

Cash flows from operating activities:
Net income	$	8,270			8,115			9,373
Adjustments for non-cash items -
(Increase) decrease in undistributed income of subsidiaries		(4,405	)		(272	)		(5,277	)
Realized gain from sale of insurance agency		-			(1,503	)		-
Other, net		(403	)		184			(11	)
Net cash flows from operating activities		3,462			6,524			4,085

Cash flows from investing activities:
Purchases of securities available-for-sale		(872	)		(3,389	)		(500	)
Proceeds from maturities of securities available-for-sale		-			59			-
Proceeds from sales of available-for-sale securities		3,384			-			-
Proceeds from sale of insurance agency		-			2,000			-
Net cash flows from investing activities		2,512			(1,330	)		(500	)

Cash flows from financing activities:
Proceeds from issuance of common stock		333			193			-
Cash dividends paid on common stock		(4,299	)		(4,283	)		(4,280	)
Other		28			-			30
Net cash flows from financing activities		(3,938	)		(4,090	)		(4,250	)
Net change in cash		2,036			1,104			(665	)
Cash at beginning of year		1,292			188			853
Cash at end of year	$	3,328			1,292			188

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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures

None

Item 9A. Controls and Procedures

Disclosure Controls and Procedures

An evaluation of the effectiveness of LCNB’s internal controls over financial reporting was carried out under the supervision and with the participation of LCNB’s management, including the Chief Executive Officer and Chief Financial Officer. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that LCNB’s disclosure controls and procedures were effective as of the end of the period covered by this annual report.

Internal Control Over Financial Reporting

Information required by this item is set forth in the “Report of Management’s Assessment of Internal Control over Financial Reporting” and the “Report of Independent Registered Public Accounting Firm” included in Item 8 of this 2012 Annual Report on Form 10-K.

Changes in Internal Control over Financial Reporting

During the fourth quarter 2012, there were no changes in LCNB's internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, LCNB's internal control over financial reporting.

Item 9B. Other Information

None

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PART III

Portions of the Company’s Definitive Proxy Statement included in the Notice of Annual Meeting of Shareholders to be held April 23, 2013, which proxy statement will be mailed to shareholders within 120 days from the end of the fiscal year ended December 31, 2012, (the “Proxy Statement”) are incorporated by reference into Part III.

Item 10. Directors, Executive Officers and Corporate Governance

The information required by this item concerning the Executive Officers and Directors of the Registrant is incorporated herein by reference under the caption "Directors and Executive Officers" of the Proxy Statement.

The information required by this item concerning the Audit Committee and Code of Business Conduct and Ethics is incorporated herein by reference under the captions "Board of Directors Meetings and Committees," "Audit Committee Report," and "Code of Ethics" of the Proxy Statement.

The information required by this item concerning Section 16(a) Beneficial Ownership Reporting Compliance is incorporated herein by reference under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" of the proxy Statement.

Item 11. Executive Compensation

The information contained in the Proxy Statement under the captions "Board of Directors Meetings and Committees" "Compensation Committee Interlocks and Insider Participation" "Equity Compensation Plan Information," "Compensation of Executive Officers," and "Compensation Committee Report on Executive Compensation" is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The information contained in the Proxy Statement under the captions "Market Price of Stock and Dividend Data" and "Voting Securities and Principal Holders" is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information contained in the Proxy Statement under the captions "Election of Directors," "Directors and Executive Officers," "Board of Directors Meetings and Committees," and "Certain Relationships and Related Transactions" is incorporated herein by reference.

Item 14. Principal Accounting Fees and Services

The information contained in the Proxy Statement under the captions "Independent Registered Accounting Firm" and "Board of Directors Meetings and Committees" is incorporated herein by reference.

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PART IV

Item 15. Exhibits, Financial Statement Schedules

(a)1.		Financial Statements

		REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
		FINANCIAL STATEMENTS
		Consolidated Balance Sheets as of December 31, 2012 and 2011.
		Consolidated Statements of Income for the Years Ended December 31, 2012, 2011, and 2010.
		Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2012, 2011, and 2010.
		Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 2012, 2011, and 2010.
		Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011, and 2010.
		Notes to Consolidated Financial Statements

2.		Financial Statement Schedules – None

3.		Exhibits required by Item 601 Regulation S-K.

		(a) Exhibit No.	Exhibit Description
		2	Agreement and Plan of Merger dated as of October 9, 2012 by and between LCNB Corp. and First Capital Bancshares, Inc. – incorporated by reference to the Registrant’s Form S-4 filed on October 29, 2012, Part I, Annex A.
		3.1	Amended and Restated Articles of Incorporation of LCNB Corp., as amended – incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2010, Exhibit 3.1.
		3.2	Code of Regulations of LCNB Corp. - Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005, Exhibit 3(ii).
		4.1	Warrant to Purchase Shares of Common Stock of the Registrant, dated January 9, 2009 - incorporated by reference to the Registrant’s Current Report on Form 8-K filed on January 9, 2009, Exhibit 4.1.
		4.2	Letter Agreement, dated as of January 9, 2009 between the Registrant and the U.S. Department of the Treasury, which includes the Securities Purchase Agreement – Standard Terms – incorporated by reference to the Registrant’s Current Report on Form 8-K filed on January 9, 2009, Exhibit 10.1.
		4.3	Substitute Warrant to Purchase Shares of Common Stock of the Registrant, dated January 9, 2009 – incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2009, Exhibit 4.3.
		4.4	Repurchase Letter Agreement, dated as of October 21, 2009 between the Registrant and the U.S. Department of the Treasury – incorporated by reference to the Registrant’s Current Report on Form 8-K filed on October 21, 2009, Exhibit 10.1.
		10.1	LCNB Corp. Ownership Incentive Plan - incorporated by reference to Registrant's Form DEF 14A Proxy Statement pursuant to Section 14(a), dated March 15, 2002, Exhibit A (000-26121).

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Item 15. Exhibits, Financial Statement Schedules (continued)

		(a) Exhibit No.	Exhibit Description
		10.2	Form of Option Grant Agreement under the LCNB Corp. Ownership Incentive Plan - incorporated by reference to the Registrant’s Form 10-K for the fiscal year ended December 31, 2005, Exhibit 10.2.
		10.3	Letter Agreement, dated as of January 9, 2009 between the Registrant and the U.S. Department of the Treasury, which includes the Securities Purchase Agreement – Standard Terms - incorporated by reference to the Registrant’s Current Report on Form 8-K filed on January 9, 2009, Exhibit 10.1.
		10.4	Nonqualified Executive Retirement Plan – incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the period ended June 30, 2009, Exhibit 10.4.
		10.5	Repurchase Letter Agreement, dated as of October 21, 2009 between the Registrant and the U.S. Department of the Treasury – incorporated by reference to the Registrant’s Current Report on Form 8-K filed on October 21, 2009, Exhibit 10.1.
		10.6	Restricted Stock Grant Agreement, dated as of February 22, 2010, between the Registrant and Stephen P. Wilson – incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the period ended March 31, 2010, Exhibit 10.6.
		13.	Portions of LCNB Corp. 2012 Annual Report
		14.1	LCNB Corp. Code of Business Conduct and Ethics - incorporated by reference to Registrant’s 2003 Form 10-K, Exhibit 14.1.
		14.2	LCNB Corp. Code of Ethics for Senior Financial Officers - Incorporated by reference to Registrant’s 2003 Form 10-K, Exhibit 14.2.
		21.	LCNB Corp. Subsidiaries.
		23.	Consent of Independent Registered Public Accounting Firm.
		31.1	Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
		31.2	Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
		32.	Certification of Chief Executive Officer and Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.
		99.1	Certification of Chief Executive Officer Pursuant to Section 111(b)(4) of the Emergency Stabilization Act of 2008 - incorporated by reference to Registrant’s 2009 Form 10-K, Exhibit 99.1.
		99.2	Certification of Chief Financial Officer Pursuant to Section 111(b)(4) of the Emergency Stabilization Act of 2008 - incorporated by reference to Registrant’s 2009 Form 10-K, Exhibit 99.2.
		101	The following financial information from LCNB Corp.’s Annual Report on Form 10-K for the year ended December 31, 2012 is formatted in Extensible Business Reporting Language: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to Consolidated Financial Statements, tagged as blocks of text.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	LCNB Corp.
	(Registrant)


	/s/ Stephen P. Wilson
	Stephen P. Wilson
	Chief Executive Officer &
	Chairman of the Board of Directors
	February 25, 2013

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:

/s/ Stephen P. Wilson		/s/ Spencer S. Cropper
Stephen P. Wilson		Spencer S. Cropper
Chief Executive Officer &		Director
Chairman of the Board of Directors		February 25, 2013
(Principal Executive Officer)
February 25, 2013

/s/ Robert C. Haines II		/s/ William H. Kaufman
Robert C. Haines II		William H. Kaufman
Executive Vice President &		Director
Chief Financial Officer (Principal Financial and Accounting Officer)		February 25, 2013
February 25, 2013

/s/ Steve P. Foster		/s/ Anne E. Krehbiel
Steve P. Foster		Anne E. Krehbiel
President, Director		Director
February 25, 2013		February 25, 2013

		/s/ George L. Leasure
Rick L. Blossom		George L. Leasure
Director		Director
February 25, 2013		February 25, 2013

		/s/ Kathleen Porter Stolle
		Kathleen Porter Stolle
		Director
		February 25, 2013

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