Document
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.   20549

FORM 10-K

(Mark One)
☒
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
or
☐
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.
☐ Yes         ☒ 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.
☐ Yes         ☒ 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.   ☒ Yes         ☐ 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).
☒ Yes         ☐ 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.     ☐
 
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. 
☐ Large accelerated filer
☒ Accelerated filer
☐ Non-accelerated filer (Do not check if a smaller reporting company)
☐ Smaller reporting company

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

The aggregate market value of the registrant’s outstanding voting common stock held by nonaffiliates on June 30, 2016, determined using a per share closing price on that date of $15.80 as quoted on the NASDAQ Capital Market, was $150,816,000.

As of March 7, 2017, 9,993,223 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 25, 2017, which Proxy Statement will be mailed to shareholders within 120 days from the end of the fiscal year ended December 31, 2016 are incorporated by reference into Part III.
 
 
 
 
 



LCNB CORP.
For the Year Ended December 31, 2016

TABLE OF CONTENTS
PART I
Item 1.  Business
Item 1A.  Risk Factors
Item 2.  Properties
 
 
PART II
Item 9B.  Other Information
 
 
PART III
 
 
PART IV
 
 


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LCNB CORP. AND SUBSIDIARY



PART I


Item 1.  Business

FORWARD-LOOKING STATEMENTS

Certain statements made in this document regarding LCNB’s financial condition, results of operations, plans, objectives, future performance and business, are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. These forward-looking statements are identified by the fact they are not historical facts and include words such as “anticipate”, “could”, “may”, “feel”, “expect”, “believe”, “plan”, and similar expressions.

These forward-looking statements reflect management's current expectations based on all information available to management and its knowledge of LCNB’s business and operations. Additionally, LCNB’s financial condition, results of operations, plans, objectives, future performance and business are subject to risks and uncertainties that may cause actual results to differ materially. These factors include, but are not limited to:
1.
the success, impact, and timing of the implementation of LCNB’s business strategies;
2.
LCNB may incur increased charge-offs in the future;
3.
LCNB may face competitive loss of customers;
4.
changes in the interest rate environment may have results on LCNB’s operations materially different from those anticipated by LCNB’s market risk management functions;
5.
changes in general economic conditions and increased competition could adversely affect LCNB’s operating results;
6.
changes in other regulations and government policies affecting bank holding companies and their subsidiaries, including changes in monetary policies, could negatively impact LCNB’s operating results;
7.
LCNB may experience difficulties growing loan and deposit balances;
8.
the current economic environment poses significant challenges for us and could adversely affect our  financial condition and results of operations;
9.
deterioration in the financial condition of the U.S. banking system may impact the valuations of investments LCNB has made in the securities of other financial institutions resulting in either actual losses or other than temporary impairments on such investments; and
10.
the effects of the Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and the regulations promulgated and to be promulgated thereunder, which may subject LCNB and its subsidiary to a variety of new and more stringent legal and regulatory requirements which adversely affect their respective businesses. 

Forward-looking statements made herein reflect management's expectations as of the date such statements are made. Such information is provided to assist shareholders and potential investors in understanding current and anticipated financial operations of LCNB and is included pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. LCNB undertakes no obligation to update any forward-looking statement to reflect events or circumstances that arise after the date such statements are made. 

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.  


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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 National”), a wholly-owned subsidiary of First Capital, was merged into LCNB National Bank.  At that time, Citizens National’s 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 office in Clarksburg, Ohio was closed on January 24, 2017.

On January 24, 2014, LCNB purchased all of the outstanding stock of Eaton National Bank & Trust Co. ("Eaton National") from its holding company, Colonial Banc Corp., in a cash transaction totaling $24.75 million. Upon consummation of the transaction, Eaton National was merged into the Bank and its five offices became offices of the Bank. Two of these offices are located in Eaton, Ohio and one office is located in each of New Paris, Ohio, Lewisburg, Ohio, and West Alexandria, Ohio.

On April 30, 2015, LCNB consummated a merger with BNB Bancorp, Inc. (“BNB”) in a stock and cash transaction valued at approximately $13.5 million. Immediately following the merger of BNB into LCNB, Brookville National Bank ("Brookville National"), a wholly-owned subsidiary of BNB, was merged into LCNB National Bank. At that time, Brookville National's two offices, both located in Brookville, Ohio, became offices of LCNB.

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, Lifetime Checking accounts (a senior citizen program), individual retirement accounts, and certificates of deposit.  Additional supportive services include online banking, bill pay, mobile banking and telephone banking. Commercial customers also have both cash management and remote deposit capture products as potential options. 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”).

Loan products offered include commercial and industrial loans, commercial and residential real estate loans, agricultural 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 Trust and Investment Management Division of the Bank provides complete trust administrative, estate settlement, and fiduciary services and also offers investment management of trusts, agency accounts, individual retirement accounts, and foundations/endowments.

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, 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.

Primary Market Area

The Bank considers its primary market area to consist of counties where it has a physical presence and neighboring counties, which includes Southwestern and South Central Ohio. At February 29, 2017, the Bank had 35 offices, including a main office in Warren County, Ohio and branch offices in Warren, Butler, Clinton, Clermont, Hamilton, Montgomery, Preble, Ross, and Fayette Counties, Ohio, and 39 ATMs.

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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 CEO/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.

The ability to access and use technology is an increasingly competitive factor in the finance services industry. Technology relating to the delivery of financial services, the security and privacy of customer information, and the processing of information is evolving rapidly. LCNB must continually make technology investments to remain competitive in the finance services industry.

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 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.  

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:

1.
Required regulatory agencies to take "prompt corrective action" with financial  institutions that do not meet minimum capital requirements;
 
2.
Established five capital tiers:  well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized;


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3.
Imposed significant restrictions on the operations of a financial institution that is not rated well-capitalized or adequately capitalized;

4.
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;
 
5.
Implemented a risk-based premium system;

6.
Required an audit committee to be comprised of outside directors;
 
7.
Required a financial institution with more than $500 million in total assets to issue annual, audited financial statements prepared in conformity with U.S. generally accepted accounting principles; and

8.
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.  FDICIA does not relieve financial institutions that are public companies, such as LCNB, from internal control reporting and attestation requirements or audit committee independence requirements prescribed by the Sarbanes-Oxley Act of 2002 (see below).
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," as defined in the act, or "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:
 
1.
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 subsidiary is made known to the certifying officers by others within the company;

2.
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;
 
3.
Accelerated reporting of stock trades on Form 4 by directors and executive officers;
 
4.
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;

5.
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;
6.
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

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7.
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:

1.
Merging the Bank Insurance Fund and the Savings Association Insurance Fund into a new fund called the Deposit Insurance Fund, effective March 31, 2006;

2.
Increasing insurance coverage for retirement accounts from $100,000 to $250,000, effective April 1, 2006; and

3.
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.

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.
The Dodd-Frank Act established a new independent regulatory body within the Federal Reserve System known as the of Consumer Financial Protection Bureau (the “CFPB”).  The CFPB 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 CFPB 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 CFPB-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 CFPB.

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.

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 advisers 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.
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, 2016, LCNB employed 282 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.

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.

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.






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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,
 
2016
 
2015
 
2014
 
(Dollars in thousands)
Securities available-for-sale:
 
 
 
 
 
U.S. Treasury notes
$
28,145

 
72,846

 
62,560

U.S. Agency notes
85,400

 
139,889

 
83,637

U.S. Agency mortgage-backed securities
71,047

 
29,378

 
38,032

Certificates of deposit
—

 
249

 
3,086

Municipal securities
132,860

 
132,420

 
93,790

Mutual funds
2,482

 
2,466

 
2,461

Trust preferred securities
48

 
50

 
50

Equity securities
677

 
680

 
1,749

Total securities available-for-sale
320,659

 
377,978

 
285,365

 
 
 
 
 
 
Securities held-to-maturity:
 

 
 

 
 

Municipal securities
41,003

 
22,633

 
22,725

 
 
 
 
 
 
Federal Reserve Bank stock
2,732

 
2,732

 
2,346

Federal Home Loan Bank stock
3,638

 
3,638

 
3,638

Total securities
$
368,032

 
406,981

 
314,074



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Contractual maturities of securities at December 31, 2016, 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
Cost
 
Fair
Value
 
Yield
 
Amortized
Cost
 
Fair
Value
 
Yield
 
(Dollars in thousands)
U.S. Treasury notes:
 
 
 
 
 
 
 
 
 
 
 
  Within one year
$
—

 
—

 
—
%
 
$
—

 
—

 
—
%
  One to five years
17,063

 
17,099

 
1.91
%
 
—

 
—

 
—
%
Five to ten years
11,117

 
11,046

 
1.99
%
 
—

 
—

 
—
%
After ten years
—

 
—

 
—
%
 
—

 
—

 
—
%
Total U.S. Treasury notes
28,180

 
28,145

 
1.94
%
 
—

 
—

 
—
%
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Agency notes:
 

 
 

 
 

 
 

 
 

 
 

Within one year
3,956

 
3,965

 
1.19
%
 
—

 
—

 
—
%
One to five years
21,994

 
22,074

 
1.65
%
 
—

 
—

 
—
%
Five to ten years
61,148

 
59,361

 
1.92
%
 
—

 
—

 
—
%
After ten years
—

 
—

 
—
%
 
—

 
—

 
—
%
Total U.S. Agency notes
87,098

 
85,400

 
1.82
%
 
—

 
—

 
—
%
 
 
 
 
 
 
 
 
 
 
 
 
Municipal securities (1):
 

 
 

 
 

 
 

 
 

 
 

Within one year
8,408

 
8,499

 
3.60
%
 
3,955

 
3,959

 
2.54
%
One to five years
58,114

 
58,328

 
2.90
%
 
4,125

 
4,068

 
2.99
%
Five to ten years
59,685

 
58,882

 
3.07
%
 
10,081

 
9,845

 
2.98
%
After ten years
7,567

 
7,151

 
2.75
%
 
22,842

 
22,618

 
5.18
%
Total Municipal securities
133,774

 
132,860

 
3.01
%
 
41,003

 
40,490

 
4.17
%
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Agency mortgage-backed securities
72,402

 
71,047

 
1.92
%
 
—

 
—

 
—
%
Mutual funds
2,527

 
2,482

 
2.10
%
 
—

 
—

 
—
%
Trust preferred securities
49

 
48

 
7.78
%
 
—

 
—

 
—
%
Equity securities
632

 
677

 
8.30
%
 
—

 
—

 
—
%
 
 
 
 
 
 
 
 
 
 
 
 
Totals
$
324,662

 
320,659

 
2.36
%
 
41,003

 
40,490

 
4.17
%

(1)
Yields on tax-exempt obligations are computed on a taxable-equivalent basis based upon a 34.2% 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, 2016.

Loan Portfolio

Administration of the lending function is the responsibility of the Chief Lending Officer and certain senior lenders. Lenders perform their 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.


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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, real estate, and consumer lending.  Board approval is required on any loan with policy exceptions or that will exceed $3.0 million in aggregate credit to any one borrower or entity, as defined by the OCC in 12 C.F.R § 32.2(b).

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.

The following table summarizes the distribution of the loan portfolio for the years indicated:
 
At December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
Amount
 
%
 
Amount
 
%
 
Amount
 
%
 
Amount
 
%
 
Amount
 
%
 
(Dollars in thousands)
Commercial and industrial
$
41,878

 
5.1
%
 
$
45,275

 
5.9
%
 
$
35,424

 
5.1
%
 
$
29,337

 
5.1
%
 
$
26,236

 
5.8
%
Commercial, secured by real estate
477,275

 
58.2
%
 
419,633

 
54.5
%
 
379,141

 
54.3
%
 
314,252

 
54.7
%
 
230,256

 
50.7
%
Residential real estate
265,788

 
32.5
%
 
273,139

 
35.4
%
 
254,087

 
36.4
%
 
215,587

 
37.6
%
 
183,132

 
40.4
%
Consumer
19,173

 
2.3
%
 
18,510

 
2.4
%
 
18,006

 
2.5
%
 
12,643

 
2.2
%
 
10,554

 
2.3
%
Agricultural
14,802

 
1.8
%
 
13,479

 
1.7
%
 
11,472

 
1.6
%
 
2,472

 
0.4
%
 
1,668

 
0.4
%
Other loans, including deposit overdrafts
633

 
0.1
%
 
665

 
0.1
%
 
680

 
0.1
%
 
91

 
—
%
 
1,875

 
0.4
%
 
819,549

 
100.0
%
 
770,701

 
100.0
%
 
698,810

 
100.0
%
 
574,382

 
100.0
%
 
453,721

 
100.0
%
Deferred origination costs (fees), net
254

 
 

 
237

 
 

 
146

 
 

 
(28
)
 
 

 
62

 
 

Total loans
819,803

 
 

 
770,938

 
 

 
698,956

 
 

 
574,354

 
 

 
453,783

 
 

Less allowance for loan losses
3,575

 
 

 
3,129

 
 

 
3,121

 
 

 
3,588

 
 

 
3,437

 
 

Loans, net
$
816,228

 
 

 
$
767,809

 
 

 
$
695,835

 
 

 
$
570,766

 
 

 
$
450,346

 
 


As of December 31, 2016, 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, 2016:
 
(In thousands)
Maturing in one year or less
$
31,968

Maturing after one year, but within five years
62,997

Maturing beyond five years
438,990

Total commercial and agricultural loans
$
533,955

 
 

Loans maturing beyond one year:
 

Fixed rate
$
185,231

Variable rate
316,756

Total
$
501,987





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Risk Elements

The following table summarizes non-accrual, past-due, and accruing restructured loans for the dates indicated:
 
At December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(Dollars in thousands)
Non-accrual loans
$
5,725

 
1,723

 
5,599

 
2,961

 
2,283

Past-due 90 days or more and still accruing
23

 
559

 
203

 
250

 
128

Accruing restructured loans
11,731

 
13,723

 
14,269

 
15,151

 
13,343

Total
$
17,479

 
16,005

 
20,071

 
18,362

 
15,754

Percent to total loans
2.13
%
 
2.08
%
 
2.87
%
 
3.20
%
 
3.47
%
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, 2016, there were no material additional loans not classified as acquired credit impaired or 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.
Allocation of the Allowance for Loan Losses

The following table presents the allocation of the allowance for loan loss:
 
At December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
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
$
350

 
5.1
%
 
$
244

 
5.9
%
 
$
129

 
5.1
%
 
$
175

 
5.1
%
 
$
320

 
5.8
%
Commercial, secured by real estate
2,179

 
58.2
%
 
1,908

 
54.5
%
 
1,990

 
54.3
%
 
2,520

 
54.7
%
 
2,296

 
50.7
%
Residential real estate
885

 
32.5
%
 
854

 
35.4
%
 
926

 
36.4
%
 
826

 
37.6
%
 
712

 
40.4
%
Consumer
96

 
2.3
%
 
54

 
2.4
%
 
63

 
2.5
%
 
66

 
2.2
%
 
108

 
2.3
%
Agricultural
60

 
1.8
%
 
66

 
1.7
%
 
11

 
1.6
%
 
—

 
0.4
%
 
—

 
0.4
%
Other loans, including deposit overdrafts
5

 
0.1
%
 
3

 
0.1
%
 
2

 
0.1
%
 
1

 
—
%
 
1

 
0.4
%
Unallocated
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Total
$
3,575

 
100.0
%
 
$
3,129

 
100.0
%
 
$
3,121

 
100.0
%
 
$
3,588

 
100.0
%
 
$
3,437

 
100.0
%





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LCNB CORP. AND SUBSIDIARY



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, 2016:
 
(In thousands)
Maturity within 3 months
$
7,129

After 3 but within 6 months
2,588

After 6 but within 12 months
7,306

After 12 months
60,747

 
$
77,770

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
On July 2, 2013, the Federal Reserve Board approved the final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. bank holding companies as well as state banks that are members of the Federal Reserve System and savings and loan holding companies (commonly known as Basel III). On July 9, 2013, the OCC adopted the same rules for national banks and federal savings associations, and the FDIC approved the same provisions, as an interim final rule, for state nonmember banks and state savings associations.

Under the final rules, minimum requirements will increase for both the quantity and quality of capital held by banks and savings associations. The rules include a new common equity Tier 1 capital to risk-weighted assets ratio of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets. The final rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and require a minimum leverage ratio of 4.0%.

The phase-in period for the final rules began for LCNB on January 1, 2015, with full compliance with all of the final rules' requirements phased in over a multi-year schedule. While management expects that LCNB's capital ratios under Basel III will continue to exceed the well capitalized minimum capital requirements, there can be no assurance that such will be the case. If LCNB is unable to meet or exceed the applicable minimum capital requirements, it may become subject to supervisory actions ranging in severity from losing its financial holding company status, to being precluded from making acquisitions or engaging in new activities or becoming subject to informal or formal regulatory enforcement actions.

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.


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Banking competition in Southwestern and South Central 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 and South Central Ohio areas 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 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 and South Central Ohio could adversely affect LCNB’s financial condition and results of operations.
LCNB conducts its operations from offices that are located in nine Southwestern and South Central Ohio counties, from which substantially all of its customer base is drawn. Because of this geographic concentration of operations and customer base, LCNB's financial performance is heavily influenced by economic conditions in these areas. Any material deterioration in economic conditions in these markets could have material direct or indirect adverse impacts on LCNB's customers and on LCNB. Such deterioration could increase the number of customers experiencing financial distress, negatively impacting their ability to obtain new loans or to repay existing loans. As a result, LCNB may experience increases in the levels of impaired loans, increased charge-offs, and increased provisions for loan losses. Deteriorating economic conditions may also effect the ability of depositors to maintain or add to deposit balances and may effect the demand for loans, trust, brokerage, and other products and services offered by LCNB. Such losses and decreased demand could have material adverse effects on LCNB's financial position, results of operations, and cash flows.

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.
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.


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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.

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. 

A decrease to the corporate federal income tax rate may impair the Company’s deferred tax assets (“DTAs”). 
At December 31, 2016, LCNB’s DTAs were approximately $1.6 million. While a decline in the corporate tax rate may lower the Company’s tax provision expense, it may also significantly impair the value of the LCNB’s DTAs in the year the rate decrease is enacted.  Such impairment could have a material adverse effect on the Company’s financial condition and results of operations.

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.






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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 CFPB 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 predict.

FDIC deposit insurance assessments may materially increase in the future.
Deposits of LCNB are insured up to statutory limits by the Federal Deposit Insurance Corporation (FDIC) and, accordingly, LCNB and other banks and financial institutions pay quarterly premiums to the FDIC to maintain the Deposit Insurance Fund. The likelihood and extent of future rate increases are indeterminable.

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.

The financial services industry, as well as the broader economy, may be subject to new legislation, regulation, and government policy. 
At this time, it is difficult to predict the legislative and regulatory changes that will result from the combination of a new President of the United States and the first year since 2010 in which both Houses of Congress and the White House have majority memberships from the same political party. In recent years, however, both the new President and senior members of the House of Representatives have advocated for significant reduction of financial services regulation, to include amendments to the Dodd-Frank Act and structural changes to the CFPB. The new Administration and Congress also may cause broader economic changes due to changes in governing ideology and governing style. New appointments to the Board of Governors of the Federal Reserve could affect monetary policy and interest rates and changes in fiscal policy could affect broader patterns of trade and economic growth. Future legislation, regulation, and government policy could affect the banking industry as a whole, including LCNB's business and results of operations, in ways that are difficult to predict. In addition, LCNB's results of operations could be adversely affected by changes in the way in which existing statutes and regulations are interpreted or applied by courts and government agencies.

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.


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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.

LCNB continually encounters technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. LCNB’s future success depends, in part, upon its ability to address customer needs by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in LCNB’s operations. LCNB may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could negatively affect LCNB’s growth, revenue and profit.

Emergence of nonbank alternatives to the financial system.
Consumers may decide not to use banks to complete their financial transactions. Technology and other changes, including the emergence of “Fintech Companies,” are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can complete transactions, such as paying bills and/or transferring funds, directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our 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.

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
 
County
 
 
 
 
 
 
 
 
 
 
 
1.
 
Main Office
 
2 North Broadway
Lebanon, Ohio  45036
 
Warren
 
Owned
 
 
 
 
 
 
 
 
 
2.
 
Auto Bank
 
Silver and Mechanic Streets
Lebanon, Ohio  45036
 
Warren
 
Owned
 
 
 
 
 
 
 
 
 
3.
 
Barron Street Office
 
1697 North Barron Street
Eaton, Ohio  45320
 
Preble
 
Leased
 
 
 
 
 
 
 
 
 
4.
 
Bridge Street Office
 
1240 North Bridge Street
Chillicothe, Ohio  45601
 
Ross
 
Owned
 
 
 
 
 
 
 
 
 
5.
 
Brookville Office
 
225 West Upper Lewisburg Salem Road Brookville, Ohio 45309
 
Montgomery
 
Owned
 
 
 
 
 
 
 
 
 
6.
 
Centerville Office
 
9605 Dayton-Lebanon Pike
Centerville, Ohio 45458
 
Montgomery
 
Owned
 
 
 
 
 
 
 
 
 
7.
 
Chillicothe Office
 
33 West Main Street
Chillicothe, Ohio  45601
 
Ross
 
Owned
 
 
 
 
 
 
 
 
 
8.
 
Clarksburg Office (closed January 24, 2017)
 
10820 Main Street
Clarksburg, Ohio  43115
 
Ross
 
Owned
 
 
 
 
 
 
 
 
 
9.
 
Colerain Township Office
 
3209 West Galbraith Road
Cincinnati, Ohio 45239
 
Hamilton
 
Owned
 
 
 
 
 
 
 
 
 
10.
 
Columbus Avenue Office
 
730 Columbus Avenue
Lebanon, Ohio  45036
 
Warren
 
Owned
 
 
 
 
 
 
 
 
 
11.
 
Eaton Office
 
110 West Main Street
Eaton, Ohio  45320
 
Preble
 
Owned
 
 
 
 
 
 
 
 
 
12.
 
Fairfield Office
 
765 Nilles Road
Fairfield, Ohio  45014
 
Butler
 
Leased
 
 
 
 
 
 
 
 
 
13.
 
Frankfort Office
 
Springfield and Main Streets
Frankfort, Ohio  45628
 
Ross
 
Owned
 
 
 
 
 
 
 
 
 
14.
 
Goshen Office
 
6726 Dick Flynn Blvd.
Goshen, Ohio  45122
 
Clermont
 
Owned
 
 
 
 
 
 
 
 
 
15.
 
Hamilton Office
 
794 NW Washington Blvd.
Hamilton, Ohio  45013
 
Butler
 
Owned
 
 
 
 
 
 
 
 
 
16.
 
Hay Avenue Office
 
121 Hay Avenue
Brookville, Ohio  45309
 
Montgomery
 
Owned
 
 
 
 
 
 
 
 
 
17.
 
Hunter Office
 
3878 State Route 122
Franklin, Ohio  45005
 
Warren
 
Owned
 
 
 
 
 
 
 
 
 
18.
 
Lewisburg Office
 
522 South Commerce Street
Lewisburg, Ohio  45338
 
Preble
 
Owned

-20-
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LCNB CORP. AND SUBSIDIARY



 
 
Name of Office
 
Address
 
County
 
 
 
 
 
 
 
 
 
 
 
19.
 
Loveland Office
 
500 Loveland-Madeira Road
Loveland, OH 45140
 
Hamilton
 
Owned
 
 
 
 
 
 
 
 
 
20.
 
Maineville Office
 
7795 South State Route 48
Maineville, Ohio  45039
 
Warren
 
Owned
 
 
 
 
 
 
 
 
 
21.
 
Mason/West Chester Office
 
1050 Reading Road
Mason, Ohio  45040
 
Warren
 
Owned
 
 
 
 
 
 
 
 
 
22.
 
Middletown Office
 
4441 Marie Drive
Middletown, Ohio  45044
 
Butler
 
Owned
 
 
 
 
 
 
 
 
 
23.
 
Monroe Office
 
101 Clarence F. Warner Drive
Monroe, Ohio  45050
 
Butler
 
Owned
 
 
 
 
 
 
 
 
 
24.
 
New Paris Office
 
201 South Washington Street
New Paris, Ohio  45347
 
Preble
 
Owned
 
 
 
 
 
 
 
 
 
25.
 
Oakwood Office
 
2705 Far Hills Avenue
Oakwood, Ohio  45419
 
Montgomery
 
(2)
 
 
 
 
 
 
 
 
 
26.
 
Otterbein Office
 
Otterbein Retirement Community
State Route 741
Lebanon, Ohio  45036
 
Warren
 
Leased
 
 
 
 
 
 
 
 
 
27.
 
Oxford Office (1)
 
30 West Park Place
Oxford, Ohio  45056
 
Butler
 
(2)
 
 
 
 
 
 
 
 
 
28.
 
Rochester/Morrow Office
 
Route 22-3 at 123
Morrow, Ohio  45152
 
Warren
 
Owned
 
 
 
 
 
 
 
 
 
29.
 
South Lebanon Office
 
603 Corwin Nixon Blvd.
South Lebanon, Ohio  45065
 
Warren
 
Owned
 
 
 
 
 
 
 
 
 
30.
 
Springboro/Franklin Office
 
525 West Central Avenue
Springboro, Ohio  45066
 
Warren
 
Owned
 
 
 
 
 
 
 
 
 
31.
 
Warrior Office
 
Lebanon High School
1916 Drake Road
Lebanon, Ohio  45036
 
Warren
 
Leased
 
 
 
 
 
 
 
 
 
32.
 
Washington Court House Office
 
100 Crossings Drive
Washington Court House, Ohio  43160
 
Fayette
 
Owned
 
 
 
 
 
 
 
 
 
33.
 
Waynesville Office
 
9 North Main Street
Waynesville, Ohio  45068
 
Warren
 
Owned
 
 
 
 
 
 
 
 
 
34.
 
West Alexandria Office
 
55 East Dayton Street
West Alexandria, Ohio  45381
 
Preble
 
Owned
 
 
 
 
 
 
 
 
 
35.
 
Western Avenue Office
 
1006 Western Avenue
Chillicothe, Ohio  45601
 
Ross
 
Owned
 
 
 
 
 
 
 
 
 
36.
 
Wilmington Office
 
1243 Rombach Avenue
Wilmington, Ohio  45177
 
Clinton
 
Owned
 
 
 
 
 
 
 
 
 

-21-
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LCNB CORP. AND SUBSIDIARY



 
 
Name of Office
 
Address
 
County
 
 
 
 
 
 
 
 
 
 
 
37.
 
Operations Center (under construction)
 
105 North Broadway
Lebanon, Ohio  45036
 
Warren
 
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.


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 material proceedings.

Item 4.  Mine Safety Disclosures

Not Applicable

-22-
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LCNB CORP. AND SUBSIDIARY



PART II


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

LCNB had approximately 980 registered holders of its common stock as of December 31, 2016.  The number of shareholders includes banks and brokers who act as nominees, each of whom may represent more than one shareholder.  LCNB’s stock trades on the NASDAQ Capital Market exchange under the symbol “LCNB.”  

Trade prices for shares of LCNB Common Stock and cash dividends per share declared and paid are set forth below.  The trade prices shown below are interdealer without retail markups, markdowns, or commissions.
 
2016
 
2015
 
High
 
Low
 
Dividends Declared
 
High
 
Low
 
Dividends Declared
First Quarter
$
17.75

 
15.51

 
0.16

 
16.40

 
13.95

 
0.16

Second Quarter
17.24

 
15.69

 
0.16

 
17.88

 
15.01

 
0.16

Third Quarter
19.13

 
15.73

 
0.16

 
16.40

 
15.26

 
0.16

Fourth Quarter
25.00

 
16.55

 
0.16

 
17.18

 
15.07

 
0.16

  Total dividends declared
 
 
 
 
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 potential 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.

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, 2016, 290,444 shares have been purchased under this program.  No shares were purchased under the Market Repurchase Program during 2016 and 2015.

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, 2016.  No shares were purchased under the Private Sale Repurchase Program during 2016 and 2015.

LCNB established an Ownership Incentive Plan (the "2002 Plan") during 2002 that allowed 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 could be in the form of stock options, share awards, and/or appreciation rights.   The 2002 Plan expired on April 16, 2012. Outstanding, unexercised options continue to be exercisable in accordance with their terms.

-23-
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LCNB CORP. AND SUBSIDIARY



The 2015 Ownership Incentive Plan (the "2015 Plan") was approved by LCNB's shareholders at the annual meeting on April 28, 2015 and allows for stock-based awards to eligible employees, as determined by the Compensation Committee of the Board of Directors. Awards may be made in the form of stock options, appreciation rights, restricted shares, and/or restricted share units. This plan provides for the issuance of up to 450,000 shares and will terminate on April 28, 2025, unless earlier terminated by the Compensation Committee.

The following table shows information relating to stock options outstanding under the 2002 Plan and 2015 Plan at December 31, 2016:
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
24,669

 
$
12.17

 
433,962

Equity compensation plans not approved by security holders
—

 
—

 
—

Total
24,669

 
$
12.17

 
433,962




-24-
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LCNB CORP. AND SUBSIDIARY



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, 2011 through December 31, 2016.  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, 2011 in LCNB common stock, the NASDAQ Composite, and the SNL Midwest Bank Index and that all dividends were reinvested.

lcnb123120_chart-12236a03.jpg
 
 
Period Ending
 
Index
12/31/2011

12/31/2012

12/31/2013

12/31/2014

12/31/2015

12/31/2016

LCNB Corp.
$
100.00

110.94

149.93

131.71

148.83

219.25

NASDAQ Composite
$
100.00

117.45

164.57

188.84

201.98

219.89

SNL Midwest Bank index
$
100.00

120.36

164.78

179.14

181.86

242.99

 
 
 
 
 
 
 
Source : SNL Financial LC, Charlottesville, VA
© 2017
 
 
 
 
 
 
www.snl.com
 
 
 
 
 
 
 
 
 
 
 
 
 


-25-
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LCNB CORP. AND SUBSIDIARY



Item 6.  Selected Financial Data
The following represents selected consolidated financial data of LCNB for the years ended December 31, 2012 through 2016 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,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(Dollars in thousands, except ratios and per share data)
Income Statement:
 

 
 

 
 

 
 

 
 

Interest income
$
43,750

 
42,659

 
39,477

 
33,497

 
29,938

Interest expense
3,504

 
3,328

 
3,590

 
4,065

 
4,889

Net interest income
40,246

 
39,331

 
35,887

 
29,432

 
25,049

Provision for loan losses
913

 
1,366

 
930

 
588

 
1,351

Net interest income after provision for loan losses
39,333

 
37,965

 
34,957

 
28,844

 
23,698

Non-interest income
10,853

 
10,123

 
9,142

 
9,090

 
9,049

Non-interest expenses
33,261

 
32,392

 
30,844

 
26,212

 
21,682

Income before income taxes
16,925

 
15,696

 
13,255

 
11,722

 
11,065

Provision for income taxes
4,443

 
4,222

 
3,386

 
2,942

 
2,795

Net income
$
12,482

 
11,474

 
9,869

 
8,780

 
8,270

 
 
 
 
 
 
 
 
 
 
Dividends per common share
$
0.64

 
0.64

 
0.64

 
0.64

 
0.64

 
 
 
 
 
 
 
 
 
 
Earnings per common share:
 

 
 

 
 

 
 

 
 

Basic
1.26

 
1.18

 
1.06

 
1.12

 
1.23

Diluted
1.25

 
1.17

 
1.05

 
1.10

 
1.22

 
 
 
 
 
 
 
 
 
 
Balance Sheet:
 

 
 

 
 

 
 

 
 

Securities
$
368,032

 
406,981

 
314,074

 
279,021

 
276,970

Loans, net
816,228

 
767,809

 
695,835

 
570,766

 
450,346

Total assets
1,306,799

 
1,280,531

 
1,108,066

 
932,338

 
788,637

Total deposits
1,110,905

 
1,087,160

 
946,205

 
785,761

 
671,471

Short-term borrowings
42,040

 
37,387

 
16,645

 
8,655

 
13,756

Long-term debt
598

 
5,947

 
11,357

 
12,102

 
13,705

Total shareholders' equity
142,944

 
140,108

 
125,695

 
118,873

 
82,006

 
 
 
 
 
 
 
 
 
 
Selected Financial Ratios and Other Data:
 

 
 

 
 

 
 

 
 

Return on average assets
0.96
%
 
0.94
%
 
0.88
%
 
0.93
%
 
1.02
%
Return on average equity
8.60
%
 
8.43
%
 
8.04
%
 
9.02
%
 
10.22
%
Equity-to-assets ratio
10.94
%
 
10.94
%
 
11.34
%
 
12.75
%
 
10.40
%
Dividend payout ratio
50.79
%
 
54.24
%
 
60.38
%
 
57.14
%
 
52.03
%
Net interest margin, fully taxable equivalent
3.51
%
 
3.64
%
 
3.66
%
 
3.57
%
 
3.52
%
First Capital merged with and into LCNB as of the close of business on January 11, 2013. As of the date of the merger, LCNB recorded additional loans of $98.9 million and additional deposits of $136.8 million.
An underwritten public offering of common stock was conducted during the fourth quarter 2013. The offering increased shareholders' equity by $26.9 million, which was the net proceeds LCNB received after deducting offering expenses. The proceeds were used to fund the acquisition of Eaton National on January 24, 2014 and the remainder was used for general corporate purposes.

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LCNB CORP. AND SUBSIDIARY



Eaton National merged with and into LCNB as of the close of business on January 24, 2014. As of the date of the merger, LCNB recorded additional loans of $115.9 million and additional deposits of $165.3 million.
BNB merged with and into LCNB as of the close of business on April 30, 2015. As of the date of the merger, LCNB recorded additional loans of $34.7 million and additional deposits of $99.1 million.


-27-
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LCNB CORP. AND SUBSIDIARY


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 contained in the 2016 Annual Report to Shareholders.

Overview

Net income for 2016 was $12,482,000 (basic and diluted earnings per share of $1.26 and $1.25, respectively), compared to $11,474,000 (basic and diluted earnings per share of $1.18 and $1.17) in 2015 and $9,869,000 (total basic and diluted earnings per share of $1.06 and $1.05) in 2014.

The following items significantly affected earnings for the years indicated:
1.
The completion of a merger with BNB Bancorp, Inc. on April 30, 2015.
2.
The completion of a merger with Eaton National Bank & Trust Co. on January 24, 2014.
3.
Impaired loans with a carrying value of approximately $4.5 million were sold during the second quarter 2015, significantly improving LCNB's loan quality metrics.
4.
Net gain on sales of securities was significantly greater in 2016 as compared to 2015 and 2014 due primarily to market rates at the time of the sales.
5.
Other real estate owned expense was significantly greater in 2016 and 2015 as compared to 2014 because of valuation writedowns and losses on sales recognized during 2016 and 2015.
6.
Other non-interest expense for 2016 included a $251,000 penalty incurred to pre-pay a Federal Home Loan Bank borrowing bearing an interest rate of 5.25%. The borrowing was pre-paid to reduce future interest expense.

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.

-28-
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LCNB CORP. AND SUBSIDIARY

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


 
Years ended December 31,
 
2016
 
2015
 
2014
 
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)
$
792,526

 
35,600

 
4.49
%
 
$
740,626

 
35,285

 
4.76
%
 
$
679,223

 
32,706

 
4.82
%
Federal funds sold
—

 
—

 
—
%
 
452

 
1

 
0.22
%
 
—

 
—

 
—
%
Interest-bearing demand deposits
12,394

 
59

 
0.48
%
 
12,245

 
30

 
0.24
%
 
12,450

 
29

 
0.23
%
Federal Reserve Bank stock
2,732

 
164

 
6.00
%
 
2,495

 
152

 
6.09
%
 
2,100

 
126

 
6.00
%
Federal Home  Loan Bank stock
3,638

 
146

 
4.01
%
 
3,638

 
146

 
4.01
%
 
3,571

 
146

 
4.09
%
Investment securities:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Taxable
243,559

 
4,582

 
1.88
%
 
245,410

 
4,197

 
1.71
%
 
219,131

 
3,757

 
1.71
%
Non-taxable (2)
140,692

 
4,862

 
3.46
%
 
115,215

 
4,315

 
3.75
%
 
102,902

 
4,111

 
4.00
%
Total earning assets
1,195,541

 
45,413

 
3.80
%
 
1,120,081

 
44,126

 
3.94
%
 
1,019,377

 
40,875

 
4.01
%
Non-earning assets
112,909

 
 

 
 

 
107,919

 
 

 
 

 
104,413

 
 

 
 

Allowance for loan losses
(3,318
)
 
 

 
 

 
(2,888
)
 
 

 
 

 
(3,275
)
 
 

 
 

Total assets
$
1,305,132

 
 

 
 

 
$
1,225,112

 
 

 
 

 
$
1,120,515

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Savings deposits
$
654,891

 
652

 
0.10
%
 
$
608,925

 
545

 
0.09
%
 
$
544,698

 
474

 
0.09
%
IRA and time certificates
217,228

 
2,788

 
1.28
%
 
219,562

 
2,464

 
1.12
%
 
223,555

 
2,687

 
1.20
%
Short-term borrowings
17,952

 
38

 
0.21
%
 
15,105

 
24

 
0.16
%
 
14,820

 
22

 
0.15
%
Long-term debt
826

 
26

 
3.15
%
 
6,177

 
295

 
4.78
%
 
11,546

 
407

 
3.53
%
Total interest-bearing liabilities
890,897

 
3,504

 
0.39
%
 
849,769

 
3,328

 
0.39
%
 
794,619

 
3,590

 
0.45
%
Demand deposits
259,060

 
 

 
 

 
230,608

 
 

 
 

 
196,273

 
 

 
 

Other liabilities
10,014

 
 

 
 

 
8,590

 
 

 
 

 
6,907

 
 

 
 

Capital
145,161

 
 

 
 

 
136,145

 
 

 
 

 
122,716

 
 

 
 

Total  liabilities  and capital
$
1,305,132

 
 

 
 

 
$
1,225,112

 
 

 
 

 
$
1,120,515

 
 

 
 

Net interest rate spread  (3)
 

 
 

 
3.41
%
 
 

 
 

 
3.55
%
 
 

 
 

 
3.56
%
Net interest income and net interest margin on a tax equivalent basis (4)
 

 
41,909

 
3.51
%
 
 

 
40,798

 
3.64
%
 
 

 
37,285

 
3.66
%
Ratio of interest-earning assets to interest-bearing liabilities
134.20
%
 
 

 
 

 
131.81
%
 
 

 
 

 
128.29
%
 
 

 
 


(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 34.2% for 2016 and 34% for 2015 and 2014.
(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.

-29-
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LCNB CORP. AND SUBSIDIARY

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,
 
2016 vs. 2015
 
2015 vs. 2014
 
Increase (decrease) due to
 
Increase (decrease) due to
 
Volume
 
Rate
 
Total
 
Volume
 
Rate
 
Total
 
(In thousands)
Interest income attributable to:
 
 
 
 
 
 
 
 
 
 
 
Loans (1)
$
2,395

 
(2,080
)
 
315

 
2,929

 
(350
)
 
2,579

Federal funds sold
(1
)
 
—

 
(1
)
 
1

 
—

 
1

Interest-bearing demand deposits
—

 
29

 
29

 
—

 
1

 
1

Federal Reserve Bank stock
14

 
(2
)
 
12

 
24

 
2

 
26

Federal Home Loan Bank stock
—

 
—

 
—

 
3

 
(3
)
 
—

Investment securities:
 

 
 

 
 

 
 

 
 

 
 

Taxable
(32
)
 
417

 
385

 
449

 
(9
)
 
440

Non-taxable (2)
900

 
(353
)
 
547

 
472

 
(268
)
 
204

Total interest income
3,276

 
(1,989
)
 
1,287

 
3,878

 
(627
)
 
3,251

Interest expense attributable to:
 

 
 

 
 

 
 

 
 

 
 

Savings deposits
43

 
64

 
107

 
57

 
14

 
71

IRA and time certificates
(26
)
 
350

 
324

 
(47
)
 
(176
)
 
(223
)
Short-term borrowings
5

 
9

 
14

 
—

 
2

 
2

Long-term debt
(193
)
 
(76
)
 
(269
)
 
(227
)
 
115

 
(112
)
Total interest expense
(171
)
 
347

 
176

 
(217
)
 
(45
)
 
(262
)
Net interest income
$
3,447

 
(2,336
)
 
1,111

 
4,095

 
(582
)
 
3,513


(1)
Non-accrual loans, if any, are included in average loan balances.
(2)
Change in interest income from non-taxable investment securities is computed based on interest income determined on a taxable-equivalent yield basis.  Interest income has been divided by a factor comprised of the complement of the incremental tax rate of 34.2% for 2016 and 34% for 2015 and 2014, respectively.

2016 vs. 2015.  Net interest income on a fully tax-equivalent basis for 2016 totaled $41,909,000, an increase of $1,111,000 from 2015.  The increase resulted from an increase in total taxable-equivalent interest income of $1,287,000, slightly offset by an increase in total interest expense of $176,000.

The increase in taxable-equivalent interest income was due to a $75.5 million increase in total average interest-earning assets, slightly offset by a 14 basis point (a basis point equals 0.01%) decrease in the average rate earned on interest-earning assets.  The increase in total average interest-earning assets reflects an increase of $51.9 million in average loans and a $25.5 million increase in non-taxable investment securities. The decrease in the average rate earned was primarily due to general decreases in market rates.

Interest expense increased primarily due to a 16 basis point increase in the average rate paid on IRA and time certificates and a 1 basis point increase in the average rate paid on savings deposits, partially offset by a 163 basis point decrease in the rate paid on long-term debt. The rate variance was partially offset by a $5.4 million decrease in average long-term debt. The decrease in the average rate paid on long-term debt and the decrease in the average balance of long-term debt was due to the pre-payment in full during the first quarter of 2016 of a $5.0 million borrowing from the Federal Home Loan Bank of Cincinnati bearing an interest rate of 5.25%.  The borrowing was pre-paid to reduce future interest expense.


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LCNB CORP. AND SUBSIDIARY

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


2015 vs. 2014.  Net interest income on a fully tax-equivalent basis for 2015 totaled $40,798,000, an increase of $3,513,000 from 2014.  The increase resulted from an increase in total taxable-equivalent interest income of $3,251,000 and a decrease in total interest expense of $262,000.

The increase in taxable-equivalent interest income was due to a $100.7 million increase in total average interest-earning assets, slightly offset by a 7 basis point decrease in the average rate earned on interest-earning assets.  The increase in total average interest-earning assets reflects an increase of $61.4 million in average loans, partially from the BNB merger and partially from organic growth, and a $38.6 million increase in investment securities. The decrease in the average rate earned was primarily due to general decreases in market rates.

Interest expense decreased primarily due to a $5.4 million decrease in average long term debt, primarily due the payment in full of a $5.0 million advance from the Federal Home Loan Bank of Cincinnati during the first quarter 2015, and to a 6 basis point decrease in the average rate paid on total interest-bearing liabilities.  


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LCNB CORP. AND SUBSIDIARY

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 2012 through 2016:
 
2016
 
2015
 
2014
 
2013
 
2012
 
(Dollars in thousands)
Balance – Beginning of year
$
3,129

 
3,121

 
3,588

 
3,437

 
2,931

 
 
 
 
 
 
 
 
 
 
Loans charged off:
 

 
 

 
 

 
 

 
 

Commercial and industrial
234

 
100

 
261

 
119

 
159

Commercial, secured by real estate
185

 
1,133

 
573

 
58

 
234

Residential real estate
127

 
304

 
652

 
244

 
486

Consumer
85

 
52

 
129

 
181

 
134

Agricultural
—

 
67

 
—

 
—

 
—

Other loans, including deposit overdrafts
119

 
74

 
79

 
67

 
85

Total loans charged off
750

 
1,730

 
1,694

 
669

 
1,098

 
 
 
 
 
 
 
 
 
 
Recoveries:
 

 
 

 
 

 
 

 
 

Commercial and industrial
26

 
7

 
42

 
4

 
—

Commercial, secured by real estate
98

 
96

 
63

 
26

 
71

Residential real estate
52

 
107

 
40

 
31

 
7

Consumer
53

 
60

 
108

 
127

 
123

Agricultural
—

 
67

 
—

 
—

 
—

Other loans, including deposit overdrafts
54

 
35

 
44

 
44

 
52

Total recoveries
283

 
372

 
297

 
232

 
253

Net charge offs
467

 
1,358

 
1,397

 
437

 
845

 
 
 
 
 
 
 
 
 
 
Provision charged to operations
913

 
1,366

 
930

 
588

 
1,351

Balance - End of year
$
3,575

 
3,129

 
3,121

 
3,588

 
3,437

 
 
 
 
 
 
 
 
 
 
Ratio of net charge-offs during the period to average loans outstanding
0.06
%
 
0.18
%
 
0.21
%
 
0.08
%
 
0.18
%
 
 
 
 
 
 
 
 
 
 
Ratio of allowance for loan losses to total loans at year-end
0.44
%
 
0.41
%
 
0.45
%
 
0.62
%
 
0.76
%

Charge-offs for the commercial, secured by real estate category had an elevated balance during 2015 due to the sale of impaired loans. Charge-offs for the commercial and industrial loan category for 2014 included a charge-off of $222,000 on one loan and charge-offs in the commercial, secured by real estate category for the same year included charge-offs totaling $469,000 on three loans.

Charge-offs and recoveries classified as “Other” include charge-offs and recoveries on checking and NOW account overdrafts.  LCNB charges off such overdrafts when considered uncollectible, but no later than 60 days from the date first overdrawn.


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LCNB CORP. AND SUBSIDIARY

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


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

Non-Interest Income

2016 vs. 2015.  Total non-interest income for 2016 was $730,000 greater than for 2015 primarily due to a $587,000 increase in net gains on sales of securities and secondarily to a $121,000 increase in bank owned life insurance income. Net gains from sales of securities increased primarily due to market rates at the times of sales. Bank owned life insurance income increased primarily due to $4 million of new policies purchased during the first quarter 2016. Increases in non-interest income was slightly offset by a $99,000 decrease in gains from sales of loans due to market pricing at the times of the sales. 

2015 vs. 2014.  Total non-interest income for 2015 was $981,000 greater than for 2014 primarily due to increases in trust income, net gains on sales of securities, and gains from sales of mortgage loans. Trust income increased $359,000 primarily due to an increase in the fair value of trust assets and brokerage accounts managed. Net gains from sales of securities increased $346,000 and gains from sales of loans increased $196,000 primarily due to higher sales volumes.  


Non-Interest Expense

2016 vs. 2015.  Total non-interest expense was $869,000 greater in 2016 than in 2015 primarily due to a $622,000 increase in salaries and employee benefits, a $251,000 penalty incurred to pre-pay a now high-rate Federal Home Loan Bank borrowing, a $135,000 increase in other real estate owned expense, and a $191,000 increase in various contracted services. Salaries and employee benefits increased primarily due to salary and wage increases, employees retained from the BNB acquisition, and an increase in the number of employees in addition to the acquisition. The FHLB advance had an interest rate of 5.25% and was paid off to reduce interest expense on long-term debt. Other real estate owned expense increased primarily due to writedowns recognized prior to the sale of a commercial property. These increases were partially offset by the absence of merger-related expenses during the 2016 period.

2015 vs. 2014.  Total non-interest expense was $1,548,000 greater in 2015 than in 2014 primarily due to a $1,831,000 increase in salaries and employee benefits, partially offset by a $757,000 decrease in merger related expenses (consisting primarily of professional fees, data system conversion costs, and employee severance payments). Salaries and employee benefits increased due to salary and wage increases, employees retained from the BNB and Eaton National acquisitions, an increase in the number of employees outside of the acquisitions, and increased retirement plan expenses. Costs related to the acquisition of BNB in April 2015 were less than the costs associated with the acquisition of Eaton National in January 2014.

Amortization of intangibles increased $126,000 due to amortization of BNB's core deposit intangible. Other real estate owned expenses increased $204,000 primarily due to impairment charges recognized on a commercial property.

Income Taxes

LCNB's effective tax rates for the years ended December 31, 2016, 2015, and 2014 were 26.3%, 26.9%, and 25.5%, respectively.  The difference between the statutory rate of 34.2% for 2016 and 34.0% for 2015 and 2014 and the effective tax rate is primarily due to tax-exempt interest income and tax-exempt earnings from bank owned life insurance. The statutory rate for 2016 is higher because LCNB's taxable income is slightly above the next tax bracket.




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LCNB CORP. AND SUBSIDIARY

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


Assets

Available-for-sale investment securities at December 31, 2016 was $57.3 million lower than the balance at December 31, 2015. During 2016, LCNB purchased $124.9 million in new securities. These additions were more than offset by sales, maturities, and calls of investment securities.

Held-to-maturity investment securities at December 31, 2016 was $18.4 million greater than at December 31, 2015. Purchases during 2016 totaled $25.0 million, mostly from government entities within LCNB's market area. These additions were partially offset by maturities and calls of other held-to-maturity securities.

Net loans at year-end 2016 was $48.4 million greater than at year-end 2015, primarily due to a $57.6 million increase in the commercial, secured by real estate category. The increase in the loan portfolio does not reflect $11.2 million of residential fixed-rate real estate loans that were originated and sold to the Federal Home Loan Mortgage Corporation during 2016.

Net premises and equipment at December 31, 2016 was $8.1 million greater than at December 31, 2015 primarily due to land
and construction costs paid during 2016 for construction of a new Operations Center in Lebanon, Ohio.

Bank owned life insurance at December 31, 2016 was $4.7 million greater than at December 31, 2015 primarily due to the
purchase of $4.0 million of new policies during the first quarter of 2016.

Liabilities

Total deposits at December 31, 2016 were $23.7 million greater than at December 31, 2015, including a $21.0 million increase in non-interest-bearing deposits and a $2.7 million increase in interest-bearing deposits. Total deposits increased despite a $9.4 million decrease in public fund deposits from local government entities. Public fund deposits can be relatively volatile due to seasonal tax collections and the financial needs of the local entities. Historically, public fund deposits tend to be at their lowest balances at year-ends.

Short-term borrowings at December 31, 2016 was $4.7 million greater than at December 31, 2015 primarily due to the decrease in public fund deposits.

Long-term debt at December 31, 2016 was $5.3 million less than at December 31, 2015 primarily due to the early payment in
full of a $5.0 million borrowing from the FHLB during January 2016. The borrowing had an interest rate of 5.25% and its payment will reduce future interest expense.

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 85.0% of total deposits at December 31, 2016 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 and cash equivalents, 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, 2016, LCNB's liquid assets amounted to $339.5 million or 26.0% of total assets, compared to $393.0 million or 30.7% of total assets at December 31, 2015. The ratio for 2016 is less than 2015 because of a decrease in securities available-for-sale.

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LCNB CORP. AND SUBSIDIARY

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


An additional source of funding is borrowings from the FHLB.  Long-term advances totaling $598,000 and short-term advances totaling $25.0 million were outstanding at December 31, 2016.  LCNB is approved to borrow up to $64.0 million in short-term advances through the FHLB’s Cash Management Advance program.   Total remaining available borrowing capacity with the FHLB, including short-term advances available through the Cash Management Advance program, at December 31, 2016 was approximately $79.5 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 short-term FHLB advances, short-term borrowings may include repurchase agreements, federal funds purchased, and advances from lines of credit with two other financial institutions.  At December 31, 2016, LCNB could borrow up to $30 million through the lines of credit and up to $10 million under a federal funds arrangements with another financial institution.

Commitments to extend credit at December 31, 2016 totaled $123.6 million, including standby letters of credit totaling $0.7 million, and are more fully described in Note 14 - Commitments and Contingent Liabilities to LCNB's consolidated 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.

The following table provides information concerning LCNB's contractual obligations at December 31, 2016:
 
 
 
Payments due by period
 
Total
 
1 year
or less
 
Over 1
through 3
years
 
Over 3
through 5
years
 
More than
5 years
 
(In thousands)
Short-term borrowings
$
42,040

 
42,040

 
—

 
—

 
—

Long-term debt obligations
598

 
295

 
303

 
—

 
—

Operating lease obligations
4,785

 
448

 
491

 
353

 
3,493

Estimated pension plan contribution for 2017
189

 
189

 
—

 
—

 
—

Commitment to purchase municipal security when issued
235

 
235

 
—

 
—

 
—

Funding commitments for affordable housing tax credit limited partnerships
1,617

 
610

 
587

 
145

 
275

Estimated capital expenditure obligations
4,750

 
4,750

 
—

 
—

 
—

Certificates of deposit:
 

 
 

 
 

 
 

 
 

$100,000 and over
77,770

 
17,023

 
27,698

 
32,132

 
917

Other time certificates
136,994

 
46,165

 
41,455

 
47,491

 
1,883

Total
$
268,978

 
111,755

 
70,534

 
80,121

 
6,568


The following table provides information concerning LCNB's commitments at December 31, 2016:
 
 
 
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
$
15,819

 
15,819

 
—

 
—

 
—

Unused lines of credit
107,076

 
41,790

 
28,480

 
17,131

 
19,675

Standby letters of credit
657

 
657

 
—

 
—

 
—

Total
$
123,552

 
58,266

 
28,480

 
17,131

 
19,675






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LCNB CORP. AND SUBSIDIARY

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). Common Equity Tier 1 Capital is the sum of common stock, related surplus, and retained earnings, net of treasury stock, accumulated other comprehensive income, and other adjustments. The first three 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. Information summarizing the regulatory capital of LCNB and the Bank at December 31, 2016 and 2015 and corresponding regulatory minimum requirements is included in Note 15 - Regulatory Matters of the consolidated financial statements.

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 a stock dividend.  Through December 31, 2016, 290,444 shares, as restated for the stock dividend, had been purchased under this program.  No shares were purchased under this program during 2016.

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, 2016.  No shares were purchased under this program during 2016.

LCNB established an Ownership Incentive Plan during 2002 that allowed for stock-based awards to eligible employees.  Under the plan, awards could be in the form of stock options, share awards, and/or appreciation rights. The plan provided for the issuance of up to 200,000 shares, as restated for a stock dividend.  The plan expired on April 16, 2012. Any outstanding unexercized options, however, continue to be exercisable in accordance with their terms.

The 2015 Ownership Incentive Plan (the "2015 Plan") was approved by LCNB's shareholders at the annual meeting on April 28, 2015 and allows for stock-based awards to eligible employees, as determined by the Compensation Committee of the Board of Directors. Awards may be made in the form of stock options, appreciation rights, restricted shares, and/or restricted share units. The 2015 Plan provides for the issuance of up to 450,000 shares. The 2015 Plan will terminate on April 28, 2025 and is subject to earlier termination by the Compensation Committee.

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 carried 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.  LCNB redeemed the warrant during the first quarter 2016.






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LCNB CORP. AND SUBSIDIARY

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


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 collectibility 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 collectibility 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.
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.

Acquired Credit Impaired Loans. LCNB accounts for acquisitions using the acquisition method of accounting, which requires that assets acquired and liabilities assumed be measured at their fair values at the acquisition date. Acquired loans are reviewed to determine if there is evidence of deterioration in credit quality since inception and if it is probable that LCNB will be unable to collect all amounts due under the contractual loan agreements. The analysis includes expected prepayments and estimated cash flows including principal and interest payments at the date of acquisition. The amount in excess of the estimated future cash flows is not accreted into earnings. The amount in excess of the estimated future cash flows over the book value of the loan is accreted into interest income over the remaining life of the loan (accretable yield). LCNB records these loans on the acquisition date at their net realizable value. Thus, an allowance for estimated future losses is not established on the acquisition date. Subsequent to the date of acquisition, expected future cash flows on loans acquired are updated and any losses or reductions in estimated cash flows which arise subsequent to the date of acquisition are reflected as a charge through the provision for loan losses. An increase in the expected cash flows adjusts the level of the accretable yield recognized on a prospective basis over the remaining life of the loan. Due to the number, size, and complexity of loans within the acquired loan portfolio, there is always a possibility of inherent undetected losses.

Accounting for Intangibles.  LCNB’s intangible assets at December 31, 2016 are composed primarily of goodwill and core deposit intangibles related to acquisitions of other financial institutions. It also includes mortgage servicing rights recorded from sales of fixed-rate mortgage loans to the Federal Home Loan Mortgage Corporation and mortgage servicing rights acquired through the acquisition of Eaton National Bank & Trust Co.  Goodwill is not subject to amortization, but is reviewed annually for impairment.  Core deposit intangibles are being amortized on a straight line basis over their respective estimated weighted average lives. 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 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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LCNB CORP. AND SUBSIDIARY



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, 2016 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
 
$
43,790

 
2,663

 
6.48
%
Up 200
 
42,857

 
1,730

 
4.21
%
Up 100
 
41,968

 
841

 
2.04
%
Base
 
41,127

 
—

 
—
%

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, 2016 EVE analysis indicates that an increase in interest rates would have a negative effect on the EVE for all shock levels.  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
 
$
135,135

 
(4,595
)
 
(3.29
)%
Up 200
 
135,815

 
(3,915
)
 
(2.80
)%
Up 100
 
136,397

 
(3,333
)
 
(2.39
)%
Base
 
139,730

 
—

 
—
 %

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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LCNB CORP. AND SUBSIDIARY



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 subsidiary 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 consolidated 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, 2016, in relation to criteria for effective internal control over financial reporting described in “Internal Control – Integrated Framework (2013)” issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on this assessment, management believes that, as of December 31, 2016, LCNB’s internal control over financial reporting met the criteria.

BKD LLP, 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, 2016.

Submitted by:

LCNB Corp.

/s/ Steve P. Foster
 
/s/ Robert C. Haines II
 
Steve P. Foster
 
Robert C. Haines II
 
Chief Executive Officer & President
 
Executive Vice President &
 
March 8, 2017
 
Chief Financial Officer
 
 
 
March 8, 2017
 

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Table of Contents

LCNB CORP. AND SUBSIDIARY



Report of Independent Registered Public Accounting Firm


Audit Committee, Board of Directors and Shareholders
LCNB Corp.
Lebanon, Ohio
We have audited LCNB Corp. and subsidiary’s (Company) internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company'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 Company’s management’s assessment of internal control over financial reporting. Our responsibility is to express an opinion on the Company'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 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 reliable financial statements in accordance with accounting principles generally accepted in the United States of America. Because management's assessment and our audit were also conducted to meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), our examination of LCNB Corp.'s internal control over financial reporting included controls over the preparation of financial statements in accordance with accounting principles generally accepted in the United States of America and with the instructions to the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C).(A) 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 accounting principles generally accepted in the United States of America, 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 and correction 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 Corp. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of LCNB Corp. and subsidiaries and our report dated March 8, 2017, expressed an unqualified opinion thereon.
/s/ BKD, LLP
 
 
BKD, LLP
 
 
 
 
 
Indianapolis, Indiana
 
 
March 8, 2017
 
 



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Table of Contents

LCNB CORP. AND SUBSIDIARY



Report of Independent Registered Public Accounting Firm


Audit Committee, Board of Directors and Shareholders
LCNB Corp.
Lebanon, Ohio

We have audited the accompanying consolidated balance sheets of LCNB Corp. and subsidiary as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2016. The Company'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 audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. Our audit included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and 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 financial position of LCNB Corp. and subsidiary as of December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), LCNB Corp. and subsidiary's internal control over financial reporting as of December 31, 2016, 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 March 8, 2017, expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.


/s/ BKD, LLP
 
 
BKD, LLP
 
 
 
 
 
Indianapolis, Indiana
 
 
March 8, 2017
 
 



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Table of Contents

LCNB CORP. AND SUBSIDIARY



FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
LCNB CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
At December 31,
(Dollars in thousands)
 
2016
 
2015
ASSETS:
 
 
 
Cash and due from banks
$
18,378

 
14,155

Interest-bearing demand deposits
487

 
832

Total cash and cash equivalents
18,865

 
14,987

 
 
 
 
Investment securities:
 
 
 
Available-for-sale, at fair value
320,659

 
377,978

Held-to-maturity, at cost
41,003

 
22,633

Federal Reserve Bank stock, at cost
2,732

 
2,732

Federal Home Loan Bank stock, at cost
3,638

 
3,638

Loans, net
816,228

 
767,809

Premises and equipment, net
30,244

 
22,100

Goodwill
30,183

 
30,183

Core deposit and other intangibles
4,582

 
5,396

Bank owned life insurance
27,307

 
22,561

Other assets
11,358

 
10,514

TOTAL ASSETS
$
1,306,799

 
1,280,531

 
 
 
 
LIABILITIES:
 
 
 
Deposits:
 
 
 
Non-interest-bearing
$
271,332

 
250,306

Interest-bearing
839,573

 
836,854

Total deposits
1,110,905

 
1,087,160

Short-term borrowings
42,040

 
37,387

Long-term debt
598

 
5,947

Accrued interest and other liabilities
10,312

 
9,929

TOTAL LIABILITIES
1,163,855

 
1,140,423

 
 
 
 
COMMITMENTS AND CONTINGENT LIABILITIES

 

 
 
 
 
SHAREHOLDERS' EQUITY:
 
 
 
Preferred shares - no par value, authorized 1,000,000 shares, none outstanding
—

 
—

Common shares - no par value; authorized 19,000,000 and 12,000,000 shares at December 31, 2016 and 2015, respectively; issued 10,751,652 and 10,679,174 shares at December 31, 2016 and 2015, respectively
76,490

 
76,908

Retained earnings
80,736

 
74,629

Treasury shares at cost, 753,627 shares at December 31, 2016 and 2015
(11,665
)
 
(11,665
)
Accumulated other comprehensive income (loss), net of taxes
(2,617
)
 
236

TOTAL SHAREHOLDERS' EQUITY
142,944

 
140,108

 
 
 
 
TOTAL LIABILITES AND SHAREHOLDERS' EQUITY
$
1,306,799

 
1,280,531


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

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Table of Contents


LCNB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
For the years ended December 31,
(Dollars in thousands, except per share data)
 
 
2016
 
2015
 
2014
INTEREST INCOME:
 
 
 
 
 
Interest and fees on loans
$
35,600

 
35,285

 
32,706

Interest on investment securities:
 

 
 

 
 

Taxable
4,582

 
4,197

 
3,757

Non-taxable
3,199

 
2,848

 
2,713

Other investments
369

 
329

 
301

TOTAL INTEREST INCOME
43,750

 
42,659

 
39,477

 
 
 
 
 
 
INTEREST EXPENSE:
 

 
 

 
 

Interest on deposits
3,440

 
3,009

 
3,161

Interest on short-term borrowings
38

 
24

 
22

Interest on long-term debt
26

 
295

 
407

TOTAL INTEREST EXPENSE
3,504

 
3,328

 
3,590

NET INTEREST INCOME
40,246

 
39,331

 
35,887

PROVISION FOR LOAN LOSSES
913

 
1,366

 
930

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
39,333

 
37,965

 
34,957

 
 
 
 
 
 
NON-INTEREST INCOME:
 

 
 

 
 

Trust income
3,286

 
3,262

 
2,903

Service charges and fees on deposit accounts
5,008

 
4,920

 
4,838

Net gain on sales of securities
1,082

 
495

 
149

Bank owned life insurance income
746

 
625

 
671

Gains from sales of loans
244

 
343

 
147

Other operating income
487

 
478

 
434

TOTAL NON-INTEREST INCOME
10,853

 
10,123

 
9,142

 
 
 
 
 
 
NON-INTEREST EXPENSE:
 

 
 

 
 

Salaries and employee benefits
18,215

 
17,593

 
15,762

Equipment expenses
1,048

 
1,257

 
1,316

Occupancy expense, net
2,271

 
2,307

 
2,232

State franchise tax
1,114

 
1,001

 
955

Marketing
696

 
720

 
703

Amortization of intangibles
753

 
700

 
574

FDIC premiums
547

 
598

 
660

ATM expense
721

 
698

 
624

Computer maintenance and supplies
790

 
782

 
794

Telephone expense
746

 
707

 
690

Contracted services
1,033

 
842

 
880

Other real estate owned
624

 
489

 
285

Merger-related expenses
—

 
643

 
1,400

Other non-interest expense
4,703

 
4,055

 
3,969

TOTAL NON-INTEREST EXPENSE
33,261

 
32,392

 
30,844

 
 
 
 
 
 
INCOME BEFORE INCOME TAXES
16,925

 
15,696

 
13,255

PROVISION FOR INCOME TAXES
4,443

 
4,222

 
3,386

NET INCOME
$
12,482

 
11,474

 
9,869

 
 
 
 
 
 
Earnings per common share:
 

 
 

 
 

  Basic
$
1.26

 
1.18

 
1.06

  Diluted
1.25

 
1.17

 
1.05

 
 
 
 
 
 
Weighted average common shares outstanding:
 

 
 

 
 

Basic
9,948,057

 
9,704,965

 
9,297,019

Diluted
9,976,370

 
9,811,467

 
9,406,346


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

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Table of Contents


LCNB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the years ended December 31,
(Dollars in thousands)
 
 
2016
 
2015
 
2014
Net income
$
12,482

 
11,474

 
9,869

 
 
 
 
 
 
Other comprehensive income (loss):
 

 
 

 
 

 
 
 
 
 
 
Net unrealized gain (loss) on available-for-sale securities (net of tax expense (benefit) of $(1,242), $(169), and $1,476 for 2016, 2015, and 2014, respectively)
(2,390
)
 
(329
)
 
2,865

 
 
 
 
 
 
Reclassification adjustment for net realized gain on sale of available-for-sale securities included in net income (net of taxes of $370, $168, and $51 for 2016, 2015 and 2014, respectively)
(712
)
 
(327
)
 
(98
)
 
 
 
 
 
 
Change in nonqualified pension plan unrecognized net gain (loss) and unrecognized prior service cost (net of tax expense (benefit) of $128, $55, and $(133) for 2016, 2015, and 2014, respectively)
249

 
107

 
(260
)
 
 
 
 
 
 
  Other comprehensive income (loss)
(2,853
)
 
(549
)
 
2,507

 
 
 
 
 
 
TOTAL COMPREHENSIVE INCOME
$
9,629

 
10,925

 
12,376

 
 
 
 
 
 
 
 
 
 
 
 
SUPPLEMENTAL INFORMATION:
 

 
 

 
 

COMPONENTS OF ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX, AS OF YEAR-END:
 

 
 

 
 

Net unrealized gain (loss) on securities available-for-sale
$
(2,633
)
 
469

 
1,125

Net unfunded liability for nonqualified pension plan
16

 
(233
)
 
(340
)
Balance at year-end
$
(2,617
)
 
236

 
785


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

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Table of Contents

LCNB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the years ended December 31,
(Dollars in thousands, except share data)
 
Common
Shares
Outstanding

 
Common
Shares

 
Retained
Earnings

 
Treasury
Shares

 
Accumulated
Other
Comprehensive
Income (Loss)

 
Total
Shareholders'
Equity

Balance, December 31, 2013
9,287,536

 
$
66,785

 
65,475

 
(11,665
)
 
(1,722
)
 
118,873

Net income
 

 
 

 
9,869

 
 

 
 

 
9,869

Other comprehensive income (loss), net of taxes
 

 
 

 
 

 
 

 
2,507

 
2,507

Dividend Reinvestment and Stock Purchase Plan
23,782

 
372

 
 

 
 

 
 

 
372

Compensation expense relating to stock options
 

 
24

 
 

 
 

 
 

 
24

Common stock dividends, $0.64 per share
 

 
 

 
(5,950
)
 
 

 
 

 
(5,950
)
Balance, December 31, 2014
9,311,318

 
67,181

 
69,394

 
(11,665
)
 
785

 
125,695

 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 
 

 
11,474

 
 

 
 

 
11,474

Other comprehensive income (loss), net of taxes
 

 
 

 
 

 
 

 
(549
)
 
(549
)
Dividend Reinvestment and Stock Purchase Plan
24,610

 
390

 
 

 
 

 
 

 
390

Acquisition of BNB Bancorp, Inc.
560,132

 
9,063

 
 
 
 
 
 
 
9,063

Exercise of stock options
13,449

 
152

 
 
 
 
 
 
 
152

Excess tax (benefit) expense on exercise and forfeiture of stock options
 
 
13

 
 
 
 
 
 
 
13

Compensation expense relating to stock options
 

 
19

 
 

 
 

 
 

 
19

Compensation expense relating to restricted stock
16,038

 
90

 
 
 
 
 
 
 
90

Common stock dividends, $0.64 per share
 

 
 

 
(6,239
)
 
 

 
 

 
(6,239
)
Balance, December 31, 2015
9,925,547

 
76,908

 
74,629

 
(11,665
)
 
236

 
140,108

 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 
 

 
12,482

 
 

 
 

 
12,482

Other comprehensive income (loss), net of taxes
 

 
 

 
 

 
 

 
(2,853
)
 
(2,853
)
Dividend Reinvestment and Stock Purchase Plan
21,088

 
379

 
 

 
 

 
 

 
379

Repurchase of stock warrants
 
 
(1,545
)
 
 
 
 
 
 
 
(1,545
)
Exercise of stock options
51,390

 
592

 
 
 
 
 
 
 
592

Excess tax benefit on exercise and forfeiture of stock options and vesting of restricted common stock
 

 
61

 
 

 
 

 
 

 
61

Compensation expense relating to stock options
 

 
5

 
 

 
 

 
 

 
5

Compensation expense relating to restricted stock


 
90

 
 
 
 
 
 
 
90

Common stock dividends, $0.64 per share
 

 
 

 
(6,375
)
 
 

 
 

 
(6,375
)
Balance, December 31, 2016
9,998,025

 
$
76,490

 
80,736

 
(11,665
)
 
(2,617
)
 
142,944


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

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Table of Contents



LCNB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31,
(Dollars in thousands)
 
2016
 
2015
 
2014
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
 
Net income
$
12,482

 
11,474

 
9,869

Adjustments to reconcile net income to net cash flows from operating activities-
 

 
 

 
 

Depreciation, amortization and accretion
2,557

 
2,997

 
2,991

Provision for loan losses
913

 
1,366

 
930

Deferred income tax provision (benefit)
928

 
(58
)
 
192

Increase in cash surrender value of bank owned life insurance
(746
)
 
(625
)
 
(671
)
Realized gain on sales of securities available-for-sale
(1,082
)
 
(495
)
 
(149
)
Realized loss (gain) on sale of premises and equipment
33

 
(1
)
 
(128
)
Realized loss from sale and write-downs of other real estate owned and repossessed assets
534

 
378

 
85

Origination of mortgage loans for sale
(11,217
)
 
(7,725
)
 
(7,480
)
Realized gains from sales of loans
(244
)
 
(343
)
 
(147
)
Proceeds from sales of loans
11,353

 
7,809

 
7,552

Penalty for prepayment of long-term debt
251

 
—

 
—

Compensation expense related to stock options
5

 
19

 
24

Compensation expense related to restricted stock
90

 
90

 
—

Changes in:
 

 
 

 
 

Income receivable
(216
)
 
(160
)
 
414

Other assets
(791
)
 
(3,302
)
 
1,898

Other liabilities
634

 
1,815

 
560

TOTAL ADJUSTMENTS
3,002

 
1,765

 
6,071

NET CASH FLOWS FROM OPERATING ACTIVITIES
15,484

 
13,239

 
15,940

 
 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 

 
 

 
 

Proceeds from sales of investment securities available-for-sale
92,455

 
97,981

 
67,296

Proceeds from maturities and calls of investment securities:
 

 
 

 
 

Available-for-sale
84,529

 
29,700

 
36,716

Held-to-maturity
6,640

 
3,515

 
4,688

Purchases of investment securities:
 

 
 

 
 

Available-for-sale
(124,934
)
 
(163,859
)
 
(92,180
)
Held-to-maturity
(25,010
)
 
(3,413
)
 
(11,090
)
Proceeds from redemption of Federal Reserve Bank stock
—

 
—

 
41

Purchase of Federal Reserve Bank stock
—

 
(256
)
 
(743
)
Proceeds from sale of impaired loans
—

 
4,559

 
—

Net increase in loans
(48,153
)
 
(42,530
)
 
(10,081
)
Purchase of bank owned life insurance
(4,000
)
 
—

 
—

Proceeds from redemption of bank owned life insurance
—

 
—

 
3,633

Proceeds from sales of other real estate owned and repossessed assets
526

 
245

 
750

Additions to other real estate owned
(182
)
 
(20
)
 
(45
)
Purchases of premises and equipment
(9,450
)
 
(504
)
 
(1,052
)
Proceeds from sales of premises and equipment
63

 
22

 
179

Net cash acquired from (paid for) acquisition
—

 
8,993

 
(9,114
)
NET CASH FLOWS USED IN INVESTING ACTIVITIES
(27,516
)
 
(65,567
)
 
(11,002
)
 
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 

 
 

 
 

Net increase (decrease) in deposits
23,745

 
41,822

 
(4,797
)
Net increase in short-term borrowings
4,653

 
20,742

 
7,339

Principal payments on long-term debt
(5,349
)
 
(5,410
)
 
(745
)
Penalty for prepayment of long-term debt
(251
)
 
—

 
—

Proceeds from issuance of common stock
52

 
66

 
58

Repurchase of stock warrants
(1,545
)
 
—

 
—

Proceeds from exercise of stock options
592

 
152

 
—

Excess tax benefit from exercise of stock options and vesting of restricted common stock
61

 
13

 
—

Cash dividends paid on common stock
(6,048
)
 
(5,915
)
 
(5,636
)
NET CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
15,910

 
51,470

 
(3,781
)
NET CHANGE IN CASH AND CASH EQUIVALENTS
3,878

 
(858
)
 
1,157

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
14,987

 
15,845

 
14,688

CASH AND CASH EQUIVALENTS AT END OF YEAR
$
18,865

 
14,987

 
15,845

 
 
 
 
 
 
SUPPLEMENTAL CASH FLOW INFORMATION:
 
 
 
 
 
CASH PAID DURING THE YEAR FOR:
 
 
 
 
 
Interest
$
3,542

 
3,396

 
3,502

Income taxes
4,420

 
4,820

 
2,610

 
 
 
 
 
 
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING ACTIVITY:
 

 
 

 
 

Transfer from loans to other real estate owned and repossessed assets
32

 
79

 
435

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

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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016

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 Southwestern and South Central Ohio.

BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and its subsidiary. 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.

Certain prior period data presented in the financial statements have been reclassified to conform with the current year presentation. These reclassifications had no effect on net income.

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 twelve 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.

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. The Company's consolidated statements of income as of December 31, 2016, 2015, and 2014, do not reflect any such impairment.

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 formulas.



-47-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)


LOANS
The Company’s loan portfolio includes most types of commercial and industrial loans, commercial loans secured by real estate, residential real estate loans, consumer 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. Non-accrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer a reasonable doubt as to the timely collection of interest or principal.

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.
 
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 collectibility 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 to 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 trailing 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.


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LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)


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 homogeneous loans, including residential mortgage and consumer installment loans, that are not evaluated individually are collectively evaluated for impairment.
 
Loans acquired from a merger are recorded at fair value with no carryover of the acquired entity's previously established allowance for loan losses.  The excess of expected cash flows over the estimated fair value of acquired loans is recognized as interest income over the remaining contractual lives of the loans using the level yield method. Subsequent decreases in expected cash flows will require additions to the allowance for loan losses.  Subsequent improvements in expected cash flows result in the recognition of additional interest income over the then-remaining contractual lives of the loans.

Impaired loans acquired are accounted for under FASB ASC 310-30.  Factors considered in evaluating whether an acquired loan was impaired include delinquency status and history, updated borrower credit status, collateral information, and updated loan-to-value information.  The difference between contractually required payments at the time of acquisition and the cash flows expected to be collected is referred to as the nonaccretable difference.  The interest component of the cash flows expected to be collected is referred to as the accretable yield and is recognized as interest income over the remaining contractual life of the loan using the level yield method.   Subsequent decreases in expected cash flows will require additions to the allowance for loan losses.  Subsequent improvements in expected cash flows will result in a reclassification from the nonaccretable difference to the accretable yield.
 
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 as incurred. Premises and equipment are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of a particular asset may not be recoverable.

OTHER REAL ESTATE OWNED
Other real estate owned includes properties acquired through 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.

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 assets relate to core deposits acquired from business combinations.  These intangible assets are amortized on a straight-line basis over their estimated useful lives.  Management evaluates whether events or circumstances have occurred that indicate the remaining useful life or carrying value of the amortizing intangible should be revised.

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LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)


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.

AFFORDABLE HOUSING TAX CREDIT LIMITED PARTNERSHIP
LCNB has elected to account for its investment in an affordable housing tax credit limited partnership using the proportional amortization method described in FASB ASU 2014-01, "Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (A Consensus of the FASB Emerging Issues Task Force)." Under the proportional amortization method, an investor amortizes the initial cost of the investment to income tax expense in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense. The investment in the limited partnership is included in other assets and the unfunded amount is included in accrued interest and other liabilities in LCNB's consolidated balance sheets.

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.

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 2016 or 2015.

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

PENSION PLANS
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.

Citizens National had a qualified noncontributory, defined benefit pension plan, which has been assumed by the Company, that covers eligible employees hired before May 1, 2005. This is a single employer plan.

TREASURY STOCK
Common stock shares repurchased are recorded at cost. Cost of shares retired or reissued is determined using the weighted average method.








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LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)


STOCK OPTIONS AND RESTRICTED STOCK AWARD PLANS
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.  The compensation cost for restricted stock awards is based on the market price of the Company's common stock at the date of grant multiplied by the number of shares granted that are expected to vest. The estimated cost is recognized on a straight-line basis 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 for stock options and restricted stock.

INCOME TAXES
Deferred income taxes are determined using the asset and 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 allocated  to common shareholders is calculated using the two-class method and is computed by dividing net income allocated to common shareholders by the weighted average number of common shares outstanding during the period.  Diluted earnings per share is adjusted for the dilutive effects of stock based compensation and warrants and is calculated using the two-class method or the treasury stock method.  The diluted average number of common shares outstanding has been increased for the assumed exercise of stock based compensation and warrants with the proceeds used to purchase treasury shares at the average market price for the period.

RECENT ACCOUNTING PRONOUNCEMENTS
From time to time the FASB issues an Accounting Standards Update ("ASU") to communicate changes to Generally Accepted Accounting Principles. The following information provides brief summaries of newly issued but not yet effective ASUs that could have an effect on LCNB’s financial position or results of operations:

ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)"
ASU No. 2014-09 was issued in May 2014 and supersedes most current revenue recognition guidance for contracts to transfer goods or services or other nonfinancial assets. Lease contracts, insurance contracts, and most financial instruments are not included in the scope of this update. ASU No. 2014-09 provides that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance enumerates five steps that entities should follow in achieving this core principle. Additional disclosures providing information about contracts with customers are required.

Guidance in ASU No. 2014-09 has been clarified by the following ASUs:
•
ASU No. 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)"
•
ASU No. 2016-10, "Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing"
•
ASU No. 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow Scope Improvements and Practical Expedients"


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LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)


As extended by ASU No. 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date," ASU No. 2014-09 and the clarifying ASUs are effective for public companies for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Transitional guidance is included in the updates. Earlier adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. LCNB's revenue is comprised of net interest income, which is explicitly excluded from the scope of ASU No. 2014-09, and non-interest income. The update may require LCNB to change how it recognizes certain recurring revenue streams related to non-interest income. However, it is not expected to have a material impact on LCNB's results of operations or financial position. Management continues to monitor the guidance from the FASB and the Transition Resource Group for Revenue Recognition in determining the impact of ASU No. 2014-09 on various types of non-interest income.

ASU No. 2014-15, "Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern"
ASU No. 2014-15 was issued in August 2014 and requires management to evaluate for each annual and interim reporting period whether it is probable that the entity will not be able to meet its obligations as they become due within one year after the date that financial statements are issued (or are available to be issued, where applicable). Certain disclosures, as described in the update, are required if management identifies substantial doubt about the entity's ability to continue as a going concern. ASU No. 2014-15 will take effect in the annual periods ending after December 15, 2016, and interim periods within annual periods beginning after December 15, 2016. Early application is permitted. Adoption of ASU No. 2014-15 is not expected to have a material impact on LCNB's results of operations or financial position.

ASU No. 2016-01, "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities"
ASU No. 2016-01 was issued in January 2016 and applies to all entities that hold financial assets or owe financial liabilities. It makes targeted changes to generally accepted accounting principles for public companies as follows:
1.
Requires most equity investments to be measured at fair value with changes in fair value recognized in net income.
2.
Simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value.
3.
Eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet.
4.
Requires use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes.
5.
Requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments.
6.
Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements.
7.
Clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets.

For public business entities, the new guidance is effective for annual reporting periods, and interim reporting periods within those annual periods, beginning after December 15, 2017. Adoption of ASU No. 2016-01 is not expected to have a material impact on LCNB's results of operations or financial position.

ASU No. 2016-02, "Leases (Topic 842)"
ASU No. 2016-02 was issued in February 2016 and requires a lessee to recognize in the statement of financial position a liability to make lease payments ("the lease liability") and a right-of-use asset representing its right to use the underlying asset for the lease term, initially measured at the present value of the lease payments. When measuring assets and liabilities arising from a lease, the lessee should include payments to be made in optional periods only if the lessee is reasonably certain, as defined, to exercise an option to the lease or not to exercise an option to terminate the lease. Optional payments to purchase the underlying asset should be included if the lessee is reasonably certain it will exercise the purchase option. Most variable lease payments should be excluded except for those that depend on an index or a rate or are in substance fixed payments.

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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)


A lessee shall classify a lease as a finance lease if it meets any of five listed criteria:
1.
The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
2.
The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
3.
The lease term is for the major part of the remaining economic life of the underlying asset.
4.
The present value of the sum of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the underlying asset.
5.
The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

For finance leases, a lessee shall recognize in the statement of comprehensive income interest on the lease liability separately from amortization of the right-of-use asset. Amortization of the right-of-use asset shall be on a straight-line basis, unless another basis is more representative of the pattern in which the lessee expects to consume the right-of-use asset’s future economic benefits. If the lease does not meet any of the five criteria, the lessee shall classify it as an operating lease and shall recognize a single lease cost on a straight-line basis over the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term.

The amendments in this update are to be applied using a modified retrospective approach, as defined, and are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2018. Early application is permitted. LCNB estimates that it will recognize discounted right of use assets and and lease liabilities totaling approximately $5 million for the leases disclosed in Note 8 - Leases. This projection is based on various assumptions, including the level of interest rates and no significant increases in leasing activity, that may change between now and the effective date.

ASU No. 2016-05, "Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships (a consensus of the Emerging Issues Task Force)"
ASU No. 2016-05 was issued in March 2016 and applies to reporting entities for which there is a change in a counterparty to a derivative instrument that has been designated a hedging instrument under Topic 815, "Derivatives and Hedging." The amendments in this update clarify that a change in a counterparty to such a derivative instrument does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria under applicable guidance continue to be met. The amendments in ASU No. 2016-05 are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2016. LCNB does not currently have any investments in derivative instruments that have been designated as hedging instruments and adoption of ASU No. 2016-05 is not expected to have an impact on LCNB's results of operations or financial position.

ASU No. 2016-06 , "Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments (a consensus of the Emerging Issues Task Force)"
ASU No. 2016-06 was issued in March 2016 and clarifies what steps are required when assessing whether the economic characteristics and risks of call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to the economic characteristics and risks of their debt hosts, which is one of the criteria for bifurcating an embedded derivative. An entity performing the assessment under the amendments in this update is required to assess the
embedded call (put) options solely in accordance with the four-step decision sequence. The four-step decision sequence requires an entity to consider whether (1) the payoff is adjusted based on changes in an index, (2) the payoff is indexed to an underlying other than interest rates or credit risk, (3) the debt involves a substantial premium or discount, and (4) the call (put) option is contingently exercisable. The amendments in ASU No. 2016-06 are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2016. LCNB does not currently have any investments in debt instruments containing such call (put) options and adoption of ASU No. 2016-06 is not expected to have an impact on LCNB's results of operations or financial position.





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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)


ASU No. 2016-09, "Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting"
ASU No. 2016-09 was issued in March 2016 and affects all entities that issue share-based payment awards to their employees. The new guidance involves several aspects of the accounting for share-based payment transactions, including income tax
consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Under ASU No. 2016-09, any excess tax benefits or tax deficiencies should be recognized as income tax expense or benefit in the income statement. Excess tax benefits are to be classified as an operating activity in the statement of cash flows. In accruing compensation cost, an entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest, as required under current guidance, or account for forfeitures when they occur. For an award to qualify for equity classification, an entity cannot partially settle the award in excess of the employer's maximum statutory withholding requirements. Such cash paid by an employer when directly withholding shares for tax withholding purposes should be classified as a financing activity in the statement of cash flows. The amendments in ASU No. 2016-09 are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. Adoption of ASU No. 2016-07 is not expected to have a material impact on LCNB's results of operations or financial position. If the provisions of the ASU had been adopted in 2014, excess tax benefits from the exercise of stock options and the vesting of restricted common stock would have reduced the provision for income taxes for 2016 and 2015 by $61,000 and $13,000, respectively. There were no excess tax benefits during 2014.

ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments"
ASU No. 2016-13 was issued in June 2016 and, once effective, will significantly change current guidance for recognizing impairment of financial instruments. Current guidance requires an "incurred loss" methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. ASU No. 2016-13 replaces the incurred loss impairment methodology with a new methodology that reflects expected credit losses over the lives of the loans and requires consideration of a broader range of information to inform credit loss estimates. The ASU requires an organization to estimate all expected credit losses for financial assets measured at amortized cost, including loans and held-to-maturity debt securities, based on historical experience, current conditions, and reasonable and supportable forecasts. Additional disclosures are required.

ASU No. 2016-13 also amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. Under the new guidance, entities will determine whether all or a portion of the unrealized loss on an available-for-sale debt security is a credit loss. Any credit loss will be recognized as an allowance for credit losses on available-for-sale debt securities rather than as a direct reduction of the amortized cost basis of the investment, as is currently required. As a result, entities will recognize improvements to estimated credit losses on available-for-sale debt securities immediately in earnings rather than as interest income over time, as currently required.

ASU No. 2016-13 eliminates the current accounting model for purchased credit impaired loans and debt securities. Instead, purchased financial assets with credit deterioration will be recorded gross of estimated credit losses as of the date of acquisition and the estimated credit losses amounts will be added to the allowance for credit losses. Thereafter, entities will account for additional impairment of such purchased assets using the models listed above.
 
ASU No. 2016-13 will take effect for U.S. Securities and Exchange Commission (SEC) filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. While LCNB's Loan Committee expects that the implementation of ASU No. 2016-13 will increase the balance of the allowance for loan losses, it is continuing to evaluate the potential impact on LCNB's results of operations and financial position.









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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)


ASU No. 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments"
ASU No. 2016-15 was issued in August 2016 and applies to all entities required to present a statement of cash flows in their financial reports. The guidance in this ASU addresses eight cash flow classification issues that have been creating diversity in practice. One of the issues is the classification of cash payments for debt prepayment or debt extinguishment costs, which are to be classified as cash outflows from financing activities under the new guidance. LCNB incurred a prepayment penalty during January 2016 upon the early payment in full of a FHLB advance and classified such penalty as a cash outflow from operating activities in its consolidated condensed statements of cash flows. Management early adopted ASU No. 2016-15 during the third quarter 2016 and reclassified the penalty as a cash outflow from financing activities.


NOTE 2 – ACQUISITIONS

On December 29, 2014, LCNB and BNB Bancorp, Inc. (“BNB”) entered into an Agreement and Plan of Merger (“Merger Agreement”) pursuant to which BNB was acquired by LCNB on April 30, 2015. Immediately following the merger of BNB into LCNB, Brookville National Bank ("Brookville National"), a wholly-owned subsidiary of BNB, was merged into LCNB National Bank. Brookville National operated a main office and a branch office, both in Brookville, Ohio.  These offices became branches of the Bank after the merger.

Under the terms of the Merger Agreement, the shareholders of BNB common stock received, for each share of BNB common stock, (i) $15.75 in cash and (ii) 2.005 LCNB common shares.

On October 28, 2013, LCNB and Colonial Banc Corp. (“Colonial”) entered into a Stock Purchase Agreement (“Purchase Agreement”) pursuant to which LCNB purchased from Colonial on January 24, 2014 all of the issued and outstanding shares of Eaton National Bank & Trust Co. ("Eaton National"). Immediately following the acquisition, Eaton National was merged into the Bank.  Eaton National operated five full–service branches with a main office and another facility in Eaton, Ohio and branch offices in each of West Alexandria, Ohio, New Paris, Ohio, and Lewisburg, Ohio.  These offices became branches of the Bank after the merger.




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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 2 – ACQUISITIONS (Continued)


The mergers with BNB and Eaton National were accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration paid were recorded at their estimated fair values as of the respective merger dates, as summarized in the following table (in thousands):
 
BNB
 
Eaton National
Consideration Paid:
 
 
 
Common shares issued
$
9,063

 
—

Cash paid to shareholder(s)
4,403

 
24,750

    Total consideration paid
13,466

 
24,750

 
 
 
 

Identifiable Assets Acquired:
 
 
 

Cash and cash equivalents
13,396

 
15,635

Investment securities
58,239

 
35,859

Federal Reserve Bank stock
130

 
41

Federal Home Loan Bank stock
—

 
784

Loans
34,661

 
115,944

Premises and equipment
2,311

 
1,314

Bank owned life insurance
—

 
3,618

Core deposit intangible
1,418

 
2,466

Other real estate owned
—

 
262

Other assets
532

 
1,624

Total identifiable assets acquired
110,687

 
177,547

 
 
 
 

Liabilities Assumed:
 
 
 

Deposits
99,133

 
165,335

Short-term borrowings
—

 
651

Deferred income taxes
576

 
—

Other liabilities
57

 
263

Total liabilities assumed
99,766

 
166,249

 
 
 
 

Total Identifiable Net Assets Acquired
10,921

 
11,298

 
 
 
 

Goodwill resulting from merger
2,545

 
13,452


The amount of goodwill recorded reflects LCNB's entrance into new markets and related synergies that are expected to result from the acquisitions and represents the excess purchase price over the estimated fair value of the net assets acquired.  The goodwill will not be amortizable on LCNB's financial records, but is deductible for tax purposes.  The core deposit intangible for BNB and Eaton National is being amortized over nine years and eight years, respectively, using the straight-line method.

Direct costs related to the acquisitions were expensed as incurred and are recorded as a merger-related expense in the consolidated statements of income.  
 
The results of operations are included in the consolidated statements of income from the dates of the mergers.  



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LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)


NOTE 3 - INVESTMENT SECURITIES

The amortized cost and fair value of available-for-sale investment securities at December 31 are summarized as follows (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
2016
 
 
 
 
 
 
 
Investment Securities Available-for-Sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
28,180

 
41

 
76

 
28,145

U.S. Agency notes
87,098

 
150

 
1,848

 
85,400

U.S. Agency mortgage-backed securities
72,402

 
89

 
1,444

 
71,047

Municipal securities:
 

 
 

 
 

 
 

Non-taxable
114,064

 
574

 
1,623

 
113,015

Taxable
19,710

 
220

 
85

 
19,845

Mutual funds
2,527

 
—

 
45

 
2,482

Trust preferred securities
49

 
—

 
1

 
48

Equity securities
632

 
55

 
10

 
677

 
$
324,662

 
1,129

 
5,132

 
320,659

 
 
 
 
 
 
 
 
Investment Securities Held-to-Maturity:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
Non-taxable
$
31,015

 
56

 
352

 
30,719

Taxable
9,988

 
—

 
217

 
9,771

 
$
41,003

 
56

 
569

 
40,490

 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
Investment Securities Available-for-Sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
72,672

 
309

 
135

 
72,846

U.S. Agency notes
140,876

 
164

 
1,151

 
139,889

U.S. Agency mortgage-backed securities
29,608

 
174

 
404

 
29,378

Certificates of deposit
248

 
1

 
—

 
249

Municipal securities:
 

 
 

 
 

 
 

Non-taxable
103,900

 
1,713

 
134

 
105,479

Taxable
26,738

 
337

 
134

 
26,941

Mutual funds
2,517

 
—

 
51

 
2,466

Trust preferred securities
49

 
1

 
—

 
50

Equity securities
659

 
40

 
19

 
680

 
$
377,267

 
2,739

 
2,028

 
377,978

 
 
 
 
 
 
 
 
Investment Securities Held-to-Maturity:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
Non-taxable
$
22,233

 
95

 
97

 
22,231

Taxable
400

 
—

 
1

 
399

 
$
22,633

 
95

 
98

 
22,630


-57-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 3 - INVESTMENT SECURITIES (Continued)

Information concerning securities with gross unrealized losses at December 31, 2016 and 2015, 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
2016
 
 
 
 
 
 
 
Investment Securities Available-for-Sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
16,076

 
76

 
—

 
—

U.S. Agency notes
69,784

 
1,848

 
—

 
—

U.S. Agency mortgage-backed securities
64,564

 
1,310

 
3,518

 
134

Municipal securities:
 

 
 

 
 

 
 
Non-taxable
72,867

 
1,621

 
451

 
2

Taxable
9,721

 
82

 
450

 
3

Mutual funds
1,205

 
37

 
277

 
8

Trust preferred securities
49

 
1

 
—

 
—

Equity securities
201

 
10

 
—

 
—

 
$
234,467

 
4,985

 
4,696

 
147

 
 
 
 
 
 
 
 
Investment Securities Held-to-Maturity:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
  Non-taxable
$
20,429

 
251

 
2,564

 
101

  Taxable
8,030

 
217

 
—

 
—

 
$
28,459

 
468

 
2,564

 
101

 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
Investment Securities Available-for-Sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
32,854

 
75

 
4,846

 
60

U.S. Agency notes
104,053

 
1,000

 
9,869

 
151

U.S. Agency mortgage-backed securities
19,190

 
256

 
4,068

 
148

Municipal securities:
 
 
 
 
 
 
 
  Non-taxable
13,124

 
74

 
7,037

 
60

  Taxable
15,601

 
114

 
880

 
20

Mutual funds
1,215

 
17

 
268

 
34

Trust preferred securities
—

 
—

 
—

 
—

Equity securities
248

 
12

 
73

 
7

 
$
186,285

 
1,548

 
27,041

 
480

 
 
 
 
 
 
 
 
Investment Securities Held-to-Maturity:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
  Non-taxable
$
832

 
3

 
3,426

 
94

  Taxable
399

 
1

 
—

 
—

 
$
1,231

 
4

 
3,426

 
94

Management has determined that the unrealized losses at December 31, 2016 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.


-58-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 3 - INVESTMENT SECURITIES (Continued)

Contractual maturities of investment securities at December 31, 2016 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
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Due within one year
$
12,364

 
12,464

 
3,955

 
3,959

Due from one to five years
97,171

 
97,501

 
4,125

 
4,068

Due from five to ten years
131,950

 
129,289

 
10,081

 
9,845

Due after ten years
7,567

 
7,151

 
22,842

 
22,618

 
249,052

 
246,405

 
41,003

 
40,490

U.S. Agency mortgage-backed securities
72,402

 
71,047

 
—

 
—

Mutual funds
2,527

 
2,482

 
—

 
—

Trust preferred securities
49

 
48

 
—

 
—

Equity securities
632

 
677

 
—

 
—

 
$
324,662

 
320,659

 
41,003

 
40,490


Investment securities with a market value of $149,990,000 and $215,952,000 at December 31, 2016 and 2015, 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):
 
2016
 
2015
 
2014
Proceeds from sales
$
92,455

 
97,981

 
67,296

Gross realized gains
1,103

 
627

 
252

Gross realized losses
21

 
132

 
103


NOTE 4 - LOANS

Major classifications of loans at December 31 were as follows (in thousands):
 
2016
 
2015
Commercial and industrial
$
41,878

 
45,275

Commercial, secured by real estate
477,275

 
419,633

Residential real estate
265,788

 
273,139

Consumer
19,173

 
18,510

Agricultural
14,802

 
13,479

Other loans, including deposit overdrafts
633

 
665

 
819,549

 
770,701

Deferred origination costs, net
254

 
237

 
819,803

 
770,938

Less allowance for loan losses
3,575

 
3,129

Loans-net
$
816,228

 
767,809



-59-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 4 - LOANS (Continued)


Loans acquired from the mergers with Eaton National and BNB were recorded at fair value with no carryover of the acquired entity's previously established allowance for loan losses.  The excess of expected cash flows over the estimated fair value of acquired loans is recognized as interest income over the remaining contractual lives of the loans using the level yield method. Subsequent decreases in expected cash flows will require additions to the allowance for loan losses.  Subsequent improvements in expected cash flows result in the recognition of additional interest income over the then-remaining contractual lives of the loans. Management estimated the cash flows expected to be collected at acquisition using a third-party risk model, which incorporated the estimate of current key assumptions, such as default rates, severity, and prepayment speeds.

Impaired loans acquired are accounted for under FASB ASC 310-30.  Factors considered in evaluating whether an acquired loan was impaired include delinquency status and history, updated borrower credit status, collateral information, and current loan-to-value information.  The difference between contractually required payments at the time of acquisition and the cash flows expected to be collected is referred to as the nonaccretable difference.  The interest component of the cash flows expected to be collected is referred to as the accretable yield and is recognized as interest income over the remaining contractual life of the loan using the level yield method.   Subsequent decreases in expected cash flows will require additions to the allowance for loan losses.  Subsequent improvements in expected cash flows will result in a reclassification from the nonaccretable difference to the accretable yield.

The following table provides certain information at the acquisition date on loans acquired from BNB on April 30, 2015 and from Eaton National on January 24, 2014, not including loans considered to be impaired (in thousands):
 
BNB
 
Eaton National
Contractually required principal at acquisition
$
32,174

 
102,483

Less fair value adjustment
199

 
1,347

Fair value of acquired loans
$
31,975

 
101,136

 
 
 
 

Contractual cash flows not expected to be collected
$
195

 
1,702


The following table provides details on acquired impaired loans obtained through the mergers with BNB and Eaton National that are accounted for in accordance with FASB ASC 310-30 (in thousands):
 
BNB
 
Eaton National
Contractually required principal at acquisition
$
3,511

 
23,414

Contractual cash flows not expected to be collected (nonaccretable difference)
(404
)
 
(6,088
)
Expected cash flows at acquisition
3,107

 
17,326

Interest component of expected cash flows (accretable discount)
(413
)
 
(2,163
)
Fair value of acquired impaired loans
$
2,694

 
15,163















-60-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 4 - LOANS (Continued)


Non-accrual, past-due, and accruing restructured loans at December 31 were as follows (in thousands):
 
2016
 
2015
Non-accrual loans:
 
 
 
Commercial and industrial
$
—

 
—

Commercial, secured by real estate
4,312

 
876

Agricultural
334

 
48

Residential real estate
1,079

 
799

Total non-accrual loans
5,725

 
1,723

Past-due 90 days or more and still accruing
23

 
559

Total non-accrual and past-due 90 days or more and still accruing
5,748

 
2,282

Accruing restructured loans
11,731

 
13,723

Total
$
17,479

 
16,005

 
 
 
 
Percentage of total non-accrual and past-due 90 days or more and still accruing to total loans
0.70
%
 
0.30
%
 
 
 
 
Percentage of total non-accrual, past-due 90 days or more and still accruing, and accruing restructured loans to total loans
2.13
%
 
2.08
%

Interest income that would have been recorded during 2016 and 2015 if loans on non-accrual status at December 31, 2016 and 2015 had been current and in accordance with their original terms was approximately $220,000 and $137,000, respectively.

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.

-61-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 4 - 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
 
Total
December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, beginning of year
$
244

 
1,908

 
854

 
54

 
66

 
3

 
3,129

Provision charged to expenses
314

 
358

 
106

 
74

 
(6
)
 
67

 
913

Losses charged off
(234
)
 
(185
)
 
(127
)
 
(85
)
 
—

 
(119
)
 
(750
)
Recoveries
26

 
98

 
52

 
53

 
—

 
54

 
283

Balance, end of year
$
350

 
2,179

 
885

 
96

 
60

 
5

 
3,575

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
9

 
55

 
100

 
13

 
—

 
—

 
177

Collectively evaluated for impairment
341

 
1,832

 
785

 
83

 
60

 
5

 
3,106

Acquired credit impaired loans
—

 
292

 
—

 
—

 
—

 
—

 
292

Balance, end of year
$
350

 
2,179

 
885

 
96

 
60

 
5

 
3,575

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
337

 
12,580

 
1,518

 
52

 
334

 
—

 
14,821

Collectively evaluated for impairment
41,466

 
458,059

 
262,266

 
19,192

 
14,475

 
178

 
795,636

Acquired credit impaired loans
98

 
6,305

 
2,471

 
17

 
—

 
455

 
9,346

Balance, end of year
$
41,901

 
476,944

 
266,255

 
19,261

 
14,809

 
633

 
819,803

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 

 
 

 
 

 
 

 
 

 
 

 
 

Allowance for loan losses:
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance, beginning of year
$
129

 
1,990

 
926

 
63

 
11

 
2

 
3,121

Provision charged to expenses
208

 
955

 
125

 
(17
)
 
55

 
40

 
1,366

Losses charged off
(100
)
 
(1,133
)
 
(304
)
 
(52
)
 
(67
)
 
(74
)
 
(1,730
)
Recoveries
7

 
96

 
107

 
60

 
67

 
35

 
372

Balance, end of year
$
244

 
1,908

 
854

 
54

 
66

 
3

 
3,129

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
9

 
306

 
48

 
—

 
—

 
—

 
363

Collectively evaluated for impairment
235

 
1,602

 
806

 
54

 
66

 
3

 
2,766

Acquired credit impaired loans
—

 
—

 
—

 
—

 
—

 
—

 
—

Balance, end of year
$
244

 
1,908

 
854

 
54

 
66

 
3

 
3,129

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
$
370

 
12,351

 
1,541

 
56

 
—

 
—

 
14,318

Collectively evaluated for impairment
43,726

 
399,092

 
269,001

 
18,516

 
13,438

 
179

 
743,952

Acquired credit impaired loans
1,191

 
7,877

 
3,039

 
27

 
48

 
486

 
12,668

Balance, end of year
$
45,287

 
419,320

 
273,581

 
18,599

 
13,486

 
665

 
770,938


-62-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 4 - LOANS (Continued)


 
Commercial
& Industrial
 
Commercial,
Secured by
Real Estate
 
Residential
Real Estate
 
Consumer
 
Agricultural
 
Other
 
Total
December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, beginning of year
$
175

 
2,520

 
826

 
66

 
—

 
1

 
3,588

Provision charged to expenses
173

 
(20
)
 
712

 
18

 
11

 
36

 
930

Losses charged off
(261
)
 
(573
)
 
(652
)
 
(129
)
 
—

 
(79
)
 
(1,694
)
Recoveries
42

 
63

 
40

 
108

 
—

 
44

 
297

Balance, end of year
$
129

 
1,990

 
926

 
63

 
11

 
2

 
3,121

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
10

 
415

 
89

 
—

 
—

 
—

 
514

Collectively evaluated for impairment
119

 
1,273

 
836

 
63

 
11

 
2

 
2,304

Acquired credit impaired loans
—

 
302

 
1

 
—

 
—

 
—

 
303

Balance, end of year
$
129

 
1,990

 
926

 
63

 
11

 
2

 
3,121


The risk characteristics of LCNB's material loan portfolio segments were as follows:

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 lines of credit.  Most commercial and industrial loans have a variable rate, with adjustment periods ranging from one month to 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” 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 global debt service, collateral value, financial strength of any guarantors, and other factors. Commercial real estate loans are generally originated with a 75% 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 the 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.”

-63-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 4 - LOANS (Continued)


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%.
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 collectibility 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 agricultural-related collateral.

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.


-64-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 4 - LOANS (Continued)


An analysis of the Company’s loan portfolio by credit quality indicators at December 31 is as follows (in thousands):
 
Pass
 
OAEM
 
Substandard
 
Doubtful
 
Total
December 31, 2016
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
41,178

 
304

 
419

 
—

 
41,901

Commercial, secured by real estate
443,781

 
5,479

 
27,684

 
—

 
476,944

Residential real estate
261,839

 
442

 
3,974

 
—

 
266,255

Consumer
19,182

 
—

 
79

 
—

 
19,261

Agricultural
13,311

 
—

 
1,498

 
—

 
14,809

Other
633

 
—

 
—

 
—

 
633

Total
$
779,924

 
6,225

 
33,654

 
—

 
819,803

 
 
 
 
 
 
 
 
 
 
December 31, 2015
 

 
 

 
 

 
 

 
 

Commercial & industrial
$
44,596

 
—

 
691

 
—

 
45,287

Commercial, secured by real estate
397,938

 
9,316

 
12,066

 
—

 
419,320

Residential real estate
267,567

 
1,935

 
4,079

 
—

 
273,581

Consumer
18,528

 
—

 
71

 
—

 
18,599

Agricultural
12,246

 
850

 
390

 
—

 
13,486

Other
665

 
—

 
—

 
—

 
665

Total
$
741,540

 
12,101

 
17,297

 
—

 
770,938


The Company evaluates the loan risk grading system definitions and allowance for loan loss methodology on an ongoing basis. No significant changes were made to either during the past year.

-65-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 4 - 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, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
19

 
—

 
—

 
19

 
41,882

 
41,901

 
—

Commercial, secured by real estate
99

 
69

 
127

 
295

 
476,649

 
476,944

 
—

Residential real estate
686

 
80

 
727

 
1,493

 
264,762

 
266,255

 
20

Consumer
59

 
16

 
3

 
78

 
19,183

 
19,261

 
3

Agricultural
125

 
—

 
—

 
125

 
14,684

 
14,809

 
—

Other
115

 
—

 
—

 
115

 
518

 
633

 
—

Total
$
1,103

 
165

 
857

 
2,125

 
817,678

 
819,803

 
23

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial & industrial
$
—

 
—

 
—

 
—

 
45,287

 
45,287

 
—

Commercial, secured by real estate
73

 
81

 
876

 
1,030

 
418,290

 
419,320

 
—

Residential real estate
777

 
198

 
1,124

 
2,099

 
271,482

 
273,581

 
516

Consumer
62

 
7

 
43

 
112

 
18,487

 
18,599

 
43

Agricultural
—

 
—

 
—

 
—

 
13,486

 
13,486

 
—

Other
109

 
—

 
—

 
109

 
556

 
665

 
—

Total
$
1,021

 
286

 
2,043

 
3,350

 
767,588

 
770,938

 
559



-66-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 4 - 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, 2016
 
 
 
 
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
109

 
263

 
—

 
998

 
151

Commercial, secured by real estate
14,195

 
15,522

 
—

 
15,274

 
1,140

Residential real estate
3,238

 
4,286

 
—

 
3,736

 
369

Consumer
26

 
27

 
—

 
37

 
29

Agricultural
334

 
334

 
—

 
392

 
136

Other
455

 
629

 
—

 
481

 
77

Total
$
18,357

 
21,061

 
—

 
20,918

 
1,902

 
 
 
 
 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

 
 

 
 

Commercial & industrial
$
326

 
326

 
9

 
341

 
19

Commercial, secured by real estate
4,690

 
4,946

 
347

 
4,194

 
257

Residential real estate
751

 
751

 
100

 
651

 
36

Consumer
43

 
43

 
13

 
43

 
3

Agricultural
—

 
—

 
—

 
—

 
—

Other
—

 
—

 
—

 
—

 
—

Total
$
5,810

 
6,066

 
469

 
5,229

 
315

 
 
 
 
 
 
 
 
 
 
Total:
 

 
 

 
 

 
 

 
 

Commercial & industrial
$
435

 
589

 
9

 
1,339

 
170

Commercial, secured by real estate
18,885

 
20,468

 
347

 
19,468

 
1,397

Residential real estate
3,989

 
5,037

 
100

 
4,387

 
405

Consumer
69

 
70

 
13

 
80

 
32

Agricultural
334

 
334

 
—

 
392

 
136

Other
455

 
629

 
—

 
481

 
77

Total
$
24,167

 
27,127

 
469

 
26,147

 
2,217

 

-67-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 4 - LOANS (Continued)


 
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
December 31, 2015
 
 
 
 
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial & industrial
$
1,205

 
1,500

 
—

 
1,467

 
206

Commercial, secured by real estate
16,345

 
18,335

 
—

 
18,575

 
2,229

Residential real estate
3,734

 
5,055

 
—

 
4,092

 
453

Consumer
81

 
109

 
—

 
106

 
25

Agricultural
48

 
151

 
—

 
81

 
487

Other
486

 
701

 
—

 
510

 
82

Total
$
21,899

 
25,851

 
—

 
24,831

 
3,482

 
 
 
 
 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

 
 

 
 

Commercial & industrial
$
356

 
356

 
9

 
370

 
21

Commercial, secured by real estate
3,883

 
4,014

 
306

 
4,007

 
114

Residential real estate
846

 
958

 
48

 
864

 
37

Consumer
2

 
1

 
—

 
—

 
—

Agricultural
—

 
—

 
—

 
—

 
—

Other
—

 
—

 
—

 
—

 
—

Total
$
5,087

 
5,329

 
363

 
5,241

 
172

 
 
 
 
 
 
 
 
 
 
Total:
 

 
 

 
 

 
 

 
 

Commercial & industrial
$
1,561

 
1,856

 
9

 
1,837

 
227

Commercial, secured by real estate
20,228

 
22,349

 
306

 
22,582

 
2,343

Residential real estate
4,580

 
6,013

 
48

 
4,956

 
490

Consumer
83

 
110

 
—

 
106

 
25

Agricultural
48

 
151

 
—

 
81

 
487

Other
486

 
701

 
—

 
510

 
82

Total
$
26,986

 
31,180

 
363

 
30,072

 
3,654



-68-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 4 - LOANS (Continued)


 
Average
Recorded
Investment
 
Interest
Income
Recognized
December 31, 2014
 
 
 
With no related allowance recorded:
 
 
 
Commercial & industrial
1,823

 
161

Commercial, secured by real estate
23,360

 
1,373

Residential real estate
4,645

 
379

Consumer
179

 
14

Agricultural
121

 
20

Other
550

 
43

Total
30,678

 
1,990

 
 
 
 
With an allowance recorded:
 
 
 
Commercial & industrial
319

 
19

Commercial, secured by real estate
4,108

 
117

Residential real estate
1,026

 
44

Consumer
18

 
2

Agricultural
—

 
—

Other
—

 
—

Total
5,471

 
182

 
 
 
 
Total:
 
 
 
Commercial & industrial
2,142

 
180

Commercial, secured by real estate
27,468

 
1,490

Residential real estate
5,671

 
423

Consumer
197

 
16

Agricultural
121

 
20

Other
550

 
43

Total
36,149

 
2,172


Of the interest income recognized on impaired loans during 2016, 2015, and 2014, approximately $51,000, $96,000, and $8,000, respectively, were recognized on a cash basis. The Company continued to accrue interest on certain loans classified as impaired during 2016, 2015, and 2014 because they were restructured or considered well secured and in the process of collection.












-69-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 4 - LOANS (Continued)


Loan modifications that were classified as troubled debt restructurings during the years ended December 31 were as follows (dollars in thousands):
 
2016
 
2015
 
2014
 
Number
of Loans
 
Pre-Modification Recorded Balance
 
Post-Modification Recorded Balance
 
Number
of Loans
 
Pre-Modification Recorded Balance
 
Post-Modification Recorded Balance
 
Number
of Loans
 
Pre-Modification Recorded Balance
 
Post-Modification Recorded Balance
Commercial and industrial
—

 
$
—

 
$
—

 
—

 
$
—

 
$
—

 
8

 
$
658

 
$
340

Commercial, secured by real estate
4

 
2,142

 
2,215

 
1

 
75

 
74

 
2

 
896

 
1,214

Residential real estate
6

 
139

 
139

 
7

 
217

 
221

 
2

 
82

 
82

Consumer
3

 
39

 
39

 
2

 
9

 
9

 
3

 
40

 
40

 
13

 
$
2,320

 
$
2,393

 
10

 
$
301

 
$
304

 
15

 
$
1,676

 
$
1,676


The pre-modification and post-modification recorded balances for the commercial and industrial and commercial, secured by real estate categories in 2014 changed because a borrower had multiple loans classified as commercial and industrial and a loan classified as commercial, secured by real estate, which were all modified into a loan classified as commercial, secured by real estate.
































-70-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 4 - LOANS (Continued)


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. Post-modification balances of newly restructured troubled debt by type of modification for the years ended December 31 were as follows (dollars in thousands):
 
Term Modification
 
Rate Modification
 
Interest Only
 
Combination
 
Total Modifications
December 31, 2016
 
 
 
 
 
 
 
 
 
Commercial & industrial
—

 
—

 
—

 
—

 
—

Commercial, secured by real estate
1,539

 
—

 
304

 
372

 
2,215

Residential real estate
38

 
47

 
—

 
54

 
139

Consumer
—

 
28

 
—

 
11

 
39

Total
1,577

 
75

 
304

 
437

 
2,393

 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
 
 
 
Commercial & industrial
—

 
—

 
—

 
—

 
—

Commercial, secured by real estate
74

 
—

 
—

 
—

 
74

Residential real estate
221

 
—

 
—

 
—

 
221

Consumer
9

 
—

 
—

 
—

 
9

Total
304

 
—

 
—

 
—

 
304

 
 
 
 
 
 
 
 
 
 
December 31, 2014
 
 
 
 
 
 
 
 
 
Commercial & industrial
340

 
—

 
—

 
—

 
340

Commercial, secured by real estate
—

 
1,136

 
—

 
78

 
1,214

Residential real estate
82

 
—

 
—

 
—

 
82

Consumer
38

 
—

 
—

 
2

 
40

Total
460

 
1,136

 
—

 
80

 
1,676


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

There were no troubled debt restructurings that subsequently defaulted within twelve months of the restructuring date for the years ended December 31, 2016, 2015, and 2014. Two commercial, secured by real estate loans to the same borrower totaling $1,236,000 that were modified during the fourth quarter 2016 subsequently defaulted in February 2017.

All troubled debt restructurings are considered impaired loans. The allowance for loan loss on such restructured loans is based on the present value of future expected cash flows.

Approximately $881,000 of impaired loans without a valuation allowance and $1,168,000 of impaired loans with a valuation allowance at December 31, 2016 consisted of loans that were modified during 2016 and were determined to be troubled debt restructurings.  Approximately $147,000 of impaired loans without a valuation allowance and $125,000 of impaired loans with a valuation allowance at December 31, 2015 consisted of loans that were modified during 2015 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, 2016, 2015 and 2014 were approximately $100,982,000, $111,837,000, and $120,433,000, respectively.
 

-71-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 4 - LOANS (Continued)


Mortgage servicing right assets are included in core deposit and other intangibles 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):
 
2016
 
2015
 
2014
Balance, beginning of year
$
488

 
591

 
498

Amount capitalized to mortgage servicing rights
109

 
78

 
292

Amortization of mortgage servicing rights
(169
)
 
(181
)
 
(199
)
Balance, end of year
$
428

 
488

 
591



NOTE 5 - ACQUIRED CREDIT IMPAIRED LOANS

The following table provides, as of December 31, the major classifications of loans acquired that are accounted for in accordance with FASB ASC 310-30 (in thousands):
 
2016
 
2015
Commercial & industrial
$
98

 
1,191

Commercial, secured by real estate
6,305

 
7,877

Residential real estate
2,471

 
3,039

Consumer
17

 
27

Agricultural
—

 
48

Other loans, including deposit overdrafts
455

 
486

 
9,346

 
12,668

Less allowance for loan losses
292

 
—

Loans, net
$
9,054

 
12,668


The following table provides the outstanding balance and related carrying amount for acquired impaired loans at December 31 (in thousands):
 
2016
 
2015
Outstanding balance
$
12,289

 
16,507

Carrying amount
9,346

 
12,668


Activity during 2016 and 2015 for the accretable discount related to acquired impaired loans is as follows (in thousands):
 
2016
 
2015
Accretable discount, beginning of year
$
1,503

 
2,674

Accretable discount acquired during period
—

 
413

Reclass from nonaccretable discount to accretable discount
423

 
983

Less disposals
(5
)
 
(850
)
Less accretion
(841
)
 
(1,717
)
Accretable discount, end of year
$
1,080

 
1,503



-72-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)


NOTE 6 – OTHER REAL ESTATE OWNED

Other real estate owned includes property acquired through foreclosure or deed-in-lieu of foreclosure and are included in other assets in the consolidated balance sheets.  Changes in other real estate owned were as follows (in thousands):
 
2016
 
2015
Balance, beginning of year
$
846

 
1,370

Additions
214

 
99

Reductions due to sales
(484
)
 
(205
)
Reductions due to valuation write downs
(576
)
 
(418
)
Balance, end of year
$
—

 
846


Other real estate owned at December 31 consisted of (in thousands):
 
2016
 
2015
Commercial real estate
$
—

 
846


The total recorded investment in residential consumer mortgage loans secured by residential real estate that was in the process of foreclosure at December 31, 2016 was $456,000.


NOTE 7 - PREMISES AND EQUIPMENT

Premises and equipment at December 31 are summarized as follows (in thousands):
 
2016
 
2015
Land
$
8,277

 
6,660

Buildings
21,400

 
21,463

Equipment
13,065

 
13,005

Construction in progress
7,362

 
9

Total
50,104

 
41,137

Less accumulated depreciation
19,860

 
19,037

Premises and equipment, net
$
30,244

 
22,100


Depreciation charged to expense was, $1,210,000 in 2016, and $1,427,000 in 2015, and $1,479,000 in 2014.

-73-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)


NOTE 8 - 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 2017 through 2021 and thereafter for non-cancelable leases having terms in excess of one year were as follows (in thousands):
2017
$
448

2018
267

2019
224

2020
193

2021
160

Thereafter
3,493

Total
$
4,785


Rental expense for all leased branches and equipment was approximately $545,000 in 2016, $542,000 in 2015, and $537,000 in 2014.

NOTE 9 - GOODWILL AND OTHER INTANGIBLE ASSETS

Changes in goodwill during 2016 and 2015 were as follows (in thousands):
 
2016
 
2015
Balance, beginning of year
$
30,183

 
27,638

Additions from acquisitions
—

 
2,545

Balance, end of year
$
30,183

 
30,183


Other intangible assets in the consolidated balance sheets at December 31, 2016 and 2015 were as follows (in thousands):
 
2016
 
2015
 
Gross
Intangible
Assets
 
Accumulated
Amortization
 
Net
Intangible
Assets
 
Gross
Intangible
Assets
 
Accumulated
Amortization
 
Net
Intangible
Assets
Core deposit intangibles
$
6,458

 
2,304

 
4,154

 
6,458

 
1,550

 
4,908

Mortgage servicing rights
1,188

 
760

 
428

 
1,496

 
1,008

 
488

Total
$
7,646

 
3,064

 
4,582

 
7,954

 
2,558

 
5,396


The estimated aggregate future amortization expense for each of the next five years for intangible assets remaining as of December 31, 2016 is as follows (in thousands):
2017
$
864

2018
843

2019
825

2020
808

2021
795


-74-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)


NOTE 10 - AFFORDABLE HOUSING TAX CREDIT LIMITED PARTNERSHIP

LCNB is a limited partner in limited partnerships that sponsor affordable housing projects utilizing the Low Income Housing Tax Credit (LIHTC) pursuant to Section 42 of the Internal Revenue Code. The purpose of the investments is to achieve a satisfactory return on capital, to facilitate the sale of additional affordable housing product offerings, and to assist in achieving goals associated with the Community Reinvestment Act. The primary activities of the limited partnerships include the identification, development, and operation of multi-family housing that is leased to qualifying residential tenants.

The following table presents the balances of LCNB's affordable housing tax credit investment and related unfunded commitment at December 31 (in thousands):
 
2016
 
2015
Affordable housing tax credit investment
$
2,000

 
1,000

Less amortization
93

 
12

Net affordable housing tax credit investment
$
1,907

 
988

 
 
 
 
Unfunded commitment
$
1,617

 
907


LCNB expects to fund the unfunded commitment over ten years.

The following table presents other information relating to LCNB's affordable housing tax credit investment for the years indicated (in thousands):
 
Year ended December 31,
 
2016
 
2015
 
2014
Tax credits and other tax benefits recognized
$
103

 
14

 
—

Tax credit amortization expense included in provision for income taxes
81

 
12

 
—



NOTE 11 - CERTIFICATES OF DEPOSIT

Contractual maturities of time deposits at December 31, 2016 were as follows (in thousands):
2017
$
63,188

2018
44,305

2019
24,848

2020
46,499

2021
33,124

Thereafter
2,800

 
$
214,764


The aggregate amount of time deposits in denominations of $250,000 or more at December 31, 2016 and 2015 was $22,410,000 and $20,987,000, respectively.

-75-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)


NOTE 12 - BORROWINGS

Funds borrowed from the FHLB at December 31 by year of maturity were as follows (dollars in thousands):
 
Outstanding Balance
 
Average Rate
December 31, 2016
 
 
 
2017
$
295

 
2.82
%
2018
248

 
2.82
%
2019
55

 
2.82
%
Total
$
598

 
2.82
%
 
 
 
 
December 31, 2015
 
 
 
2016
$
349

 
2.82
%
2017
5,295

 
5.11
%
2018
248

 
2.82
%
2019
55

 
2.82
%
Total
$
5,947

 
4.86
%
 
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 $229 million and $231 million at December 31, 2016 and 2015, 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, 2016 was approximately $79.5 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.
 
Short-term borrowings at December 31 were as follows (dollars in thousands):
 
2016
 
2015
 
Amount
 
Rate
 
Amount
 
Rate
Line of credit
$
—

 
—
%
 
$
13,187

 
1.00
%
FHLB short-term advance
25,000

 
0.63
%
 
10,000

 
0.35
%
Repurchase agreements
17,040

 
0.10
%
 
14,200

 
0.10
%
 
$
42,040

 
0.42
%
 
$
37,387

 
0.48
%

At December 31, 2016, the Company had short-term borrowing arrangements with three financial institutions and the Federal Home Loan Bank of Cincinnati.  The first arrangement is a short-term line of credit for a maximum amount of $10 million 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 $64.0 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 25, 2017.


-76-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 12 - BORROWINGS (continued)

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 fully secured by U.S. Agency notes and such collateral securities are held by the Federal Reserve Bank.  The maximum amount of outstanding agreements at any month-end during 2016 and 2015 totaled $18,715,000 and $16,250,000, respectively.  The average balance during 2016 and 2015 was $13,891,000 and $12,699,000, respectively.

As of December 31, 2016 and 2015, approximately $3.1 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.

NOTE 13 - INCOME TAXES

The provision for federal income taxes consists of (in thousands):
 
2016
 
2015
 
2014
Income taxes currently payable
$
3,515

 
4,280

 
3,194

Deferred income tax provision (benefit)
928

 
(58
)
 
192

Provision for income taxes
$
4,443

 
4,222

 
3,386


A reconciliation between the statutory income tax and the Company's effective tax rate follows:
 
2016
 
2015
 
2014
Statutory tax rate
34.2
 %
 
34.0
 %
 
34.0
 %
Increase (decrease) resulting from -
 

 
 

 
 

Tax exempt interest
(6.3
)%
 
(6.0
)%
 
(6.8
)%
Tax exempt income on bank owned life insurance
(1.5
)%
 
(1.4
)%
 
(1.7
)%
Other – net
(0.1
)%
 
0.3
 %
 
—
 %
Effective tax rate
26.3
 %
 
26.9
 %
 
25.5
 %


-77-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 13 - INCOME TAXES (continued)


Deferred tax assets and liabilities, included with Other Assets in the Consolidated Balance Sheets, at December 31 consist of the following (in thousands):
 
2016
 
2015
Deferred tax assets:
 
 
 
Allowance for loan losses
$
1,223

 
1,064

Net unrealized losses on investment securities available-for-sale
1,369

 
246

Fair value adjustment on loans acquired from merger with First Capital
592

 
847

Write-down of other real estate owned
—

 
338

Pension and deferred compensation
1,157

 
971

Other
546

 
440

 
4,887

 
3,906

Deferred tax liabilities:
 

 
 

Depreciation of premises and equipment
(1,332
)
 
(1,332
)
Amortization of intangibles
(1,567
)
 
(840
)
Deferred loan fees
(2
)
 
(2
)
FHLB stock dividends
(351
)
 
(349
)
Fair value adjustment on securities acquired from merger with First Capital
(19
)
 
(70
)
 
(3,271
)
 
(2,593
)
Net deferred tax assets
$
1,616

 
1,313


As of December 31, 2016 and 2015 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, 2016.

The Company is no longer subject to examination by federal tax authorities for years before 2013.

NOTE 14 - COMMITMENTS AND CONTINGENT LIABILITIES

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

LCNB uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.






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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 14 - COMMITMENTS AND CONTINGENT LIABILITIES (continued)


Financial instruments whose contract amounts represent off-balance-sheet credit risk at December 31 were as follows (in thousands):
 
2016
 
2015
Commitments to extend credit:
 
 
 
Commercial loans
$
10,350

 
8,160

Other loans:
 
 
 
Fixed rate
4,425

 
2,293

Adjustable rate
1,044

 
1,362

Unused lines of credit:
 
 
 
Fixed rate
9,731

 
6,378

Adjustable rate
80,222

 
90,153

Unused overdraft protection amounts on demand and NOW accounts
17,123

 
10,057

Standby letters of credit
657

 
457

 
$
123,552

 
118,860


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.  These guarantees generally are fully secured and have varying maturities.

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.

Capital expenditures include the construction or acquisition of new office buildings, improvements to LCNB's offices,
purchases of furniture and equipment, and additions or improvements to LCNB's information technology system.
Commitments outstanding for capital expenditures as of December 31, 2016 totaled approximately $4,750,000, which includes estimated remaining costs for a new operations center being built in Lebanon, Ohio.

The Company and its subsidiary 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 15 - REGULATORY MATTERS

The Federal Reserve Act requires depository institutions to maintain cash reserves with the Federal Reserve Bank.  In 2016 and 2015, the Bank maintained average reserve balances of $10,903,000 and $11,329,000, respectively.  The reserve balances at December 31, 2016 and 2015 were $4,313,000 and $633,000, 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 2017, the restrictions generally limit dividends to the aggregate of net income for the year 2017 plus the net earnings retained for 2016 and 2015.  In addition, dividend payments may not reduce capital levels below minimum regulatory guidelines. At December 31, 2016, approximately $14,147,000 of the Bank’s earnings retained was available for dividends in 2017 under this guideline.  Dividends in excess of these limitations would require the prior approval of the Comptroller of the Currency.

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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 15 - 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.

A new rule requiring a Capital Conservation Buffer began phase-in on January 1, 2016 and will be fully implemented in 2019. Under the fully-implemented rule, a financial institution will need to maintain a Capital Conservation Buffer composed of Common Equity Tier 1 Capital of at least 2.5% above its minimum risk-weighted capital requirements to avoid limitations on its ability to make capital distributions, including dividend payments to shareholders and certain discretionary bonus payments to executive officers. A financial institution with a buffer below 2.5% will be subject to increasingly stringent limitations on capital distributions as the buffer approaches zero.

For various regulatory purposes, financial institutions are classified into categories based upon capital adequacy:
 
Minimum
Requirement
 
Minimum Requirement with Capital Conservation Buffer
 
To Be Considered
Well-Capitalized
Ratio of Common Equity Tier 1 Capital to risk-weighted assets
4.5
%
 
5.125
%
 
6.5
%
Ratio of tier 1 capital to risk-weighted assets
6.0
%
 
6.625
%
 
8.0
%
Ratio of total capital (tier 1 capital plus tier 2 capital) to risk-weighted assets
8.0
%
 
8.625
%
 
10.0
%
Leverage ratio (tier 1 capital to adjusted quarterly average total assets)
4.0
%
 
N/A

 
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.

A summary of the regulatory capital of the Consolidated Company and Bank at December 31 follows (dollars in thousands):
 
2016
 
2015
 
Consolidated
Company
 
Bank
 
Consolidated
Company
 
Bank
Regulatory Capital:
 
 
 
 
 
 
 
Shareholders' equity
$
142,944

 
141,325

 
140,108

 
138,396

Goodwill and other intangible assets
(32,676
)
 
(32,676
)
 
(32,146
)
 
(32,146
)
Accumulated other comprehensive (income) loss
2,617

 
2,605

 
(256
)
 
(261
)
Tier 1 risk-based capital
112,885

 
111,254

 
107,706

 
105,989

Eligible allowance for loan losses
3,575

 
3,575

 
3,129

 
3,129

Total risk-based capital
$
116,460

 
114,829

 
110,835

 
109,118

Capital Ratios:
 

 
 

 
 

 
 

Common Equity Tier 1 Capital to risk-weighted assets
13.00
%
 
12.82
%
 
13.46
%
 
13.26
%
Tier 1 capital to risk-weighted assets
13.00
%
 
12.82
%
 
13.46
%
 
13.26
%
Total capital (tier 1 capital plus tier 2 capital) to risk-weighted assets
13.41
%
 
13.24
%
 
13.85
%
 
13.65
%
Leverage ratio (tier 1 capital to adjusted quarterly average total assets)
8.81
%
 
8.69
%
 
8.62
%
 
8.49
%


-80-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 15 - REGULATORY MATTERS (continued)


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.

Two warrants for the purchase of an aggregate total of 217,063 common shares of LCNB stock at an exercise price of $9.26 per share were outstanding at December 31, 2015.  The warrants carried a ten year term and were 100% vested at the date of grant, which was January 9, 2009. During March 2016, LCNB repurchased both warrants for $1,545,000, which was accounted for as a reduction to common shares in the shareholders’ equity section of the consolidated balance sheets.


NOTE 16 - ACCUMULATED OTHER COMPREHENSIVE INCOME
 
Changes in accumulated other comprehensive income (loss) for 2016 and 2015 were as follows (in thousands):
 
2016
 
2015
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Changes in Pension Plan Assets and Benefit Obligations
 
Total
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Changes in Pension Plan Assets and Benefit Obligations
 
Total
Balance at beginning of year
$
469

 
(233
)
 
236

 
1,126

 
(341
)
 
785

Before reclassifications
(2,390
)
 
249

 
(2,141
)
 
(330
)
 
108

 
(222
)
Reclassifications
(712
)
 
—

 
(712
)
 
(327
)
 
—

 
(327
)
Balance at end of year
$
(2,633
)
 
16

 
(2,617
)
 
469

 
(233
)
 
236


Reclassifications out of accumulated other comprehensive income (loss) during 2016 and 2015 and the affected line items in the consolidated statements of income were as follows (in thousands):
 
2016
 
2015
 
Affected Line Item in the Consolidated Statements of Income
Realized gain on sales of securities
$
1,082

 
495

 
Net gain on sale of securities
Less provision for income taxes
370

 
168

 
Provision for income taxes
Reclassification adjustment, net of taxes
$
712

 
327

 
 

NOTE 17 - 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.








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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 17 - RETIREMENT PLANS (continued)


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, 2016 and 2015.  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):
 
2016
 
2015
 
2014
Qualified noncontributory defined benefit retirement plan
$
969

 
984

 
967

401(k) plan
359

 
346

 
326


The Company expects a minimum contribution of $189,000 to the qualified noncontributory defined benefit retirement plan in 2017.  The Company expects to contribute $250,000 to the 401(k) plan in 2017.  The Company’s contributions to the qualified noncontributory defined benefit retirement plan do not represent more than 5% of total contributions to the plan.

Citizens National had a qualified noncontributory defined benefit pension plan which covered employees hired before May 1, 2005.  The Company assumed this plan at the time of the merger. At December 31, 2016, the amount of the asset for this plan was $30,000, representing the funded status of 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, 2016 and 2015 was $3,407,000 and $3,199,000, respectively.

The Bank also has supplemental income plans which provide certain employees an amount based on a percentage of average compensation, payable in accordance with individually defined schedules upon retirement. The projected benefit obligation included in other liabilities for the supplemental income plans at December 31, 2016 and 2015 is $1,284,000 and $1,295,000, respectively. The average discount rate used to determine the present value of the obligations was approximately 5.2% in 2016 and 5.0% in 2015. The service cost associated with the plans was $0 for 2016, $183,000 for 2015, and $43,000 for 2014.  Interest costs were $63,000, $56,000, and $56,000 for 2016, 2015, and 2014, respectively.

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



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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 17 - RETIREMENT PLANS (continued)


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):
 
2016
 
2015
 
2014
Service cost
$
41

 
38

 
68

Interest cost
78

 
68

 
60

Amortization of unrecognized (gain) loss
168

 
171

 
—

Amortization of unrecognized prior service cost
—

 
—

 
15

Net periodic pension cost
$
287

 
277

 
143


A reconciliation of changes in the projected benefit obligation of the nonqualified defined benefit retirement plan at December 31 follows (in thousands):
 
2016
 
2015
 
2014
Projected benefit obligation at beginning of year
$
1,843

 
1,741

 
1,213

Service cost
41

 
38

 
68

Interest cost
78

 
68

 
60

Actuarial (gain) or loss
(209
)
 
10

 
407

Benefits paid
(26
)
 
(14
)
 
(7
)
Projected benefit obligation at end of year
$
1,727

 
1,843

 
1,741


Amounts recognized in other liabilities in the consolidated balance sheets for the nonqualified defined benefit retirement plan at December 31, 2016 and 2015 were $1,727,000 and $1,843,000, respectively.

The accumulated benefit obligation for the nonqualified defined benefit retirement plan at December 31, 2016 and 2015 was $1,727,000 and $1,752,000, respectively.

Amounts recognized in accumulated other comprehensive income, net of tax, at December 31 for the nonqualified defined benefit retirement plan consists of (in thousands):
 
2016
 
2015
 
2014
Net actuarial (gain)/loss
$
(16
)
 
233

 
339

Past service cost
—

 
—

 
—

 
$
(16
)
 
233

 
339


The estimated unrecognized net actuarial gain that will be amortized from accumulated other comprehensive income into net periodic benefit cost during 2017 for the nonqualified defined benefit retirement plan is $0.







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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 17 - 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:
 
2016
 
2015
 
2014
Benefit obligation:
 
 
 
 
 
Discount rate
4.14
%
 
4.34
%
 
3.95
%
Salary increase rate
2.00
%
 
2.00
%
 
2.00
%
 
 
 
 
 
 
Net periodic pension cost:
 

 
 

 
 

Discount rate
4.34
%
 
3.95
%
 
4.95
%
Salary increase rate
2.00
%
 
2.00
%
 
3.00
%
Amortization period in years
1.00

 
1.98

 
3.95


The nonqualified defined benefit retirement plan is not funded.  Therefore no contributions will be made in 2017.  Estimated future benefit payments reflecting expected future service for the years ended after December 31, 2016 are (in thousands):
2017
$
105

2018
122

2019
122

2020
122

2021
122

2022-2026
600


NOTE 18 - STOCK-BASED COMPENSATION

LCNB established an Ownership Incentive Plan (the "2002 Plan") during 2002 that allowed for stock-based awards to eligible employees, as determined by the Board of Directors.  The awards were in the form of stock options, share awards, and/or appreciation rights.  The 2002 Plan provided for the issuance of up to 200,000 shares. The 2002 Plan expired on April 16, 2012. Any outstanding unexercised options, however, continue to be exercisable in accordance with their terms.

The 2015 Ownership Incentive Plan (the "2015 Plan") was approved by LCNB's shareholders at the annual meeting on April 28, 2015 and allows for stock-based awards to eligible employees, as determined by the Compensation Committee of the Board of Directors. Awards may be made in the form of stock options, appreciation rights, restricted shares, and/or restricted share units. The 2015 Plan provides for the issuance of up to 450,000 shares. The 2015 Plan will terminate on April 28, 2025 and is subject to earlier termination by the Compensation Committee.

Stock-based awards may be in the form of treasury shares or new shares.


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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 18 - STOCK-BASED COMPENSATION (continued)


LCNB has not granted stock options since 2012. Option awards granted to date under the 2002 Plan vest ratably over a five year period and expire ten years after the date of grant. Stock options outstanding at December 31, 2016 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
 
4,356

 
$
9.00

 
2.1
 
4,356

 
$
9.00

 
2.1
$11.00 - 12.99
 
17,797

 
12.13

 
3.8
 
16,052

 
12.08

 
3.7
$17.00 - 18.99
 
2,516

 
17.88

 
0.1
 
2,516

 
17.88

 
0.1
 
 
24,669

 
12.17

 
3.1
 
22,924

 
12.13

 
3.0

The following table summarizes stock option activity for the years indicated:
 
2016
 
2015
 
2014
 
 
 
Options
 
Weighted
Average
Exercise
Price
 
 
 
Options
 
Weighted
Average
Exercise
Price
 
 
 
Options
 
Weighted
Average
Exercise
Price
Outstanding at January 1,
83,861

 
12.39

 
99,810

 
$
12.16

 
104,966

 
$
12.43

Granted
—

 
—

 
—

 
—

 
—

 
—

Exercised
(51,390
)
 
11.53

 
(13,449
)
 
11.31

 
—

 
—

Expired
(7,802
)
 
18.76

 
(2,500
)
 
9.00

 
(5,156
)
 
17.66

Outstanding at December 31,
24,669

 
12.17

 
83,861

 
12.39

 
99,810

 
12.16

Exercisable at December 31,
22,924

 
12.13

 
75,072

 
12.40

 
79,909

 
12.18


The following table provides information related to stock options exercised during the years indicated (in thousands):
 
2016
 
2015
 
2014
Intrinsic value of options exercised
$
288

 
67

 
—

Cash received from options exercised
592

 
152

 
—

Tax benefit realized from options exercised
59

 
13

 
—


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, 2016 that were “in the money” (market price greater than exercise price) was $273,000.  The aggregate intrinsic value at that date for only the options that were exercisable was $255,000.  The aggregate intrinsic value for options outstanding at December 31, 2015 that were in the money was $360,000 and the aggregate intrinsic value at that date for only the options that were exercisable was $324,000. The intrinsic value changes based on changes in the market value of the Company’s stock.

Total expense related to options included in salaries and wages in the consolidated statements of income for the years ended December 31, 2016, 2015, and 2014 was $5,000, $19,000, and $24,000, respectively. The related tax benefit for 2016, 2015, and 2014 was $2,000, $6,000, and $8,000, respectively. Total compensation cost related to option awards to be recognized through the first quarter of 2017 is approximately $1,000.


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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 18 - STOCK-BASED COMPENSATION (continued)


Restricted stock awards granted under the 2015 Plan were as follows:
 
2016
 
2015
 
 
 
Shares
 
Weighted Average Grant Date Fair Value
 
Shares
 
Weighted Average Grant Date Fair Value
Outstanding at January 1,
16,038

 
$
15.47

 
—

 
$
—

Granted
—

 
—

 
16,038

 
15.47

Vested
(7,414
)
 
15.47

 
—

 
—

Forfeited
—

 
—

 
—

 
—

Outstanding at December 31,
8,624

 
$
15.47

 
16,038

 
$
15.47


Total expense related to restricted stock awards included in salaries and wages in the consolidated statements of income for the years ended December 31, 2016 and 2015 was $90,000 and $90,000, respectively. The related tax benefit for the years ended December 31, 2016 and 2015 was $31,000 and $31,000, respectively. Unrecognized compensation expense for restricted stock awards was $68,000 at December 31, 2016 and is expected to be recognized over a period of four years.

NOTE 19 - EARNINGS PER SHARE

LCNB has granted restricted stock awards with non-forfeitable dividend rights, which are considered participating securities. Accordingly, earnings per share is computed using the two-class method as required by FASB ASC 260-10-45. Basic earnings per common share is calculated by dividing net income allocated to common shareholders by the weighted average number of common shares outstanding during the period, which excludes the participating securities.  Diluted earnings per common share is adjusted for the dilutive effects of stock options, warrants, and restricted stock.  The diluted average number of common shares outstanding has been increased for the assumed exercise of stock options and warrants with proceeds used to purchase treasury shares at the average market price for the period.  

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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)

NOTE 19 - EARNINGS PER SHARE (continued)


Earnings per share for the years ended December 31 were calculated as follows (in thousands, except share and per share data):
 
2016
 
2015
 
2014
Net income
$
12,482

 
11,474

 
9,869

  Less allocation of earnings and dividends to participating securities
13

 
—

 
—

  Net income allocated to common shareholders
12,469

 
11,474

 
9,869

 
 
 
 
 
 
Weighted average common shares outstanding, gross
9,958,300

 
9,704,965

 
9,297,019

   Less average participating securities
10,243

 
—

 
—

Weighted average number of shares outstanding used in the calculation of basic earnings per common share
9,948,057

 
9,704,965

 
9,297,019

Add dilutive effect of:
 

 
 

 
 

Stock options
10,765

 
17,174

 
18,545

Stock warrants
17,548

 
89,328

 
90,782

Adjusted weighted average number of shares outstanding used in the calculation of diluted earnings per common share
9,976,370

 
9,811,467

 
9,406,346

 
 
 
 
 
 
Earnings per common share:
 

 
 

 
 

Basic
$
1.26

 
1.18

 
1.06

Diluted
1.25

 
1.17

 
1.05


Options to purchase 12,962, and 12,962 shares of common stock at weighted average prices of $18.41 and $18.41 per share were outstanding at December 31, 2015 and 2014, respectively, and were not included in the computation of diluted earnings per common share because the exercise prices of the options were greater than the average market prices of the common shares. There were no such options at December 31, 2016.

NOTE 20 - RELATED PARTY TRANSACTIONS

LCNB 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 collectibility or present other unfavorable features.  The following table provides a summary of the loan activity for these officers and directors for the years ended December 31 (in thousands):
 
2016
 
2015
Beginning balance
$
1,091

 
1,192

New loans and advances
64

 
106

Change in composition of related parties
506

 
—

Reductions
(214
)
 
(207
)
Ending Balance
$
1,447

 
1,091

Deposits from executive officers, directors and related interests of such persons held by the Company at December 31, 2016 and 2015 amounted to $4,618,000 and $3,577,000, respectively.

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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)



NOTE 21 - 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.

LCNB utilizes a pricing service for determining the fair values of most of its investment securities. Fair value for U.S. Treasury notes 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, LCNB has invested in trust preferred securities, equity securities, and four mutual funds that are not priced by the pricing service. Market quotations (level 1) are used to determine fair values for the trust preferred securities and equity securities. Investments in mutual funds that are publicly traded in active markets and that publish daily net asset values are considered to have level 1 inputs. An investment in a mutual fund that is not traded in an active market is considered to have level 2 inputs because 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 fair value, which approximates cost.

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. 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. These inputs are also considered to be level 3.

























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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)
NOTE 21 - 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)
December 31, 2016
 
 
 
 
 
 
 
Recurring fair value measurements:
 
 
 
 
 
 
 
Investment securities available-for-sale:
 
 
 
 
 
 
 
U.S. Treasury notes
$
28,145

 
28,145

 
—

 
—

U.S. Agency notes
85,400

 
—

 
85,400

 
—

U.S. Agency mortgage-backed securities
71,047

 
—

 
71,047

 
—

Certificates of deposit with other banks
—

 
—

 
—

 
—

Municipal securities:
 

 
 

 
 

 
 

Non-taxable
113,015

 
—

 
113,015

 
—

Taxable
19,845

 
—

 
19,845

 
—

Mutual funds
1,000

 
—

 
1,000

 
—

Mutual funds measured at net asset value (a)
1,482

 
 
 
 
 
 
Trust preferred securities
48

 
48

 
—

 
—

Equity securities
677

 
677

 
—

 
—

Total recurring fair value measurements
$
320,659

 
28,870

 
290,307

 
—

 
 
 
 
 
 
 
 
 
Nonrecurring fair value measurements:
 

 
 

 
 

 
 

Impaired loans
$
5,340

 
—

 
—

 
5,340

 
 
 
 
 
 
 
 
 
December 31, 2015
 

 
 

 
 

 
 

Recurring fair value measurement:
 

 
 

 
 

 
 

Investment securities available-for-sale:
 

 
 

 
 

 
 

U.S. Treasury notes
$
72,846

 
72,846

 
—

 
—

U.S. Agency notes
139,889

 
—

 
139,889

 
—

U.S. Agency mortgage-backed securities
29,378

 
—

 
29,378

 
—

Certificates of deposit with other banks
249

 
—

 
249

 
—

Municipal securities:
 

 
 

 
 

 
 

Non-taxable
105,479

 
—

 
105,479

 
—

Taxable
26,941

 
—

 
26,941

 
—

Mutual funds
1,018

 
18

 
1,000

 
—

Mutual funds measured at net asset value (a)
1,448

 
 
 
 
 
 
Trust preferred securities
50

 
50

 
—

 
—

Equity securities
680

 
680

 
—

 
—

Total recurring fair value measurements
$
377,978

 
73,594

 
302,936

 
—

 
 
 
 
 
 
 
 
 
Nonrecurring fair value measurements:
 

 
 

 
 

 
 

Impaired loans
$
4,722

 
—

 
—

 
4,722

Other real estate owned and repossessed assets
846

 
—

 
—

 
846

Total nonrecurring fair value measurements
$
5,568

 
—

 
—

 
5,568

 
 
 
 
 
 
 
 
 
(a)
In accordance with Subtopic 820-10, certain investments that are measured at fair value using the net asset value per share practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the Consolidated Balance Sheets.


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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)


The following table presents quantitative information about unobservable inputs used in nonrecurring Level 3 fair value measurements at December 31, 2016 and 2015 (dollars in thousands):
 
 
 
 
 
 
 
 
Range
 
 
Fair Value
 
Valuation Technique
 
Unobservable Inputs
 
High
 
Low
 
Weighted Average
2016
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans
 
$
5,340

 
Estimated sales price
 
Adjustments for comparable properties, discounts to reflect current market conditions
 
Not applicable
 
 
 
 
Discounted cash flows
 
Discount rate
 
8.25
%
 
4.50
%
 
5.56
%
 
 
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans
 
$
4,722

 
Estimated sales price
 
Adjustments for comparable properties, discounts to reflect current market conditions
 
Not applicable
 
 
 
 
Discounted cash flows
 
Discount rate
 
11.00%
 
4.00%
 
5.27%
Other real estate owned
 
846

 
Estimated sales price
 
Adjustments for comparable properties, discounts to reflect current market conditions
 
 
 
 
 
 

-90-
Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)


Carrying amounts and estimated fair values of financial instruments as of December 31 were as follows (in thousands):
 
 
 
 
 
Fair Value Measurements at the End of
the Reporting Period Using
 
Carrying
Amount
 
Fair
Value
 
Quoted
Prices
in Active
 Markets for
Identical
Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
2016
 
 
 
 
 
 
 
 
 
FINANCIAL ASSETS:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
18,865

 
18,865

 
18,865

 
—

 
—

Investment securities, held-to-maturity
41,003

 
40,490

 
—

 
—

 
40,490

Federal Reserve Bank stock
2,732

 
2,732

 
2,732

 
—

 
—

Federal Home Loan Bank stock
3,638

 
3,638

 
3,638

 
—

 
—

Loans, net
816,228

 
799,791

 
—

 
—

 
799,791

Accrued interest receivable
3,559

 
3,559

 
—

 
3,559

 
—

 
 
 
 
 
 
 
 
 
 
FINANCIAL LIABILITIES:
 

 
 

 
 
 
 
 
 
Deposits
1,110,905

 
1,113,187

 
896,147

 
217,040

 
—

Short-term borrowings
42,040

 
42,040

 
42,040

 
—

 
—

Long-term debt
598

 
614

 
—

 
614

 
—

Accrued interest payable
307

 
307

 
—

 
307

 
—

 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
FINANCIAL ASSETS:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
14,987

 
14,987

 
14,987

 
—

 
—

Investment securities, held-to-maturity
22,633

 
22,630

 
—

 
—

 
22,630

Federal Reserve Bank stock
2,732

 
2,732

 
2,732

 
—

 
—

Federal Home Loan Bank stock
3,638

 
3,638

 
3,638

 
—

 
—

Loans, net
767,809

 
761,388

 
—

 
—

 
761,388

Accrued interest receivable
3,380

 
3,380

 
—

 
3,380

 
—

 
 
 
 
 
 
 
 
 
 
FINANCIAL LIABILITIES:
 

 
 

 
 
 
 
 
 
Deposits
1,087,160

 
1,087,914

 
869,940

 
217,974

 
—

Short-term borrowings
37,387

 
37,387

 
37,387

 
—

 
—

Long-term debt
5,947

 
6,290

 
—

 
6,290

 
—

Accrued interest payable
345

 
345

 
—

 
345

 
—


The fair values of off-balance-sheet financial instruments such as loan commitments and letters of credit are based on fees
currently charged to enter into similar agreements, taking into account the remaining terms of the agreements. The fair values of
such instruments were not material at December 31, 2016 and 2015.
 




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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)
NOTE 21 - 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, held-to-maturity
Fair values for securities, held-to-maturity is estimated using discounted cash flow analysis, using interest rates offered on investments with similar maturities and investment quality.  

Federal Home Loan Bank and Federal Reserve Bank stock
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. These current rates approximate market rates.

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, which approximates market rates.

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.

Accrued interest receivable and Accrued interest payable
Carrying amount approximates fair value.


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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)


NOTE 22 – QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following table sets forth certain quarterly results for the years ended December 31, 2016 and 2015 (dollars in thousands, except per share data):
 
Three Months Ended
 
March 31
 
June 30
 
Sep. 30
 
Dec. 31
2016
 
 
 
 
 
 
 
Interest income
$
10,621

 
11,008

 
10,895

 
11,226

Interest expense
849

 
883

 
885

 
887

Net interest income
9,772

 
10,125

 
10,010

 
10,339

Provision for loan losses
90

 
396

 
372

 
55

Net interest income after provision
9,682

 
9,729

 
9,638

 
10,284

Total non-interest income
2,642

 
2,750

 
2,846

 
2,615

Total non-interest expenses
8,292

 
8,468

 
8,593

 
7,908

Income before income taxes
4,032

 
4,011

 
3,891

 
4,991

Provision for income taxes
1,068

 
1,043

 
995

 
1,337

Net income
$
2,964

 
2,968

 
2,896

 
3,654

 
 
 
 
 
 
 
 
Earnings per common share:
 

 
 

 
 

 
 

  Basic
$
0.30

 
0.30

 
0.29

 
0.37

  Diluted
0.30

 
0.29

 
0.29

 
0.37

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2015
 

 
 

 
 

 
 

Interest income
$
10,090

 
11,348

 
10,409

 
10,812

Interest expense
762

 
748

 
912

 
906

Net interest income
9,328

 
10,600

 
9,497

 
9,906

Provision for loan losses
69

 
677

 
240

 
380

Net interest income after provision
9,259

 
9,923

 
9,257

 
9,526

Total non-interest income
2,306

 
2,831

 
2,386

 
2,600

Total non-interest expenses
7,649

 
8,426

 
8,088

 
8,229

Income before income taxes
3,916

 
4,328

 
3,555

 
3,897

Provision for income taxes
1,082

 
1,205

 
922

 
1,013

Net income
$
2,834

 
3,123

 
2,633

 
2,884

 
 
 
 
 
 
 
 
Earnings per common share:
 

 
 

 
 

 
 

  Basic
$
0.30

 
0.33

 
0.26

 
0.29

  Diluted
0.30

 
0.32

 
0.26

 
0.29



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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)


NOTE 23 - PARENT COMPANY FINANCIAL INFORMATION

Condensed financial information for LCNB Corp., parent company only, follows (in thousands):
Condensed Balance Sheets:
 
 
 
December 31,
2016
 
2015
Assets:
 
 
 
Cash on deposit with subsidiary
$
491

 
534

Investment securities available-for-sale, at fair value
893

 
888

Investment in subsidiary
141,325

 
138,396

Other assets
235

 
290

Total assets
$
142,944

 
140,108

 
 
 
 
Liabilities
$
—

 
—

 
 
 
 
Shareholders' equity
142,944

 
140,108

Total liabilities and shareholders' equity
$
142,944

 
140,108


Condensed Statements of Income
 
 
 
 
 
Year ended December 31,
2016
 
2015
 
2014
Income:
 
 
 
 
 
Dividends from subsidiary
$
7,300

 
5,400

 
8,800

Interest and dividends
38

 
58

 
91

Net gain on sales of securities
8

 
254

 
10

Total income
7,346

 
5,712

 
8,901

 
 
 
 
 
 
Total expenses
1,014

 
1,016

 
1,077

 
 
 
 
 
 
Income before income tax expense/benefit and equity in undistributed income of subsidiary
6,332

 
4,696

 
7,824

Income tax benefit
336

 
250

 
350

Equity in undistributed income of subsidiary
5,814

 
6,528

 
1,695

Net income
$
12,482

 
11,474

 
9,869


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Table of Contents
LCNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
(Continued)
NOTE 23 - PARENT COMPANY FINANCIAL INFORMATION (continued)


Condensed Statements of Cash Flows
 
 
 
 
 
Year ended December 31,
2016
 
2015
 
2014
Cash flows from operating activities:
 
 
 
 
 
Net income
$
12,482

 
11,474

 
9,869

Adjustments for non-cash items -
 

 
 

 
 

Increase in undistributed income of subsidiary
(5,814
)
 
(6,528
)
 
(1,695
)
Other, net
126

 
42

 
(474
)
Net cash flows from operating activities
6,794

 
4,988

 
7,700

 
 
 
 
 
 
Cash flows from investing activities:
 

 
 

 
 

Purchases of securities available-for-sale
(177
)
 
(215
)
 
(107
)
Proceeds from maturities of securities available-for-sale
55

 
—

 
—

Proceeds from sales of available-for-sale securities
173

 
1,217

 
227

Cash paid for business acquisition
—

 
(3,757
)
 
(24,750
)
Net cash flows from (used in) investing activities
51

 
(2,755
)
 
(24,630
)
 
 
 
 
 
 
Cash flows from financing activities:
 

 
 

 
 

Proceeds from issuance of common stock
379

 
390

 
372

Repurchase of stock warrants
(1,545
)
 
—

 
—

Cash dividends paid on common stock
(6,375
)
 
(6,239
)
 
(5,950
)
Other
653

 
165

 
—

Net cash flows used in financing activities
(6,888
)
 
(5,684
)
 
(5,578
)
Net change in cash
(43
)
 
(3,451
)
 
(22,508
)
Cash at beginning of year
534

 
3,985

 
26,493

Cash at end of year
$
491

 
534

 
3,985


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LCNB CORP. AND SUBSIDIARY



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 2016 Annual Report on Form 10-K.

Changes in Internal Control over Financial Reporting

During the fourth quarter 2016, 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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LCNB CORP. AND SUBSIDIARY



PART III

Portions of the Company’s Definitive Proxy Statement (the “Proxy Statement”) included in the Notice of Annual Meeting of Shareholders to be held April 25, 2017, which Proxy Statement will be mailed to shareholders within 120 days from the end of the fiscal year ended December 31, 2016, 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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LCNB CORP. AND SUBSIDIARY



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, 2016 and 2015.
 
Consolidated Statements of Income for the Years Ended December 31, 2016, 2015, and 2014.
 
     Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2016, 2015, and 2014.
 
     Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 2016, 2015, and 2014.
 
     Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015, and 2014.
 
Notes to Consolidated Financial Statements
 
 
2.
Financial Statement Schedules – None
 
 
3.
Exhibits required by Item 601 Regulation S-K.

(a) Exhibit No.
 
 
Exhibit Description
 
2.1
 
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.
 
2.2
 
Stock Purchase Agreement between LCNB Corp. and Colonial Banc Corp. dated as of October 28, 2013 - incorporated by reference to the Registrant's Current Report on Form 8-K filed on October 28, 2013, Exhibit 2.1.
 
2.3
 
Agreement and Plan of Merger dated as of December 29, 2014 by and between LCNB Corp. and BNB Bancorp, Inc., - incorporated by reference to the Registrant's Current Report on Form 8-K filed on January 2, 2015, Exhibit 2.1.
 
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).
 
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).
 
10.2
 
LCNB Corp. 2015 Ownership Incentive Plan - incorporated by reference to Registrant's Form DEF 14A Proxy Statement pursuant to Section 14(a), dated March 13, 2015, Exhibit A (001-35292)
 
10.3
 
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.
 
10.5
 
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.
 
10.7
 
Form of Restricted Share Grant Agreement under the LCNB Corp. 2015 Ownership Incentive Plan - incorporated by reference to Registrant's 2015 Form 10-K, Exhibit 10.7.
 
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.

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LCNB CORP. AND SUBSIDIARY



(a) Exhibit No.
 
 
Exhibit Description
 
21
 
LCNB Corp. subsidiary.
 
23.1
 
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.
 
101
 
The following financial information from LCNB Corp.’s Annual Report on Form 10-K for the year ended December 31, 2016 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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LCNB CORP. AND SUBSIDIARY



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/ Steve P. Foster
 
 
Steve P. Foster
 
 
Chief Executive Officer & President
 
 
March 8, 2017
 
 
 
 

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/ Steve P. Foster
 
/s/ William H. Kaufman
 
Steve P. Foster
 
William H. Kaufman
 
Chief Executive Officer, President, & Director
 
Director
 
(Principal Executive Officer)
 
March 8, 2017
 
March 8, 2017
 
 
 
 
 
 
 
 
 
/s/ Anne E. Krehbiel
 
/s/ Robert C. Haines II
 
Anne E. Krehbiel
 
Robert C. Haines II
 
Director
 
Executive Vice President & Chief Financial
 
March 8, 2017
 
Officer (Principal Financial and Accounting
 
 
 
Officer)
 
 
 
March 8, 2017
 
 
 
 
 
John H. Kochensparger III
 
 
 
Director
 
/s/ Stephen P. Wilson
 
March 8, 2017
 
Stephen P. Wilson
 
 
 
Chairman of the Board of Directors
 
 
 
March 8, 2017
 
/s/ Valerie S. Krueckeberg
 
 
 
Valerie S. Krueckeberg
 
 
 
Director
 
/s/ Spencer S. Cropper
 
March 8, 2017
 
Spencer S. Cropper
 
 
 
Director
 
 
 
March 8, 2017
 
/s/ George L. Leasure
 
 
 
George L. Leasure
 
 
 
Director
 
 
 
March 8, 2017
 

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