LCNB CORP. 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. Please refer to LCNB's Annual Report on Form 10-K for the year endedDecember 31, 2020 , as well as its other filings with theSEC , for a more detailed discussion of risks, uncertainties and factors that could cause actual results to differ from those discussed in the forward-looking statements. 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.the significant risks and uncertainties for LCNB's business, results of operations and financial condition, as well as its regulatory capital and liquidity ratios and other regulatory requirements, caused by the COVID-19 pandemic, which will depend on several factors, including the scope and duration of the pandemic, its influence on financial markets, the effectiveness of LCNB's work from home arrangements and staffing levels in operational facilities, the impact of market participants on which LCNB relies and actions taken by governmental authorities and other third parties in response to the pandemic; 3.the disruption of global, national, state, and local economies associated with the COVID-19 pandemic, which could affect LCNB's liquidity and capital positions, impair the ability of our borrowers to repay outstanding loans, impair collateral values, and further increase the allowance for credit losses; 4.LCNB's ability to integrate future acquisitions may be unsuccessful or may be more difficult, time-consuming, or costly than expected; 5.LCNB may incur increased loan charge-offs in the future; 6.LCNB may face competitive loss of customers; 7.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; 8.changes in general economic conditions and increased competition could adversely affect LCNB's operating results; 9.changes in regulations and government policies affecting bank holding companies and their subsidiaries, including changes in monetary policies, could negatively impact LCNB's operating results; 10.LCNB may experience difficulties growing loan and deposit balances; 11.United States trade relations with foreign countries could negatively impact the financial condition of LCNB's customers, which could adversely affect LCNB 's operating results and financial condition; 12.deterioration in the financial condition of theU.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; 13.difficulties with technology or data security breaches, including cyberattacks, that could negatively affect LCNB's ability to conduct business and its relationships with customers, vendors, and others; 14.adverse weather events and natural disasters and global and/or national epidemics; and 15.government intervention in theU.S. financial system, including the effects of legislative, tax, accounting, and regulatory actions and reforms, including the CARES Act, the Dodd-Frank Act, the Jumpstart Our Business Startups Act, theConsumer Financial Protection Bureau , the capital ratios of Basel III as adopted by the federal banking authorities, and the Tax Cuts and Jobs Act. 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. 35
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LCNB CORP. AND SUBSIDIARIES Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Coronavirus Update/Status The COVID-19 pandemic has created extensive disruptions to the global economy and to the lives of individuals throughout the world. Governments, businesses, and the public have taken and are taking unprecedented actions to contain the spread of COVID-19 and to mitigate its effects, including quarantines, travel bans, shelter-in-place orders, closures of or restrictions on the operations of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief. While the effects of COVID-19 are rapidly evolving and not fully known, the pandemic and related efforts to contain it have disrupted economic activity, adversely affected the functioning of financial markets, impacted interest rates, increased economic and market uncertainty, and disrupted trade and supply chains. While vaccination efforts are underway, the pandemic has not yet been contained and economic activity has not yet returned to pre-pandemic levels. OnMay 12, 2021 ,Ohio GovernorMike DeWine announced that the vast majority ofOhio Department of Health orders related to COVID-19 would be rescinded onJune 2, 2021 . Measures that have been removed include facial covering protocols, social distancing guidelines, and capacity restrictions for indoor and outdoor events. Businesses can choose to continue facial mask and social distancing protocols in their facilities. Further, onJune 17, 2021 ,Governor DeWine announced thatOhio's State of Emergency caused by the COVID-19 pandemic would be lifted, effective the next day. The National Emergency Declaration remains in force, as does the National Public Health Emergency Declaration. In response, LCNB management rescinded requirements to wear facial masks and practice social distancing, effectiveJune 2, 2021 , except for branches located in areas with local mandates. Employees and customers at branches without local mandates who wish to continue wearing facial masks may continue to do so. Depending on local conditions, some branches transitioned to drive-up only operations or shortened hours for brief periods of time. Plexiglass barriers remain at teller stations and will remain until and if management decides to remove them. Because of the economic disruption caused by the pandemic, LCNB has provided COVID-19 related payment deferrals, primarily agreements to accept interest only payments for a period of time or agreements to defer principal and interest payments for a period of time, on a number of loans. There were no loans remaining on deferral for COVID-19 reasons atSeptember 30, 2021 . Loans still on deferral atDecember 31, 2020 were as follows (in thousands):December 31, 2020 Commercial, secured by real estate 20,231 Residential real estate 324 Consumer 21 20,576 LCNB participated in the CARES Act PPP that provided government guaranteed and potentially forgivable loans to applicants. The PPP was implemented by the SBA with support from theDepartment of the Treasury and provided small businesses with funds to pay up to eight or twenty-four weeks, depending on the date of the loan, of payroll costs including benefits. Funds could also be used to pay interest on mortgages, rent, utilities, covered operations expenditures, covered property damage costs, covered supplier costs, and covered worker protection expenditures. Outstanding PPP loans atSeptember 30, 2021 andDecember 31, 2020 totaled$12,971,000 and$21,088,000 , respectively, and unrecognized fees at those dates totaled$498,000 and$747,000 , respectively.
LCNB continues to closely monitor the COVID-19 pandemic and expects to make future changes to respond to the pandemic as this situation continues to evolve.
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LCNB CORP. AND SUBSIDIARIES Item 2. 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 typically 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 fair values. 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 atSeptember 30, 2021 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 mortgage loans to the Federal Home Loan Mortgage Corporation and mortgage servicing rights acquired through the acquisition ofEaton National Bank & Trust Co. andColumbus First Bancorp, Inc. Goodwill is not subject to amortization, but is reviewed annually for impairment or sooner if circumstances indicate a possible 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 forDebt Securities . Debt 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 forU.S. Treasury 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. 37
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LCNB CORP. AND SUBSIDIARIES Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Results of Operations Net income for the three and nine months endedSeptember 30, 2021 was$4,817,000 (total basic and diluted earnings per share of$0.39 ) and$15,347,000 (total basic and diluted earnings per share of$1.21 ), respectively. This compares to net income of$4,250,000 (total basic and diluted earnings per share of$0.33 ) and$14,333,000 (total basic and diluted earnings per share of$1.11 ) for the same three and nine month periods in 2020. Net interest income for the three and nine months endedSeptember 30, 2021 was$14,073,000 and$42,814,000 , respectively. This compares to net interest income of$13,529,000 and$41,705,000 for the same periods in 2020. Favorably contributing to the variances for both the three- and nine-month periods were fees recognized from PPP loans and market driven decreases in the average rates paid on deposits, aided by a shift from higher cost certificates of deposit to lower cost demand and savings products. Increases in the provision for loan losses, partially due to adjustments for estimated impacts from the economic downturn caused by the COVID-19 pandemic, negatively affected earnings during the 2020 period. LCNB recorded provisions of$306,000 and$239,000 for the three and nine months endedSeptember 30, 2021 , respectively. This compares to respective provisions of$976,000 and$2,165,000 for the same three and nine month periods in 2020. Non-interest income for the three months and nine months endedSeptember 30, 2021 , was$4,106,000 and$11,885,000 , respectively. This compares to$4,278,000 and$11,436,000 for the same periods last year. For the three month comparative periods, the increases in fiduciary income and deposit service charges were more than offset by decreases in gains from sales of loans. For the nine-month comparative periods, fiduciary income and deposit service charges increased and were partially offset by decreases in gains from loan sales. Non-interest income for the nine-month period also benefited from a one-time refund onLCNB's Ohio Financial Institution tax, which was included in other operating income. Non-interest expense for the three and nine months endedSeptember 30, 2021 , was$12,029,000 and$35,729,000 , respectively. This compares to$11,653,000 and$33,841,000 for the same three and nine month periods in 2020. The 2021 periods saw increases in salaries and employee benefits, equipment,FDIC insurance premiums, contracted services, and other non-interest expenses. A decrease in marketing expenses partially offset these increases. 38
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LCNB CORP. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Net Interest Income
Three Months Ended September 30, 2021 vs. September 30, 2020
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 three
months ended September 30, 2021 and September 30, 2020 , 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.
Three Months Ended September 30,
2021 2020
Average Interest Average Average Interest Average
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Balance Paid Rate
(Dollars in thousands)
Loans (1) $ 1,321,629 13,729 4.12 % $ 1,339,608 14,379 4.27 %
Interest-bearing demand deposits 10,746 11 0.41 % 21,490 17 0.31 %
Federal Reserve Bank stock 4,652 - - % 4,652 - - %
Federal Home Loan Bank stock 5,203 26 1.98 % 5,203 26 1.99 %
Investment securities:
Equity securities 4,588 17 1.47 % 4,329 18 1.65 %
Debt securities, taxable 309,136 1,027 1.32 % 146,847 633 1.71 %
Debt securities, non-taxable (2) 32,635 271 3.29 % 36,757 315 3.41 %
Total earnings assets 1,688,589 15,081 3.54 % 1,558,886 15,388 3.93 %
Non-earning assets 196,292 188,362
Allowance for loan losses (5,567) (5,250)
Total assets $ 1,879,314 $ 1,741,998
Savings deposits $ 908,670 291 0.13 % $ 730,858 348 0.19 %
IRA and time certificates 207,010 545 1.04 % 281,586 1,219 1.72 %
Short-term borrowings 1,320 2 0.60 % - - - %
Long-term debt 15,000 113 2.99 % 33,020 226 2.72 %
Total interest-bearing liabilities 1,132,000 951 0.33 % 1,045,464 1,793 0.68 %
Demand deposits 480,093 433,129
Other liabilities 26,245 24,415
Capital 240,976 238,990
Total liabilities and capital $ 1,879,314 $ 1,741,998
Net interest rate spread (3) 3.21 % 3.25 %
Net interest income and net interest
margin on a taxable-equivalent basis (4) 14,130 3.32 % 13,595 3.47 %
Ratio of interest-earning assets to
interest-bearing liabilities 149.17 % 149.11 %
(1)Includes non-accrual loans. (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 21%.
(3)The net interest spread is the difference between the average rate on total
interest-earning assets and interest-bearing liabilities.
(4)The net interest margin is the taxable-equivalent net interest income divided
by average interest-earning assets.
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LCNB CORP. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
The following table presents the changes in taxable-equivalent basis 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 three months ended September 30, 2021 as compared to the
same period in 2020. 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.
Three Months Ended
September 30, 2021 vs. 2020
Increase (decrease) due to:
Volume Rate Total
(In thousands)
Interest-earning Assets:
Loans $ (191) (459) (650)
Interest-bearing demand deposits (10) 4 (6)
Federal Reserve Bank stock - - - Federal Home Loan Bank stock - - - Investment securities: Equity securities 1 (2) (1) Debt securities, taxable 567 (173) 394 Debt securities, non-taxable (34) (10) (44) Total interest income 333
(640) (307)
Interest-bearing Liabilities: Savings deposits 73 (130) (57) IRA and time certificates (272) (402) (674) Short-term borrowings 2 - 2 Long-term debt (134) 21 (113) Total interest expense (331) (511) (842) Net interest income $ 664 (129) 535 Net interest income on a fully taxable-equivalent basis for the three months endedSeptember 30, 2021 totaled$14,130,000 , an increase of$535,000 from the comparable period in 2020. Total interest expense decreased$842,000 , which was partially offset by a$307,000 decrease in total interest income. The$307,000 decrease in total interest income was due primarily to a$650,000 decrease in loan interest income, which was partially offset by a$394,000 increase in interest income from taxable debt securities. The decrease in loan interest income was primarily due to a 15 basis point (a basis point equals 0.01%) decrease in the average rate earned on loans and secondarily due to a$18.0 million decrease in the average balance of LCNB's loan portfolio. Loan interest income for the third quarter 2021 included$492,000 of PPP loan fees recognized. The increase in interest income from taxable debt securities was due to a$162.3 million increase in average securities, which was partially offset by a 39 basis point decrease in the average rate earned on these securities. The decrease in average rates for both loans and investment securities was primarily due to market conditions. The$842,000 decrease in total interest expense was due to a$674,000 decrease in interest expense for IRA and time certificates and a$113,000 decrease in interest expense for long-term debt. Interest expense for IRA and time certificates decreased primarily due to a 68 basis point decrease in the average rate paid for these deposits and secondarily to an$74.6 million decrease in the average balance of these deposits. Management believes the decrease reflects customer preferences for liquidity during uncertain economic periods. Balances in demand deposits and NOW and savings accounts have grown, while balances in IRA and time deposits have decreased. Interest expense for long-term debt decreased due to a$18.0 million decrease in average debt outstanding, slightly offset by a 27 basis point increase in the average rate paid. 40
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LCNB CORP. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Nine Months EndedSeptember 30, 2021 vs.September 30, 2020 The following table presents, for the nine months endedSeptember 30, 2021 andSeptember 30, 2020 , average balances for interest-earning assets and interest-bearing liabilities, the income or expense related to each item, and the resulting average yields earned or rates paid. Nine Months Ended September 30, 2021 2020 Average Interest Average Average Interest Average Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Balance Paid Rate Balance Paid Rate (Dollars in thousands) Loans (1)$ 1,321,426 42,372 4.29 %$ 1,303,770 44,428 4.55 % Interest-bearing demand deposits 17,031 38 0.30 % 18,164 65 0.48 % Federal Reserve Bank stock 4,652 140 4.02 % 4,652 140 4.02 % Federal Home Loan Bank stock 5,203 78 2.00 % 5,203 91 2.34 % Investment securities: Equity securities 4,569 54 1.58 % 4,283 73 2.28 % Debt securities, taxable 262,245 2,650 1.35 % 141,625 2,250 2.12 % Debt securities, non-taxable (2) 33,335 830 3.33 % 39,270 997 3.39 % Total earnings assets 1,648,461 46,162 3.74 % 1,516,967 48,044 4.23 % Non-earning assets 193,079 182,866 Allowance for loan losses (5,653) (4,730) Total assets$ 1,835,887 $ 1,695,103 Savings deposits$ 857,289 872 0.14 %$ 704,708 1,141 0.22 % IRA and time certificates 220,157 1,937 1.18 % 302,431 4,275 1.89 % Short-term borrowings 796 4 0.67 % 497 7 1.88 % Long-term debt 16,736 361 2.88 % 35,427 707 2.67 % Total interest-bearing liabilities 1,094,978 3,174 0.39 % 1,043,063 6,130 0.79 % Demand deposits 474,281 394,497 Other liabilities 25,249 22,318 Capital 241,379 235,225 Total liabilities and capital$ 1,835,887 $ 1,695,103 Net interest rate spread (3) 3.35 % 3.44 % Net interest income and net interest margin on a taxable-equivalent basis (4) 42,988 3.49 % 41,914 3.69 % Ratio of interest-earning assets to interest-bearing liabilities 150.55 % 145.43 %
(1)Includes non-accrual loans. (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 21%.
(3)The net interest spread is the difference between the average rate on total
interest-earning assets and interest-bearing liabilities.
(4)The net interest margin is the taxable-equivalent net interest income divided
by average interest-earning assets.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
The following table presents the changes in taxable-equivalent basis 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 nine months ended September 30, 2021 as compared to the
same period in 2020. 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.
Nine Months Ended
September 30, 2021 vs. 2020
Increase (decrease) due to:
Volume Rate Total
(In thousands)
Interest-earning Assets:
Loans $ 595 (2,651) (2,056)
Interest-bearing demand deposits (4) (23) (27)
Federal Reserve Bank stock - - - Federal Home Loan Bank stock - (13) (13) Investment securities: Equity securities 5 (24) (19) Debt securities, taxable 1,428 (1,028) 400 Debt securities, non-taxable (148) (19) (167) Total interest income 1,876
(3,758) (1,882)
Interest-bearing Liabilities: Savings deposits 213 (482) (269) IRA and time certificates (979) (1,359) (2,338) Short-term borrowings 3 (6) (3) Long-term debt (399) 53 (346) Total interest expense (1,162) (1,794) (2,956) Net interest income $ 3,038 (1,964) 1,074 Net interest income on a fully taxable-equivalent basis for the nine months endedSeptember 30, 2021 totaled$42,988,000 , an increase of$1,074,000 from the comparable period in 2020. Total interest expense decreased$2,956,000 , which was partially offset by a$1,882,000 decrease in total interest income. The$1,882,000 decrease in total interest income was due primarily to a$2,056,000 decrease in loan interest income, which was partially offset by a$400,000 increase in interest income from taxable debt securities. The decrease in loan interest income was primarily due to a 26 basis point decrease in the average rate earned on loans, which was partially offset by a$17.7 million increase in the average balance of LCNB's loan portfolio. Loan interest income for the first three quarters of 2021 included$1,415,000 of PPP loan fees recognized. The increase in interest income from taxable debt securities was due to a$120.6 million increase in average securities, which was largely offset by a 77 basis point decrease in the average rate earned on these securities. The decrease in average rates for both loans and investment securities was primarily due to market conditions. The$2,956,000 decrease in total interest expense was primarily due to a$2,338,000 decrease in interest expense for IRA and time certificates. Interest expense for IRA and time certificates decreased primarily due to a 71 basis point decrease in the average rate paid for these deposits and secondarily to an$82.3 million decrease in the average balance of these deposits. 42
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LCNB CORP. AND SUBSIDIARIES Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Provision and Allowance For Loan Losses The total provision for loan losses is determined based upon management's evaluation as to the amount needed to maintain the allowance for loan losses at a level considered appropriate in relation to the risk of losses inherent in the portfolio. For analysis purposes, the loan portfolio is separated into pools of similar loans. These pools include commercial & industrial loans, owner occupied commercial real estate loans, non-owner occupied commercial real estate loans, real estate loans secured by farms, real estate loans secured by multi-family dwellings, residential real estate loans secured by senior liens on 1-4 family dwellings, residential real estate loans secured by junior liens on 1-4 family dwellings, home equity line of credit loans, consumer loans, loans for agricultural purposes not secured by real estate, construction loans secured by 1-4 family dwellings, construction loans secured by other real estate, and several smaller classifications. Within each pool of loans, LCNB examines a variety of factors to determine the adequacy of the allowance for loan losses, including historic charge-off percentages, overall pool quality, a review of specific problem loans, current economic trends and conditions that may affect borrowers' ability to pay, and the nature, volume, and consistency of the loan pool. The provision for loan losses for the three and nine months endedSeptember 30, 2021 was respectively$306,000 and$239,000 , compared to provisions of$976,000 and$2,165,000 for the same periods in 2020. The 2020 periods included qualitative adjustments for estimated impacts from the economic downturn caused by the COVID-19 pandemic. Calculating an appropriate level for the allowance and provision for loan losses involves a high degree of management judgment and is, by its nature, imprecise. Revisions may be necessary as more information becomes available.
Net charge-offs for the three and nine months ended
Non-Interest Income
A comparison of non-interest income for the three and nine months ended
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 Difference 2021 2020 Difference
Fiduciary income $ 1,695 1,275 420 4,959 3,579 1,380
Service charges and fees on deposit accounts 1,621 1,506 115 4,506 4,038 468
Net gains from sales of debt securities,
available-for-sale - - - - 221 (221)
Bank owned life insurance income 269 275 (6) 805 1,163 (358) Gains from sales of loans 366 999 (633) 560 1,436 (876) Other operating income 155 223 (68) 1,055 999 56 Total non-interest income$ 4,106 4,278 (172) 11,885 11,436 449 Reasons for changes include: •Fiduciary income increased primarily due to growth in the market value of assets serviced. •Service charges and fees on deposit accounts for the three month period increased primarily due to increases in check card income, overdraft fees, and Mastercard incentive income. Service charges and fees on deposit accounts for the nine month period increased primarily due to an increase in check card income, which was partially offset by a decrease in fee income recognized on Insured Cash Sweep ("ICS") deposit products due to lower volumes and a decrease in the amount of fees received due to lower market rates. •Bank owned life insurance income for the nine months endedSeptember 30, 2020 included a mortality benefit, while no mortality benefits were recognized during the 2021 period. •Gains from sales of loans decreased primarily due to a lower volume of residential real estate loan sales. •Other operating income for the three month period decreased primarily due to decreases in realized and unrealized net gains or losses recognized on equity securities. Other operating income increased for the nine month period due to a state tax refund of$508,000 recognized during the second quarter 2021, which was partially offset by decreases in realized and unrealized net gains or losses recognized on equity security investments. 43
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LCNB CORP. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Non-Interest Expense
A comparison of non-interest expense for the three and nine months ended
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 Difference 2021 2020 Difference
Salaries and employee benefits $ 7,096 6,863 233 20,640 20,279 361
Equipment expenses 421 341 80 1,232 917 315
Occupancy expense, net 713 740 (27) 2,236 2,145 91
State financial institutions tax 437 424 13 1,318 1,280 38
Marketing 253 471 (218) 878 906 (28)
Amortization of intangibles 263 263 - 780 783 (3)
FDIC insurance premiums, net 129 112 17 365 142 223
Contracted services 655 435 220 1,818 1,312 506
Other non-interest expense 2,062 2,004 58 6,462 6,077 385
Total non-interest expense $ 12,029 11,653 376 35,729 33,841 1,888
Reasons for changes include:
•Salaries and employee benefits increased primarily due to increased health care
costs, increased bonus expense accruals, and a decrease in salaries and benefits
netted against deferred costs on loans, reflecting a lower volume of
originations during the 2021 period.
•Equipment expenses increased primarily due to increased equipment rental costs
and increased depreciation charges for furniture and equipment. During 2020,
LCNB gradually replaced ATMs that it had previously owned with new ATMs obtained
through an outsourcing arrangement.
•FDIC insurance premiums increased during the nine month period in 2021 because
LCNB received small bank assessment credits from the FDIC during the first and
second quarters 2020. Premium payments returned to their normal levels after the
second quarter 2020.
•Contracted services increased due to employee recruitment services, increased
usage of technology services, and to price increases in general.
•Other non-interest expense increased partially due to a strategic decision to
outsource LCNB's ATM operations to a third-party vendor during 2020, relieving
LCNB branch personnel from various ATM maintenance responsibilities.
Income Taxes
LCNB's effective tax rate for the three and nine months endedSeptember 30, 2021 was 17.6% and 18.1%, respectively, compared to 17.9% and 16.4% for the three and nine months endedSeptember 30, 2020 . The difference between the statutory rate of 21% and the effective tax rates is primarily due to tax-exempt interest income from municipal securities, tax-exempt earnings from bank owned life insurance, tax-exempt earnings fromLCNB Risk Management, Inc. , and tax credits and losses related to investments in affordable housing tax credit limited partnerships. A one-time tax benefit recognized as a result of certain provisions in the CARES Act passed byCongress and signed byPresident Trump during the first quarter 2020 also contributed to the effective tax rate for the nine months endedSeptember 30, 2020 . 44
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Financial Condition
A comparison of balance sheet line items at
September 30,
2021 December 31, 2020 Difference $ Difference %
ASSETS:
Total cash and cash equivalents$ 23,852 31,730 (7,878)
(24.83) %
Investment securities: Equity securities with a readily determinable fair value, at fair value
2,478 2,389 89 3.73 %
Equity securities without a readily determinable fair value, at cost
2,099 2,099 - - %
Debt securities, available-for-sale, at fair value 313,214 209,471 103,743 49.53
%
Debt securities, held-to-maturity, at cost 24,420 24,810 (390) (1.57) % Federal Reserve Bank stock, at cost 4,652 4,652 - -
%
Federal Home Loan Bank stock, at cost 5,203 5,203 - - % Loans, net 1,334,331 1,293,693 40,638 3.14 % Premises and equipment, net 35,154 35,376 (222) (0.63) % Operating lease right-of-use assets 6,608 6,274 334 5.32 % Goodwill 59,221 59,221 - - % Core deposit and other intangibles 2,671 3,453 (782) (22.65) % Bank owned life insurance 42,954 42,149 805 1.91 % Interest receivable 8,624 8,337 287 3.44 % Other assets 18,771 17,027 1,744 10.24 % Total assets$ 1,884,252 1,745,884 138,368 7.93 % LIABILITIES: Deposits: Non-interest-bearing$ 483,920 455,073 28,847 6.34 % Interest-bearing 1,119,283 1,000,350 118,933 11.89 % Total deposits 1,603,203 1,455,423 147,780 10.15 % Short-term borrowings - - - - % Long-term debt 15,000 22,000 (7,000) (31.82) % Operating lease liabilities 6,693 6,371 322 5.05 % Accrued interest and other liabilities 20,937 21,265 (328) (1.54) % Total liabilities 1,645,833 1,505,059 140,774 9.35 % TOTAL SHAREHOLDERS' EQUITY 238,419 240,825 (2,406) (1.00) % Total liabilities and shareholders' equity$ 1,884,252 1,745,884 138,368 7.93 % Reasons for changes include: •Debt securities, available-for-sale, increased due to purchases of additional securities totaling$132.4 million , which was partially offset by maturities and calls of securities totaling$23.5 million . •Net loans increased due to organic growth in the loan portfolio, partially offset by a net decrease in PPP loans of$8.1 million . Most of the growth occurred in the commercial real estate and residential real estate portfolios, partially offset by a decrease in the commercial and industrial loan portfolio. •Operating lease right-of-use assets and operating lease liabilities increased due to a new lease for theUnion Village branch and the renewal of a postage machine lease. •Core deposit and other intangibles decreased due to amortization of core deposit intangibles and mortgage servicing rights. •Other assets increased due to an additional$3.0 investment in Affordable Housing Tax Credit Limited Partnerships and increases in prepaid expenses and federal income tax receivable. 45
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
•Non-interest-bearing deposits and interest-bearing deposits have grown substantially since the start of the COVID-19 pandemic and this trend continued during the first nine months of 2021. Management believes the growth reflects customer preferences for liquidity during uncertain economic periods. Balances in demand deposits and NOW and savings accounts have grown, while balances in IRA and time deposits have decreased. •Long-term debt decreased due to payoffs of matured debt. •Total shareholders' equity decreased primarily due to a decrease in accumulated other comprehensive income, net of taxes caused by market-driven decreases in the fair value of LCNB's debt security investments, dividends paid to shareholders, and treasury shares purchased. These decreases were partially offset by earnings retained during the first six months of 2021.
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. LCNB's and the Bank's capital amounts and classification are also subject to qualitative judgments by regulators about components, risk weightings, and other factors. In addition to the minimum capital requirements, a financial institution needs 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% is 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
with Capital To Be Considered
Minimum Requirement Conservation Buffer Well-Capitalized
Ratio of Common Equity Tier 1 Capital to risk-weighted assets 4.5 % 7.0 % 6.5 %
Ratio of Tier 1 Capital to risk-weighted assets 6.0 % 8.5 % 8.0 %
Ratio of Total Capital (Tier 1 Capital plus Tier 2 Capital) to 8.0 % 10.5 % 10.0 %
risk-weighted assets
Leverage Ratio (Tier 1 Capital to adjusted quarterly average 4.0 % N/A 5.0 %
total assets)
As of the most recent notification from their regulators, the Bank and LCNB 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 or LCNB's category.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
A summary of the Bank's regulatory capital and capital ratios follows (dollars
in thousands):
September 30,
2021 December 31, 2020
Regulatory Capital :
Shareholders' equity $ 233,502 234,092
Goodwill and other intangibles (60,918) (61,698)
Accumulated other comprehensive (income) loss (896) (4,043)
Tier 1 risk-based capital 171,688 168,351
Eligible allowance for loan losses 5,828 5,728
Total risk-based capital $ 177,516 174,079
Capital ratios:
Common Equity Tier 1 Capital to risk-weighted assets 12.29 % 12.48 %
Tier 1 Capital to risk-weighted assets 12.29 % 12.48 %
Total Capital to risk-weighted assets 12.71 % 12.91 %
Leverage 9.48 % 10.06 %
On September 17, 2019 , the FDIC finalized a rule that introduced an optional
simplified measure of capital adequacy for qualifying community banking
organizations, as required by the Economic Growth, Regulatory Relief and
Consumer Protection Act. The simplified rule was designed to reduce burden by
removing the requirements for calculating and reporting risk-based capital
ratios for qualifying community banking organizations that opt into the
framework. Its use was permitted beginning with the March 31, 2020 Call Report.
Qualifications to use the simplified approach include having a tier 1 leverage
ratio of greater than 9%, less than $10 billion in total consolidated assets,
and limited amounts of off-balance-sheet exposures and trading assets and
liabilities. A qualifying community banking organization that opts into the
Community Bank Leverage Ratio framework and meets all requirements under the
framework will be considered to have met the well-capitalized ratio requirements
under the Prompt Corrective Action regulations and will not be required to
report or calculate risk-based capital. LCNB qualifies to use the simplified
measure, but did not opt in for the September 30, 2021 regulatory capital
calculations.
Liquidity
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 for the current year plus retained net income for the previous two years. Prior approval from the OCC, the Bank's primary regulator, is 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 dividends to LCNB without needing to request approval. The Bank is not aware of any reasons why it would not receive such approval, if required. Effective liquidity management ensures that cash is available to meet the cash flow needs of borrowers and depositors, as well as meeting LCNB's operating cash needs. Primary funding sources include customer deposits with the Bank, short-term and long-term borrowings from theFederal Home Loan Bank , short-term line of credit arrangements with two correspondent banks, and interest and repayments received from LCNB's loan and investment portfolios. Total remaining borrowing capacity with theFederal Home Loan Bank atSeptember 30, 2021 was approximately$167.5 million . In addition, additional borrowings of approximately$55.0 million were available through the line of credit arrangements atSeptember 30, 2021 . OnApril 9, 2020 , theFederal Reserve established the PPPLF to bolster the effectiveness of the SBA's PPP. The PPPLF will extend credit to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. LCNB management has decided not to currently use the PPPLF as a source of liquidity, as other sources of liquidity are believed to be adequate at this time. 47
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LCNB CORP. AND SUBSIDIARIES Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Management closely monitors the level of liquid assets available to meet ongoing funding needs. 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 as a result of current liquidity levels. 48
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