LCNB CORP. 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. Please refer to LCNB's Annual Report on Form 10-K for the year endedDecember 31, 2019 , 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.LCNB's ability to integrate recent and any future acquisitions may be unsuccessful or may be more difficult, time-consuming, or costly than expected; 4.LCNB may incur increased loan charge-offs in the future; 5.LCNB may face competitive loss of customers; 6.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; 7.changes in general economic conditions and increased competition could adversely affect LCNB's operating results; 8.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; 9.LCNB may experience difficulties growing loan and deposit balances; 10.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; 11.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; 12.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; 13.adverse weather events and natural disasters and global and/or national epidemics; and 14.government intervention in theU.S. financial system, including the effects of legislative, tax, accounting, and regulatory actions and reforms, including the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), the Dodd-Frank Wall Street Reform and Consumer Protection 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. 37
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
0 Coronavirus Update/Status The coronavirus (COVID-19) pandemic has placed significant health, economic and other major pressure throughout the communities LCNB serves, the state ofOhio ,the United States and the entire world. LCNB has implemented a number of procedures in response to the pandemic to support the safety and well-being of our employees, customers, and shareholders that continue through the date of this report, including the following: •We addressed the safety of our 33 branches, following the guidelines of theCenter for Disease Control , by temporarily closing our lobbies from March throughMay 2020 in an effort to encourage use of mobile banking applications and our drive-thru facilities, while allowing access to the lobbies by appointment only and only when necessary; •We re-opened most lobbies during June andJuly 2020 and introduced various safety measures including the installation of clear barriers at the teller windows, placing markers on the floor to properly space customers as they wait, enhancing our cleaning procedures, and encouraging the wearing of masks; •We hold daily executive management meetings to address issues that change rapidly; •We have encouraged non customer service employees to work remotely from home as much as possible and have adopted technological improvements to make this possible; •We moved our Annual Shareholders' Meeting, held onApril 21, 2020 , from a physical meeting to a virtual meeting; •We provided payment deferrals to 582 loan customers with loans totaling approximately$384 million atJune 30, 2020 who were affected by COVID-19, provided such customers were not 30 days past due atDecember 31, 2019 ; and •We chose to participate in the CARES Act Paycheck Protection Program ("PPP") that provided government guaranteed and potentially forgivable loans to applicants. The PPP was implemented by theSmall Business Administration with support from theDepartment of the Treasury and provided small businesses with funds to pay up to eight weeks of payroll costs including benefits. Funds could also be used to pay interest on mortgages, rent, and utilities. ThroughJune 30, 2020 , we were able to assist 316 small businesses and had funded$45.5 million of such loans. We believe these loans and our participation in the program is good for our customers, the employees who work for these companies, and the communities we serve.
LCNB continues to closely monitor this pandemic and expects to make future changes to respond to the pandemic as this situation continues to evolve.
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.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
0 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 atJune 30, 2020 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.
Results of Operations
Net income for the three and six months endedJune 30, 2020 was$5,057,000 (total basic and diluted earnings per share of$0.39 ) and$10,083,000 (total basic and diluted earnings per share of$0.78 ), respectively. This compares to net income of$4,728,000 (total basic and diluted earnings per share of$0.36 ) and$9,355,000 (total basic and diluted earnings per share of$0.71 ) for the same three and six month periods in 2019. 39
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
0 Net Interest Income Three Months EndedJune 30, 2020 vs. 2019 LCNB's primary source of earnings is net interest income, which is the difference between earnings from loans and other investments and interest paid on deposits and other liabilities. The following table presents, for the three months endedJune 30, 2020 and 2019, average balances for interest-earning assets and interest-bearing liabilities, the income or expense related to each item, and the resulting average yields earned or rates paid. Three Months Ended June 30, 2020 2019 Average Interest Average Average Interest Average Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Balance Paid Rate Balance Paid Rate (Dollars in thousands) Loans (1)$ 1,318,753 $ 14,822 4.52 %$ 1,217,726 $ 14,662 4.83 % Interest-bearing demand deposits 27,486 17 0.25 % 11,545 76 2.64 % Interest-bearing time deposits - - - % 602 3 2.00 % Federal Reserve Bank stock 4,652 140 12.10 % 4,652 140 12.07 % Federal Home Loan Bank stock 5,203 32 2.47 % 5,175 66 5.12 % Investment securities: Equity securities 4,206 25 2.39 % 4,292 31 2.90 % Debt securities, taxable 131,018 667 2.05 % 161,302 933 2.32 % Debt securities, non-taxable (2) 37,292 322 3.47 % 73,931 528 2.86 % Total earnings assets 1,528,610 16,025 4.22 % 1,479,225 16,439 4.46 % Non-earning assets 180,691 162,508 Allowance for loan losses (4,998) (4,088) Total assets$ 1,704,303 $ 1,637,645 Savings deposits$ 703,889 307 0.18 %$ 685,229 601 0.35 % IRA and time certificates 305,284 1,425 1.88 % 331,214 1,863 2.26 % Short-term borrowings 82 - - % 243 2 3.30 % Long-term debt 34,964 227 2.61 % 42,567 272 2.56 % Total interest-bearing liabilities 1,044,219 1,959 0.75 % 1,059,253 2,738 1.04 % Demand deposits 402,909 336,006 Other liabilities 21,588 18,183 Capital 235,587 224,203 Total liabilities and capital$ 1,704,303 $ 1,637,645 Net interest rate spread (3) 3.47 % 3.42 % Net interest income and net interest margin on a taxable-equivalent basis (4)$ 14,066 3.70 %$ 13,701 3.72 % Ratio of interest-earning assets to interest-bearing liabilities 146.39 % 139.65 %
(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)
0 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 endedJune 30, 2020 as compared to the same period in 2019. 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
(decrease) due to:
Volume Rate Total
(In thousands)
Interest-earning Assets:
Loans $ 1,172 (1,012) 160
Interest-bearing demand deposits 48 (107) (59)
Interest-bearing time deposits (3) - (3)
Federal Reserve Bank stock - - -
Federal Home Loan Bank stock - (34) (34)
Investment securities:
Equity securities (1) (5) (6)
Debt securities, taxable (162) (104) (266)
Debt securities, non-taxable (300) 94 (206)
Total interest income 754 (1,168) (414)
Interest-bearing Liabilities:
Savings deposits 16 (310) (294)
IRA and time certificates (138) (300) (438)
Short-term borrowings (1) (1) (2)
Long-term debt (49) 4 (45)
Total interest expense (172) (607) (779) Net interest income$ 926 (561) 365 Net interest income on a fully taxable-equivalent basis for the three months endedJune 30, 2020 totaled$14,066,000 , an increase of$365,000 from the comparable period in 2019. Total interest income decreased$414,000 and total interest expense decreased$779,000 . The$414,000 decrease in total interest income was due primarily to a$472,000 total decrease in interest income from taxable and non-taxable debt securities, partially offset by a$160,000 increase in loan interest income. The decrease in interest income from taxable and non-taxable debt securities was due to a$66.9 million decrease in average debt securities. Decreases in debt securities were invested in the loan portfolio and were also used to enhance liquidity. The increase in loan interest income was primarily due to a$101.0 million increase in the average balance of LCNB's loan portfolio, largely offset by a 31 basis point (a basis point equals 0.01%) decrease in the average rate earned on loans. The$779,000 decrease in total interest expense was due to a$294,000 decrease in interest expense for savings deposits and a$438,000 decrease in interest expense for IRA and time certificates. Interest expense for savings deposits decreased primarily due to a 17 basis point market-driven decrease in the average rate paid for these deposits, slightly offset by a$18.7 million increase in the average balance of these deposits. Interest expense for IRA and time certificates decreased primarily due to a 38 basis point decrease in the average rate paid for these deposits and secondarily to a$25.9 million decrease in the average balance of these deposits. Interest expense for long-term debt decreased due to a$7.6 million decrease in average debt outstanding, slightly offset by a 5 basis point increase in the average rate paid. 41
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
0 Six Months EndedJune 30, 2020 vs. 2019 The following table presents, for the six months endedJune 30, 2020 and 2019, average balances for interest-earning assets and interest-bearing liabilities, the income or expense related to each item, and the resulting average yields earned or rates paid. Six Months Ended June 30, 2020 2019 Average Interest Average Average Interest Average Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Balance Paid Rate Balance Paid Rate (Dollars in thousands) Loans (1)$ 1,285,654 $ 30,049 4.70 %$ 1,213,292 $ 29,200 4.85 % Interest-bearing demand deposits 16,483 48 0.59 % 8,661 127 2.96 % Interest-bearing time deposits - - - % 781 8 2.07 % Federal Reserve Bank stock 4,652 140 6.05 % 4,652 140 6.07 % Federal Home Loan Bank stock 5,203 65 2.51 % 5,011 139 5.59 % Investment securities: Equity securities 4,260 55 2.60 % 4,256 64 3.03 % Debt securities, taxable 138,986 1,617 2.34 % 156,494 1,802 2.32 % Debt securities, non-taxable (2) 40,541 682 3.38 % 86,778 1,216 2.83 % Total earnings assets 1,495,779 32,656 4.39 % 1,479,925 32,696 4.46 % Non-earning assets 180,083 160,527 Allowance for loan losses (4,468) (4,081) Total assets$ 1,671,394 $ 1,636,371 Savings deposits$ 691,490 793 0.23 %$ 692,926 1,262 0.37 % IRA and time certificates 312,968 3,056 1.96 % 320,998 3,488 2.19 % Short-term borrowings 749 7 1.88 % 11,675 221 3.82 % Long-term debt 36,644 481 2.64 % 43,616 489 2.26 % Total interest-bearing liabilities 1,041,851 4,337 0.84 % 1,069,215 5,460 1.03 % Demand deposits 374,968 329,118 Other liabilities 21,253 15,194 Capital 233,322 222,844 Total liabilities and capital$ 1,671,394 $ 1,636,371 Net interest rate spread (3) 3.55 % 3.43 % Net interest income and net interest margin on a taxable-equivalent basis (4)$ 28,319 3.81 %$ 27,236 3.71 % Ratio of interest-earning assets to interest-bearing liabilities 143.57 % 138.41 %
(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)
0 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 six months endedJune 30, 2020 as compared to the same period in 2019. 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. Six Months Ended June 30, 2020 vs. 2019 Increase (decrease) due to: Volume Rate Total (In thousands) Interest-earning Assets: Loans$ 1,708 (859) 849 Interest-bearing demand deposits 66 (145) (79) Interest-bearing time deposits (8) - (8) Federal Reserve Bank stock - - - Federal Home Loan Bank stock 5 (79) (74) Investment securities: Equity securities - (9) (9) Debt securities, taxable (204) 19 (185) Debt securities, non-taxable (742) 208 (534) Total interest income 825 (865) (40) Interest-bearing Liabilities: Savings deposits (3) (466) (469) IRA and time certificates (86) (346) (432) Short-term borrowings (139) (75) (214) Long-term debt (85) 77 (8) interest income from non-taxable debt securities (313) (810) (1,123) Net interest income$ 1,138 (55) 1,083 Net interest income on a fully taxable-equivalent basis for the six months endedJune 30, 2020 totaled$28,319,000 , an increase of$1,083,000 from the comparable period in 2019. Total interest income decreased$40,000 and total interest expense decreased$1,123,000 . The$40,000 decrease in total interest income was due primarily to a$719,000 total decrease in interest income from taxable and non-taxable debt securities and several smaller decreases in other line items, largely offset by an$849,000 increase in loan interest income. The decrease in interest income from taxable and non-taxable debt securities was due to a$63.7 million decrease in average debt securities, partially offset by a 55 basis point increase in the average rate earned on non-taxable debt securities. Decreases in debt securities were invested in the loan portfolio and used to pay down short-term borrowings and long-term debt. The increase in loan interest income was caused by a$72.4 million increase in the average balance of LCNB's loan portfolio, partially offset by a 15 basis point decrease in the average rate earned on loans. The$1,123,000 decrease in total interest expense was due to a$469,000 decrease in interest expense for savings deposits, a$432,000 decrease in interest expense for IRA and time certificates, and a$214,000 decrease in interest expense for short-term borrowings. Interest expense for savings deposits and IRA and time certificates decreased primarily due to, respectively, a 14 basis point and a 13 basis point market-driven decrease in the average rates paid for these deposits and secondarily to a$9.5 million total decrease in the average balance of these deposits. Interest expense for short-term borrowings decreased due to a$10.9 million decrease in average debt outstanding and to a 194 basis point decrease in the average rate paid. 43
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
0
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. 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, and current economic conditions that may affect borrowers' ability to pay. The provision for loan losses for the three months endedJune 30, 2020 was$38,000 less than the comparable period in 2019 and the six month period was$1,240,000 greater than the comparable period in 2019. Approximately 69% of the increase in the provision for the six month period was due to an adjustment to the allowance for potential impacts from the economic recession 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 six months endedJune 30, 2020 were, respectively,$8,000 and$210,000 , as compared to net charge-offs of$68,000 for the three month period and a net recovery of$117,000 for the six month period in 2019. Non-Interest Income
A comparison of non-interest income for the three and six months ended
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 Difference 2020 2019 Difference
Fiduciary income$ 1,201 1,058 143$ 2,304 2,092 212 Service charges and fees on deposit accounts 1,237 1,497 (260) 2,532 2,805 (273) Net gains (losses) from sales of debt securities, available-for-sale - 1 (1) 221 (17) 238 Bank owned life insurance income 287 183 104 888 365 523 Gains from sales of loans 317 64 253 437 93 344 Other operating income 277 195 82 776 432 344 Total non-interest income$ 3,319 2,998 321$ 7,158 5,770 1,388 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 decreased primarily due to decreases in overdraft fees and fee income recognized on Insured Cash Sweep ("ICS") deposit products, partially offset by increases in check card income. •Net gains (losses) from sales of available-for-sale debt securities for the six month period increased due to market valuations at the times of sales, as the volume of debt securities sold during the 2020 period was less than that for the 2019 period. •Bank owned life insurance income increased due to$12.0 million of new policies purchased at the beginning of the third quarter 2019 and to a mortality benefit recognized during the first quarter 2020. •Gains from sales of loans increased primarily due to a greater volume of sales. •Other operating income increased during the six month period primarily due to net gains realized from the sale of equity security investments. 44
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
0 Non-Interest Expense
A comparison of non-interest expense for the three and six months ended
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 Difference 2020 2019 Difference
Salaries and employee benefits $ 6,648 $ 6,243 $ 405 $ 13,416 12,405 1,011
Equipment expenses 289 278 11 576 544 32
Occupancy expense, net 723 744 (21) 1,405 1,507 (102)
State financial institutions tax 420 436 (16) 856 874 (18)
Marketing 258 297 (39) 435 599 (164)
Amortization of intangibles 260 260 - 520 517 3
FDIC insurance premiums 31 112 (81) 30 238 (208)
Contracted services 475 475 - 877 939 (62)
Other real estate owned 1 48 (47) (9) 51 (60)
Merger-related expenses - 20 (20) - 87 (87)
Other non-interest expense 2,011 1,920 91 4,082 3,772 310
Total non-interest expense $ 11,116 $ 10,833 $ 283 $ 22,188 21,533 655
Reasons for changes include:
•Salaries and employee benefits increased 6.5% and 8.1% for the respective three
and six month periods primarily due to salary and wage increases and newly hired
employees, including additional business development positions. An increase in
health insurance costs also contributed to the increase in salaries and employee
benefits.
•Marketing decreased primarily due to a realignment of the marketing strategy
within LCNB.
•FDIC insurance premiums for the 2020 period reflects Small Bank Assessment
Credits received from the FDIC because the Deposit Insurance Fund was above the
mandated 1.35% level. LCNB has received the full amount of the credit and
anticipates quarterly premium payments will return to normal levels in future
quarters.
Income Taxes
LCNB's effective tax rate for the three and six months ended June 30, 2020 was
18.2% and 15.7%, respectively, compared to 17.1% and 17.0% for the respective
three and six months ended June 30, 2019 . 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 from LCNB 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 Coronavirus Aid, Relief, & Economic Security ("CARES") Act
passed by Congress and signed by President Trump during the first quarter 2020
also contributed to the difference during the 2020 six month period.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
0 Financial Condition
A comparison of balance sheet line items at
June 30, 2020 December 31, 2019 Difference $ Difference %ASSETS:
Total cash and cash equivalents$ 42,736 $ 20,765$ 21,971 105.81 %
Investment securities: Equity securities with a readily determinable fair value, at fair value
2,163 2,312 (149) (6.44) %
Equity securities without a readily determinable fair value, at cost
2,099 2,099 - - %
Debt securities, available-for-sale, at fair value 153,529 178,000 (24,471) (13.75) %
Debt securities, held-to-maturity, at cost 27,237 27,525 (288) (1.05) %
Federal Reserve Bank stock, at cost 4,652 4,652 - - %
Federal Home Loan Bank stock, at cost 5,203 5,203 - - %
Loans, net 1,330,422 1,239,406 91,016 7.34 %
Premises and equipment, net 35,383 34,787 596 1.71 %
Operating lease right-of-use assets 5,532 5,444 88 1.62 %
Goodwill 59,221 59,221 - - %
Core deposit and other intangibles 3,558 4,006 (448) (11.18) %
Bank owned life insurance 41,596 41,667 (71) (0.17) %
Interest receivable 8,215 3,926 4,289 109.25 %
Other assets 13,786 10,295 3,491 33.91 %
Total assets $ 1,735,332 $ 1,639,308 $ 96,024 5.86 %
LIABILITIES:
Deposits:
Non-interest-bearing $ 431,697 $ 354,391 $ 77,306 21.81 %
Interest-bearing 1,007,224 993,889 13,335 1.34 %
Total deposits 1,438,921 1,348,280 90,641 6.72 %
Long-term debt 33,998 40,994 (6,996) (17.07) %
Operating leases liability 5,558 5,446 112 2.06 %
Accrued interest and other liabilities 19,808 16,540 3,268 19.76 %
Total liabilities 1,498,285 1,411,260 87,025 6.17 %
TOTAL SHAREHOLDERS' EQUITY 237,047 228,048 8,999 3.95 %
Total liabilities and shareholders' equity $ 1,735,332 $ 1,639,308 $ 96,024 5.86 %
Reasons for changes include:
•Debt securities, available-for-sale, decreased due to sales of securities with
a total book value of $8.6 million and maturities and calls of securities
totaling $39.6 million . These decreases were partially offset by purchases
totaling $20.0 million and by a net increase in fair values totaling $4.0
million . The net funds received were invested in the loan portfolio, used to
help pay down long-term debt, and used to increase liquidity.
•Net loans increased due to organic growth in the loan portfolio, including PPP
loans with carrying value of $45.3 million at June 30, 2020 . Most of the growth
occurred in the commercial and industrial and commercial real estate portfolios.
•Premises and equipment, net increased due primarily to Main Office remodeling
costs, partially offset by depreciation expense.
•Core deposit and other intangibles decreased due to amortization of core
deposit intangibles.
•Interest-bearing deposits increased primarily due to increases in NOW and
savings accounts, partially offset by decreases in IRA and time certificates.
•Long-term debt decreased due to payoffs of matured debt. There were no new
borrowings during 2020.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
0 •Total shareholders' equity increased primarily due to earnings retained during the first six months of 2020 and to a$3.1 million increase in accumulated other comprehensive income, net of taxes caused by market-driven increases in the fair value of LCNB's debt security investments. These increases were partially offset by dividends paid to shareholders. LCNB performs an impairment test of the carrying value of goodwill annually in the fourth quarter or sooner if circumstances indicate a possible impairment. Impairment indicators that may be considered include the condition of the economy and banking industry; estimated future cash flows; government intervention and regulatory updates; the impact of recent events to financial performance and cost factors of the reporting unit; performance of LCNB's stock and other relevant events. These and other factors could lead to a conclusion that goodwill is impaired, which would require LCNB to write off the difference between the estimated fair value of the company and the carrying value. Given the current economic environment resulting from the COVID-19 pandemic, the probability of such impairments has increased. Accordingly, an interim impairment test was conducted as ofJune 30, 2020 . At the conclusion of the assessment, management determined that fair value exceeded carrying value and that an impairment charge is not necessary at this time. Management will continue to monitor developments regarding the COVID-19 pandemic and measures implemented in response to the pandemic, market capitalization, overall economic conditions and any other triggering events or circumstances that may indicate an impairment of goodwill in the future.
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. A rule requiring a Capital Conservation Buffer began phase-in onJanuary 1, 2016 and was fully implemented at the beginning of 2019. Under the fully-implemented rule, 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) 8.0 % 10.5 % 10.0 %
to 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)
0 OnSeptember 17, 2019 , theFDIC 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. It may be used beginning with theMarch 31, 2020 Call Report. Qualifications to use the simplified approach include having a tier 1 leverage ratio of greater than 9%, less than$10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital. LCNB qualifies to use the simplified measure, but did not opt in for theJune 30, 2020 regulatory capital calculations. A summary of the Bank's regulatory capital and capital ratios follows (dollars in thousands): December 31, June 30, 2020 2019Regulatory Capital : Shareholders' equity$ 233,312 $ 222,065 Goodwill and other intangibles (62,224) (62,744) Accumulated other comprehensive (income) loss (3,868) (673) Tier 1 risk-based capital 167,220 158,648 Eligible allowance for loan losses 5,016 4,045 Total risk-based capital$ 172,236 $ 162,693 Capital ratios: Common Equity Tier 1 Capital to risk-weighted assets 12.13 % 12.21 % Tier 1 Capital to risk-weighted assets 12.13 % 12.21 % Total Capital to risk-weighted assets 12.49 % 12.52 % Leverage 10.23 % 10.06 % 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 theOffice of the Comptroller of the Currency, 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 atJune 30, 2020 was approximately$70.6 million . One of the factors limiting remaining borrowing capacity is ownership of FHLB stock. LCNB could increase its borrowing capacity by purchasing additional FHLB stock. In addition, additional borrowings of approximately$55.0 million were available through the line of credit arrangements atJune 30, 2020 . OnApril 9, 2020 , theFederal Reserve established the Paycheck Protection Program Liquidity Facility ("PPPLF") to bolster the effectiveness of theSmall Business Administration's Paycheck Protection Program. 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. 48
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
0
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.
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