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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LCNB CORP. AND SUBSIDIARIES Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Coronavirus Update/Status The coronavirus (COVID-19) pandemic has created unprecedented challenges 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 requiring the wearing of masks; •We hold frequent 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 COVID-19 related payment deferrals to 596 loan customers with aggregate loan balances at the various times of deferral totaling approximately$407.4 million ; 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 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, and utilities. ThroughSeptember 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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LCNB CORP. AND SUBSIDIARIES Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) 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, 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 nine months endedSeptember 30, 2020 was$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 ), respectively. This compares to net income of$4,727,000 (total basic and diluted earnings per share of$0.36 ) and$14,082,000 (total basic and diluted earnings per share of$1.07 ) for the same three and nine month periods in 2019. 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 periods. The provision for the three and nine months endedSeptember 30, 2020 was$976,000 and$2,165,000 , respectively, compared to$264,000 and$213,000 for the same three and nine month periods in 2019. 39
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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, 2020 vs. September 30, 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 ended September 30, 2020 and September 30, 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 September 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) $ 1,339,608 14,379 4.27 % $ 1,227,806 14,872 4.81 %
Interest-bearing demand deposits 21,490 17 0.31 % 8,737 68 3.09 %
Interest-bearing time deposits - - - % 268 3 4.44 %
Federal Reserve Bank stock 4,652 - - % 4,652 - - %
Federal Home Loan Bank stock 5,203 26 1.99 % 5,203 58 4.42 %
Investment securities:
Equity securities 4,329 18 1.65 % 4,343 31 2.83 %
Debt securities, taxable 146,847 633 1.71 % 163,385 918 2.23 %
Debt securities, non-taxable (2) 36,757 315 3.41 % 65,702 480 2.90 %
Total earnings assets 1,558,886 15,388 3.93 % 1,480,096 16,430 4.40 %
Non-earning assets 188,362 177,924
Allowance for loan losses (5,250) (3,986)
Total assets $ 1,741,998 $ 1,654,034
Savings deposits $ 730,858 348 0.19 % $ 695,449 651 0.37 %
IRA and time certificates 281,586 1,219 1.72 % 336,678 1,824 2.15 %
Short-term borrowings - - - % 468 3 2.54 %
Long-term debt 33,020 226 2.72 % 41,988 273 2.58 %
Total interest-bearing liabilities 1,045,464 1,793 0.68 % 1,074,583 2,751 1.02 %
Demand deposits 433,129 333,575
Other liabilities 24,415 20,660
Capital 238,990 225,216
Total liabilities and capital $ 1,741,998 $ 1,654,034
Net interest rate spread (3) 3.25 % 3.38 %
Net interest income and net interest
margin on a taxable-equivalent basis (4) 13,595 3.47 % 13,679 3.67 %
Ratio of interest-earning assets to
interest-bearing liabilities 149.11 % 137.74 %
(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 endedSeptember 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 $ 1,286 (1,779) (493)
Interest-bearing demand deposits 44 (95) (51)
Interest-bearing time deposits (3) - (3)
Federal Reserve Bank stock - - -
Federal Home Loan Bank stock - (32) (32)
Investment securities:
Equity securities - (13) (13)
Debt securities, taxable (86) (199) (285)
Debt securities, non-taxable (238) 73 (165)
Total interest income 1,003 (2,045) (1,042)
Interest-bearing Liabilities:
Savings deposits 32 (335) (303)
IRA and time certificates (272) (333) (605)
Short-term borrowings (3) - (3)
Long-term debt (61) 14 (47)
Total interest expense (304) (654) (958)
Net interest income $ 1,307 (1,391) (84)
Net interest income on a fully taxable-equivalent basis for the three months
ended September 30, 2020 totaled $13,595,000 , a decrease of $84,000 from the
comparable period in 2019. Total interest income decreased $1,042,000 ,
substantially offset by a $958,000 decrease in total interest expense.
The $1,042,000 decrease in total interest income was due primarily to a $493,000
decrease in loan interest income and a $450,000 total decrease in interest
income from taxable and non-taxable debt securities. The decrease in loan
interest income was primarily due to a 54 basis point (a basis point equals
0.01%) decrease in the average rate earned on loans, partially offset by a
$111.8 million increase in the average balance of LCNB's loan portfolio. The
decrease in interest income from taxable and non-taxable debt securities was due
to a $45.5 million combined decrease in average debt securities and to a 52
basis point decrease in the average rate earned on taxable debt securities.
Decreases in debt securities were invested in the loan portfolio and were also
used to enhance liquidity.
The $958,000 decrease in total interest expense was due to a $303,000 decrease
in interest expense for savings deposits and a $605,000 decrease in interest
expense for IRA and time certificates. Interest expense for savings deposits
decreased primarily due to an 18 basis point market-driven decrease in the
average rate paid for these deposits, slightly offset by a $35.4 million
increase in the average balance of these deposits. Interest expense for IRA and
time certificates decreased primarily due to a 43 basis point decrease in the
average rate paid for these deposits and secondarily to a $55.1 million decrease
in the average balance of these deposits. Interest expense for long-term debt
decreased due to a $9.0 million decrease in average debt outstanding, slightly
offset by a 14 basis point increase in the average rate paid.
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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 Ended September 30, 2020 vs. September 30, 2019
The following table presents, for the nine months ended September 30, 2020 and
September 30, 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.
Nine Months Ended September 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) $ 1,303,770 44,428 4.55 % $ 1,218,183 44,072 4.84 %
Interest-bearing demand deposits 18,164 65 0.48 % 8,687 195 3.00 %
Interest-bearing time deposits - - - % 608 11 2.42 %
Federal Reserve Bank stock 4,652 140 4.02 % 4,652 140 4.02 %
Federal Home Loan Bank stock 5,203 91 2.34 % 5,076 197 5.19 %
Investment securities:
Equity securities 4,283 73 2.28 % 4,285 95 2.96 %
Debt securities, taxable 141,625 2,250 2.12 % 158,816 2,720 2.29 %
Debt securities, non-taxable (2) 39,270 997 3.39 % 79,676 1,696 2.85 %
Total earnings assets 1,516,967 48,044 4.23 % 1,479,983 49,126 4.44 %
Non-earning assets 182,866 166,252
Allowance for loan losses (4,730) (4,049)
Total assets $ 1,695,103 $ 1,642,186
Savings deposits $ 704,708 1,141 0.22 % $ 693,776 1,913 0.37 %
IRA and time certificates 302,431 4,275 1.89 % 326,282 5,312 2.18 %
Short-term borrowings 497 7 1.88 % 7,898 224 3.79 %
Long-term debt 35,427 707 2.67 % 43,067 762 2.37 %
Total interest-bearing liabilities 1,043,063 6,130 0.79 % 1,071,023 8,211 1.03 %
Demand deposits 394,497 330,620
Other liabilities 22,318 16,899
Capital 235,225 223,644
Total liabilities and capital $ 1,695,103 $ 1,642,186
Net interest rate spread (3) 3.44 % 3.41 %
Net interest income and net interest
margin on a taxable-equivalent basis (4) 41,914 3.69 % 40,915 3.70 %
Ratio of interest-earning assets to
interest-bearing liabilities 145.43 % 138.18 %
(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 nine months ended September 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.
Nine Months Ended
September 30, 2020 vs. 2019
Increase (decrease) due to:
Volume Rate Total
(In thousands)
Interest-earning Assets:
Loans $ 2,998 (2,642) 356
Federal funds sold - - -
Interest-bearing demand deposits 112 (242) (130)
Interest-bearing time deposits (11) - (11)
Federal Reserve Bank stock - - -
Federal Home Loan Bank stock 5 (111) (106)
Investment securities:
Equity securities - (22) (22)
Debt securities, taxable (282) (188) (470)
Debt securities, non-taxable (980) 281 (699)
Total interest income 1,842 (2,924) (1,082)
Interest-bearing Liabilities:
Savings deposits 30 (802) (772)
IRA and time certificates (370) (667) (1,037)
Short-term borrowings (141) (76) (217)
Long-term debt (145) 90 (55)
interest income from non-taxable debt securities (626) (1,455) (2,081)
Net interest income $ 2,468 (1,469) 999
Net interest income on a fully taxable-equivalent basis for the nine months
ended September 30, 2020 totaled $41,914,000 , an increase of $999,000 from the
comparable period in 2019. Total interest income decreased $1,082,000 and total
interest expense decreased $2,081,000 .
The $1,082,000 decrease in total interest income was due primarily to a
$1,169,000 total decrease in interest income from taxable and non-taxable debt
securities and several smaller decreases in other line items, partially offset
by a $356,000 increase in loan interest income. The decrease in interest income
from taxable and non-taxable debt securities was due to a $57.6 million combined
decrease in average debt securities, partially offset by a 54 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 $85.6 million increase in the average balance of LCNB's loan
portfolio, partially offset by a 29 basis point decrease in the average rate
earned on loans.
The $2,081,000 decrease in total interest expense was due to a $772,000 decrease
in interest expense for savings deposits, a $1,037,000 decrease in interest
expense for IRA and time certificates, and a $217,000 decrease in interest
expense for short-term borrowings. Interest expense for savings deposits and IRA
and time certificates decreased primarily due to, respectively, a 15 basis point
and a 29 basis point market-driven decrease in the average rates paid for these
deposits and secondarily to a $23.9 million total decrease in the average
balance of IRA and time certificates. Interest expense for short-term borrowings
decreased due to a $7.4 million decrease in average debt outstanding and to a
191 basis point decrease in the average rate paid.
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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 and 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, 2020 was, respectively,$712,000 and$1,952,000 greater than the comparable periods in 2019. 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 endedSeptember 30, 2020 were, respectively,$18,000 and$236,000 , as compared to respective net charge-offs of$209,000 and$92,000 for the same three and nine month periods in 2019.
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,
2020 2019 Difference 2020 2019 Difference
Fiduciary income $ 1,275 1,123 152 3,579 3,215 364
Service charges and fees on deposit accounts 1,506 1,616 (110) 4,038 4,421 (383)
Net gains (losses) from sales of debt securities, available-for-sale - (20) 20 221 (37)
258
Bank owned life insurance income 275 289 (14) 1,163 654 509 Gains from sales of loans 999 114 885 1,436 207 1,229 Other operating income 223 234 (11) 999 666 333 Total non-interest income$ 4,278 3,356 922 11,436 9,126 2,310 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 nine 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 during the nine month period 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 residential real estate loan sales; approximately$42.2 million of loans were sold during the nine months endedSeptember 30, 2020 compared to$10.4 million of loan sales during the same period in 2019. •Other operating income increased during the nine month period primarily due to net gains realized from the sale of equity security investments, partially offset by unrealized net losses from equity securities held in the portfolio. 44
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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,
2020 2019 Difference 2020 2019 Difference
Salaries and employee benefits $ 6,863 6,403 460 20,279 18,808 1,471
Equipment expenses 341 322 19 917 866 51
Occupancy expense, net 740 751 (11) 2,145 2,258 (113)
State financial institutions tax 424 433 (9) 1,280 1,307 (27)
Marketing 471 410 61 906 1,009 (103)
Amortization of intangibles 263 263 - 783 780 3
FDIC insurance premiums 112 (13) 125 142 225 (83)
Contracted services 435 455 (20) 1,312 1,394 (82)
Other real estate owned 2 1 1 (7) 52 (59)
Merger-related expenses - 27 (27) - 114 (114)
Other non-interest expense 2,002 1,930 72 6,084 5,702 382
Total non-interest expense $ 11,653 10,982 671 33,841 32,515 1,326
Reasons for changes include:
•Salaries and employee benefits increased 7.2% and 7.8% for the respective three
and nine 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.
•Occupancy expense decreased during the nine month period primarily due to
decreases in facility repair and maintenance costs.
•Marketing decreased during the nine month period primarily due to a realignment
of LCNB's marketing strategy.
•FDIC insurance premiums for the nine month period of 2020 reflects Small Bank
Assessment Credits received from the FDIC during the first and second quarters
2020 because the Deposit Insurance Fund was above the mandated 1.35% level. LCNB
has received the full amount of the credit during the first two quarters of 2020
and the third quarter premium payment was at its normal level.
•Other non-interest expense increased partially due to a strategic decision to
outsource LCNB's ATM operations to a third-party vendor, relieving LCNB branch
personnel from various ATM maintenance responsibilities
.
Income Taxes
LCNB's effective tax rate for the three and nine months ended September 30, 2020
was 17.9% and 16.4%, respectively, compared to 16.9% and 17.0% for the
respective three and nine months ended September 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 nine month
period.
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LCNB CORP. AND SUBSIDIARIES 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,
2020 December 31, 2019 Difference $ Difference %
ASSETS:
Total cash and cash equivalents$ 24,485 20,765 3,720 17.91
%
Investment securities: Equity securities with a readily determinable fair value, at fair value
2,213 2,312 (99) (4.28) % Equity securities without a readily determinable fair value, at cost
2,099 2,099 - - %
Debt securities, available-for-sale, at fair value 157,936 178,000 (20,064) (11.27) % Debt securities, held-to-maturity, at cost 26,941 27,525 (584) (2.12) % Federal Reserve Bank stock, at cost 4,652 4,652 - -
%
Federal Home Loan Bank stock, at cost 5,203 5,203 - - % Loans, net 1,334,186 1,239,406 94,780 7.65 % Premises and equipment, net 35,309 34,787 522 1.50
%
Operating lease right-of-use assets 5,729 5,444 285 5.24 % Goodwill 59,221 59,221 - - % Core deposit and other intangibles 3,539 4,006 (467) (11.66) % Bank owned life insurance 41,871 41,667 204 0.49 % Interest receivable 9,559 3,926 5,633 143.48 % Other assets 12,672 10,295 2,377 23.09 % Total assets$ 1,725,615 1,639,308 86,307 5.26 % LIABILITIES: Deposits: Non-interest-bearing$ 426,989 354,391 72,598 20.49 % Interest-bearing 1,003,405 993,889 9,516 0.96 % Total deposits 1,430,394 1,348,280 82,114 6.09 % Long-term debt 31,999 40,994 (8,995) (21.94) % Operating lease liabilities 5,790 5,446 344 6.32 % Accrued interest and other liabilities 18,847 16,540 2,307 13.95 % Total liabilities 1,487,030 1,411,260 75,770 5.37 % TOTAL SHAREHOLDERS' EQUITY 238,585 228,048 10,537 4.62 % Total liabilities and shareholders' equity$ 1,725,615 1,639,308 86,307 5.26 % 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$48.6 million . These decreases were partially offset by purchases totaling$33.4 million and by a net increase in fair values totaling$4.4 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 atSeptember 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. •Operating lease right-of-use assets and operating lease liabilities increased due to the replacement of previously owned ATMs with outsourced ATMs. •Core deposit and other intangibles decreased due to amortization of core deposit intangibles. •Interest receivable increased primarily due to interest accrued on COVID-19 related loan payment deferrals. 46
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LCNB CORP. AND SUBSIDIARIES Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) •Other assets increased primarily due to a$3.0 million affordable housing tax credit investment made during the second quarter 2020. •Non-interest-bearing deposits and interest-bearing deposits have grown substantially since the start of the COVID-19 pandemic. 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. There were no new borrowings during 2020. •Accrued interest and other liabilities increased primarily due to payables connected with the$3.0 million affordable housing tax credit investment mentioned above. •Total shareholders' equity increased primarily due to earnings retained during the first nine months of 2020 and to a$3.5 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. Specifically, the market price of LCNB's common stock decreased, similar to decreases experienced by other financial institutions. 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 was not necessary at that time. After reviewing developments during the third quarter 2020, management determined that an impairment test was not necessary atSeptember 30, 2020 . 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. In addition to the minimum 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)
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
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.
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. It may be used 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 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
the September 30, 2020 regulatory capital calculations.
A summary of the Bank's regulatory capital and capital ratios follows (dollars
in thousands):
September 30,
2020 December 31, 2019
Regulatory Capital:
Shareholders' equity $ 235,371 222,065
Goodwill and other intangibles (61,961) (62,744)
Accumulated other comprehensive (income) loss (4,155) (673)
Tier 1 risk-based capital 169,255 158,648
Eligible allowance for loan losses 5,974 4,045
Total risk-based capital $ 175,229 162,693
Capital ratios:
Common Equity Tier 1 Capital to risk-weighted assets 12.28 % 12.21 %
Tier 1 Capital to risk-weighted assets 12.28 % 12.21 %
Total Capital to risk-weighted assets 12.72 % 12.52 %
Leverage 10.12 % 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 the Office 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 the Federal 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 the Federal Home Loan Bank at
September 30, 2020 was approximately $167.5 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 at September 30, 2020 .
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LCNB CORP. AND SUBSIDIARIES Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) 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 ("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. 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. 49
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