10-K 1 lnb1231201210-k.htm 10-K LNB 12.31.2012 10-K
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2012
Commission file number 0-13203
LNB Bancorp, Inc.
(Exact name of the registrant as specified in its charter)
Ohio
 
34-1406303
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
457 Broadway, Lorain, Ohio
 
44052-1769
(Address of principal executive offices)
 
(Zip Code)
(440) 244-6000
(Registrant’s telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Shares,
par value $1.00 per share
Preferred Share Purchase Rights
 
The NASDAQ Stock Market
The NASDAQ Stock Market
Securities Registered Pursuant to Section 12(g) of the Act:
Title of Each Class
 
Name of Each Exchange on Which Registered
None
 
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨        No  þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  ¨        No  þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ        No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ        No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  o
  
Accelerated filer  o
  
Non-accelerated filer  þ
  
Smaller reporting company   o
 
  
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨        No  þ
The aggregate market value of the common shares held by non-affiliates of the registrant at June 30, 2012 was approximately $45,092,641.
The number of common shares of the registrant outstanding on March 1, 2013 was 7,944,354.
Documents Incorporated By Reference
Portions of the Registrant’s definitive Proxy Statement to be filed in connection with its 2013 Annual Meeting of Shareholders are incorporated by reference into Part III (Items 10, 11, 12, 13 and 14) of this report.
Except as otherwise stated, the information contained in this Annual Report on Form 10-K is as of December 31, 2012.
 



TABLE OF CONTENTS
 
 
 
Page
PART I
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
PART II
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
PART III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
PART IV
Item 15.



PART I
 
Item 1.
Business
LNB Bancorp, Inc. (the “Corporation”) is a diversified banking services company headquartered in Lorain, Ohio. It is organized as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). Its predecessor, The Lorain Banking Company, was a state chartered bank founded in 1905. It merged with the National Bank of Lorain in 1961, and in 1984 became a wholly-owned subsidiary of LNB Bancorp, Inc.
The Corporation engages in lending and depository services, investment services, and other traditional banking services. These services are generally offered through the Corporation's wholly-owned subsidiary, The Lorain National Bank (the “Bank”).
The primary business of the Bank is providing personal, mortgage and commercial banking products, along with investment management and trust services. The Lorain National Bank operates through 20 retail-banking locations and 28 automated teller machines (“ATM's”) in Lorain, Erie, Cuyahoga and Summit counties in the Ohio communities of Lorain, Elyria, Amherst, Avon, Avon Lake, LaGrange, North Ridgeville, Oberlin, Olmsted Township, Vermilion, Westlake and Hudson, as well as a business development office in Cuyahoga County.
Services
Commercial Lending.    The Bank's commercial lending activities consist of commercial and industrial loans, commercial real estate loans, construction and equipment loans, letters of credit, revolving lines of credit, Small Business Administration loans and government guaranteed loans. The Bank's wholly-owned subsidiary, North Coast Community Development Corporation, offers commercial loans with preferred interest rates on projects that meet the standards for the federal government's New Markets Tax Credit Program.
Residential, Installment and Personal Lending.    The Bank's residential mortgage lending activities consist of loans for the purchase of personal residences, originated for portfolio or to be sold in the secondary markets. The Bank's installment lending activities consist of traditional forms of financing for automobile and personal loans, indirect automobile loans, second mortgages, and home equity lines of credit. The Bank provides indirect lending services to new and used automobile dealerships located in Ohio, Kentucky, Indiana, North Carolina, Tennessee and Georgia. Through this program, the Bank has generated high-quality short-term assets that have been placed in its own portfolio or sold to several investor banks.
Deposit Services.    The Bank's deposit services include traditional transaction and time deposit accounts, as well as cash management services for corporate and municipal customers. The Bank has occasionally supplemented local deposit generation with time deposits generated through a broker relationship. Deposits of the Bank are insured by the Bank Insurance Fund administered by the Federal Deposit Insurance Corporation (the “FDIC”).
Other Services.    Other bank services offered include safe deposit boxes, night depository, U.S. savings bonds, travelers' checks, money orders, cashiers checks, ATM's, debit cards, wire transfer, electronic funds transfers, foreign drafts, foreign currency, electronic banking by phone or through the internet, lockbox and other services tailored for both individuals and businesses.
Competition and Market Information
The Corporation competes primarily with 18 other financial institutions with operations in Lorain County, Ohio, which have Lorain County-based deposits ranging in size from approximately $930 thousand to over $970 million. These competitors, as well as credit unions and financial intermediaries, compete for Lorain County deposits of approximately of $3.9 billion.
 
The Bank's market share of total deposits in Lorain County was 22.14% in 2012 and 22.05% in 2011, and the Bank ranked number two in market share in Lorain County in 2012 and 2011.
The Corporation's Morgan Bank division operates from one location in Hudson, Ohio. The Morgan Bank division competes primarily with 10 other financial institutions for $637 million in deposits in the City of Hudson, and holds a market share of 20.09%.
The Bank has a limited presence in Cuyahoga County, competing primarily with 28 other financial institutions. Cuyahoga County deposits as of June 30, 2012 totaled $37.1 billion. The Bank's market share of deposits in Cuyahoga County was 0.07% in 2012 and 2011 based on the FDIC Summary of Deposits for specific market areas dated June 30, 2012.


1


Business Strategy
The Bank seeks to compete with larger financial institutions by providing exceptional local service that emphasizes direct customer access to the Bank's officers and compete with smaller local banks by providing more convenient distribution channels and a wider array of products. The Bank endeavors to provide informed and courteous personal services. The Corporation's management team (“Management”) believes that the Bank is well-positioned to compete successfully in its market area. Competition among financial institutions is based largely upon interest rates offered on deposit accounts, interest rates charged on loans, the relative level of service charges, the quality and scope of the services rendered, the convenience of the banking centers and, in the case of loans to commercial borrowers, relative lending limits. Management believes that the commitment of the Bank to provide quality personal service and its local community involvement give the Bank a competitive advantage over other financial institutions operating in its markets.
Supervision and Regulation
The Corporation is subject to the supervision and examination of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The BHC Act requires prior approval of the Federal Reserve Board before acquiring or holding more than a 5% voting interest in any bank. It also restricts interstate banking activities.
The Bank is subject to extensive regulation, supervision and examination by applicable federal banking agencies, including the Office of the Comptroller of the Currency (the “OCC”) and the Federal Reserve Board. Because domestic deposits in the Bank are insured (up to applicable limits) and certain deposits of the Bank and debt obligations of the Bank are temporarily guaranteed (up to applicable limits) by the FDIC, the FDIC also has certain regulatory and supervisory authority over the Bank under the Federal Deposit Insurance Act (the “FDIA”).
Regulatory Capital Standards and Related Matters
Bank holding companies are required to comply with the Federal Reserve Board's risk-based capital guidelines. The FDIC and the OCC have adopted risk-based capital ratio guidelines to which depository institutions under their respective supervision, such as the Bank, are subject. The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet commitments to four risk-weighted categories, with higher levels of capital being required for the categories perceived as representing greater risk. The Corporation and the Bank met all risk-based capital requirements of the Federal Reserve Board, FDIC and OCC as of December 31, 2012.
Both federal and state law extensively regulate various aspects of the banking business, such as reserve requirements, truth-in-lending and truth-in-savings disclosures, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations. To the extent statutory or regulatory provisions are described in this section, such descriptions are qualified in their entirety by reference to the particular statutory or regulatory provisions.

The Corporation and the Bank are subject to the Federal Reserve Act, which restricts financial transactions between banks and affiliated companies. The statute limits credit transactions between banks, affiliated companies and its executive officers and its affiliates. The statute prescribes terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices, and restrict the types of collateral security permitted in connection with a bank's extension of credit to an affiliate. Additionally, all transactions with an affiliate must be on terms substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions with nonaffiliated parties.

EESA and ARRA

The Emergency Economic Stabilization Act of 2008 (“EESA”), as amended by the American Recovery and Reinvestment Act of 2009 (“ARRA”) and the related interim final rule promulgated by the U.S. Treasury, among other things, imposed certain employee compensation and corporate expenditure limits on all participants in the U.S. Treasury's TARP Capital Purchase Program (“CPP”). The Corporation was a participant in the CPP as a result of its issuance and sale of Fixed Rate Cumulative Perpetual Preferred Stock, Series B (“Series B Preferred Stock”), to the Treasury in December 2008. As part of the Treasury's strategy for winding down its remaining investments in TARP, particularly in community banks, the Treasury conducted various public auctions of TARP preferred stock in 2012. On June 19, 2012, the Treasury completed a sale of the Series B Preferred Stock to the public through a modified Dutch auction. As a result, the Corporation is no longer subject to the employee compensation and corporate expenditure limits in EESA, ARRA and the related interim final rule. For details regarding the Corporation's participation in the CPP and the Treasury's sale of the Series B Preferred Stock, see Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations.”


2


Dodd-Frank Act
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law, which significantly changes the regulation of financial institutions and the financial services industry. The Dodd-Frank Act, together with the related regulations that are to be implemented, includes provisions affecting large and small financial institutions alike, including several provisions that will affect how community banks, thrifts, and small bank and thrift holding companies will be regulated in the future.
The Dodd-Frank Act, among other things, imposes new capital requirements on bank holding companies; changes the base for FDIC insurance assessments to a bank's average consolidated total assets minus average tangible equity, rather than upon its deposit base, and permanently raises the current standard deposit insurance limit to $250,000; and expands the FDIC's authority to raise insurance premiums. The legislation also calls for the FDIC to raise the ratio of reserves to deposits from 1.15% to 1.35% for deposit insurance purposes by September 30, 2020 and to “offset the effect” of increased assessments on insured depository institutions with assets of less than $10 billion. The Dodd-Frank Act also limits interchange fees payable on debit card transactions, establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which has broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards, and contains provisions on mortgage-related matters such as steering incentives, determinations as to a borrower's ability to repay and prepayment penalties. The Dodd-Frank Act also includes provisions that affect corporate governance and executive compensation at all publicly-traded companies and allows financial institutions to pay interest on business checking accounts. The law also restricts proprietary trading, places restrictions on the owning or sponsoring of hedge and private equity funds, and regulates the derivatives activities of banks and their affiliates. In addition, the law restricts the amount of trust preferred securities that may be considered Tier 1 capital. For depository institution holding companies with total assets of less than $15 billion, such as the Corporation, trust preferred securities issued before May 19, 2010 may continue to be included in Tier 1 capital, but future issuances of trust preferred securities will no longer be eligible for treatment as Tier 1 capital.

Because most aspects of this legislation continue to be subject to intensive agency rulemaking and subsequent public comment prior to implementation, which may occur over the next 12 months or more, it is difficult to predict at this time the ultimate effect of the Dodd-Frank Act on the Corporation.
Federal Deposit Insurance Act
Deposit Insurance Coverage Limits.    Under the Dodd-Frank Act, the FDIC standard maximum depositor insurance coverage limit has been permanently increased to $250,000. The Dodd-Frank Act also provided that certain non-interest bearing transaction accounts had unlimited deposit insurance coverage through December 31, 2012.
Deposit Insurance Assessments.    Substantially all of the Bank's domestic deposits are insured up to applicable limits by the FDIC. Accordingly, the Bank is subject to deposit insurance premium assessments by the FDIC. In February 2011, the FDIC approved an amendment to its deposit insurance assessment regulations. The rule implements a provision in the Dodd-Frank Act that changes the assessment base for deposit insurance premiums from one based on domestic deposits to one based on average consolidated total assets minus average Tier 1 capital. The rule also changes the assessment rate schedules for insured depository institutions so that approximately the same amount of revenue would be collected under the new assessment base as would be collected under the current rate schedule and the schedules previously proposed by the FDIC.
FICO Assessments.    Since 1997, all FDIC-insured depository institutions have been required through assessments collected by the FDIC to service the annual interest on 30-year noncallable bonds issued by the Financing Corporation (“FICO”) in the late 1980s to fund losses incurred by the former Federal Savings and Loan Insurance Corporation. FICO assessments are separate from and in addition to deposit insurance assessments, are adjusted quarterly and, unlike deposit insurance assessments, are assessed uniformly without regard to an institution's risk category.
Conservatorship and Receivership of Institutions.    If any insured depository institution becomes insolvent and the FDIC is appointed its conservator or receiver, the FDIC may, under federal law, disaffirm or repudiate any contract to which such institution is a party, if the FDIC determines that performance of the contract would be burdensome, and that disaffirmance or repudiation of the contract would promote the orderly administration of the institution's affairs. Such disaffirmance or repudiation would result in a claim by its holder against the receivership or conservatorship. The amount paid upon such claim would depend upon, among other factors, the amount of receivership assets available for the payment of such claim and its priority relative to the priority of others. In addition, the FDIC as conservator or receiver may enforce most contracts entered into by the institution notwithstanding any provision providing for termination, default, acceleration, or exercise of rights upon or solely by reason of insolvency of the institution, appointment of a conservator or receiver for the institution, or exercise of rights or powers by a conservator or receiver for the institution. The FDIC as conservator or receiver also may transfer any asset or liability of the institution without obtaining any approval or consent of the institution's shareholders or creditors.


3


Depositor Preference.    The FDIA provides that, in the event of the liquidation or other resolution of an insured depository institution, the claims of its depositors (including claims by the FDIC as subrogee of insured depositors) and certain claims for administrative expenses of the FDIC as receiver would be afforded a priority over other general unsecured claims against such an institution. If an insured depository institution fails, insured and uninsured depositors along with the FDIC will be placed ahead of unsecured, nondeposit creditors, including a parent holding company and subordinated creditors, in order of priority of payment.
Prompt Corrective Action.    The “prompt corrective action” provisions of the FDIA create a statutory framework that applies a system of both discretionary and mandatory supervisory actions indexed to the capital level of FDIC-insured depository institutions. These provisions impose progressively more restrictive constraints on operations, management, and capital distributions of the institution as its regulatory capital decreases, or in some cases, based on supervisory information other than the institution's capital level. This framework and the authority it confers on the federal banking agencies supplement other existing authority vested in such agencies to initiate supervisory actions to address capital deficiencies. Moreover, other provisions of law and regulation employ regulatory capital level designations the same as or similar to those established by the prompt corrective action provisions both in imposing certain restrictions and limitations and in conferring certain economic and other benefits upon institutions. These include restrictions on brokered deposits, limits on exposure to interbank liabilities, determination of risk-based FDIC deposit insurance premium assessments, and action upon regulatory applications.
Basel III
Internationally, both the Basel Committee on Banking Supervision and the Financial Stability Board (established in April 2009 by the Group of Twenty (“G-20”) Finance Ministers and Central Bank Governors to take action to strengthen regulation and supervision of the financial system with greater international consistency, cooperation and transparency) have committed to raise capital standards and liquidity buffers within the banking system (“Basel III”). On September 12, 2010, the Group of Governors and Heads of Supervision agreed to the calibration and phase-in of the Basel III minimum capital requirements (raising the minimum Tier 1 common equity ratio to 4.5% and minimum Tier 1 equity ratio to 6.0%, with full implementation by January 2015) and introducing a capital conservation buffer of common equity of an additional 2.5% with implementation by January 2019. In June 2012, the Federal Reserve Board released proposed rules regarding implementation of the Basel III regulatory capital rules for U.S. banking organizations. The proposed rules address a significant number of outstanding issues and questions regarding how certain provisions of Basel III are proposed to be adopted in the United States. Key provisions of the proposed rules include the total phase-out from Tier 1 capital of trust preferred securities for all banks, a capital conservation buffer of 2.5% above minimum capital ratios, inclusion of accumulated other comprehensive income in Tier 1 common equity, inclusion in Tier 1 capital of perpetual preferred stock, and an effective minimum Tier 1 common equity ratio of 7.0%. Final rules are expected to be adopted in 2013.
USA PATRIOT Act
The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”) and the federal regulations issued pursuant to it substantially broaden previously existing anti-money laundering law and regulation, increase compliance, due diligence and reporting obligations for financial institutions, create new crimes and penalties, and require the federal banking agencies, in reviewing merger and other acquisition transactions, to consider the effectiveness of the parties in combating money laundering activities.
Employees
As of December 31, 2012, the Corporation employed 262 full-time equivalent employees. The Corporation is not a party to any collective bargaining agreement. Management considers its relationship with its employees to be good. Employee benefits programs are considered by the Corporation to be competitive with benefits programs provided by other financial institutions and major employers within the current market area.
Industry Segments
The Corporation and the Bank are engaged in one line of business, which is banking services. See Item 8, “Financial Statements and Supplementary Data” for financial information regarding the Corporation's business.
Available Information
LNB Bancorp, Inc.'s internet website is www.4LNB.com. Copies of the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are made available through this website or directly through the Securities and Exchange Commission (the “SEC”) website which is www.sec.gov.
 


4


Forward-Looking Statements
This Form 10-K contains forward-looking statements within the meaning of the “Safe Harbor” provisions of the Private Securities Litigation Reform Act of 1995. Terms such as “will,” “should,” “plan,” “intend,” “expect,” “continue,” “believe,” “anticipate” and “seek,” as well as similar comments, are forward-looking in nature. Actual results and events may differ materially from those expressed or anticipated as a result of risks and uncertainties which include but are not limited to:

a worsening of economic conditions or slowing of any economic recovery, which could negatively impact, among other things, business activity and consumer spending and could lead to a lack of liquidity in the credit markets;
changes in the interest rate environment which could reduce anticipated or actual margins;
increases in interest rates or further weakening of economic conditions that could constrain borrowers' ability to repay outstanding loans or diminish the value of the collateral securing those loans;
market conditions or other events that could negatively affect the level or cost of funding, affecting the Corporation's ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth, and new business transactions at a reasonable cost, in a timely manner and without adverse consequences;
changes in political conditions or the legislative or regulatory environment, including new or heightened legal standards and regulatory requirements, practices or expectations, which may impede profitability or affect the Corporation's financial condition (such as, for example, the Dodd-Frank Act and rules and regulations that have been or may be promulgated under the Act);
persisting volatility and limited credit availability in the financial markets, particularly if market conditions limit the Corporation's ability to raise funding to the extent required by banking regulators or otherwise;
significant increases in competitive pressure in the banking and financial services industries, particularly in the geographic or business areas in which the Corporation conducts its operations;
limitations on the Corporation's ability to return capital to shareholders, including the ability to pay dividends, and the dilution of the Corporation's common shares that may result from, among other things, funding any repurchase or redemption of the Corporation's outstanding preferred stock;
adverse effects on the Corporation's ability to engage in routine funding transactions as a result of the actions and commercial soundness of other financial institutions;
general economic conditions becoming less favorable than expected, continued disruption in the housing markets and/or asset price deterioration, which have had and may continue to have a negative effect on the valuation of certain asset categories represented on the Corporation's balance sheet;
increases in deposit insurance premiums or assessments imposed on the Corporation by the FDIC;
a failure of the Corporation's operating systems or infrastructure, or those of its third-party vendors, that could disrupt its business;
risks that are not effectively identified or mitigated by the Corporation's risk management framework; and
difficulty attracting and/or retaining key executives and/or relationship managers at compensation levels necessary to maintain a competitive market position; as well as the risks and uncertainties described from time to time in the Corporation's reports as filed with the SEC.
The Corporation undertakes no obligation to update or clarify forward-looking statements, whether as a result of new information, future events or otherwise.

Item 1A.
Risk Factors
As a competitor in the banking and financial services industries, the Corporation and its business, operations and financial condition are subject to various risks and uncertainties. You should carefully consider the risks and uncertainties described below, together with all of the other information in this Annual Report on Form 10-K and in the Corporation's other filings with the SEC, before making any investment decision with respect to the Corporation's securities. In particular, you should consider the discussion contained in Item 7 of this Annual Report on Form 10-K, which contains Management's Discussion and Analysis of Financial Condition and Results of Operations.
The risks and uncertainties described below may not be the only ones the Corporation faces. Additional risks and uncertainties not presently known by the Corporation or that the Corporation currently deems immaterial may also affect the Corporation's business. If any of these known or unknown risks or uncertainties actually occur or develop, the Corporation's business, financial


5


condition, results of operations and future growth prospects could change. Under those circumstances, the trading prices of the Corporation's securities could decline, and you could lose all or part of your investment.
Economic trends have adversely affected the Corporation's industry and business and may continue to do so.
Difficult economic conditions, particularly over the last few years, led to dramatic declines in the housing market that resulted in decreasing home prices and increasing delinquencies and foreclosures which negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions. In addition, the values of real estate collateral supporting many loans have declined and may continue to decline. These general economic trends, the reduced availability of commercial credit and relatively high rates of unemployment have all negatively impacted the credit performance of commercial and consumer credit and resulted in additional write-downs. Concerns over the stability of the financial markets and the economy resulted in decreased lending by financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets have adversely affected the Corporation's business, financial condition, results of operations and share price and may continue to do so. Also, the Corporation's ability to assess the creditworthiness of customers and to estimate the losses inherent in its credit exposure is made more complex by these difficult market and economic conditions. Business activity across a wide range of industries and regions remains slow to recover and local governments and many companies continue to be in difficulty due to the lack of consumer spending and the lack of liquidity in the credit markets. Any worsening of current conditions or slowing of any economic recovery would have an adverse effect on the Corporation, its customers and the other financial institutions in its market. As a result, the Corporation may experience increases in foreclosures, delinquencies and customer bankruptcies.
Changes in interest rates could adversely affect the Corporation's earnings and financial condition.
The Corporation's earnings and cash flows depend substantially upon its net interest income. Net interest income is the difference between interest income earned on interest-earnings assets, such as loans and investment securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are sensitive to many factors that are beyond the Corporation's control, including general economic conditions, competition and policies of various governmental and regulatory agencies and, in particular, the policies of the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, could influence not only the interest the Corporation receives on loans and investment securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect: (1) the Corporation's ability to originate loans and obtain deposits; (2) the fair value of the Corporation's financial assets and liabilities, including its securities portfolio; and (3) the average duration of the Corporation's interest-earning assets. This also includes the risk that interest-earning assets may be more responsive to changes in interest rates than interest-bearing liabilities, or vice versa (repricing risk), the risk that the individual interest rates or rates indices underlying various interest-earning assets and interest-bearing liabilities may not change in the same degree over a given time period (basis risk), and the risk of changing interest rate relationships across the spectrum of interest-earning asset and interest-bearing liability maturities (yield curve risk), including a prolonged flat or inverted yield curve environment. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse affect on the Corporation's financial condition and results of operations.
The Corporation's allowance for loan losses may not be adequate to cover actual future losses.
The Corporation maintains an allowance for loan losses to cover probable and incurred loan losses. Every loan the Corporation makes carries a certain risk of non-repayment, and the Corporation makes various assumptions and judgments about the collectibility of its loan portfolio including the creditworthiness of its borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. Through a periodic review and consideration of the loan portfolio, Management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations with the Corporation. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond the Corporation's control, and these losses may exceed current estimates. The Corporation cannot fully predict the amount or timing of losses or whether the loss allowance will be adequate in the future. If the Corporation's assumptions prove to be incorrect, its allowance for loan losses may not be sufficient to cover losses inherent in its loan portfolio, resulting in additions to the allowance. Excessive loan losses and significant additions to the Corporation's allowance for loan losses could have a material adverse impact on its financial condition and results of operations.
Federal regulators, as an integral part of their examination process, periodically review our allowance for loan losses and could require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs.  Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations.


6


Changes in economic and political conditions could adversely affect the Corporation's earnings.
The Corporation's success depends, to a certain extent, upon economic and political conditions, local and national, as well as governmental monetary policies. Conditions such as inflation, recession, unemployment, changes in interest rates, money supply and other factors beyond the Corporation's control may adversely affect its asset quality, deposit levels and loan demand and, therefore, its earnings. Because the Corporation has a significant amount of real estate loans, additional decreases in real estate values could adversely affect the value of property used as collateral and the Corporation's ability to sell the collateral upon foreclosure. Adverse changes in the economy may also have a negative effect on the ability of the Corporation's borrowers to make timely repayments of their loans, which would have an adverse impact on the Corporation's earnings. If during a period of reduced real estate values the Corporation is required to liquidate the collateral securing a loan to satisfy the debt or to increase its allowance for loan losses, it could materially reduce the Corporation's profitability and adversely affect its financial condition. The substantial majority of the Corporation's loans are to individuals and businesses in Ohio. Consequently, significant declines in the economy in Ohio could have a materially adverse effect on the Corporation's financial condition and results of operations. Furthermore, future earnings are susceptible to declining credit conditions in the markets in which the Corporation operates.
Certain industries, including the financial services industry, are disproportionately affected by certain economic indicators such as unemployment and real estate asset values. Should the improvement of these economic indicators lag the improvement of the overall economy, the Corporation could be adversely affected.
Should the stabilization of the U.S. economy lead to a general economic recovery, the improvement of certain economic indicators, such as unemployment and real estate asset values and rents, may nevertheless continue to lag behind the overall economy. These economic indicators typically affect certain industries, such as real estate and financial services, more significantly. Furthermore, financial services companies with a substantial lending business are dependent upon the ability of their borrowers to make debt service payments on loans. Should unemployment or real estate asset values fail to recover for an extended period of time, the Corporation's results of operations could be negatively affected.
Strong competition may reduce the Corporation's ability to generate loans and deposits in its market.
The Corporation competes in a consolidating industry. A large part of the Corporation's competition continues to be large regional companies which have the capital resources to substantially impact such things as loan and deposit pricing, delivery channels and products. This may allow those companies to offer what may be perceived in the market as better pricing, better products and better convenience relative to smaller competitors like the Corporation, which could impact the Corporation's ability to grow its assets and earnings.
The Corporation's earnings and reputation may be adversely affected if credit risk is not properly managed.
Originating and underwriting loans is critical to the success of the Corporation. This activity exposes the Corporation to credit risk, which is the risk of losing principal and interest income because the borrower cannot repay the loan in full. The Corporation depends on collateral in underwriting loans, and the value of this collateral is impacted by interest rates and economic conditions.
The Corporation's earnings may be adversely affected if management does not understand and properly manage loan concentrations. The Corporation's commercial loan portfolio is concentrated in commercial real estate. This includes significant commercial and residential development customers. This means that the Corporation's credit risk profile is dependent upon, not only the general economic conditions in the market, but also the health of the local real estate market. Certain of these loans are not fully amortized over the loan period, but have a balloon payment due at maturity. The borrower's ability to make a balloon payment typically will depend on being able to refinance the loan or to sell the underlying collateral. This factor, combined with others, including the Corporation's geographic concentration, can lead to unexpected credit deterioration and higher provisions for loan losses.
The Corporation is subject to liquidity risk.
Market conditions or other events could negatively affect the level or cost of funding, affecting the Corporation's ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth and new business transactions at a reasonable cost, in a timely manner and without adverse consequences. Although management has implemented strategies to maintain sufficient sources of funding to accommodate planned as well as unanticipated changes in assets and liabilities under both normal and adverse conditions, any substantial, unexpected and/or prolonged change in the level or cost of liquidity could adversely affect the Corporation's business, financial condition and results of operations.
As a result of the Dodd-Frank Act and international accords, financial institutions will become subject to new and increased capital and liquidity requirements. While it is not yet clear what form these requirements will take or how they will apply to the Corporation, it is possible that the Corporation could be required to increase its capital levels above the levels in its current financial


7


plans. These new requirements could have a negative impact on the Corporation's ability to lend, grow deposit balances or make acquisitions and on its ability to make capital distributions in the form of dividends or share repurchases. Higher capital levels could also lower the Corporation's return on equity.
Legislative or regulatory changes or actions, or significant litigation, could adversely impact the Corporation or the businesses in which it is engaged.
The financial services industry is extensively regulated. The Corporation is subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of its operations. Laws and regulations may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds, and not to benefit the Corporation's shareholders. The impact of any changes to laws and regulations or other actions by regulatory agencies may negatively impact the Corporation or its ability to increase the value of its business.
The US government has undertaken major reform of the financial services industry, including new efforts to protect consumers and investors from financial abuse. The Corporation expects to face further increased regulation of its industry as a result of current and future initiatives intended to provide economic stimulus, financial market stability and enhanced regulation of financial services companies and to enhance the liquidity and solvency of financial institutions and markets. The Corporation also expects in many cases more aggressive enforcement of regulations on both the federal and state levels. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy of an institution's allowance for loan losses. Additionally, actions by regulatory agencies or significant litigation against the Corporation could require it to devote significant time and resources to defending its business and may lead to penalties that materially affect the Corporation and its shareholders.
In June 2012, the Federal Reserve Board released proposed rules regarding implementation of the Basel III regulatory capital rules for U.S. banking organizations. The proposed rules would substantially increase the complexity of capital calculations and the amount of required capital to be maintained. Specifically, the proposed rules would reduce the items that count as capital, establish higher capital ratios for all banks and increase risk weighting of a number of asset classes a bank holds. The potential impact of the proposed rules includes, but is not limited to, reduced lending and negative pressure on profitability and return on equity due to the higher capital requirements. The cost of implementation and ongoing compliance with the proposed rules may also negatively impact operating costs. To the extent the Company is required to increase capital in the future to comply with the proposed rules, existing shareholders may be diluted and/or our ability to pay common share dividends may be reduced.
The Dodd-Frank Act may adversely affect the Corporation's business, financial conditions and results of operations.
The Dodd-Frank Act, which became law in July 2010, imposes new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions. Because the Dodd-Frank Act requires various federal agencies to adopt a broad range of regulations with significant discretion, the effects of the Act on the Corporation's business will depend largely on the implementation of the Act by those agencies, and many of the details of the new law and the effects they will have on the Corporation may not be known for months or even years.
Many of the provisions of the Dodd-Frank Act apply directly only to institutions much larger than the Corporation, and some will affect only institutions that engage in activities in which the Corporation does not engage. Among the changes to occur pursuant to the Dodd-Frank Act that can be expected to have an effect on the Corporation are the following:
The OTS has been merged into the OCC and the authority of the other remaining bank regulatory agencies restructured;
An independent Consumer Financial Protection Bureau has been established within the Federal Reserve Board, empowered to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws;
New trust preferred securities will no longer count toward Tier 1 capital;
The prohibition on the payment of interest on demand deposits has been repealed, effective July 21, 2011;
The standard maximum amount of deposit insurance per customer is permanently increased to $250,000 and certain non-interest bearing transaction accounts had unlimited deposit insurance coverage through December 31, 2012;
The deposit insurance assessment base calculation has been expanded to equal a depository institution's total assets minus the sum of its average tangible equity during the assessment period;
New corporate governance requirements applicable generally to all public companies in all industries have required or will require new compensation practices, including, but not limited to, requiring companies to “claw back” incentive compensation under certain circumstances, to provide shareholders the opportunity to cast a non-binding vote on executive compensation, to consider the independence of compensation advisors and new executive compensation disclosure requirements;


8


Establish new rules and restrictions regarding the origination of mortgages;
Permit the Federal Reserve to prescribe regulations regarding interchange transaction fees, and limit them to an amount reasonable and proportional to the cost incurred by the issuer for the transaction in question.
Many provisions of the Dodd-Frank Act will not be implemented immediately and will require interpretation and rule making by federal regulators. The Corporation is closely monitoring all relevant sections of the Dodd-Frank Act to ensure continued compliance with laws and regulations. While the ultimate effect of the Dodd-Frank Act on the Corporation cannot be determined yet, the law is likely to result in increased compliance costs and fees paid to regulators, along with possible restrictions on the Corporation's operations.
The Corporation may be adversely impacted by weakness in the local economies it serves.
The Corporation's business activities are geographically concentrated in Northeast Ohio and, in particular, Lorain County, Ohio, where commercial activity has deteriorated at a greater rate than in other parts of Ohio and in the national economy. The Corporation is less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. This has led to and may lead to further unexpected deterioration in loan quality, slower asset and deposit growth, which may adversely affect the Corporation's operating results. Moreover, the Corporation cannot give any assurance that it will benefit from any market growth or favorable economic conditions in its primary market areas if they do occur.
Future FDIC premiums could be substantially higher and would have an unfavorable effect on earnings.
Higher levels of bank failures over the last few years have dramatically increased resolution costs of the FDIC and depleted the deposit insurance fund. In addition, the FDIC now insures deposit accounts up to $250,000 per customer (up from $100,000) and noninterest-bearing transactional accounts were fully insured with unlimited coverage through December 31, 2012. These programs have placed additional stress on the deposit insurance fund. In order to maintain a strong funding position and restore reserve ratios of the deposit insurance fund, the FDIC has increased assessment rates of insured institutions. The Dodd-Frank Act also imposes additional assessments and costs with respect to deposits, requiring the FDIC to impose deposit insurance assessments based on total assets rather than total deposits. These announced increases, legislative and regulatory changes and any future increases or required prepayments of FDIC insurance premiums may adversely impact the Corporation's earnings and financial condition. If there are additional bank or financial institution failures, or the cost of resolving prior failures exceeds expectations, the Corporation may be required to pay even higher FDIC premiums than the recently increased levels.
The soundness of other financial institutions could adversely affect the Corporation.
The Corporation's ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. The Corporation has exposure to many different industries and counterparties, and it routinely executes transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by the Corporation or by other institutions. Many of these transactions expose the Corporation to credit risk in the event of default of the Corporation's counterparty or client. In addition, the Corporation's credit risk may be exacerbated when the collateral held by it cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due the Corporation. There is no assurance that any such losses would not materially and adversely affect the Corporation's results of operations.
A failure of the Corporation's operating systems or infrastructure, or those of its third-party vendors, could disrupt its business.
The Corporation's business is dependent on its ability to process and monitor large numbers of daily transactions in compliance with legal and regulatory standards and the Corporation's product specifications, which it changes to reflect its business needs. As processing demands change and the Corporation's loan portfolios grow in both volume and differing terms and conditions, developing and maintaining the Corporation's operating systems and infrastructure becomes increasingly challenging and there is no assurance that the Corporation can adequately or efficiently develop and maintain such systems. The Corporation's loan originations and conversions and the servicing, financial, accounting, data processing or other operating systems and facilities that support them may fail to operate properly or become disabled as a result of events that are beyond the Corporation's control, adversely affecting its ability to process these transactions. Any such failure could adversely affect the Corporation's ability to service its customers, result in financial loss or liability to its customers, disrupt its business, result in regulatory action or cause reputational damage. Despite the plans and facilities the Corporation has in place, its ability to conduct business may be adversely affected by a disruption in the infrastructure that supports its businesses. This may include a disruption involving electrical, communications, internet, transportation or other services used by the Corporation or third parties with which it conducts business.


9


Notwithstanding the Corporation's efforts to maintain business continuity, a disruptive event impacting its processing locations could adversely affect its business, financial condition and results of operations. The Corporation's operations rely on the secure processing, storage and transmission of personal, confidential and other information in its computer systems and networks. Although the Corporation takes protective measures, its computer systems, software and networks may be vulnerable to unauthorized access, computer viruses, malicious attacks and other events that could have a security impact beyond the Corporation's control. If one or more of such events occur, personal, confidential and other information processed and stored in, and transmitted through, the Corporation's computer systems and networks, could be jeopardized or otherwise interruptions or malfunctions in its operations could result in significant losses or reputational damage. The Corporation also routinely transmits and receives personal, confidential and proprietary information, some through third parties. The Corporation has put in place secure transmission capability, and works to ensure third parties follow similar procedures. An interception, misuse or mishandling of personal, confidential or proprietary information being sent to or received from a customer or third party could result in legal liability, regulatory action and reputational harm. In the event personal, confidential or other information is jeopardized, intercepted, misused or mishandled, the Corporation may be required to expend significant additional resources to modify its protective measures or to investigate and remediate vulnerabilities or other exposures, and it may be subject to fines, penalties, litigation costs and settlements and financial losses that are either not insured against or not fully covered through any insurance maintained by it. If one or more of such events occur, the Corporation's business, financial condition or results of operations could be significantly and adversely affected.

The Corporation is subject to risk from the failure of third party vendors.
The Corporation relies on other companies to provide components of the Corporation's business infrastructure. Third party vendors provide certain components of the Corporation's business infrastructure, such the Bank's processing and electronic banking systems, item processing and Internet connections. While the Corporation has selected these third party vendors carefully, it does not control their actions. Any problems caused by these third parties not providing the Corporation their services for any reason or their performing their services poorly, could adversely affect the Corporation's ability to deliver products and services to the Corporation's operations directly through interference with communications, including the interruption or loss of the Corporation's websites, which could adversely affect the Corporation's business, financial condition and results of operations.

The Corporation may have fewer resources than many of its competitors to invest in technological improvements.
 
The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services.  The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs.  The Corporation's future success will depend, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in its operations.  Many of the Corporation's competitors have substantially greater resources to invest in technological improvements. The Corporation may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers.
Changes in accounting standards could materially impact the Corporation's financial statements.
The Financial Accounting Standards Board (FASB) may change the financial accounting and reporting standards that govern the preparation of the Corporation's financial statements. These changes can be difficult to predict and can materially impact how the Corporation records and reports it financial condition and results of operations.
The Corporation may not be able to attract and retain skilled people.
The Corporation's success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities in which the Corporation is engaged can be intense, and the Corporation may not be able to retain or hire the people it wants and/or needs. In order to attract and retain qualified employees, the Corporation must compensate its employees at market levels. If the Corporation is unable to continue to attract and retain qualified employees, or do so at rates necessary to maintain its competitive position, the Corporation's performance, including its competitive position, could suffer, and, in turn, adversely affect the Corporation's business, financial condition and results of operations.
The Corporation's issuance of Series B Preferred Stock may limit the Corporation's ability to return capital to its shareholders. If the Corporation is unable to redeem such preferred shares, the dividend rate will increase substantially.
As long as the Corporation's Series B Preferred Stock is outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including the Corporation's common shares, are prohibited to the extent there are then any accrued and unpaid dividends on such preferred stock, subject to certain limited exceptions. These restrictions may have an adverse effect on the market price of the Corporation's Common Shares, and, as a result, they could adversely affect the Corporation's business, financial condition and results of operations.


10


Unless the Corporation is able to repurchase or redeem the Series B Preferred Stock by February 14, 2014, the dividend payments on this capital will increase substantially at that point, from 5% (approximately $0.9 million annually) to 9% (approximately $1.7 million annually). Depending on market conditions at the time, this increase in dividends could significantly impact the Corporation's liquidity, and as a result, adversely affect the Corporation's business, financial condition and results of operations.
The Corporation's ability to pay dividends is subject to limitations.
Holders of the Corporation's common shares are only entitled to receive such dividends as the Board of Directors may declare out of funds legally available for such payments. Furthermore, the Corporation's common shareholders are subject to the prior dividend rights of holders of its preferred stock.
In September 2009, the Corporation reduced its quarterly dividend on its common shares to $0.01 per share and does not expect to increase the quarterly dividend above $0.01 until after such time as the Corporation's Series B Preferred Stock has been repurchased or redeemed in full. The Corporation could determine to eliminate its common shares dividend altogether. Furthermore, as long as the Series B Preferred Stock is outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including the Corporation's common shares, are prohibited to the extent that there are then any accrued and unpaid dividends on such preferred stock, subject to certain limited exceptions. This could adversely affect the market price of the Corporation's common shares. Also, the Corporation is a bank holding company and its ability to declare and pay dividends is dependent on certain federal regulatory considerations, including the guidelines of the Federal Reserve Board regarding capital adequacy and dividends.
In addition, the terms of the Corporation's outstanding trust preferred securities prohibit it from declaring or paying any dividends or distributions on its capital stock, including its common shares, if an event of default has occurred and is continuing under the applicable indenture or if the Corporation has given notice of its election to defer interest payments but the related deferral period has not yet commenced or a deferral period is continuing.
Additional capital may not be available to the Corporation if and when it is needed.
The Corporation and the Bank are subject to capital-based regulatory requirements. The ability of the Corporation and the Bank to meet capital requirements is dependent upon a number of factors, including results of operations, level of nonperforming assets, interest rate risk, future economic conditions, future changes in regulatory and accounting policies and capital requirements, and the ability to raise additional capital if and when it is needed. Certain circumstances, such as a reduction of capital due to losses from nonperforming assets or otherwise, could cause the Corporation or the Bank to become unable to meet applicable regulatory capital requirements, which may materially and adversely affect the Corporation's financial condition, liquidity and results of operations. In such an event, additional capital may be required to meet requirements. The Corporation's ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time which are outside its control, and on the Corporation's financial performance. Accordingly, additional capital, if needed, may not be available on terms acceptable to the Corporation. Furthermore, if any such additional capital is raised through the offering of equity securities, it may dilute the holdings of the Corporation's existing shareholders or reduce the market price of the Corporation's common shares, or both.
The Corporation's risk management framework may not effectively identify or mitigate its risks.
The Corporation's risk management framework seeks to mitigate risk and appropriately balance risk and return. The Corporation has established processes and procedures intended to identify, measure, monitor and report the types of risk to which it is subject, including credit risk, market risk, liquidity risk, operational risk, legal and compliance risk, and strategic risk. The Corporation seeks to monitor and control its risk exposure through a framework of policies, procedures and reporting requirements. Management of the Corporation's risks in some cases depends upon the use of analytical and/or forecasting models. If the models that the Corporation uses to mitigate these risks are inadequate, the Corporation may incur increased losses. In addition, there may be risks that exist, or that develop in the future, that the Corporation has not appropriately anticipated, identified or mitigated. If the Corporation's risk management framework does not effectively identify or mitigate its risks, it could suffer unexpected losses and could be materially adversely affected.
If the Corporation is required to write down goodwill recorded in connection with its acquisitions, the Corporation's profitability would be negatively impacted.
Applicable accounting standards require the Corporation to use the purchase method of accounting for all business combinations. Under purchase accounting, if the purchase price of an acquired company exceeds the fair value of the acquired company's net assets, the excess is carried on the acquirer's balance sheet as goodwill. At December 31, 2012, the Corporation had approximately $21.6 million of goodwill on its balance sheet. Goodwill must be evaluated for impairment at least annually. Write downs of the amount of any impairment, if necessary, are to be charged to the results of operations in the period in which


11


the impairment occurs. There can be no assurance that future evaluations of goodwill will not result in findings of impairment and related write downs, which would have an adverse effect on the Corporation's financial condition and results of operations.
Our compensation expense may increase substantially as a result of the sale of the Corporation's Series B Preferred Stock by the United States Department of the Treasury.
As a result of the United States Department of the Treasury's sale of the Corporation's Series B Preferred Stock, certain executive compensation restrictions and corporate governance standards, as set forth in the Interim Final Rule on TARP Standards for Compensation and Corporate Governance published June 15, 2009, are no longer be applicable and the Corporation's compensation expense for its executive officers and other senior employees may increase substantially.

Item 1B.
Unresolved Staff Comments
Not applicable.
Item 2.
Properties
The Corporation's corporate offices are located at 457 Broadway, Lorain, Ohio. As of December 31, 2012, the Corporation and its subsidiaries operated a total of 26 facilities, including its banking centers, loan production offices, corporate offices, and maintenance, purchasing, operations and professional development centers, which are located in Lorain, eastern Erie, western Cuyahoga and Summit counties of Ohio. Of these facilities, 13 were owned, including the corporate offices. The other 13 facilities were leased from unaffiliated third parties on varying lease terms. See Note 8 to the consolidated financial statements contained in Item 8, “Financial Statement and Supplementary Data.”

The 26 facilities and their addresses are listed in the following table:  

Main Banking Center & Corporate Offices
457 Broadway, Lorain
Vermilion
4455 East Liberty Avenue, Vermilion
Amherst
1175 Cleveland Avenue, Amherst
Lake Avenue
42935 North Ridge Road, Elyria Township
Avon
2100 Center Road, Avon
Avon Lake
32960 Walker Road, Avon Lake
Pearl Avenue
2850 Pearl Avenue, Lorain
Oberlin
24 East College Street, Oberlin
Ely Square
124 Middle Avenue, Elyria
Oberlin Avenue
3660 Oberlin Avenue, Lorain
Olmsted Township
27095 Bagley Road, Olmsted Township
Kendal at Oberlin
600 Kendal Drive, Oberlin
The Renaissance
26376 John Road, Olmsted Township
Chestnut Commons
105 Chestnut Commons Drive, Elyria
North Ridgeville
34085 Center Ridge Road, North Ridgeville
Village of LaGrange
540 North Center Street, LaGrange
Westlake Village
28550 Westlake Village Drive, Westlake
Wesleyan Village
807 West Avenue, Elyria
Morgan Bank
178 West Streetsboro Street, Hudson
Solon Mortgage Center
 34305 Solon Rd., Franklin's Row #30, Solon
Cuyahoga Loan Production Office
2 Summit Park Drive, Independence
Operations Center
2130 West Park Drive, Lorain
Maintenance Center
2140 West Park Drive, Lorain
Purchasing Center
2150 West Park Drive, Lorain
Professional Development Center
521 Broadway, Lorain
Sixth Street Drive-In
200 West 6th Street, Lorain



12


The Corporation also owns and leases equipment for use in its business. The Corporate headquarters at 457 Broadway is currently 75% occupied. The remaining space is expected to be utilized to accommodate future growth. The Corporation considers all its facilities to be in good condition, well-maintained and more than adequate to conduct the business of banking.

Item 3.
Legal Proceedings
On April 18, 2008, the Corporation and Richard M. Osborne and certain other parties entered into a settlement agreement (the “Settlement Agreement”) to settle certain contested matters relating to the Corporation's 2008 annual meeting of shareholders. Under the Settlement Agreement, among other things, Mr. Osborne agreed not to seek representation on the Corporation's Board of Directors or to solicit proxies with respect to the voting of the Corporation's common shares for a period of at least 18 months after April 18, 2008. In proxy materials filed with the SEC on March 20, 2009, Mr. Osborne indicated his intent to solicit proxies in favor of the election of two nominees for election as directors at the Corporation's 2009 annual meeting of shareholders. On March 24, 2009, the Corporation filed a complaint against Mr. Osborne for a declaratory judgment and preliminary and permanent injunctive relief in the United States District Court for the Northern District of Ohio, Eastern Division, to enforce the “standstill” provisions of the Settlement Agreement and restrain Mr. Osborne from (a) engaging in any solicitation of proxies or consents, (b) seeking to advise, encourage or influence any person or entity with respect to the voting of any voting securities of the Corporation, (c) initiating, proposing or otherwise soliciting shareholders of the Corporation for the approval of shareholder proposals, (d) entering into any discussions, negotiations, agreements, arrangements or understanding with any third party with respect to any of the foregoing and (e) disseminating his proposed proxy materials to shareholders of the Corporation. The Corporation also sought an order from the Court temporarily restraining Mr. Osborne from engaging in any of the foregoing activities. On March 28, 2009, the Court issued an order granting the Corporation's motion for a temporary restraining order. On April 3, 2009, the Court issued an order granting the Corporation's motion for a preliminary injunction restraining Mr. Osborne from engaging in any of the foregoing activities. On February 15, 2010, Mr. Osborne filed a motion to dissolve the preliminary injunction, which the Corporation opposed. On March 23, 2010, the Court denied Mr. Osborne's motion to dissolve the preliminary injunction. Prior to the Court's decision, on March 19, 2010, Mr. Osborne filed a motion for summary judgment and the Corporation filed a motion for partial summary judgment. On April 14, 2010, Mr. Osborne filed an interlocutory appeal of the denial of his motion to dissolve the preliminary injunction with the Sixth Circuit Court of Appeals. Proceedings in the District Court were stayed pending resolution of Mr. Osborne's appeal by the Sixth Circuit Court of Appeals. On July 25, 2011, the Sixth Circuit affirmed the decision of the District Court. The case was remanded to the District Court, and, on November 30, 2011, the Court granted the Corporation's motion for partial summary judgment, ruling that Mr. Osborne must refrain from engaging in any of the conduct specified in the “standstill” provisions of the Settlement Agreement until such time as both of the directors designated by Mr. Osborne pursuant to the Settlement Agreement no longer serve on the Corporation's Board of Directors. With respect to the remaining claims, the Court scheduled the commencement of a trial on the merits for March 13, 2012. In the meantime, Osborne appealed the District Court's decision granting a permanent injunction to the Sixth Circuit. The Corporation filed a motion to dismiss the appeal, which remains pending in the Sixth Circuit. The District Court has stayed all proceedings pending resolution of the matter in the Sixth Circuit. The appeal has been fully briefed and the Sixth Circuit has not set a date for oral argument. All other claims remain pending in the District Court, but have been stayed pending resolution of the appeal.




13


Item 4.
Mine Safety Disclosures
Not applicable.


Supplemental Item — Executive Officers of the Registrant
Pursuant to Form 10-K, General Instruction G(3), the following information on Executive Officers is included as an additional item in this Part I:
 
Name

Age 

Principal Occupation For Past Five Years

Positions and
Offices
Held with
LNB Bancorp, Inc.

Executive
Officer Since 

Daniel E. Klimas
54
President and Chief Executive Officer, LNB Bancorp, Inc., February 2005 to present. President, Northern Ohio Region, Huntington Bank from 2001 to February 2005.
President and Chief Executive
Officer
2005
 
 
 
 
 
Gary J. Elek
61
Chief Financial Officer, LNB Bancorp, Inc., from April 2009 to present. Vice President and Controller for North America of A. Schulman, Inc. in Akron, Ohio from 2006 to 2008. Corporate Controller of A. Schulman, Inc. from 2004 to 2006. Executive Vice President, Corporate Development from 1999 to 2004, as Senior Vice President, Corporate Development from 1997 to 1999 and as Senior Vice President and Treasurer from 1988 to 1997 of FirstMerit Corporation.
Chief Financial Officer and Principal Accounting Officer
2009
 
 
 
 
 
David S. Harnett
61
Senior Vice President and Chief Credit Officer, LNB Bancorp, Inc., August 2007 to present. Senior Lender and Chief Credit Officer, January 2006 to August 2007, and Senior Vice President and Chief Credit Officer, January 2002 to January 2006, of the Cleveland, Ohio affiliate of Fifth Third Bank.
Senior Vice President and Chief Credit Officer
2007
 
 
 
 
 
Kevin Nelson
49
Senior Vice President, LNB Bancorp, Inc., from April 2009 to present. Director of Indirect Lending, The Lorain National Bank, from May 2007 to present. Senior Vice President, Bank Sales and Loan Originations, Morgan Bank (a division of the Bank), from September 2006 to May 2007. President, Nelson Marketing Group, LLC, from November 2005 to September 2006.
Senior Vice President and Director of Indirect Lending
2009
 
 
 
 
 
Frank A. Soltis
60
Senior Vice President, LNB Bancorp, Inc., July 2005 to present. Senior Vice President, Lakeland Financial Corporation, 1997 to 2005.
Senior Vice President and Director of Technology & Operations
2005
 
 
 
 
 
Mary E. Miles
54
Senior Vice President, LNB Bancorp, Inc., April 2005 to present. President, Miles Consulting, Inc. from 2001 to 2005.
Senior Vice President and Director of Human Resources, Professional Development & Security
2005
 
 
 
 
 
John Simacek
60
Senior Vice President, LNB Bancorp, Inc., from April 2009 to present. Senior Retail Executive, The Lorain National Bank (a subsidiary of the Corporation), October 2005 to present. Vice President and Regional Manager of the Cleveland, Ohio affiliate of Fifth Third Bank, 1999 to October 2005.
Senior Vice President and Senior Retail Executive
2009
 
 
 
 
 
Robert F. Heinrich
59
Senior Vice President, LNB Bancorp, Inc., from April 2009 to present. Corporate Secretary, LNB Bancorp, Inc., from February 2008 to Present. Director of Risk Management, LNB Bancorp, Inc., from 2005 to present. Controller, LNB Bancorp, Inc., from January 2004 to March 2005. Auditor, LNB Bancorp, Inc., from May 2003 to January 2004.
Senior Vice President, Corporate Secretary and Director of Risk Management
2009
 
 
 
 
 
Peter R. Catanese
56
Senior Vice President and Marketing Director, LNB Bancorp, Inc., from September 2005 to present. Vice President, Charter One Bank, May 1998 to September 2005.
Senior Vice President and Director of Marketing
2011




14


PART II
 
Item 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information; Equity Holders; Dividends.    LNB Bancorp, Inc. common shares, par value $1.00 per share, are traded on The NASDAQ Stock Market® under the ticker symbol “LNBB”. The prices below represent the high and low sales prices reported on The NASDAQ Stock Market for each specified period. All prices reflect inter-dealer prices without markup, markdown or commission and may not necessarily represent actual transactions.
LNB Bancorp, Inc. has paid a cash dividend to shareholders each year since becoming a holding company in 1984. At present, the Corporation expects to pay cash dividends to shareholders in an amount equal to $0.01 per share if approved by the Board of Directors. The Corporation could decide to eliminate its common share dividend altogether. In addition, as long as the Series B Preferred Stock issued by the Corporation is outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including the Corporation’s common shares, are prohibited to the extent that there are then any accrued and unpaid dividends on such preferred stock, subject to certain limited exceptions. Furthermore, the terms of the Corporation's outstanding trust preferred securities prohibit it from declaring or paying any dividends or distributions on its capital stock, including its common shares, if an event of default has occurred and is continuing under the applicable indenture or if the Corporation has given notice of its election to defer interest payments but the related deferral period has not yet commenced or a deferral period is continuing.
The common shares of LNB Bancorp, Inc. are usually listed in publications as “LNB Bancorp”. LNB Bancorp Inc.’s common stock CUSIP is 502100100.
As of March 4, 2013, LNB Bancorp, Inc. had 1,769 shareholders of record and the closing price per share of the Corporation’s common shares was $7.77.
Common Stock Trading Ranges and Cash Dividends Declared
 
 
2012
 
High
 
Low
 
Cash
Dividends
Declared
Per Share
First Quarter
$
7.34

 
$
4.60

 
$
0.01

Second Quarter
6.93

 
6.00

 
0.01

Third Quarter
6.75

 
5.46

 
0.01

Fourth Quarter
6.70

 
5.78

 
0.01

 
 
 
 
 
 
 
2011
 
High
 
Low
 
Cash
Dividends
Declared
Per Share
First Quarter
$
5.70

 
$
4.94

 
$
0.01

Second Quarter
6.02

 
5.33

 
0.01

Third Quarter
5.92

 
3.60

 
0.01

Fourth Quarter
4.70

 
4.55

 
0.01













15



The following graph shows a five-year comparison of cumulative total returns for LNB Bancorp, the Standard & Poor’s 500 Stock Index© and the Nasdaq Bank Index.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among LNB Bancorp, Inc., The S&P 500 Index
And The NASDAQ Bank Index
 
*
$100 invested on 12/31/07 in stock or index. Including reinvestment of dividends. Fiscal year ending December 31.
The graph shown above is based on the following data points:
 
 
12/07
 
12/08
 
12/09
 
12/10
 
12/11
 
12/12
LNB Bancorp, Inc. 
$100.00
 
$38.00
 
$32.54
 
$37.84
 
$36.08
 
$45.58
S&P 500 Index
100.00
 
63.00
 
79.67
 
91.67
 
93.61
 
108.59
NASDAQ Bank Index
100.00
 
78.22
 
68.07
 
82.40
 
70.08
 
82.33
Issuer Purchases of Equity Securities
The following table summarizes common share repurchase activity for the quarter ended December 31, 2012:
 
Period
Total Number of
Shares  (or Units)
Purchased
 
Average Price Paid
Per  Share (or Unit)
 
Total Number of
Shares  (or Units)
Purchased as
Part of Publicly
Announced Plans
or Programs
 
Maximum
Number of
Shares (or Units)
that may yet be
Purchased Under
the Plans or Programs (1)
October 1, 2012 — October 31, 2012

 
n/a
 

 
129,500

November 1, 2012 — November 30, 2012

 
n/a
 

 
129,500

December 1, 2012 — December 31, 2012

 
n/a
 

 
129,500

Total

 
n/a
 

 
129,500






16






(1) On July 28, 2005, the Corporation announced a share repurchase program of up to 5 percent, or about 332,000, of its common shares outstanding. Repurchased shares can be used for a number of corporate purposes, including the Corporation’s stock option and employee benefit plans. The share repurchase program provides that share repurchases are to be made primarily on the open market from time-to-time until the 5 percent maximum is repurchased or the earlier termination of the repurchase program by the Board of Directors, at the discretion of management based upon market, business, legal and other factors. Under the terms of the Series B Preferred Stock issued by the Corporation, so as long as the Series B Preferred Stock is outstanding, repurchases or redemptions relating to certain equity securities, including the Corporation’s common shares, are prohibited to the extent that there are then any accrued and unpaid dividends on such preferred stock, subject to certain limited exceptions. As of December 31, 2012, the Corporation had repurchased an aggregate of 202,500 shares under this program. No shares were repurchased under this program during 2012.

During the fourth quarter of 2012, the Company purchased a total of 6,343 shares of its Series B Preferred Stock in open market or privately negotiated transactions for an average price per share of $970.84, plus accrued and unpaid interest. The Corporation may continue from time to time to seek to repurchase the Series B Preferred Stock in open market purchases, privately negotiated transactions or otherwise.


17


Item 6.
Selected Financial Data
 
Year Ended December 31,
 
2012
 
2011
 
2010
 
2009
 
2008
 
(Dollars in thousands except share and per share amounts and ratios)
Total interest income
$
45,948

 
$
49,349

 
$
51,372

 
$
57,647

 
$
58,328

Total interest expense
7,509

 
10,108

 
12,764

 
19,925

 
26,189

Net interest income
38,439

 
39,241

 
38,608

 
37,722

 
32,139

Provision for Loan Losses
7,242

 
10,353

 
10,225

 
19,017

 
6,809

Other income
10,075

 
9,987

 
10,290

 
10,180

 
11,213

Net gain on sale of assets
1,672

 
1,428

 
1,277

 
1,776

 
1,246

Gain on extinguishment of debt

 

 
2,210

 

 

Other expenses
34,903

 
34,144

 
35,569

 
35,330

 
34,281

Income (loss) before income taxes
8,041

 
6,159

 
6,591

 
(4,669
)
 
3,508

Income tax (benefit)
1,934

 
1,156

 
1,226

 
(2,668
)
 
112

Net income (loss)
6,107

 
5,003

 
5,365

 
(2,001
)
 
3,396

Preferred stock dividend and accretion
1,266

 
1,276

 
1,276

 
1,256

 
91

Net income (loss) available to common shareholders
$
4,841

 
$
3,727

 
$
4,089

 
$
(3,257
)
 
$
3,305

Cash dividend declared
$
317

 
$
315

 
$
304

 
$
1,459

 
$
3,940

Per Common Share(1)


 

 

 

 

Basic earnings (loss)
$
0.61

 
$
0.47

 
$
0.55

 
$
(0.45
)
 
$
0.45

Diluted earnings (loss)
0.61

 
0.47

 
0.55

 
(0.45
)
 
0.45

Cash dividend declared
0.04

 
0.04

 
0.04

 
0.20

 
0.54

Book value per share
$
11.50

 
$
11.18

 
$
10.75

 
$
10.84

 
$
11.24

Financial Ratios

 

 

 

 

Return on average assets
0.51
%
 
0.43
%
 
0.46
%
 
(0.17
)%
 
0.31
%
Return on average common equity
5.29

 
4.47

 
4.97

 
(1.86
)
 
4.09

Net interest margin (FTE)(2)
3.49

 
3.67

 
3.60

 
3.39

 
3.23

Efficiency ratio
68.71

 
66.69

 
70.18

 
70.37

 
76.12

Period end loans to period end deposits
88.29

 
85.07

 
83.04

 
82.68

 
87.23

Dividend payout
6.56

 
8.46

 
7.28

 
            n/a

 
120.00

Average shareholders’ equity to average assets
9.65

 
9.58

 
9.32

 
8.99

 
7.67

Net charge-offs to average loans
0.77

 
1.14

 
1.62

 
1.46

 
0.38

Allowance for loan losses to period end total loans
2.00

 
2.02

 
1.99

 
2.34

 
1.45

Nonperforming loans to period end total loans
3.15

 
4.09

 
5.15

 
4.84

 
2.44

Allowance for loan losses to nonperforming loans
63.45

 
49.50

 
38.57

 
48.39

 
59.47

At Year End

 

 

 

 

Cash and cash equivalents
$
30,659

 
$
40,647

 
$
48,220

 
$
26,933

 
$
36,923

Securities and interest-bearing deposits
203,763

 
226,012

 
222,073

 
255,841

 
234,665

Restricted stock
5,741

 
5,741

 
5,741

 
4,985

 
4,884

Loans held for sale
7,634

 
3,448

 
5,105

 
3,783

 
3,580

Gross loans
882,548

 
843,088

 
812,579

 
803,197

 
803,551

Allowance for loan losses
17,637

 
17,063

 
16,136

 
18,792

 
11,652

Net loans
864,911

 
826,025

 
796,443

 
784,405

 
791,899

Other assets
65,546

 
66,549

 
74,955

 
73,562

 
64,184

Total assets
1,178,254

 
1,168,422

 
1,152,537

 
1,149,509

 
1,136,135

Total deposits
999,592

 
991,080

 
978,526

 
971,433

 
921,175

Other borrowings
63,861

 
58,962

 
59,671

 
64,582

 
96,905

Other liabilities
4,657

 
5,106

 
4,876

 
9,353

 
10,996

Total liabilities
1,068,110

 
1,055,148

 
1,043,073

 
1,045,368

 
1,029,076

Total shareholders’ equity
110,144

 
113,274

 
109,464

 
104,141

 
107,059

Total liabilities and shareholders’ equity
$
1,178,254

 
$
1,168,422

 
$
1,152,537

 
$
1,149,509

 
$
1,136,135

_________________________
(1)
Basic and diluted earnings (loss) per share are computed using the weighted-average number of shares outstanding during each year.
(2)
Tax exempt income was converted to a fully taxable equivalent basis at a 34% statutory Federal income tax rate for years presented.


18


Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following commentary presents a discussion and analysis of the Corporation’s financial condition and results of operations by its management. The review highlights the principal factors affecting earnings for 2012, 2011 and 2010 and significant changes in the balance sheet for 2012 and 2011. Financial information for the prior five years is presented where appropriate. The objective of this financial review is to enhance the reader’s understanding of the accompanying tables and charts, the consolidated financial statements, notes to the financial statements and financial statistics appearing elsewhere in the report. Where applicable, this discussion also reflects management’s insights of known events and trends that have or may reasonably be expected to have a material effect on the Corporation’s operations and financial condition.
Summary (Dollars in thousands, except per share data)
The Corporation continued to grow its core business during 2012 while improving asset quality and controlling operating expenses. Loans grew 4.7% during 2012, led by a 5.3% increase in commercial lending and an 11.0% increase in indirect auto loans over 2011. The Corporation’s investment in hiring additional business development personnel helped drive the increase in commercial and small business lending. In 2012, Lorain National Bank became the first community bank to rank in the top five SBA 7(a) lenders in the Cleveland district of the U.S. Small Business Administration. On the consumer side, the Corporation expanded its refinancing loan options for homeowners and opened a mortgage office in Solon, Ohio to market the bank to new customers in Bainbridge, Chagrin Falls, Beachwood, Highland Hills, Orange and other eastern suburbs in the Cleveland metropolitan area. The Corporation’s indirect auto loan portfolio grew $19,835 during 2012, as management decided to maintain a higher percentage of these loans on the balance sheet in comparison to previous years. The increase was a result of focusing on local markets and access to higher growth markets in other parts of the country.
Net income for 2012 was $6,107 and net income available to common shareholders was $4,841, or $0.61 per diluted common share. Net income for 2011 was $5,003 and net income available to common shareholders was $3,727, or $0.47 per diluted common share. Net income in 2010 was $5,365. Net Income available to common shareholders was $4,089, or $0.55 per diluted common share, in 2010. Net income and net income available to common shareholders in 2010 were affected by a $1,459 after-tax gain on the extinguishment of debt related to the issuance of common shares in exchange for a portion of the Corporation’s outstanding trust preferred securities. This gain and the issuance of the additional shares had a $0.23 per share positive impact on the 2010 per share results. Net income as a percent of average assets in 2012 was 0.51% compared to a return of 0.43% in 2011. Net income as a percentage of average shareholders’ equity was 5.29% for 2012 compared to 4.47% in 2011.
The Corporation aggressively managed credit quality in 2012 with non-performing loans decreasing from $34,471 for 2011 to $27,796 or 19.4 % for 2012. On a year-over-year basis, the bank's net charge-off rate decreased to .77 % from 1.14 % as net charged-off loans for 2012 decreased to $6,668 from $9,426 for 2011. The allowance for loan losses increased to $17,637 for 2012 from $17,063 for 2011. The Corporation recorded loan loss provision of $7,242 in 2012 compared to a provision for loan loss of $10,353 in 2011, in light of the continuing uncertainty in the economy. The allowance as a percentage of total loans decreased from 2.02% at December 31, 2011 to 2.00% at December 31, 2012.
Net interest income decreased by 2.0% to $38,439 in 2012 from $39,241 in 2011. The net interest margin on a fully tax-equivalent (FTE) basis for 2012 was 3.49% versus 3.67% for 2011. The decreases in net interest income and net interest margin were driven by lower loan and investment yields as a result of a continued low interest rate environment. The average yield on earning assets decreased 43 basis points while the cost of funds decreased 29 basis points from December 31, 2011.
Reflective of the Corporation’s commitment to support business lending activities in its markets, average commercial loan portfolio balances increased from $454,210 for the year ended December 31, 2011 to $481,875 for the year ended December 31, 2012. Installment loans increased 11.4% for the year ended December 31, 2012, in comparison to average installment loan portfolio balances for the year ended December 31, 2011, mainly driven by indirect auto loan growth, both through local markets as well in higher growth markets in other parts of the country and management’s decision to retain these loans on the Corporation’s balance sheet. Average residential mortgage loan portfolio balances decreased from $60,804 for the year ended December 31, 2011 to $56,412 for the year ended December 31, 2012. This decrease is mainly attributable to refinancing activity in the existing seasoned mortgage portfolio given the low interest rate environment and the Corporation’s practice of selling new mortgage production into the secondary market.
Average interest-bearing deposits for the year ended December 31, 2012 slightly increased in comparison to average interest-bearing deposits for the year ended December 31, 2011. Average noninterest-bearing deposits increased for 2012, from $121,786 in 2011 to $137,077, an increase of $15,291, or 12.6%.
Noninterest income for 2012 was $11,747, an increase of $332, or 2.9% compared to 2011. The largest component of noninterest income is deposit and other service charges and fees which were $6,893 and $7,325 for 2012 and 2011 respectively.


19


Deposit service charges decreased to $3,811 for 2012 compared to $4,079 for the prior year and were negatively impacted by federal legislation limiting overdraft fees on debit card transactions. Other service charges and fees, which include electronic banking and merchant service fees, decreased $164 over the prior year. Noninterest income derived from trust and investment management services decreased by $47 or 2.9% during 2012 compared to 2011 primarily due to lower assets under management.
For the year ended 2012, the Corporation reported an efficiency ratio of 68.71%, compared to 66.69% for 2011. The “lower is better” efficiency ratio indicates the percentage of operating costs that are used to generate each dollar of net revenue - that is during 2012, it cost the Corporation 68.71 cents to generate each $1 of net revenue. Net revenue is defined as net interest income, on a fully-taxable equivalent basis, plus noninterest income.
Noninterest expense was $34,903 in 2012, compared to $34,144 in 2011, an increase of $759 or 2.2%. Salaries and employee benefits were $16,768 for 2012 compared to $15,944 for 2011, an increase of $824 or 5.2%. The increase is primarily the result of the Corporation's investment in seasoned consumer and commercial lenders. Professional fees increased $180, or 9.7%, compared to 2011, primarily as a result of costs associated with the U.S. Department of Treasury's auction of TARP preferred stock to private investors. Marketing and public relations expense increased by $229 to $1,231 in 2012 from $1,002 in 2011. The increase was largely attributable to costs associated with the conversion of the Corporation’s bank operating system for both retail and commercial customers.
Expenses associated with furniture and equipment increased $972 or 31.5%, compared to 2011, mainly as a result of conversion of the Corporation’s bank operating system. Expenses related to the collection of delinquent loans and foreclosed properties decreased in 2012 compared to 2011. Other real estate owned expenses decreased $451 or 44.2% compared to 2011, mainly as a result of fewer property foreclosures in 2012. Loan and collection expense decreased $214 or 15.7%, primarily due to lower non-performing assets and improvements in credit quality. Expense management continues to be a major area of focus for the Corporation.



20



Table 1: Condensed Consolidated Average Balance Sheets
Interest, Rate, and Rate/ Volume differentials are stated on a Fully-Tax Equivalent (FTE) Basis.
Table 1 presents the condensed consolidated average balance sheets for the three years ended December 31, 2012, December 31, 2011 and December 31, 2010.
 
 
Year ended December 31,
 
2012
 
2011
 
2010
 
Average
Balance
 
Interest
 
Rate
 
Average
Balance
 
Interest
 
Rate
 
Average
Balance
 
Interest
 
Rate
 
(Dollars in thousands)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Govt agencies and
corporations
$
194,967

 
$
4,677

 
2.40
%
 
$
204,308

 
$
5,847

 
2.86
%
 
$
221,600

 
$
7,220

 
3.26
%
State and political subdivisions
31,859

 
1,656

 
5.20

 
25,612

 
1,490

 
5.82

 
23,565

 
1,423

 
6.04

Federal funds sold and short-term investments
11,422

 
35

 
0.31

 
21,574

 
57

 
0.26

 
37,027

 
46

 
0.12

Restricted stock
5,741

 
285

 
4.96

 
5,741

 
277

 
4.82

 
5,532

 
269

 
4.86

Commercial loans
481,875

 
23,421

 
4.86

 
454,210

 
23,937

 
5.27

 
442,041

 
23,690

 
5.36

Residential real estate loans
56,412

 
3,007

 
5.33

 
60,804

 
3,380

 
5.56

 
72,327

 
3,940

 
5.45

Home equity lines of credit
108,125

 
4,280

 
3.96

 
109,217

 
4,255

 
3.90

 
109,593

 
4,325

 
3.95

Installment loans
227,086

 
9,198

 
4.05

 
203,946

 
10,650

 
5.22

 
175,934

 
10,963

 
6.23

Total Earning Assets
$
1,117,487

 
$
46,559

 
4.17
%
 
$
1,085,412

 
$
49,893

 
4.60
%
 
$
1,087,619

 
$
51,876

 
4.77
%
Allowance for loan loss
(17,461
)
 
 
 
 
 
(17,317
)
 
 
 
 
 
(18,551
)
 
 
 
 
Cash and due from banks
29,951

 
 
 
 
 
30,263

 
 
 
 
 
17,904

 
 
 
 
Bank owned life insurance
18,180

 
 
 
 
 
17,470

 
 
 
 
 
16,756

 
 
 
 
Other assets
47,846

 
 
 
 
 
51,833

 
 
 
 
 
52,992

 
 
 
 
Total Assets
$
1,196,003

 
 
 
 
 
$
1,167,661

 
 
 
 
 
$
1,156,720

 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer time deposits
$
429,928

 
$
5,050

 
1.17
%
 
$
453,680

 
$
7,365

 
1.62
%
 
$
466,583

 
$
9,386

 
2.01
%
Public time deposits
65,188

 
419

 
0.64

 
68,756

 
305

 
0.44

 
83,818

 
551

 
0.66

Savings deposits
110,936

 
98

 
0.09

 
97,686

 
160

 
0.16

 
87,082

 
157

 
0.18

Money market accounts
105,951

 
201

 
0.19

 
99,948

 
285

 
0.29

 
91,255

 
369

 
0.40

Interest-bearing demand
162,431

 
176

 
0.11

 
149,667

 
252

 
0.17

 
137,543

 
246

 
0.18

Short-term borrowings
942

 
1

 
0.11

 
763

 
2

 
0.20

 
1,734

 
4

 
0.23

FHLB advances
47,828

 
865

 
1.81

 
42,640

 
1,053

 
2.47

 
42,941

 
1,272

 
2.96

Trust preferred securities
16,315

 
699

 
4.28

 
16,321

 
686

 
4.20

 
19,249

 
779

 
4.05

Total Interest-Bearing Liabilities
$
939,519

 
$
7,509

 
0.80
%
 
$
929,461

 
$
10,108

 
1.09
%
 
$
930,205

 
$
12,764

 
1.37
%
Noninterest-bearing deposits
137,077

 
 
 
 
 
121,786

 
 
 
 
 
112,787

 
 
 
 
Other liabilities
3,984

 
 
 
 
 
4,605

 
 
 
 
 
5,919

 
 
 
 
Shareholders’ Equity
115,423

 
 
 
 
 
111,809

 
 
 
 
 
107,809

 
 
 
 
Total Liabilities and Shareholders’ Equity
$
1,196,003

 
 
 
 
 
$
1,167,661

 
 
 
 
 
$
1,156,720

 
 
 
 
Net interest Income (FTE)
 
 
$
39,050

 
3.49
%
 
 
 
$
39,785

 
3.67
%
 
 
 
$
39,112

 
3.60
%
Taxable Equivalent Adjustment
 
 
(611
)
 
(0.05
)
 
 
 
(544
)
 
(0.05
)
 
 
 
(504
)
 
(0.05
)
Net Interest Income Per Financial Statements
 
 
$
38,439

 
 
 
 
 
$
39,241

 
 
 
 
 
$
38,608

 
 
Net Yield on Earning Assets
 
 
 
 
3.44
%
 
 
 
 
 
3.62
%
 
 
 
 
 
3.55
%
Note: Interest income on tax-exempt securities and loans has been adjusted to a fully-taxable equivalent basis. Nonaccrual loans have been included in the average balances




21


Results of Operations (Dollars in thousands except per share data)

2012 versus 2011 Net Interest Income Comparison
Net interest income, the Corporation’s principal source of earnings, is the difference between interest income generated by earning assets (primarily loans and investment securities) and interest paid on interest-bearing funds (namely customer deposits and borrowings). Net interest income is affected by multiple factors including: market interest rates on both earning assets and interest-bearing liabilities; the level of earning assets being funded by interest-bearing liabilities; noninterest-bearing liabilities; the mix of funding between interest bearing liabilities, noninterest-bearing liabilities and equity and the growth in earning assets.
Net interest income for the year ended December 31, 2012 was $38,439 compared to $39,241 for the year ended 2011. Total interest income was $45,948 for 2012 compared to $49,349 for 2011, a decrease of $3,401. Total interest expense decreased $2,599 for the year-ended December 31, 2012, from $10,108 for 2011 to $7,509 for 2012. This resulted in a decrease in net interest income of $802 or 2.0% for 2012.
For purposes of the discussion below, net interest income is presented on a FTE basis, to provide a comparison among all types of interest earning assets. Accordingly, interest on tax-free securities and tax-exempt loans has been restated as if such interest were taxed at the statutory Federal income tax rate of 34% adjusted for the non-deductible portion of interest expense incurred to acquire the tax-free assets. Net interest income presented on a FTE basis is a non-GAAP financial measure widely used by financial services corporations. The FTE adjustment for full year December 31, 2012 was $611 compared with $544 in 2011, which has been included as the Corporation considers it an important metric with which to analyze and evaluate the Corporation’s results of operations.
Table 2 summarizes net interest income and the net interest margin for the three years ended December 31, 2012.
Table 2: Net Interest Income
 
 
Year ended December 31,
 
2012
 
2011
 
2010
 
(Dollars in thousands)
Net interest income
$
38,439

 
$
39,241

 
$
38,608

Tax equivalent adjustments
611

 
544

 
504

Net interest income (FTE)
$
39,050

 
$
39,785

 
$
39,112

Net interest margin
3.44
%
 
3.62
%
 
3.55
%
Tax equivalent adjustments
0.05
%
 
0.05
%
 
0.05
%
Net interest margin (FTE)
3.49
%
 
3.67
%
 
3.60
%
The Corporation’s net interest income on a fully tax equivalent basis was $39,050 in 2012, compared to $39,785 in 2011. This follows an increase of $673, or 1.7%, between 2011 and 2010. The net interest margin (FTE), which is determined by dividing tax equivalent net interest income by average earning assets, was 3.49% in 2012, a decrease of 18 basis points from 2011. This follows an increase of 7 basis points for 2011 compared to 2010.
Interest income on a fully tax equivalent basis totaled $46,559 for 2012 compared to $49,893 in 2011, a decline of $3,334, or 6.7%. The decline in interest income was primarily a result of the continued lower interest rate environment and their impact on increased cash flow and reinvestment opportunities especially in the investment securities and indirect loan portfolios. Both portfolios have relatively short average life's and the lower interest rates have led to increased prepayments and lower reinvestment opportunities. Conversely the shorter average lives should benefit the Corporation in a rising interest rate environment. Overall, average earning assets increased $32,075, or 3.0%, to $1,117,487 in 2012 as compared to $1,085,412 in 2011. Deposits generally have had a shorter average life and have repriced more quickly than loans, as evidenced by the decrease in interest expense which ended 2012 at $7,509 compared to $10,108 in 2011. The cost of funds dropped by 29 basis points from December 31, 2011 to December 31, 2012.

Average loans increased $45,321, or 5.5%, to $873,498 in 2012 as compared to $828,177 in 2011. The increase in average loans was mainly attributable to growth in the installment and commercial loan portfolios which increased $23,140 and $27,665, respectively. Offsetting these increases was a decline in the real estate mortgage portfolio of $4,392. Average home equity loans decreased $1,092 or 1.0% from 2011. Investment securities, both taxable and tax-free, decreased $3,094, to


22


$226,826 in 2012 compared to $229,920 in 2011. Federal funds sold and other short-term investments decreased $10,152 over the same period.
Average interest-bearing deposits increased by $4,697, or 0.5%, and average noninterest-bearing deposits increased $15,291, or 12.6%, during 2012, resulting in an increase in total average deposits of $19,988, or 2.0%, compared to 2011. The increase in average interest-bearing deposits was mainly a result of an increase in average interest-bearing demand accounts of $12,764, or 8.5%, as well as increases of $6,003 and $13,250, or 6.0% and 13.6%, in average money market accounts and savings accounts, respectively. These increases were offset by decreases in public and consumer time deposit accounts of $3,568 and $23,752, respectively. The Corporation uses FHLB advances as an alternative wholesale funding source. The use of FHLB advances as an alternative funding source remained relatively constant during 2012 in comparison to 2011. The Corporation may also use from time to time brokered time deposits as they are a comparably priced substitute for FHLB advances. Brokered deposits require no collateralization compared to FHLB advances which require collateral in the form of real estate mortgage loans and securities. At the end of 2012 and 2011, there were no outstanding brokered time deposits.
Net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. Table 3 presents an analysis of increases and decreases in interest income and expense due to changes in volume (changes in the balance sheet) and rate (changes in interest rates) during the two years ended December 31, 2012. Changes that are not due solely to either a change in volume or a change in rate have been allocated proportionally to both changes due to volume and rate. The table is presented on a tax-equivalent basis.
Table 3: Rate/Volume Analysis of Net Interest Income (FTE)
 
 
Year Ended December 31,
 
Increase (Decrease) in Interest
Income/Expense in 2012 over 2011
 
Increase (Decrease) in Interest
Income/Expense in 2011 over 2010
 
Volume
 
Rate
 
Total
 
Volume
 
Rate
 
Total
 
(Dollars in thousands)
U.S. Govt agencies and corporations
$
(224
)
 
$
(946
)
 
$
(1,170
)
 
$
(495
)
 
$
(878
)
 
$
(1,373
)
State and political subdivisions
325

 
(159
)
 
166

 
119

 
(52
)
 
67

Federal funds sold and short-term investments
(31
)
 
9

 
(22
)
 
(40
)
 
51

 
11

Restricted stock

 
8

 
8

 
10

 
(2
)
 
8

Commercial loans
1,345

 
(1,861
)
 
(516
)
 
641

 
(394
)
 
247

Residential real estate loans
(234
)
 
(139
)
 
(373
)
 
(641
)
 
81

 
(560
)
Home equity lines of credit
(43
)
 
68

 
25

 
(15
)
 
(55
)
 
(70
)
Installment loans
937

 
(2,389
)
 
(1,452
)
 
1,463

 
(1,776
)
 
(313
)
Total Interest Income
2,075

 
(5,409
)
 
(3,334
)
 
1,042

 
(3,025
)
 
(1,983
)
Consumer time deposits
(279
)
 
(2,035
)
 
(2,314
)
 
(209
)
 
(1,812
)
 
(2,021
)
Public time deposits
(23
)
 
137

 
114

 
(67
)
 
(179
)
 
(246
)
Savings deposits
12

 
(74
)
 
(62
)
 
17

 
(14
)
 
3

Money market accounts
11

 
(95
)
 
(84
)
 
25

 
(109
)
 
(84
)
Interest-bearing demand
14

 
(91
)
 
(77
)
 
20

 
(14
)
 
6

Short-term borrowings

 
(1
)
 
(1
)
 
(1
)
 
(1
)
 
(2
)
FHLB advances
94

 
(283
)
 
(189
)
 
(7
)
 
(212
)
 
(219
)
Trust preferred securities

 
13

 
13

 
(123
)
 
30

 
(93
)
Total Interest Expense
(171
)
 
(2,429
)
 
(2,600
)
 
(345
)
 
(2,311
)
 
(2,656
)
Net Interest Income (FTE)
$
2,246

 
$
(2,980
)
 
$
(734
)
 
$
1,387

 
$
(714
)
 
$
673


Total interest income on a fully tax equivalent basis was $46,559 in 2012 as compared to $49,893 in 2011, a decrease of $3,334, or 6.7%. The decrease was attributable to an increase in volume of $2,075 and a decrease of $5,409 attributable to rate, when comparing 2012 to 2011. Of the $2,075 increase due to volume, loans accounted for $2,005 with both installment and commercial increasing $937 and $1,345, respectively. Given the continued lower interest rate environment and the competitive nature of indirect lending, installment loans accounted for $2,389 of the decrease in interest income due to rate. Commercial loans by their structure are also sensitive to interest rates, accounting for $1,861 of the decline in interest income due to rate.


23


Total interest expense was $7,509 in 2012 compared to $10,108 in 2011. This is a decrease of $2,599, or 25.7%. Interest expense decreased $171 attributable to volume and $2,429 as a result of a decline in rates.
Although difficult to isolate, changing customer preferences and competition impact the rate and volume factors. Due to the current lower interest rate environment, loans and investments continue to reprice at lower interest rates resulting in a decrease in net interest income due to rate of $2,980. The effect of changes in both rate and volume was a decrease of $734 in net interest income on a fully tax equivalent basis during 2012.
2011 versus 2010 Net Interest Income Comparison
Net interest income for the year ended December 31, 2011 was $39,241 compared to $38,608 for the year ended December 31, 2010. Total interest income was $49,349 for 2011 compared to $51,372 for 2010, a decrease of $2,023. Total interest expense decreased $2,656 for the year-ended December 31, 2011, from $12,764 for 2010 to $10,108 for 2011. This resulted in an increase in net interest income of $633 for 2011.
Net interest income is presented on a FTE basis, to provide a comparison among all types of interest earning assets. Accordingly, interest on tax-free securities and tax-exempt loans has been restated as if such interest were taxed at the statutory Federal income tax rate of 34% adjusted for the non-deductible portion of interest expense incurred to acquire the tax-free assets. Net interest income presented on a FTE basis is a non-GAAP financial measure widely used by financial services corporations. The FTE adjustment for full year 2011 was $544 compared with $504 in 2010, which has been included as the Corporation considers it an important metric with which to analyze and evaluate the Corporation’s results of operations.
Total interest income on a fully tax equivalent basis was $49,893 in 2011 as compared to $51,876 in 2010, a decrease of $1,983, or 3.8%. The decrease was attributable to an increase in volume of $1,042 and a decrease of $3,025 attributable to rate, when comparing 2011 to 2010. Of the $1,042 increase due to volume, loans accounted for $1,448 with both installment and commercial increasing $1,463 and $641, respectively. Given the continued lower interest rate environment and the competitive nature of indirect lending, installment loans accounted for $1,776 of the decrease in interest income due to rate. Commercial loans by their structure are also sensitive to interest rates, accounting for $394 of the decline in interest income due to rate. Total interest expense was $10,108 in 2011 compared to $12,764 in 2010. This is a decrease of $2,656, or 20.8%. Interest expense decreased $345 attributable to volume and $2,311 as a result of a decline in rates.
Increased loan demand during 2011 was primarily responsible for the increase in net interest income from volume of $1,387. Due to the current lower interest rate environment, loans and investments continue to reprice at lower interest rates resulting in a decrease in net interest income due to rate of $714. The effect of changes in both rate and volume was an increase of $673 in net interest income during 2011.




24


Noninterest Income
Table 4: Details of Noninterest Income
 
 
Year ended December 31,
 
2012
 
2011
 
2010
 
2012 versus
2011
 
2011 versus
2010
 
(Dollars in thousands)
Investment and trust services
$
1,563

 
$
1,610

 
$
1,797

 
(2.9
)%
 
(10.4
)%
Deposit service charges
3,811

 
4,079

 
4,247

 
(6.6
)%
 
(4.0
)%
Other service charges and fees
3,082

 
3,246

 
3,208

 
(5.1
)%
 
1.2
 %
Income from bank owned life insurance
742

 
722

 
709

 
2.8
 %
 
1.8
 %
Other income
877

 
330

 
329

 
165.8
 %
 
0.3
 %
Total fees and other income
10,075

 
9,987

 
10,290

 
0.9
 %
 
(2.9
)%
Securities gains, net
189

 
832

 
393

 
(77.3
)%
 
111.7
 %
Gain on sale of loans
1,575

 
889

 
1,000

 
77.2
 %
 
(11.1
)%
Loss on sale of other assets, net
(92
)
 
(293
)
 
(116
)
 
(68.6
)%
 
152.6
 %
Gain on extinguishment of debt

 

 
2,210

 
 %
 
100.0
 %
Total noninterest income
$
11,747

 
$
11,415

 
$
13,777

 
2.9
 %
 
(17.1
)%
2012 versus 2011 Noninterest Income Comparison
Generation of noninterest income is important to the long-term success of the Corporation. Total noninterest income was $11,747 in 2012 compared to $11,415 in 2011. This was an increase of $332, or 2.9%.
Total fees and other income, which consists of noninterest income before gains and losses, was $10,075 in 2012 as compared to $9,987 in 2011. This was an increase of $88, or 0.9%. Deposit service charges, which include overdraft, stop payment and return item fees, amounted to $3,811 for 2012 as compared to $4,079 for 2011 and were negatively impacted by federal legislation limiting overdraft fees on debit card transactions. Other service charges and fees include debit, ATM and merchant services, which were $3,082 during 2012, a decrease of $164, or 5.1%, compared to 2011. Also included in other service charges and fees are servicing fees from sold loans. The Corporation retains the servicing rights for both sold mortgage loans and indirect auto loans. Net servicing fee income for 2012 was $272 compared to $298 for 2011.
Other income increased $547 to $877 in 2012 as compared to $330 in 2011. The increase is attributed to fees collected as part of the Corporation's decision to switch providers of its retail debit cards and from an increase in the fair value of interest rate lock commitments resulting from the strategy to grow its mortgage banking activities in 2012 and going forward.
The Corporation originates residential mortgage loans and indirect auto loans in the normal course of business. In managing its interest rate risk, fixed rate and adjustable rate mortgage loans are sold into the secondary market with the Corporation retaining servicing. The gains on the sale of mortgages for 2012 were $1,287 compared to $598 for 2011. This increase is due primarily to mortgage rates remaining near record lows, leading to a continuation of strong refinance activity and an increase in local home buying. In the third quarter of 2012, the Corporation announced the opening of a Mortgage Banking Center in Solon, Ohio, as well as adding a sales team responsible for growing the mortgage business in Eastern Cuyahoga County.
The Corporation originates indirect auto loans for a niche market of high quality borrowers. A portion of these loans is booked to the Corporation’s portfolio and the remainder is sold to a number of other financial institutions with servicing retained by the Corporation. The gain on the sale of indirect auto loans was $288 for 2012, compared to $291 for 2011.
Due to the record low market interest rates, securities purchased at a premium were subject to faster prepayment rates, which reduced the yield on investments. To mitigate further margin pressure, the Corporation sold $25,462 of its available-for-sale securities prior to call or maturity in order to reinvest the proceeds in other securities before any further interest rate cuts reduced the yield on securities available for purchase. Gains on the sale of available-for-sale securities were $189 in 2012 compared to $832 in 2011.


25


2011 versus 2010 Noninterest Income Comparison
Total noninterest income was $11,415 in 2011 compared to $13,777 in 2010. This was a decrease of $2,362, or 17.1%. Noninterest income was favorably impacted in 2010 by a $2,210 gain from the extinguishment of debt related to the Corporation’s issuance of common shares in exchange for trust preferred securities.
Total fees and other income, which consists of noninterest income before gains and losses, was $9,987 in 2011 as compared to $10,290 in 2010. This was a decrease of $303, or 2.9%. Deposit service charges, which include overdraft, stop payment and return item fees, amounted to $4,079 for 2011 and were negatively impacted by lower number of transactions and federal legislation limiting overdraft fees on debit card transactions. Other service charges and fees include debit, ATM and merchant services, which were $3,246 during 2011, an increase of $38, or 1.2%, compared to 2010. Also included in other service charges and fees are servicing fees from sold loans. The Corporation retains the servicing rights for both sold mortgage loans and indirect auto loans. Net servicing fee income for 2011 was $298 compared to $331 for 2010.
Noninterest income from investment and trust services decreased $187 in 2011 due to management’s decision to exit the brokerage line of business in mid-2010 as well as the negative impact of lower market valuations on management fees. Brokerage fee income was $163 in 2010. Trust and investment management fees decreased $125, or 7.2%, during 2011 in comparison to 2010.
During 2011, income from bank owned life insurance increased $13, or 1.8%, in comparison to 2010. Other income was $330 in 2011 as compared to $329 in 2010. Other income consists of miscellaneous fees such as safe deposit box rentals and fees and other miscellaneous income.
Given the low interest rate environment, mortgage loan activity remained relatively constant during most of 2011 with a slight increase in activity during the latter part of the year as customers took advantage of government sponsored programs to refinance their existing mortgages. The gains on the sale of mortgages for 2011 were $598 compared to $705 for 2010. The gain on the sale of indirect auto loans was $291 for 2011, compared to $295 for 2010.
During 2011, available-for-sale securities which were due to be called or mature during the year were assessed and, in some cases, sold and replaced with purchases of primarily mortgage-backed securities and some agency securities. Because of the lower interest rate environment, the interest rates available on mortgage-backed securities made these securities more attractive to holders than agency securities. Prior to the decline in interest rates, agency securities had been producing a similar yield to mortgage-backed securities, but without the prepayment option and the longer term to maturity. The Corporation sold $35,469 of its available-for-sale securities prior to call or maturity in order to reinvest the proceeds in other securities before any further interest rate cuts reduced the yield on securities available for purchase. Gains on the sale of available-for-sale securities were $832 during 2011.


26


Noninterest Expense
Table 5: Details on Noninterest Expense
 
 
Year ended December 31,
 
2012
 
2011
 
2010
 
2012 versus
2011
 
2011 versus
2010
 
(Dollars in thousands)
Salaries and employee benefits
$
16,768

 
$
15,944

 
$
15,854

 
5.2
 %
 
0.6
 %
Furniture and equipment
4,060

 
3,088

 
3,550

 
31.5
 %
 
(13.0
)%
Net occupancy
2,207

 
2,310

 
2,355

 
(4.5
)%
 
(1.9
)%
Professional fees
2,034

 
1,854

 
2,182

 
9.7
 %
 
(15.0
)%
Marketing and public relations
1,231

 
1,002

 
1,065

 
22.9
 %
 
(5.9
)%
Supplies, postage and freight
1,091

 
1,107

 
1,225

 
(1.4
)%
 
(9.6
)%
Telecommunications
731

 
727

 
802

 
0.6
 %
 
(9.4
)%
Ohio franchise tax
1,232

 
1,298

 
1,113

 
(5.1
)%
 
16.6
 %
FDIC assessments
1,304

 
1,749

 
2,241

 
(25.4
)%
 
(22.0
)%
Other real estate owned
570

 
1,021

 
597

 
(44.2
)%
 
71.0
 %
Electronic banking expenses
722

 
899

 
873

 
(19.7
)%
 
3.0
 %
Other charge-offs and losses
220

 
220

 
274

 
 %
 
(19.7
)%
Loan and collection expense
1,150

 
1,364

 
1,715

 
(15.7
)%
 
(20.5
)%
Other expense
1,583

 
1,561

 
1,723

 
1.4
 %
 
(9.4
)%
Total noninterest expense
$
34,903

 
$
34,144

 
$
35,569

 
2.2
 %
 
(4.0
)%
2012 versus 2011 Noninterest Expense Comparison
Noninterest expense was $34,903 in 2012, compared to $34,144 in 2011, an increase of $759 or 2.2%. Expense management continues to be a major area of focus for the Corporation. Salaries and employee benefit costs represent the Corporation's largest noninterest expense, accounting for 48.0% of total noninterest expense, which is inherent in a service based industry such as financial services. Salaries and employee benefits increased $824 or 5.2%. The increase in salaries and employee benefits is part of the Corporation's strategy to increase revenues by expanding its market presence within northeast Ohio through the addition of experienced commercial and mortgage lenders and underwriters to support such growth. Professional fees increased $180, or 9.7%, compared to 2011, primarily as a result of legal expenses related to the U.S Treasury's auction of TARP preferred shares to private investors and costs associated with the conversion of the Corporation’s bank operating system.
While actions taken by the FDIC have increased FDIC assessment costs in prior years, new regulations which are required by the Dodd-Frank Act and which became effective in 2011 reduced the Corporation's FDIC insurance cost. FDIC assessments cost decreased $445 or 25.4%. Overall expenses related to the collection of delinquent loans and foreclosed properties decreased in 2012 compared to 2011. Other real estate owned expenses decreased $451 or 44.2% for 2012, mainly as a result of the lower number of properties transferred from the loan portfolio as a result of foreclosures. Loan and collection expense also decreased $214 or 15.7% in 2012, primarily due lower problem assets under management in addition to overall improvements in credit quality.


27


2011 versus 2010 Noninterest Expense Comparison
Noninterest expense was $34,144 in 2011, compared to $35,569 in 2010, a decrease of $1,425 or 4.0%. Salaries and employee benefits remained relatively constant for 2011 compared to 2010, increasing $90 or 0.6%. Professional fees declined $328, or 15.0%, compared to 2010, primarily as a result of reduced litigation costs as well as efficiencies realized from the Corporation’s establishment of an internal legal function. FDIC assessments also declined relative to 2010 due to the new risk-based assessment system adopted by the FDIC during the second quarter of 2011. Expenses associated with furniture and equipment decreased $462, or 13.0%, compared to 2010, mainly as a result of the consolidation of data servicing centers in early 2010 as well as management’s decision to purchase previously leased equipment in an effort to reduce expenses. Expenses related to the collection of delinquent loans and foreclosed properties increased in 2011 compared to 2010. Other real estate owned expenses increased $424 compared to 2010, mainly as a result of the higher number of properties transferred from the loan portfolio as a result of foreclosures throughout 2011. This was offset by a decrease of $351 in loan and collection expense.
Income Taxes
2012 versus 2011 Income taxes
The Corporation recognized tax expense of $1,934 during 2012 compared to $1,156 for 2011. The Corporation’s effective tax rate was 24.1% for 2012. Included in net income for 2012 was $1,989 of nontaxable income, including $617 related to life insurance policies and $1,372 of tax-exempt investment and loan interest income. The tax-exempt income, together with the Corporation’s relatively small amount of nondeductible expenses, led to income subject to tax that was significantly less than the Corporation’s income before income tax expense. The new market tax credit generated by North Coast Community Development Corporation (NCCDC), a wholly-owned subsidiary of the Bank, also had a significant impact on income tax expense and contributes to a lower effective tax rate for the Corporation. NCCDC’s new market tax credit award was granted on December 29, 2003 and will remain in effect through 2020. Over the remaining eight years of the award, it is expected that projects will be financed through NCCDC with the intent of improving the overall economic conditions in Lorain County and generating additional interest income through the funding of qualified loans for these projects and tax credits for the Corporation. The Corporation had total qualified investments in NCCDC of $9,000 at December 31, 2012 and December 31, 2011, generating a tax credit of $208 and $270, respectively.
2011 versus 2010 Income taxes
The Corporation recognized tax expense of $1,156 during 2011 compared to $1,226 for 2010. The Corporation’s effective tax rate was 18.8% for 2011. Included in net income for 2011 was $1,786 of nontaxable income, including $597 related to life insurance policies and $1,189 of tax-exempt investment and loan interest income. The Corporation had total qualified investments in NCCDC of $9,000 at December 31, 2011 and December 31, 2010, generating a tax credit of $270 and $536, respectively.

Financial Condition
Overview
The Corporation’s total assets at December 31, 2012 were $1,178,254 compared to $1,168,422 at December 31, 2011. This was an increase of $9,832, or 0.8%. Total securities decreased $22,249, or 9.8%, over December 31, 2011. Portfolio loans increased by $39,460, or 4.7%, from December 31, 2011. Total deposits at December 31, 2012 were $999,592 compared to $991,080 at December 31, 2011. Total interest-bearing liabilities were $1,063,453 at December 31, 2012 compared to $1,050,042 at December 31, 2011.
Securities
The distribution of the Corporation’s securities portfolio at December 31, 2012 and December 31, 2011 is presented in Note 5 to the Consolidated Financial Statements contained within this Form 10-K. The Corporation continues to employ the securities portfolio to manage the Corporation’s interest rate risk and liquidity needs. Currently, the entire portfolio consists of available for sale securities which are comprised of 18.2% U.S. Government agencies, 54.8% U.S. agency mortgage backed securities, 11.2% U.S. collateralized mortgage obligations and 15.8% municipal securities. This compares to 25.1% U.S. Government agencies, 47.4% U.S. agency mortgaged backed securities, 13.4% U.S. collateralized mortgage obligations and 14.1% municipal securities as of December 31, 2011.

As with any investment, the yield on an available for sale security depends on the purchase price in relation to the interest rate and the length of time the investor's principal remains outstanding. Mortgage-backed security yields are often quoted in


28


relation to yields on treasury securities with maturities closest to the mortgage security's estimated average life. The estimated yield on a mortgage security reflects its estimated average life based on the assumed prepayment rates for the underlying mortgage loans. If actual prepayment rates are faster or slower than anticipated, the investor holding the mortgage security until maturity may realize a different yield. Due to the sustained low interest rate environment and the flattening of the yield curve, the Corporation repositioned its investment portfolio. In the fourth quarter of 2012, the Corporation sold approximately $18,000 mortgage backed securities with elevated prepayment risk for a $143 gain and re-invested the proceeds in higher earning investment securities.
At December 31, 2012, the available for sale securities portfolio had unrealized gains of $5,330 and unrealized losses of $338. The unrealized losses represent 0.2% of the total amortized cost of the Corporation’s available for sale securities. At December 31, 2012, the Corporation held no available for sale securities with an unrealized loss position for greater than twelve months. Available for sale securities with an unrealized loss position for less than twelve months totaled $338 at December 31, 2012. The unrealized gains and losses at December 31, 2011 were $6,426 and $337, respectively. See Note 5 to the Consolidated Financial Statements for further detail.
Tables 6 and 7 present the maturity distribution of securities and the weighted average yield for each maturity range for the year ended December 31, 2012.
Table 6: Maturity Distribution of Available for Sale Securities at Amortized Cost
 
 
From 1 to 5
Years
 
From 5 to 10
Years
 
After
10 Years
 
At December 31,
 
2012
 
2011
 
2010
 
(Dollars in thousands)
Securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agencies and corporations
$
36,868

 
$

 
$

 
$
36,868

 
$
56,762

 
$
56,239

Mortgage backed securities
82,428

 
19,365

 
7,647

 
109,440

 
103,624

 
91,793

Collateralized mortgage obligations
19,539

 
2,670

 
274

 
22,483

 
29,537

 
44,297

State and political subdivisions
12,017

 
11,349

 
6,614

 
29,980

 
30,000

 
24,125

Total securities available for sale
$
150,852

 
$
33,384

 
$
14,535

 
$
198,771

 
$
219,923

 
$
216,454

Although the above table indicates a portion of the Corporation’s investment portfolio maturing after ten years, the actual average life and duration of the investment portfolio is effectively much shorter due to imbedded call features of several U.S. government agencies as well as monthly cash flows received from U.S. mortgage-backed securities and U.S. collateralized mortgage obligations.

Table 7: The Weighted Average Yield for Each Range of Maturities of Securities
 
 
From 1 to 5
Years    
 
From 5 to 10
Years    
 
After
  10 Years  
 
At December 31,
 
2012
 
2011
 
2010
Securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agencies and corporations
1.30
%
 
%
 
%
 
1.30
%
 
2.07
%
 
1.84
%
Mortgage backed securities
2.82

 
2.61

 
2.36

 
2.75

 
3.76

 
4.27

Collateralized mortgage obligations
2.76

 
2.52

 
2.69

 
2.73

 
4.21

 
4.12

State and political subdivisions (1)
3.59

 
4.20

 
3.80

 
3.87

 
6.04

 
6.43

Total securities available for sale
2.49
%
 
3.18
%
 
3.05
%
 
2.65
%
 
3.69
%
 
3.85
%
____________________________
(1)
Yields on tax-exempt obligations are computed on a tax equivalent basis based upon a 34% statutory Federal income tax rate.


29


Loans
The detail of loan balances are presented in Note 7 to the Consolidated Financial Statements contained within this Form 10-K.
Total portfolio loans at December 31, 2012 were $882,548. This was an increase of $39,460, or 4.7 %, over December 31, 2011. The increase is the primarily result of the Corporation adding several new commercial bankers. The Corporation believes that its loan portfolio was well-diversified at December 31, 2012. Commercial and commercial real estate loans represented 54.7%, indirect loans represented 22.6%, home equity loans comprised of 13.9%, residential real estate mortgage loans represented 7.4% and consumer loans comprised of 1.4% of total portfolio loans.
Loan balances and loan mix are presented by type for the five years ended December 31, 2012 in Table 8 below.
Table 8: Loan Portfolio Distribution
 
 
At December 31,
 
2012
 
2011
 
2010
 
2009
 
2008
 
(Dollars in thousands)
Commercial real estate
$
414,005

 
$
381,852

 
$
375,803

 
$
369,539

 
$
371,191

Commercial
68,705

 
76,570

 
65,662

 
67,772

 
64,328

Residential real estate
64,983

 
64,524

 
74,685

 
96,298

 
115,893

Home equity loans
122,830

 
126,958

 
132,536

 
134,489

 
128,075

Indirect
199,924

 
180,089

 
150,031

 
120,101

 
109,892

Consumer
12,101

 
13,095

 
13,862

 
14,998

 
14,172

Total Loans
882,548

 
843,088

 
812,579

 
803,197

 
803,551

Allowance for loan losses
(17,637
)
 
(17,063
)
 
(16,136
)
 
(18,792
)
 
(11,652
)
Net Loans
$
864,911

 
$
826,025