Loans

Major classifications of loans at March 31, 2014 and December 31, 2013 are as follows (in thousands):



	March 31, 2014						December 31, 2013
	Acquired Credit Impaired		Other		Total		Acquired Credit Impaired	Other		Total
Commercial and industrial	$	1,803	38,329		40,132		332	29,005		29,337
Commercial, secured by real estate	11,723		364,387		376,110		4,363	309,889		314,252
Residential real estate	6,116		232,122		238,238		1,332	214,255		215,587
Consumer	218		20,779		20,997		—	12,643		12,643
Agricultural	243		7,639		7,882		—	2,472		2,472
Other loans, including deposit overdrafts	—		1,922		1,922		—	91		91
	20,103		665,178		685,281		6,027	568,355		574,382
Deferred net origination costs (fees)	—		(85	)	(85	)	—	(28	)	(28	)
	20,103		665,093		685,196		6,027	568,327		574,354
Less allowance for loan losses	—		3,370		3,370		—	3,588		3,588
Loans, net	$	20,103	661,723		681,826		6,027	564,739		570,766

Loans acquired from the mergers with First Capital and ENB are recorded at fair value with no carryover of the acquired entity's previously established allowance for loan losses. The excess of expected cash flows over the estimated fair value of acquired loans is recognized as interest income over the remaining contractual lives of the loans using the level yield method.

Subsequent decreases in expected cash flows will require additions to the allowance for loan losses. Subsequent improvements in expected cash flows result in the recognition of additional interest income over the then-remaining contractual lives of the loans.

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

The following table provides certain information at the acquisition date on loans acquired from ENB, not including loans considered to be impaired (in thousands):



Contractually required principal at acquisition	$	102,731
Less fair value adjustment	1,347
Fair value of acquired loans	$	101,384

Contractual cash flows not expected to be collected	$	1,702

The following table provides details on acquired credit impaired loans obtained through the merger with ENB that are accounted for in accordance with FASB ASC 310-30 (in thousands):



Contractually required principal at acquisition	$	23,233
Contractual cash flows not expected to be collected (nonaccretable difference)	(5,930		)
Expected cash flows at acquisition	17,303
Interest component of expected cash flows (accretable discount)	(2,153		)
Fair value of acquired impaired loans	$	15,150

The following table provides the outstanding balance and related carrying amount for acquired credit impaired loans at the dates indicated (in thousands):

Activity during 2014 for the accretable discount related to acquired credit impaired loans is as follows (in thousands):



Accretable discount at December 31, 2013	$	1,107
Accretable discount acquired during period	2,153
Less transferred to other real estate owned	(61		)
Less accretion	(47		)
Accretable discount at March 31, 2014	$	3,152

Non-accrual, past-due, and accruing restructured loans as of March 31, 2014 and December 31, 2013 are as follows (in thousands):



	March 31, 2014					December 31, 2013
	Acquired Credit Impaired		Other	Total		Acquired Credit Impaired	Other	Total
Non-accrual loans:
Commercial and industrial	$	318	—	318		—	144	144
Commercial, secured by real estate	1,483		2,200	3,683		370	1,048	1,418
Residential real estate	227		1,146	1,373		143	1,256	1,399
Total non-accrual loans	2,028		3,346	5,374		513	2,448	2,961
Past-due 90 days or more and still accruing	—		825	825		—	250	250
Total non-accrual and past-due 90 days or more and still accruing	2,028		4,171	6,199		513	2,698	3,211
Accruing restructured loans	680		13,559	14,239		670	14,481	15,151
Total	$	2,708	17,730	20,438		1,183	17,179	18,362
Percentage of total non-accrual loans and loans past-due 90 days or more and still accruing to total loans				0.90	%			0.56	%
Percentage of total non-accrual loans, loans past-due 90 days or more and still accruing, and accruing restructured loans to total loans				2.98	%			3.20	%

Loans sold to and serviced for the Federal Home Loan Mortgage Corporation and other investors are not included in the accompanying consolidated balance sheets. The unpaid principal balances of those loans at March 31, 2014 and December 31, 2013 are $133,504,000 and $90,343,000, respectively. Loans sold during the three months ended March 31, 2014 and 2013 totaled $610,000 and $7,175,000, respectively.

The allowance for loan losses and recorded investment in loans for the three months ended March 31, 2014 and 2013 are as follows (in thousands):



	Commercial & Industrial			Commercial, Secured by Real Estate		Residential Real Estate		Consumer		Agricultural	Other		Total
March 31, 2014
Allowance for loan losses:
Balance, beginning of year	$	175		2,520		826		66		—	1		3,588
Provision charged to expenses	(109		)	213		(25	)	(3	)	—	5		81
Losses charged off:
Other loans	—			(203	)	(119	)	(23	)	—	(18	)	(363	)
Recoveries	6			—		21		24		—	13		64
Balance, end of period	$	72		2,530		703		64		—	1		3,370

Individually evaluated for impairment	$	—		648		167		—		—	—		815
Collectively evaluated for impairment	72			1,882		536		64		—	1		2,555
Acquired credit impaired loans	—			—		—		—		—	—		—
Balance, end of period	$	72		2,530		703		64		—	1		3,370

Loans:
Individually evaluated for impairment	$	164		14,448		1,977		17		—	—		16,606
Collectively evaluated for impairment	38,123			349,549		230,410		20,844		7,639	1,922		648,487
Acquired credit impaired loans	1,803			11,723		6,116		218		243	—		20,103
Balance, end of period	$	40,090		375,720		238,503		21,079		7,882	1,922		685,196

March 31, 2013
Allowance for loan losses:
Balance, beginning of year	$	320		2,296		712		108		—	1		3,437
Provision charged to expenses	20			87		14		22		—	6		149
Losses charged off	(83		)	(30	)	(27	)	(63	)	—	(16	)	(219	)
Recoveries	—			—		5		23		—	9		37
Balance, end of period	$	257		2,353		704		90		—	—		3,404

Individually evaluated for impairment	$	71		657		157		—		—	—		885
Collectively evaluated for impairment	186			1,696		547		90		—	—		2,519
Balance, end of period	$	257		2,353		704		90		—	—		3,404

Loans:
Individually evaluated for impairment	$	181		14,006		1,294		7		—	—		15,488
Collectively evaluated for impairment	35,234			268,838		213,190		13,966		1,805	1,146		534,179
Balance, end of period	$	35,415		282,844		214,484		13,973		1,805	1,146		549,667

Commercial and Industrial Loans. LCNB’s commercial and industrial loan portfolio consists of loans for various purposes, including loans to fund working capital requirements (such as inventory and receivables financing) and purchases of machinery and equipment. LCNB offers a variety of commercial and industrial loan arrangements, including term loans, balloon loans, and line of credit. Most commercial and industrial loans have a variable rate, with adjustments occurring monthly, annually, every three years, or every five years. Adjustments are generally based on a publicly available index rate plus a margin. The margin varies based on the terms and collateral securing the loan. Commercial and industrial loans are offered to businesses and professionals for short and medium terms on both a collateralized and uncollateralized basis. Commercial and industrial loans typically are underwritten on the basis of the borrower’s ability to make repayment from the cash flow of the business. Collateral, when obtained, may include liens on furniture, fixtures, equipment, inventory, receivables, or other assets. As a result, such loans involve complexities, variables, and risks that require thorough underwriting and more robust servicing than other types of loans.

Commercial, Secured by Real Estate Loans. Commercial real estate loans include loans secured by a variety of commercial, retail, and office buildings, religious facilities, multifamily (more than two-family) residential properties, construction and land development loans, and other land loans. Commercial real estate loan products generally amortize over five to twenty-five years and are payable in monthly principal and interest installments. Some have balloon payments due within one to ten years after the origination date. Many have adjustable interest rates with adjustment periods ranging from one to ten years, some of which are subject to established “floor” interest rates.

Commercial real estate loans are underwritten based on the ability of the property, in the case of income producing property, or the borrower’s business to generate sufficient cash flow to amortize the debt. Secondary emphasis is placed upon global debt service, collateral value, financial strength of any guarantors, and other factors. Commercial real estate loans are generally originated with a 75 percent maximum loan to appraised value ratio.

Residential Real Estate Loans. Residential real estate loans include loans secured by first or second mortgage liens on one-to-two family residential property. Home equity lines of credit and mortgage loans secured by owner-occupied agricultural property are included in this category. First and second mortgage loans are generally amortized over five to thirty years with monthly principal and interest payments. Home equity lines of credit generally have a five year draw period with interest only payments followed by a repayment period with monthly payments based on the amount outstanding. LCNB offers both fixed and adjustable rate mortgage loans. Adjustable rate loans are available with adjustment periods ranging between one to ten years and adjust according to an established index plus a margin, subject to certain floor and ceiling rates. Home equity lines of credit have a variable rate based on the Wall Street Journal prime rate plus a margin.

LCNB does not originate reverse mortgage loans or residential real estate loans generally considered to be “subprime.”

Residential real estate loans are underwritten primarily based on the borrower’s ability to repay, prior credit history, and the value of the collateral. LCNB requires private mortgage insurance for first mortgage loans that have a loan to appraised value ratio of greater than 80%.

Consumer Loans. LCNB’s portfolio of consumer loans generally includes secured and unsecured loans to individuals for household, family and other personal expenditures. Secured loans include loans to fund the purchase of automobiles, recreational vehicles, boats, and similar acquisitions. Consumer loans made by LCNB generally have fixed rates and terms ranging up to 72 months, depending upon the nature of the collateral, size of the loan, and other relevant factors.

Consumer loans generally have higher interest rates, but pose additional risks of collectability and loss when compared to certain other types of loans. Collateral, if present, is generally subject to damage, wear, and depreciation. The borrower’s ability to repay is of primary importance in the underwriting of consumer loans.

Agricultural Loans. LCNB’s portfolio of agricultural loans includes loans for financing agricultural production or for financing the purchase of equipment used in the production of agricultural products. LCNB’s agricultural loans are generally secured by farm machinery, livestock, crops, vehicles, or other agri-related collateral.

LCNB uses a risk-rating system to quantify loan quality. A loan is assigned to a risk category based on relevant information about the ability of the borrower to service the debt including, but not limited to, current financial information, historical payment experience, credit documentation, public information, and current economic trends. The categories used are:


•	Pass – loans categorized in this category are higher quality loans that do not fit any of the other categories described below.


•	Other Assets Especially Mentioned (OAEM) - loans in this category are currently protected but are potentially weak. These loans constitute a risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitute an undue risk in light of the circumstances surrounding a specific asset.


•	Substandard – loans in this category are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the possibility that LCNB will sustain some loss if the deficiencies are not corrected.


•	Doubtful – loans classified in this category have all the weaknesses inherent in loans classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

A breakdown of the loan portfolio by credit quality indicators at March 31, 2014 and December 31, 2013 is as follows (in thousands):



	Pass		OAEM	Substandard	Doubtful	Total
March 31, 2014
Acquired credit impaired:
Commercial & industrial	$	—	—	1,803	—	1,803
Commercial, secured by real estate	—		756	10,967	—	11,723
Residential real estate	—		—	6,116	—	6,116
Consumer	—		—	218	—	218
Agricultural	—		—	243	—	243
Total	$	—	756	19,347	—	20,103

Other:
Commercial & industrial	$	36,984	30	1,273	—	38,287
Commercial, secured by real estate	349,285		3,217	11,495	—	363,997
Residential real estate	227,881		336	4,170	—	232,387
Consumer	20,798		—	63	—	20,861
Agricultural	7,450		—	189	—	7,639
Other	1,922		—	—	—	1,922
Total	$	644,320	3,583	17,190	—	665,093

Total:
Commercial & industrial	$	36,984	30	3,076	—	40,090
Commercial, secured by real estate	349,285		3,973	22,462	—	375,720
Residential real estate	227,881		336	10,286	—	238,503
Consumer	20,798		—	281	—	21,079
Agricultural	7,450		—	432	—	7,882
Other	1,922		—	—	—	1,922
Total	$	644,320	4,339	36,537	—	685,196

December 31, 2013
Acquired credit impaired:
Commercial & industrial	$	—	—	332	—	332
Commercial, secured by real estate	—		761	3,602	—	4,363
Residential real estate	—		—	1,332	—	1,332
Total	$	—	761	5,266	—	6,027

Other:
Commercial & industrial	$	27,563	44	1,367	—	28,974
Commercial, secured by real estate	295,189		3,206	11,155	—	309,550
Residential real estate	208,881		1,136	4,493	—	214,510
Consumer	12,681		—	49	—	12,730
Agricultural	2,472		—	—	—	2,472
Other	91		—	—	—	91
Total	$	546,877	4,386	17,064	—	568,327

Total:
Commercial & industrial	$	27,563	44	1,699	—	29,306
Commercial, secured by real estate	295,189		3,967	14,757	—	313,913
Residential real estate	208,881		1,136	5,825	—	215,842
Consumer	12,681		—	49	—	12,730
Agricultural	2,472		—	—	—	2,472
Other	91		—	—	—	91
Total	$	546,877	5,147	22,330	—	574,354

A loan portfolio aging analysis at March 31, 2014 and December 31, 2013 is as follows (in thousands):



	30-59 Days Past Due		60-89 Days Past Due	Greater Than 90 Days Past Due	Total Past Due	Current	Total Loans Receivable	Total Loans Greater Than 90 Days and Accruing
March 31, 2014
Acquired credit impaired:
Commercial & industrial	$	288	302	—	590	1,213	1,803	—
Commercial, secured by real estate	2,301		878	421	3,600	8,123	11,723	—
Residential real estate	337		40	168	545	5,571	6,116	—
Consumer	23		9	—	32	186	218	—
Agricultural	231		—	—	231	12	243	—
Total	$	3,180	1,229	589	4,998	15,105	20,103	—

Other:
Commercial & industrial	$	—	—	800	800	37,487	38,287	800
Commercial, secured by real estate	307		—	2,006	2,313	361,684	363,997	—
Residential real estate	702		72	890	1,664	230,723	232,387	18
Consumer	75		27	7	109	20,752	20,861	7
Agricultural	83		—	—	83	7,556	7,639	—
Other	57		—	—	57	1,865	1,922	—
Total	$	1,224	99	3,703	5,026	660,067	665,093	825

Total:
Commercial & industrial	$	288	302	800	1,390	38,700	40,090	800
Commercial, secured by real estate	2,608		878	2,427	5,913	369,807	375,720	—
Residential real estate	1,039		112	1,058	2,209	236,294	238,503	18
Consumer	98		36	7	141	20,938	21,079	7
Agricultural	314		—	—	314	7,568	7,882	—
Other	57		—	—	57	1,865	1,922	—
Total	$	4,404	1,328	4,292	10,024	675,172	685,196	825

December 31, 2013
Acquired credit impaired:
Commercial & industrial	$	273	—	—	273	59	332	—
Commercial, secured by real estate	729		—	126	855	3,508	4,363	—
Residential real estate	—		41	143	184	1,148	1,332	—
Total	$	1,002	41	269	1,312	4,715	6,027	—

Other:
Commercial & industrial	$	4	—	144	148	28,826	28,974	—
Commercial, secured by real estate	222		582	1,048	1,852	307,698	309,550	—
Residential real estate	1,131		258	1,461	2,850	211,660	214,510	236
Consumer	38		35	13	86	12,644	12,730	14
Agricultural	—		—	—	—	2,472	2,472	—
Other	91		—	—	91	—	91	—
Total	$	1,486	875	2,666	5,027	563,300	568,327	250

Total:
Commercial & industrial	$	277	—	144	421	28,885	29,306	—
Commercial, secured by real estate	951		582	1,174	2,707	311,206	313,913	—
Residential real estate	1,131		299	1,604	3,034	212,808	215,842	236
Consumer	38		35	13	86	12,644	12,730	14
Agricultural	—		—	—	—	2,472	2,472	—
Other	91		—	—	91	—	91	—
Total	$	2,488	916	2,935	6,339	568,015	574,354	250

Impaired loans, excluding acquired credit impaired loans, at March 31, 2014 and December 31, 2013 are as follows (in thousands):



	Recorded Investment		Unpaid Principal Balance	Related Allowance
March 31, 2014
With no related allowance recorded:
Commercial & industrial	$	164	269	—
Commercial, secured by real estate	10,483		10,506	—
Residential real estate	798		909	—
Consumer	—		—	—
Total	$	11,445	11,684	—

With an allowance recorded:
Commercial & industrial	$	—	—	—
Commercial, secured by real estate	3,965		4,159	648
Residential real estate	1,179		1,434	167
Consumer	17		17	—
Total	$	5,161	5,610	815

Total:
Commercial & industrial	$	164	269	—
Commercial, secured by real estate	14,448		14,665	648
Residential real estate	1,977		2,343	167
Consumer	17		17	—
Total	$	16,606	17,294	815

December 31, 2013
With no related allowance recorded:
Commercial & industrial	$	—	—	—
Commercial, secured by real estate	6,797		6,810	—
Residential real estate	487		763	—
Consumer	—		—	—
Total	$	7,284	7,573	—

With an allowance recorded:
Commercial & industrial	$	165	270	2
Commercial, secured by real estate	7,725		7,725	760
Residential real estate	1,645		1,663	270
Consumer	27		27	—
Total	$	9,562	9,685	1,032

Total:
Commercial & industrial	$	165	270	2
Commercial, secured by real estate	14,522		14,535	760
Residential real estate	2,132		2,426	270
Consumer	27		27	—
Total	$	16,846	17,258	1,032

The following presents information related to the average recorded investment and interest income recognized on impaired loans, excluding acquired credit impaired loans, for the three months ended March 31, 2014 and 2013 (in thousands):



	Three Months Ended March 31, 2014			Three Months Ended March 31, 2013
	Average Recorded Investment		Interest Income Recognized	Average Recorded Investment	Interest Income Recognized
With no related allowance recorded:
Commercial & industrial	$	164	—	—	—
Commercial, secured by real estate	10,587		82	9,516	89
Residential real estate	845		9	591	3
Consumer	3		—	3	—
Total	$	11,599	91	10,110	92

With an allowance recorded:
Commercial & industrial	$	—	—	202	—
Commercial, secured by real estate	4,076		27	4,548	32
Residential real estate	1,191		11	764	3
Consumer	17		—	7	—
Total	$	5,284	38	5,521	35

Total:
Commercial & industrial	$	164	—	202	—
Commercial, secured by real estate	14,663		109	14,064	121
Residential real estate	2,036		20	1,355	6
Consumer	20		—	10	—
Total	$	16,883	129	15,631	127

Loan modifications that were classified as troubled debt restructurings during the three months ended March 31, 2014 and 2013 are as follows (dollars in thousands):



	Three Months Ended March 31, 2014			Three Months Ended March 31, 2013
	Number of Loans	Balance at Modification		Number of Loans	Balance at Modification
Commercial and industrial	1	$	10	—	$	—
Residential real estate	—	—		1	80
Consumer	1	2		—	—
Total	2	$	12	1	$	80

Each restructured loan is separately negotiated with the borrower and includes terms and conditions that reflect the borrower's ability to pay the debt as modified. Modifications may include interest only payments for a period of time, temporary or permanent reduction of the loan's interest rate, capitalization of delinquent interest, or extensions of the maturity date.

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

A restructured automobile loan with a balance of $13,000 was charged off during the first quarter 2013, which was within twelve months of the loan's modification date. There were no other troubled debt restructurings that subsequently defaulted within twelve months of the restructuring date for the three months ended March 31, 2014 and 2013.

March 31,
2014

December 31,
2013

Outstanding balance

Carrying amount