Loans

Major classifications of loans at June 30, 2015 and December 31, 2014 are as follows (in thousands):



	June 30, 2015	December 31, 2014
Commercial and industrial	47,958	35,424
Commercial, secured by real estate	399,551	379,141
Residential real estate	273,249	254,087
Consumer	19,718	18,006
Agricultural	13,434	11,472
Other loans, including deposit overdrafts	638	680
	754,548	698,810
Deferred net origination costs (fees)	188	146
	754,736	698,956
Less allowance for loan losses	2,879	3,121
Loans, net	751,857	695,835

All advances from the Federal Home Loan Bank of Cincinnati are secured by a blanket pledge of LCNB's 1-4 family first lien mortgage loans in the amount of approximately $232 million and $212 million at June 30, 2015 and December 31, 2014, respectively. Additionally, LCNB is required to hold minimum levels of FHLB stock, based on the outstanding borrowings.

Loans acquired through mergers 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 BNB on April 30, 2015 and Eaton National on January 24, 2014, not including loans considered to be impaired (in thousands):



	BNB		Eaton National
Contractually required principal at acquisition	$	32,174	102,483
Less fair value adjustment	199		1,347
Fair value of acquired loans	$	31,975	101,136

Contractual cash flows not expected to be collected	$	195	1,702

The following table provides details on acquired impaired loans obtained through the mergers with BNB and Eaton National that are accounted for in accordance with FASB ASC 310-30 (in thousands):



	BNB			Eaton National
Contractually required principal at acquisition	$	3,511		23,414
Contractual cash flows not expected to be collected (nonaccretable difference)	(404		)	(6,088	)
Expected cash flows at acquisition	3,107			17,326
Interest component of expected cash flows (accretable discount)	(413		)	(2,163	)
Fair value of acquired impaired loans	$	2,694		15,163

Non-accrual, past-due, and accruing restructured loans as of June 30, 2015 and December 31, 2014 are as follows (in thousands):



	June 30, 2015		December 31, 2014
Non-accrual loans:
Commercial and industrial	$	—	—
Commercial, secured by real estate	883		4,277
Agricultural	34		70
Residential real estate	1,044		1,252
Total non-accrual loans	1,961		5,599
Past-due 90 days or more and still accruing	128		203
Total non-accrual and past-due 90 days or more and still accruing	2,089		5,802
Accruing restructured loans	14,041		14,269
Total	$	16,130	20,071

LCNB sold impaired loans with a carrying value of approximately $4.5 million during the second quarter 2015. The decrease in non-accrual loans at June 30, 2015 as compared to December 31, 2014 is primarily due to this sale.

The allowance for loan losses for the three and six months ended June 30, 2015 and 2014 are as follows (in thousands):



	Commercial & Industrial			Commercial, Secured by Real Estate		Residential Real Estate		Consumer		Agricultural		Other		Total
Three Months Ended June 30, 2015
Allowance for loan losses:
Balance, beginning of period	$	131		1,640		934		54		77		1		2,837
Provision charged to expenses	41			552		53		16		6		9		677
Losses charged off	(11		)	(633	)	(115	)	(18	)	(67	)	(12	)	(856	)
Recoveries	1			96		42		10		67		5		221
Balance, end of period	$	162		1,655		914		62		83		3		2,879

Six Months Ended June 30, 2015
Allowance for loan losses:
Balance, beginning of year	$	129		1,990		926		63		11		2		3,121
Provision charged to expenses	42			515		117		(13	)	72		13		746
Losses charged off	(11		)	(946	)	(197	)	(29	)	(67	)	(26	)	(1,276	)
Recoveries	2			96		68		41		67		14		288
Balance, end of period	$	162		1,655		914		62		83		3		2,879

Three Months Ended June 30, 2014
Allowance for loan losses:
Balance, beginning of period	$	72		2,530		703		64		—		1		3,370
Provision charged to expenses	255			(294	)	264		17		8		5		255
Losses charged off	—			(168	)	(56	)	(38	)	—		(15	)	(277	)
Recoveries	4			—		5		26		—		11		46
Balance, end of period	$	331		2,068		916		69		8		2		3,394

Six Months Ended June 30, 2014
Allowance for loan losses:
Balance, beginning of year	$	175		2,520		826		66		—		1		3,588
Provision charged to expenses	146			(81	)	239		14		8		10		336
Losses charged off	—			(371	)	(175	)	(61	)	—		(33	)	(640	)
Recoveries	10			—		26		50		—		24		110
Balance, end of period	$	331		2,068		916		69		8		2		3,394

A breakdown of the allowance for loan losses and the loan portfolio by loan segment at June 30, 2015 and December 31, 2014 are as follows (in thousands):



	Commercial & Industrial		Commercial, Secured by Real Estate	Residential Real Estate	Consumer	Agricultural	Other	Total
June 30, 2015
Allowance for loan losses:
Individually evaluated for impairment	$	10	299	64	—	—	—	373
Collectively evaluated for impairment	152		1,356	850	62	83	3	2,506
Acquired credit impaired loans	—		—	—	—	—	—	—
Balance, end of period	$	162	1,655	914	62	83	3	2,879

Loans:
Individually evaluated for impairment	$	385	12,561	1,648	51	—	—	14,645
Collectively evaluated for impairment	45,709		378,388	268,752	19,695	13,404	138	726,086
Acquired credit impaired loans	1,881		8,281	3,247	57	39	500	14,005
Balance, end of period	$	47,975	399,230	273,647	19,803	13,443	638	754,736

December 31, 2014
Allowance for loan losses:
Individually evaluated for impairment	$	10	415	89	—	—	—	514
Collectively evaluated for impairment	119		1,273	836	63	11	2	2,304
Acquired credit impaired loans	—		302	1	—	—	—	303
Balance, end of period	$	129	1,990	926	63	11	2	3,121

Loans:
Individually evaluated for impairment	$	401	13,022	1,701	55	—	—	15,179
Collectively evaluated for impairment	33,941		352,774	249,374	17,954	11,371	167	665,581
Acquired credit impaired loans	1,092		12,984	3,425	81	101	513	18,196
Balance, end of period	$	35,434	378,780	254,500	18,090	11,472	680	698,956

The risk characteristics of LCNB's material loan portfolio segments are as follows:

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 lines 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% 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 agricultural 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 June 30, 2015 and December 31, 2014 is as follows (in thousands):



	Pass		OAEM	Substandard	Doubtful	Total
June 30, 2015
Commercial & industrial	$	46,303	797	875	—	47,975
Commercial, secured by real estate	378,598		6,619	14,013	—	399,230
Residential real estate	267,972		1,386	4,289	—	273,647
Consumer	19,727		—	76	—	19,803
Agricultural	13,063		—	380	—	13,443
Other	638		—	—	—	638
Total	$	726,301	8,802	19,633	—	754,736

December 31, 2014
Commercial & industrial	$	34,322	—	1,112	—	35,434
Commercial, secured by real estate	353,957		6,421	18,402	—	378,780
Residential real estate	246,335		920	7,245	—	254,500
Consumer	17,979		—	111	—	18,090
Agricultural	11,273		—	199	—	11,472
Other	680		—	—	—	680
Total	$	664,546	7,341	27,069	—	698,956

A loan portfolio aging analysis at June 30, 2015 and December 31, 2014 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
June 30, 2015
Commercial & industrial	$	484	—	—	484	47,491	47,975	—
Commercial, secured by real estate	632		78	991	1,701	397,529	399,230	—
Residential real estate	290		84	891	1,265	272,382	273,647	95
Consumer	62		14	33	109	19,694	19,803	33
Agricultural	—		—	—	—	13,443	13,443	—
Other	64		—	—	64	574	638	—
Total	$	1,532	176	1,915	3,623	751,113	754,736	128

December 31, 2014
Commercial & industrial	$	4	—	—	4	35,430	35,434	—
Commercial, secured by real estate	1,000		83	3,179	4,262	374,518	378,780	9
Residential real estate	648		297	1,289	2,234	252,266	254,500	177
Consumer	59		28	17	104	17,986	18,090	17
Agricultural	73		70	—	143	11,329	11,472	—
Other	106		—	—	106	574	680	—
Total	$	1,890	478	4,485	6,853	692,103	698,956	203

Impaired loans, including acquired credit impaired loans, at June 30, 2015 and December 31, 2014 are as follows (in thousands):



	Recorded Investment		Unpaid Principal Balance	Related Allowance
June 30, 2015
With no related allowance recorded:
Commercial & industrial	$	1,882	2,196	—
Commercial, secured by real estate	17,057		19,555	—
Residential real estate	3,990		5,320	—
Consumer	91		159	—
Agricultural	38		161	—
Other	500		712	—
Total	$	23,558	28,103	—

With an allowance recorded:
Commercial & industrial	$	385	385	10
Commercial, secured by real estate	3,785		3,915	299
Residential real estate	904		972	64
Consumer	18		18	—
Agricultural	—		—	—
Other	—		—	—
Total	$	5,092	5,290	373

Total:
Commercial & industrial	$	2,267	2,581	10
Commercial, secured by real estate	20,842		23,470	299
Residential real estate	4,894		6,292	64
Consumer	109		177	—
Agricultural	38		161	—
Other	500		712	—
Total	$	28,650	33,393	373

December 31, 2014
With no related allowance recorded:
Commercial & industrial	$	1,092	2,077	—
Commercial, secured by real estate	21,822		26,715	—
Residential real estate	4,057		5,549	—
Consumer	117		178	—
Agricultural	101		619	—
Other	513		744	—
Total	$	27,702	35,882	—

With an allowance recorded:
Commercial & industrial	$	401	406	10
Commercial, secured by real estate	4,184		4,538	717
Residential real estate	1,069		1,265	90
Consumer	19		20	—
Total	$	5,673	6,229	817

Total:
Commercial & industrial	$	1,493	2,483	10
Commercial, secured by real estate	26,006		31,253	717
Residential real estate	5,126		6,814	90
Consumer	136		198	—
Agricultural	101		619	—
Other	513		744	—
Total	$	33,375	42,111	817

The following presents information related to the average recorded investment and interest income recognized on impaired loans, including acquired credit impaired loans, for the three and six months ended June 30, 2015 and 2014 (in thousands):



	2015			2014
	Average Recorded Investment		Interest Income Recognized	Average Recorded Investment	Interest Income Recognized
Three Months Ended June 30,
With no related allowance recorded:
Commercial & industrial	$	1,609	60	2,057	38
Commercial, secured by real estate	19,259		742	23,282	327
Residential real estate	4,175		138	4,528	101
Consumer	93		3	234	2
Agricultural	110		35	118	7
Other	516		20	560	10
Total	$	25,762	998	30,779	485

With an allowance recorded:
Commercial & industrial	$	389	6	494	2
Commercial, secured by real estate	3,746		29	4,344	—
Residential real estate	884		10	1,352	11
Consumer	18		—	—	—
Agricultural	—		—	—	—
Other	—		—	—	—
Total	$	5,037	45	6,190	13

Total:
Commercial & industrial	$	1,998	66	2,551	40
Commercial, secured by real estate	23,005		771	27,626	327
Residential real estate	5,059		148	5,880	112
Consumer	111		3	234	2
Agricultural	110		35	118	7
Other	516		20	560	10
Total	$	30,799	1,043	36,969	498

Six Months Ended June 30,
With no related allowance recorded:
Commercial & industrial	$	1,437	82	2,088	70
Commercial, secured by real estate	20,317		1,099	23,839	616
Residential real estate	4,305		221	4,682	177
Consumer	101		7	246	9
Agricultural	107		132	129	9
Other	515		39	564	17
Total	$	26,782	1,580	31,548	898

With an allowance recorded:
Commercial & industrial	$	393	11	291	13
Commercial, secured by real estate	3,694		56	4,228	50
Residential real estate	862		20	1,296	23
Consumer	18		1	—	—
Agricultural	—		—	—	—
Other	—		—	—	—
Total	$	4,967	88	5,815	86

Total:
Commercial & industrial	$	1,830	93	2,379	83
Commercial, secured by real estate	24,011		1,155	28,067	666
Residential real estate	5,167		241	5,978	200
Consumer	119		8	246	9
Agricultural	107		132	129	9
Other	515		39	564	17
Total	$	31,749	1,668	37,363	984

Of the interest income recognized on impaired loans during the six months ended June 30, 2015 and 2014, approximately $81,000 and $0, respectively, were recognized on a cash basis.

Loan modifications that were classified as troubled debt restructurings during the three and six months ended June 30, 2015 and 2014 are as follows (dollars in thousands):



	2015				2014
	Number of Loans	Pre-Modification Recorded Balance		Post-Modification Recorded Balance	Number of Loans	Pre-Modification Recorded Balance		Post-Modification Recorded Balance
Three Months Ended June 30,
Commercial & industrial	1	$	72	74	6	$	628	628
Commercial, secured by real estate	—	—		—	1	818		818
Residential real estate	1	50		50	1	78		78
Consumer	—	—		—	—	—		—
Total	2	$	122	124	8	$	1,524	1,524

Six Months Ended June 30,
Commercial & industrial	1	$	72	74	7	$	638	628
Commercial, secured by real estate	—	—		—	1	818		818
Residential real estate	4	137		137	1	78		78
Consumer	—	—		—	1	2		2
Total	5	$	209	211	10	$	1,536	1,526

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 commercial real estate loan with a recorded balance of $77,000 was classified as non-accrual at June 30, 2015, which was within twelve months of the loan's modification date. There were no troubled debt restructurings that subsequently defaulted within twelve months of the restructuring date for the six months ended June 30, 2014.