Loans

Major classifications of loans at March 31, 2016 and December 31, 2015 are as follows (in thousands):



	March 31, 2016		December 31, 2015
Commercial and industrial	$	45,324	45,275
Commercial, secured by real estate	430,179		419,633
Residential real estate	271,812		273,139
Consumer	17,925		18,510
Agricultural	12,589		13,479
Other loans, including deposit overdrafts	643		665
	778,472		770,701
Deferred net origination costs (fees)	242		237
	778,714		770,938
Less allowance for loan losses	3,150		3,129
Loans, net	$	775,564	767,809

All advances from the Federal Home Loan Bank ("FHLB") of Cincinnati are secured by a blanket pledge of LCNB's 1-4 family first lien mortgage loans in the amount of approximately $230 million and $231 million at March 31, 2016 and December 31, 2015, 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.

Non-accrual, past-due, and accruing restructured loans as of March 31, 2016 and December 31, 2015 are as follows (in thousands):



	March 31, 2016		December 31, 2015
Non-accrual loans:
Commercial and industrial	$	—	—
Commercial, secured by real estate	1,759		876
Agricultural	413		48
Residential real estate	1,144		799
Consumer	12		—
Total non-accrual loans	3,328		1,723
Past-due 90 days or more and still accruing	99		559
Total non-accrual and past-due 90 days or more and still accruing	3,427		2,282
Accruing restructured loans	13,955		13,723
Total	$	17,382	16,005

The allowance for loan losses for the three months ended March 31, 2016 and 2015 are as follows (in thousands):



	Commercial & Industrial		Commercial, Secured by Real Estate		Residential Real Estate		Consumer		Agricultural		Other		Total
Three Months Ended March 31, 2016
Allowance for loan losses:
Balance, beginning of year	$	244	1,908		854		54		66		3		3,129
Provision charged to expenses	—		(35	)	66		61		(10	)	8		90
Losses charged off	—		(23	)	(28	)	(44	)	—		(23	)	(118	)
Recoveries	3		18		4		10		—		14		49
Balance, end of period	$	247	1,868		896		81		56		2		3,150

Three Months Ended March 31, 2015
Allowance for loan losses:
Balance, beginning of year	$	129	1,990		926		63		11		2		3,121
Provision charged to expenses	1		(37	)	64		(29	)	66		4		69
Losses charged off	—		(313	)	(82	)	(11	)	—		(14	)	(420	)
Recoveries	1		—		26		31		—		9		67
Balance, end of period	$	131	1,640		934		54		77		1		2,837

A breakdown of the allowance for loan losses and the loan portfolio by loan segment at March 31, 2016 and December 31, 2015 are as follows (in thousands):



	Commercial & Industrial		Commercial, Secured by Real Estate	Residential Real Estate	Consumer	Agricultural	Other	Total
March 31, 2016
Allowance for loan losses:
Individually evaluated for impairment	$	8	210	93	13	—	—	324
Collectively evaluated for impairment	239		1,629	803	68	56	2	2,797
Acquired credit impaired loans	—		29	—	—	—	—	29
Balance, end of period	$	247	1,868	896	81	56	2	3,150

Loans:
Individually evaluated for impairment	$	362	13,065	1,593	63	384	—	15,467
Collectively evaluated for impairment	44,236		410,441	267,682	17,934	12,184	139	752,616
Acquired credit impaired loans	739		6,351	2,986	22	29	504	10,631
Balance, end of period	$	45,337	429,857	272,261	18,019	12,597	643	778,714

December 31, 2015
Allowance for loan losses:
Individually evaluated for impairment	$	9	306	48	—	—	—	363
Collectively evaluated for impairment	235		1,602	806	54	66	3	2,766
Acquired credit impaired loans	—		—	—	—	—	—	—
Balance, end of period	$	244	1,908	854	54	66	3	3,129

Loans:
Individually evaluated for impairment	$	370	12,351	1,541	56	—	—	14,318
Collectively evaluated for impairment	43,726		399,092	269,001	18,516	13,438	179	743,952
Acquired credit impaired loans	1,191		7,877	3,039	27	48	486	12,668
Balance, end of period	$	45,287	419,320	273,581	18,599	13,486	665	770,938

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 adjustment periods ranging from one month to 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 generally 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 March 31, 2016 and December 31, 2015 is as follows (in thousands):



	Pass		OAEM	Substandard	Doubtful	Total
March 31, 2016
Commercial & industrial	$	44,585	—	752	—	45,337
Commercial, secured by real estate	409,710		7,521	12,626	—	429,857
Residential real estate	266,809		1,198	4,254	—	272,261
Consumer	17,911		—	108	—	18,019
Agricultural	11,111		728	758	—	12,597
Other	643		—	—	—	643
Total	$	750,769	9,447	18,498	—	778,714

December 31, 2015
Commercial & industrial	$	44,596	—	691	—	45,287
Commercial, secured by real estate	397,938		9,316	12,066	—	419,320
Residential real estate	267,567		1,935	4,079	—	273,581
Consumer	18,528		—	71	—	18,599
Agricultural	12,246		850	390	—	13,486
Other	665		—	—	—	665
Total	$	741,540	12,101	17,297	—	770,938

A loan portfolio aging analysis at March 31, 2016 and December 31, 2015 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, 2016
Commercial & industrial	$	61	—	—	61	45,276	45,337	—
Commercial, secured by real estate	75		73	836	984	428,873	429,857	—
Residential real estate	1,008		2	1,025	2,035	270,226	272,261	64
Consumer	54		9	48	111	17,908	18,019	35
Agricultural	—		—	—	—	12,597	12,597	—
Other	70		—	—	70	573	643	—
Total	$	1,268	84	1,909	3,261	775,453	778,714	99

December 31, 2015
Commercial & industrial	$	—	—	—	—	45,287	45,287	—
Commercial, secured by real estate	73		81	876	1,030	418,290	419,320	—
Residential real estate	777		198	1,124	2,099	271,482	273,581	516
Consumer	62		7	43	112	18,487	18,599	43
Agricultural	—		—	—	—	13,486	13,486	—
Other	109		—	—	109	556	665	—
Total	$	1,021	286	2,043	3,350	767,588	770,938	559

Impaired loans, including acquired credit impaired loans, at March 31, 2016 and December 31, 2015 are as follows (in thousands):



	Recorded Investment		Unpaid Principal Balance	Related Allowance
March 31, 2016
With no related allowance recorded:
Commercial & industrial	$	752	1,036	—
Commercial, secured by real estate	16,811		18,584	—
Residential real estate	3,746		4,976	—
Consumer	38		60	—
Agricultural	413		504	—
Other	504		700	—
Total	$	22,264	25,860	—

With an allowance recorded:
Commercial & industrial	$	349	354	8
Commercial, secured by real estate	2,605		2,731	239
Residential real estate	833		937	93
Consumer	47		66	13
Agricultural	—		—	—
Other	—		—	—
Total	$	3,834	4,088	353

Total:
Commercial & industrial	$	1,101	1,390	8
Commercial, secured by real estate	19,416		21,315	239
Residential real estate	4,579		5,913	93
Consumer	85		126	13
Agricultural	413		504	—
Other	504		700	—
Total	$	26,098	29,948	353

December 31, 2015
With no related allowance recorded:
Commercial & industrial	$	1,205	1,500	—
Commercial, secured by real estate	16,345		18,335	—
Residential real estate	3,734		5,055	—
Consumer	81		109	—
Agricultural	48		151	—
Other	486		701	—
Total	$	21,899	25,851	—

With an allowance recorded:
Commercial & industrial	$	356	356	9
Commercial, secured by real estate	3,883		4,014	306
Residential real estate	846		958	48
Consumer	2		1	—
Total	$	5,087	5,329	363

Total:
Commercial & industrial	$	1,561	1,856	9
Commercial, secured by real estate	20,228		22,349	306
Residential real estate	4,580		6,013	48
Consumer	83		110	—
Agricultural	48		151	—
Other	486		701	—
Total	$	26,986	31,180	363

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 months ended March 31, 2016 and 2015 (in thousands):



	2016			2015
	Average Recorded Investment		Interest Income Recognized	Average Recorded Investment	Interest Income Recognized
With no related allowance recorded:
Commercial & industrial	$	978	29	1,232	35
Commercial, secured by real estate	17,631		387	21,608	362
Residential real estate	3,778		67	4,326	82
Consumer	41		7	107	4
Agricultural	422		12	20	97
Other	495		20	522	19
Total	$	23,345	522	27,815	599

With an allowance recorded:
Commercial & industrial	$	352	5	380	5
Commercial, secured by real estate	2,624		19	3,989	27
Residential real estate	834		10	944	10
Consumer	61		1	18	1
Agricultural	—		—	121	—
Other	—		—	—	—
Total	$	3,871	35	5,452	43

Total:
Commercial & industrial	$	1,330	34	1,612	40
Commercial, secured by real estate	20,255		406	25,597	389
Residential real estate	4,612		77	5,270	92
Consumer	102		8	125	5
Agricultural	422		12	141	97
Other	495		20	522	19
Total	$	27,216	557	33,267	642

Of the interest income recognized on impaired loans during the three months ended March 31, 2016 and 2015, approximately $0 and $11,000, respectively, were recognized on a cash basis.

Loan modifications that were classified as troubled debt restructurings during the three months ended March 31, 2016 and 2015 are as follows (dollars in thousands):



	2016				2015
	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 March 31,
Commercial, secured by real estate	1	$	299	372	—	—		—
Residential real estate	1	18		18	3	87		87
Consumer	1	17		17	—	—		—
Total	3	$	334	407	3	$	87	87

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.

There were no troubled debt restructurings that subsequently defaulted within twelve months of the restructuring date for the three months ended March 31, 2016 and 2015 and that remained in default at period end.