Loans

Major classifications of loans at March 31, 2018 and December 31, 2017 are as follows (in thousands):



	March 31, 2018		December 31, 2017
Commercial and industrial	$	37,118	$	36,057
Commercial, secured by real estate	542,890		527,947
Residential real estate	246,487		251,582
Consumer	17,176		17,450
Agricultural	12,217		15,194
Other loans, including deposit overdrafts	506		539
	856,394		848,769
Deferred origination costs, net	263		291
	856,657		849,060
Less allowance for loan losses	3,529		3,403
Loans, net	$	853,128	$	845,657

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 Accounting Standards Codification ("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, 2018 and December 31, 2017 are as follows (in thousands):



	March 31, 2018		December 31, 2017
Non-accrual loans:
Commercial and industrial	$	—	$	—
Commercial, secured by real estate	1,876		2,183
Residential real estate	691		604
Consumer	—		—
Agricultural	177		178
Total non-accrual loans	2,744		2,965
Past-due 90 days or more and still accruing	146		—
Total non-accrual and past-due 90 days or more and still accruing	2,890		2,965
Accruing restructured loans	10,366		10,469
Total	$	13,256	$	13,434

The allowance for loan losses for the three months ended March 31, 2018 and 2017 are as follows (in thousands):



	Commercial & Industrial			Commercial, Secured by Real Estate			Residential Real Estate			Consumer			Agricultural			Other			Total
Three Months Ended March 31, 2018
Balance, beginning of year	$	378		$	2,178		$	717		$	76		$	53		$	1		$	3,403
Provision charged to expenses	15			(131		)	186			8			(9		)	10			79
Losses charged off	—			(29		)	(35		)	(11		)	—			(31		)	(106		)
Recoveries	—			125			1			5			—			22			153
Balance, end of period	$	393		$	2,143		$	869		$	78		$	44		$	2		$	3,529

Three Months Ended March 31, 2017
Balance, beginning of year	$	350		$	2,179		$	885		$	96		$	60		$	5		3,575
Provision charged to expenses	(2		)	90			(107		)	23			6			5			15
Losses charged off	—			(262		)	(17		)	(45		)	—			(30		)	(354		)
Recoveries	5			—			48			17			—			22			92
Balance, end of period	$	353		$	2,007		$	809		$	91		$	66		$	2		$	3,328

A breakdown of the allowance for loan losses and the loan portfolio by loan segment at March 31, 2018 and December 31, 2017 are as follows (in thousands):



	Commercial & Industrial		Commercial, Secured by Real Estate		Residential Real Estate		Consumer		Agricultural		Other		Total
March 31, 2018
Allowance for loan losses:
Individually evaluated for impairment	$	11	$	4	$	189	$	12	$	—	$	—	$	216
Collectively evaluated for impairment	382		2,139		680		66		44		2		3,313
Acquired credit impaired loans	—		—		—		—		—		—		—
Balance, end of period	$	393	$	2,143	$	869	$	78	$	44	$	2	$	3,529

Loans:
Individually evaluated for impairment	$	294	$	10,879	$	1,468	$	46	$	178	$	—	$	12,865
Collectively evaluated for impairment	36,603		527,656		243,526		17,240		12,053		94		837,172
Acquired credit impaired loans	258		3,989		1,961		—		—		412		6,620
Balance, end of period	$	37,155	$	542,524	$	246,955	$	17,286	$	12,231	$	506	$	856,657

December 31, 2017
Allowance for loan losses:
Individually evaluated for impairment	$	8	$	146	$	29	$	8	$	—	$	—	$	191
Collectively evaluated for impairment	370		2,032		688		68		53		1		3,212
Acquired credit impaired loans	—		—		—		—		—		—		—
Balance, end of period	$	378	$	2,178	$	717	$	76	$	53	$	1	$	3,403

Loans:
Individually evaluated for impairment	$	303	$	11,289	$	1,351	$	47	$	177	$	—	$	13,167
Collectively evaluated for impairment	34,792		512,259		248,674		17,516		15,033		137		828,411
Acquired credit impaired loans	1,008		4,048		2,024		—		—		402		7,482
Balance, end of period	$	36,103	$	527,596	$	252,049	$	17,563	$	15,210	$	539	$	849,060

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% to 80% maximum loan to appraised value ratio, depending upon borrower occupancy.

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 collectibility 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 as 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, 2018 and December 31, 2017 is as follows (in thousands):



	Pass		OAEM		Substandard		Doubtful		Total
March 31, 2018
Commercial & industrial	$	36,716	$	155	$	284	$	—	$	37,155
Commercial, secured by real estate	523,298		796		18,430		—		542,524
Residential real estate	244,998		—		1,957		—		246,955
Consumer	17,252		—		34		—		17,286
Agricultural	11,669		—		562		—		12,231
Other	506		—		—		—		506
Total	$	834,439	$	951	$	21,267	$	—	$	856,657

December 31, 2017
Commercial & industrial	$	35,683	$	176	$	244	$	—	$	36,103
Commercial, secured by real estate	506,833		2,180		18,583		—		527,596
Residential real estate	250,039		—		2,010		—		252,049
Consumer	17,522		—		41		—		17,563
Agricultural	14,233		—		977		—		15,210
Other	539		—		—		—		539
Total	$	824,849	$	2,356	$	21,855	$	—	$	849,060

A loan portfolio aging analysis at March 31, 2018 and December 31, 2017 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, 2018
Commercial & industrial	$	6	$	—	$	—	$	6	$	37,149	$	37,155	$	—
Commercial, secured by real estate	59		—		335		394		542,130		542,524		—
Residential real estate	420		77		576		1,073		245,882		246,955		146
Consumer	30		8		—		38		17,248		17,286		—
Agricultural	185		—		177		362		11,869		12,231		—
Other	42		—		—		42		464		506		—
Total	$	742	$	85	$	1,088	$	1,915	$	854,742	$	856,657	$	146

December 31, 2017
Commercial & industrial	$	—	$	—	$	—	$	—	$	36,103	$	36,103	$	—
Commercial, secured by real estate	124		—		598		722		526,874		527,596		—
Residential real estate	362		135		496		993		251,056		252,049		—
Consumer	29		2		—		31		17,532		17,563		—
Agricultural	—		—		177		177		15,033		15,210		—
Other	82		—		—		82		457		539		—
Total	$	597	$	137	$	1,271	$	2,005	$	847,055	$	849,060	$	—

Impaired loans, including acquired credit impaired loans, at March 31, 2018 and December 31, 2017 are as follows (in thousands):



	March 31, 2018						December 31, 2017
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:
Commercial & industrial	$	264	$	348	$	—	$	1,015	$	1,100	$	—
Commercial, secured by real estate	14,713		15,504		—		12,677		13,608		—
Residential real estate	2,688		3,413		—		2,822		3,516		—
Consumer	6		6		—		6		6		—
Agricultural	178		178		—		177		177		—
Other	412		553		—		402		554		—
Total	$	18,261	$	20,002	$	—	$	17,099	$	18,961	$	—

With an allowance recorded:
Commercial & industrial	$	288	$	288	$	11	$	296	$	301	$	8
Commercial, secured by real estate	155		155		4		2,660		2,660		146
Residential real estate	741		772		189		553		572		29
Consumer	40		40		12		41		41		8
Agricultural	—		—		—		—		—		—
Other	—		—		—		—		—		—
Total	$	1,224	$	1,255	$	216	$	3,550	$	3,574	$	191

Total:
Commercial & industrial	$	552	$	636	$	11	$	1,311	$	1,401	$	8
Commercial, secured by real estate	14,868		15,659		4		15,337		16,268		146
Residential real estate	3,429		4,185		189		3,375		4,088		29
Consumer	46		46		12		47		47		8
Agricultural	178		178		—		177		177		—
Other	412		553		—		402		554		—
Total	$	19,485	$	21,257	$	216	$	20,649	$	22,535	$	191

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, 2018 and 2017 (in thousands):



	2018				2017
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial & industrial	$	639	$	11	$	261	$	26
Commercial, secured by real estate	14,991		196		15,859		186
Residential real estate	2,791		45		3,219		89
Consumer	6		—		21		—
Agricultural	177		—		334		—
Other	407		11		463		18
Total	$	19,011	$	263	$	20,157	$	319

With an allowance recorded:
Commercial & industrial	$	291	$	4	$	322	$	4
Commercial, secured by real estate	157		3		1,931		24
Residential real estate	755		9		704		8
Consumer	41		1		52		1
Agricultural	—		—		—		—
Other	—		—		—		—
Total	$	1,244	$	17	$	3,009	$	37

Total:
Commercial & industrial	$	930	$	15	$	583	$	30
Commercial, secured by real estate	15,148		199		17,790		210
Residential real estate	3,546		54		3,923		97
Consumer	47		1		73		1
Agricultural	177		—		334		—
Other	407		11		463		18
Total	$	20,255	280		$	23,166	$	356

Of the interest income recognized on impaired loans during the three months ended March 31, 2018 and 2017, approximately $20,000 and $0, respectively, were recognized on a cash basis.

Loan modifications that were classified as troubled debt restructurings during the three months ended March 31, 2018 and 2017 are as follows (dollars in thousands):



	2018					2017
	Number of Loans	Pre-Modification Recorded Balance		Post-Modification Recorded Balance		Number of Loans	Pre-Modification Recorded Balance		Post-Modification Recorded Balance

Commercial & industrial	—	$	—	$	—	—	$	—	$	—
Commercial, secured by real estate	—	—		—		—	—		—
Residential real estate	—	—		—		1	18		9
Consumer	—	—		—		1	14		14
Total	—	$	—	$	—	2	$	32	$	23

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, forgiveness of principal, or extensions of the maturity date. Post-modification balances of newly restructured troubled debt by type of modification for the three months ended March 31, 2018 and 2017 were as follows (in thousands):



	Term Modification		Rate Modification		Interest Only		Principal Forgiveness		Combination		Total Modifications
Three Months Ended March 31, 2018
Commercial & industrial	$	—	$	—	$	—	$	—	$	—	$	—
Commercial, secured by real estate	—		—		—		—		—		—
Residential real estate	—		—		—		—		—		—
Consumer	—		—		—		—		—		—
Total	$	—	$	—	$	—	$	—	$	—	$	—

Three Months Ended March 31, 2017
Commercial & industrial	$	—	$	—	$	—	$	—	$	—	$	—
Commercial, secured by real estate	—		—		—		—		—		—
Residential real estate	—		—		—		9		—		9
Consumer	14		—		—		—		—		14
Total	$	14	$	—	$	—	$	9	$	—	$	23

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

Two commercial, secured by real estate loans to the same borrower totaling $1,236,000 that were modified during the fourth quarter 2016 subsequently defaulted in February 2017. There were no troubled debt restructurings that subsequently defaulted within twelve months of the restructuring date for the three months ended March 31, 2018 and that remained in default at period end.

No impaired loans without a valuation allowance and no impaired loans with a valuation allowance at March 31, 2018 consisted of loans that were modified during the three months ended March 31, 2018 and were determined to be troubled debt restructurings. Approximately $23,000 of impaired loans without a valuation allowance and $0 of impaired loans with a valuation allowance at March 31, 2017 consisted of loans that were modified during the three months ended March 31, 2017 and were determined to be troubled debt restructurings.

Mortgage loans sold to and serviced for the Federal Home Loan Mortgage Corporation and other investors are not included in the accompanying consolidated condensed balance sheets. The unpaid principal balances of those loans at March 31, 2018 and December 31, 2017 were approximately $90,630,000 and $92,818,000, respectively.

The total recorded investment in residential consumer mortgage loans secured by residential real estate that were in the process of foreclosure at March 31, 2018 was $335,000.