Loans

Major classifications of loans at September 30, 2018 and December 31, 2017 are as follows (in thousands):



	September 30, 2018		December 31, 2017
Commercial and industrial	$	78,002	$	36,057
Commercial, secured by real estate	704,987		527,947
Residential real estate	347,920		251,582
Consumer	17,505		17,450
Agricultural	13,280		15,194
Other loans, including deposit overdrafts	498		539
Loans, gross	1,162,192		848,769
Deferred origination costs, net	133		291
Loans, net of deferred origination costs	1,162,325		849,060
Less allowance for loan losses	4,016		3,403
Loans, net	$	1,158,309	$	845,657

Non-accrual, past-due, and accruing restructured loans as of September 30, 2018 and December 31, 2017 are as follows (in thousands):



	September 30, 2018		December 31, 2017
Non-accrual loans:
Commercial and industrial	$	—	$	—
Commercial, secured by real estate	1,785		2,183
Residential real estate	627		604
Consumer	14		—
Agricultural	177		178
Total non-accrual loans	2,603		2,965
Past-due 90 days or more and still accruing	1		—
Total non-accrual and past-due 90 days or more and still accruing	2,604		2,965
Accruing restructured loans	10,307		10,469
Total	$	12,911	$	13,434

The allowance for loan losses for the three and nine months ended September 30, 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 September 30, 2018
Balance, beginning of period	$	407		$	2,383		$	690		$	70		$	52	$	1		$	3,603
Provision charged to expenses	(3		)	488			25			95			2		52			659
Losses charged off	—			(116		)	—			(88		)	—		(81		)	(285		)
Recoveries	—			3			—			4			—		32			39
Balance, end of period	$	404		$	2,758		$	715		$	81		$	54	$	4		$	4,016

Nine Months Ended September 30, 2018
Balance, beginning of year	$	378		$	2,178		$	717		$	76		$	53	$	1		$	3,403
Provision charged to expenses	26			546			211			102			1		76			962
Losses charged off	—			(145		)	(227		)	(109		)	—		(142		)	(623		)
Recoveries	—			179			14			12			—		69			274
Balance, end of period	$	404		$	2,758		$	715		$	81		$	54	$	4		$	4,016

Three Months Ended September 30, 2017
Balance, beginning of period	$	273		$	2,136		$	822		$	86		$	61	$	4		$	3,382
Provision charged to expenses	8			(9		)	(139		)	(6		)	113		21			(12		)
Losses charged off	—			(118		)	—			(30		)	—		(37		)	(185		)
Recoveries	19			106			38			44			—		15			222
Balance, end of period	$	300		$	2,115		$	721		$	94		$	174	$	3		$	3,407

Nine Months Ended September 30, 2017
Balance, beginning of year	$	350		$	2,179		$	885		$	96		$	60	$	5		3,575
Provision charged to expenses	(84		)	287			(137		)	(3		)	114		48			225
Losses charged off	—			(462		)	(135		)	(84		)	—		(98		)	(779		)
Recoveries	34			111			108			85			—		48			386
Balance, end of period	$	300		$	2,115		$	721		$	94		$	174	$	3		$	3,407

A breakdown of the allowance for loan losses and the loan portfolio by loan segment at September 30, 2018 and December 31, 2017 are as follows (in thousands):



	Commercial & Industrial		Commercial, Secured by Real Estate		Residential Real Estate		Consumer		Agricultural		Other		Total
September 30, 2018
Allowance for loan losses:
Individually evaluated for impairment	$	10	$	3	$	26	$	—	$	—	$	—	$	39
Collectively evaluated for impairment	394		2,755		689		81		54		4		3,977
Acquired credit impaired loans	—		—		—		—		—		—		—
Balance, end of period	$	404	$	2,758	$	715	$	81	$	54	$	4	$	4,016

Loans:
Individually evaluated for impairment	$	276	$	10,529	$	1,151	$	50	$	177	$	—	$	12,183
Collectively evaluated for impairment	76,643		686,654		343,912		17,566		13,120		119		1,138,014
Acquired credit impaired loans	1,136		7,352		3,261		—		—		379		12,128
Balance, end of period	$	78,055	$	704,535	$	348,324	$	17,616	$	13,297	$	498	$	1,162,325

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 fixed rate, with maturities ranging from one to ten years. 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, hotels, multifamily (more than four-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. The majority 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 and all guarantors, and other factors. Commercial real estate loans are generally originated with a 75% to 85% 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 four-family residential properties. 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 or less 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 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 September 30, 2018 and December 31, 2017 is as follows (in thousands):



	Pass		OAEM		Substandard		Doubtful		Total
September 30, 2018
Commercial & industrial	$	74,748	$	1,417	$	1,890	$	—	$	78,055
Commercial, secured by real estate	683,230		1,549		19,756		—		704,535
Residential real estate	345,478		—		2,846		—		348,324
Consumer	17,567		—		49		—		17,616
Agricultural	13,120		—		177		—		13,297
Other	498		—		—		—		498
Total	$	1,134,641	$	2,966	$	24,718	$	—	$	1,162,325

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 September 30, 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
September 30, 2018
Commercial & industrial	$	1	$	—	$	—	$	1	$	78,054	$	78,055	$	—
Commercial, secured by real estate	569		139		309		1,017		703,518		704,535		—
Residential real estate	878		303		354		1,535		346,789		348,324		—
Consumer	9		10		15		34		17,582		17,616		1
Agricultural	—		—		177		177		13,120		13,297		—
Other	69		—		—		69		429		498		—
Total	$	1,526	$	452	$	855	$	2,833	$	1,159,492	$	1,162,325	$	1

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 September 30, 2018 and December 31, 2017 are as follows (in thousands):



	September 30, 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	$	1,141	$	1,667	$	—	$	1,015	$	1,100	$	—
Commercial, secured by real estate	17,730		19,082		—		12,677		13,608		—
Residential real estate	3,854		4,621		—		2,822		3,516		—
Consumer	28		28		—		6		6		—
Agricultural	177		177		—		177		177		—
Other	379		515		—		402		554		—
Total	$	23,309	$	26,090	$	—	$	17,099	$	18,961	$	—

With an allowance recorded:
Commercial & industrial	$	271	$	277	$	10	$	296	$	301	$	8
Commercial, secured by real estate	151		151		3		2,660		2,660		146
Residential real estate	558		601		26		553		572		29
Consumer	22		22		—		41		41		8
Agricultural	—		—		—		—		—		—
Other	—		—		—		—		—		—
Total	$	1,002	$	1,051	$	39	$	3,550	$	3,574	$	191

Total:
Commercial & industrial	$	1,412	$	1,944	$	10	$	1,311	$	1,401	$	8
Commercial, secured by real estate	17,881		19,233		3		15,337		16,268		146
Residential real estate	4,412		5,222		26		3,375		4,088		29
Consumer	50		50		—		47		47		8
Agricultural	177		177		—		177		177		—
Other	379		515		—		402		554		—
Total	$	24,311	$	27,141	$	39	$	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 and nine months ended September 30, 2018 and 2017 (in thousands):



	2018				2017
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Three Months Ended September 30,
With no related allowance recorded:
Commercial & industrial	$	1,261	$	35	$	945	$	10
Commercial, secured by real estate	17,364		269		13,671		184
Residential real estate	3,935		77		3,268		45
Consumer	68		1		16		—
Agricultural	177		—		142		—
Other	374		10		438		12
Total	$	23,179	$	392	$	18,480	$	251

With an allowance recorded:
Commercial & industrial	$	276	$	4	$	306	$	4
Commercial, secured by real estate	152		3		2,970		11
Residential real estate	573		8		604		7
Consumer	23		—		43		1
Agricultural	—		—		178		—
Other	—		—		—		—
Total	$	1,024	$	15	$	4,101	$	23

Total:
Commercial & industrial	$	1,537	$	39	$	1,251	$	14
Commercial, secured by real estate	17,516		272		16,641		195
Residential real estate	4,508		85		3,872		52
Consumer	91		1		59		1
Agricultural	177		—		320		—
Other	374		10		438		12
Total	$	24,203	$	407	$	22,581	$	274

Nine Months Ended September 30,
With no related allowance recorded:
Commercial & industrial	$	950	$	56	$	603	$	46
Commercial, secured by real estate	16,143		657		14,099		685
Residential real estate	3,420		174		3,280		180
Consumer	37		2		24		2
Agricultural	177		—		57		—
Other	390		31		450		43
Total	$	21,117	$	920	$	18,513	$	956

With an allowance recorded:
Commercial & industrial	$	283	$	13	$	314	$	13
Commercial, secured by real estate	154		9		3,085		35
Residential real estate	577		23		634		23
Consumer	24		1		43		2
Agricultural	—		—		240		—
Other	—		—		—		—
Total	$	1,038	$	46	$	4,316	$	73

Total:
Commercial & industrial	$	1,233	$	69	$	917	$	59
Commercial, secured by real estate	16,297		666		17,184		720
Residential real estate	3,997		197		3,914		203
Consumer	61		3		67		4
Agricultural	177		—		297		—
Other	390		31		450		43
Total	$	22,155	966		$	22,829	$	1,029

Of the interest income recognized on impaired loans during the nine months ended September 30, 2018 and 2017, approximately $85,000 and $3,000, respectively, were recognized on a cash basis.

From time to time, the terms of certain loans are modified as troubled debt restructurings ("TDRs") where concessions are granted to borrowers experiencing financial difficulties. The modification of the terms of such loans may have included one, or a combination of, the following: a temporary or permanent reduction of the stated interest rate of the loan, an increase in the stated rate of interest lower than the current market rate for new debt with similar risk, forgiveness of principal, an extension of the maturity date, or a change in the payment terms.

Loan modifications that were classified as TDRs during the three and nine months ended September 30, 2018 and 2017 were as follows:



	2018				2017
	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 September 30,
Commercial and industrial	0	$	—	—	0	$	—	—
Commercial, secured by real estate	0	—		—	0	—		—
Residential real estate	1	199		199	0	—		—
Consumer	0	—		—	0	—		—
Total	1	$	199	199	0	$	—	—

Nine Months Ended September 30,
Commercial and industrial	0	$	—	—	0	$	—	—
Commercial, secured by real estate	0	—		—	0	—		—
Residential real estate	1	199		199	1	18		9
Consumer	0	—		—	1	14		14
Total	1	$	199	199	2	$	32	23

Post-modification balances of newly restructured troubled debt by type of modification for the three and nine months ended September 30, 2018 and 2017 were as follows (in thousands):



	Term Modification		Rate Modification		Interest Only		Principal Forgiveness		Combination		Total Modifications
Three Months Ended September 30, 2018
Commercial & industrial	$	—	$	—	$	—	$	—	$	—	$	—
Commercial, secured by real estate	—		—		—		—		—		—
Residential real estate	199		—		—		—		—		199
Consumer	—		—		—		—		—		—
Total	$	199	$	—	$	—	$	—	$	—	$	199

Nine Months Ended September 30, 2018
Commercial & industrial	$	—	$	—	$	—	$	—	$	—	$	—
Commercial, secured by real estate	—		—		—		—		—		—
Residential real estate	199		—		—		—		—		199
Consumer	—		—		—		—		—		—
Total	$	199	$	—	$	—	$	—	$	—	$	199

Three Months Ended September 30, 2017
Commercial & industrial	$	—	$	—	$	—	$	—	$	—	$	—
Commercial, secured by real estate	—		—		—		—		—		—
Residential real estate	—		—		—		—		—		—
Consumer	—		—		—		—		—		—
Total	$	—	$	—	$	—	$	—	$	—	$	—

Nine Months Ended September 30, 2017
Commercial & industrial	$	—	$	—	$	—	$	—	$	—	$	—
Commercial, secured by real estate	—		—		—		—		—		—
Residential real estate	—		—		—		9		—		9
Consumer	14		—		—		—		—		14
Total	$	14	$	—	$	—	$	9	$	—	$	23

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 nine months ended September 30, 2018 and that remained in default at period end.

Information concerning loans that were modified during the nine months ended September 30, 2018 and 2017 and that were determined to be troubled debt restructurings follows (in thousands):



	Modified During the Nine Months Ended September 30,
	2018	2017
Impaired loans without a valuation allowance at the end of the period	199	0
Impaired loans with a valuation allowance at the end of the period	0	23

Mortgage loans sold to and serviced for investors are not included in the accompanying consolidated condensed balance sheets. The unpaid principal balances of those loans at September 30, 2018 and December 31, 2017 were approximately $115,647,000 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 September 30, 2018 was $392,000.