LOANS

Major classifications of loans at December 31 were as follows (in thousands):



	2018		2017
Commercial and industrial	$	77,740	36,057
Commercial, secured by real estate	740,647		527,947
Residential real estate	349,127		251,582
Consumer	17,283		17,450
Agricultural	13,297		15,194
Other loans, including deposit overdrafts	450		539
	1,198,544		848,769
Deferred origination costs, net	79		291
	1,198,623		849,060
Less allowance for loan losses	4,046		3,403
Loans-net	$	1,194,577	845,657

Non-accrual, past-due, and accruing restructured loans at December 31 were as follows (dollars in thousands):



	2018			2017
Non-accrual loans:
Commercial and industrial	$	—		—
Commercial, secured by real estate	1,767			2,183
Residential real estate	1,007			604
Agricultural	177			178
Total non-accrual loans	2,951			2,965
Past-due 90 days or more and still accruing	149			—
Total non-accrual and past-due 90 days or more and still accruing	3,100			2,965
Accruing restructured loans	10,516			10,469
Total	$	13,616		13,434

Percentage of total non-accrual and past-due 90 days or more and still accruing to total loans	0.26		%	0.35	%

Percentage of total non-accrual, past-due 90 days or more and still accruing, and accruing restructured loans to total loans	1.14		%	1.58	%

Interest income that would have been recorded during 2018 and 2017 if loans on non-accrual status at December 31, 2018 and 2017 had been current and in accordance with their original terms was approximately $187,000 and $202,000, respectively.

The Company is not committed to lend additional funds to debtors whose loans have been modified to provide a reduction or deferral of principal or interest because of deterioration in the financial position of the borrower.

The allowance for loan losses and recorded investment in loans for the years ended December 31 were as follows (in thousands):



	Commercial & Industrial			Commercial, Secured by Real Estate		Residential Real Estate		Consumer		Agricultural		Other		Total
2018
Allowance for loan losses:
Balance, beginning of year	$	378		2,178		717		76		53		1		3,403
Provision charged to expenses	21			473		213		133		(7	)	90		923
Losses charged off	—			(145	)	(234	)	(135	)	—		(179	)	(693	)
Recoveries	1			239		71		13		—		89		413
Balance, end of year	$	400		2,745		767		87		46		1		4,046

Individually evaluated for impairment	$	10		3		49		—		—		—		62
Collectively evaluated for impairment	390			2,742		718		87		46		1		3,984
Acquired credit impaired loans	—			—		—		—		—		—		—
Balance, end of year	$	400		2,745		767		87		46		1		4,046

Loans:
Individually evaluated for impairment	$	268		15,101		1,558		36		177		—		17,140
Collectively evaluated for impairment	76,609			718,709		344,751		17,363		13,135		114		1,170,681
Acquired credit impaired loans	922			6,315		3,229		—		—		336		10,802
Balance, end of year	$	77,799		740,125		349,538		17,399		13,312		450		1,198,623

2017
Allowance for loan losses:
Balance, beginning of year	$	350		2,179		885		96		60		5		3,575
Provision charged to expenses	(71		)	348		(83	)	(44	)	(7	)	72		215
Losses charged off	—			(462	)	(225	)	(90	)	—		(138	)	(915	)
Recoveries	99			113		140		114		—		62		528
Balance, end of year	$	378		2,178		717		76		53		1		3,403

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 year	$	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 year	$	36,103		527,596		252,049		17,563		15,210		539		849,060



	Commercial & Industrial			Commercial, Secured by Real Estate		Residential Real Estate		Consumer		Agricultural		Other		Total
2016
Allowance for loan losses:
Balance, beginning of year	$	244		1,908		854		54		66		3		3,129
Provision charged to expenses	314			358		106		74		(6	)	67		913
Losses charged off	(234		)	(185	)	(127	)	(85	)	—		(119	)	(750	)
Recoveries	26			98		52		53		—		54		283
Balance, end of year	$	350		2,179		885		96		60		5		3,575

Individually evaluated for impairment	$	9		55		100		13		—		—		177
Collectively evaluated for impairment	341			1,832		785		83		60		5		3,106
Acquired credit impaired loans	—			292		—		—		—		—		292
Balance, end of year	$	350		2,179		885		96		60		5		3,575

The risk characteristics of LCNB's material loan portfolio segments were 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 year 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, 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 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 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 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.

The Company 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 the Company 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.

An analysis of the Company’s loan portfolio by credit quality indicators at December 31 is as follows (in thousands):



	Pass		OAEM	Substandard	Doubtful	Total
2018
Commercial & industrial	$	74,530	89	3,180	—	77,799
Commercial, secured by real estate	718,233		768	21,124	—	740,125
Residential real estate	344,432		—	5,106	—	349,538
Consumer	17,381		—	18	—	17,399
Agricultural	13,116		—	196	—	13,312
Other	450		—	—	—	450
Total	$	1,168,142	857	29,624	—	1,198,623

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

The Company evaluates the loan risk grading system definitions and allowance for loan loss methodology on an ongoing basis. No significant changes were made to either during the past year.

A loan portfolio aging analysis at December 31 is as follows (in thousands):



	30-59 Days Past Due		60-89 Days Past Due	Greater Than 90 Days	Total Past Due	Current	Total Loans Receivable	Total Loans Greater Than 90 Days and Accruing
2018
Commercial & industrial	$	626	173	—	799	77,000	77,799	—
Commercial, secured by real estate	347		141	347	835	739,290	740,125	—
Residential real estate	905		536	1,046	2,487	347,051	349,538	149
Consumer	14		—	—	14	17,385	17,399	—
Agricultural	19		—	178	197	13,115	13,312	—
Other	114		—	—	114	336	450	—
Total	$	2,025	850	1,571	4,446	1,194,177	1,198,623	149

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, for the years ended December 31 were as follows (in thousands):



	Recorded Investment		Unpaid Principal Balance	Related Allowance	Average Recorded Investment	Interest Income Recognized
2018
With no related allowance recorded:
Commercial & industrial	$	926	1,457	—	945	71
Commercial, secured by real estate	21,266		22,451	—	17,353	1,136
Residential real estate	4,122		4,872	—	3,580	258
Consumer	13		13	—	32	3
Agricultural	177		177	—	177	—
Other	336		475	—	379	41
Total	$	26,840	29,445	—	22,466	1,509

With an allowance recorded:
Commercial & industrial	$	264	269	10	279	17
Commercial, secured by real estate	150		150	3	153	11
Residential real estate	665		684	49	583	37
Consumer	23		23	—	24	1
Agricultural	—		—	—	—	—
Other	—		—	—	—	—
Total	$	1,102	1,126	62	1,039	66

Total:
Commercial & industrial	$	1,190	1,726	10	1,224	88
Commercial, secured by real estate	21,416		22,601	3	17,506	1,147
Residential real estate	4,787		5,556	49	4,163	295
Consumer	36		36	—	56	4
Agricultural	177		177	—	177	—
Other	336		475	—	379	41
Total	$	27,942	30,571	62	23,505	1,575



	Recorded Investment		Unpaid Principal Balance	Related Allowance	Average Recorded Investment	Interest Income Recognized
2017
With no related allowance recorded:
Commercial & industrial	$	1,015	1,100	—	685	88
Commercial, secured by real estate	12,677		13,608	—	14,113	1,068
Residential real estate	2,822		3,516	—	3,216	546
Consumer	6		6	—	20	2
Agricultural	177		177	—	269	12
Other	402		554	—	441	55
Total	$	17,099	18,961	—	18,744	1,771

With an allowance recorded:
Commercial & industrial	$	296	301	8	311	18
Commercial, secured by real estate	2,660		2,660	146	2,739	45
Residential real estate	553		572	29	596	19
Consumer	41		41	8	43	3
Agricultural	—		—	—	—	—
Other	—		—	—	—	—
Total	$	3,550	3,574	191	3,689	85

Total:
Commercial & industrial	$	1,311	1,401	8	996	106
Commercial, secured by real estate	15,337		16,268	146	16,852	1,113
Residential real estate	3,375		4,088	29	3,812	565
Consumer	47		47	8	63	5
Agricultural	177		177	—	269	12
Other	402		554	—	441	55
Total	$	20,649	22,535	191	22,433	1,856



	Average Recorded Investment		Interest Income Recognized
2016
With no related allowance recorded:
Commercial & industrial	$	998	151
Commercial, secured by real estate	15,274		1,140
Residential real estate	3,736		369
Consumer	37		29
Agricultural	392		136
Other	481		77
Total	$	20,918	1,902

With an allowance recorded:
Commercial & industrial	$	341	19
Commercial, secured by real estate	4,194		257
Residential real estate	651		36
Consumer	43		3
Agricultural	—		—
Other	—		—
Total	$	5,229	315

Total:
Commercial & industrial	$	1,339	170
Commercial, secured by real estate	19,468		1,397
Residential real estate	4,387		405
Consumer	80		32
Agricultural	392		136
Other	481		77
Total	$	26,147	2,217

Of the interest income recognized on impaired loans during 2018, 2017, and 2016, approximately $89,000, $28,000, and $51,000, respectively, were recognized on a cash basis. The Company continued to accrue interest on certain loans classified as impaired during 2018, 2017, and 2016 because they were restructured or considered well secured and in the process of collection.

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 troubled debt restructurings during the years ended December 31 were 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 and industrial	—	$	—	$	—	—	$	—	$	—
Commercial, secured by real estate	—	—		—		—	—		—
Residential real estate	3	505		505		1	18		9
Consumer	1	1		1		1	14		14
Totals	4	$	506	$	506	2	$	32	$	23

Post-modification balances of newly restructured troubled debt by type of modification for the years ended December 31 were as follows (in thousands):



	Term Modification		Rate Modification	Interest Only	Principal Forgiveness	Combination	Total Modifications
2018
Commercial & industrial	$	—	—	—	—	—	—
Commercial, secured by real estate	—		—	—	—	—	—
Residential real estate	380		—	—	—	125	505
Consumer	—		—	—	—	1	1
Total	$	380	—	—	—	126	506

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.

There were no troubled debt restructurings that subsequently defaulted within twelve months of the restructuring date for the years ended December 31, 2018 and 2016. 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.

All troubled debt restructurings are considered impaired loans. The allowance for loan loss on such restructured loans is based on the present value of future expected cash flows.

Information concerning the post-modification balances of loans that were modified during the year ended December 31 and that were determined to be troubled debt restructurings follows (in thousands):



	2018	2017
Impaired loans without a valuation allowance at the end of the period	380	—
Impaired loans with a valuation allowance at the end of the period	126	23

Mortgage 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 December 31, 2018 and 2017 were approximately $97,685,000 and $92,818,000, respectively.

Mortgage servicing right assets are included in core deposit and other intangibles in the consolidated balance sheets. Amortization of mortgage servicing rights is an adjustment to loan servicing income, which is included with other operating income in the consolidated statements of income. Activity in the mortgage servicing rights portfolio during the years ended December 31 was as follows (in thousands):



	2018			2017		2016
Balance, beginning of year	$	396		428		488
Amount obtained through a merger	91			—		—
Amount capitalized to mortgage servicing rights	113			91		109
Amortization of mortgage servicing rights	(125		)	(123	)	(169	)
Balance, end of year	$	475		396		428