Note 3 - Loans

Major classifications of loans at September 30, 2011 and December 31, 2010 are as follows (in thousands):

	September 30,		December 31,
	2011		2010

Commercial and industrial	$	32,156		36,122
Commercial, secured by real estate		204,174		196,136
Residential real estate		183,878		190,277
Consumer		16,047		19,691
Agricultural		3,245		2,966
Other loans, including deposit overdrafts		9,759		9,413
		449,259		454,605
Deferred net origination costs		277		386
		449,536		454,991
Less allowance for loan losses		3,241		2,641
Loans, net	$	446,295		452,350

Non-accrual, past-due, and restructured loans as of September 30, 2011 and December 31, 2010 were as follows (dollars in thousands):

	September 30,			December 31,
	2011			2010
Non-accrual loans	$	3,120			3,761
Past-due 90 days or more and still accruing		667			300
Restructured loans		9,605			9,088
Total	$	13,392			13,149
Percent to total loans		2.98	%		2.89	%

Non-accrual loans at September 30, 2011 decreased from the balance at December 31, 2010 primarily due to the receipt of a $594,000 guarantee payment on a Small Business Administration loan during the first quarter 2011. Restructured loans at September 30, 2011 increased from the balance at December 31, 2010 primarily due to the modification of two commercial real estate loans to the same borrower totaling $626,000 during the first quarter 2011.

Loans sold to and serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of those loans at September 30, 2011 and December 31, 2010 were $67,956,000 and $70,705,000, respectively. Loans sold to the Federal Home Loan Mortgage Corporation during the three and nine months ended September 30, 2011 totaled $2,173,000 and $4,871,000, respectively, and $9,958,000 and $12,512,000 during the three and nine months ended September 30, 2010, respectively.

The allowance for loan losses and recorded investment in loans for the nine months ended September 30 were as follows (in thousands):

	Commercial & Industrial			Commercial, Secured by Real Estate			Residential Real Estate			Consumer			Agricultural		Other			Unallocated		Total
September 30, 2011
Allowance for loan losses:
Balance, beginning of year	$	305			1,625			459			246			-		6			-		2,641
Provision charged to expenses		499			409			501			36			-		31			-		1,476
Losses charged off		(251	)		(203	)		(371	)		(183	)		-		(100	)		-		(1,108	)
Recoveries		-			30			28			105			-		69			-		232
Balance, end of period	$	553			1,861			617			204			-		6			-		3,241

Ending balance: individually evaluated for impairment	$	337			303			93			-			-		-			-		733
Ending balance: collectively evaluated for impairment		216			1,558			524			204			-		6			-		2,508

Loans:
Ending balance	$	32,156			204,174			183,878			16,047			3,245		9,759			-		449,259
Ending balance: individually evaluated for impairment		904			11,621			596			10			-		-			-		13,131
Ending balance: collectively evaluated for impairment		31,252			192,553			183,282			16,037			3,245		9,759			-		436,128

	Commercial & Industrial			Commercial, Secured by Real Estate			Residential Real Estate			Consumer			Agricultural		Other			Unallocated			Total
September 30, 2010
Allowance for loan losses:
Balance, beginning of year	$	546			1,628			491			313			-		9			11			2,998
Provision charged to expenses		(30	)		720			96			179			-		33			(11	)		987
Losses charged off		(289	)		(1,011	)		(111	)		(343	)		-		(109	)		-			(1,863	)
Recoveries		6			-			1			88			-		73			-			168
Balance, end of period	$	233			1,337			477			237			-		6			-			2,290

Ending balance: individually evaluated for impairment	$	-			210			-			-			-		-			-			210
Ending balance: collectively evaluated for impairment		233			1,127			477			237			-		6			-			2,080

Loans:
Ending balance	$	35,853			193,422			194,703			21,384			3,191		9,415			-			457,968
Ending balance: individually evaluated for impairment		947			10,712			533			-			-		-			-			12,192
Ending balance: collectively evaluated for impairment		34,906			182,710			194,170			21,384			3,191		9,415			-			445,776

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.

An analysis of LCNB's loan portfolio by credit quality indicators at September 30, 2011 and December 31, 2010 is as follows (in thousands):

	No Grade		Pass		OAEM		Substandard		Doubtful		Total
September 30, 2011
Commercial & industrial	$	1,094		26,975		1,101		2,408		578		32,156
Commercial, secured by real estate		2,831		189,346		1,292		8,592		2,113		204,174
Residential real estate		18,404		161,527		1,569		2,296		82		183,878
Consumer		405		15,504		-		117		21		16,047
Agricultural		373		1,472		-		1,400		-		3,245
Other		192		9,567		-		-		-		9,759
Total	$	23,299		404,391		3,962		14,813		2,794		449,259

December 31, 2010
Commercial & industrial	$	1,299		32,421		1,177		1,225		-		36,122
Commercial, secured by real estate		2,053		179,710		4,897		8,574		902		196,136
Residential real estate		17,346		170,900		264		1,702		65		190,277
Consumer		394		19,144		-		72		81		19,691
Agricultural		247		2,719		-		-		-		2,966
Other		116		9,297		-		-		-		9,413
Total	$	21,455		414,191		6,338		11,573		1,048		454,605

A loan portfolio aging analysis at September 30, 2011 and December 31, 2010 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

September 30, 2011
Commercial & industrial	$	-		-		578		578		31,578		32,156		578
Commercial, secured by real estate		-		110		2,113		2,223		201,951		204,174		-
Residential real estate		440		108		887		1,435		182,443		183,878		80
Consumer		118		102		9		229		15,818		16,047		9
Agricultural		-		-		-		-		3,245		3,245		-
Other		192		-		-		192		9,567		9,759		-
Total	$	750		320		3,587		4,657		444,602		449,259		667

December 31, 2010
Commercial & industrial	$	138		-		595		733		35,389		36,122		1
Commercial, secured by real estate		753		-		1,766		2,519		193,617		196,136		114
Residential real estate		482		36		698		1,216		189,061		190,277		110
Consumer		231		54		76		361		19,330		19,691		75
Agricultural		-		-		-		-		2,966		2,966		-
Other		5		-		-		5		9,408		9,413		-
Total	$	1,609		90		3,135		4,834		449,771		454,605		300

Impaired loans at September 30, 2011 and December 31, 2010 were as follows (in thousands):

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
September 30, 2011
With no related allowance recorded:
Commercial & industrial	$	-		-		-		-		-
Commercial, secured by real estate		6,897		6,897		-		7,009		216
Residential real estate		332		332		-		332		-
Consumer		1		1		-		1		-
Total		7,230		7,230		-		7,342		216

With an allowance recorded:
Commercial & industrial		567		904		337		1,181		44
Commercial, secured by real estate		4,421		4,724		303		4,943		117
Residential real estate		172		264		92		255		-
Consumer		8		9		1		5		-
Total		5,168		5,901		733		6,384		161

Total:
Commercial & industrial		567		904		337		1,181		44
Commercial, secured by real estate		11,318		11,621		303		11,952		333
Residential real estate		504		596		92		587		-
Consumer		9		10		1		6		-
Total	$	12,398		13,131		733		13,726		377

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
December 31, 2010
With no related allowance recorded:
Commercial & industrial	$	594		594		-		751		9
Commercial, secured by real estate		8,350		8,350		-		9,058		372
Residential real estate		533		533		-		534		-
Total		9,477		9,477		-		10,343		381

With an allowance recorded:
Commercial & industrial		356		476		120		693		29
Commercial, secured by real estate		2,974		3,150		176		3,403		142
Residential real estate		-		-		-		-		-
Total	$	3,330		3,626		296		4,096		171

Total:
Commercial & industrial	$	950		1,070		120		1,444		38
Commercial, secured by real estate		11,324		11,500		176		12,461		514
Residential real estate		533		533		-		534		-
Total	$	12,807		13,103		296		14,439		552

Non-accrual loans at September 30, 2011 and December 31, 2010 were as follows (in thousands):

	September 30, 2011		December 31, 2010

Commercial and industrial	$	-		595
Commercial, secured by real estate		2,113		2,377
Residential real estate		1,007		789
		3,120		3,761

Loan modifications that were classified as troubled debt restructurings during the three and nine months ended September 30, 2011 and 2010 were as follows (dollars in thousands):

	Three Months Ended September 30,								Nine Months Ended September 30,
	2011				2010				2011				2010
	Number of Loans		Balance at Modification		Number of Loans		Balance at Modification		Number of Loans		Balance at Modification		Number of Loans		Balance at Modification

Commercial and industrial		-	$	-		-	$	-		1	$	204		-	$	-
Commercial, secured by real estate		2		626		1		1,170		2		626		2		3,505
Residential real estate		-		-		-		-		5		64		-		-
Consumer		-		-		-		-		3		11		-		-
		2	$	626		1	$	1,170		11	$	905		2	$	3,505

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, 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.

Troubled debt restructurings that subsequently defaulted within twelve months of the restructuring date were as follows (dollars in thousands):

	Three Months Ended September 30,								Nine Months Ended September 30,
	2011				2010				2011				2010
	Number of Loans		Recorded Balance		Number of Loans		Recorded Balance		Number of Loans		Recorded Balance		Number of Loans		Recorded Balance

Commercial and industrial		-	$	-		-	$	-		-	$	-		1	$	595
Commercial, secured by real estate		-		-		-		-		-		-		1		750
		-	$	-		-	$	-		-	$	-		2	$	1,345

As a result of adopting the amendments in Accounting Standards Update No. 2011-02, “Receivables (Topic 310): A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring,” LCNB reassessed all restructurings that occurred on or after the beginning of the current fiscal year (January 1, 2011) for identification as troubled debt restructurings. LCNB identified as troubled debt restructurings certain receivables for which the allowance for credit losses had previously been measured under a general allowance for credit losses methodology. Upon identifying those receivables as troubled debt restructurings, LCNB identified them as impaired under the guidance in Section 310-10-35. The amendments in Accounting Standards Update No. 2011-02 require prospective application of the impairment measurement guidance in Section 310-10-35 for those receivables newly identified as impaired. At the end of the first interim period of adoption (September 30, 2011), the recorded investment in receivables for which the allowance for credit losses was previously measured under a general allowance for credit losses methodology and are now impaired under Section 310-10-35 was $192,000 and the allowance for credit losses associated with those receivables, on the basis of a current evaluation of loss, was $1,000.