LCNB Corp. - 10-Q quarterly report FY2012 Q2

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____________________ to _____________________

Commission File Number 000-26121

LCNB Corp.

(Exact name of registrant as specified in its charter)

Ohio		31-1626393
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

2 North Broadway, Lebanon, Ohio 45036

(Address of principal executive offices, including Zip Code)

(513) 932-1414

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

x Yes oNo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

x Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o	Accelerated filer x
Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

o Yes xNo

The number of shares outstanding of the issuer's common stock, without par value, as of August 6, 2012 was 6,720,907 shares.

LCNB CORP. AND SUBSIDIARIES

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION	2

Item 1. Financial Statements	2

CONSOLIDATED BALANCE SHEETS	2

CONSOLIDATED STATEMENTS OF INCOME	3

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME	4

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY	5

CONSOLIDATED STATEMENTS OF CASH FLOWS	6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS	7

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	35

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	36

Item 3. Quantitative and Qualitative Disclosures about Market Risks	46

Item 4. Controls and Procedures	47

PART II. OTHER INFORMATION	48

Item 1. Legal Proceedings	48

Item 1A. Risk Factors	48

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	48

Item 3. Defaults Upon Senior Securities	48

Item 4. Mine Safety Disclosures	48

Item 5. Other Information	48

Item 6. Exhibits	49

SIGNATURES	50

Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

	June 30,			December 31,
	2012			2011
ASSETS:	(Unaudited)
Cash and due from banks	$	16,928			12,449
Interest-bearing demand deposits		9,968			7,086
Total cash and cash equivalents		26,896			19,535

Investment securities:
Available-for-sale, at fair value		285,141			254,006
Held-to-maturity, at cost		11,474			10,734
Federal Reserve Bank stock, at cost		949			940
Federal Home Loan Bank stock, at cost		2,091			2,091
Loans, net		458,629			458,331
Premises and equipment, net		16,953			17,346
Goodwill		5,915			5,915
Bank owned life insurance		15,125			14,837
Other assets		8,402			7,835
TOTAL ASSETS	$	831,575			791,570

LIABILITIES:
Deposits:
Noninterest-bearing	$	117,813			106,793
Interest-bearing		592,843			556,769
Total deposits		710,656			663,562
Short-term borrowings		13,142			21,596
Long-term debt		20,391			21,373
Accrued interest and other liabilities		6,921			7,079
TOTAL LIABILITIES		751,110			713,610

SHAREHOLDERS’ EQUITY:
Preferred shares – no par value, authorized 1,000,000 shares, none outstanding		-			-
Common shares – no par value, authorized 12,000,000 shares, issued 7,474,269 and 7,460,494 shares at June 30, 2012 and December 31, 2011, respectively		26,952			26,753
Retained earnings		59,989			57,877
Treasury shares at cost, 753,627 and 755,771 shares at June 30, 2012 and December 31, 2011, respectively		(11,665	)		(11,698	)
Accumulated other comprehensive income, net of taxes		5,189			5,028
TOTAL SHAREHOLDERS’ EQUITY		80,465			77,960

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	831,575			791,570

The accompanying notes to consolidated financial statements are an integral part of these statements.

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LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share data)

(Unaudited)

	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2012		2011			2012		2011
INTEREST INCOME:
Interest and fees on loans	$	5,920		6,477			12,128		12,995
Interest on investment securities –
Taxable		982		914			1,869		1,790
Non-taxable		610		640			1,216		1,347
Other short-term investments		59		68			89		97
TOTAL INTEREST INCOME		7,571		8,099			15,302		16,229

INTEREST EXPENSE:
Interest on deposits		1,117		1,499			2,282		3,083
Interest on short-term borrowings		5		7			8		17
Interest on long-term debt		150		161			304		339
TOTAL INTEREST EXPENSE		1,272		1,667			2,594		3,439
NET INTEREST INCOME		6,299		6,432			12,708		12,790
PROVISION FOR LOAN LOSSES		91		224			306		888

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		6,208		6,208			12,402		11,902

NON-INTEREST INCOME:
Trust income		473		536			1,239		1,019
Service charges and fees on deposit accounts		909		952			1,787		1,853
Net gain on sales of securities		79		124			459		419
Bank owned life insurance income		139		148			287		294
Gains from sales of mortgage loans		102		24			209		57
Other operating income		53		51			110		108
TOTAL NON-INTEREST INCOME		1,755		1,835			4,091		3,750

NON-INTEREST EXPENSE:
Salaries and employee benefits		2,963		2,955			5,945		6,007
Equipment expenses		264		240			526		457
Occupancy expense, net		390		407			797		862
State franchise tax		196		196			402		392
Marketing		169		110			280		225
FDIC insurance premiums		104		188			215		468
Other non-interest expense		1,244		1,211			2,613		2,681
TOTAL NON-INTEREST EXPENSE		5,330		5,307			10,778		11,092
INCOME BEFORE INCOME TAXES		2,633		2,736			5,715		4,560
PROVISION FOR INCOME TAXES		646		713			1,451		1,059
INCOME FROM CONTINUING OPERATIONS		1,987		2,023			4,264		3,501
INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAX		-		(31	)		-		793
NET INCOME	$	1,987		1,992			4,264		4,294

Dividends declared per common share	$	0.16		0.16			0.32		0.32

Basic earnings per common share:
Continuing operations	$	0.30		0.30			0.64		0.52
Discontinued operations		-		-			-		0.12

Diluted earnings per common share:
Continuing operations	$	0.29		0.30			0.63		0.52
Discontinued operations		-		-			-		0.12

Weighted average common shares outstanding:
Basic		6,713,847		6,689,743			6,710,062		6,689,743
Diluted		6,789,776		6,746,791			6,781,614		6,744,375

The accompanying notes to consolidated financial statements are an integral part of these statements.

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LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2012			2011			2012			2011

Net Income	$	1,987			1,992			4,264			4,294

Other comprehensive income:

Net unrealized gain on available-for-sale securities (net of taxes of $490 and $926 for the three months ended June 30, 2012 and 2011, respectively, and $231 and $696 for the six months ended June 30, 2012 and 2011, respectively)		954			1,798			449			1,351

Reclassification adjustment for net realized gain on sale of available-for-sale securities included in net income (net of taxes of $26 and $42 for the three months ended June 30, 2012 and 2011, respectively, and $155 and $143 for the six months ended June 30, 2012 and 2011, respectively)		(53	)		(82	)		(304	)		(276	)

Change in nonqualified pension plan unrecognized net gain (loss) and unrecognized prior service cost (net of taxes of $3 and $1 for the three months ended June 30, 2012 and 2011, respectively, and $8 and $2 for the six months ended June 30, 2012 and 2011, respectively)		9			(1	)		16			4

Nonqualified pension plan curtailment (net of taxes of $80)		-			-			-			155

TOTAL COMPREHENSIVE INCOME	$	2,897			3,707			4,425			5,528

The accompanying notes to consolidated financial statements are an integral part of these statements.

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LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(Dollars in thousands, except per share amounts)

(Unaudited)

	Common Shares Outstanding		Common Stock		Retained Earnings			Treasury Shares			Accumulated Other Comprehensive Income			Total Shareholders’ Equity

Balance December 31, 2010		6,689,743	$	26,515		54,045			(11,698	)		1,845			70,707
Net income						4,294									4,294
Net unrealized gain (loss) on available-for-sale securities, net of taxes												1,351			1,351
Reclassification adjustment for net realized gain on sale of available-for-sale securities included in net income, net of taxes												(276	)		(276	)
Change in nonqualified pension plan unrecognized net gain (loss) and unrecognized prior service cost, net of taxes												4			4
Nonqualified pension plan curtailment entry, net of taxes												155			155
Compensation expense relating to stock options				22											22
Common stock dividends, $0.32 per share						(2,141	)								(2,141	)
Balance June 30, 2011		6,689,743	$	26,537		56,198			(11,698	)		3,079			74,116

Balance December 31, 2011		6,704,723	$	26,753		57,877			(11,698	)		5,028			77,960
Net income						4,264									4,264
Net unrealized gain (loss) on available-for-sale securities, net of taxes												449			449
Reclassification adjustment for net realized gain on sale of available-for-sale securities included in net income, net of taxes												(304	)		(304	)
Change in nonqualified pension plan unrecognized net gain (loss) and unrecognized prior service cost, net of taxes												16			16
Dividend Reinvestment and Stock Purchase Plan		13,775		179											179
Exercise of stock options		2,144				(5	)		33						28
Compensation expense relating to stock options				20											20
Common stock dividends, $0.32 per share						(2,147	)								(2,147	)
Balance June 30, 2012		6,720,642	$	26,952		59,989			(11,665	)		5,189			80,465

The accompanying notes to consolidated financial statements are an integral part of these statements.

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LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)


	Six Months Ended
	June 30,
	2012			2011
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	4,264			4,294
Adjustments to reconcile net income to net cash flows from operating activities:
Depreciation, amortization, and accretion		1,558			1,351
Provision for loan losses		306			888
Curtailment charge for nonqualified defined benefit retirement plan		-			191
Increase in cash surrender value of bank owned life insurance		(287	)		(294	)
Realized (gain) loss from sales of securities available-for-sale		(459	)		(419	)
Realized (gain) loss from sales of premises and equipment		-			(5	)
Realized gain from sale of insurance agency		-			(1,503	)
Realized (gain) loss from sales and write-downs of other real estate owned and repossessed assets		80			(31	)
Origination of mortgage loans for sale		(11,394	)		(2,698	)
Realized gains from sales of mortgage loans		(209	)		(57	)
Proceeds from sales of mortgage loans		11,486			2,726
Compensation expense related to stock options		20			22
Changes in:
Accrued income receivable		(122	)		21
Other assets		22			57
Other liabilities		(218	)		(335	)
TOTAL ADJUSTMENTS		783			(86	)
NET CASH FLOWS FROM OPERATING ACTIVITIES		5,047			4,208

CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of investment securities available-for-sale		31,484			18,982
Proceeds from maturities and calls of investment securities:
Available-for-sale		16,680			15,729
Held-to-maturity		1,442			2,628
Purchases of investment securities:
Available-for-sale		(79,400	)		(48,203	)
Held-to-maturity		(2,182	)		(1,730	)
Purchase of Federal Reserve Bank stock		(8	)		(2	)
Net (increase) decrease in loans		(1,212	)		(3,281	)
Proceeds from sale of other real estate owned and repossessed assets		20			148
Purchases of premises and equipment		(212	)		(1,692	)
Additions to other real owned		(16	)		-
Proceeds from sales of premises and equipment		-			13
Proceeds from sale of insurance agency, net of cash disposed		-			1,523
NET CASH FLOWS FROM INVESTING ACTIVITIES		(33,404	)		(15,885	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits		47,094			40,212
Net increase (decrease) in short-term borrowings		(8,454	)		(9,493	)
Proceeds from long-term debt		-			5,000
Principal payments on long-term debt		(982	)		(6,059	)
Proceeds from issuance of common stock		30			-
Proceeds from exercise of stock options		28			-
Cash dividends paid on common stock		(1,998	)		(2,141	)
NET CASH FLOWS FROM FINANCING ACTIVITIES		35,718			27,519

NET CHANGE IN CASH AND CASH EQUIVALENTS		7,361			15,842

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		19,535			10,999
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	26,896			26,841

SUPPLEMENTAL CASH FLOW INFORMATION:
CASH PAID DURING THE YEAR FOR:
Interest	$	2,655			3,514
Income taxes		1,125			1,714

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES:
Transfer from loans to other real estate owned and repossessed assets		564			229

The accompanying notes to consolidated financial statements are an integral part of these statements.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 - Basis of Presentation

Substantially all of the assets, liabilities and operations of LCNB Corp. ("LCNB") are attributable to its wholly-owned subsidiary, LCNB National Bank (the "Bank"). The accompanying unaudited consolidated financial statements include the accounts of LCNB and the Bank. LCNB completed the sale of its subsidiary, Dakin Insurance Agency, Inc. (“Dakin”) on March 23, 2011. The financial results of Dakin are included as income from discontinued operations, net of tax, in the accompanying unaudited consolidated financial statements through the date of sale.

The unaudited interim consolidated financial statements, which have been reviewed by J.D. Cloud & Co. L.L.P., LCNB’s independent registered public accounting firm, in accordance with standards established by the Public Company Accounting Oversight Board, as indicated by their report included herein and which does not express an opinion on those statements, have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and the rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, the unaudited interim consolidated financial statements include all adjustments (consisting of normal, recurring accruals) considered necessary for a fair presentation of financial position, results of operations, and cash flows for the interim periods, as required by Regulation S-X, Rule 10-01.

Certain prior period data presented in the financial statements have been reclassified to conform with the current year presentation.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of the results to be expected for the full year ending December 31, 2012. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements, accounting policies, and financial notes thereto included in LCNB's 2011 Annual Report on Form 10-K filed with the SEC.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 2 - Investment Securities

The amortized cost and estimated fair value of available-for-sale investment securities at June 30, 2012 and December 31, 2011 are summarized as follows (in thousands):

	June 30, 2012
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
U.S. Treasury notes	$	20,848		321		-		21,169
U.S. Agency notes		99,700		1,577		35		101,242
U.S. Agency mortgage-backed securities		56,814		1,498		15		58,297
Corporate securities		6,280		53		1		6,332
Municipal securities:
Non-taxable		69,854		3,427		48		73,233
Taxable		19,983		1,195		-		21,178
Mutual funds		2,118		35		-		2,153
Trust preferred securities		498		26		9		515
Equity securities		977		78		33		1,022
	$	277,072		8,210		141		285,141

	December 31, 2011
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value

U.S. Treasury notes	$	17,385		165		-		17,550
U.S. Agency notes		81,415		1,517		5		82,927
U.S. Agency mortgage-backed securities		50,923		1,475		111		52,287
Corporate securities		6,334		47		16		6,365
Municipal securities:
Non-taxable		65,896		3,827		20		69,703
Taxable		21,027		894		14		21,907
Mutual fund		2,103		22		-		2,125
Trust preferred securities		549		37		22		564
Equity securities		526		57		5		578
	$	246,158		8,041		193		254,006

The fair value of held-to-maturity investment securities, consisting of taxable and non-taxable municipal securities, approximates amortized cost at June 30, 2012 and December 31, 2011.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 2 - Investment Securities (continued)

Information concerning available-for-sale investment securities with gross unrealized losses at June 30, 2012, aggregated by length of time that individual securities have been in a continuous loss position, is as follows (in thousands):

	Less than Twelve Months				Twelve Months or Greater
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses

U.S. Treasury notes	$	-		-		-		-
U.S. Agency notes		16,819		35		-		-
U.S. Agency mortgage-backed securities		4,355		15		-		-
Corporate securities		2,192		1		-		-
Municipal securities:
Non-taxable		5,272		30		2,148		18
Taxable		-		-		-		-
Mutual fund		-		-		-		-
Trust preferred securities		99		1		141		8
Equity securities		415		28		59		5
	$	29,152		110		2,348		31

Management has determined that the unrealized losses at June 30, 2012 are primarily due to fluctuations in market interest rates and do not reflect credit quality deterioration of the securities. Because LCNB does not have the intent to sell the investments and it is more likely than not that LCNB will not be required to sell the investments before recovery of their amortized cost bases, which may be at maturity, LCNB does not consider these investments to be other-than-temporarily impaired.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 3 - Loans

Major classifications of loans at June 30, 2012 and December 31, 2011 are as follows (in thousands):

	June 30,		December 31,
	2012		2011

Commercial and industrial	$	25,350		30,990
Commercial, secured by real estate		230,285		219,188
Residential real estate		187,752		186,904
Consumer		12,498		14,562
Agricultural		1,641		2,835
Other loans, including deposit overdrafts		3,922		6,554
		461,448		461,033
Deferred net origination costs		133		229
		461,581		461,262
Less allowance for loan losses		2,952		2,931
Loans, net	$	458,629		458,331

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 3 – Loans (continued)

Non-accrual, past-due, and accruing restructured loans as of June 30, 2012 and December 31, 2011 are as follows (in thousands):

	June 30,			December 31,
	2012			2011
Non-accrual loans:
Commercial and industrial	$	243			495
Commercial, secured by real estate		1,007			1,950
Residential real estate		1,998			1,223
Total non-accrual loans		3,248			3,668
Past-due 90 days or more and still accruing		73			39
Total non-accrual and past-due 90 days or more and still accruing		3,321			3,707
Accruing restructured loans		13,447			14,739
Total	$	16,768			18,446

Percentage of total non-accrual and past-due 90 days or more and still accruing to total loans		0.72	%		0.80	%

Percentage of total non-accrual, past-due 90 days or more and still accruing, and accruing restructured loans to total loans		3.63	%		4.00	%

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 June 30, 2012 and December 31, 2011 are $68,938,000 and $67,410,000, respectively. Loans sold to the Federal Home Loan Mortgage Corporation during the three and six months ended June 30, 2012 totaled $5,528,000 and $11,394,000, respectively, and $976,000 and $2,698,000 during the three and six months ended June 30, 2011, respectively.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 3 – Loans (continued)

The allowance for loan losses and recorded investment in loans for the six months ended June 30 are as follows (in thousands)

	Commercial & Industrial			Commercial Real Estate			Residential Real Estate			Consumer			Agricultural		Other			Total
2012
Allowance for loan losses:
Balance, beginning of year	$	162			1,941			656			166			-		6			2,931
Provision charged to expenses		(10	)		(77	)		422			(39	)		-		10			306
Losses charged off		-			(206	)		(153	)		(57	)		-		(40	)		(456	)
Recoveries		-			71			7			68			-		25			171
Balance, end of period	$	152			1,729			932			138			-		1			2,952

Ending balance:
Individually evaluated for impairment	$	-			83			378			-			-		-			461
Collectively evaluated for impairment		152			1,646			554			138			-		1			2,491
Totals	$	152			1,729			932			138			-		1			2,952

Loans:
Ending balance:
Individually evaluated for impairment	$	242			10,232			5,614			8			-		-			16,096
Collectively evaluated for impairment		25,087			219,866			182,380			12,589			1,641		3,922			445,485
Totals	$	25,329			230,098			187,994			12,597			1,641		3,922			461,581

2011
Allowance for loan losses:
Balance, beginning of year	$	305			1,625			459			246			-		6			2,641
Provision charged to expenses		321			279			250			23			-		15			888
Losses charged off		(251	)		-			(132	)		(138	)		-		(58	)		(579	)
Recoveries		-			30			4			82			-		43			159
Balance, end of period	$	375			1,934			581			213			-		6			3,109

Ending balance:
Individually evaluated for impairment	$	133			341			82			-			-		-			556
Collectively evaluated for impairment		242			1,593			499			213			-		6			2,553
Totals	$	375			1,934			581			213			-		6			3,109

Loans:
Ending balance:
Individually evaluated for impairment	$	780			11,920			533			-			-		-			13,233
Collectively evaluated for impairment		32,713			194,939			187,248			17,113			2,844		9,466			444,323
Totals	$	33,493			206,859			187,781			17,113			2,844		9,466			457,556

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Note 3 – Loans (continued)

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.

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Note 3 – Loans (continued)

A breakdown of the loan portfolio by credit quality indicators at June 30, 2012 and December 31, 2011 is as follows (in thousands):

	Pass		OAEM		Substandard		Doubtful		Total
June 30, 2012
Commercial & industrial	$	22,146		2,526		657		-		25,329
Commercial, secured by real estate		219,325		2,236		8,537		-		230,098
Residential real estate		178,178		2,632		7,184		-		187,994
Consumer		12,540		-		57		-		12,597
Agricultural		1,637		-		4		-		1,641
Other		3,922		-		-		-		3,922
Total	$	437,748		7,394		16,439		-		461,581

December 31, 2011
Commercial & industrial	$	26,099		1,700		2,804		370		30,973
Commercial, secured by real estate		206,728		2,133		9,633		568		219,062
Residential real estate		182,409		1,681		2,682		376		187,148
Consumer		14,601		-		50		39		14,690
Agricultural		1,430		-		1,405		-		2,835
Other		6,554		-		-		-		6,554
Total	$	437,821		5,514		16,574		1,353		461,262

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Note 3 – Loans (continued)

A loan portfolio aging analysis at June 30, 2012 and December 31, 2011 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

June 30, 2012
Commercial & industrial	$	-		-		242		242		25,087		25,329		-
Commercial, secured by real estate		468		81		1,007		1,556		228,542		230,098		-
Residential real estate		617		411		2,038		3,066		184,928		187,994		39
Consumer		71		20		34		125		12,472		12,597		34
Agricultural		-		-		-		-		1,641		1,641		-
Other		45		-		-		45		3,877		3,922		-
Total	$	1,201		512		3,321		5,034		456,547		461,581		73

December 31, 2011
Commercial & industrial	$	2		-		495		497		30,476		30,973		-
Commercial, secured by real estate		-		83		1,769		1,852		217,210		219,062		-
Residential real estate		1,132		22		1,202		2,356		184,792		187,148		-
Consumer		82		37		39		158		14,532		14,690		39
Agricultural		-		-		-		-		2,835		2,835		-
Other		59		-		-		59		6,495		6,554		-
Total	$	1,275		142		3,505		4,922		456,340		461,262		39

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Note 3 – Loans (continued)

Impaired loans at June 30, 2012 and December 31, 2011 are as follows (in thousands):

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
June 30, 2012
With no related allowance recorded:
Commercial & industrial	$	243		572		-		2,054		43
Commercial real estate		12,920		13,364		-		12,326		229
Residential real estate		521		521		-		398		1
Consumer		8		8		-		8		-
Total	$	13,692		14,465		-		14,786		273

With an allowance recorded:
Commercial & industrial	$	170		170		-		172		3
Commercial real estate		1,502		1,591		142		1,795		26
Residential real estate		733		733		319		717		1
Consumer		-		-		-		1		-
Total	$	2,405		2,494		461		2,685		30

Total:
Commercial & industrial	$	413		742		-		2,226		46
Commercial real estate		14,422		14,955		142		14,121		255
Residential real estate		1,254		1,254		319		1,115		2
Consumer		8		8		-		9		-
Total	$	16,097		16,959		461		17,471		303

December 31, 2011
With no related allowance recorded:
Commercial & industrial	$	2,881		3,211		-		3,015		139
Commercial real estate		12,373		12,587		-		12,686		529
Residential real estate		332		332		-		332		-
Consumer		8		8				5		1
Total	$	15,594		16,138		-		16,038		669

With an allowance recorded:
Commercial & industrial	$	177		177		-		330		14
Commercial real estate		2,120		3,136		257		2,514		67
Residential real estate		264		264		142		257		-
Consumer		2		2		-		1		-
Total	$	2,563		3,579		399		3,102		81

Total:
Commercial & industrial	$	3,058		3,388		-		3,345		153
Commercial real estate		14,493		15,723		257		15,200		596
Residential real estate		596		596		142		589		-
Consumer		10		10		-		6		1
Total	$	18,157		19,717		399		19,140		750

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Note 3 – Loans (continued)

Loan modifications that were classified as troubled debt restructurings during the three and six months ended June 30, 2012 and 2011 are as follows (dollars in thousands):

	Three Months Ended June 30,								Six Months Ended June 30,
	2012				2011				2012				2011
	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		625
Residential real estate		1		143		-		-		2		173		-		-
Consumer		-		-		2		9		-		-		3		11
		1		143		2	$	9		2		173		6	$	840

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 or six months ended June 30, 2012 and 2011.

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Note 4 – Other Real Estate Owned

Other real estate owned includes property acquired through foreclosure or deed-in-lieu of foreclosure and also includes property deemed to be in-substance foreclosed and are included in “other assets” in the consolidated balance sheets. Changes in other real estate owned are as follows (in thousands):

	Six Months Ended
	June 30,
	2012		2011
Balance, beginning of year	$	1,619		2,088
Additions		580		-
Reductions due to valuation write downs		76		-
Balance, end of period	$	2,123		2,088

Other real estate owned at June 30, 2012 and December 31, 2011 consisted of (dollars in thousands):

	June 30, 2012				December 31, 2011
	Number		Balance		Number		Balance

Commercial real estate		2	$	2,063		1	$	1,579
Residential real estate		2		60		1		40
		4	$	2,123		2	$	1,619

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Note 5 – Borrowings

Funds borrowed from the Federal Home Loan Bank of Cincinnati at June 30, 2012 and December 31, 2011 are as follows (dollars in thousands):

	Current
	Interest			June 30,		December 31,
	Rate			2012		2011

Fixed Rate Advances, due at maturity:
Advance due August 2012		1.99	%	$	6,000		6,000
Advance due January 2015		2.00	%		5,000		5,000
Advance due March 2017		5.25	%		5,000		5,000

Fixed Rate Advances, with monthly principal and interest payments:
Advance due March 2014		2.45	%		1,820		2,326
Advance due March 2019		2.82	%		2,571		3,047
				$	20,391		21,373

All advances from the Federal Home Loan Bank of Cincinnati are secured by a blanket pledge of LCNB’s 1-4 family first lien mortgage loans in the amount of approximately $145 million and $147 million at June 30, 2012 and December 31, 2011, respectively. Additionally, LCNB is required to hold minimum levels of FHLB stock, based on the outstanding borrowings.

Short-term borrowings at June 30, 2012 and December 31, 2011 are as follows (dollars in thousands):

	June 30, 2012					December 31, 2011
	Amount		Rate			Amount		Rate
FHLB short-term advance	$	-		-	%		12,000		0.04	%
Repurchase agreements		13,142		0.10	%		9,596		0.10	%
	$	13,142		0.10	%		21,596		0.07	%

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Note 6 – Income Taxes

A reconciliation between the statutory income tax and LCNB's effective tax rate follows:

	For the three months ended June 30,						For the six months ended June 30,
	2012			2011			2012			2011

Statutory tax rate		34.0	%		34.0	%		34.0	%		34.0	%
Increase (decrease) resulting from:
Tax exempt interest		(7.6	)%		(7.6	)%		(6.9	)%		(9.5	)%
Tax exempt income on bank owned life insurance		(1.8	)%		(1.8	)%		(1.7	)%		(2.2	)%
Other, net		(0.1	)%		1.5	%		-	%		0.9	%
Effective tax rate		24.5	%		26.1	%		25.4	%		23.2	%

Note 7 - Commitments and Contingent Liabilities

LCNB is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments included commitments to extend credit. They involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. Exposure to credit loss in the event of nonperformance by the other parties to financial instruments for commitments to extend credit is represented by the contract amount of those instruments.

LCNB offers the Bounce Protection product, a customer deposit overdraft program, which is offered as a service and does not constitute a contract between the customer and LCNB.

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Note 7 – Commitments and Contingent Liabilities (continued)

LCNB uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Financial instruments whose contract amounts represent off-balance-sheet credit risk at June 30, 2012 and December 31, 2011 are as follows (in thousands):

	June 30,		December 31,
	2012		2011
Commitments to extend credit:
Commercial loans	$	1,332		3,227
Other loans
Fixed rate		2,560		1,391
Adjustable rate		1,194		2,099
Unused lines of credit:
Fixed rate		3,750		3,883
Adjustable rate		51,966		55,274
Unused Bounce Protection amounts on demand and NOW accounts		9,772		9,810
Standby letters of credit		5,575		5,575
	$	76,149		81,259

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Unused lines of credit include amounts not drawn in line of credit loans. Commitments to extend credit and unused lines of credit generally have fixed expiration dates or other termination clauses.

Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. At June 30, 2012 and December 31, 2011, outstanding guarantees of approximately $546,000 and $546,000, respectively, were issued to developers and contractors. These guarantees generally are fully secured and have varying maturities. In addition, LCNB has a participation in four letters of credit securing payment of principal and interest on a bond issue. The participation amounts at June 30, 2012 and December 31, 2011 totaled approximately $5.0 million. The letters of credit have a final maturity date of July 15, 2014, as extended.

LCNB evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation of the borrower. Collateral held varies, but may include accounts receivable; inventory; property, plant and equipment; residential realty; and income-producing commercial properties.

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Note 7 – Commitments and Contingent Liabilities (continued)

Capital expenditures include the construction or acquisition of new office buildings, improvements to existing offices, purchases of furniture and equipment, and additions or improvements to LCNB’s information technology system. Commitments for capital expenditures outstanding as of June 30, 2012 totaled approximately $70,000.

Management believes that LCNB has sufficient liquidity to fund its lending and capital expenditure commitments.

LCNB and its subsidiary are parties to various claims and proceedings arising in the normal course of business. Management, after consultation with legal counsel, believes that the liabilities, if any, arising from such proceedings and claims will not be material to the consolidated financial position or results of operations.

Note 8 – Regulatory Capital

The Bank and LCNB are required by regulators to meet certain minimum levels of capital adequacy. These are expressed in the form of certain ratios. Capital is separated into Tier 1 capital (essentially shareholders' equity less goodwill and other intangibles) and Tier 2 capital (essentially the allowance for loan losses limited to 1.25% of risk-weighted assets). The first two ratios, which are based on the degree of credit risk in LCNB's assets, provide for weighting assets based on assigned risk factors and include off-balance sheet items such as loan commitments and stand-by letters of credit. The ratio of Tier 1 capital to risk-weighted assets must be at least 4.0% and the ratio of Total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8.0%. The capital leverage ratio supplements the risk-based capital guidelines. Banks are required to maintain a minimum ratio of Tier 1 capital to adjusted quarterly average total assets of 3.0%.

For various regulatory purposes, financial institutions are classified into categories based upon capital adequacy. The highest "well-capitalized" category requires capital ratios of at least 10% for total risk-based, 6% for Tier 1 risk-based, and 5% for leverage. As of the most recent notification from their regulators, The Bank and LCNB were categorized as "well-capitalized" under the regulatory framework for prompt corrective action. Management believes that no conditions or events have occurred since the last notification that would change the Bank's or LCNB's category.

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Note 8 – Regulatory Capital (continued)

A summary of the regulatory capital and capital ratios of LCNB follows (dollars in thousands):

	At June 30,			At December 31,
	2012			2011
Regulatory Capital:
Shareholders' equity	$	80,465			77,960
Goodwill and other intangibles		(6,044	)		(6,071	)
Accumulated other comprehensive (income) loss		(5,190	)		(5,028	)
Tier 1 risk-based capital		69,231			66,861

Eligible allowance for loan losses		2,952			2,931
Total risk-based capital	$	72,183			69,792

Capital ratios:
Total risk-based (required 8.00%)		14.86	%		14.54	%
Tier 1 risk-based (required 4.00%)		14.25	%		13.93	%
Leverage (required 3.00%)		8.65	%		8.51	%

Note 9 – Employee Benefits

LCNB participates in a noncontributory defined benefit retirement multi-employer plan that covers substantially all regular full-time employees hired before January 1, 2009.

Employees of LCNB also participate in a defined contribution retirement plan. Employees hired on or after January 1, 2009 receive a 50% employer match on their contributions into the 401(k) plan, up to a maximum LCNB contribution of 3% of each individual employee’s annual compensation. Employees hired before January 1, 2009 who received a benefit reduction under certain amendments to the defined benefit retirement plan receive an automatic contribution of 5% or 7% of annual compensation, depending on the sum of an employee’s age and vesting service, into the 401(k) plan, regardless of the contributions made by the employees. This contribution is made annually and these employees do not receive any employer matches to their 401(k) contributions.

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Note 9 – Employee Benefits (continued)

Funding and administrative costs of the qualified noncontributory defined benefit retirement plan and 401(k) plan charged to pension and other employee benefits in the consolidated statements of income for the three and six-month periods ended June 30, 2012 and 2011 are as follows (in thousands):

	For the Three Months				For the Six Months
	Ended June 30,				Ended June 30,
	2012		2011		2012		2011

Qualified noncontributory defined benefit retirement plan	$	149		134		291		258

401(k) plan		74		82		110		157

Certain highly compensated employees participate in a nonqualified defined benefit retirement plan. The nonqualified plan ensures that participants receive the full amount of benefits to which they would have been entitled under the noncontributory defined benefit retirement plan in the absence of limits on benefit levels imposed by certain sections of the Internal Revenue Code.

The components of net periodic pension cost of the nonqualified defined benefit retirement plan for the three and six months ended June 30, 2012 and 2011 are summarized as follows (in thousands):

	Three Months Ended June 30,					Six Months Ended June 30,
	2012		2011			2012		2011
Service cost	$	22		22			44		66
Interest cost		11		8			22		17
Amortization of unrecognized net (gain) loss		5		(8	)		10		(12	)
Amortization of unrecognized prior service cost		7		7			14		18
Net periodic pension cost	$	45		29			90		89

Amounts recognized in accumulated other comprehensive income, net of deferred federal income taxes, at June 30, 2012 and December 31, 2011 for the nonqualified defined benefit retirement plan consists of (in thousands):

	June 30,		December 31,
	2012		2011
Net actuarial loss	$	142		156
Past service cost		64		74
	$	206		230

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Note 10 - Stock Based Compensation

LCNB established an Ownership Incentive Plan (the "Plan") during 2002 that allows for stock-based awards to eligible employees, as determined by the Board of Directors. The awards may be in the form of stock options, share awards, and/or appreciation rights. The Plan provides for the issuance of up to 200,000 shares.

Options granted to date vest ratably over a five year period and expire ten years after the date of grant. Stock options outstanding at June 30, 2012 are as follows:

	Outstanding Stock Options						Exercisable Stock Options
Exercise Price Range	Number		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)		Number		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)

$9.00 - $10.99		29,110	$	9.00		5.8		18,964	$	9.00		5.3
$11.00 - $12.99		74,290		12.03		7.2		29,159		12.01		5.0
$13.00 - $14.99		8,912		13.09		0.5		8,912		13.09		0.5
$17.00 - $18.99		24,158		18.16		2.7		24,158		18.16		2.7
		136,470		12.54		5.6		81,193		13.25		3.9

The following table summarizes stock option activity for the periods indicated:

	2012					2011
	Options			Weighted Average Exercise Price		Options		Weighted Average Exercise Price
Outstanding, January 1		124,123		$	12.54		99,040	$	12.71
Granted		14,491			12.60		25,083		11.85
Exercised		(2,144	)		13.09		-		-
Outstanding, June 30		136,470			12.54		124,123		12.54
Exercisable, June 30		81,193			13.25		57,746		14.06

The aggregate intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) for options outstanding at June 30, 2012 that were “in the money” (market price greater than exercise price) was $225,000. The aggregate intrinsic value at that date for only the options that were exercisable was $123,000. The aggregate intrinsic value for options outstanding at June 30, 2011 that were in the money was $95,000 and the aggregate intrinsic value at that date for only the options that were exercisable was $36,000. The intrinsic value changes based on changes in the market value of LCNB’s stock.

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Note 10 - Stock Based Compensation (continued)

The fair value of options granted is estimated at the date of grant using the Black-Scholes option-pricing model. The following table shows the estimated weighted-average fair value of options granted and the assumptions used in calculating that value for the years indicated:

	2012			2011
Estimated weighted-average fair value of options granted	$	2.80		$	2.09
Risk-free interest rate		0.84	%		2.84	%
Average dividend	$	0.64		$	0.64
Volatility factor of the expected market price of LCNB's common stock		39.56	%		27.37	%
Average life in years		6.5			6.5

Total expense related to options included in salaries and employee benefits in the consolidated statements of income for the three and six months ended June 30, 2012 were $11,000 and $20,000, respectively, and $11,000 and $22,000 for the three and six months ended June 30, 2011, respectively.

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Note 11 - Earnings per Common Share

Basic earnings per common share is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is adjusted for the dilutive effects of stock options, warrant, and restricted stock. The diluted average number of common shares outstanding has been increased for the assumed exercise of stock options, warrant, and restricted stock with proceeds used to purchase treasury shares at the average market price for the period. The computations are as follows for the three and six months ended June 30, 2012 and 2011 (dollars in thousands, except share and per share data):

	For the Three Months					For the Six Months
	Ended June 30,					Ended June 30,
	2012		2011			2012		2011

Income from continuing operations	$	1,987		2,023			4,264		3,501
Income from discontinued operations, net of tax		-		(31	)		-		793
Net income	$	1,987		1,992			4,264		4,294

Weighted average number of shares outstanding used in the calculation of basic earnings per common share		6,713,847		6,689,743			6,710,062		6,689,743

Add dilutive effect of:
Stock options		9,606		4,476			8,292		4,188
Stock warrant		66,323		52,572			63,260		50,444
		75,929		57,048			71,552		54,632

Adjusted weighted average number of shares outstanding used in the calculation of diluted earnings per common share		6,789,776		6,746,791			6,781,614		6,744,375

Basic earnings per common share:
Continuing operations	$	0.30		0.30			0.64		0.52
Discontinued operations		-		-			-		0.12

Diluted earnings per common share:
Continuing operations	$	0.29		0.30			0.63		0.52
Discontinued operations		-		-			-		0.12

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 12 - Fair Value of Financial Instruments

LCNB measures certain assets at fair value using various valuation techniques and assumptions, depending on the nature of the asset. Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.

The inputs to valuation techniques used to measure fair value are assigned to one of three broad levels:

Level 1 – quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the reporting date.

Level 2 – inputs other than quoted prices included within level 1 that are observable for the asset or liability either directly or indirectly. Level 2 inputs may include quoted prices for similar assets in active markets, quoted prices for identical assets or liabilities in markets that are not active, inputs other than quoted prices (such as interest rates or yield curves) that are observable for the asset or liability, and inputs that are derived from or corroborated by observable market data.

Level 3 - inputs that are unobservable for the asset or liability.

The majority of LCNB’s financial debt securities are classified as available-for-sale. The securities are reported at fair value with unrealized holding gains and losses reported net of income taxes in accumulated other comprehensive income.

LCNB utilizes a pricing service for determining the fair values of most of its investment securities. Fair value for U.S. Treasury notes and corporate securities are determined based on market quotations (level 1). Fair value for most of the other investment securities is calculated using the discounted cash flow method for each security. The discount rates for these cash flows are estimated by the pricing service using rates observed in the market (level 2). Cash flow streams are dependent on estimated prepayment speeds and the overall structure of the securities given existing market conditions. In addition, LCNB has invested in two mutual funds that invest in debt securities or loans that qualify for credit under the Community Reinvestment Act. The investment in one of the mutual funds is considered to have level 2 inputs because, among other factors, the fund invests primarily in U.S. Government and Agency Obligations, which are considered to be level 2 investments. The investment in the other mutual fund is considered to have level 3 inputs because its shares are not traded in an active market, it does not publish a daily net asset value, and it is primarily a loan fund. Additionally, LCNB owns trust preferred securities in various financial institutions and equity securities in non-financial companies. Market quotations (level 1) are used to determine fair values for these investments.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 12 - Fair Value Measurements (continued)

Assets that may be recorded at fair value on a nonrecurring basis include impaired loans, other real estate owned, and other repossessed assets. A loan is considered impaired when management believes it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. Impaired loans are carried at the present value of estimated future cash flows using the loan’s existing rate or the fair value of collateral if the loan is collateral dependent, if this value is less than the loan balance. When the fair value of the collateral is based on an observable market price or current appraised value, the inputs are considered to be level 2. When an appraised value is not available and there is not an observable market price, the inputs are considered to be level 3.

Other real estate owned is adjusted to fair value upon transfer of the loan to foreclosed assets, usually based on an appraisal of the property. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. The inputs for a valuation based on current appraised value are considered to be level 2.

Table of Contents

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 12 - Fair Value Measurements (continued)

The following table summarizes the valuation of LCNB’s assets recorded at fair value by input levels as of June 30, 2012 and December 31, 2011 (in thousands):

			Fair Value Measurements at the End of the Reporting Period Using
	Fair Value Measurements		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Gains (Losses)
June 30, 2012
Recurring fair value measurements:
Investment securities available-for-sale:
U.S. Treasury notes	$	21,169		21,169		-		-
U.S. Agency notes		101,242		-		101,242		-
U.S. Agency mortgage-backed securities		58,297		-		58,297		-
Corporate securities		6,332		4,140		2,192		-
Municipal securities:
Non-taxable		73,233		-		73,233		-
Taxable		21,178		-		21,178		-
Mutual funds		2,153		-		1,153		1,000
Trust preferred securities		515		515		-		-
Equity securities		1,022		1,022		-		-
Total recurring fair value measurements	$	285,141		26,846		257,295		1,000

Nonrecurring fair value measurements:
Impaired loans	$	1,944		-		830		1,114		-
Other real estate owned and repossessed assets (a) (b)		2,123		-		2,123		-		(79	)
Total nonrecurring fair value measurements	$	4,067		-		2,953		1,114		(79	)

December 31, 2011
Recurring fair value measurement:
Investment securities available-for-sale:
U.S. Treasury notes	$	17,550		17,550		-		-
U.S. Agency notes		82,927		-		82,927		-
U.S. Agency mortgage-backed securities		52,287		-		52,287		-
Corporate securities		6,365		4,152		2,213		-
Municipal securities:
Non-taxable		69,703		-		69,703		-
Taxable		21,907		-		21,907		-
Mutual funds		2,125		-		1,125		1,000
Trust preferred securities		564		564		-		-
Equity securities		578		578		-		-
Total recurring fair value measurements	$	254,006		22,844		230,162		1,000

Nonrecurring fair value measurements:
Impaired loans	$	2,563		-		1,300		1,263		-
Other real estate owned and repossessed assets (c)		1,642		-		1,619		23		31
Total nonrecurring fair value measurements	$	4,205		-		2,919		1,286		31

(a)	Two other real estate owned properties with a total carrying amount of $1,619,000 were written down to their combined fair value of $1,543,000, resulting in an impairment charge of $76,000, which was included in other non-interest expense for the period.

(b)	Repossessed assets with a carrying value of $23,000 were sold for a combined total of $20,000, resulting in a net loss of $3,000, which was included in other non-interest expense for the period.

(c)	Repossessed assets with a carrying value of $117,000 were sold for a combined total of $148,000, resulting in a net gain of $31,000, which was included in other non-interest expense for the period.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 12 - Fair Value of Financial Instruments (continued)

The following table is a reconciliation of the beginning and ending balances of recurring fair value measurements that use significant unobservable inputs (level 3) for the six months ended June 30, 2011 (in thousands):

	Mutual Funds

Beginning balance	$	1,053
Purchases		500
Dividends reinvested		17
Net change in unrealized gains (losses) included in other comprehensive income		11
Ending balance	$	1,581

Carrying amounts and estimated fair values of financial instruments as of June 30, 2012 and December 31, 2011 are as follows (in thousands):

	June 30, 2012				December 31, 2011
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
FINANCIAL ASSETS:
Cash and cash equivalents	$	26,896		26,896		19,535		19,535
Investment securities:
Available-for-sale		285,141		285,141		254,006		254,006
Held-to-maturity		11,474		11,474		10,734		10,734
Federal Reserve Bank stock		949		949		940		940
Federal Home Loan Bank stock		2,091		2,091		2,091		2,091
Loans, net		458,629		465,106		458,331		470,846

FINANCIAL LIABILITIES:
Deposits		710,656		715,931		663,562		669,383
Short-term borrowings		13,142		13,142		21,596		21,596
Long-term debt		20,391		21,553		21,373		22,570

The fair value of off-balance-sheet financial instruments at June 30, 2012 and December 31, 2011 was not material.

Fair values of financial instruments are based on various assumptions, including the discount rate and estimates of future cash flows. Therefore, the fair values presented may not represent amounts that could be realized in actual transactions. In addition, because the required disclosures exclude certain financial instruments and all nonfinancial instruments, any aggregation of the fair value amounts presented would not represent the underlying value of LCNB. The following methods and assumptions were used to estimate the fair value of certain financial instruments:

Table of Contents

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 12 - Fair Value of Financial Instruments (continued)

Cash and cash equivalents

The carrying amounts presented are deemed to approximate fair value.

Investment securities

Fair values for securities, excluding Federal Home Loan Bank and Federal Reserve Bank stock, are based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities and/or discounted cash flow analyses or other methods. The carrying value of Federal Home Loan Bank and Federal Reserve Bank stock approximates fair value based on the respective redemptive provisions.

Loans

Fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, incorporating assumptions of current and projected prepayment speeds. These current rates approximate market rates.

Deposits

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities, which approximates market rates.

Borrowings

The carrying amounts of federal funds purchased, repurchase agreements, and U.S. Treasury demand note borrowings are deemed to approximate fair value of short-term borrowings. For long-term debt, fair values are estimated based on the discounted value of expected net cash flows using current interest rates.

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LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 12 - Fair Value of Financial Instruments (continued)

The following table summarizes the categorization by input level as of June 30, 2012 and December 31, 2011 of LCNB’s financial assets and liabilities not recorded at fair value but for which fair value is disclosed (in thousands):

			Fair Value Measurements at the End of the Reporting Period Using
	Fair Value Measurements		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
June 30, 2012
Assets:
Loans, net	$	463,162		-		463,162		-
Investment securities, non-taxable, held-to-maturity		11,474		-		-		11,474
Federal Reserve Bank stock		949		949		-		-
Federal Home Loan Bank stock		2,091		2,091		-		-

Liabilities:
Deposits		715,931		-		715,931		-
Long-term debt		21,553		-		21,553		-

December 31, 2011
Assets:
Loans, net	$	468,283		-		468,283		-
Investment securities, non-taxable, held-to-maturity		10,734		-		-		10,734
Federal Reserve Bank stock		940		940		-		-
Federal Home Loan Bank stock		2,091		2,091		-		-

Liabilities:
Deposits		669,383		-		669,383		-
Long-term debt		22,570		-		22,570		-

Table of Contents

LCNB CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Continued)

Note 13 – Discontinued Operations

LCNB sold its insurance agency subsidiary on March 23, 2011 and therefore its financial results are reported in the income statements as income from discontinued operations, net of taxes. Income from discontinued operations for the six months ended June 30, 2011 includes the gain recognized from the sale less certain related closing costs, taxes, and a curtailment expense recognized in LCNB’s nonqualified defined benefit retirement plan due to the sale. The following table summarizes income (loss) from discontinued operations for the periods indicated (in thousands):

	For the Three Months			For the Six Months
	Ended June 30,			Ended June 30,
	2011			2011

Dakin Insurance Agency financial results:
Revenue	$	-			381
Non-interest expenses		(2	)		301
Income from operations before income taxes		2			80
Gain from sale of insurance agency		-			1,503
Closing costs related to sale		(13	)		(60	)
Curtailment expense on nonqualified defined benefit retirement plan		-			(191	)
Provision for income taxes		(20	)		(539	)
Total income (loss) from discontinued operations, net of taxes	$	(31	)		793

Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

LCNB Corp.

Lebanon, Ohio

We have reviewed the accompanying consolidated balance sheet of LCNB Corp. and subsidiaries (“LCNB”) as of June 30, 2012, and the related consolidated statements of income and comprehensive income for each of the three-month and six-month periods ended June 30, 2012 and 2011, and the related consolidated statements of shareholders’ equity and cash flows for each of the six-month periods ended June 30, 2012 and 2011. These interim financial statements are the responsibility of LCNB's management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of LCNB as of December 31, 2011 and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for the year then ended (not presented herein), and in our report dated February 27, 2012, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2011, is fairly stated in all material respects, in relation to the consolidated balance sheet from which it has been derived.

	/s/ J.D. Cloud & Co. L.L.P.


Cincinnati, Ohio
August 6, 2012

Table of Contents

LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

Certain matters disclosed herein may be deemed to be forward-looking statements that involve risks and uncertainties. Forward looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualifying words and their derivatives such as “expects,” “anticipates,” “believes,” “estimates,” “plans,” “projects,” or other statements concerning opinions or judgments of LCNB and its management about future events. Factors that could influence the accuracy of such forward looking statements include, but are not limited to, regulatory policy changes, interest rate fluctuations, loan demand, loan delinquencies and losses, general economic conditions and other risks. Such forward-looking statements represent management's judgment as of the current date. Actual strategies and results in future time periods may differ materially from those currently expected. LCNB disclaims, however, any intent or obligation to update such forward-looking statements. LCNB intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

Results of Operations

Net income for the three months ended June 30, 2012 was $1,987,000 (total basic and diluted earnings per common share of $0.30 and $0.29, respectively) and $4,264,000 (total basic and diluted earnings per common share of $0.64 and $0.63, respectively) for the six months ended June 30, 2012. This compares to net income from continuing operations of $2,023,000 (total basic and diluted earnings per common share of $0.30) and $3,501,000 (total basic and diluted earnings per common share of $0.52) for the same three and six-month periods in 2011.

Net income for the six months ended June 30, 2011 included income from discontinued operations of $793,000, which consisted of a gain recognized on the sale of LCNB’s insurance agency subsidiary, Dakin Insurance Agency, Inc., less certain related closing costs, taxes, and a curtailment expense recognized in LCNB’s nonqualified defined benefit retirement plan due to the sale.

Net loan charge-offs for the first six months of 2012 and 2011 totaled $285,000 and $420,000, respectively. Non-accrual loans and loans past due 90 days or more and still accruing interest totaled $3,321,000 or 0.72% of total loans at June 30, 2012, compared to $3,707,000 or 0.80% of total loans at December 31, 2011. The decrease was primarily due to the transfer of a non-accrual commercial real estate loan to other real estate owned during the first quarter 2012. Consequently, other real estate owned (which includes property acquired through foreclosure or deed-in-lieu of foreclosure and also includes property deemed to be in-substance foreclosed) and other repossessed assets increased from $1,642,000 at December 31, 2011 to $2,123,000 at June 30, 2012.

Net interest income for the three months and six months ended June 30, 2012 decreased $133,000 and $82,000, respectively, from the comparative periods in 2011. The decreases for both periods were primarily due to decreases in the net interest margin, partially offset by increases in average interest-earning assets.

Table of Contents

LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

Non-interest income for the three-month period in 2012 was $80,000 less than the comparative period in 2011 primarily due to decreases in trust income, service charges and fees on deposit accounts, and gains from sales of investment securities. These decreases were partially offset by an increase in net gains recognized from sales of mortgage loans. Non-interest income for the six-month period in 2012 was $341,000 greater than the comparative period in 2011 primarily due to one-time fees recognized by the trust department during the first quarter 2012 and increases in gains from sales of investment securities and mortgage loans. These increases were partially offset by a decrease in service charges and fees on deposit accounts.

Non-interest expense for the three months ended June 30, 2012 was $23,000 greater than the comparative period in 2011. Non-interest expense for the six months ended June 30, 2012 was $314,000 less than the comparative period in 2011 primarily due to decreases in FDIC insurance premiums and other expenses. The decrease in other expenses in 2012 reflects the absences of losses recognized during 2011 on a standby letter of credit and certain environmental remediation costs.

Table of Contents

LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

Net Interest Income

Three Months Ended June 30, 2012 vs. 2011.

LCNB's primary source of earnings is net interest income, which is the difference between earnings from loans and other investments and interest paid on deposits and other liabilities. The following table presents, for the three months ended June 30, 2012 and 2011, average balances for interest-earning assets and interest-bearing liabilities, the income or expense related to each item, and the resulting average yields earned or rates paid.

	Three Months Ended June 30,
	2012								2011
	Average			Interest		Average			Average			Interest		Average
	Outstanding			Earned/		Yield/			Outstanding			Earned/		Yield/
	Balance			Paid		Rate			Balance			Paid		Rate
	(Dollars in thousands)
Loans (1)	$	457,443		$	5,920		5.19	%	$	461,448		$	6,477		5.63	%
Interest-bearing demand deposits		10,650			9		0.34	%		26,263			17		0.26	%
Federal Reserve Bank stock		949			28		11.83	%		941			28		11.93	%
Federal Home Loan Bank stock		2,091			22		4.22	%		2,091			23		4.41	%
Investment securities:
Taxable		200,162			982		1.97	%		164,484			914		2.23	%
Non-taxable (2)		82,277			924		4.50	%		77,029			970		5.05	%
Total earnings assets		753,572			7,885		4.20	%		732,256			8,429		4.62	%
Non-earning assets		63,315								66,961
Allowance for loan losses		(2,893	)							(2,935	)
Total assets	$	813,994							$	796,282

Interest-bearing deposits	$	579,774			1,117		0.77	%	$	582,606			1,499		1.03	%
Short-term borrowings		12,665			5		0.16	%		11,997			7		0.23	%
Long-term debt		20,506			150		2.93	%		22,176			161		2.91	%
Total interest-bearing liabilities		612,945			1,272		0.83	%		616,779			1,667		1.08	%
Demand deposits		114,235								101,798
Other liabilities		6,816								4,918
Capital		79,998								72,787
Total liabilities and capital	$	813,994							$	796,282

Net interest rate spread (3)							3.37	%							3.54	%

Net interest income and net interest margin on a taxable-equivalent basis (4)				$	6,613		3.52	%				$	6,762		3.70	%

Ratio of interest-earning assets to interest-bearing liabilities		122.94	%							118.72	%

(1)	Includes nonaccrual loans, if any.

(2)	Income from tax-exempt securities is included in interest income on a taxable-equivalent basis. Interest income has been divided by a factor comprised of the complement of the incremental tax rate of 34%.

(3)	The net interest spread is the difference between the average rate on total interest-earning assets and interest-bearing liabilities.

(4)	The net interest margin is the taxable-equivalent net interest income divided by average interest-earning assets.

Table of Contents

LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

The following table presents the changes in taxable-equivalent basis interest income and expense for each major category of interest-earning assets and interest-bearing liabilities and the amount of change attributable to volume and rate changes for the three months ended June 30, 2012 as compared to the same period in 2011. Changes not solely attributable to rate or volume have been allocated to volume and rate changes in proportion to the relationship of absolute dollar amounts of the changes in each.

	Three Months Ended
	June 30, 2012 vs. 2011
	Increase (decrease) due to:
	Volume			Rate			Total
	(In thousands)
Interest-earning Assets:
Loans	$	(56	)		(501	)		(557	)
Interest-bearing demand deposits		(12	)		4			(8	)
Federal Reserve Bank stock		-			-			-
Federal Home Loan Bank stock		-			(1	)		(1	)
Investment securities:
Taxable		183			(115	)		68
Nontaxable		63			(109	)		(46	)
Total interest income		178			(722	)		(544	)
Interest-bearing Liabilities:
Deposits		(7	)		(375	)		(382	)
Short-term borrowings		-			(2	)		(2	)
Long-term debt		(12	)		1			(11	)
Total interest expense		(19	)		(376	)		(395	)
Net interest income	$	197			(346	)		(149	)

Net interest income on a fully tax-equivalent basis for the three months ended June 30, 2012 totaled $6,613,000, a decrease of $149,000 from the comparable period in 2011. Total interest income decreased $544,000, partially offset by a decrease in total interest expense of $395,000.

The decrease in total interest income was due to a 42 basis point (one basis point equals 0.01%) decrease in the average rate earned on earning assets, partially offset by a $21.3 million increase in average earning assets. The increase in interest earning assets was primarily due to a $40.9 million increase in average investment securities, partially offset by a $15.6 million decrease in average interest-bearing demand deposits. The decrease in the average rate earned on earning assets was primarily due to general decreases in market interest rates.

The decrease in total interest expense was primarily due to a 25 basis point decrease in the average rate paid, primarily due to general decreases in market interest rates.

Table of Contents

LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

Six Months Ended June 30, 2012 vs. 2011.

The following table presents, for the six months ended June 30, 2012 and 2011, average balances for interest-earning assets and interest-bearing liabilities, the income or expense related to each item, and the resultant average yields earned or rates paid.

	Six Months Ended June 30,
	2012								2011
	Average			Interest		Average			Average			Interest		Average
	Outstanding			Earned/		Yield/			Outstanding			Earned/		Yield/
	Balance			Paid		Rate			Balance			Paid		Rate
						(Dollars in thousands)

Loans (1)	$	459,261		$	12,128		5.31	%	$	459,428		$	12,995		5.70	%
Interest-bearing demand deposits		12,926			15		0.23	%		18,540			22		0.24	%
Federal Reserve Bank stock		945			28		5.96	%		940			28		6.01	%
Federal Home Loan Bank stock		2,091			46		4.42	%		2,091			47		4.53	%
Investment securities:
Taxable		187,242			1,869		2.01	%		157,459			1,790		2.29	%
Non-taxable (2)		81,010			1,842		4.57	%		79,903			2,041		5.15	%
Total earnings assets		743,475			15,928		4.31	%		718,361			16,923		4.75	%
Non-earning assets		64,242								66,434
Allowance for loan losses		(2,855	)							(2,775	)
Total assets	$	804,862							$	782,020

Interest-bearing deposits	$	575,377			2,282		0.80	%	$	569,469			3,083		1.09	%
Short-term borrowings		11,791			8		0.14	%		12,384			17		0.28	%
Long-term debt		20,775			304		2.94	%		23,822			339		2.87	%
Total interest-bearing liabilities		607,943			2,594		0.86	%		605,675			3,439		1.15	%
Demand deposits		110,610								99,346
Other liabilities		6,678								5,115
Capital		79,631								71,884
Total liabilities and capital	$	804,862							$	782,020

Net interest rate spread (3)							3.45	%							3.60	%

Net interest income and net interest margin on a taxable-equivalent basis (4)				$	13,334		3.61	%				$	13,484		3.79	%

Ratio of interest-earning assets to interest-bearing liabilities		122.29	%							118.61	%

(1)	Includes nonaccrual loans, if any. Income from tax-exempt loans is included in interest income on a tax-equivalent basis, using an incremental rate of 34%.

(2)	Income from tax-exempt securities is included in interest income on a taxable-equivalent basis. Interest income has been divided by a factor comprised of the complement of the incremental tax rate of 34%.

(3)	The net interest spread is the difference between the average rate on total interest-earning assets and interest-bearing liabilities.

(4)	The net interest margin is the taxable-equivalent net interest income divided by average interest-earning assets.

Table of Contents

LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)

	Six Months Ended
	June 30, 2012 vs. 2011
	Increase (decrease) due to:
	Volume			Rate			Total
	(In thousands)
Interest-earning Assets:
Loans	$	(5	)		(862	)		(867	)
Interest-bearing demand deposits		(7	)		-			(7	)
Federal Reserve Bank stock		-			-			-
Federal Home Loan Bank stock		-			(1	)		(1	)
Investment securities:
Taxable		313			(234	)		79
Nontaxable		28			(227	)		(199	)
Total interest income		329			(1,324	)		(995	)

Interest-bearing Liabilities:
Deposits		32			(833	)		(801	)
Short-term borrowings		(1	)		(8	)		(9	)
Long-term debt		(44	)		9			(35	)
Total interest expense		(13	)		(832	)		(845	)
Net interest income	$	342			(492	)		(150	)

Net interest income on a fully tax-equivalent basis for the first half of 2012 totaled $13,334,000, a $150,000 decrease from the first half of 2011. Total interest income decreased $995,000, largely offset by an $845,000 decrease in total interest expense.

The decrease in total interest income was due to a 44 basis point decrease in the average rate earned on earning assets, partially offset by a $25.1 million increase in average total earning assets. The increase in average earning assets was due to a $30.9 million increase in average investment securities. The decrease in the average rate earned on earning assets was primarily due to general decreases in market interest rates.

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LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

The decrease in total interest expense was due primarily to a 29 basis point decrease in the average rate paid on interest-bearing liabilities, partially offset by a $2.3 million increase in average interest-bearing liabilities. The increase in average interest-bearing liabilities was due to a $5.9 million increase in average interest-bearing deposits primarily resulting from an increase in public funds. The decrease in the average rate paid also reflects a general decrease in market rates.

Provision and Allowance For Loan Losses

The total provision for loan losses is determined based upon management's evaluation as to the amount needed to maintain the allowance for loan losses at a level considered appropriate in relation to the risk of losses inherent in the portfolio. In addition to historic charge-off percentages, factors taken into consideration to determine the adequacy of the allowance for loan losses include the nature, volume, and consistency of the loan portfolio, overall portfolio quality, a review of specific problem loans, and current economic conditions that may affect borrowers’ ability to pay. The provision for loan losses for the three months ended June 30, 2012 and 2011 was $91,000 and $224,000, respectively, and $306,000 and $888,000 for the six months ended June 30, 2012 and 2011, respectively. The decrease in the provision reflects a decrease in net charge-offs coupled with relatively stable regional market conditions.

Non-Interest Income

Three Months Ended June 30, 2012 vs. 2011.

Non-interest income for the second quarter of 2012 was $80,000 less than for the comparable period in 2011 primarily due to a $63,000 decrease in trust income, a $43,000 decrease in service charges and fees on deposit accounts, and a $45,000 decrease in net gains on sales of securities. Trust income decreased primarily due to a decrease in the market value of trust assets. Services charges and fees decreased primarily due to decreased overdraft fees, partially offset by an increase in check card income. Net gains on sales of securities decreased during the 2012 period primarily due to a lower volume of securities sold. These decreases were partially offset by a $78,000 increase in gains from sales of mortgage loans, primarily due to a greater volume of loans sold during the 2012 period as borrowers refinanced loans for lower interest rates.

Six Months Ended June 30, 2012 vs. 2011.

Non-interest income for the first half of 2012 was $341,000 greater than for the comparable period in 2011. The increase was due to a $220,000 increase in trust income and a $152,000 increase in gains from sales of mortgage loans. Trust income increased, despite the decrease during the second quarter, primarily due to estate fees recognized during the first quarter 2012. Gains from sales of mortgage loans increased for substantially the same reasons mentioned above. These increases were partially offset by a $66,000 decrease in service charges and fee on deposit accounts for substantially the same reasons mentioned above.

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LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

Non-Interest Expense

Three Months Ended June 30, 2012 vs. 2011.

Total non-interest expense increased $23,000 during the second quarter 2012 as compared to the second quarter 2011 primarily due to a $24,000 increase in equipment expenses, a $59,000 increase in marketing expenses, and a $33,000 increase in other non-interest expense. Equipment expenses increased primarily due to increased depreciation expense from data technology upgrades. Marketing expenses increased due to increased use of television advertising and promotional activities. Other non-interest expense increased due to smaller increases in a variety of expenses. These increases were partially offset by an $84,000 decrease in FDIC insurance premiums primarily due to the implementation of a new assessment base that uses total assets and tier one capital as opposed to deposits.

Six Months Ended June 30, 2012 vs. 2011.

Total non-interest expense decreased $314,000 during the first half of 2012 as compared to the first half of 2011 primarily due to a $253,000 decrease in FDIC insurance premiums for the same reason described above. An additional $68,000 decrease in other non-interest expense reflects the absence during the 2012 period of a $56,000 loss, net of recoveries, recognized during the first half 2011 on a standby letter of credit and $52,000 in environmental remediation costs recognized during the first quarter 2011 for the lot on which the new Lebanon drive-up facility was constructed.

Income Taxes

LCNB’s effective tax rates for continuing operations for the six months ended June 30, 2012 and 2011 were 25.4% and 23.2%, respectively. The difference between the statutory rate of 34.0% and the effective tax rate is primarily due to tax-exempt interest income from municipal securities and tax-exempt earnings from bank owned life insurance.

Financial Condition

Total assets at June 30, 2012 were $40.0 million greater than at December 31, 2011, caused by a $47.1 million increase in total deposits. The deposit growth was primarily invested in cash and cash equivalents, which grew $7.4 million, and in investment securities, which grew $31.9 million.

Net loans increased $298,000, but the mix between loan categories changed during the first half of 2012. The commercial real estate loan portfolio increased $11.1 million and residential real estate loans increased $848,000. All other loan categories experienced decreases during 2012. The $848,000 increase in residential real estate loans does not reflect $11.4 million of residential real estate loans that were originated and sold to the Federal Home Loan Mortgage Corporation during the first half of 2012.

The increase in total deposits was primarily due to a $39.1 million increase in public fund deposits by local government entities. Public fund deposits can be relatively volatile due to seasonal tax collections and the financial needs of the local entities. The deposit growth was used to reduce short-term borrowings, which decreased $8.5 million between June 30, 2012 and December 31, 2011, fund growth in the investment portfolio, and enhance LCNB’s liquidity position for anticipated future needs.

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LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

During June 2012, the Board of Governors of the Federal Reserve System, Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation issued three proposed rules that would significantly revise current regulatory capital requirements for financial institutions. Among other items, the proposals would:

Introduce a new requirement that common equity Tier 1capital be at least 4.5% of risk-weighted assets;

Increase the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6%;

Introduce a new requirement to maintain a capital conservation buffer in excess of other minimum risk-based capital ratios of at least 2.5% of risk-weighted assets;

Revise capital definitions and risk-weighting categories for various assets; and

Revise the prompt corrective action framework by increasing category thresholds to reflect the new requirements.

Financial institutions not meeting the 2.5% capital conservation buffer would be subject to limits on capital distributions, including dividend payments to shareholders and treasury share purchases, and would also be limited in awarding certain discretionary bonus payments to executive officers.

If issued as proposed, the new requirements would be phased-in starting in 2013 with full implementation in 2019. LCNB already meets the new fully phased-in capital requirements.

Liquidity

LCNB depends on dividends from its subsidiaries for the majority of its liquid assets, including the cash needed to pay dividends to its shareholders. National banking law limits the amount of dividends the Bank may pay to the sum of retained net income, as defined, for the current year plus retained net income for the previous two years. Prior approval from the Office of the Comptroller of the Currency, the Bank’s primary regulator, is necessary for the Bank to pay dividends in excess of this amount. In addition, dividend payments may not reduce capital levels below minimum regulatory guidelines. Management believes the Bank will be able to pay anticipated dividends to LCNB without needing to request approval.

Liquidity is the ability to have funds available at all times to meet the commitments of LCNB. Asset liquidity is provided by cash and assets which are readily marketable or pledgeable or which will mature in the near future. Liquid assets include cash and cash equivalents and securities available for sale. At June 30, 2012, LCNB’s liquid assets amounted to $312.0 million or 37.5% of total assets, an increase from $273.5 million or 34.6% of total assets at December 31, 2011.

Liquidity is also provided by access to core funding sources, primarily core depositors in LCNB’s market area. Approximately 76.3% of total deposits at June 30, 2012 were “core” deposits, compared to 79.9% of deposits at December 31, 2011. Core deposits, for this purpose, are defined as total deposits less public funds and certificates of deposit greater than $100,000. The percentage of core deposits to total deposits decreased because of the growth in public fund deposits discussed above in relation to total growth in deposits.

Secondary sources of liquidity include LCNB’s ability to sell loan participations, borrow funds from the Federal Home Loan Bank, purchase federal funds, issue repurchase agreements, or use a line of credit established with another bank.

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LCNB CORP. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

Management closely monitors the level of liquid assets available to meet ongoing funding needs. It is management’s intent to maintain adequate liquidity so that sufficient funds are readily available at a reasonable cost. LCNB experienced no liquidity or operational problems as a result of the current liquidity levels.

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LCNB CORP. AND SUBSIDIARIES

Item 3. Quantitative and Qualitative Disclosures about Market Risks

Market risk for LCNB is primarily interest rate risk. LCNB attempts to mitigate this risk through asset/liability management strategies designed to decrease the vulnerability of its earnings to material and prolonged changes in interest rates. LCNB does not use derivatives such as interest rate swaps, caps, or floors to hedge this risk. LCNB has not entered into any market risk instruments for trading purposes.

The Bank's Asset and Liability Management Committee ("ALCO") primarily uses a combination of Interest Rate Sensitivity Analysis (“IRSA”) and Economic Value of Equity (“EVE”) analysis for measuring and managing interest rate risk. IRSA is used to estimate the effect on net interest income during a one-year period of instantaneous and sustained movements in interest rates, also called interest rate shocks, of 100, 200, and 300 basis points. Management considers the results of the down 200 and down 300 basis point scenarios to not be meaningful in the current interest rate environment. The base projection uses a current interest rate scenario. As shown below, the June 30, 2012 IRSA indicates that an increase in interest rates would have a positive effect on net interest income (“NII”) and a decrease in interest rates would have a negative effect on NII. The changes in NII for all rate assumptions are within LCNB’s acceptable ranges.

Rate Shock Scenario in Basis Points	Amount		$ Change in NII			% Change in NII
	(Dollars in thousands)
Up 300	$	27,733		1,360			5.16	%
Up 200		27,222		849			3.22	%
Up 100		26,740		367			1.39	%
Base		26,373		-			-	%
Down 100		26,091		(282	)		(1.07	)%

IRSA shows the effect on NII during a one-year period only. A more long-range model is the EVE analysis, which shows the estimated present value of future cash inflows from interest-earning assets less the present value of future cash outflows for interest-bearing liabilities for the same rate shocks. As shown below, the June 30, 2012 EVE analysis indicates that an increase in interest rates would have a negative effect on the EVE and a decrease in rates would have a positive effect on the EVE. The change in EVE for the up 300 basis points scenario is outside LCNB’s policy range of a 25% change, but management has determined the change is acceptable in the current economic environment.

Rate Shock Scenario in Basis Points	Amount		$ Change in EVE			% Change in EVE
	(Dollars in thousands)
Up 300	$	58,441		(25,958	)		(30.76	%)
Up 200		66,506		(17,893	)		(21.20	)%
Up 100		75,079		(9,320	)		(11.04	)%
Base		84,399		-			-	%
Down 100		94,057		9,658			11.44	%

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LCNB CORP. AND SUBSIDIARIES

Item 3. Quantitative and Qualitative Disclosures about Market Risks (continued)

The IRSA and EVE simulations discussed above are not projections of future income or equity and should not be relied on as being indicative of future operating results. Assumptions used, including the nature and timing of interest rate levels, yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment or replacement of asset and liability cash flows, are inherently uncertain and, as a result, the models cannot precisely measure future net interest income or equity. Furthermore, the models do not reflect actions that borrowers, depositors, and management may take in response to changing economic conditions and interest rate levels.

Item 4. Controls and Procedures

a) Disclosure controls and procedures. The Chief Executive Officer and the Chief Financial Officer have carried out an evaluation of the effectiveness of LCNB's disclosure controls and procedures that ensure that information relating to LCNB required to be disclosed by LCNB in the reports that it files or submits under the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that such information is accumulated and communicated to LCNB’s management, including its principal executive officer and principal financial officer, as appropriate, in order to allow timely decisions to be made regarding required disclosures. Based upon this evaluation, these officers have concluded, that as of June 30, 2012, LCNB's disclosure controls and procedures were effective.

b) Changes in internal control over financial reporting. During the period covered by this report, there were no changes in LCNB's internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, LCNB's internal control over financial reporting.

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PART II. OTHER INFORMATION

LCNB CORP. AND SUBSIDIARIES

Item 1. Legal Proceedings

Not applicable

Item 1A. Risk Factors

No material changes

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

During the period of this report, LCNB did not sell any of its securities that were not registered under the Securities Act.

During the period covered by this report, LCNB did not purchase any shares of its equity securities.

Item 3. Defaults Upon Senior Securities

Not applicable

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

Not applicable

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LCNB CORP. AND SUBSIDIARIES

Item 6. Exhibits

Exhibit No.		Exhibit Description
3.1		Amended and Restated Articles of Incorporation of LCNB Corp., as amended – incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2010, Exhibit 3.1.

3.2		Code of Regulations of LCNB Corp. – incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005, Exhibit 3(ii).

10.1		LCNB Corp. Ownership Incentive Plan – incorporated by reference to Registrant’s Form DEF 14A Proxy Statement pursuant to Section 14(a), dated March 15, 2002, Exhibit A (000-26121).

10.2		Form of Option Grant Agreement under the LCNB Corp. Ownership Incentive Plan – incorporated by reference to the Registrant’s Form 10-K for the fiscal year ended December 31, 2005, Exhibit 10.2.

10.3		Nonqualified Executive Retirement Plan – incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the period ended June 30, 2009, Exhibit 10.4.

31.1		Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.

32		Certification of Chief Executive Officer and Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.

101		The following financial information from LCNB Corp.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2012 is formatted in Extensible Business Reporting Language: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to Consolidated Financial Statements.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		LCNB Corp.

August 6, 2012		/s/ Stephen P. Wilson
		Stephen P. Wilson, Chief Executive Officer and
		Chairman of the Board of Directors


August 6, 2012		/s/Robert C. Haines, II
		Robert C. Haines, II, Executive Vice President
		and Chief Financial Officer

LCNB Corp. - 10-Q quarterly report FY2012 Q2

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