EX-13 3 lcnbexh13t.txt EXHIBIT 13 LCNB Corp. 2002 Annual Report President's Letter to Shareholders (pages 2 - 3 of Annual Report): ---------------------------------- Dear Shareholder, The theme of this year's annual report is "Personal Service Powered by Technology". Through these five words we hope to highlight our major strengths. Strengths that conveniently provide our customers with the financial services they want and need in today's fast paced world. To use a modern day phrase, "you're connected". First and foremost, you are connected to the people of LCNB. People who care, people who answer the phone in person (no 'push one, push two'), people who greet you when you walk into any of our 18 offices. These are the same people who efficiently take care of your transactions, answer your questions, or quickly get you to the right expert within our organization depending on your financial need. While this style of personal service has been the cornerstone of LCNB for 126 years, in today's world this is not enough. Today, "you're connected" must also mean the technologies available to allow you to be connected to your financial institution in a variety of ways from anywhere and at anytime. The competitive advantage we offer is not just great personal service or the very best and latest in technology, but the unique combination of both. When you are unable to come to the bank, we come to you. "You're connected" through our worldwide VISA ATM network; BankLine, our automated telephone banking system; and through LCNB On-Line, our PC banking option. You can even bank with us when you are not actively participating in the transaction with direct deposit, DirectLink ACH origination, payroll services or bill pay. Banking with LCNB today is truly a 24-hours a day, 7 days a week, service connection. We also use the very latest in technology to provide you detailed statements with images of your checks and deposits (Advantage Statement). By mid-year 2003 we will add delivery capabilities that will allow these statements to be sent with images directly to your computer through email. For our business customers we will add a CD ROM option that will not only provide images of checks and deposit slips, but also images of all deposited items whether or not they are drawn on us. During 2002, we continued to invest in people, products and technologies. You responded by continuing to use our services, by expanding your business with us, and by providing us with another great year financially. Net income for 2002 was a record $6.5 million representing a 1.32% return on average assets and a 13.00% return on average shareholders' equity. Earnings per share were $3.79, a 10.50% or $0.36 per share increase from 2001. Total assets increased to a record $506.7 million from $480.4 million one year ago, an increase of $26.3 million or 5.48%. Total capital, or shareholders' equity, at December 31, 2002 is a record $51.9 million having increased 4.89% from December 31, 2001. Due to these excellent results, the Board of Directors increased the dividend paid to shareholders for the 17th consecutive year. The total dividend paid during 2002 was $2.025 per share, up from the $1.85 paid in 2001. I direct your attention to the graphs included in this report. These graphs display key statistical information highlighting LCNB's performance for the last five years. -1- It was gratifying to see continued strong deposit growth during 2002. Total deposits of $442.2 million at December 31, 2002, represent an increase of $27.4 million or 6.62% from December 31, 2001. Our loan totals decreased by $2.3 million during 2002. Loan growth continued to be negatively affected by refinancing activity on residential mortgage loans and the sale of a large majority of fixed rate residential loans originated during 2002. Approximately $20.9 million of residential real estate loans were sold to FHLMC during 2002. We began selling the loans after determining that current, historically low market rates for residential loans were not profitable in the long run. Offsetting the decline in residential loans was a $4.3 million increase in the commercial loan portfolio and a $13.8 million increase in consumer lending. This continued shift away from long-term fixed rate mortgage loans reduced our future interest rate risk. Our asset quality remained high with a low delinquency rate of 0.61% and no non-accrual loans at year-end. Additional statistical data and information on our financial performance for 2002 are available in the Management Discussion and Analysis (MD&A) document. The MD&A document is enclosed with the initial mailing of this Annual Report to shareholders and is also available in the LCNB Corp. Form 10-K report. This report, filed annually with the Securities and Exchange Commission, is available upon request or from the Internet. Refer to the inside front cover of this report for options to obtain this SEC document. In keeping with our Powered by Technology theme, 2002 was a very busy year. Our technology committee and various conversion teams successfully took us through five conversions, updating both systems and software. We updated our telecommunications, improving quality and reducing cost. We converted from MAC directly to VISA, eliminating an unnecessary middleman in order to provide you with world class ATM service. Our largest conversion was a change in our core processing system to Jack Henry's "Silverlake". The Silverlake software is the very latest, state-of-the-art, financial product delivery system. We closed out the conversions by updating our "BankLine" automated telephone banking system followed by moving to LCNB On-Line for PC banking and bill pay. Our 2002 investment in technology will pay great dividends for many years to come. The Trust Department, in cooperation with Dakin Insurance, our insurance subsidiary, developed and launched our securities brokerage unit. This new venture is in partnership with Uvest, a national brokerage firm. This new unit adds significantly to the investment products we can offer you, our customer, and solidifies our claim to be a one-stop financial services company. Dakin Insurance continued to grow and to position itself for the future. In September, Dakin purchased substantially all of the insurance renewal rights and client list of an insurance agency in Dayton, Ohio. It has successfully integrated the client base into our Lebanon service center. This purchase increased both commission dollars and the number of insurance companies we represent. The most significant result of this acquisition was to greatly increase our premium volume with a major underwriter. Besides representing various specialty underwriters, we now have the volume and, thus, the clout with three of the regions' primary insurance providers. This allows us to obtain the very best in prices, coverage and service for our customers. All of this was accomplished as a direct result of the hard work and dedication of our 251 LCNB and Dakin employees. Our employees, honoring the traditions of the past, building for the future and taking care of our customers one at a time, day in and day out, are what make our success possible. -2- I trust that we have properly conveyed our readiness for and our dedication to the future. We want to continue to be your partner in the growth and prosperity of our region. We recommit ourselves to providing the necessary financial stability and dependability that will make that future growth and prosperity possible. The Annual Meeting for LCNB Corp. will be April 15, 2003 at 10:00 a.m. at our Main Office, 2 North Broadway in Lebanon, Ohio. Proxy material is included with this mailing. Please review, sign and return the proxy in the envelope provided. We would be pleased to have you attend the meeting in person. Thank you for your continued support. Stephen P. Wilson President & CEO -3- Financial Statements and Supplementary Data (pages 15-24 of Annual Report) ------------------------------------------- -4- INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders LCNB Corp. and subsidiaries Lebanon, Ohio We have audited the accompanying consolidated balance sheets of LCNB Corp. and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with U.S. generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of LCNB Corp. and Subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with U.S. generally accepted accounting principles. /s/J.D. Cloud & Co. L.L.P. ----------------------------- Certified Public Accountants Cincinnati, Ohio January 24, 2003 -5- LCNB CORP. AND SUBSDIARIES CONSOLIDATED BALANCE SHEETS At December 31 ($000's)
2002 2001 ASSETS: Cash and due from banks $ 13,679 14,286 Federal funds sold 11,925 19,950 ------- ------- Total cash and cash equivalents 25,604 34,236 Securities available for sale, at market value 136,178 98,610 Federal Reserve Bank and Federal Home Loan Bank stock, at cost 2,871 2,772 Loans, net 322,832 325,165 Premises and equipment, net 11,688 11,628 Intangibles 3,121 3,729 Other assets 4,457 4,295 ------- ------- TOTAL ASSETS $506,751 480,435 ======= ======= LIABILITIES: Deposits- Noninterest-bearing $ 58,921 59,137 Interest-bearing 383,299 355,635 ------- ------- Total deposits 442,220 414,772 Long-term debt 6,253 12,306 Accrued interest and other liabilities 6,348 3,850 ------- ------- TOTAL LIABILITIES 454,821 430,928 ------- ------- SHAREHOLDERS' EQUITY: Common shares, no par value, authorized 4,000,000 shares; 1,775,942 shares issued 10,560 10,560 Surplus 10,553 10,553 Retained earnings 30,768 27,714 Treasury shares at cost, 54,917 and 12,997 shares at December 31, 2002 and 2001, respectively (2,193) (516) Accumulated other comprehensive income net of taxes 2,242 1,196 ------- ------- TOTAL SHAREHOLDERS' EQUITY 51,930 49,507 ------- ------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $506,751 480,435 ======= ======= The accompanying notes to consolidated financial statements are an integral part of these statements.
-6- LCNB CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME For the years ended December 31 ($000's, except per share amounts)
2002 2001 2000 INTEREST INCOME: Interest and fees on loans $24,792 27,266 26,233 Dividends on Federal Reserve Bank and Federal Home Loan Bank stock 139 171 70 Interest on investment securities- Taxable 3,068 2,601 3,542 Non-taxable 1,825 1,459 1,606 Other short-term investments 339 667 700 ------ ------ ------ TOTAL INTEREST INCOME 30,163 32,164 32,151 ------ ------ ------ INTEREST EXPENSE: Interest on deposits 10,102 13,737 15,569 Interest on short-term borrowings 13 33 83 Interest on long-term borrowings 555 570 270 ------ ------ ------ TOTAL INTEREST EXPENSE 10,670 14,340 15,922 ------ ------ ------ NET INTEREST INCOME 19,493 17,824 16,229 PROVISION FOR LOAN LOSSES 348 237 197 ------ ------ ------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 19,145 17,587 16,032 ------ ------ ------ NON-INTEREST INCOME: Trust income 1,145 1,115 1,365 Service charges and fees 2,521 2,327 2,087 Net gain on sales of securities 429 17 12 Insurance agency income 1,164 1,108 811 Other operating income 364 275 125 ------ ------ ------ TOTAL NON-INTEREST INCOME 5,623 4,842 4,400 ------ ------ ------ NON-INTEREST EXPENSE: Salaries and wages 6,531 5,962 5,529 Pension and other employee benefits 1,702 1,577 1,415 Equipment expenses 877 664 629 Occupancy expense - net 1,029 1,043 1,044 State franchise tax 529 509 407 Marketing 394 386 422 Intangible amortization 608 602 581 ATM expense 412 349 290 Other non-interest expense 3,623 2,830 2,784 ------ ------ ------ TOTAL NON-INTEREST EXPENSE 15,705 13,922 13,101 ------ ------ ------ INCOME BEFORE INCOME TAXES 9,063 8,507 7,331 PROVISION FOR INCOME TAXES 2,523 2,440 2,091 ------ ------ ------ NET INCOME $ 6,540 6,067 $ 5,240 ====== ====== ====== Basic earnings per common share $ 3.79 3.43 2.95 ====== ====== ====== Weighted average shares outstanding (000's) 1,724 1,769 1,776 ====== ====== ====== The accompanying notes to consolidated financial statements are an integral part of these statements.
-7- LCNB CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY For the years ended December 31, (000's, except per share amounts)
Accumulated Other Total Common Retained Treasury Comprehensive Shareholders' Comprehensive Shares Surplus Earnings Shares Income Equity Income ------ ------- -------- ------ ------ ------ ------ Balance January 1, 2000 $10,560 10,553 22,872 (1,298) 42,687 Net income 5,240 5,240 5,240 Net unrealized gain on available-for-sale securities (net of taxes of $817) 1,587 1,587 1,587 Reclassification adjustment for net realized gain on sale of available-for-sale securities included in net income (net of taxes of $4) (8) (8) (8) ----- Total comprehensive income 6,819 ===== Cash dividends declared- $1.80 per share (3,196) (3,196) ------ ------ ------ ------ ----- ------ Balance December 31, 2000 10,560 10,553 24,916 281 46,310 Net income 6,067 6,067 6,067 Net unrealized gain on available-for-sale securities (net of taxes of $478) 928 928 928 Reclassification adjustment for net realized gain on sale of available-for-sale securities included in net income (net of taxes of $7) (13) (13) (13) ----- Total comprehensive income 6,982 ====== Treasury shares purchased (516) (516) Cash dividends declared- $1.85 per share (3,269) (3,269) ------ ------ ------ ----- ----- ------ Balance December 31, 2001 10,560 10,553 27,714 (516) 1,196 49,507 Net income 6,540 6,540 6,540 Net unrealized gain on available-for-sale securities (net of taxes of $685) 1,329 1,329 1,329 Reclassification adjustment for net realized gain on sale of available-for-sale securities included in net income (net of taxes of $146) (283) (283) (283) ----- Total comprehensive income 7,586 ===== Treasury shares purchased (1,677) (1,677) Cash dividends declared- $2.025 per share (3,486) (3,486) ------ ------ ------- ----- ----- ------ Balance December 31, 2002 $10,560 10,553 30,768 (2,193) 2,242 51,930 ====== ====== ====== ===== ===== ====== The accompanying notes to consolidated financial statements are an integral part of these statements.
-8- LCNB CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31 ($000's)
2002 2001 2000 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 6,540 6,067 5,240 Adjustments to reconcile net income to net cash provided by operating activities- Depreciation, amortization and accretion 2,548 2,259 1,997 Provision for loan losses 348 237 197 Deferred income tax benefit (63) (64) (70) Realized gains on sales of securities available for sale (429) (17) (12) Origination of mortgage loans for sale (20,852) (13,395) - Proceeds from sales of mortgage loans 21,087 13,462 - (Increase) decrease in income receivable 98 88 223 (Increase) decrease in other assets (595) (259) 705 Increase (decrease) in other liabilities (308) 549 (548) ------ ------ ------ TOTAL ADJUSTMENTS 1,834 2,860 2,492 ------ ------ ------ NET CASH PROVIDED BY OPERATING ACTIVITIES 8,374 8,927 7,732 ------ ------ ------ CASH FLOWS FROM INVESTING ACTIVITIES: Net decrease in interest-bearing deposits in banks - - 5,492 Proceeds from sales of securities available for sale 25,739 13,609 5,852 Proceeds from maturities of securities available for sale 29,093 15,916 28,899 Purchases of securities available for sale (91,171) (44,544) (10,224) Purchases of Federal Home Loam Bank stock - (252) (1,741) Net decrease (increase) in loans 1,829 2,599 (43,666) Purchases of premises and equipment (1,061) (2,215) (3,067) Proceeds from sales of premises and equipment 3 189 - ------ ------ ------ NET CASH USED IN INVESTING ACTIVITIES (35,568) (14,698) (18,455) ------ ------ ------ CASH FLOWS FROM FINANCING ACTIVITIES: Net change in deposits 27,449 19,986 3,216 Net change in short-term borrowings 2,329 (406) (1,175) Proceeds from issuance of long-term debt - 6,000 6,000 Principal payments on long-term debt (6,053) (50) - Cash dividends paid (3,486) (3,269) (3,196) Purchases of treasury shares (1,677) (516) - ------ ------ ------ NET CASH PROVIDED BY FINANCING ACTIVITIES 18,562 21,745 4,845 ------ ------ ------ NET CHANGE IN CASH AND CASH EQUIVALENTS (8,632) 15,974 (5,878) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 34,236 18,262 24,140 ------ ------ ------ CASH AND CASH EQUIVALENTS AT END OF YEAR $25,604 34,236 18,262 ====== ====== ====== SUPPLEMENTAL CASH FLOW INFORMATION: CASH PAID DURING THE YEAR FOR: Interest $10,968 14,585 15,778 Income taxes 2,540 2,562 1,877 The accompanying notes to consolidated financial statements are an integral part of these statements.
-9- NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES LCNB Corp. (the Company) was incorporated in December 1998. In the second quarter of 1999, each shareholder of Lebanon Citizens National Bank (the Bank) received ten common shares of the Company in exchange for each share of the Bank. Lebanon Citizens National Bank, as a result of the merger, became a wholly-owned subsidiary of LCNB Corp. In April 2000, the Company acquired Dakin Insurance Agency, Inc. (Dakin) as a wholly-owned subsidiary of LCNB Corp. and accounted for the merger as a pooling of interests. The Bank was founded in 1877 and provides full banking services, including trust services, to customers primarily in the southwestern Ohio area of Warren, Hamilton, Clermont, Clinton and Butler counties. Dakin is an independent insurance agency founded in 1876 and offers a wide range of insurance products for businesses and individuals in the Bank's primary market area. BASIS OF PRESENTATION- The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions are eliminated in consolidation. USE OF ESTIMATES- 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. INVESTMENT SECURITIES- Debt securities which the Company has the intent and ability to hold to maturity are reported at amortized cost. Debt securities classified as available for sale and all equity securities are reported at fair value with unrealized holding gains and losses reported net of income taxes as Accumulated Other Comprehensive Income, a separate component of shareholders' equity. Amortization of premiums and accretion of discounts are recognized as adjustments to interest income using the level yield method. Realized gains or losses from the sale of securities are computed using the specific identification method. Currently, the Company and its subsidiaries do not hold any derivatives or conduct hedging activities. Federal Home Loan Bank (FHLB) stock is an equity interest in the Federal Home Loan Bank of Cincinnati. It can be sold only at its par value of $100 per share and only to the FHLB or to another member institution. In addition, the equity ownership rights are more limited than would be the case for a public company, because of the oversight role exercised by the Federal Housing Finance Board in the process of budgeting and approving dividends. Federal Reserve Bank stock is similarly restricted in marketability and value. Both investments are carried at cost, which is their par value. -10- LOANS AND ALLOWANCE FOR LOAN LOSSES- Loans are stated at the principal amount outstanding, net of unearned income, deferred origination fees and costs, and the allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amount outstanding. The accrual of interest on loans is discontinued when there is a clear indication that the borrower's cash flow may not be sufficient to meet payments as they become due. Subsequent cash receipts on nonaccrual loans are recorded as a reduction of principal, and interest income is recorded once principal recovery is reasonably assured. The current year's accrued interest on loans placed on nonaccrual status is charged against earnings. Previous years' accrued interest is charged against the allowance for loan losses. Loan origination fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment of loan yields. These amounts are being amortized over the lives of the related loans. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible, based on evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers' ability to pay. Loans are considered impaired when management believes, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured by the present value of expected future cash flows using the loan's effective interest rate. Impaired collateral-dependent loans may be measured based on collateral value. Smaller-balance homogenous loans, including residential mortgage and consumer installment loans, are collectively evaluated for impairment. PREMISES AND EQUIPMENT- Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on both the straight-line and accelerated methods over the estimated useful lives of the assets. Costs incurred for maintenance and repairs are expensed currently. INTANGIBLE ASSETS- Statement of Financial Accounting Standards (SFAS) No. 147, Acquisitions of Certain Financial Institutions, was issued on October 1, 2002. The Financial Accounting Standards Board (FASB) issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets, on July 20, 2001. SFAS No. 147 amended certain provisions of SFAS No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institution, and SFAS No. 144, Accounting for Impairment or Disposal of Long-Level Assets. SFAS No. 147 requires that acquisitions of financial institutions be accounted for in accordance with SFAS No. 141, Business Combinations, if the acquisition meets the definition of a business combination. Any goodwill that results will be accounted for in accordance with the provisions of SFAS No. 142. If the acquisition does not meet the definition of a business combination, the cost of the assets acquired -11- shall be allocated to the individual assets acquired and liabilities assumed based on their relative fair values and shall not give rise to goodwill. Existing unidentifiable intangible assets shall continue to be amortized unless the transaction in which the intangible asset arose meets the definition of a business combination. In addition, SFAS No. 147 requires that long-term customer-relationship intangible assets of financial institutions, such as depositor- and borrower-relationship intangible assets and credit-cardholder intangible assets, be subject to the same undiscounted cash flow recoverability tests and impairment loss recognition and measurement provisions that SFAS No. 144 requires for long-term tangible assets and other finite-lived intangible assets that are held and used. The Company's intangible assets at December 31, 2002 primarily represent the unamortized intangible related to the Company's 1997 acquisition of three branch offices from another bank. Management does not believe its 1997 branch office acquisition meets the definition of a business combination and intends to continue amortizing the intangible over ten years, subject to periodic review for impairment in accordance with SFAS No. 144. At December 31, 2002, the carrying amount of this intangible was $3.1 million, net of accumulated amortization of $2.9 million. MARKETING EXPENSE- Marketing costs are expensed as incurred. EMPLOYEE BENEFITS- The Bank has a noncontributory pension plan covering full-time employees. The retirement plan cost is made up of several components that reflect different aspects of the Company's financial arrangements as well as the cost of benefits earned by employees. These components are determined using the projected unit credit actuarial cost method and are based on certain actuarial assumptions. INCOME TAXES- Certain income and expenses are recognized in different periods for financial reporting than for purposes of computing income taxes currently payable. Deferred taxes are provided on such temporary differences between the financial reporting and tax bases of the related assets and liabilities. STATEMENTS OF CASH FLOWS- For purposes of reporting cash flows, cash equivalents include all highly liquid investments with original maturities of three months or less. EARNINGS PER SHARE- Basic earnings per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. There are no warrants, options or other arrangements that would increase the number of shares outstanding. RECLASSIFICATIONS- Certain prior period data presented in the financial statements has been reclassified to conform with the current year presentation. RECENT ACCOUNTING PRONOUNCEMENTS- FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, was issued on November 25, 2002. The Interpretation elaborates on existing -12- disclosure requirements for most guarantees, including loan guarantees such as financial and performance standby letters of credit routinely issued by financial institutions. At the time a guarantor issues a guarantee, the guarantor must recognize an initial liability for the fair value of the obligations it assumes under the guarantee. Normally, the fair value is assumed to be the fee the guarantor receives for issuing the guarantee. The initial recognition and measurement provisions of the Interpretation apply to guarantees issued or modified after December 31, 2002, regardless of the guarantor's fiscal year-end. The disclosure requirements are effective for interim and annual financial statements ending after December 15, 2002. The provisions of the Interpretation are not expected to have a material effect on the Company's financial statements. SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, was issued by the FASB on December 31, 2002. This statement amends certain sections of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 recommended, but did not require, companies use a fair value based method of accounting for stock-based employee compensation. Under SFAS No. 123, companies electing to adopt the recommended fair value method were required to apply that method prospectively for new stock option awards. SFAS No. 148 provides two additional transition methods, which allows companies to either immediately recognize stock-based employee compensation cost in the year of adoption relating to all activity since 1994 or restate all periods presented in the financial statements to reflect stock-based employee compensation cost for all periods since 1994. SFAS No. 148 also changed disclosure requirements for stock-based compensation. The Company adopted an Ownership Incentive Plan during 2002 that allows for stock-based awards to eligible employees, but no awards have been granted as of December 31, 2002. Management believes any effect on the 2003 financial statements will be immaterial. NOTE 2 - INVESTMENT SECURITIES The amortized cost and estimated market value of available-for-sale investment securities at December 31 are summarized as follows ($000's):
2002 ----------------------------------------- Amortized Unrealized Unrealized Market Cost Gains Losses Value ---- ----- ------ ----- U.S. Treasury notes $ 999 20 - 1,019 U.S. Agency notes 46,436 653 - 47,089 U.S. Agency mortgage- backed securities 18,742 310 - 19,052 Municipal securities: Non-taxable 54,924 2,012 80 56,856 Taxable 11,681 487 6 12,162 ------- ----- -- ------- $132,782 3,482 86 136,178 ======= ===== == ======= -13- 2001 ----------------------------------------- Amortized Unrealized Unrealized Market Cost Gains Losses Value ---- ----- ------ ----- U.S. Treasury notes $ 1,996 48 - 2,044 U.S. Agency notes 36,033 388 93 36,328 U.S. Agency mortgage- backed securities 9,432 139 1 9,570 Municipal securities: Non-taxable 40,943 1,230 70 42,103 Taxable 8,395 199 29 8,565 ------ ----- --- ------ $ 96,799 2,004 193 98,610 ====== ===== === ======
Contractual maturities of debt securities at December 31, 2002 were as follows ($000'). Actual maturities may differ from contractual maturities when issuers have the right to call or prepay obligations.
Amortized Market Cost Value Due within one year $ 15,317 15,467 Due from one to five years 73,573 75,585 Due from five to ten years 19,258 19,790 Due after ten years 5,892 6,284 ------- ------- 114,040 117,126 U.S. Agency mortgage- backed securities 18,742 19,052 ------- ------- $132,782 136,178 ======= =======
Gross gains realized on sales of securities available for sale were $446,000, $46,000, and $31,000 for 2002, 2001 and 2000, respectively. Gross realized losses during 2002, 2001 and 2000 amounted to $17,000, $29,000 and $19,000, respectively. Investment securities with a market value of $42,254,000 and $51,785,000 at December 31, 2002 and 2001, respectively, were pledged to secure public deposits and for other purposes required or permitted by law. -14- NOTE 3 - LOANS Major classifications of loans at December 31 are as follows ($000's):
2002 2001 Commercial and industrial $ 35,198 40,486 Commercial, secured by real estate 80,882 72,477 Residential real estate 151,502 165,710 Consumer, excluding credit card 51,184 41,006 Agricultural 1,314 2,020 Credit card 2,689 2,658 Other loans 57 112 Lease financing 1,256 2,088 ------- ------- 324,082 326,557 Deferred net origination costs 750 608 ------- ------- 324,832 327,165 Allowance for loan losses (2,000) (2,000) ------- ------- Loans-net $322,832 325,165 ======= =======
Mortgage loans sold to and serviced for the Federal Home Loan Mortgage Corporation are not included in the accompanying balance sheets. The unpaid principal balances of those loans at December 31, 2002, 2001 and 2000 were $36,592,000, $23,734,000, and $14,046,000 respectively. Gains from sales of loans recognized in the accompanying income statements in 2002, 2001 and 2000 were $235,000, $67,000 and $-0-, respectively. Changes in the allowance for loan losses were as follows ($000's):
2002 2001 2000 BALANCE-BEGINNING OF YEAR $2,000 2,000 2,000 Provision for loan losses 348 237 197 Charge-offs (390) (277) (255) Recoveries 42 40 58 ----- ----- ----- BALANCE-END OF YEAR $2,000 2,000 2,000 ===== ===== =====
There were no nonaccrual loans at December 31, 2002 or 2001. Interest income that would have been recorded in 2002, 2001 and 2000 if loans on nonaccrual status at various times during the respective years had been current and in accordance with their original terms, was not material. At December 31, 2002 and 2001, the recorded investment in loans which are considered to be impaired in accordance with SFAS Statement No. 114 was not material. At December 31, 2002 and 2001, loans past due 90 days or more and still accruing were -15- $232,000 and $146,000, respectively. The Bank is not committed to lend additional funds to debtors whose loans have been modified to provide a reduction or deferral of principal or interest because of a deterioration in the financial position of the borrower. NOTE 4 - PREMISES AND EQUIPMENT Premises and equipment at December 31 are summarized as follows ($000's):
2002 2001 Land $ 2,251 2,251 Buildings 9,715 9,830 Equipment 9,903 8,763 ------ ------ Total 21,869 20,844 Less-Accumulated depreciation 10,181 9,216 ------ ------ Premises and Equipment-Net $11,688 11,628 ====== ======
Depreciation charged to income was $999,000 in 2002, $898,000 in 2001, and $796,000 in 2000. Some of the Bank' branches, telephone equipment, and other equipment are leased under agreements expiring at various dates through 2050. These leases are accounted for as operating leases. At December 31, 2002, required minimum annual rentals due in the future on noncancelable leases having terms in excess of one year aggregated $2,562,000. Minimum annual rentals for each of the years 2003 through 2007 are $268,000, $259,000, $251,000, $230,000 and $124,000, respectively. Rental expense for all leased branches and equipment amounted to $305,000 in 2002, $294,000 in 2001 and $263,000 in 2000. NOTE 5 - DEPOSIT LIABILITIES Contractual maturities of certificates of deposit at December 31, 2002 were as follows ($000's):
Certificates All other over $100,000 Certificates Total 2003 $ 9,799 42,685 52,484 2004 9,376 32,921 42,297 2005 3,803 12,711 16,514 2006 3,898 11,426 15,324 2007 2,845 11,076 13,921 Thereafter - 211 211 ------ ------- ------- $29,721 111,030 140,751 ====== ======= =======
-16- NOTE 6 - EMPLOYEE BENEFITS The Company's noncontributory defined benefit retirement plan covers all regular full-time employees. The benefits are based on years of service and the employee's highest average compensation during five consecutive years. Pension costs are funded based on the Plan's actuarial cost method. The components of net periodic pension cost are summarized as follows ($000's):
2002 2001 2000 Service cost $629 566 423 Interest cost 262 212 205 Actual return on Plan assets (248) (164) (192) Amortization of unrecognized transition obligation 10 17 17 Recognized net actuarial loss (gain) 5 (52) 55 --- --- --- Net periodic pension cost $658 579 508 === === ===
A summary of the Plan's prepaid benefit cost, included in other assets on the consolidated balance sheets, and the Plan's funded status at December 31 follows ($000's):
2002 2001 Change in projected benefit obligations --------------------------------------- Projected benefit obligation at beginning of year $4,785 3,854 Service cost 629 566 Interest cost 262 212 Actuarial loss 80 163 Benefits paid (23) (10) ----- ----- Projected benefit obligation at end of year 5,733 4,785 ----- ----- Change in plan assets --------------------- Fair value of plan assets at beginning of year 4,782 4,030 Actual return on plan assets 248 164 Employer contribution 671 598 Benefits paid (23) (10) ----- ----- Fair value of plan assets at end of year 5,678 4,782 ----- ----- Funded status (55) (3) Unrecognized net actuarial loss 916 840 Unrecognized transition obligation - 10 ----- ----- Prepaid benefit cost $ 861 847 ===== =====
-17- Significant actuarial assumptions used for 2002 and 2001 included a discount rate, an expected long-term rate of return on Plan assets, and an expected future compensation rate increase of 5.50%, 5.50% and 4.00%, respectively. The Bank has a benefit plan which permits eligible officers to defer a portion of their compensation. The deferred compensation balance, which accrues interest at 8% annually, is distributable in cash after retirement or termination of employment. The amount of such deferred compensation at December 31, 2002 and 2001 was $544,000 and $434,000, respectively. The Bank also has a supplemental income plan which provides a covered employee an amount based on a percentage of average compensation, payable annually for ten years upon retirement. The projected benefit obligation included in other liabilities for this supplemental income plan at December 31, 2002 and 2001 is $132,000 and $110,000, respectively. The discount rate used to determine the present value of the obligation was 6.5% in 2002 and 2001. The service cost associated with this plan in each of the three years 2002, 2001, and 2000 was approximately $16,000. Interest costs were not material. Both of these plans are nonqualified and unfunded. Participation in each plan is limited to a select group of management. NOTE 7 - LONG-TERM DEBT AND OTHER BORROWINGS Long-term debt consists of the following at December 31 (000's):
2002 2001 Federal Home Loan Bank notes $6,000 12,000 Note payable to former shareholder of Dakin 253 306 ----- ------ Total $6,253 12,306 ===== ======
Maturities of long-term debt in the years ending December 31 are as follows (000's)
2003 $2,056 2004 2,060 2005 64 2006 2,067 2007 6
-18- In August 2002, LCNB retired $4.0 million in Federal Home Loan Bank notes bearing a weighted average interest rate of 7.72%. These notes were scheduled to mature in 2004 and 2005. In connection with this transaction, the Company recorded an expense of $425,000 in other non-interest expense in the 2002 consolidated statement of income, which is the required prepayment penalty. At December 31, 2002, the Federal Home Loan Bank borrowings consist of three notes with two, three, and five-year maturities and have a weighted average interest rate of 4.52%. Interest on the notes is fixed and payable monthly. The notes are collateralized by a blanket pledge of 1-4 family residential mortgage loans. Additionally, the Company is required to hold minimum levels of FHLB stock, based on the outstanding borrowings. The note payable matures in 2007. Payments are due monthly at a nominal interest rate of 6%. At December 31, 2002 and 2001, accrued interest and other liabilities include U.S. Treasury demand note borrowings of approximately $3,022,000 and $693,000, respectively. NOTE 8 - INCOME TAXES The provision for federal income taxes consists of ($000's):
2002 2001 2000 Income taxes currently payable $2,586 2,528 2,161 Deferred income tax benefit (63) (88) (70) ----- ----- ----- Provision for income taxes $2,523 2,440 2,091 ===== ===== =====
A reconciliation between the statutory income tax rate and the Company's effective tax rate follows:
2002 2001 2000 Statutory tax rate 34.0% 34.0% 34.0% Increase (decrease) resulting from- Tax exempt interest (6.1) (5.4) (6.5) Other-net (.1) .1 1.0 ---- ---- ---- Effective tax rate 27.8% 28.7% 28.5% ==== ==== ====
-19- Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company has not recorded a valuation reserve related to deferred tax assets. Deferred tax assets and liabilities at December 31 consist of the following ($000's):
2002 2001 Deferred tax assets: Allowance for loan losses $ 522 522 Amortization of intangibles 315 258 ----- ----- 837 780 ----- ----- Deferred tax liabilities: Depreciation of premises and equipment (314) (275) Unrealized gains on securities available-for-sale (1,155) (616) Deferred loan fees (60) (91) Pension and deferred compensation (61) (109) FHLB stock dividends (89) (55) ----- ----- (1,679) (1,146) ----- ----- Net deferred tax asset (liability( $ (842) (366) ===== =====
NOTE 9 - COMMITMENTS AND CONTINGENT LIABILITIES The Company 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 include 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. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contract amount of those instruments. The Company 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 December 31 were as follows (000's):
2002 2001 Commitments to extend credit $69,521 56,738 Standby letters of credit 6,938 6,410
-20- 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. Commitments generally have fixed expiration dates or other termination clauses. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. At December 31, 2002 and 2001, outstanding guarantees of $2,048,000 and $1,520,000, respectively, were issued to developers and contractors. These guarantees generally expire within one year and are fully secured. In addition, the Company has an approximate $5 million participation at December 31, 2002 and 2001 in a letter of credit securing payment of principal and interest on a bond issue. This letter of credit will expire July 15, 2005, and is secured by an assignment of rents and the underlying real property. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Company 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. The Company and its subsidiaries 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 10 - RELATED PARTY TRANSACTIONS The Company has entered into related party transactions with various directors and executive officers. Such transactions originate in the normal course of the Bank's operations as a depository and lending institution and were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated customers. Management believes these loans do not involve more than a normal risk of collectibility or present other unfavorable features. At December 31, 2002 and 2001, certain executive officers, directors and associates of such persons were indebted to the Bank directly or as guarantors in the aggregate amount of $3,961,000 and $3,169,000, respectively. During 2002, $2,376,000 in new loans were made and repayments totaled $1,584,000. Deposits from certain executive officers, directors and associates of such persons held by the Company at December 31, 2002 and 2001 amounted to $7,577,000 and $6,340,000, -21- NOTE 11 - FAIR VALUE OF FINANCIAL INSTRUMENTS Carrying amounts and estimated fair values of financial instruments as of December 31, were as follows ($000's):
2002 2001 ----------------- ----------------- Carrying Fair Carrying Fair Amount Value Amount Value FINANCIAL ASSETS: Cash and cash equivalents $ 25,604 25,604 34,236 34,236 Federal Reserve Bank and Federal Home Loan Bank stock 2,871 2,871 2,772 2,772 Securities available-for-sale 136,178 136,178 98,610 98,610 Loans, net 322,832 329,447 325,165 328,131 FINANCIAL LIABILITIES: Deposits 442,221 449,644 414,772 418,700 Short-term borrowings 3,022 3,022 693 693 Long-term debt 6,253 6,545 12,306 12,693
The fair value of off-balance-sheet financial instruments at December 31, 2002 and 2001 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 the Bank. The following methods and assumptions were used to estimate the fair value of certain financial instruments: Cash and cash equivalents: The carrying amounts presented are deemed to approximate fair value. Investment Securities: Fair values 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. 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. 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. -22- Borrowings: The carrying amounts of federal funds purchased and U.S. Treasury notes 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 rate. NOTE 12 - REGULATORY MATTERS The Federal Reserve Act requires depository institutions to maintain cash reserves with the Federal Reserve Bank. In 2002 and 2001, the Bank was required to maintain average reserve balances of $1,743,000 and $4,849,000, respectively. The Company (consolidated) and the Bank must meet certain minimum capital requirements set by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company's and Bank's financial statements. The minimum regulatory capital ratios are 8% for total risk-based, 4% for Tier 1 risk-based, and 4% for leverage. For various regulatory purposes, 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 Company and Bank 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 category. A summary of the regulatory capital of the Consolidated Company and Bank at December 31 follows ($000's):
2002 2001 ---------------------------------- Consolidated Consolidated Company Bank Company Bank Regulatory Capital: Shareholders' equity $51,930 44,099 49,507 42,165 Goodwill and other intangibles (3,121) (3,011) (3,729) (3,585) Net unrealized securities losses (gains) (2,242) (2,152) (1,196) (1,071) ------ ------ ------ ------ Tier 1 risk-based capital 46,567 38,936 44,582 37,509 Eligible allowance for loan losses 2,000 2,000 2,000 2,000 ------ ------ ------ ------ Total risk-based capital $48,567 40,936 46,582 39,509 ====== ====== ====== ====== Capital Ratios: Total risk-based 15.36% 13.03% 15.40% 13.24% Tier 1 risk-based 14.73% 12.39% 14.74% 12.57% Leverage 9.21% 7.79% 9.46% 8.06%
The principal source of income and funds for LCNB Corp. is dividends paid by the Bank. The payment of dividends is subject to restriction by regulatory authorities. For 2003, the restrictions generally limit dividends to the aggregate of net income for the year 2003 plus the retained net earnings for 2002 and 2001. In addition, dividend payments may not reduce capital levels below minimum regulatory guidelines. Accordingly, future dividends may require the prior approval of the Comptroller of the Currency. -23- NOTE 13 - PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for LCNB Corp. parent company only follows ($000's):
Condensed Balance Sheets December 31 2002 2001 Assets: Cash on deposit with subsidiary $ 1,493 91 Corporate and municipal debt securities 6,231 7,141 Investment in subsidiary 44,199 42,195 Other assets 30 80 ------ ------ Total assets $51,953 49,507 ====== ====== Liabilities $ 23 - Shareholders' equity 51,930 49,507 ------ ------ Total liabilities and shareholders' equity $51,953 49,507 ====== ====== Condensed Statements of Income Year ended December 31 2002 2001 2000 Income: Dividends from subsidiary $ 5,485 5,676 3,197 Interest 243 217 202 Gain on sale of investment securities 9 - 7 ------ ----- ----- Total income 5,737 5,893 3,406 Total expense 40 45 40 ----- ----- ----- Income before income tax benefit and equity in undistributed income of subsidiary 5,697 5,848 3,366 Income tax (expense) benefit (80) 15 10 Equity in undistributed income of subsidiary 923 204 1,864 ----- ----- ----- Net income $6,540 6,067 5,240 ===== ===== ===== -24- Condensed Statements of Cash Flows Year ended December 31 2002 2001 2000 Cash flows from operating activities: Net income $ 6,540 $6,067 5,240 Adjustments for non-cash items - Equity in undistributed (income) excess dividends of subsidiary (923) (204) (1,864) Other, net 105 44 59 ----- ----- ----- Net cash provided by operating activities 5,722 5,907 3,435 ----- ----- ----- Cash flows from investing activities: Capital contribution to subsidiary - - (185) Purchases of securities available-for- sale (4,224) (2,379) (2,143) Proceeds from sales of securities available-for-sale 3,992 300 773 Proceeds from maturities of securities available-for-sale 1,075 - 1,347 ----- ----- ----- Cash flow used in investing activities 843 (2,079) (208) ----- ----- ----- Cash flows from financing activities: Treasury shares purchased (1,677) (516) - Cash dividends paid (3,486) (3,269) (3,196) ----- ----- ----- Cash flow used in financing activities (5,163) (3,785) (3,196) ----- ----- ----- Net change in cash 1,402 43 31 Cash at beginning of year 91 48 17 ----- ----- ----- Cash at end of year $1,493 91 48 ===== ===== =====
-25-