10-Q 1 lnb0331201410-q.htm 10-Q LNB 03.31.2014 10-Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
FORM 10-Q
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2014
OR
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: 0-13203
LNB Bancorp, Inc.
(Exact name of the registrant as specified in its charter)
Ohio
 
34-1406303
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
457 Broadway, Lorain, Ohio
 
44052-1769
(Address of principal executive offices)
 
(Zip Code)
(440) 244-6000
(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.    Yes  þ        No  ¨
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ        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. (Check one):
Large accelerated filer  o
  
Accelerated filer  o
  
Non-accelerated filer  þ
  
Smaller reporting company   o
 
  
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨        No  þ

The number of common shares of the registrant outstanding on May 2, 2014 was 9,664,972.
 



TABLE OF CONTENTS
 
 
 
Page
 
 




PART I - Financial Information
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
 
March 31, 2014
 
December 31, 2013
 
(unaudited)
 
 
 
(Dollars in thousands
except share amounts)
ASSETS
 
 
 
Cash and due from banks
$
38,939

 
$
36,717

Federal funds sold and interest bearing deposits in banks
29,302

 
15,555

Cash and cash equivalents (Note 3)
68,241

 
52,272

Securities available for sale, at fair value (Note 5)
217,510

 
216,122

Restricted stock
5,741

 
5,741

Loans held for sale
1,811

 
4,483

Loans:
 
 
 
Portfolio loans (Note 6)
910,189

 
902,299

Allowance for loan losses (Note 6)
(17,497
)
 
(17,505
)
Net loans
892,692

 
884,794

Bank premises and equipment, net
8,013

 
8,198

Other real estate owned
979

 
579

Bank owned life insurance
19,532

 
19,362

Goodwill, net (Note 4)
21,582

 
21,582

Intangible assets, net (Note 4)
424

 
457

Accrued interest receivable
3,774

 
3,621

Other assets
15,094

 
13,046

Total Assets
$
1,255,393

 
$
1,230,257

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Deposits: (Note 7)
 
 
 
Demand and other noninterest-bearing
$
149,530

 
$
148,961

Savings, money market and interest-bearing demand
430,142

 
393,778

Time deposits
497,179

 
502,850

Total deposits
1,076,851

 
1,045,589

Short-term borrowings (Note 8)
3,725

 
4,576

Federal Home Loan Bank advances (Note 9)
46,760

 
46,708

Junior subordinated debentures (Note 10)
16,238

 
16,238

Accrued interest payable
701

 
789

Accrued expenses and other liabilities
4,004

 
4,901

Total Liabilities
1,148,279

 
1,118,801

Shareholders’ Equity
 
 
 
Preferred stock, Series A Voting, no par value, authorized 150,000 shares, none issued at March 31, 2014 and December 31, 2013.

 

Fixed rate cumulative preferred stock, Series B, no par value, $1,000 liquidation value, no shares were issued at March 31, 2014 and 7,689 shares authorized and issued at December 31, 2013

 
7,689

Discount on Series B preferred stock

 
(19
)
Common stock, par value $1 per share, authorized 15,000,000 shares, issued 10,001,717 shares at March 31, 2014 and 10,001,717 at December 31, 2013
10,002

 
10,002

Additional paid-in capital
51,166

 
51,098

Retained earnings
55,440

 
53,966

Accumulated other comprehensive income (loss)
(3,317
)
 
(5,188
)
Treasury shares at cost, 336,745 shares at March 31, 2014 and 328,194 shares at December 31, 2013
(6,177
)
 
(6,092
)
Total Shareholders’ Equity
107,114

 
111,456

Total Liabilities and Shareholders’ Equity
$
1,255,393

 
$
1,230,257

See accompanying notes to consolidated financial statements.

3



CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited)

 
Year Ended Three Months Ended
 
March 31, 2014
 
March 31, 2013
 
 
(Dollars in thousands except share and per share amounts)
Interest and Dividend Income
 
 
 
 
Loans
$
8,928

 
$
9,054

 
Securities:

 

 
U.S. Government agencies and corporations
1,028

 
841

 
State and political subdivisions
303

 
289

 
Other debt and equity securities
117

 
70

 
Federal funds sold and short-term investments
17

 
20

 
Total interest income
10,393

 
10,274

 
Interest Expense
 
 
 
 
Deposits
1,082

 
1,249

 
Federal Home Loan Bank advances
155

 
154

 
Short-term borrowings
26

 
1

 
Junior subordinated debentures
169

 
166

 
Total interest expense
1,432

 
1,570

 
Net Interest Income
8,961

 
8,704

 
Provision for Loan Losses (Note 6)
900

 
1,350

 
Net interest income after provision for loan losses
8,061

 
7,354

 
Noninterest Income
 
 
 
 
Investment and trust services
400

 
375

 
Deposit service charges
770

 
816

 
Other service charges and fees
753

 
831

 
Income from bank owned life insurance
169

 
168

 
Other income (loss)
151

 
321

 
Total fees and other income
2,243

 
2,511

 
Securities gains, net (Note 5)

 
178

 
Gains on sale of loans
703

 
656

 
Loss on sale of other assets, net
(34
)
 
(13
)
 
Total noninterest income
2,912

 
3,332

 
Noninterest Expense
 
 
 
 
Salaries and employee benefits
4,595

 
5,027

 
Furniture and equipment
1,148

 
949

 
Net occupancy
613

 
588

 
Professional fees
494

 
490

 
Marketing and public relations
400

 
289

 
Supplies, postage and freight
214

 
307

 
Telecommunications
151

 
162

 
Intangible asset amortization
33

 
33

 
Ohio franchise tax
224

 
308

 
FDIC assessments
272

 
242

 
Other real estate owned
24

 
77

 
Loan and collection expense
298

 
388

 
Other expense
393

 
421

 
Total noninterest expense
8,859

 
9,281

 
Income before income tax expense
2,114

 
1,405

 
Income tax expense
508

 
292

 
Net Income
1,606

 
1,113

 
Other comprehensive income (loss), net of taxes:


 
 
 
Changes in unrealized securities' holding gain (loss) net of taxes
1,871

 
(714
)
 
Less: reclassification adjustments for securities' gains realized in net income,

 
117

 
Total other comprehensive income (loss), net of taxes
1,871

 
(831
)
 
Comprehensive income (loss)
3,477

 
282

 
Net Income
1,606

 
1,113

 
Dividends and accretion on preferred stock
35

 
257

 
Net Income Available to Common Shareholders
$
1,571

 
$
856

 

4


 
 
 
 
 
Net Income Per Common Share (Note 2)
 
 
 
 
Basic
$
0.16

 
$
0.10

 
Diluted
0.16

 
0.10

 
Dividends declared
0.01

 
0.01

 
 
 
 
 
 
Average Common Shares Outstanding
 
 
 
 
Basic
9,668,297

 
8,201,120

 
Diluted
9,705,432

 
8,212,038

 
See accompanying notes to consolidated financial statements

5


CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Unaudited)

Preferred
Stock
(net of
discount)
 
Warrant to
Purchase
Common
Stock
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Treasury
Stock
 
Total
 
(Dollars in thousands except share and per share amounts)
Balance, December 31, 2012
$
18,815

 
$

 
$
8,273

 
$
39,141

 
$
48,767

 
$
1,240

 
$
(6,092
)
 
$
110,144

Net Income

 

 

 

 
1,113

 

 

 
1,113

Other comprehensive loss

 

 

 

 

 
(831
)
 

 
(831
)
Share-based compensation

 

 

 
72

 

 

 

 
72

Issuance of common stock (1,359 shares)


 

 
1,359

 
8,374

 


 

 

 
9,733

Redemption of preferred stock (9,733 shares)
(9,701
)
 

 
 
 


 
7

 
 
 
 
 
(9,694
)
Preferred dividends and accretion of discount
4

 

 


 


 
(257
)
 

 

 
(253
)
Common dividends declared, $.01 per share


 

 

 

 
(79
)
 

 

 
(79
)
Balance, March 31, 2013
$
9,118

 
$

 
$
9,632

 
$
47,587

 
$
49,551

 
$
409

 
$
(6,092
)
 
$
110,205

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2013
$
7,670

 
$

 
$
10,002

 
$
51,098

 
$
53,966

 
$
(5,188
)
 
$
(6,092
)
 
$
111,456

Net Income

 

 

 


 
1,606

 

 

 
1,606

Other comprehensive income

 

 

 

 

 
1,871

 

 
1,871

Share-based compensation

 

 

 
68

 

 

 

 
68

Purchase of treasury stock


 

 


 


 

 

 
(85
)
 
(85
)
Redemption of preferred stock (7,689 shares)
(7,689
)
 

 

 

 


 

 

 
(7,689
)
Preferred dividends and accretion of discount
19

 


 


 


 
(35
)
 


 


 
(16
)
Common dividends declared, $.01 per share


 


 


 


 
(97
)
 


 


 
(97
)
Balance, March 31, 2014
$

 
$

 
$
10,002

 
$
51,166

 
$
55,440

 
$
(3,317
)
 
$
(6,177
)
 
$
107,114

See accompanying notes to consolidated financial statements

6


CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
Three Months Ended
 
March 31, 2014
 
March 31, 2013
 
 
(Dollars in thousands)
Operating Activities
 
 
 
 
Net income
$
1,606

 
$
1,113

 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 
Provision for loan losses
900

 
1,350

 
Depreciation and amortization
232

 
262

 
Amortization of premiums and discounts
460

 
512

 
Amortization of intangibles
33

 
33

 
Amortization of loan servicing rights
72

 
86

 
Amortization of deferred loan fees
(43
)
 
(114
)
 
Income from cash surrender value of bank-owned life insurance policies
(169
)
 
(168
)
 
Federal deferred income tax expense (benefit)
191

 
860

 
Securities gains, net

 
(178
)
 
Share-based compensation expense
68

 
72

 
Loans originated for sale
(18,361
)
 
(29,879
)
 
Proceeds from sales of loan originations
21,734

 
31,919

 
Net gain from loan sales
(703
)
 
(656
)
 
Net loss on sale of other assets
34

 
13

 
Net increase (decrease) in accrued interest receivable and other assets
(3,237
)
 
(4,054
)
 
Net increase (decrease) in accrued interest payable, taxes and other liabilities
(1,176
)
 
2,493

 
Net cash provided by operating activities
1,641

 
3,664

 
Investing Activities
 
 
 
 
Proceeds from sales of available-for-sale securities

 
2,280

 
Proceeds from maturities of available-for-sale securities
11,387

 
31,171

 
Purchase of available-for-sale securities
(10,399
)
 
(54,455
)
 
Net increase in loans made to customers
(9,364
)
 
(8,453
)
 
Proceeds from the sale of other real estate owned
172

 
141

 
Purchase of bank premises and equipment
(53
)
 
(129
)
 
Proceeds from sale of bank premises and equipment
9

 

 
Net cash used in investing activities
(8,248
)
 
(29,445
)
 
Financing Activities
 
 
 
 
Net increase (decrease) in demand and other noninterest-bearing
569

 
(3,581
)
 
Net increase in savings, money market and interest-bearing demand
36,364

 
19,793

 
Net increase (decrease) in time deposits
(5,671
)
 
33,372

 
Net increase in short-term borrowings
(851
)
 
774

 
Proceeds from Federal Home Loan Bank advances

 
53

 
Payment of Federal Home Loan Bank advances
52

 
(3
)
 
Redemption of Fixed-Rate Cumulative Perpetual Preferred stock
(7,670
)
 

 
Purchase of Treasury Stock
(85
)
 

 
Dividends paid
(132
)
 
(332
)
 
Net cash provided by financing activities
22,576

 
50,076

 
Net increase in cash and cash equivalents
15,969

 
24,295

 
Cash and cash equivalents, January 1
52,272

 
30,659

 
Cash and cash equivalents, March 31
$
68,241

 
$
54,954

 
Supplemental cash flow information
 
 
 
 
Interest paid
$
1,520

 
$
1,623

 
Income taxes paid

 
465

 
Transfer of loans to other real estate owned
609

 
40

 
See accompanying notes to consolidated financial statements

7


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands except per share amounts)

(1)    Summary of Significant Accounting Policies

Basis of Presentation
The consolidated financial statements include the accounts of LNB Bancorp, Inc. (the “Corporation”) and its wholly-owned subsidiary, The Lorain National Bank (the “Bank”). The consolidated financial statements also include the accounts of North Coast Community Development Corporation which is a wholly-owned subsidiary of the Bank. All intercompany transactions and balances have been eliminated in consolidation.
The accounting and reporting policies followed in the presentation of the accompanying Unaudited Consolidated Financial Statements are consistent with those described in Note 1 of the Notes to the Consolidated Financial Statements in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2013, as updated by the information contained in this Form 10-Q. Management has evaluated all significant events and transactions that occurred after March 31, 2014, for potential recognition or disclosure in these consolidated financial statements. In the opinion of management, these consolidated financial statements reflect all adjustments necessary to present fairly such information for the periods and dates indicated. Such adjustments are normal and recurring in nature. The Consolidated Balance Sheet at December 31, 2013, contained herein has been derived from the audited Consolidated Balance Sheet included in Corporation’s Annual Report on Form 10-K.
The preparation of the consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Results of operations for interim periods are not necessarily indicative of the results to be expected for the full year, due in part to seasonal variations and unusual or infrequently occurring items.
Certain reclassifications of prior years' amounts have been made to conform to current year presentation. Such reclassifications had no effect on prior year net income or shareholders' equity.
New Accounting Pronouncements:
In January 2014, the Financial Accounting Standards Board issued an accounting standards update allowing entities to make an accounting policy election with respect to using the proportional amortization method for investments in qualified affordable housing projects, if certain conditions are met. This standard will be effective for public companies for interim and annual periods beginning after December 15, 2014. The Corporation will adopt this new guidance as required, and it is not expected to have a material impact on the Corporation's Consolidated Financial Statements.
Also in January 2014, the Financial Accounting Standards Board issued an accounting standards update clarifying guidance for in substance repossessions and foreclosures, and requiring additional disclosures regarding foreclosed residential real estate property and recorded investments in consumer mortgage loans collateralized by residential real estate in the process of foreclosure. This standard will be effective for public companies for interim and annual periods beginning after December 15, 2014. The Corporation will adopt this new guidance as required, and it is not expected to have a material impact on the Corporation's Consolidated Financial Statements.



















8








(2)    Earnings Per Common Share

The Corporation calculates earnings per common share (EPS) using the two-class method. The two-class method allocates net income to each class of Common Stock and participating security according to the common dividends declared and participation rights in undistributed earnings. Participating securities consist of unvested stock-based payment awards that contain nonforfeitable rights to dividends. The Corporation also uses the treasury stock method to calculate dilutive EPS. The treasury stock method assumes that the Corporation uses the proceeds from a hypothetical exercise of options to repurchase Common Stock at the average market price during the period. The reconciliation between basic and diluted earnings per share is presented as follows (Dollars in thousands, except per share data) :

 
Three Months Ended
 
March 31, 2014
 
March 31, 2013
Basic EPS
 
 
 
Net income
$
1,606

 
$
1,113

Less:
 
 
 
Preferred stock dividend and accretion
35

 
257

Income allocated to participating securities
6

 
11

Net income allocated to common shareholders
$
1,565

 
$
845

 
 
 
 
Average common shares outstanding
9,668,297

 
8,201,120

Less: participating shares included in average common shares outstanding
53,169

 
117,031

Average common shares outstanding used in basic EPS
9,615,128

 
8,084,089

Basic net income per common share
$
0.16

 
$
0.10

 
 
 
 
Diluted EPS:
 
 
 
Income used in diluted earnings per share calculation
$
1,565

 
$
845

 
 
 
 
Average common shares outstanding
9,668,297

 
8,201,120

Add: Common Stock equivalents:
 
 
 
Stock Options
37,135

 
10,918

Average common stock shares outstanding
9,705,432

 
8,212,038

Diluted earnings per common share
$
0.16

 
$
0.10


For the three months ended March 31, 2014, approximately 172,000 of options to purchase shares of common stock were not included in the computation of diluted earnings per share because the effect would be antidilutive. For the three months ended March 31, 2013, approximately 194,500 of options to purchase shares of common stock were not included in the computation of diluted earnings per share because the effect would be antidilutive.

(3)    Cash and Cash Equivalents
For purposes of the Consolidated Statements of Cash Flows, the Corporation considers cash and cash equivalents to include cash on hand, cash items in the process of collection, non-interest bearing amounts due from correspondent banks, federal funds sold and securities purchased under resale agreements with original maturities of three months or less.


9



(4)    Goodwill and Intangible Assets
The Corporation has goodwill of $21,582 primarily from an acquisition completed in 2007. The Corporation assesses goodwill for impairment annually and more frequently in certain circumstances. In September 2011, FASB issued an update on the testing of goodwill for impairment under ASC Topic 350, Intangibles – Goodwill and Other. ASC 350 requires a corporation to test goodwill for impairment, on at least an annual basis, by comparing the fair value of a reporting unit with its carrying amount. The overall objective of the update is to simplify how entities, both public and private, test goodwill for impairment. Simplification has resulted in an entity having the option to first assess qualitative factors to determine whether the existence or circumstances lead to a determination that it is more likely than not (that is, a likelihood of more than fifty percent) that the fair value of a reporting unit is less than its carrying amount. For 2013, the Corporation determined the Bank was one reporting unit and assessed the following qualitative factors to determine if there is likelihood that goodwill is impaired: (a) industry and market considerations such as a deterioration in the environment in which the Corporation operates; (b) overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods; (c) events affecting a reporting unit such as a change in the composition or carrying amount of the Corporation’s assets unit; (d) share price — considered in both absolute terms and relative to peers; (e) non-performing loans and allowance for loans losses; and (f) bank capital analysis. The Corporation evaluates goodwill impairment annually as of November 30th of each year. Based upon this assessment the Corporation determined that there is no likelihood of goodwill impairment therefore no impairment charge was recognized as of December 31, 2013.
The Corporation cannot predict the occurrences of certain future events that might adversely affect the reported value of goodwill. Such events include, but are not limited to, strategic decisions in response to economic and competitive conditions, the effect of the economic environment on the Corporation’s customer base or a material negative change in the relationship with significant customers. Core deposit intangibles are amortized over their estimated useful life of 10 years. A summary of core deposit intangible assets follows:
 
March 31, 2014
 
December 31, 2013
 
(Dollars in thousands)
Core deposit intangibles
$
1,367

 
$
1,367

Less: accumulated amortization
943

 
910

Carrying value of core deposit intangibles
$
424

 
$
457




























10




(5)    Securities

The amortized cost, gross unrealized gains and losses and fair values of securities at March 31, 2014 and December 31, 2013 follows:
 
March 31, 2014
 
Amortized 
Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair
Value
 
(Dollars in thousands)
Securities available for sale:
 
 
 
 
 
 
 
U.S. Government agencies and corporations
$
71,683

 
$

 
$
(4,242
)
 
$
67,441

Mortgage backed securities: residential
94,222

 
1,360

 
(1,063
)
 
94,519

Collateralized mortgage obligations
22,163

 
247

 
(271
)
 
22,139

State and political subdivisions
32,503

 
1,273

 
(365
)
 
33,411

Total Securities
$
220,571

 
$
2,880

 
$
(5,941
)
 
$
217,510

 
 
 
 
 
 
 
 
 
At December 31, 2013
 
Amortized 
Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair
Value
 
(Dollars in thousands)
Securities available for sale:
 
 
 
 
 
 
 
U.S. Government agencies and corporations
$
71,851

 
$

 
$
(6,463
)
 
$
65,388

Mortgage backed securities: residential
94,313

 
1,362

 
(1,245
)
 
94,430

Collateralized mortgage obligations
18,650

 
255

 
(250
)
 
18,655

State and political subdivisions
32,521

 
1,137

 
(693
)
 
32,965

Preferred securities
4,684

 

 

 
4,684

Total Securities
$
222,019

 
$
2,754

 
$
(8,651
)
 
$
216,122


U.S. Government agencies and corporations include callable and bullet agency issues and agency-backed mortgage backed securities. Maturities may differ from contractual terms because borrowers may have the right to call or prepay obligations with or without penalties. Periodic payments are received on mortgage-backed securities based upon payment patterns of the underlying collateral.
The amortized cost and fair value of available for sale debt securities by contractual maturity date at March 31, 2014 is provided in the following table. Mortgage backed securities and collaterlized mortgage obligations are not due at a single maturity date and are therefore shown separately.
 
At March 31, 2014
  
Amortized Cost
 
Fair
Value
 
(Dollars in thousands)
Securities available for sale:
 
 
 
Due in one year or less
$
22,033

 
$
21,144

Due from one year to five years
46,819

 
45,340

Due from five years to ten years
29,740

 
28,680

Due after ten years
5,594

 
5,687

Mortgage backed securities and collateralized mortgage obligations
116,385

 
116,659

 
$
220,571

 
$
217,510


The following table shows the proceeds from sales of available-for-sale securities for the three months ended March 31, 2014 and 2013. The gross realized gains and losses on those sales that have been included in earnings. Gains or losses on the sales of available-for-sale securities are recognized upon sale and are determined using the specific identification method.

11


 
March 31,
 
2014
 
2013
 
(Dollars in thousands)
Gross realized gains
$

 
$
178

Gross realized losses

 

Net Securities Gains
$

 
$
178

Proceeds from the sale of available for sale securities
$

 
$
2,280

The carrying value of securities pledged to secure trust deposits, public deposits, lines of credit, and for other purposes required by law amounted to $193,354 and $154,479 at March 31, 2014 and December 31, 2013, respectively.
The following is a summary of securities that had unrealized losses at March 31, 2014 and December 31, 2013. The information is presented for securities that have been in an unrealized loss position for less than 12 months and for more than 12 months. At March 31, 2014, the Corporation held 50 securities with unrealized losses totaling $5,941. At December 31, 2013, there were 53 securities with unrealized losses totaling $8,651. Securities may temporarily be valued at less than amortized cost if the current levels of interest rates, as compared to the coupons on the securities held by the Corporation, are higher or if impairment is not due to credit deterioration. The Corporation has the intent and the ability to hold these securities until their value recovers, which may be until maturity.
 
 
At March 31, 2014
 
Less than 12 months
 
12 months or longer
 
Total
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
(Dollars in thousands)
U.S. Government agencies and corporations
$
58,282

 
$
(3,405
)
 
$
9,159

 
$
(837
)
 
$
67,441

 
(4,242
)
Mortgage backed securities: residential
29,332

 
(454
)
 
24,875

 
(609
)
 
54,207

 
(1,063
)
Collateralized mortgage obligations
6,741

 
(86
)
 
4,287

 
(185
)
 
11,028

 
(271
)
State and political subdivisions
7,526

 
(316
)
 
488

 
(49
)
 
8,014

 
(365
)
Total
$
101,881

 
$
(4,261
)
 
$
38,809

 
$
(1,680
)
 
$
140,690

 
$
(5,941
)
 
 
 
 
 
 
 
 
 
 
 
 
 
At December 31, 2013
 
Less than 12 months
 
12 months or longer
 
Total
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
(Dollars in thousands)
U.S. Government agencies and corporations
$
65,388

 
$
(6,463
)
 
$

 
$

 
$
65,388

 
$
(6,463
)
Mortgage backed securities: residential
28,603

 
(566
)
 
31,051

 
(679
)
 
59,654

 
(1,245
)
Collateralized mortgage
obligations
5,079

 
(59
)
 
4,411

 
(191
)
 
9,490

 
(250
)
State and political subdivisions
9,188

 
(602
)
 
447

 
(91
)
 
9,635

 
(693
)
Total
$
108,258

 
$
(7,690
)
 
$
35,909

 
$
(961
)
 
$
144,167

 
$
(8,651
)

On a quarterly basis, the Corporation performs a comprehensive security-level impairment assessment on all securities in an unrealized loss position to determine if other-than-temporary impairment ("OTTI") exists. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. For debt securities, an OTTI loss must be recognized for a debt security in an unrealized loss position if the Corporation intends to sell the security or it is more likely than not that the Corporation will be required to sell the security before recovery of its amortized cost basis. In this situation, the amount of loss recognized in income is equal to the difference between the fair value and the amortized cost basis of the individual security. If the Corporation does not expect to sell the security, the Corporation must evaluate the expected cash

12


flows to be received to determine if a credit loss has occurred. If a credit loss is present, only the amount of impairment associated with the credit loss is recognized in income. The portion of the unrealized loss relating to other factors, such as liquidity conditions in the market or changes in market interest rates, is recorded in other comprehensive income.
Equity securities are also evaluated to determine whether the unrealized loss is expected to be recoverable based on whether evidence exists to support a realizable value equal to or greater than the amortized cost basis. If it is probable that the Corporation will not recover the amortized cost basis, taking into consideration the estimated recovery period and its ability to hold the equity security until recovery, OTTI is recognized. The Corporation held no equity securities as of March 31, 2014.
The security-level assessment is performed on each security, regardless of the classification of the security as available for sale or held to maturity. The assessments are based on the nature of the securities, the financial condition of the issuer, the extent and duration of the securities, the extent and duration of the loss and the intent and whether management intends to sell or it is more likely than not that it will be required to sell a security before recovery of its amortized cost basis, which may be maturity. For those securities for which the assessment shows the Corporation will recover the entire cost basis, management does not intend to sell these securities and it is not more likely than not that the Corporation will be required to sell them before the anticipated recovery of the amortized cost basis, the gross unrealized losses are recognized in other comprehensive income, net of tax.
Management does not believe that the investment securities that were in an unrealized loss position as of March 31, 2014 represent an other-than-temporary impairment. Total gross unrealized losses were primarily attributable to changes in interest rates, relative to when the investment securities were purchased, and not due to the credit quality of the investment securities. The Corporation does not intend to sell the investment securities that were in an unrealized loss position and it is not more likely than not that the Corporation will be required to sell the investment securities before recovery of their amortized cost bases, which may be at maturity.

(6)    Loans and Allowance for Loan Losses
The allowance for loan losses is maintained by the Corporation at a level considered by management to be adequate to cover probable incurred credit losses in the loan portfolio. The amount of the provision for loan losses charged to operating expenses is the amount necessary, in the estimation of management, to maintain the allowance for loan losses at an adequate level. While management’s periodic analysis of the allowance for loan losses may dictate portions of the allowance be allocated to specific problem loans, the entire amount is available for any loan charge-offs that may occur. Loan losses are charged off against the allowance when management believes that the full collectability of the loan is unlikely. Recoveries of amounts previously charged-off are credited to the allowance.
The allowance is comprised of a general allowance and a specific allowance for identified problem loans. The general allowance is determined by applying estimated loss factors to the credit exposures from outstanding loans. For residential real estate, installment and other loans, loss factors are applied on a portfolio basis. Loss factors are based on the Corporation’s historical loss experience and are reviewed for appropriateness on a quarterly basis, along with other factors affecting the collectability of the loan portfolio. These other factors include but are not limited to: changes in lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices; changes in national and local economic and business conditions, including the condition of various market segments; changes in the nature and volume of the portfolio; changes in the experience, ability, and depth of lending management and staff; changes in the volume and severity of past due and classified loans, the volume of nonaccrual loans, troubled debt restructurings and other loan modifications; the existence and effect of any concentrations of credit, and changes in the level of such concentrations; and the effect of external factors, such as legal and regulatory requirements, on the level of estimated credit losses in the Corporation’s current portfolio. Specific allowances are established for all impaired loans when management has determined that, due to identified significant conditions, it is probable that a loss will be incurred.
The general component covers non‑impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent three years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.




13



Activity in the allowance for loan losses by segment for the three months ended March 31, 2014 and 2013 are summarized as follows:
Three Months Ended March 31, 2014
 
Commercial
Real Estate
 
Commercial
 
Residential
Real Estate
 
Home
Equity Loans
 
Indirect
 
Consumer
 
Total
 
(Dollars in thousands)
Allowance for loan losses:

Balance, beginning of period
$
10,122

 
$
497

 
$
1,411

 
$
3,484

 
$
1,593

 
$
398

 
$
17,505

Losses charged off
(546
)
 

 
(77
)
 
(222
)
 
(70
)
 
(83
)
 
(998
)
Recoveries
6

 
1

 
2

 
11

 
58

 
12

 
90

Provision charged to expense
662

 
(34
)
 
147

 
205

 
(68
)
 
(12
)
 
900

Balance, end of period
$
10,244

 
$
464

 
$
1,483

 
$
3,478

 
$
1,513

 
$
315

 
$
17,497

Ending allowance balance attributable to loans:

 

 

 

 

 

 

Individually evaluated for impairment
$
838

 
$
73

 
$
6

 
$

 
$

 
$

 
$
917

Collectively evaluated for impairment
9,406

 
391

 
1,477

 
3,478

 
1,513

 
315

 
16,580

Total ending allowance balance
$
10,244

 
$
464

 
$
1,483

 
$
3,478

 
$
1,513

 
$
315

 
$
17,497

Loans:

 

 

 

 

 

 

Individually evaluated for impairment
$
16,175

 
$
460

 
$
1,254

 
$
980

 
$
190

 
$
65

 
$
19,124

Collectively evaluated for impairment
392,292

 
82,837

 
67,417

 
121,844

 
209,504

 
17,171

 
891,065

Total ending loans balance
$
408,467

 
$
83,297

 
$
68,671

 
$
122,824

 
$
209,694

 
$
17,236

 
$
910,189


Three Months Ended March 31, 2013
 
Commercial
Real Estate
 
Commercial
 
Residential
Real Estate
 
Home
Equity
Loans
 
Indirect
 
Consumer
 
Total
 
(Dollars in thousands)
Allowance for loan losses:
 
Balance, beginning of period
$
11,386

 
$
835

 
$
1,559

 
$
2,357

 
$
1,230

 
$
270

 
$
17,637

Losses charged off
(123
)
 
(63
)
 
(513
)
 
(436
)
 
(216
)
 
(77
)
 
(1,428
)
Recoveries
7

 
4

 
64

 
47

 
94

 
31

 
247

Provision charged to expense
(486
)
 
(242
)
 
554

 
980

 
502

 
42

 
1,350

Balance, end of period
$
10,784

 
$
534

 
$
1,664

 
$
2,948

 
$
1,610

 
$
266

 
$
17,806

Ending allowance balance attributable to loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
1,778

 
$
192

 
$


$


$


$

 
$
1,970

Collectively evaluated for impairment
9,006

 
$
342

 
$
1,664

 
$
2,948

 
$
1,610

 
$
266

 
15,836

Total ending allowance balance
$
10,784

 
$
534

 
$
1,664

 
$
2,948

 
$
1,610

 
$
266

 
$
17,806

Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
23,941

 
$
564

 
$
1,991

 
$
483

 
$
99

 
$
59

 
$
27,137

Collectively evaluated for impairment
391,812

 
75,345

 
62,495

 
121,281

 
199,865

 
11,996

 
862,794

Total ending loans balance
$
415,753

 
$
75,909

 
$
64,486

 
$
121,764

 
$
199,964

 
$
12,055

 
$
889,931


14





Year Ended December 31, 2013
 
Commercial
Real Estate
 
Commercial
 
Residential
Real Estate
 
Home
Equity
Loans
 
Indirect
 
Consumer
 
Total
 
(Dollars in thousands)
Allowance for loan losses:
 
Balance, beginning of year
$
11,386

 
$
835

 
$
1,559

 
$
2,357

 
$
1,230

 
$
270

 
$
17,637

Losses charged off
(2,325
)
 
(121
)
 
(754
)
 
(1,775
)
 
(678
)
 
(366
)
 
(6,019
)
Recoveries
697

 
8

 
350

 
66

 
335

 
56

 
1,512

Provision charged to expense
364

 
(225
)
 
256

 
2,836

 
706

 
438

 
4,375

Balance, end of year
$
10,122

 
$
497

 
$
1,411

 
$
3,484

 
$
1,593

 
$
398

 
$
17,505

Ending allowance balance attributable to loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
865

 
$
73

 
$

 
$

 
$

 
$

 
$
938

Collectively evaluated for impairment
9,257

 
424

 
1,411

 
3,484

 
1,593

 
398

 
16,567

Total ending allowance balance
$
10,122

 
$
497

 
$
1,411

 
$
3,484

 
$
1,593

 
$
398

 
$
17,505

Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
17,842

 
$
472

 
$
1,731

 
$
1,111

 
$
195

 
$
160

 
$
21,511

Collectively evaluated for impairment
383,749

 
88,174

 
64,776

 
121,965

 
206,128

 
15,996

 
880,788

Total ending loans balance
$
401,591

 
$
88,646

 
$
66,507

 
$
123,076

 
$
206,323

 
$
16,156

 
$
902,299


Delinquencies
Management monitors delinquency and potential problem loans. Bank-wide delinquency at March 31, 2014 was 1.64% of total loans. Total 30-59 day delinquency and 60-89 day delinquency was 0.25% and 0.25% of total loans at March 31, 2014, respectively. Bank-wide delinquency at December 31, 2013 was 1.69% of total loans. Total 30-59 day delinquency and 60-89 day delinquency was 0.26% and 0.19% of total loans at December 31, 2013, respectively. Information regarding delinquent loans as of March 31, 2014 and December 31, 2013 is as follows:

Age Analysis of Past Due Loans as of March 31, 2014
(Dollars in thousands)
30-59 Days
Past Due
 
60-89 Days
Past Due
 

90 Days and Greater
 
Total Past Due
 
Current
 
Total Loans
 
Recorded
Investment
>
90 Days
and
Accruing
Commercial real estate
$
741

 
$
1,260

 
$
6,319

 
$
8,320

 
$
400,147

 
$
408,467

 
$

Commercial
68

 

 
159

 
227

 
83,070

 
83,297

 

Residential real estate
422

 
340

 
2,076

 
2,838

 
65,833

 
68,671

 

Home equity loans
872

 
591

 
1,643

 
3,106

 
119,718

 
122,824

 

Indirect
169

 
51

 
5

 
225

 
209,469

 
209,694

 

Consumer
33

 
60

 
95

 
188

 
17,048

 
17,236

 

Total
$
2,305

 
$
2,302

 
$
10,297

 
$
14,904

 
$
895,285

 
$
910,189

 
$





15


Age Analysis of Past Due Loans as of December 31, 2013
(Dollars in thousands)
30-59 Days
Past Due
 
60-89 Days
Past Due
 

90 Days and Greater
 
Total Past Due
 
Current
 
Total Loans
 
Recorded
Investment
>
90 Days
and
Accruing
Commercial real estate
$
525

 
$
4

 
$
7,401

 
$
7,930

 
$
393,661

 
$
401,591

 
$

Commercial

 
18

 
219

 
237

 
88,409

 
88,646

 

Residential real estate
347

 
960

 
2,252

 
3,559

 
62,948

 
66,507

 
158

Home equity loans
932

 
707

 
1,078

 
2,717

 
120,359

 
123,076

 
43

Indirect
332

 
30

 
23

 
385

 
205,938

 
206,323

 

Consumer
183

 
25

 
191

 
399

 
15,757

 
16,156

 

Total
$
2,319

 
$
1,744

 
$
11,164

 
$
15,227

 
$
887,072

 
$
902,299

 
$
201


Impaired Loans
A loan is considered impaired when it is probable that not all principal and interest amounts will be collected according to the loan contract. Consumer residential mortgage, installment and other consumer loans are evaluated collectively for impairment. Individual commercial loans are evaluated for impairment. Impaired loans are written down by the establishment of a specific allowance where necessary. Interest income recognized on impaired loans while the loan was considered impaired was immaterial for all periods.

16


Impaired loans for the Period Ended March 31, 2014 and December 31, 2013 are as follows:
 
 
At March 31, 2014
 
Three Months Ended
March 31, 2014
 
Recorded
Investment
 
Unpaid Principal
Balance
 
Related
Allowance
 
Average Recorded
Balance
 
(Dollars in thousands)
With no related allowance recorded:
 
 
 
 
 
 
 
Commercial real estate
$
12,512

 
$
16,899

 
$

 
$
14,021

Commercial
202

 
255

 

 
208

Residential real estate
1,233

 
1,371

 

 
1,482

Home equity loans
980

 
1,563

 

 
1,045

Indirect
190

 
263

 

 
192

Consumer
65

 
97

 

 
113

With allowance recorded:

 

 

 
 
Commercial real estate
3,663

 
5,553

 
838

 
2,988

Commercial
258

 
258

 
73

 
258

Residential real estate
21

 
82

 
6

 
11

Home equity loans

 

 

 

Indirect

 

 

 

Consumer

 

 

 

Total
$
19,124

 
$
26,341

 
$
917

 
$
20,318

 
 
 
 
 
 
 
 
 
At December 31, 2013
 
Twelve Months Ended December 31, 2013
 
Recorded
Investment
 
Unpaid Principal
Balance
 
Related
Allowance
 
Average Recorded
Balance
 
(Dollars in thousands)
With no related allowance recorded:
 
 
 
 
 
 
 
Commercial real estate
$
15,530

 
$
20,438

 
$

 
$
16,705

Commercial
214

 
267

 

 
186

Residential real estate
1,731

 
1,940

 

 
1,832

Home equity loans
1,111

 
1,623

 

 
847

Indirect
195

 
268

 

 
178

Consumer
160

 
204

 

 
111

With allowance recorded:
 
 
 
 
 
 

Commercial real estate
2,312

 
2,319

 
865

 
4,374

Commercial
258

 
258

 
73

 
346

Residential real estate

 

 

 

Home equity loans

 

 

 

Indirect

 

 

 

Consumer

 

 

 

Total
$
21,511

 
$
27,317

 
$
938

 
$
24,579

 
 
 
 
 
 
 
 
*impaired loans shown in the tables above included loans that were classified as troubled debt restructurings ("TDRs"). The restructuring of a loan is considered a TDR if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession.

17




Troubled Debt Restructuring
A restructuring of debt constitutes a troubled debt restructuring (“TDR”) if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. That concession either stems from an agreement between the creditor and the debtor or is imposed by law or a court. The Corporation adheres to ASC 310-40, Troubled Debt Restructurings by Creditors, to determine whether a troubled debt restructuring applies in a particular instance. Prior to loans being modified and classified as a TDR, specific reserves are generally assessed, as most of these loans have been specifically allocated for as part of the Corporation's normal loan loss provisioning methodology. The Corporation has allocated reserves of $40 for the TDR loans at March 31, 2014.
During the first quarter of 2014 there were no loans that were modified as a TDR.
The following table provides the number of loans modified in a TDR and the recorded investment and unpaid principal balance by loan segment as of March 31, 2014 and 2013.
 
Three Months Ended March 31, 2014
 
(Dollars in thousands)
 
Number of Contracts
 
Recorded Investment
 
Unpaid Principal
Commercial real estate
18
 
$6,214
 
$8,530
Commercial
1
 
 
171
Residential real estate
13
 
964
 
1,070
Home equity loans
28
 
786
 
1,322
Indirect Loans
39
 
190
 
263
Consumer Loans
1
 
65
 
65
Total
100
 
$8,219
 
$11,421

 
Three Months Ended March 31, 2013
 
(Dollars in thousands)
 
Number of Contracts
 
Recorded Investment
 
Unpaid Principal
Commercial real estate
14
 
$6,796
 
$8,772
Commercial
1
 
 
171
Residential real estate
10
 
946
 
973
Home equity loans
14
 
483
 
688
Indirect Loans
14
 
99
 
161
Consumer Loans
1
 
59
 
59
Total
54
 
$8,383
 
$10,824



18




The following table summarizes the loans that were modified as a TDR during the period ended December 31, 2013.
At December 31, 2013
 
Number of Contracts
 
Pre-Modification
Outstanding Recorded
Investment
 
Post-Modification
Outstanding Recorded
Investment
Commercial real estate
3
 
$93
 
$93
Residential real estate
3
 
$236
 
$236
Home equity loans
15
 
$774
 
$774
Indirect Loans
25
 
$195
 
$195
Consumer Loans
3
 
$34
 
$34
There were no loans modified in a TDR that subsequently defaulted during the twelve months periods ended March 31, 2014 and 2013 respectively (i.e., 90 days or more past due following a modification).
A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Corporation offers various types of concessions when modifying a loan, however, forgiveness of principal is rarely granted. Commercial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor may be requested. Commercial mortgage and construction loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor. Construction loans modified in a TDR may also involve extending the interest-only payment period. Land loans are also included in the class of commercial real estate loans. Land loans are typically structured as interest-only monthly payments with a balloon payment due at maturity. Land loans modified in a TDR typically involve extending the balloon payment by one to three years and changing the monthly payments from interest-only to principal and interest, while leaving the interest rate unchanged.
Loans modified in a TDR are typically already on nonaccrual status and partial charge-offs have in some cases already been taken against the outstanding loan balance. As a result, loans modified in a TDR for the Corporation may have the financial effect of increasing the specific allowance associated with the loan. The allowance for impaired loans that have been modified in a TDR is measured based on the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent or on the present value of expected future cash flows discounted at the loan’s effective interest rate. Management exercises significant judgment in developing these estimates.
The OCC regulatory guidance requires loans to be accounted for as collateral-dependent loans when borrowers have filed Chapter 7 bankruptcy, the debt has been discharged and the borrower has not reaffirmed the debt, regardless of the delinquency status of the loan. The filing of bankruptcy by the borrower is evidence of financial difficulty and the discharge of the obligation by the bankruptcy court is deemed to be a concession granted to the borrower.
The Corporation had approximately $628 of additional commitments to lend additional funds to the related debtors whose terms have been modified in a TDR at March 31, 2014.












19





Nonaccrual Loans
Nonaccrual loan balances at March 31, 2014 and December 31, 2013 are as follows:
 
Loans On Non-Accrual Status
March 31,
2014
 
December 31,
2013
 
(Dollars in thousands)
Commercial real estate
$
10,145

 
$
11,241

Commercial
227

 
289

Residential real estate
5,127

 
5,231

Home equity loans
4,845

 
4,464

Indirect
362

 
443

Consumer
212

 
318

Total Nonaccrual Loans
$
20,918

 
$
21,986

Credit Risk Grading
Sound credit systems, practices and procedures such as credit risk grading systems; effective credit review and examination processes; effective loan monitoring, problem identification, and resolution processes; and a conservative loss recognition process and charge-off policy are integral to management’s proper assessment of the adequacy of the allowance. Many factors are considered when grades are assigned to individual loans such as current and historic delinquency, financial statements of the borrower, current net realizable value of collateral and the general economic environment and specific economic trends affecting the portfolio. Commercial, commercial real estate and residential construction loans are assigned internal credit risk grades. The loan’s internal credit risk grade is reviewed on at least an annual basis and more frequently if needed based on specific borrower circumstances. Credit quality indicators used in management’s periodic analysis of the adequacy of the allowance include the Corporation’s internal credit risk grades which are described below and are included in the table below for March 31, 2014 and December 31, 2013:
Grades 1 -5: defined as “Pass” credits — loans which are protected by the borrower’s current net worth and paying capacity or by the value of the underlying collateral. Pass credits are current or have not displayed a significant past due history.
Grade 6: defined as “Special Mention” credits — loans where a potential weakness or risk exists, which could cause a more serious problem if not monitored. Loans listed for special mention generally demonstrate a history of repeated delinquencies, which may indicate a deterioration of the repayment abilities of the borrower.
Grade 7: defined as “Substandard” credits — loans that have a well-defined weakness based on objective evidence and are characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected.
Grade 8: defined as “Doubtful” credits — loans classified as doubtful have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable.
Grade 9: defined as “Loss” credits — loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted.
For the residential real estate segment, the Corporation monitors credit quality using a combination of the delinquency status of the loan and/or the Corporation’s internal credit risk grades as indicated above.

20



The following tables present the recorded investment of commercial real estate, commercial and residential real estate loans by internal credit risk grade and the recorded investment of residential real estate, home equity, indirect and consumer loans based on delinquency status as of March 31, 2014 and December 31, 2013:
Commercial
Credit Exposure
Commercial
Real Estate
 
Commercial
 
Residential
Real
Estate*
 
Home
Equity
Loans
 
Indirect
 
Consumer
 
Total
March 31, 2014
 
(Dollars in thousands)
Loans graded by internal credit risk grade:
 
 
 
 
 
 
 
 
 
 
 
 
 
Grade 1 — Minimal
$

 
$
51

 
$

 
$

 
$

 
$

 
$
51

Grade 2 — Modest

 
39

 

 

 

 

 
39

Grade 3 — Better than average
848

 

 

 

 

 

 
848

Grade 4 — Average
20,204

 
164

 
611

 

 

 

 
20,979

Grade 5 — Acceptable
361,379

 
79,884

 
5,654

 

 

 

 
446,917

Total Pass Credits
382,431

 
80,138

 
6,265

 

 

 

 
468,834

Grade 6 — Special mention
3,341

 
118

 
32

 

 

 

 
3,491

Grade 7 — Substandard
22,695

 
3,041

 
615

 

 

 

 
26,351

Grade 8 — Doubtful

 

 

 

 

 

 

Grade 9 — Loss

 

 

 

 

 

 

Total loans internally credit risk graded
408,467

 
83,297

 
6,912

 

 

 

 
498,676

Loans not monitored by internal risk grade:

 

 

 

 

 

 

Current loans not internally risk graded

 

 
59,525

 
119,718

 
209,469

 
17,048

 
405,760

30-59 days past due loans not internally risk graded

 

 
65

 
872

 
169

 
33

 
1,139

60-89 days past due loans not internally risk graded

 

 
340

 
591

 
51

 
60

 
1,042

90+ days past due loans not internally risk graded

 

 
1,829

 
1,643

 
5

 
95

 
3,572

Total loans not internally credit risk graded

 

 
61,759

 
122,824

 
209,694

 
17,236

 
411,513

Total loans internally and not internally credit risk graded
$
408,467

 
$
83,297

 
$
68,671

 
$
122,824

 
$
209,694

 
$
17,236

 
$
910,189

 
*
Residential loans with an internal commercial credit risk grade include loans that are secured by non owner occupied 1-4 family residential properties and conventional 1-4 family residential properties.


21


Commercial
Credit Exposure
Commercial
Real Estate
 
Commercial
 
Residential
Real
Estate*
 
Home
Equity
Loans
 
Indirect
 
Consumer
 
Total
December 31, 2013
 
(Dollars in thousands)
Loans graded by internal credit risk grade:

 

 

 

 

 

 

Grade 1 — Minimal
$

 
$
52

 
$

 
$

 
$

 
$

 
$
52

Grade 2 — Modest

 
37

 

 

 

 

 
37

Grade 3 — Better than average
857

 

 

 

 

 

 
857

Grade 4 — Average
22,580

 
271

 
613

 

 

 

 
23,464

Grade 5 — Acceptable
352,781

 
84,979

 
5,589

 

 

 

 
443,349

Total Pass Credits
376,218

 
85,339

 
6,202

 

 

 

 
467,759

Grade 6 — Special mention
2,146

 
2,891

 
35

 

 

 

 
5,072

Grade 7 — Substandard
23,227

 
416

 
625

 

 

 

 
24,268

Grade 8 — Doubtful

 

 

 

 

 

 

Grade 9 — Loss

 

 

 

 

 

 

Total loans internally credit risk graded
401,591

 
88,646

 
6,862

 

 

 

 
497,099

Loans not monitored by internal risk grade:

 

 

 

 

 

 

Current loans not internally risk graded

 

 
56,390

 
120,359

 
205,938

 
15,757

 
398,444

30-59 days past due loans not internally risk graded

 

 
64

 
932

 
332

 
183

 
1,511

60-89 days past due loans not internally risk graded

 

 
960

 
707

 
30

 
25

 
1,722

90+ days past due loans not internally risk graded

 

 
2,231

 
1,078

 
23

 
191

 
3,523

Total loans not internally credit risk graded

 

 
59,645

 
123,076

 
206,323

 
16,156

 
405,200

Total loans internally and not internally credit risk graded
$
401,591

 
$
88,646

 
$
66,507

 
$
123,076

 
$
206,323

 
$
16,156

 
$
902,299

 * Residential loans with an internal commercial credit risk grade include loans that are secured by non owner occupied 1-4 family residential properties and conventional 1-4 family residential properties.
The Corporation adheres to underwriting standards consistent with its Loan Policy for indirect and consumer loans. Final approval of a consumer credit depends on the repayment ability of the borrower. Repayment ability generally requires the determination of the borrower’s capacity to meet current and proposed debt service requirements. A borrower’s repayment ability is monitored based on delinquency, generally for time periods of 30 to 59 days past due, 60 to 89 days past due and 90 days or greater past due. This information is provided in the above past due loans table.


22


(7)    Deposits
Deposit balances are summarized as follows:
 
March 31, 2014
 
December 31, 2013
 
(Dollars in thousands)
Demand and other noninterest-bearing
$
149,530

 
$
148,961

Interest checking
176,028

 
164,662

Savings
129,976

 
125,582

Money market accounts
124,138

 
103,534

Consumer time deposits
362,732

 
382,137

Public time deposits
134,447

 
120,713

Total deposits
$
1,076,851

 
$
1,045,589


The aggregate amount of certificates of deposit in denominations of $100,000 or more amounted to $295,426 and $293,330 at March 31, 2014 and December 31, 2013, respectively.
The maturity distribution of certificates of deposit as of March 31, 2014 are as follows:
 
 
March 31, 2014
 
(Dollars in thousands)
0-12 months
$
323,856

12-24 months
109,561

24-36 months
48,056

36-48 months
11,634

48-60 months
4,072

Total
$
497,179


(8)    Short-Term Borrowings
The Bank has a line of credit for advances and discounts with the Federal Reserve Bank of Cleveland. The amount of this line of credit varies on a monthly basis. The line is equal to 50% of the balances of qualified home equity lines of credit that are pledged as collateral. At March 31, 2014, the Bank had pledged approximately $88,150 in qualifying home equity lines of credit, resulting in an available line of credit of approximately $44,075. No amounts were outstanding under the line of credit at March 31, 2014 or December 31, 2013. The Corporation also has a $6,000 line of credit with an unaffiliated financial institution. The Corporation also has a $6,000 line of credit with an unaffiliated financial institution under which the Corporation had borrowings of $2,500 was outstanding at a rate of 3.50% as of March 31, 2014. At December 31, 2013, the Corporation had borrowings of $3,000 outstanding under the line of credit.
Short-term borrowings include securities sold under repurchase agreements and Federal funds purchased from correspondent banks. At March 31, 2014 and December 31, 2013, the outstanding balance of securities sold under repurchase agreements totaled $1,225 and $1,576, respectively. No Federal funds were purchased as of March 31, 2014 and December 31, 2013.

The following table presents the components of federal funds purchased and securities sold under agreements to repurchase and short-term borrowings as of March 31, 2014 and December 31, 2013.

23


 
 
March 31, 2014
 
December 31, 2013
Federal funds purchased and securities sold under agreements to repurchase
 
1,225

 
1,576

Line of credit with an unaffiliated financial institution
 
2,500

 
3,000

Total short-term borrowings
 
$
3,725

 
$
4,576

 
 
 
 
 
 
 
 
 
 
Short-term borrowings
 
March 31, 2014
 
December 31, 2013
Average balance during the year
 
$
4,664

 
$
1,803

Weighted-average annual interest rate during the year
 
3.60
%
 
0.10
%
Maximum month-end balance
 
$
3,725

 
$
4,576



(9)    Federal Home Loan Bank Advances
Federal Home Loan Bank advances amounted to $46,760 and $46,708 at March 31, 2014 and December 31, 2013 respectively. All advances were bullet maturities with no call features. At March 31, 2014, collateral pledged for FHLB advances consisted of qualified multi-family and residential real estate mortgage loans and investment securities of $88,238 and $16,985, respectively. The maximum borrowing capacity of the Bank at March 31, 2014 was $73,971. The Bank maintains a $40,000 cash management line of credit (CMA) with the FHLB. No amounts were outstanding for the CMA line of credit at March 31, 2014 and December 31, 2013.
Maturities of FHLB advances outstanding at March 31, 2014 and December 31, 2013 are as follows:
 
March 31,
2014
 
December 31,
2013
 
(Dollars in thousands)
Maturity January 2014 with fixed rate 3.55%
$

 
$
1

Maturity January 2015 with fixed rate 0.80%
20,000

 
20,000

Maturity December 2016 with fixed rate 0.79%
10,000

 
10,000

Maturities June 2017 through December 2017, with fixed rates ranging from 0.89% to 0.99%
15,000

 
15,000

Maturity June 2018 fixed rate 1.24%
2,500

 
2,500

Restructuring prepayment penalty
(740
)
 
(793
)
Total FHLB advances
$
46,760

 
$
46,708



In 2012, the Corporation prepaid $27,500 of fixed rate FHLB advances with a contractual average interest rate of 2.47% and a remaining maturity of 12 to 31 months. The prepaid FHLB advances were replaced with $27,500 of fixed rate FHLB advances with a contractual average interest rate of 0.88% and terms of 49 to 67 months. In accordance with the restructure, the Corporation was required to pay a prepayment penalty of $1,017 to the FHLB. The present value of the cash flows under the terms of the new FHLB advances (including the prepayment penalties) were not more than 10% different from the present value of the cash flows under the terms of the prepaid FHLB advances and therefore the new advances were not considered to be substantially different from the original advances in accordance with ASC 470-50, Debt – Modifications and Exchanges. As a result, the prepayment penalties have been treated as a discount on the new debt and are being amortized over the life of the new advances as an adjustment to yield. The prepayment penalty effectively increases the interest rate on the new advances over the lives of the new advances at the time of the transaction. The benefit of prepaying these advances was an immediate decrease in interest expense and a decrease in interest rate sensitivity as the maturity of each of the refinanced FHLB advances was extended at a lower rate.


24


At March 31, 2014, the advances were structured to contractually pay down as follows:
 
Balance
 
Weighted Average Rate
2015
$

 
—%
2016
20,000

 
0.80
2017
10,000

 
0.79
2018
15,000

 
0.96
Thereafter
2,500

 
1.24
Total
$
47,500

 
0.87%
Restructuring prepayment penalty
(740
)
 
 
Total
$
46,760

 
 
 
(10)    Trust Preferred Securities
In May 2007, LNB Trust I (“Trust I”) and LNB Trust II (“Trust II”) each sold $10.0 million of preferred securities to outside investors and invested the proceeds in junior subordinated debentures issued by the Corporation. The Corporation’s obligations under the transaction documents, taken together, have the effect of providing a full guarantee by the Corporation, on a subordinated basis, of the payment obligation of the Trusts. The subordinated notes mature in 2037. Trust I bears a floating interest rate (current three-month LIBOR plus 148 basis points). Trust II bears a fixed rate of 6.64% through June 15, 2017, and then becomes a floating interest rate (current three-month LIBOR plus 148 basis points). Interest on the notes is payable quarterly. The interest rates in effect as of the last determination date in 2013 were 1.71% and 6.64% for Trust I and Trust II, respectively. At March 31, 2014 and December 31, 2013, accrued interest payable for Trust I was $5 and $6 and for Trust II was $21 and $22, respectively.
The subordinated notes are redeemable in whole or in part, without penalty, at the Corporation’s option and mature on June 15, 2037. The notes are junior in right of payment to the prior payment in full of all senior indebtedness of the Corporation, whether outstanding at the date of the indenture governing the notes or thereafter incurred.

(11)    Commitments and Contingencies
In the normal course of business, the Bank enters into commitments with off-balance sheet risk to meet the financing needs of its customers. These instruments are currently limited to commitments to extend credit and standby letters of credit. Commitments to extend credit involve elements of credit risk and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the commitment is represented by the contractual amount of the commitment. The Bank uses the same credit policies in making commitments as it does for on-balance sheet instruments. Interest rate risk on commitments to extend credit results from the possibility that interest rates may have moved unfavorably from the position of the Bank since the time the commitment was made.
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 of 30 to 120 days or other termination clauses and may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
The Bank evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained by the Bank upon extension of credit is based on management’s credit evaluation of the applicant. Collateral held is generally single-family residential real estate and commercial real estate. Substantially all of the obligations to extend credit are variable rate. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party.






25



A summary of the contractual amount of commitments at March 31, 2014 and December 31, 2013 follows:
 
 
March 31,
2014
 
December 31,
2013
 
(Dollars in thousands)
Commitments to extend credit
$
78,779

 
$
84,283

Home equity lines of credit
90,189

 
89,331

Standby letters of credit
8,543

 
8,448

Total
$
177,511

 
$
182,062

The nature of the Corporation’s business may result in litigation. Management, after reviewing with counsel all actions and proceedings pending against or involving the Corporation and its subsidiaries, considers that the aggregate liability or loss, if any, resulting from them will not be material to the Corporation’s financial position, results of operation or liquidity.

(12)    Estimated Fair Value of Financial Instruments
The Corporation discloses estimated fair values for its financial instruments. Fair value estimates, methods and assumptions are set forth below for the Corporation’s financial instruments.
Fair Value Measurements
The fair value of financial assets and liabilities recorded at fair value is categorized in three levels. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. These levels are as follows:
Level 1 — Valuations based on quoted prices in active markets, such as the New York Stock Exchange. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2 — Valuations of assets and liabilities traded in less active dealer or broker markets. Valuations include quoted prices for similar assets and liabilities traded in the same market; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable. Valuations may be obtained from, or corroborated by, third-party pricing services.
Level 3 — Assets and liabilities with valuations that include methodologies and assumptions that may not be readily observable, including option pricing models, discounted cash flow models, yield curves and similar techniques. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities, but in all cases are corroborated by external data, which may include third-party pricing services.
Limitations
Estimates of fair value are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Estimates of fair value are based on existing on-and-off balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Bank has an Investment and Trust Services Division that contributes net fee income annually. The Investment and Trust Services Division is not considered a financial instrument and its value has not been incorporated into the fair value estimates. Other significant assets and liabilities that are not considered financial instruments include premises and equipment and deferred tax assets. The estimated fair values of the Corporation’s financial instruments at March 31, 2014 and December 31, 2013 are summarized as follows:
 

26


 
March 31, 2014
December 31, 2013
 
Carrying
Value
Estimated
Fair Value
Level 1
Level 2
Level 3
Carrying
Value
Estimated
Fair Value
 
(Dollars in thousands)
Financial assets
 
 
 
 
 
 
 
Cash and due from banks, Federal funds sold and interest
bearing deposits in other banks
$
68,241

$
68,241

$
68,241

$

$

$
52,272

$
52,272

Securities
217,510

217,510


217,510


216,122

216,122

Restricted stock
5,741

N/A

N/A

N/A

N/A

5,741

5,741

Portfolio loans, net
892,692

888,730



888,730

884,794

884,211

Loans held for sale
1,811

1,815


1,815


4,483

4,487

Accrued interest receivable
3,774

3,744


970

2,774

3,621

3,621

Financial liabilities
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
Demand, savings and money market
579,672

574,086


574,086


542,739

542,739

Certificates of deposit
497,179

498,475


498,475


502,850

504,381

Short-term borrowings
3,725

3,725


3,725


4,576

4,576

Federal Home Loan Bank advances
46,760

46,899


46,899


46,708

46,923

Junior subordinated debentures
16,238

16,650


16,650


16,238

16,778

Accrued interest payable
701

701


701


789

789

Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. As of March 31, 2014 and December 31, 2013, Cash and due from banks, Federal funds sold and interest bearing deposits in other banks were classified as Level 1.
Restricted stock

It is not practical to determine the fair value of Restricted stock due to restrictions placed on its transferability. Restricted stock is carried at cost and valued based on the ultimate recoverability of par value.
Loans

Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price. The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

Deposits

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 2 classification. The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date resulting in a Level 2 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.


27


Short-term Borrowings
The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.

Other Borrowings

The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

The fair values of the Company’s Subordinated Debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in Level 2 and Level 3 classification. The level disclosed should be consistent with the asset and liability that the accrued interest is associated with.

Off-balance Sheet Instruments

Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.

The following table presents information about the Corporation’s assets and liabilities measured at fair value on a recurring basis as of March 31, 2014 and December 31, 2013, and the valuation techniques used by the Corporation to determine those fair values.
 
Description
Fair Value as of
March 31, 2014
 
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
 
Significant Other
Observable
Inputs (Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
U.S. Government agencies and corporations
$
67,441

 
$

 
$
67,441

 
$

Mortgage backed securities: residential
94,519

 

 
94,519

 

Collateralized mortgage obligations
22,139

 

 
22,139

 

State and political subdivisions
33,411

 

 
33,411

 

Interest rate swaps
158

 

 
158

 

Total
$
217,668

 
$

 
$
217,668

 
$

Description
Fair Value as of
December 31, 2013
 
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
 
Significant Other
Observable
Inputs (Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 

 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
U.S. Government agencies and corporations
$
65,388

 
$

 
$
65,388

 
$

Mortgage backed securities: residential
94,430

 

 
94,430

 

Collateralized mortgage obligations
18,655

 

 
18,655

 

State and political subdivisions
32,965

 

 
32,965

 

Preferred Securities
4,684

 

 

 
4,684

Interest rate swaps

222

 

 
222

 

Total
$
216,344

 
$

 
$
211,660

 
$
4,684



28


Fair value measurements of U.S. Government agencies and mortgage backed securities use pricing models that vary and may consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Fair value of debt securities such as obligations of state and political subdivisions may be determined by matrix pricing. Matrix pricing is a mathematical technique that is used to value debt securities without relying exclusively on quoted prices for specific securities, but rather by relying on the securities relationship to other benchmark quoted prices.
There were no transfers between Levels 1 and 2 of the fair value hierarchy during the periods ended March 31, 2014 and December 31, 2013. For the available for sale securities, the Corporation obtains fair value measurements from an independent third-party service or independent brokers.
The Corporation has assets that, under certain conditions, are subject to measurement at fair value on a nonrecurring basis. At March 31, 2014 and December 31, 2013, such assets consist primarily of impaired loans and other property. The Corporation has estimated the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections.

The following table presents the balances of assets and liabilities measured at fair value on a nonrecurring basis:
 
March 31, 2014
Quoted Market
Prices in Active
Markets (Level 1)
 
Internal
Models with
Significant
Observable
Market
Parameters
(Level 2)
 
Internal
Models with
Significant
Unobservable
Market
Parameters
(Level 3)
 
Total
 
(Dollars in thousands)
Impaired and nonaccrual loans
$

 
$

 
$
18,207

 
$
18,207

Other real estate

 

 
979

 
979

Total assets at fair value on a nonrecurring basis
$

 
$

 
$
19,186

 
$
19,186

 
 
 
 
 
 
 
 
December 31, 2013
Quoted Market
Prices in Active
Markets (Level 1)
 
Internal
Models with
Significant
Observable
Market
Parameters
(Level 2)
 
Internal
Models with
Significant
Unobservable
Market
Parameters
(Level 3)
 
Total
 
(Dollars in thousands)
Impaired and nonaccrual loans
$

 
$

 
$
21,986

 
$
21,986

Other real estate

 

 
579

 
579

Total assets at fair value on a nonrecurring basis
$

 
$

 
$
22,565

 
$
22,565


Impaired and nonaccrual loans:    Fair value adjustments for these items typically occur when there is evidence of impairment. Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair market value of the collateral. The Corporation measures fair value based on the value of the collateral securing the loans. Collateral may be in the form of real estate or personal property including equipment and inventory. The vast majority of collateral is real estate. The value of the collateral is determined based on internal estimates as well as third party appraisals or non-binding broker quotes. These measurements were classified as Level 3.
Other Real Estate:    Other real estate includes foreclosed assets and properties securing residential and commercial loans. Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

29


Foreclosed assets are adjusted to fair value less costs to sell upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at lower of carry value or fair value less costs to sell. Fair value is generally based upon internal estimates and third party appraisals or non-binding broker quotes and, accordingly, considered a Level 3 classification.

The following table presents additional quantitative information about assets measured at fair value on a recurring and nonrecurring basis for which the Corporation has utilized Level 3 inputs to determine fair value (dollars in thousands).

Asset
 
Fair Value

 
Valuation Technique

 
Unobservable Input

Collateral dependent impaired loans

 
$18,207
 
Sales comparison approach

 
Adjustment for differences between the comparable sales

Other real estate
 
$979
 
Sales comparison approach
 
Adjustment for differences between the comparable sales


Changes in Level 3 Fair Value Measurements

There were no assets measured at fair value on a recurring basis using significant unobservable inputs that were transferred to Level 3 as of or during the three months ended March 31, 2014.

(13)    Share-Based Compensation
A broad-based stock incentive plan, the 2006 Stock Incentive Plan, was adopted by the Corporation’s shareholders on April 18, 2006 and was amended and restated on May 2, 2012. Awards granted under this Plan as of March 31, 2014 were stock options granted in 2007, 2008, 2009, 2012 and 2013 and long-term restricted shares issued in 2010, 2011, 2012 and 2013. In addition, the Corporation has nonqualified stock option agreements outside of the 2006 Stock Incentive Plan. Grants under the nonqualified stock option agreements were made from 2005 to 2007.
Stock Options
During the three months ended March 31, 2014, the Corporation granted no stock options. All outstanding stock options are granted at an excercise price equal to the fair value of the common stock on the date of grant. The maximum option term is ten years and the options generally vest over three years as follows: one-third after one year from the grant date, two-thirds after two years and completely after three years.
The Corporation recognizes compensation expense for awards with graded vesting schedule on a straight-line basis over the requisite service period for the entire award. The expense recorded for stock options was $30, and $5 for the three months ended March 31, 2014 and 2013, respectively.
The following table summarizes the Corporation's stock options outstanding at March 31, 2014:
 
Outstanding
 
Exercisable
 
Number
 
Weighted Average
Remaining
Contractual Life
(Years)
 
Number
 
Weighted Average
Exercise Price
Range of Exercise Prices
 
 
 
 
 
 
 
$5.34-$5.39
37,500

 
7.66
 
25,833

 
$
5.39

$9.07-$9.56
128,196

 
9.17
 

 

$14.47
79,500

 
3.85
 
79,500

 
14.47

$16.00-$16.50
32,500

 
2.72
 
32,500

 
16.04

$19.10
30,000

 
1.84
 
30,000

 
19.10

$19.17
30,000

 
0.84
 
30,000

 
19.17

Outstanding at end of period
337,696

 
5.74
 
197,833

 
14.96


A summary of the status of stock options at March 31, 2014 and 2013 is presented in the table below:
 

30


 
2014
 
2013
 
Options
 
Weighted Average
Exercise
Price per Share
 
Options
 
Weighted Average
Exercise
Price per Share
Outstanding at beginning of period
337,696

 
12.43

 
232,000

 
14.50

Granted

 

 

 

Forfeited or expired

 

 

 

Exercised

 

 

 

Stock dividend or split

 

 

 

Outstanding at end of period
337,696

 
12.43

 
232,000

 
14.50

Exercisable at end of period
197,833

 
14.96

 
197,000

 
16.12


There were no options exercised during the three months of 2014, therefore the total intrinsic value of options exercised was $0. The aggregate intrinsic value represents the total pre-tax intrinsic value (the difference between the Corporation’s closing stock price on the last trading day of the quarter and the exercise price, multiplied by the number of in-the-money options). The Corporation’s closing stock price on March 31, 2014 was $11.42.


Restricted Shares

Shares of long-term restricted stock generally vest in two equal installments on the second and third anniversaries of the date of grant, or upon the earlier death or disability of the recipient or a qualified change of control of the Corporation. The expense recorded for long-term restricted stock for the three months ended March 31, 2014 and 2013 was $38,and $72, respectively.

The market price of the Corporation’s common shares at the date of grant is used to estimate the fair value of restricted stock awards. A summary of the status of restricted shares at March 31, 2014 is presented in the table below:
 
 
Nonvested
Shares
 
Weighted Average
Grant Date
Fair Value
Nonvested at January 1, 2014
83,355

 
$
5.86

Granted

 

Vested
(44,803
)
 
5.35

Forfeited or expired

 

Nonvested at March 31, 2014
38,552

 
6.45

Stock Appreciation Rights (“SARS”)
In 2006, the Corporation issued an aggregate of 30,000 SARS at $19.00 per share, 15,500 of which have expired due to employee terminations. The SARS vest over three years as follows: one-third after one year from the grant date, two-thirds after two years and completely after three years. Any unexercised portion of the SARS shall expire at the end of the stated term which is specified at the date of grant and shall not exceed ten years. The SARS issued in 2006 will expire in January 2016. The expense recorded for SARS for the three months ended March 31, 2014, was $0 and for 2013 was $4.


31


(14) Accumulated Other Comprehensive Income (Loss)
The following table details the change in the components of the Corporation’s accumulated other comprehensive income (loss) for the three months ended March 31, 2014 and 2013:
 
 
March 31, 2014
 
 
Unrealized securities
gains and losses
 
Pension and post- retirement costs
 
Total
Balance at the beginning of the period
 
$
(3,892
)
 
$
(1,296
)
 
$
(5,188
)
Amounts recognized in other comprehensive income, net of taxes of $964
 
1,871

 

 
1,871

Reclassified amounts out of accumulated other comprehensive income, net of tax
 

 

 

Balance at the end of the period
 
$
(2,021
)
 
$
(1,296
)
 
$
(3,317
)

 
 
March 31, 2013
 
 
Unrealized securities
gains and losses
 
Pension and post- retirement costs
 
Total
Balance at the beginning of the period
 
$
3,295

 
$
(2,055
)
 
$
1,240

Amounts recognized in other comprehensive income, net of taxes of $368
 
(714
)
 

 
(714
)
Reclassified amounts out of accumulated other comprehensive income, net of tax
 
117

 

 

Balance at the end of the period
 
$
2,464

 
$
(2,055
)
 
$
409



32


Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following commentary presents a discussion and analysis of the Corporation’s financial condition and results of operations by its management (“Management”). This Management’s Discussion and Analysis (“MD&A”) section discusses the financial condition and results of operations of the Corporation for the three months ended March 31, 2014. This MD&A should be read in conjunction with the financial information contained in the Corporation’s Form 10-K for the fiscal year ended December 31, 2013, and in the accompanying consolidated financial statements and notes contained in this Form 10-Q. The objective of this financial review is to enhance the reader’s understanding of the accompanying tables and charts, the consolidated financial statements, notes to the financial statements and financial statistics appearing elsewhere in the report. Where applicable, this discussion also reflects Management’s insights as to known events and trends that have or may reasonably be expected to have a material effect on the Corporation’s operations and financial condition.
Summary (Dollars in thousands, except per share data)
LNB Bancorp, Inc. (the “Corporation”) is a diversified banking services company headquartered in Lorain, Ohio. It is organized as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). Its predecessor, The Lorain Banking Company, was a state chartered bank founded in 1905. It merged with the National Bank of Lorain in 1961, and in 1984 became a wholly-owned subsidiary of LNB Bancorp, Inc.
The Corporation engages in lending and depository services, investment services, and other traditional banking services. These services are generally offered through the Corporation's wholly-owned subsidiary, The Lorain National Bank (the “Bank”).
The primary business of the Bank is providing personal, mortgage and commercial banking products, along with investment management and trust services. The Lorain National Bank operates through 20 retail-banking locations and 28 automated teller machines (“ATM's”) in Lorain, Erie, Cuyahoga and Summit counties in the Ohio communities of Lorain, Elyria, Amherst, Avon, Avon Lake, LaGrange, North Ridgeville, Oberlin, Olmsted Township, Vermilion, Westlake and Hudson, as well as a business development office in Cuyahoga County. The Bank also operates an office in Columbus, Ohio that specializes in originating Small Business Administration (SBA) related loans.
Net income for the first quarter 2014 was $1,606 compared to $1,113 for the same period one year ago. Net income available to common shareholders for the first quarter 2014 was $1,571, or $0.16 per diluted common share, compared to $856, or $0.10 per diluted common shares, for the first quarter 2013. In the first quarter of 2013, net income available to common shareholders of $856 included Supplemental Executive Retirement Plan (SERP) compensation expense of $455 net of tax. Excluding the SERP expense, the adjusted net income available to common shareholders would have been $1,311 in the first quarter of 2013. The adjusted net income available to common shareholders increased of $260 or 19.8% when compared to the first quarter of 2013.
Net interest income on a fully taxable equivalent (FTE) basis for the first quarter 2014 was $9,117, an increase of 2.9%, compared to $8,860 for the first quarter 2013. The net interest margin FTE, determined by dividing tax equivalent net interest income by average assets, for the first quarter 2014 was 3.21% compared to 3.23% for the first quarter 2013.
The provision for loan losses was $900 for the quarter ended March 31, 2014 compared to $1,350 for the quarter ended March 31, 2013. See Note 6: Loans and Allowance for Loan Losses and table 7: Analysis of Allowance for Loan Losses for further details.
Noninterest income was $2,912 for the first quarter 2014 compared to $3,332, or a 12.6% decrease when compared to the first quarter 2013. The 12.6% decrease was attributable to $178 or 100% decrease in gain on the sale of securities, a decrease of $46 or 5.6% in deposit service charges and a decrease of $78 or 9.4% in other service charges and fees. The decreases in the first quarter of 2014 in deposit service charges and other service charges and fees are attributed to the harsh weather conditions experienced.
Noninterest expense for the first quarter was $8,859, a decrease of $422, or 4.5%, when compared to $9,281, for the same period one year ago. The decrease year over year in noninterest expense was mainly attributable to the $693 SERP charge recognized in the first quarter of 2013.
During the first quarter 2014, loans increased slightly as total portfolio loans ended at $910,189, a 0.9% increase, compared to $902,299 at December 31, 2013. Total assets for the first quarter 2014 ended at $1,255,393 compared to $1,230,257 at December 31, 2013, an increase of $25,136, or 2.0%. Total deposits grew to $1,076,851 at March 31, 2014, an increase of 3.0%, from $1,045,589 at December 31, 2013.

33


The Corporation continued its efforts in improving credit metrics. The Corporation’s non-performing loans totaled $20,918 at March 31, 2014, or 2.30% of total loans, a decrease from $21,986, or 2.44% of total loans, at December 31, 2013, and a decrease of $7,596 from $28,514, or 26.6%, from the first quarter 2013.
The allowance for possible loan losses was $17,497 at March 31, 2014, compared to $17,505 at December 31, 2013, and 1.92% compared to 1.94% of total portfolio loans at December 31, 2013. Annualized net charge-offs to average loans at March 31, 2014 was 0.40% compared to 0.51% at December 31, 2013, and 0.54% at March 31, 2013.


34



Results of Operations (Dollars in thousands except per share data)
Table 1: Condensed Consolidated Average Balance Sheets
Interest, Rate, and Rate/ Volume differentials are stated on a Fully-Tax Equivalent (FTE) Basis.
Table 1 presents the condensed consolidated average balance sheets for the three months ended March 31, 2014, and 2013.
 
 
Three Months Ended March 31,
 
2014
 
2013
 
Average
Balance
 
Interest
 
Rate
 
Average
Balance
 
Interest
 
Rate
 
(Dollars in thousands)
Assets:
 
 
 
 
 
 
 
 
 
 
 
U.S. Govt agencies and corporations
$
184,487

 
$
1,078

 
2.37
%
 
$
175,589

 
$
841

 
1.94
%
State and political subdivisions
33,267

 
434

 
5.29

 
32,202

 
415

 
5.22

Federal funds sold and short-term investments
16,740

 
17

 
0.41

 
7,230

 
20

 
1.13

Restricted stock
5,221

 
67

 
5.22

 
6,627

 
70

 
4.26

Commercial loans
496,647

 
5,370

 
4.38

 
491,326

 
5,423

 
4.48

Residential real estate loans
46,763

 
564

 
4.89

 
54,761

 
652

 
4.83

Home equity lines of credit
110,266

 
1,056

 
3.79

 
107,664

 
1,016

 
3.83

Installment loans
257,109

 
1,963

 
3.13

 
237,893

 
1,993

 
3.40

Total Earning Assets
$
1,150,500

 
$
10,549

 
3.67
%
 
$
1,113,292

 
$
10,430

 
3.80
%
Allowance for loan loss
(17,540
)
 
 
 
 
 
(17,762
)
 
 
 
 
Cash and due from banks
35,775

 
 
 
 
 
34,926

 
 
 
 
Bank owned life insurance
19,421

 
 
 
 
 
18,680

 
 
 
 
Other assets
46,224

 
 
 
 
 
46,494

 
 
 
 
Total Assets
$
1,234,380

 
 
 
 
 
$
1,195,630

 
 
 
 
Liabilities and Shareholders’ Equity:
 
 
 
 
 
 
 
 
 
 
 
Consumer time deposits
$
411,774

 
$
861

 
0.85
%
 
$
437,118

 
$
1,047

 
0.97
%
Public time deposits
81,954

 
135

 
0.67

 
57,612

 
115

 
0.81

Savings deposits
127,636

 
11

 
0.04

 
120,510

 
16

 
0.05

Money market accounts
119,243

 
55

 
0.19

 
105,365

 
43

 
0.17

Interest-bearing demand
169,732

 
20

 
0.05

 
158,603

 
28

 
0.07

Short-term borrowings
4,663

 
26

 
2.32

 
1,514

 
1

 
0.10

FHLB advances
46,737

 
155

 
1.34

 
46,531

 
154

 
1.35

Junior subordinated debentures
16,334

 
169

 
4.20

 
16,313

 
166

 
4.13

Total Interest-Bearing Liabilities
$
978,073

 
$
1,432

 
0.59
%
 
$
943,566

 
$
1,570

 
0.68
%
Noninterest-bearing deposits
145,640

 
 
 
 
 
137,760

 
 
 
 
Other liabilities
3,986

 
 
 
 
 
3,888

 
 
 
 
Shareholders’ Equity
106,681

 
 
 
 
 
110,416

 
 
 
 
Total Liabilities and Shareholders’ Equity
$
1,234,380

 
 
 
 
 
$
1,195,630

 
 
 
 
Net interest Income (FTE)
 
 
$
9,117

 
3.21
%
 
 
 
$
8,860

 
3.23
%
Taxable Equivalent Adjustment
 
 
(156
)
 
(0.05
)
 
 
 
(156
)
 
(0.06
)
Net Interest Income Per Financial Statements
 
 
$
8,961

 
 
 
 
 
$
8,704

 
 
Net Yield on Earning Assets
 
 
 
 
3.16
%
 
 
 
 
 
3.17
%
Note: Interest income on tax-exempt securities and loans has been adjusted to a fully-taxable equivalent basis. Nonaccrual loans have been included in the average balances.







35


Results of Operations (Dollar in thousand except per share data)

Three Months Ended March 31, 2014, versus Three Months Ended March 31, 2013, Net Interest Income Comparison
Net interest income is the difference between interest income earned on interest-earning assets and the interest expense paid on interest-bearing liabilities. Net interest income is the Corporation’s principal source of revenue, accounting for 75.5% of the Corporation’s revenues for the three months ended March 31, 2014. The amount of net interest income is affected by changes in the volume and mix of earning assets and interest-bearing liabilities, the level of rates earned or paid on those assets and liabilities and the amount of loan fees earned. The Corporation reviews net interest income on a fully taxable equivalent (FTE) basis, which presents interest income with an adjustment for tax-exempt interest income on an equivalent pre-tax basis assuming a 34% statutory Federal tax rate. These rates may differ from the Corporation’s actual effective tax rate. The net interest margin is net interest income as a percentage of average earning assets.
Net interest income was $8,961 for the first quarter 2014 compared to $8,704 during the same quarter of 2013, an increase of 2.95%. Contributing to the increase in net interest income was $20,258, or 2.28% growth in portfolio loans from the first quarter of 2013. Adjusting for tax-exempt income, net interest income FTE for the first quarter of 2014 and 2013 was $9,117 and $8,860, respectively. The net interest margin FTE, determined by dividing tax equivalent net interest income by average earning assets, was 3.21% for the three months ended March 31, 2014, compared to 3.23% for the three months ended March 31, 2013.
Average earning assets for the first quarter of 2014, were $1,150,500, an increase of $37,208 or 3.3%, compared to $1,113,292 for the first quarter of last year. The yield on average loans during the first quarter of 2014 was 3.99%, which was 14 basis points lower than the yield on average loans during the first quarter of 2013 of 4.13%. Interest income from securities was $1,512 (FTE) for the three months ended March 31, 2014, compared to $1,256 during the first quarter of 2013. The yield on average securities increased to 2.82% from 2.45% for these periods, respectively. The increase in interest income from securities is the result of higher long-term interest rates year over year which led to a decrease in prepayments within the Corporation's mortgage-backed securities portfolio. This resulted in a decline in premium amortization expense for the first quarter of 2014.
 
The cost of interest-bearing liabilities was 0.59% during the first quarter of 2014 compared to 0.68% during the same period in 2013. This decrease is primarily due to the sustained low interest rate environment. Noninterest-bearing accounts were $145,640, an increase of 5.7%, compared to $137,760 for the same period a year ago. Total average interest-bearing liabilities of $978,073 for the quarter ended March 31, 2014 increased $34,507, or 3.7%, compared to the quarter ended March 31, 2013. The average cost of trust preferred securities was 4.20% for the first quarter of 2014, compared to 4.13% for the first quarter of 2013. One half of the Corporation’s outstanding trust preferred securities accrued dividends at a fixed rate of 6.64%, and the other half accrued dividends at LIBOR plus 1.48%, which was 1.71% as of March 31, 2014.
















36


Net interest income may also be analyzed by comparing the volume and rate components of interest income and interest expense. Table 2 is an analysis of the changes in interest income and expense between the quarters ended March 31, 2014, and March 31, 2013. The table is presented on a fully tax-equivalent basis.

Table 2: Rate/Volume Analysis of Net Interest Income (FTE)
 
Three Months Ended March 31,
 
Increase (Decrease) in Interest Income/Expense
 in 2014 over 2013
 
Volume
 
Rate
 
Total
 
(Dollars in thousands)
U.S. Govt agencies and corporations
$
51

 
$
186

 
$
237

State and political subdivisions
14

 
5

 
19

Federal funds sold and short-term investments
10

 
(13
)
 
(3
)
Restricted stock
(18
)
 
15

 
(3
)
Commercial loans
58

 
(111
)
 
(53
)
Residential real estate loans
(96
)
 
8

 
(88
)
Home equity lines of credit
25

 
15

 
40

Installment loans
148

 
(178
)
 
(30
)
Total Interest Income
192

 
(73
)
 
119

Consumer time deposits
(53
)
 
(133
)
 
(186
)
Public time deposits
40

 
(20
)
 
20

Savings deposits
1

 
(6
)
 
(5
)
Money market accounts
6

 
6

 
12

Interest-bearing demand
1

 
(9
)
 
(8
)
Short-term borrowings
18

 
7

 
25

FHLB advances
1

 

 
1

Trust preferred securities

 
3

 
3

Total Interest Expense
14

 
(152
)
 
(138
)
Net Interest Income (FTE)
$
178

 
$
79

 
$
257


Net interest income (FTE) for the first quarter 2014 and 2013 was $9,117 and $8,860, respectively. Net interest income (FTE) for the first quarter of 2014 increased by $257, or 3.0%, in comparison to the same period in 2013. This increase is primarily attributable to the improvement in the Corporation's investment portfolio. Interest income on securities of U.S. Government agencies and of corporations increased $237, of which $186 is attributable to rate and $51 is attributable to volume. Overall higher longer-term interest rates have decreased the number of agency securities being called. In addition, a slowdown in prepayments within the Corporation's mortgage-backed securities resulted in a corresponding decline in premium amortization.
Interest income on commercial loans decreased $53. This decrease is primarily attributable to the sustained low interest rate environment, with a decrease in rate of $111, which was offset by an increase in volume of $58. Interest income on installment loans decreased $30, with a decrease in rate of $178, which was offset by an increase in volume of $148. The decrease was the result of the continued lower interest rate environment and the competitive nature of indirect lending.
The $186 decrease in consumer time deposits was due primarily to lower market interest rates as existing accounts continued to renew at favorable lower market interest rates. Total interest expense decreased $138, with the decrease being attributable to a $152 decrease due to rate and an increase due to volume of $14.




37


Noninterest Income
Table 3: Details of Noninterest Income
 
 
Three Months Ended March 31,

 
 
2014
 
2013
 
 
(Dollars in thousands)
 
Investment and trust services
$
400

 
$
375

 
Deposit service charges
770

 
816

 
Other service charges and fees
753

 
831

 
Income from bank owned life insurance
169

 
168

 
Other income
151

 
321

 
Total fees and other income
2,243

 
2,511

 
Securities gains, net

 
178

 
Gain on sale of loans
703

 
656

 
Loss on sale of other assets, net
(34
)
 
(13
)
 
Total noninterest income
$
2,912

 
$
3,332

 

Three Months Ended March 31, 2014, versus Three Months Ended March 31, 2013, Noninterest Income Comparison
Total fees and other income for the three months ended March 31, 2014, was $2,243, a decrease of $268, or 10.7%, from $2,511 for the same period in 2013. The Corporation utilizes derivatives as part of its risk management strategy in conducting its mortgage activities. Consequently, changes in fair value, both gains and losses, of the instruments are recorded in the Consolidated Statements of Income in other income. The decrease of $170, or 53% in other income from the first quarter of 2014 compared to the first quarter of 2013 is the result of changes in the fair value of mortgage interest rate lock pipeline loans. Interest rate locked pipeline loans have significantly decreased year over year as an increase in mortgage interest rates resulted in the transition in the mortgage market from a refinance era to a purchase market.
For the three months ended March 31, 2014, deposit service charges were $770 compared to $816 for the same period one year ago. For the three months ended March 31, 2014, other service charges and fees decreased to $753 from $831. The decreases reflect lower activity primarily due to the harsh weather conditions experienced in the first quarter of 2014. Income earned on investment and trust services for the first quarter of 2014 increased $25 compared to the first quarter of 2013.
Gain on the sale of loans was $703 for the first quarter of 2014, compared to $656 for the first quarter of 2013, an increase of $47 or 7.2%.
The following table details the gain on the sale of loans recognized for the three months ended March 31, 2014 and 2013:
 
 
Three Months Ended March 31,
 
 
2014
 
2013
 
 
 
Gain on sale of mortgage loans
 
$
110

 
$
591

Gain on sale of indirect auto consumer loans
 
98

 
65

Gain on sale of SBA loans
 
495

 

 
 
$
703

 
$
656

As noted above, the Corporation experienced a decrease in the demand for mortgage lending, primarily in the refinancing market due to rising interest rates year over year. As a result the gain on the sale of mortgage loans for the first quarter of 2014 decreased $481, or 81.4%. This was offset by the Small Business Administration (SBA) lending team generating over $12 million in loans, which resulted in a gain on sale of $495 in the first quarter of 2014. The Corporation retains the unguaranteed portion of these loans and sells the guaranteed portion of these loans. The Corporation continues to service these loans after sale and is required under the SBA programs to retain specified amounts. During the fourth quarter of 2013, the Corporation invested in a new loan office in Columbus, Ohio, with a focus on business loan growth and increasing revenue through the SBA programs. In the first quarter 2014, gain on the sale of indirect auto consumer loans was $98 compared to $65 for the first quarter of 2013. The increase of $33, or 50.8%, is due to the Corporation electing to sell more indirect auto consumer loans.


38


Noninterest Expense
Table 4: Details on Noninterest Expense
 
 
Three Months Ended March 31,
 
2014
 
2013
 
(Dollars in thousands)
Salaries and employee benefits
$
4,595

 
$
5,027

Furniture and equipment
1,148

 
949

Net occupancy
613

 
588

Professional fees
494

 
490

Marketing and public relations
400

 
289

Supplies, postage and freight
214

 
307

Telecommunications
151

 
162

Ohio franchise tax
224

 
308

Intangible asset amortization
33

 
33

FDIC assessments
272

 
242

Other real estate owned
24

 
77

Loan and collection expense
298

 
388

Other expense
393

 
421

Total noninterest expense
$
8,859

 
$
9,281

Three Months Ended March 31, 2014 versus Three Months Ended March 31, 2013 Noninterest Expense Comparison
Noninterest expense for the first quarter of 2014 decreased $422, or 4.5%, compared to the same period of 2013. The decrease year over year in noninterest expense was mainly attributable to the $693 SERP expense recognized in the first quarter of 2013. Furniture and equipment expense increased $199, or 21.0%, compared to the same period one year ago due to an increase in data processing expense with the introduction of mobile banking. Marketing and public relations expense increased $111, or 38.4%, compared to the same period one year ago. The increase is primarily due to the Corporation's communication and advertising for mobile banking, the SBA lending program and the implementation of a relationship checking account product which offers rewards as the customer's relationship with the bank grows. Ohio franchise tax decreased $84, or 27.3%, compared to same period one year ago due to state legislation changes resulting in a change in the calculation of Ohio franchise tax for community banks from an equity based method to an asset based method. Loan and collection expense decreased $90, or 23.2%, compared to same period one year ago due to improved asset quality.
Income taxes
Three Months Ended March 31, 2014 versus Three Months Ended March 31, 2013 Income Taxes Comparison
The Corporation recognized income tax expense of $508 and $292 for the first quarter 2014 and 2013, respectively. The increase in the Corporation’s effective tax rate to 24.0% for March 31, 2014, from 20.8% for March 31, 2013, compared to the Federal statutory tax rate of 34%, is due to higher pre-tax income year over year. Included in net income for the three months ended March 31, 2014, and March 31, 2013, was $486 and $485 of nontaxable income, respectively, which is comprised of $137 and $135, respectively, related to life insurance policies and $349 and $349, respectively, of tax-exempt investment and loan interest income.

39


Financial Condition
Overview
The Corporation’s total assets at March 31, 2014, were $1,255,393 compared to $1,230,257 at December 31, 2013, an increase of $25,136, or 2.0%. This increase is primarily due to the increase in total deposits of $31,262. Total deposits at March 31, 2014, were $1,076,851 compared to $1,045,589 at December 31, 2013. The increase in total deposits was due to increases in money market and interest-bearing demand accounts of $36,364 and decreases in time deposits of $5,671. Other increases to note when compared to December 31, 2013 are in portfolio loans of $7,890, cash and cash equivalents of $15,969 and securities available for sale of $1,388.
Securities
The distribution of the Corporation’s securities portfolio at March 31, 2014 and December 31, 2013, is presented in Note 5 to the Consolidated Financial Statements contained within this Form 10-Q. The Corporation continued to employ the securities portfolio to manage the Corporation’s interest rate risk and liquidity needs. Total securities increased $1,388, or 0.6%, compared to December 31, 2013. As of March 31, 2014, the portfolio was comprised of 97.4% available-for-sale securities and 2.6% restricted stock. Available for sale securities were comprised of 31.0% U.S. Government Agencies, 43.5% U.S. Agency mortgage-backed securities, 10.2% U.S. collateralized mortgage obligations, and 15.4% municipal securities at March 31, 2014. The available-for-sale securities had a net temporary unrealized loss of $3,061, representing 1.4% of the total amortized cost of the Corporation's available-for-sale securities.
As with any investment, the yield on an available-for-sale security depends on the purchase price in relation to the interest rate and the length of time the investor's principal remains outstanding. Mortgage-backed security yields are often quoted in relation to yields on treasury securities with maturities closest to the mortgage security's estimated average life. The estimated yield on a mortgage security reflects its estimated average life based on the assumed prepayment rates for the underlying mortgage loans. If actual prepayment rates are faster or slower than anticipated, the investor holding the mortgage security until maturity may realize a different yield. Due to the fluctuating interest rate environment and the flattening of the yield curve, the Corporation focused investment opportunities to short-term duration investments.
At March 31, 2014, the available-for-sale securities portfolio had gross unrealized gains of $2,880 and gross unrealized losses of $5,941. The gross unrealized losses represented 2.7% of the total amortized cost of the Corporation’s available-for-sale securities at March 31, 2014. At March 31, 2014, the Corporation held twelve available-for-sale securities with an unrealized loss position for greater than twelve months totaling $1,680. Available-for-sale securities with an unrealized loss position for less than twelve months totaled $4,261 at March 31, 2014. The unrealized gains and losses at December 31, 2013, were $2,754 and $8,651, respectively. See Note 5 to the Consolidated Financial Statements for further detail.
Loans
The detail of loan balances is presented in Note 6 to the Consolidated Financial Statements contained within this Form 10-Q. Table 7 provides detail by loan segment.
Total portfolio loans at March 31, 2014 were $910,189. This was an increase of $7,890 over total portfolio loans of at December 31, 2013. The Corporation believes that its loan portfolio was well-diversified at March 31, 2014. Commercial and commercial real estate loans represented 54.1%, indirect loans represented 23.0%, home equity loans represented 13.5%, residential real estate mortgage loans represented 7.5% and consumer loans represented 1.9% of total portfolio loans at March 31, 2014.



40


Table 5: Loan Portfolio Distribution
 
 
March 31, 2014
 
December 31, 2013
 
March 31, 2013
 
(Dollars in thousands)
Commercial real estate
$
408,467

 
$
401,591

 
$
415,753

Commercial
83,297

 
88,646

 
75,909

Residential real estate
68,671

 
66,507

 
64,486

Home equity loans
122,824

 
123,076

 
121,764

Indirect
209,694

 
206,323

 
199,964

Consumer
17,236

 
16,156

 
12,055

Total Loans
910,189

 
902,299

 
889,931

Allowance for loan losses
(17,497
)
 
(17,505
)
 
(17,806
)
Net Loans
$
892,692

 
$
884,794

 
$
872,125

 
 
 
 
 
 
Loan Mix Percent
 
 
 
 
 
Commercial real estate
44.9
%
 
44.5
%
 
46.7
%
Commercial
9.2
%
 
9.8
%
 
8.5
%
Residential real estate
7.5
%
 
7.4
%
 
7.2
%
Home equity loans
13.5
%
 
13.6
%
 
13.7
%
Indirect
23.0
%
 
22.9
%
 
22.5
%
Consumer
1.9
%
 
1.8
%
 
1.4
%
Total Loans
100.0
%
 
100.0
%
 
100.0
%

Commercial loans and commercial real estate loans totaled $491,764 at March 31, 2014. This was an increase of $1,527, or 0.3%, over December 31, 2013, and a slight increase of $102 from March 31, 2013. Commercial real estate loans are loans secured by commercial real estate properties. Commercial loans are primarily lines-of-credit as well as loans secured by property other than commercial real estate, generally equipment or other business assets.
Real estate mortgages are 1-4 rate family mortgage loans and construction loans made to individuals. The Corporation generally requires a loan-to-value ratio of 80% or private mortgage insurance for loan-to-value ratios in excess of 80% for real estate mortgages. Construction loans comprised $188 of the $68,671 residential real estate mortgage loan portfolio at March 31, 2014. At March 31, 2014 residential real estate mortgage loans increased by $2,164, or 3.3%, in comparison to December 31, 2013 and increased $4,185, or 6.5%, from March 31, 2013. As interest rates have risen year over year, the refinancing market has slowed, contributing to the decrease in loans year over year.
Indirect auto loans increased by $3,371, or 1.6%, compared to December 31, 2013, and increased $9,730, or 4.9%, compared to March 31, 2013. The increase is primarily attributable to strong demand in the auto sales in the first quarter of 2014. The Corporation currently originates high quality indirect auto loans, defined as loans with borrowers that have personal credit scores that are greater than 750, in Ohio, Kentucky, Indiana, Georgia, North Carolina, Pennsylvania, and Tennessee.
Home equity loans decreased $252, or 0.2%, when compared to December 31, 2013, and increased $1,060, or 0.9%, compared to March 31, 2013. Due to strong marketing efforts, consumer loans have increased $1,080, or 6.7%, in comparison to December 31, 2013 and increased $5,181, or 43.0%, compared to March 31, 2013.
Loans held for sale are not included in portfolio loans and as of March 31, 2014. Total loans classified as held for sale were $1,811 compared to $6,250 as of March 31, 2013. Residential real estate mortgage loans represented $249, or 13.7%, and indirect loans represented $1,562, or 86.3%, of loans held for sale at March 31, 2014. At March 31, 2013, residential real estate mortgage loans represented $4,563, or 73.0%, and indirect loans represented $1,687, or 27.0%.
Table 6 shows the amount of portfolio loans outstanding as of March 31, 2014 based on the remaining scheduled principal payments or principal amounts repricing in the periods indicated. All loans that, by their terms, are due after one year, but which are subject to more frequent repricing, have been classified as due in one year or less for purposes of the table.


41


Table 6: Cash Flow and Interest Rate Information for Loans:
 
 
March 31, 2014
Due in one year or less
$
218,966

Due after one year but within five years
427,327

Due after five years
263,896

Totals
$
910,189

Due after one year with a predetermined fixed interest rate
$
533,818

Due after one year with a floating interest rate
157,405

Totals
$
691,223

Provision and Allowance for Loan Losses
The allowance for loan losses is maintained by the Corporation at a level considered by management to be adequate to cover probable incurred credit losses in the loan portfolio. The amount of the provision for loan losses charged to operating expenses is the amount necessary, in the estimation of management, to maintain the allowance for loan losses at an adequate level. Management determines the adequacy of the allowance based upon past experience, changes in portfolio size and mix, relative quality of the loan portfolio and the rate of loan growth, assessments of current and future economic conditions and information about specific borrower situations, including their financial position and collateral values, and other factors, which are subject to change over time. While management’s periodic analysis of the allowance for loan losses may dictate portions of the allowance be allocated to specific problem loans, the entire amount is available for any loan charge-offs that may occur.
As the economy faced significant challenges over the past several years, the Corporation responded by adding additional internal resources at the end of 2009, continuing to utilize outside resources and implementing a process to improve asset quality going forward. This process, which includes executive management, finance, credit, lending and legal, is charged with monitoring problem loans on a regular basis to insure proper grading of the loans, identifying loans as “troubled debt restructured,” adequate allowances and timely resolution of problem credits. In addition, the Corporation's bank subsidiary has a Loan and Credit Review Committee which provides board oversight in areas such as underwriting, concentrations, delinquencies, production goals and performance trends.
The Corporation uses a historical loss methodology in determining the level of allowances for various loan segments. It is supplemented by a migration analysis which estimates probable incurred losses, similar to the Basel formula, for commercial loans based on a history of loans migrating through the various loan grades.
The effect of these initiatives has resulted in an improvement in asset quality as measured by the level of nonperforming loans as well as criticized loans. The use of a historical loss methodology tends to have a lag effect when estimating the adequacy of the allowance as specific reserves related to impaired loans are replaced with general reserves related to the various pools of loans.
While the local economy has shown signs of improvement, it has remained fragile, as has the local real estate market and valuations. With the Corporation's exposure to commercial real estate loans, including construction and development loans, and consumer real estate in the form of home equity loans, management continues to monitor loan performance in light of the past and recent volatility in real estate valuations.












42


Table 7 presents the Corporation's detailed activity in the allowance for loan losses and related charge-off activity for the three months ended March 31, 2014, and 2013.
Table 7: Analysis of Allowance for Loan Losses
 
 
Three Months Ended
 
 
March 31, 2014
 
March 31, 2013
 
 
(Dollars in thousands)
 
Balance at beginning of year
$
17,505

 
17,637

 
Charge-offs:

 
 
 
Commercial real estate
(546
)
 
(123
)
 
Commercial

 
(63
)
 
Residential real estate
(77
)
 
(513
)
 
Home equity loans
(222
)
 
(436
)
 
Indirect
(70
)
 
(216
)
 
Consumer
(83
)
 
(77
)
 
Total charge-offs
(998
)
 
(1,428
)
 
Recoveries:

 
 
 
Commercial real estate
6

 
7

 
Commercial
1

 
4

 
Residential real estate
2

 
64

 
Home equity loans
11

 
47

 
Indirect
58

 
94

 
Consumer
12

 
31

 
Total Recoveries
90

 
247

 
Net Charge-offs
(908
)
 
(1,181
)
 
Provision for loan losses
900

 
1,350

 
Balance at end of year
$
17,497

 
$
17,806

 
 
 
 
 
 
Average Portfolio loans outstanding
$
906,843

 
$
884,893

 
Annualized ratio to average loans:
 
 
 
 
Net Charge-offs
0.41
%
 
0.54
%
 
Provision for loan losses
0.39
%
 
0.62
%
 
 
 
 
 
 
Loans outstanding
$
910,189

 
$
889,931

 
 
 
 
 
 
As a percent of outstanding loans
1.92
%
 
2.00
%
 
* Loans held for sale are excluded in the average portfolio loans outstanding balance.

The allowance for loan losses at March 31, 2014, was $17,497, or 1.92% of outstanding loans, compared to $17,806, or 2.00% of outstanding loans at March 31, 2013. The allowance for loan losses was 83.65% and 62.45% of nonperforming loans at March 31, 2014 and 2013, respectively.
Net charge-offs for the three months ended March 31, 2014, were $908, compared to $1,181 for the three months ended March 31, 2013. Net charge-offs as a percent of average loans was 0.41% for the quarter of 2014 and 0.54% for the same period in 2013. Net charge-offs on commercial and commercial real estate loans were primarily a result of loans that are collateral dependent and deemed uncollectible. As a result, the loans are written down to their net realizable value, which is determined based upon current appraised value less costs to sell.

The provision for loan losses was $900 for the three months ended March 31, 2014, compared to $1,350 for the three months ended March 31, 2013. Real estate market conditions have improved resulting in higher valuations for underlying

43


collateral. This coupled with overall better asset quality has resulted in lower level of charged-off loans in the the Corporation's loan portfolio. Consumer loans, especially home equity loans, while somewhat affected by the real estate market, have been largely influenced by the level of unemployment, which has been relatively high over the past several years. Management continues to allocate a portion of the allowance to general reserves for loans having higher risk factors. As specific reserves have been charged-off, the composition of the allowance has continued to shift to a lesser allocation of specific reserves and an increase in general reserves.
The allowance for loan losses is, in the opinion of management, sufficient given its analysis of the information available about the portfolio at March 31, 2014. Management continues to work toward prompt resolution of nonperforming loan situations and to adjust underwriting standards as conditions warrant.
The following table sets forth the allocation of the allowance for loan losses by loan category as of March 31, 2014, and December 31, 2013, as well as the percentage of loans in each category to total loans.  This allocation is based on management's assessment, as of a given point in time, of the risk characteristics of each of the component parts of the total loan portfolio and is subject to changes when the risk factors of each component part change.  The allocation is not indicative of either the specific amounts of the loan categories in which future charge-offs may be taken, nor should it be taken as an indicator of future loss trends.  The allocation of the allowance to each category does not restrict the use of the allowance to absorb losses in any category.

Allocation of the Allowance for Loan Losses by Loan Type
 
March 31, 2014
 
December 31, 2013
 
(Dollars in thousands)
 
Allowance
 
Percent of loans
in each category
to total loans
 
Allowance
 
Percent of loans
in each category to total loans
Commercial real estate
$
10,244

 
44.9
%
 
$
10,122

 
44.5
%
Commercial
464

 
9.2
%
 
497

 
9.8
%
Residential real estate
1,483

 
7.5
%
 
1,411

 
7.4
%
Home equity loans
3,478

 
13.5
%
 
3,484

 
13.6
%
Indirect
1,513

 
23.0
%
 
1,593

 
22.9
%
Consumer
315

 
1.9
%
 
398

 
1.8
%
Total
$
17,497

 
100.0
%
 
$
17,505

 
100.0
%

The balance in the allowance for loan losses is determined based on management's review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions, and other pertinent factors, including management's assumptions as to future delinquencies, recoveries and losses. Increases to the allowance for loan and lease losses are made by charges to the provision for loan losses. Credit exposures deemed to be uncollectible are charged against the allowance for loan losses. Recoveries of previously charged-off amounts are credited to the allowance for loan losses.
Changes in the allowance for loan losses for all categories of the loan portfolio reflect the net effect of changes in historical net loss rates by risk grade for commercial real estate and commercial loans and for the total of other categories, changes in loan balances for each category or by risk grade, the level of nonperforming and other impaired loans, and management’s judgment with respect to economic and other relevant factors. Additional information regarding the allowance for loan losses is included in Note 6 (Loans and Allowance for Loan Losses) in the notes to the consolidated financial statements.
Funding Sources
  The primary source of funds continues to be the generation of deposit accounts within the Corporation's primary markets. In order to achieve deposit account growth, the Corporation offers retail and business customers a full line of deposit products that includes interest and noninterest-bearing checking accounts, savings accounts and time deposits. The Corporation also generates funds through local borrowings generated by a business sweep product. Wholesale funding sources include lines of credit with correspondent banks, advances through the Federal Home Loan Bank of Cincinnati and a secured line of credit with the Federal Reserve Bank of Cleveland. The Corporation from time to time will also utilize brokered time deposits to provide term funding at rates comparable to other wholesale funding sources. Table 8 highlights the average balances and the average rates paid on these sources of funds for the three months ended March 31, 2014, and December 31, 2013.

44





The following table shows the various sources of funding for the Corporation.

Table 8: Funding Sources
 
Average Balances Outstanding
Average Rates Paid
 
For the three months ended
 
March 31, 2014
 
December 31, 2013
 
March 31, 2014
 
December 31, 2013
 
(Dollars in thousands)
Noninterest-bearing checking
$
145,640

 
$
141,639

 
%
 
%
Interest-bearing checking
169,732

 
165,846

 
0.05
%
 
0.05
%
Savings deposits
127,636

 
123,179

 
0.04
%
 
0.04
%
Money market accounts
119,243

 
104,758

 
0.19
%
 
0.17
%
Consumer time deposits
411,774

 
434,771

 
0.85
%
 
0.93
%
Public time deposits
81,954

 
67,080

 
0.67
%
 
0.73
%
Total Deposits
$
1,055,979

 
$
1,037,273

 
0.42
%
 
0.54
%
Short-term borrowings
4,663

 
1,807

 
2.32
%
 
0.40
%
FHLB borrowings
46,737

 
46,609

 
1.34
%
 
1.35
%
Junior subordinated debentures
16,334

 
16,322

 
4.20
%
 
4.19
%
Total borrowings
$
67,734

 
$
64,738

 
2.10
%
 
2.04
%
Total funding
$
1,123,713

 
$
1,102,011

 
0.59
%
 
0.64
%
Deposit accounts and the generation of deposit accounts continued to be the primary source of funds for the Corporation. The Corporation offers various deposit products to both retail and business customers. The Corporation also has available its business sweep accounts to generate funds as well as the brokered CD market to provide funding comparable to other national market borrowings, which include the Federal Home Loan Bank of Cincinnati and the Federal Reserve Bank of Cleveland. At March 31, 2014 and December 31, 2013, the Corporation had no brokered time deposit balances.
Average deposit balances increased from $1,037,273 at December 31, 2013, to $1,055,979 at March 31, 2014. Low-cost deposits, namely checking, savings and money market accounts accounted for 53.2% of total deposits at March 31, 2014. The improved mix and extended lower interest rate environment has contributed to the Corporation's lower funding cost. These low-cost funds had an average yield of 0.42% compared to 0.54% at December 31, 2013. Included in these funds are consumer time deposits which carried an average yield of 0.85% compared to 0.93% at December 31, 2013. Time deposits to total average deposits were 493,728 or 46.8% of total deposits at March 31, 2014.
Borrowings
The Corporation utilizes both short-term and long-term borrowings to assist in the growth of earning assets. For the Corporation, short-term borrowings include Federal funds purchased and repurchase agreements. Short term borrowings decreased 18.6%, to $3,725 at March 31, 2014 compared to $4,576 at December 31, 2013. Of the $3,725, repurchase agreements represented $1,225 and $2,500 represented a line of credit with an unaffiliated financial institution as of March 31, 2014. The Corporation did not have any Federal funds purchased at March 31, 2014, or December 31, 2013.
As part of the Corporation’s redemption of the Series B Preferred Stock, approximately $3.0 million was drawn on a line of credit with an unaffiliated financial institution in December of 2013. The Corporation has maintained a $6.0 million line of credit with this institution since 2009 at prime rate, which was 3.50% at December 31, 2013 and 3.50% at March 31, 2014. In the first quarter 2014 the Corporation made a payment of $500 on the line of credit. Following the $500 payment made in the first quarter of 2014, $2.5 million remained outstanding at prime rate of 3.50% at March 31, 2014.
Long-term borrowings by the Corporation consist of Federal Home Loan Bank (FHLB) advances and junior subordinated debentures. FHLB advances were $46,760 at March 31, 2014 compared to $46,708 at December 31, 2013, while the junior subordinated debentures remained constant at $16,238. In the fourth quarter of 2012, the Corporation prepaid $27,500 of fixed rate FHLB advances with a contractual average interest rate of 2.47% and a weighted average remaining term to maturity of 1.63 years. The transaction was accomplished by extending the maturity date of the advances and rolling the net present value of the advances into the funding cost of the new structure. As a result of the restructure, the Corporation was required to pay a

45


prepayment penalty of $1,017 to the FHLB. In accordance with ASC 470-50, Debt - Modification and Exchanges, the new advances were considered a minor modification. The prepayment penalty was deferred and will be recognized in interest expense over the life of the new advances. Additional information regarding the FHLB advances is included in Note 9 (Federal Home Loan Bank Advances) in the notes to the consolidated financial statements.
During 2007, the Corporation completed a private offering of trust preferred securities. The securities were issued in two $10 million tranches, one of which pays dividends at a fixed rate of 6.64% per annum and the other of which pays dividends at LIBOR plus 1.48% per annum. In August 2010, the Corporation entered into an agreement with certain holders of its non-pooled trust preferred securities and exchanged $2,125 in principal amount of the securities issued by Trust I and $2,125 in principal amount of the securities issued by Trust II for 462,234 newly issued common shares of the Corporation at a volume-weighted average price of $4.41 per share. At March 31, 2014, the balance of the subordinated notes payable to Trust I and Trust II was $8,119 each.
Capital Management
The Bank is subject to various regulatory capital requirements administered by the Office of the Comptroller of the Currency (“OCC”), including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At March 31, 2014 and December 31, 2013, the Bank exceeded all of its regulatory capital requirements and was considered “well-capitalized” under regulatory guidelines.
 
Actual
 
For Capital Adequacy Purposes
 
To Be Well Capitalized Under Prompt Corrective Action Provisions
March 31, 2014 (Unaudited)
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
Total Capital (to Risk Weighted Assets)
$
116,693

 
12.15
%
 
$
76,815

 
8.0
%
 
$
96,018

 
10.0
%
Tier 1 Capital (to Risk Weighted Assets)
104,623

 
10.90

 
38,407

 
4.0

 
57,611

 
6.0

Tier 1 Leverage Capital (to Adjusted Total Assets)
104,623

 
8.61

 
48,604

 
4.0

 
60,755

 
5.0

 
 
 
 
 
 
 
 
 
 
 
 
 
Actual
 
For Capital Adequacy Purposes
 
To Be Well Capitalized Under Prompt Corrective Action Provisions
December 31, 2013
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
Total Capital (to Risk Weighted Assets)
$
122,795

 
12.89
%
 
$
76,230

 
8.0
%
 
$
95,290

 
10.0
%
Tier 1 Capital (to Risk Weighted Assets)
110,815

 
11.63

 
38,116

 
4.0

 
57,174

 
6.0

Tier 1 Leverage Capital (to Adjusted Total Assets)
110,815

 
9.22

 
48,086

 
4.0

 
60,108

 
5.0

Capital Resources
The Corporation continues to maintain a capital position that exceeds regulatory capital requirements. Total shareholders' equity was $107,114 at March 31, 2014, compared to $111,456 at December 31, 2013, a decrease of 3.9%, or $4,342. The regulatory capital ratios at December 31, 2013 include the proceeds from the Corporation entering into a common shares purchase agreement (the “Purchase Agreement”) with certain investors party thereto (the “Investors”), which included certain third-party investors and certain directors of the Corporation. Pursuant to the Purchase Agreement, the Corporation sold to the Investors an aggregate of 367,321 Common Shares at a purchase price of $9.9087 per share (except that Investors who are directors of the Corporation or are related thereto paid $10.30 per share), for an aggregate purchase price of $3.68 million.
Following the completion of the issuance and sale of Common Shares pursuant to the Purchase Agreement, on December 17, 2013, the Corporation issued a notice of redemption of all 9,147 remaining shares of Series B Preferred Stock, to be funded with the proceeds from the sale of Common Shares along with cash from $3,000 in borrowings under the Corporation’s line of credit with an unaffiliated financial institution and from the Corporation’s accumulated earnings and excess capital.
On January 17, 2014, the Corporation completed the retirement of the remaining shares of Series B Preferred Stock. The Corporation repurchased 1,458 of such shares in a private transaction in December, 2013, and redeemed the remaining 7,689 shares of Series B Preferred Stock on January 17, 2014, the redemption date. As of March 31, 2014, the Corporation no longer has Series B Preferred Stock issued or outstanding.

46


On July 28, 2005, the Corporation announced a share repurchase program of up to 5 percent, or about 332,000, of its common shares outstanding. Repurchased shares can be used for a number of corporate purposes, including the Corporation’s stock option and employee benefit plans. The share repurchase program provides that share repurchases are to be made primarily on the open market from time-to-time until the 5 percent maximum is repurchased or the earlier termination of the repurchase program by the Board of Directors, at the discretion of management based upon market, business, legal and other factors. No repurchase were made under this program during the first quarter of 2014. At March 31, 2014, the Corporation held 336,745 shares of common stock as treasury stock at a cost of $6,177. In the first three months of 2014, 8,551 shares were surrendered to the Corporation by employees to cover tax withholding in conjunction with vesting of restricted stock, as treasury stock at a cost of $85.
On December 12, 2008, the Corporation issued 25,223 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B, $1,000 per share liquidation preference (“Series B Preferred Stock”) to the U.S. Treasury in the TARP Capital Purchase Program for a purchase price of approximately $25,223. In connection with that issuance, the Corporation also issued a warrant to the U.S. Treasury ("Treasury") to purchase 561,343 common shares of the Corporation at an exercise price of $6.74 per share (the “Warrant”).
On June 19, 2012, the Treasury completed the offer and sale of all 25,223 shares of the Series B Preferred Stock to the public in a modified Dutch auction. The Corporation did not bid nor receive any of the proceeds from the offering. On July 18, 2012, the Corporation repurchased the Warrant from the Treasury at a mutually agreed upon price of $860, of which $146 represented the value of the warrant on the Corporation's books and a decrease in equity of $714 was subsequently recognized by the Corporation. Following settlement of the Warrant repurchase, the Treasury had no remaining investment in the Corporation.
On December 24, 2012, the Corporation completed the repurchase of $6.3 million in par value, or approximately 25% of the outstanding shares, of its Series B Preferred Stock in exchange for cash at a price representing a discount to par value. The transaction was funded by cash from accumulated earnings and excess capital. As a result of the discount on the purchase price, the Corporation recognized a net increase to retained earnings of $141.
In the fourth quarter of 2012, the Corporation completed the repurchase of 6,343 shares of Series B Preferred Stock from private investors, representing $6.3 million in face liquidation amount of the shares, or approximately 25% of the outstanding shares, of the Series B Preferred Stock in exchange for cash at an average price per share of $970.84, plus accrued and unpaid interest. The transaction was funded by cash from accumulated earnings and excess capital. As a result of the discount on the purchase price, the Corporation recognized an increase to retained earnings of $141.
On March 15, 2013, the Corporation completed the exchange (the “Exchange”) of newly issued common shares, $1.00 par value per share, of the Company (“Common Shares”) for shares of the Company’s Series B Preferred Stock with certain institutional and private investors (the "Sellers"). In the Exchange, the Company issued an aggregate of 1,359,348 Common Shares at a price of $7.16 per share to the Sellers in exchange for an aggregate of 9,733 shares of Series B Preferred Stock at a price of 100% of the per share liquidation preference, or $1,000 per share. The Company also delivered cash to the Sellers in lieu of fractional Common Shares and cash in an amount equal to the accrued and unpaid dividends due on the shares of Series B Preferred Stock.
On December 12, 2013, the Corporation entered into the Purchase Agreement. The Corporation sold to the Investors an aggregate of 367,321 Common Shares at a purchase price of $9.9087 per share (except that Investors who are directors of the Corporation or are related thereto paid $10.30 per share), for an aggregate purchase price of $3.68 million. The transactions were approved by the Board of Directors of the Corporation, by a majority of the disinterested directors of the Corporation and by the Corporation’s Audit and Finance Committee. The Purchase Agreement, among other things, provided the Investors with certain registration rights, pursuant to which the Corporation filed a Registration Statement on Form S-3 with the SEC, which was declared effective on January 16, 2014.
Off-Balance Sheet Arrangements
In the normal course of business, the Corporation enters into commitments with off-balance sheet risk to meet the financing needs of its customers. These arrangements include commitments to extend credit and standby letters of credit. Commitments to extend credit and standby letters of credit involve elements of credit risk and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Corporation uses the same credit policies in making commitments to extend credit and standby letters of credit as it does for on-balance sheet instruments.
The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the commitment is represented by the contractual amount of the commitment. Interest rate risk on commitments to extend credit results from the

47


possibility that interest rates may have moved unfavorably from the position of the Corporation since the time the commitment was made.
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 of 30 to 120 days or other termination clauses and may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Most of these arrangements mature within two years and are expected to expire without being drawn upon. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party.
The Corporation evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained by the Corporation upon extension of credit is based on management’s credit evaluation of the applicant. Collateral held is generally single-family residential real estate and commercial real estate. Substantially all of the obligations to extend credit are variable rate.
The Corporation does not believe that off-balance sheet arrangements will have a material impact on its liquidity or capital resources. See Note 11 to the Consolidated Financial Statements for further detail.
Critical Accounting Policies and Estimates
The Corporation’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The Corporation follows general practices within the banking industry and application of these principles requires management to make assumptions, estimates and judgments that affect the financial statements and accompanying notes. These assumptions, estimates and judgments are based on information available as of the date of the financial statements.
The most significant accounting policies followed by the Corporation are presented in Note 1 to the Consolidated Financial Statements. These policies are fundamental to the understanding of results of operation and financial conditions.
The accounting policies considered to be critical by management are as follows:
 
Allowance for loan losses
The allowance for loan losses is an amount that management believes will be adequate to absorb probable incurred credit losses in the loan portfolio taking into consideration such factors as past loss experience, changes in the nature and volume of the portfolio, overall portfolio quality, loan concentrations, specific problem loans and current economic conditions that affect the borrower’s ability to pay. Determination of the allowance is subjective in nature. Loan losses are charged off against the allowance when management believes that the full collectability of the loan is unlikely. Recoveries of amounts previously charged-off are credited to the allowance.

A loan is impaired when based on current information and events it is probable the Corporation will be unable to collect the scheduled payment of principal and interest when due under the contractual terms of the loan agreement. Impairment is evaluated in total for smaller-balance loans of similar nature such as real estate mortgages and installment loans, and on an individual loan basis for commercial loans that are graded substandard or below. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis. If a loan is impaired, a portion of the allowance may be allocated so that the loan is reported, net, using either the present value of estimated future cash flows discounted at the loans effective interest rate, the loan's observable market value or at the fair value of collateral if repayment is expected solely from the collateral.
The Corporation maintains the allowance for loan losses at a level adequate to absorb management’s estimate of probable incurred credit losses in the loan portfolio. The allowance is comprised of a general allowance, a specific allowance for identified problem loans and an unallocated allowance representing estimations pursuant to either Statement of Financial Accounting Standards ASC 450,“Accounting for Contingencies,” or ASC 310-10-45, “Accounting by Creditors for Impairment of a Loan.

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The general allowance is determined by applying estimated loss factors to the credit exposures from outstanding loans. For commercial and commercial real estate loans, the Corporation uses historical loss experience along with factors that are considered when loan grades are assigned to individual loans such as current and past delinquency, financial statements of the borrower, current net realizable value of collateral and the general economic environment and specific economic trends affecting the portfolio. For residential real estate, installment and other loans, loss factors are applied on a portfolio basis. Loss factors are based on the Corporation’s historical loss experience and are reviewed for appropriateness on a quarterly basis, along with other factors affecting the collectability of the loan portfolio.
Specific allowances are established for all loans when management has determined that, due to identified significant conditions, it is probable that a loss has been incurred that exceeds the general allowance loss factor from these loans. These conditions are reviewed quarterly by management and include general economic conditions, credit quality trends and internal loan review and regulatory examination findings.
Management believes that it uses the best information available to determine the adequacy of the allowance for loan losses. However, future adjustments to the allowance may be necessary and the results of operations could be significantly and adversely affected if circumstances differ substantially from the assumptions used in making the determinations.
 
Income Taxes
The Corporation’s income tax expense and related current and deferred tax assets and liabilities are presented as prescribed in ASC 740, “Accounting for Income Taxes.” The accounting requires the periodic review and adjustment of tax assets and liabilities based on many assumptions. These assumptions include predictions as to the Corporation’s future profitability, as well as potential changes in tax laws that could impact the deductibility of certain income and expense items. Since financial results could be significantly different than these estimates, future adjustments may be necessary to tax expense and related balance sheet accounts.

Goodwill
During 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-08, Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment. This ASU gives an entity the option to first assess qualitative factors to determine whether it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount (impairment). If the entity finds after the qualitative assessment that it is more likely than not (impairment indicators) that the fair value of a reporting unit is less than its carrying amount, the entity is then required to perform a full impairment test. The full impairment test is a two-step process that requires management to make judgments in determining what assumptions to use in the calculation. The first step in impairment testing is to estimate the fair value based on valuation techniques including a discounted cash flow model with revenue and profit forecasts and comparing those estimated fair values with the carrying values, which includes the allocated goodwill. If the carrying value exceeds its fair value, goodwill impairment may be indicated and a second step is performed to compute the amount of the impairment by determining an “implied fair value” of goodwill. The determination of an “implied fair value” of goodwill requires the Corporation to allocate fair value to the assets and liabilities. Any unallocated fair value represents the “implied fair value” of goodwill, which is compared to its corresponding carrying value. An impairment loss would be recognized as a charge to earnings to the extent the carrying amount of the goodwill exceeds the implied fair value of the goodwill. Based upon the qualitative assessment the Corporation determined that there is no likelihood of goodwill impairment therefore no impairment charge was recognized as of December 31, 2013. No significant changes since the previous assessment at December 31, 2013 have occurred, thus no additional information to indicate goodwill is impaired has been reviewed.
 
New Accounting Pronouncements
Management is not aware of any proposed regulations or current recommendations by the Financial Accounting Standards Board or by regulatory authorities, which, if they were implemented, would have a material effect on the liquidity, capital resources, or operations of the Corporation.





ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk.
RISK ELEMENTS

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Risk management is an essential aspect in operating a financial services company successfully and effectively. The most prominent risk exposures, for a financial services company, are credit, operational, interest rate, market and liquidity risk. Credit risk involves the risk of uncollectible interest and principal balance on a loan when it is due. Fraud, legal and compliance issues, processing errors, technology and the related disaster recovery and breaches in business continuation and internal controls are types of operational risks. Changes in interest rates affecting net interest income are considered interest rate risks. Market risk is the risk that a financial institution’s earnings and capital or its ability to meet its business objectives are adversely affected by movements in market rates or prices. Such movements include fluctuations in interest rates, foreign exchange rates, equity prices that affect the changes in value of available-for-sale securities, credit spreads and commodity prices. The inability to fund obligations due to investors, borrowers or depositors is liquidity risk. For the Corporation, the dominant risks are market, credit and liquidity risk.
Credit Risk Management
Uniform underwriting criteria, ongoing risk monitoring and review processes, and well-defined, centralized credit policies dictate the management of credit risk for the Corporation. As such, credit risk is managed through the Bank’s allowance for loan loss policy which requires the loan officer, lending officers and the loan review committee to manage loan quality. The Corporation’s credit policies are reviewed and modified on an ongoing basis in order to remain suitable for the management of credit risks within the loan portfolio as conditions change. The Corporation uses a loan rating system to properly classify and assess the credit quality of individual commercial loan transactions. The loan rating system is used to determine the adequacy of the allowance for loan losses for financial reporting purposes and to assist in the determination of the frequency of review for credit exposures.
Most of the Corporation’s business activity is with customers located within the Corporation’s defined market area. As of March 31, 2014, the Corporation had concentrations of credit risk in its loan portfolio for the following loan categories: non-farm, non-residential real estate loans, home equity loans and indirect consumer loans. A concentration is defined as greater than 10% of outstanding loans. The Corporation has no exposure to highly leveraged transactions and no foreign credits in its loan portfolio.
Nonperforming Assets
Total nonperforming assets consist of nonperforming loans, loans which have been restructured and other foreclosed assets. As such, a loan is considered nonperforming if it is 90 days past due and/or in management’s estimation the collection of interest on the loan is doubtful. Nonperforming loans no longer accrue interest and are accounted for on a cash basis. The classification of restructured loans involves the deterioration of a borrower’s financial ability leading to original terms being favorably modified or either principal or interest being forgiven.

Table 9 sets forth nonperforming assets at March 31, 2014, and December 31, 2013.
















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Table 9: Nonperforming Assets
 
 
March 31, 2014
 
December 31, 2013
 
(Dollars in thousands)
Commercial real estate
$
10,145

 
$
11,241

Commercial
227

 
289

Residential real estate
5,127

 
5,231

Home equity loans
4,845

 
4,464

Indirect
362

 
443

Consumer
212

 
318

Total nonperforming loans
20,918

 
21,986

Other foreclosed assets
979

 
579

Total nonperforming assets
$
21,897

 
$
22,565

Loans 90 days past due accruing interest
$

 
$
158

 
 
 
 
Total nonperforming loans as a percent of total loans
2.30
%
 
2.44
%
Total nonperforming assets as a percent of total assets
1.74
%
 
1.83
%
Allowance for loan losses to nonperforming loans
83.65
%
 
79.62
%
The Corporation continues to actively manage credit quality and has made progress managing problem loans. Nonperforming loans at March 31, 2014, were $20,918 compared to $21,986 at December 31, 2013, a decrease of $1,068 or 4.9%. Nonperforming commercial real estate loans were $10,145 for March 31, 2014, compared to $11,241 at December 31, 2013. These loans are primarily secured by real estate and, in some cases, by SBA guarantees, and have either been charged-down to their realizable value or a specific reserve has been established for any collateral short-fall. All nonperforming loans are being actively managed and monitored.
Management continues to monitor delinquency and potential problem loans. Bank-wide delinquency at March 31, 2014, was 1.64% of total loans, down from 1.69% at December 31, 2013. Additionally, total 30-59 day and 60-89 day delinquencies were 0.25% and 0.25% of total loans at March 31, 2014, compared to 0.26% and 0.19% of total loans at December 31, 2013, respectively.
Other foreclosed assets were $979 as of March 31, 2014, compared to $579 at December 31, 2013. The $979 is comprised of two commercial properties totaling $252 and nine residential properties, totaling $727. This compares to three commercial properties totaling $304 and seven residential properties, totaling $275 as of December 31, 2013 .
Liquidity
Management of liquidity is a continual process in the banking industry. The liquidity of the Bank reflects its ability to meet loan demand, the possible outflow of deposits and its ability to take advantage of market opportunities made possible by potential rate environments. Assuring adequate liquidity requires the management of the cash flow characteristics of the assets the Bank originates and the availability of alternative funding sources. The Bank monitors liquidity according to limits established in its liquidity policy. The policy establishes minimums for the ratio of cash and cash equivalents to total assets and the loan to deposit ratio. At March 31, 2014, the Bank’s liquidity was within its policy limits.
The Bank maintains borrowing capacity at the Federal Home Loan Bank of Cincinnati, the Federal Reserve Bank of Cleveland and Federal Fund lines with correspondent banks. The Corporation has a $6,000 line of credit through an unaffiliated financial institution. The term of the line is one year, with principal due at maturity, and is subject to renewal on an annual basis. The interest rate on the line of credit is the unaffiliated financial institution’s prime rate. Liquidity is also provided by unencumbered, or unpledged investment securities that totaled $24,156 at March 31, 2014.
As part of the Corporation’s redemption of the Series B Preferred Stock, approximately $3.0 million was drawn on a line of credit with an unaffiliated financial institution in December 2013. The Corporation has maintained a $6.0 million line of credit with this institution since 2009 at prime rate, which was 3.50% at December 31, 2013 and 3.50% at March 31, 2014. In the first quarter 2014, the Corporation made a payment of $500 on the line of credit. Following the $500 payment, $2.5 million remained outstanding at prime rate of 3.50% at March 31, 2014.

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The Corporation is the bank holding company of the Bank and conducts no operations. The Corporation’s primary ongoing needs for liquidity are the payment of the quarterly shareholder dividend, if declared, and miscellaneous expenses related to the regulatory and reporting requirements of a publicly traded corporation. The holding company’s main source of operating liquidity are the dividends that it receives from the Bank. Dividends from the Bank are subject to restrictions by banking regulators. The holding company from time-to-time has access to additional sources of liquidity through correspondent lines of credit as of March 31, 2014.
Market Risk Management
The Corporation manages market risk through its Asset/Liability Management Committee (“ALCO”) at the Bank level governed by policies set forth and established by the Board of Directors. This committee assesses interest rate risk exposure through two primary measures: rate sensitive assets divided by rate sensitive liabilities and earnings-at-risk simulation of net interest income over the one year planning cycle and the longer term strategic horizon in order to provide a stable and steadily increasing flow of net interest income.
The difference between a financial institution’s interest rate sensitive assets and interest rate sensitive liabilities is referred to as the interest rate gap. An institution that has more interest rate sensitive assets than interest rate sensitive liabilities in a given period is said to be asset sensitive or has a positive gap. This means that if interest rates rise a corporation’s net interest income may rise and if interest rates fall its net interest income may decline. If interest sensitive liabilities exceed interest sensitive assets then the opposite impact on net interest income may occur. The usefulness of the gap measure is limited. It is important to know the gross dollars of assets and liabilities that may re-price in various time horizons, but without knowing the frequency and basis of the potential rate changes the predictive power of the gap measure is limited.
Two more useful tools in managing market risk are earnings-at-risk simulation and economic value of equity simulation. An earnings-at-risk analysis is a modeling approach that combines the repricing information from gap analysis, with forecasts of balance sheet growth and changes in future interest rates. The result of this simulation provides management with a range of possible net interest margin outcomes. Trends that are identified in earnings-at-risk simulation can help identify product and pricing decisions that can be made currently to assure stable net interest income performance in the future. At March 31, 2014, a “shock” treatment of the balance sheet, in which a parallel shift in the yield curve occurs and all rates increase immediately, indicates that in a +200 basis point shock, net interest income would decrease $515 or 1.4%, and in a -200 basis point shock, net interest income would decrease $2,466, or 6.7%. The reason for the lack of symmetry in these results is the implied floors in many of the Corporation’s core funding which limits their downward adjustment from current offering rates. This analysis is done to describe a best or worst case scenario. Factors such as non-parallel yield curve shifts, management pricing changes, customer preferences and other factors are likely to produce different results.
The economic value of equity approach measures the change in the value of the Corporation’s equity as the value of assets and liabilities on the balance sheet change with interest rates. At March 31, 2014, this analysis indicated that a +200 basis point change in rates would reduce the value of the Corporation’s equity by 21.4% while a -200 basis point change in rates would increase the value of the Corporation’s equity by 15.1%.

Item 4.
Controls and Procedures
The Corporation’s Management carried out an evaluation, under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934) as of March 31, 2014, pursuant to the evaluation of these controls and procedures required by Rule 13a-15 of the Securities Exchange Act of 1934.
Based upon that evaluation, the Chief Executive Officer along with the Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures as of March 31, 2014, were: (1) designed to ensure that information required to be disclosed by the Corporation in the reports it files or submits under the Exchange Agreement relating to the Corporation and its subsidiaries is made known to the Chief Executive Officer and Chief Financial Officer by others within the entities as appropriate to allow for timely decisions regarding required disclosure, and (2) effective, in that they provide reasonable assurance that information required to be disclosed by the Corporation in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. No change in the Corporation’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15(d)-15(f) under the Exchange Act) occurred during the fiscal quarter ended March 31, 2014, that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
Part II
Other Information

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Item 1.
Legal Proceedings

There were no new material legal proceedings or material changes to existing legal proceedings involving the Corporation during the first quarter of 2014.
Item 1A.
Risk Factors
In addition to the other information set forth in this report, you should carefully consider the risk factors disclosed in Item 1A of the Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013.
Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

Issuer Purchases of Equity Securities
The following table summarizes common share repurchase activity for the quarter ended March 31, 2014:

Period
Total Number of
Shares  (or Units)
Purchased (1)
 
Average Price Paid
Per  Share (or Unit)
 
Total Number of
Shares  (or Units)
Purchased as
Part of Publicly
Announced Plans
or Programs
 
Maximum
Number of
Shares (or Units)
that may yet be
Purchased Under
the Plans or Programs (2)
January 1, 2014 — January 31, 2014

 

 

 
129,500

February 1, 2014 — February 28, 2014
8,551

 
$
9.95

 

 
129,500

March 1, 2014 — March 31, 2014

 

 

 
129,500

Total
8,551

 
$
9.95

 

 
129,500


(1)
All shares were surrendered to the Corporation by employees for tax withholding purposes in conjunction with the vesting of restricted stock awarded to the employees by the Corporation under the 2006 Stock Incentive Plan, as amended.
(2)
On July 28, 2005, the Corporation announced a share repurchase program of up to 5 percent, or about 332,000, of its common shares outstanding. Repurchased shares can be used for a number of corporate purposes, including the Corporation’s stock option and employee benefit plans. The share repurchase program provides that share repurchases are to be made primarily on the open market from time-to-time until the 5 percent maximum is repurchased or the earlier termination of the repurchase program by the Board of Directors, at the discretion of management based upon market, business, legal and other factors. As of March 31, 2014, the Corporation had repurchased an aggregate of 202,500 shares under this program. No shares were repurchased under this program during the first quarter of 2014.
During the fourth quarter of 2013, the Corporation issued a notice to redeem all of its 9,147 outstanding shares of Series B Preferred Stock. On January 17, 2014, the Corporation completed the repurchase and redemption of all of the Series B Preferred Stock for an aggregate price of $9,147,000, the face liquidation amount of the shares, plus approximately $74,000 of accrued but unpaid dividends.


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Item 6.
Exhibits
(a) The exhibits to this Form 10-Q are referenced in the Exhibit Index attached hereto.


54


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.
 
 
 
LNB BANCORP, INC.
 
 
(Registrant)
 
 
 
 
Date: May 7, 2014
 
By:
/s/ Gary J. Elek
 
 
 
Gary J. Elek
 
 
 
Executive Vice President and Chief Financial Officer
 
 
 
(Duly Authorized Officer, and Principal Accounting and Financial Officer)


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Exhibit Index
Exhibit
No.
 
Exhibit
 
 
 
 
 
 
31.1
 
Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a)/15-d-14(a).
 
 
 
31.2
 
Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a)/15-d-14(a).
 
 
 
32.1
 
Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Enacted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.2
 
Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Enacted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101
 
Financial statements from the quarterly report on Form 10-Q of LNB Bancorp, Inc. for the quarter ended March 31, 2014, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets at March 31, 2014 (unaudited) and December 31, 2013; (ii) Consolidated Statements of Income and Comprehensive Income (unaudited) for the three months ended March 31, 2014 and 2013; (iii) Consolidated Statements of Shareholders' Equity (unaudited) for the three months ended March 31, 2014 and 2013; (iv) Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2014 and 2013; and (v) Notes to the Unaudited Consolidated Financial Statements.


 


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