10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

ý	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
	SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended December 31, 2008
	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:  0-25070

LSB FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

INDIANA	35-1934975
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
101 Main Street, Lafayette, Indiana	47901
(Address of principal executive offices)	(Zip Code)

(765) 742-1064

(Registrant’s telephone number, including area code)

None

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class:	Name of each exchange on which registered:
Common Stock, par value $0.01 per share	The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes [   ]No  [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.Yes [   ]No  [X]

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 [X]                                           No  [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [X]

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 o (Do not check if a smaller reporting company)	Smaller Reporting Company ý

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes [   ]No  [X]

As of June 30, 2008, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $20,018,426 based on the closing sale price as reported on the NASDAQ National Market.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Outstanding at March 30, 2009
Common Stock, $0.01 par value per share	1,553,525 shares

DOCUMENTS INCORPORATED BY REFERENCE

Document	Parts Into Which Incorporated
Annual Report to Shareholders for the Fiscal Year Ended December 31, 2008	Parts I and II
Proxy Statement for the Annual Meeting of Shareholders to be held April 15, 2009	Part III

Exhibit Index on Page E-1

LSB Financial Corp.

Form 10-K

Index

			Page
Forward-Looking Statements			2
Part I			3
	Item 1.	Business	3
	Item 1A.	Risk Factors	31
	Item 1B.	Unresolved Staff Comments	31
	Item 2.	Properties	31
	Item 3.	Legal Proceedings	31
	Item 4.	Submission of Matters to a Vote of Security Holders	31
	Item 4.5.	Executive Officers of the Registrant	31
Part II			33
	Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	33
	Item 6.	Selected Financial Data	34
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
	Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	34
	Item 8.	Financial Statements and Supplementary Data	34
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	34
	Item 9A(T).	Controls and Procedures	34
	Item 9B.	Other Information	35
Part III			36
	Item 10.	Directors, Executive Officers and Corporate Governance	36
	Item 11.	Executive Compensation	36
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	36
	Item 13.	Certain Relationships and Related Transactions, and Director Independence	37
	Item 14.	Principal Accounting Fees and Services	37
Part IV			38
	Item 15.	Exhibits, Financial Statement Schedules	38

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DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

This document, including information included or incorporated by reference, contains, and future filings by LSB Financial on Form 10-Q and Form 8-K and future oral and written statements by LSB Financial and our management may contain, forward-looking statements about LSB Financial and its subsidiaries which we believe are within the meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements include, without limitation, statements with respect to anticipated future operating and financial performance, growth opportunities, interest rates, cost savings and funding advantages expected or anticipated to be realized by management.  Words such as “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify these forward-looking statements.  Forward-looking statements by LSB Financial and its management are based on beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions of management and are not guarantees of future performance.  We disclaim any obligation to update or revise any forward-looking statements based on the occurrence of future events, the receipt of new information, or otherwise.  The important factors we discuss below and elsewhere in this document, as well as other factors discussed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report to Shareholders attached to this Form 10-K as Exhibit 13 and identified in our filings with the Securities and Exchange Commission (“SEC”) and those presented elsewhere by our management from time to time, could cause actual results to differ materially from those indicated by the forward-looking statements made in this document.

The following factors, many of which are subject to change based on various other factors beyond our control, could cause our financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: 

·   the strength of the United States economy in general and the strength of the local economies in which we conduct our operations; 

·   the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board; 

·   financial market, monetary and interest rate fluctuations, particularly the relative relationship of short-term interest rates to long-term interest rates;

·   the timely development of and acceptance of new products and services of Lafayette Savings Bank and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors’ products and services;

·   the willingness of users to substitute competitors’ products and services for our products and services;

·   the impact of changes in financial services laws and regulations (including laws concerning taxes, accounting standards, banking, securities and insurance); 

·   the impact of  technological changes;

·   acquisitions; 

·   changes in consumer spending and saving habits; and

·   our success at managing the risks involved in the foregoing.

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PART I

Item  1. Business

General

LSB Financial Corp. (“LSB Financial” or the “Company”) is an Indiana corporation which was organized in 1994 by Lafayette Savings Bank, FSB (“Lafayette Savings” or the “Bank”) for the purpose of becoming a thrift institution holding company.  Lafayette Savings is a federally chartered stock savings bank headquartered in Lafayette, Indiana.  Originally organized in 1869, Lafayette Savings converted to a federal savings bank in 1984.  Lafayette Savings’ deposits are insured up to the applicable limits by the Bank Insurance Fund of the Federal Deposit Insurance Corporation (the “FDIC”).  In February 1995, Lafayette Savings converted to the stock form of organization through the sale and issuance of 1,029,576 shares of its common stock to LSB Financial.  LSB Financial’s principal asset is the outstanding stock of Lafayette Savings.  LSB Financial presently has no separate operations and its business consists only of the business of Lafayette Savings.  References in this Form 10-K to “we,” “us,” and “our” refer to LSB Financial and/or Lafayette Savings as the context requires.

We have been, and intend to continue to be, a community-oriented financial institution. Our principal business consists of attracting retail deposits from the general public and investing those funds primarily in permanent first mortgage loans secured by owner-occupied, one- to four-family residences, and to a lesser extent, non-owner occupied one- to four-family residential, commercial real estate, multi-family, construction and development, consumer and commercial business loans. We currently serve Tippecanoe County, Indiana and its surrounding counties through our five retail banking offices.  At December 31, 2008, we had total assets of $373.0 million, deposits of $258.6 million and shareholders’ equity of $34.1 million.

Our revenues are derived principally from interest on mortgage and other loans and interest on securities.

Our executive offices are located at 101 Main Street, Lafayette, Indiana 47901.  Our telephone number at that address is (765) 742-1064.

Market Area

Tippecanoe County and the eight surrounding counties comprise Lafayette Savings’ primary market area.  Lafayette is the county seat of Tippecanoe County and West Lafayette is the home of Purdue University.  The greater Lafayette area enjoys diverse employment including several major manufacturers; a strong education sector with Purdue University which employs almost 15,000 people and has enrollment at the West Lafayette campus of over 40,000, and a large local campus of Ivy Tech Community College; government offices of Lafayette, West Lafayette and Tippecanoe County and a growing high-tech presence with the Purdue Research Park.  This diversity served to insulate us from some of the severity of the effects of economic downturns being felt in other parts of the country.  A year-end report by the Lafayette Chamber of Commerce noted nearly $600 million in new capital investments in 2008 with more projects underway as the two new hospitals in the area spur growth of a medical corridor and Purdue University and the Purdue Research Park plan additional growth.

In the manufacturing sector, Wabash National, after struggling in the last few years, temporarily shut down their plant at the end of December 2008, anticipating calling back all laid-off employees by the second quarter of 2009.  They invested $8 million in new equipment, $1 million on real estate improvements and plan a $3 million facility improvement as part of a new strategic plan.  They project that sales will increase from $15 million in 2008 to $35 million in 2009, to $80 million in 2012 due to, among other things, multi-year contracts signed with several national corporations including orders for their new utility trucks, cargo trailers and storage units, and orders for a projected 34,270 new trailers.  Federal Express announced in 2008 it will build a distribution center in Lafayette in 2009, TRW plans to expand its operations with a new $29 million facility in south Lafayette that will employ 200 people.   Subaru of Indiana projected production of 195,000 vehicles in 2008 and increased its national sales by 3% in 2008, the only major auto manufacturer to do so.   Enhancing its reputation as a regional health care center, Greater Lafayette has two new hospitals (one already in operation) and a medical corridor currently being developed between the two to accommodate the office space needed for related services.  In addition, the success of the Purdue Research Park in attracting high-tech companies to the Lafayette area continues as seen in the 52 buildings with 1.3

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million square feet owned or leased by 160 companies employing 3,100 people. Its 195,000 square feet of incubator space makes it the largest institutionally operated incubator program in the nation.  One new addition, EDS Indiana Technical Resource Center, leases 13,000 square feet in Purdue Research Park and has hired 92 people with additional growth planned for 45,000 square feet occupied in 2009 and 200 employees hired by 2010.

Tippecanoe County consistently shows better growth and lower unemployment rates than Indiana or the national economy because of the diverse employment base.  The Tippecanoe County unemployment rate at December 2008 was 5.9%, compared to 7.8% for the State of Indiana and 7.2% nationally.

Lending Activities

General.  Our principal lending activity is the origination of conventional mortgage loans for the purpose of purchasing, constructing, or refinancing owner-occupied one- to four-family residential real estate located in our primary market area.  We also originate non-owner occupied one- to four-family residential, multi-family and land development, commercial real estate, consumer and commercial business loans.

We originate both adjustable rate loans and fixed rate loans.  We generally originate adjustable rate loans for retention in our portfolio in an effort to increase the percentage of loans with more frequent repricing than traditional long-term fixed rate loans.  As a result of continued consumer demand for long-term fixed rate loans, we have continued to originate such loans.  We underwrite these mortgages utilizing secondary market guidelines allowing them to be salable without recourse.  The sale of these loans results in additional short-term income and improves our interest-rate risk position.  We generally retain servicing rights on loans sold to Freddie Mac, but release the servicing rights on loans sold to other third parties.  Furthermore, in order to limit our potential exposure to increasing interest rates caused by our traditional emphasis on originating single-family mortgage loans, we have diversified our portfolio by increasing our emphasis on the origination of short-term or adjustable rate multi-family and commercial real estate loans and commercial business and consumer loans.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset/Liability Management” in the Annual Report to Shareholders filed as Exhibit 13 to this Form 10-K.

Where a borrower’s aggregate indebtedness is less than $500,000 our loan officers and certain executive officers in combination with a senior loan officer have approval authority on individual loans up to $500,000 over certain minimum debt service coverage thresholds. Where a borrower’s aggregate indebtedness is less than $1.5 million our officers’ loan committee has approval authority on individual loans up to $500,000, also over certain minimum debt service coverage thresholds. The Board of Directors’ loan committee approves all individual loans over $500,000 and all loans where aggregate debt is over $1.5 million or where debt coverage is below certain minimum thresholds.  Any member of the loan committee may request a loan be moved to the Board of Directors’ loan committee for approval.  Any member of the Board of Directors’ loan committee may refer a loan to the full Board for approval.

At December 31, 2008, the maximum amount we could have loaned to any one borrower and the borrower’s related entities was $5.5 million. Our largest lending relationship to a single borrower or a group of related borrowers at December 31, 2008, totaled $5.3 million, consisting of 29 loans on one- to four-family rental properties, seven loans on multi-family properties, four loans on commercial real estate, a residential mortgage and a home equity line of credit.  The second largest lending relationship at December 31, 2008 to a single borrower or a group of related borrowers totaled $5.3 million, consisting of one loan on a commercial property, one secured commercial business loans, and a loan secured by a one- to four-family residence.  The third largest lending relationship to a single borrower or a group of related borrowers totaled $5.1 million, consisting of a single loan secured by multi-family properties.  Sixteen of these loans were past due 30-89 days at December 31, 2008.  At December 31, 2008, we had 39 other loans or lending relationships to a single borrower or group of related borrowers with a principal balance in excess of $2.0 million.

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Loan Portfolio Composition.  The following table sets forth information concerning the composition of our loan portfolio, including loans held for sale, in dollar amounts and in percentages of the total loan portfolio, before deductions for loans in process, deferred fees and discounts and allowances for losses.

	December 31,
	2004					2005					2006					2007					2008
	Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent
	(Dollars in Thousands)
Real Estate Loans
One- to four-family	$	140,356		42.95	%	$	136,982		40.31	%	$	142,045		43.70	%	$	137,611		45.48	%	$	145,442		43.43	%
Multi-family		40,279		12.33			40,094		11.80			30,160		9.28			29,764		9.84			39,892		11.91
Commercial		70,644		21.62			83,834		24.67			74,710		22.98			71,601		23.67			90,606		27.06
Land and land development		14,306		4.38			17,596		5.18			18,466		5.68			18,067		5.97			17,756		5.30
Construction		21,277		6.51			18,500		5.44			19,228		5.91			9,741		3.22			11,436		3.42
Total real estate loans		286,862		87.79			297,006		87.40			284,609		87.55			266,784		88.18			305,132		91.12
Other Loans
Consumer loans:
Home equity		21,468		6.58			19,786		5.82			16,276		5.01			14,018		4.63			13,610		4.06
Home improvement		432		0.13			412		0.12			417		0.13			315		.10			174		0.05
Automobile		1,838		0.56			2,029		0.60			2,285		0.70			1,757		.58			1,265		0.38
Deposit account		82		0.03			121		0.04			285		0.09			231		.08			291		0.09
Other		251		0.08			272		0.08			267		0.08			136		.04			113		0.03
Total consumer loans		24,071		7.37			22,620		6.66			19,530		6.01			16,457		5.44			15,453		4.61
Commercial business  loans		15,823		4.84			20,180		5.94			20,935		6.44			19,307		6.38			14,277		2.17
Total other loans		39,894		12.21			42,800		12.60			40,465		12.45			35,764		11.82			29,730		70.38
Total loans		326,755		100.00	%		339,806		100.00	%		325,074		100.00	%		302,548		100.00	%		334,862		100.00	%
Less:
Loans in process		5,294					5,508					4,167					1,581					4,180
Deferred fees and discounts		439					475					446					357					346
Allowance for losses		2,095					2,852					2,770					3,702					3,697
Total loans receivable, net	$	318,927				$	330,971				$	317,691				$	296,908				$	326,638

5

The following table shows the composition of our loan portfolio, including loans held for sale, by fixed and adjustable rate at the dates indicated.  The one- to four-family fixed rate loans include $4.5 million, $4.1 million and $5.4 million of loans at December 31, 2006, 2007 and 2008, respectively, which carry a fixed rate of interest for the initial five or seven years and then convert to a one-year adjustable rate of interest for the remaining term of the loan.

	December 31,
	2004					2005					2006					2007					2008
	Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent
	(Dollars in Thousands)
Fixed Rate Loans:
Real estate:
One- to four-family	$	43,840		13.42	%	$	41,050		12.08	%	$	41,105		12.65	%	$	43,707		14.45	%	$	56,814		16.97	%
Multi-family		3,869		1.17			2,934		0.86			2,793		0.86			3,860		1.27			5,113		1.53
Commercial		10,294		3.15			13,893		4.09			10,797		3.32			13,753		4.55			23,794		7.11
Construction		3,221		0.99			2,800		0.82			1,989		0.61			5,223		1.73			1,405		0.42
Land and land development		7,862		2.41			10,629		3.13			7,358		2.26			2,305		.76			3,216		0.96
Total real estate loans		69,086		21.14			71,306		20.98			64,042		19.70			68,848		22.76			90,342		26.98
Consumer		2,546		0.78			2,814		0.83			3,234		1.00			2,419		.80			1,843		0.55
Commercial business		9,608		2.94			9,851		2.90			9,372		2.88			9,749		3.22			7,011		2.09
Total fixed rate loans		81,240		24.86			83,971		24.71			96,648		23.58			81,016		26.78			99,196		29.62
Adjustable Rate Loans:
Real estate:
One- to four-family		96,515		29.54			95,931		28.23			100,940		31.05			93,904		31.04			88,628		26.47
Multi-family		36,410		11.14			37,160		10.94			27,367		8.42			25,904		8.56			34,780		10.39
Commercial		60,350		18.47			69,941		20.58			63,913		19.66			57,848		19.12			66,812		19.95
Construction		11,085		3.39			14,797		4.35			16,477		5.07			4,518		1.49			16,350		4.88
Land and land development		13,416		4.11			7,871		2.32			11,870		3.65			15,762		5.21			8,220		2.45
Total real estate loans		217,776		66.65			225,700		66.42			220,567		67.85			197,936		65.42			214,790		64.14
Consumer		21,524		6.60			19,805		5.83			16,296		5.01			14,039		4.64			13,610		4.06
Commercial business		6,215		1.89			10,329		3.04			11,563		3.56			9,557		3.16			7,266		2.17
Total adjustable rate loans		245,515		75.14			255,834		75.29			248,426		76.42			221,532		73.22			235,666		70.38
Total loans		326,755		100.00	%		339,805		100.00	%		325,074		100.0	%		302,548		100.00	%		334,862		100.00	%
Less:
Loans in process		5,294					5,508					4,167					1,581					4,180
Deferred fees and discounts		439					475					446					357					346
Allowance for losses		2,095					2,852					2,770					3,702					3,697
Total loans receivable, net	$	318,927				$	330,971				$	317,691				$	296,908				$	326,638

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The following schedule illustrates the maturities of our loan portfolio at December 31, 2008.  Loans which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due.  The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses. 

	Real Estate
	Mortgage(1)					Construction, Land and Land Development					Consumer					Commercial Business					Total
Due During Years Ending December 31,	Amount		Weighted Average Rate			Amount		Weighted Average Rate			Amount		Weighted Average Rate			Amount		Weighted Average Rate			Amount		Weighted Average Rate
(Dollars in Thousands)
2009	$	12,947		6.36	%	$	10,520		6.10	%	$	2,435		4.07	%	$	4,950		5.87	%	$	30,852		6.01	%
2010 to  2013		20,437		6.07			7,034		5.18			12,850		4.10			5,251		7.01			45,572		5.49
2014 and following		242,556		6.33			11,638		5.97			168		3.95			4,076		6.77			258,438		6.32
TOTAL	$	275,940		6.31	%	$	29,192		5.82	%	$	15,453		4.09	%	$	14,277		6.55	%	$	334,862		6.18	%

(1) Includes one- to four-family, multi-family and commercial real estate loans.

The total amount of loans due to mature after December 31, 2009 which have fixed interest rates is $84.1 million, and which have adjustable or renegotiable interest rates is $219.9 million.

One- to Four-Family Residential Real Estate Lending

Our lending program focuses on the origination of permanent loans secured by mortgages on owner-occupied, one- to four-family residences. We also originate loans secured by non-owner occupied, one- to four-family residences.  Substantially all of these loans are secured by properties located in our primary market area.  We originate a variety of residential loans, including conventional 15- and 30-year fixed rate loans, fixed rate loans convertible to adjustable rate loans, adjustable rate loans and balloon loans.

Our one- to four-family residential adjustable rate loans are fully amortizing loans with contractual maturities of up to 30 years.  The interest rates on the majority of the adjustable rate loans originated by us are subject to adjustment at one-, three- or five-year intervals.  Our adjustable rate mortgage products generally carry interest rates which are reset to a stated margin over the weekly average of the one-, three- or five-year U.S. Treasury rates.  Increases or decreases in the interest rate of our one-year adjustable rate loans are generally limited to 2% annually with a lifetime interest rate cap of 6% over the initial rate.  Increases or decreases in the interest rate of three-year and five-year adjustable rate loans are limited to a 3% periodic adjustment cap with a 5% lifetime interest rate cap over the initial rate.  Our one-year adjustable rate loans may be convertible into fixed rate loans after the first year and before the sixth year upon payment of a fee, do not contain prepayment penalties and do not produce negative amortization.  Initial interest rates offered on our adjustable rate loans may be below the fully indexed rate.  Borrowers are generally qualified at 2% over the initial interest rate for our one-year adjustable rate loans and at the initial interest rate for our three-year and five-year adjustable rate loans.  We generally retain adjustable rate loans in our portfolio pursuant to our asset/liability management strategy.  Five-year adjustable rate mortgage loans represented $18.1 million, three-year adjustable rate mortgage loans represented $61.7 million and one-year adjustable rate mortgage loans represented $6.1 million of our adjustable rate mortgage loans at December 31, 2008.  We also offer a floating rate mortgage loan based on national prime rate, generally on non-owner-occupied residential loans.  These loans represented $2.7 million of our adjustable rate mortgage loans at December 31, 2008.

We offer fixed rate mortgage loans to owner-occupants with maturities up to 30 years and which conform to Freddie Mac standards.  We currently sell in the secondary market the majority of our long-term, conforming, fixed rate loans.  Loans designated as held for sale are carried on the balance sheet at the lower of cost or market value.  At December 31, 2008, we had $1.3 million of 1oans held for sale. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset/Liability Management” in the Annual Report to

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Shareholders filed as Exhibit 13 to this Form 10-K.  Interest rates charged on these fixed rate loans are priced on a daily basis in accordance with Freddie Mac pricing standards.  These loans do not include prepayment penalties.

We also offer 30-year fixed rate mortgage loans, which, after five or seven years, convert to our standard one-year adjustable rate mortgage for the remainder of the term.  Of these, $5.2 million have less than three years to their adjustment date and are included in adjustable rate loans.

We had $71.4 million in non-owner occupied one- to four-family residential loans at December 31, 2008.  These loans are underwritten using the same criteria as owner-occupied, one- to four-family residential loans, but are provided at higher rates than owner-occupied loans. We offer fixed rate, adjustable rate and convertible rate loans, with terms of up to 30 years.

We originate residential mortgage loans with loan-to-value ratios of up to 95% for owner-occupied residential loans and up to 80% for non-owner occupied residential loans.  We typically require private mortgage insurance in an amount intended to reduce our exposure to 80% or less of the lesser of the purchase price or appraised value of the underlying collateral.  We occasionally originate FHA loans in excess of 95% loan-to-value, all of which are sold, with the servicing rights released, to a third party.

In underwriting one- to four-family residential real estate loans, we evaluate both the borrower’s ability to make monthly payments and the value of the property securing the loan.  Properties securing owner-occupied one- to four-family residential real estate loans that we make are appraised by independent fee appraisers. We require borrowers to obtain title insurance and fire insurance, extended coverage casualty insurance and flood insurance, if appropriate.  Real estate loans that we originate contain a “due on sale” clause allowing us to declare the unpaid principal balance due and payable upon the sale of the security property.

Multi-Family and Commercial Real Estate Lending

We originate permanent loans secured by multi-family and commercial real estate.  Our permanent multi-family and commercial real estate loan portfolio includes loans secured by apartment buildings, office buildings, churches, warehouses, retail stores, restaurants, shopping centers, small business facilities and farm properties, most of which are located within our primary market area.

Permanent multi-family and commercial real estate loans are originated as three-year and five-year adjustable rate loans with up to a 25-year amortization.  To a substantially lesser extent, such loans are originated as fixed rate or balloon loans or at a floating rate based on national prime rate, at terms up to 15 years.  The adjustable rate loans are tied to an index based on the weekly average of the three-year or five-year U.S. Treasury rate, respectively, plus a stated margin over the index.  Multi-family loans and commercial real estate loans have been written in amounts of up to 85% of the lesser of the appraised value of the property or the purchase price, and borrowers are generally personally liable for all or part of the indebtedness.

Appraisals on properties securing multi-family and commercial real estate loans originated in excess of $100,000 by us are performed by independent appraisers designated by us at the time the loan is made and reviewed by management.  In addition, our underwriting procedures generally require verification of the borrower’s credit history, income and financial statements, banking relationships and income projections for the property.

Multi-family and commercial real estate loans generally present a higher level of risk than loans secured by one- to four-family residences.  This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income-producing properties and the increased difficulty of evaluating and monitoring these types of loans.  Furthermore, the repayment of loans secured by multi-family and commercial real estate is typically dependent upon the successful operation of the related real estate project.  If the cash flow from the project is reduced (for example, if leases are not obtained or renewed, or a bankruptcy court modifies a lease term, or a major tenant is unable to fulfill its lease obligations), the borrower’s ability to repay the loan may be impaired.

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Construction, Land and Land Development Lending

We make construction loans to individuals for the construction of their residences as well as to builders and developers for the construction of one- to four-family residences, multi-family dwellings and commercial real estate projects.  At December 31, 2008, substantially all of these loans were secured by property located within our primary market area.

Construction loans to individuals for their residences typically run six to eight months and are generally structured to be converted to permanent loans at the end of the construction phase.  These construction loans are typically fixed rate loans, with interest rates higher than those we offer on permanent one- to four-family residential loans.  During the construction phase, the borrower pays interest only.  Residential construction loans are underwritten pursuant to the same guidelines used for originating permanent residential loans.  At December 31, 2008, we had $1.9 million of construction loans to borrowers intending to live in the properties upon completion of construction.

Construction loans to builders of one- to four-family residences generally have terms of six to eight months and require the payment of interest only at a fixed rate for the loan term.  We generally limit builders to one home construction loan at a time, but would consider requests for more than one if the homes are presold.  At December 31, 2008, we had $1.9 million of this type of construction loans to builders of one- to four-family residences.  We also had $635,000 of loans to builders of one- to four-family residences structured to be converted to permanent loans at the end of the construction phase.

We make construction loans to builders of multi-family dwellings and commercial projects with terms up to one year and require payment of interest only at a fixed rate for the construction phase of the loan.  These loans are generally structured to be converted to one of our permanent commercial loan products at the end of the construction phase.  At December 31, 2008, we had $7.0 million of loans to finance the construction of multi-family dwellings and commercial projects.

We also make loans to builders for the purpose of developing one- to four-family lots and residential condominium projects.  These loans typically have terms of two to three years with interest rates tied to national prime.  The maximum loan-to-value ratio is 75%.  The principal in these loans is typically paid down as lots or units are sold.  These loans may be structured as revolving lines of credit with maturities of generally two years or less.  At December 31, 2008, we had $14.8 million of development loans to builders.  We also make land acquisition loans.  At December 31, 2008, we had $2.9 million in loans secured by land.

Construction and development loans are obtained principally through continued business from developers and builders who have previously borrowed from us, as well as referrals from existing customers and realtors, and walk-in customers.  The application process includes a submission to us of accurate plans, specifications and costs of the project to be constructed/developed which are used as a basis to determine the appraised value of the subject property.  Loans are based on the lesser of current appraised value and/or the cost of construction, which is the land plus the building. At December 31, 2008, our largest construction and development loan was a development loan for a commercial mixed use subdivision for $2.9 million.

Construction and land development loans generally present a higher level of risk than loans secured by one- to four-family residences.  Because of the uncertainties inherent in estimating land development and construction costs and the market for the project upon completion, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, the related loan-to-value ratios and the likelihood of ultimate success of the project.  Construction and land development loans to borrowers other than owner-occupants also involve many of the same risks discussed above regarding multi-family and commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans.  We had three non-performing construction and development loans totaling $487,000 and three restructured but performing loans totaling $846,000 at December 31, 2008.

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Consumer Lending

We originate a variety of different types of consumer loans, including home equity loans, direct automobile loans, home improvement loans, deposit account loans and other secured and unsecured loans for household and personal purposes.  Consumer loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower.  The largest component of consumer lending is home equity loans, which totaled $13.6 million or 4.1% of the total loan portfolio at December 31, 2008.  We are currently offering a revolving line of credit home equity loan on which the total commitment amount, when combined with the balance of the first mortgage lien and other priority liens, may not exceed 90% of the appraised value of the property, with a ten-year term and minimum monthly payment requirement of interest only.  At December 31, 2008, we had $14.3 million of unused credit available under our home equity line of credit program.

Our underwriting standards for consumer loans include a determination of the applicant’s payment history on other debts and the applicant’s ability to meet existing obligations and payments on the proposed loan.  Although creditworthiness of the applicant is of primary consideration, our underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.  Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles.  In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.  In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances.  Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

Commercial Business Lending

Our current commercial business lending activities encompass predominantly secured and unsecured lines of credit and loans secured by small business equipment and vehicles.  At December 31, 2008, we had $3.6 million of unsecured loans and lines of credit outstanding (with $3.2 million of unused credit available) and $10.6 million of loans and lines of credit (with $5.7 million of unused credit available) secured by inventory or accounts receivable, small business equipment and vehicles.  We also had $239,000 of unused credit available on letters of credit.

Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income and which are secured by real property the value of which tends to be more easily ascertainable, commercial business loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.  As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself, which is likely to be dependent upon the general economic environment.  Our commercial business loans are sometimes, but not always, secured by business assets.  However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.

We recognize the increased risks associated with commercial business lending.  Our commercial business lending policy emphasizes credit file documentation and analysis of the borrower’s character, capacity to repay the loan, the adequacy of the borrower’s capital and collateral as well as an evaluation of the industry conditions affecting the borrower.  Analysis of the borrower’s past, present and future cash flows is also an important aspect of our credit analysis.

Loan Originations, Purchases and Sales

Real estate loans are originated by our staff of salaried loan officers and our residential mortgage loan originators who receive applications from existing customers, walk-in customers, and referrals from realtors.  While we originate both adjustable rate and fixed rate loans, our ability to originate loans is dependent upon the relative customer demand for loans in our market.  Demand is affected by the interest rate environment.  Currently, the majority of conforming fixed rate residential mortgage loans with maturities of 15 years and over are originated for sale in the secondary market.  Based on our interest-rate risk considerations, we occasionally will keep fixed rate residential mortgage loans in our portfolio to generate income and to be available for substitution in the event a loan

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committed for sale fails to close as expected.  These loans are sold either to Freddie Mac while we retain the servicing rights, or to BB&T or other secondary market mortgage purchasers with servicing released.  These loans are originated to satisfy customer demand and to generate fee income and are sold to achieve the goals of our asset/liability management program.

When loans are sold to Freddie Mac, we retain the responsibility for collecting and remitting loan payments, inspecting the properties, making certain that insurance and real estate tax payments are made on behalf of borrowers, and otherwise servicing the loans. We receive a servicing fee for performing these services.  We serviced mortgage loans for others totaling $114.6 million at December 31, 2008.

In periods of rising interest rates, our ability to originate large dollar volumes of real estate loans may be substantially reduced or restricted, with a resultant decrease in related operating earnings.  In addition, our ability to sell loans may substantially decrease as potential buyers reduce their purchasing activities.

We occasionally purchase a limited amount of participation interests in real estate loans from other financial institutions outside our primary market area.  We review and underwrite all loans to be purchased to insure that they meet our underwriting standards.

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The following table shows our loan and mortgage-backed security origination, purchase, sale and repayment activities for the periods indicated. One- to four-family fixed rate loans include $1.5 million, $469,000 and $0 loans originated during 2006, 2007 and 2008 respectively, which carry a fixed rate of interest for the initial five or seven years and then convert to a one-year adjustable rate of interest for the remaining term of the loan.

	Year Ended December 31,
	2006			2007			2008
	(In Thousands)
Originations by type:
Adjustable rate:
Real estate – one- to four-family	$	14,408		$	13,916			$	11,041
- multi-family		1,027			4,628				18,758
- commercial		14,156			6,643				19,979
- construction, land and land development		17,896			7,147				10,675
Non-real estate – consumer		3,105			---				---
- commercial business		8,651			8,224				4,688
Total adjustable rate		59,243			40,557				65,141
Fixed rate:
Real estate – one- to four-family		25,932			34,527				32,701
- multi-family		653			1,866				906
- commercial		7,610			4,681				8,434
- construction, land and land development		8,904			3,579				3,689
Non-real estate – consumer		2,435			897				564
- commercial business		5,708			5,478				2,588
Total fixed rate		51,242			51,027				48,882
Total loans originated		110,485			91,584				114,023
Purchases:
Total loans purchased		403			---				---
Total mortgage-backed securities purchased		5,547			---				---
Total purchases		5,950			---				---
Sales and Repayments:
Real estate – one- to four-family		16,645			19,735				10,247
- multi-family		---			---				---
- commercial		1,000			---				---
Total loans sold		17,645			19,735				10,247
Principal repayments		107,805			94,333				72,880
Total loans sold and repayments		125,450			114,068				83,127
Mortgage-backed securities:
Principal repayments		411			1,132				1,125
Increase (decrease) in other items, net		(150	)		20				49
Net increase (decrease)	$	(9,576	)	$	(23,597	)		$	29,820

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Asset Quality

Loan payments are generally due the first day of each month.  When a borrower fails to make a required payment on a loan, we attempt to cause the delinquency to be cured by contacting the borrower.  In the case of residential loans, a late notice is sent for accounts fifteen or more days delinquent.  For delinquencies not cured by the 15th day, borrowers will be assessed a late charge.  Additional written and oral contacts may be made with the borrower between 20 and 30 days after the due date.  If the full scheduled payment on the loan is not received prior to the 1st day of the succeeding month, the loan is considered 30 days past due and more formal collection procedures may be instituted.  If the delinquency continues for a period of 60 days, we usually send a default letter to the borrower and, after 90 days, institute appropriate action up to and including foreclosing on the property.  If foreclosed, the property is sold at public auction and we may purchase it.  Delinquent consumer loans are handled in a similar manner.  Our procedures for repossession and sale of consumer collateral are subject to various requirements under Indiana consumer protection laws.

Delinquent Loans.  The following table sets forth information concerning delinquent loans at December 31, 2008, in dollar amounts and as a percentage of each category of our loan portfolio.  The amounts represent the total remaining principal balances of the related loans, rather than the actual payment amounts which are overdue.

	Loans Delinquent For:
	60-89 Days							90 Days and Over							Total Delinquent Loans
	Number		Amount		Percent of Loan Category			Number		Amount		Percent of Loan Category			Number		Amount		Percent of Loan Category
	(Dollars in Thousands)
Real Estate:
One- to four-family		37	$	2,813		1.93	%		50	$	5,267		3.62	%		88	$	8,080		5.56	%
Multi-family		1		0		0.00			0		0		0.00			1		0		0. 00
Commercial		1		85		0.09			7		1,385		1.53			8		1,470		1.62
Construction and land development		0		0		0.00			0		0		0.00			0		0		0.00
Consumer		5		44		0.29			9		118		0.76			14		162		1.05
Commercial Business		2		245		1.71			7		366		2.56			9		611		4.28
Total		48	$	3,187		0.95	%		73	$	7,136		2.36	%		121	$	10,323		3.08	%

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Non-Performing Assets.  The table below sets forth the amounts and categories of non-performing assets.  Interest income on loans is accrued over the term of the loans based upon the principal outstanding except where serious doubt exists as to the collectability of a loan, in which case the accrual of interest is discontinued.  The amounts shown do not reflect reserves set up against such assets.  See “ - Allowance for Loan Losses” below.

	December 31,
	2004			2005			2006			2007			2008
	(Dollars in Thousands)
Non-accruing loans:
One- to four- family	$	2,863		$	5,309		$	6,851		$	7,250		$	4,781
Multi-family		---			841			328			341			---
Commercial real estate		501			1,652			---			648			1,385
Construction and land development		547			547			93			1,210			1,326
Consumer		34			76			89			103			118
Commercial business		262			8			3			383			366
Total		4,207			8,432			7,364			9,935			7,976
Accruing loans delinquent more than 90 days:
One- to-four-family		484			127			147			---			---
Commercial real estate		---			---			---			59			---
Total		484			127			147			59			---
Foreclosed assets:
One- to four-family		742			1,366			2,228			1,565			1,192
Multi-family		---			---			---			1,022			---
Commercial real estate		102			331			1,709			1,310			220
Construction or development		387			300			232			30			---
Consumer		---			7			---			17			---
Commercial business		---			---			---			---			---
Total		1,231			2,003			4,169			3,944			1,412
Total non-performing assets	$	5,922		$	10,563		$	11,680		$	13,938		$	9,388
Total as a percentage of total assets		1.67	%		2.83	%		3.17	%		4.08	%		2.52	%
Total assets	$	355,045		$	372,664		$	368,400		$	342,010		$	373,012

For the year ended December 31, 2008, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms was $510,000 none of which was included in interest income.

Other Loans of Concern. In addition to the non-performing assets set forth in the table above under the caption “Non-Performing Assets,” as of December 31, 2008, there was also an aggregate of $29.2 million in net book value of loans with respect to which past payment history or a decrease in the debt service coverage of the borrowers may cause management to have doubts as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the non-performing asset categories. Included in the other loans of concern are (i) 152 loans to nine borrowers who each hold an average of 17 one- to four-family rental properties with a total outstanding balance of $10.8 million, where management has concerns

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about the ability of the borrowers to keep the rental properties leased and about the cash flow of the borrowers; (ii) two loans secured by multi-family rental properties and four loans secured by one- to four-family rental properties to a single borrower with an outstanding balance of $2.9 million, where management has concerns about the cash flow of the borrower; and (iii) two land development loans to a single borrower with an outstanding balance of $2.1 million, where management has concerns that the absorption period is somewhat longer than projected.

Classified Assets.  Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered by the Office of Thrift Supervision (the “OTS”) to be of lesser quality, as “substandard,” “doubtful” or “loss.”  An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected.  Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.”  Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.  Assets which do not currently expose the institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated “special mention” by management.

When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management.  General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets.  When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount.  An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS and the FDIC, which may order the establishment of additional general or specific loss allowances.

In connection with the filing of our periodic reports with the OTS and in accordance with our classification of assets policy, we regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations.  At December 31, 2008, we had classified $20.0 million of our loans as substandard, none as doubtful and none as loss.  At December 31, 2008, we had designated $5.2 million in loans as special mention.

Allowance for Loan Losses.   We establish our provision for loan losses based on a systematic analysis of risk factors in the loan portfolio.  The analysis includes consideration of concentrations of credit, past loss experience, current economic conditions, the amount and composition of the loan portfolio, estimated fair value of the underlying collateral, delinquencies, and other factors.  We also consider the loss experience of similar portfolios in comparable lending markets as well as using the services of a consultant to assist in the evaluation of our growing commercial loan portfolio.  On at least a quarterly basis, a formal analysis of the adequacy of the allowance is prepared and reviewed by management and the Board of Directors.  This analysis serves as a point-in-time assessment of the level of the allowance and serves as a basis for provisions for loan losses.

Our analysis of the loan portfolio begins by assigning each new loan a risk rating at the time the loan is originated, corresponding to one of ten risk categories.  If the loan is a commercial credit, the borrower will also be assigned a rating.  Adjustments are made to these ratings on a quarterly basis, based on the performance of the individual loan.  Loans no longer performing as agreed are assigned a lower risk rating, eventually resulting in their being regarded as classified loans.  A collateral re-evaluation form is completed on all classified loans, identifying expected losses, generally based on an analysis of the collateral securing those loans.  A portion of the loan loss reserve is allocated to the classified loans in the amount identified as at risk.

Portions of the allowance are also allocated to non-classified loan portfolios which have been segregated into categories of loans having similar characteristics and similar inherent risk.  These categories include loans on:  one- to four-family owner-occupied properties, one- to four-family non-owner-occupied properties, multi-family rental properties, non-residential properties, land and land development projects, construction projects, second mortgages and home equity loans, unsecured commercial business loans, secured commercial business loans, and consumer loans.  Factors considered in determining the percentage allocation for each category include: historical loss experience, underwriting standards, trends in property values, trends in delinquent and non-performing loans, and economic trends affecting our market.  Although we believe we use the best information available to make such

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determinations, future adjustments to reserves may be necessary, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the initial determinations.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Provision for Loan Losses” in the Annual Report to Shareholders filed as Exhibit 13 to this Form 10-K.

The following table sets forth an analysis of our allowance for loan losses.

	Year Ended December 31,
	2004			2005			2006			2007			2008
	(Dollars in Thousands)
Balance at beginning of period	$	3,098		$	2,095		$	2,852		$	2,770		$	3,702
Charge-offs:
One- to four-family		566			218			585			672			782
Commercial real estate		---			16			274			---			---
Construction or development		876			184			278			---			159
Consumer		76			52			4			4			32
Commercial business		2			22			8			---			210
Total charge-offs		1,520			492			1,149			676			1,183
Recoveries:
One- to four-family		---			---			---			10			49
Construction or development		3			42			46			27			25
Consumer		11			7			3			1			3
Commercial business		3			---			---			---			---
Total recoveries		17			49			49			38			77
Net charge-offs		1,503			443			1,100			638			1,107
Additions charged to operations		500			1,200			1,018			1,570			1,102
Balance at end of period	$	2,095		$	2,852		$	2,770		$	3,702		$	3,697
Net charge-offs to average loans outstanding		0.50	%		0.13	%		0.34	%		0.21	%		0.35	%
Allowance for loan losses to non-performing assets		35.37	%		26.99	%		23.72	%		26.56	%		39.38	%
Allowance for loan losses to net loans at end of period		0.66	%		0.86	%		0.87	%		1.23	%		1.12	%

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The allocation of our allowance for losses on loans, including loans held for sale, at the dates indicated is summarized as follows:

	At December 31,
	2004							2005							2006							2007							2008
	Amount of Loan Loss Allowance		Loan Amounts by Category		Percent of Loans in Each Category to Total Loans			Amount of Loan Loss Allowance		Loan Amounts By Category		Percent of Loans in Each Category to Total Loans			Amount of Loan Loss Allowance		Loan Amounts By Category		Percent of Loans in Each Category to Total Loans			Amount of Loan Loss Allowance		Loan Amounts By Category		Percent of Loans in Each Category to Total Loans			Amount of Loan Loss Allowance		Loan Amounts By Category		Percent of Loans in Each Category to Total Loans
	(Dollars in Thousands)
Real estate:
One- to four-family	$	470	$	140,355		42.95	%	$	636	$	136,981		40.31	%	$	1,201	$	142,045		43.70	%	$	1,917	$	137,590		45.47	%	$	1,791	$	145,442		43.43	%
Multi-family		211		40,279		12.33			219		40,094		11.80			116		30,160		9.28			99		29,765		9.84			265		39,892		11.91
Commercial real estate		586		70,644		21.62			620		83,834		24.67			459		74,710		22.98			297		71,601		23.67			802		90,606		27.06
Land and land development		253		14,306		4.38			354		17,596		5.18			390		18,466		5.68			343		18,067		5.97			229		17,756		5.30
Construction		162		21,277		6.51			192		18,500		5.44			260		19,228		5.91			323		9,741		3.22			190		11,436		3.42
Consumer		155		24,071		7.37			171		22,620		6.66			126		19,530		6.01			127		16,457		5.44			143		15,453		4.62
Commercial business		143		15,823		4.84			363		20,180		5.94			120		20,935		6.44			494		19,327		6.39			201		14,277		4.26
Unallocated		114		---		---			297		---		---			98		---		---			102		---		---			76		---		---
Total	$	2,094	$	326,755		100.00	%	$	2,852	$	339,805		100.00	%	$	2,770	$	325,074		100.00	%	$	3,702	$	302,548		100.00	%	$	3,697	$	334,862		100.00	%

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Investment Activities

We must maintain minimum levels of securities that qualify as liquid assets under the OTS regulations.  Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans.  Historically, we have maintained liquid assets at levels we believe adequate to meet the requirements of normal operations, including potential deposit outflows.  Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained.  At December 31, 2008 our liquidity ratio—liquid assets as a percentage of net withdrawable savings deposits and current borrowings—was 5.07%.  Our level of liquidity is a result of management’s asset/liability strategy.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset/Liability Management” and “– Liquidity and Capital Resources” in the Annual Report to Shareholders filed as Exhibit 13 to this Form 10-K.

Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds.  Subject to various restrictions, federally chartered savings institutions may also invest their assets in investment grade commercial paper and corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly.

Generally, we invest funds among various categories of investments and maturities based upon our asset/liability management policies, concern for the highest investment quality, liquidity needs and performance objectives.  It is our general policy to purchase securities which are U.S. Government securities, investment grade municipal and corporate bonds, commercial paper, federal agency obligations and interest-bearing deposits with the Federal Home Loan Bank.

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The following table sets forth the composition of our securities portfolio at the dates indicated.  As of December 31, 2008, our investment portfolio did not contain securities of any issuer with an aggregate book value in excess of 10% of our shareholders’ equity, excluding those issued by the U.S. Government and its agencies.

	December 31,
	2006					2007					2008
	Carrying Value		% of Total			Carrying Value		% of Total			Carrying Value		% of Total
	(Dollars in Thousands)
Debt securities:
Federal agency obligations	$	3,159		21.96	%	$	503		4.07	%	$	509		4.19	%
Municipal bonds		7,228		50.25			7,860		63.59			7,639		62.90
Subtotal		10,387		72.21			8,363		67.66			8,148		67.09
Other:
Federal Home Loan Bank stock		3,997		27.79			3,997		32.34			3,997		32.91
Total debt securities and Federal Home Loan Bank stock	$	14,384		100.00	%	$	12,360		100.00	%	$	12,145		100.00	%
Average remaining life of debt securities	4.30 years					6.33 years					3.40 years
Other interest-earning assets:
Interest-bearing deposits with Federal Home Loan Bank	$	8,336		100.00	%	$	4,846		100.00	%	$	9,179		100.00	%
Mortgage-backed securities:
Fannie Mae certificates	$	3,101		52.31	%	$	2,506		51.59	%	$	1,814		48.96	%
Freddie Mac certificates		2,828		47.69	%		2,352		48.41	%		1,891		51.04	%
Total mortgage-backed securities	$	5,929		100.00	%	$	4,858		100.00	%	$	3,705		100.00	%

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The following table sets forth the composition and contractual maturities of our securities portfolio at December 31, 2008.  Expected maturities will differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties. At December 31, 2008, all of our securities were classified as available for sale and as such were reported at fair value. The weighted average yields on tax exempt obligations have been computed on a tax equivalent basis.

	December 31, 2008
	Less than 1 year			1 to 5 Years			5 to 10 Years			Over 10 Years			Total Investment Securities
	(Dollars in Thousands)
Federal agency obligations	$	---		$	---		$	509		$	---		$	509
Municipal bonds		812			3,301			3,008			518			7,639
Fannie Mae certificates		---			---			1,814			---			1,814
Freddie Mac certificates		1			---			1,890			---			1,891
Total investment securities	$	813		$	3,301		$	7,221		$	518		$	11,853
Weighted average yield		4.03	%		4.63	%		5.43	%		4.95	%		5.07	%

Sources of Funds

General.  Our primary sources of funds are deposits, repayment and prepayment of loans, interest earned on or maturation of investment securities and short-term investments, borrowings and funds provided from operations.

Deposits.  We offer a variety of deposit accounts.  Our deposits consist of statement savings accounts, money market accounts, NOW accounts and certificate accounts.  In addition, we periodically solicit broker originated certificates of deposit when issues are available that meet our interest rate and liquidity needs.  Brokered deposits at December 31, 2008 totaled $61.0 million.  We rely primarily on competitive pricing policies, on-line and off-line advertising, and customer service to attract and retain these deposits.

The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and competition.  The variety of deposit accounts we offer has allowed us to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand.  We manage the pricing of our deposits in keeping with our asset/liability management, profitability and growth objectives.  Based on our experience, we believe that our savings, interest- and non-interest-bearing checking accounts are relatively stable sources of deposits.  However, our ability to attract and maintain certificates of deposit, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions.

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The following table sets forth our savings flows during the periods indicated.

	Year Ended December 31,
	2006			2007			2008
	(Dollars in Thousands)
Opening balance	$	265,993		$	255,304		$	232,030
Deposits		1,165,305			1,256,486			1,327,719
Withdrawals		(1,182,612	)		(1,286,988	)		(1,308,010	)
Interest credited		6,618			7,228			6,848
Ending balance	$	255,304		$	232,030		$	258,587
Net increase (decrease)	$	(10,689	)	$	(23,274	)	$	26,557
Percent increase (decrease)		(4.02	) %		(9.12	) %		11.45	%

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The following table sets forth the dollar amount of savings deposits in the various types of deposit programs offered by us at the dates indicated.

	December 31,
	2006					2007					2008
	Amount		Percent of Total			Amount		Percent of Total			Amount		Percent of Total
	(Dollars in Thousands)
Transaction and Savings Deposits:
Noninterest-bearing	$	18,358		7.18	%	$	18,823		8.10	%	$	16,739		6.47	%
Savings accounts (0.50% - 1.88% at December 31, 2008)		18,764		7.34			20,196		8.69			22,796		8.81
NOW Accounts (0.00% - 1.49% at December 31, 2008)		25,881		10.12			20,838		8.97			26,520		10.25
Money Market Accounts (1.0% - 2.37% at December 31, 2008)		12,273		4.80			16,082		6.92			15,486		5.98
Total Non-Certificates		75,276		29.44			75,939		32.68			81,541		31.51
Certificates:
0.00 - 1.99%		642		0.25			304		0.13			3,037		1.17
2.00 - 3.99%		90,877		35.55			35,925		15.46			105,400		40.73
4.00 - 5.99%		88,493		34.62			119,844		51.60			68,590		26.51
6.00 - 7.99%		17		0.01			18		0.01			19		.01
Total certificates		180,029		70.43			156,091		67.19			177,046		68.42
Accrued interest		323		0.13			244		0.13			169		0.07
Total deposits	$	255,628		100.00	%	$	232,274		100.00	%	$	258,756		100.00	%

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The following table shows rate and maturity information for our certificates of deposit as of December 31, 2008.

		0.00- 1.99	%		2.00- 3.99	%		4.00- 5.99	%		6.00- 7.99	%	Total			Percent of Total
	(Dollars in Thousands)
Certificate accounts maturing in quarter ending:
March 31, 2009	$	860		$	14,335		$	14,980		$	---		$	30,175			17.04	%
June 30, 2009		2,126			28,254			2,190			---			32,570			18.40
September 30, 2009		51			26,115			9,888			---			36,054			20.36
December 31, 2009		---			18,389			10,834			---			29,223			16.51
March 31, 2010		---			5,005			6,439			---			11,444			6.46
June 30, 2010		---			3,524			2,103			---			5,627			3.18
September 30, 2010		---			3,552			6,323			12			9,888			5.58
December 31, 2010		---			1,870			5,424			---			7,294			4.12
March 31, 2011		---			1,267			4,208			---			5,475			3.09
June 30, 2011		---			237			35			5			276			0.16
September 30, 2011		---			448			332			1			781			0.44
December 31, 2011		---			1,232			1,310			---			2,542			1.44
Thereafter		---			1,172			4,524			1			5,697			3.22
Total	$	3,037		$	105,400		$	68,590		$	19		$	177,046			100.00	%
Percent of total		1.72	%		59.53	%		38.74	%		0.01	%		100.00	%		100.00	%

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The following table indicates the amount of our certificates of deposit by time remaining until maturity as of December 31, 2008.

	Maturity
	3 Months or Less		Over 3 to 6 Months		Over 6 to 12 Months		Over 12 months		Total
	(In Thousands)
Certificates of deposit less than $100,000, excluding public funds	$	13,184	$	9,849	$	40,001	$	6,324	$	69,358
Certificates of deposit of $100,000 or more, excluding public funds		16,940		20,715		23,230		42,585		103,470
Public funds		51		2,006		2,046		115		4,218
Total certificates of deposit	$	30,175	$	32,570	$	65,277	$	49,024	$	177,046

Borrowings.  Our other available sources of funds include borrowings from the Federal Home Loan Bank (FHLB) of Indianapolis and other borrowings.  As a member of the FHLB of Indianapolis, we are required to own capital stock in the FHLB and are authorized to apply for borrowings from the FHLB.  Each FHLB credit program has its own interest rate, which may be fixed or variable, and the programs have a range of maturities.  The FHLB of Indianapolis may prescribe the acceptable uses for these funds, as well as limitations on the size of the borrowings and repayment provisions. All FHLB advances must be fully secured by sufficient collateral as determined by the FHLB. The Federal Housing Finance Board, an independent agency, controls the FHLB of Indianapolis.

The FHLB of Indianapolis is required to provide funds for the resolution of troubled savings associations and to contribute to affordable housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. For the year ended December 31, 2008, dividends paid by the FHLB of Indianapolis to the Bank totaled approximately $202,000, for an annualized rate of 5.05%. Due to various financial difficulties in the financial institution industry in 2008, including the write-down of various mortgage-backed securities held by the FHLB of Indianapolis (which lowered its regulatory capital levels), the FHLB of Indianapolis temporarily suspended dividends during the first quarter of 2009. Dividends paid by the FHLB of Indianapolis in the first quarter of 2009 were reduced by 75 basis points from the dividend rate paid in the prior quarter. Continued and additional financial difficulties at the FHLB of Indianapolis could further reduce or eliminate the dividends we receive from the FHLB of Indianapolis.

Generally, the loan terms from the FHLB of Indianapolis are better than the terms the Bank can receive from other sources making it cheaper to borrow money from the FHLB of Indianapolis. Continued and additional financial difficulties at the FHLB of Indianapolis could reduce or eliminate our additional borrowing capacity with the FHLB of Indianapolis which could force us to borrow money from other sources. Such other monies may not be available when we need them or, more likely, will be available at higher interest rates and on less advantageous terms, which will impact our net income and could impact our ability to grow.

We utilize FHLB borrowings as part of our asset/liability management strategy in order to extend the maturity of our liabilities in a cost-effective manner.  We may be required to pay a commitment fee upon application and may be subject to a prepayment fee if we prepay the advance. See Note 8 of the Notes to the Consolidated Financial Statements contained in the Annual Report to Shareholders attached as Exhibit 13 to this Form 10-K.

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The following table sets forth the maximum month-end balance and average balance of Federal Home Loan Bank advances for the periods indicated.

	Year Ended December 31,
	2006		2007		2008
	(Dollars in Thousands)
Maximum Balance  Federal Home Loan Bank Advances	$	76,618	$	75,256	$	78,756
Average Balance  Federal Home Loan Bank Advances		70,513		70,777		76,025

The following table sets forth certain information as to the Federal Home Loan Bank advances at the dates indicated.

	Year Ended December 31,
	2006			2007			2008
	(Dollars in Thousands)
Federal Home Loan Bank Advances	$	76,618		$	74,256		$	78,500
Weighted average interest rate of  Federal Home Loan Bank Advances		4.96	%		5.03	%		4.02	%

Subsidiaries and Other Activities

Lafayette Savings owns a service corporation, L.S.B. Service Corporation.  In April 1994, Lafayette Savings made an initial investment of $51,000 in L.S.B. Service Corporation when it became a 14.16% limited partner in a low-income housing project in Lafayette, Indiana, pursuant to a 10-year commitment totaling $500,000.  During 2008, L.S.B. Service Corporation recorded a $10,000 tax loss related to its investment in the project and recorded net losses of $25,000.  At December 31, 2008, our total investment in L.S.B. Service Corporation was $494,000.

Lafayette Savings formed Lafayette Insurance and Investments, Inc., an Indiana corporation, on December 31, 1996.  Lafayette Insurance and Investments, Inc. began offering various insurance, annuity and investment products and services to our customers in June of 1997.  At December 31, 2008, our total investment in Lafayette Insurance and Investments, Inc. was $22,000.  During 2002, Lafayette Insurance and Investments, Inc. became inactive and remained so in 2008.

Competition

We face strong competition, both in originating real estate and other loans and in attracting deposits.  Competition in originating real estate loans comes primarily from other savings institutions, commercial banks, credit unions and mortgage bankers making loans secured by real estate located in Tippecanoe County, our primary market area.  Other savings institutions, commercial banks, credit unions and finance companies provide vigorous competition in consumer lending.

We attract the majority of our deposits through our branch offices, primarily from the communities in which those branch offices are located; therefore, competition for those deposits is principally from other savings institutions, commercial banks and credit unions located in the same communities as well as mutual funds and other financial intermediaries.  We compete for these deposits by offering a variety of deposit accounts at competitive rates, convenient business hours and branch locations and Internet banking with interbranch deposit and withdrawal privileges.

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There are 19 other savings institutions, credit unions and banks in our primary market area. We estimate our share of the savings market in Tippecanoe County to be approximately 12% and our share of the mortgage loan market to be approximately 4%.

Regulation

General.  Lafayette Savings is a federally chartered savings bank, the deposits of which are federally insured and backed by the full faith and credit of the United States Government.  Accordingly, we are subject to broad federal regulation, primarily by the OTS, and oversight extending to all of our operations.  Lafayette Savings is a member of the Federal Home Loan Bank of Indianapolis and is subject to certain limited regulation by the Board of Governors of the Federal Reserve System.  As the thrift holding company of Lafayette Savings, LSB Financial is also subject to federal regulation and oversight by the OTS.

Insurance of Deposits. The Bank's deposits are insured by the Deposit Insurance Fund (“DIF”) of the Federal Deposit Insurance Corporation (“FDIC”) up to a maximum amount, which is generally $250,000 per depositor until January 1, 2010, subject to aggregation rules. The enactment of the Emergency Economic Stabilization Act of 2008 (“EESA”) temporarily raised the applicable limit from $100,000 to $250,000, but the limit will return to $100,000 after December 31, 2009.

Insured depository institutions that were in existence on December 31, 1996 and paid assessments prior to that date (or their successors) are entitled to a one-time credit against future assessments based on their past contributions to the BIF or SAIF (the DIF’s predecessors).  In 2006, the Bank received a one-time credit of $163,379 against future assessments.

Pursuant to the Reform Act, the FDIC is authorized to set the reserve ratio for the DIF annually at between 1.15% and 1.5% of estimated insured deposits and the FDIC has been given discretion to set assessment rates according to risk regardless of the level of the fund reserve ratio. The FDIC adopted final regulations that set the designated reserve ratio for the DIF at 1.25% beginning January 1, 2007.  Federal law also provides for the possibility that the FDIC may pay dividends to insured institutions once the DIF reserve ratio equals or exceeds 1.35% of estimated insured deposits.

The Bank is subject to deposit insurance assessments by the FDIC pursuant to its regulations establishing a risk related deposit insurance assessment system.  Under the risk-based assessment system, the FDIC will evaluate each institution's risk based on three primary sources of information: supervisory ratings for all insured institutions, financial ratios for most institutions, and long-term debt issuer ratings for large institutions that have such ratings. An institution’s assessment rate will be based on the insured institution's ranking in one of four risk categories. For 2008, assessments ranged from 5 to 43 basis points of assessable deposits, and the Bank paid assessments at the rate of 11 basis points for each $100 of insured deposits.

Due to losses incurred by the DIF in 2008 from failed institutions, and anticipated future losses, the FDIC published a restoration plan in 2008 designed to replenish the DIF. In order to implement the restoration plan, the FDIC proposes to change both its risk-based assessment system and its base assessment rates. For the first quarter of 2009, the FDIC has adopted an across-the-board 7 basis point increase in the assessment range. The FDIC has also adopted further refinements to its risk-based assessment, effective April 1, 2009, that make the range of total base assessment rates 7 to 77 ½ basis points, starting with the quarter beginning April 1, 2009. The FDIC may adjust the scale uniformly from one quarter to the next, except that no adjustment can exceed 3 basis points from the base scale without notice and comment rulemaking.  No institution may pay a dividend if in default of the federal deposit insurance assessment.

A significant increase in the risk category of the Bank or adjustment to the base assessment rates causing increased insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.

FDIC-insured institutions remain subject to the requirement to pay quarterly debt service assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation (“FICO”), an agency of the Federal government established to recapitalize the predecessor to the SAIF. These assessments will continue until the FICO bonds are repaid between 2017 and 2019. During 2008, the FICO assessment rate ranged between 1.10 and 1.14 basis points for each $100 of insured deposits per quarter. For the first quarter of 2009, the FICO assessment rate is 1.14 basis points.

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As another response to difficult economic conditions, the FDIC adopted an optional Temporary Liquidity Guarantee Program by which, for a fee, non-interest bearing transaction accounts would receive unlimited insurance coverage until December 31, 2009 and, for a fee, certain senior unsecured debt issued by institutions and their holding companies between October 13, 2008 and June 30, 2009 would be guaranteed by the FDIC through June 30, 2012. The Bank has made the business decision to obtain unlimited deposit insurance protection for non-interest bearing transaction deposit accounts under the FDIC’s Temporary Liquidity Guarantee Program, which will increase its insurance premiums by 10 basis points per annum.

The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe and unsound condition to continue operations or has violated any applicable law, regulation, order or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital.

On February 27, 2009, the FDIC announced the imposition of a special assessment and changes to assessment rates for the risk-based assessment system that will take effect beginning April 1, 2009. The FDIC adopted an interim rule that imposes a special assessment of 20 basis points as of June 30, 2009, which is to be collected on September 30, 2009. Then, on March 5, 2009, FDIC Chairman Sheila Bair announced that if Congress adopts legislation expanding the FDIC’s line of credit with Treasury from $30 billion to $100 billion, the FDIC might have the flexibility to reduce the special emergency assessment, possibly from 20 to 10 basis points. Assuming that deposit levels remain constant, we anticipate that the special assessment for the Bank would total approximately $517,000 at the 20 basis points level, but if the FDIC is able to reduce the special assessment to 10 basis points, the Bank’s assessment would total approximately $258,000. Either assessment would have a material impact on the 2009 results of operations.

The FDIC’s rule also provides for the imposition of additional special assessments of up to 10 basis points if necessary. The FDIC also announced an amendment to the restoration plan to extend the period of the plan from five to seven years.

Federal Regulation of Savings Associations. The OTS has extensive authority over the operations of savings institutions. As part of this authority, we are required to file periodic reports with the OTS and are subject to periodic examinations by the OTS and the FDIC.

The OTS also has extensive enforcement authority over all savings institutions and their holding companies. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions.

Lafayette Savings’ general permissible lending limit for loans to one borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus, except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus. At December 31, 2008, our lending limit under this restriction was $5.5 million.

Regulatory Capital Requirements. To be considered adequately capitalized, under the prompt corrective action regulations, a savings association must maintain the following capital ratios: a leverage ratio (the ratio of Tier 1 capital to total assets) of at least 4% (unless its supervisory condition allows a 3% ratio), a Tier 1 risk-based ratio (the ratio of Tier 1 capital to risk-weighted assets) of at least 4%, and a total risk-based capital ratio (the ratio of total capital to risk-weighted assets) of at least 8%. Total capital consists of Tier 1 and Tier 2 capital.

Tier 1 capital generally consists of common stockholders’ equity, noncumulative perpetual preferred stock and other tangible capital plus certain intangible assets, including a limited amount of purchased credit card receivables. Tier 2 capital consists generally of certain permanent and maturing capital instruments and allowances for loan and lease losses up to 1.25% of risk-weighted assets. When determining total capital, Tier 2 capital may not exceed Tier 1 capital. At December 31, 2008, we had no intangible assets which were included in Tier 1 capital, other than mortgage servicing rights of $991,000.

To determine the amount of risk-weighted assets, all assets, including certain off-balance sheet items, will be multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset. For example, the OTS has assigned a risk weight of 50% for prudently underwritten permanent one- to four-family first

27

lien mortgage loans not more than 90 days delinquent and having a loan-to-value ratio of not more than 90% at origination unless insured to such ratio by an insurer approved by Fannie Mae or Freddie Mac.

To be considered well capitalized, a savings association must have a leverage ratio of at least 5%, a Tier 1 risk-based ratio of at least 6% and a total risk-based capital ratio of 10%. As of December 31, 2008, Lafayette Savings qualified as well capitalized, with a leverage ratio of 9.1%, a Tier 1 risk-based capital ratio of 11.9% and a total risk-based capital ratio of 12.8%. The OTS may reclassify a savings association in a lower capital category or require it to hold additional capital based upon supervisory concerns on a case-by-case basis.

Under the prompt corrective action regulations, the OTS and the FDIC are authorized, and under certain circumstances required, to take certain actions against a savings association that is not at least adequately capitalized. Such an association must submit a capital restoration plan and, until the plan is approved by the OTS, may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. For a savings association controlled by a holding company, the capital restoration plan must include a guarantee by the holding company limited to the lesser of 5% of the association’s assets when it failed the “adequately capitalized” standard or the amount needed to satisfy the plan, and, in the event of the bankruptcy of the holding company, the guaranty would have priority over the claims of general creditors. Additional and more stringent restrictions may be applicable, depending on the financial condition of the association and other circumstances. If an association becomes critically undercapitalized, because it has a ratio of tangible equity to total assets of 2% or less, appointment of a receiver or conservator may be required.

Limitations on Dividends and Other Capital Distributions.  OTS regulations impose various restrictions on savings institutions with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account.

A savings association that is a subsidiary of a holding company, such as Lafayette Savings, may make a capital distribution with prior notice to the OTS, in an amount that does not exceed its net income for the calendar year-to-date plus retained net income for the previous two calendar years (less any dividends previously paid) if the savings association has a regulatory rating in the two top examination categories, is not of supervisory concern, and would remain well-capitalized following the proposed distribution.  All other institutions or those seeking to exceed the noted amounts must obtain approval from the OTS for a capital distribution before making the distribution.

Qualified Thrift Lender Test.  All savings institutions are required to meet a qualified thrift lender test to avoid certain restrictions on their operations.  This test requires a savings institution to have at least 65% of its portfolio assets in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis.  As an alternative, the savings institution may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code of 1986, as amended.  Under either test, these assets primarily consist of residential housing related loans and investments.  At December 31, 2008, Lafayette Savings met the test.

Any savings institution that fails to meet the qualified thrift lender test must either convert to a national bank or restrict its branching rights, new activities and investments and dividends to those permissible for a national bank.  If the institution has not requalified or converted to a national bank within three years after the failure, it must sell all investments and stop all activities not permissible for a national bank.  If any institution that fails the qualified thrift lender test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies.

Transactions with Affiliates. Generally, transactions between a savings association or its subsidiaries and its affiliates are required to be on terms as favorable to the association as transactions with non-affiliates.  In addition, certain of these transactions, such as loans to an affiliate, are restricted to a percentage of the association’s capital and are subject to collateralization requirements.  Affiliates of Lafayette Savings include LSB Financial and any company which is under common control with Lafayette Savings. In addition, a savings association may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of an affiliate.  The OTS has the discretion to further restrict transactions of a savings association with an affiliate on a case-by-case basis.

Community Reinvestment Act.  Under the Community Reinvestment Act, every FDIC insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods.  The Community Reinvestment

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Act requires the OTS, in connection with our examination, to assess our record of meeting the credit needs of our community and to take this record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by Lafayette Savings.  An unsatisfactory rating may be used as the basis for the denial of an application by the OTS.  We were examined for Community Reinvestment Act compliance in 2007 and received a rating of “Outstanding.”

Holding Company Regulation.  LSB Financial is a unitary savings and loan holding company subject to regulatory oversight by the OTS. LSB Financial is required to register and file reports with the OTS and is subject to regulation and examination by the OTS.  In addition, the OTS has enforcement authority over us and our non-savings institution subsidiaries.

LSB Financial generally is not subject to activity restrictions.  If LSB Financial acquired control of another savings institution as a separate subsidiary, it would become a multiple savings and loan holding company, and its activities and any of its subsidiaries (other than Lafayette Savings or any other savings institution) would generally become subject to additional restrictions. 

USA PATRIOT Act of 2001.  On October 26, 2001, President Bush signed the USA PATRIOT Act of 2001 (the “PATRIOT Act”). The PATRIOT Act, among other things, is intended to strengthen the ability of U.S. law enforcement to combat terrorism on a variety of fronts. The PATRIOT Act contains sweeping anti-money laundering and financial transparency laws and requires financial institutions to implement additional policies and procedures with respect to, or additional measures designed to address, any or all the following matters, among others: money laundering, suspicious activities and currency transaction reporting, and currency crimes. Many of the provisions in the PATRIOT Act were to have expired December 31, 2005, but the U.S. Congress authorized renewals that extended the provisions until March 10, 2006. In early March 2006, the U.S. Congress approved the USA PATRIOT Improvement and Reauthorization Act of 2005 (the “Reauthorization Act”) and the USA PATRIOT Act Additional Reauthorizing Amendments Act of 2006 (the “PATRIOT Act Amendments”), and they were signed into law by President Bush on March 9, 2006. The Reauthorization Act makes permanent all but two of the provisions that had been set to expire and provides that the remaining two provisions, which relate to surveillance and the production of business records under the Foreign Intelligence Surveillance Act, will expire in four years. The PATRIOT Act Amendments include provisions allowing recipients of certain subpoenas to obtain judicial review of nondisclosure orders and clarifying the use of certain subpoenas to obtain information from libraries. We do not anticipate that these changes will materially affect our operations.

Sarbanes-Oxley Act of 2002. On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”).  The Sarbanes-Oxley Act’s stated goals include enhancing corporate responsibility, increasing penalties for accounting and auditing improprieties at publicly traded companies and protecting investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.  The Sarbanes-Oxley Act generally applies to all companies that file or are required to file periodic reports with the SEC under the Securities Exchange Act of 1934 (the “Exchange Act”).

Among other things, the Sarbanes-Oxley Act creates the Public Company Accounting Oversight Board as an independent body subject to SEC supervision with responsibility for setting auditing, quality control and ethical standards for auditors of public companies.  The Sarbanes-Oxley Act also requires public companies to make faster and more extensive financial disclosures, requires the chief executive officer and chief financial officer of public companies to provide signed certifications as to the accuracy and completeness of financial information filed with the SEC, and provides enhanced criminal and civil penalties for violations of the federal securities laws.

The Sarbanes-Oxley Act also addresses functions and responsibilities of audit committees of public companies. The statute makes the audit committee directly responsible for the appointment, compensation and oversight of the work of the company’s outside auditor, and requires the auditor to report directly to the audit committee.  The Sarbanes-Oxley Act authorizes each audit committee to engage independent counsel and other advisors, and requires a public company to provide the appropriate funding, as determined by its audit committee, to pay the company’s auditors and any advisors that its audit committee retains.  The Sarbanes-Oxley Act also requires public companies to include an internal control report and assessment by management, along with an attestation to this report prepared by the company’s registered public accounting firm, in their annual reports to stockholders.

Although LSB Financial will incur additional expense in complying with the provisions of the Sarbanes-Oxley Act and the resulting regulations, management does not expect that such compliance will have a material impact on LSB Financial’s results of operations or financial condition.

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Recent Legislative Developments. In response to recent unprecedented financial market turmoil, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted on October 3, 2008. EESA authorizes the U.S. Treasury Department to provide up to $700 billion in funding for the financial services industry. Pursuant to the EESA, the Treasury was initially authorized to use $350 billion for the Troubled Asset Relief Program (“TARP”). Of this amount, the Treasury allocated $250 billion to the TARP Capital Purchase Program (“CPP”). The CPP allows financial institutions, like the Company, to issue non-voting preferred stock to the Treasury in an amount ranging between 1% and 3% of its total risk-weighted assets. On January 15, 2009, the second $350 billion of TARP monies was released to the Treasury. The Secretary’s authority under TARP expires on December 31, 2009 unless the Secretary certifies to Congress that extension is necessary provided that his authority may not be extended beyond October 3, 2010. The Company has decided not to participate in the TARP CPP, as discussed further in “Management’s Discussion and Analysis of Financial Condition and Results of Operation” in the Annual Report to Shareholders filed as Exhibit 13 to this Form 10-K.

In addition, on October 14, 2008, after receiving a recommendation from the boards of the FDIC and the Board of Governors of the Federal Reserve System, and consulting with the President, Secretary Paulson signed the systemic risk exception to the Federal Deposit Insurance Act, enabling the FDIC to temporarily provide a 100% guarantee of the senior debt of all FDIC-insured institutions and their holding companies, as well as unlimited deposit insurance on funds in non-interest bearing transaction deposit accounts under a Temporary Liquidity Guarantee Program. Coverage under the Temporary Liquidity Guarantee Program is available to those who opt in to one or both of the programs at a cost of 75 basis points per annum for senior unsecured debt and 10 basis points per annum for non-interest bearing transaction deposits. The Bank made the business decision to participate in the Transaction Account Guarantee Program, which provides, without charge to depositors, a full guarantee on all non-interest bearing transaction accounts through December 31, 2009.

The American Recovery and Reinvestment Act of 2009 (“ARRA”), signed into law on February 17, 2009, amended the EESA as it applies to institutions that receive financial assistance under TARP. ARRA, more commonly known as the economic stimulus or economic recovery package, includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. In addition, ARRA imposes certain new executive compensation and corporate expenditure limits on all current and future TARP recipients until the institution has repaid the Treasury. As noted above, the Company has decided not to participate in the TARP CPP.

Before and after EESA, there have been numerous actions by the Federal Reserve Board, Congress, the Treasury, the FDIC, the IRS, the SEC and others to further the economic and banking industry stabilization efforts. It remains unclear at this time what further legislative and regulatory measures will be implemented affecting the Company. To date, the Company has elected to participate only in the FDIC’s Transaction Account Guarantee Program, which is a part of the FDIC’s Temporary Liquidity Guarantee Program and is discussed above in“Regulation – Insurance of Deposits.”

Federal and State Taxation

Federal Taxation.  Savings institutions that meet certain definitional tests relating to the composition of assets and other conditions prescribed by the Internal Revenue Code of 1986, as amended, are permitted to establish reserves for bad debts and to make annual additions which may, within specified formula limits, be taken as a deduction in computing taxable income for federal income tax purposes.  The amount of the bad debt reserve deduction is computed under the experience method. 

In addition to the regular income tax, corporations, including savings institutions, generally are subject to a minimum tax.  An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum taxable income, which is the sum of a corporation’s regular taxable income (with certain adjustments) and tax preference items, less any available exemption.  The alternative minimum tax is imposed to the extent it exceeds the corporation’s regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income. 

A portion of our reserves for losses on loans which are presented on the statement of financial condition of retained earnings, may not, without adverse tax consequences, be utilized for the payment of cash dividends or other distributions to a shareholder, including distributions on redemption, dissolution or liquidation, or for any other purpose except to absorb bad debt losses.  As of December 31, 2008, the portion of our reserves subject to this treatment for tax purposes totaled approximately $1.9 million.  We file consolidated federal income tax returns with

30

our subsidiaries on a calendar year basis using the accrual method of accounting.  We have not been audited by the IRS during the last five fiscal years.

Indiana Taxation.  The State of Indiana imposes an 8.5% franchise tax on corporations transacting the business of a financial institution in Indiana.  Included in the definition of corporations transacting the business of a financial institution in Indiana are holding companies of thrift institutions, as well as thrift institutions.  Net income for franchise tax purposes will constitute federal taxable income before net operating loss deductions and special deductions, adjusted for certain items, including Indiana income taxes and bad debts.  Other applicable Indiana taxes include sales, use and property taxes.

Employees

At December 31, 2008, we had a total of 91 employees, including 6 part-time employees.  Our employees are not represented by any collective bargaining group.  Management considers its employee relations to be good.

Item 1A. Risk Factors

Not Applicable.

 Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

We conduct our business at our main office and four other locations in Lafayette and West Lafayette, Indiana.  We own our main office and three branch offices.  The fourth branch office is leased with the term of the lease expiring in 2009.  The total net book value of our premises and equipment (including land, building and leasehold improvements and furniture, fixtures and equipment) at December 31, 2008 was approximately $6.5 million.  We have also purchased an office building adjacent to the main office location as our growth rate has required space for additional personnel and will for the next few years.

We maintain an on-line database of depositor and borrower customer information.  The net book value of our data processing, computer equipment and software at December 31, 2008 was $448,000.

Item  3. Legal Proceedings

We are, from time to time, involved as plaintiff or defendant in various legal actions arising in the normal course of business.  While the ultimate outcome of these proceedings cannot be predicted with certainty, it is the opinion of management, after consultation with counsel representing us in the proceedings, that the resolution of any prior and pending proceedings should not have a material effect on our financial condition or results of operations.

Item  4. Submission of Matters to a Vote of Security Holders

No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the quarter ended December 31, 2008.

Item  4.5 Executive Officers of the Registrant

The executive officers of LSB Financial are identified below.  The executive officers are elected annually by the Board of Directors of LSB Financial.

Randolph F. Williams (age 60).  Mr. Williams is President and Chief Executive Officer of LSB Financial and its wholly-owned subsidiary, Lafayette Savings.  Mr. Williams was appointed to the Board of Directors of LSB Financial in September 2001.  He was appointed President of LSB Financial in September 2001 and Chief Executive Officer in January 2002.  Mr. Williams served as President and Chief Operating Officer of Delaware Place Bank in Chicago, Illinois from 1996 until joining LSB Financial.  Mr. Williams has over 25 years of banking-related experience.

31

Mary Jo David (age 59).  Ms. David is Vice President, Chief Financial Officer and Secretary of LSB Financial and Lafayette Savings.  She has held these positions with the Company since its formation in 1994 and with Lafayette Savings since 1992 and was elected a Director of LSB Financial and Lafayette Savings in 1999.

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PART II

Item  5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

(a)           We have not sold any equity securities during the period covered by this report that were not registered under the Securities Act of 1933.  Additionally, pages 65 through 66 of our 2008 Annual Report to Shareholders attached to this document as Exhibit 13 are incorporated herein by reference.  In addition, the “Equity Compensation Plan Information” contained in Part III, Item 12 of this Form 10-K is incorporated herein by reference.

(b)           We have no information to furnish pursuant to Rule 463 of the Securities Act of 1933 and Item 701(f) of Regulation S-K.

(c)           The following table sets forth the number and price paid for repurchased shares.

Issuer Purchases of Equity Securities
Month of Purchase	Total Number of Shares Purchased	Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plan1	Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plan
October 1 – October 31, 2008	---	---	---	52,817
November 1 – November 30, 2008	---	---	---	52,817
December 1 – December 31, 2008	---	---	---	52,817
		---	---
Total	---	---	---	52,817

1We have in place a program, announced February 6, 2007, to repurchase up to 100,000 shares of our common stock.

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Item  6. Selected Financial Data

Not Applicable.

Item  7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Pages 3 through 30 of our 2008 Annual Report to Shareholders attached to this document as Exhibit 13 are incorporated herein by reference.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Not Applicable.

Item 8. Financial Statements and Supplementary Data

Pages 31 through 61 of our 2008 Annual Report to Shareholders attached to this document as Exhibit 13 are incorporated herein by reference.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable.

Item 9A(T). Controls and Procedures

Evaluation of Disclosure Controls and Procedures.  An evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act), as of December 31, 2008 (the “Evaluation Date”), was carried out under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer and several other members of our senior management. Our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures in effect as of the Evaluation Date are effective in ensuring that the information required to be disclosed by us in the reports we file or submit under the Act is (i) accumulated and communicated to our management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

Management’s Report on Internal Control over Financial Reporting.

The management of LSB Financial Corp. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting (as such term is defined in defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Securities Exchange Act of 1934).  Our internal control over financial reporting process was designed, under supervision of our Chief Executive Officer, Chief Financial Officer and several other members of our senior management, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

· Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company;

· Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and

· Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations in any internal control, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Further, the evaluation of the effectiveness of internal control over financial reporting was made as of a specific date, and

34

projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies and procedures may deteriorate.

The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008.  In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.

Based on our assessment, management has determined that, as of December 31, 2008, the Company’s internal control over financial reporting is effective based on those criteria.

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by its registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

Changes in Internal Controls over Financial Reporting.  There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Act) identified in connection with our evaluation of controls that occurred during the quarter ended December 31, 2008, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Item 9B. Other Information

We have no information that was required to be reported on a Form 8-K in the fourth quarter covered by this 10-K, but was not reported on a Form 8-K during the fourth quarter.

35

PART III

Item 10. Directors, Executive Officers and Corporate Governance

Information concerning LSB Financial directors is incorporated herein by reference to the sections of the definitive Proxy Statement for the Annual Meeting of Shareholders to be held in April 2009 under the caption “Proposal 1 - Election of Directors.” Information concerning LSB Financial executive officers is included in Item 4.5 in Part I of this Form 10-K and is incorporated herein by reference.

The information relating to corporate governance required by this item is incorporated herein by reference to the section of our definitive Proxy Statement for the Annual Meeting of Shareholders to be held in April 2009 under the caption “Corporate Governance.”

Section 16(a) of the Exchange Act requires our directors and executive officers and persons who own more than 10% of a registered class of our equity securities, to file with the SEC initial reports of ownership and reports of changes in ownership of our common stock and our other equity securities by the end of the second business day following a change.  Officers, directors and greater than 10% stockholders are required by SEC regulation to furnish us with copies of all Section 16(a) forms they file.

To our knowledge, based solely on a review of the copies of such reports furnished to us and written representations that no other reports were required, during the fiscal year ended December 31, 2008, all Section 16(a) filing requirements applicable to our officers, directors and 10% beneficial owners were complied with except as disclosed in our definitive Proxy Statement for the Annual Meeting of Shareholders to be held in April 2009 under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” incorporated herein by reference.

LSB Financial has a written code of ethics that applies to all of our directors, officers and employees. The code of ethics is available on our website at www.lsbank.com.

Item 11. Executive Compensation

Information concerning executive compensation is incorporated herein by reference to the sections of our definitive Proxy Statement for the Annual Meeting of Shareholders to be held in April 2009 with the captions “Executive Compensation” and “Compensation of Directors.”

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference to the section of our definitive Proxy Statement for the Annual Meeting of Shareholders to be held in April 2009 with the caption “Principal Holders of Common Stock.”

36

Equity Compensation Plan Information. The following table summarizes our equity compensation plans as of December 31, 2008.

Plan Category	Number of securities to be issued upon exercise of outstanding options warrants and rights (a)	Weighted-average exercise price of outstanding options warrants and rights (b)	Number of Securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c)
Equity compensation plans approved by security holders(1)	35,701(2)	18.77 (3)	81,000(4)
Equity compensation plans not approved by security holders	---	---	---
(1)  LSB Financial Corp.’s 1995 Stock Option and Incentive Plan terminated on August 22, 2005 so no further options may be granted under the 1995 Stock Option and Incentive Plan.  LSB Financial Corp.’s Recognition and Retention Plan terminated by its terms on August 22, 2005, so no further awards may be made under the Recognition and Retention Plan. (2) Includes 35,701 shares under LSB Financial Corp.’s 1995 Stock Option and Incentive Plan and no shares under LSB Financial Corp.’s Recognition and Retention Plan. (3) The total in Column (b) includes only the weighted-average price of stock options, as the restricted shares awarded under the Recognition and Retention Plan have no exercise price and no shares have been awarded under the Recognition and Retention Plan. (4) Includes 81,000 shares reserved for issuance under the LSB Financial Corp. 2007 Stock Option and Incentive Plan.  No options have yet been granted or awards made under the 2007 Stock Option and Incentive Plan.

Item 13. Certain Relationships and Related Transactions, and Director Independence

Information concerning director independence and certain relationships and transactions is incorporated herein by reference to the sections of our definitive Proxy Statement for the Annual Meeting of Shareholders to be held in April 2009 with the captions “Corporate Governance” and “Transactions with Related Persons.”

Item 14. Principal Accountant Fees and Services

Information concerning principal accountant fees and services are incorporated herein by reference to the sections of our definitive Proxy Statement for the Annual Meeting of Shareholders to be held in April 2009 with the captions “Accountants” and “Accountant’s Fees.”

37

PART IV

Item 15. Exhibits, Financial Statement Schedules

(a)           The following documents are filed as part of this report:

	Annual Report Page No(s).
Financial Statements:
Report of BKD, LLP, Independent Registered Public Accounting Firm	33
Consolidated Balance Sheets at December 31, 2008 and 2007	34
Consolidated Statements of Income for the Years Ended December 31, 2008 and 2007	35
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2008 and 2007	36
Consolidated Statements of Cash Flows for the Years Ended December 31, 2008 and 2007	37
Notes to Consolidated Financial Statements	38-61
Financial Statement Schedules: All schedules are omitted as the required information either is not applicable or is included in the consolidated financial statements or related notes.

(b)           The exhibits filed herewith or incorporated by reference herein are set forth on the Index to Exhibits.

38

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

		LSB FINANCIAL COP.
Date:	3/30/09	By:	/s/ Randolph F. Williams
			Randolph F. Williams, President,
			Chief Executive Officer and Director
			(Duly Authorized Representative)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

	/s/ Mariellen M. Neudeck	/s/ Randolph F. Williams
	Mariellen M. Neudeck, Chairman of the Board	Randolph F. Williams, President, Chief Executive Officer and Director (Principal Executive and Operating Officer)
Date:	3/27/2009	Date:	3/30/09
	/s/  James A. Andrew	/s/ Kenneth P. Burns
	James A. Andrew, Director	Kenneth P. Burns, Director
Date:	3/30/2009	Date:	3/27/09
	/s/ Philip W. Kemmer	/s/ Peter Neisel
	Philip W. Kemmer, Director	Peter Neisel, Director
Date:	March 27, 2009	Date:	3/30/09
	/s/  Jeffrey A. Poxon	/s/ Thomas R. McCully
	Jeffrey A. Poxon, Director	Thomas R. McCully, Director
Date:	3/30/09	Date:	3/28/09
	/s/ Mary Jo David	/s/ Charles W. Shook
	Mary Jo David, Vice President, Chief Financial Officer, Secretary-Treasurer and Director (Principal Financial and Accounting Officer)	Charles W. Shook, Director
Date:	3/31/09	Date:	3/30/09

39

	INDEX TO EXHIBITS
Regulation S-K Exhibit    Number	Document
3.1	Articles of Incorporation, filed on September 21, 1994 as an exhibit to Registrant’s Registration Statement on Form S-1 (File No. 33-84266), are incorporated by reference.
3.2	Bylaws, as amended and restated, filed as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on September 19, 2007 (File No. 0-25070), are incorporated herein by reference.
4	Registrant’s Specimen Stock Certificate, filed on September 21, 1994 as an exhibit to Registrant’s Registration Statement on Form S-1 (File No. 33-84266), is incorporated herein by reference.
10.1*	Registrant’s 1995 Stock Option and Incentive Plan, filed as Exhibit 10.1 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005 (File No. 0-25070), is incorporated herein by reference.
10.2*	Registrant’s 1995 Recognition and Retention Plan, filed as Exhibit 10.2 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005 (File No. 0-25070), is incorporated herein by reference.
10.3*	Form of 1995 Stock Option and Incentive Plan Non-Qualified Stock Option Agreement, filed as Exhibit 10.4 to the Registrant’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2004 (File No. 0-25070), is incorporated herein by reference.
10.4*	Form of 1995 Stock Option and Incentive Plan Incentive Stock Option Agreement, filed as Exhibit 10.5 to the Registrant’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2004 (File No. 0-25070), is incorporated herein by reference.
10.5*	Form of Recognition and Retention Plan Restricted Stock Agreement, filed as Exhibit 10.6 to the Registrant’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2004 (File No. 0-25070), is incorporated herein by reference.
10.6*	Deferred Compensation Agreement between Lafayette Savings Bank and Randolph F. Williams, filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K for the event occurring on September 29, 2005 (File No. 0-25070), is incorporated herein by reference.
10.7*	Amended and Restated Employment Agreement dated February 27, 2008 between LSB Financial Corp. and Randolph F. Williams filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on March 3, 2008 (File No. 0-25070) is incorporated herein by reference.
10.8*	Amended and Restated Employment Agreement dated February 27, 2006 between LSB Financial Corp. and Mary Jo David filed as Exhibit 10.2 to the Registrant’s 8-K filed on March 3, 2008 (File No. 0-25070), is incorporated herein by reference.
10.9*	LSB Financial Corp. 2007 Stock Option and Incentive Plan, filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on April 24, 2007 (File No. 0-25070), is incorporated herein by reference.
10.10*	Form of 2007 Stock Option and Incentive Plan Incentive Stock Option Agreement, filed as Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2007 (File No. 0-25070) is incorporated herein by reference.
10.11*	Form of 2007 Stock Option and Incentive Plan Non-qualified Stock Option Agreement, filed as Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2007 (File No. 0-25070), is incorporated herein by reference.

E-1

10.12*	Form of Agreement for Restricted Stock Granted under LSB Financial Corp. 2007 Stock Option and Incentive Plan, filed as Exhibit 10.3 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2007 (File No. 0-25070), is incorporated herein by reference.
13	Annual Report to Shareholders for the Year Ended December 31, 2008.
21	Subsidiaries of Registrant.
23	Consent of BKD, LLP, Independent Registered Public Accounting Firm.
31.1	Rule 13a - 14(a) Certification (Chief Executive Officer).
31.2	Rule 13a - 14(a) Certification (Chief Financial Officer).
32	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	* Indicates exhibits that describe or evidence management contracts and plans required to be filed as exhibits.

E-2

EX-13

EXHIBIT 13

 

ANNUAL MEETING

The Annual Meeting of Shareholders of LSB Financial Corp.

will be held April 15, 2009 at 9:00 a.m. local time at the LSB

Building, located at 22 N. Second Street, Lafayette, Indiana.

LSB FINANCIAL CORP.

TABLE OF CONTENTS
Letter to Shareholders	i
Selected Financial Information	1
Management’s Discussion and Analysis	3
Disclosure Regarding Forward-Looking Statements	30
Auditors’ Report	31
Consolidated Financial Statements	34
Directors and Executive Officers	62
Shareholder Information	64
		FINANCIAL HIGHLIGHTS
		December 31, 2008
		(Dollars in Thousands)
		Total assets	$373,012
		Total loans, net of allowance	326,639
		Securities and short-term investments	21,032
		Deposits	258,587
		Borrowings	78,500
		Shareholders’ equity	34,075
		Shareholders’ equity as percent of assets	9.14%
		Net Income	$1,740

ANNUAL MEETING

The Annual Meeting of Shareholders of LSB Financial Corp. will be held April 15, 2009 at 9:00 a.m. local time at the LSB Building, located at 22 N. Second Street, Lafayette, Indiana.

LSB FINANCIAL CORP.

Dear Fellow Shareholder:

In what may have been the most difficult year in banking since the Great Depression, the performance of our outstanding LSB team enables us to report a number of accomplishments:

1.  In a year where nearly one-third of all FDIC-insured savings institutions lost money, we increased earnings by 10.6%.  Our net income for the year was $1,740,000, or $1.12 per share, compared to $1,574,000 or $0.99 per share, the previous year.  This equates to a return on average equity of 5.08% and a return on average assets of 0.48%, comparing favorably to an industry average loss of -5.94% and -0.55%, respectively.

2.  Remarkably, we were able to hold the net interest margin erosion to 45 basis points, ending the year at 2.97%.  Total loans increased by $29.7 million, or 10.0%, deposits grew to $258.6 million, up 11.5%, and assets ended the year at $373.0 million, an increase of 9.1%.  Net interest income declined by $1.1 million because the Fed’s seven interest rate cuts in 2008 caused the prime rate to fall by 400 basis points.  Although these rate decreases immediately affected loan rates, deposit rates resisted the cuts as the largest banks continued to offer higher interest rates to attract more deposits and improve their liquidity.

3.  We were able to decrease our nonperforming loans from $10.0 million to $8.0 million during the year.  We approached 2008 with some trepidation about the recession’s effect on the local economy but with continued determination to work closely with struggling borrowers in an effort to improve the bank’s credit quality.  Our focus on credit quality began in earnest in December 2006 with the establishment of an independent credit department which, at the time, was working through an overbuilt housing market and steep increases in property taxes.  As you may recall, in 2007 we allocated $1.6 million to loan loss reserves, anticipating that many of our foreclosed properties that had been working through the foreclosure process would be sold at sheriff’s sales in 2008.  We acquired and moved $3.0 million of foreclosed properties in 2008 and wrote off additional losses on approved short sales, where properties were sold by borrowers for less than the amount of their loan.  Our charge-offs to loan loss reserves totaled $1.2 million in 2008.  Although we cannot predict how hard the national recession will affect us, this is our lowest level for nonperforming loans since December 2006.  The adjustments we made to other real estate owned (OREO) property values in 2007 put us in a good position for 2008.  We sold over $4.6 million of OREO properties and recognized additional losses of only $156,000.  Compared to $3.9 million at December 31, 2007, our OREO properties at December 31, 2008, totaled $1.4 million, our lowest balance since mid-2005.  An all important ratio, nonperforming loans compared to total loans dropped from 3.32% at December 31, 2007, to 2.41% at December 31, 2008.

4.  Although we feel privileged to have been approved to receive Troubled Assets Relief Program (TARP) money, our strong capitalization level, improving loan quality, and generally stable local economy, as well as the continuing lack of clarity about the final government-mandated stipulations for those who accept this money, have led our board of directors to respectfully decline to participate.  In October of last year, the Treasury announced TARP under emergency legislation to address the tremendous challenges facing the financial industry.  Federal regulators were encouraging banks to apply for capital infusions through the plan’s

i

Capital Purchase Program (CPP); at the same time, the U.S. Treasury was encouraging banks to apply for the money to help unfreeze lending. Applications were due in less than a month, which made careful evaluation of the program difficult.  Nevertheless, because of concern about the economy, many banks, including LSB, applied for the funds as a way to secure time to consider their position.

With a Tier 1 capital to assets ratio of 9.14% at year-end, Lafayette Savings Bank is considered well capitalized compared to the regulatory well-capitalized Tier 1 to assets ratio of 5.0%.  Despite the cushion, we applied various stress tests to determine whether our capital was sufficient to keep us well capitalized should the national economic downturn severely affect the local economy.  We evaluated that likelihood in light of the diverse local economy, the presence of Purdue University and its thriving Research Park, and the reported $600 million of capital invested in Greater Lafayette in 2008.  We took into account that our business plan has resulted in a balance sheet not troubled by subprime loans, with no derivative investment products purchased to obtain high returns, and no preferred stock from Freddie Mac or Fannie Mae.  On January 6, 2009, we received preliminary approval from the Treasury to receive $8.6 million of CPP money.  We declined the funds because our community-oriented approach to banking has served us well for the past 140 years and we believe it will continue to provide us with sufficient capital to weather the effects of the national slowdown.

5.  As growth slowed back in the third quarter of 2007, we increased the dividend to $0.25 per share.  That rate held for the next six quarters, until we lowered it to $0.125 in the first quarter of 2009. We completely agree with the original goals of the TARP, that building up capital during hard times is prudent and that continuing to lend to keep a stable economy is crucial.  We believe that the money we save by reducing our dividend directly accomplishes both those things.  Despite the troubled national economy, locally we continue to see substantial numbers of well-qualified borrowers applying for loans, and we acted on our belief that using our equity to fund loans and thus grow the balance sheet is a prudent way to manage our capital.  Also, the reduced dividend will give us the flexibility to make strategic repurchases of our own stock, which like most bank stock is selling below book value.  Further, any capital we are able to retain because of this lower dividend rate will bolster capital levels internally rather than taking CPP money.

Despite our improved performance, we are nonetheless a financial stock.  As did most financial stocks, our price decreased over the year, ending the year at $9.95.  At year-end we were trading at 45% of book value and 8.9 times earnings.  It is our hope that continued strong earnings, along with recognition as having been “TARP qualified” and our own decision not to participate in the program, will identify us as a solid investment.

During the year, Harry A. Dunwoody, senior vice president, retired from the bank.  Harry worked for the bank for over 19 years and served 14 years as a director of the company.  Those of you who know Harry (at one time or another, he probably made most of you a loan) realize what a caring person he was.  When he retired he asked us to use his accumulated vacation and sick days to establish a pool of paid time off to lessen the burden for employees who had exhausted theirs.  Thus the Compassionate Time-Off Program became an official benefit to our employees.

As the banking industry picks its way through the minefield of 2009, we have no clear idea just how much the national recession will affect out local economy.  We will continue our

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efforts to manage our capital, control expenses, and grow the interest margin.   Thank you for your continued support.  Our team is committed to exceeding expectations every day, whether for customers, shareholders, or each other.

Respectfully,

Randolph F. Williams

President & Chief Executive Officer

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SELECTED FINANCIAL INFORMATION

The selected financial data presented below should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations, as well as the audited Consolidated Financial Statements contained elsewhere in this Annual Report.

	December 31,
	2008		2007		2006		2005		2004
	(Dollars in Thousands)
Selected Financial Condition Data:
Total assets	$	373,012	$	342,010	$	368,400	$	372,664	$	355,045
Loans receivable, including loans held for sale, net		326,639		296,908		317,691		330,971		318,927
Securities available-for-sale		11,853		13,221		16,316		11,611		7,947
Short-term investments		9,179		4,846		8,336		7,687		6,818
Deposits		258,587		232,030		255,304		265,993		256,631
Total borrowings		78,500		74,256		76,618		72,033		66,808
Shareholders’ equity		34,075		33,932		34,840		32,821		30,393

	December 31,
	2008			2007			2006		2005		2004
	(Dollars in Thousands, except share data)
Selected Operations Data:
Total interest income	$	21,319		$	22,882		$	23,263	$	21,498	$	19,286
Total interest expense		11,286			11,655			11,142		9,664		8,416
Net interest income		10,033			11,227			12,121		11,834		10,870
Provision for loan losses		1,102			1,570			1,018		1,200		500
Net interest income after provision for loan losses		8,931			9,657			11,103		10,634		10,370
Deposit account service charges		1,736			1,838			1,766		1,423		889
Gain on sales of mortgage loans		117			201			214		322		593
Gain on call of securities		---			6			---		---		---
Loss on real estate owned		(156	)		(1,097	)		---		---		---
Other non-interest income		1,194			1,098			858		764		747
Total non-interest income		2,891			2,046			2,838		2,509		2,240
Total non-interest expense		9,286			9,322			8,593		8,111		7,554
Income before taxes		2,536			2,381			5,348		5,032		5,056
Income taxes		796			807			1,998		1,764		1,792
Net income	$	1,740		$	1,574		$	3,350	$	3,268	$	3,264
Earnings per share	$	1.12		$	1.00		$	2.08	$	2.03	$	2.10
Earnings per share, assuming dilution		1.12			0.99			2.07		2.02		2.03
Dividends paid per share		1.00			0.90			0.68		0.61		0.51

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	December 31,
	2008			2007			2006			2005			2004
Selected Financial Ratios and Other Data:
Performance Ratios:
Return on assets (ratio of net income to average total assets)		0.48	%		0.45	%		0.91	%		0.89	%		0.95	%
Return on equity (ratio of net income to average equity)		5.08			4.52			9.88			10.21			11.19
Average interest rate spread during period		2.82			3.25			3.33			3.23			3.20
Net interest margin(1)		2.97			3.42			3.48			3.37			3.32
Operating expense to average total assets		2.58			2.66			2.33			2.20			2.20
Average interest-earning assets to average interest-bearing liabilities		1.05	x		1.05	x		1.05	x		1.05	x		1.05	x
Quality Ratios:
Non-performing assets to total assets at end of period		2.52	%		4.08	%		3.17	%		2.83	%		1.67	%
Allowance for loan losses to non-performing loans		46.35			37.04			23.72			27.00			35.38
Allowance for loan losses to loans receivable		1.12			1.23			0.86			0.85			0.66
Capital Ratios:
Shareholders’ equity to total assets at end of period		9.14			9.92			9.46			8.81			8.56
Average shareholders’ equity to average total assets		9.53			9.92			9.19			8.69			8.50
Dividend payout ratio		89.43			90.00			32.69			30.05			24.54
Other Data:
Number of full-service offices		5			5			5			5			5

(1)  Net interest income divided by average interest-earning assets.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Executive Overview

General

LSB Financial Corp., an Indiana corporation (“LSB Financial” or the “Company”), is the holding company of Lafayette Savings Bank, FSB (“Lafayette Savings” or the “Bank”).  LSB Financial has no separate operations and its business consists only of the business of Lafayette Savings.  References in this Annual Report to “we,” “us” and “our” refer to LSB Financial and/or Lafayette Savings as the context requires.

Lafayette Savings is, and intends to continue to be, an independent, community-oriented financial institution.  The Bank has been in business for 139 years and differs from many of our competitors in having a local board and local decision-making in all areas of business.  In general, our business consists of attracting or acquiring deposits and lending that money out primarily as real estate loans to construct and purchase single-family residential properties and, to a lesser extent, multi-family and commercial properties and to fund land development projects.  We also make a limited number of commercial business and consumer loans.

We have an experienced and committed staff and enjoy a good reputation for serving the people of the community and understanding their financial needs and for finding a way to meet those needs.  We contribute time and money to improve the quality of life in our market area and many of our employees volunteer for local non-profit agencies.  We believe this sets us apart from the other 19 banks and credit unions that compete with us.  We also believe that operating independently under the same name for over 139 years is a benefit to us—especially as acquisitions and consolidations periodically disrupt financial institutions and services.  Focusing time and resources on acquiring customers who may be feeling disenfranchised by their no-longer-local bank has proved to be a successful strategy.

In this year of worsening recession and extraordinary economic times, we find ourselves in a community that to some extent has been sheltered from the worst effects of the slowdown.  The greater Lafayette area enjoys diverse employment including several major manufacturers; a strong education sector with Purdue University and a large local campus of Ivy Tech Community College; government offices of Lafayette, West Lafayette and Tippecanoe County and a growing high-tech presence with the Purdue Research Park.  This diversity served to insulate us from some of the severity of the effects of economic downturns felt in other parts of the country.  A year-end report by the Lafayette Chamber of Commerce noted nearly $600 million in new capital investments in 2008 with new projects underway as the two new hospitals in the area spur growth of a medical corridor and Purdue University and the Purdue Research Park plan additional growth.  That report indicated that only one local employer surveyed anticipated reductions in staff although that one, Wabash National, the area’s second largest industrial employer, experienced a plant shutdown at year-end.  Wabash National expects that new product lines and new contracts will increase levels of production by the second quarter of 2009.  The Tippecanoe County unemployment rate a December 2008 was 6.0%, a higher than usual level likely caused by temporary layoffs at Wabash National discussed below.  The local economy has stayed relatively strong thanks to the presence of Purdue University which employs almost

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15,000 people and has enrollment at the West Lafayette campus of over 40,000.  The University’s new construction in 2008 provided capital investments of over $242 million, thanks in part to their successful fundraising campaign which raised over $7 billion. The success of the Purdue Research Park in attracting high-tech companies to the Lafayette area is seen in the 52 buildings with 1.3 million square feet owned or leased by 160 companies employing 3,100 people. Its 195,000 square feet of incubator space makes it the largest institutionally operated incubator program in the nation.  The county also has a relatively strong manufacturing sector. Some examples of new growth in 2008 include Federal Express announcing it will build a distribution center in Lafayette in 2009, EDS Indiana Technical Resource Center leasing 13,000 square feet in Purdue Research Park and hiring 92 people with additional growth planned for 45,000 square feet occupied in 2009 and 200 employees hired by 2010.  TRW plans to expand its operations with a new $29 million facility in south Lafayette that will employ 200 people.  Caterpillar currently has a $1.6 million office building underway and increased employment by 350 in 2008 with 50 more projected to be hired in 2009.  Subaru of Indiana projected production of 195,000 vehicles in 2008 and increased its national sales by 3% in 2008, the only major auto manufacturer to do so.  Wabash National, after struggling in the last few years and shutting down their plant from December 2008 through February 2009, invested $8 million in new equipment, $1 million on real estate improvements and plans a $3 million facility improvement as part of a new strategic plan.  They project that sales will increase from $15 million in 2008 to $35 million in 2009, to $80 million in 2012 due to, among other things, multi-year contracts signed with several national corporations including orders for their new utility trucks, cargo trailers and storage units, and orders for a projected 34,270 new trailers.  They anticipate calling back all laid-off employees by the second quarter of 2009.  The other area of growth involves the construction of two new hospitals (one already in operation) and the resulting medical corridor currently being developed to accommodate the office space needed for related services.

The community is making progress working through the effects of the overbuilding of one- to four-family housing when housing starts increased from a somewhat typical 858 starts in 2001 to 1,219 in 2004.  New construction has dropped every year since, to 448 in 2008.   Many of the houses which had been sold to marginally qualified borrowers reappeared on the market as foreclosed properties, further slowing the need for new housing.  While this increase in foreclosed properties and distressed housing sales has been a drag on the economy, this was due more to aggressive marketing of houses to people who couldn’t afford them rather than because of increased levels of unemployment.  In addition, unlike in other parts of the country, housing values in the Metropolitan Statistical Area of which Tippecanoe County is a part have increased by 2.88% over the last 12 months according to a report from the Office of Federal Housing Enterprise Oversight.

We continue to work with borrowers who have fallen behind on their loans.  The majority of our delinquent loans are secured by real estate and we believe we have sufficient reserves to cover incurred losses.  The challenge is to get delinquent borrowers back on a workable payment schedule or to get control of their properties through an overburdened court system.  We acquired 29 properties in 2008 through foreclosure or deeds-in-lieu of foreclosure.

The funds we use to make loans come primarily from deposits from customers in our market area, from brokered deposits and from Federal Home Loan Bank (“FHLB”) advances.  In addition we maintain an investment portfolio of available-for-sale securities to provide liquidity as needed.  Our intention is to seek out the least expensive source of funds, but if the need is immediate we will acquire pre-payable FHLB advances which are immediately available for

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member banks within their borrowing tolerance and can then be replaced with local or brokered deposits as they become available.  Our reliance on brokered funds as a percentage of total deposits increased in 2008 from 20.6% to 23.6% with the actual dollar amount increasing from $47.8 million to $61.0 million.  We generally prefer brokered deposits over FHLB advances when the rates are competitive with the cost of raising money locally.  The deposits are available with a range of terms, there is no collateral requirement and the money is predictable as it cannot be withdrawn early except in the case of the death of a depositor and there is no option to have the money rollover at maturity.  While we always welcome local deposits, the cost and convenience of brokered funds make them a useful alternative.  We will also continue to rely on FHLB advances to provide immediate liquidity and help manage interest rate risk.

Our primary source of income is net interest income, which is the difference between the interest income earned on our loan and investment portfolio and the interest expense incurred on deposits and borrowings.  Our net interest income depends on the balance of our loan and investment portfolios and the size of our net interest margin – the difference between the income generated from loans and the cost of funding.  Our net interest income also depends on the shape of the yield curve.  Since January 2007, the Federal Reserve has lowered short-term rates from around 5.0% to almost zero while long-term rates which had also been near 5.0% fell to under 3.0%.  Because deposits are generally tied to shorter-term market rates and loans are generally tied to longer-term rates this would typically be viewed as a positive step.  In reality, loans—especially those immediately repriceable to prime—fell immediately while deposits generally stayed high due to a demand for liquidity, especially by big banks whose presence in the deposit markets was ubiquitous.  Our expectation for 2009 is that deposits will gradually respond to the lower market rates as banks are less concerned about the loss of liquidity.  Overall loan rates are expected to stay low.

Rate changes can typically be expected to have an impact on interest income.  Falling rates generally increase borrower preference for fixed rate products, which we typically sell on the secondary market, and existing adjustable rate loans can be expected to reprice to lower rates, which could be expected to have a negative impact on our interest income.  Also any new loans put on the books will be at comparatively low rates.  Because the government is working to push long-term rates to fall further to help ease the housing crisis, we expect to see a return to a high volume of refinancing.

Our primary expense is interest on deposits and FHLB advances which are used to fund loan growth.  We offer customers in our market area time deposits for terms ranging from three months to five years, checking accounts and savings accounts.  We also purchase brokered deposits and FHLB advances as needed to provide funding or improve our interest rate risk position.  Generally when interest rates are low, depositors will choose shorter-term products and conversely when rates are high, depositors will choose longer-term products.

We consider expected changes in interest rates when structuring our interest-earning assets and our interest-bearing liabilities.  When rates are expected to increase we try to book shorter-term assets that will reprice relatively quickly to higher rates over time, and book longer-term liabilities that will remain for a longer time at lower rates.  Conversely, when rates are expected to fall, we would like our balance sheet to be structured such that loans will reprice more slowly to lower rates and deposits will reprice more quickly.  We currently offer a three-year and a five-year certificate of deposit that allows depositors one opportunity to have their rate adjusted to the market rate at a future date to encourage them to choose longer-term deposit

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products.  However, since we are not able to predict market interest rate fluctuations, our asset/liability management strategy may not prevent interest rate changes from having an adverse effect on our results of operations and financial condition.

Our results of operations may also be affected by general and local competitive conditions, particularly those with respect to changes in market rates, government policies and actions of regulatory authorities.

2008 Summary

Our strategy in 2008 was similar to that in 2007 - enhancing the credit analysis department, working to manage non-performing loans and dispose of other real estate owned, controlling the cost of funds and other expenses and focusing on growth in other income.  Later in the year we focused on selectively extending credit to borrowers who had been denied credit at larger, national banks who were hesitant to loan in the current environment, and in enhancing our secondary loan market availability to enable us to provide VA and FHA loans to qualified borrowers.

Because the local economy fared better in 2008 than the rest of the country, the opportunity for loan growth was better than expected.  Unit residential real estate sales in 2008 were one unit below 2007 and were trending higher at year end.  Commercial real estate activity was centered in the new medical corridor connecting the two new hospitals, industrial growth on the south side of town, and ongoing building at Purdue University and in the Purdue Research Park.  The loan increase was across all real estate related categories.  Non-real estate and home equity loans declined over 2008.  Our credit department is now fully staffed with a department manager, two experienced credit analysts and two collectors, including one experienced in workouts and debt restructuring.  In 2008, we sold $4.6 million of other real estate owned (OREO) properties, consisting of 42 properties.  Our residential loan originators originated and sold $10.2 million of residential loans on the secondary market for a gain of $117,000.

In 2007 we allocated $1.6 million to loan loss reserves anticipating that many of our delinquent loans would be foreclosed in 2008.  The allocation increased the ratio of loan loss reserves to total loans at December 31, 2007 to 1.23%, the highest rate we have ever shown.  We charged off $1.2 million to loan loss reserves in 2008 which resulted in the addition of $2.3 million of foreclosed properties to OREO. We also wrote off additional losses on properties sold through approved short sales where properties were sold by borrowers for less than the amount of their loan.  We were able to decrease our non-performing loans from $10.0 million at December 31, 2007 to $8.0 million at December 31, 2008.  This is our lowest level for non-performing loans since December 2006.  At December 31, 2008, our allowance for loan losses compared to non-performing loans was 46.35% compared to 37.04% at December 31, 2007.  Non-performing loans compared to total loans dropped from 3.32% at December 31, 2007 to 2.52% at December 31, 2008.  Our OREO properties at December 31, 2008 were $1.4 million, our lowest balance since mid-2005, and compared to $3.9 million at December 31, 2007.  In addition, even after working through this number of properties, the ratio of loan loss reserves to total loans ended the year at 1.12% which we believe to be adequate to absorb estimated incurred losses inherent in our loan portfolio.  While we continue to seek to lower our delinquencies, based on our analysis we believe we have sufficient reserves to cover incurred losses.  In 2008 we also wrote off losses of $156,000 on the sale of OREO properties including $16,000 of net

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loss on the actual sale of properties and $140,000 of writedowns taken to adjust the value of OREO properties to the estimated, realizable value.

The Federal Reserve rate adjustments which took short-term rates to virtually zero and longer-term rates to the 2% to 3% range, while returning the yield curve to a more normal shape, did not have the expected effect of maintaining interest rate margins.  All loans tied to prime reacted immediately to the rate cuts.  New loan rates fell as well, as have, gradually, other variable rate loans.  Deposit rates however remained high due to the liquidity demands of bigger banks that kept deposit rates well over Treasury indications.  Because banks were unsure about whether their normal borrowing sources would be available, many of them turned to the brokered CD markets and/or paid premium rates for customer deposits.  For banks like us with routine funding needs the cost of funds stayed frustratingly high.

Other non-interest income, excluding the gain on sale of loans and the loss on the sale of OREO, decreased by $12,000 primarily from a $102,000 decrease in deposit service fees offset by a $60,000 increase in loan fees due to higher fees for loan closings and an increase in loan modification fees and a $28,000 increase in fees from our new in-house wealth management department.

The results of our loan and deposit activity in 2008 are illustrated in the chart on page 14 and include:

· Residential mortgage loans (including loans held for sale) increased by 4.7% from $137.6 million to $144.1 million.

· All other real estate loans, net, including multi-family, land, land development, construction and commercial real estate loans increased 21.9% from $127.6 million to $159.7 million.

· Commercial business lending decreased 26.1% from $19.3 million to $14.3 million.

· At December 31, 2008, 70.4% of our gross loan portfolio had adjustable interest rates.

· Total deposit accounts increased 11.5% from $232.0 million at December 31, 2007 to $258.6 million at December 31, 2008, with core deposits increasing 7.9% from $75.9 million to $81.9 million over the same period.

2009 Overview

We expect to see continued slow-to-moderate growth in our residential loan portfolio through 2009 with interest rates remaining low and rates on residential mortgage loans at historically low levels.  While we expect to see significant residential mortgage loan refinance activity as borrowers take advantage of lower rates to bring down their mortgage costs, we intend to primarily originate these loans for sale on the secondary market, only keeping some of our shorter-term fixed rate loans in our portfolio.  We expect to have the opportunity to consider new commercial loan relationships as some of the larger banks have moved to tighten credit.  We anticipate some increase in commercial real estate and commercial business loan activity from

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the medical corridor being built around the two new hospitals and from building related to the Purdue Research Park and other areas of expansion.  We are fortunate that the local economy is showing such resilience in the face of the recession. However, portfolio loan growth overall is expected to be modest.

Our operating results will continue to be affected by several factors involving the disposition of properties in foreclosure or held in other real estate owned, including the level of the provision for loan losses, gains and losses on the sale of properties once we acquire title to them, the loss of interest income on non-performing assets and non-interest expenses incurred in obtaining, marketing and disposing of the properties.  These factors are expected to have less of an impact than in 2008 since the level of OREO properties at year-end was at its lowest point in three years and our non-performing loans were down $2.0 million from last year.  Our allowance for loan losses to non-performing loans is at 46.4%, the highest level in four years.  The allowance for loan losses ended the year at 1.12%.  Because of staff increases in the credit area, we expect the quality of our loan portfolio to improve as improved credit analysis translates into higher credit quality of our new loans while we proactively work with troubled borrowers while their situation is still salvageable.  We monitor these and all other loans in our portfolio carefully and perform specific impairment analyses on any loans over 90 days delinquent.  Based on our analysis, we believe that our current loan loss reserve is sufficient to cover probable losses.

We intend to continue to follow a strategy for growth in 2009 that includes (1) maintaining a strong capital position, (2) managing our vulnerability to changes in interest rates by emphasizing adjustable rate and/or shorter-term loans, (3) optimizing our net interest margin by supplementing our traditional mortgage lending with prudent multi-family and commercial real estate, consumer and construction loans, (4) working to originate and sell residential mortgage loans in the secondary market for a fee, (5) originating FHA and VA loans to access a market not previously available to us, and (6) funding our growth by using a mix of local and brokered deposits and FHLB advances, whichever is most cost-effective.

Possible Implications of Current Events

Significant external factors impact our results of operations including the general economic environment, changes in the level of market interest rates, government policies, actions by regulatory authorities and competition.  Our cost of funds is influenced by interest rates on competing investments and general market rates of interest.  Lending activities are influenced by the demand for real estate loans and other types of loans, which are in turn affected by the interest rates at which such loans are made, general economic conditions affecting loan demand and the availability of funds for lending activities.

Management continues to assess the impact on the Company of the uncertain economic and regulatory environment affecting the country at large and the financial services industry in particular.  The level of turmoil in the financial services industry does present unusual risks and challenges for the Company, as described below:

In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law.  Pursuant

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to the EESA, the U.S. Department of Treasury (the “Treasury”) has the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets.

On October 14, 2008, the Treasury also announced it would offer to qualifying U.S. banking organizations the opportunity to sell preferred stock, along with warrants to purchase common stock, to the Treasury under the Troubled Asset Relief Program (“TARP”) Capital Purchase Program (the “CPP”).On January 6, 2009, the Company received preliminary approval of its application under the TARP CPP to sell $8.6 million in preferred stock to the Treasury.  However, based on the Company’s strong capitalization level, improving loan quality, generally stable local economy and the lack of clarity regarding final government-mandated stipulations for those who accept the TARP money, the Company’s board of directors has decided the Company will not participate in the TARP CPP.

The Current Economic Environment Poses Challenges For Us and Could Adversely Affect Our Financial Condition and Results of Operations. We are operating in a challenging and uncertain economic environment, including generally uncertain national conditions which could have implications for our local markets. The capital and credit markets have been experiencing volatility and disruption for more than 12 months. In recent months, the volatility and disruption has reached unprecedented levels. The risks associated with our business become more acute in periods of a slowing economy or slow growth. Financial institutions continue to be affected by sharp declines in the real estate market and constrained financial markets. While we are taking steps to decrease and limit our exposure to problem loans, and while our local economy has remained somewhat insulated from the most severe effects of the current economic environment, all financial institutions nonetheless retain direct exposure to the residential and commercial real estate markets and are affected by these events.

Our loan portfolio includes commercial real estate loans, residential mortgage loans, and construction and land development loans. Continued declines in real estate values, home sales volumes and financial stress on borrowers as a result of the uncertain economic environment, including job losses, could have an adverse effect on our borrowers or their customers, which could adversely affect our financial condition and results of operations. In addition, a national economic recession or further deterioration in local economic conditions in our markets could drive losses beyond that which is provided for in our allowance for loan losses and result in the following other consequences: loan delinquencies, problem assets and foreclosures may increase; demand for our products and services may decline; deposits may decrease, which would adversely impact our liquidity position; and collateral for our loans, especially real estate, may decline in value, in turn reducing customers’ borrowing power, and reducing the value of assets and collateral associated with our existing loans.

Impact of Recent and Future Legislation. As noted above, Congress and the U.S. Treasury Department have recently adopted legislation and taken actions to address the disruptions in the financial system and declines in the housing market.  It is not clear at this time what impact the EESA, TARP, other liquidity and funding initiatives of the Treasury and other bank regulatory agencies that have been previously announced, and any additional programs that may be initiated in the future, will have on the financial markets and the financial services industry. The actual impact that EESA and such related measures undertaken to alleviate the credit crisis will have generally on the financial markets, including the extreme levels of

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volatility and limited credit availability currently being experienced, is unknown.  The failure of such measures to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect all financial institutions, including the Company.

In addition to the legislation mentioned above, federal and state governments could pass additional legislation responsive to current credit conditions. As an example, the Bank could experience higher credit losses because of federal or state legislation or regulatory action that reduces the amount the Bank’s borrowers are otherwise contractually required to pay under existing loan contracts. Also, the Bank could experience higher credit losses because of federal or state legislation or regulatory action that limits its ability to foreclose on property or other collateral or makes foreclosure less economically feasible.

Adverse Effect On Our Industry from Difficult Market Conditions. Although the Metropolitan Statistical Area of which Tippecanoe County is a part has experienced a slight increase in housing values over the past 12 months, widespread downturns in the U.S. housing market may have an effect here. The market turmoil and tightening of credit generally have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity. We do not expect that the difficult conditions in the financial markets are likely to dissipate in the near future. A worsening of these conditions would likely have adverse effects on us and others in the financial institutions industry. In particular, we may face the following risks in connection with these events:

· We expect to face increased regulation of our industry. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities.

· Our ability to assess the creditworthiness of our customers may be impaired if the models and approaches we use to select, manage and underwrite our customers become less predictive of future behaviors.

· The process we use to estimate losses inherent in our credit exposure requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic predictions might impair the ability of our borrowers to repay their loans, which may no longer be capable of accurate estimation which may, in turn, impact the reliability of the process.

· Competition in our industry could intensify as a result of the increasing consolidation of financial services companies in connection with current market conditions.

· We may be required to pay significantly higher deposit insurance premiums because market developments have significantly depleted the insurance fund of the Federal Deposit Insurance Corporation and reduced the ratio of reserves to insured deposits.

Current Levels of Market Volatility Are Unprecedented. The capital and credit markets have been experiencing unprecedented levels of volatility and disruption for more than a year.  In some cases the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If current levels of market disruption and volatility continue or worsen, our ability to access capital may be

10

adversely affected which, in turn, could adversely affect our business, financial condition and results of operations.

Additional Increases in Insurance Premiums. The Federal Deposit Insurance Corporation (“FDIC”) insures the Bank’s deposits up to certain limits. The FDIC charges us premiums to maintain the Deposit Insurance Fund. The Bank elected to obtain unlimited deposit insurance protection for non-interest bearing transaction deposit accounts under the FDIC’s Temporary Liquidity Guarantee Program, which will increase its insurance premiums by 10 basis points per annum.

Current economic conditions have increased expectations for bank failures. The FDIC takes control of failed banks and ensures payment of deposits up to insured limits using the resources of the Deposit Insurance Fund. The FDIC has designated the Deposit Insurance Fund long-term target reserve ratio at 1.25 percent of insured deposits. Due to recent bank failures, the FDIC insurance fund reserve ratio has fallen below 1.15 percent, the statutory minimum. The FDIC has developed a restoration plan that will uniformly increase insurance assessments by 7 basis points (annualized) effective January 1, 2009. In 2008, assessments ranged from 5 to 43 basis points of assessable deposits depending upon the institution’s risk profile. Effective April 1, 2009, the range of assessments increases to between 7 and 77 1/2 basis points, with possible future adjustments not to exceed 3 basis points from the base scale per quarter without notice and comment. Further increases in premium assessments would increase the Company’s expenses.

On February 27, 2009, the FDIC proposed an interim rule to impose a 20 basis point emergency special assessment on June 30, 2009. The assessment would be collected on September 30, 2009. On March 5, 2009, FDIC Chairman Sheila Bair announced that if Congress adopts legislation expanding the FDIC’s line of credit with Treasury from $30 billion to $100 billion, the FDIC might have the flexibility to reduce the special emergency assessment, from 20 to possibly 10 basis points.  Assuming that deposit levels remain constant, we anticipate that the special assessment for the Bank would total approximately $517,000 at the 20 basis points level, but if the FDIC is able to reduce the special assessment to 10 basis points, the Bank’s assessment would total approximately $258,000. The interim rule would also allow an additional emergency assessment of up to 10 basis points after June 30, 2009 as deemed necessary by the Board of the FDIC.   Either assessment would have a material impact on the 2009 results of operations.

Future Reduction in Liquidity in the Banking System. The Federal Reserve Bank has been providing vast amounts of liquidity in to the banking system to compensate for weaknesses in short-term borrowing markets and other capital markets. A reduction in the Federal Reserve’s activities or capacity could reduce liquidity in the markets, thereby increasing funding costs to the Bank or reducing the availability of funds to the Bank to finance its existing operations.

Concentrations of Real Estate Loans Could Subject the Company to Increased Risks in the Event of a Real Estate Recession or Natural Disaster. A significant portion of the Company’s loan portfolio is secured by real estate. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. While property values in this area have been relatively unaffected by the economic downturn and actually increased in 2008, a weakening of the real estate market in our primary market area could result in an increase in the number of borrowers unable to refinance or who may default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability

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and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected.

Significant natural disasters can also negatively affect the value to real estate that secures our loans or interrupt our business operations, also negatively impacting our operating results or financial condition.

Credit Risk Could Adversely Affect Our Operating Results or Financial Condition. One of the greatest risks facing lenders is credit risk – that is, the risk of losing principal and interest due to a borrower’s failure to perform according to the terms of a loan agreement. During 2007, the banking industry experienced increasing trends in problem assets and credit losses which resulted from weakening national economic trends and a decline in housing values. While management attempts to provide an allowance for loan losses at a level adequate to cover probable incurred losses based on loan portfolio growth, past loss experience, general economic conditions, information about specific borrower situations, and other factors, future adjustments to reserves may become necessary, and net income could be significantly affected, if circumstances differ substantially from assumptions used with respect to such factors.

Interest Rate Risk Could Adversely Affect Our Operations. The Company's earnings depend to a great extent upon the level of net interest income, which is the difference between interest income earned on loans and investments and the interest expense paid on deposits and other borrowings. Interest rate risk is the risk that the earnings and capital will be adversely affected by changes in interest rates. While the Company attempts to adjust its asset/liability mix in order to limit the magnitude of interest rate risk, interest rate risk management is not an exact science. Rather, it involves estimates as to how changes in the general level of interest rates will impact the yields earned on assets and the rates paid on liabilities. Moreover, rate changes can vary depending upon the level of rates and competitive factors. From time to time, maturities of assets and liabilities are not balanced, and a rapid increase or decrease in interest rates could have an adverse effect on net interest margins and results of operations of the Company. Volatility in interest rates can also result in disintermediation, which is the flow of funds away from financial institutions into direct investments, such as U.S. Government and corporate securities and other investment vehicles, including mutual funds, which, because of the absence of federal insurance premiums and reserve requirements, generally pay higher rates of return than financial institutions.

Critical Accounting Policies

Generally accepted accounting principles are complex and require management to apply significant judgments to various accounting, reporting and disclosure matters. Management of LSB Financial Corp. must use assumptions and estimates to apply these principles where actual measurement is not possible or practical. For a complete discussion of LSB Financial Corp.’s significant accounting policies, see Note 1 to the Consolidated Financial Statements as of December 31, 2008.  Certain policies are considered critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such estimates may have a significant impact on the financial statements. Management has reviewed the application of these policies with the Audit Committee of LSB Financial Corp.’s Board of Directors. These policies include the following:

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Allowance for Loan Losses

The allowance for loan losses represents management’s estimate of probable losses inherent in Lafayette Savings’ loan portfolios. In determining the appropriate amount of the allowance for loan losses, management makes numerous assumptions, estimates and assessments.

The strategy also emphasizes diversification on an industry and customer level, regular credit quality reviews and quarterly management reviews of large credit exposures and loans experiencing deterioration of credit quality.

Lafayette Savings’ allowance consists of three components: probable losses estimated from individual reviews of specific loans, probable losses estimated from historical loss rates, and probable losses resulting from economic or other deterioration above and beyond what is reflected in the first two components of the allowance.

Larger commercial loans that exhibit probable or observed credit weaknesses and all loans that are rated substandard or lower are subject to individual review.  Where appropriate, reserves are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Bank. Included in the review of individual loans are those that are impaired as provided in SFAS 114, Accounting by Creditors for Impairment of a Loan.  Any allowances for impaired loans are determined by the present value of expected future cash flows discounted at the loan’s effective interest rate or fair value of the underlying collateral.  Historical loss rates are applied to other commercial loans not subject to specific reserve allocations.

Homogenous smaller balance loans, such as consumer installment and residential mortgage loans are not individually risk graded. Reserves are established for each pool of loans based on the expected net charge-offs for one year. Loss rates are based on the average net charge-off history by loan category.

Historical loss rates for commercial and consumer loans may be adjusted for significant factors that, in management’s judgment, reflect the impact of any current conditions on loss recognition.  Factors which management considers in the analysis include the effects of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs and non-accrual loans), changes in mix, asset quality trends, risk management and loan administration, changes in the internal lending policies and credit standards, collection practices and examination results from bank regulatory agencies and the Bank’s internal loan review.

Allowances on individual loans are reviewed quarterly and historical loss rates are reviewed annually and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience.

Lafayette Savings’ primary market area for lending is Tippecanoe County, Indiana. When evaluating the adequacy of allowance, consideration is given to this regional geographic concentration and the closely associated effect of changing economic conditions on Lafayette Savings’ customers.

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Mortgage Servicing Rights

Mortgage servicing rights (MSRs) associated with loans originated and sold, where servicing is retained, are capitalized and included in other intangible assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio.  Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests.  The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance.  Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value.  For purposes of measuring impairment, the servicing rights are compared to a valuation prepared based on a discounted cash flow methodology, utilizing current prepayment speeds and discount rates.  Impairment, if any, is recognized through a valuation allowance and is recorded as amortization of intangible assets.

Financial Condition at December 31, 2008 compared to Financial Condition at December 31, 2007.

SELECTED FINANCIAL CONDITION DATA
(Dollars in thousands)
	December 31,		December 31,		$				%
	2008		2007		Difference			Difference
Total assets	$	373,012	$	342,010	$	31,002			9.06	%
Loans receivable, including loans held for sale, net		326,639		296,908		29,731			10.01
Residential mortgage loans		144,100		137,611		6,489			4.72
Home equity lines of credit		13,610		14,018		(408	)		(2.91	)
Other real estate loans		155,510		127,593		27,917			21.88
Commercial business loans		14,277		19,307		(5,030	)		(26.05	)
Consumer loans		1,843		2,439		(596	)		(24.44	)
Loans sold		10,247		19,735		(9,488	)		(48.08	)
Nonperforming loans		7,976		9,935		(1,959	)		(19.72	)
Loans past due 90 days, still accruing		---		59		(59	)		(100.00	)
Other real estate owned		1,412		3,944		(2,532	)		(64.20	)
Nonperforming assets		9,388		13,938		(4,550	)		(23.64	)
Available-for-sale securities		11,853		13,221		(1,368	)		(10.35	)
Short-term investments		9,179		4,846		4,333			89.41
Deposits		258,587		232,030		26,557			11.45
Core deposits		81,907		75,939		5,968			7.86
Brokered deposits		61,001		47,766		13,235			27.71
FHLB advances		78,500		74,256		4,244			5.72
Shareholders’ equity (net)		34,075		33,932		143			0.42

As shown in the chart above, the net balance in our loan portfolio increased by $29.7 million from December 31, 2007 to December 31, 2008.  Loans increased primarily due to the decision by larger banks to withdraw existing or fail to extend new credit, resulting in many

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good borrowers looking for new lending relationships. The increase also can be attributed to the resilience of the local economy driven by the medical sector and Purdue University and the Purdue Research Park.

In mid-2008 we began the process necessary to allow the bank to offer FHA and VA loans which had been missing from our portfolio offerings.  In the last quarter of 2008 when mortgage rates fell, we were able to offer not just FHA and VA loans but a wide array of mortgage products and compete more effectively in the local market.  We sold $19.7 million of residential loans in 2007 compared to $10.2 in 2008, with over 40% of those in the fourth quarter.  These loans were sold based on asset/liability considerations and to increase income from the gain on sale of loans.  See “Asset/Liability Management.”

The $1.4 million decrease in our securities was primarily due to runoff while the $4.3 million increase in short-term investments reflected the flow of cash needed to fund loans held for sale until remittance was received.

Deposit balances increased by $26.6 million to fund higher loan demand.  $5.6 million was in core deposit growth and $21.0 million was in time deposits, $13.2 million of which were brokered funds.

We utilize advances available through the FHLB to provide additional funding for loan growth as well as for asset/liability management purposes.  At December 31, 2008, we had $78.5 million in FHLB advances outstanding.  Based on the collateral we currently have listed under a blanket collateral arrangement with the FHLB, we could borrow up to $15.0 million in additional advances.  We have other collateral available if needed.  These advances are generally available on the same day as requested and allow us the flexibility of keeping our daily cash levels tighter than might otherwise be prudent.

Non-performing assets, which include non-accruing loans, accruing loans 90 days past due and foreclosed assets, decreased from $13.9 million at December 31, 2007 to $9.4 million at December 31, 2008.  Non-performing assets at December 31, 2008 consisted of $5.4 million of loans on residential real estate, $2.2 million on land or commercial real estate loans, $23,000 on consumer loans and $366,000 on commercial business loans.  Foreclosed assets consisted of $1.2 million of residential property and $220,000 of commercial real estate.  At December 31, 2008, our allowance for losses equaled 1.12% of total loans (including loans held for sale) compared to 1.23% at December 31, 2007.  The allowance for loan losses at December 31, 2008 totaled 39.38% of nonperforming assets compared to 26.56% at December 31, 2007, and 46.35% of non-performing loans at December 31, 2008 compared to 37.04% at December 31, 2007.  Our non-performing assets equaled 2.52% of total assets at December 31, 2008 compared to 4.08% at December 31, 2007.

When a non-performing loan is added to our classified loan list, an impairment analysis is completed to determine expected losses upon final disposition of the property.  An adjustment to loan loss reserves is made at that time for any anticipated losses.  This analysis is updated quarterly thereafter.  Because of the large numbers of foreclosures—according to Forbes, Indiana reported foreclosure rates among the top ten in the nation in 2006 and in 2007 moved from second to ninth—the court systems frequently have backlogs in scheduling loan hearings.  It may take up to two years to move a foreclosed property through the system to the point where we can obtain title to and dispose of it.  We attempt to acquire properties through deeds-in-lieu of

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foreclosure if there are no other liens on the properties.  In 2007, we acquired 7 properties through deeds-in-lieu of foreclosure and an additional 24 properties through foreclosure.  In 2008, we acquired 25 properties through deeds-in-lieu of foreclosure and an additional 9 properties through foreclosure.  As a result, $1.2 million was charged against loan loss reserves for these properties in 2008 to reduce the carrying value of the property to the estimated realizable value.  Although we believe we use the best information available to determine the adequacy of our allowance for loan losses, future adjustments to the allowance may be necessary, and net income could be significantly affected if circumstances and/or economic conditions cause substantial changes in the estimates we use in making the determinations about the levels of the allowance for losses.  Additionally, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses.  These agencies may require the recognition of additions to the allowance based upon their judgments of information available at the time of their examination.

Shareholders’ equity increased $143,000, or 0.42%, during 2008 primarily as a result of net income of $1.7 million, offset by our payment of dividends on common stock and the repurchase of 8,900 shares of our stock as part of a stock repurchase program.  Shareholders’ equity to total assets was 9.14% at December 31, 2008 compared to 9.92% at December 31, 2007.

Results of Operations

Our results of operations depend primarily on the levels of net interest income, which is the difference between the interest income earned on loans and securities and other interest-earning assets, and the interest expense on deposits and borrowed funds.  Our results of operations are also dependent upon the level of our non-interest income, including fee income and service charges, gains or losses on the sale of loans and the level of our non-interest expenses, including general and administrative expenses.  Net interest income is dependent upon the volume of interest-earning assets and interest-bearing liabilities and upon the interest rate which is earned or paid on these items.  Our results of operations are also affected by the level of the provision for loan losses.  We, like other financial institutions, are subject to interest rate risk to the degree that our interest-bearing liabilities mature or reprice at different times, or on a different basis, than our interest-earning assets.

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Average Balances, Interest Rates and Yields

The following table presents for the periods indicated the total dollar amount of interest income earned on average interest-earning assets and the resultant yields on such assets, as well as the interest expense paid on average interest-bearing liabilities, and the rates paid on such liabilities.   No tax equivalent adjustments were made.  All average balances are monthly average balances.  Non-accruing loans have been included in the table as loans carrying a zero yield.

	2008								2007
	Average Outstanding Balance			Interest Earned/ Paid		Yield/ Rate			Average Outstanding Balance			Interest Earned/ Paid		Yield/ Rate
Interest-Earning Assets:
Loans receivable(1)	$	312,923			20,492		6.55	%	$	302,947			21,894		7.23	%
Mortgage-backed securities		4,171			213		5.11			5,274			272		5.16
Other investments		16,594			412		2.48			16,208			534		3.29
FHLB stock		3,997			202		5.05			3,997			182		4.55
Total interest-earning assets		337,686			21,319		6.31			328,426			22,882		6.97
Non-interest earning assets		21,611								22,655
Total assets	$	359,296							$	351,081
Liabilities and Shareholders’ Equity:
Interest-Bearing Liabilities:
Savings deposits	$	22,135			237		1.07		$	19,304			199		1.03
Demand and NOW deposits		61,710			514		0.83			58,460			601		1.03
Time deposits		162,789			6,930		4.26			165,353			7,285		4.41
Borrowings		76,025			3,605		4.74			70,778			3,570		5.04
Total interest-bearing liabilities		322,659			11,286		3.50			313,895			11,655		3.71
Other liabilities		3,402								3,292
Total liabilities		325,061								317,187
Shareholders’ equity		34,235								33,894
Total liabilities and shareholders’ equity	$	359,296							$	351,081
Net interest income				$	10,033							$	11,227
Net interest rate spread							2.82	%							3.25	%
Net earning assets	$	15,027							$	14,531
Net yield on average interest-earning assets							2.97	%							3.42	%
Average interest-earning assets to  average interest-bearing liabilities		1.05	x							1.05	x

_________________

(1)  Calculated net of deferred loan fees, loan discounts, loans in process and loss reserves.

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Rate/Volume Analysis of Net Interest Income

The following table presents the dollar amount of changes in interest income and interest expense for the major categories of interest-earning assets and interest-bearing liabilities.  The change in total interest income and total interest expense is allocated between those related to changes in the outstanding balances and those due to changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume).  For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and change due to rate.

	Year Ended December 31,
	2007 vs. 2008									2006 vs. 2007
	Increase (Decrease) Due to						Total Increase			Increase (Decrease) Due to						Total Increase
	Volume			Rate			Decrease			Volume			Rate			Decrease
	(In thousands)
Interest-earning assets:
Loans receivable	$	703		$	(2,105	)	$	(1,402	)	$	(1,429	)	$	880		$	(549	)
Mortgage-backed securities		(56	)		(3	)		(59	)		135			39			174
Other investments		12			(134	)		(122	)		(71	)		84			13
FHLB stock		--			20			20			(5	)		(14	)		(19	)
Total interest-earning assets	$	659		$	(2,222	)	$	(1,563	)	$	(1,370	)	$	989		$	(381	)
Interest-bearing liabilities:
Savings deposits	$	30		$	8		$	38		$	5		$	30		$	35
Demand deposits and NOW   accounts		32			(119	)		(87	)		23			201			224
Time deposits		(112	)		(243	)		(355	)		(899	)		904			5
Borrowings		256			(221	)		35			13			236			249
Total interest-bearing liabilities	$	206		$	(575	)	$	(369	)	$	(858	)	$	1,371		$	513
Net interest income							$	(1,194	)							$	(894	)

Comparison of Operating Results for the Years Ended December 31, 2008 and December 31, 2007.

General.  Net income for the year ended December 31, 2008 was $1.7 million, an increase of $166,000, or 10.55%, over net income for the year ended December 31, 2007.  This increase was primarily due to an $845,000 increase in non-interest income a $468,000 decrease in the provision for loan losses, a $36,000 decrease in non-interest expense and an $11,000 decrease in income taxes, partially offset by a $1.2 million decrease in net interest income.

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Our return on average assets was 0.48% for the year ended 2008, compared to 0.45% for the year ended 2007.  Return on equity was 5.08% for the year ended 2008 compared to 4.52% for 2007.  During 2008 we paid regular quarterly cash dividends on common stock totaling $1.6 million, or $1.00 per share, for the year, representing a dividend payout ratio (dividends declared per share divided by diluted net income per share) of approximately 89.43%.

Net Interest Income.    Net interest income for the year ended December 31, 2008 decreased $1.2 million over the same period in 2007.  Our net interest margin (net interest income divided by average interest-earnings assets) decreased from 3.42% at December 31, 2007 to 2.97% at December 31, 2008.  The largest factor in the decrease was the decrease in the average rate on loans from 7.23% in 2007 to 6.55% in 2008 caused primarily by the aggressive rate cuts by the Federal Reserve.  This decrease was partially offset by an increase in loan volume from an average balance of $303 million in 2007 to an average balance of $313 million in 2008.  Similarly, interest expenses on deposits and advances decreased but to a much smaller extent.   The average rate on deposits decreased from 3.33% in 2007 to 3.11% in 2008 while advances decreased from 5.04% in 2007 to 4.74% in 2008.   Overall, the average rate on loans and investments decreased by 66 basis points while the average rate on investments and advances decreased by 21 basis points.

Interest income on loans decreased $1.4 million for the year ended December 31, 2008 compared to the year ended December 31, 2007 primarily because of reduced rates.  The volume of loans in our portfolio increased by $10.0 million while the average yield decreased from 7.23% for the year ended December 31, 2007 to 6.55% for the year ended December 31, 2008.

Interest income on investments decreased $161,000 including an increase of $20,000 in interest income on FHLB stock for the year ended December 31, 2008 compared to the year ended December 31, 2007.  The decrease in interest on investments was primarily due to lower rates particularly on short-term investments, as well as the $1.1 million paydown of mortgage-backed securities.  Average investments decreased $717,000 from 2007 to 2008 with a decrease in the average rate earned from 3.75% in 2007 to 3.01% in 2008.  The increase in interest income on FHLB stock was due to an increase in the average rate paid from 4.55% in 2007 to 5.05% in 2008.

Interest expense for the year ended December 31, 2008 decreased $369,000 over the same period in 2007.  This decrease was primarily due to a decrease in the average rate paid on interest-bearing liabilities from 3.71% in 2007 to 3.50% in 2008 reflecting the generally lower rates over the period.  The decrease in interest expense was comprised of a $404,000 decrease in the average rate on deposit accounts from 3.33% to 3.11% offset by a $3.5 million increase in the average balance of deposit accounts.  A decrease in the average rate of FHLB advances from 5.04% in 2007 to 4.74% in 2008 was almost completely offset by the increase in the average balance from $70.8 million to $76.0 million over the same period.

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Provision for Loan Losses.    The evaluation of the level of loan loss reserves is an ongoing process that includes closely monitoring loan delinquencies. The following chart shows delinquent loans as well as a breakdown of non-performing assets.  Over $3.0 million of the total delinquencies are related to scheduled property sales in the first quarter of 2009 and are expected to be paid off or brought current at that time.

	12/31/08		12/31/07		12/31/06
Loans delinquent 30-59 days	$	1,483	$	364	$	1,086
Loans delinquent 60-89 days		3,187		1,763		3,961
Total delinquencies		4,670		2,127		5,070
Accruing loans past due 90 days		0		59		147
Non-accruing loans		7,976		9,935		7,364
Total non-performing loans		7,976		9,994		7,511
OREO		1,412		3,944		4,169
Total non-performing assets	$	9,388	$	13,938	$	11,680

The accrual of interest income is discontinued when a loan becomes 90 days and three payments past due.  Loans 90 days past due but not yet three payments past due will continue to accrue interest as long as it has been determined that the loan is well secured and the borrower has the capacity to repay.  Troubled debt restructurings are considered non-accruing loans until sufficient time has passed for them to establish a pattern of compliance with the terms of the restructure.   Delinquent loans, non-performing loans and other real estate owned (“OREO”) properties all showed improvement compared to the prior quarter and the prior year, reflecting the efforts of the staff and the condition of the local economy.

The decrease in non-performing loans at December 31, 2008 compared to December 31, 2007 was generally due to properties being taken into OREO, payoffs or improvements in the borrower’s situation which brought them back to performing status.  We took $2.3 million of foreclosed properties into OREO in 2008 and sold a total of $4.6 million of OREO properties, writing off $156,000 or 6.8% in the process.

We establish our provision for loan losses based on a systematic analysis of risk factors in the loan portfolio.  The analysis includes consideration of concentrations of

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credit, past loss experience, current economic conditions, the amount and composition of the loan portfolio, estimated fair value of the underlying collateral, delinquencies and other relevant factors.  From time to time, we also use the services of a consultant to assist in the evaluation of our growing commercial real estate loan portfolio. On at least a quarterly basis, a formal analysis of the adequacy of the allowance is prepared and reviewed by management and the Board of Directors.  This analysis serves as a point-in-time assessment of the level of the allowance and serves as a basis for provisions for loan losses.

More specifically, our analysis of the loan portfolio will begin at the time the loan is originated, at which time each loan is assigned a risk rating.  If the loan is a commercial credit, the borrower will also be assigned a similar rating.  Loans that continue to perform as agreed will be included in one of ten non-classified loan categories.  Portions of the allowance are allocated to loan portfolios in the various risk grades, based upon a variety of factors, including historical loss experience, trends in the type and volume of the loan portfolios, trends in delinquent and non-performing loans, and economic trends affecting our market.  Loans no longer performing as agreed are assigned a higher risk rating, eventually resulting in their being regarded as classified loans.  A collateral re-evaluation is completed on all classified loans.  This process results in the allocation of specific amounts of the allowance to individual problem loans, generally based on an analysis of the collateral securing those loans.  These components are added together and compared to the balance of our allowance at the evaluation date.

We recorded a $1.1 million provision for loan losses during 2008 as a result of our analyses of our current loan portfolios, compared to $1.6 million during 2007.  The provisions were necessary to maintain the allowance for loan losses at a level considered adequate to absorb losses inherent and incurred in the loan portfolio.  During the year 2008, we charged $1.2 million against loan loss reserves on 47 loans either written off or taken into other real estate owned in 2008.  We expect to obtain possession of more properties in 2009 that are currently in the process of foreclosure.  The final disposition of these properties may be expected to result in a loss in some cases.  The $1.1 million provision for loan losses in 2008 was considered adequate to cover further charge-offs based on our evaluation and our loan mix.

At December 31, 2008, non-performing assets, consisting of non-performing loans, accruing loans 90 days or more delinquent and other real estate owned, totaled $9.4 million compared to $13.9 million at December 31, 2007.  In addition to our non-performing assets, we identified $5.2 million in other loans of concern where information about possible credit problems of borrowers causes management to have doubts as to the ability of the borrowers to comply with present repayment terms and that may result in disclosure of such loans as non-performing assets in the future.  The vast majority of these loans, as well as our non-performing assets, are well collateralized.

At December 31, 2008, we believe that our allowance for loan losses was adequate to absorb estimated incurred losses inherent in our loan portfolio.  Our allowance for losses equaled 1.12% of net loans receivable and 46.35% of non-

21

performing loans at December 31, 2008, compared to 1.23% and 37.04% at December 31, 2007, respectively.  Our nonperforming assets equaled 2.52% of total assets at December 31, 2008 compared to 4.08% at December 31, 2007.

Non-Interest Income.    Non-interest income for the year ended December 31, 2008 increased by $845,000, or 41.30%, compared to the same period in 2007.  The increase was primarily due to a $941,000 decrease in the loss recognized on the sale of OREO properties or adjustments to the values of properties still held to reflect updated appraisal values. There was also a $96,000 increase in other non-interest income primarily due to a $60,000 increase in loan fees due to higher fees for loan closings and an increase in loan modification fees and a $28,000 increase in fees from our new in-house wealth management department.   These increases were partially offset by a $102,000 decrease in service charges and fees on deposit accounts and by an $84,000 decrease in the gain on sale of loans due to the decrease in the volume of loans sold from $19.7 million in 2007 to $10.2 million in 2008.

Non-Interest Expense.    Non-interest expense for the year ended December 31, 2008 decreased $36,000 over the same period in 2007.  The decrease was primarily due to a $236,000 decrease in other expenses largely due to a $132,000 improvement in the costs of disposing of impaired loans and a $70,000 decrease in loan expenses due to the end of a loan promotion in 2007 that waived closing costs, offset by a $97,000 increase in salaries due to costs of staffing the new loan credit department and increased health insurance costs, a $56,000 increase in computer expenses due partly to program enhancements and a $52,000 increase in occupancy costs due primarily to periodic maintenance costs.

Income Tax Expense.    Our income tax provision decreased by $11,000 for the year ended December 31, 2008 compared to the year ended December 31, 2007 primarily due to decreases in effective state income tax expense as well as increases in income not subject to tax.

Asset/Liability Management

We, like other financial institutions, are subject to interest rate risk to the extent that our interest-bearing liabilities reprice on a different basis than our interest-earning assets.  The Office of Thrift Supervision (“OTS”), our primary regulator, supports the use of a net portfolio value (“NPV”) approach to the quantification of interest rate risk.  In essence, this approach calculates the difference between the present value of expected cash flows from assets and the present value of expected cash flows from liabilities, as well as cash flows from off-balance-sheet contracts.  An NPV ratio in any interest rate scenario, is defined as the NPV in that rate scenario divided by the market value of assets in the same scenario—essentially a market value adjusted capital ratio.

It has been and continues to be a priority of the Board of Directors and management to manage interest rate risk to maintain an acceptable level of potential changes to interest income as a result of interest rate changes.  Our asset/liability policy,

22

established by the Board of Directors, sets forth acceptable limits on the amount of change in net portfolio value given certain changes in interest rates.  We have an asset/liability management committee which meets quarterly to review our interest rate position, and an investment committee which reviews the interest rate risk position and other related matters with the Board of Directors, and makes recommendations for adjusting this position to the full Board of Directors.  In addition, the investment committee of the Board of Directors meets semi-annually with our outside investment advisors to review our investment portfolio and strategies relating to interest rate risk.  Specific strategies have included the sale of long-term, fixed rate loans to reduce the average maturity of our interest-earning assets and the use of FHLB advances to lengthen the effective maturity of our interest-bearing liabilities.  In the future, our community banking emphasis, including the origination of commercial business loans, is intended to further increase our portfolio of short-term and/or adjustable rate loans.

Presented below, as of December 31, 2008 and 2007, is an analysis of our interest rate risk as measured by the effect on NPV caused by instantaneous and sustained parallel shifts in the yield curve, in 100 basis point increments, up 300 basis points and down 200 basis points, and compared to our Board policy limits.  (One hundred basis points equals one percent.)   The Board Limit column indicates the lowest allowable limits for NPV after each interest rate shock.  Assumptions used in calculating the amounts in this table are OTS assumptions.  No information is provided for a negative 200 basis point shift in interest rates, due to a low prevailing interest rate environment making such scenarios unlikely.

Change in		Board Limit		At December 31, 2008				At December 31, 2007
Interest Rate		Post-shock		Post-shock		Change		Post-shock		Change
(Basis Points)		NPV Ratio		NPV Ratio		(Basis Points)		NPV Ratio		(Basis Points)
300	bp	6.00	%	9.27	%	(113	)	10.59	%	(128	)
200		7.00		9.81		(59	)	11.21		(65	)
100		8.00		10.18		(22	)	11.62		(24	)
0		8.00		10.40		---		11.86		---
-100		8.00		10.40		---		11.97		11
-200		7.00						12.04		18

In evaluating our exposure to interest rate risk, certain shortcomings inherent in the method of analysis presented in the foregoing table must be noted.  For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates.  Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates.  Further, in the event of a change in interest rates, prepayments and early withdrawal levels may deviate significantly from those assumed in calculating the table.  Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase.  As a result, the actual effect of changing interest rates may differ from that presented in the foregoing table.

23

Liquidity and Capital Resources

Our primary sources of funds are deposits, repayment and prepayment of loans, interest earned on or maturation of investment securities and short-term investments, borrowings and funds provided from operations.  While maturities and the scheduled amortization of loans, investments and mortgage-backed securities are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general market interest rates, economic conditions and competition.

We monitor our cash flow carefully and strive to minimize the level of cash held in low-rate overnight accounts or in cash on hand.  We also carefully track the scheduled delivery of loans committed for sale to be added to our cash flow calculations.

Our primary investing activities are the origination of loans and the purchase of securities.   During the year ended December 31, 2008, the Bank originated loans totaling $114.0 million and purchased no securities.  These activities were funded primarily by principal repayments and prepayments on loans and maturities of investment securities totaling $74.3 million.The proceeds from the sale of loans totaled $10.2 million for the year ended December 31, 2008.  There were no security sales in 2007 or 2008.

Because there was an increase in the balance of loans in our portfolio in 2008, increases in our deposits, primarily time deposits were also used to fund loans.  We also currently use, and intend to continue to use, FHLB advances as a source of funding for loans when advantages on interest rate risk matches can be found.

Liquidity management is both a daily and long-term function for our senior management.  We adjust our investment strategy, within the limits established by the investment policy, based upon assessments of expected loan demand, expected cash flows, FHLB advance opportunities, market yields and the objectives of our asset/liability management program.  Base levels of liquidity have generally been invested in interest-earning overnight and time deposits with the Federal Home Loan Bank of Indianapolis.  Funds for which a demand is not foreseen in the near future are invested in investment and other securities for the purpose of yield enhancement and asset/liability management.

Our current internal policy for liquidity is 4%.  Our liquidity ratio at December 31, 2008 was 5.07% as a percentage of total assets.

We anticipate that we will have sufficient funds available to meet current loan commitments.  At December 31, 2008 we had outstanding commitments to originate loans and available lines of credit totaling $41.3 million and commitments to provide borrowers the funds needed to complete current construction projects in the amount of $4.2 million.  Certificates of deposit that will mature in one year or less at December 31, 2008 totaled $128.0 million.  Based on our experience, our certificates of deposit have been a relatively stable source of long-term funds as such certificates are generally renewed upon maturity since we have established long-term banking relationships with

24

our customers.  Therefore, we believe a significant portion of such deposits will remain with us, although that cannot be assured.  An exception to this rule would be the brokered certificates of deposit.  Of the certificates maturing in one year or less at December 31, 2008, $39.8 million were brokered deposits which will be leaving the bank at maturity.  However, there is no reason to expect that replacement funds would not be available in the brokered market.

LSB Financial also has a need for, and sources of, liquidity.  Liquidity is required to fund our operating expenses and fund stock repurchase programs, as well as for the payment of dividends to shareholders.  At December 31, 2008, LSB Financial had $10,000 in liquid assets on hand.  The primary source of liquidity on an ongoing basis is dividends from Lafayette Savings.  Dividends totaling $1.6 million were paid from the Bank to LSB Financial during the year ended December 31, 2008.  For the year ended December 31, 2008, LSB Financial paid dividends to shareholders totaling $1.6 million.

Regulatory agencies have established capital adequacy standards which are used in their monitoring and control of the industry.  These standards relate capital to levels of risk by assigning different weightings to assets and certain off-balance-sheet activity.  As shown in Note 11 to the Consolidated Financial Statements (“Regulatory Matters”), our capital levels exceed the requirements to be considered well capitalized at December 31, 2008.

Off-Balance-Sheet Arrangements

As of the date of this Annual Report, we do not have any off-balance-sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, change in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.  The term “off-balance-sheet arrangement” generally means any transaction, agreement, or other contractual arrangement to which any entity unconsolidated with the Company is a party and under which the Company has (i) any obligation arising under a guarantee contract, derivative instrument or variable interest or (ii) a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets.

See Note 16 to the Consolidated Financial  Statements regarding off-balance-sheet commitments.

25

Future Accounting Matters

Statement of Financial Accounting Standards No. 141 (Revised 2007), Business Combinations (“SFAS 141(R)”).   During December 2007, the FASB issued SFAS 141(R). This Statement replaces SFAS 141 “Business Combinations” (“Statement 141”). SFAS 141(R) retains the fundamental requirements in Statement 141 that the acquisition method of accounting (called the ’purchase method’) be used for all business combinations and for an acquirer to be identified for each business combination. This Statement defines the acquirer as the entity that obtains control of one or more businesses, including those sometimes referred to as “true mergers” or “mergers of equals” and combinations achieved without the transfer of consideration, for example, by contract alone or through the lapse of minority veto rights. This is broader than in Statement 141 which applied only to business combinations in which control was obtained by transferring consideration. This Statement requires an acquirer to recognize the assets acquired, liabilities assumed and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date. SFAS 141(R) recognizes and measures the goodwill acquired in the business combination and defines a bargain purchase as a business combination in which the total acquisition-date fair value of the identifiable net assets acquired exceeds the fair value of the consideration transferred plus any noncontrolling interest in the acquiree, and it requires the acquirer to recognize that excess as a gain attributable to the acquirer. In contrast, Statement 141 required the “negative goodwill” amount to be allocated as a pro rata reduction of the amounts assigned to assets acquired. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after December 15, 2008. An entity may not apply it before that date.

Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (“SFAS 158”).   In September 2006, the FASB issued SFAS 158. Except for the measurement requirement, the Corporation adopted this accounting guidance as of December 31, 2006. Additional information regarding the adoption of SFAS 158 is included in Note 1 to the Consolidated Financial Statements (“Summary of Significant Accounting Policies”). The requirement to measure plan assets and benefit obligations as of the end of an employer’s fiscal year is effective for years ending after December 15, 2008 (December 31, 2008 for the Corporation). Adoption of this guidance did not have a material effect on the Corporation’s financial condition or results of operations.

Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51 (“SFAS 160”). During December 2007, the FASB issued SFAS 160 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statement, but separate from the parent’s equity. Before the Statement was issued these so-called minority interests were reported in the consolidated

26

statement of financial position as liabilities or in the mezzanine section between liabilities and equity. The amount of consolidated net income attributable to the parent and to the noncontrolling interest must be clearly identified and presented in the consolidated statement of income. This Statement requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. Management does not anticipate that this Statement will have a material impact on the Corporation’s consolidated financial condition or results of operations.

Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133 (“SFAS 161”).   During March 2008, the FASB issued SFAS 161. SFAS 161 amends and expands the disclosure requirement of SFAS 133 No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments; (b) how derivative instrument and related hedged items are accounted for under SFAS 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. To meet those objectives, SFAS 161 requires qualitative disclosures about objectives and strategies for using derivative, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. Early application is encouraged.

Statement of Financial Accounting Standards, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”).   During May 2008, the FASB issued SFAS 162. This Statement identifies the sources of account principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States. This Statement is effective 60 days following the SEC approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” Adoption of SFAS 162 will not be a change in the Corporation’s current accounting practices; therefore, it will not have a material impact on the Corporation’s consolidated financial condition or results of operations.

FASB Staff Position EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities (“FSP EITF 03-6-1”).   During June 2008, the FASB issued FSP EITF 03-6-1. FSP EITF 03-6-1 clarifies whether instruments, such as restricted stock, granted in share-based payments are participating securities prior to vesting. Such participating securities must be included in the computation of earnings per share under the two-class method as described in SFAS No. 128, “Earnings per Share.” FSP EITF 03-6-1 requires companies to treat unvested share-based payment awards that have non-forfeitable rights to dividend or

27

dividend equivalents as a separate class of securities in calculating earnings per share. FSP EITF 03-6-1 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008, and requires a company to retrospectively adjust its earning per share data. Early adoption is not permitted. It is not expected that the adoption of FSP EITF 03-6-1 will have a material effect on consolidated results of operations or earnings per share.

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Impact of Inflation and Changing Prices

The Consolidated Financial Statements presented herein have been prepared in accordance with generally accepted accounting principles.  These principles require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.

The Company’s primary assets and liabilities are monetary in nature.  As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation.  Interest rates, however, do not necessarily move in the same direction or with the same magnitude as the price of goods and services, since such prices are affected by inflation.  In a period of rapidly rising interest rates, the liquidity and maturities structures of our assets and liabilities are critical to the maintenance of acceptable performance levels.

The principal effect of inflation, as distinct from levels of interest rates, on earnings is in the area of noninterest expense.  Such expense items as employee compensation, employee benefits and occupancy and equipment costs may be subject to increases as a result of inflation.  An additional effect of inflation is the possible increase in the dollar value of the collateral securing loans that the Company has made.  The Company is unable to determine the extent, if any, to which properties securing our loans have appreciated in dollar value due to inflation.

Quarterly Results of Operations

Quarter Ending	Interest Income		Interest Expense		Net Interest Income		Provision For Loan Losses		Net Income			Basic Earnings Per Share			Diluted Earnings Per Share
2008
March	$	5,421	$	2,878	$	2,543	$	250	$	515		$	0.33		$	0.33
June		5,374		2,774		2,600		250		521			0.34			0.33
September		5,295		2,855		2,440		352		392			0.25			0.25
December		5,229		2,779		2,450		250		312			0.20			0.20
	$	21,319	$	11,286	$	10,033	$	1,102	$	1,740
2007
March	$	5,869	$	2,903	$	2,966	$	250	$	779		$	0.49		$	0.48
June		5,728		2,854		2,874		490		451			0.28			0.28
September		5,769		2,929		2,840		180		717			0.46			0.46
December		5,516		2,969		2,547		650		(373	)		(0.24	)		(0.24	)
	$	22,882	$	11,655	$	11,227	$	1,570	$	1,574

29

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

This document, including information included or incorporated by reference, contains, and future filings by LSB Financial on Form 10-K, Form 10-Q and Form 8-K and future oral and written statements by LSB Financial and our management may contain, forward-looking statements about LSB Financial and its subsidiaries which we believe are within the meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements include, without limitation, statements with respect to anticipated future operating and financial performance, growth opportunities, interest rates, cost savings and funding advantages expected or anticipated to be realized by management.  Words such as may, could, should, would, believe, anticipate, estimate, expect, intend, plan and similar expressions are intended to identify forward-looking statements.  Forward-looking statements by LSB Financial and its management are based on beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions of management and are not guarantees of future performance.  We disclaim any obligation to update or revise any forward-looking statements based on the occurrence of future events, the receipt of new information or otherwise.  The important factors we discuss below and elsewhere in this document, as well as other factors discussed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this document and identified in our filings with the SEC and those presented elsewhere by our management from time to time, could cause actual results to differ materially from those indicated by the forward-looking statements made in this document.

The following factors, many of which are subject to change based on various other factors beyond our control, could cause our financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements:

· the strength of the United States economy in general and the strength of the local economies in which we conduct our operations;

· the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board;

· financial market, monetary and interest rate fluctuations, particularly the relative relationship of short-term interest rates to long-term interest rates;

· the timely development of and acceptance of new products and services of Lafayette Savings and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors’ products and services;

· the willingness of users to substitute competitors’ products and services for our products and services;

· the impact of changes in financial services laws and regulations (including laws concerning taxes, accounting standards, banking, securities and insurance);

· the impact of technological changes;

· acquisitions;

· changes in consumer spending and saving habits; and

· our success at managing the risks involved in the foregoing.

30

LSB Financial Corp.

Accountants’ Report and Consolidated Financial Statements

December 31, 2008 and 2007

31

LSB Financial Corp.

December 31, 2008 and 2007

Contents

Report of Independent Registered Public Accounting Firm	33
Consolidated Financial Statements
Balance Sheets	34
Statements of Income	35
Statements of Stockholders’ Equity	36
Statements of Cash Flows	37
Notes to Financial Statements	38

32

Report of Independent Registered Public Accounting Firm

Audit Committee, Board of Directors and Stockholders

LSB Financial Corp.

Lafayette, Indiana

We have audited the accompanying consolidated balance sheets of LSB Financial Corp. as of December 31, 2008 and 2007, and the related consolidated statements of income, stockholders’ equity and cash flows for the years then ended.  The Company's management is responsible for these financial statements.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing auditing procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting.  Accordingly, we express no such opinion.  Our audits also included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of LSB Financial Corp. as of December 31, 2008 and 2007, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 15, the Company changed its method of accounting for fair value measurements in accordance with Statement of Financial Accounting Standards No. 157 in 2008.

BKD,llp

Indianapolis, Indiana

March 16, 2009

33

LSB Financial Corp.

Consolidated Balance Sheets

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Assets

	2008		2007
Cash and due from banks	$	2,046	$	1,644
Short-term investments		9,179		4,846
Cash and cash equivalents		11,225		6,490
Available-for-sale securities		11,853		13,221
Loans held for sale		1,342		—
Loans, net of allowance for loan losses of $3,697 and $3,702		325,297		296,908
Premises and equipment, net		6,461		6,815
Federal Home Loan Bank stock		3,997		3,997
Interest receivable and other assets		6,996		8,966
Bank-owned life insurance		5,841		5,613
Total assets	$	373,012	$	342,010
Liabilities and Stockholders’ Equity
Liabilities
Deposits	$	258,587	$	232,030
Federal Home Loan Bank advances		78,500		74,256
Interest payable and other liabilities		1,850		1,792
Total liabilities		338,937		308,078
Commitments and Contingencies
Stockholders’ Equity
Common stock, $.01 par value; authorized 7,000,000 shares; issued and outstanding 2008 - 1,553,525 shares, 2007 - 1,557,968 shares		15		15
Additional paid-in capital		10,983		11,066
Retained earnings		22,961		22,777
Accumulated other comprehensive income		116		74
Total stockholders’ equity		34,075		33,932
Total liabilities and stockholders’ equity	$	373,012	$	342,010

34

LSB Financial Corp.

Consolidated Statements of Income

Years Ended December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

	2008			2007
Interest and Dividend Income
Loans	$	20,492		$	21,894
Securities
Taxable		463			550
Tax-exempt		273			264
Other		91			174
Total interest and dividend income		21,319			22,882
Interest Expense
Deposits		7,681			8,085
Borrowings		3,605			3,570
Total interest expense		11,286			11,655
Net Interest Income		10,033			11,227
Provision for Loan Losses		1,102			1,570
Net Interest Income After Provision for Loan Losses		8,931			9,657
Noninterest Income
Deposit account service charges and fees		1,736			1,838
Net gains on loan sales		117			201
Net realized gains on calls of available-for-sale securities		—			6
Net loss on other real estate owned		(156	)		(1,097	)
Other		1,194			1,098
Total noninterest income		2,891			2,046
Noninterest Expense
Salaries and employee benefits		4,585			4,488
Net occupancy and equipment expense		1,382			1,330
Computer service		549			493
Advertising		294			299
Other		2,476			2,712
Total noninterest expense		9,286			9,322
Income Before Income Tax		2,536			2,381
Provision for Income Taxes		796			807
Net Income	$	1,740		$	1,574
Basic Earnings Per Share	$	1.12		$	1.00
Diluted Earnings Per Share	$	1.12		$	0.99

See Notes to Consolidated Financial Statements

35

LSB Financial Corp.

Consolidated Statements of Stockholders’ Equity

Years Ended December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

									Accumulated
									Other
			Additional						Comprehensive
	Common		Paid-in			Retained			Income
	Stock		Capital			Earnings			(Loss)			Total
Balance, January 1, 2007	$	15	$	12,227		$	22,623		$	(25	)	$	34,840
Comprehensive income
Net income							1,574						1,574
Change in unrealized appreciation on available-for-sale securities, net of reclassifications and taxes										99			99
Total comprehensive income													1,673
Dividends on common stock, $.90 per share							(1,420	)					(1,420	)
Purchase and retirement of stock (47,500 shares)				(1,212	)								(1,212	)
Stock options exercised (2,259 shares)				34									34
Tax benefit related to stock options exercised				3									3
Amortization of stock option compensation				14									14
Balance, December 31, 2007		15		11,066			22,777			74			33,932
Comprehensive income
Net income							1,740						1,740
Change in unrealized appreciation on available-for-sale securities, net of taxes										42			42
Total comprehensive income													1,782
Dividends on common stock, $1.00 per share							(1,556	)					(1,556	)
Purchase and retirement of stock (8,900 shares)				(165	)								(165	)
Stock options exercised (4,457 shares)				68									68
Tax benefit related to stock options exercised				6									6
Amortization of stock option compensation				8									8
Balance, December 31, 2008	$	15	$	10,983		$	22,961		$	116		$	34,075

See Notes to Consolidated Financial Statements

36

LSB Financial Corp.

Consolidated Statements of Cash Flows

Years Ended December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

	2008			2007
Operating Activities
Net income	$	1,740		$	1,574
Items not requiring (providing) cash
Depreciation		561			522
Provision for loan losses		1,102			1,570
Amortization of premiums and discounts on securities		21			18
Deferred income taxes		12			(328	)
Gain on called available-for-sale securities		—			(6	)
Loss on other real estate owned		156			1,097
Gain on sale of loans		(117	)		(201	)
Loans originated for sale		(11,488	)		(18,558	)
Proceeds on loans sold		10,247			19,735
Compensation cost of stock options		8			14
Tax benefit related to stock options exercised		(6	)		(3	)
Changes in
Interest receivable and other assets		(789	)		(141	)
Interest payable and other liabilities		58			154
Net cash provided by operating activities		1,505			5,447
Investing Activities
Purchases of available-for-sale securities		—			(2,357	)
Proceeds from maturities of available-for-sale securities		1,417			5,606
Net change in loans		(31,779	)		14,887
Proceeds from sale of real estate owned		4,645			2,148
Purchase of premises and equipment		(207	)		(737	)
Net cash provided by (used in) investing activities		(25,924	)		19,547
Financing Activities
Net change in demand deposits, money market, NOW and savings accounts		5,602			663
Net change in certificates of deposit		20,955			(23,937	)
Proceeds from Federal Home Loan Bank advances		40,000			60,000
Repayment of Federal Home Loan Bank advances		(35,756	)		(62,362	)
Proceeds from stock options exercised		68			34
Tax benefit related to stock options exercised		6			3
Repurchase of stock		(165	)		(1,212	)
Dividends paid		(1,556	)		(1,420	)
Net cash provided by (used in) financing activities		29,154			(28,231	)
Increase (Decrease) in Cash and Cash Equivalents		4,735			(3,237	)
Cash and Cash Equivalents, Beginning of Year		6,490			9,727
Cash and Cash Equivalents, End of Year	$	11,225		$	6,490
Supplemental Cash Flows Information
Interest paid	$	11,390		$	11,726
Income taxes paid		387			1,647
Supplemental Non-Cash Disclosures
Capitalization of mortgage servicing rights	$	16		$	16
Loans transferred to other real estate		2,288			3,334

See Notes to Consolidated Financial Statements

37

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Note 1:     Nature of Operations and Summary of Significant Accounting Policies

Nature of Operations

LSB Financial Corp. (“Company”) is a thrift holding company whose principal activity is the ownership and management of its wholly owned subsidiary, Lafayette Savings Bank (the “Bank”).  The Bank is primarily engaged in providing a full range of banking and financial services to individual and corporate customers in Tippecanoe and surrounding counties in Indiana.  The Bank is subject to competition from other financial institutions.  The Bank is subject to the regulation of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities.

The Bank’s wholly owned subsidiaries, LSB Service Corporation (LSBSC) and Lafayette Insurance and Investments, Inc. (LI&I) provide various financial services to its customers.  A substantial portion of the loan portfolio is secured by single and multi-family residential mortgages.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company, the Bank, LSBSC and LI&I.  All significant intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

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

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, fair value of servicing rights and financial instruments.  In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties.

Cash Equivalents

The Company considers all liquid investments with original maturities of three months or less to be cash equivalents.

38

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Securities

Available-for-sale securities, which include any security for which the Company has no immediate plan to sell but which may be sold in the future, are carried at fair value.  Unrealized gains and losses are recorded, net of related income tax effects, in other comprehensive income.

Amortization of premiums and accretion of discounts are recorded as interest income from securities.  Realized gains and losses are recorded as net security gains (losses).  Gains and losses on sales of securities are determined on the specific-identification method.

Loans Held for Sale

Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or fair value in the aggregate.  Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoffs are reported at their outstanding principal balances adjusted for any charge-offs, the allowance for loan losses, any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.  Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term.  Generally, loans are placed on non-accrual status at ninety days past due and interest is considered a loss, unless the loan is well-secured.  Accrued interest for loans placed on non-accrual status is reversed against interest income.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income.  Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

39

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  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, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogenous loans are collectively evaluated for impairment.  Accordingly, the Company does not separately identify individual consumer and residential loans for impairment measurements.

Premises and Equipment

Depreciable assets are stated at cost less accumulated depreciation.  Depreciation is charged to expense using the straight-line and accelerated methods over the estimated useful lives of the assets ranging from 3 to 39 years.

Federal Home Loan Bank Stock

Federal Home Loan Bank stock is a required investment for institutions that are members of the Federal Home Loan Bank system.  The required investment in the common stock is based on a predetermined formula.

Foreclosed Assets Held for Sale

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis.  Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell.  Revenue and expenses from operations and changes in the valuation allowance are included in net income or expense from foreclosed assets.

40

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Servicing Rights

Servicing rights on originated loans that have been sold are initially recorded at fair value.  Capitalized servicing rights are amortized in proportion to and over the period of estimated servicing revenues.  Impairment of mortgage servicing rights is assessed based on the fair value of those rights.  Fair values are estimated using discounted cash flows based on a current market interest rate.  For purposes of measuring impairment, the rights are stratified based on the predominant risk characteristics of the underlying loans.  The predominant characteristic currently used for stratification is type of loan.  The amount of impairment recognized is the amount by which the capitalized mortgage servicing rights for a stratum exceed their fair value and is recorded through a valuation allowance.

Stock Options

At December 31, 2006, the Company has a stock-based employee compensation plan, which is described more fully in Note 13.  Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123(R), Share-Based Payment.

Income Taxes

Deferred tax assets and liabilities are recognized for the tax effects of differences between the financial statement and tax bases of assets and liabilities.  A valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized.  The Company files consolidated income tax returns with its subsidiary.

Earnings Per Share

Earnings per share have been computed based upon the weighted-average common shares outstanding during each year.

Operating Segments

While the chief decision-makers monitor the revenue streams of the various products and services, the identifiable segments are not material and operations are managed and financial performance is evaluated on a Company-wide basis.  Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.

Adoption of Accounting Standards

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.  SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting standards and expands disclosures about fair value measurements.  SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.  The adoption of SFAS No. 157 was not significant to our financial condition or results of operations.

41

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Current Economic Conditions

The current economic environment presents financial institutions with unprecedented circumstances and challenges which in some cases have resulted in large declines in the fair values of investments and other assets, constraints on liquidity and significant credit quality problems, including severe volatility in the valuation of real estate and other collateral supporting loans.  The financial statements have been prepared using values and information currently available to the Company.

Given the volatility of current economic conditions, the values of assets and liabilities recorded in the financial statements could change rapidly, resulting in material future adjustments in asset values, the allowance for loan losses and capital that could negatively impact the Company’s ability to meet regulatory capital requirements and maintain sufficient liquidity.

Note 2:     Restriction on Cash and Due From Banks

The Bank is required to maintain reserve funds in cash and/or on deposit with the Federal Reserve Bank.  The reserve required at December 31, 2008 was $1,085.

Note 3:     Securities

The amortized cost and approximate fair values of securities are as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Approximate Fair Value
Available-for-sale Securities:
December 31, 2008
U.S. Government sponsored agencies	$	500	$	9	$	—		$	509
Mortgage-backed securities		3,661		61		(17	)		3,705
State and political subdivision		7,498		151		(10	)		7,639
	$	11,659	$	221	$	(27	)	$	11,853
December 31, 2007
U.S. Government sponsored agencies	$	500	$	3	$	—		$	503
Mortgage-backed securities		4,782		78		(2	)		4,858
State and political subdivision		7,815		55		(10	)		7,860
	$	13,097	$	136	$	(12	)	$	13,221

42

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

The amortized cost and fair value of available-for-sale securities at December 31, 2008, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized Cost		Fair Value
Within one year	$	810	$	812
One to five years		3,228		3,301
Five to ten years		3,465		3,517
After ten years		495		518
		7,998		8,148
Mortgage-backed securities		3,661		3,705
Totals	$	11,659	$	11,853

Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost.  Total fair value of these investments at December 31, 2008 and 2007 was $2,162 and $2,025, which is approximately 18% and 15% of the Company’s available-for-sale investment portfolio.

Based on evaluation of available evidence, including recent changes in market interest rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these securities are temporary.

Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

The following table shows our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2008:

	Less than 12 Months				12 Months or More				Total
Description of Securities	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-backed securities	$	1,757	$	16	$	59	$	1	$	1,816	$	17
State and political subdivisions		346		10		—		—		346		10
Total temporarily impaired securities	$	2,103	$	26	$	59	$	1	$	2,162	$	27

43

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

The following table shows our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2007:

	Less than 12 Months				12 Months or More				Total
Description of Securities	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-backed securities	$	59	$	—	$	289	$	2	$	348	$	2
State and political subdivisions		—		—		1,677		10		1,677		10
Total temporarily impaired securities	$	59	$	—	$	1,966	$	12	$	2,025	$	12

Note 4: Loans and Allowance for Loan Losses

Categories of loans at December 31, include:

	2008			2007
Real Estate
One-to-four family residential	$	144,100		$	137,611
Multi-family residential		39,892			29,764
Commercial real estate		90,606			71,601
Construction and land development		29,192			27,808
Commercial		14,277			19,307
Consumer and other		1,843			2,439
Home equity lines of credit		13,611			14,018
Total loans		333,521			302,548
Less
Net deferred loan fees, premiums and discounts		(346	)		(357	)
Undisbursed portion of loans		(4,180	)		(1,581	)
Allowance for loan losses		(3,697	)		(3,702	)
Net loans	$	325,297		$	296,908

Activity in the allowance for loan losses was as follows:

	2008			2007
Balance, beginning of year	$	3,702		$	2,770
Provision charged to expense		1,102			1,570
Losses charged off, net of recoveries of $77 for 2008 and $38 for 2007		(1,107	)		(638	)
Balance, end of year	$	3,697		$	3,702

44

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Loan balances to related parties at December 31, 2007 were $1,749 reduced by paydowns of $268 and increased by new debt of $644.  Loans to related parties at December 31, 2008 totaled $2,125.

Impaired loans totaled $5,740 and $7,528 at December 31, 2008 and 2007, respectively.  An allowance for loan losses of $811 and $1,367 relates to impaired loans of $5,490 and $7,528 at December 31, 2008 and 2007, respectively.

Interest of $234 and $764 was recognized on average impaired loans of $6,243 and $8,721 for 2008 and 2007, respectively.  Interest of $234 and $451 was recognized on impaired loans on a cash basis during 2008 and 2007, respectively.

At December 31, 2008 and 2007, accruing loans delinquent 90 days or more totaled $0 and $59, respectively.  Non-accruing loans at December 31, 2008 and 2007 were $7,976 and $9,935, respectively.

Note 5: Premises and Equipment

Major classifications of premises and equipment, stated at cost, are as follows:

	2008			2007
Land	$	1,681		$	1,681
Buildings and improvements		6,386			6,444
Equipment		3,584			3,714
		11,651			11,839
Less accumulated depreciation		(5,190	)		(5,024	)
Net premises and equipment	$	6,461		$	6,815

Note 6: Loan Servicing

Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets.  The unpaid principal balances of mortgage loans serviced for others was $114,612 and $131,157 at December 31, 2008 and 2007, respectively.

45

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Comparable market values and a valuation model that calculates the present value of future cash flows were used to estimate fair value.  For purposes of measuring impairment, risk characteristics including product type, investor type and interest rates, were used to stratify the originated mortgage servicing rights.

	2008			2007
Mortgage servicing rights
Balance, beginning of year	$	1,132		$	1,261
Additions		16			16
Amortization of servicing rights		(157	)		(145	)
Balance, end of year	$	991		$	1,132

The fair value of servicing rights subsequently measured using the amortization method was as follows:

	2008		2007
Fair value, beginning of period	$	1,354	$	1,445
Fair value, end of period		1,340		1,354

Note 7: Deposits

Deposits at year-end are summarized as follows:

	2008					2007
	Amount		Percent			Amount		Percent
Non interest-bearing deposits	$	16,739		6.47	%	$	18,823		8.11	%
NOW accounts		42,006		16.24			36,919		15.92
Savings accounts		22,796		8.82			20,196		8.70
		81,541		31.53			75,938		32.73
Certificates of deposit
0.00% to 1.99%		3,037		1.17			305		.13
2.00% to 3.99%		105,400		40.76			35,925		15.48
4.00% to 5.99%		68,590		26.53			119,844		51.65
6.00% to 7.99%		19		.01			18		.01
		177,046		68.47			156,092		67.27
	$	258,587		100.00	%	$	232,030		100.00	%

46

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

At December 31, 2008, scheduled maturities of certificates of deposit are as follows:

2009	$	128,022
2010		34,253
2011		9,074
2012		2,147
Thereafter		3,550
	$	177,046

Time deposits of $100 or more, including brokered deposits, were $103,470 and $85,082 at December 31, 2008 and 2007.

Deposits from related parties held by the Company at December 31, 2008 and 2007 totaled $1,296 and $1,700, respectively.

Total brokered deposits totaled approximately $61,001 and $52,266 at December 31, 2008 and 2007, respectively.

Note 8: Federal Home Loan Bank Advances

Federal Home Loan Bank advances totaled $78,500 and $74,256 at December 31, 2008 and 2007.  At December 31, 2008, the advances range in interest rates from 0.65% to 6.03% and are secured by mortgage loans totaling $137,183.

Aggregate annual maturities of the advance at December 31, 2008, are:

2009	$	34,500
2010		35,500
2011		8,500
2012		—
Thereafter		—
	$	78,500

Advances totaling $12,500 may, at certain dates, be converted to adjustable rate advances by the FHLB.  If converted, the advances may be prepaid without penalty.

47

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Note 9: Income Taxes

The provision for income taxes includes these components:

	2008		2007
Taxes currently payable	$	784	$	1,135
Deferred income taxes		12		(328	)
Income tax expense	$	796	$	807

A reconciliation of income tax expense at the statutory rate to the Company’s actual income tax expense is shown below:

	2008			2007
Computed at the statutory rate (34%)	$	862		$	810
Increase (decrease) resulting from
Tax exempt interest		(85	)		(76	)
State income taxes		62			78
Other		(43	)		(5	)
Actual tax expense	$	796		$	807

The tax effects of temporary differences related to deferred taxes shown on the balance sheets were:

	2008		2007
Deferred tax assets
Allowance for loan losses	$	1,115	$	1,212
Non-accrual loan income		90		141
Other		143		123
		1,348		1,476
Deferred tax liabilities
Depreciation		181		240
Mortgage servicing rights		417		476
FHLB stock dividends		164		164
Unrealized gain on available-for-sale securities		77		50
Other		174		172
		1,013		1,102
Net deferred tax asset	$	335	$	374

48

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Retained earnings at December 31, 2008 and 2007, include approximately $1,861 for which no deferred federal income tax liability has been recognized.  This amount represents an allocation of income to bad debt deductions for tax purposes only.  Reduction of amounts so allocated for purposes other than tax bad debt losses or adjustments arising from carryback of net operating losses would create income for tax purposes only, which would be subject to the then-current corporate income tax rate.  The deferred income tax liabilities on the preceding amounts that would have been recorded if they were expected to reverse into taxable income in the foreseeable future were approximately $737 at December 31, 2008 and 2007.

Note 10: Other Comprehensive Income

Other comprehensive income components and related taxes were as follows:

	2008		2007
Unrealized gains on available-for-sale securities	$	70	$	170
Less:  reclassification adjustment for gain realized in the income statement		—		6
Net unrealized gains on available-for-sale securities		70		164
Tax expense		28		65
Other comprehensive income	$	42	$	99

The only component of accumulated other comprehensive income was unrealized gains on securities available for sale.

Note 11: Regulatory Matters

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.  The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

49

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below).  Management believes, as of December 31, 2008 and 2007, that the Bank meets all capital adequacy requirements to which it is subject.

As of December 31, 2008, the most recent notification from the Office of Thrift Supervision categorized the Bank as well capitalized under the regulatory framework for prompt corrective action.  To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table.  There are no conditions or events since that notification that management believes have changed the Bank’s category.

The Bank’s actual capital amounts and ratios are also presented in the table.

	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2008
Total risk-based capital (to risk-weighted assets)	$	36,409		12.8	%	$	22,763		8.0	%	$	28,453		10.0	%
Tier I capital (to risk-weighted assets)		33,763		11.9			11,381		4.0			17,072		6.0
Tier I capital (to adjusted total assets)		33,763		9.1			11,158		3.0			18,597		5.0
Tier I capital (to adjusted tangible assets)		33,763		9.1			7,439		2.0			N/A		N/A
Tangible capital (to adjusted tangible assets)		33,763		9.1			5,579		1.5			N/A		N/A
As of December 31, 2007
Total risk-based capital (to risk-weighted assets)	$	36,320		13.9	%	$	20,954		8.0	%	$	26,192		10.0	%
Tier I capital (to risk-weighted assets)		33,444		12.8			10,477		4.0			15,716		6.0
Tier I capital (to adjusted total assets)		33,444		9.8			10,249		3.0			17,081		5.0
Tier I capital (to adjusted tangible assets)		33,444		9.8			6,833		2.0			N/A		N/A
Tangible capital (to adjusted tangible assets)		33,444		9.8			5,124		1.5			N/A		N/A

The Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval.  At December 31, 2008, regulatory approval was required for all dividend declarations.

LSB converted from a mutual to a stock institution, and a “liquidation account” was established at $8,066, which was net worth reported in the conversion prospectus.  Eligible depositors who have maintained their accounts, less annual reduction to the extent they have reduced their deposits, would receive a distribution from this account if the Bank liquidated.  Dividends may not reduce shareholders’ equity below the required liquidation account balance.

50

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Note 12: Employee Benefits

The Bank maintains an ESOP, which purchased 8% of the stock offered in the conversion using funds provided by an $824 loan from LSB, which was repaid by contributions to the ESOP by the Bank.  Dividends paid on allocated shares are charged to retained earnings.

There was no ESOP expense recorded for 2008 and 2007.

	2008		2007
ESOP shares allocated		96,098		96,013

The Company has a retirement savings 401(k) plan covering substantially all employees.  Employees may contribute up to 100% of their compensation with the Company matching 100% of the employee’s contribution on the first 4% of the employee’s compensation.  Employer contributions charged to expense for 2008 and 2007 were $97 and $100, respectively.

Note 13: Stock Option Plan

The Company’s Incentive Stock Option Plan (Plan), which is shareholder approved, permits the grant of stock options to its directors, officers and other key employees.  The Plan authorized the grant of options for up to 81,000 shares of the Company’s common stock, which generally vest at a rate of 20 percent a year and have a 10-year contractual term.  The Company believes that such awards better align the interests of its directors and employees with those of its shareholders.  Option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of grant.  Certain option awards provide for accelerated vesting if there is a change in control (as defined in the Plans).  The Company generally issues shares from its authorized shares to satisfy option exercises.

A summary of option activity under the Plan as of December 31, 2008, and changes during the years then ended, is presented below:

	2008
	Shares			Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding, beginning of year		41,316		$	18.52
Granted		—			—
Exercised		(4,457	)		15.48
Forfeited or expired		(1,158	)		22.48
Outstanding, end of year		35,701		$	18.77	5.46 years	$	—
Exercisable, end of year		20,202		$	15.47	6.05 years	$	—

51

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

The total intrinsic value of options exercised during the years ended December 31, 2008 and 2007 was $16 and $10, respectively.

As of December 31, 2008, there was $2 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan.  That cost is expected to be recognized over the next year.

Note 14: Earnings Per Share

Earnings per share (EPS) were computed as follows:

	Year Ended December 31, 2008
	Income		Weighted-Average Shares		Per Share Amount
Net income	$	1,740		1,555,206
Basic earnings per share
Income available to common stockholders					$	1.12
Effect of dilutive securities
Stock options				963
Diluted earnings per share
Income available to common stockholders and assumed conversions	$	1,740		1,556,169	$	1.12

23,140 options outstanding at December 31, 2008 were considered anti-dilutive.

	Year Ended December 31, 2007
	Income		Weighted-Average Shares		Per Share Amount
Net income	$	1,574		1,579,792
Basic earnings per share
Income available to common stockholders					$	1.00
Effect of dilutive securities
Stock options				8,978
Diluted earnings per share
Income available to common stockholders and assumed conversions	$	1,574		1,588,770	$	0.99

There were no options outstanding at December 31, 2007 that were considered anti-dilutive.

52

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Note 15: Disclosures About Fair Value of Financial Instruments

Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157 (FAS 157), Fair Value Measurements.  FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  FAS 157 has been applied prospectively as of the beginning of the year.

FAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  FAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputs that may be used to measure fair value:

Level 1 Quoted prices in active markets for identical assets or liabilities.

Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities

Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying consolidated balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Available-for-Sale Securities

Where quoted market prices are not available, fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows.  Level 2 securities include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions.  All of our available-for-sale securities are Level 2 securities.

			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available-for-sale securities	$	11,853	$	—	$	11,853	$	—

53

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Following is a description of the valuation methodologies used for instruments measured at fair value on a non-recurring basis and recognized in the accompanying balance sheet, as well as the general classification of those instruments under the valuation hierarchy.

Impaired Loans

Loan impairment is reported when scheduled payments under contractual terms are deemed uncollectible.  Impaired loans are carried at the present value of estimated future cash flows using the loan’s existing rate, or the fair value of collateral if the loan is collateral dependent.  A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance.  If these allocations cause the allowance for loan losses to increase, such increase is reported as a component of the provision for loan losses.  Loan losses are charged against the allowance when management believes the uncollectability of the loan is confirmed.  During the nine months of 2008, impaired loans were partially charged-off or re-evaluated.  This valuation would be considered Level 3, consisting of appraisals of underlying collateral and discounted cash flow analysis.

The following table presents the fair value measurements of assets and liabilities recognized in the accompanying consolidated balance sheet measured at fair value on a nonrecurring basis and the level within the FAS 157 fair value hierarchy in which the fair value measurements fall at December 31, 2008:

			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	4,803	$	—	$	—	$	4,803

54

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

The following table presents estimated fair values of the Company’s financial instruments recognized in the accompanying balance sheets at amounts other than fair value.  The fair values of certain of these instruments were calculated by discounting expected cash flows, which involves significant judgments by management and uncertainties.  Because no market exists for certain of these financial instruments and because management does not intend to sell these financial instruments, the Company does not know whether the fair values shown below represent values at which the respective financial instruments could be sold individually or in the aggregate.

	December 31, 2008				December 31, 2007
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets
Cash and cash equivalents	$	11,225	$	11,225	$	6,490	$	6,490
Available-for-sale securities		11,853		11,853		13,221		13,221
Loans including loans held for sale, net of allowance for loan losses		326,639		336,892		296,908		300,755
Federal Home Loan Bank stock		3,997		3,997		3,997		3,997
Interest receivable		1,627		1,627		1,641		1,641
Financial liabilities
Deposits		258,587		264,228		232,030		233,566
Federal Home Loan Bank advances		78,500		80,556		74,256		75,248
Interest payable		317		317		421		421

The following methods and assumptions were used to estimate the fair value of each class of financial instruments.

Cash and Cash Equivalents, Interest-Bearing Deposits and Federal Home Loan Bank Stock

The carrying amount approximates fair value.

Securities

Fair values equal quoted market prices, if available.  If quoted market prices are not available, fair value is estimated based on quoted market prices of similar securities.

55

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Loans

The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  Loans with similar characteristics were aggregated for purposes of the calculations.

Deposits

Deposits include demand deposits, savings accounts, NOW accounts and certain money market deposits.  The carrying amount approximates fair value.  The fair value of fixed-maturity time deposits is estimated using a discounted cash flow calculation that applies the rates currently offered for deposits of similar remaining maturities.

Interest Receivable and Interest Payable

The carrying amount approximates fair value.

Federal Home Loan Bank Advances

Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate the fair value of existing debt.

Commitments to Originate Loans, Letters of Credit and Lines of Credit

Loan commitments and letters-of-credit generally have short-term, variable rate features and contain clauses which limit the Bank’s exposure to changes in customer credit quality.  Accordingly, their carrying values, which are immaterial at the respective balance sheet dates, are reasonable estimates of fair value.

Note 16: Commitments and Contingent Liabilities

Some financial instruments, such as loan commitments, credit lines, letters of credit and overdraft protection, are issued to meet customer financing needs.  These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates.  Commitments may expire without being used.  Off-balance-sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated.  The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment.

56

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

At year-end, these financial instruments are summarized as follows:

	2008		2007
Commitments to extend credit
Fixed rate	$	7,678	$	9,215
Variable rate		2,803		830
Unused portions of lines of credit		31,039		26,355
Letters of credit		238		829

The commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established under the contract.  Generally, such commitments are for no more than 60 days.  At December 31, 2007, the fixed rate loan commitments were at rates ranging from 4.63 to 7.25%.  Unused portions of lines of credit include balances available on commercial and home equity loans and are variable rate.

Note 17: Condensed Financial Information (Parent Company Only)

Presented below is condensed financial information as to financial position, results of operations and cash flows of the Company:

Condensed Balance Sheets
	December 31
	2008		2007
Assets
Cash	$	10	$	38
Securities available-for-sale		171		184
Investment in the Bank		33,880		33,565
Other assets		35		166
Total assets	$	34,096	$	33,953
Liabilities	$	21	$	21
Stockholders' Equity		34,075		33,932
Total liabilities and stockholders' equity	$	34,096	$	33,953

57

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Condensed Statements of Income
	Years Ending December 31
	2008			2007
Income
Dividends from the Bank	$	1,606		$	2,275
Other income		10			11
Total income		1,616			2,286
Expenses		(231	)		(251	)
Income Before Income Tax and Equity in Undistributed Income of Subsidiaries		1,385			2,035
Income Tax Benefit		90			98
Income Before Equity in Undistributed Income of Subsidiaries		1,475			2,133
Equity in Undistributed Income of Subsidiaries		265			(559	)
Net Income	$	1,740		$	1,574

Condensed Statements of Cash Flows
	Years Ending December 31
	2008			2007
Operating Activities
Net income	$	1,740		$	1,574
Equity in undistributed (distributions in excess of) income of the Bank		(265	)		559
Change in other assets		131			443
Net cash provided by operating activities		1,606			2,576
Investing Activities
Proceeds from paydowns of securities		13			11
Proceeds from ESOP loan repayment		—			—
Net cash provided by investing activities		13			11
Financing Activities
Dividends paid		(1,556	)		(1,420	)
Stock options exercised		74			37
Repurchase of stock		(165	)		(1,212	)
Net cash used in financing activities		(1,647	)		(2,595	)
Net Change in Cash		(28	)		(8	)
Cash at Beginning of Year		38			46
Cash at End of Year	$	10		$	38

58

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Note 18: Recent Accounting Pronouncements

Future Accounting Matters

Statement of Financial Accounting Standards No. 141 (Revised 2007), Business Combinations (SFAS 141(R)).  During December 2007, the FASB issued SFAS 141(R).  This Statement replaces SFAS 141, Business Combinations (Statement 141).  SFAS 141(R) retains the fundamental requirements in Statement 141 that the acquisition method of accounting (called the “purchase method”) be used for all business combinations and for an acquirer to be identified for each business combination.  This Statement defines the acquirer as the entity that obtains control of one or more businesses, including those sometimes referred to as “true mergers” or “mergers of equals” and combinations achieved without the transfer of consideration, for example, by contract alone or through the lapse of minority veto rights.  This is broader than in Statement 141, which applied only to business combinations in which control was obtained by transferring consideration.  This Statement requires an acquirer to recognize the assets acquired, liabilities assumed and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date.  SFAS 141(R) recognizes and measures the goodwill acquired in the business combination and defines a bargain purchase as a business combination in which the total acquisition-date fair value of the identifiable net assets acquired exceeds the fair value of the consideration transferred plus any noncontrolling interest in the acquiree, and it requires the acquirer to recognize that excess as a gain attributable to the acquirer.  In contrast, Statement 141 required the “negative goodwill” amount to be allocated as a pro rata reduction of the amounts assigned to assets acquired.  SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after December 15, 2008.  An entity may not apply it before that date.

Statement of Financial Accounting Standards No. 160 (SFAS 160), Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51.  During December 2007, the FASB issued SFAS 160 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary.  It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statement, but separate from the parent’s equity.  Before the Statement was issued, these so-called minority interests were reported in the consolidated statement of financial position as liabilities or in the mezzanine section between liabilities and equity.  The amount of consolidated net income attributable to the parent and to the noncontrolling interest must be clearly identified and presented in the consolidated statement of income.  This Statement requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008.  Earlier adoption is prohibited.  Management does not anticipate that this Statement will have a material impact on the Company consolidated financial condition or results of operations.

59

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Statement of Financial Accounting Standards No. 161 (SFAS 161), Disclosures About Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133.  During March 2008, the FASB issued SFAS 161.  SFAS 161 amends and expands the disclosure requirement of SFAS No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities, with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments; (b) how derivative instrument and related hedged items are accounted for under SFAS 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows.  To meet those objectives, SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements.  SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.  Early application is encouraged.

Statement of Financial Accounting Standards (SFAS 162), The Hierarchy of Generally Accepted Accounting Principles.  During May 2008, the FASB issued SFAS 162.  This Statement identifies the sources of account principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States.  This Statement is effective 60 days following the SEC approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.  Adoption of SFAS 162 will not be a change in the Company’s current accounting practices; therefore, it will not have a material impact on the Company’s consolidated financial condition or results of operations.

FASB Staff Position EITF 03-6-1 (FSP EITF 03-6-1), Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities.  During June 2008, the FASB issued FSP EITF 03-6-1.  FSP EITF 03-6-1 clarifies whether instruments, such as restricted stock, granted in share-based payments are participating securities prior to vesting.  Such participating securities must be included in the computation of earnings per share under the two-class method as described in SFAS No. 128, Earnings per Share.  FSP EITF 03-6-1 requires companies to treat unvested share-based payment awards that have non-forfeitable rights to dividend or dividend equivalents as a separate class of securities in calculating earnings per share.  FSP EITF 03-6-1 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008, and requires a company to retrospectively adjust its earning per share data.  Early adoption is not permitted.  It is not expected that the adoption of FSP EITF 03-6-1 will have a material effect on consolidated results of operations or earnings per share.

60

LSB Financial Corp.

Notes to Consolidated Financial Statements

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Data)

Note 19: Federal Deposit Insurance Corporation (FDIC) Special Assessment

Subsequent to December 31, 2008, the Board of Directors of the FDIC voted to adopt an interim rule that would impose a special assessment on insured institutions on outstanding deposits as of June 30, 2009.  This assessment is to be collected on September 30, 2009.  The interim rule would also permit the Board to impose an emergency special assessment after June 30, 2009, of up to 10 basis points on outstanding deposits, if deemed necessary by the Board.  Assuming that deposit levels remain constant, we anticipate that the special assessment for the Bank would total approximately $517 at the 20 basis points level, but if the FDIC is able to reduce the special assessment to 10 basis points, the Bank’s assessment would total approximately $258.

61

LSB FINANCIAL CORP.

and

Lafayette Savings Bank, FSB

Directors and Executive Officers

Directors

Randolph F. Williams President and Chief Executive Officer,   LSB Financial and Lafayette Savings	Philip W. Kemmer Transportation Supervisor,   Lafayette School Corp., retired
Mariellen M. Neudeck Chairman of the Board, LSB Financial and   Lafayette Savings Vice President, Greater Lafayette  Health Services, Inc., retired	Thomas R. McCully Partner, Stuart & Branigin Peter Neisel Owner, President and CEO, Schwab Corp., retired
James A. Andrew President and Owner, Henry Poor Lumber Co. and Homeworks	Jeffrey A. Poxon Senior Vice President, Investments and   Chief Investment Officer, The Lafayette Life Insurance Company
Kenneth P. Burns Executive Vice President and Treasurer,   Purdue University, retired	Charles W. Shook President and Owner, The Shook Agency
Mary Jo David Vice President, Chief Financial Officer   and Secretary-Treasurer of LSB Financial and Lafayette Savings

Executive Officers

Randolph F. Williams President and Chief Executive Officer     Mary Jo David Vice President, Chief Financial Officer   and Secretary-Treasurer    

62

DIRECTORS AND OFFICERS

    James A. Andrew.  Mr. Andrew is President and owner of Henry Poor Lumber Co. and Homeworks, retailers of building materials.  He is also involved in residential and commercial land development.

    Kenneth P. Burns.  Mr. Burns served as Executive Vice President and the Treasurer of Purdue University prior to his retirement on August 31, 2005.

    Philip W. Kemmer.  Mr. Kemmer is currently employed by Greater Lafayette Public Transportation Corporation.  Formerly he served as Transportation Supervisor for the Lafayette School Corp. until his retirement from that position in July 2003.  Prior to joining the Lafayette School Corp., Mr. Kemmer was the business administrator for the Assembly of God Church from July 1995 through December 1999.

    Randolph F. Williams.  Mr. Williams is President and Chief Executive Officer of LSB Financial and its wholly-owned subsidiary, Lafayette Savings.  Mr. Williams was appointed to the Board of Directors of LSB Financial in September 2001.  He was appointed President of LSB Financial in September 2001 and Chief Executive Officer in January 2002.  Mr. Williams served as President and Chief Operating Officer of Delaware Place Bank in Chicago, Illinois from 1996 until joining LSB Financial.  Mr. Williams has over 25 years of banking-related experience.

    Mary Jo David.  Ms. David is Vice President, Chief Financial Officer and Secretary of LSB Financial and Lafayette Savings.  She has held these positions with LSB Financial since its formation in 1994 and with Lafayette Savings since 1992 and was elected a Director of LSB Financial and Lafayette Savings in 1999.

    Thomas R. McCully.  Mr. McCully is a partner in the law firm of Stuart & Branigin LLP and has worked there since 1966.

    Mariellen M. Neudeck.  Ms. Neudeck, retired as of June 30, 2001, was a Vice President of Greater Lafayette Health Services, Inc. where she was responsible for 18 professional services departments operating in two hospitals.  She was elected as Chairman of the Board of Lafayette Savings in 1993 and of LSB Financial in 1994.

    Peter Neisel.  Mr. Neisel, retired as of December 31, 2002, was the Owner, President and Chief Executive Officer of Schwab Corp., a manufacturer and seller of office equipment.

    Jeffrey A. Poxon.  Mr. Poxon is the Senior Vice President-Investments and Chief Investment Officer of The Lafayette Life Insurance Company.

Charles W. Shook.  Mr. Shook is the President and owner of the Shook Agency, a residential and commercial real estate brokerage firm based in Lafayette, Indiana.

63

SHAREHOLDER INFORMATION

Corporate Office   101 Main Street Lafayette, Indiana 47902   Branch Offices   1020A Sagamore Park Centre West Lafayette, IN 47906   1501 Sagamore Parkway North Lafayette, Indiana 47905   833 Twyckenham Boulevard Lafayette, Indiana 47905   3510 S.R. 38 E Lafayette, Indiana 47905     Independent Auditors   BKD, LLP 201 N. Illinois Street, Suite 700 P.O. Box 44998 Indianapolis, Indiana 46244-0998   Transfer Agent   Computershare Investor Services 350 Indiana Street, Suite 800 Golden, Colorado 80401   Local Counsel   Stuart & Branigin LLP 300 Main Street, Suite 800 Lafayette, Indiana  47902   Special Counsel   Barnes & Thornburg LLP 11 South Meridian Street Indianapolis, Indiana  46204    

Form 10-K Report

A copy of LSB Financial’s Annual Report on Form 10-K without exhibits for the fiscal year ended December 31, 2008, as filed with the SEC, will be furnished without charge to shareholders of LSB Financial upon written request to the Secretary, LSB Financial Corp., 101 Main Street, P.O. Box 1628, Lafayette, Indiana 47902, or by calling (765) 742-1064.  Copies of the exhibits filed with the Form 10-K may be obtained by shareholders at a charge of $0.25 per page.

64

Common Stock

As of February 22, 2008, there were approximately 985 holders of record of LSB Financial Common Stock and 1,553,525 shares of issued and outstanding common stock.   LSB Financial’s stock is quoted on the Nasdaq National Stock Market under the symbol “LSBI.”

The following table sets forth, for the periods shown, the high and low sale price of the common stock and cash dividends per share declared.  All amounts have been adjusted to reflect stock dividends and stock splits declared by the Company to date.  The last stock dividend was declared in 2006.

Quarter Ended	High	Low	Cash Dividends Declared
March 31, 2007	26.90	24.25	0.20
June 30, 2007	26.00	24.80	0.20
September 30, 2007	26.515	23.00	0.25
December 31, 2007	24.85	18.41	0.25
March 31, 2008	19.94	18.15	0.25
June 30, 2008	19.35	16.21	0.25
September 30, 2008	19.50	14.52	0.25
December 31, 2008	17.00	9.94	0.25

Dividend payment decisions are made with consideration of a variety of factors including earnings, financial condition, market considerations and regulatory restrictions.  Restrictions on dividend payments are described in Note 11 of the Notes to Consolidated Financial Statements included in this Annual Report.

65

Performance Graph

The following graph shows the performance of the Company’s common stock since December 31, 2003 in comparison to the NASDAQ Composite Index, the NASDAQ Bank Index and the SNL Bank and Thrift Index.

 

EX-21

EXHIBIT 21

SUBSIDIARIES OF THE REGISTRANT

Parent	Subsidiary	Jurisdiction of Incorporation of Subsidiary
LSB Financial Corp.	Lafayette Savings Bank, FSB	Federal
Lafayette Savings Bank, FSB	L.S.B. Service Corporation	Indiana
Lafayette Savings Bank, FSB	Lafayette Insurance and Investments, Inc.	Indiana

The financial statements of LSB Financial Corp. are consolidated with those of its subsidiaries.

EX-23

EXHIBIT 23

Consent of Independent Registered Public Accounting Firm

We consent to the incorporation by reference in the Registration Statements on Form S-8 File Nos. 33-98518, 33-98516, and 333-143442of LSB Financial Corp. of our Report of Independent Registered Public Accounting Firm, dated March 16, 2009 on the consolidated balance sheets of LSB Financial Corp. as of December 31, 2008 and 2007 and on the consolidated statements of income, changes in shareholders’ equity and cash flows for the years then ended, which report is included in Form 10-K of LSB Financial Corp. for the year ended December 31, 2008.

Indianapolis, Indiana

March 30, 2009

EX-31.1

EXHIBIT 31.1

CERTIFICATION

I, Randolph F. Williams, certify that:

1.   I have reviewed this annual report on Form 10-K of LSB Financial Corp. (the “Registrant”);

2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.   Based on my knowledge, the consolidated financial statements, and other financial information included in this report, fairly present in all material respects the consolidated financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;

4.   The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have:

a.   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b.   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c.   Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

d.   Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that have materially affected, or are reasonably likely to materially affect, the Registrant’s internal control over financial reporting.

5.   The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of the Registrant’s board of directors (or persons performing the equivalent functions):

a.   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and

b.   Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Dated:	March 31, 2009	/s/ Randolph F. Williams
		Randolph F. Williams
		President and Chief Executive Officer

EX-31.2

EXHIBIT 31.2

CERTIFICATION

I, Mary Jo David, certify that:

1.   I have reviewed this annual report on Form 10-K of LSB Financial Corp. (the “Registrant”);

2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.   Based on my knowledge, the consolidated financial statements, and other financial information included in this report, fairly present in all material respects the consolidated financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;

4.   The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have:

a.   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b.   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c.   Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

d.   Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that have materially affected, or are reasonably likely to materially affect, the Registrant’s internal control over financial reporting.

5.   The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of the Registrant’s board of directors (or persons performing the equivalent functions):

a.   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and

b.   Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Dated:	March 31, 2009	/s/ Mary Jo David
		Mary Jo David
		Vice President and Chief Financial Officer

EX-32

EXHIBIT 32

CERTIFICATION

By signing below, each of the undersigned hereby certifies pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, in his or her capacity as an officer of LSB Financial Corp. (the “Registrant”) that (i) this report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and (ii) the information contained in this report fairly presents, in all material respects, the consolidated financial condition of the Registrant at the end of such period and the results of operations of the Registrant for such period.

Signed this 31st day of March, 2009.

/s/ Randolph F. Williams	/s/ Mary Jo David
Randolph F. Williams	Mary Jo David
President and Chief Executive Officer	Vice President and Chief Financial Officer

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to LSB Financial Corp. and will be retained by LSB Financial Corp. and furnished to the Securities and Exchange Commission or its staff upon request.