UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
	SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended June 30, 2013
	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 incorporation or organization)	(I.R.S. Employer 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)

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

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]

The number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date is indicated below.

Class	Outstanding at August 10, 2013
Common Stock, $.01 par value per share	1,559,343 shares

LSB FINANCIAL CORP.

INDEX

PART I  FINANCIAL INFORMATION		1
Item 1.	Financial Statements	1
	Consolidated Condensed Balance Sheets	1
	Consolidated Condensed Statements of Income and Comprehensive Income	2
	Consolidated Condensed Statements of Changes in Shareholders’ Equity	3
	Consolidated Condensed Statements of Cash Flows	4
	Notes to Consolidated Condensed Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	47
Item 4.	Controls and Procedures.	49
PART II.  OTHER INFORMATION		49
Item 1.	Legal Proceedings	49
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	52
Item 3.	Defaults Upon Senior Securities	52
Item 4.	Mine Safety Disclosures	52
Item 5.	Other Information	52
Item 6.	Exhibits	53
SIGNATURES		54

  i

PART I  FINANCIAL INFORMATION

Item 1.  Financial Statements

LSB FINANCIAL CORP.

Consolidated Condensed Balance Sheets

(Dollars in thousands, except per share data)

	June 30, 2013			December 31, 2012
	(unaudited)
Assets
Cash and due from banks	$	1,349		$	25,643
Interest-bearing deposits		23,701			5,778
Cash and cash equivalents		25,050			31,421
Interest-bearing time deposits		1,748			1,740
Available-for-sale securities		47,780			28,004
Loans held for sale		1,476			1,363
Total loans		273,342			286,157
Less: Allowance for loan losses		(6,346	)		(5,900	)
Net loans		266,996			280,257
Premises and equipment, net		7,243			7,069
Federal Home Loan Bank stock, at cost		3,185			3,185
Bank owned life insurance		6,671			6,595
Interest receivable and other assets		5,263			4,976
Total assets	$	365,412		$	364,610
Liabilities and Shareholders’ Equity
Liabilities
Deposits	$	313,856		$	308,637
Federal Home Loan Bank advances		10,000			15,000
Interest payable and other liabilities		1,986			2,018
Total liabilities		325,842			325,655
Commitments and Contingencies
Shareholders’ Equity
Common stock, $.01 par value
Authorized - 7,000,000 shares Issued and outstanding 2013 - 1,559,343 shares, 2012 - 1,555,972 shares		15			15
Additional paid-in-capital		11,151			11,121
Retained earnings		28,656			27,495
Accumulated other comprehensive income (loss)		(252	)		324
Total shareholders’ equity		39,570			38,955
Total liabilities and shareholders’ equity	$	365,412		$	364,610

See notes to consolidated condensed financial statements.

1

LSB FINANCIAL CORP.

Consolidated Condensed Statements of Income and Comprehensive Income

(Dollars in thousands, except per share data)

(Unaudited)

	Three months ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
Interest and Dividend Income
Loans	$	3,261		$	3,806		$	6,738		$	7,881
Securities
Taxable		141			90			245			157
Tax-exempt		49			39			94			78
Other		11			15			27			29
Total interest and dividend income		3,462			3,950			7,104			8,145
Interest Expense
Deposits		537			747			1,106			1,558
Borrowings		59			104			138			204
Total interest expense		596			851			1,244			1,762
Net Interest Income		2,866			3,099			5,860			6,383
Provision for Loan Losses		225			500			625			1,100
Net Interest Income After Provision for Loan Losses		2,641			2,599			5,235			5,283
Non-interest Income
Deposit account service charges and fees		300			321			573			646
Net gains on loan sales		527			425			957			832
Loss on other real estate owned		---			(56	)		(2	)		(139	)
Other		331			185			749			445
Total non-interest income		1,158			875			2,277			1,784
Non-Interest Expense
Salaries and employee benefits		1,551			1,496			3,078			3,015
Net occupancy and equipment expense		321			283			640			601
Computer service		156			152			297			300
Advertising		97			89			212			177
FDIC insurance premiums		117			120			233			240
Other		528			543			985			1,011
Total non-interest expense		2,770			2,683			5,445			5,344
Income  Before Income Taxes		1,029			791			2,067			1,723
Provision for Income Taxes		365			282			750			619
Net Income		664			509			1,317			1,104
Unrealized appreciation (depreciation) on available-for-sale securities net of taxes of ($391) and $49 for the three months ended June 30, 2013 and 2012, and of ($384) and $36, for the six months ended June 30, 2013 and 2012, respectively		(587	)		73			(576	)		54
Total comprehensive income	$	77		$	582		$	741		$	1,158
Basic Earnings Per Share	$	0.43		$	0.33		$	0.85		$	0.71
Diluted Earnings Per Share	$	0.42		$	0.33		$	0.85		$	0.71
Dividends Declared Per Share	$	0.05		$	0.00		$	0.10		$	0.00

See notes to consolidated condensed financial statements.

2

LSB FINANCIAL CORP.

Consolidated Condensed Statements of Changes in Shareholders’ Equity

For the Six Months Ended June 30, 2013 and 2012

 (Dollars in thousands, except per share data)

(Unaudited)

	Common Stock		Additional Paid-In Capital		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total
Balance, January 1, 2012	$	15	$	11,010	$	24,913		$	236		$	36,174
Net income						1,104						1,104
Other comprehensive income									54			54
Stock options exercised (750 shares)				7								7
Tax benefit related to stock options exercised				2								2
Share-based compensation expense				42								42
Balance, June 30, 2012	$	15	$	11,061	$	26,017		$	290		$	37,383
Balance, January 1, 2013	$	15	$	11,121	$	27,495		$	324		$	38,955
Net  income						1,317						1,317
Other comprehensive loss									(576	)		(576	)
Stock options exercised (1,110 shares)				14								14
Tax benefit related to stock options exercised				3								3
Dividends on common stock, $0.10 per share						(156	)					(156	)
Share-based compensation expense				13								13
Balance, June 30, 2013	$	15	$	11,151	$	28,656		$	(252	)	$	39,570

See notes to consolidated condensed financial statements.

3

LSB FINANCIAL CORP.

Consolidated Condensed Statements of Cash Flows

(Dollars in thousands)

(Unaudited)

	Six months ended June 30,
	2013			2012
Operating Activities
Net income	$	1,317		$	1,104
Items not requiring (providing) cash
Depreciation		224			228
Provision for loan losses		625			1,100
Amortization of premiums and discounts on securities		103			(140	)
Loss on sale of other real estate owned		2			139
Gain on sale of loans		(957	)		(832	)
Loans originated for sale		(28,669	)		(28,281	)
Proceeds on loans sold		29,513			29,931
Share-based compensation expense		13			42
Changes in
Interest receivable and other assets		(457	)		176
Interest payable and other liabilities		352			151
Net cash provided by operating activities		2,066			3,618
Investing Activities
Purchases of available-for-sale securities		(21,795	)		(12,827	)
Proceeds from maturities of available-for-sale securities		948			2,368
Net change in loans		12,474			11,877
Proceeds from sale of other real estate owned		254			1,560
Purchase of premises and equipment		(398	)		(164	)
Net cash provided by investing activities		(8,517	)		2,814
Financing Activities
Net change in demand deposits, money market, NOW and savings accounts		9,195			(1,299	)
Net change in certificates of deposit		(3,976	)		2,863
Repayment of Federal Home Loan Bank advances		(5,000	)		---
Proceeds from stock options exercised		14			7
Tax benefit related to stock options exercised		3			2
Dividends paid		(156	)		---
Net cash provided by financing activities		80			1,573
Increase (decrease) in Cash and Cash Equivalents		(6,371	)		8,005
Cash and Cash Equivalents, Beginning of Period		31,421			21,708
Cash and Cash Equivalents, End of Period	$	25,050		$	29,713
Supplemental Cash Flows Information
Interest paid	$	1,284		$	1,762
Income taxes paid		1,275			125
Supplemental Non-Cash Disclosures
Capitalization of mortgage servicing rights		192			103
Loans transferred to other real estate owned		162			654

See notes to consolidated condensed financial statements.

4

LSB FINANCIAL CORP.

Notes to Consolidated Condensed Financial Statements

June 30, 2013

Note 1 – General

The financial statements were prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all of the disclosures necessary for a complete presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America.  These interim financial statements have been prepared on a basis consistent with the annual financial statements and include, in the opinion of management, all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the results of operations and financial position for and at the end of such interim periods.  The consolidated condensed balance sheet of LSB Financial Corp. as of December 31, 2012 has been derived from the audited consolidated balance sheet of LSB Financial Corp. as of that date.

Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted.  These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K annual report for the fiscal year ended December 31, 2012 filed with the Securities and Exchange Commission.  The results of operations for the periods are not necessarily indicative of the results to be expected for the full year.

Note 2 – Principles of Consolidation

The accompanying financial statements include the accounts of LSB Financial Corp., its wholly owned subsidiary Lafayette Savings Bank, FSB (“Lafayette Savings”), and Lafayette Savings’ wholly owned subsidiaries, LSB Service Corporation and Lafayette Insurance and Investments, Inc.  All significant intercompany transactions have been eliminated upon consolidation.

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Note 3 – Earnings per share

Earnings per share are based upon the weighted average number of shares outstanding during the period.  Diluted earnings per share further assume the issuance of any potentially dilutive shares. For the three and six month periods ended June 30, 2013, 35,815 shares related to stock options outstanding were dilutive and 14,885 were antidilutive.  For the three month period ended June 30, 2012, 40,317 shares related to stock options outstanding were dilutive and 17,116 were antidilutive and for the six month period ended June 30, 2012, 6,000 shares related to stock options outstanding were dilutive and 51,433 were antidilutive.

	(Unaudited)
	Three months ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
Weighted average shares outstanding		1,557,082		1,555,972		1,556,492		1,555,646
Stock options		5,853		724		4,725		---
Shares used to compute diluted  earnings per share		1,562,935		1,556,696		1,561,217		1,555,646
Basic earnings per share	$	0.43	$	0.33	$	0.85	$	0.71
Diluted earnings per share	$	0.42	$	0.33	$	0.85	$	0.71

Note 4 – Securities

The amortized cost and approximate fair values, together with gross unrealized gains and losses, of securities are as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Approximate Fair Value
Available-for-sale Securities:			(in Thousands)
June 30, 2013: (Unaudited)
U.S. Government sponsored agencies	$	23,568	$	15	$	(374	)	$	23,209
Mortgage-backed securities - government sponsored entities		11,335		130		(191	)		11,274
State and political subdivisions		13,309		167		(179	)		13,297
	$	48,212	$	312	$	(744	)	$	47,780
Available-for-sale Securities:
December 31, 2012
U.S. Government sponsored agencies	$	10,639	$	83	$	(13	)	$	10,709
Mortgage-backed securities - government sponsored entities		6,989		209		---			7,198
State and political subdivisions		9,840		271		(14	)		10,097
	$	27,468	$	563	$	(27	)	$	28,004

6

The amortized cost and fair value of available-for-sale securities at June 30, 2013, 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.

	Available for Sale
	Amortized Cost		Fair Value
	June 30, 2013
	(in thousands)
Within one year	$	641	$	642
One to five years		20,275		20,191
Five to ten years		15,961		15,673
After ten years		---		---
		36,877		36,506
Mortgage-backed securities		11,335		11,274
Totals	$	48,212	$	47,780

The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $1.8 million at June 30, 2013 and $2.0 million at December 31, 2012.

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 June 30, 2013 and December 31, 2012 was $32.6 million and $5.6 million, which is approximately 68% and 20%, respectively, 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 had been in a continuous unrealized loss position at June 30, 2013 and December 31, 2012.

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	Less Than 12 Months				12 Months or More				Total
Description of Securities	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In thousands)
June 30, 2013
U.S. Government sponsored agencies	$	17,668	$	374	$	---	$	---	$	17,668	$	374
Mortgage-backed securities – government sponsored entities		7,242		191		---		---		7,242		191
State and political subdivisions		7,650		179		---		---		7,650		179
Total temporarily impaired securities	$	32,560	$	744	$	---	$	---	$	32,560	$	744
December 31, 2012
U.S. Government sponsored agencies	$	3,076	$	13	$	---	$	---	$	3,076	$	13
State and political subdivisions		2,541		14		---		---		2,541		14
Total temporarily impaired securities	$	5,617	$	27	$	---	$	---	$	5,617	$	27

Note 5 - Loans and 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.

All loans that are rated substandard and impaired, or are troubled debt restructures 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 Financial Accounting Standards Board (“FASB”) ASC 310-10 (formerly FAS 114, Accounting by Creditors for Impairment of a Loan). Any allowances for impaired loans are determined by the fair value of the underlying collateral based on the discounted appraised value.  Allowances for loans that are not collateral dependent are determined by the present

8

value of expected future cash flows discounted at the loan’s effective interest rate.  Historical loss rates are applied to all loans not included in the ASC 310-10 calculation.

Historical loss rates for commercial and consumer loans may be adjusted for significant qualitative 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 nonaccrual loans), changes in mix, asset quality trends, risk management and loan administration, changes in the internal lending policies and credit standards, collection practices, examination results from bank regulatory agencies and Lafayette Savings’ internal loan review.

Allowances on individual loans and historical loss rates are reviewed quarterly 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 and to a lesser extent the eight surrounding counties. When evaluating the adequacy of the allowance, consideration is given to this regional geographic concentration and the closely associated effect of changing economic conditions on Lafayette Savings’ customers.

Categories of loans include:

	(Unaudited) June 30, 2013			December 31, 2012
	(In thousands)
Real Estate
One-to-four family residential	$	93,576		$	99,216
Multi-family residential		61,458			62,823
Commercial real estate		72,975			82,430
Construction and land development		19,191			14,113
Commercial		12,918			13,290
Consumer and other		1,204			1,131
Home equity lines of credit		15,781			16,421
Total loans		277,103			289,424
Less
Net deferred loan fees, premiums and discounts		(415	)		(469	)
Undisbursed portion of loans		(3,346	)		(2,798	)
Allowance for loan losses		(6,346	)		(5,900	)
Net loans	$	266,996		$	280,257

9

The risk characteristics of each loan portfolio segment are as follows:

Commercial

Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate

These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

Construction

Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Residential and Consumer

With respect to residential loans that are secured by one- to four-family residences and are generally owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in one- to four-family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

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Additional information on the allocation of loan loss reserves by loan category, which does not include loans held for sale, for the three and six month periods ending June 30, 2013 and for the year ended December 31, 2012 is provided below.

Allowance for Loan Losses and Recorded Investment in Loans for the Three Months Ended June 30, 2013 (Unaudited)
Three Months Ended June 30, 2013	Commercial		Owner Occupied 1-4		Non-owner Occupied 1-4			Multi- family		Commercial Real Estate		Construction		Land			Consumer and Home Equity		Total
Allowance for losses	(In thousands)
Beginning balance	$	859	$	525	$	1,053		$	981	$	2,135	$	42	$	290		$	177	$	6,062
Provision charged to expense		55		26		(119	)		20		124		4		57			58		225
Losses charged off		---		---		---			---		---		---		(10	)		---		(10	)
Recoveries		1		1		56			---		---		---		11			---		69
Ending balance	$	915	$	552	$	990		$	1,001	$	2,259	$	46	$	348		$	235	$	6,346

Allowance for Loan Losses and Recorded Investment in Loans for the Six Months Ended June 30, 2013 (Unaudited)
Six Months Ended June 30, 2013	Commercial			Owner Occupied 1-4			Non-owner Occupied 1-4			Multi- family			Commercial Real Estate			Construction			Land			Consumer and Home Equity		Total
Allowance for losses	(In thousands)
Beginning balance	$	633		$	589		$	1,022		$	1,055		$	2,177		$	62		$	154		$	208	$	5,900
Provision charged to expense		294			(38	)		93			(54	)		133			(16	)		186			27		625
Losses charged off		(29	)		---			(241	)		---			(51	)		---			(10	)		---		(331	)
Recoveries		17			1			116			---			---			---			18			---		152
Ending balance		915			552			990			1,001			2,259			46			348			235		6,346
ALL individually evaluated		---			10			20			17			530			---			47			40		664
ALL collectively evaluated		915			542			970			984			1,729			46			301			195		5,682
Total ALLL		915			552			990			1,001			2,259			46			348			235		6,346
Loans individually evaluated		7			1,319			5,978			2,158			8,637			---			829			156		19,084
Loans collectively evaluated		12,911			43,934			42,345			59,300			64,338			8,009			10,353			16,829		258,019
Total loans evaluated	$	12,918		$	45,253		$	48,323		$	61,458		$	72,975		$	8,009		$	11,182		$	16,985	$	277,103

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Allowance for Loan Losses and Recorded Investment in Loans for the Three Months Ended June 30, 2012 (Unaudited)
Three Months Ended June 30, 2012	Commercial			Owner Occupied 1-4			Non-owner Occupied 1-4			Multi- family		Commercial Real Estate			Construction			Land			Consumer and Home Equity		Total
Allowance for losses	(In thousands)
Beginning balance	$	716		$	411		$	1,221		$	664	$	2,000		$	13		$	127		$	153	$	5,305
Provision charged to expense		99			31			(108	)		224		276			(5	)		(23	)		6		500
Losses charged off		(148	)		(10	)		(12	)		---		(417	)		---			---			---		(587	)
Recoveries		17			---			17			---		---			---			16			---		50
Ending balance	$	684		$	432		$	1,118		$	888	$	1,859		$	8		$	120		$	159	$	5,268

Allowance for Loan Losses and Recorded Investment in Loans for the Six Months Ended June 30, 2012 (Unaudited)
Six Months Ended June 30, 2012	Commercial			Owner Occupied 1-4			Non-owner Occupied 1-4			Multi- family			Commercial Real Estate			Construction			Land			Consumer and Home Equity			Total
Allowance for losses	(In thousands)
Beginning balance	$	667		$	436		$	1,330		$	646		$	1,788		$	64		$	264		$	136		$	5,331
Provision charged to expense		462			12			(195	)		500			488			(56	)		(145	)		34			1,100
Losses charged off		(462	)		(16	)		(37	)		(259	)		(417	)		---			(15	)		(11	)		(1,217	)
Recoveries		17			---			20			1			---			---			16			---			54
Ending balance	$	684		$	432		$	1,118		$	888		$	1,859		$	8		$	120		$	159		$	5,268

Allowance for Loan Losses and Recorded Investment in Loans at December 31, 2012
ALL individually evaluated	$	---	$	14	$	27	$	24	$	253	$	---	$	---	$	---	$	318
ALL collectively evaluated		633		575		993		1,031		1,924		62		154		208		5,582
Total ALLL		633		589		1,021		1,055		2,177		62		154		208		5,900
Loans individually evaluated		49		1,653		5,917		2,891		6,233		---		1,379		92		18,214
Loans collectively evaluated		13,241		46,892		44,754		59,932		76,197		8,928		3,806		17,460		271,210
Total loans evaluated	$	13,290	$	48,545	$	50,671	$	62,823	$	82,430	$	8,928	$	5,185	$	17,552	$	289,424

Management’s general practice is to charge down collateral dependent loans individually evaluated

for impairment to the fair value of the underlying collateral.

Consistent with regulatory guidance, charge-offs on all loan segments are taken when specific loans, or portions thereof, are considered uncollectible. The Company’s policy is to promptly charge these loans off in the period the uncollectible loss is reasonably determined.

12

For all loan portfolio segments except one- to four-family residential properties and consumer, the Company promptly charges-off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

The Company charges-off one- to four-family residential and consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down of one- to four-family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 120 days past due, charge-off of unsecured open-end loans when the loan is 120 days past due, and charge-down to the net realizable value when other secured loans are 120 days past due. Loans at these respective delinquency thresholds for which the Company can clearly document that the loan is both well-secured and in the process of collection, such that collection will occur regardless of delinquency status, need not be charged off.   Charge-offs may be taken sooner than the above-referenced timeframes if circumstances warrant.

The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date.

The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the prior four years.  Management believes the four year historical loss experience methodology is appropriate in the current economic environment, as it captures loss rates that are comparable to the current period being analyzed.

We rate all loans by credit quality using the following designations:

GRADE 1 - Pass, superior credit quality

Loans of the highest quality.  Financial strength of the borrower (exhibited by extremely low debt-to-income ratios/high debt-service coverage, low loan-to-value ratio, and clean credit history) is such that no loss is anticipated.  Probability of serious or rapid deterioration is extremely small.

GRADE 2 - Pass, good credit quality

Loans of good quality.  Overall above average credit, with strong capacity to repay (exhibited by higher debt-to-income ratios/lower debt-service coverage than Grade 1, but still better than average levels), sound credit history and employment.  Loan-to-value is not as strong as Grade 1, but is greater than Grade 3.  Minor loss exposure with the probability of serious financial deterioration unlikely.

GRADE 3 - Pass, low risk

Loans of satisfactory quality.  Average quality due to average capacity to repay (exhibited by higher debt-to-income ratios/lower debt-service coverage than Grade 2 but better than levels requiring Loan Committee approval), employment, credit history, loan-to-value ratio, or paying habits.  Deterioration possible if adverse factors occur.

13

GRADE 4 - Pass, acceptable risk

Loans of marginal, but acceptable quality due to below average capacity to repay (exhibited by high debt-to-income ratios/low debt-service coverage), high loan-to-value, or poor paying habits. Deterioration likely if adverse factors occur.

GRADE W-4 - Pass, watch list credit

These loans have the same characteristics as standard Grade 4 loans, with an added significant weakness such as the global debt-service coverage of the borrower being below 1.00. Such loans should have no delinquencies within the previous 12 months.

GRADE 5- Special Mention

Loans in this classification are in a state of change that could adversely affect paying ability, collateral value or which require monthly monitoring to protect the asset value.

GRADE 6- Substandard

A substandard asset with a defined weakness.  Heavy debt condition, deterioration of collateral, poor paying habits, or conditions present that unless deficiencies are corrected will result in some loss. Loans 90 or more days past due should be automatically included in this grade.

GRADE 7- Doubtful

Poor quality.  Loans in this group are characterized by less than adequate collateral and all of the characteristics of a loan classified as substandard.  The possibility of a loss is extremely high, but factors may be underway to minimize the loss or maximize the recovery.

GRADE 8 - Loss

Loans classified loss are considered uncollectible and of such little value that their continuance as an asset is not warranted.

Interest income on loans individually classified as impaired is recognized on a cash basis after all past due and current principal payments have been made.

Subsequent payments on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured.  Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. The Company requires a period of satisfactory performance of not less than six months before returning a nonaccrual loan to accrual status.

14

The following table provides an analysis of loan quality using the above designations, based on property type at June 30, 2013 (Unaudited).

Credit Rating	Commercial		Owner Occupied 1-4		Non-owner Occupied 1-4		Multi- Family		Commercial Real Estate		Construction		Land		Consumer and Home Equity		Total
	(In thousands)
1- Superior	$	23	$	3,516	$	238	$	---	$	100	$	--	$	189	$	1,689	$	5,755
2 - Good		1,541		19,158		4,062		7,824		10,271		2,210		1,442		10,487		56,995
3 - Pass Low risk		4,983		15,078		12,101		30,885		17,874		5,059		5,192		3,685		94,857
4 - Pass		3,886		5,357		23,093		17,646		25,591		740		1,332		1,030		78,675
4W - Watch		131		1,065		2,185		3,373		7,719		---		2,198		28		16,699
5 - Special mention		---		---		2,310		1,659		827		---		594		---		5,390
6 - Substandard		2,354		1,079		4,334		71		10,593		---		235		66		18,732
7 - Doubtful		---		---		---		---		---		---		---		---		---
8 - Loss		---		---		---		---		---		---		---		---		---
Total	$	12,918	$	45,253	$	48,323	$	61,458	$	72,975	$	8,009	$	11,182	$	16,985	$	277,103

The following table provides an analysis of loan quality using the above designations, based on property type at December 31, 2012.

Credit Rating	Commercial		Owner Occupied 1-4		Non-owner Occupied 1-4		Multi- Family		Commercial Real Estate		Construction		Land		Consumer and Home Equity		Total
	(In thousands)
1- Superior	$	27	$	3,849	$	246	$	---	$	103	$	667	$	193	$	1,787	$	6,872
2 - Good		3,061		20,104		4,299		7,661		10,924		1,123		172		11,311		58,655
3 - Pass Low risk		7,982		16,459		12,625		31,281		31,853		5,383		286		3,374		109,243
4 - Pass		1,689		6,221		24,623		18,010		22,993		1,755		1,387		1,078		77,756
4W - Watch		186		746		2,894		2,954		5,014		---		1,769		---		13,563
5 - Special mention		296		---		2,535		2,139		4,658		---		---		---		9,628
6 - Substandard		49		1,166		3,449		778		6,885		---		1,378		2		13,707
7 - Doubtful		---		---		---		---		---		---		---		---		---
8 - Loss		---		---		---		---		---		---		---		---		---
Total	$	13,290	$	48,545	$	50,671	$	62,823	$	82,430	$	8,928	$	5,185	$	17,552	$	289,424

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Analyses of past due loans segregated by loan type as of June 30, 2013 and December 31, 2012 are provided below.

	Loan Portfolio Aging Analysis as of June 30, 2013 (Unaudited)
	30-59 Days		60-89 Days		Over 90 Days		Total Past Due		Current		Total Loans		Under 90 Days and Not Accruing		Total 90 Days and Accruing
							(Inthousands)
Commercial	$	4	$	---	$	7	$	11	$	12,907	$	12,918	$	---	$	---
Owner occupied 1-4		84		405		383		872		44,381		45,253		533		---
Non owner occupied 1-4		---		209		1,334		1,543		46,780		48,323		1,172		---
Multi-family		---		71		---		71		61,387		61,458		71		---
Commercial Real Estate		---		16		111		127		72,848		72,975		16		---
Construction		---		---		---		---		8,009		8,009		---		---
Land		---		---		140		140		11,042		11,182		---		---
Consumer and home equity		30		18		37		85		16,900		16,985		---		---
Total	$	118	$	719	$	2,012	$	2,849	$	274,254	$	277,103	$	1,792	$	---

	Loan Portfolio Aging Analysis as of December 31, 2012
	30-59 Days		60-89 Days		Over 90 Days		Total Past Due		Current		Total Loans		Under 90 Days and Not Accruing		Total 90 Days and Accruing
							(In thousands)
Commercial	$	---	$	---	$	49	$	49	$	13,241	$	13,290	$	---	$	---
Owner occupied 1-4		184		406		107		697		47,848		48,545		862		---
Non owner occupied 1-4		291		216		2,124		2,631		48,040		50,671		543		---
Multi-family		700		78		---		778		62,045		62,823		76		---
Commercial Real Estate		---		---		487		487		81,943		82,430		815		---
Construction		---		---		---		---		8,928		8,928		---		---
Land		---		79		140		219		4,966		5,185		1,238		---
Consumer and home equity		1		2		---		3		17,549		17,552		2		---
Total	$	1,176	$	781	$	2,907	$	4,864	$	284,560	$	289,424	$	3,536	$	---

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Impaired loans are those for which we believe it is probable that we will not collect all principal and interest due in accordance with the original terms of the loan agreement.  The following table presents impaired loans and interest recognized on them for the quarter and six months ended June 30, 2013 and impaired loans for the year ended December 31, 2012 and interest recognized for the quarter and six months ended June 30, 2012.

	Impaired Loans as of and for the Quarter and Six months ended June 30,2013 (Unaudited)
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Quarterly Average Impaired Loans		Year to date Average Impaired Loans		Quarterly Interest Income Recognized		Year to date Interest Income Recognized
	(In thousands)
Loans without specific valuation allowance
Commercial	$	7	$	151	$	---	$	13	$	25	$	---	$	---
Owner occupied 1-4		1,091		1,187		---		1,259		1,294		22		14
Non owner occupied 1-4		5,711		6,316		---		5,685		5,679		71		166
Multi-family		2,087		2,098		---		2,094		2,333		26		61
Commercial Real Estate		3,329		3,776		---		2,959		3,528		82		127
Construction		---		---		---		---		---		---		---
Land		724		990		---		729		946		6		---
Consumer and Home Equity		90		92		---		91		91		1		3
Total loans without a specific valuation allowance		13,039		14,610		---		12,830		13,896		208		371
Loans with a specific valuation allowance
Commercial		---		---		---		---		---		---		---
Owner occupied 1-4		228		238		10		229		230		2		---
Non owner occupied 1-4		267		267		20		269		273		---		1
Multi-family		71		78		17		72		74		1		---
Commercial Real Estate		5,308		5,308		530		3,425		2,806		99		26
Construction		---		---		---		---		---		---		---
Land		105		105		47		52		35		1		---
Consumer and Home Equity		66		69		40		46		39		---		---
Total loans with a specific valuation allowance		6,045		6,065		664		4,093		3,457		103		27
Total
Commercial		7		151		---		13		25		---		---
Owner occupied 1-4		1,319		1,425		10		1,488		1,524		24		14
Non owner occupied 1-4		5,978		6,583		20		5,954		5,952		71		167
Multi-family		2,158		2,176		17		2,166		2,407		27		61
Commercial Real Estate		8,637		9,084		530		6,384		6,334		181		153
Construction		---		---		---		---		---		---		---
Land		829		1,095		47		781		981		7		---
Consumer and Home Equity		156		161		40		137		130		1		3
Total impaired loans	$	19,084	$	20,675	$	664	$	16,923	$	17,353	$	311	$	398

17

	Impaired loans as of and for the Year Ended December 31, 2012						Impaired loans for the Quarter and Six Months Ended June 30, 2012 (Unaudited)
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Quarterly Average Impaired Loans		Year to date Average Impaired Loans		Quarterly Interest Income Recognized		Year to date Interest Income Recognized
	(In thousands)
Loans without specific valuation allowance
Commercial	$	49	$	521	$	---	$	139	$	910	$	---	$	4
Owner occupied 1-4		1,421		1,535		---		1,374		1,584		11		33
Non owner occupied 1-4		5,636		5,900		---		6,286		6,829		63		157
Multi-family		2,813		2,865		---		2,428		3,001		46		93
Commercial Real Estate		4,667		5,720		---		7,763		7,994		90		180
Construction		---		---		---		---		---		---		---
Land		1,379		1,615		---		1,780		1,900		2		3
Consumer and Home Equity		92		114		---		158		183		2		4
Total loans without a specific valuation allowance		16,057		18,360		---		19,928		22,401		214		474
Loans with a specific valuation allowance
Commercial		---		---		---		240		160		---		2
Owner occupied 1-4		232		240		14		123		82		---		---
Non owner occupied 1-4		281		281		27		392		395		1		2
Multi-family		78		83		24		404		406		---		---
Commercial Real Estate		1,566		1,567		253		3,249		3,268		12		29
Construction		---		---		---		---		---		---		---
Land		---		---		---		---		---		---		---
Consumer and Home Equity		---		---		---		---		---		---		---
Total loans with a specific valuation allowance		2,157		2,171		318		4,407		4,311		13		33
Total
Commercial		49		521		---		379		1,070		---		6
Owner occupied 1-4		1,653		1,775		14		1,479		1,666		11		33
Non owner occupied 1-4		5,917		6,271		27		6,678		7,224		64		159
Multi-family		2,891		2,948		24		2,831		3,407		46		93
Commercial Real Estate		6,233		7,287		253		11,012		11,263		102		209
Construction		---		---		---		---		---		---		---
Land		1,379		1,615		---		1,780		1,900		2		3
Consumer and Home Equity		92		114		---		158		183		2		4
Total impaired loans	$	18,214	$	20,531	$	318	$	24,336	$	26,712	$	227	$	507

All loans rated substandard that have had an impairment allocated to them and all troubled debt restructures are considered impaired.  A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due (both principal and interest) according to contractual terms of the loan agreement.   Loans that are considered impaired are reviewed to determine if a specific allowance is required based on the borrower’s financial condition, resources and payment record, support from guarantors and the realizable value of any collateral.  As a practical expedient the Bank will typically use the collateral fair market value method to determine impairments unless circumstances preclude its use.  In this method, any portion of

18

the investment above the current fair market value of the collateral should be identified as an impairment. Fair market value is determined using a current appraisal or evaluation in compliance with federal appraisal regulations.

The following table gives a breakdown of non-accruing loans by loan class at June 30, 2013 and at December 31, 2012.

	(Unaudited)
Loan Class	June 30, 2013		December 31, 2012
	(In thousands)
Commercial	$	7	$	49
Owner occupied 1-4		916		969
Non owner occupied 1-4		2,506		2,667
Multi-family		71		76
Commercial Real Estate		127		1,302
Construction		---		---
Land		140		1,378
Consumer and home equity		37		2
Total	$	3,804	$	6,443

Loans are placed on non-accrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual.  All interest accrued, but not received for loans placed on non-accrual, is reversed against interest income.  Interest subsequently received on such loans is accounted for by using the cost-recovery basis for commercial loans and the cash basis for retail loans until qualifying for return to accrual status.

The following tables present information regarding troubled debt restructurings by class for the three months and six months ended June 30, 2013 and 2012.

	Newly restructured loans for the three months ended June 30, 2013 (Unaudited)
	(Dollars in thousands)
	Number of loans		Pre-modification Recorded Balance		Post-modification Recorded Balance		Type of Modification
Commercial		---	$	---	$	---	---
Owner occupied 1-4		1		38		38	Below market rate
Non owner occupied 1-4		2		277		277	Term
Multi-family		---		---		---	---
Commercial Real Estate		1		778		760	Term
Construction		---		---		---	---
Land		---		---		---	---
Consumer and home equity		1		29		29	Term
Total		5	$	1,122	$	1,104

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	Newly restructured loans for the three months ended June 30, 2012 (Unaudited)
	(Dollars in thousands)
	Number of loans		Pre-modification Recorded Balance		Post-modification Recorded Balance		Type of Modification
Commercial		---	$	---	$	---	---
Owner occupied 1-4		---		---		---	---
Non owner occupied 1-4		---		---		---	---
Multi-family		---		---		---	---
Commercial Real Estate		1		100		100	Below market rate
Construction		---		---		---	---
Land		---		---		---	---
Consumer and home equity		---		---		---	---
Total		1	$	100	$	100

	Newly restructured loans for the six months ended June 30, 2013 (Unaudited)
	(Dollars in thousands)
	Number of loans		Pre-modification Recorded Balance		Post-modification Recorded Balance		Type of Modification
Commercial		---	$	---	$	---	---
Owner occupied 1-4		1		38		38	Below market rate
Non owner occupied 1-4		7		1,520		1,246	A/B note, payment adjustment, term
Multi-family		---		---		---	---
Commercial Real Estate		1		778		761	Term
Construction		---		---		---	---
Land		---		---		---	---
Consumer and home equity		1		29		29	Term
Total		10	$	2,365	$	2,074

	Newly restructured loans for the six months ended June 30, 2012 (Unaudited)
	(Dollars in thousands)
	Number of loans		Pre-modification Recorded Balance		Post-modification Recorded Balance		Type of Modification
Commercial		---	$	---	$	---	---
Owner occupied 1-4		1		108		108	Below market rate
Non owner occupied 1-4		---		---		---	---
Multi-family		---		---		---	---
Commercial Real Estate		2		345		345	Below market rate
Construction		---		---		---	---
Land		---		---		---	---
Consumer and home equity		---		---		---	---
Total		3	$	453	$	453

20

	Troubled debt restructurings that subsequently defaulted for the three months ended June 30, 2012
	(Unaudited)
	(Dollars in thousands)
	Number of loans		Recorded Balance
Commercial		1	$	125
Owner occupied 1-4		---		---
Non owner occupied 1-4		---		---
Multi-family		---		---
Commercial Real Estate		---		---
Construction		---		---
Land		---		---
Consumer and home equity		---		---
Total		1	$	125

	Troubled debt restructurings that subsequently defaulted for the six months ended June 30, 2012 (Unaudited)
	(Dollars in thousands)
	Number of loans		Recorded Balance
Commercial		1	$	125
Owner occupied 1-4		---		---
Non owner occupied 1-4		---		---
Multi-family		---		---
Commercial Real Estate		---		---
Construction		---		---
Land		---		---
Consumer and home equity		---		---
Total		1	$	125

There were no troubled debt restructurings modified in the past 12 months that subsequently defaulted for the three months and six months ended June 30, 2013.

Note 6 - Disclosures About Fair Value of Assets and Liabilities

Fair value is 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.  Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs.  There is a hierarchy of three levels of inputs that may be used to measure fair value:

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

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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 supported by little or no market activity and are significant to the fair value of the assets or liabilities

Recurring Measurements

The following table presents the fair value measurements of assets recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2013 and December 31, 2012:

			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)
					(In thousands)
Available-for-sale securities
June 30, 2013 (Unaudited):
U.S. Government-sponsored agencies	$	23,209		---	$	23,209		---
Mortgage-backed securities		11,274		---		11,274		---
State and political subdivision securities		13,297		---		13,297		---
Totals		47,780		---		47,780		---
December 31, 2012:
U.S. Government-sponsored agencies	$	10,709		---	$	10,709		---
Mortgage-backed securities		7,198		---		7,198		---
State and political subdivision securities		10,097		---		10,097		---
Totals		28,004		---		28,004		---

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.  There have been no significant changes in the valuation techniques during the quarter ended June 30, 2013.  For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Available-for-sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy.  If quoted market prices are not available, then fair values are estimated by using

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quoted prices of securities with similar characteristics or independent asset pricing services and pricing models, the inputs of which are market-based or independently sourced market parameters, including, but not limited to, yield curves, interest rates, volatilities, prepayments, defaults, cumulative loss projections and cash flows.  Such securities are classified in Level 2 of the valuation hierarchy.  In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.  See the table below for inputs and valuation techniques used for Level 3 securities.

Nonrecurring Measurements

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2013 and December 31, 2012.

			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)
			(in thousands)
June 30, 2013 (Unaudited):
Collateral-dependent impaired loans	$	5,916		—		—	$	5,916
December 31, 2012:
Collateral-dependent impaired loans	$	527		—		—	$	527

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.  For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Collateral-Dependent Impaired Loans, Net of Allowance for Loan and Lease Losses

The estimated fair value of collateral-dependent impaired loans is based on the appraised fair value of the collateral, less estimated cost to sell.  Collateral-dependent impaired loans are classified within Level 3 of the fair value hierarchy.

The Company considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value.  Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary by the Company’s Controller’s office.  Appraisals are reviewed for accuracy and consistency by the Controller’s office.  Appraisers are selected from the list of approved appraisers maintained by management.  The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral.  These discounts and estimates are developed by the Controller’s office by comparison to historical results.

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Unobservable (Level 3) Inputs

The following table presents quantitative information about unobservable inputs used in nonrecurring Level 3 fair value measurements.

	Fair Value	Valuation Technique	Unobservable Inputs	Range (Weighted Average)
	(In thousands)
June 30, 2013 (Unaudited):
Collateral-dependent impaired loans	$5,916	Market comparable properties	Marketability discount	10%
December 31, 2012:
Collateral-dependent impaired loans	$   527	Market comparable properties	Marketability discount	10%

Fair Value of Financial Instruments

The following table presents estimated fair values of the Company’s financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2013 and December 31, 2012.

			Fair Value Measurements Using
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
			(In thousands)
June 30, 2013 (Unaudited):
Financial assets
Cash and cash equivalents	$	25,050	$	25,050	$	—	$	—
Interest bearing time deposits		1,748		—		1,748		—
Loans held for sale		1,476		—		1,476		—
Loans, net of allowance for losses		266,966		—		---		281,105
Federal Home Loan Bank stock		3,185		—		3,185		---
Accrued interest receivable		1,229		—		1,229		—
Financial liabilities
Transaction and Savings Deposits		176,899		176,899		—		—
Time Deposits		136,957		—		—		139,305
Federal Home Loan Bank advances		10,000		—		10,289		—
Accrued interest payable		44		—		44		—
December 31, 2012:
Financial assets
Cash and cash equivalents	$	31,421	$	31,421	$	—	$	—
Interest bearing time deposits		1,740		—		1,740		—
Loans held for sale		1,363		—		1,363		—
Loans, net of allowance for losses		280,257		—		---		299,010
Federal Home Loan Bank stock		3,185		—		3,185		---
Accrued interest receivable		1,133		—		1,133		—
Financial liabilities
Transaction and Savings Deposits		167,704		167,704		—		—
Time Deposits		140,933		—		—		143,181
Federal Home Loan Bank advances		15,000		—		15,515		—
Accrued interest payable		40		—		40		—

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The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying balance sheets at amounts other than fair value.

Cash and Cash Equivalents and Interest Bearing Time Deposits

The carrying amount approximates fair value.

Loans Held For Sale

The carrying amount approximates fair value due to the insignificant time between origination and date of sale.  The carrying amount is the amount funded and accrued interest.

Loans

Fair value is estimated by discounting the future cash flows using the market rates at which similar notes would be made to borrowers with similar credit ratings and for the same remaining maturities.  The market rates used are based on current rates the Bank would impose for similar loans and reflect a market participant assumption about risks associated with non-performance, illiquidity, and the structure and term of the loans along with local economic and market conditions.

Federal Home Loan Bank Stock

Fair value is estimated at book value due to restrictions that limit the sale or transfer of such securities.

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Accrued Interest Receivable and Payable

The carrying amount approximates fair value.  The carrying amount is determined using the interest rate, balance and last payment date.

Deposits

Fair value of term deposits is estimated by discounting the future cash flows using rates of similar deposits with similar maturities.  The market rates used were obtained from a knowledgeable independent third party and reviewed by the Company.  The rates were the average of current rates offered by local competitors of the Bank.

The estimated fair value of demand, NOW, savings and money market deposits is the book value since rates are regularly adjusted to market rates and amounts are payable on demand at the reporting date.

Federal Home Loan Bank Advances

Fair value is estimated by discounting the future cash flows using rates of similar advances with similar maturities.  These rates were obtained from current rates offered by FHLB.

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

The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.  For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.

The fair value of commitments to sell securities is estimated based on current market prices for securities of similar terms and credit quality.

The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.

Note 8 –Accounting Developments

In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.  The objective of this Update is to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments in this Update require an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (GAAP) to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. For public entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2012. The adoption of this ASU did not have a significant impact on the Company’s consolidated financial statements.

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In January 2013, the FASB issued ASU No. 2013-01, Balance Sheet (Topic 210);Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.  The main objective of this standard is to address implementation issues about the scope of Accounting Standards Update No. 2011-11, Balance Sheet (Topic 210): Disclosures About offsetting Assets and Liabilities.  The amendments clarify that the scope of Update 2011-11 applies to derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with Section 210-20-45 or Section 815-10-45 or subject to an enforceable master netting arrangement or similar agreement. An entity is required to apply the amendments for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the required disclosures retrospectively for all comparative period presented.   The adoption of this ASU did not have a significant impact on the Company’s consolidated financial statements.

In December, 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities, in an effort to improve comparability between U.S. GAAP and international financial reporting standards (“IFRS”) financial statements with regard to the presentation of offsetting assets and liabilities on the statement of financial position arising from financial and derivative instruments, and repurchase agreements. The ASU establishes additional disclosures presenting the gross amounts of recognized assets and liabilities, offsetting amounts, and the net balance reflected in the statement of financial position. Descriptive information regarding the nature and rights of the offset must also be disclosed. The new standard is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. The adoption of this ASU did not have a significant impact on the Company’s consolidated financial statements.

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

Executive Summary

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 Form 10-Q 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 144 years and differs from many of our competitors by 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, multi-family and commercial properties and to fund land development projects. We also make a limited number of commercial business and consumer loans.

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We have an experienced and committed staff and enjoy a good reputation for serving the people of the community, for 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 22 banks and credit unions that compete with us. We also believe that operating independently under the same name for over 144 years is a benefit to us - especially as local offices of large banks often have less local authority as their companies strive to consolidate. Focusing time and resources on acquiring customers who may be feeling disenfranchised by their no-longer-local or very large bank has proved to be a successful strategy.

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. There are three things that set Greater Lafayette apart from other urban areas of the country: the presence of a world class university, Purdue University; a government sector due to the presence of the county seat; and the mix of heavy industry and high-tech innovative start-up companies tied to Purdue University. In addition, Greater Lafayette is a regional health care center serving nine counties and has a large campus of Ivy Tech Community College.

Tippecanoe County typically shows better growth and lower unemployment rates than Indiana or the national economy because of the diverse employment base, although this has not been the case lately. The Tippecanoe County unemployment rate peaked at 10.6% in July 2009 and at June 30, 2013 was at 8.6% compared to 8.7% for Indiana and 7.8% nationally.  The June unemployment rate was an increase of 1.4% from May which is a traditional pattern in the county as so much of the county employment is tied to education as noted above.  The average increase in the unemployment rate from May to June is 17% and this year’s increase was in that range at 19%. Activity in the local housing market is improving with 834 unit sales reported through May 31, 2013 compared to 750 for the same period last year.  As of the most recent first quarter of 2013 results provided by the Federal Housing Finance Agency, the five year percent change in house prices for the Lafayette Metropolitan Statistical Area (“MSA”) was a -1.02% decrease with the one-year change a 2.41% increase.

The area’s diversity did not make us immune to the ongoing effects of the recession; however, growth continues, although not at the same rate as before the recession. Current signs of recovery, based on a report from Greater Lafayette Commerce, include increasing manufacturing employment, a continuing commitment to new facilities and renovations at Purdue University, and signs of renewed activity in residential development projects. Capital investments announced and/or made in 2012 totaled $605 million compared to $444 million in 2011 and $640 million in 2010. Purdue, the area’s largest employer, increased enrollment to over 40,000 for the 2012-2013 school year.

Subaru, the area’s largest industrial employer and producer of the Subaru Legacy, Outback and Tribeca, recently announced the addition of more production capacity for a new model to be built there. It intends to hire 900 new employees by the end of 2016.  Wabash National, the area’s second largest industrial employer, continues to hire and intends to employ 60 more welders for a new line for production of bulk liquid storage containers.

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Nanshan America began operating its new aluminum extrusion plant in Lafayette in 2012 which will employ 200 people. Alcoa will be adding a 115,000 square foot aluminum lithium plant to begin production in 2014.  Overall, about 470 new jobs were created in 2012.  While the developments noted above lead us to believe the most serious problems are behind us as increased hiring and new industry moving to town have continued, we expect the recovery to be long term.

We have seen progress in our problem loans as more borrowers who had fallen behind on their loans are qualifying for troubled debt restructures, have resumed payments or we have acquired control of their properties. Our percentage of loans delinquent over 30 days is less than 1.0% of total loans and is the lowest it has been in over ten years. 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 if that is not feasible, to get control of their properties through an overburdened court system. In 2012, we acquired 5 properties through deeds-in-lieu of foreclosure and 5 properties through foreclosure and sold 36 OREO properties.  Through June 30, 2013, we have acquired one property through a sheriff’s sale and sold the one property we had in OREO at December 31, 2012.

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 preference is to rely on local deposits unless the cost is not competitive, but if the need is immediate we will acquire pre-payable FHLB advances which are immediately available for member banks within their borrowing tolerance and can then be replaced with local or brokered deposits as they become available. We will also consider purchasing fixed term FHLB advances or brokered deposits as needed. We generally prefer brokered deposits over FHLB advances when the cost of raising money locally is not competitive. 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.  Base deposits in 2013 have remained fairly flat.  There was a $5 million deposit on the last day of the month, most of which was reallocated within a few weeks, which accounted for the $5.2 million increase in deposits from $308.6 million at December 31, 2012 to $313.9 million at June 30, 2013. Our reliance on brokered funds remained unchanged in the first two quarters of 2013 with the balance remaining at $13.7 million as we wait for maturities which give us the opportunity to repay these funds. 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. The Federal Reserve has held short-term rates at almost zero for the last three years while long-term rates have fallen to the 3.0% range. 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 and in fact our net interest margin increased to a record high of 4.12% in the first quarter of 2012 before falling to 3.42% at June 30, 2013.

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The decrease was generally due to the continued decline in loan rates while deposit rates have started to level out.  Our expectation for most of 2013 is that deposits rates will remain at these low levels as the Federal Reserve continues to focus on strengthening the economy. However there appears to be an increased expectation that rates will begin to increase late in 2013.  Overall loan rates are expected to stay low or fall slightly through the end of the year.

Rate changes can typically be expected to have an impact on interest income. Because the Federal Reserve has stated it intends to keep rates low, we expect to see little change in the money supply or market rates until late 2013. Low rates generally increase borrower preference for fixed rate products which we typically sell on the secondary market. Some 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, although many of our loans have already reached their interest rate floors. While we would expect to sell the majority of our fixed rate loans on the secondary market, we expect to book some higher quality loans to replace runoff in the portfolio. Although new loans put on the books in 2012 will be at comparatively low rates we expect they will provide a return above any other opportunities for investment.

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 66 months, 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 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.

Effect of Current Events

The level of turmoil in the financial services industry does present unusual risks and challenges for the Company, as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Possible Implications of Current Events” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

As noted in the Annual Report, on July 21, 2010, President Obama signed into law the Dodd-Frank Act, which significantly changes the regulation of financial institutions and the financial services

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industry. The Dodd-Frank Act includes provisions affecting large and small financial institutions alike, including several provisions that will profoundly affect how community banks, thrifts, and small bank and thrift holding companies, such as LSB Financial, will be regulated in the future. Among other things, these provisions abolished the OTS effective July 21, 2011 and transferred its functions to the other federal banking agencies.  The Dodd-Frank Act also relaxes rules regarding interstate branching, allows financial institutions to pay interest on business checking accounts, changes the scope of federal deposit insurance coverage, imposes new capital requirements on bank and thrift holding companies, and imposes limits on debit card interchange fees charged by large banks (commonly known as the Durbin Amendment).

The Dodd-Frank Act also established the Consumer Financial Protection Bureau (the “CFPB”) within the Federal Reserve, which has broad authority to regulate consumer financial products and services and entities offering such products and services, including banks. Many of the consumer financial protection functions formerly assigned to the federal banking and other designated agencies are now performed by the CFPB. The CFPB has a large budget and staff, and has broad rulemaking authority over providers of credit, savings, and payment services and products. In this regard, the CFPB has the authority to implement regulations under federal consumer protection laws and enforce those laws against, and examine, financial institutions. State officials also will be authorized to enforce consumer protection rules issued by the CFPB. This bureau also is authorized to collect fines and provide consumer restitution in the event of violations, engage in consumer financial education, track consumer complaints, request data, and promote the availability of financial services to underserved consumers and communities. The CFPB also is directed to prevent “unfair, deceptive or abusive practices” and ensure that all consumers have access to markets for consumer financial products and services, and that such markets are fair, transparent, and competitive.  Although the CFPB has begun to implement its regulatory, supervisory, examination and enforcement authority, there continues to be significant uncertainty as to how the agency’s strategies and priorities will impact the Bank and LSB Financial.

The CFPB has indicated that mortgage lending is an area of supervisory focus and that it will concentrate its examination and rulemaking efforts on the variety of mortgage-related topics required under the Dodd-Frank Act, including steering consumers to less-favorable products, discrimination, abusive or unfair lending practices, predatory lending, origination disclosures, minimum mortgage underwriting standards, mortgage loan originator compensation, and servicing practices.  The CFPB recently published several final regulations impacting the mortgage industry, including rules related to ability-to-repay, mortgage servicing, escrow accounts, and mortgage loan originator compensation. The ability-to-repay rule makes lenders liable if they fail to assess ability to repay under a prescribed test, but also creates a safe harbor for so-called “qualified mortgages.”  The “qualified mortgages” standards include a tiered cap structure that places limits on the total amount of certain fees that can be charged on a loan, a 43% cap on debt-to-income (i.e., total monthly payments on debt to monthly gross income), exclusion of interest-only products, and other requirements.  The 43% debt-to-income cap does not apply for the first seven years the rule is in effect for loans that are eligible for sale to Fannie Mae or Freddie Mac or eligible for government guarantee through the FHA or the Veterans Administration. Failure to comply with the ability-to-repay rule may result in possible CFPB enforcement action and special statutory damages plus actual, class action, and attorneys fees damages, all of which a borrower may claim in defense of a foreclosure action at any time.  LSB Financial’s management is continuing to assess the impact of these requirements on its mortgage lending business.

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In addition, the Federal Reserve and other federal bank regulatory agencies have issued a proposed rule under the Dodd-Frank Act that would exempt “qualified residential mortgages” from the securitization risk retention requirements of the Dodd-Frank Act.  The final definition of what constitutes a “qualified residential mortgage” may impact the pricing and depth of the secondary market into which we may sell mortgages we originate.  At this time, we cannot predict the content of final CFPB and other federal agency regulations or the impact they might have on the Company’s financial results.  The CFPB’s authority over mortgage lending, and its authority to change regulations adopted in the past by other regulators (i.e., regulations issued under the Truth in Lending Act, for example), or to rescind or ignore past regulatory guidance, could increase the Company’s compliance costs and litigation exposure.

The January 25, 2013 decision of the D.C. Circuit Court of Appeals invalidating recess appointments to the National Labor Relations Board, calls into question the recess appointment of Richard Cordray as head of the CFPB. What impact this potentially invalid appointment will have on the CFPB regulations promulgated in January, 2013 or actions taken prior to that time is undetermined at this time. The decision may also play a part in determining whether new legislation will be passed respecting the structure and funding of the CFPB, and whether Director Cordray will be appointed when his current term expires. Though it is not possible to predict the outcome of the recess appointment controversy, the decision will have implications for the Company and the Bank with respect to regulations that apply to them and to competition from other entities that may or may not be subject to regulations promulgated by the CFPB.

In addition to the CFPB’s authority over mortgage lending, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards, and pre-payments. Moreover, the Dodd-Frank Act requires public companies like the Company to hold shareholder advisory “say-on-pay” votes on executive compensation at least once every three years and submit related proposals to a vote of shareholders. LSB Financial held its first such “say-on-pay” vote at its 2013 annual meeting. At the annual meeting, shareholders cast over 76% of votes in favor of holding future say-on-pay votes on an annual basis. The Company’s Board of Directors had recommended a vote for annual frequency of say-on-pay votes. In light of this result and other factors it considered, the Board has determined that the Corporation will hold future say-on-pay votes on an annual basis until the next advisory vote on the frequency of say-on-pay votes occurs. The next advisory vote regarding the frequency of say-on-pay votes is required to occur no later than the Corporation’s 2019 Annual Meeting of Shareholders.

The Dodd-Frank Act contains numerous other provisions affecting financial institutions of all types, many of which may have an impact on the operating environment of the Company in substantial and unpredictable ways. Consequently, the Dodd-Frank Act is expected to increase our cost of doing business, it may limit or expand our permissible activities, and it may affect the competitive balance within our industry and market areas. The nature and extent of future legislative and regulatory changes affecting financial institutions, including as a result of the Dodd-Frank Act, is very unpredictable at this time. The Company’s management continues to actively monitor the implementation of the Dodd-Frank Act and the regulations promulgated thereunder and assess its probable impact on the business, financial condition, and results of operations of the Company. However, the ultimate effect of the Dodd-Frank Act on the financial services industry in general, and the Company in particular, remains uncertain.

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On July 2, 2013, the Federal Reserve approved final rules that substantially amend the regulatory risk-based capital rules applicable to the Bank.  The FDIC and the OCC have subsequently approved these rules.  The final rules were adopted following the issuance of proposed rules by the Federal Reserve in June 2012, and  implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act.  “Basel III” refers to two consultative documents released by the Basel Committee on Banking Supervision in December 2009, the rules text released in December 2010, and loss absorbency rules issued in January 2011, which include significant changes to bank capital, leverage and liquidity requirements.

The rules include new risk-based capital and leverage ratios, which would be phased in from 2015 to 2019, and would refine the definition of what constitutes “capital” for purposes of calculating those ratios.  The new minimum capital level requirements applicable to the Bank under the final rules would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions.  The final rules also establish a “capital conservation buffer”  above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital.  The capital conservation buffer will be phased in over four years beginning on January 1, 2016, as follows: the maximum buffer will be 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. This will result in the following minimum ratios beginning in 2019: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%.  Under the final rules, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount.  These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

Basel III provided discretion for regulators to impose an additional buffer, the “countercyclical buffer,” of up to 2.5% of common equity Tier 1 capital to take into account the macro-financial environment and periods of excessive credit growth.  However, the final rules permit the countercyclical buffer to be applied only to “advanced approach banks” ( i.e. , banks with $250 billion or more in total assets or $10 billion or more in total foreign exposures), which currently excludes the Bank.  The final rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that will no longer qualify as Tier 1 capital, some of which will be phased out over time.  However, the final rules provide that small depository institution holding companies with less than $15 billion in total assets as of December 31, 2009 (which includes the Company) will be able to permanently include non-qualifying instruments that were issued and included in Tier 1 or Tier 2 capital prior to May 19, 2010 in additional Tier 1 or Tier 2 capital until they redeem such instruments or until the instruments mature.

The final rules also contain revisions to the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels begin to show signs of weakness.  These revisions take effect January 1, 2015.  Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions will be required to meet the following increased capital level requirements in order to qualify as “well capitalized:” (i) a new common equity Tier 1 capital ratio of 6.5%; (ii) a Tier 1 capital ratio of 8% (increased from 6%); (iii) a total capital ratio of 10% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 5% (increased from 4%).

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The final rules set forth certain changes for the calculation of risk-weighted assets, which we will be required to utilize beginning January 1, 2015.  The standardized approach final rule utilizes an increased number of credit risk exposure categories and risk weights, and also addresses: (i) an alternative standard of creditworthiness consistent with Section 939A of the Dodd-Frank Act; (ii) revisions to recognition of credit risk mitigation; (iii) rules for risk weighting of equity exposures and past due loans; (iv) revised capital treatment for derivatives and repo-style transactions; and (v) disclosure requirements for top-tier banking organizations with $50 billion or more in total assets that are not subject to the “advance approach rules” that apply to banks with greater than $250 billion in consolidated assets.

Based on our current capital composition and levels, we believe that we would be in compliance with the requirements as set forth in the final rules if they were presently in effect.

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 must use assumptions and estimates to apply these principles where actual measurement is not possible or practical. For a complete discussion of LSB Financial’s significant accounting policies, see Note 1 to the Consolidated Financial Statements as of December 31, 2012 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. 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’s Board of Directors. These policies include the following:

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 FASB ASC 310-10 (formerly FAS 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

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loan’s effective interest rate or fair value of the underlying collateral based on the discounted appraised value.   Historical loss rates are applied to other commercial loans not subject to specific reserve allocations.

Homogenous smaller balance loans, such as consumer installment and mortgage loans secured by various property types are not individually risk graded. Reserves are established for each pool of loans based on the expected net charge-offs. 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 nonaccrual loans), changes in mix, asset quality trends, risk management and loan administration, changes in the internal lending policies and credit standards, collection practices, examination results from bank regulatory agencies and Lafayette Savings’ 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 and to a lesser extent the eight surrounding counties. When evaluating the adequacy of the allowance, consideration is given to this regional geographic concentration and the closely associated effect of changing economic conditions on Lafayette Savings’ customers.

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.

Accounting for Foreclosed Assets

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.

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Financial Condition

SELECTED FINANCIAL CONDITION DATA
(Dollars in Thousands)
	(Unaudited)
	June 30,		December 31,		$				%
	2013		2012		Difference			Difference
Total assets	$	365,412	$	364,610	$	802			0.22	%
Loans receivable, including loans held for sale, net		268,472		281,620		(13,148	)		(4.67	)
1-4 family residential mortgage loans		95,052		100,579		(5,527	)		(5.50	)
Home equity lines of credit		15,781		16,421		(640	)		(3.90	)
Other real estate loans net of undisbursed portion of loans		153,624		159,367		(5,743	)		(3.60	)
Commercial business loans		12,918		13,290		(372	)		(2.80	)
Consumer loans		1,204		1,131		73			6.45
Loans sold (for the six months)		29,513		29,930		(417	)		(1.39	)
Non-performing loans over 90 days past due		2,012		2,907		(895	)		(30.79	)
Loans less than 90 days past due, not accruing		1,792		3,536		(1,744	)		(49.32	)
Other real estate owned		162		256		(94	)		(36.72	)
Non-performing assets		3,966		6,699		(2,733	)		(40.80	)
Cash and due from banks		1,349		25,643		(24,294	)		(94.74	)
Short-term investments		23,701		5,778		17,923			310.19
Available-for-sale securities		47,780		28,004		19,776			70.62
Interest bearing time deposits		1,748		1,740		8			0.46
Deposits		313,856		308,637		5,219			1.69
Core deposits		176,899		167,704		9,195			5.48
Time accounts		136,957		140,933		(3,976	)		(2.82	)
Brokered deposits		13,690		13,690		---			---
FHLB advances		10,000		15,000		(5,000	)		(33.33	)
Shareholders’ equity (net)		39,570		38,955		615			1.58

Comparison of Financial Condition at June 30, 2013 and December 31, 2012

Our total assets increased $802,000, or 0.22%, during the six months from December 31, 2012 to June 30, 2013.  Primary components of this increase were a $19.8 million increase in available-for-sale securities and a $537,000 increase in other assets, offset by a $13.1 million decrease in net loans receivable including loans held for sale, and a $6.4 million decrease in cash and interest-bearing deposits and interest-bearing time deposits.  Management attributes the decrease in loans to the paydown of loans as borrowers continued to take advantage of unprecedented low rates to refinance their mortgages to lower rate fixed rate mortgages which we sell on the secondary market, and to continuing low commercial loan demand.  We invested most of the proceeds from loan paydowns and excess cash in available-for-sale securities to generate some return until the demand for loans increases.  Deposits increased $5.2 million primarily in core transaction and savings accounts as depositors’ uncertainty about the economy led them to place the money in accounts where it was readily available if needed.  We also paid back a maturing $5.0 million advance from the Federal Home Loan Bank. The increase in other assets was primarily due to the purchase of land for a new branch office and an increase in our deferred tax asset.

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Non-performing assets, which include non-accruing loans and foreclosed assets, decreased from $6.7 million at December 31, 2012 to $4.0 million at June 30, 2013.  Non-accruing loans at June 30, 2013 were comprised of $3.5 million, or 90.92%, of one- to four-family residential real estate loans including home equity loans, $140,000, or 3.69%, of loans on land, $127,000, or 3.34%, of commercial property loans, $71,000, or 1.87%, multi-family property loans, and $7,000, or 0.18%,of non-real estate and consumer loans.  Non-performing assets at June 30, 2013 also included $162,000 of foreclosed assets compared to $256,000 at December 30, 2012.  At June 30, 2013, our allowance for loan losses equaled 2.32% of net loans including loans held for sale, compared to 2.06% at December 31, 2012. The allowance for loan losses at June 30, 2013 totaled 160.01% of non-performing assets compared to 88.06% at December 31, 2012, and 166.82% of non-performing loans at June 30, 2013 compared to 91.57% at December 31, 2012.  Our non-performing assets equaled 1.09% of total assets at June 30, 2013 compared to 1.84% at December 31, 2012.  Non-performing loans totaling $331,000 were charged off in the first six months of 2013, offset by $152,000 of recoveries.

When a 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.  It may take up to two years to move a foreclosed property through the system to the point where we can obtain title to the property and dispose of it.  We attempt to acquire properties through deeds in lieu of foreclosure if there are no other liens on the properties.  We acquired one property in the first quarter of 2013 through a sheriff’s sale.  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.  Effective August 31, 2010, the Bank entered into a Supervisory Agreement (the “Supervisory Agreement”) with the OTS requiring the Bank, among other things, to submit for review by the OTS revised policies and procedures related to the allowance for loan losses.  The Bank has implemented the revised policy which it presumes addressed the concerns expressed by the OTS and has not been notified of any continuing concerns.  The Supervisory Agreement did not require an additional provision for loan loss reserves.  As noted above, as of July 21, 2011, all functions and all rulemaking authority of the OTS relating to federal savings associations were transferred to the OCC.  As a result, the OCC will now enforce the Supervisory Agreement with the Bank.

Shareholders’ equity increased from $39.0 million at December 31, 2012 to $39.6 million at June 30, 2013, an increase of $615,000, or 1.58%, primarily as a result of net income of $1.3 million offset by a $576,000 decrease in accumulated other comprehensive income due to a decline in the market value of available-for-sale securities.  Shareholders’ equity to total assets was 10.83% at June 30, 2013 compared to 10.68% at December 31, 2012.

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Average Balances, Interest Rates and Yields

The following two tables present, for the periods indicated, the total dollar amount of interest income earned on average interest-earning assets and the resulting 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.

	Three months ended								Three months ended
	June 30, 2013								June 30, 2012
	Average Outstanding Balance			Interest Earned/ Paid		Yield/ Rate			Average Outstanding Balance			Interest Earned/ Paid		Yield/ Rate
	(Dollars in Thousands)
Interest-Earning Assets:
Loans receivable(1)	$	270,939		$	3,261		5.18	%	$	294,157		$	3,806		5.18	%
Other investments		70,986			201		1.13			31,594			144		1.82
Total interest-earning assets		341,925			3,462		4.05			325,751			3,950		4.85
Interest-Bearing Liabilities
Savings deposits	$	31,759			5		0.06		$	27,503			6		0.09
Demand and NOW deposits		141,527			71		0.20			135,404			125		0.37
Time deposits		137,988			461		1.34			149,975			616		1.64
Borrowings		10,000			59		2.36			18,000			104		2.31
Total interest-bearing liabilities		321,274			596		0.74			330,882			851		1.03
Net interest income				$	2,866							$	3,099
Net interest rate spread							3.31	%							3.82	%
Net earning assets	$	20,651							$	(5,131	)
Net yield on average interest-earning assets							3.35	%							3.81	%
Average interest-earning assets to average interest-bearing liabilities		1.06	x							0.98	x

_________________

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

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	Six months ended June 30, 2013								Six months ended June 30, 2012
	Average Outstanding Balance			Interest Earned/ Paid		Yield/ Rate			Average Outstanding Balance			Interest Earned/ Paid		Yield/ Rate
	(Dollars in Thousands)
Interest-Earning Assets:
Loans receivable(1)	$	274,411		$	6,738		4.91	%	$	295,945		$	7,881		5.33	%
Other investments		67,859			366		1.08			26,423			264		2.00
Total interest-earning assets		342,270			7,104		4.15			322,368			8,145		5.05
Interest-Bearing Liabilities
Savings deposits	$	30,919			9		0.06		$	26,913			11		0.08
Demand and NOW deposits		138,707			148		0.21			132,875			265		0.40
Time deposits		139,908			949		1.36			152,395			1,282		1.68
Borrowings		11,667			138		2.37			18,000			204		2.27
Total interest-bearing liabilities		321,201			1,244		0.77			330,183			1,762		1.07
Net interest income				$	5,860							$	6,383
Net interest rate spread							3.38	%							3.98	%
Net earning assets	$	21,069							$	(7,815	)
Net yield on average interest-earning assets							3.42	%							3.96	%
Average interest-earning assets to average interest-bearing liabilities		1.07	x							0.98	x

_________________

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

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Results of Operations

Comparison of Operating Results for the Six Months and the Quarter ended June 30, 2013 and June 30, 2012

General.  Net income for the six months ended June 30, 2013 was $1.3 million, an increase of $213,000, or 19.29%, from the six months ended June 30, 2012.  The increase was primarily due to a $493,000, or 27.63%, increase in non-interest income and a $475,000, or 43.18%, decrease in the provision for loan losses, partially offset by a $523,000, or 8.19%, decrease in net interest income, a $131,000, or 21.16% increase in taxes and a $101,000, or 1.89%, increase in noninterest expenses.

Net income for the three months ended June 30, 2013 was $664,000, an increase of $155,000, or 30.45%, from the three months ended June 30, 2012.  The increase was primarily due to a $283,000, or 32.34%, increase in non-interest income and a $275,000, or 55.00%, decrease in the provision for loan losses, partially offset by a $233,000, or 7.52%, decrease in net interest income, an $87,000, or 3.24%, increase in noninterest expenses, and an $83,000 or 29.43% increase in taxes.

Net Interest Income.  Net interest income for the six months ended June 30, 2013 decreased $523,000, or 8.19%, over the same period in 2012.  This decrease was primarily due to a 60 basis point decline in our net interest rate spread as the average yield on interest earning assets decreased by 90 basis points while the yield on interest earning liabilities decreased by only 30 basis points.  Interest earning assets increased by $19.9 million as the average balance of investment securities increased $41.4 million offset by a $21.5 million decrease in average loans receivable.  The investment securities were purchased using excess cash balances and loan paydowns.  This movement of cash into earning assets increased the ratio of average interest-earning assets to average interest-bearing liabilities from 0.98 to 1.07, but reduced the average rate on investments from 2.00% to 1.08%.  Our net interest margin (net interest income divided by average interest-earning assets) decreased from 3.96% to 3.42%.

Interest income on loans decreased $1.1 million, or 14.50%, for the six months ended June 30, 2013 compared to the same six months in 2012 because the average balance of loans held in our portfolio decreased by $21.5 million from $295.9 million for the six month period in 2012 to $274.4 million in 2013.  The average yield on loans decreased by 42 basis points from 5.33% to 4.91% over the same period.

Interest earned on other investments and Federal Home Loan Bank stock increased by $102,000, or 38.64%, for the six months ended June 30, 2013 compared to the same period in 2012.  This was primarily the result of a $41.4 million increase in average investment securities partially offset by a 92 basis point decrease in the average yield on the investments and Federal Home Loan Bank stock from 2.00% to 1.08% over the comparable periods.  The decrease in rate was primarily due to the lower market rate for investments.

Interest expense for the six months ended June 30, 2013 decreased $518,000, or 29.40%, compared to the same period in 2012 consisting of a $452,000 decrease in interest paid on deposits and a $66,000 decrease in interest expenses on Federal Home Loan Bank advances.  The lower deposit costs were primarily due to a decrease in the average rate paid on deposits from 1.00% for the first six months of 2012 to 0.71% for the first six months of 2013 and by a

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$2.6 million decrease in the average balance of deposit accounts.  The average balance in lower rate transaction and savings accounts increased by $9.8 million while their average rate decreased from 35 basis points to 19 basis points.  The increase in these balances was largely due to depositors opting for fund availability over higher rates until they feel more confident about the economic situation.   The decrease in Federal Home Loan Bank advance expense was due to a $6.3 million decrease in the average balance of advances offset by a slight increase in the average rate paid on advances from 2.27% for the six months of 2012 to 2.37% for the first six months of 2013 because of the maturity and repayment of a shorter term, lower rate advance.

Net interest income for the three months ended June 30, 2013 decreased $233,000, or 7.52%, over the same period in 2012.  This decrease was primarily due to a 51 basis point decline in our net interest rate spread as the average yield on interest earning assets decreased by 80 basis points while the yield on interest earning liabilities decreased by only 29 basis points.  Interest-earning assets increased by $16.2 million as the average balance of investment securities increased $39.4 million offset by a $23.2 million decrease in average loans receivable.  The investment securities were purchased using excess cash balances and loan paydowns.  This movement of cash into earning assets increased the ratio of average interest-earning assets to average interest-bearing liabilities from 0.98 to 1.06 but reduced the average rate on investments from 1.82% to 1.13%.  Our net interest margin (net interest income divided by average interest-earning assets) decreased from 3.81% to 3.35%.

Interest income on loans decreased $545,000, or 14.32%, for the three months ended June 30, 2013 compared to the same three months in 2012 because the average balance of loans held in our portfolio decreased by $23.2 million from $294.2 million from the three month period in 2012 to $270.9 million in 2013.  The average yield on loans was unchanged over this period at 5.18%.

Interest earned on other investments and Federal Home Loan Bank stock increased by $57,000, or 39.58%, for the three months ended June 30, 2013 compared to the same period in 2012.  This was primarily the result of a $39.4 million increase in average investment securities partially offset by a 69 basis point decrease in the average yield on the investments and Federal Home Loan Bank stock from 1.82% to 1.13% over the comparable periods.  The decrease in rate was primarily due to the lower market rate for investments.

Interest expense for the three months ended June 30, 2013 decreased $255,000, or 29.96%, compared to the same period in 2012 consisting of a $210,000 decrease in interest paid on deposits and a $45,000 decrease in interest expenses on Federal Home Loan Bank advances.  The lower deposit costs were primarily due to a decrease in the average rate paid on deposits from 0.95% for the first three months of 2012 to 0.69% for the first three months of 2013 and by a $1.6 million decrease in the average balance of deposit accounts.  The average balance in lower rate transaction and savings accounts increased by $10.4 million while the average rate decreased from 32 basis points to 18 basis points.  The increase in these balances was largely due to depositors opting for fund availability over higher rates until they feel more confident about the economic situation.   The decrease in Federal Home Loan Bank advance expense was due to a $8.0 million decrease in the average balance of advances offset by a slight increase in the average rate paid on advances from 2.31% for the three months of 2012 to 2.36% for the first three months of 2013 because of the maturity and repayment of a shorter term, lower rate advance.

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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.

	06/30/13		12/31/12		06/30/12
	(Dollars in Thousands)
Loans delinquent 30-59 days	$	118	$	1,176	$	---
Loans delinquent 60-89 days		719		781		1,640
Total delinquencies		839		1,957		1,640
Non-performing loans		3,804		6,443		10,317
OREO		162		256		787
Total non-performing assets	$	3,966	$	6,699	$	11,104

Loans are included in the delinquent 30-59 days category when they become one month past due.  Loans are included in the delinquent 60-89 days category when they become two months past due.  Loans that are less than 90 days delinquent but are non-accruing are included in the non-accruing loan category but not in the delinquencies under 90 days.

The accrual of interest income is generally discontinued when a loan becomes 90 days 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 in the process of collection.  Troubled debt restructurings that were non-performing at the time of their restructure are considered non-accruing loans until sufficient time has passed for them to establish a pattern of compliance with the terms of the restructure.

Changes in non-performing loans at June 30, 2013 compared to December 31, 2012 were primarily due to the Bank restoring two relationships representing $2.2 million of loans to accrual status due to greatly improved financial situations making full collectability of principal and interest likely, taking $205,000 into OREO, charging off $185,000 of non-performing loans, and receiving payoffs of $166,000.  In addition we received principal payments of $160,000. Over this six month period we also had $291,000 of loans on residential properties become non-performing.

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 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.

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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 the 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.

At June 30, 2013 our largest areas of concern were loans on one- to four-family non-owner occupied rental properties and loans on one- to four-family owner occupied properties.  Loans totaling $1.5 million on one- to four-family rental properties and $872,000 on one- to four-family owner occupied properties were past due more than 30 days at June 30, 2013.  Because of the presence of Purdue University, student housing has been a niche for us, but because of the economy we are seeing problems with vacancies, especially in non-campus housing.  The owner occupied property delinquencies typically reflect the elevated unemployment rate in the county.

We recorded a $625,000 provision for loan losses for the six months ended June 30, 2013 as a result of our analyses of our current loan portfolios, compared to $1.1 million during the same period in 2012.  The provisions were necessary to maintain the allowance for loan losses at a level considered appropriate to absorb probable incurred losses in the loan portfolio.  The main reason for the decrease for the first six months of 2013 compared to the same period in 2012 was the improvement in non-accruing and delinquent loans during the period.  During the first six months of 2013, we charged $331,000 against loan loss reserves and had recoveries of $152,000.  We expect to obtain possession of more properties in 2013 that are currently in the process of foreclosure.  The final disposition of these properties may result in a loss.  The $6.3 million allowance for loan losses was considered appropriate to cover probable incurred losses based on our evaluation and our loan mix.  Our ratio of allowance for loan losses to non-performing assets increased from 88.06% at December 31, 2012 to 160.01% at June 30, 2013.

Our loan portfolio contains no option ARM products, interest-only loans, or loans with initial teaser rates.  While we occasionally make loans with credit scores in the subprime range, these loans are only made if there are sufficient mitigating factors, not as part of a subprime mortgage plan.   We occasionally make mortgages that exceed high loan-to-value regulatory guidelines for property type.  We currently have $8.4 million of mortgage loans that are other than one- to four-family loans that qualify as high loan-to-value.  We typically make these loans only to well-qualified borrowers. None of these loans are delinquent more than 30 days.  We also have $5.7 million of one- to four-family loans which, either alone or combined with a second mortgage, exceed high loan-to-value guidelines.  Of these loans, one loan of $262,000 was delinquent more than 30 days.  Our total high loan-to-value loans at June 30, 2013 were at 33% of capital, well under regulatory guidelines of 100% of capital.  We have $15.78 million of Home Equity Lines of Credit, two of which were delinquent more than 30 days at June 30, 2013.

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An analysis of the allowance for loan losses for the three months ended June 30, 2013 and 2012 follows:

	Three months ended June 30,
	2013			2012
	(Dollars in Thousands)
Balance at March 31	$	6,062		$	5,331
Loans charged off		(10	)		(1,217	)
Recoveries		69			54
Provision		225			1,100
Balance at June 30	$	6.346		$	5,268

At June 30, 2013, non-performing assets, consisting of non-accruing loans, accruing loans 90 days or more delinquent and other real estate owned, totaled $4.0 million compared to $6.7 million at December 31, 2012.  In addition to our non-performing assets, we identified $16.7 million in other loans of concern at June 30, 2013 compared to $13.6 million at December 31, 2012 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 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 June 30, 2013, we believe that our allowance for loan losses was appropriate to absorb probable incurred losses inherent in our loan portfolio.  Our allowance for losses equaled 2.32% of net loans receivable and 166.82% of non-performing loans at June 30, 2013 compared to 2.06% and 91.57% at December 31, 2012, respectively.  Our non-performing assets equaled 1.09% of total assets at June 30, 2013 compared to 1.84% at December 31, 2012.

Non-Interest Income.  Non-interest income for the six months ended June 30, 2013 increased by $493,000, or 27.63%, compared to the same period in 2012.  This was primarily due to a $304,000 increase in other income, a $137,000 improvement in losses on the sale or writedown of OREO properties from $139,000 of losses in the first six months of 2012 to $2,000 of losses in the same period of 2013, a $125,000 increase in the gain on the sale of mortgage loans offset by a $73,000 decrease in service charges and fee income.  The increase in other income was due to a $147,000 increase in the fees generated by our wealth management department and a $145,000 increase in mortgage loan servicing fees due to an increase in our servicing portfolio.   The increase in the gain on sale of mortgage loans was due to an increase in loans sold with the servicing retained where the prepaid servicing fee included in the gain on the sale in the first six months of 2013 was $192,000 compared to $103,000 for the same period in 2012, and to an increase in the number of federally insured loans which generate higher fee income.  The decrease in service fees was primarily due to changes in our fee structure mandated by the Dodd-Frank Act.

Non-interest income for the second quarter of 2013 increased by $283,000, or 32.34%, compared to the same period in 2012 due primarily to a $146,000 increase in other income, a

44

$102,000 increase in the gain on the sale of mortgage loans, a $56,000 improvement in losses on the sale or writedown of OREO properties from $56,000 of losses in the first three months of 2012 to no losses in the same period of 2013, offset by a $21,000 decrease in service charges and fee income.    The reasons for these changes were the same as those mentioned above.

Non-Interest Expense.  Non-interest expense for the six months ended June 30, 2013 increased $101,000, or 1.89%, compared to the same period in 2012 due primarily to a $63,000 increase in salaries and employee benefits due mainly to a higher level of loan origination activity by commission-based loan originators, a $39,000 increase in occupancy and equipment costs due generally to higher monthly maintenance fees, and a $35,000 increase in advertising expenses due to expenses related to updating our marketing image, offset by a $26,000 decrease in other expenses due to lower consulting fees (which is primarily a timing issue), as well as lower legal and accounting fees as there have been fewer changes to regulatory compliance to be incorporated, and a $7,000 decrease in FDIC insurance premiums.

Non-interest expense for the three months ended June 30, 2013 increased $87,000, or 3.24%, compared to the same period in 2012 due primarily to a $55,000 increase in salaries and employee benefits, a $38,000 increase in occupancy and equipment costs due generally to higher monthly maintenance fees, an $8,000 increase in advertising expenses related to updating our marketing image, offset by a $15,000 decrease in other expenses due to reasons mentioned above.

Income Tax Expense.   Our income tax provision increased by $131,000 for the six months ended June 30, 2013 compared to the six months ended June 30, 2012 and by $83,000 for the three months ended June 30, 2013 compared to the three months ended June 30, 2012, due primarily to increased pre-tax income.

Liquidity

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.

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, Federal Home Loan Bank advance opportunities, market yields and 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 and more recently at the Federal Reserve since they have started to pay interest on deposits in excess of reserve requirements and because of increasing wire transfer requests due to a change in funding methods now required by

45

title companies.  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 5% of total assets.  Because of the increase in short term deposits and slow commercial loan activity as mentioned above, our liquidity ratio at June 30, 2013 was 18.27% as a percentage of total assets compared to 17.32% at December 31, 2012.

We anticipate that we will have sufficient funds available to meet current funding commitments.  At June 30, 2013, we had outstanding commitments to originate loans and available lines of credit totaling $35.5 million and commitments to provide funds to complete current construction projects in the amount of $3.3 million. We had $1.3 million of outstanding commitments to sell residential loans.  Certificates of deposit which will mature in one year or less totaled $76.6 million at June 30, 2013.  Included in that number are $2.1 million of brokered deposits.  Based on our experience, certificates of deposit held by local depositors 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 our customers.  Therefore, we believe a significant portion of such deposits will remain with us, although this cannot be assured.  Brokered deposits can be expected not to renew at maturity and will have to be replaced with other funding upon maturity.  We have no Federal Home Loan Bank advances maturing in the next twelve months.

Capital Resources

Shareholders’ equity totaled $39.6 million at June 30, 2013 compared to $39.0 million at December 31, 2012, an increase of $615,000, or 1.58%, due primarily to net income of $1.3 million offset by a $576,000 decrease in other comprehensive income.  Shareholders’ equity to total assets was 10.83% at June 30, 2013 compared to 10.68% at December 31, 2012.

Federal insured savings institutions are required to maintain a minimum level of regulatory capital.  If the requirement is not met, regulatory authorities may take legal or administrative actions, including restrictions on growth or operations or, in extreme cases, seizure.  As of June 30, 2013 and December 31, 2012, Lafayette Savings was categorized as well capitalized.  Our actual and required capital amounts and ratios at June 30, 2013 and December 31, 2012 are presented below:

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	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in Thousands)
As of June 30, 2013
Total risk-based capital (to risk-weighted assets)	$	42,845		16.4	%	$	20,913		8.0	%	$	26,416		10.0	%
Tier I capital (to risk-weighted assets)		39,539		15.1			10,457		4.0			15,685		6.0
Tier I capital (to adjusted total assets)		39,539		10.8			10,980		3.0			18,300		5.0
As of December 31, 2012
Total risk-based capital (to risk-weighted assets)	$	41,400		16.0	%	$	20,694		8.0	%	$	25,868		10.0	%
Tier I capital (to risk-weighted assets)		38,134		14.7			10,347		4.0			15,521		6.0
Tier I capital (to adjusted total assets)		38,134		10.5			10,928		3.0			18,213		5.0

Effective August 31, 2010, the Company entered into a Memorandum of Understanding (“MOU”) with the OTS, requiring the Company to submit to the OTS by October 31, 2010 a capital plan for enhancing the consolidated capital of the Company for the period January 1, 2011 through December 31, 2012.  In its submitted capital plan, the Company proposes to maintain risk-based capital ratios above twelve percent (200 basis points above the ten percent well-capitalized level), and core capital above eight percent (300 basis points above the five percent well-capitalized level). The current capital levels shown in the table above are at least 1% above these levels.  On July 14, 2011, the OTS notified the Company that certain revisions to the capital plan primarily relating to consolidated capital ratios and consolidated financial statements of the Company were needed. As noted above, as a result of the Dodd-Frank Act, the Bank is being supervised by the OCC and the Company is being supervised by the Federal Reserve from and after July 21, 2011.  The Company requested clarification from the Federal Reserve regarding the requested information and submitted a response on August 30, 2011 explaining a labeling correction that the Company believes addresses the concerns noted by the OTS.

The Bank’s Supervisory Agreement and the MOU require prior written non-objection of the OCC and the Federal Reserve (formerly the OTS) of the declaration or payment of dividends or other capital distributions by the Bank or the Company, respectively.  In addition, the MOU requires prior approval by the Federal Reserve of any debt at the holding company level not in the ordinary course (including loans, cumulative preferred stock and subordinated debt), unless such debt is contemplated by the capital plan.  LSB Financial does not now hold any such debt.  The Company paid a quarterly cash dividend to its shareholders in June 2013. All required regulatory non-objections to the dividend were obtained.

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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-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.

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Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Not Applicable for Smaller Reporting Companies.

Item 4.  Controls and Procedures.

Evaluation of Disclosure Controls and Procedures.  An evaluation of the Company’s disclosure controls and procedures (as defined in Sections 13a-15(e) and 15d-15(e) of the regulations promulgated under the Securities Exchange Act of 1934, as amended (the “Act”)), as of June 30, 2013, was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and several other members of the Company’s senior management.  The Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s 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 Securities and Exchange Commission’s rules and forms.

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 the Company’s evaluation of controls that occurred during the quarter ended June 30, 2013, that have materially affected, or are reasonably likely to materially affect, our internal control over the financial reporting.

PART II. OTHER INFORMATION

Item 1.  Legal Proceedings

Effective August 31, 2010, the Bank executed an updated Supervisory Agreement (the “Supervisory Agreement”) with the Office of Thrift Supervision (“OTS”) and LSB Financial Corp. (the “Company”) entered into a Memorandum of Understanding (the “MOU”) with the OTS under which the Bank and the Company have agreed to take a number of actions within specified timeframes to address concerns identified by the OTS in connection with its 2010 examination of the Bank. These agreements replace the prior Memorandum of Understanding and Supervisory Agreement between the Bank and the OTS. As a result of the Dodd-Frank Act, from and after July 21, 2011, the Bank is being supervised by the OCC and the Company is being supervised by the Federal Reserve. As a result, the OCC will now enforce the Bank’s Supervisory Agreement and the Federal Reserve will enforce the MOU. The Supervisory Agreement and the MOU will remain in effect until terminated, modified or superseded by the OCC or Federal Reserve, respectively.

The updated Supervisory Agreement eliminates certain requirements satisfied in the Bank’s prior agreement with the OTS.

Under the Supervisory Agreement, by September 30, 2010, the Bank’s board of directors was required to provide to the OTS written workout plans for each adversely classified asset or group of classified assets to any one borrower or loan relationship of $500,000 or greater certain

49

classified assets. The Bank must also present quarterly status reports to the OCC (formerly, the OTS). The Bank timely submitted the required workout plans and has provided, and will continue to provide, the quarterly written asset status reports as required. The Bank believes it is in compliance with this provision of the Supervisory Agreement and that these plans are a useful tool in monitoring the progress of its workouts of classified assets.

The Bank’s board of directors was also required to revise its policy on concentrations of credit and, in the event the revised limits are lower, adopt a plan to bring the Bank into compliance with the revised policy. The Bank’s board must also, on a quarterly basis, review the Bank’s compliance with the revised policy and the appropriateness of its concentration limits given current economic conditions and the Bank’s capital position. On September 20, 2010, the Bank’s board of directors approved a revised Concentrations of Credit Policy and Reduction Plan and continues to review the policy and compliance therewith on a quarterly basis. The Bank believes it is in compliance with these provisions of the Supervisory Agreement, and that its concentrations in the area of one- to four-family non-owner occupied rental properties have been reduced as a result of these actions.

The Bank was also required to revise its policies and procedures related to the establishment and maintenance of its allowance for loan losses and submit the revised policy to the Regional Director of the OTS for review and comment. However, the Supervisory Agreement did not require an additional provision for loan loss reserves. The Bank revised its allowance for loan losses policy on September 21, 2010. On June 20, 2011, the Bank’s board of directors further revised the policy to add clarification with respect to the requirement for outside appraisals. As a result of these actions, the Bank now obtains appraisals performed by a state-certified appraiser on all higher risk transactions. The Bank believes that it is in compliance with this provision of the Supervisory Agreement.

The Supervisory Agreement also required the Bank to revise its written internal asset review and classification program. The Bank revised its internal asset review and classification program policy on September 21, 2010. The Bank’s board of directors has also approved establishment of an asset review committee that will review any loan rating changes. As a result of these actions, the Bank believes it has improved its loan classification process and its identification of troubled debt restructurings and nonaccrual loans. The Bank believes that it is in compliance with this provision of the Supervisory Agreement.

The Bank was required to submit to the OTS an updated business plan for the period beginning January 1, 2011 through December 31, 2012. The Bank submitted a three-year Business Plan to the OTS by October 31, 2010 which sets forth minimum capital goals of 8 percent and 12 percent for Tier 1 (Core) and risk-based capital, respectively. The Plan outlines strategies that will be employed to boost earnings and preserve capital, and includes pro-forma financial projections and budget assumptions. Any material modifications to the Business Plan must receive prior, written non-objection of the OCC (formerly the OTS). By December 31, 2011, and each December 31st thereafter while the Supervisory Agreement remains in effect, the Business Plan must be updated and submitted to the OCC (formerly the OTS). The OTS Regional Director notified the Bank on July 14, 2011 that the Plan was acceptable and should be implemented immediately. The Bank has implemented the Business Plan and there have been no material modifications to the Business Plan since submission. The Bank believes it is in compliance with this provision of the Supervisory Agreement, except to the extent not yet applicable. The Bank believes that these actions relating to its Business Plan have improved its budgeting process.

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The Bank’s board of directors is also required to review written quarterly variance reports on the Bank’s compliance with the Business Plan. A copy of each variance report is to be provided to the OCC (formerly the OTS) within five (5) days after review by the board. A budget variance report explaining the reasons for material variances from original projections is submitted to the Bank’s board of directors within 45 days of the quarter end. The board discusses the impact of noted variances and determines whether or not corrective action is required. The Bank believes it is in compliance with this provision of the Supervisory Agreement.

The Supervisory Agreement requires prior written non-objection of the OCC (formerly the OTS) of the declaration or payment of dividends or other capital distributions by the Bank. The Bank has not declared or paid dividends, nor has it made any other capital distribution to the Company without the required prior approval. The Bank’s last approved dividend to the Company was paid in June, 2013. All required regulatory non-objections to the dividend declaration were obtained. . The Bank is in compliance with this provision of the Supervisory Agreement.

The Supervisory Agreement places restrictions on the Bank with respect to certain operating activities, requiring prior notice to the OCC (formerly the OTS) of changes in directors and senior executive officers and prior written non-objection from the OCC (formerly the OTS) with respect to senior executive officer or director compensation, material third party service provider contracts, and asset growth over certain levels until the approval of the Bank’s Business Plan. Asset growth resulting from lending activities has not exceeded interest credited since third quarter 2010 (the quarter in which the Supervisory Agreement was executed). No payments covered by the Supervisory Agreement’s restriction on “golden parachute payments” as defined in 12 CFR § 359.1(f) have been made or requested since the effective date of the Supervisory Agreement. The appointments of Thomas Parent and Sarah Byrn to the Board of Directors were approved by the OCC.  The Bank believes it is in compliance with these provisions of the Supervisory Agreement.

Under the MOU, the Company was required to submit to the OTS by October 31, 2010, a capital plan for enhancing the consolidated capital of the Company for the period January 1, 2011 through December 31, 2012. The capital plan is to be updated each year during which the MOU is effective. On July 14, 2011, the OTS notified the Company that certain revisions to the capital plan primarily relating to consolidated capital ratios and consolidated financial statements of the Company were needed. The Company requested clarification from the Federal Reserve regarding the requested information and submitted a response on August 30, 2011 explaining a labeling correction that the Company believes addresses the concerns noted by the OTS.

The MOU also requires prior written non-objection of the Federal Reserve (formerly the OTS) of the declaration or payment of dividends or other capital distributions by the Company and of any Company debt not in the ordinary course (including loans, cumulative preferred stock and subordinated debt) unless such debt is contemplated by the capital plan. The Company does not now hold any such debt. The Company believes it is in compliance with the provisions of the MOU. The Company paid a quarterly cash dividend to its shareholders in June 2013 after receiving all required regulatory non-objections.

The Company believes that the Supervisory Agreement and the MOU have not had, and will not have, a material impact on the financial condition or results of operations of the Bank or the Company, taken as a whole.

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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 2.  Unregistered Sales of Equity Securities and Use of Proceeds

The following table sets forth the number and prices paid for repurchased shares.

Issuer Purchases of Equity Securities
Month of Purchase	Total Number of Shares Purchased1	Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs2	Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs2
April 1 – April 30, 2013	---	---	---	52,817
May 1 – May 31, 2013	---	---	---	52,817
June 1 – June 30, 2013	---	---	---	52,817
Total	---	---	---	52,817

_______________________

1 There were no shares repurchased other than through a publicly announced plan or program.

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

Item 3.  Defaults Upon Senior Securities

None.

Item 4.  Mine Safety Disclosures

Not Applicable.

Item 5.  Other Information

None.

Item 6.  Exhibits

The exhibits listed in the Index to Exhibits are incorporated herein by reference.

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SIGNATURES

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

	LSB FINANCIAL CORP.
	(Registrant)
Date:  August 14, 2013	By:	/s/ Randolph F. Williams
		Randolph F. Williams, President
		(Principal Executive Officer)
Date:  August 14, 2013	By:	/s/ Mary Jo David
		Mary Jo David, Treasurer
		(Principal Financial and Accounting Officer)

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INDEX TO EXHIBITS

Regulation S-K Exhibit Number	Document
31.1	Rule 13(a)-14(a) Certification (Chief Executive Officer)
31.2	Rule 13(a)-14(a) Certification (Chief Financial Officer)
32	Section 906 Certification
101	The following materials from the Company’s Form 10-Q for the quarterly period ending June 30, 2013, formatted in an XBRL Interactive Data File: (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Income and Comprehensive Income; (iii) Consolidated Statements of Changes in Shareholders’ Equity; (iv) Consolidated Statements of Cash Flows; and (v) Notes to Consolidated Financial Statements, tagged as blocks of text.*

*  Users of the XBRL-related information in Exhibit 101 of this Quarterly Report on Form 10-Q are advised, in accordance with Regulation S-T Rule 406T, that this Interactive Data File is deemed not filed as a part of a registration statement for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.  The financial information contained in the XBRL-related documents is unaudited and unreviewed.