LSB FINANCIAL CORP - FORM 10-Q

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EX-31.1 - CEO CERTIFICATION - LSB FINANCIAL CORP	lsb_10q063014ex311.htm
EX-32 - JOINT CERTIFICATION - LSB FINANCIAL CORP	lsb_10q063014ex32.htm
EX-31.2 - CFO CERTIFICATION - LSB FINANCIAL CORP	lsb_10q063014ex312.htm
EXCEL - IDEA: XBRL DOCUMENT - LSB FINANCIAL CORP	Financial_Report.xls

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, 2014

			OR

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

For the transition period from ________________ to ________________

Commission file number: 0-25070

LSB FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

Indiana		35-1934975
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

101 Main Street, Lafayette, Indiana		47901
(Address of principal executive offices)		(Zip Code)

(765) 742-1064

(Registrant’s telephone number, including area code)

None

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

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 ý No o

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 ý No 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 o No ý

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, 2014
Common Stock, $.01 par value per share		1,567,764 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		28

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	50

Item 4.	Controls and Procedures.	50

PART II.	OTHER INFORMATION	50

Item 1.	Legal Proceedings	50

Item 1A.	Risk Factors	50

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	51

Item 3.	Defaults Upon Senior Securities	51

Item 4.	Mine Safety Disclosures	51

Item 5.	Other Information	51

Item 6.	Exhibits	51

SIGNATURES		52

PART I FINANCIAL INFORMATION

Item 1. Financial Statements

LSB FINANCIAL CORP.

Consolidated Condensed Balance Sheets

(Dollars in thousands, except per share data)

	June 30, 2014			December 31, 2013
	(unaudited)
Assets
Cash and due from banks	$	16,735		$	21,961
Interest-bearing deposits		8,311			2,237
Cash and cash equivalents		25,046			24,198
Interest-bearing time deposits		1,247			1,743
Available-for-sale securities		64,326			62,705
Loans held for sale		488			657
Total loans		259,840			261,051
Less: Allowance for loan losses		(6,088	)		(6,348	)
Net loans		253,752			254,703
Premises and equipment, net		8,370			7,933
Federal Home Loan Bank stock, at cost		3,185			3,185
Bank-owned life insurance		6,817			6,745
Interest receivable and other assets		5,457			5,712
Total assets	$	368,688		$	367,581

Liabilities and Shareholders’ Equity
Liabilities
Deposits	$	314,510		$	314,620
Federal Home Loan Bank advances		10,000			10,000
Interest payable and other liabilities		2,568			2,234
Total liabilities		327,078			326,854

Commitments and Contingencies

Shareholders’ Equity
Common stock, $.01 par value
Authorized - 7,000,000 shares Issued and outstanding 2014 - 1,567,764 shares 2013 - 1,564,838 shares,		15			15
Additional paid-in-capital		11,451			11,348
Retained earnings		30,154			29,658
Accumulated other comprehensive loss		(10	)		(294	)
Total shareholders’ equity		41,610			40,727

Total liabilities and shareholders’ equity	$	368,688		$	367,581

See notes to consolidated condensed financial statements.

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,
	2014			2013			2014		2013
Interest and Dividend Income
Loans	$	2,897		$	3,261		$	5,836	$	6,738
Securities
Taxable		228			141			465		245
Tax-exempt		62			49			123		94
Other		6			11			13		27
Total interest and dividend income		3,193			3,462			6,437		7,104
Interest Expense
Deposits		423			537			859		1,106
Borrowings		59			59			118		138
Total interest expense		482			596			977		1,244
Net Interest Income		2,711			2,866			5,460		5,860

Provision for Loan Losses		100			225			100		625
Net Interest Income After Provision for Loan Losses		2,611			2,641			5,360		5,235

Non-interest Income
Deposit account service charges and fees		302			300			566		573
Net gains on loan sales		327			527			516		957
Gain (loss) on other real estate owned		(3	)		---			1		(2	)
Other		319			331			653		749
Total non-interest income		945			1,158			1,736		2,277

Non-Interest Expense
Salaries and employee benefits		1,480			1,551			2,976		3,078
Net occupancy and equipment expense		313			321			718		640
Computer service		158			156			312		297
Advertising		81			97			161		212
FDIC insurance premiums		117			117			232		233
Other		824			528			1,312		985
Total non-interest expense		2,973			2,770			5,711		5,445

Income Before Income Taxes		583			1,029			1,385		2,067
Provision for Income Taxes		325			365			607		750
Net Income	$	258		$	664		$	778	$	1,317
Unrealized appreciation (depreciation) on available-for-sale securities net of taxes of $109 and ($391) for the three months ended June 30, 2014 and 2013, and of $189 and ($384), for the six months ended June 30, 2014 and 2013, respectively		165			(587	)		284		(576	)
Total comprehensive income	$	423		$	77		$	1,062	$	741

Basic Earnings Per Share	$	0.16		$	0.43		$	0.50	$	0.85
Diluted Earnings Per Share	$	0.16		$	0.42		$	0.49	$	0.85
Dividends Declared Per Share	$	0.09		$	0.05		$	0.18	$	0.10

See notes to consolidated condensed financial statements

LSB FINANCIAL CORP.

Consolidated Condensed Statements of Changes in Shareholders’ Equity

For the Six Months Ended June 30, 2014 and 2013

(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, 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



Balance, January 1, 2014	$	15	$	11,348	$	29,658		$	(294	)	$	40,727
Net income						778						778
Other comprehensive income									284			284
Stock options exercised (2,926 shares)				36								36
Tax benefit related to stock options exercised				5								5
Dividends on common stock, $0.18 per share						(282	)					(282	)
Share-based compensation expense				62								62
Balance, June 30, 2014	$	15	$	11,451	$	30,154		$	(10	)	$	41,610

See notes to consolidated condensed financial statements.

LSB FINANCIAL CORP.

Consolidated Condensed Statements of Cash Flows

(Dollars in thousands)

(Unaudited)

	Six months ended June 30,
	2014			2013
Operating Activities
Net income	$	778		$	1,317
Items not requiring (providing) cash
Depreciation		235			224
Provision for loan losses		100			625
Amortization of premiums and discounts on securities		158			103
Gain (loss) on sale of other real estate owned		(1	)		2
Gain on sale of loans		(516	)		(957	)
Loans originated for sale		(11,324	)		(28,669	)
Proceeds on loans sold		12,009			29,513
Amortization of stock options		62			13
Changes in
Interest receivable and other assets		282			(457	)
Interest payable and other liabilities		145			352
Net cash provided by operating activities		1,928			2,066

Investing Activities
Net change in interest-bearing deposits		498			---
Purchases of available-for-sale securities		(6,273	)		(21,795	)
Proceeds from paydowns and maturities of available-for-sale securities		4,966			948
Net change in loans		675			12,474
Proceeds from sale of other real estate owned		77			254
Purchase of premises and equipment		(672	)		(398	)
Net cash used in investing activities		(729	)		(8,517	)

Financing Activities
Net change in demand deposits, money market, NOW and savings accounts		8,887			9,195
Net change in certificates of deposit		(8,997	)		(3,976	)
Repayment of Federal Home Loan Bank advances		---			(5,000	)
Proceeds from stock options exercised		36			14
Tax benefits related to stock options exercised		5			3
Dividends paid		(282	)		(156	)
Net cash provided by (used in) financing activities		(351	)		80

Increase (Decrease) in Cash and Cash Equivalents		848			(6,371	)
Cash and Cash Equivalents, Beginning of Period		24,198			31,421
Cash and Cash Equivalents, End of Period	$	25,046		$	25,050

Supplemental Cash Flows Information
Interest paid	$	972		$	1,284
Income taxes paid		620			1,275

Supplemental Non-Cash Disclosures
Capitalization of mortgage servicing rights		113			192
Loans transferred to other real estate owned		176			162

See notes to consolidated condensed financial statements.

LSB FINANCIAL CORP.

Notes to Consolidated Condensed Financial Statements

June 30, 2014

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, 2013 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, 2013 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. (“LSB Financial” or the “Company”), its wholly owned subsidiary Lafayette Savings Bank, FSB (“Lafayette Savings” or the “Bank”), and Lafayette Savings’ wholly owned subsidiary, L.S.B. Service Corporation. All significant intercompany transactions have been eliminated upon consolidation.

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, 2014, 76,272 shares related to stock options outstanding were dilutive and none were antidilutive. 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.

The following table presents information about the number of shares used to compute earnings per share and the results of the computations:

	(Unaudited)
	Three months ended June 30,				Six months ended June 30,
	2014		2013		2014		2013

Weighted average shares outstanding		1,566,171		1,557,082		1,566,618		1,556,492
Stock options		13,351		5,853		10,661		4,725
Shares used to compute diluted earnings per share		1,579,522		1,562,935		1,577,279		1,561,217
Basic earnings per share	$	0.16	$	0.43	$	0.50	$	0.85
Diluted earnings per share	$	0.16	$	0.42	$	0.49	$	0.85

Note 4 – Pending merger

On June 4, 2014, the Company and Old National Bancorp (“Old National”) jointly announced the signing of a definitive agreement on June 3, 2014 (the “Merger Agreement”) pursuant to which the Company will be merged with and into Old National (the “Merger”). Simultaneously with the Merger, the Bank will merge with and into Old National Bank, a national banking association and wholly-owned subsidiary of Old National.

Under the terms of the Merger Agreement, which was approved by the boards of directors of both companies, Company shareholders will receive 2.269 shares of Old National common stock and $10.63 in cash (fixed) for each share of Company common stock. As provided in the Merger Agreement, the exchange ratio is subject to certain adjustments, calculated prior to closing, in the event shareholders’ equity of the Company is below a specified amount.

When the Merger becomes effective, each outstanding option to purchase Company common stock will fully vest (if unvested) and be converted into the right to receive in cash an amount equal to the positive difference, if any, of $10.63 plus the Merger exchange ratio (as may be adjusted as described above) multiplied by the Average ONB Closing Price (as defined in the Merger Agreement) less the option exercise price, subject to the consent of option holders. As previously disclosed, two employees will terminate their employment agreements on or before the closing of the Merger and will receive the change of control payments to which they are entitled under their existing employment agreements.

In addition, the Company has agreed to pay Old National a termination fee of $3,000,000 upon termination of the Merger Agreement if (1) the Company’s Board of Directors fails to recommend the Merger to its shareholders, makes an adverse recommendation or enters into or announces a competing acquisition proposal, or fails to publicly reaffirm its recommendation of the Merger upon Old National’s request; (2) the Company’s shareholders vote against the Merger or a quorum is not convened, and 12 months later the Company is acquired by a third party; or (3) the Merger Agreement is terminated because the Merger is not consummated by March 31, 2015, and prior to that date the Company receives an acquisition proposal that closes within 12 months after termination of the Merger Agreement.

The transaction is expected to close in the fourth quarter of 2014. It remains subject to approval by the Company’s shareholders at a special meeting called and to be held on September 3, 2014, and approval by federal regulatory authorities as well as the satisfaction of other customary closing conditions provided in the Merger Agreement.

Note 5 – 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
			(In thousands)
Available-for-sale Securities:
June 30, 2014 (Unaudited)
U.S. Treasury bonds	$	2,927	$	8	$	---		$	2,935
U.S. Government sponsored agencies		25,686		38		(253	)		25,471
Mortgage-backed securities– government sponsored entities		18,052		152		(104	)		18,100
Corporate bonds		1,041		12		---			1,053
State and political subdivisions		16,644		180		(57	)		16,767
	$	64,350	$	390	$	(414	)	$	64,326
Available-for-sale Securities:
December 31, 2013
U.S. Government sponsored agencies	$	28,982	$	39	$	(417	)	$	28,604
Mortgage-backed securities–government sponsored entities		16,704		122		(227	)		16,599
Corporate bonds		1,050		13		---			1,063
State and political subdivisions		16,465		172		(198	)		16,439
	$	63,201	$	346	$	(842	)	$	62,705

The amortized cost and fair value of available-for-sale securities at June 30, 2014, 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
	(Unaudited; In thousands)

Within one year	$	1,267	$	1,275
One to five years		38,626		38,632
Five to ten years		6,405		6,319
After ten years		---		---
		46,298		46,226

Mortgage-backed securities		18,052		18,100

Totals	$	64,350	$	64,326

The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $1.8 million at June 30, 2014 and at December 31, 2013. 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, 2014 and December 31, 2013 was $36.6 million and $40.8 million, which is approximately 57% and 65%, 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, 2014 and December 31, 2013.

	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, 2014 (Unaudited)
U.S. Government sponsored agencies	$	9,891	$	16	$	10,855	$	237	$	20,746	$	253
Mortgage-backed securities–government sponsored entities		6,640		29		2,616		75		9,256		104
State and political subdivisions		1,579		7		4,971		50		6,550		57
Total temporarily impaired securities	$	18,110	$	52	$	18,442	$	362	$	36,552	$	414

December 31, 2013
U.S. Government sponsored agencies	$	21,587	$	417	$	---	$	---	$	21,587	$	417
Mortgage-backed securities–government sponsored entities		9,781		226		7		1		9,788		227
State and political subdivisions		9,401		198		---		---		9,401		198
Total temporarily impaired securities	$	40,769	$	841	$	7	$	1	$	40,776	$	842

U.S. Government Agencies

The unrealized losses on the Company’s investments in direct obligations of U.S. government agencies were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not the

Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2014.

Residential Mortgage-backed Securities

The unrealized losses on the Company’s investment in residential mortgage-backed securities were caused by interest rate increases. The Company expects to recover the amortized cost bases over the term of the securities. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2014.

State and Political Subdivisions

The unrealized losses on the Company’s investments in securities of state and political subdivisions were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2014.

Note 6 - 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. 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 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 non-accrual loans), changes in mix, asset quality trends, risk management and loan administration, changes in the internal lending policies and credit standards, collection practices, 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:

	June 30, 2014 (Unaudited)			December 31, 2013
Real Estate	(In thousands)
One- to four-family residential	$	97,498		$	98,061
Multi-family residential		51,270			49,866
Commercial real estate		71,209			72,030
Construction and land development		16,066			15,318
Commercial		10,290			11,461
Consumer and other		1,260			1,160
Home equity lines of credit		16,059			16,050
Total loans		263,652			263,946
Less
Net deferred loan fees, premiums and discounts		(425	)		(408	)
Undisbursed portion of loans		(3,387	)		(2,487	)
Allowance for loan losses		(6,088	)		(6,348	)
Net loans	$	253,752		$	254,703

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, Home Equity and Consumer

With respect to residential loans that are secured by one- to four-family residences that are usually 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.

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 ended June 30, 2014 and June 30, 2013 and for the year ended December 31, 2013 is provided below.

	Allowance for Loan Losses and Recorded Investment in Loans for the Three Months Ended June 30, 2014 (Unaudited)

Three Months Ended June 30, 2014	Commercial			Owner Occupied 1-4			Non-owner Occupied 1-4			Multi- family			Commercial Real Estate			Construction			Land			Consumer and Home Equity			Total
	(In thousands)
Allowance for losses
Beginning balance	$	535		$	772		$	1,069		$	1,112		$	2,494		$	44		$	110		$	258		$	6,394
Provision charged to expense		125			(130	)		209			(87	)		58			(1	)		(39	)		(35	)		100
Losses charged off		(100	)		---			(251	)		---			(109	)		---			---			---			(460	)
Recoveries		16			5			18			1			---			---			14			---			54
Ending balance	$	576		$	647		$	1,045		$	1,026		$	2,443		$	43		$	,85		$	223		$	6,088

	Allowance for Loan Losses and Recorded Investment in Loans for the Six Months Ended June 30, 2014 (Unaudited)
Six Months Ended June 30, 2014	Commercial			Owner Occupied 1-4			Non-owner Occupied 1-4			Multi- family		Commercial Real Estate			Construction		Land			Consumer and Home Equity			Total
										(In thousands)
Allowance for losses
Beginning balance	$	649		$	753		$	1,045		$	1,023	$	2,436		$	38	$	146		$	258		$	6,348
Provision charged to expense		(6	)		(111	)		199			1		188			4		(140	)		(35	)		100
Losses charged off		(100	)		---			(272	)		---		(184	)		---		---			---			(556	)
Recoveries		33			5			73			2		4			---		79			---			196
Ending balance	$	576		$	647		$	1,045		$	1,026	$	2,444		$	42	$	85		$	223		$	6,088
ALL individually evaluated	$	5		$	19		$	117		$	65	$	748		$	---	$	1		$	---		$	955
ALL collectively evaluated		571			628			928			961		1,696			42		84			223			5,133
Total ALLL	$	576		$	647		$	1,045		$	1,026	$	2,444		$	42	$	85		$	223		$	6,088
Loans individually evaluated	$	1,073		$	869		$	2,181		$	755	$	6,567		$	---	$	554		$	90		$	12,089
Loans collectively evaluated		9,217			52,852			41,596			50,515		64,642			7,407		8,105			17,229			251,563
Total loans evaluated	$	10,290		$	53,721		$	43,777		$	51,270	$	71,209		$	7,407	$	8,659		$	17,319		$	263,652

	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
	(In thousands)
Allowance for losses
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
										(In thousands)
Allowance for losses
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

		Allowance for Loan Losses and Recorded Investment in Loans at December 31, 2013

ALL individually evaluated	$	5	$	13	$	30	$	---	$	749	$	---	$	1	$	---	$	798
ALL collectively evaluated		644		740		1,015		1,023		1,687		38		145		258		5,550
Total ALLL	$	649	$	753	$	1,045	$	1,023	$	2,436	$	38	$	146	$	258	$	6,348
Loans individually evaluated	$	1,250	$	921	$	2,820	$	522	$	6,703	$	---	$	779	$	90	$	13,085
Loans collectively evaluated		10,211		51,098		43,222		49,344		65,327		5,446		9,093		17,120		250,861
Total loans evaluated	$	11,461	$	52,019	$	46,042	$	49,866	$	72,030	$	5,446	$	9,872	$	17,210	$	263,946

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.

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.

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. Non-accrual 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 non-accrual loan to accrual status.

The following table provides an analysis of loan quality using the above designations, based on property type at June 30, 2014.

Credit Rating	Commercial		Owner Occupied 1-4		Non-owner Occupied 1-4		Multi- Family		Commercial Real Estate		Construction		Land		Consumer and Home Equity		Total
	(Unaudited; In thousands)

1- Superior	$	16	$	3,550	$	216	$	---	$	96	$	---	$	72	$	1,764	$	5,714
2 - Good		2,648		26,264		3,288		3,015		12,759		2,663		1,755		11,172		63,564
3 - Pass Low risk		3,298		17,138		11,740		19,970		20,512		3,880		4,573		3,647		84,758
4 - Pass		1,555		4,667		21,655		19,999		19,763		864		1,551		686		70,740
4W - Watch		422		1,246		4,359		6,555		7,120		---		54		14		19,770
5 - Special mention		---		196		---		1,673		2,761		---		154		36		4,820
6 - Substandard		2,351		660		2,519		58		8,198		---		500		---		14,286
7 - Doubtful		---		---		---		---		---		---		---		---		---
8 - Loss		---		---		---		---		---		---		---		---		---
Total	$	10,290	$	53,721	$	43,777	$	51,270	$	71,209	$	7,407	$	8,659	$	17,319	$	263,652

The following table provides an analysis of loan quality using the above designations, based on property type at December 31, 2013.

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	$	20	$	3,703	$	427	$	---	$	98	$	---	$	139	$	1,854	$	6,241
2 - Good		1,528		24,965		3,307		1,755		10,784		2,393		1,752		11,419		57,903
3 - Pass Low risk		3,872		16,321		10,896		22,131		16,340		2,806		4,552		3,274		80,192
4 - Pass		3,035		5,088		22,579		19,006		23,604		247		2,239		589		76,387
4W - Watch		860		926		4,518		5,447		12,397		---		85		35		24,268
5 - Special mention		---		274		1,248		1,461		343		---		412		38		3,776
6 - Substandard		2,146		742		3,067		66		8,464		---		693		1		15,179
7 - Doubtful		---		---		---		---		---		---		---		---		---
8 - Loss		---		---		---		---		---		---		---		---		---
Total	$	11,461	$	52,019	$	46,042	$	49,866	$	72,030	$	5,446	$	9,872	$	17,210	$	263,946

Analyses of past due loans segregated by loan type as of June 30, 2014 and December 31, 2013 are provided below.

	Loan Portfolio Aging Analysis as of June 30, 2014

	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
							(Unaudited; In thousands)

Commercial	$	---	$	---	$	40	$	40	$	10,250	$	10,290	$	---	$	---
Owner occupied 1-4		49		391		---		440		53,281		53,721		242		---
Non-owner occupied 1-4		110		288		481		879		42,898		43,777		510		---
Multi-family		---		---		---		---		51,270		51,270		58		---
Commercial real estate		13		---		---		13		71,196		71,209		---		---
Construction		---		---		---		---		7,407		7,407		---		---
Land		---		---		---		---		8,659		8,659		---		---
Consumer and home equity		13		---		---		13		17,307		17,319		---		---
Total	$	185	$	679	$	521	$	1,385	$	262,267	$	263,652	$	810	$	---

	Loan Portfolio Aging Analysis as of December 31, 2013

	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	$	---	$	140	$	---	$	140	$	11,321	$	11,461	$	---	$	---
Owner occupied 1-4		84		---		---		84		51,935		52,019		553		---
Non-owner occupied 1-4		362		183		1,152		1,697		44,345		46,042		554		---
Multi-family		---		65		---		65		49,801		49,866		65		---
Commercial real estate		---		---		111		111		71,919		72,030		16		---
Construction		---		---		---		---		5,446		5,446		---		---
Land		35		---		121		156		9,716		9,872		---		---
Consumer and home equity		2		---		---		2		17,208		17,210		---		---
Total	$	483	$	388	$	1,384	$	2,255	$	261,691	$	263,946	$	1,188	$	---

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 tables present impaired loans and interest recognized on them as of and for the quarter and six months ended June 30, 2014, for the year ended December 31, 2013, and for the quarter and six months ended June 30, 2013.

	Impaired Loans as of and for the Quarter and Six Months ended June 30, 2014 (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	$	40	$	140	$	---	$	90	$	60	$	---	$	---
Owner occupied 1-4		730		765		---		755		768		9		20
Non owner occupied 1-4		1,707		1,932		---		2,010		2,200		20		44
Multi-family		501		522		---		506		511		5		17
Commercial Real Estate		2,211		2,235		---		2,223		2,299		29		60
Construction		---		---		---		---		---		---		---
Land		500		610		---		500		565		---		10
Consumer and Home Equity		90		100		---		90		90		1		2
Total loans without a specific valuation allowance		5,779		6,304		---		6,174		6,493		64		153

Loans with a specific valuation allowance
Commercial		1,033		1,033		5		1,041		1,111		15		30
Owner occupied 1-4		139		145		19		140		136		2		5
Non owner occupied 1-4		474		475		117		361		361		1		3
Multi-family		254		253		65		255		170		3		3
Commercial Real Estate		4,356		4,357		748		4,369		4,330		59		105
Construction		---		---		---		---		---		---		---
Land		54		54		1		65		71		1		2
Consumer and Home Equity		---		---		---		---		---		---		---
Total loans with a specific valuation allowance		6,310		6,317		955		6,231		6,179		81		148

Total
Commercial		1,073		1,173		5		1,131		1,171		15		30
Owner occupied 1-4		869		910		19		895		904		11		25
Non owner occupied 1-4		2,181		2,407		117		2,371		2,561		21		47
Multi-family		755		775		65		761		681		8		20
Commercial Real Estate		6,567		6,592		748		6,592		6,629		88		165
Construction		---		---		---		---		---		---		---
Land		554		664		1		565		636		1		12
Consumer and Home Equity		90		100		---		90		90		1		2
Total impaired loans	$	12,089	$	12,621	$	955	$	12,405	$	12,672	$	145	$	301

	Impaired loans 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	$	---	$	---	$	---	$	13	$	25	$	---	$	---
Owner occupied 1-4		793		922		---		1,259		1,294		22		14
Non owner occupied 1-4		2,543		3,264		---		5,685		5,679		71		166
Multi-family		522		541		---		2,094		2,333		26		61
Commercial Real Estate		2,452		2,646		---		2,959		3,528		82		127
Construction		---		---		---		---		---		---		---
Land		694		959		---		729		946		6		---
Consumer and Home Equity		90		91		---		91		91		1		3
Total loans without a specific valuation allowance		7,094		8,423		---		12,830		13,896		208		371

Loans with a specific valuation allowance
Commercial		1,250		1,250		5		---		---		---		---
Owner occupied 1-4		128		132		13		229		230		2		---
Non owner occupied 1-4		277		277		30		269		273		---		1
Multi-family		---		---		---		72		74		1		---
Commercial Real Estate		4,251		3,769		749		3,425		2,806		99		26
Construction		---		---		---		---		---		---		---
Land		85		85		1		52		35		1		---
Consumer and Home Equity		---		---		---		46		39		---		---
Total loans with a specific valuation allowance		5,991		5,513		798		4,093		3,457		103		27

Total
Commercial		1,250		1,250		5		13		25		---		---
Owner occupied 1-4		921		1,054		13		1,488		1,524		24		14
Non owner occupied 1-4		2,820		3,541		30		5,954		5,952		71		167
Multi-family		522		541		---		2,166		2,407		27		61
Commercial Real Estate		6,703		6,415		749		6,384		6,334		181		153
Construction		---		---		---		---		---		---		---
Land		779		1,044		1		782		981		7		---
Consumer and Home Equity		90		91		---		136		130		1		3
Total impaired loans	$	13,085	$	13,936	$	798	$	16,923	$	17,353	$	311	$	397

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 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, 2014 and at December 31, 2013.

Loan Class	June 30, 2014		December 31, 2013
	(Unaudited)
	(In thousands)

Commercial	$	40	$	---
Owner occupied 1-4		242		553
Non-owner occupied 1-4		991		1,706
Multi-family		58		66
Commercial real estate		---		126
Land		---		21
Total	$	1,331	$	2,572

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.

Loans to related parties at June 30, 2014 totaled $1.4 million. Loans to related parties at December 31, 2013 of $2.6 million were reduced by paydowns of $1.2 million. There was no new debt.

The following tables present information regarding troubled debt restructurings by class for the three months ended June 30, 2013 and the six months ended June 30, 2014 and June 30, 2013. There were no restructurings in the three months ended June 30, 2014.

	Newly Classified Troubled Debt Restructurings for the Three Months ended June 30, 2013
	Number of loans		Pre-modification Recorded Balance		Post-modification Recorded Balance		Type of Modification
	(Unaudited) (Dollars in thousands)
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

	Newly Classified Troubled Debt Restructurings for the Six Months ended June 30, 2014
	Number of loans		Pre-modification Recorded Balance		Post-modification Recorded Balance		Type of Modification
	(Unaudited; Dollars in thousands)

Commercial	$	---	$	---	$	---	---
Owner occupied 1-4		3		277		277	Rate
Non owner occupied 1-4		5		257		257	Term extended
Multi-family		1		256		256	Assumption
Commercial real estate		3		4,021		4,021	Term extended, payment
Construction		---		---		---	---
Land		---		---		---	---
Consumer and home equity		---		---		---	---
Total	$	12	$	4,811	$	4,811

	Newly Classified Troubled Debt Restructurings for the Six Months ended June 30, 2013
	Number of loans		Pre-modification Recorded Balance		Post-modification Recorded Balance		Type of Modification
			(Unaudited) (Dollars in thousands)

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

There were no troubled debt restructurings modified in the past 12 months that subsequently defaulted for the three months ended June 30, 2014 or 2013. As of June 30, 2014, borrowers with loans designated as troubled debt restructures and totaling $10.8 million met the criteria for placement back on accrual status. These criteria are a minimum of six months payment performance under existing or modified terms.

Note 7 - 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

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, 2014 and December 31, 2013:

			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, 2014 (Unaudited)
U.S. treasury bonds	$	2,935	$	---	$	2,935	$	---
U.S. government-sponsored agencies		25,471		---		25,471		---
Mortgage-backed securities		18,100		---		18,100		---
Corporate bonds		1,053		---		1,053		---
State and political subdivision securities		16,767		---		16,767		---
Totals	$	64,326	$	---	$	64,326	$	---

December 31, 2013
U.S. government-sponsored agencies	$	28,604	$	---	$	28,604	$	---
Mortgage-backed securities		16,599		---		16,599		---
Corporate bonds		1,063		---		1,063		---
State and political subdivision securities		16,439		---		16,439		---
Totals	$	62,705	$	---	$	62,705	$	---

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, 2014.

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 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.

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, 2014 and December 31, 2013:

		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, 2014 (Unaudited)

Collateral-dependent impaired loans	$ 778	---	---	$ 778

December 31, 2013

Collateral-dependent impaired loans	$3,637	---	---	$3,637

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.

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 Office of the Company’s Controller. 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 comparison to historical results.

Unobservable (Level 3) Inputs

The following table presents quantitative information about unobservable inputs used in nonrecurring Level 3 fair value measurements at June 30, 2014 and December 31, 2013.

	Fair Value at June 30, 2014	Valuation Technique	Unobservable Inputs	Range (Weighted Average)
	(Unaudited; In thousands)
June 30, 2014:
Collateral-dependent impaired loans	$ 778	Market comparable properties	Marketability discount	10%-20%

	Fair Value at December 31, 2013	Valuation Technique	Unobservable Inputs	Range (Weighted Average)
December 31, 2013:	(Unaudited; In thousands)

Collateral-dependent impaired loans	$ 3,637	Market comparable properties	Marketability discount	10%-20%

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, 2014 and December 31, 2013.

			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, 2014 (Unaudited)
Financial assets
Cash and cash equivalents	$	25,046	$	25,046	$	---	$	---
Interest-bearing time deposits		1,247		---		1,247		---
Loans held for sale		488		---		488		---
Loans, net of allowance for losses		253,752		---		---		264,899
Federal Home Loan Bank stock		3,185		---		3,185		---
Mortgage servicing rights		1,128		---		1,128		---
Accrued interest receivable		1,130		---		1,130		---


Financial liabilities
Transaction and savings deposits		193,993		193,993		---		---
Time deposits		120,517		---		---		121,560
Federal Home Loan Bank advances		10,000		---		10,235		---
Accrued interest payable		39		---		39		---

December 31, 2013:
Financial assets
Cash and cash equivalents	$	24,198	$	24,198	$	---	$	---
Interest-bearing time deposits		1,743		---		1,743		---
Loans held for sale		657		---		657		---
Loans, net of allowance for losses		254,703		---		---		265,715
Federal Home Loan Bank stock		3,185		---		3,185		---
Mortgage servicing rights		1,087		---		1,087		---
Accrued interest receivable		1,114		---		1,114		---

Financial liabilities
Transaction and savings deposits		185,106		185,106		---		---
Time deposits		129,514		---		---		130,892
Federal Home Loan Bank advances		10,000		---		10,289		---
Accrued interest payable		34		---		34		---

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.

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 the Federal Home Loan Bank.

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. The fair value of commitments was not material at June 30, 2014 and December 31, 2013.

Note 8 –Accounting Developments

Accounting Standards Update No. 2014-08- Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity – In April 2014, FASB issued ASU 2014-08. This update seeks to better define the groups of assets which qualify for discontinued operations, in order to ease the burden and cost for preparers and stakeholders. This issue changed the criteria for reporting discontinued operations and related reporting requirements, including the provision for disclosures about the disposal of an individually significant component of an entity that does not qualify for discontinued operations presentation. The amendments in this Update are effective for fiscal years beginning after December 15, 2014. Early adoption is permitted only for disposals or classifications as held for sale. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

Accounting Standards Update No. 2014-09- Revenue from Contracts with Customers – In May 2014, FASB, in joint cooperation with the International Accounting Standards Board (“IASB”), issued ASU 2014-09. The topic of revenue recognition had become broad, with several other regulatory agencies issuing standards which lacked cohesion. The new guidance establishes a common framework and reduces the number of requirements which an entity must consider in recognizing revenue and yet provides improved disclosures to assist stakeholders reviewing financial statements. The amendments in this Update are effective for annual reporting periods beginning after December 15, 2016. Early adoption is not permitted. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

Accounting Standards Update No. 2014-11- Transfers and Servicing – In June 2014, FASB issued ASU 2014-11. This update addresses the concerns of stakeholders by changing the accounting practices surrounding repurchase agreements. The new guidance changes the “accounting for repurchase-to-maturity transactions and linked repurchase financings to secured borrowing accounting, which is consistent with the accounting for other repurchase agreements.” The amendments in this Update are effective for the first interim or annual reporting period beginning after December 15, 2014, since the Company is a “public business entity” within the meaning of ASU 2013-12. Early adoption is prohibited. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

Accounting Standards Update No. 2014-12- Compensation – Stock Compensation – In June 2014, FASB issued ASU 2014-12. This update defines the accounting treatment for share-based payments and “resolves the diverse accounting treatment of those awards in practice.” The new requirement mandates that “a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition.” Compensation cost will now be recognized in the period in which it becomes likely that the performance target will be met. The amendments in this Update are effective for annual and interim reporting periods beginning after December 15, 2015. Early adoption is permitted. The Company will adopt the methodologies

prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

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

Merger Update

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 Annual Report to “we,” “us” and “our” refer to LSB Financial and/or Lafayette Savings as the context requires.

Lafayette Savings is an independent, community-oriented financial institution. The Bank has been in business for 145 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.

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 145 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. The Tippecanoe County unemployment rate peaked at 10.6% in July 2009 and at June 30, 2014 was at 6.2% compared to 5.9% for Indiana and 6.1% nationally. Because of the high percentage of jobs in education, the unemployment rate in the county consistently shows an increase in unemployment during the summer months, averaging about a 1.7% increase in the unemployment rate. The local housing market has remained fairly stable for the last several years with no price bubble and no resulting price swings. As of the most recent first quarter 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 1.44% decrease with the one-year change a 1.04% decrease. For the third quarter of 2013, housing prices in the MSA increased 0.67%. The 172 single family building permits issued in the first five months of 2014 in Tippecanoe County were just slightly over the five-year average of 170. There were 457 new home starts in 2013.

The area’s diversity did not make us immune to the ongoing effects of the recession; however, growth continues, although still 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 2013 totaled over $1 billion compared to $605 million in 2012. Purdue, the area’s largest employer, had enrollment of almost 39,000 in the fall 2013 semester.

Subaru, the area’s largest industrial employer and producer of the Subaru Legacy, Outback and Tribeca, recently announced addition of more production capacity for a new model to be built there. They expect to hire 900 additional employees by 2016. Wabash National, the area’s second largest industrial employer, continues to secure contracts to maintain its production level. Nanshan America began operating its new aluminum extrusion plant in Lafayette in 2012 and expects to employ 200 people. Alcoa will be adding a 115,000 square foot aluminum lithium plant to begin production in 2014 and employ 75 people. 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. In addition GE Aviation has started work on a $100 million jet engine plant in Lafayette that will employ 200 people.

We have seen progress in our problem loans as more borrowers who had fallen behind on their loan payments are qualifying for troubled debt restructures, or have resumed payments or, less often, we have acquired control of their properties. 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 2013, we acquired one property through foreclosure and sold two OREO properties. In the first half of 2014, we took four properties into OREO and have sold two.

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 brokered 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. Deposits in the first six months have remained fairly flat, decreasing by only $110,000, or 0.03%, from $314.6 million to $314.5 million. Our reliance on brokered funds as a percentage of total deposits decreased slightly in 2014 from 4.35% of deposits to 3.80%, from $13.7 million to $11.6 million. 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 portfolios 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 four years while long-term rates have stayed in 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. We expect that the interest rate margins which began to decline late in 2013 will continue to do so as deposits are already at very low levels but because of the relatively weak demand for loans, those rates continue to fall. Our expectation for 2014 is that deposit rates will remain at these low levels as the Federal Reserve continues to focus on strengthening the economy. Overall loan rates are expected to remain low.

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 in 2014. 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 during these times 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.

Possible Implications of Current Events

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

Management continues to assess the impact on the Company of the uncertain economic and regulatory environment affecting the country at large and the financial services industry in particular. The level of turmoil in the financial services industry, and the resulting actions of legislators and regulators, have presented additional risks and challenges for the Company, as described below:

Extensive financial system reform, including implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), has imposed and will continue to impose new requirements on us. On July 21, 2010, President Obama signed into law the Dodd-Frank Act, which significantly changed the regulation of financial institutions and the financial services industry. Many of its provisions went into effect on July 21, 2011, the one-year anniversary. The Dodd-Frank Act includes provisions affecting large and small financial institutions alike, including several provisions that profoundly affect how community banks, thrifts, and small bank and thrift holding companies, such as LSB Financial, are regulated. Among other things, these provisions abolished the OTS and transferred its functions to the other federal banking agencies, relaxed rules regarding interstate branching, allowed financial institutions to pay interest on business checking accounts, changed the scope of federal deposit insurance coverage, imposed new capital requirements

on bank and thrift holding companies, and imposed limits on debit card interchange fees charged by large banks (commonly known as the Durbin Amendment).

The Dodd-Frank Act created a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which was granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act, and certain other statutes. In July 2011, many of the consumer financial protection functions formerly assigned to the federal banking and other designated agencies transferred to the CFBP. The CFBP has a large budget and staff, and has the authority to implement regulations under federal consumer protection laws and enforce those laws against financial institutions. The CFPB will have examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by the federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive or abusive practice in connection with the offering of consumer financial products. Additionally, this bureau 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. Moreover, the Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, the Dodd-Frank Act will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB

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 minimum standards for the origination of residential mortgages. The CFPB has 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.” 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 currently assessing the impact of these requirements on its mortgage lending business.

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 and the CFPB, is 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 and the CFPB on the financial services industry in general, and the Company in particular, remains uncertain.

Mortgage reform and anti-predatory lending regulations have been evolving. Title XIV of the Dodd-Frank Act, the Mortgage Reform and Anti-Predatory Lending Act, includes a series of

amendments to the Truth In Lending Act with respect to mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards and pre-payments. With respect to mortgage loan originator compensation, except in limited circumstances, an originator is prohibited from receiving compensation that varies based on the terms of the loan (other than the principal amount). The amendments to the Truth In Lending Act also prohibit a creditor from making a residential mortgage loan unless it determines, based on verified and documented information of the consumer’s financial resources, that the consumer has a reasonable ability to repay the loan. The amendments also prohibit certain pre-payment penalties and require creditors offering a consumer a mortgage loan with pre-payment penalty to offer the consumer the option of a mortgage loan without such a penalty. In addition, the Dodd-Frank Act expands the definition of a “high-cost mortgage” under the Truth In Lending Act, and imposes new requirements on high-cost mortgages and new disclosure, reporting and notice requirements for residential mortgage loans, as well as new requirements with respect to escrows and appraisal practices.

New capital rules have been approved that will affect the Company and the Bank as they are phased in from 2015 to 2019. On July 2, 2013, the Federal Reserve approved final rules that substantially amend the regulatory risk-based capital rules applicable to the Company and the Bank. The FDIC and the OCC subsequently approved these rules. The final rules 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 final rules include new risk-based capital and leverage ratios, which will be phased in from 2015 to 2019, and will refine the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements applicable to the Company and the Bank under the final rules are: (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 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 requirement 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 would 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 Company and 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 would be phased out over time.

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%).

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.

The current economic environment poses challenges for us and could adversely affect our financial condition and results of operations. We continue to operate in a challenging and uncertain economic environment, including generally uncertain national conditions and local conditions in our markets. Overall economic growth continues to be slow and national and regional unemployment rates remain at elevated levels. The risks associated with our business remain acute in periods of slow economic growth and high unemployment. Moreover, many financial institutions continue to be affected by an uncertain real estate market. While we continue to take steps to decrease and limit our exposure to problem loans, and while our local economy has remained somewhat insulated from the most severe effects of the current economic environment, we nonetheless retain direct exposure to the residential and commercial real estate markets and we are affected by these events.

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

Difficult market conditions have adversely affected our industry. We are particularly exposed to downturns in the U.S. housing market. Dramatic declines in the housing market over the past five years, with falling home prices and increasing foreclosures, unemployment and under-employment,

have negatively impacted the credit performance of mortgage and construction loans and securities and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities, major commercial and investment banks, and regional financial institutions. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have continued to observe tight lending standards, including with respect to other financial institutions, although there have been signs that lending is increasing. These market conditions have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, and increased market volatility. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on the Company and others in the financial institutions industry. In particular, the Company may face the following risks in connection with these events:

•

We are experiencing, and expect to continue experiencing increased regulation of our industry, particularly as a result of the Dodd-Frank Act and the CFPB. Compliance with such regulation is expected to increase our costs and may limit our ability to pursue business opportunities.

•

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

•

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

•

Our ability to borrow from other financial institutions on favorable terms or at all could be adversely affected by disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations.

•

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

•

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

Future reduction in liquidity in the banking system could pose challenges for us. The Federal Reserve Bank has been injecting vast amounts of liquidity into the banking system to compensate for weaknesses in short-term borrowing markets and other capital markets. However, the Federal Reserve has recently announced that it will begin cutting back and reducing its bond-buying program during 2014. A reduction in the Federal Reserve’s activities or capacity could reduce liquidity in the markets, thereby increasing funding costs to the Company or reducing the availability of funds to the Company to finance its existing operations.

Changes in insurance premiums could adversely affect our financial condition and results of operations. The FDIC insures the Bank’s deposits up to a maximum amount, generally $250,000 per depositor. Current economic conditions have increased expectations for bank failures. The FDIC takes

control of failed banks and ensures payment of deposits up to insured limits using the resources of the Deposit Insurance Fund. The FDIC charges us premiums to maintain the Deposit Insurance Fund. The FDIC has set the designated reserve ratio for the Deposit Insurance Fund at 2.0% of insured deposits. The Bank is also subject to assessment for the Financing Corporation (“FICO”) to service the interest on its bond obligations. The amount assessed is in addition to the amount paid for deposit insurance. These assessments will continue until the FICO bonds are repaid between 2017 and 2019. Future increases in deposit insurance premiums or changes in risk classification would increase the Bank’s costs.

The FDIC, pursuant to the Dodd-Frank Act, changed the assessment base for deposit insurance premiums from adjusted domestic deposits to average consolidated total assets minus average tangible equity, and scaled the insurance premium rates to the increased assessment base. As a result of the change to an asset-based assessment, the Company experienced a decrease in premiums.

The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.

Concentrations of real estate loans could subject the Company to increased risks in the event of a real estate recession or natural disaster. A significant portion of the Company’s loan portfolio is secured by real estate. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. While property values in the Midwest show signs of stabilizing, a further weakening of the real estate market in our primary market area could result in an increase in the number of borrowers unable to refinance or who may default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. Significant natural disasters can also negatively affect the value of real estate that secures our loans or interrupt our business operations, also negatively impacting our operating results or financial condition.

Credit risk could adversely affect our operating results or financial condition. One of the greatest risks facing lenders is credit risk – that is, the risk of losing principal and interest due to a borrower’s failure to perform according to the terms of a loan agreement. During the recession, the banking industry experienced an increase in problem assets and credit losses, resulting from weakened national economic trends and a decline in housing values. Although improving, economic recovery has been slow. While management attempts to provide an allowance for loan losses at a level adequate to cover probable incurred losses based on loan portfolio growth, past loss experience, general economic conditions, information about specific borrower situations, and other factors, future adjustments to reserves may become necessary, and net income could be significantly affected, if circumstances differ substantially from assumptions used with respect to such factors.

Interest rate risk could adversely affect our operating results or financial condition. The Company’s earnings depend to a great extent upon the level of net interest income, which is the difference between interest income earned on loans and investments and the interest expense paid on deposits and other borrowings. Interest rate risk is the risk that the earnings and capital will be adversely affected by changes in interest rates. While the Company attempts to adjust its asset/liability mix in order to limit the magnitude of interest rate risk, interest rate risk management is not an exact science. Rather, it involves estimates as to how changes in the general level of interest rates will

impact the yields earned on assets and the rates paid on liabilities. Moreover, rate changes can vary depending upon the level of rates and competitive factors. From time to time, maturities of assets and liabilities are not balanced, and a rapid increase or decrease in interest rates could have an adverse effect on net interest margins and results of operations of the Company. Volatility in interest rates can also result in disintermediation, which is the flow of funds away from financial institutions into direct investments, such as U.S. Government and corporate securities and other investment vehicles, including mutual funds, which, because of the absence of federal insurance premiums and reserve requirements, generally pay higher rates of return than financial institutions.

Critical Accounting Policies

Generally accepted accounting principles are complex and require management to apply significant judgments to various accounting, reporting and disclosure matters. Management of LSB Financial 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, 2013, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. 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.

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 FASB ASC 310-10. 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 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 ASC310-10 calculation.

loans), changes in mix, asset quality trends, risk management and loan administration, changes in the internal lending policies and credit standards, collection practices and examination results from bank regulatory agencies and the Bank’s internal loan review.

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.

Financial Condition

SELECTED FINANCIAL CONDITION DATA
(Dollars in thousands)

	June 30,		December 31,		$			%
	2014		2013		Difference			Difference
	(Unaudited)

Total assets	$	368,688	$	367,581		1,107			0.30	%

Loans receivable, including loans held for sale, net		254,240		255,360		(1,120	)		(0.44	)
1-4 family residential mortgage loans		97,498		98,719		(1,221	)		(1.24	)
Home equity lines of credit		16,060		16,050		10			0.06
Other real estate loans net of undisbursed portion of loans		138,545		137,213		1,332			0.97
Commercial business loans		10,290		11,461		(1,171	)		(10.22	)
Consumer loans		1,260		1,160		100			8.62
Loans sold (for six months and year, respectively)		12,009		45,272		(33,263	)		(73.47	)

Non-performing loans over 90 days past due		521		1,384		(863	)		(62.36	)
Loans less than 90 days past due, not accruing		810		1,188		(378	)		(31.82	)
Other real estate owned		117		18		99			550.00
Non-performing assets		1,448		2,590		(1,142	)		(44.09	)

Cash and due from banks		16,735		21,961		(5,226	)		(23.80	)
Available-for-sale securities		64,326		62,705		1,621			2.59
Short-term investments		8,311		2,237		6,074			271.5
Interest-bearing time deposits		1,247		1,743		(496	)		(28.46	)

Deposits		314,510		314,620		(110	)		(0.03	)
Core deposits		193,993		185,106		8,887			4.80
Time accounts		120,517		129,514		(8,997	)		(6.95	)
Brokered deposits		11,556		13,690		(2,134	)		(15.59	)

FHLB advances		10,000		10,000		---			---
Shareholders’ equity (net)		41,610		40,727		883			2.17

Comparison of Financial Condition at June 30, 2014 and December 31, 2013

Our total assets increased $1.1 million, or 0.30%, during the six months from December 31, 2013 to June 30, 2014. Primary components of this increase were a $1.1 million increase in securities and interest-bearing time deposits, an $848,000 net increase in cash and cash equivalents, and a $254,000 increase in fixed and other assets. These were offset by a $1.1 million decrease in net loans receivable including loans held for sale. The increase in securities and cash were primarily due to the investment of loan run-off in interest-earning securities. The decrease in loans was due to slow loan demand combined with continuing competition for existing loans. We also opened a new branch this quarter to replace a leased facility.

Non-performing assets, which include non-accruing loans and foreclosed assets, decreased from $2.6 million at December 31, 2013 to $1.4 million at June 30, 2014. Changes in non-performing loans at June 30, 2014 compared to December 31, 2013 were primarily due to the Bank agreeing to short sales on $777,000, upgrading loans of $676,000, taking $142,000 into OREO and charging off

$36,000, offset by the addition of $437,000 of loans to non-accrual status due to concerns about the full collectability of principal and interest. In addition, we received principal payments of $48,000. Non-accruing loans at June 30, 2014 were comprised of $1.2 million, or 92.66%, of one- to four-family residential real estate loans; $58,000, or 4.33%, of multi-family residential real estate loans and $40,000, or 3.01%, of non-real estate loans. Non-performing assets at June 30, 2014 also included $117,000 of foreclosed property compared to $18,000 at December 31, 2013 with the addition of three non-owner occupied residential properties. At June 30, 2014, our allowance for loan losses equaled 2.34% of total loans compared to 2.43% at December 31, 2013. The allowance for loan losses at June 30, 2014 totaled 420.44% of non-performing assets compared to 245.13% at December 31, 2013, and 457.40% of non-performing loans at June 30, 2014 compared to 246.81% at December 31, 2013. Our non-performing assets equaled 0.39% of total assets at June 30, 2014 compared to 0.70% at December 31, 2013.

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 four properties in the first quarter of 2014 through a sheriff’s sale and none in the second quarter. Although we believe we use the best information available to determine the adequacy of our allowance for loan losses, future adjustments to the allowance may be necessary, and net income could be significantly affected if circumstances and/or economic conditions cause substantial changes in the estimates we use in making the determinations about the levels of the allowance for losses. Additionally, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses. These agencies may require the recognition of additions to the allowance based upon their judgments of information available at the time of their examination.

Shareholders’ equity increased from $40.7 million at December 31, 2013 to $41.6 million at June 30, 2014, an increase of $883,000, or 2.17%, primarily as a result of net income of $778,000. Shareholders’ equity to total assets was 11.29% at June 30, 2014 compared to 11.08% at December 31, 2013. Dividends to common shareholders for the six-month period ended June 30, 2014 were $.18 per share. As required by the Federal Reserve, the Company’s Board of Directors adopted resolutions confirming the Company’s commitment to continue to obtain written approval from the Federal Reserve prior to declaring dividends, increasing debt or redeeming Company common stock.

Average Balances, Interest Rates and Yields

The following table presents, for the periods indicated, the total dollar amount of interest income earned on average interest-earning assets and the 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. Deposits at the Federal Reserve are included in interest-earning assets and not in cash accounts.

	Three months ended June 30,								Three months ended June 30,
	2014								2013
	Average Outstanding Balance			Interest Earned/ Paid		Yield/ Rate			Average Outstanding Balance			Interest Earned/ Paid		Yield/ Rate
	(Unaudited; Dollars in thousands)
Interest-Earning Assets:
Loans receivable(1)	$	253,641		$	2,897		4.57	%	$	270,939		$	3,261		5.18	%
Other investments		87,542			296		1.36			70,986			201		1.13
Total interest-earning assets		341,183			3,193		3.74			341,925			3,462		4.05
Interest-Bearing Liabilities
Savings deposits		32,342			5		0.06			31,759			5		0.06
Demand and NOW deposits		155,943			71		0.18			141,527			71		0.20
Time deposits		121,369			347		1.14			137,988			461		1.34
Borrowings		10,000			59		2.36			10,000			59		2.36
Total interest-bearing liabilities		319,654			482		0.60			321,274			596		0.74

Net interest income				$	2,711							$	2,866
Net interest rate spread							3.14	%							3.31	%
Net earning assets	$	21,529							$	20,651
Net yield on average interest-earning assets							3.18	%							3.35	%
Average interest-earning assets to average interest-bearing liabilities		1.07	x							1.06	x

_________________

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

	Six months ended June 30, 2014								Six months ended June 30, 2013
	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)	$	254,861		$	5,836		4.58	%	$	274,411		$	6,738		4.91	%
Other investments		86,272			601		1.39			67,859			366		1.08
Total interest-earning assets		341,133			6,437		3.77			342,270			7,104		4.15

Interest-Bearing Liabilities
Savings deposits	$	31,351			9		0.06		$	30,919			9		0.06
Demand and NOW deposits		155,890			144		0.18			138,707			148		0.21
Time deposits		122,326			706		1.15			139,908			949		1.36
Borrowings		10,000			118		2.36			11,667			138		2.37
Total interest-bearing liabilities		319,567			977		0.61			321,201			1,244		0.77

Net interest income				$	5,460							$	5,860
Net interest rate spread							3.16	%							3.38	%
Net earning assets	$	21,566							$	21,069
Net yield on average interest-earning assets							3.20	%							3.42	%
Average interest-earning assets to average interest-bearing liabilities		1.07	x							1.07	x

Results of Operations

Comparison of Operating Results for the Six Months and the Quarter ended June 30, 2014 and June 30, 2013

General. Net income for the six months ended June 30, 2014 was $778,000, a decrease of $539,000, or 40.93%, from the six months ended June 30, 2013. The decrease was primarily due to a $541,000, or 23.76%, decrease in non-interest income, a $400,000, or 6.83%, decrease in net interest income and a $266,000, or 4.89%, increase in non-interest expenses, partially offset by a $525,000, or 84.00%, decrease in the provision for loan losses and a $143,000, or 19.07%, decrease in taxes.

Net income for the three months ended June 30, 2014 was $258,000, a decrease of $406,000, or 61.14%, from the three months ended June 30, 2013. The decrease was primarily due to a $213,000, or 18.39%, decrease in non-interest income, a $203,000, or 7.33%, increase in non-interest expenses and a $155,000, or 5.41%, decrease in net interest income, partially offset by a $125,000, or 55.56%, decrease in the provision for loan losses, and a $40,000, or 10.96%, decrease in taxes.

Net Interest Income. Net interest income for the six months ended June 30, 2014 decreased $400,000, or 6.83%, over the same period in 2013. This decrease was primarily due to a 22 basis point decline in our net interest rate spread as the average yield on interest-earning assets decreased by 38 basis points while the yield on interest-earning liabilities decreased by only 16 basis points. Interest-earning assets decreased by $1.1 million as the average balance of investment securities increased $18.4 million offset by a $19.6 million decrease in average loans receivable. The investment securities were purchased using excess cash balances and loan paydowns. Our net interest margin (net interest income divided by average interest-earning assets) decreased from 3.42% to 3.20%.

Interest income on loans decreased $902,000, or 13.39%, for the six months ended June 30, 2014 compared to the same six months in 2013 because the average balance of loans held in our portfolio decreased by $19.6 million from $274.4 million for the six month period in 2013 to $254.9 million in 2014. The average yield on loans decreased by 33 basis points from 4.91% to 4.58% over the same period.

Interest earned on other investments and FHLB stock increased by $235,000, or 64.21%, for the six months ended June 30, 2014 compared to the same period in 2013. This was primarily the result of an $18.4 million increase in the average balance of investments and FHLB stock from $67.9 million to $86.3 million over the same periods. The average yield increased from 1.08% to 1.39% over the comparable periods, an increase helped by our success in deploying cash items into higher earning investments.

Interest expense for the six months ended June 30, 2014 decreased $267,000, or 21.46%, compared to the same period in 2013 consisting of a $247,000 decrease in interest paid on deposits and a $20,000 decrease in interest on FHLB advances. The lower deposit costs were primarily due to a decrease in the average rate paid on deposits from 0.71% for the first six months of 2013 to 0.55% for the first six months of 2014. Average deposits were virtually unchanged during this period while we saw a $17.5 million decrease in the average balance of higher rate time deposits offset by a $17.1 million increase in the average balance of

comparatively lower rate demand deposit accounts. The increase in demand deposit accounts was largely due to depositors opting for fund availability over higher rates, which could enable them to move their money into higher earning accounts when rates start to rise. The decrease in FHLB advance expense was primarily due to a decrease in the average balance of advances from $11.7 million for the first six months of 2013 to $10.0 million for the first six months of 2014 as we paid off a maturing advance since slow loan demand reduced our need for additional funds. The average rate on advances decreased from 2.37% to 2.36%.

Net interest income for the three months ended June 30, 2014 decreased $155,000, or 5.41%, over the same period in 2013. This decrease was primarily due to a 17 basis point decline in our net interest rate spread as the average yield on interest-earning assets decreased by 31 basis points while the yield on interest-earning liabilities decreased by only 14 basis points. Interest-earning assets decreased by $742,000 as the average balance of investment securities increased $16.6 million offset by a $17.3 million decrease in average loans receivable. The investment securities were purchased using excess cash balances and loan paydowns. Our net interest margin (net interest income divided by average interest-earning assets) decreased from 3.35% to 3.18%.

Interest income on loans decreased $364,000, or 11.16%, for the three months ended June 30, 2014 compared to the same three months in 2013 because the average balance of loans held in our portfolio decreased by $17.3 million from $270.9 million from the three month period in 2013 to $253.6 million in 2014. The average yield on loans fell from 5.18% to 4.57% over this period.

Interest earned on other investments and FHLB stock increased by $95,000, or 47.26%, for the three months ended June 30, 2014 compared to the same period in 2013. This was primarily the result of a $16.6 million increase in average investment securities and a 23 basis point increase in the average yield on the investments and FHLB stock from 1.13% to 1.36% over the comparable periods. The increase in rate was primarily due to the movement of cash into earning assets.

Interest expense for the three months ended June 30, 2014 decreased $114,000, or 19.13%, compared to the same period in 2013 consisting entirely of a decrease in interest paid on deposit accounts with the average rate on certificates of deposit falling from 1.34% for the three month period in 2013 to 1.14% for the same period in 2014 and by a $16.6 million decrease in the average balance of certificate accounts which were moved to lower rate transaction and savings accounts which increased by $14.60 million. 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 and preserving the option to move their money into higher earning accounts when rates start to rise.

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.

	June 30, 2014		December 31, 2013		June 30, 2013
	(Dollars in thousands)

Loans delinquent 30-59 days	$	185	$	483	$	118
Loans delinquent 60-89 days		679		388		719
Total delinquencies under 90 days	$	864	$	871	$	837

Non-accruing loans	$	1,331	$	2,572	$	3,804
OREO		117		18		162
Total non-performing assets	$	1,448	$	2,590	$	3,966

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, 2014 compared to December 31, 2013 were primarily due to the Bank agreeing to short sales on $777,000, upgrading loans of $676,000, taking $142,000 into OREO and charging off $36,000, offset by the addition of $437,000 of loans to non-accrual status due to concerns about the full collectability of principal and interest. In addition, we received principal payments of $48,000.

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.

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, 2014, our largest areas of concern were loans on one- to four-family non-owner occupied rental properties and to a lesser extent on loans on one- to four-family owner-occupied properties, loans on non-campus multi-family properties and commercial non-real estate loans. Loans totaling $991,000 on one- to four-family rental properties, $242,000 on one- to four-family owner-occupied properties, $58,000 on a multi-family property and $40,000 on commercial non-real estate loans were past due more than 30 days at June 30, 2014. There has been some improvement in the local economy and we are seeing enough improvement in our one- to four-family rental property market to warrant restructuring a number of those relationships. However, we are working to decrease our concentrations in that sector, especially in non-campus housing.

We recorded a $100,000 provision for loan losses for the six months ended June 30, 2014 as a result of our analyses of our current loan portfolios, compared to $625,000 during the same period in 2013. The main reason for the decrease was the improvement in non-accruing and delinquent loans during the period. During the first six months of 2014, the net cost of taking properties into OREO and charging off losses was $556,000. We had recoveries of $196,000. We expect to obtain possession of more properties in 2014 that are currently in the process of foreclosure. The final disposition of these properties may result in a loss. The $6.1 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 245.13% at December 31, 2013 to 420.44% at June 30, 2014. Non-performing assets to total assets decreased from 0.70% at December 31, 2013 to 0.39% at June 30, 2014.

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 $9.0 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 is delinquent more than 30 days. We also have $5.0 million of one- to four-family loans which either alone or combined with a second mortgage exceed high loan-to-value guidelines. None of these loans was delinquent more than 30 days. Our total high loan-to-value loans at June 30, 2014 were at 33% of capital, well under regulatory guidelines of 100% of capital. We have $16.1 million in home equity lines of credit, one of which was delinquent more than 30 days at June 30, 2014.

An analysis of the allowance for loan losses for the three months ended June 30, 2014 and 2013 follows:

	Three months ended June 30,
	2014			2013
	(Dollars in thousands)
Balance at March 31	$	6,394		$	6,062
Loans charged off		(460	)		(10	)
Recoveries		54			69
Provision		100			225
Balance at June 30	$	6,088		$	6,346

At June 30, 2014, non-performing assets, consisting of non-accruing loans and other real estate owned, totaled $1.4 million compared to $2.6 million at December 31, 2013. In addition to our non-performing assets, we identified $19.8 million in other loans of concern where information about possible credit problems of borrowers causes management to have doubts as to the ability of the borrowers to comply with present repayment terms and 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. Delinquent loans have remained under $1 million for the last 12 months.

At June 30, 2014, 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 2.34% of net loans receivable and 457.40% of non-performing loans at June 30, 2014 compared to 2.43% and 246.81% at December 31, 2013, respectively. Our non-performing assets equaled 0.39% of total assets at June 30, 2014 compared to 0.70% at December 31, 2013.

Non-Interest Income. Non-interest income for the six months ended June 30, 2014 decreased by $541,000, or 23.76%, compared to the same period in 2013. This was primarily due to a $441,000 decrease in the gain on sale of mortgage loans due to a $17.8 million decrease in loans sold from $29.9 million in the first six months of 2013 to $12.0 million in the first six months of 2014, a $114,000 decrease in the fees from the sale of non-bank investment products through our Money Concepts program due to less sales activity, partially offset by $26,000 increase in mortgage loan servicing fees due to a decrease in the cost of servicing problem loans, and a $7,000 decrease in service charges and fee income primarily due to a lower volume of customer overdrafts.

Non-interest income for the second quarter of 2014 decreased by $213,000, or 18.39%, compared to the same period in 2013 due primarily to a $200,000 decrease in the gain on the sale of mortgage loans due to a $9.5 million decrease in loans sold, and a $12,000 decrease in other income due to a decrease in fees from the sale of non-bank investment products as noted above.

Non-Interest Expense. Non-interest expense for the six months ended June 30, 2014 increased $266,000, or 4.89%, compared to the same period in 2013 due primarily to a $327,000 increase in other expenses due to costs involved with the merger, a $78,000 increase in occupancy costs due to first quarter winter maintenance related expenses and higher utility charges due to the unusually harsh weather and second quarter expenses related to our new branch, and a $15,000 increase in computer costs due to an increase in the new products and services offered by the bank to its customers. These were offset by a $102,000 decrease in

salaries and employee benefits resulting from lower commission earned by loan originators caused by less loan origination activity and a $51,000 decrease in advertising costs due to a decision to reduce ongoing product marketing and focus marketing dollars on keeping customers aware of changes related to the merger with Old National Bank as they occur.

Non-interest expense for the three months ended June 30, 2014 increased $203,000, or 7.33%, compared to the same period in 2013 due primarily to a $296,000 increase in other expenses due to costs involved with the merger, offset by a $71,000 decrease in salaries and employee benefits resulting from lower commission earned by loan originators caused by less loan origination activity and a $16,000 decrease in advertising costs due to a decision to reduce ongoing product marketing and focus marketing dollars on keeping customers aware of changes related to the merger with Old National Bank as they occur, and an $8,000 decrease in occupancy costs due to an adjustment to personal property tax expenses.

Income Tax Expense. Our income tax provision decreased by $144,000 for the six months ended June 30, 2014 compared to the six months ended June 30, 2013 and decreased by $40,000 for the three months ended June 30, 2014 compared to the three months ended June 30, 2013 due primarily to decreased 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, FHLB 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 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. Our liquidity ratio at June 30, 2014 was 22.34% as a percentage of total assets compared to 22.16% at December 31, 2013.

We anticipate that we will have sufficient funds available to meet current funding commitments. At June 30, 2014, we had outstanding commitments to originate loans and available lines of credit totaling $30.5 million and commitments to provide funds to complete

current construction projects in the amount of $3.4 million. Certificates of deposit which will mature in one year or less totaled $78.3 million at June 30, 2014. Included in that number are $3.9 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 $3.0 million in FHLB advances maturing in the next twelve months.

Capital Resources

Shareholders’ equity totaled $41.6 million at June 30, 2014 compared to $40.7 million at December 31, 2013, an increase of $883,000 or 2.17%, due primarily to net income of $778,000. Shareholders’ equity to total assets was 11.29% at June 30, 2014 compared to 11.08% at December 31, 2013.

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, 2014 and December 31, 2013, Lafayette Savings was categorized as well capitalized. Our actual and required capital amounts and ratios at June 30, 2014 and December 31, 2013 are presented below:

	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of June 30, 2014
Total risk-based capital (to risk-weighted assets)	$	44,460		17.8	%	$	19,957		8.0	%	$	24,946		10.0	%
Tier I capital (to risk-weighted assets)		41,305		16.6			9,978		4.0			14,968		6.0
Tier I capital (to adjusted total assets)		41,305		11.2			11,064		3.0			18,440		5.0

As of December 31, 2013
Total risk-based capital (to risk-weighted assets)	$	43,604		17.4	%	$	20,054		8.0	%	$	25,067		10.0	%
Tier I capital (to risk-weighted assets)		40,431		16.1			10,027		4.0			15,040		6.0
Tier I capital (to adjusted total assets)		40,431		11.0			11,048		3.0			18,413		5.0

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.

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, 2014, 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, 2014, 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

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 1A. Risk Factors

Not Applicable to Smaller Reporting Companies.

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, 2014		---		---		---		52,817

May 1 – May 31, 2014		---		---		---		52,817

June 1 – June 30, 2014		---		---		---		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.

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, 2014	By:	/s/ Randolph F. Williams
		Randolph F. Williams, President
		(Principal Executive Officer)


Date: August 14, 2014	By:	/s/ Mary Jo David
		Mary Jo David, Treasurer
		(Principal Financial and Accounting Officer)

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, 2014, formatted in an XBRL Interactive Data File: (i) Consolidated Condensed Balance Sheets; (ii) Consolidated Condensed Statements of Income and Comprehensive Income; (iii) Consolidated Condensed Statements of Changes in Shareholders’ Equity; (iv) Consolidated Condensed Statements of Cash Flows; and (v) Notes to Consolidated Condensed Financial Statements with detailed tagging of Notes and financial statement schedules.

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