UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





FORM 10-Q





ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934For the quarterly period ended September 30, 2010ORo
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934For the transition period from ________________ to ________________




Commission file number:  0-25070






LSB FINANCIAL CORP.


(Exact name of registrant as specified in its charter)




Indiana

35-1934975(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)101 Main Street, Lafayette, Indiana

47901(Address of principal executive offices)

(Zip Code)




(765) 742-1064


(Registrant’s telephone number, including area code)




None


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




Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.




Yes x        No 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 o        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 oNon-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 x




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





Class

Outstanding at November 3, 2010Common Stock, $.01 par value per share

1,553,525 shares









LSB FINANCIAL CORP.





INDEX







PART I
FINANCIAL INFORMATION
1Item 1.
Financial Statements
1Consolidated Condensed Balance Sheets
1Consolidated Condensed Statements of Income
2Consolidated Condensed Statements of Changes in Shareholders’ Equity
3Consolidated Condensed Statements of Cash Flows
4Notes to Consolidated Condensed Financial Statements
5Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
13Item 3.
Quantitative and Qualitative Disclosures About Market Risk
31Item 4T.
Controls and Procedures.
31PART II.
OTHER INFORMATION
31Item 1.
Legal Proceedings
31Item 1A.
Risk Factors
32Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
33Item 3.
Defaults Upon Senior Securities
33Item 4.
[Removed and Reserved]
33Item 5.
Other Information
33Item 6.
Exhibits
33SIGNATURES
34








i


PART I                FINANCIAL INFORMATION




Item 1.
Financial Statements







LSB FINANCIAL CORP.


Consolidated Condensed Balance Sheets


(Dollars in thousands, except per share data)





September 30,2010


December 31,2009(unaudited)AssetsCash and due from banks

$
11,069


$
8,084Short-term investments


4,943



4,817Cash and cash equivalents


16,012



12,901Available-for-sale securities


11,560



11,345Loans held for sale


4,114



3,303Total loans


333,168



321,597Less: Allowance for loan losses


(4,832
)


(3,737
)Net loans


328,336



317,860Premises and equipment, net


6,152



6,209Federal Home Loan Bank stock, at cost


3,997



3,997Bank owned life insurance


6,219



6,071Interest receivable and other assets


8,346



9,364Total Assets

$
384,736


$
371,050Liabilities and Shareholders’ EquityLiabilitiesDeposits

$
321,289


$
277,866Federal Home Loan Bank advances


25,500



57,000Interest payable and other liabilities


2,869



2,300Total liabilities


349,658



337,166Commitments and ContingenciesShareholders’ EquityCommon stock, $.01 par valueAuthorized - 7,000,000 sharesIssued and outstanding 2010 - 1,553,525 shares, 2009 - 1,553,525 shares


15



15Additional paid-in-capital


10,987



10,985Retained earnings


23,772



22,646Accumulated other comprehensive income


304



238Total shareholders’ equity


35,078



33,884Total liabilities and shareholders’ equity

$
384,736


$
371,050





See notes to consolidated condensed financial statements.


1


LSB FINANCIAL CORP.


Consolidated Condensed Statements of Income


(Dollars in thousands, except per share data)


(Unaudited)





Three months ended

September 30,


Nine months ended

September 30,2010


2009


2010


2009Interest and Dividend IncomeLoans

$
4,760


$
4,719


$
13,900


$
14,485SecuritiesTaxable


54



88



172



214Tax-exempt


58



64



182



198Other


4



3



14



8Total interest and dividend income


4,876



4,874



14,268



14,905Interest ExpenseDeposits


1,256



1,659



3,788



5,252Borrowings


233



603



996



2,119Total interest expense


1,489



2,262



4,784



7,371Net Interest Income


3,387



2,612



9,484



7,534Provision for Loan Losses


910



865



1,809



1,823Net Interest Income After Provision for Loan Losses


2,477



1,747



7,675



5,711Non-interest IncomeDeposit account service charges and fees


393



387



1,157



1,093Net gains on loan sales


366



167



542



1,141Loss on other real estate owned


(189
)


(40
)


(449
)


(106
)Other


248



285



806



778Total non-interest income


818



799



2,056



2,906Non-Interest ExpenseSalaries and employee benefits


1,372



1,245



4,013



3,977Net occupancy and equipment expense


321



325



986



994Computer service


147



143



421



424Advertising


68



81



203



198FDIC insurance premiums


171



256



494



624Other


428



539



1,362



1,609Total non-interest expense


2,507



2,589



7,479



7,826Income (Loss) Before Income Taxes


788



(43
)


2,252



791Provision for Income Taxes (Credits)


262



(67
)


737



152Net Income

$
526


$
24


$
1,515


$
639Basic Earnings Per Share

$
0.34


$
0.02


$
0.98


$
0.41Diluted Earnings Per Share

$
0.34


$
0.02


$
0.98


$
0.41Dividends Declared Per Share

$
0.00


$
0.125


$
0.25


$
0.375


See notes to consolidated condensed financial statements.


2


LSB FINANCIAL CORP.


Consolidated Condensed Statements of Changes in Shareholders’ Equity


For the Nine Months Ended September 30, 2010 and 2009


(Dollars in thousands, except per share data)


(Unaudited)





Common Stock


Additional Paid-In Capital


Retained Earnings


Accumulated Other Comprehensive Income


TotalBalance, January 1, 2009

$
15


$
10,983


$
22,961


$
116


$
34,075Comprehensive incomeNet income










639







639Change in unrealized appreciation on available-for-sale securities, net of taxes














150



150Total comprehensive income


















789Dividends on common stock, $0.375 per share










(581
)






(581
)Share-based compensation expense





2









2Balance, September 30, 2009

$
15


$
10,985


$
23,019


$
266


$
34,285Balance, January 1, 2010

$
15


$
10,985


$
22,646


$
238


$
33,884Comprehensive incomeNet income










1,515







1,515Change in unrealized appreciation on available-for-sale securities, net of taxes














66



66Total comprehensive income


















1,581Dividends on common stock, $0.25 per share










(389
)






(389
)Share-based compensation expense





2









2Balance, September 30, 2010

$
15


$
10,987


$
23,772


$
304


$
35,078





See notes to consolidated condensed financial statements.




3


LSB FINANCIAL CORP.


Consolidated Condensed Statements of Cash Flows


(Dollars in thousands)


(Unaudited)





Nine months ended

September 30,2010


2009Operating ActivitiesNet income

$
1,515


$
639Items not requiring (providing) cashDepreciation


324



360Provision for loan losses


1,809



1,823Amortization of premiums and discounts on securities


34



31Loss on sale of other real estate owned


449



106Gain on sale of loans


(542
)


(1,141
)Loans originated for sale


(24,206
)


(57,374
)Proceeds on loans sold


23,937



58,455Amortization of stock options


2



2Changes inInterest receivable and other assets


2



436Interest payable and other liabilities


569



1,027Net cash provided by operating activities


3,894



4,364Investing ActivitiesPurchases of available-for-sale securities


(2,021
)


(2,894
)Proceeds from maturities of available-for-sale securities


1,881



1,724Net change in loans


(12,579
)


2,923Proceeds from sale of other real estate owned


669



1,771Purchase of premises and equipment


(267
)


(188
)Net cash (used in)provided by investing activities


(12,317
)


3,336Financing ActivitiesNet change in demand deposits, money market, NOW and savings accounts


37,284



18,332Net change in certificates of deposit


6,139



(8,434
)Proceeds from Federal Home Loan Bank advances


16,000



9,000Repayment of Federal Home Loan Bank advances


(47,500
)


(29,500
)Dividends paid


(389
)


(581
)Net cash provided by (used in) financing activities


11,534



(11,183
)Increase (Decrease) in Cash and Cash Equivalents


3,111



(3,483
)Cash and Cash Equivalents, Beginning of Period


12,901



11,225Cash and Cash Equivalents, End of Period

$
16,012


$
7,742Supplemental Cash Flows InformationInterest paid

$
4,851


$
7,506Income taxes paid


1,090



271Supplemental Non-Cash DisclosuresCapitalization of mortgage servicing rights


75



339Loans transferred to other real estate owned


582



2,208





See notes to consolidated condensed financial statements.


4





LSB FINANCIAL CORP.


Notes to Consolidated Condensed Financial Statements


September 30, 2010





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, 2009 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 condensed consolidated 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, 2009 filed with the Securities and Exchange Commission.  The results of operations for the periods are not necessarily indicative of the results to be expected for the full year.









Note 2 – Principles of Consolidation




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




5


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 nine month periods in 2009, 462 shares related to stock options outstanding were included in the diluted earnings per share calculation as their effect would be dilutive; 33,035 were antidilutive.  For the three and nine month periods in 2010, 3,750 shares related to stock options outstanding were dilutive and 33,035 were antidilutive.  The following table presents information about the number of shares used to compute earnings per share and the results of the computations:





Three months ended

September 30,


Nine months ended

September 30,2010


2009


2010


2009Weighted average shares outstanding


1,553,525



1,553,525



1,553,525



1,553,525Stock options


0



61



0



73Shares used to compute diluted earnings per share


1,553,525



1,555,586



1,553,525



1,553,598Earnings per share

$
0.34


$
0.02


$
0.98


$
0.41Diluted earnings per share

$
0.34


$
0.02


$
0.98


$
0.41







Note 4 – Securities





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




Amortized Cost


Gross Unrealized Gains


Gross Unrealized Losses


Approximate Fair Value(in Thousands)Available-for-sale Securities:September 30, 2010:U.S. Government agencies

$
2,090


$
30


$
---


$
2,120Mortgage-backed securities – government sponsored entities


2,627



167



---



2,794State and political subdivisions


6,337



309



---



6,646$
11,054


$
506


$
---


$
11,560December 31, 2009:U.S. Government agencies

$
529


$
7


$
---


$
536Mortgage-backed securities – government sponsored agencies


3,131



176



---



3,307State and political subdivisions


7,288



214



---



7,502$
10,948


$
397


$
---


$
11,345







6


The amortized cost and fair value of available-for-sale securities at September 30, 2010, 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 SaleAmortized Cost


Fair ValueSeptember 30, 2010(in thousands)Within one year

$
768


$
775One to five years


4,591



4,707Five to ten years


2,583



2,780After ten years


485



5048,427



8,766Mortgage-backed securities


2,627



2,794Totals

$
11,054


$
11,560







The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $3.0 million at September 30, 2010 and $3.7 million at December 31, 2009.  There were no sales of securities during either period.




Certain investments in debt securities may be reported in the financial statements at an amount less than their historical cost.  None of the investments at September 30, 2010 or December 31, 2009 was reported at less than historical cost.







Note 5 - Loans and Allowance for Loan Losses




Categories of loans include:




September 30,2010


December 31,2009Real EstateOne-to-four family residential

$
126,792


$
120,199Multi-family residential


54,344



52,790Commercial real estate


97,700



90,571Construction and land development


21,782



30,194Commercial


16,934



16,638Consumer and other


1,249



1,321Home equity lines of credit


16,388



14,698Total loans


335,190



326,411LessNet deferred loan fees, premiums and discounts


(514
)


(431
)Undisbursed portion of loans


(1,508
)


(4,383
)Allowance for loan losses


(4,832
)


(3,737
)Net loans

$
328,336


$
325,297






7




Activity in the allowance for loan losses was as follows:




2010


2009Balance, beginning of year

$
3,737


$
3,697Provision charged to expense


1,809



3,197Losses charged off, net of recoveries of $109 for 2010 and $28 for 2009


(714
)


(3,157
)Balance, end of year

$
4,832


$
3,737







Loans to related parties at December 31, 2009 totaled $2,097 reduced by paydowns of $1,192 and increased by new debt of $1,161.  Loans to related parties at September 30, 2010 totaled $2,066.




Impaired loans totaled $11,555 and $10,954 at September 30, 2010 and December 31, 2009, respectively. An allowance for loan losses of $1.3 million and $305 relates to impaired loans of $12,145 and $11,555 at September 30, 2010 and December 31, 2009, respectively.




Interest of $288 and $653 was recognized on average impaired loans of $12,705 and $8,403 for the first nine months of 2010 and the twelve months of 2009, respectively. Interest of $156 and $373 was recognized on impaired loans on a cash basis during the same periods, respectively.







Note 6 - Other Comprehensive Income




Other comprehensive income components and related taxes were as follows:




September 30,2010


2009(in Thousands)Net unrealized gain on securities available-for-sale

$
109


$
250Tax expense


43



100Other comprehensive income

$
66


$
150







Note 7 - Disclosures About Fair Value of Assets and Liabilities




FASB ASC 820-10 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  FASB ASC 820-10 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputs that may be used to measure fair value:


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


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




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




8


Following is a description of the inputs and valuation methodologies 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.  Third-party vendors compile prices from various sources and may apply such techniques as matrix pricing to determine the value of identical or similar investment securities (Level 2).  Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on the investment securities’ relationship to other benchmark quoted investment securities.







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 pricing models, quoted prices of securities with similar characteristics or discounted cash flows.  Level 2 securities include U.S. government agencies, mortgage-backed securities and state and political subdivisions.   In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.




The following table presents the fair value measurement of assets measured at fair value on a recurring basis and the level within the FASB ASC 820-10 fair value hierarchy in which the fair value measurements fall at September 30, 2010 and December 31, 2009:




9







Fair Value Measurements UsingFair 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 securitiesSeptember 30, 2010U.S. government agencies

$
2,120


$
---


$
2,120


$
---Mortgage-backed securities


2,794



---



2,794



---State and political subdivisions


6,646



---



6,646



---Totals


11,560



---



11,560



---Available-for-sale securitiesDecember 31, 2009U.S. government agencies

$
536


$
---


$
536


$
---Mortgage-backed securities


3,307



---



3,307



---State and political subdivisions


7,502



---



7,502



---Totals


11,345



---



11,345



---




Impaired Loans (Collateral Dependent)




Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment in accordance with the provisions of FASB ASC 310-10 (formerly FAS 114, Accounting by Creditors for Impairment of a Loan).  Allowable methods for estimating fair value include using the fair value of the collateral for collateral dependent loans.




If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized.  This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.




Impaired loans are classified within Level 3 of the fair value hierarchy.




The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the FASB ASC 820-10 fair value hierarchy in which the fair value measurements fall at September 30, 2010 and December 31, 2009:




10




Fair Value Measurements UsingFair Value


Quoted Prices in Active Markets for Identical Assets

(Level 1)


Significant Other Observable Inputs

(Level 2)


Significant Unobservable Inputs

(Level 3)(in Thousands)Impaired loans

September 30, 2010

$
1,048


$
---


$
---


$
1,048Impaired loans

December 31, 2009

$
9,218


$
---


$
---


$
9,218







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, Loans Held for Sale, Federal Home Loan Bank Stock, Interest Receivable and Interest Payable




The carrying amount approximates fair value.






Loans




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






Deposits




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






Federal Home Loan Bank Advances




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






Commitments to Originate Loans, 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




11


considers the difference between current levels of interest rates and the committed rates.  The fair value of forward sale commitments is estimated based on current market prices for loans 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 following table presents estimated fair values of the Company’s financial instruments in accordance with FASB ASC 825 (formerly FAS 107) not previously disclosed at September 30, 2010.




September 30, 2010


December 31, 2009Carrying Amount


Fair Value


CarryingAmount


Fair Value(in Thousands)Financial assetsCash and cash equivalents

$
16,012


$
16,012


$
12,901


$
12,901Available-for-sale securities


11,560



11,560



11,345



11,345Loans including loans held for sale, net of allowance for loan losses


332,450



347,264



321,163



331,739Federal Home Loan Bank stock


3,997



3,997



3,997



3,997Interest receivable


1,914



1,914



1,447



1,447Financial liabilitiesDeposits


321,289



327,366



277,866



281,663Federal Home Loan Bank advances


25,500



26,243



57,000



57,993Interest payable


109



109



171



171








Note 8 –Accounting Developments




In July 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.  ASU 2010-20 requires that more information be disclosed about the credit quality of a company’s loans and the allowance for loan losses held against those loans.  A company will need to disaggregate new and existing disclosure based on how it develops its allowance for loan losses and how it manages credit exposures.  Existing disclosures to be presented on a disaggregated basis include a roll-forward of the allowance for loan losses, the related recorded investment in such loans, the nonaccrual status of loans, and impaired loans.  Additional disclosure is also required about the credit quality indicators of loans by class at the end of the reporting period, the aging of the past due loans, information about troubled debt restructurings, and significant purchases and sales of loans during the reporting period by class.  For public companies, ASU 2010-20 requires certain disclosures as of the end of a reporting period effective for periods ending on or after December 15, 2010.  Other required disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010.  The Company anticipates that adoption of these additional disclosures will not have a material effect on its financial position or results of operations.





In February 2010, the FASB issued ASU No. 2010-09, Subsequent Events (Topic 855): Amendment to Certain Recognition and Disclosure Requirements.  The amendments remove the requirement for an SEC registrant to disclose the date through which subsequent events were evaluated as this requirement would have potentially conflicted with SEC reporting requirements.  Removal of the


12


disclosure requirement did not have an effect on the nature or timing of subsequent events evaluations performed by the Company.  ASU 2010-09 became effective upon issuance.





In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820):  Improving Disclosures about Fair Value Measurements.  ASU 2010-06 revises two disclosure requirements concerning fair value measurements and clarifies two others.  It requires separate presentation of significant transfers into and out of Levels 1 and 2 of the fair value hierarchy and disclosure of the reasons for such transfers.  It will also require the presentation of purchases, sales, issuances, and settlements within Level 3 on a gross basis rather than a net basis.  The amendments also clarify that disclosures should be disaggregated by class of asset or liability and that disclosures about inputs and valuation techniques should be provided for both recurring and non-recurring fair value measurements.  The Company’s disclosures about fair value measurements are presented in Note 3: Fair Value Measurements.  Those new disclosure requirements were effective for the period ended March 31, 2010, except for the requirement concerning gross presentation of Level 3 activity, which is effective for fiscal years beginning after December 15, 2010.  There was no significant effect on the Company’s financial statement disclosure upon adoption of this ASU.





In June 2009, the FASB issued ASU No. 2009-16, Transfers and Servicing (Topic 860): Accounting for Transfers of Financial Assetswhich pertains to securitizations.  ASU 2009-16 requires more information about transfers of financial assets, including securitization transactions, and where entities have continued exposure to the risks related to transferred assets.  The Company adopted this ASU effective January 1, 2010 and adoption did not have a material effect on its financial position or results of operations.





In June 2009, the FASB issued ASU No. 2009-17, Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities.  ASU 2009-17 replaces the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with a qualitative approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity.  The Company adopted the ASU effective January 1, 2010 and adoption did not have a material effect on its financial position or results of operations since the Company does not have any special purpose entities.







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




Executive Summary




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




Lafayette Savings is, and intends to continue to be, an independent, community-oriented financial institution. The Bank has been in business for 140 years and differs from many of our competitors in having a local board and local decision-making in all areas of business. In general, our business consists of attracting or acquiring deposits and lending that money out primarily as real estate loans to construct and purchase single-family residential properties, multi-family and commercial




13


properties and to fund land development projects. We also make a limited number of commercial business and consumer loans.




We have an experienced and committed staff and enjoy a good reputation for serving the people of the community and understanding their financial needs and for finding a way to meet those needs.  We contribute time and money to improve the quality of life in our market area and many of our employees volunteer for local non-profit agencies.  We believe this sets us apart from the other 19 banks and credit unions that compete with us.  We also believe that operating independently under the same name for over 140 years is a benefit to us—especially as local offices of large banks have less local authority than was once the case.  Focusing time and resources on acquiring customers who may be feeling disenfranchised by their no-longer-local bank has proved to be a successful strategy.




Tippecanoe County and the eight surrounding counties comprise Lafayette Savings’ primary market area.  Lafayette is the county seat of Tippecanoe County and West Lafayette is the home of Purdue University.  The Greater Lafayette area enjoys diverse employment including major manufacturers such as Subaru/Toyota, Caterpillar, and Wabash National; a strong education sector with Purdue University and a large local campus of Ivy Tech Community College; government offices of Lafayette, West Lafayette and Tippecanoe County; a growing high-tech presence with the Purdue Research Park, and the growth of a new medical corridor spurred by the building of two new hospitals.  The area wasn’t immune to the effects of the recession but there are signs of recovery.  Based on a mid-year report from Greater Lafayette Commerce, “Greater Lafayette is feeling renewed economic vigor at mid-year 2010. Among the markers: manufacturing employment is slowly returning to pre-recession levels, healthcare facility growth is continuing at a record pace, Purdue University continues an aggressive construction agenda, and $430.6M in capital investments were announced and/or made already in 2010 (exceeding 2009’s full-year total by nearly $90M).”  Wabash National, the area’s second largest industrial employer earlier this year announced a contract to make 3,100 trailers over the next 12 months and has since announced an order for an additional 4,000.  An article in Bloomburg Businessweek stated, “The semi-truck trailer manufacturer is the No. 2 performer in the Russell 2000 index in 2010, after a near-bankruptcy in 2009... It has been an especially good year for investors in Wabash National Corp. (WNC), the second-best-performing stock in the Russell 2000 index of small-cap stocks in 2010. Year to date through Aug. 18, the stock has almost quadrupled, vs. the index's return of 0.42 percent.”  Subaru, the area’s largest industrial employer announced record sales for September.  From PR Newswire, “Subaru sold 21,432 units in September 2010 versus 14,593 units in September 2009, resulting in a 47-percent gain year-over-year. Year-to-date sales of 193,614 units in 2010 versus 158,421 units sold in 2009, resulting in a 22-percent gain compared with the same period last year.”  Non-manufacturing sectors of the economy are also showing improvement.  In the education sector, Purdue’s West Lafayette 2010 enrollment is up slightly from last year and Ivy Tech’s 2010 enrollment set a record this year.




Despite the continued sales of foreclosed properties and distressed housing, the data shows that Tippecanoe County is faring reasonably well with home sales year-to-date at 1,176, the same as last year, and with the median price down 1.2% - all indications of a stabilizing market.  The Tippecanoe County unemployment rate spiked in July as it typically does because of the huge education sector, but has fallen each month since.  The July unemployment rate was 10.2% and September was 8.5%.





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




14


acquired one property in the third quarter of 2010 through foreclosure and sold six properties in the same period.




Our primary source of income is net interest income, which is the difference between the interest income earned on our loan and investment portfolio and the interest expense incurred on deposits and borrowings.  Our net interest income depends on the balance of our loan and investment portfolios and the size of our net interest margin – the difference between the income generated from loans and investments and the cost of funding.  Our net interest income also depends on the shape of the yield curve.  Since January 2007, the Federal Reserve has lowered short-term rates from around 5.0% to almost zero while long-term rates, which had also been near 5.0%, fell to under 3.0%.  Since then, the yield curve has remained steep with short-term rates still near zero but long-term rates nearing 4.0%. Because deposits are generally tied to shorter-term market rates and loans are generally tied to longer-term rates this would typically be viewed as a positive step.  In reality, loans—especially those immediately repriceable to prime—fell immediately while deposits generally stayed high due to a demand for liquidity, especially by big banks whose presence in the deposit markets was ubiquitous.  We have started to see deposit rates gradually respond to the lower market rates as banks become less concerned about the loss of liquidity.  Our expectation for 2010 is that deposits rates will gradually increase as the Federal Reserve begins to respond to inflation concerns by raising rates. Overall loan rates are expected to gradually rise.




Rate changes can be expected to have an impact on interest income.  Rising rates generally increase borrower preference for adjustable rate products which we typically keep in our portfolio, and existing adjustable rate loans can be expected to reprice to higher rates which could be expected to have a positive impact on our interest income. Lower rates increase borrower preference for fixed rate mortgages which we typically sell on the secondary market.  With mortgage loans at historically low levels we would expect to make and sell an increased number of loans on the secondary market.




Our primary expense is interest on deposits and Federal Home Loan Bank advances which are used to fund loan growth. We offer customers in our market area time deposits for terms ranging from three months to five years, checking accounts and savings accounts. We also purchase brokered deposits and Federal Home Loan Bank 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.  If 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, if rates are expected to fall, we intend to structure our balance sheet 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, changes in market interest rates, government policies and actions of regulatory authorities.




The level of turmoil in the financial services industry does present unusual risks and challenges for the Company, as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Possible Implications of Current Events” in the Annual Report to Shareholders filed as Exhibit 13 to the Company’s Form 10-K for the year ended December 31, 2009.




15




In addition, on July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which significantly changes the regulation of financial institutions and the financial services industry.  The Dodd-Frank Act includes provisions affecting large and small financial institutions alike, including several provisions that will profoundly affect how community banks, thrifts, and small bank and thrift holding companies, such as the Company, will be regulated in the future.  Among other things, these provisions abolish the Office of Thrift Supervision and transfer its functions to the other federal banking agencies, relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, change the scope of federal deposit insurance coverage, and impose new capital requirements on bank and thrift holding companies.  The Dodd-Frank Act also establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which will be given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks.  Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards, and pre-payments.  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 likely to affect our cost of doing business, it may limit or expand our permissible activities, and it may affect the competitive balance within our industry and market areas.  The nature and extent of future legislative and regulatory changes affecting financial institutions, including as a result of the Dodd-Frank Act, is very unpredictable at this time.  The Company’s management is actively reviewing the provisions of the Dodd-Frank Act and assessing its probable impact on the business, financial condition, and results of operations of the Company.  However, the ultimate effect of the Dodd-Frank Act on the financial services industry in general, and the Company in particular, is uncertain at this time.







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, 2009 included in the Annual Report to Shareholders filed as Exhibit 13 to the Company’s Form 10-K for the year ended December 31, 2009. Certain policies are considered critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such estimates may have a significant impact on the financial statements. Management has reviewed the application of these policies with the Audit Committee of LSB Financial’s Board of Directors. These policies include the following:






Allowance for Loan Losses




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




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




Lafayette Savings’ allowance consists of three components: probable losses estimated from individual reviews of specific loans, probable losses estimated from historical loss rates, and probable




16


losses resulting from economic or other deterioration above and beyond what is reflected in the first two components of the allowance.




Larger commercial loans that exhibit probable or observed credit weaknesses and all loans that are rated substandard or lower are subject to individual review. Where appropriate, reserves are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Bank. Included in the review of individual loans are those that are impaired as provided in FASB ASC 310-10 (formerly FAS 114, Accounting by Creditors for Impairment of a Loan). Any allowances for impaired loans are determined by the present value of expected future cash flows discounted at the loan’s effective interest rate or fair value of the underlying collateral based on the discounted appraised value.   Historical loss rates are applied to other commercial loans not subject to specific reserve allocations.




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




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




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




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






Mortgage Servicing Rights




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




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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




Comparison of Financial Condition at September 30, 2010 and December 31, 2009




Our total assets increased $13.7 million, or 3.68%, during the nine months from December 31, 2009 to September 30, 2010.  Primary components of this increase were an $11.3 million increase in net loans receivable including loans held for sale and a $3.1 million increase in cash and short-term investments offset by a $1.0 million decrease in other assets.  Management attributes the increase in loans to an increase in residential mortgage loan activity due to the ongoing interest of residential borrowers in refinancing their mortgages in response to continuing low interest rates.  Many of these loans are sold on the secondary market, but as a Thrift we are required to hold a certain percentage of our assets in residential mortgages and we increased our residential mortgage portfolio to meet that requirement.  Net loans for the last quarter were down slightly.  A $43.4 million increase in deposits was generally due to an increase in public funds and customer deposits as bank customers chose the safety of a bank offering FDIC deposit insurance coverage rather than leave them in more risky investments, as well as the increased security offered by the Company’s participation in the FDIC’s Temporary Liquidity Guarantee Program (“TLGP”).  The Company’s participation in the TLGP allows non-interest-bearing transaction accounts to receive unlimited insurance coverage until December 31, 2010 (recently extended from June 30, 2010).  The increased deposits were used to repay $31.5 million of maturing Federal Home Loan Bank advances.  We reduced Federal Home Loan Bank advances from $57.0 million at December 31, 2009 to $25.5 million at September 30, 2010.




Non-performing assets, which include non-accruing loans and foreclosed assets, increased from $14.5 million at December 31, 2009 to $15.8 million at September 30, 2010, down from $18.9 million at March 31, 2010.  Non-performing loans totaled $14.7 million at September 30, 2010 and consisted of $7.4 million, or 50.44%, of one- to four-family or multi-family residential real estate loans, $7.1 million, or 47.95%, of loans on land or commercial property, $230,000, or 1.57%,of commercial business loans, and $6,000 of consumer loans.  Non-performing assets also include $1.1 million in foreclosed assets.  At September 30, 2010, our allowance for loan losses equaled 1.47% of total loans compared to 1.16% at December 31, 2009.  The allowance for loan losses at September 30, 2010 totaled 30.63% of non-performing assets compared to 25.78% at December 31, 2009, and 32.86% of non-performing loans at September 30, 2010 compared to 29.65% at December 31, 2009.  Our non-performing assets equaled 4.10% of total assets at September 30, 2010 compared to 3.91% at December 31, 2009.  Non-performing loans totaling $823,000 were charged off in the nine months of 2010, offset by $109,000 of recoveries.




When a loan is added to our classified loan list, an impairment analysis is completed to determine expected losses upon final disposition of the property.  An adjustment to loan loss reserves is made at that time for any anticipated losses.  This analysis is updated quarterly thereafter.  It may take up to two years to move a foreclosed property through the system to the point where we can obtain title to the property and dispose of it.  We attempt to acquire properties through deeds in lieu of




18




foreclosure if there are no other liens on the properties.  The six properties acquired in the first nine months of 2010 were acquired through foreclosure. $104,000 was charged against loan loss reserves based on new information received to reduce the carrying value of the property to the estimated realizable value.  Although we believe we use the best information available to determine the adequacy of our allowance for loan losses, future adjustments to the allowance may be necessary, and net income could be significantly affected if circumstances and/or economic conditions cause substantial changes in the estimates we use in making the determinations about the levels of the allowance for losses.  Additionally, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses.  These agencies may require the recognition of additions to the allowance based upon their judgments of information available at the time of their examination.  Effective August 31, 2010, the Bank entered into a Supervisory Agreement (the “Supervisory Agreement”) with the Office of Thrift Supervision (“OTS”) requiring the Bank, among other things, to submit for review by the OTS revised policies and procedures related to the allowance for loan losses.  Upon notification from the OTS that it is acceptable, the Bank will implement the revised policy.  The Supervisory Agreement does not require an additional provision for loan loss reserves.




Shareholders’ equity increased from $33.9 million at December 31, 2009 to $35.1 million at September 30, 2010, an increase of $1.2 million, or 3.52%, primarily as a result of net income of $1.5 million partially offset by our payment of $389,000 of dividends on common stock.  Shareholders’ equity to total assets was 9.12% at September 30, 2010 compared to 9.13% at December 31, 2009.




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Average Balances, Interest Rates and Yields





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





Three months ended

September 30,2010


Three months ended

September 30,2009Average Outstanding Balance


Interest Earned/Paid


Yield/ Rate


Average OutstandingBalance


Interest Earned/ Paid


Yield/ Rate(Dollars in Thousands)Interest-Earning Assets:Loans receivable(1)

$
333,687


$
4,760



5.71
%

$
319,755



4,719



5.90
%Other investments


20,128



116



2.31



26,920



155



2.30Total interest-earning assets


353,815



4,876



5.51



346,674



4,874



5.62Interest-Earning LiabilitiesSavings deposits

$
26,629



22



0.33


$
26,171



61



0.93Demand and NOW deposits


116,812



185



0.63



75,396



141



0.75Time deposits


176,407



1,049



2.38



174,559



1,457



3.34Borrowings


27,167



233



3.43



56,000



603



4.31Total interest-bearing liabilities


347,015



1,489



1.72



332,127



2,262



2.72Net interest income





$
3,387










$
2,612Net interest rate spread










3.80
%










2.90
%Net earning assets

$
6,800










$
14,547Net yield on average interest-earning assets










3.83
%










3.01
%Average interest-earning assets to average interest-bearing liabilities


1.02
x










1.04
x


_________________


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




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Nine months ended

September 30,2010


Nine months ended

September 30,2009Average Outstanding Balance


Interest Earned/ Paid


Yield/ Rate


Average Outstanding Balance


Interest Earned/ Paid


Yield/ Rate(Dollars in Thousands)Interest-Earning Assets:Loans receivable(1)

$
327,650


$
13,900



5.66
%

$
322,845



14,485



5.98
%Other investments


20,057



368



2.45



32,355



420



1.73Total interest-earning assets


347,707



14,268



5.47



355,200



14,905



5.59Interest-Earning LiabilitiesSavings deposits

$
26,179



93



0.47


$
25,596



191



0.99Demand and NOW deposits


100,462



478



0.63



70,308



395



0.75Time deposits


175,319



3,217



2.45



178,552



4,666



3.48Borrowings


40,056



996



3.32



64,500



2,119



4.38Total interest-bearing liabilities


342,016



4,784



1.87



338,956



7,371



2.90Net interest income





$
9,484










$
7,535Net interest rate spread










3.61
%










2.69
%Net earning assets

$
5,691










$
16,244Net yield on average interest-earning assets










3.64
%










2.83
%Average interest-earning assets to average interest-bearing liabilities


1.02
x










1.05
x


_________________


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


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Results of Operations




Comparison of Operating Results for the Nine Months and the Quarter ended September 30, 2010 and September 30, 2009





General.  Net income for the nine months ended September 30, 2010 was $1.5 million, an increase of $876,000, or 137.09%, over the nine months ended September 30, 2009.  The increase was primarily due to a $2.0 million, or 25.88% increase in net interest income, a $347,000 decrease in non-interest expenses and a $14,000 decrease in the provision for loan losses, partially offset by an $850,000 decrease in non-interest income caused by a decrease in the gain on sale of mortgage loans and increased losses on the sale and revaluation of other real estate owned (“OREO”) properties.




Net income for the quarter ended September 30, 2010 was $526,000, an increase of $502,000 over the $24,000 in net income in the comparable quarter in 2009.  The increase for the three month period was primarily due to a $775,000, or 29.67%, increase in net interest income, an $82,000 decrease in non-interest expenses and a $19,000 increase in non-interest income partially offset by a $45,000 increase in the provision for loan losses.




Net Interest Income.  Net interest income for the nine months ended September 30, 2010 increased $2.0 million, or 25.88%, over the same period in 2009.  This increase was due to an 81 basis point increase in our net interest margin (net interest income divided by average interest-earning assets) from 2.83% for the nine months ended September 30, 2009 to 3.64%for the nine months ended September 30, 2010 partly offset by a $10.6 million decrease in average net interest-earning assets.  The increase in net interest margin is primarily due to the 103 basis point decrease in the average rate on interest-bearing liabilities from 2.90% for the nine months ended September 30, 2009 to 1.87% for the nine months ended September 30, 2010. The average rate on interest-earning assets decreased 12 basis points from 5.59% to 5.47% for the same respective periods.




Interest income on loans decreased $585,000, or 4.04%, for the nine months ended September 30, 2010 compared to the same nine months in 2009.  The average rate on loans fell from 5.98% to 5.66% partly due to the aggressive rate cuts by the Federal Reserve starting in 2007 which left the prime rate at 3.25% at September 30, 2010, lowered the three-year Treasury rate from 4.06% to 0.74% and the thirty-year Treasury rate from 4.79% to 3.77% over this same period.




Interest earned on other investments and Federal Home Loan Bank stock decreased by $52,000, or 12.38%, for the nine months ended September 30, 2010 compared to the same period in 2009.  This was the result of a $12.3 million decrease in average balances offset by a 72 basis point increase in the average yield on other investments and Federal Home Loan Bank stock.  Much of the decrease in average balances was due to the Bank using the low-rate, short-term investments to fund withdrawal of brokered deposits and reduce the level of Federal Home Loan Bank advances.




Interest expense for the nine months ended September 30, 2010 decreased $2.6 million, or 35.10%, over the same period in 2009 due to a $1.5 million decrease in interest paid on deposits and a $1.1 million decrease in interest expenses on Federal Home Loan Bank advances.  The lower deposit costs were primarily due to a decrease in the average rate paid on time deposits from 3.48% for the first nine months of 2009 to 2.45% for the first nine months of 2010 partially offset by a $27.5 million




22


increase in average deposits due to an increase in public funds and customer deposits as depositors opted for the safety of a bank offering FDIC deposit insurance coverage rather than leave them in more risky investments.  Deposit rates generally decreased from 2.55% for the first nine months of 2009 to 1.67% for the first nine months of 2010.  The decrease in Federal Home Loan Bank advance expense was due to a decrease in the average rate paid on advances from 4.38% for the first nine months of 2009 to 3.32% for the first nine months of 2010 and a $24.4 million decrease in average balances. The lower rates were generally due to the lower interest rates in the economy.




Net interest income for the three months ended September 30, 2010 increased $775,000, or 29.67% over the same period in 2009 due to an 82 basis point increase in our net interest margin from 3.01% for the third quarter of 2009 to 3.83% for the third quarter of 2010.  Interest income on loans increased $41,000 for the third quarter of 2010 compared to the third quarter of 2009 primarily due to a $13.9 increase in average outstanding balances offset by a 0.19% decrease in the average yield on loans from 5.90% for the third quarter of 2009 to 5.71% for the third quarter of 2010.  Interest income on other investments and Federal Home Loan Bank stock decreased $39,000 for the third quarter of 2010 compared to the third quarter of 2009 due to a $6.8 million decrease in average balances.  The average yield on other investments and Federal Home Loan Bank stock remained at 2.30%.  Interest expense decreased $773,000, or 34.17%, for the third quarter of 2010 from the same period in 2009 primarily due to a 1.0% decrease in the average rate paid on interest-earning liabilities from 2.72% for the third quarter of 2009 to 1.72% for the same period in 2010 offset by a $14.9 million increase in average interest-earning liabilities for the same periods.









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Provision for Loan Losses.  The evaluation of the level of loan loss reserves is an ongoing process that includes closely monitoring loan delinquencies. The following chart shows delinquent loans as well as a breakdown of non-performing assets.




09/30/10


12/31/09


09/30/09(in Thousands)Loans delinquent 30-59 days

$
2,683


$
677


$
1,333Loans delinquent 60-89 days


1,674



3,169



1,736Total delinquencies  under 90 days


4,357



3,846



3,069Accruing loans past due 90 days


0



0



0Non-accruing loans


14,707



12,554



11,982Total non-performing loans


14,707



12,554



11,982OREO


1,068



1,892



1,116Total non-performing assets

$
15,775


$
14,446


$
13,098







The accrual of interest income is discontinued when a loan becomes 90 days and three payments past due.  Loans 90 days past due but not yet three payments past due will continue to accrue interest as long as it has been determined that the loan is well secured and 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.




The $2.2 million increase in non-performing loans at September 30, 2010 compared to December 31, 2009 was primarily due to the addition of $9.1 million in new loans of which $4.8 million were residential properties and $4.1 million were nonresidential or land loans.  This amount was offset by $5.9 million in loans removed from non-performing status because of payment from the sale of the properties ($3.3 million), loans that had paid as agreed for a sufficient time to be moved to performing status ($1.6 million), loans paid or assumed by guarantors or from other means ($604,000), or loans that were taken into OREO or written off ($431,000).  Loans which remained on non-accrual status throughout the period were paid down or written down $1.1 million.




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




24


time to time, we also use the services of a consultant to assist in the evaluation of our growing commercial real estate loan portfolio. On at least a quarterly basis, a formal analysis of the adequacy of the allowance is prepared and reviewed by management and the Board of Directors.  This analysis serves as a point-in-time assessment of the level of the allowance and serves as a basis for provisions for loan losses.




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




At September 30, 2010 our largest areas of concern were loans on one- to four-family non-owner occupied rental properties, non-residential properties and, to a lesser extent land development loans.  Loans totaling $6.3 million on one- to four-family rental properties, $4.8 million on non-residential properties and $3.0 million on land development were past due more than 30 days at September 30, 2010.  Because of the presence of Purdue University, student housing has been a niche for us, but because of the economy we are seeing problems with vacancies, especially in non-campus housing.  The non-residential properties are typically smaller loans averaging about $112,000 and the borrowers are typically seeing increased vacancies and late rent payments because of the economy.  Land loans are of some concern as absorption rates are slower than anticipated on development loans, although sales have improved lately.




We recorded a $910,000 provision for loan losses for the three months ended September 30, 2010 and $1.8 million year-to-date as a result of our analyses of our current loan portfolios, compared to $865,000 and $1.8 million during the same respective periods in 2009.  The provisions were necessary to maintain the allowance for loan losses at a level considered appropriate to absorb probable incurred losses in the loan portfolio.  During the first nine months of 2010, we charged $823,000 against loan loss reserves and had recoveries of $109,000.  Included in the $823,000 was $366,000 on short sales and $166,000 of loans taken into other real estate owned or charged off.  We expect to obtain possession of more properties in 2010 that are currently in the process of foreclosure.  The final disposition of these properties may result in a loss.  The $4.8 million allowance for loan losses was considered appropriate to cover probable incurred losses based on our evaluation and our loan mix.




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




25


guidelines for property type.  We currently have $9.9 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 and none of these loans is delinquent.  We also have $7.6 million of one- to four-family loans which either alone or combined with a second mortgage exceed high loan-to-value guidelines.  Of these loans, $490,000 are currently over 30 days past due.  Our total high loan-to-value loans at September 30, 2010 were at 46% of capital, well under regulatory guidelines of 100% of capital.  We have $16.4 million of Home Equity Lines of Credit of which six loans totaling $203,000 were delinquent more than 30 days at September 30, 2010.




An analysis of the allowance for loan losses for the nine months ended September 30, 2010 and 2009 follows:




Nine months ended September 30,2010


2009(Dollars in Thousands)Balance at January 1

$
3,737


$
3,697Loans charged off


(823
)


(1,863
)Recoveries


109



21Provision


1,809



1,823Balance at June 30

$
4,832


$
3,678







At September 30, 2010, non-performing assets, consisting of non-performing loans, accruing loans 90 days or more delinquent and other real estate owned, totaled $15.8 million compared to $14.5 million at December 31, 2009.  In addition to our non-performing assets, we identified $11.3 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.




At September 30, 2010, 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 1.45% of net loans receivable and 32.86% of non-performing loans at September 30, 2010 compared to 1.16% and 29.65% at December 31, 2009, respectively.  Our nonperforming assets equaled 4.10% of total assets at September 30, 2010 compared to 3.91% at December 31, 2009.




Non-Interest Income.  Non-interest income for the nine months ended September 30, 2010 decreased by $850,000, or 29.25%, compared to the same period in 2009.  This was primarily due to a $599,000 decrease in the gain on the sale of mortgage loans due to the increase in mortgage loan rates early in the year that resulted in fewer borrowers refinancing their mortgages and because we elected to keep more of the residential mortgages in our




26


portfolio to stay in compliance with the Qualified Thrift Lender test which requires that we keep a certain percentage of our loans in residential products.  We completed sales of $23.9 million of loans in the first nine months of 2010 compared to $58.5 million in the first nine months of 2009.  We also recorded increased losses on the sale or writedown of OREO properties of $343,000 as we either sold properties at a loss or reduced the carrying value to reflect new valuations.  These decreases were offset by a $64,000 increase in fees on deposit accounts due to an increase in the volume of fees and a $28,000 increase in other income primarily due to an increase in debit card fees and a decrease in the amortization of mortgage servicing rights.




Non-interest income for the third quarter of 2010 increased by $19,000 compared to the same period in 2009 due to a $199,000 increase in the gain on the sale of mortgage loans and a $6,000 increase in fees on deposit accounts, partially offset by a $149,000 increase in the loss on sale of OREO properties and a $37,000 decrease in other income due primarily to an increase in the amortization of mortgage servicing rights.




Non-Interest Expense.  Non-interest expense for the nine months ended September 30, 2010 decreased $347,000 compared to the same period in 2009 due primarily to a $247,000 decrease in the cost of maintaining OREO and foreclosed properties primarily due to a decrease in the number of foreclosed properties, a $130,000 decrease in FDIC insurance premiums and an $8,000 decrease in occupancy expenses offset by a $36,000 increase in salaries due to the increase in health insurance.




Non-interest expense for the third quarter of 2010 decreased by $82,000 over the same period in 2009, due largely to the factors mentioned above including a $111,000 decrease in other expenses due primarily to lower OREO and foreclosed property related expenses, an $85,000 decrease in FDIC insurance premiums and a $13,000 decrease in advertising costs offset by a $127,000 increase in salaries due primarily to increased health insurance costs.




Income Tax Expense.Our income tax provision increased by $585,000 for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009, and by $329,000 for the quarter ended September 30, 2010 compared to September 30, 2009 due primarily to increased pre-tax income.






Liquidity




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




We monitor our cash flow carefully and strive to minimize the level of cash held in low-rate overnight accounts or in cash on hand.  We also carefully track the scheduled delivery of loans committed for sale to be added to our cash flow calculations.   Our current internal policy for liquidity requires minimum liquidity of 4.0% of total assets.




27


Liquidity management is both a daily and long-term function for our senior management. We adjust our investment strategy, within the limits established by the investment policy, based upon assessments of expected loan demand, expected cash flows, Federal Home Loan Bank advance opportunities, market yields and objectives of our asset/liability management program.  Base levels of liquidity have generally been invested in interest-earning overnight and time deposits with the Federal Home Loan Bank of Indianapolis and more recently at the Federal Reserve since they have started to pay interest on deposits in excess of reserve requirements and because of increasing wire transfer requests due to a change in funding methods now required by 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 liquidity ratios at September 30, 2010 and December 31, 2009 were 7.26% and 7.16%, respectively, compared to a regulatory liquidity base, and 6.16% and 5.94% compared to total assets at the end of each period.




We anticipate that we will have sufficient funds available to meet current funding commitments.  At September 30, 2010, we had outstanding commitments to originate loans and available lines of credit totaling $34.4 million and commitments to provide funds to complete current construction projects in the amount of $1.5 million. We had outstanding commitments to sell $1.9 million of residential loans.  Certificates of deposit which will mature in one year or less totaled $95.6 million at September 30, 2010.  Included in that number are $5.2 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 also have $14.5 million of Federal Home Loan Bank advances maturing in the next twelve months.






Capital Resources




Shareholders’ equity totaled $35.1 million at September 30, 2010 compared to $33.9 million at December 31, 2009, an increase of $1.2 million, or 3.52%, due primarily to net income of $1.5 million, partially offset by our payment of dividends on common stock.  Shareholders’ equity to total assets was 9.12% at September 30, 2010 compared to 9.13% at December 31, 2009.




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 September 30, 2010 and December 31, 2009, Lafayette Savings was categorized as well capitalized.  Our actual and required capital amounts and ratios at September 30, 2010 and December 31, 2009 are presented below:




28







Actual

For Capital Adequacy Purposes

To Be Well Capitalized Under Prompt Corrective Action ProvisionsAmount


Ratio

Amount


Ratio

Amount


RatioAs of September 30, 2010

(Dollars in Thousands)Total risk-based capital

(to risk-weighted assets)

$
37,952



13.1
%

$
23,118



8.0
%

$
28,897



10.0
%Tier I capital

(to risk-weighted assets)


34,340



11.9



11,559



4.0



17,338



6.0Tier I capital

(to adjusted total assets)


34,340



9.0



11,517



3.0



19,195



5.0Tier I capital

(to adjusted tangible assets)


34,340



9.0



7,678



2.0



N/A



N/ATangible capital

(to adjusted tangible assets)


34,340



9.0



5,758



1.5



N/A



N/AAs of December 31, 2009Total risk-based capital

(to risk-weighted assets)

$
37,223



12.9
%

$
23,132



8.0
%

$
28,915



10.0
%Tier I capital

(to risk-weighted assets)


33,609



11.6



11,566



4.0



17,349



6.0Tier I capital

(to adjusted total assets)


33,609



9.1



11,123



3.0



18,538



5.0Tier I capital

(to adjusted tangible assets)


33,609



9.1



7,415



2.0



N/A



N/ATangible capital

(to adjusted tangible assets)


33,609



9.1



5,561



1.5



N/A



N/A








Effective August 31, 2010, the Company entered into a Memorandum of Understanding (“MOU”) with the OTS, requiring the Company to submit to the OTS by October 31, 2010 a capital plan for enhancing the consolidated capital of the Company for the period January 1, 2011 through December 31, 2012.  In its submitted capital plan, the Company proposes to maintain risk-based capital ratios above twelve percent (200 basis points above the ten percent well-capitalized level), and core capital above eight percent (300 basis points above the five percent well-capitalized level). The current capital levels shown in the table above are at least 1% above these levels.  The Company is awaiting notification from the OTS as to whether the capital plan is acceptable.




The Bank’s Supervisory Agreement and the MOU require prior OTS approval of dividends by the Bank or the Company, respectively.  In addition, the MOU requires prior approval by the OTS of any debt at the holding company level not in the ordinary course (including loans, cumulative preferred stock and subordinated debt), unless such debt is contemplated by the capital plan.  The holding company does not now hold any such debt.




29


Disclosure Regarding Forward-Looking Statements




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




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




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




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




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




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




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




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


·
the impact of technological changes;




30


·
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.






Item 4T.  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 September 30, 2010, 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 September 30, 2010, that have materially affected, or are reasonably likely to materially affect, our internal control over the financial reporting.






PART II. OTHER INFORMATION




Item 1.  Legal Proceedings




Effective August 31, 2010, the Bank executed an updated Supervisory Agreement (the “Supervisory Agreement”) with the Office of Thrift Supervision (“OTS”) and LSB Financial Corp. (the “Company”) entered into a Memorandum of Understanding (the “MOU”) with the OTS under which the Bank and the Company have agreed to take a number of actions within specified timeframes to address concerns identified by the OTS in connection with its most recent examination of the Bank.  These agreements replace the prior Memorandum of Understanding and Supervisory Agreement between the Bank and the OTS.




The updated Supervisory Agreement eliminates certain requirements satisfied in the Bank’s prior agreement with the OTS. Among other things, under the Supervisory Agreement, the Bank’s board of directors must continue to provide written workout plans for certain classified assets and present quarterly status reports to the OTS.  The Bank’s board of directors must also revise its policy on concentrations of credit and in the event the revised limits are lower adopt a plan to bring the Bank into compliance with the revised policy.  The Bank must




31


also revise its policies and procedures related to the establishment and maintenance of its allowance for loan losses.  However, the Supervisory Agreement does not require an additional provision for loan loss reserves.  The Supervisory Agreement places restrictions on the Bank with respect to certain operating activities, requiring prior notice to the OTS of changes in directors and senior executive officers and prior written non-objection from the OTS with respect to senior executive officer or director compensation, material third party service provider contracts, and asset growth over certain levels until the approval of the Bank’s business plan.




Under the MOU, the Company was required to submit to the OTS by October 31, 2010, a capital plan for enhancing the consolidated capital of the Company for the period January 1, 2011 through December 31, 2012.  The capital plan is to be updated each year during which the MOU is effective.  The MOU also requires prior written non-objection of the OTS of any Company debt not in the ordinary course (including loans, cumulative preferred stock and subordinated debt) unless such debt is contemplated by the capital plan.  The holding company does not now hold any such debt.




Both the Supervisory Agreement and the MOU require prior written non-objection of the OTS of the declaration or payment of dividends or other capital distributions by the Bank or the Company, respectively.




The board of directors and management of the Bank and the Company have been taking actions intended to comply with the Supervisory Agreement and the MOU. The Supervisory Agreement and the MOU will remain in effect until terminated, modified or superseded by the OTS. The Company believes that the Supervisory Agreement and the MOU will not have a material adverse effect on the financial condition or results of operations of the Bank or the Company, taken as a whole.






Item 1A.  Risk Factors




Not Applicable.




32




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 SecuritiesMonth of Purchase

Total Number of Shares Purchased1


Average Price Paid per Share


Total Number of Shares Purchased as Part of Publicly Announced Plans orPrograms2


Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans orPrograms2July 1 – July 31, 2010


---



---



---



52,817August 1 – August 31, 2010


---



---



---



52,817September 1 – September 30, 2010


---



---



---



52,817Total


---



---



---



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.  [Removed and Reserved]








Item 5.  Other Information




None.






Item 6.  Exhibits




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




33




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: November 15, 2010
By:
/s/ Randolph F. WilliamsRandolph F. Williams, President(Principal Executive Officer)Date: November 15, 2010
By:
/s/ Mary Jo DavidMary Jo David, Treasurer(Principal Financial and Accounting Officer)





34


INDEX TO EXHIBITS








Regulation S-K Exhibit Number

Document31.1

Rule 13(a)-14(a) Certification (Chief Executive Officer)31.2

Rule 13(a)-14(a) Certification (Chief Financial Officer)32

Section 906 Certification







35