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 June 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 oNo  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 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 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
12Item 3.
Quantitative and Qualitative Disclosures About Market Risk
29Item 4T.
Controls and Procedures.
29PART II.
OTHER INFORMATION
29Item 1.
Legal Proceedings
29Item 1A.
Risk Factors
29Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
30Item 3.
Defaults Upon Senior Securities
30Item 4.
[Removed and Reserved]
30Item 5.
Other Information
30Item 6.
Exhibits
30SIGNATURES
31








i


PART I      FINANCIAL INFORMATION




Item 1.   Financial Statements







LSB FINANCIAL CORP.


Consolidated Condensed Balance Sheets


(Dollars in thousands, except per share data)





June 30,2010


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

$
5,648


$
8,084Short-term investments


3,381



4,817Cash and cash equivalents


9,029



12,901Available-for-sale securities


11,362



11,345Loans held for sale


853



3,303Total loans


336,939



321,597Less: Allowance for loan losses


(4,240
)


(3,737
)Net loans


332,699



317,860Premises and equipment, net


6,195



6,209Federal Home Loan Bank stock, at cost


3,997



3,997Bank owned life insurance


6,171



6,071Interest receivable and other assets


8,274



9,364Total Assets

$
378,580


$
371,050Liabilities and Shareholders’ EquityLiabilitiesDeposits

$
300,721


$
277,866Federal Home Loan Bank advances


41,000



57,000Interest payable and other liabilities


2,366



2,300Total liabilities


344,087



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


10,986



10,985Retained earnings


23,246



22,646Accumulated other comprehensive income


246



238Total shareholders’ equity


34,493



33,884Total liabilities and shareholders’ equity

$
378,580


$
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 endedJune 30,


Six months endedJune 30,2010


2009


2010


2009Interest and Dividend IncomeLoans

$
4,596


$
4,910


$
9,140


$
9,766SecuritiesTaxable


59



80



118



126Tax-exempt


62



66



125



133Other


4



3



10



6Total interest and dividend income


4,721



5,059



9,393



10,031Interest ExpenseDeposits


1,261



1,778



2,532



3,593Borrowings


311



745



763



1,516Total interest expense


1,572



2,523



3,295



5,109Net Interest Income


3,149



2,536



6,098



4,922Provision for Loan Losses


465



389



899



958Net Interest Income After Provision for Loan Losses


2,684



2,147



5,199



3,964Non-interest IncomeDeposit account service charges and fees


397



370



764



706Net gains on loan sales


92



451



177



974Loss on other real estate owned


(228
)


(100
)


(261
)


(66
)Other


283



250



558



494Total non-interest income


544



971



1,238



2,108Non-Interest ExpenseSalaries and employee benefits


1,349



1,380



2,641



2,732Net occupancy and equipment expense


326



317



665



670Computer service


148



147



275



281Advertising


78



60



134



117FDIC insurance premiums


164



235



323



368Other


494



552



935



1,070Total non-interest expense


2,559



2,691



4,973



5,238Income Before Income Taxes


669



427



1,464



834Provision for Income Taxes


212



115



475



220Net Income

$
457


$
312


$
989


$
614Basic Earnings Per Share

$
0.29


$
0.20


$
0.64


$
0.40Diluted Earnings Per Share

$
0.29


$
0.20


$
0.64


$
0.40Dividends Declared Per Share

$
0.125


$
0.125


$
0.25


$
0.25





See notes to consolidated condensed financial statements.


2


LSB FINANCIAL CORP.


Consolidated Condensed Statements of Changes in Shareholders’ Equity


For the Six Months Ended June 30, 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










614







614Change in unrealized appreciation on available-for-sale securities, net of taxes














28



28Total comprehensive income


















642Dividends on common stock, $0.125 per share










(388
)






(388
)Share-based compensation expense






2











2Balance, June 30, 2009

$
15


$
10,985


$
23,187


$
144


$
34,331Balance, January 1, 2010

$
15


$
10,985


$
22,646


$
238


$
33,884Comprehensive incomeNet income










989







989Change in unrealized appreciation on available-for-sale securities, net of taxes














8



8Total comprehensive income


















997Dividends on common stock, $0.125 per share










(389
)






(389
)Share-based compensation expense






1











1Balance, June 30, 2010

$
15


$
10,986


$
23,246


$
246


$
34,493





See notes to consolidated condensed financial statements.


3


LSB FINANCIAL CORP.


Consolidated Condensed Statements of Cash Flows


(Dollars in thousands)


(Unaudited)





Six months endedJune 30,2010


2009Operating ActivitiesNet income

$
989


$
614Items not requiring (providing) cashDepreciation


218



246Provision for loan losses


899



958Amortization of premiums and discounts on securities


21



12(Gain)loss on sale of other real estate owned


261



66Gain on sale of loans


(166
)


(685
)Loans originated for sale


(9,826
)


(47,317
)Proceeds on loans sold


12,442



47,206Amortization of stock options


1



2Changes inInterest receivable and other assets


270



1,485Interest payable and other liabilities


66



914Net cash provided by operating activities


5,175



3,501Investing ActivitiesPurchases of available-for-sale securities


(971
)


(1,877
)Proceeds from maturities of available-for-sale securities


945



1,465Net change in loans


(15,868
)


3,935Proceeds from sale of other real estate owned


584



1,218Purchase of premises and equipment


(203
)


(168
)Net cash (used in)provided by investing activities


(15,513
)


4,573Financing ActivitiesNet change in demand deposits, money market, NOW and savings accounts


13,523



26,991Net change in certificates of deposit


9,332



(4,639
)Proceeds from Federal Home Loan Bank advances


16,000



---Repayment of Federal Home Loan Bank advances


(32,000
)


(21,000
)Dividends paid


(389
)


(388
)Net cash provided by financing activities


6,466



964Increase (Decrease) in Cash and Cash Equivalents


(3,872
)


9,036Cash and Cash Equivalents, Beginning of Period


12,901



11,225Cash and Cash Equivalents, End of Period

$
9,029


$
20,263Supplemental Cash Flows InformationInterest paid

$
3,362


$
5,189Income taxes paid


720



100Supplemental Non-Cash DisclosuresCapitalization of mortgage servicing rights


11



281Loans transferred to other real estate owned


317



1,707





See notes to consolidated condensed financial statements


4





LSB FINANCIAL CORP.


Notes to Consolidated Condensed Financial Statements


June 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 period 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 month period in 2009, 12,039 shares related to stock options outstanding were included in the diluted earnings per share calculation as their effect would be dilutive; 21,458 were antidilutive.  For the six month period in 2009, 462 shares related to stock options outstanding were dilutive and 33,035 were antidilutive. For the three and six 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 endedJune 30,


Six months ended June 30,2010


2009


2010


2009Weighted average shares outstanding


1,553,525



1,553,525



1,553,525



1,553,525Shares used to compute diluted earnings per share


1,553,538



1,555,084



1,553,525



1,553,525Earnings per share

$
0.29


$
0.20


$
0.64


$
0.40Diluted earnings per share

$
0.29


$
0.20


$
0.64


$
0.40







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:June 30, 2010:U.S. Government agencies

$
1,046


$
19


$
---



1,065Mortgage-backed securities – government sponsored entities


2,803



181



---



2,984State and political subdivisions


7,103



210



---



7,313$
10,952


$
410


$
---


$
11,362December 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 June 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

ValueJune 30, 2010(in thousands)Within one year

$
1,531


$
1,545One to five years


3,549



3,641Five to ten years


2,584



2,685After ten years


485



5078,149



8,378Mortgage-backed securities


2,803



2,984Totals

$
10,952


$
11,362







The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $3,196 at June 30, 2010 and $3,703 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 June 30, 2010 or December 31, 2009 was reported at less than historical cost.







Note 5 - Other Comprehensive Income




Other comprehensive income components and related taxes were as follows:





2010


2009Net unrealized gain on securities available-for-sale

$
13


$
46Tax expense


5



18Other comprehensive income

$
8


$
28







7


Note 6 - 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




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 June 30, 2010 and December 31, 2009:




8




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 securities

June 30, 2010U.S. government agencies

$
1,065


$
---


$
1,065


$
---Mortgage-backed securities


2,984



---



2,984



---State and political subdivisions


7,313



---



7,313



---Totals


11,362



---



11,362



---Available-for-sale securities

December 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 June 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)Impaired loansJune 30, 2010

$
2,301


$
---


$
---


$
2,301Impaired loansDecember 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




10


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 June 30, 2010.




June 30, 2010


December 31, 2009Carrying Amount


Fair Value


Carrying Amount


Fair Value(in Thousands)Financial assetsCash and cash equivalents

$
9,029


$
9,029


$
12,901


$
12,901Available-for-sale securities


11,362



11,362



11,345



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


333,552



348,135



321,163



331,739Federal Home Loan Bank stock


3,997



3,997



3,997



3,997Interest receivable


1,625



1,625



1,447



1,447Financial liabilitiesDeposits


300,721



305,533



277,866



281,663Federal Home Loan Bank advances


41,000



41,748



57,000



57,993Interest payable


105



105



171



171








Note 7 –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 rollforward 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


11


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




12




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 Purdue Research Park has more than 3,700 employees earning an average annual wage of $54,000.  Eleven new life science/high-tech startups were launched in 2009 and two new high tech buildings with 150,000 square feet total space opened in 2009.  With the addition of the two new buildings in May, 2009, the Purdue Research Park of West Lafayette has about 364,000 square feet of incubation space, making it the largest business incubator complex in the state.  However the area is not immune to the effects of the recession.  The Tippecanoe County unemployment rate peaked at 10.6% in July 2009, was at 9.2% in March 2010 and rose to 10.2% in June 2010.  Comparable numbers for June were 10.1%, for Indiana and 9.5% nationally.  Much of the increase of the county rate was due to layoffs at the end of the school session.  Over the last four years, the unemployment rate increased an average of 17% from May to June for this reason.  The increase in 2010 was 15%.  The news from the manufacturing sector is largely positive as Wabash National has added over 500 production staff because of new orders, Caterpillar’s June earnings were up 91% and Subaru is working to increase production by 40% at its Lafayette plant from 100,000 to 140,000 vehicles per year by year end.





Housing values in the Metropolitan Statistical Area (“MSA”) of which Tippecanoe County is a part did not show the huge increases experienced in some parts of the country and consequently have not seen the offsetting decreases after the housing bubble burst.  House prices within our Metropolitan Statistical Area increased by 2.08% over the last five years and although prices were down 1.20% over the last 12 months according to a report from the Office of Federal Housing Enterprise Oversight, they ranked the Lafayette, Indiana MSA in the top 10% in the country.  Tippecanoe County’s population grew slightly in 2009 and this has helped reduce the number of unoccupied houses.




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




13


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, short-term rates have stayed at historically low levels, well under 1.0%, while long-term rates have gradually moved to over 4.0%.  At June 2010 the yield curve 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.  Because the government is expected to discontinue some programs designed to help with the housing crisis, we expect to see higher market rates. 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. With fewer fixed rate loans we would expect to sell fewer loans on the secondary market. Although new loans put on the books early in 2010 were at comparatively low rates we expect higher rates later in the year will result in an increase in the average rate of new loans.




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.




14




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.




15


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




Larger commercial loans that exhibit probable or observed credit weaknesses and all loans that are rated substandard or lower are subject to individual review. Where appropriate, reserves are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Bank. Included in the review of individual loans are those that are impaired as provided in FASB ASC 310-10 (formerly FAS 114, Accounting by Creditors for Impairment of a Loan). Any allowances for impaired loans are determined by the present value of expected future cash flows discounted at the 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.




16




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 June 30, 2010 and December 31, 2009




Our total assets increased $7.5 million, or 2.03%, during the six months from December 31, 2009 to June 30, 2010.  Primary components of this increase were a $14.8 million increase in net loans receivable including loans held for sale offset by a $3.9 million decrease in cash and short-term investments and by a $1.1 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, and the response to the tax credit for first time borrowers.  As a Thrift, we are required to hold a certain percentage of our assets in residential mortgages and we made a conscious decision to hold many of these mortgages to stay above that threshold.  A $22.9 million increase in deposits was generally due to a decision by bank customers to move funds to 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 $16.0 million of maturing Federal Home Loan Bank advances.  We reduced Federal Home Loan Bank advances from $57.0 million at December 31, 2009 to $41.0 million at June 30, 2010.




Non-performing assets, which include non-accruing loans, accruing loans 90 days past due and foreclosed assets, increased from $14.5 million at December 31, 2009 to $15.8 million at June 30, 2010, down from $18.9 million at March 31, 2010.  Non-performing loans totaled $14.6 million at June 30, 2010 and consisted of $6.7 million, or 45.67%, of one- to four-family or multi-family residential real estate loans, $7.7 million, or 52.73%, of loans on land or commercial property, $234,000, or 1.60%,of commercial business loans, and a $2,000 consumer loan.  Non-performing assets also include $1.2 million in foreclosed assets.  At June 30, 2010, our allowance for loan losses equaled 1.27% of total loans (including loans held for sale) compared to 1.16% at December 31, 2009.  The allowance for loan losses at June 30, 2010 totaled 26.78% of non-performing assets compared to 25.78% at December 31, 2009, and 29.00% of non-performing loans at June 30, 2010 compared to 29.65% at December 31, 2009.  Our non-performing assets equaled 4.18% of total assets at June 30, 2010 compared to 3.91% at December 31, 2009.  Non-performing loans totaling $403,000 were charged off in the six months of 2010, offset by $7,000 of recoveries.




17




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 maytake 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.  The five properties acquired in the first six months of 2010 were acquired through foreclosure resulting in $58,000 charged against loan loss reserves to reduce the carrying value of the property to the estimated realizable value.  Although we believe we use the best information available to determine the adequacy of our allowance for loan losses, future adjustments to the allowance may be necessary, and net income could be significantly affected if circumstances and/or economic conditions cause substantial changes in the estimates we use in making the determinations about the levels of the allowance for losses.  Additionally, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses.  These agencies may require the recognition of additions to the allowance based upon their judgments of information available at the time of their examination.




Shareholders’ equity increased from $33.9 million at December 31, 2009 to $34.5 million at June 30, 2010, an increase of $609,000, or 1.80%, primarily as a result of net income of $989,000, partially offset by our payment of $389,000 of dividends on common stock.  Shareholders’ equity to total assets was 9.11% at June 30, 2010 compared to 9.13% at December 31, 2009.




18


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 endedJune 30, 2010


Three months endedJune 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)

$
328,335


$
4,596



5.60
%

$
324,704



4,910



6.05
%Other investments


19,323



125



2.59



36,657



149



1.61Total interest-earning assets


347,658



4,721



5.43



361,361



5,059



5.60Interest-Earning LiabilitiesSavings deposits

$
26,091



32



0.49


$
26,728



69



1.03Demand and NOW deposits


96,468



153



0.63



72,097



142



0.79Time deposits


176,550



1,076



2.44



178,522



1,567



3.51Borrowings


41,000



311



3.03



66,000



745



4.52Total interest-bearing liabilities


340,109



1,572



1.85



343,348



2,523



2.94Net interest income





$
3,149










$
2,536Net interest rate spread










3.58
%










2.66
%Net earning assets

$
7,549










$
18,013Net yield on average interest-earning assets










3.62
%










2.81
%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.


19




Six months endedJune 30, 2010


Six months endedJune 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)

$
324,549


$
9,140



5.63
%

$
324,391



9,766



6.02
%Other investments


20,021



253



2.53



35,072



266



1.52Total interest-earning assets


344,570



9,393



5.45



359,463



10,032



5.58Interest-Earning LiabilitiesSavings deposits

$
25,954



71



0.55


$
25,309



130



1.03Demand and NOW deposits


92,276



293



0.64



67,764



254



0.75Time deposits


174,775



2,168



2.48



180,548



3,209



3.55Borrowings


46,500



763



3.28



68,750



1,516



4.41Total interest-bearing liabilities


339,504



3,295



1.94



342,371



5,109



2.98Net interest income





$
6,098










$
4,923Net interest rate spread










3.51
%










2.60
%Net earning assets

$
5,066










$
18,013Net yield on average interest-earning assets










3.54
%










2.74
%Average interest-earning assets to average interest-bearing liabilities


1.01
x










1.05
x





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


20


Results of Operations




Comparison of Operating Results for the Six Months and the Quarter ended June 30, 2010 and June 30, 2009





General.  Net income for the six months ended June 30, 2010 was $989,000, an increase of $375,000, or 61.07%, over the six months ended June 30, 2009.  The increase was primarily due to a $1.2 million, or 23.89% increase in net interest income, a $265,000 decrease in noninterest expenses and a $59,000 decrease in the provision for loan losses, partially offset by an $870,000 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 June 30, 2010 was $457,000, an increase of $145,000, or 46.47%, over the comparable quarter in 2009.  The increase for the three month period was primarily due to a $613,000, or 24.17%, increase in net interest income and a $132,000 decrease in noninterest expenses partially offset by a $76,000 increase in the provision for loan losses, a $427,000 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 OREO properties.




Net Interest Income.  Net interest income for the six months ended June 30, 2010 increased $1.2 million, or 23.89%, over the same period in 2009.  This increase was due to an 80 basis point increase in our net interest margin (net interest income divided by average interest-earning assets) from 2.74% for the six months ended June 30, 2009 to 3.54%for the six months ended June 30, 2010 partly offset by a $14.9 million decrease in average net interest-earning assets.  The increase in net interest margin is primarily due to the 104 basis point decrease in the average rate on interest-bearing liabilities from 2.98% for the six months ended June 30, 2009 to 1.94% for the six months ended June 30, 2010. The average rate on interest-earning assets decreased 13 basis points from 5.58% to 5.45% for the same respective periods.




Interest income on loans decreased $626,000, or 6.41%, for the six months ended June 30, 2010 compared to the same six months in 2009.  The average rate on loans fell from 6.02% to 5.63% partly due to the aggressive rate cuts by the Federal Reserve starting in 2007 which left the prime rate at 3.25% at June 30, 2010.  The average balance of loans remained virtually constant over this period.




Interest earned on other investments and Federal Home Loan Bank stock decreased by $12,000, or 4.53%, for the six months ended June 30, 2010 compared to the same period in 2009.  This was the result of a 101 basis point increase in the average yield on other investments and Federal Home Loan Bank stock offset by a $15.1 million decrease in average balances.  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 six months ended June 30, 2010 decreased $1.8 million, or 35.51%, over the same period in 2009 due to a $1.1 million decrease in interest on deposits and a $753,000 decrease in interest expense 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 2.63% for


21


the first six months of 2009 to 1.73% for the first six months of 2010 partially offset by a $19.4 million increase in average deposits.  The decrease in Federal Home Loan Bank advance expense was due to a decrease in the average rate paid on advances from 4.41% for the first six months of 2009 to 3.28% for the first six months of 2010 and a $22.3 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 June 30, 2010 increased $613,000, or 24.17%, over the same period in 2009 due to an 81 basis point increase in our net interest margin.  Interest income on loans decreased $314,000 for the second quarter of 2010 compared to the second quarter of 2009 primarily due to a decrease in the average yield on loans from 6.05% for the second quarter of 2009 to 5.60% for the second quarter of 2010.  Average outstanding balances increased by $3.6 million over this period.  Interest income on other investments and Federal Home Loan Bank stock decreased $24,000 for the second quarter of 2010 compared to the second quarter of 2009 due to a $17.3 million decrease in average balances offset by a 98 basis point increase in the average yield on other investments and Federal Home Loan Bank stock from 1.61% for the second quarter of 2009 to 2.59% over the same period in 2010.  Interest expense decreased $951,000, or 37.69%, for the second quarter of 2010 from the same period in 2009 primarily due to a 109 basis point decrease in the average rate paid on interest-earning liabilities from 2.94% for the second quarter of 2009 to 1.85% for the same period in 2010 and by a $3.2 million decrease in average interest-bearing liabilities for the same periods.












22


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




06/30/10


12/31/09


06/30/09(in Thousands)Loans delinquent 30-59 days

$
771


$
677


$
599Loans delinquent 60-89 days


2,004



3,169



2,141Total delinquencies  under 90 days


2,775



3,846



2,740Accruing loans past due 90 days


0



0



1,147Non-accruing loans


14,621



12,554



9,687Total non-performing loans


14,621



12,554



10,834OREO


1,210



1,892



1,471Total non-performing assets

$
15,831


$
14,446


$
12,305







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 increase in non-performing loans at June 30, 2010 compared to December 31, 2009 was primarily due to the addition of four loans to a single borrower which had been paying as agreed but had been placed in a receivership because of the actions of another bank holding subordinate mortgages.  Payments are still being made as agreed but we have been precluded from applying them by the court.   In addition, between December 31, 2009 and June 30, 2010, $317,000 of properties were added to OREO and $999,000 were sold or written off.




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.







23


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 June 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 $7.4 million on one- to four-family rental properties, $3.9 million on non-residential properties and $3.5 million on land development were past due more than 30 days at June 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 $343,000 and the borrowers are typically seeing decreased business 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 $465,000 provision for loan losses for the three months ended June 30, 2010 and $899,000 year-to-date as a result of our analyses of our current loan portfolios, compared to $389,000 and $958,000 during the same periods in 2009.  The provisions were necessary to maintain the allowance for loan losses at a level considered adequate to absorb probable incurred losses in the loan portfolio.  During the first six months of 2010, we charged $403,000 against loan loss reserves on four loans either written off or taken into other real estate owned.  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 $4.2 million allowance for loan losses was considered adequate 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 guidelines for property type.  We currently have $9.6 million of mortgage loans that are not 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 $8.2 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, $344,000 are currently over 30 days past due.  Our total high loan-to-value loans at June 30, 2010 were at 47% of capital, well under regulatory guidelines of 100% of capital.  We have $16.3 million of Home Equity Lines of Credit of which two loans totaling $32,000 were delinquent more than 30 days at June 30, 2010.




24


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




Six months ended June 30,2010


2009(Dollars in Thousands)Balance at January 1

$
3,737


$
3,697Loans charged off


(403
)


(583
)Recoveries


7



13Provision


899



958Balance at June 30

$
4,240


$
4,085








At June 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 $3.2 million in other loans of concern where information about possible credit problems of borrowers causes management to have doubts as to the ability of the borrowers to comply with present repayment terms and may result in disclosure of such loans as non-performing assets in the future.  The vast majority of these loans, as well as our non-performing assets, are well collateralized.




At June 30, 2010, we believe that our allowance for loan losses was adequate to absorb probable incurred losses inherent in our loan portfolio.  Our allowance for losses equaled 1.27% of net loans receivable and 29.00% of non-performing loans at June 30, 2010 compared to 1.16% and 29.65% at December 31, 2009, respectively.  Our nonperforming assets equaled 4.18% of total assets at June 30, 2010 compared to 3.91% at December 31, 2009.




Non-Interest Income.  Non-interest income for the six months ended June 30, 2010 decreased by $870,000, or 41.27%, compared to the same period in 2009.  This was primarily due to a $797,000 decrease in the gain on the sale of mortgage loans due to the increase in mortgage loan rates that resulted in fewer borrowers refinancing their mortgages and because we elected to keep more of the residential mortgages in our 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 $12.3 million of loans in the first six months of 2010 compared to $47.2 million in the first six months of 2009.  We also recorded increased losses on the sale or writedown of OREO properties of $195,000 as we either sold properties at a loss or reduced the carrying value to reflect new valuations.  These decreases were offset by a $58,000 increase in fees on deposit accounts due to an increase in the number of fees charged and a $64,000 increase in other income primarily due to a reduction in the amortization of mortgage servicing rights.




25




Non-interest income for the second quarter of 2010 decreased by $427,000 compared to the same period in 2009 due to a $360,000 decrease in the gain on the sale of mortgage loans and a $127,000 increase in the loss of sale of OREO properties, offset by a $27,000 increase in fees on deposit accounts and a $33,000 increase in other income for the same reasons stated above for the six month periods.




Non-Interest Expense.  Non-interest expense for the six months ended June 30, 2010 decreased $265,000 compared to the same period in 2009 due to a $91,000 decrease in salaries due to the decrease in loan origination activity by commission-based loan originators and a $135,000 decrease in the cost of maintaining OREO and foreclosed properties primarily due to a decrease in the number of foreclosed properties, and a $45,000 decrease in FDIC insurance premiums.




Non-interest expense for the second quarter of 2010 decreased by $132,000 over the same period in 2009, due largely to the factors mentioned above including a $31,000 decrease in salaries, a $58,000 decrease in other primarily OREO and foreclosed property related expenses and a $71,000 decrease in FDIC insurance premiums.




Income Tax Expense.Our income tax provision increased by $255,000 for the six months ended June 30, 2010 compared to the six months ended June 30, 2009, and by $97,000 for the quarter ended June 30, 2010 compared to June 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.




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.




26




Our liquidity ratios at June 30, 2010 and December 31, 2009 were 5.36% and 7.16%, respectively, compared to a regulatory liquidity base, and 4.49% 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 June 30, 2010, we had outstanding commitments to originate loans and available lines of credit totaling $33.7 million and commitments to provide funds to complete current construction projects in the amount of $2.9 million. We had outstanding commitments to sell $162,000 of residential loans.  Certificates of deposit which will mature in one year or less totaled $106.0 million at June 30, 2010.  Included in that number are $9.2 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 $27.0 million of Federal Home Loan Bank advances maturing in the next twelve months.






Capital Resources




Shareholders’ equity totaled $34.5 million at June 30, 2010 compared to $33.9 million at December 31, 2009, an increase of $609,000, or 1.80%, due primarily to net income of $989,000, partially offset by our payment of dividends on common stock.  Shareholders’ equity to total assets was 9.11% at June 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 June 30, 2010 and December 31, 2009, Lafayette Savings was categorized as well capitalized.  Our actual and required capital amounts and ratios at June 30, 2010 and December 31, 2009 are presented below:




Actual


For Capital Adequacy Purposes


To Be Well Capitalized Under Prompt Corrective Action ProvisionsAmount


Ratio


Amount


Ratio


Amount


RatioAs of June 30, 2010

(Dollars in Thousands)Total risk-based capital

(to risk-weighted assets)

$
37,875



13.0
%

$
23,230



8.0
%

$
29,038



10.0
%Tier I capital

(to risk-weighted assets)


34,299



11.8



11,615



4.0



17,423



6.0Tier I capital

(to adjusted total assets)


34,299



9.1



11,348



3.0



18,913



5.0Tier I capital

(to adjusted tangible assets)


34,299



9.1



7,565



2.0



N/A



N/ATangible capital

(to adjusted tangible assets)


34,299



9.1



5,674



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





27


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;




28




·
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 June 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 June 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




None.






Item 1A.   Risk Factors




Not Applicable.




29




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 orPrograms2April 1 – April 30, 2010


---



---



---



52,817May 1 – May 31, 2010


---



---



---



52,817June 1 – June 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.




30


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 13, 2010
By:
/s/ Randolph F. WilliamsRandolph F. Williams, President(Principal Executive Officer)Date:  August 13, 2010
By:
/s/ Mary Jo DavidMary Jo David, Treasurer(Principal Financial and Accounting Officer)





31


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