UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q





ý
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the quarterly period ended September 30, 2008ORo
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 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 [   ]
 
 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 [   ]       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 10, 2008Common
      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 Financial Statements
            5Item
      2.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            11Item
      3.
            Quantitative
      and Qualitative Disclosures About Market Risk
            25Item
      4T.
            Controls
      and Procedures
            25PART
      II.   OTHER INFORMATION
            25Item
      1.
            Legal
      Proceedings
            25Item
      1A.
            Risk
      Factors
            25Item
      2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            26Item
      3.
            Defaults
      Upon Senior Securities
            26Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            26Item
      5.
            Other
      Information
            26Item
      6.
            Exhibits
            26SIGNATURES
            27














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,
              2008
            
            
            December
      31,
              2007(unaudited)AssetsCash
      and due from banks
            
            $
            1,370
            
            
            $
            1,644Short-term
      investments
            
            
            8,281
            
            
            
            4,846Cash
      and cash equivalents
            
            
            9,651
            
            
            
            6,490Available-for-sale
      securities
            
            
            11,938
            
            
            
            13,221Loans
      held for sale
            
            
            548
            
            
            
            ---Total
      loans
            
            
            326,044
            
            
            
            300,610Less:
      Allowance for loan losses
            
            
            (3,614
            )
            
            
            (3,702
            )Net
      loans
            
            
            322,430
            
            
            
            296,908Premises
      and equipment, net
            
            
            6,569
            
            
            
            6,815Federal
      Home Loan Bank stock, at cost
            
            
            3,997
            
            
            
            3,997Bank
      owned life insurance
            
            
            5,784
            
            
            
            5,613Interest
      receivable and other assets
            
            
            6,440
            
            
            
            8,966Total
      Assets
            
            $
            367,357
            
            
            $
            342,010Liabilities
      and Shareholders’ EquityLiabilitiesDeposits
            
            $
            254,246
            
            
            $
            232,030Federal
      Home Loan Bank advances
            
            
            76,756
            
            
            
            74,256Interest
      payable and other liabilities
            
            
            2,246
            
            
            
            1,792Total
      liabilities
            
            
            333,248
            
            
            
            308,078Commitments
      and ContingenciesShareholders’
      EquityCommon
      stock, $.01 par valueAuthorized
      - 7,000,000 shares
              Issued
      and outstanding 2008 - 1,553,525 shares, 2007 - 1,557,968
      shares
            
            
            15
            
            
            
            15Additional
      paid-in-capital
            
            
            10,980
            
            
            
            11,066Retained
      earnings
            
            
            23,039
            
            
            
            22,777Accumulated
      other comprehensive income
            
            
            75
            
            
            
            74Total
      shareholders’ equity
            
            
            34,109
            
            
            
            33,932Total
      liabilities and shareholders’ equity
            
            $
            367,357
            
            
            $
            342,010





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
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Interest
      and Dividend IncomeLoans
            
            $
            5,081
            
            
            $
            5,529
            
            
            $
            15,437
            
            
            $
            16,600SecuritiesTaxable
            
            
            116
            
            
            
            135
            
            
            
            362
            
            
            
            427Tax-exempt
            
            
            68
            
            
            
            70
            
            
            
            205
            
            
            
            194Other
            
            
            30
            
            
            
            35
            
            
            
            86
            
            
            
            145Total
      interest and dividend income
            
            
            5,295
            
            
            
            5,769
            
            
            
            16,090
            
            
            
            17,366Interest
      ExpenseDeposits
            
            
            1,942
            
            
            
            2,005
            
            
            
            5,759
            
            
            
            6,065Borrowings
            
            
            913
            
            
            
            924
            
            
            
            2,748
            
            
            
            2,621Total
      interest expense
            
            
            2,855
            
            
            
            2,929
            
            
            
            8,507
            
            
            
            8,686Net
      Interest Income
            
            
            2,440
            
            
            
            2,840
            
            
            
            7,583
            
            
            
            8,680Provision
      for Loan Losses
            
            
            352
            
            
            
            180
            
            
            
            852
            
            
            
            920Net
      Interest Income After Provision for Loan Losses
            
            
            2,088
            
            
            
            2,660
            
            
            
            6,731
            
            
            
            7,760Non-interest
      IncomeDeposit
      account service charges and fees
            
            
            465
            
            
            
            486
            
            
            
            1,293
            
            
            
            1,371Net
      gains on loan sales
            
            
            34
            
            
            
            37
            
            
            
            58
            
            
            
            174Gain
      (loss) on sale of other real estate owned
            
            
            11
            
            
            
            (115
            )
            
            
            31
            
            
            
            (148
            )Other
            
            
            288
            
            
            
            293
            
            
            
            920
            
            
            
            790Total
      non-interest income
            
            
            798
            
            
            
            701
            
            
            
            2,302
            
            
            
            2,187Non-Interest
      ExpenseSalaries
      and employee benefits
            
            
            1,095
            
            
            
            996
            
            
            
            3,467
            
            
            
            3,430Net
      occupancy and equipment expense
            
            
            361
            
            
            
            320
            
            
            
            1,046
            
            
            
            990Computer
      service
            
            
            138
            
            
            
            127
            
            
            
            409
            
            
            
            364Advertising
            
            
            61
            
            
            
            77
            
            
            
            201
            
            
            
            229Other
            
            
            689
            
            
            
            702
            
            
            
            1,869
            
            
            
            1,868Total
      non-interest expense
            
            
            2,344
            
            
            
            2,222
            
            
            
            6,992
            
            
            
            6,881Income
      Before Income Taxes
            
            
            542
            
            
            
            1,139
            
            
            
            2,041
            
            
            
            3,066Provision
      for Income Taxes
            
            
            150
            
            
            
            422
            
            
            
            612
            
            
            
            1,120Net
      income
            
            $
            392
            
            
            $
            717
            
            
            $
            1,429
            
            
            $
            1,946Basic
      Earnings Per Share
            
            $
            0.25
            
            
            $
            0.46
            
            
            $
            0.92
            
            
            $
            1.23Diluted
      Earnings Per Share
            
            $
            0.25
            
            
            $
            0.46
            
            
            $
            0.92
            
            
            $
            1.22Dividends
      Declared Per Share
            
            $
            0.25
            
            
            $
            0.25
            
            
            $
            0.75
            
            
            $
            0.65See
      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, 2008 and 2007


(Dollars
in thousands)


(Unaudited)





Common
      Stock
            
            
            Additional
      Paid-In Capital
            
            
            Retained
      Earnings
            
            
            Accumulated
      Other Comprehensive Income (Loss)
            
            
            TotalBalance,
      January 1, 2007
            
            $
            15
            
            
            $
            12,227
            
            
            $
            22,623
            
            
            $
            (25
            )
            
            $
            34,840Comprehensive
      incomeNet
      income
            
            
            
            
            
            
            
            
            
            
            1,946
            
            
            
            
            
            
            
            1,946Change
      in unrealized appreciation (depreciation) on available-for-sale
      securities, net of taxes
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            34
            
            
            
            34Total
      comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,980Dividends
      on common stock, $0.65 per share
            
            
            
            
            
            
            
            
            
            
            (1,030
            )
            
            
            
            
            
            
            (1,030
            )Purchase
      and retirement of stock (37,500 shares)
            
            
            
            
            
            
            (973
            )
            
            
            
            
            
            
            
            
            
            
            (973
            )Stock
      options exercised (290 shares)
            
            
            
            
            
            
            4
            
            
            
            
            
            
            
            
            
            
            
            4Amortization
      of stock option compensation
            
            
            
            
            
            11
            
            
            
            
            
            
            
            
            
            117Balance,
      September 30, 2007
            
            $
            15
            
            
            $
            11,269
            
            
            $
            23,539
            
            
            $
            9
            
            
            $
            34,832Balance,
      January 1, 2008
            
            $
            15
            
            
            $
            11,066
            
            
            $
            22,777
            
            
            $
            74
            
            
            $
            33,932Comprehensive
      incomeNet
      income
            
            
            
            
            
            
            
            
            
            
            1,429
            
            
            
            
            
            
            
            1,429Change
      in unrealized appreciation (depreciation) on available-for-sale
      securities, net of taxes
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1
            
            
            
            1Total
      comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,430Dividends
      on common stock, $0.75 per share
            
            
            
            
            
            
            
            
            
            
            (1,167
            )
            
            
            
            
            
            
            (1,167
            )Purchase
      and retirement of stock (8,900 shares)
            
            
            
            
            
            
            (166
            )
            
            
            
            
            
            
            
            
            
            
            (166
            )Stock
      options exercised (4,457 shares)
            
            
            
            
            
            
            68
            
            
            
            
            
            
            
            
            
            
            
            68Tax
      benefit of stock options exercised
            
            
            
            
            
            
            6
            
            
            
            
            
            
            
            
            
            
            
            6Amortization
      of stock option compensation
            
            
            
            
            
            6
            
            
            
            
            
            
            
            
            
            6Balance,
      September 30, 2008
            
            $
            15
            
            
            $
            10,980
            
            
            $
            23,039
            
            
            $
            75
            
            
            $
            34,109







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
      30,2008
            
            
            2007Operating
      ActivitiesNet
      income
            
            $
            1,429
            
            
            $
            1,946Items
      not requiring (providing) cashDepreciation
            
            
            417
            
            
            
            381Provision
      for loan losses
            
            
            852
            
            
            
            920Amortization
      of premiums and discounts on securities
            
            
            15
            
            
            
            11Gain
      on sale of loans
            
            
            (48
            )
            
            
            (162
            )Loans
      originated for sale
            
            
            (1,460
            )
            
            
            (129
            )Proceeds
      on loans sold
            
            
            960
            
            
            
            1,173Loss
      on sale and writedowns of OREO
            
            
            154
            
            
            
            267Amortization
      of stock options
            
            
            6
            
            
            
            11Tax
      benefit related to stock options exercised
            
            
            (6
            )
            
            
            0Changes
      inInterest
      receivable and other assets
            
            
            284
            
            
            
            (311
            )Interest
      payable and other liabilities
            
            
            454
            
            
            
            389Net
      cash from operating activities
            
            
            3,057
            
            
            
            4,496Investing
      ActivitiesPurchases
      of available-for-sale securities
            
            
            ---
            
            
            
            (1,856
            )Proceeds
      from maturities of available-for-sale securities
            
            
            1,269
            
            
            
            3,774Net
      change in loans
            
            
            (28,620
            )
            
            
            15,943Proceeds
      from sale of OREO
            
            
            4,169
            
            
            
            1,773Purchase
      of premises and equipment
            
            
            (171
            )
            
            
            (657
            )Net
      cash from investing activities
            
            
            (23,353
            )
            
            
            18,977Financing
      ActivitiesNet
      change in demand deposits, money market, NOW and savings
      accounts
            
            
            9,943
            
            
            
            1,656Net
      change in certificates of deposit
            
            
            12,273
            
            
            
            (20,057
            )Proceeds
      from Federal Home Loan Bank advances
            
            
            27,000
            
            
            
            43,000Repayment
      of Federal Home Loan Bank advances
            
            
            (24,500
            )
            
            
            (48,500
            )Proceeds
      from stock options exercised
            
            
            68
            
            
            
            4Tax
      benefit related to stock options exercised
            
            
            6
            
            
            
            0Repurchase
      of stock
            
            
            (166
            )
            
            
            (973
            )Dividends
      paid
            
            
            (1,167
            )
            
            
            (1,030
            )Net
      cash from financing activities
            
            
            23,457
            
            
            
            (25,900
            )Increase
      (Decrease) in Cash and Cash Equivalents
            
            
            3,161
            
            
            
            (2,428
            )Cash
      and Cash Equivalents, Beginning of Period
            
            
            6,490
            
            
            
            9,727Cash
      and Cash Equivalents, End of Period
            
            $
            9,651
            
            
            $
            7,300Supplemental
      Cash Flows InformationInterest
      paid
            
            
            8,595
            
            
            
            8,787Income
      taxes paid
            
            
            566
            
            
            
            1,095Supplemental
      Non-Cash DisclosuresCapitalization
      of mortgage servicing rights
            
            
            10
            
            
            
            12Loans
      transferred to OREO
            
            
            2,246
            
            
            
            1,977See
      notes to consolidated condensed financial statements.








4




LSB
FINANCIAL CORP.


Notes to
Consolidated Financial Statements


September
30, 2008


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, 2007 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, 2007 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, 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, 12,560 shares related to stock options outstanding were included in the
diluted earnings per share calculation as their effect would be dilutive; 23,140
were antidilutive.  For the nine month period, 16,901 shares related
to stock options outstanding were dilutive and 18,799 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
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Weighted
      average shares outstanding (excluding unearned ESOP shares in
      2007)
            
            
            1,553,502
            
            
            
            1,567,129
            
            
            
            1,555,770
            
            
            
            1,586,694Shares
      used to compute diluted earnings per share
            
            
            1,554,245
            
            
            
            1,573,546
            
            
            
            1,557,381
            
            
            
            1,594,100Earnings
      per share
            
            $
            0.25
            
            
            $
            0.46
            
            
            $
            0.92
            
            
            $
            1.23Diluted
      earnings per share
            
            $
            0.25
            
            
            $
            0.46
            
            
            $
            0.92
            
            
            $
            1.22








Note 4 –
Disclosures About Fair Value of Assets and Liabilities





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




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





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





6




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








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





Available-for-sale
Securities





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


Fair
      Value Measurements UsingQuoted
      Prices inActive Markets forIdentical Assets
              
              
              SignificantOtherObservable
      Inputs
              
              
              SignificantUnobservableInputsFair
      Value
              
              
              (Level
      1)
              
              
              (Level
      2)
              
              
              (Level
      3)Available-for-sale
      securities
              
              $
      11,938
              
              
              $    
      0
              
              
              $
      11,938
              
              
              $    
      0








Impaired
Loans





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







The
following table presents the fair value measurements of assets and liabilities
recognized in the accompanying balance sheet measured at fair value on a
nonrecurring basis and the level within the FAS 157 fair value hierarchy in
which the fair value measurements fall at September 30, 2008:




Fair
      Value Measurements UsingFair
      Value
            
            
            Quoted
      Prices inActive Markets forIdentical Assets
              (Level
      1)
            
            
            Significant
      OtherObservable Inputs
              (Level
      2)
            
            
            SignificantUnobservable
      Inputs
              (Level
      3)Impaired
      loans
            
            $ 
      3,049
            
            
            $  
      ---
            
            
            $  
      ---
            
            
            $ 
      3,049








7




Note 5 –
Future Accounting Pronouncements
 
 Financial
Accounting Standards Board Statement No. 141 (SFAS 141R), “Business Combinations (Revised
2007),” was issued in December 2007 and is effective for years beginning
after December 15, 2008, for the Company January 1, 2009,  and
replaces SFAS 141 which applies to all transactions and other events in which
one entity obtains control over one or more other businesses.  SFAS
141R requires an acquirer, upon initially obtaining control of another entity,
to recognize the assets, liabilities and any non-controlling interest in the
acquiree at fair value as of the acquisition date.  Contingent
consideration is required to be recognized and measured at fair value on the
date of acquisition rather than at a later date when the amount of that
consideration may be determinable beyond a reasonable doubt.  SFAS
141R requires acquirers to expense acquisition-related costs as incurred rather
than allocating such costs to the assets acquired and liabilities
assumed.  Under SFAS 141R, the requirements of SFAS 146, “Accounting for Costs Associated
with Exit or Disposal Activities,”would have to be met in order to
accrue for a restructuring plan in purchase accounting.
 
 Financial
Accounting Standards Board Statement No. 160 (SFAS 160), “Noncontrolling Interest in
Consolidated Financial Statements, an amendment of ARB Statement No. 51,”
was issued in December 2007 and establishes accounting and reporting standards
for the non-controlling interest in a subsidiary and for the deconsolidation of
a subsidiary.  SFAS 160 clarifies that a non-controlling interest in a
subsidiary, which is sometimes referred to as a minority interest, is an
ownership interest in the consolidated entity that should be reported as a
component of equity in the consolidated financial statements.  Among
other requirements, SFAS 160 requires consolidated net income to be reported at
amounts that are attributable to both the parent and the non-controlling
interest.  It also requires disclosure, on the face of the
consolidated income statement, of the amounts of consolidated net income
attributable to the parent and to the non-controlling interest.  SFAS
160 is effective for the Company on January 1, 2009 and is not expected to have
a significant impact on the Company’s financial statements.
 
 Financial
Accounting Standards Board Statement No. 161 (SFAS 161), “Disclosures About Derivative
Instruments and Hedging Activities, an Amendment of FASB Statement No. 133,”was issued in March 2008 and amends and expands the disclosure
requirements of SFAS 133 to provide greater transparency about (i) how and why
an entity uses derivative instruments, (ii) how derivative instruments and
related hedge items are accounted for under SFAS 133 and its related
interpretations, and (iii) how derivative instruments and related hedged items
affect an entity’s financial position, results of operations and cash
flows.  To meet those objectives, SFAS 161 requires qualitative
disclosures about objectives and strategies for using derivatives, quantitative
disclosures about fair value amounts of gains and losses on derivative
instruments and disclosures about credit-risk-related contingent features in
derivative agreements.  SFAS 161 is effective for the Company on
January 1, 2009 and is not expected to have a significant impact on the
Company’s financial statements.
 
 Note 6 –
Subsequent Event
 
 The
global and U.S. economies are experiencing significantly reduced business
activity as a result of, among other factors, disruptions in the financial
system during the past year, and in particular, the last several weeks. Dramatic
declines in the housing market during the past year,
   8
 
  with
falling home prices and increasing foreclosures and unemployment, have resulted
in significant write-downs of asset values by financial institutions, including
government-sponsored entities and major commercial and investment banks. These
write-downs, initially of mortgage-backed securities but spreading to credit
default swaps and other derivative securities, have caused many financial
institutions to seek additional capital, to merge with larger and stronger
institutions and, in some cases, to fail.
  Reflecting concern about
the stability of the financialmarkets generally and the strength of
counterparties, many lenders and institutional investors have reduced, and in
some cases, ceased to provide funding to borrowers, including other financial
institutions. The availability of credit, confidence in the financial sector,
and level of volatility in the financial markets have been significantly
adversely affected as a result. In recent weeks, volatility and disruption in
the capital and credit markets has reached unprecedented levels. In some cases,
the markets have produced downward pressure on stock prices and credit capacity
for certain issuers without regard to those issuers’ underlying financial
strength.
 
 In
response to the financial crises affecting the banking system and financial
markets and going concern threats to investment banks and other financial
institutions, on October 3, 2008, the Emergency Economic Stabilization Act of
2008 (the “EESA”) was signed into law. Pursuant to the EESA, the U.S. Department
of Treasury (the “Treasury”) has the authority to, among other things, purchase
up to $700 billion of mortgages, mortgage-backed securities and certain other
financial instruments from financial institutions for the purpose of stabilizing
and providing liquidity to the U.S. financial markets.
 
 On
October 14, 2008, the Treasury also announced it will offer to qualifying U.S.
banking organizations the opportunity to sell preferred stock, along with
warrants to purchase common stock, to the Treasury on what may be considered
attractive terms under the Troubled Asset Relief Program (“TARP”) Capital
Purchase Program (the “CPP”). The CPP allows financial institutions, like the
Company, to issue non-voting preferred stock to the Treasury in an amount
ranging between 1% and 3% of its total risk-weighted assets.
 
 Although
the Bank currently meets all applicable regulatory capital requirements and
remains well capitalized, the Company has preliminarily determined that
obtaining additional Tier 1 capital pursuant to the CPP for contribution in
whole or in part to the Bank may be advisable. As a result, the Company is
considering filing an initial application with the Treasury pursuant to the CPP
seeking approval to sell up to $8.6 million in preferred stock to the Treasury
(which will equal approximately 3.0% of its total risk weighted assets as of
September 30, 2008).
 
 For
companies accepting capital available through the TARP CPP, the general terms of
the preferred stock that would be issued under the CPP are expected to be as
follows:
 
 •
              Dividends
      at the rate of 5% per annum, payable quarterly in arrears, are required to
      be paid on the preferred stock for the first five years and dividends at
      the rate of 9% per annum are required thereafter until the stock is
      redeemed by the Company;
   9
  •
              Without
      the prior consent of the Treasury, the Company will be prohibited from
      increasing its common stock dividends or repurchasing its common stock for
      the first three years while Treasury is an
  investor;
 
 •
              During
      the first three years the preferred stock is outstanding, the Company will
      be prohibited from repurchasing such preferred stock, except with the
      proceeds from a sale of Tier 1 qualifying common or other preferred stock
      of the Company in an offering that raises at least 25% of the initial
      offering price of the preferred stock sold to the Treasury. After the
      first three years, the preferred stock can be redeemed at any time with
      any available cash;
 
 •
              Under
      the CPP, the Company is also required to issue the Treasury warrants
      entitling the Treasury to buy an amount of the Company’s common stock
      equal to 15% of the Treasury’s total investment in the preferred stock;
      and
 
 •
              The
      Company must agree to certain compensation restrictions for its senior
      executive officers and restrictions on the amount of executive
      compensation which is tax
deductible.
 
 Should it
choose to file an initial application, the Company’s participation in the CPP
would remain subject to various contingencies, including, but not limited to,
acceptance by the Treasury of any application it decides to file, review and
approval of the preferred stock investment documents by the Company’s Board of
Directors, and verification that the Company can otherwise comply with various
other detailed requirements of the investment. In the event the Company
ultimately elects to participate in the CPP, the Company anticipates using the
proceeds from the preferred stock sale to increase its overall capital levels,
provide funds for additional loans, and for other general corporate
purposes.
 
 Also on
October 14, 2008, after receiving a recommendation from the boards of the FDIC
and the Board of Governors of the Federal Reserve System, and consulting with
the President, Secretary Paulson signed the systemic risk exception to the
Federal Deposit Insurance Act, enabling the FDIC to temporarily provide a 100%
guarantee of the senior debt of all FDIC-insured institutions and their holding
companies, as well as unlimited deposit insurance protection for funds in
non-interest bearing transaction deposit accounts under a Temporary Liquidity
Guarantee Program. Coverage under the Temporary Liquidity Guarantee Program is
available until December 5, 2008, without charge and thereafter at a cost of 75
basis points per annum for senior unsecured debt and 10 basis points per annum
for non-interest bearing transaction deposits. Prior to December 5, 2008, in
order to avoid the increased insurance premiums, the Bank must inform the FDIC
whether it will opt out of either the temporary senior unsecured debt guarantee
program or the enhanced deposit insurance program or both.The
Company intends to pay the 10 basis points per annum for the unlimited deposit
insurance protection on non-interest bearing transaction accounts, but is likely
to opt out of the senior debt guarantee.






10




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




Executive
Summary




LSB
Financial Corp. (the “Company” or “LSB Financial”) is an Indiana corporation
which was organized in 1994 by Lafayette Savings Bank, FSB (“Lafayette Savings”)
for the purpose
of becoming a thrift institution holding company. Lafayette Savings is a
federally chartered stock savings bank headquartered in Lafayette,
Indiana.  References in this Form 10-Q to “we,” “us,” and “our” refer
to LSB Financial and/or Lafayette Savings as the context requires.




Lafayette
Savings has been, and intends to continue to be, a community-oriented financial
institution. Our principal business consists of attracting retail deposits from
the general public and investing those funds primarily in permanent first
mortgage loans secured by owner-occupied, one- to four-family residences and, to
a lesser extent, non-owner occupied one- to four-family residential, commercial
real estate, multi-family, construction and development, consumer and commercial
business loans. Our revenues are derived principally from interest on mortgage
and other loans and interest on securities.




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 138 years is a benefit to us—especially as acquisitions and
consolidations of local financial institutions continue.  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,
Caterpillar, Wabash National and Greater Lafayette Health Services; a strong
education sector with Purdue University and a large local campus of Ivy Tech
Community College; government offices of Lafayette, West Lafayette and
Tippecanoe County; and a growing high-tech presence with the Purdue Research
Park.  This diversity typically provides a buffer against economic
downturns, but the slowdown of the last few years had a noticeable effect on the
area.  More recently we have seen signs of returning growth and
development.  Housing values appreciated 1.3% in the second quarter of
2008, and 4.9% over the last five years.  According to the
Lafayette-West Lafayette Development Corporation (LWLDC), in the first quarter
of 2008 expansions were announced in manufacturing, life sciences, technology
employment and healthcare.  Two new hospitals are scheduled to open,
one in the fourth quarter of 2008 and one in 2009.   The LWLDC
also notes that five new hotels are in progress, and the retail/restaurant
sector is welcoming newcomers.  The unemployment rate in Tippecanoe
County most recently measured at 4.5% in September 2008.





The community has made good progress
in working through the effects of the overbuilding of one- to four-family
housing.  Information from the Lafayette Board of
Realtors






11




indicates
that 1,690 properties were sold in Tippecanoe County from January 1, 2007
through January 1, 2008 with an average market time of 82
days.  Existing home sales for the first half of 2008 for homes under
$200,000 were down only 1% from that level. Our loan portfolio showed a $26
million, or 8.6%, increase in the first nine months of 2008.




While the local economy
continues to improve, 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 havesufficient reserves to cover probable
losses.  The challenge is to get delinquent borrowers back on a
workable payment schedule or if that is not possible, to get control of their
properties through an overburdened court system.  In September 2008,
loans delinquent more than 30 days were at $9.8 million compared to $14.9
million in September 2007.





Our primary source of income is net
interest income, which is the difference between the interest income earned on
our loan and investment portfolios and the interest expense incurred on deposits
and borrowings.  Our net interest income depends on the balance of our
loan and investment portfolios and the size of our net interest margin, which is
the difference between the income generated from loans and the cost of the
funding.  Our net interest income also depends on the shape of the
yield curve.  In 2008, the yield curve has generally had a more normal
upward slope although in a lower range than usual.  Deposits are
generally tied to shorter-term market rates, but liquidity pressure from
financial institutions concerned about their funding levels has kept deposit
rates higher than would ordinarily be expected.  Loans are generally
tied to longer-term rates but the flight to safety by investors has driven
long-term treasury rates down to a level where loans priced at a typical spread
over treasury rates no longer yield an adequate spread over
deposits.  Our expectation is for the yield curve to go even lower
while maintaining a generally upward slope throughout the rest of the
year.





Rate
changes could be expected to have an impact on interest
income.  Rising rates generally increase borrower preference for
variable-rate products which we typically keep in our portfolio, and existing
adjustable rate loans can be expected to reprice to higher rates, both of which
could be expected to have a favorable impact on interest
income.  Alternatively, continuing low interest rates could have a
negative impact on our interest income as new loans are put on the books at
comparatively low rates and our existing adjustable rate loans reprice to lower
rates, as is the case now.  Because of the uncertainty in the economy,
we do not expect to see a return to a high volume of
refinancing.  However, we may see borrowers looking for financing for
their existing loans as some banks pare their borrowing base because of
liquidity and loan quality concerns.




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






12
 
  strategy
may not prevent interest rate changes from having an adverse effect on our
results of operations and financial condition.




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






Effect
of Current Events




Management
continues to assess the impact on the Company of the uncertain economic and
regulatory environment affecting the country at large and the financial services
industry in particular.  The Company is considering filing an
application under the Troubled Asset Relief Program  (“TARP”) Capital
Purchase Program (“CPP”) with the U. S. Department of Treasury seeking approval
to sell $8.6 million in preferred stock to the Treasury.  See
Note 6, Subsequent Event, to the Company’s Unaudited Consolidated Condensed
Financial Statements, included in this Form 10-Q and incorporated herein, for
further information related to this decision.





Both the
level of turmoil in the financial services industry and the Company’s
participation in the TARP’s CPP, if it decides to participate, will present
unusual risks and challenges for the Company, as described below:





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





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




Impact
of Recent and Future Legislation. Congress and the Treasury Department
have recently adopted legislation and taken actions to address the disruptions
in the financial system and declines in the housing market. See Note 6,
Subsequent Event, to the Company’s Unaudited






13
 
  Consolidated Condensed
Financial Statements, included in this Form 10-Q and incorporated
herein.  It is not clear at this time what impact the Emergency
Economic Stabilization Act (“EESA”), TARP, other liquidity and funding
initiatives of the Treasury and other bank regulatory agencies that have been
previously announced, and any additional programs that may be initiated in the
future, will have on the financial markets and the financial services industry.
The extreme levels of volatility and limited credit availability currently being
experienced could continue to affect the U.S. banking industry and the broader
U.S. and global economies,which will have an effect on all financial
institutions, including the Company.




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




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





Current
economic conditions have increased expectations for bank failures. The FDIC
takes control of failed banks and ensures payment of deposits up to insured
limits using the resources of the Deposit Insurance Fund. The FDIC has
designated the Deposit Insurance Fund long-term target reserve ratio at 1.25
percent of insured deposits. Due to recent bank failures, the FDIC insurance
fund reserve ratio has fallen below 1.15 percent, the statutory minimum. The
FDIC has developed a proposed restoration plan that will uniformly increase
insurance assessments by 7 basis points (annualized). The plan also proposes
changes to the deposit insurance assessment system requiring riskier
institutions to pay a larger share. Further increases in premium assessments
would increase the Company’s expenses.





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





Our Possible
Participation in the TARP Capital Purchase Program May Adversely Affect the
Value of Our Common Stock and the Rights of Our Common Stockholders.The
terms of the preferred stock the Company would issue under the TARP CPP if the
Company decides to apply and its application is accepted by the Treasury and the
transaction closes could reduce investment returns to the Company’s common
stockholders by restricting dividends, diluting existing shareholders’ ownership
interests, and restricting capital management practices. Without the prior
consent of the Treasury, the Company would be prohibited from increasing its





14




common
stock dividends or repurchasing shares of its common stock for the first three
years while the Treasury holds the preferred stock.




Also, the preferred stock
requires quarterly dividends to be paid at the rate of 5% per annum for the
first five years and 9% per annum thereafter until the stock is redeemed by the
Company. The payments of these dividends would decrease the excess cashthe Company otherwise has available to pay dividends on its common stock
and to use for general corporate purposes, including working capital, if the
Company decides to participate.





Finally,
the Company would be prohibited from continuing to pay dividends on its common
stock unless it has fully paid all required dividends on the preferred stock
issued to the Treasury. Although the Company fully expects to be able to pay all
required dividends on the preferred stock (and to continue to pay dividends on
its common stock at current levels) if it decides to participate in the TARP
CPP, there is no guarantee that it will be able to do so in the
future.






Critical
Accounting Policies









Allowance
for Loan Losses




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




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




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




Larger
commercial loans that exhibit probable or observed credit weaknesses 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 Lafayette Savings.  Included








15
 
  in the
review of individual loans are those that are impaired as provided in SFAS No.
114, Accounting
by Creditors for Impairment of a Loan.  Any allowances for
impaired loans are determined by the present value of expected future cash flows
discounted at the loan’s effective interest rate or fair value of the underlying
collateral.  Historical loss rates are applied to other commercial
loans not subject to specific reserve allocations.




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




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




Financial
Condition




Comparison
of Financial Condition at September 30, 2008 and December 31, 2007




Our total
assets increased $25.3 million, or 7.41%, during the nine months from December
31, 2007 to September 30, 2008.  Primary components of this increase
were a $26.1 million increase in net loans receivable including loans held for
sale and a $3.4 million increase in short term investments, offset by a $2.5
million decrease in other assets due partly to a $2.4 million decrease in other
real estate owned, and a $1.3 million decrease in investments available for
sale.  Management attributes the increase in loans to an increase in
commercial loan activity due to borrowers either moving their lending
relationships to a local bank or seeing opportunities as the community shows
signs of recovery, and from the decision to take advantage of the Bank’s minimal
interest rate risk exposure, as measured by the OTS Interest Rate Risk Exposure
Report, to book, rather than sell, fixed rate residential
mortgages.  Because of the increase in lending, we raised $22.2
million of deposits including a $6.3 million increase in demand deposit
accounts.  Additionally, we increased Federal Home Loan Bank advances
by $2.5 million.





Non-performing
assets, which include non-accruing loans, accruing loans 90 days past due,
restructured but performing loans, and foreclosed assets, decreased from $13.9
million at December 31, 2007 to $10.4 million at September 30,
2008.  Non-performing loans and accruing loans 90 days past due
totaled $8.7 million at September 30, 2008 and consisted of $5.6 million, or
64.78%, of one- to four-family or multi-family residential real estate loans,
$2.7 million, or 30.54%, of loans on land or commercial property, $381,000, or
4.38%,of
commercial business loans and $26,000, or 0.30%,of consumer
loans.  Included in this group are $1.8 million of loans that have
been restructured and are performing as agreed.  Non-performing assets
also include $1.7 million of foreclosed assets.  At September 30,
2008, our allowance for loan losses equaled 1.11% of total loans compared to
1.23% at December 31, 2007.  The allowance for loan losses at
September 30, 2008 totaled 34.85% of non-performing assets compared to 26.56% at
December 31, 2007, and 41.62% of non-performing loans at September 30, 2008
compared to 37.04% at December 31, 2007.  Our non-performing assets
equaled 2.82% of total assets at September 30, 2008 compared to 4.08% at
December 31, 2007.  Non-performing assets totaling $959,000 were
charged off in the first nine months of 2008, offset by recoveries of
$19,000.  These charge-offs were largely covered by existing reserves
and there was no need for additional provisions to the allowance for the amounts
charged off.  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, 2007 to $34.1 million at
September 30, 2008, an increase of $177,000, or 0.52%, primarily as a result of
net income of $1.4 million, partially offset by our payment of $1.2 million of
dividends on common stock, and the repurchase of 8,900 shares of our stock as
part of a stock repurchase program.  Shareholders’ equity to total
assets was 9.28% at September 30, 2008 compared to 9.92% at December 31,
2007.







17




Results
of Operations




Comparison
of Operating Results for the Nine Months and the Quarter Ended September 30,
2008 and September 30, 2007




General.  Net income for
the nine months ended September 30, 2008 was $1.4 million, a decrease of
$517,000, or 26.57%, over the nine months ended September 30,
2007.  The decrease for the nine month period was primarily due to a
$1.1 million decrease in net interest income and a $111,000 increase in
non-interest expenses partially offset by a $508,000 decrease in taxes on
income, a $115,000 increase in non-interest income, and a $68,000 decrease in
the provision for loan losses.  Net income for the quarter ended
September 30, 2008 was $392,000, a decrease of $325,000, or 45.33%, over the
comparable quarter in 2007.  The decrease for the three month period
was primarily due to a $400,000 decrease in net interest income, a $172,000
increase in the provision for losses and a $122,000 increase in non-interest
expenses partially offset by a $272,000 decrease in taxes on income and a
$97,000 increase in non-interest income.




Net Interest
Income.  Net interest
income for the nine months ended September 30, 2008 decreased $1.1 million, or
12.64%, over the same period in 2007.  This decrease was due to a 47
basis point decrease in our net interest margin (net interest income divided by
average interest-earning assets) from 3.49% for the nine months ended September
30, 2007 to 3.02% for the nine months ended September 30, 2008 together with a
$3.3 million decrease in average net interest-earning assets.  The
decrease in net interest margin is primarily due to the 57 basis point decrease
in the average rate on interest-earning assets from 6.99% for the nine months
ended September 30, 2007 to 6.42% for the nine months ended September 30,
2008.  The average rate on interest-bearing liabilities decreased from
3.70% to 3.55% for the same respective periods.  Net interest income
for the three months ended September 30, 2008 decreased $400,000, or 14.08%,
over the same period in 2007 for similar reasons.




Interest
income on loans decreased $1.2 million, or 7.01%, for the nine months ended
September 30, 2008 compared to the same nine months in 2007.  The
average rate on loans fell from 7.26% to 6.67% as the lower market interest
rates are affecting not only new loans but our variable rate loans, both those
that are tied to treasury rates and those tied to prime rate.  Some of
the prime rate loans have reached their rate floor due to the decrease in rates
by the Federal Reserve, which had already lowered rates a total of 300 basis
points from September 2007 to March 2008.  The average balance of
loans increased by $4.1 million due to an increase in commercial loan activity
due to borrowers either moving their lending relationships to a local bank or
seeing opportunities as the community shows signs of recovery, and from
management’s decision to take advantage of the Bank’s minimal interest rate risk
exposure, as measured by the OTS Interest Rate Risk Exposure Report, to book,
rather than sell, fixed rate residential mortgages.  Interest income
on loans decreased $448,000 for the third quarter of 2008 compared to the third
quarter of 2007 due to a decrease in the average yield on loans from 7.42% for
the third quarter of 2007 to 6.36% for the third quarter of 2008 offset by a
$21.5 million increase in the average balance of loans from $298.1 million for
the third quarter of 2007 to $319.6 million for the third quarter of 2008 for
reasons mentioned above.




Interest
earned on other investments and Federal Home Loan Bank stock decreased by
$113,000, or 14.75%, for the nine months ended September 30, 2008 compared to
the same period in 2007.  This was the result of a 42 basis point
decrease in the average yield on other investments and Federal Home Loan Bank
stock and a $1.1 million decrease in average balances.







18




The
decrease in yield was primarily caused by the decrease in the return on
short-term investments due to the Federal Reserve rate cuts mentioned
above.  Interest income on other investments and Federal Home Loan
Bank stock decreased $26,000 for the third quarter of 2008 compared to the third
quarter of 2007 due to a decrease in the average yield on other investments and
Federal Home Loan Bank stock from 3.86% for the third quarter of 2007 to 3.43%
over the same period in 2008, as well as a slight decrease in average
balances.




Interest expense for the
nine months ended September 30, 2008 decreased $179,000, or 2.06%, over the same
period in 2007 due to a $306,000 decrease in interest on deposits partially
offset by a $127,000 increase in interest expense on Federal Home Loan Bank
advances.  The lower deposit costs were due to a decrease in the
average rate paid on deposits from 3.33% for the first nine months of 2007 to
3.16% for the first nine months of 2008.  The average deposit balancesdecreased from $246.5 million to $243.2 million for the same respective
periods.  The increase in Federal Home Loan Bank advance expense was
due to a $6.31 million increase in average balances partially offset by a
decrease in the average rate paid on advances from 4.99% for the first nine
months of 2007 to 4.80% for the first nine months of 2008. The lower rates were
generally due to the lower interest rates in the economy, especially for
shorter-term products.   Interest expense decreased $74,000, or
2.53%, for the third quarter of 2008 from the same period in 2007 primarily due
to a decrease in the average rate paid on average interest-bearing liabilities
from 3.80% to 3.46% for the three month period ended September 30, 2008 compared
to the same period in 2007, partially offset by a $21.4 million increase in
average interest-bearing liabilities.




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.




09/30/08
            
            
            12/31/07
            
            
            09/30/07Loans
      delinquent 30-59 days
            
            $
            386
            
            
            $
            364
            
            
            $
            291Loans
      delinquent 60-89 days
            
            
            2,507
            
            
            
            1,763
            
            
            
            6,287Total
      delinquencies
            
            
            2,893
            
            
            
            2,127
            
            
            
            6,578Accruing
      loans past due 90 days
            
            $
            0
            
            
            $
            59
            
            
            $
            0Non-accruing
      loans
            
            
            8,683
            
            
            
            9,935
            
            
            
            11,246Total
      non-performing loans
            
            
            8,683
            
            
            
            9,994
            
            
            
            11,246OREO
            
            
            1,686
            
            
            
            3,944
            
            
            
            3,926Total
      non-performing assets
            
            $
            10,369
            
            
            $
            13,938
            
            
            $
            15,172










19





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




The
decrease in non-performing loans at September 30, 2008 compared to December 31,
2007 was generally due to payoffs or improvements in the borrower’s situation
which brought them back to performing status or the Bank taking properties
securing non-performing loans into OREO.  We took $1.8 million of
properties into OREO in the first nine months of 2008 and of these, $1.1 million
were received and sold within that time period.  We sold an additional
$3.3 million of OREO properties during the first nine months of
2008.




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 industry standards. 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.  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.




Our
analysis of the loan portfolio begins at the time the loan is originated, when
each loan is assigned a risk rating.  If the loan is a commercial
credit, the borrower will also be assigned a similar rating.  Loans
that continue to perform as agreed will be included in one of the non-impaired
loan categories.  Loans no longer performing as agreed are assigned a
numerically lower risk rating, eventually resulting in their being regarded as
classified loans.  An analysis is completed on all classified loans to
determine if an impairment should be established.  This process
results in the allocation of specific amounts of the allowance to individual
problem loans, generally based on an analysis of the expected cash flows or the
collateral securing those loans.




The
remainder of the portfolio is assigned a reserve based on a five-year average of
historical charge-off levels.  In addition, a qualitative analysis is
done on environmental factors that may have an impact on future loan losses and
the resulting estimated potential loss is applied to the entire
portfolio.   In September 2008, we adjusted four of these
factors.  The risk from the levels of and trends in delinquencies was
reduced as a result of the reduction in delinquent loans discussed
above.  The risk from the trends in volume and terms of loans was
increased to reflect the loan growth in the third quarter of
2008.  The risk from the change in underwriting standards was
decreased to reflect the new credit analysis guidelines and credit department
which have effectively changed the credit culture of the bank.  The
risk from national and local economic conditions was increased due to the
perilous economic times which, while not as apparent in this







20




market,
can be expected to result in stresses on borrowers generally. These components
are added together and compared to the balance of our allowance at the
evaluation date.




At
September 30, 2008, specifically reviewed loans totaled $58.8 million compared
to $51.1 million at December 31, 2007.  Most of the increase was due
to a $4.1 million increase in substandard loans and a $2.8 million increase in
watch loans.  Substandard loans are loans with a defined weakness
which will result in a loss unless the weakness is addressed.  Watch
loans are loans that are performing as agreed but are loans in which management
has detected some weakness that warrants closer monitoring.  We are
proactive in identifying and addressing potential problem loans and believe this
is a reason for our success in reducing non-performing loans.  In
addition, the use of a third-party independent loan review for commercial loans
increases our confidence that potential problems will be identified and
addressed early.  Individual impairment reports are prepared each
quarter for all substandard loans and an expected impairment is determined based
on the estimated realizable value of the collateral.




As a
result of our analysis we recorded a $852,000 provision for loan losses for the
nine months ended September 30, 2008, compared to $920,000 for the same period
in 2007.  This provision was deemed appropriate by management to
maintain the allowance for loan losses at a level considered adequate to absorb
losses inherent in the loan portfolio and cover anticipated
charge-offs.  An analysis of the allowance for loan losses for the
nine months ended September 30, 2008 and 12 months ended December 31, 2007
follows:




(Dollars
      in Thousands)2008
            
            
            2007Balance
      at January 1
            $3,702
            
            Balance
      at January 1
            2,770Loans
      charged off
            (959)
            
            Loans
      charged off
            (672)Recoveries
            19
            
            Recoveries
            34Provision
            852
            
            Provision
            1,570Balance
      at September 30
            $3,614
            
            Balance
      at December 31
            $3,702







The
balance of loan loss reserves decreased $88,000, from $3.7 million at December
31, 2007 to $3.6 million at September 30, 2008.  This decrease
primarily reflects the charge-off of $959,000 of loans previously identified as
impaired and specifically reserved.  These charge-offs resulted in a
decrease in the specific allowance on impaired loans of $601,000.  The
balance of loan loss reserves increased by $144,000 in the third quarter of
2008.




Non-Interest
Income.  Non-interest income for the nine months ended
September 30, 2008 increased by $115,000, or 5.26%, compared to the same period
in 2007.  This was primarily due to a $130,000 increase in other
income generally due to higher fees for loan







21





closings
and increased debit card usage fees due to increases in volume.  We
also recognized a $179,000 increase in the gain on other real estate owned as we
were able to dispose of, at higher prices than expected, several properties we
had previously written down.  These increases were partially offset by
a $116,000 decrease in the gain on the sale of mortgage loans due to a decrease
in loans sold and a $78,000 decrease in service charges and fees due to a
decrease in non-sufficient funds fees.  Non-interest income for the
third quarter of 2008 increased by $97,000 compared to the same period in 2007
primarily due to a $126,000 increase in the gain on other real estate owned as
we were able to dispose of, at higher prices than expected, several properties
we had previously written down, partially offset by a $21,000 decrease in fees
on deposit accounts.




Non-Interest
Expense.  Non-interest expense for the nine months ended
September 30, 2008 increased $111,000 over the same period in 2007 due to
relatively small changes in salaries, occupancy and computer service
costs.  Salaries were up $37,000 primarily due to an increase in
health insurance costs, occupancy costs increased $56,000 due to higher
depreciation and maintenance expense, and a $45,000 increase in computer service
expense, partially offset by a $28,000 decrease in advertising
expenses.  Non-interest expense for the third quarter of 2008
increased by $122,000 over the same period in 2007, due largely to the factors
mentioned above.




Income
Tax Expense.Our income tax
provision decreased by $508,000 for the nine months ended September 30, 2008
compared to the nine months ended September 30, 2007, due primarily to decreased
income and because of the effects of negative earnings in December,
2007.  Our income tax provision decreased by $272,000 for the third
quarter of 2008 compared to the third quarter of 2007 for the same
reasons.






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.  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.







22





Our
liquidity ratios at September 30, 2008 and December 31, 2007 were 6.49% and
5.83%, respectively, compared to a regulatory liquidity base, and 4.75% and
4.36% 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, 2008, 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 $6.2 million. We had one outstanding commitment for $118,000 to sell a
residential loan.  Certificates of deposit which will mature in one
year or less totaled $116.9 million at September 30, 2008.  Included
in that number are $31.4 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 $31.8 million of Federal Home Loan Bank advances maturing in the next
twelve months.






Capital
Resources




Shareholders’
equity totaled $34.1 million at September 30, 2008 compared to $33.9 million at
December 31, 2007, an increase of $177,000, or 0.52%, due primarily to net
income of $1.5 million, partially offset by our payment of dividends on common
stock and the repurchase of 8,900 shares of our stock as part of a stock
repurchase program.  Shareholders’ equity to total assets was 9.30% at
September 30, 2008 compared to 9.92% at December 31, 2007.




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, 2008 and December 31, 2007, Lafayette Savings was categorized as well
capitalized.  Our actual and required capital amounts and ratios at
September 30, 2008 and December 31, 2007 are presented below:




Actual
            
            
            For
      Capital Adequacy Purposes
            
            
            To Be Well Capitalized Under Prompt Corrective
      Action ProvisionsAmount
            
            
            Ratio
            
            
            Amount
            
            
            Ratio
            
            
            Amount
            
            
            RatioAs
      of September 30, 2008Total
      risk-based capital(to
      risk-weighted assets)
            
            $
            36,547
            
            
            
            12.7
            %
            
            $
            22,971
            
            
            
            8.0
            %
            
            $
            28,714
            
            
            
            10.0
            %Tier
      I capital(to
      risk-weighted assets)
            
            
            33,810
            
            
            
            11.8
            
            
            
            11,486
            
            
            
            4.0
            
            
            
            17,228
            
            
            
            6.0Tier
      I capital(to
      adjusted total assets)
            
            
            33,810
            
            
            
            9.2
            
            
            
            11,006
            
            
            
            3.0
            
            
            
            18,343
            
            
            
            5.0Tier
      I capital(to
      adjusted tangible assets)
            
            
            33,810
            
            
            
            9.2
            
            
            
            7,337
            
            
            
            2.0
            
            
            
            N/A
            
            
            
            N/ATangible
      capital(to
      adjusted tangible assets)
            
            
            33,810
            
            
            
            9.2
            
            
            
            5,503
            
            
            
            1.5
            
            
            
            N/A
            
            
            
            N/AAs
      of December 31, 2007Total
      risk-based capital(to
      risk-weighted assets)
            
            $
            36,320
            
            
            
            13.9
            %
            
            $
            20,954
            
            
            
            8.0
            %
            
            $
            26,192
            
            
            
            10.0
            %Tier
      I capital(to
      risk-weighted assets)
            
            
            33,444
            
            
            
            12.8
            
            
            
            10,477
            
            
            
            4.0
            
            
            
            15,716
            
            
            
            6.0Tier
      I capital(to
      adjusted total assets)
            
            
            33,444
            
            
            
            9.8
            
            
            
            10,249
            
            
            
            3.0
            
            
            
            17,081
            
            
            
            5.0Tier
      I capital(to
      adjusted tangible assets)
            
            
            33,444
            
            
            
            9.8
            
            
            
            6,833
            
            
            
            2.0
            
            
            
            N/A
            
            
            
            N/ATangible
      capital(to
      adjusted tangible assets)
            
            
            33,444
            
            
            
            9.8
            
            
            
            5,124
            
            
            
            1.5
            
            
            
            N/A
            
            
            
            N/A








23




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;




·
            turmoil
      and governmental intervention in the financial services
      industry;




·
            the
      timely development of and acceptance of our 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);







24







·
            the
      impact of technological changes;




·
            acquisitions;




·
            changes
      in consumer spending and saving habits;
and




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









Item
      3.   Quantitative
      and Qualitative Disclosures About Market Risk




Not
Applicable.






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, 2008, 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, 2008, 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.







25





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, 2008
            
            
            ---
            
            
            
            ---
            
            
            
            ---
            
            
            
            ---August
      1 – August 31, 2008
            
            
            ---
            
            
            
            ---
            
            
            
            ---
            
            
            
            ---September
      1 – September 30, 2008
            
            
            ---
            
            
            
            ---
            
            
            
            ---
            
            
            
            ---Total
            
            
            ---
            
            
            
            ---
            
            
            
            ---
            
            
            
            52,817


_______________________


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


2 We have
in place a program, announced February 6, 2007, to repurchase up to 100,000
shares of our common stock.  There are
52,817 shares that may yet be purchased under that previously announced
program.




Item
      3.   Defaults
      Upon Senior Securities




None.




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




None.





Item
      5.   Other
      Information




None.




Item
      6.   Exhibits




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







26






SIGNATURES
















LSB
      FINANCIAL CORP.(Registrant)Date: 
      November 13, 2008
            By:
            /s/
      Randolph F. WilliamsRandolph
      F. Williams, President(Principal
      Executive Officer)Date: 
      November 13, 2008
            By:
            /s/
      Mary Jo DavidMary
      Jo David, Treasurer(Principal
      Financial and AccountingOfficer)








27





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