Form 10-Q

SECURITIES AND EXCHANGE COMMISSION

OR

Commission file number: 0-13203

(440) 244-6000
Registrant’s telephone number, including area code

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(Former: name, address and 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, and (2) has been subject to such requirements for the past 90 days. YES [X]   NO [ ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) YES [X]   NO [ ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

		Outstanding at August 5, 2004: 6,641,083 shares
		Class of Common Stock: $1.00 par value

LNB Bancorp, Inc.
Table of Contents

LNB Bancorp, Inc.

See accompanying notes to the consolidated financial statements.

LNB Bancorp, Inc.

See accompanying notes to the consolidated financial statements.

LNB Bancorp, Inc.

See accompanying notes to the consolidated financial statements.

LNB Bancorp, Inc.

See accompanying notes to the consolidated financial statements.

LNB Bancorp, Inc.

1. Basis of Presentation

These consolidated financial statements include the accounts of LNB Bancorp, Inc. (the Parent Company) and its wholly-owned subsidiaries, Lorain National Bank (the “Bank”) and Charleston Insurance Agency, Inc. Charleston Title Agency, LLC, a 49%-owned subsidiary, is accounted for under the equity method. The term “the Corporation” refers to LNB Bancorp, Inc. and its wholly-owned subsidiaries, The Lorain National Bank and Charleston Insurance Agency, Inc., and a 49% interest in Charleston Title Agency, LLC. All significant inter-company balances and transactions have been eliminated in consolidation. Also included is the Bank’s wholly-owned subsidiary, North Coast Community Development Corporation (“NCCDC”). All dollar amounts in this report are reported in thousands of dollars, except per share amounts.

Management believes that these unaudited consolidated interim financial statements reflect all adjustments of a normal recurring nature and disclosures that are necessary for a fair presentation of the results for the interim periods presented. Some previously reported results have been reclassified to conform to current reporting practices. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full year. The LNB Bancorp’s 2003 Annual Report to Shareholders (Form 10-K) should be read in conjunction with these statements.

2. Earnings Per Share Data

Earnings per share data for the three and six month periods ended June 30, 2004 and 2003 are calculated as follows.

3. Critical Accounting Policies and New Accounting and Regulatory Pronouncements

Critical Accounting Policies

The Corporation maintains critical accounting policies for the allowance for loan losses, classification and evaluation of securities valuation and a deferred tax asset valuation reserve. Refer to notes 1,5,7 and 12 of the Notes to Consolidated Financial Statements for additional information incorporated by reference to the 2003 Annual Report to Shareholders on Form 10-K.

Impacts of Accounting and Regulatory Pronouncements

Corporate management is not aware of any proposed regulations or current recommendations by the Financial Accounting Standards Board or by regulatory authorities, which, if they were implemented, would have a material effect on the financial position, results of operations or liquidity of the Corporation. However, the potential impact of certain accounting and regulatory pronouncements warrant further discussion.

Financial Accounting Standards Board:

The Financial Accounting Standards Board (FASB) has issued:

SFAS No. 132(Revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits”

In December 2003, the FASB issued SFAS No. 132 (Revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” This Statement expands upon the existing disclosure requirements as prescribed under the original SFAS No. 132 by requiring more details about pension plan assets, benefit obligations, cash flows, benefit costs and related information. SFAS No. 132® also requires companies to disclose various elements of pension and postretirement benefit costs in interim-period financial statements beginning after December 15, 2003. This Statement is effective for financial statements with fiscal years ending after December 15, 2003. The Corporation adopted the additional year-end disclosure requirements under SFAS No. 132® during the fourth quarter of 2003 and the interim-period financial statement disclosure requirements starting in the first quarter of 2004. Its adoption did not have a material impact on our financial position, results of operation, or liquidity. SFAS No. 132® disclosures are included in Note 5.

FASB Interpretation No. 46 (FIN No. 46), “Consolidation of Variable Interest Entities.” and FASB Interpretation No. 46R (FIN No. 46(R)), “Consolidation of Variable Interest Entities— an interpretation of ARB 51 (revised December 2003)”

In January 2003, the FASB issued Interpretation No. 46 (FIN No. 46), “Consolidation of Variable Interest Entities.” This Interpretation clarifies the application of ARB No. 51, “Consolidated Financial Statements,” for certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated support from other parties. This Interpretation requires variable interest entities (VIE’s) to be consolidated by the primary beneficiary which represents the enterprise that will absorb the majority of the VIE’s expected losses if they occur, receive a majority of the VIE’s residual returns if they occur, or both. Qualifying Special Purpose Entities (QSPE) are exempt from the consolidation requirements of FIN No. 46. This Interpretation was effective for VIE’s created after January 31, 2003 and for VIE’s in which an enterprise obtains an interest after that date. In December 2003, the FASB issued Interpretation No. (46R) (FIN No. 46(R)), Consolidation of Variable Interest Entities — an interpretation of ARB 51 (revised December 2003),” which replaces FIN No. 46. FIN No. 46(R) was primarily issued to clarify the required accounting for interests in VIE’s. Additionally, this Interpretation exempts certain entities from its requirements and provides for special effective dates for enterprises that have fully or partially applied FIN No. 46 (R) as of December 24, 2003. Application of FIN No. 46(R) is required in financial statements of public enterprises that have interests in structures that are commonly referred to as special-purpose entities, or SPE’s, for periods ending after December 15, 2003. Application by public enterprises, other than small business issuers, for all other types of VIE’s (i.e., non-SPE’s) is required in financial statements for periods ending after March 15, 2004. The Corporation had no variable interest entities and therefore, the interpretation of FIN No. 46(R) had no impact on the financial position, results of operations or liquidity.

Other Statements of Financial Accounting Standards

All other applicable Statements of Financial Accounting Standards that have been issued and have effective dates impacting 2004 and prior years financial statements were adopted by the Corporation. Corporate management believes there are no Statements of Financial Accounting Standards, which have been issued and have implementation dates in the future that will materially impact the financial statements of future years. Significant actions by the Federal government and its agencies, affecting the financial institutions industry in general, are currently having and will continue to have an impact on the Corporation. A discussion of these actions follows:

SEC Staff Accounting Bulletin: No. 105, “Application of Accounting Principles to Loan Commitments”

In March 2004, the SEC issued Staff Accounting Bulletin No. 105 “Application of Accounting Principles to Loan Commitments.” This Staff Accounting Bulletin summarizes the views of the SEC staff regarding the application of generally accepted accounting principles to loan commitments accounted for as derivative instruments, a loan committed at a specified rate, but funded later. Presently, the Corporation does not make loan commitments that will be funded at a later date, and therefore, the SEC Staff Accounting Bulletin had no impact on the Corporation’s financial position, results of operations or liquidity.

FASB Exposure Draft “Proposed Statement of Financial Accounting Standard – Fair Value Measurement”

On June 23, 2004, The Financial Accounting Standards Board released an exposure draft “Proposed Statement of Financial Accounting Standard – Fair Value Measurement”. This proposed standard related to the application of methods for measuring the fair value of assets and liabilities and related expanded disclosure requirements. This proposal, in final form, is expected to become effective for fiscal years ending after June 15, 2005. When adopted, this proposed standard is not expected to have a material impact the financial position, results of operations or liquidity of the Corporation.

Sarbanes-Oxley Act of 2002

On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002, which contains important new requirements for public companies in the area of financial disclosure and corporate governance. Although portions of the act are still being fully implemented, we do not anticipate any significant changes in the operations of and reporting by the Corporation as a result of the act. In accordance with the requirements of the Sarbanes-Oxley Act, written certifications for this quarterly report on Form 10-Q by the chief executive officer and the chief financial officer of the Corporation are filed in this report under Exhibit index (31(a)), (31(b)), (32(a)), and (32(b)). See “Controls and Procedures” for the Corporation’s evaluation of disclosure controls and procedures.

4. Common Stock

On February 25, 2003, the Board of Directors of LNB Bancorp, Inc. declared a three-for-two split of common stock. Shareholders received one additional common share for every two shares owned on the stock-split record date of March 10, 2003. Shareholders participating in the Bancorp’s dividend reinvestment plan, LNBB Direct (the Plan), were issued fractional shares. Shareholders not participating in the Plan were issued cash in lieu of fractional shares. For additional information see Form 8-K filed on February 25, 2003. Prior year share and per share data were restated to reflect this stock-split.

On February 17, 2004, the Board of Directors of LNB Bancorp, Inc. declared a first quarter cash dividend of $.18 per share payable April 1, 2004, to shareholders of record on March 15, 2004. This represents a 5.9 percent increase from last year’s first quarter cash dividend of $.17 per share.

On May 18, 2004, the Board of Directors of LNB Bancorp, Inc. declared a second quarter cash dividend of $.18 per share payable in July 1, 2004, to shareholders of record on June 14, 2004. This represents a 5.9 increase from last year’s second quarter cash dividend of $.17 per share.

5. Stock-Based Compensation

The FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure.” SFAS No. 148 provides guidance on how to transition from the intrinsic value method of accounting for stock-based employee compensation under APB No. 25 to SFAS No. 123’s fair value method for accounting, if a company so elects. In accordance with the transitional guidance of SFAS No. 148, the fair value method of accounting for stock options should be applied prospectively to awards granted subsequent to January 1, 2003. As permitted, options granted prior to January 1, 2003, will continue to be accounted for under APB Opinion 25, and the pro forma impact of accounting for these options at fair value will continue to be disclosed in the notes to the consolidated financial statements. The Corporation did not issue any stock options during the first six months of 2004 or during 2003. All stock options issued were 100% vested at June 30, 2004 and 2003, and therefore had compensation cost for the Corporation’s stock-based compensation plans been determined consistent with SFAS No. 123, net income and net income per share would not have been impacted.

6. Retirement Pension Plan

The Bank’s non-contributory defined benefit pension plan (the “Plan”) covers substantially all of its employees. Effective December 31, 2002, the benefits under the Plan were frozen and no additional benefits will be accrued under the Plan after December 31, 2002. The 2003 loss recognized due to settlement in the amount of $10 results from significant lump sum distributions paid in 2003, but not actuarially projected for 2003.

The net periodic pension cost charged to salaries and benefits expense in the income statements amounted to $19 and $38 for the second quarter and six month periods ended June 30, 2004. This compares to $29 and $58 for the same periods in 2003.

Employer Contributions

The Corporation previously disclosed in its 2003 Annual Report to Shareholders on Form 10-K, that it expected to contribute $500 to the Lorain National Bank Retirement Pension Plan in 2004. Accordingly, a $500 cash contribution was made to the Plan in March 2004.

7. Contingent Liabilities, Guarantees, Commitments and Related Party Transactions

Litigation

In the ordinary course of business the Corporation is subject to legal actions that involve claims of monetary relief. Based on information presently known, management does not believe there are any legal actions or proceedings to which the Corporation or any of its subsidiaries are a party, will have a material impact on the financial position, results of operations or liquidity of the Corporation.

Commitments

Commitments to extend credit are agreements to lend to a customer as long as there are no violations of any conditions in the contract. Substantially all these commitments are variable rate. Most of the Bank’s activities are in its defined market area. There is no exposure to high leveraged transactions or foreign credits. Since many of these commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash-flow requirements.

8. Acquisition

On July 2, 2004, LNB Bancorp, Inc. issued a press release on Form 8-K regarding the signing of a definitive agreement to acquire Mortgage One Services, Inc., an Ohio corporation with headquarters in Lorain, Ohio. This transaction is expected to close in August 2004. The new entity will be incorporated as LNB Mortgage LLC and conduct business under the trademark name Mortgage One Banc. LNB Mortgage LLC will operate as a wholly-owned subsidiary of Lorain National Bank. This transaction will be accounted for as a purchase of assets and assumption of certain liabilities of Mortgage One Services, Inc. The assets are predominately the furniture and fixtures of Mortgage One Services, Inc. and intangibles. LNB Mortgage LLC will also assume the remaining term of a lease on the one location of Mortgage One Services, Inc. For more information on this transaction see The Asset Purchase Agreement between Lorain National Bank and Mortgage One Banc that is included in this Form 10-Q filing as Exhibit 2. As part of this transaction, Lorain National Bank will enter into an Employment Contract with the President of Mortgage One Banc, to continue in his current role after this transaction closes.

Part I

The following is management’s discussion and analysis of certain significant factors that affected the Corporation’s financial condition and results of operations during the periods included in the Consolidated Financial Statements which are part of this filing.

Certain statements contained herein are not based on historical facts and are “forward-looking statements”. Forward-looking statements which are based on various assumptions (some of which are beyond the Corporation’s control), may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as “may,” “will,” “believe,” “expect,” “estimate,” “anticipate,” “continue,” or similar terms or variations of those terms, or the negative of these terms. Actual results could differ materially from those set forth in forward-looking statements, due to a variety of factors, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Corporation operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset/liability management, the financial and securities markets and the availability of and costs associated with sources of liquidity.

The Corporation does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Introduction

LNB Bancorp, Inc. is the financial holding company for Lorain National Bank. The Corporation is headquartered in Lorain, Ohio and operates 19 offices in three counties in northern Ohio. As disclosed in the Corporation’s 2003 Annual Report on Form 10-K, two new offices were scheduled to open during 2004. The first new office, located in Avon, Ohio opened for business in March 2004. The second new office, located in Avon Lake, Ohio opened in May 2004. The most material current trend continues to be the trends in revenue growth. As disclosed in the Results of Operations section of this report, expense control efforts have been successful this year, but the efficiency ratio has risen due to depressed revenue. The primary source of the Corporation’s revenue is net interest income. The economy and competitive pressures have clearly impacted this component of revenue. The local economy has continued to depress the Company’s asset growth and more specifically loan growth. The local area conditions have also impacted the deposit market which has grown more slowly in 2004 than historically. Competitive pressures have also impacted asset and deposit growth. With the economy weak, a fewer number of loans and deposits are being generated, and these are being subjected to extreme competitive pressure.

Results of Operations (Dollars in Thousands)

Net income for the second quarter of 2004 was $1,980, a decrease of $344 from $2,324 reported in the same period in 2003. Basic and diluted earnings per common share for the second quarter of 2004 were $.30, as compared to $.35 for the same period in 2003. Net income for the first six months of 2004 was $4,236, a decrease of $279 from $4,515 reported in the same period in 2003. Basic and diluted earnings per common share for the first six months of 2004 were $.64, as compared to $.68 for the same period in 2003.

Return on average assets (ROAA) and return on average equity (ROAE) were 1.05% and 11.60%, respectively, for the second quarter of 2004, as compared to 1.27% and 13.68% for the same period in 2003. ROAA and ROAE were 1.13% and 12.39%, respectively, for the six month period ended June 30, 2004, as compared to 1.26% and 13.45% for the same period in 2003.

Table 1 containing selected operating data follows:

Net Interest Income

Net interest income is the difference between the interest and dividend income earned on our loans and investments and interest expense on our deposits and borrowings. Net interest income is affected by a number of factors including the level, pricing and maturity of interest earning assets and interest bearing liabilities, interest rate fluctuations and asset quality in general, as well as general economic conditions and regulatory policies. Net interest income is the most significant component of the Corporation’s earnings.

Net interest income for the second quarter of 2004 was $6,881, a decrease of $393 or 5.4% from $7,274 in the second quarter of 2003. The structure of the balance sheet and competitive market pressures contributed to this result. The balance sheet is structured to benefit from rising rates. The average yield on earnings assets declined 74 basis points in the three month period ended June 30, 2004 as compared to the same period in 2003. This is primarily the result of a 126 basis point decline, and a 57 basis point decline, in the yields on securities and loans respectively during the quarter, as compared to the second quarter of 2003. The prolonged declining rate environment has impacted the yields on securities by accelerating cashflow in an unattractive reinvestment environment. The decline in the average loan yield is a function of the prime rate nature of the portfolio and competitive pressure.

The Corporation’s net interest income has also been impacted by the slow recovery of the local economy. Average earning assets were $710.4 million during the second quarter of 2004, an increase of $32.4 million or 4.8% from the second quarter last year. Modest commercial and home equity loan growth was supplemented by consumer loans purchased from another financial institution. Offsetting some of this growth was continued runoff in the mortgage loan portfolio. Average deposits were $585.4 million for the second quarter of 2004, down $1.4 million or .2% from the same quarter last year. Time deposits averaged $209.5 million for the quarter ended June 30, 2004, a decline of $6.5 million from the same period in 2003. A portion of this decline was offset by growth in savings deposits. With deposits declining slightly, asset growth was funded with substantially higher levels of average borrowings. Total borrowings increased by 37.1% to average $99.4 million for the second quarter of 2004, as compared to the same quarter last year. The majority of this increase was in term Federal Home Loan Bank borrowings which grew of 43.8%. The migration from core funding to borrowings has a tangible cost, as the average rate on interest bearing deposits was 1.31% as compared to the average rate on borrowings of 2.34% in the second quarter of 2004.

Table 2 presents the components of the Corporation’s net interest income for the three month periods ended June 30, 2004 and 2003. Rates are computed on a tax equivalent basis and non-accrual loans are included in the average balances.

The Corporation’s net interest margin for the six months ended June 30, 2004 was $13,751, a decrease of $683, or 4.73% from the first half of 2003. The impact of the prolonged interest rate environment can be seen in the overall yield on earning assets of 5.20%, which is a decline of 72 basis points for the first six months of 2004 as compared to the same period in 2003. Earning asset yields continue to be impacted by competitive market pressures and the prepayment of assets resulting in shorter durations and considerable cashflow. The low interest rate environment, in addition to compressing asset yields has also impacted the cost of funding. This can be seen in the average rate on interest bearing liabilities, which was 1.47% for the first six months of 2004 compared to 1.74% for the first six months of 2003. Although this is a 27 basis point decrease from the rate paid on interest bearing deposits and purchased funds in the first six months of 2003, it represents less than half the yield decline that was experienced by the earnings assets being funded by these sources. This demonstrates the impact of the practical rate floors that have been reached on the savings and transaction accounts. In recent weeks, market rates on deposit accounts have begun to rise in anticipation of what is expected to be a series of Federal Reserve Bank rate increases. This has had the effect of reducing the demand for term investment such as certificates of deposit, and increasing the demand for more liquid transaction accounts.

The impact of the slow economic recovery in the local market can be seen in the change in earnings assets. For the six month period ended June 30, 2004, average earning assets were $703.7 million as compared to $674.0 million of the same period in 2003. This is an increase of 4.4%, or about half the historical annual growth rate experienced by the Corporation. The Corporation believes that the improving economy and the associated asset growth, combined with increasing interest rates and slower prepayment rates, will begin to improve net interest income in future periods.

Table 3 presents the components of the Corporation’s net interest income for the six month periods ended June 30, 2004 and 2003. Rates are computed on a tax equivalent basis and non-accrual loans are included in the average balances.

Provision for loan losses

The provision for loan losses represents the charge to income necessary to adjust the reserve for loan losses to an amount that represents management’s assessment of the estimated probable credit losses inherent in the Corporation’s loan portfolio which have been incurred at the balance sheet date. The provision for loan losses decreased $145 or 25.4% to $425 in the second quarter of 2004 compared to $570 in the second quarter of 2003. The provision for loan losses for the six month period ended June 30, 2004 was $950, as compared to $1,134 for the same period in 2003. This represents a $184 reduction or 16.2%. The lower provision for loans losses is due to two factors. First, actual net charge-offs for the first six months of 2004 were nearly unchanged from the same period in 2003, and the forecast for charge-offs over the next 12 months indicates improving economic conditions. Net charge-offs were $255 and $691 for the three and six month periods ended June 30, 2004. This compares to $168 and $682 for the same periods ended June 30, 2003. On an annualized basis, these totals represent .19% and .26% of average loans during the three and six month periods ended June 30, 2004, as compared to .13% and .27% for the same periods in 2003. The second factor is the perceived and actual trends in the level of potential problem loans, other foreclosed assets and nonaccrual loans. Management does not expect that the level of nonaccrual loans will significantly decline in the next six months, but trends indicate improvements in the levels of potential problem loans and foreclosed assets. Table 4 presents a summary of The Corporation’s loan loss experience for the three and six months ended June 30, 2004 and 2003.