Form 10-Q

SECURITIES AND EXCHANGE COMMISSION

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

OR

Commission file number: 0-13203

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

Not Applicable
(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 o

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

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

Outstanding at November 5, 2004: 6,641,155 shares
Class of Common Stock: $1.00 par value

LNB Bancorp, Inc.
Table of Contents

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LNB Bancorp, Inc.

See accompanying notes to the unaudited consolidated financial statements.

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LNB Bancorp, Inc.

See accompanying notes to the unaudited consolidated financial statements.

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LNB Bancorp, Inc.

See accompanying notes to the unaudited consolidated financial statements.

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LNB Bancorp, Inc.

See accompanying notes to the unaudited consolidated financial statements.

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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”) and LNB Mortgage LLC, the mortgage company acquired during the third quarter of 2004. 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. Certain items have been reclassified to conform to the current presentation including the cash flow statement, which is now being reported using the indirect method instead of the direct method previously used. 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.

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2. Earnings Per Share Data

Earnings per share data for the three and nine month periods ended September 30, 2004 and 2003 are calculated as follows. All amounts have been restated after the stock split in 2003.

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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 are discussed below.

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.

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FASB Interpretation No. 46 (FIN No. 46), “Consolidation of Variable Interest Entities.” and FASB Interpretation No. 46R (FIN No. 46®), “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®), Consolidation of Variable Interest Entities — an interpretation of ARB 51 (revised December 2003),” which replaces FIN No. 46. FIN No. 46® 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 ® as of December 24, 2003. Application of FIN No. 46® 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® 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:

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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.

AICPA Statement of Position (SOP) 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer”

This statement of position addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. The key principle of SOP 03-3 is the prohibition on the “carrying over” or creation of an allowance for loan losses when initially accounting for the purchase of an impaired loan. The price that the purchaser is willing to pay for an impaired loan reflects the purchaser’s estimate of the credit losses over the life of the loan. In the AICPA’s view, using a loan loss allowance to address the collectibility of the cash flow that the purchaser does not expect to receive and, therefore, was not willing to pay for would not properly reflect the substance of the loan purchase. Thus, the AICPA concluded that the loan loss allowances recorded by the purchaser of the impaired loan should reflect only those losses incurred by the purchaser after the acquisition and not losses incurred by the seller of the loan prior to the sale.

Presently, the Corporation does not purchase impaired loans, and therefore, the AICPA Statement of Position (SOP) 03-3 had no impact on the Corporation’s financial position, results of operation or liquidity.

EITF No. 03-01 “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments”

In June 2004, the Emerging Issues Task Force (“EITF”) issued EITF No. 03-01, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. Based on the guidance available at the present time, this pronouncement did not have any material effect on the fair value disclosure of securities available for sale.

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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 percentage increase from last year’s second quarter cash dividend of $.17 per share.

On September 28, 2004, the Board of Directors of LNB Bancorp, Inc. declared a third quarter cash dividend of $.18 per share payable on October 1, 2004, to shareholders of record on September 14, 2004. This represents a 5.9 percentage increase from last year’s third 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 issued 10,000 new stock options during August 2004, which were immediately vested. All stock options issued during prior periods are 100% vested at September 30, 2004 and 2003. The Corporation accounts for these stock options per guidance provided by SFAS No. 123 and accordingly did not report any impact on net income.

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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 were accrued after December 31, 2002.

The net periodic pension cost charged to salaries and benefits expense in the consolidated statements of income amounted to $18 and $56 for the third quarter and nine month periods ended September 30, 2004. This compares to $29 and $87 for the same periods in 2003.

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.

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8. Acquisition

On September 2, 2004, LNB Bancorp, Inc. issued a press release on Form 8-K announcing the completion of the acquisition of Mortgage One Services, Inc., an Ohio corporation specializing in mortgage originations. This transaction closed on August 31, 2004 and the new entity has been incorporated as LNB Mortgage LLC. It is conducting business under the trademark name Mortgage One Banc. LNB Mortgage LLC is operated as a wholly-owned subsidiary of Lorain National Bank. This transaction has been accounted for as a purchase of assets and assumption of certain liabilities of Mortgage One Services, Inc. The Bank paid $350,000 for this company and the assets purchased are predominately the furniture and fixtures of Mortgage One Services, Inc. and intangibles. LNB Mortgage LLC. assumed the remaining term of a lease on the one location of Mortgage One Services, Inc. As part of this transaction, Lorain National Bank has entered into an Employment Contract with the President of Mortgage One Banc, to continue in his current role. The consolidated financial statements include the operations of LNB Mortgage LLC since the date of acquisition.

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Part I

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

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 serves its customers through 20 retail banking centers and 23 ATMs in three counties in northern Ohio. The bank operates one loan production office in Westlake, Ohio. As disclosed in the Corporation’s 2003 Annual Report on Form 10-K, two new offices opened in 2004, one in Avon, Ohio and the other in Avon Lake, Ohio. In July 2004, the branch office in Westlake, Ohio was closed and reopened as a loan production office. The most material current trend for this quarter is the growth in loans and deposits. Net loans grew to a record level as the quality of the loans improves. Total deposits have continued to increase since the first quarter of the year, with growth in both non interest bearing deposits and time deposits. The primary source of the Corporation’s revenue is net interest income and it is beginning to show improvement as evidenced during the third quarter, due to the improved loan growth, and higher interest rates.

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Results of Operations (Dollars in Thousands)

Net income for the third quarter of 2004 was $2,074, a decrease of $281 from $2,355 reported in the same period in 2003. Basic and diluted earnings per common share for the third quarter of 2004 were $.31, as compared to $.36 for the same period in 2003. Net income for the first nine months of 2004 was $6,310, a decrease of $560 from $6,870 reported in the same period in 2003. Basic and diluted earnings per common share for the first nine months of 2004 were $.95, as compared to $1.04 for the same period in 2003.

Return on average assets (ROAA) and return on average equity (ROAE) were 1.09% and 11.87%, respectively, for the third quarter of 2004, as compared to 1.24% and 13.65% for the same period in 2003. ROAA and ROAE were 1.12% and 12.22%, respectively, for the nine month period ended September 30, 2004, as compared to 1.25% and 13.52% for the same period in 2003.

Table 1 containing selected operating data follows:

Table 1 — Operating Data

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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, and its balance sheet is structured to produce better net interest income performance when rates rise.

Net interest income for the third quarter of 2004 was $7,172 a decrease of $42 or .6% from $7,214 in the third quarter of 2003. The net interest margin for the three month period ending September 30, 2004 was 4.04% as compared to 4.12% for the same period in 2003. For the past three years the Company’s net interest margin has been compressed by the rapidly falling interest rates followed by a period of stable, but historically low interest rates. Net interest income has been also impacted by a slowing of asset growth as the local economy continues to slowly recover from recession. Both of these factors began to change in the third quarter, as the Federal Reserve Bank increased interest rates and loan growth improved during September 2004.

Average earning assets were $707.9 million during the third quarter of 2004, compared to average earning assets of $702.1 for the third quarter of 2003. This is an increase of $5.8 million or .8%. Average loans experienced renewed growth of 3.1% for the quarter ended 2004 as compared to the same time period in 2003. Loan growth was particularly strong in the commercial, home equity and purchased consumer loan categories. The acquisition of LNB Mortgage LLC, is expected to improve the mortgage loans origination activity as all mortgage activity of the Corporation will be conducted by this subsidiary, but the majority of originations will be sold in the secondary market. Average interest bearing deposits were $499.1 million for the third quarter of 2004, compared to $490.5 million from the third quarter of 2003, an increase of $8.6 million, or 1.7%. Time deposit growth of $5.9 million, or 2.8%, for the quarter ended 2004 versus the same time period in 2003, accounted for the bulk of the average interest bearing deposit growth. Time deposits account for 43.6% of interest bearing deposits, and averaged $217.5 million for the quarter ended September 30, 2004.

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Table 2 presents the components of the Corporation’s net interest income for the three month periods ended September 30, 2004 and 2003. Net interest income is discussed and presented on a on a tax equivalent basis, recognizing that interest on certain loans and securities is not taxed for Federal income tax purposes. The interest earned on these tax-exempt assets is adjusted to a pretax-equivalent amount based upon the marginal Federal income tax rate of 35%. Tax equivalent adjustment to net interest income was $27 for the third quarter of 2004. Non-accrual loans of $124 are included in the average balances.

Table 2 — Components of net interest income

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The Corporation’s net interest income for the nine months ended September 30, 2004 was $20,923, a decrease of $725, or 3.4% from $21,648 during the same period in 2003. The net interest margin for the nine month period ended September 30, 2004 was 4.00% as compared to 4.28% for the same period in 2003. The impact of the prolonged declining interest rate environment can be seen in the overall yield on earning assets of 5.25% for the first nine months of 2004, a decline of 41 basis points from 5.66% compared to the same period in 2003. Earning asset yields continue to be impacted by competitive market pressures, but the negative impact of prepayments has slowed and higher interest rates have begun to improve the net interest margin trends. This can be seen in the third quarter net interest margin of 4.04% as compared to the full year result of 4.00%. 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 1.49% for the first nine months of 2004 compared to 1.65% for the first nine months of 2003. Although this is a 16 basis point decrease from the rate paid on interest bearing deposits and purchased funds in the first nine months of 2003, it represents less than half the yield decline that was experienced by the earnings assets being funded by these sources. Prior to recent Federal Reserve actions to raise the Federal Funds rate, the impact of practical rate floors on savings and transaction accounts, and a noticeable rise in market rates on deposit accounts in anticipation of Federal Reserve Bank actions, had been depressing the net interest margin. These funding cost factors have eased and the asset yields began to quickly recover in September.

The impact of the slow economic recovery in the local market can still be seen in the nine month comparisons. For the nine month period ended September 30, 2004, average earning assets were $705.1 million as compared to $683.5 million of the same period in 2003. This is an increase of 3.2%, 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, have begun to improve both net interest income and net interest margin performance.

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Table 3 presents the components of the Corporation’s net interest income for the nine month periods ended September 30, 2004 and 2003. Net interest income is discussed and presented on a on a tax equivalent basis, recognizing that interest on certain loans and securities is not taxed for Federal income tax purposes. The interest earned on these tax-exempt assets is adjusted to a pretax-equivalent amount based upon the marginal Federal income tax rate of 35%. Tax equivalent adjustment to net interest income was $176 for the nine months ended September 30, 2004. Non-accrual loans of 5,576 are included in the average balances.

Table 3 — Components of net interest income

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Provision for Loan Losses

The provision for loan losses represents the charge to income necessary to adjust the allowance 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 $592 or 59.7% to $399 in the third quarter of 2004 compared to $991 in the third quarter of 2003. The provision for loan losses for the nine month period ended September 30, 2004 was $1,349 as compared to $2,125 for the same period in 2003. This represents a $776 reduction or 36.5%. The provision for loan losses is influenced by not only the level of non performing assets but also by the Corporation’s level of classified assets and historical loan losses. During the past year the level of non performing loans have stabilized and classified loans have declined. The final result of this cycle is that charge-offs that were recorded in 2004 were a significant component of the increased 2003 provision for loan losses and are presented in Table 4. The table below is a summary of the Corporation’s loan loss experience for the three and nine months ended September 30, 2004 and 2003.

Table 4 – Allowance for loan losses

For more information see sections titled “Non-performing Assets” and “Allowance for Loan Losses”.

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Noninterest Income

Management views noninterest income as composed of core and non-core components. In general, core components include service charges on deposit accounts, electronic banking fees, investment, trust and brokerage income, income from investment in life insurance, and other banking fees. Non-core components include asset sales. Noninterest income for the third quarter of 2004 was $2,976, a decrease of $531 or 15.1% from $3,507 for the same quarter of 2003.

Core components totaled $2,516, a decrease of $118 or 4.5% from $2,634 for the same quarter of 2003. Investment, Trust and Brokerage Income has been particularly strong in 2004 and during the third quarter this revenue totaled $539, an increase of 10.9% from $486 during the same period in 2003. Account growth, fee adjustments and the improving financial markets all contributed to this increase. Offsetting a portion of this were slight declines in service charges on deposit accounts, electronic banking fees and income from investment in life insurance. Service charges on deposit accounts are typically composed of about 70% overdraft and return item charges. This 70% is sensitive to general economic conditions. With the local economy somewhat weak the level of economic activity is reflected in less transaction volume. This has a direct impact on the level of these fees. Electronic banking fees are driven by transaction volume and by the fees received from the processor. Transaction volume has been impacted by the local economy but has still been increasing, therefore management attributes this revenue weakness to a reduction in the per-item interchange fees that are earned from VISA. The Income from investment in life insurance is earned on the Corporation’s investment in Bank Owned Life Insurance. This is a long-term investment and the earnings are related to the level of interest rates. The income on this investment reflects the historically low rate environment.

Non-core components totaled $460 in the third quarter of 2004, a $413 decline from $873, or 47.3%, in the third quarter of 2003 due in part to the 2003 sale of the Corporation’s VISA credit card portfolio in which an $820 gain was recognized in the third quarter. In 2004 the Corporation sold the Avon Lake office building that had been vacated when the new Avon Lake office was opened earlier this year. The gain on this sale was $285. Also impacting the current quarter was Gain on sale of securities which totaled $158 as compared to a loss of $(1) in the same period last year. The securities sales were exclusively related to the liquidation of most of the non-rated municipal bond portfolio of the Corporation.

Noninterest income for the first nine months of 2004 was $8,428, a decrease of $636 or 7.0% from $9,064 for the same period in 2003.

Core components totaled $7,662, an increase of $62 or .8% from $7,600 for the same nine month period in 2003. The same factors that describe the third quarter performance are generally applicable to the nine month period comparison. Investment, trust and brokerage income has been very strong, while other components of fee income have been down slightly on a year-over-year comparison.

Non-core components totaled $766 for the nine months ended September 30, 2004, a decline of $698 from the same period in 2003. The same general factors that explain the third quarter performance explain this change.

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Noninterest Expense

Noninterest expense for the third quarter of 2004 was $6,764, an increase of $374 or 5.9%, from $6,390 reported for the same quarter of 2003. With the exception of Salaries and employee benefits all categories of expenses contributed to this increase. The largest increases were in net occupancy expenses and furniture and equipment expense which reflect the two new offices, as well as expenses related to necessary repairs to the main office and the operations center, and the continuing network upgrade project. Professional services were $306 for the third quarter of 2004, an increase of $57 from $249 during the same period last year. Legal fees are down from 2003 levels, but costs related to compliance are up due to SOX 404 and similar regulations. The efficiency ratio was 65.0% for the third quarter of 2004, up from 57.9% for the same quarter last year. Higher quarterly noninterest expenses and slightly lower revenue contributed to this result.

Noninterest expense for the nine month period ended September 30, 2004 was $19,018, an increase of $407 or 2.2%, from $18,611 reported for the same period of 2003. The same trends in the expense components highlighted in the quarter over quarter comparison are present in the nine month comparison. The Corporation expects that professional services related to audit and compliance will continue to trend up, while net occupancy and furniture and equipment expenses should begin to moderate.

Income Taxes

The provision for income taxes for the third quarter and first nine months of 2004 were $911 and $2,674 respectively. This represents reductions from $985 and $3,106 for the same periods in 2003. These reductions are attributable to lower pretax income and the impact of North Coast Community Development Corporation (NCCDC) activities that have begun to generate tax credits in 2004.

North Coast Community Development Corporation is a subsidiary of Lorain National Bank. It was formed in late 2002 as a Community Development Corporation (CDC) in order to make investments in low income census tracts and to apply for the related Federal tax credits made available to such CDC’s. NCCDC was awarded tax credits in late 2003 for investments up to $9 million.

In 2004, despite the weak local economy, NCCDC was capitalized for $4.5 million, and at September 30, 2004 had approved several qualified investments and thereby have generated tax credits in 2004. The impact of these credits reduced the Corporation’s effective tax rate to 29.5% for the three month period ended September 30, 2004 as compared to 30.5% for the same period in 2003. The effective tax rate for the nine month period ended September 30, 2004 was 29.8% a decrease from 31.1% for the same period in 2003.

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Financial Condition (Dollars in thousands)

At September 30, 2004, total assets were $770,794, an increase of $29,573 from December 31, 2003. This increase is attributable to increases in loans of $32,126. This growth in loans was funded by sales from the securities portfolio and by increased borrowings, including Federal Home Loan Bank advances, of $5.8 million or 8.1%. During the quarter all held to maturity securities were moved to the available for sale category. The transfer brings the securities portfolio more in line with its primary purpose of providing liquidity. Total deposits increased 3.6% or $21.1 million, to $602,391 at September 30, 2004 when compared to December 31, 2003. This increase in deposits was primarily due to growth in non interest bearing deposits and time deposits. Shareholders’ equity totaled $70,609 at September 30, 2004, increasing $2,474 from December 31, 2003. Net retained earnings (net income less cash dividends) for the nine months ended September 30, 2004 totaled $2,728. Accumulated other comprehensive income (loss) was $(1,292), which represents a change from December 31, 2003 of $588. This was due to a decrease in the market value of securities available for sale. The net effect of the issuance of Treasury stock under stock option plans was $334.

Components of the Loan Portfolio

Loans are generally reported at the principal amount outstanding, net of unearned income. Loans held for sale are valued on an aggregate basis at the lower of carrying amount or fair value. Interest income is recognized on the accrual basis. Loan origination fees, certain direct costs, and unearned discounts are deferred and amortized into interest income as an adjustment to the yield over the term of the loan. Loan commitment fees are generally deferred and amortized into fee income on a straight-line basis over the commitment period. Other credit related fees, including letter and line of credit fees are recognized as fee income when earned.

Table 5 presents the components of total loans at September 30, 2004, December 31, 2003 and September 30, 2003.

Table 5 — Loan Portfolio

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Nonperforming Assets

The level of nonperforming assets at September 30, 2004 is down $42 from the level at December 31, 2003, and down $347 from the level at June 30, 2004. Management believes nonperforming assets are well collateralized. Table 6 presents the level of nonperforming assets and respective ratios at the end of the last five calendar quarters.

Commercial loans secured by real estate are designated as non-performing when either principal or interest payments are 90 days or more past due, terms are renegotiated below market level, or when an individual analysis of a borrower’s credit worthiness indicates a credit should be placed on nonperforming status.

Consumer loans are subject to mandatory charge-off at a specific delinquency date and except for residential real estate loans, are not classified as nonperforming prior to being charge-off. Closed-end consumer loans, which include installment and student loans are generally charged-off in full no later than 120 days past due.

Table 6 — Nonperforming Assets

Classified loans which are performing but have concerns regarding the ability of the borrower to comply with present loan repayment terms, excluding nonperforming loans, approximated $20,321, $22,836, $23,242 and $21,747 at September 30, 2004, June 30, 2004, March 31, 2004 and December 31, 2003, respectively, and are being closely monitored by management and the Board of Directors. The amounts include results from a loan-by-loan evaluation of loans classified as “special mention”, “substandard” and “doubtful”, but are not included in the nonperforming loan category. The classification of these loans, however, does not imply that management expects losses on each of these loans, but believes that a higher level of scrutiny is prudent under the circumstances. These loans require close monitoring despite the fact that they are currently performing. Such classifications relate to specific concerns relating to each individual borrower and do not relate to any concentrated risk elements common to all loans in this group.

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