Form 10-Q

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

OR

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

Commission file number: 0-13203

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

Not Applicable
(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, and (2) has been subject to such requirements for the past 90 days. YES þ NO o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) YES þ 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 April 30, 2005: 6,641,173 shares
Class of Common Stock: $1.00 par value

LNB Bancorp, Inc.
Table of Contents

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Consolidated Balance Sheets (unaudited)

See Notes Consolidated Financial Statements

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Consolidated Statements of Income (unaudited)

See Notes to Consolidated Financial Statements

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Consolidated Statements of Shareholders’ Equity (unaudited)

See Notes to Consolidated Financial Statements

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Consolidated Statements of Cash Flows (unaudited)

See Notes to Consolidated Financial Statements

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Summary of Significant Accounting Policies

Consolidation

Use of Estimates

Segment Information

Statement of Cash Flows

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Securities

Federal Reserve Bank (FRB) and Federal Home Loan Bank (FHLB) Stock

Loans

     Held for sale loans are carried at the lower of amortized cost or estimated fair value, determined on an aggregate basis for each type of loan available for sale. Net unrealized losses are recognized by charges to income. Gains and losses on loan sales (sales proceeds minus carrying value) are recorded in noninterest income.

     Loans are generally placed on nonaccrual status (1) when they are 90 days past due for interest or principal, (2) when the full and timely collection of interest or principal becomes uncertain or (3) when part of the principal balance has been charged off. When a loan has been placed on nonaccrual status, the accrued and unpaid interest receivable is reversed to interest income. Generally, a loan is returned to accrual status (a) when all delinquent interest and principal becomes current under the terms of the loan agreement or (b) when the loan is both well-secured and in the process of collection and collectibility is no longer doubtful.

     A loan is considered impaired, based on current information and events, if it is probable that the Bank will not be able to collect the amounts due according to the loan contract, including scheduled interest payments. The measurement of impaired loans is generally based on the present value of the expected future cash flows discounted at initial effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. If the loan valuation is less than the recorded investment in the loan, an impairment allowance is established for the difference.

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Allowance for Loan Losses

     The provision for loan losses is determined based on Management’s evaluation of the loan portfolio and the adequacy of the allowance for loan losses under current economic conditions and such other factors which, in Management’s judgment, deserve current recognition. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize additions to the allowance for loan losses based on their judgments about information available to them at the time of their examinations.

Bank Premises and Equipment

Goodwill and Core Deposit Intangibles

     Core deposit intangible assets which have finite lives continue to be amortized using an accelerated method over ten years and are subject to annual impairment testing.

Income Taxes

Comprehensive Income

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Stock-Based Compensation

Reclassifications

2. New Accounting Pronouncements

SFAS No. 123(revised) “Share Based Payment”

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

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

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Investments” (“EITF 03-01”). EITF 03-01 provides guidance for determining when an investment is considered impaired, whether impairment is other-than-temporary, and measurement of an impairment loss. An investment is considered impaired if the fair value of the investment is less than its cost. Generally, an impairment is considered other-than-temporary unless the investor has the ability and intent to hold the investment for a reasonable period of time sufficient for the forecasted recovery of fair value up to (or beyond) the cost of the investment, and evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. If impairment is determined to be other-than-temporary, then an impairment loss should be recognized through earnings equal to the difference between the investment’s cost and its fair value. In September 2004, the FASB delayed the accounting requirements of EITF 03-01 until additional implementation guidance is issued and goes into effect. The Corporation does not expect the requirements of EITF 03-01 to have a material impact on the Corporation’s results of operations, financial position or liquidity.

3. Earnings Per Share

     Basic earnings per share is computed by dividing income by the weighted average number of shares outstanding during the year. Diluted earnings per share is computed based on the weighted average number of shares outstanding plus the effects of dilutive stock options outstanding during the year. All outstanding options were anti-dilutive at March 31, 2005.

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4. Securities

     The amortized cost, gross unrealized gains and losses and fair values of securities at March 31, 2005 and December 31, 2004 were as follows:

5. Loans

     Loan balances at March 31, 2005 and December 31, 2004 are summarized as follows:

6. Retirement Pension Plan

     The net periodic pension costs charged to expense amounted to $25 in the period ending March 31, 2005 and $19 in the period ending March 31, 2004. The following table sets forth the net periodic pension and total pension expense for the periods ended March 31, 2005 and 2004. Effective December 31, 2002, the benefits under the Plan were frozen and no additional benefits are accrued under the Plan after December 31, 2002.

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7. Stock Option Plans

     At December 31, 2004 all options issued under qualified incentive stock option plans had been issued or had expired.

     At March 31, 2005, the Corporation had nonqualified stock option agreements with two executives, granted in 2004 and 2000. Exercise prices for these nonqualified options outstanding as of March 31, 2005, ranged from $19.21 to $19.60. The weighted average remaining contractual life of the nonqualified incentive stock option agreements is 6.2 years. Stock option activity follows:

     Had compensation cost for the Corporation’s stock-based compensation agreements been determined consistent with SFAS No. 123, net income and net income per share would have been as summarized below. No stock based compensation, as defined by the provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation” was generated under any of the Corporation’s stock-based benefit agreements during the first quarter of 2005.

     The fair value of the options granted in 2004 and 2000 is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:

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     The table below shows the proforma net income effect, if the fair value of these stock options were expensed.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION RESULTS OF OPERATIONS

FINANCIAL REVIEW

     The financial review section discusses the financial condition and results of operations of the Corporation for the three months ended March 31, 2005 and serves to update the 2004 Annual Report on Form 10-K. The financial review should be read in conjunction with the financial information contained on Form 10-K and in the accompanying consolidated financial statements and notes on this Form 10-Q.

Introduction

     For the three months ended March 31, 2005, net income was $1.6 million compared to $2.3 million in the three months ended March 31, 2004. Net interest income and noninterest income both increased in the quarter as compared to the same period in 2004. These improving revenue trends, however, were more than offset by substantial increases in many components of noninterest expense. These components included salaries and benefits, marketing and public relations, and net occupancy expenses.

     Portfolio loans increased 8.3% between March 31, 2005 and March 31, 2004. Nonperforming loans at March 31, 2005 increased by 33% from December 31, 2004 and by 22% from March 31, 2004.

     Total deposits increased 8.1% for the period ended March 31, 2005 as compared to March 31, 2004. There was growth in demand, interest bearing and time deposits. Growth continued in the first quarter of 2005 as compared to December 31, 2004, with total deposits increasing $3.6 million. Historically the first quarter of the year is a period of weak deposit growth for the Corporation.

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Results of Operations (Dollars in thousands except per share data)

Net Interest Income

     Net interest income is the difference between interest income earned on interest-earning assets and the interest expense paid on interest-bearing liabilities. Throughout this discussion, net interest income is presented on a fully taxable equivalent (FTE) basis, which restates interest on tax-exempt securities and loans as if such interest was subject to federal income tax at the statutory rate of 35%. Net interest income is the most significant component of the Corporation’s revenue, accounting for 77% in the three months ended March 31, 2005. Net interest income is affected by changes in the volumes, rates and composition of interest-earning assets and interest-bearing liabilities. The net interest margin is net interest income as a percentage of average earning assets.

     Table 1 reflects the detailed components of the Corporation’s net interest income for the three months ended March 31, 2005 and 2004. The rates are computed on a tax equivalent basis and non-accrual loans are included in the average loan balances. Table 2 presents, for the periods indicated, a summary of the changes in interest earned and interest paid resulting from changes in volume and rates for the major components of interest-earning assets and interest-bearing liabilities on a fully taxable equivalent basis. The impact of changes in the mix of interest-earning assets and interest-bearing liabilities is reflected in net interest income.

Interest Income

     Total interest income (FTE) was $10,106 for the three months ended March 31, 2005. This is an increase of $1,081, or 12.0%, as compared to the three months ended March 31, 2004. Earning asset growth was responsible for $422 of this increase. Growth in average commercial loans of $43.3 million and average growth of $10.6 million in installment and home equity loans were the primary drivers of earning asset growth. Offsetting a portion of this growth was the continued runoff of real estate mortgage loans and a decline of $5 million in average securities. Interest income also was positively impacted by the current rate environment. The yield on average earning assets was 5.64% in the first three months of 2005 as compared to 5.23% in the same period in 2004. The Corporation’s commercial and home equity loan portfolios are primarily variable rate. Most of these loans are tied to the prime rate; consequently with the increases in the prime rate over the last two quarters, the yield on these portfolios improved 71 and 60 basis points respectively in the first quarter of 2005 as compared to the same period in 2004. With the exception of real estate mortgages and tax exempt municipal securities, all other earning asset portfolios experienced improved yields as compared to the first quarter of 2004.

Interest Expense

     Total interest expense was $2,720 for the three months ended March 31, 2005. This is an increase of $614, or 29.2%, as compared to the three month period ended March 31, 2004. Average interest–bearing liabilities were $606.6 million in the first three months of 2005 as compared to $584.0 for the same period in 2004. This growth in average interest-bearing liabilities is responsible for $97 of the $614 increase in total interest expense. The growth in interest-bearing deposits was primarily certificates of deposit and money market accounts. Some of this growth was offset by lower borrowings which declined $8.7 million. Interest expense was also impacted by the current rate environment. The average cost of interest-bearing liabilities in the first quarter of 2005 was 1.82% as compared to 1.47% in the same period last year. Of the total interest expense increase of $614 between periods, $517 was due to increased rates. All components of interest bearing liabilities contributed to this result.

Net Interest Income

     Net interest income (FTE) was $7,386 in the first quarter of 2005, an increase of $467, or 6.7%, over the same period last year. The net interest margin (FTE) was 4.12% in the first quarter of 2005 as

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compared to 4.01% in the first quarter of last year. The trend in both net interest income and the net interest margin are expected to continue into the second quarter of 2005.

Table 1: Condensed Consolidated Average Balance Sheets — Interest, Rate, and Rate/ Volume differentials are stated on a Fully-Tax Equivalent (FTE) Basis.

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Table 2: Rate/Volume Analysis of Net Interest Income (FTE)

Noninterest Income

Table 3: Details on Noninterest Income

     Noninterest income increased $48, or 1.7%, in the three months ended March 31, 2005 compared to the same period in 2004. Revenue generated by Investment and Trust services was down 11.8% for the first quarter of 2005 as compared to the same period in 2004. This revenue is highly dependent upon the performance of the stock market which was weak in the first quarter of 2005. Deposit service charges were down 8.4% for the quarter as compared to the same period in 2004. The primary reason for this decrease was a lower level of overdraft fees in the current quarter as compared to the first quarter of 2004. As discussed in prior reports, electronic banking fees continue to decline due to changes in merchant processing and interchange income earned on debit card and ATM transactions. Offsetting these areas of weakness were gains on the sale of loans of $132, and the revenue generated by LNB Mortgage LLC of $370, which was acquired in September 2004. Gains on the sale of loans increased $95 in the first quarter of 2005 as compared to the same period in 2004. These gains were generated by the sale of two commercial loans. Other noninterest income was $161 in the first quarter of 2005 as compared to $64 in the same period of 2004. Other noninterest income includes commercial loan placement fees, a new revenue initiative started in the second half of 2004. Of this $97 increase in noninterest income, $86 was attributable to this activity.

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Noninterest Expense

Table 4: Details on Noninterest Expense

     Noninterest expense increased $1.7 million, or 28.4%, for the three months ended March 31, 2005 compared to the same period in 2004. The largest increases in noninterest expense related to salaries and employee benefits, net occupancy, outside services, marketing and public relations and other noninterest expense.

     The $940, or 30.9%, increase in salaries and employee benefits is attributable to several factors. First, LNB Mortgage, LLC added $361 to the salaries in the quarter. This company was acquired in the third quarter of 2004. Additionally, the Corporation recognized various costs related to the hiring of the new President and CEO in the first quarter.

     Net occupancy expense increased by $143, or 38.2%, for the three months ended March 31, 2005 versus the three months ended March 31, 2004. This increase was primarily related to the maintenance and renovation of the Corporation’s facilities.

     Outside services were $309 for the first three months of 2005 as compared to $234 in the same period last year. This increase was primarily due to higher audit and compliance expenses incurred to comply with section 404 of the Sarbanes-Oxley Act of 2002.

     Marketing and public relations increased by $128, or 71.5%, for the three months ended March 31, 2005 versus the three months ended March 31, 2004. In the current quarter, there was more activity for brand marketing and costs associated with the celebration of the Corporation’s 100th anniversary. These activities also impacted supplies and postage expense which increased 36.4% in the first quarter of 2005 as compared to the same period in 2004.

     Other expenses increased by $463, or 67.3%, for the three months ended March 31, 2005 versus the three months ended March 31, 2004. The increase in other expenses relates to increases in communications expenses of $171, or 121.3%, increases in loan and collection expenses of $152, or 155.1%, and increases in miscellaneous losses of $96, or 192.0%. Increases in communication expenses relate to the upgrade of the Corporation’s voice and data telecom system that began in September 2004 to provide enhanced service and reliability. The project is expected to be completed in the third quarter of 2005. Increases in loan and collection expense stem from increased commercial collection activity, and the activities of LNB Mortgage LLC. The increase in miscellaneous losses was primarily a single charge-off for an ATM loss of $82.

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Income taxes

     Income taxes decreased $351, or 36.2%, for the three months ended March 31, 2005 versus the three months ended March 31, 2004. The main reason for the decline is the decline in pretax income. The effective tax rate in the first three months of 2005 was 28.2% as compared to 30.0% for the same period in 2004. The change in the effective tax rate is due to the activities of North Coast Community Development, a bank subsidiary. This subsidiary generates tax credits by making qualified investments in economic development projects. The first of these credits was recognized in the second quarter of 2004.

Balance Sheet Analysis

Securities

     The maturity distribution of the Corporation’s securities portfolio for the three months ended March 31, 2005 is presented in Note 4 to the Consolidated Financial Statements. The Corporation continues to employ the securities portfolio to mitigate interest rate risk and manage its liquidity needs. Currently, the portfolio comprises approximately 43% U.S. Government agencies, 46% U.S. agency mortgage backed securities, 8% municipals, and 3% in other securities. Other securities are Federal Home Loan Bank stock and Federal Reserve Bank stock. At March 31, 2005 the securities portfolio had a net temporary $3.4 million unrealized loss, representing 2.4% of total securities. In the first quarter of 2005, FNMA and FHLMC preferred stock were sold, along with $500 in zero coupon municipals, and most remaining equity investments. The Corporation purchased $5 million of agency securities and $500 of municipal securities during the three months ended March 31, 2005.

Loans

     Total portfolio loans for the period ended March 31, 2005 were $574 million, or 8.3%, higher versus the comparable time period in 2004, and experienced an increase of $2 million, or .35%, from December 31, 2004. Commercial loans comprise 61.4% of total portfolio loans and have increased by $56 million, or 18.8%, versus the comparable period in 2004 and $16 million, or 4.7%, versus December 31, 2004. The growth in the commercial portfolio is a function of new business developments in emerging markets and an expanded lending effort into the Cuyahoga County market. Lorain County continues to struggle as the market’s recovery is slow and arduous.

     Consumer loans, consisting of installment loans and home equity loans, comprise 22.7% of total portfolio loans, an increase of $9 million, or 7.6%, from the period ended March 31, 2004, and an increase of $8.7 million, or 7.1%, from December 31, 2004. Consumer loans made to borrowers are on a both secured and unsecured basis dependent on the term and nature of the loan. The Corporation also purchases consumer loans from another institution in the Cleveland area. During the three months ended March 31, 2005, the Corporation purchased $4.8 million of these loans.

     Real estate mortgages comprise 15.9% of total portfolio loans. These loans decreased $16.6 million, or 15.3%, for the period ended March 31, 2005 versus the comparable period in 2004 and decreased $21 million, or 18.3%, from December 31, 2004. The decrease is primarily the result of all mortgage business being generated via the Corporation’s subsidiary LNB Mortgage, LLC. All production, both fixed and variable rate loans, generated by LNB Mortgage is sold in the secondary market.

Deposits

     Total deposits at March 31, 2005 were $609 million an increase of $3.5 million, or 1%, from December 31, 2004 and an increase of $45 million, or 8.0%, from March 31, 2004. Demand deposits and certificates of deposit represented the largest changes in total deposits.

     Deposit accounts and the generation of deposit accounts continue to be the primary source of funds within our market area. The Corporation offers various deposit products to both retail and business customers. However, this is not the only source of funding for the Corporation, albeit the primary

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source. The Corporation also utilizes its business sweep accounts to generate funds as well as tapping into the brokered CD market providing term funding rates comparable to other national market borrowings, which include the Federal Home Loan Bank of Cincinnati and the Federal Reserve Bank of Cleveland.

     Noninterest bearing deposits comprise 15.4% of total deposits providing a large concentration of low cost funding. Coupled with noninterest bearing deposits are savings accounts and interest bearing checking accounts that additionally contribute to low cost funding. However, the Corporation is increasingly dependent on brokered CDs and public fund CDs.

Borrowings

     The Corporation utilizes both short-term and long-term borrowings to assist in the growth of earning assets. For the Corporation, short-term borrowings include federal funds purchased and repurchase agreements. As of March 31, 2005 the Corporation had $22 million of short-term borrowings. This was a decrease of $9.3 million, or 29.3%, from December 31, 2004 and a decrease of $619, or 2.7%, from March 31, 2004. Long-term borrowings for the Corporation were at $75 million, an increase of $6 million, or 8.9%, from December 31, 2004 and a decrease of $15 million, or 16.4%, from March 31, 2004. Throughout the first three months of March 31, 2005, the Corporation realized $5.8 million of maturities from the Federal Home Loan Bank leading to a repayment of FHLB borrowings.

Regulatory Capital

     The Corporation continues to maintain a strong capital position. Total shareholders’ equity was $68,356, at March 31, 2005, a decrease of $2,218, or 3.1%, from December 31, 2004. This decrease resulted primarily from $1,571 of net income generated for the three months ended March 31, 2005 less cash dividends payable to shareholders of $1,195. The first quarter change in intermediate term interest rates caused a decrease in the fair value of available for sale securities which resulted in a decrease in shareholders’ equity within accumulated other comprehensive income of $2,595 for the three months ended March 31, 2005. As of March 31, 2005, the Corporation held 125,686 shares of common stock as treasury stock at a cost of $2,430.

     The Corporation and the Bank continue to monitor growth to stay within the constraints established by applicable regulatory authorities. Under Federal banking regulations, at March 31, 2005 and December 31, 2004, the Corporation and Bank maintained capital ratios consistent with guidelines to be deemed well-capitalized. These capital positions for the Corporation and the Bank are presented in Table 5.

Table 5 — Capital Ratios

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

RISK ELEMENTS

     Risk management is an essential aspect to operate a financial services company successfully and effectively. The most prominent risk exposures, for a financial services company, are credit, residual, operational, interest rate, market, and liquidity risk. Credit risk involves the risk of uncollectible interest

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and principal balance on a loan when it is due. Residual risk involves the potential end-of-term value of leased assets or related cash flows on asset securitizations or other off balance sheet structures. Fraud, legal and compliance issues, processing errors, technology and the related disaster recovery, and breaches in business continuation and internal controls are types of operational risks. Changes in interest rates affecting net interest income are considered interest rate risks. Market risk is the risk that a financial institution’s earnings and capital or its ability to meet its business objectives are adversely affected by movements in market rates or prices. Such movements include fluctuations in interest rates, foreign exchange rates, equity prices that affect the changes in value of available-for-sale securities, credit spreads, and commodity prices. The inability to fund obligations due to investors, borrowers, or depositors is liquidity risk. For the Corporation, the dominant risks are market risk, specifically our exposure to changes in interest rates, and credit risk.

Credit Risk Management

     Uniform underwriting criteria, ongoing risk monitoring and review processes, and well-defined, centralized credit policies dictate the management of credit risk for the Corporation. As such, credit risk is managed through the Bank’s loan loss review policy which requires the loan officer, lending officers, and the loan review committee to manage loan quality. The Corporation’s credit policies are reviewed and modified on an ongoing basis in order to remain suitable for the management of credit risks within the loan portfolio as conditions change. The Corporation uses a loan rating system to properly classify and assess the credit quality of individual commercial loan transactions. The loan rating system is used to determine the adequacy of the allowance for loan losses for regulatory reporting purposes and to assist in the determination of the frequency of review for credit exposures.

     Credit quality was stable for the three months ended March 31, 2005 as compared to the same period in 2004. General economic conditions have contributed to improved credit quality, but a more stringent and defined credit review policy has been the driving force for the decline.

Nonperforming Assets

     Total nonperforming assets consist of nonperforming loans, loans which have been restructured, and other foreclosed assets. As such, any loan that is 90 days past due and/or in management’s estimation the collection of interest is doubtful are considered nonperforming. These loans no longer accrue interest and are accounted for on a cash basis. The classification of restructured loans involves the deterioration of a borrower’s financial ability thus leading to original terms being favorably modified or either principal or interest has been forgiven.

     Nonperforming loans at March 31, 2005 were $6.6 million, an increase of $1.7 million, or 32.2%, from December 31, 2004 and an increase of $1.2 million or 16.9%, from March 31, 2004. At March 31, 2005, commercial, mortgage and consumer loans represented 81.5%, 14.5%, and 4%, of nonperforming loans, respectively. At December 31, 2004 these ratios were 66.1%, 22.7%, and 11.2% of commercial, mortgage, and consumer, respectively. The increase in nonperforming loans is attributable to the classification of two commercial loan customers as nonaccrual. Although payments are current on these loans, other loans to these customers are nonperforming, and management felt that it was prudent to put these two commercial loans on nonaccrual. Nonperforming trends in all other loan portfolios during the quarter were improved.

     Nonperforming assets at March 31, 2005 compared to December, 31, 2004, and March 31, 2004 increased by $1.7 million, and $1 million, respectively due to an increase in nonaccrual loans of $1.7 million, and $1.2 million, respectively, and an increase in other foreclosed assets of $56 versus December 31, 2004 and a decrease of $186 versus March 31, 2004. Nonperforming loans at March 31, 2005 are substantially secured by commercial real estate and did not have a material impact on interest income for the three months ended March 31, 2005. The overall quality of the portfolio remains good as the ratio of nonperforming loans to total loans is at 1.14% at March 31, 2005 as compared to .93% at

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March 31, 2004. Additionally, there were no particular industry or geographic concentrations in nonperforming or delinquent loans or net charge-offs.

     The Corporation’s credit policies are reviewed and modified on an ongoing basis to remain suitable for the management of credit risks within the loan portfolio as conditions change. At March 31, 2005 there were no significant concentrations of credit risk in the loan portfolio.

     Table 6 sets forth nonperforming assets for the periods ended March 31, 2005 and December 31, 2004.

Table 6: Nonperforming Assets

Provision and Allowance for Loan Losses

     The allowance for loan losses in maintained by the Corporation at a level considered by management to be adequate to cover probable credit losses inherent in the loan portfolio. The amount of the provision for loan losses charged to operating expenses is the amount necessary, in the estimation of management, to maintain the allowance for loan losses at an adequate level. Management determines the adequacy of the allowance based upon past experience, changes in portfolio size and mix, relative quality of the loan portfolio and the rate of loan growth, assessments of current and future economic conditions, and information about specific borrower situations, including their financial position and collateral values, and other factors, which are subject to change over time. While management’s periodic analysis of the allowance for loan losses may dictate portions of the allowance be allocated to specific problem loans, the entire amount is available for any loan charge-offs that may occur. Table 7 presents the detailed activity in the allowance for loan losses and related charge-off activity for the three months ended March 31, 2005 and March 31, 2004, respectively.

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Table 7: Analysis of Allowance for Loan Losses

     The allowance for loan losses on March 31, 2005 was $7.5 million, or 1.30%, of outstanding loans, compared to $7,819, or 1.46% of outstanding loans at March 31, 2004. The provision charged to expense was $399 for the three months ended March 31, 2005, and $525 for the three months ended March 31, 2004. This is a $126, or 24% decrease in the provision for loan losses in the first quarter of 2005 as compared to the same period in 2004. This decline reflects the stabilizing trends in potential problems loans that began about mid-year 2004 and continued into the first quarter of 2005. Net charge-offs for the three months ended March 31, 2005 were $240, as compared to $436 for the three months ended March 31, 2004. Net charge-offs in the first quarter of 2005 were down 45% from the same period in 2004. Charge-offs in the first quarter of 2005 were in-line with expectations, and reflect better charge-off experience in all portfolios as compared to the same period in 2004. The provision for the three months ended March 31, 2005 was, in the opinion of management, adequate when factoring the improving charge-off trends with the deterioration of nonperforming loans in the quarter. The Corporation continues to aggressively address potential problem loans, and underwriting standards continue to been adjusted in response to trends and asset review findings.

Market Risk Management

     The Corporation manages market risk through its Asset/Liability Management Committee (“ALCO”) at the Bank level. This committee assesses interest rate risk exposure through two primary measures: rate sensitive assets divided by rate sensitive liabilities and earnings-at-risk simulation of net interest income.

     The difference between a financial institution’s interest rate sensitive assets and interest rate sensitive liabilities is referred to as the interest rate gap. An institution that has more interest rate sensitive assets than interest rate sensitive liabilities in a given period is said to be asset sensitive or has a positive gap. This means that if interest rates rise a corporation’s net interest income may rise and if interest rates fall its net interest income may decline. If interest sensitive liabilities exceed interest sensitive assets then the opposite impact on net interest income may occur. The usefulness of the gap measure is limited. It is important to know the gross dollars of assets and liabilities that reprice in

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various time horizons, but without knowing the frequency and basis of the potential rate changes its predictive power is limited.

     Two more useful tools in managing market risk are earnings-at-risk simulation and economic value of equity simulation. An earnings at risk analysis is a modeling approach that combines the repricing information from gap analysis, with forecasts of balance sheet growth and changes in future interest rates. The result of this simulation provides management with a range of possible net interest margin outcomes. Trends that are identified in earnings-at-risk simulation can help identify product and pricing decisions that can be made currently to assure stable net interest income performance in the future. At March 31, 2005, a “shock” treatment of the balance sheet, in which a parallel shift in the yield curve occurs and all rates increase immediately, indicates that in a +200 basis point shock, net interest income would increase 9.7% and in a
- -200 basis point shock, net interest income would increase 14.0%. The reason for the lack of symmetry in these results is the implied floors in many of the Corporation’s core funding which limits their downward adjustment from current offering rates. This analysis is done to describe a best or worst case scenario. Factors such as non-parallel yield curve shifts, management pricing changes, customer preferences and other factors are likely to produce different results.

     The economic value of equity approach measures the change in the value of the Corporation’s equity as the value of assets and liabilities on the balance sheet change with interest rates. At March 31, 2005, this analysis indicated that a +200 basis point change in rates would reduce the value of the Corporation’s equity by 4.6%, while a -200 basis point change in rates would increase the value of the Corporation’s equity by 9.3%.

Critical Accounting Policy and Estimates

     The Corporation’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. It follows general practices within the banking industry and application of these principles requires management to make assumptions, estimates and judgments that affect the financial statements and accompanying notes. These assumptions, estimates and judgments are based on information available as of the date of the financial statements.

     The most significant accounting policies followed by the Corporation are presented in Note 1 of the Consolidated Financial Statement in the December 31, 2004 Form 10-K. These policies are fundamental to the understanding of results of operation and financial conditions. The accounting policies considered to be critical by management are as follows:

Allowance for loan losses

     The allowance for loan losses is an amount that management believes will be adequate to absorb probable credit losses inherent in the loan portfolio, taking into consideration such factors as past loss experience, changes in the nature and volume of the portfolio, overall portfolio quality, loan concentrations, specific problem loans, and current economic conditions that affect the borrower’s ability to pay. Determination of the allowance is subjective in nature. Loan losses are charged off against the allowance when management believes that the full collectability of the loan is unlikely. Recoveries of amounts previously charged-off are credited to the allowance.

     A loan is considered impaired when it is probable that not all principal and interest amounts will be collected according to the loan contract. Residential mortgage, installment and other consumer loans are evaluated collectively for impairment. Individual commercial loans exceeding size thresholds established by management are evaluated for impairment. Impaired loans are recorded at the loan’s fair value by the establishment of a specific allowance where necessary. The fair value of all loans currently

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evaluated for impairment are collateral-dependent and therefore the fair value is determined by the fair value of the underlying collateral.

     The Corporation maintains the allowance for loan losses at a level adequate to absorb management’s estimate of probable credit losses inherent in the loan portfolio. The allowance is comprised of a general allowance, a specific allowance for identified problem loans and an unallocated allowance representing estimations done pursuant to either Standard of Financial Accounting Standards (SFAS) No. 5 “Accounting for Contingencies,” or SFAS 114, “Accounting by Creditors for Impairment of a Loan.”

     The general allowance is determined by applying estimated loss factors to the credit exposures from outstanding loans. For commercial and commercial real estate loans, loss factors are applied based on internal risk grades of these loans. Many factors are considered when these grades are assigned to individual loans such as current and past delinquency, financial statements of the borrower, current net realizable value of collateral and the general economic environment and specific economic trends affecting the portfolio. For residential real estate, consumer and other loans, loss factors are applied on a portfolio basis. Loss factors are based on the Corporation’s historical loss experience and are reviewed for appropriateness on a quarterly basis, along with other factors affecting the collectibility of the loan portfolio.

     Specific allowances are established for all classified loans when management has determined that, due to identified significant conditions, it is probable that a loss has been incurred that exceeds the general allowance loss factor for those loans. The unallocated allowance recognizes the estimation risk associated with the allocated general and specific allowances and incorporates management’s evaluation of existing conditions that are not included in the allocated allowance determinations. These conditions are reviewed quarterly by management and include general economic conditions, credit quality trends and internal loan review and regulatory examination findings.

     Management believes that it uses the best information available to determine the adequacy of the allowance for loan losses. However, future adjustments to the allowance may be necessary and the results of operations could be significantly and adversely affected if circumstances differ substantially from the assumptions used in making the determinations

Pension accounting

     Four key variables are used for calculating the annual pension cost (1) size of employee population, (2) actuarial assumptions, (3) expected long-term rate of return on plan assets and (4) discount rate. Described below is the effect of each of the variables on the pension expense:

     Size of employee population has stayed relatively constant over the last few years, thereby causing pension cost relating to this variable to remain relatively stable.

     Actuarial assumptions are required for mortality rate, turnover rate, retirement rate, disability rate and the rate of compensation increases. These factors generally do not change over time, so the range of assumptions and their impact on pension expense is generally narrow.

     Expected long-term rate of return on plan assets are based on the balance in the pension asset portfolio at the beginning of the plan year and the expected long-term rate of return on that portfolio. The expected long-term rate of return is designed to approximate the actual long term rate of return on plan assets over time. The expected long-term rate of return is generally held constant so the pattern of income/expense recognition more closely matches the stable pattern of services provided by the employees over the life of pension obligation. In 2005 the expected long term rate of return on plan assets is 7.50%.

     A discount rate is used to determine the present value of the future benefit obligations. It reflects the rates available on long-term high quality fixed income debt instruments, reset annually on the measurement date. The discount rate being used in 2005 is 5.75%

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Income Taxes

     The Corporation’s income tax expense and related current and deferred tax assets and liabilities are presented as prescribed in SFAS No. 109 “Accounting for Income Taxes.” SFAS 109 requires the periodic review and adjustment of tax assets and liabilities based on many assumptions. These assumptions include predictions as to the Corporation’s future profitability, as well as potential changes in tax laws that could impact the deductibility of certain income and expense items. Since financial results could be significantly different than these estimates, future adjustments may be necessary to tax expense and related balance sheet accounts.

ITEM 4. CONTROLS AND PROCEDURES

     The Corporation’s management carried out an evaluation, under the supervision and with the participation of the chief executive officer and the chief financial officer, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, the “Exchange Act”) as of March 31, 2005, pursuant to the evaluation of these controls and procedures required by Rule 13a-15 promulgated under the Exchange Act. Based upon that evaluation, the chief executive officer along with the chief financial officer concluded that the Corporation’s disclosure controls and procedures as of March 31, 2005 are effective in alerting them, on a timely basis, to material information required to be included in the Corporation’s periodic filings with the Securities and Exchange Commission.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

     Not Applicable

Item 2. Changes in Securities and Use of Proceeds

Issuer Purchases of Equity Securities

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     The Corporation currently does not have any common share repurchase plans.

Item 3. Defaults Upon Senior Securities

     Not applicable.

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

     Not applicable.

Item 5. Other Information

     Not applicable.

Item 6. Exhibits and Reports on Form 8-K

     (a) The exhibits required by Item 601 (a) of Regulation S-K are contained in the Exhibit Index which is found on page 28 of this Form 
10-Q.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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LNB Bancorp, Inc.

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