Attached files

file filename
EX-23 - CONSENT - LSB FINANCIAL CORPlsb_10kex23.htm
EX-21 - SUBSIDIARIES - LSB FINANCIAL CORPlsb_10kex21.htm
EX-13 - ANNUAL REPORT - LSB FINANCIAL CORPlsb_10kex13.htm
EX-32 - SECTION 1350 CERTIFICATION - LSB FINANCIAL CORPlsb_10kex32.htm
EX-31.2 - CFO CERTIFICATION - LSB FINANCIAL CORPlsb_10kex312.htm
EX-31.1 - CEO CERTIFICATION - LSB FINANCIAL CORPlsb_10kex311.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

ý
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
For the fiscal year ended December 31, 2010
     
   
OR
     
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
   
For the transition period from ____________ to ____________

Commission file number:  0-25070

LSB FINANCIAL CORP.
(Exact name of registrant as specified in its charter)

INDIANA
 
35-1934975
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
     
101 Main Street, Lafayette, Indiana
 
47901
(Address of principal executive offices)
 
(Zip Code)

(765) 742-1064
(Registrant’s telephone number, including area code)

None
(Former name, former address and former fiscal year, if changed since last report)

 
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class:
 
Name of each exchange on which registered:
Common Stock, par value $0.01 per share
 
The NASDAQ Stock Market LLC
 
Securities registered pursuant to Section 12(g) of the Act:
 
None
 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
 
Yes o No ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
 
 
Yes o No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
 
Yes  ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
 
Yes  o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
 
ý


 
1

 


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

Large Accelerated Filer o
Accelerated Filer o
   
Non-Accelerated Filer o (Do not check if a smaller reporting company)
Smaller Reporting Company ý

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes  o No ý


As of June 30, 2010, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $14,889,564 based on the closing sale price as reported on the NASDAQ Global Market.

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

Class
 
Outstanding at March 15, 2011
Common Stock, $0.01 par value per share
 
1,553,525  shares
 

DOCUMENTS INCORPORATED BY REFERENCE

Document
 
Parts Into Which Incorporated
Annual Report to Shareholders for the Fiscal Year Ended December 31, 2010
 
Parts I and II
Proxy Statement for the Annual Meeting of Shareholders to be held April 20, 2011
 
Part III

Exhibit Index on Page E-1



 
2

 


LSB Financial Corp.
Form 10-K
Index



 
Page
   
Forward-Looking Statements                                                                                                                                
4
         
Part I
     
         
 
Item 1.
 
Business
5
 
Item 1A.
 
Risk Factors
32
 
Item 1B.
 
Unresolved Staff Comments
32
 
Item 2.
 
Properties
32
 
Item 3.
 
Legal Proceedings
32
 
Item 4.
 
(Removed and Reserved)
33
 
Item 4.5.
 
Executive Officers of the Registrant
33
         
Part II
     
         
 
Item 5.
 
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
33
 
Item 6.
 
Selected Financial Data
34
 
Item 7.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operation
34
 
Item 7A.
 
Quantitative and Qualitative Disclosures about Market Risk
34
 
Item 8.
 
Financial Statements and Supplementary Data
34
 
Item 9.
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
34
 
Item 9A.
 
Controls and Procedures
34
 
Item 9B.
 
Other Information
35
         
Part III
     
         
 
Item 10.
 
Directors, Executive Officers and Corporate Governance
35
 
Item 11.
 
Executive Compensation
36
 
Item 12.
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
36
 
Item 13.
 
Certain Relationships and Related Transactions, and Director Independence
36
 
Item 14.
 
Principal Accountant Fees and Services
36
         
Part IV
     
         
 
Item 15.
 
Exhibits and Financial Statement Schedules
37




 
3

 

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
 
This document, including information included or incorporated by reference, contains, and future filings by LSB Financial on Form 10-Q and Form 8-K and future oral and written statements by LSB Financial and our management may contain, forward-looking statements about LSB Financial and its subsidiaries which we believe are within the meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements include, without limitation, statements with respect to anticipated future operating and financial performance, growth opportunities, interest rates, cost savings and funding advantages expected or anticipated to be realized by management.  Words such as “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify these forward-looking statements.  Forward-looking statements by LSB Financial and its management are based on beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions of management and are not guarantees of future performance.  We disclaim any obligation to update or revise any forward-looking statements based on the occurrence of future events, the receipt of new information, or otherwise.  The important factors we discuss below and elsewhere in this document, as well as other factors discussed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operation” in our Annual Report to Shareholders attached to this Form 10-K as Exhibit 13 and identified in our filings with the Securities and Exchange Commission (“SEC”) and those presented elsewhere by our management from time to time, could cause actual results to differ materially from those indicated by the forward-looking statements made in this document.
 
The following factors, many of which are subject to change based on various other factors beyond our control, could cause our financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: 
 
·  
the strength of the United States economy in general and the strength of the local economies in which we conduct our operations;
 
·  
the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board;
 
·  
financial market, monetary and interest rate fluctuations, particularly the relative relationship of short-term interest rates to long-term interest rates;
 
·  
the timely development of and acceptance of new products and services of Lafayette Savings Bank and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors’ products and services;
 
·  
the willingness of users to substitute competitors’ products and services for our products and services;
 
·  
the impact of changes in financial services laws and regulations (including laws concerning taxes, accounting standards, banking, securities and insurance);
 
·  
the impact of  technological changes;
 
·  
acquisitions;
 
·  
changes in consumer spending and saving habits; and
 
·  
our success at managing the risks involved in the foregoing.
 

 
4

 

PART I
 
Item 1.   Business
 
General
 
LSB Financial Corp. (“LSB Financial” or the “Company”) is an Indiana corporation which was organized in 1994 by Lafayette Savings Bank, FSB (“Lafayette Savings” or the “Bank”) for the purpose of becoming a thrift institution holding company.  Lafayette Savings is a federally chartered stock savings bank headquartered in Lafayette, Indiana.  Originally organized in 1869, Lafayette Savings converted to a federal savings bank in 1984.  Lafayette Savings’ deposits are insured up to the applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (the “FDIC”).  In February 1995, Lafayette Savings converted to the stock form of organization through the sale and issuance of 1,029,576 shares of its common stock to LSB Financial.  LSB Financial’s principal asset is the outstanding stock of Lafayette Savings.  LSB Financial presently has no separate operations and its business consists only of the business of Lafayette Savings.  References in this Form 10-K to “we,” “us,” and “our” refer to LSB Financial and/or Lafayette Savings as the context requires.
 
We have been, and intend to continue to be, a community-oriented financial institution. Our principal business consists of attracting retail deposits from the general public and investing those funds primarily in permanent first mortgage loans secured by owner-occupied, one- to four-family residences, and to a lesser extent, non-owner occupied one- to four-family residential, commercial real estate, multi-family, construction and development, consumer and commercial business loans. We currently serve Tippecanoe County, Indiana and its surrounding counties through our five retail banking offices.  At December 31, 2010, we had total assets of $371.8 million, deposits of $311.5 million and shareholders’ equity of $35.6 million.
 
Our revenues are derived principally from interest on mortgage and other loans and interest on securities.
 
Our executive offices are located at 101 Main Street, Lafayette, Indiana 47901.  Our telephone number at that address is (765) 742-1064.
 
Market Area
 
Tippecanoe County and the eight surrounding counties comprise Lafayette Savings’ primary market area.  Lafayette is the county seat of Tippecanoe County and West Lafayette is the home of Purdue University.  The greater Lafayette area enjoys diverse employment including several major manufacturers including Subaru/Toyota, Caterpillar, and Wabash National; a strong education sector including Purdue University with 40,000 students and a large local campus of Ivy Tech Community College with over 8,000 students; government offices of Lafayette, West Lafayette and Tippecanoe County; a growing high-tech presence with the Purdue Research Park; and a growing medical corridor spurred by the building of two new hospitals. This diversity served to insulate us from some of the severity of the effects of economic downturns felt in other parts of the country. The Purdue Research Park includes about 364,000 square feet of incubation space, making it the largest business incubator complex in the state.
 
Based on a report from Greater Lafayette Commerce, manufacturing employment is slowly returning to pre-recession levels, healthcare facility growth is continuing at a record pace and Purdue University continues an aggressive construction agenda.  Capital investments announced and/or made in 2010 totaled $640 million compared to $341 million in 2009 and $593 million in 2008.  Wabash National, the area’s second largest industrial employer, reported fourth quarter operating results which were the best since 2007 and noted that forecasts for 2011 showed “an approximate increase of 30 to 60 percent over 2010 levels.”  Subaru, the area’s largest industrial employer and producer of the Subaru Legacy, Outback and Tribeca, announced the addition of 100 full-time production positions and projected 2010 volume to exceed 2009 by about 30%.
 
Tippecanoe County typically shows better growth and lower unemployment rates than Indiana or the national economy because of the diverse employment base.  The Tippecanoe County unemployment rate peaked at 10.6% in July 2009 and ended at 7.9% for 2010 compared to 9.5% for Indiana and 9.4% nationally.  The housing market has remained fairly stable for the last several years with no price bubble and no resulting price swings.  As of

 
5

 

December 31, 2010, the five year percent change in house prices according to the Federal Housing Finance Agency was a 1.89% increase with the one-year change a 0.99% increase.  The number of houses sold in the county in 2010 was down 7% from last year, influenced in part by the timing of the tax credits offered to new home buyers.  Building permits were virtually unchanged from last year and were in the same relatively low range for housing permits over the last four years.  Some of this slowdown is believed to be in reaction to earlier overbuilding in the county as well as the increase in available properties due to foreclosure.

Lending Activities
 
General.  Our principal lending activity is the origination of conventional mortgage loans for the purpose of purchasing, constructing, or refinancing owner-occupied one- to four-family residential real estate located in our primary market area.  We also originate non-owner occupied one- to four-family residential, multi-family and land development, commercial real estate, consumer and commercial business loans.
 
We originate both adjustable rate loans and fixed rate loans.  We generally originate adjustable rate loans for retention in our portfolio in an effort to increase the percentage of loans with more frequent repricing than traditional long-term fixed rate loans.  As a result of continued consumer demand for long-term fixed rate loans, we have continued to originate such loans.  We underwrite these mortgages utilizing secondary market guidelines allowing them to be salable without recourse.  The sale of these loans results in additional short-term income and improves our interest-rate risk position.  We generally retain servicing rights on loans sold to Freddie Mac, but release the servicing rights on loans sold to other third parties.  Furthermore, in order to limit our potential exposure to increasing interest rates caused by our traditional emphasis on originating single-family mortgage loans, we have diversified our portfolio by increasing our emphasis on the origination of short-term or adjustable rate multi-family and commercial real estate loans and commercial business and consumer loans.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Asset/Liability Management” in the Annual Report to Shareholders filed as Exhibit 13 to this Form 10-K.
 
Where a borrower’s aggregate indebtedness is less than $500,000 our loan officers and certain executive officers in combination with a senior loan officer have approval authority on individual loans up to $500,000 over certain minimum debt service coverage thresholds. Where a borrower’s aggregate indebtedness is less than $1.5 million our officers’ loan committee has approval authority on individual loans up to $500,000, also over certain minimum debt service coverage thresholds. The Board of Directors’ loan committee approves all individual loans over $500,000 and all loans where aggregate debt is over $1.5 million or where debt coverage is below certain minimum thresholds.  Any member of the loan committee may request a loan be moved to the Board of Directors’ loan committee for approval.  Any member of the Board of Directors’ loan committee may refer a loan to the full Board for approval.
 
At December 31, 2010, the maximum amount we could have loaned to any one borrower and the borrower’s related entities was $5.7 million. Our largest lending relationship to a single borrower or a group of related borrowers at December 31, 2010, totaled $5.4 million, consisting of one loan on multi-family properties, a secured commercial line of credit and a home equity loan.   The second largest lending relationship at December 31, 2010 to a single borrower or a group of related borrowers totaled $5.3 million, consisting of three loans on multi-family properties and a secured line of credit.  The third largest lending relationship to a single borrower or a group of related borrowers totaled $5.3 million, consisting of one loan on a commercial property and a secured commercial line of credit.  None of these loans was past due 30-89 days at December 31, 2010.  At December 31, 2010, we had 39 other loans or lending relationships to a single borrower or group of related borrowers with a principal balance in excess of $2.0 million.
 

 

 
6

 

Loan Portfolio Composition.  The following table sets forth information concerning the composition of our loan portfolio, including loans held for sale, in dollar amounts and in percentages of the total loan portfolio, before deductions for loans in process, deferred fees and discounts and allowances for losses.
 
   
December 31,
 
   
2006
   
2007
   
2008
   
2009
   
2010
 
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
Real Estate Loans
 
(Dollars in Thousands)
 
One- to four-family
  $ 142,045       43.70 %   $ 137,611       45.48 %   $ 145,442       43.43 %   $ 123,502       37.46 %   $ 125,121       37.46 %
Multi-family
    30,160       9.28       29,764       9.84       39,892       11.91       52,790       16.01       53,458       16.00  
Commercial
    74,710       22.98       71,601       23.67       90,606       27.06       90,571       27.47       90,395       27.06  
Land and land development
    18,466       5.68       18,067       5.97       17,756       5.30       17,192       5.21       14,510       4.34  
Construction
    19,228       5.91       9,741       3.22       11,436       3.42       13,002       3.95       15,957       4.78  
Total real estate loans
    284,609       87.55       266,784       88.18       305,132       91.12       297,057       90.10       299,441       89.65  
                                                                                 
Other Loans
                                                                               
Consumer loans:
                                                                               
Home equity
    16,276       5.01       14,018       4.63       13,610       4.06       14,698       4.46       17,043       5.10  
Home improvement
    417       0.13       315       0.10       174       0.05       124       0.04       ---       ---  
Automobile
    2,285       0.70       1,757       0.58       1,265       0.38       930       0.28       871       0.26  
Deposit account
    285       0.09       231       0.08       291       0.09       196       0.06       211       0.06  
Other
    267       0.08       136       0.04       113       0.03       71       0.02       126       0.03  
Total consumer loans
    19,530       6.01       16,457       5.44       15,453       4.62       16,019       4.86       18,251       5.46  
Commercial business  loans
    20,935       6.44       19,307       6.38       14,277       4.26       16,638       5.04       16,332       4.89  
Total other loans
    40,465       12.45       35,764       11.82       29,730       8.88       32,657       9.90       34,583       10.35  
Total loans
    325,074       100.00 %     302,548       100.00 %     334,862       100.00 %     329,714       100.00 %     334,024       100.00 %
                                                                                 
Less:
                                                                               
Loans in process
    4,167               1,581               4,180               4,383               5,107          
Deferred fees and discounts
    446               357               346               431               499          
Allowance for losses
    2,770               3,702               3,697               3,737               5,343          
Total loans receivable, net
  $ 317,691             $ 296,908             $ 326,639             $ 321,163             $ 323,075          


 
7

 

The following table shows the composition of our loan portfolio, including loans held for sale, by fixed and adjustable rate at the dates indicated.  The one- to four-family fixed rate loans include $5.4 million and $2.3 million of loans at December 31, 2008 and 2010, respectively, which carry a fixed rate of interest for the initial five or seven years and then convert to a one-year adjustable rate of interest for the remaining term of the loan.  There were no such loans included in 2009.
 
   
December 31,
 
   
2006
   
2007
   
2008
   
2009
   
2010
 
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
   
(Dollars in Thousands)
 
Fixed Rate Loans:
                                                           
Real estate:
                                                           
One- to four-family
  $ 41,105       12.65 %   $ 43,707       14.45 %   $ 56,814       16.97 %   $ 45,059       13.67 %   $ 51,621       15,46 %
Multi-family
    2,793       0.86       3,860       1.27       5,113       1.53       2,443       0.74       2,179       0.65  
Commercial
    10,797       3.32       13,753       4.55       23,794       7.11       21,611       6.55       14,825       4.44  
Construction
    1,989       0.61       5,223       1.73       1,405       0.42       2,660       0.81       4,625       1.38  
Land and land development
    7,358       2.26       2,305       0.76       3,216       0.96       4,698       1.42       5,108       1.53  
Total real estate loans
    64,042       19.70       68,848       22.76       90,342       26.98       76,471       23.19       78,358       23.46  
Consumer
    3,234       1.00       2,419       0.80       1,843       0.55       1,452       0.44       1,208       0.36  
Commercial business
    9,372       2.88       9,749       3.22       7,011       2.09       7,293       2.21       8,182       2.45  
Total fixed rate loans
    96,648       23.58       81,016       26.78       99,196       29.62       85,216       25.84       87,748       26.27  
                                                                                 
Adjustable Rate Loans:
                                                                               
Real estate:
                                                                               
One- to four-family
    100,940       31.05       93,904       31.04       88,628       26.47       78,443       23.79       73,500       22.00  
Multi-family
    27,367       8.42       25,904       8.56       34,780       10.39       50,347       15.27       51,278       15.35  
Commercial
    63,913       19.66       57,848       19.12       66,812       19.95       68,960       20.91       75,570       22.63  
Construction
    16,477       5.07       4,518       1.49       16,350       4.88       14,532       4.41       9,886       2.96  
Land and land development
    11,870       3.65       15,762       5.21       8,220       2.45       8,304       2.52       10,849       3.25  
Total real estate loans
    220,567       67.85       197,936       65.42       214,790       64.14       220,586       66.90       221,083       66.19  
Consumer
    16,296       5.01       14,039       4.64       13,610       4.06       14,568       4.42       17,043       5.10  
Commercial business
    11,563       3.56       9,557       3.16       7,266       2.17       9,345       2.84       8,150       2.44  
Total adjustable rate loans
    248,426       76.42       221,532       73.22       235,666       70.38       244,499       74.16       246,276       73.73  
Total loans
    325,074       100.00 %     302,548       100.00 %     334,862       100.00 %     329,714       100.00 %     334,024       100.00 %
                                                                                 
Less:
                                                                               
Loans in process
    4,167               1,581               4,180               4,383               5,107          
Deferred fees and discounts
    446               357               346               431               499          
Allowance for losses
    2,770               3,702               3,697               3,737               5,343          
Total loans receivable, net
  $ 317,691             $ 296,908             $ 326,639             $ 321,163             $ 323,075          


 
8

 

The following schedule illustrates the maturities of our loan portfolio at December 31, 2010.  Loans which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due.  The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses. 
 
   
Real Estate
                   
   
Mortgage(1)
   
Construction, Land and Land Development
   
Consumer
   
Commercial Business
   
Total
 
Due During Years
Ending December 31,
 
Amount
   
Weighted Average Rate
   
Amount
   
Weighted Average Rate
   
Amount
   
Weighted Average Rate
   
Amount
   
Weighted Average Rate
   
Amount
   
Weighted Average Rate
 
(Dollars in Thousands)
 
2011
  $ 8,265       5.82 %   $ 9,485       4.89 %   $ 1,702       4.39 %   $ 7,264       6.64 %   $ 26,716       5.62 %
2012 to  2015
    10,584       5.69       5,974       6.61       16,384       4.06       4,537       6.74       37,479       5.25  
2016 and following
    250,125       5.58       15,008       5.10       165       4.59       4.531       6.46       269,829       5.57  
TOTAL
  $ 268,974       5.59 %   $ 30,467       5.33 %   $ 18,251       4.10 %   $ 16,332       6.62 %   $ 334,024       5.54 %

(1) Includes one- to four-family, multi-family and commercial real estate loans.

The total amount of loans due to mature after December 31, 2011 which have fixed interest rates is $72.7 million, and which have adjustable or renegotiable interest rates is $234.6 million.
 
One- to Four-Family Residential Real Estate Lending
 
Our lending program focuses on the origination of permanent loans secured by mortgages on owner-occupied, one- to four-family residences. We also originate loans secured by non-owner occupied, one- to four-family residences.  Substantially all of these loans are secured by properties located in our primary market area.  We originate a variety of residential loans, including conventional 15- and 30-year fixed rate loans, fixed rate loans convertible to adjustable rate loans, adjustable rate loans and balloon loans.
 
Our one- to four-family residential adjustable rate loans are fully amortizing loans with contractual maturities of up to 30 years.  The interest rates on the majority of the adjustable rate loans originated by us are subject to adjustment at one-, three- or five-year intervals.  Our adjustable rate mortgage products generally carry interest rates which are reset to a stated margin over the weekly average of the one-, three- or five-year U.S. Treasury rates.  Increases or decreases in the interest rate of our one-year adjustable rate loans are generally limited to 2% annually with a lifetime interest rate cap of 6% over the initial rate.  Increases or decreases in the interest rate of three-year and five-year adjustable rate loans are limited to a 3% periodic adjustment cap with a 5% lifetime interest rate cap over the initial rate.  Our one-year adjustable rate loans may be convertible into fixed rate loans after the first year and before the sixth year upon payment of a fee, do not contain prepayment penalties and do not produce negative amortization.  Initial interest rates offered on our adjustable rate loans may be below the fully indexed rate.  Borrowers are generally qualified at 2% over the initial interest rate for our one-year adjustable rate loans and at the initial interest rate for our three-year and five-year adjustable rate loans.  We generally retain adjustable rate loans in our portfolio pursuant to our asset/liability management strategy.  Five-year adjustable rate mortgage loans represented $12.1 million, three-year adjustable rate mortgage loans represented $48.4 million and one-year and two-year adjustable rate mortgage loans represented $5.8 million of our adjustable rate mortgage loans at December 31, 2010.  We also offer a floating rate mortgage loan based on national prime rate, generally on non-owner-occupied residential loans.  These loans represented $2.2 million of our adjustable rate mortgage loans at December 31, 2010.
 

 
9

 

We offer fixed rate mortgage loans to owner-occupants with maturities up to 30 years and which conform to Freddie Mac standards.  We currently sell in the secondary market the majority of our long-term, conforming, fixed rate loans.  Loans designated as held for sale are carried on the balance sheet at the lower of cost or market value.  At December 31, 2010, we had $2.3 million of 1oans held for sale. See “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Asset/Liability Management” in the Annual Report to Shareholders filed as Exhibit 13 to this Form 10-K.  Interest rates charged on these fixed rate loans are priced on a daily basis in accordance with Freddie Mac pricing standards.  These loans do not include prepayment penalties.
 
We also offer 30-year fixed rate mortgage loans, which, after five or seven years, convert to our standard one-year adjustable rate mortgage for the remainder of the term.  Of these, $2.3 million have more than three years to their adjustments and are included in fixed rate loans and $4.9 million have less than three years to their adjustment date and are included in adjustable rate loans.
 
We had $62.6 million in non-owner occupied one- to four-family residential loans at December 31, 2010.  These loans are underwritten using the same criteria as owner-occupied, one- to four-family residential loans, but are provided at higher rates than owner-occupied loans. We offer fixed rate, adjustable rate and convertible rate loans, with terms of up to 30 years.
 
We originate residential mortgage loans with loan-to-value ratios of up to 95% for owner-occupied residential loans and up to 80% for non-owner occupied residential loans.  We typically require private mortgage insurance in an amount intended to reduce our exposure to 80% or less of the lesser of the purchase price or appraised value of the underlying collateral.  We occasionally originate FHA loans in excess of 95% loan-to-value, all of which are sold, with the servicing rights released, to a third party.
 
In underwriting one- to four-family residential real estate loans, we evaluate both the borrower’s ability to make monthly payments and the value of the property securing the loan.  Properties securing owner-occupied one- to four-family residential real estate loans that we make are appraised by independent fee appraisers. We require borrowers to obtain title insurance and fire insurance, extended coverage casualty insurance and flood insurance, if appropriate.  Real estate loans that we originate contain a “due on sale” clause allowing us to declare the unpaid principal balance due and payable upon the sale of the security property.
 
Multi-Family and Commercial Real Estate Lending
 
We originate permanent loans secured by multi-family and commercial real estate.  Our permanent multi-family and commercial real estate loan portfolio includes loans secured by apartment buildings, office buildings, churches, warehouses, retail stores, restaurants, shopping centers, small business facilities and farm properties, most of which are located within our primary market area.
 
Permanent multi-family and commercial real estate loans are originated as three-year and five-year adjustable rate loans with up to a 25-year amortization.  To a substantially lesser extent, such loans are originated as fixed rate or balloon loans or at a floating rate based on national prime rate, at terms up to 15 years.  The adjustable rate loans are tied to an index based on the weekly average of the three-year or five-year U.S. Treasury rate, respectively, plus a stated margin over the index.  Multi-family loans and commercial real estate loans have been written in amounts of up to 85% of the lesser of the appraised value of the property or the purchase price, and borrowers are generally personally liable for all or part of the indebtedness.
 
Appraisals on properties securing multi-family and commercial real estate loans originated in excess of $250,000 are performed by independent appraisers designated by us at the time the loan is made and reviewed by management.  Appraisals or evaluations are typically performed on properties securing multi-family and commercial real estate loans originated between $50,000 and $250,000. In addition, our underwriting procedures generally require verification of the borrower’s credit history, income and financial statements, banking relationships and income projections for the property.
 

 
10

 

Multi-family and commercial real estate loans generally present a higher level of risk than loans secured by one- to four-family residences.  This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income-producing properties and the increased difficulty of evaluating and monitoring these types of loans.  Furthermore, the repayment of loans secured by multi-family and commercial real estate is typically dependent upon the successful operation of the related real estate project.  If the cash flow from the project is reduced (for example, if leases are not obtained or renewed, or a bankruptcy court modifies a lease term, or a major tenant is unable to fulfill its lease obligations), the borrower’s ability to repay the loan may be impaired.
 
Construction, Land and Land Development Lending
 
We make construction loans to individuals for the construction of their residences as well as to builders and developers for the construction of one- to four-family residences, multi-family dwellings and commercial real estate projects.  At December 31, 2010, substantially all of these loans were secured by property located within our primary market area.
 
Construction loans to individuals for their residences typically run six to eight months and are generally structured to be converted to permanent loans at the end of the construction phase.  These construction loans are typically fixed rate loans, with interest rates higher than those we offer on permanent one- to four-family residential loans.  During the construction phase, the borrower pays interest only.  Residential construction loans are underwritten pursuant to the same guidelines used for originating permanent residential loans.  At December 31, 2010, we had $1.8 million of construction loans to borrowers intending to live in the properties upon completion of construction.
 
Construction loans to builders of one- to four-family residences generally have terms of six to eight months and require the payment of interest only at a fixed rate for the loan term.  We generally limit builders to one home construction loan at a time, but would consider requests for more than one if the homes are presold.  At December 31, 2010, we had $1.9 million of this type of construction loans to builders of one- to four-family residences.
 
We make construction loans to builders of multi-family dwellings and commercial projects with terms up to one year and require payment of interest only at a fixed rate for the construction phase of the loan.  These loans are generally structured to be converted to one of our permanent commercial loan products at the end of the construction phase.  At December 31, 2010, we had $9.9 million of loans to finance the construction of multi-family dwellings and commercial projects.  We also had $2.4 million of loans to builders of multi-family dwellings and commercial projects structured to run for the construction phase only.
 
We also make loans to builders for the purpose of developing one- to four-family lots and residential condominium projects.  These loans typically have terms of two to three years with interest rates tied to national prime.  The maximum loan-to-value ratio is 75%.  The principal in these loans is typically paid down as lots or units are sold.  These loans may be structured as closed-end revolving lines of credit with maturities of generally two years or less.  At December 31, 2010, we had $12.1 million of development loans to builders.  We also make land acquisition loans.  At December 31, 2010, we had $2.4 million in loans secured by land.
 
Construction and development loans are obtained principally through continued business from developers and builders who have previously borrowed from us, as well as referrals from existing customers and realtors, and walk-in customers.  The application process includes a submission to us of accurate plans, specifications and costs of the project to be constructed/developed which are used as a basis to determine the appraised value of the subject property.  Loans are based on the lesser of current appraised value or the cost of construction, which is the land plus the building. At December 31, 2010, our largest construction and development loan was a construction loan for a commercial building for $2.5 million.
 

 
11

 

Construction and land development loans generally present a higher level of risk than loans secured by one- to four-family residences.  Because of the uncertainties inherent in estimating land development and construction costs and the market for the project upon completion, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, the related loan-to-value ratios and the likelihood of ultimate success of the project.  Construction and land development loans to borrowers other than owner-occupants also involve many of the same risks discussed above regarding multi-family and commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans.  We had $2.5 million non-performing land loans at December 31, 2010 and no non-performing construction and development loans.
 
Consumer Lending
 
We originate a variety of different types of consumer loans, including home equity loans, direct automobile loans, home improvement loans, deposit account loans and other secured and unsecured loans for household and personal purposes.  Consumer loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower.  The largest component of consumer lending is home equity loans, which totaled $17.0 million or 5.1% of the total loan portfolio at December 31, 2010.  We are currently offering a revolving line of credit home equity loan on which the total commitment amount, when combined with the balance of the first mortgage lien and other priority liens, may not exceed 90% of the appraised value of the property, with a ten-year term and minimum monthly payment requirement of interest only.  At December 31, 2010, we had $15.1 million of unused credit available under our home equity line of credit program.
 
Our underwriting standards for consumer loans include a determination of the applicant’s payment history on other debts and the applicant’s ability to meet existing obligations and payments on the proposed loan.  Although creditworthiness of the applicant is of primary consideration, our underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.  Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles.  In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.  In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances.  Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.
 
Commercial Business Lending
 
Our current commercial business lending activities encompass predominantly secured and unsecured lines of credit and loans secured by small business equipment and vehicles.  At December 31, 2010, we had $1.4 million of unsecured loans and lines of credit outstanding (with $3.5 million of unused credit available) and $14.9 million of loans and lines of credit (with $5.7 million of unused credit available) secured by inventory or accounts receivable, small business equipment and vehicles.  We also had $663,000 of unused credit available on letters of credit.
 
Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income and which are secured by real property the value of which tends to be more easily ascertainable, commercial business loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.  As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself, which is likely to be dependent upon the general economic environment.  Our commercial business loans are sometimes, but not always, secured by business assets.  However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.
 
We recognize the increased risks associated with commercial business lending.  Our commercial business lending policy emphasizes credit file documentation and analysis of the borrower’s character, capacity to repay the loan, the adequacy of the borrower’s capital and collateral as well as an evaluation of the industry conditions affecting the borrower.  Analysis of the borrower’s past, present and future cash flows is also an important aspect of our credit analysis.
 

 
12

 

Loan Originations, Purchases and Sales
 
Real estate loans are originated by our staff of salaried loan officers and our residential mortgage loan originators who receive applications from existing customers, walk-in customers, referrals from realtors and other outreach programs.  While we originate both adjustable rate and fixed rate loans, our ability to originate loans is dependent upon the relative customer demand for loans in our market.  Demand is affected by the interest rate environment.  Currently, the majority of conforming fixed rate residential mortgage loans with maturities of 15 years and over are originated for sale in the secondary market.  Based on our interest-rate risk considerations, we occasionally will keep fixed rate residential mortgage loans in our portfolio to generate income and to be available for substitution in the event a loan committed for sale fails to close as expected.  Residential loans originated for sale are sold either to Freddie Mac while we retain the servicing rights, or to BB&T or other secondary market mortgage purchasers with servicing released.  These loans are originated to satisfy customer demand and to generate fee income and are sold to achieve the goals of our asset/liability management program.
 
When loans are sold to Freddie Mac, we retain the responsibility for collecting and remitting loan payments, inspecting the properties, making certain that insurance and real estate tax payments are made on behalf of borrowers, and otherwise servicing the loans. We receive a servicing fee for performing these services.  We serviced mortgage loans for others totaling $119.3 million at December 31, 2010.
 
In periods of rising interest rates, our ability to originate large dollar volumes of real estate loans may be substantially reduced or restricted, with a resultant decrease in related operating earnings.  In addition, our ability to sell loans may substantially decrease as potential buyers reduce their purchasing activities.
 
We occasionally purchase a limited amount of participation interests in real estate loans from other financial institutions outside our primary market area.  We review and underwrite all loans to be purchased to insure that they meet our underwriting standards.
 

 
13

 

The following table shows our loan and mortgage-backed security origination, purchase, sale and repayment activities for the periods indicated. One- to four-family fixed rate loans for 2010 include $1.4 million of loans originated which carry a fixed rate of interest for the initial five or seven years and then convert to a one-year adjustable rate of interest for the remaining term of the loan.
 
   
Year Ended December 31,
   
2008
   
2009
2010
   
(In Thousands)
Originations by Type:
                 
Adjustable rate:
                 
Real estate
                 
One- to four-family
  $ 11,041     $ 1,478     $ 7,729  
Multi-family
    18,758       15,183       1,776  
Commercial
    19,979       13,955       14,577  
Construction, land and land development
    10,675       4,568       7,848  
Non-real estate
                       
Consumer
    ---       1,233       5,441  
Commercial business
    4,688       3,782       1,473  
Total adjustable rate
    65,141       40,199       38,844  
Fixed rate:
                       
Real estate
                       
One- to four-family
    32,701       75,716       68,700  
Multi-family
    906       ---       81  
Commercial
    8,434       2,410       828  
Construction, land and land development
    3,689       3,098       3,696  
Non-real estate
                       
Consumer
    564       3,339       526  
Commercial business
    2,588       2,931       3,836  
Total fixed rate
    48,882       87,494       77,667  
Total loans originated
    114,023       127,693       116,511  
                         
Sales and Repayments:
                       
Real estate loans sold
                       
One- to four-family
    10,247       68,726       49,389  
Total loans sold
    10,247       68,726       49,389  
Principal repayments
    72,880       64,408       65,210  
Total loans sold and repayments
    83,127       133,134       114,599  
Mortgage-backed securities:
                       
Principal repayments
    1,125       534       633  
Increase in other items, net
    49       51       50  
Net increase (decrease)
  $ 29,820     $ (5,924 )   $ 1,329  

 
14

 

Asset Quality
 
Loan payments are generally due the first day of each month.  When a borrower fails to make a required payment on a loan, we attempt to cause the delinquency to be cured by contacting the borrower.  In the case of residential loans, a late notice is sent for accounts 15 or more days delinquent.  For delinquencies not cured by the 15th day, borrowers will be assessed a late charge.  Additional written and oral contacts may be made with the borrower between 20 and 30 days after the due date.  If the full scheduled payment on the loan is not received prior to the 1st day of the succeeding month, the loan is considered 30 days past due and more formal collection procedures may be instituted.  If the delinquency continues for a period of 60 days, we usually send a default letter to the borrower and, after 90 days, institute appropriate action up to and including foreclosing on the property.  If foreclosed, the property is sold at public auction and we may purchase it.  Delinquent consumer loans are handled in a similar manner.  Our procedures for repossession and sale of consumer collateral are subject to various requirements under Indiana consumer protection laws.
 
Delinquent Loans.  The following table sets forth information concerning delinquent loans at December 31, 2010, in dollar amounts and as a percentage of each category of our loan portfolio.  The amounts represent the total remaining principal balances of the related loans, rather than the actual payment amounts which are overdue.
 
   
Loans Delinquent For:
 
   
60-89 Days
   
90 Days and Over
   
Total Delinquent Loans
 
   
Number
   
Amount
   
Percent of Loan
Category
   
Number
   
Amount
   
Percent of Loan
Category
   
Number
   
Amount
   
Percent of Loan
Category
 
   
(Dollars in Thousands)
 
Real Estate:
                                                     
One- to four-family
    13     $ 715       0.57 %     28     $ 3,808       3.04 %     41     $ 4,523       3.61 %
Multi-family
    ---       ---       0.00       1       2,289       4.28       1       2,289       4.28  
Commercial
    2       55       0.06       12       5,639       6.24       14       5,693       6.30  
Construction and land development
    ---       ---       0.00       2       1,022       3.35       2       1,022       3.35  
Consumer
    2       39       0.21       6       134       0.73       8       173       0.95  
Commercial Business
    ---       ---       0.00       4       251       1.54       4       251       1.54  
Total
    17     $ 809       0.24 %     53     $ 13,143       3.93 %     70     $ 13,951       4.18 %

 

 
15

 

Non-Performing Assets.  The table below sets forth the amounts and categories of non-performing assets.  Interest income on loans is accrued over the term of the loans based upon the principal outstanding except where serious doubt exists as to the collectability of a loan, in which case the accrual of interest is discontinued.  The amounts shown do not reflect reserves set up against such assets.  See “ - Allowance for Loan Losses” below.
 
   
December 31,
 
   
2006
   
2007
   
2008
   
2009
   
2010
 
   
(Dollars in Thousands)
 
Non-accruing loans:
                             
One- to four- family
  $ 6,851     $ 7,250     $ 4,781     $ 7,137     $ 3,760  
Multi-family
    328       341       ---       22       2,289  
Commercial real estate
    ---       648       1,385       4,218       5,011  
Construction and land development
    93       1,210       1,326       1,120       1,022  
Consumer
    89       103       118       3       134  
Commercial business
    3       383       366       104       251  
Total
    7,364       9,935       7,976       12,604       12,467  
                                         
Accruing loans delinquent more than 90 days:
                                       
One- to-four-family
    147       ---       ---       ---       ---  
Multi-family
    ---       ---       ---       ---       48  
Commercial real estate
    ---       59       ---       ---       628  
Total
    147       59       ---       ---       676  
                                         
Non-accruing loans less than 90 days:
                                       
One- to four-family
    ---       ---       ---       ---       2,633  
Multi-family
    ---       ---       ---       ---       559  
Commercial real estate
    ---       ---       ---       ---       213  
Construction or development
    ---       ---       ---       ---       1,468  
Consumer
    ---       ---       ---       ---       30  
Total
    ---       ---       ---       ---       4,903  
                                         
Foreclosed assets
                                       
   One- to four-family
    2,228       1,565       1,192       1,686       1,071  
Multi-family
    ---       1,022       ---       ---       ---  
Commercial real estate
    1,709       1,310       220       206       143  
Construction or development
    232       30       ---       ---       ---  
Consumer
    ---       17       ---       ---       ---  
Total
    4,169       3,944       1,412       1,892       1,214  
                                         
Total non-performing assets
  $ 11,680     $ 13,938     $ 9,388     $ 14,496     $ 19,260  
Total as a percentage of total assets
    3.17 %     4.08 %     2.52 %     3.91 %     5.18 %
                                         
Total assets
  $ 368,400     $ 342,010     $ 373,012     $ 371,050     $ 371,847  

 

 
16

 

For the year ended December 31, 2010, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms was $711,000, none of which was included in interest income.
 
Other Loans of Concern. In addition to the non-performing assets set forth in the table above under the caption “Non-Performing Assets,” as of December 31, 2010, there was also an aggregate of $22.4 million in net book value of loans with respect to which past payment history or a decrease in the debt service coverage of the borrowers may cause management to have doubts as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the non-performing asset categories. Included in the other loans of concern are (i) 77 loans to eight borrowers who each hold an average of 9 one- to four-family rental properties with a total outstanding balance of $5.0 million, where management has concerns about the ability of the borrowers to keep the rental properties leased and about the cash flow of the borrowers; (ii) one land development loan to a group of borrowers with an outstanding balance of $2.5 million where management has concerns about the viability of the project; and (iii) three loans secured by non-residential properties and two loans secured by one- to four-family rental properties to a single borrower with an outstanding balance of $2.1 million, where management has concerns about the cash flow of the borrower.
 
Classified Assets.  Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered by the Office of Thrift Supervision (the “OTS”) to be of lesser quality, as “substandard,” “doubtful” or “loss.”  An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected.  Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.”  Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.  Assets which do not currently expose the institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated “special mention” by management.
 
When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management.  General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets.  When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount.  An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS and the FDIC, which may order the establishment of additional general or specific loss allowances.
 
In connection with the filing of our periodic reports with the OTS and in accordance with our classification of assets policy, we regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations At December 31, 2010, we had classified $25.0 million of our loans as substandard and none as doubtful or loss.  At December 31, 2010, we had designated $17.3 million in loans as special mention.
 
Allowance for Loan Losses.   We establish our provision for loan losses based on a systematic analysis of risk factors in the loan portfolio.  The analysis includes consideration of concentrations of credit, past loss experience, current economic conditions, the amount and composition of the loan portfolio, estimated fair value of the underlying collateral, delinquencies, and other factors.  We also consider the loss experience of similar portfolios in comparable lending markets as well as using the services of a consultant to assist in the evaluation of our growing commercial loan portfolio.  On at least a quarterly basis, a formal analysis of the adequacy of the allowance is prepared and reviewed by management and the Board of Directors.  This analysis serves as a point-in-time assessment of the level of the allowance and serves as a basis for provisions for loan losses.
 
Our analysis of the loan portfolio begins by assigning each new loan a risk rating at the time the loan is originated, corresponding to one of ten risk categories.  If the loan is a commercial credit, the borrower will also be assigned a rating.  Adjustments are made to these ratings on a quarterly basis, based on the performance of the individual loan.  Loans no longer performing as agreed are assigned a lower risk rating, eventually resulting in their being regarded as classified loans.  A collateral re-evaluation form is completed on all classified loans, identifying
 

 
17

 

expected losses, generally based on an analysis of the collateral securing those loans.  A portion of the loan loss reserve is allocated to the classified loans in the amount identified as at risk.
 
Portions of the allowance are also allocated to non-classified loan portfolios which have been segregated into categories of loans having similar characteristics and similar inherent risk.  These categories include loans on:  one- to four-family owner-occupied properties, one- to four-family non-owner-occupied properties, multi-family rental properties, non-residential properties, land and land development projects, construction projects, home equity loans and consumer loans, unsecured and secured commercial business loans,.  Factors considered in determining the percentage allocation for each category include: historical loss experience, underwriting standards, trends in property values, trends in delinquent and non-performing loans, trends in charge-offs and recoveries, trends in volume and terms of loans, experience and depth of the lending department, concentrations of credit, and economic, industry and regulatory trends affecting our market.  Although we believe we use the best information available to make such determinations, future adjustments to reserves may be necessary, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the initial determinations.  Additionally, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses.  These agencies may require the recognition of additions to the allowance based upon their judgments of information available at the time of their examination.  The Bank’s Supervisory Agreement with the OTS required the Bank, among other things, to submit for review by the OTS revised policies and procedures related to the allowance for loan losses.  The Supervisory Agreement does not require an additional provision for loan loss reserves. See “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Comparison of Operating Results for the Years Ended December 31, 2010 and December 31, 2009 – Provision for Loan Losses” in the Annual Report to Shareholders filed as Exhibit 13 to this Form 10-K.
 
The following table sets forth an analysis of our allowance for loan losses.
 
   
Year Ended December 31,
 
   
2006
   
2007
   
2008
   
2009
   
2010
 
   
(Dollars in Thousands)
 
                               
Balance at beginning of period
  $ 2,852     $ 2,770     $ 3,702     $ 3,697     $ 3,737  
                                         
Charge-offs:
                                       
One- to four-family
    585       672       782       1,573       696  
Multi-family
    ---       ---       ---       97       ---  
Commercial real estate
    274       ---       ---       336       211  
Construction or development
    278       ---       159       45       402  
Consumer
    4       4       32       91       5  
Commercial business
    8       ---       210       1,043       68  
Total charge-offs
    1,149       676       1,183       3,185       1,382  
Recoveries:
                                       
One- to four-family
    ---       10       49       ---       153  
Commercial real estate
    ---       ---       ---       ---       37  
Construction or development
    46       27       25       25       35  
Consumer
    3       1       3       2       3  
Commercial business
    ---       ---       ---       1       ---  
Total recoveries
    49       38       77       28       229  
                                         
Net charge-offs
    1,100       638       1,107       3,157       1,153  
Additions charged to operations
    1,018       1,570       1,102       3,197       2,759  
Balance at end of period
  $ 2,770     $ 3,702     $ 3,697     $ 3,737     $ 5,343  
                                         
Net charge-offs to average loans outstanding
    0.34 %     0.21 %     0.35 %     0.98 %     0.35 %
                                         
Allowance for loan losses to non-performing assets
    23.72 %     26.56 %     39.38 %     25.78 %     27.67 %
                                         
Allowance for loan losses to net loans at end of period
    0.87 %     1.23 %     1.12 %     1.16 %     1.65 %

 
18

 

The allocation of our allowance for losses on loans, including loans held for sale, at the dates indicated is summarized as follows:
 

   
At December 31,
 
   
2006
   
2007
   
2008
   
2009
   
2010
 
   
Amount
of
Loan Loss
Allowance
   
Loan
Amounts
by
Category
   
Percent
of Loans
in Each
Category
to Total
Loans
   
Amount
of
Loan Loss
Allowance
   
Loan
Amounts
By
Category
   
Percent
of Loans
in Each
Category
to Total
Loans
   
Amount
of
Loan Loss
Allowance
   
Loan
Amounts
By
Category
   
Percent
of Loans
in Each
Category
to Total
Loans
   
Amount
of
Loan Loss
Allowance
   
Loan
Amounts
By
Category
   
Percent
of
Loans
in Each
Category
to Total
Loans
   
Amount
of
Loan Loss
Allowance
   
Loan
Amounts
By
Category
   
Percent
of Loans
in Each
Category
to Total
Loans
 
   
(Dollars in Thousands)
 
Real estate:
                                                                                         
One- to four-family
  $ 1,201     $ 142,045       43.70 %   $ 1,917     $ 137,590       45.47 %   $ 1,791     $ 145,442       43.43 %   $ 1,705     $ 123,502       37.46 %   $ 1,015     $ 125,121       37.46 %
Multi-family
    116       30,160       9.28       99       29,765       9.84       265       39,892       11.91       321       52,790       16.01       1,138       53,458       16.00  
Commercial real estate
    459       74,710       22.98       297       71,601       23.67       802       90,606       27.06       801       90,571       27.47       2,061       90,395       27.06  
Land and land development
    390       18,466       5.68       343       18,067       5.97       229       17,756       5.30       283       17,192       5.21       480       14,510       4.35  
Construction
    260       19,228       5.91       323       9,741       3.22       190       11,436       3.42       102       13,002       3.94       ---       15,957       4.78  
Consumer
    126       19,530       6.01       127       16,457       5.44       143       15,453       4.62       110       16,019       4.86       84       18,251       5.46  
Commercial business
    120       20,935       6.44       494       19,327       6.39       201       14,277       4.26       384       16,638       5.05       565       16,332       4.89  
Unallocated
    98       ---       ---       102       ---       ---       76       ---       ---       31       ---       ---       ---       ---       ---  
Total
  $ 2,770     $ 325,074       100.00 %   $ 3,702     $ 302,548       100.00 %   $ 3,697     $ 334,862       100.00 %   $ 3,737     $ 329,714       100.00 %   $ 5,343     $ 334,024       100.00 %

 
Investment Activities
 
We must maintain minimum levels of securities that qualify as liquid assets under the OTS regulations.  Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans.  Historically, we have maintained liquid assets at levels we believe adequate to meet the requirements of normal operations, including potential deposit outflows.  Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained.  At December 31, 2010 our liquidity ratio—liquid assets as a percentage of net withdrawable savings deposits and current borrowings—was 6.06%.  Our level of liquidity is a result of management’s asset/liability strategy.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Asset/Liability Management” and “– Liquidity and Capital Resources” in the Annual Report to Shareholders filed as Exhibit 13 to this Form 10-K.
 
The Bank’s Supervisory Agreement and LSB Financial’s Memorandum of Understanding (“MOU”) with the OTS also require prior OTS approval of dividends by the Bank or the Company, respectively.  LSB Financial is currently not paying dividends to its shareholders.  In addition, the MOU requires prior approval by the OTS of any debt at the holding company level not in the ordinary course (including loans, cumulative preferred stock and subordinated debt), unless such debt is contemplated by the capital plan.  The holding company does not now hold any such debt.
 
Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds.  Subject to various restrictions, federally chartered savings institutions may also invest their assets in investment grade commercial paper and corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly.
 
Generally, we invest funds among various categories of investments and maturities based upon our asset/liability management policies, concern for the highest investment quality, liquidity needs and performance objectives.  It is our general policy to purchase securities which are U.S. Government securities, investment grade municipal and corporate bonds, commercial paper, federal agency obligations and interest-bearing deposits with the Federal Home Loan Bank.
 

 
19

 

The following table sets forth the composition of our securities portfolio at the dates indicated.  As of December 31, 2010, our investment portfolio did not contain securities of any issuer with an aggregate book value in excess of 10% of our shareholders’ equity, excluding those issued by the U.S. Government and its agencies.
 
   
December 31,
 
   
2008
   
2009
   
2010
 
   
Carrying
Value
   
% of
Total
   
Carrying
Value
   
% of
Total
   
Carrying
Value
   
% of
Total
 
   
(Dollars in Thousands)
 
Debt securities:
                                   
Federal agency obligations
  $ 509       4.19 %   $ 536       4.46 %   $ 2,096       16.49 %
Municipal bonds
    7,639       62.90       7,502       62.33       7,035       55.33  
Subtotal
    8,148       67.09       8,038       66.79       9,131       71.82  
                                                 
Other:
                                               
Federal Home Loan Bank stock
    3,997       32.91       3,997       33.21       3,583       28.18  
Total debt securities and Federal Home Loan Bank stock
  $ 12,145       100.00 %   $ 12,035       100.00 %   $ 12,714       100.00 %
                                                 
Average remaining life of debt securities
 
3.40 years
   
5.07 years
   
4.07 years
 
                                                 
Other interest-earning assets:
                                               
Interest-bearing deposits with Federal Home Loan Bank
  $ 9,179       100.00 %   $ 4,817       100.00 %   $ 2,980       100.00 %
                                                 
Mortgage-backed securities:
                                               
Fannie Mae certificates
  $ 1,814       48.96 %   $ 1,773       53.61 %   $ 1,473       55.09 %
Freddie Mac certificates
    1,891       51.04       1,534       46.39       1,201       44.91  
Total mortgage-backed securities
  $ 3,705       100.00 %   $ 3,307       100.00 %   $ 2,674       100.00 %

 
The following table sets forth the composition and contractual maturities of our securities portfolio at December 31, 2010.  Expected maturities will differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties.  At December 31, 2010, all of our securities were classified as available for sale and as such were reported at fair value. The weighted average yields on tax exempt obligations have been computed on a tax equivalent basis.
 
   
December 31, 2010
 
   
Less than 1 year
   
1 to 5 Years
   
5 to 10 Years
   
Over
10 Years
   
Total
Investment Securities
 
   
(Dollars in Thousands)
 
       
Federal agency obligations
  $ 520     $ 1,576     $ ---     $ ---     $ 2,096  
Municipal bonds
    767       3,311       2,461       497       7,035  
Fannie Mae certificates
    ---       ---       1,472       ---       1,473  
Freddie Mac certificates
    ---       ---       1,201       ---       1,201  
Total investment securities
  $ 1,287     $ 4,886     $ 5,134     $ 497     $ 11,805  
                                         
Weighted average yield
    3.64 %     3.20 %     4.76 %     5.04 %     3.93 %

 
Sources of Funds
 
General.  Our primary sources of funds are deposits, repayment and prepayment of loans, interest earned on or maturation of investment securities and short-term investments, borrowings and funds provided from operations.
 

 
20

 

Deposits.  We offer a variety of deposit accounts.  Our deposits consist of statement savings accounts, money market accounts, NOW accounts and certificate accounts.  In addition, we periodically solicit broker originated certificates of deposit when issues are available that meet our interest rate and liquidity needs.  Brokered deposits at December 31, 2010 totaled $17.0 million.  We rely primarily on competitive pricing policies, on-line and off-line advertising, and customer service to attract and retain these deposits.
 
The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and competition.  The variety of deposit accounts we offer has allowed us to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand.  We manage the pricing of our deposits in keeping with our asset/liability management, profitability and growth objectives.  Based on our experience, we believe that our savings, interest- and non-interest-bearing checking accounts are relatively stable sources of deposits.  However, our ability to attract and maintain certificates of deposit, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions.
 
The following table sets forth our savings flows during the periods indicated.
 
   
Year Ended December 31,
 
   
2008
   
2009
   
2010
 
   
(Dollars in Thousands)
 
                   
Opening balance
  $ 232,030     $ 258,587     $ 277,866  
Deposits
    1,327,719       1,363,514       1,578,438  
Withdrawals
    (1,308,010 )     (1,350,295 )     (1,549,254 )
Interest credited
    6,848       6,060       4,408  
                         
Ending balance
  $ 258,587     $ 277,866     $ 311,458  
                         
Net increase (decrease)
  $ 26,557     $ 19,279     $ 33,592  
                         
Percent increase
    11.45 %     7.46 %     12.09 %

 
The following table sets forth the dollar amount of savings deposits in the various types of deposit programs offered by us at the dates indicated.
 
   
At December 31,
 
   
2008
   
2009
   
2010
 
   
Amount
   
Percent of Total
   
Amount
   
Percent of Total
   
Amount
   
Percent of Total
 
   
(Dollars in Thousands)
 
Transaction and Savings Deposits:
                                   
Non-interest-bearing
  $ 16,739       6.47 %   $ 21,359       7.68 %   $ 25,023       8.03 %
Savings accounts (0.10% - 1.00% at December 31, 2010)
    22,796       8.81       27,099       9.75       25,297       8.12  
NOW Accounts (0.00% - 1.50% at December 31, 2010)
    26,520       10.25       30,027       10.80       31,768       10.20  
Money Market Accounts (0.25% - 1.40% at December 31, 2010)
    15,486       5.98       29,701       10.69       63,919       20.52  
Total Non-Certificates
    81,541       31.51       108,186       38.92       146,007       46.87  
                                                 
Certificates:
                                               
                                                 
 0.00 - 1.99%       3,037       1.17       63,177       22.73       74,582       23.95  
 2.00 - 3.99%       105,400       40.73       74,326       26.74       79,303       25.46  
 4.00 - 5.99%       68,590       26.51       32,158       11.57       11,560       3.71  
 6.00 - 7.99%       19       0.01       19       0.01       6       0.00  
Total certificates
    177,046       68.42       169,680       61.05       165,451       53.12  
Accrued interest
    169       0.07       75       0.03       33       0.01  
                                                   
Total deposits with interest
  $ 258,756       100.00 %   $ 277,941       100.00 %   $ 311,491       100.00 %


 
21

 

The following table shows rate and maturity information for our certificates of deposit as of December 31, 2010.
 
      0.00- 1.99%       2.00- 3.99%       4.00- 5.99%       6.00- 7.99%    
Total
   
Percent
of Total
 
   
(Dollars in Thousands)
 
Certificate accounts maturing in quarter ending:
                                           
                                             
March 31, 2011
  $ 17,681     $ 7,171     $ 4,309     $ ---     $ 29,161       17.62 %
June 30, 2011
    18,254       3,876       40       ---       22,170       13.40  
September 30, 2011
    14,981       3,704       335       ---       19,020       11.50  
December 31, 2011
    10,772       4,349       1,371       ---       16,492       9.97  
March 31, 2012
    3,934       2,430       705       ---       7,069       4.27  
June 30, 2012
    1,043       3,628       557       1       5,229       3.16  
September 30, 2012
    1,846       5,215       153       ---       7,214       4.36  
December 31, 2012
    1,099       6,598       315       ---       8.012       4.84  
March 31, 2013
    159       2,911       236       ---       3,306       2.00  
June 30, 2013
    51       2,931       182       ---       3,164       1.91  
September 30, 2013
    668       3,565       691       ---       4,923       2.98  
December 31, 2013
    3,748       12       1,372       ---       5,132       3.10  
Thereafter
    346       32,914       1,299       ---       34,559       20.89  
                                                 
Total
  $ 74,582     $ 79,303     $ 11,565     $ 1     $ 165,451       100.00 %
                                                 
Percent of total
    45.08 %     47.93 %     6.99 %     0.00 %     100.00 %     100.00 %

 
The following table indicates the amount of our certificates of deposit by time remaining until maturity as of December 31, 2010.
 
   
Maturity
 
   
3 Months
or Less
   
Over
3 to 6
Months
   
Over
6 to 12
Months
   
Over
12 months
   
Total
 
   
(In Thousands)
 
                               
Certificates of deposit less than $100,000, excluding public funds
  $ 15,497     $ 12,189     $ 20,747     $ 42,535     $ 90,968  
Certificates of deposit of $100,000 or more, excluding public funds
    12,119       9,903       14,711       34,662       71,395  
Public funds
    1,545       77       54       1,412       3,088  
Total certificates of deposit
  $ 29,161     $ 22,169     $ 35,512     $ 78,609     $ 165,451  

 
Borrowings.  Our other available sources of funds include borrowings from the Federal Home Loan Bank (FHLB) of Indianapolis and other borrowings.  As a member of the FHLB of Indianapolis, we are required to own capital stock in the FHLB and are authorized to apply for borrowings from the FHLB.  Each FHLB credit program has its own interest rate, which may be fixed or variable, and the programs have a range of maturities.  The FHLB of Indianapolis may prescribe the acceptable uses for these funds, as well as limitations on the size of the borrowings and repayment provisions. All FHLB advances must be fully secured by sufficient collateral as determined by the FHLB. The Federal Housing Finance Board, an independent agency, controls the FHLB of Indianapolis.
 

 
22

 

The FHLB of Indianapolis is required to provide funds for the resolution of troubled savings associations and to contribute to affordable housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. For the year ended December 31, 2010, dividends paid by the FHLB of Indianapolis to the Bank totaled approximately $75,000, for an annualized rate of 1.91%. Due to various financial difficulties in the financial institution industry in the last few years, including the write-down of various mortgage-backed securities held by the FHLB of Indianapolis (which lowered its regulatory capital levels), the FHLB of Indianapolis temporarily suspended dividends during the first quarter of 2009. Dividends paid by the FHLB of Indianapolis in the first quarter of 2009 were reduced by 75 basis points from the dividend rate paid in the prior quarter.  Continued and additional financial difficulties at the FHLB of Indianapolis could further reduce or eliminate the dividends we receive from the FHLB of Indianapolis.
 
Generally, the loan terms from the FHLB of Indianapolis are better than the terms the Bank can receive from other sources making it cheaper to borrow money from the FHLB of Indianapolis. Continued and additional financial difficulties at the FHLB of Indianapolis could reduce or eliminate our additional borrowing capacity with the FHLB of Indianapolis which could force us to borrow money from other sources. Such other monies may not be available when we need them or, more likely, will be available at higher interest rates and on less advantageous terms, which will impact our net income and could impact our ability to grow.
 
We utilize FHLB borrowings as part of our asset/liability management strategy in order to extend the maturity of our liabilities in a cost-effective manner.  We may be required to pay a commitment fee upon application and may be subject to a prepayment fee if we prepay the advance. See Note 8 of the Notes to the Consolidated Financial Statements contained in the Annual Report to Shareholders attached as Exhibit 13 to this Form 10-K.
 
The following table sets forth the maximum month-end balance and average balance of Federal Home Loan Bank advances for the periods indicated.
 
   
Year Ended December 31,
 
   
2008
   
2009
   
2010
 
   
(Dollars in Thousands)
 
                   
Maximum Balance - Federal Home Loan Bank Advances
  $ 78,756     $ 71,500     $ 57,000  
Average Balance - Federal Home Loan Bank Advances
  $ 76,025     $ 62,708     $ 35,667  

 
The following table sets forth actual balances of Federal Home Loan Bank advances and the weighted average interest rate of those advances at the dates indicated.
 
   
December 31,
 
   
2008
   
2009
   
2010
 
   
(Dollars in Thousands)
 
                   
Federal Home Loan Bank Advances
  $ 78,500     $ 57,000     $ 22,500  
Weighted average interest rate of Federal Home Loan Bank Advances
    4.02 %     3.59 %     2.78 %

 
Subsidiaries and Other Activities
 
Lafayette Savings owns a service corporation, L.S.B. Service Corporation.  In April 1994, Lafayette Savings made an initial investment of $51,000 in L.S.B. Service Corporation when it became a 14.16% limited partner in a low-income housing project in Lafayette, Indiana, pursuant to a 10-year commitment totaling $500,000.  During 2010, L.S.B. Service Corporation recorded a $22 tax gain related to its investment in the project and recorded net gains of $55,000.  At December 31, 2010, our total investment in L.S.B. Service Corporation was $513,000.
 

 

 
23

 

Competition
 
We face strong competition, both in originating real estate and other loans and in attracting deposits.  Competition in originating real estate loans comes primarily from other savings institutions, commercial banks, credit unions and mortgage bankers making loans secured by real estate located in Tippecanoe County, our primary market area.  Other savings institutions, commercial banks, credit unions and finance companies provide vigorous competition in consumer lending.
 
We attract the majority of our deposits through our branch offices, primarily from the communities in which those branch offices are located; therefore, competition for those deposits is principally from other savings institutions, commercial banks and credit unions located in the same communities as well as mutual funds and other financial intermediaries.  We compete for these deposits by offering a variety of deposit accounts at competitive rates, convenient business hours and branch locations and Internet banking with interbranch deposit and withdrawal privileges.
 
There are 22 other savings institutions, credit unions and banks in our primary market area. We estimate our share of the savings market in Tippecanoe County to be approximately 12% and our share of the mortgage loan market to be approximately 5%.
 
Regulation
 
General. Lafayette Savings is a federally chartered savings bank, the deposits of which are federally insured and backed by the full faith and credit of the United States Government. Accordingly, we are subject to broad federal regulation, primarily by the OTS, and oversight extending to all of our operations. Lafayette Savings is a member of the Federal Home Loan Bank of Indianapolis and is subject to certain limited regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). As the thrift holding company of Lafayette Savings, until July 21, 2011, LSB Financial is also subject to federal regulation and oversight by the OTS.
 
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) calls for the elimination of the OTS as of July 21, 2011, although this deadline can be extended for an additional six months. The Dodd-Frank Act transfers to the Office of the Comptroller of the Currency (the “OCC”) all functions and all rulemaking authority of the OTS relating to federal savings associations. The Dodd-Frank Act also transfers to the Federal Reserve all functions of the OTS relating to savings and loan holding companies and their non-depository institution subsidiaries. Thus, LSB Financial and all of its subsidiaries other than the Bank will be supervised by the Federal Reserve from and after July 21, 2011, subject to a possible six month extension. The Federal Reserve is also to regulate loans to insiders, transactions with affiliates, and tying arrangements. No later than the effective date of the transfer of these responsibilities, the OCC and the Federal Reserve are to publish regulations that will apply to the entities that they are to regulate for the first time. OTS guidance, orders, interpretations, and policies to which federal savings associations like the Bank and savings and loan holding companies like LSB Financial are subject are to remain in effect until they are suspended.
 
Insurance of Deposits. Deposits in the Bank are insured by the Deposit Insurance Fund of the FDIC up to a maximum amount, which is generally $250,000 per depositor, subject to aggregation rules. The Bank is subject to deposit insurance assessments by the FDIC pursuant to its regulations establishing a risk-related deposit insurance assessment system, based upon the institution’s capital levels and risk profile. Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk-weighted categories based on supervisory evaluations, regulatory capital levels, and certain other factors with less risky institutions paying lower assessments. An institution’s initial assessment rate depends upon the category to which it is assigned. There are also adjustments to a bank’s initial assessment rates based on levels of long-term unsecured debt, secured liabilities in excess of 25% of domestic deposits and, for certain institutions, brokered deposit levels. For 2010, initial assessments ranged from 12 to 45 basis points of assessable deposits, and the Bank paid assessments at the rate of 21 basis points for each $100 of insured deposits.
 
The Bank is also subject to assessment for the Financing Corporation (FICO) to service the interest on its bond obligations. The amount assessed on individual institutions, including the Bank, by FICO is in addition to the amount paid for deposit insurance according to the risk-related assessment rate schedule. These assessments will continue until the FICO bonds are repaid between 2017 and 2019. During 2010, the FICO assessment rate ranged between 1.04 and 1.06 basis points for each $100 of insured deposits per quarter. For the first quarter of 2011, the FICO assessment rate is 1.02 basis points. The Bank expensed deposit insurance assessments (including the FICO assessments) of $679,000 during the year ended December 31, 2010. Future increases in deposit insurance premiums or changes in risk classification would increase the Bank’s deposit related costs.
 

 
24

 

On December 30, 2009, banks were required to pay the fourth quarter FDIC assessment and to prepay estimated insurance assessments for the years 2010 through 2012. The pre-payment did not affect the Bank’s earnings when paid. The Bank paid its quarterly assessment for the fourth quarter of 2009 and prepaid all quarterly assessments for 2010, 2011, and 2012 on December 30, 2009 in the amount of $2.3 million.
 
Under the Dodd-Frank Act, the FDIC is authorized to set the reserve ratio for the Deposit Insurance Fund at no less than 1.35%, and must achieve the 1.35% designated reserve ratio by September 30, 2020. The FDIC must offset the effect of the increase in the minimum designated reserve ratio from 1.15% to 1.35% on insured depository institutions of less than $10 billion, and may declare dividends to depository institutions when the reserve ratio at the end of a calendar quarter is at least 1.5%, although the FDIC has the authority to suspend or limit such permitted dividend declarations. In December, 2010, the FDIC adopted a final rule setting the designated reserve ratio for the deposit insurance fund at 2% of estimated insured deposits.
 
On October 19, 2010, the FDIC proposed a comprehensive long-range plan for deposit insurance fund management with the goals of maintaining a positive fund balance, even during periods of large fund losses, and maintaining steady, predictable assessment rates throughout economic and credit cycles. The FDIC determined not to increase assessments in 2011 by 3 basis points, as previously proposed, but to keep the current rate schedule in effect. In addition, the FDIC proposed adopting a lower assessment rate schedule when the designated reserve ratio reaches 1.15% so that the average rate over time should be about 8.5 basis points. In lieu of dividends, the FDIC proposed adopting lower rate schedules when the reserve ratio reaches 2% and 2.5%, so that the average rates will decline about 25 percent and 50 percent, respectively.
 
Under the Dodd-Frank Act, the assessment base for deposit insurance premiums is to be changed from adjusted domestic deposits to average consolidated total assets minus average tangible equity. Tangible equity for this purpose means Tier 1 capital. Since this is a larger base than adjusted domestic deposits, assessment rates are expected to be lowered. In February, 2011, the FDIC approved a new rule effective April 1, 2011 (to be reflected in invoices for assessments due September 30, 2011), which will implement these changes. The proposed rule includes new rate schedules scaled to the increase in the assessment base, including schedules that will go into effect when the reserve ratio reaches 1.15%, 2% and 2.5%. The FDIC staff projected that the new rate schedules would be approximately revenue neutral.  The Bank does not believe that its insurance premiums will increase as a result of these changes, but has not yet been advised by the FDIC of the adjusted premiums that it will be required to pay  from and after April 1, 2011.
 
The schedule would reduce the initial base assessment rate in each of the four risk-based pricing categories.
 
·  
For small Risk Category I banks, the rates would range from 5-9 basis points.
 
·  
The proposed rates for small institutions in Risk Categories II, III and IV would be 14, 23 and 35 basis points, respectively.
 
·  
For large institutions and large, highly complex institutions, the proposed rate schedule ranges from 5 to 35 basis points.
 
There are also adjustments made to the initial assessment rates based on long-term unsecured debt, depository institution debt, and brokered deposits.
 
The FDIC also revised the assessment system for large depository institutions with over $10 billion in assets.
 
Due to the recent difficult economic conditions, the FDIC adopted an optional Temporary Liquidity Guarantee Program by which, for a fee, noninterest bearing transaction accounts would receive unlimited insurance coverage until June 30, 2010 (which was later extended to December 31, 2010) and, for a fee, certain senior unsecured debt issued by institutions and their holding companies between October 13, 2008 and October 31, 2009 would be guaranteed by the FDIC through December 31, 2012. The Bank made the business decision to participate in the unlimited noninterest bearing transaction account coverage but the Bank elected not to participate in the unsecured debt guarantee program. The assessments for unlimited noninterest bearing transaction account coverage were 15 basis points per $100 of insured deposits during 2010.
 
The Dodd-Frank Act extended unlimited insurance on non-interest bearing accounts for no additional charges through December 31, 2012. Under this program, traditional non-interest demand deposit (or checking)
 

 
25

 

accounts that allow for an unlimited number of transfers and withdrawals at any time, whether held for a business, individual, or other type of depositor, are covered. Later, Congress added Lawyers’ Trust Accounts (IOLTA) to this unlimited insurance protection through December 31, 2012.
 
The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.
 
The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe and unsound condition to continue operations or has violated any applicable law, regulation, order or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital.
 
Federal Regulation of Savings Associations. The OTS has extensive authority over the operations of savings institutions. As part of this authority, we are required to file periodic reports with the OTS and are subject to periodic examinations by the OTS and the FDIC.
 
The OTS also has extensive enforcement authority over all savings institutions and their holding companies. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions.
 
As indicated above, effective July 21, 2011 (subject to a possible six-month extension), these regulatory responsibilities will be transferred from the OTS to the OCC.
 
Lafayette Savings’ general permissible lending limit for loans to one borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus, except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus. At December 31, 2010, our lending limit under this restriction was $5.7 million.
 
Regulatory Capital Requirements of Lafayette Savings and LSB Financial.
 
Lafayette Savings. To be considered adequately capitalized, under the prompt corrective action regulations, a savings association must maintain the following capital ratios: a leverage ratio (the ratio of Tier 1 capital to total assets) of at least 4% (unless its supervisory condition allows a 3% ratio), a Tier 1 risk-based ratio (the ratio of Tier 1 capital to risk-weighted assets) of at least 4%, and a total risk-based capital ratio (the ratio of total capital to risk-weighted assets) of at least 8%. Total capital consists of Tier 1 and Tier 2 capital.
 
Tier 1 capital generally consists of common stockholders’ equity, noncumulative perpetual preferred stock and other tangible capital plus certain intangible assets, including a limited amount of purchased credit card receivables. Tier 2 capital consists generally of certain permanent and maturing capital instruments and allowances for loan and lease losses up to 1.25% of risk-weighted assets. When determining total capital, Tier 2 capital may not exceed Tier 1 capital. At December 31, 2010, we had no intangible assets which were included in Tier 1 capital, other than mortgage servicing rights of $1.1 million.
 
To determine the amount of risk-weighted assets, all assets, including certain off-balance sheet items, will be multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset. For example, the OTS has assigned a risk weight of 50% for prudently underwritten permanent one- to four-family first lien mortgage loans not more than 90 days delinquent and having a loan-to-value ratio of not more than 90% at origination unless insured to such ratio by an insurer approved by Fannie Mae or Freddie Mac.
 
To be considered well capitalized, a savings association must have a leverage ratio of at least 5%, a Tier 1 risk-based ratio of at least 6% and a total risk-based capital ratio of 10%. As of December 31, 2010, Lafayette Savings qualified as well capitalized, with a leverage ratio of 9.4%, a Tier 1 risk-based capital ratio of 12.6% and a total risk-based capital ratio of 13.8%. The OTS may reclassify a savings association in a lower capital category or require it to hold additional capital based upon supervisory concerns on a case-by-case basis.
 
Under the prompt corrective action regulations, the OTS and the FDIC are authorized, and under certain circumstances required, to take certain actions against a savings association that is not at least adequately
 

 
26

 

capitalized. Such an association must submit a capital restoration plan and, until the plan is approved by the OTS, may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. For a savings association controlled by a holding company, the capital restoration plan must include a guarantee by the holding company limited to the lesser of 5% of the association’s assets when it failed the “adequately capitalized” standard or the amount needed to satisfy the plan, and, in the event of the bankruptcy of the holding company, the guaranty would have priority over the claims of general creditors. Additional and more stringent restrictions may be applicable, depending on the financial condition of the association and other circumstances. If an association becomes critically undercapitalized, because it has a ratio of tangible equity to total assets of 2% or less, appointment of a receiver or conservator may be required.
 
LSB Financial. Effective as of the transfer of regulatory responsibilities from the OTS to the OCC and the Federal Reserve, the Federal Reserve will be authorized to establish capital requirements for savings and loan holding companies. These capital requirements must be counter-cyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness. Savings and loan holding companies will also be required to serve as a source of financial strength for their depository institution subsidiaries.
 
Within five years after the enactment of the Dodd-Frank Act, the Federal Reserve is to apply consolidated capital requirements to depository institution holding companies that are no less stringent than those currently applied to depository institutions that were not supervised by the Federal Reserve as of May 19, 2010. Under this provision, the components of Tier 1 capital of depository institution holding companies would be restricted to capital instruments that are currently considered Tier 1 capital for insured depository institutions. Thus, for the first time savings and loan holding companies will be subject to consolidated capital requirements. Under these standards, trust preferred securities will be excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010, by a savings and loan holding company with less than $15 billion in assets. LSB Financial has not issued any trust preferred securities.
 
Under the Dodd-Frank Act, LSB Financial is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances in which LSB Financial might not otherwise do so. For this purpose, “source of financial strength” means LSB Financial’s ability to provide financial assistance to the Bank in the event of the Bank’s financial distress.
 
Limitations on Dividends and Other Capital Distributions. OTS regulations impose various restrictions on savings institutions with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account.
 
A savings association that is a subsidiary of a holding company, such as Lafayette Savings, may make a capital distribution with prior notice to the OTS, in an amount that does not exceed its net income for the calendar year-to-date plus retained net income for the previous two calendar years (less any dividends previously paid) if the savings association has a regulatory rating in the two top examination categories, is not of supervisory concern, and would remain well-capitalized following the proposed distribution. All other institutions or those seeking to exceed the noted amounts must obtain approval from the OTS for a capital distribution before making the distribution.
 
LSB Financial’s declaration of dividends is subject to Indiana law, which generally prohibits the payment of dividends to amounts that will not affect the ability of LSB Financial, after the dividend has been distributed, to pay its debts in the ordinary course of business. Moreover, such dividends may not exceed the difference between LSB Financial’s total assets and total liabilities plus preferential amounts payable to shareholders with rights superior to those of the holders of common stock. In addition, the OTS may prohibit LSB Financial’s payment of dividends if it concludes such payment would raise safety and soundness concerns at either the Bank or LSB Financial. Similar restrictions could be applied to dividend declarations by the Federal Reserve once it replaces the OTS as the federal regulator of LSB Financial.
 
Under the Bank’s Supervisory Agreement and LSB Financial’s Memorandum of Understanding with the OTS any declaration or payment of dividends or other capital distributions by the Bank or LSB Financial must be approved by the OTS. LSB Financial is currently not paying dividends to its shareholders.
 
Qualified Thrift Lender Test. All savings institutions are required to meet a qualified thrift lender test to avoid certain restrictions on their operations. This test requires a savings institution to have at least 65% of its portfolio assets in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings institution may maintain 60% of its assets in those assets specified in Section
 

 
27

 

7701(a)(19) of the Internal Revenue Code of 1986, as amended. Under either test, these assets primarily consist of residential housing related loans and investments. At December 31, 2010, Lafayette Savings met the test.
 
Any savings institution that fails to meet the qualified thrift lender test must either convert to a national bank or restrict its branching rights, new activities and investments to those permissible for a national bank. In addition, under the Dodd-Frank Act, a savings association that fails the qualified thrift lender test will be prohibited from paying dividends, except for dividends that are permissible for national banks, are necessary to meet obligations of the company that controls the savings association, and are specifically approved by the OCC and the Federal Reserve. If the institution has not requalified or converted to a national bank within three years after the failure, it must sell all investments and stop all activities not permissible for a national bank. If any institution that fails the qualified thrift lender test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies. Under the Dodd-Frank Act, the failure to satisfy the qualified thrift lender test may also result in regulatory enforcement action.
 
Transactions with Affiliates. Generally, transactions between a savings association or its subsidiaries and its affiliates are required to be on terms as favorable to the association as transactions with non-affiliates. In addition, certain of these transactions, such as loans to an affiliate, are restricted to a percentage of the association’s capital and are subject to collateralization requirements. Affiliates of Lafayette Savings include LSB Financial and any company which is under common control with Lafayette Savings. In addition, a savings association may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of an affiliate. The OTS has the discretion to further restrict transactions of a savings association with an affiliate on a case-by-case basis.
 
Community Reinvestment Act. Under the Community Reinvestment Act, every FDIC insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods. The Community Reinvestment Act requires the OTS, in connection with our examination, to assess our record of meeting the credit needs of our community and to take this record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by Lafayette Savings. An unsatisfactory rating may be used as the basis for the denial of an application by the OTS. We were examined for Community Reinvestment Act compliance in 2010 and received a rating of “Outstanding.”
 
Holding Company Regulation. LSB Financial is a unitary savings and loan holding company subject to regulatory oversight by the OTS. LSB Financial is required to register and file reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over us and our non-savings institution subsidiaries. Under the Dodd-Frank Act, on July 21, 2011 (subject to a possible six-month extension) these regulatory responsibilities will be transferred from the OTS to the Federal Reserve.
 
LSB Financial generally is not subject to activity restrictions. If LSB Financial acquired control of another savings institution as a separate subsidiary, it would become a multiple savings and loan holding company, and its activities and any of its subsidiaries (other than Lafayette Savings or any other savings institution) would generally become subject to additional restrictions. 
 
USA PATRIOT Act of 2001. On October 26, 2001, President Bush signed the USA PATRIOT Act of 2001 (the “PATRIOT Act”). The PATRIOT Act, among other things, is intended to strengthen the ability of U.S. law enforcement to combat terrorism on a variety of fronts. The PATRIOT Act contains sweeping anti-money laundering and financial transparency laws and requires financial institutions to implement additional policies and procedures with respect to, or additional measures designed to address, any or all the following matters, among others: money laundering, suspicious activities and currency transaction reporting, and currency crimes. Many of the provisions in the PATRIOT Act were to have expired December 31, 2005, but the U.S. Congress authorized renewals that extended the provisions until March 10, 2006. In early March 2006, the U.S. Congress approved the USA PATRIOT Improvement and Reauthorization Act of 2005 (the “Reauthorization Act”) and the USA PATRIOT Act Additional Reauthorizing Amendments Act of 2006 (the “PATRIOT Act Amendments”), and they were signed into law by President Bush on March 9, 2006. The Reauthorization Act makes permanent all but two of the provisions that had been set to expire and provides that the remaining two provisions, which relate to surveillance and the production of business records under the Foreign Intelligence Surveillance Act, will expire in four years. The PATRIOT Act Amendments include provisions allowing recipients of certain subpoenas to obtain judicial review of nondisclosure orders and clarifying the use of certain subpoenas to obtain information from libraries. We do not anticipate that these changes will materially affect our operations.
 

 
28

 

Federal Securities Law. The shares of Common Stock of LSB Financial have been registered with the SEC under the Securities Exchange Act (the “Exchange Act”). LSB Financial is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Exchange Act and the rules of the SEC thereunder. If LSB Financial has fewer than 300 shareholders, it may deregister its shares under the Exchange Act and cease to be subject to the foregoing requirements.
 
Shares of Common Stock held by persons who are affiliates of LSB Financial may not be resold without registration unless sold in accordance with the resale restrictions of Rule 144 under the Securities Act of 1933. If LSB Financial meets the current public information requirements under Rule 144, each affiliate of LSB Financial who complies with the other conditions of Rule 144 (including those that require the affiliate’s sale to be aggregated with those of certain other persons) would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of (i) 1% of the outstanding shares of LSB Financial or (ii) the average weekly volume of trading in such shares during the preceding four calendar weeks.
 
Shares of Common Stock held by persons who are affiliates of LSB Financial may not be resold without registration unless sold in accordance with the resale restrictions of Rule 144 under the Securities Act of 1933. If LSB Financial meets the current public information requirements under Rule 144, each affiliate of LSB Financial who complies with the other conditions of Rule 144 (including those that require the affiliate’s sale to be aggregated with those of certain other persons) would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of (i) 1% of the outstanding shares of LSB Financial or (ii) the average weekly volume of trading in such shares during the preceding four calendar weeks.
 
Under the Dodd-Frank Act, beginning in 2013, LSB Financial will be required to provide its shareholders an opportunity to vote on the executive compensation payable to its named executive officers and on golden parachute payments made in connection with mergers or acquisitions. These votes will be non-binding and advisory. Beginning in 2013, LSB Financial must also permit shareholders at least once every six years to determine on an advisory basis whether such votes should be held every one, two, or three years.
 
Sarbanes-Oxley Act of 2002. On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”). The Sarbanes-Oxley Act’s stated goals include enhancing corporate responsibility, increasing penalties for accounting and auditing improprieties at publicly traded companies and protecting investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies that file or are required to file periodic reports with the SEC under the Exchange Act.
 
Among other things, the Sarbanes-Oxley Act creates the Public Company Accounting Oversight Board as an independent body subject to SEC supervision with responsibility for setting auditing, quality control and ethical standards for auditors of public companies. The Sarbanes-Oxley Act also requires public companies to make faster and more extensive financial disclosures, requires the chief executive officer and chief financial officer of public companies to provide signed certifications as to the accuracy and completeness of financial information filed with the SEC, and provides enhanced criminal and civil penalties for violations of the federal securities laws.
 
The Sarbanes-Oxley Act also addresses functions and responsibilities of audit committees of public companies. The statute makes the audit committee directly responsible for the appointment, compensation and oversight of the work of the company’s outside auditor, and requires the auditor to report directly to the audit committee. The Sarbanes-Oxley Act authorizes each audit committee to engage independent counsel and other advisors, and requires a public company to provide the appropriate funding, as determined by its audit committee, to pay the company’s auditors and any advisors that its audit committee retains. The Sarbanes-Oxley Act also requires public companies to include an internal control report and assessment by management. As a small reporting company, under the Dodd-Frank Act LSB Financial is not subject to any obligation to have an auditor attestation to the effectiveness of its controls included in its annual report.
 
Although LSB Financial will continue to incur additional expense in complying with the provisions of the Sarbanes-Oxley Act and the resulting regulations, management does not expect that such compliance will have a material impact on LSB Financial’s results of operations or financial condition.
 
Emergency Economic Stabilization Act of 2008. In response to recent unprecedented financial market turmoil, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted on October 3, 2008. EESA authorizes the U.S. Treasury Department to provide up to $700 billion in funding for the financial services industry. Pursuant to the EESA, the Treasury was initially authorized to use $350 billion for the Troubled Asset Relief
 

 
29

 

Program (“TARP”). Of this amount, the Treasury allocated $250 billion to the TARP Capital Purchase Program (“CPP”). The CPP allows financial institutions, like the Company, to issue non-voting preferred stock to the Treasury in an amount ranging between 1% and 3% of its total risk-weighted assets. The Company decided not to participate in the TARP CPP.
 
The American Recovery and Reinvestment Act of 2009 (“ARRA”), signed into law on February 17, 2009, amended the EESA as it applies to institutions that receive financial assistance under TARP. ARRA, more commonly known as the economic stimulus or economic recovery package, includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. In addition, ARRA imposes certain new executive compensation limits on all current and future TARP recipients until the institution has repaid the Treasury.
 
In addition, on July 21, 2010, President Obama signed into law the Dodd-Frank Act, which significantly changes the regulation of financial institutions and the financial services industry. The Dodd-Frank Act includes provisions affecting large and small financial institutions alike, including several provisions that will profoundly affect how community banks, thrifts, and small bank and thrift holding companies, such as LSB Financial, will be regulated in the future. Among other things, these provisions abolish the OTS and transfer its functions to the other federal banking agencies, relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, change the scope of federal deposit insurance coverage, and impose new capital requirements on bank and thrift holding companies. The Dodd-Frank Act also establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which will be given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks. Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards, and pre-payments. The Dodd-Frank Act contains numerous other provisions affecting financial institutions of all types, many of which may have an impact on the operating environment of LSB Financial in substantial and unpredictable ways. Consequently, the Dodd-Frank Act is likely to affect our cost of doing business, it may limit or expand our permissible activities, and it may affect the competitive balance within our industry and market areas. The nature and extent of future legislative and regulatory changes affecting financial institutions, including as a result of the Dodd-Frank Act, is very unpredictable at this time. LSB Financial’s management is actively reviewing the provisions of the Dodd-Frank Act and assessing its probable impact on the business, financial condition, and results of operations of LSB Financial. However, the ultimate effect of the Dodd-Frank Act on the financial services industry in general, and LSB Financial in particular, is uncertain at this time.
 
Before and after EESA, there have been numerous actions by the Federal Reserve Board, Congress, the Treasury, the FDIC, the Internal Revenue Service, the SEC and others to further the economic and banking industry stabilization efforts. It remains unclear at this time what further legislative and regulatory measures will be implemented affecting LSB Financial.
 
Consumer Financial Protection Bureau. The Dodd-Frank Act creates a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB will have examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, the Dodd-Frank Act will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations. Federal preemption of state consumer protection law requirements, traditionally an attribute of the federal savings association charter, has also been modified by the Dodd-Frank Act and now requires a case-by-case determination of preemption by the OCC and eliminates preemption for subsidiaries of a bank. Depending on the implementation of this revised federal preemption standard, the operations of the Bank could become subject to additional compliance burdens in the states in which it operates.
 

 
30

 

Mortgage Reform and Anti-Predatory Lending. Title XIV of the Dodd-Frank Act, the Mortgage Reform and Anti-Predatory Lending Act, includes a series of amendments to the Truth In Lending Act with respect to mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards and pre-payments. With respect to mortgage loan originator compensation, except in limited circumstances, an originator is prohibited from receiving compensation that varies based on the terms of the loan (other than the principal amount). The amendments to the Truth In Lending Act also prohibit a creditor from making a residential mortgage loan unless it determines, based on verified and documented information of the consumer’s financial resources, that the consumer has a reasonable ability to repay the loan. The amendments also prohibit certain pre-payment penalties and require creditors offering a consumer a mortgage loan with a pre-payment penalty to offer the consumer the option of a mortgage loan without such a penalty. In addition, the Dodd-Frank Act expands the definition of a “high-cost mortgage” under the Truth In Lending Act, and imposes new requirements on high-cost mortgages and new disclosure, reporting and notice requirements for residential mortgage loans, as well as new requirements with respect to escrows and appraisal practices.
 
Predatory Lending. The Federal Reserve Board issued a regulation that became effective on October 1, 2002 that is aimed at curbing “predatory lending.” The term “predatory lending” encompasses a variety of practices, but the term generally is used to refer to abusive lending practices involving fraud, deception or unfairness. Predatory lending typically involves one or more of the following: (i) making unaffordable loans based on the assets of the borrower rather than on the borrower’s ability to repay an obligation (“asset-based lending”); (ii) inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced (“loan flipping”); or (iii) engaging in fraud or deception to conceal the true nature of the loan obligation from an unsuspecting or unsophisticated borrower. The Federal Reserve Board amended Regulation Z to broaden the scope of loans subject to the protections of the Home Ownership and Equity Protection Act of 1994 (“HOEPA”). Among other things, the regulation brings within the scope of HOEPA first-lien mortgage loans with interest rates that are at least 8 percentage points above Treasury securities having a comparable maturity. In addition, the regulation requires that the cost of optional insurance and similar debt protection products paid by a borrower at closing be included in calculating the finance charge paid by the borrower. HOEPA coverage is triggered if such finance charges exceed 8 percent of the total loan. Finally, the regulation restricts creditors from engaging in repeated refinancings of their own HOEPA loans over a short time period when the transactions are not in the borrower’s interest. Lenders that violate the rules face cancellation of loans and penalties equal to the finance charges paid. The Bank does not anticipate that these provisions, or any similar state predatory lending regulations, will materially affect its financial condition or results of operations.
 

Federal and State Taxation
 
Federal Taxation.  Savings institutions that meet certain definitional tests relating to the composition of assets and other conditions prescribed by the Internal Revenue Code of 1986, as amended, are permitted to establish reserves for bad debts and to make annual additions which may, within specified formula limits, be taken as a deduction in computing taxable income for federal income tax purposes.  The amount of the bad debt reserve deduction is computed under the experience method. 
 
In addition to the regular income tax, corporations, including savings institutions, generally are subject to a minimum tax.  An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum taxable income, which is the sum of a corporation’s regular taxable income (with certain adjustments) and tax preference items, less any available exemption.  The alternative minimum tax is imposed to the extent it exceeds the corporation’s regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income. 
 
A portion of our reserves for losses on loans which are presented on the statement of financial condition of retained earnings, may not, without adverse tax consequences, be utilized for the payment of cash dividends or other distributions to a shareholder, including distributions on redemption, dissolution or liquidation, or for any other purpose except to absorb bad debt losses.  As of December 31, 2010, the portion of our reserves subject to this treatment for tax purposes totaled approximately $1.9 million.  We file consolidated federal income tax returns with our subsidiaries on a calendar year basis using the accrual method of accounting.  We have not been audited by the IRS during the last five fiscal years.
 

 
31

 

Indiana Taxation.  The State of Indiana imposes an 8.5% franchise tax on corporations transacting the business of a financial institution in Indiana.  Included in the definition of corporations transacting the business of a financial institution in Indiana are holding companies of thrift institutions, as well as thrift institutions.  Net income for franchise tax purposes will constitute federal taxable income before net operating loss deductions and special deductions, adjusted for certain items, including Indiana income taxes and bad debts.  Other applicable Indiana taxes include sales, use and property taxes.
 
Employees
 
At December 31, 2010, we had a total of 93 employees, including 4 part-time employees.  Our employees are not represented by any collective bargaining group.  Management considers its employee relations to be good.
 
Item 1A.   Risk Factors
 
Not Applicable.
 
Item 1B.   Unresolved Staff Comments
 
None.
 
Item 2.   Properties
 
We conduct our business at our main office and four other locations in Lafayette and West Lafayette, Indiana.  We own our main office and three branch offices.  The fourth branch office is leased with the term of the lease expiring in 2014. The total net book value of our premises and equipment (including land, building and leasehold improvements and furniture, fixtures and equipment) at December 31, 2010 was approximately $6.1 million.  We have also purchased an office building adjacent to the main office location as our growth rate has required space for additional personnel and will for the next few years.
 
We maintain an on-line database of depositor and borrower customer information.  The net book value of our data processing, computer equipment and software at December 31, 2010 was $315,000.
 
 
Item 3.   Legal Proceedings
 
Effective August 31, 2010, the Bank executed an updated Supervisory Agreement (the “Supervisory Agreement”) with the Office of Thrift Supervision (“OTS”) and LSB Financial Corp. (the “Company”) entered into a Memorandum of Understanding (the “MOU”) with the OTS under which the Bank and the Company have agreed to take a number of actions within specified timeframes to address concerns identified by the OTS in connection with its most recent examination of the Bank.  These agreements replace the prior Memorandum of Understanding and Supervisory Agreement between the Bank and the OTS.
 
The updated Supervisory Agreement eliminates certain requirements satisfied in the Bank’s prior agreement with the OTS. Among other things, under the Supervisory Agreement, the Bank’s board of directors must continue to provide written workout plans for certain classified assets and present quarterly status reports to the OTS.  The Bank’s board of directors must also revise its policy on concentrations of credit and in the event the revised limits are lower adopt a plan to bring the Bank into compliance with the revised policy.  The Bank must also revise its policies and procedures related to the establishment and maintenance of its allowance for loan losses.  However, the Supervisory Agreement does not require an additional provision for loan loss reserves.  The Supervisory Agreement places restrictions on the Bank with respect to certain operating activities, requiring prior notice to the OTS of changes in directors and senior executive officers; and prior written non-objection from the OTS with respect to senior executive officer or director compensation, material third party service provider contracts, and asset growth over certain levels until the approval of the Bank’s business plan.
 
Under the MOU, the Company was required to submit to the OTS by October 31, 2010, a capital plan for enhancing the consolidated capital of the Company for the period January 1, 2011 through December 31, 2012.  The capital plan is to be updated each year during which the MOU is effective.  The MOU also requires prior written non-objection of the OTS of any Company debt not in the ordinary course (including loans, cumulative preferred stock and subordinated debt) unless such debt is contemplated by the capital plan.  The holding company does not now hold any such debt.
 
 
 
32

 
 
Both the Supervisory Agreement and the MOU require prior written non-objection of the OTS of the declaration or payment of dividends or other capital distributions by the Bank or the Company, respectively.
 
The board of directors and management of the Bank and the Company have been taking actions intended to comply with the Supervisory Agreement and the MOU. The Supervisory Agreement and the MOU will remain in effect until terminated, modified or superseded by the OTS. The Company believes that the Supervisory Agreement and the MOU will not have a material adverse effect on the financial condition or results of operations of the Bank or the Company, taken as a whole.
 
We are, from time to time, involved as plaintiff or defendant in various legal actions arising in the normal course of business.  While the ultimate outcome of these proceedings cannot be predicted with certainty, it is the opinion of management, after consultation with counsel representing us in the proceedings, that the resolution of any prior and pending proceedings should not have a material effect on our financial condition or results of operations.
 
Item 4.   (Removed and Reserved)
 
Item 4.5   Executive Officers of the Registrant
 
The executive officers of LSB Financial are identified below.  The executive officers are elected annually by the Board of Directors of LSB Financial.
 
Randolph F. Williams (age 62).  Mr. Williams is President and Chief Executive Officer of LSB Financial and its wholly-owned subsidiary, Lafayette Savings.  Mr. Williams was appointed to the Board of Directors of LSB Financial in September 2001.  He was appointed President of LSB Financial in September 2001 and Chief Executive Officer in January 2002.  Mr. Williams served as President and Chief Operating Officer of Delaware Place Bank in Chicago, Illinois from 1996 until joining LSB Financial.  Mr. Williams has over 25 years of banking-related experience.
 
Mary Jo David (age 61).  Ms. David is Vice President, Chief Financial Officer and Secretary of LSB Financial and Lafayette Savings.  She has held these positions with the Company since its formation in 1994 and with Lafayette Savings since 1992 and was elected a Director of LSB Financial and Lafayette Savings in 1999.
 
 
PART II
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
(a)           We have not sold any equity securities during the period covered by this report that were not registered under the Securities Act of 1933.  Additionally, pages 54 through 55 and page 68 of our 2010 Annual Report to Shareholders attached to this document as Exhibit 13 are incorporated herein by reference.  In addition, the “Equity Compensation Plan Information” contained in Part III, Item 12 of this Form 10-K is incorporated herein by reference.
 
(b)           We have no information to furnish pursuant to Rule 463 of the Securities Act of 1933 and Item 701(f) of Regulation S-K.
 
 
 
33

 
 
(c)           The following table sets forth the number and price paid for repurchased shares.
 
Issuer Purchases of Equity Securities
 
Month of Purchase
 
Total Number of
Shares Purchased(1)
   
Average Price
Paid per Share
   
Total Number of
Shares Purchased
as Part of Publicly
Announced Plan(2)
   
Maximum Number
(or Approximate
Dollar Value) of
Shares that May
Yet Be Purchased
Under the Plan(2)
 
October 1 – October 31, 2010
    ---       ---       ---       52,817  
November 1 – November 30, 2010
    ---       ---       ---       52,817  
December 1 – December 31, 2010
    ---       ---       ---       52,817  
                                 
Total
    ---       ---       ---       52,817  

(1) There were no shares repurchased other than through a publicly announced plan or program.
(2) We have in place a program, announced February 6, 2007, to repurchase up to 100,000 shares of our common stock.
 
 
Item 6.   Selected Financial Data
 
Not Applicable.
 
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operation
 
Pages 3 through 27 of our 2010 Annual Report to Shareholders attached to this document as Exhibit 13 are incorporated herein by reference.
 
Item 7A.   Quantitative and Qualitative Disclosures about Market Risk
 
Not Applicable.
 
Item 8.   Financial Statements and Supplementary Data
 
Pages 32 through 64 of our 2010 Annual Report to Shareholders attached to this document as Exhibit 13 are incorporated herein by reference.
 
Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
Not Applicable.
 
Item 9A.   Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures.  An evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act), as of December 31, 2010 (the “Evaluation Date”), was carried out under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer and several other members of our senior management. Our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures in effect as of the Evaluation Date are effective in ensuring that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and were designed to ensure that information required to be disclosed in those reports is accumulated and communicated to our management (including the Chief Executive Officer and Chief Financial Officer) as appropriate to allow timely decisions regarding required disclosure.
 
Management’s Report on Internal Control over Financial Reporting.
 
The management of LSB Financial Corp. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting (as such term is defined in defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Securities Exchange Act of 1934).  Our internal control over financial reporting process was
 
 
 
34

 
 
designed, under supervision of our Chief Executive Officer, Chief Financial Officer and several other members of our senior management, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
 
 
·
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;

 
·
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

 
·
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
 
Because of the inherent limitations in any internal control, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Further, the evaluation of the effectiveness of internal control over financial reporting was made as of a specific date, and projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies and procedures may deteriorate.
 
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010.  In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.
 
Based on our assessment, management has determined that, as of December 31, 2010, the Company’s internal control over financial reporting is effective based on those criteria.
 
Changes in Internal Controls over Financial Reporting.  There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Act) identified in connection with our evaluation of controls that occurred during the quarter ended December 31, 2010, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
Item 9B.   Other Information
 
We have no information that was required to be reported on a Form 8-K in the fourth quarter covered by this 10-K, but was not reported on a Form 8-K during the fourth quarter.
 
 
PART III
 
Item 10.   Directors, Executive Officers and Corporate Governance
 
Information concerning LSB Financial directors is incorporated herein by reference to the sections of the definitive Proxy Statement for the Annual Meeting of Shareholders to be held in April 2011 under the caption “Proposal 1 - Election of Directors.” Information concerning LSB Financial executive officers is included in Item 4.5 in Part I of this Form 10-K and is incorporated herein by reference.
 
The information relating to corporate governance required by this item is incorporated herein by reference to the section of our definitive Proxy Statement for the Annual Meeting of Shareholders to be held in April 2011 under the caption “Corporate Governance.”
 
Section 16(a) of the Exchange Act requires our directors and executive officers and persons who own more than 10% of a registered class of our equity securities, to file with the SEC initial reports of ownership and reports of changes in ownership of our common stock and our other equity securities by the end of the second business day following a change.  Officers, directors and greater than 10% stockholders are required by SEC regulation to furnish us with copies of all Section 16(a) forms they file.
 
 
 
35

 
 
To our knowledge, based solely on a review of the copies of such reports furnished to us and written representations that no other reports were required, during the fiscal year ended December 31, 2010, all Section 16(a) filing requirements applicable to our officers, directors and 10% beneficial owners were complied with except as disclosed in our definitive Proxy Statement for the Annual Meeting of Shareholders to be held in April 2011 under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” incorporated herein by reference.
 
LSB Financial has a written code of ethics that applies to all of our directors, officers and employees. The code of ethics is available on our website at www.lsbank.com.
 
Item 11.   Executive Compensation
 
Information concerning executive compensation is incorporated herein by reference to the sections of our definitive Proxy Statement for the Annual Meeting of Shareholders to be held in April 2011 with the captions “Executive Compensation” and “Compensation of Directors.”
 
Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference to the section of our definitive Proxy Statement for the Annual Meeting of Shareholders to be held in April 2011 with the caption “Principal Holders of Common Stock.”
 
Equity Compensation Plan Information. The following table summarizes our equity compensation plans as of December 31, 2010.
 
Plan Category
Number of securities to
be issued upon exercise
of outstanding options
warrants and rights
(a)
Weighted-average
exercise price of
outstanding options
warrants and rights
(b)
Number of Securities
remaining available for
future issuance under
equity compensation plans
(excluding securities reflected in
column (a))
(c)
Equity compensation plans approved by security holders(1)
36,785 (2)
17.82 (3)
77,250 (4)
Equity compensation plans not approved by security holders
---
---
---
       
(1)  LSB Financial Corp.’s 1995 Stock Option and Incentive Plan terminated on August 22, 2005 so no further options may be granted under the 1995 Stock Option and Incentive Plan.  LSB Financial Corp.’s Recognition and Retention Plan terminated by its terms on August 22, 2005, so no further awards may be made under the Recognition and Retention Plan.
(2) Includes 33,035 shares under LSB Financial Corp.’s 1995 Stock Option and Incentive Plan, 3,750 shares under the LSB Financial Corp. 2007 Stock Option and Incentive Plan and no shares under LSB Financial Corp.’s Recognition and Retention Plan.
(3) The total in Column (b) includes only the weighted-average price of stock options, as the restricted shares awarded under the Recognition and Retention Plan have no exercise price and no shares have been awarded under the Recognition and Retention Plan.
(4) The total in Column (c) is the number of shares reserved for issuance under the LSB Financial Corp. 2007 Stock Option and Incentive Plan excluding the 3,750 shares included in Column (a).

Item 13.   Certain Relationships and Related Transactions, and Director Independence
 
Information concerning director independence and certain relationships and transactions is incorporated herein by reference to the sections of our definitive Proxy Statement for the Annual Meeting of Shareholders to be held in April 2011 with the captions “Corporate Governance” and “Transactions with Related Persons.”
 
Item 14.   Principal Accountant Fees and Services
 
Information concerning principal accountant fees and services are incorporated herein by reference to the sections of our definitive Proxy Statement for the Annual Meeting of Shareholders to be held in April 2011 with the caption “Accountant’s Fees.”
 

 
36

 

PART IV

Item 15.   Exhibits and Financial Statement Schedules

(a)           The following documents are filed as part of this report:
 
   
Annual Report Page No(s).
 
Financial Statements:
 
 
Report of BKD, LLP, Independent Registered Public Accounting Firm
31
 
Consolidated Balance Sheets at December 31, 2010 and 2009
32
 
Consolidated Statements of Income for the Years Ended December 31, 2010 and 2009
33
 
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2010 and 2009
34
 
Consolidated Statements of Cash Flows for the Years Ended December 31, 2010 and 2009
35
 
Notes to Consolidated Financial Statements
36-64
     
 
Financial Statement Schedules:
All schedules are omitted as the required information either is not applicable or is included in the consolidated financial statements or related notes.
 
 
(b)           The exhibits filed herewith or incorporated by reference herein are set forth on the Index to Exhibits.
 


 
37

 

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
     
LSB FINANCIAL CORP.
         
Date:  March 16, 2011
   
By:
/s/ Randolph F. Williams 
       
Randolph F. Williams, President,
       
Chief Executive Officer and Director
       
(Duly Authorized Representative)

 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
 
/s/ Mariellen M. Neudeck   /s/ Randolph F. Williams
Mariellen M. Neudeck, Chairman of the Board
 
 
Randolph F. Williams, President, Chief Executive Officer and Director
(Principal Executive and Operating Officer)
   
 
     
Date:  March 16, 2011
 
Date: March 16, 2011
     
     
/s/ James A. Andrew   /s/ Kenneth P. Burns
James A. Andrew, Director
 
Kenneth P. Burns, Director
     
Date:  March 16, 2011
 
Date:  March 16, 2011
     
     
/s/ Philip W. Kemmer   /s/ Stephen E. Belter
Philip W. Kemmer, Director
 
Stephen E. Belter, Director
     
Date:  March 16, 2011
 
Date:  March 16, 2011
     
     
    /s/ Thomas R. McCully
Jeffrey A. Poxon, Director
 
Thomas R. McCully, Director
     
Date:  March    , 2011
 
Date:  March 16, 2011
     
     
/s/ Mary Jo David    
Mary Jo David, Vice President, Chief Financial Officer, Secretary-Treasurer and Director
(Principal Financial and Accounting Officer)
 
Charles W. Shook, Director
 
     
Date:  March 16, 2011
 
Date:  March    , 2011


 
38

 

INDEX TO EXHIBITS
Regulation
S-K Exhibit
Number
 
Document
     
3.1
 
Articles of Incorporation, filed on September 21, 1994 as an exhibit to Registrant’s Registration Statement on Form S-1 (File No. 33-84266), are incorporated by reference. 
 
3.2
 
Bylaws, as amended and restated, filed as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on July 22, 2009, are incorporated herein by reference.
 
4
 
Registrant’s Specimen Stock Certificate, filed on September 21, 1994 as an exhibit to Registrant’s Registration Statement on Form S-1 (File No. 33-84266), is incorporated herein by reference.
 
10.1*
 
Registrant’s 1995 Stock Option and Incentive Plan, filed as Exhibit 10.1 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005, is incorporated herein by reference.
 
10.2*
 
Registrant’s 1995 Recognition and Retention Plan, filed as Exhibit 10.2 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005, is incorporated herein by reference.
 
10.3*
 
Form of 1995 Stock Option and Incentive Plan Non-Qualified Stock Option Agreement, filed as Exhibit 10.4 to the Registrant’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2004, is incorporated herein by reference.
 
10.4*
 
Form of 1995 Stock Option and Incentive Plan Incentive Stock Option Agreement, filed as Exhibit 10.5 to the Registrant’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2004, is incorporated herein by reference.
 
10.5*
 
Form of Recognition and Retention Plan Restricted Stock Agreement, filed as Exhibit 10.6 to the Registrant’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2004, is incorporated herein by reference.
 
10.6*
 
Deferred Compensation Agreement between Lafayette Savings Bank and Randolph F. Williams, filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K for the event occurring on September 29, 2005, is incorporated herein by reference.
 
10.7*
 
Amended and Restated Employment Agreement dated February 27, 2008 between LSB Financial Corp. and Randolph F. Williams filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on March 3, 2008, is incorporated herein by reference.
 
10.8*
 
Amended and Restated Employment Agreement dated February 27, 2006 between LSB Financial Corp. and Mary Jo David filed as Exhibit 10.2 to the Registrant’s 8-K filed on March 3, 2008, is incorporated herein by reference.
 
10.9*
 
LSB Financial Corp. 2007 Stock Option and Incentive Plan, filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on April 24, 2007, is incorporated herein by reference.
 
10.10*
 
Form of 2007 Stock Option and Incentive Plan Incentive Stock Option Agreement, filed as Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2007, is incorporated herein by reference.
     


E-1
 
 

 


10.11*
 
Form of 2007 Stock Option and Incentive Plan Non-qualified Stock Option Agreement, filed as Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2007, is incorporated herein by reference.
     
10.12*
 
Form of Agreement for Restricted Stock Granted under LSB Financial Corp. 2007 Stock Option and Incentive Plan, filed as Exhibit 10.3 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2007, is incorporated herein by reference.
     
13
 
Annual Report to Shareholders for the Year Ended December 31, 2010.
 
21
 
 
Subsidiaries of Registrant.
23
 
Consent of BKD, LLP, Independent Registered Public Accounting Firm.
     
31.1
 
Rule 13a - 14(a) Certification (Chief Executive Officer).
     
31.2
 
Rule 13a - 14(a) Certification (Chief Financial Officer).
     
32
 
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
   
* Indicates exhibits that describe or evidence management contracts and plans required to be filed as exhibits.
 
 
 
E-2