1 Form 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2003 OR [ ] 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: 0-13203 LNB Bancorp, Inc. (Exact name of the registrant as specified on its charter) Ohio 34-1406303 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 457 Broadway, Lorain, Ohio 44052 - 1769 (Address of principal executive offices) (Zip Code) (440) 244 - 6000 Registrant's telephone number, including area code Not Applicable (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such requirements for the past 90 days. YES X NO Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Outstanding at May 13, 2003: 6,603,211 shares Class of Common Stock: $1.00 par value 2 LNB Bancorp, Inc. Quarterly Report on Form 10-Q Quarter Ended March 31, 2003 Part I - Financial Information Item 1 - Financial Statements Interim financial information required by Rule 10-01 of Regulation S-X is included in this Form 10-Q as referenced below: Page Number(s) Condensed Consolidated Balance Sheets 3 Condensed Consolidated Statements of Income 5 Condensed Consolidated Statements of Cash Flows 7 Notes to Condensed Consolidated Financial Statements 10 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 3 - Quantitative and Qualitative Disclosures about Market Risk 21 Item 4 - Controls and Procedures Part II - Other Information Item 1 - Legal Proceedings 22 Item 2 - Changes in Securities 22 Item 3 - Defaults upon Senior Securities 22 Item 4 - Submission of matters to a Vote of Security Holders 22 Item 5 - Other Information 22 Item 6 - Exhibits and Reports on Form 8-K 22 Signatures 23 Certifications 24 Exhibit Index 28 3 FORM 10-Q LNB BANCORP, INC. PART I - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS MARCH 31, DECEMBER 31, CONDENSED CONSOLIDATED BALANCE SHEETS 2003 2002 ------------- -------------- (Unaudited) (See Note 1) ASSETS: Cash and due from banks $ 25,527,000 $ 23,608,000 Federal funds sold and short-term investments 3,235,000 3,224,000 Securities: Available for sale, at fair value 146,005,000 137,909,000 Held to maturity, at cost (fair value $5,539,000 and $10,903,000, respectively) 5,312,000 10,648,000 Federal Home Loan Bank, Federal Reserve Bank and other equity stock, at cost 3,772,000 3,738,000 -------------- -------------- Total securities 155,089,000 152,295,000 -------------- -------------- Loans: Portfolio loans 500,385,000 500,551,000 Loans available for sale 11,094,000 8,999,000 -------------- -------------- Total loans 511,479,000 509,550,000 Reserve for loan losses (6,703,000) (6,653,000) -------------- -------------- Net loans 504,776,000 502,897,000 -------------- -------------- Bank owned life insurance 12,115,000 11,930,000 Bank premises and equipment, net 10,573,000 10,748,000 Intangible assets 3,329,000 3,358,000 Accrued interest receivable 3,106,000 3,045,000 Other assets 4,298,000 4,272,000 Foreclosed assets -0- 22,000 -------------- -------------- TOTAL ASSETS $722,048,000 $715,399,000 ============== ============== STATEMENT CONTINUED ON NEXT PAGE 4 STATEMENT CONTINUED FROM PREVIOUS PAGE LIABILITIES AND SHAREHOLDERS' EQUITY: Deposits: Demand and other noninterest-bearing deposits $ 87,054,000 $ 80,879,000 Savings, Market Access and passbook accounts 276,540,000 280,616,000 Certificates of deposit 215,261,000 204,632,000 -------------- -------------- Total deposits 578,855,000 566,127,000 -------------- -------------- Securities sold under repurchase agreements and other short-term borrowings 16,839,000 26,866,000 Federal Home Loan Bank advances 52,425,000 48,925,000 Accrued interest payable 983,000 983,000 Accrued taxes, expenses, and other liabilities 5,574,000 5,885,000 -------------- -------------- TOTAL LIABILITIES 654,676,000 648,786,000 -------------- -------------- SHAREHOLDERS' EQUITY: Preferred stock, no par value: Shares authorized 1,000,000, and shares outstanding, none Common stock $1.00 par: Shares authorized 15,000,000, Shares issued 6,752,988 and 4,501,232, respectively and Shares outstanding 6,603,211 and 4,401,232, respectively 6,753,000 4,501,000 Additional capital 26,086,000 28,319,000 Retained earnings 36,701,000 35,639,000 Accumulated other comprehensive income 726,000 1,054,000 Treasury stock at cost, 149,777 and 100,000 shares, respectively (2,894,000) (2,900,000) -------------- -------------- TOTAL SHAREHOLDERS' EQUITY 67,372,000 66,613,000 -------------- -------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $722,048,000 $715,399,000 ============== ============== See notes to unaudited condensed consolidated financial statements. 5 FORM 10-Q LNB BANCORP, INC. PART I - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS THREE MONTHS ENDED CONDENSED CONSOLIDATED STATEMENTS MARCH 31, OF INCOME (UNAUDITED) ---------------------------- 2003 2002 INTEREST INCOME: ---------------------------- Interest and fees on loans $ 8,202,000 $ 8,372,000 Interest and dividends on securities: U.S. Treasury securities -0- 6,000 U.S. Government agencies and corporations 1,238,000 1,535,000 States and political subdivisions 155,000 134,000 Other debt and equity securities 79,000 123,000 Interest on Federal funds sold and other interest-bearing instruments 12,000 19,000 ------------- ------------ TOTAL INTEREST INCOME 9,686,000 10,189,000 ------------- ------------ INTEREST EXPENSE: Interest on Deposits: Time certificates of $100,000 and over 375,000 298,000 Other deposits 1,676,000 2,276,000 Interest on securities sold under repurchase agreements and other short-term borrowings 68,000 151,000 Interest on Federal Home Loan Bank advances 407,000 381,000 ------------- ------------ TOTAL INTEREST EXPENSE 2,526,000 3,106,000 ------------- ------------ NET INTEREST INCOME 7,160,000 7,083,000 Provision for loan losses 564,000 600,000 NET INTEREST INCOME AFTER PROVISION ------------- ------------ FOR LOAN LOSSES 6,596,000 6,483,000 ------------- ------------ NONINTEREST INCOME: Investment and Trust Services Division income 454,000 575,000 Service charges on deposit accounts 946,000 916,000 Other service charges, exchanges and fees 787,000 731,000 Gains from sales of securities 203,000 275,000 Other operating income 116,000 141,000 ------------- ------------ TOTAL NONINTEREST INCOME 2,506,000 2,638,000 ------------- ------------ STATEMENT CONTINUED ON NEXT PAGE 6 STATEMENT CONTINUED FROM PREVIOUS PAGE NONINTEREST EXPENSES: Salaries and employee benefits 2,964,000 2,917,000 Net occupancy expense of premises 412,000 381,000 Furniture and equipment expenses 549,000 531,000 Supplies and postage 282,000 276,000 Ohio franchise tax 181,000 61,000 Credit card and merchant expenses 292,000 302,000 Other operating expenses 1,266,000 1,460,000 ------------- ------------ TOTAL NONINTEREST EXPENSES 5,946,000 5,928,000 ------------- ------------ INCOME BEFORE INCOME TAXES 3,156,000 3,193,000 INCOME TAXES 965,000 1,045,000 ------------- ------------ NET INCOME $ 2,191,000 $ 2,148,000 ============= ============ PER SHARE DATA: BASIC EARNINGS PER SHARE $ .33 $ .32 ======= ======= DILUTED EARNINGS PER SHARE $ .33 $ .32 ======= ======= DIVIDENDS DECLARED PER SHARE $ .17 $ .16 ======= ======= See notes to unaudited condensed consolidated financial statements. 7 FORM 10-Q LNB BANCORP, INC. PART I - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS THREE MONTHS ENDED CONDENSED CONSOLIDATED STATEMENTS MARCH 31, OF CASH FLOWS (UNAUDITED) ---------------------------- 2003 2002 CASH FLOWS FROM OPERATING ACTIVITIES: ---------------------------- Interest received $ 9,827,000 $10,905,000 Other income received 2,161,000 1,983,000 Interest paid (2,526,000) (3,181,000) Cash paid for salaries and employee benefits (3,620,000) (2,796,000) Net occupancy expense of premises paid (333,000) (305,000) Furniture and equipment expenses paid (235,000) (215,000) Cash paid for supplies and postage (282,000) (276,000) Cash paid for other operating expenses (2,402,000) (1,911,000) Federal income taxes paid -0- (250,000) ------------- ------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 2,590,000 3,954,000 ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities of securities held to maturity 5,325,000 4,300,000 Proceeds from sales and maturities of Securities available for sale 30,190,000 27,332,000 Proceeds from sales of loans 5,295,000 7,104,000 Purchases of securities held to maturity -0- (337,000) Purchases of securities available for sale (38,352,000) (26,287,000) Increase in loans available for sale 1,269,000 3,471,000 Net (increase) in loans made to customers (9,215,000) (22,827,000) Purchases of bank premises and equipment and intangible assets (228,000) (117,000) Proceeds from sales of bank premises and Equipment 9,000 24,000 Purchases of BOLI -0- -0- Proceeds from liquidation of other foreclosed assets 22,000 33,000 Purchases of other foreclosed assets -0- (51,000) ------------- ------------- NET CASH USED IN INVESTING ACTIVITIES (5,685,000) (7,355,000) ------------- ------------- STATEMENT CONTINUED ON NEXT PAGE 8 STATEMENT CONTINUED FROM PREVIOUS PAGE CASH FLOWS FROM FINANCING ACTIVITIES: Net increase(decrease) in demand and other noninterest-bearing deposits 6,175,000 (10,506,000) Net increase (decrease) in savings and passbook deposits (4,076,000) 11,370,000 Net increase in certificates of deposit 10,629,000 3,191,000 Net (decrease) in securities sold under repurchase agreements and other short-term borrowings (10,027,000) (27,407,000) Proceeds from Federal Home Loan Bank advances 75,500,000 22,330,000 Payment on Federal Home Loan Bank advances (72,000,000) (2,300,000) Cash paid in lieu of fractional shares related to three-for-two stock split (13,000) -0- Proceeds from exercise of stock options 19,000 -0- (Purchase) Redemption of Treasury Stock 6,000 -0- Dividends paid (1,188,000) (1,165,000) ------------- ------------- NET CASH (USED) BY FINANCING ACTIVITIES (5,025,000) (4,487,000) NET INCREASE(DECREASE) IN CASH AND ------------- ------------- CASH EQUIVALENTS 1,930,000 (7,888,000) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 26,832,000 31,505,000 ------------- ------------- CASH AND CASH EQUIVALENTS AT END OF QUARTER $28,762,000 $23,617,000 ============= ============= 9 RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: NET INCOME $2,191,000 $2,148,000 Adjustments to reconcile net income to net cash provided by operating activities: Gain on sale of investments & loans (265,000) 307,000 Depreciation and amortization 393,000 392,000 Amortization of intangible assets 29,000 28,000 Amortization of premiums on investment securities 280,000 41,000 Amortization of deferred loan fees and costs, net (80,000) (58,000) Provision for loan losses 564,000 600,000 Increase in CSV - BOLI (185,000) -0- (Increase)Decrease in accrued interest receivable (61,000) 617,000 (Increase) in other assets (26,000) (58,000) (Decrease) in accrued interest payable -0- (75,000) Increase (Decrease) in accrued taxes, expenses and other liabilities (239,000) 352,000 Others, net (11,000) (340,000) -------------- -------------- NET CASH PROVIDED BY OPERATING ACTIVITIES $2,590,000 $3,954,000 ============== ============== See notes to unaudited condensed consolidated financial statements. 10 FORM 10-Q LNB Bancorp, Inc. PART I - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES INTRODUCTION The following areas of discussion pertain to the unaudited condensed consolidated balance sheets of LNB Bancorp, Inc. (The Parent Company) and its wholly-owned subsidiaries, Lorain National Bank (The Bank) and Charleston Insurance Agency, Inc. and a 49% interest in Charleston Title Insurance Agency, LLC., at March 31, 2003, compared to December 31, 2002 and the related unaudited condensed consolidated statements of income and cash flows for the three months ended March 31, 2003. The term "the Corporation" refers to LNB Bancorp, Inc. and its wholly-owned subsidiaries. It is the intent of this discussion to provide the reader with a more thorough understanding of the unaudited condensed consolidated financial statements and should be read in conjunction with those unaudited condensed consolidated financial statements and the Corporation's December 31, 2002 Annual Report. LNB Bancorp, Inc. is not aware of any trends, events, or uncertainties that might have a material effect on the soundness of operations; neither is LNB Bancorp, Inc. aware of any proposed recommendations by regulatory authorities which would have a similar effect if implemented. BASIS OF PRESENTATION The unaudited condensed consolidated balance sheet as of March 31, 2003 and the unaudited condensed consolidated statements of income and cash flows for the three months ended March 31, 2003 and 2002 are prepared in accordance with accounting principles generally accepted in the United States of America. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. The above mentioned statements reflect all normal and recurring adjustments which are, in the opinion of Management, necessary for a fair presentation of the financial position and the results of operations for the interim periods presented. All adjustments are normal and recurring in nature. The condensed consolidated balance sheet at December 31, 2002 has been taken from the audited Financial Statements and condensed. The results of operations for the three months ended March 31, 2003 are not necessarily indicative of the operating results for the full year. 11 All 2002 financial statements and related per-share amounts herein have been restated to reflect the adoption of Statement of Financial Accounting Standards (SFAS) No. 147 "Acquisitions of Certain Financial Institutions" and SFAS No. 142 "Goodwill and Other Intangible Assets" as related to intangibles. Per-share amounts have also been adjusted to reflect a two- percent stock dividend on July 2, 2002, and a three-for two stock split on March 14, 2003. COMMON STOCK On February 25, 2003, the Board of Directors of LNB Bancorp, Inc. declared a three-for-two split of common stock. Shareholders received one additional common share for every two shares owned on the stock-split record date of March 10, 2003. Shareholders participating in the Bancorp's dividend reinvestment plan, LNBB Direct (the Plan), were issued fractional shares. Shareholders not participating in the Plan were issued cash in lieu of fractional shares. For additional information see Form 8-K filed on February 25, 2003. RESERVE FOR LOAN LOSSES Because some loans may not be repaid in full, a reserve for loan losses is recorded. This reserve is increased by provisions charged to earnings and is reduced by loan charge-offs, net of recoveries. Estimating the risk of loss on any loan is necessarily subjective. Accordingly, the reserve is maintained by Management at a level considered adequate to cover loan losses that are currently anticipated based on Management's evaluation of several key factors including information about specific borrower situations, their financial position and collateral values, current economic conditions, changes in the mix and levels of the various types of loans, past charge-off experience and other pertinent information. The reserve for loan losses is based on estimates using currently available information, and ultimate losses may vary from current estimates due to changes in circumstances. These estimates are reviewed periodically and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. While Management may periodically allocate portions of the reserve for specific problem situations, the entire reserve is available for any charge- offs that may occur. Charge-offs are made against the reserve for loan losses when Management concludes that it is probable that all or a portion of a loan is uncollectible. After a loan is charged-off, collection efforts continue and future recoveries may occur. A loan is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of the expected future cash flows discounted at the loans initial effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. If 12 the loan valuation is less than the recorded value of the loan, an impairment reserve is established for the difference. The impairment reserve is established by either an allocation of the reserve for loan losses or by a provision for loan losses, depending upon the adequacy of the reserve for loan losses. RECLASSIFICATIONS Certain 2002 amounts have been reclassified to conform to 2003 presentation. 2. EARNINGS PER SHARE Earnings per share is calculated as follows: For the Quarter ended March 31, 2003 Income Shares Per-Share (Numerator) (Denominator) Amount Net Income $2,191,000 Basic EPS Income available to common shareholders $2,191,000 6,602,127 $ .33 ===== Effect of Dilutive Securities Incentive Stock Options -0- 14,839 ---------- --------- Diluted EPS Income available to common shareholders + assumed conversions $2,191,000 6,616,966 $ .33 ========== ========= ===== For the Quarter ended March 31, 2002 Income Shares Per-Share (Numerator) (Denominator) Amount Net Income $2,148,000 Basic EPS Income available to common shareholders $2,148,000 6,473,337 $ .32 ===== Effect of Dilutive Securities Incentive Stock Options -0- 2,193 ---------- --------- 13 Diluted EPS Income available to common shareholders + assumed conversions $2,148,000 6,475,530 $ .32 ========== ========= ===== 3. COMPREHENSIVE INCOME The Corporation's comprehensive income for the quarters ended March 31, 2003 and 2002 are as follows: For the quarters ended March 31, 2003 2002 -------------------------------- Net income $2,191,000 $2,148,000 Other comprehensive income: Change in unrealized gain (loss) on securities available for sale, net of tax (benefit) of $(169,000) and $(415,000) (328,000) (807,000) ------------ ------------ Comprehensive Income $1,863,000 $1,341,000 ============ ============ For the quarters ended March 31, 2003 2002 -------------------------------- Disclosure of Reclassification Amount Unrealized holding gains arising during the period, net of tax $ (462,000) $ (988,000) Less reclassification adjustment for gains included in the net income, net of tax of $69,000 and $94,000 134,000 181,000 ------------ ------------ Change in unrealized (loss) on securities available for sale, net of tax $ (328,000) $ (807,000) ============ ============ 4. CRITICAL ACCOUNTING POLICIES The Corporation maintains critical accounting policies for reserve for loan losses, classification and evaluation of securities and a deferred tax asset valuation allowance. Refer to notes 1,5,7 and 12 of Notes to Consolidated Financial Statements for additional information incorporated by reference to the 2002 Annual Report to Shareholders for the year ended December 31, 2002. 14 5. STOCK OPTION PLANS The FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 provides guidance on how to transition from the intrinsic value method of accounting for stock-based employee compensation under APB No. 25 to SFAS No. 123's fair value method for accounting, if a company so elects. In accordance with the transitional guidance of SFAS No. 148, the fair value method of accounting for stock options should be applied prospectively to awards granted subsequent to January 1, 2003. As permitted, options granted prior to January 1, 2003, will continue to be accounted for under APB Opinion 25, and the pro forma impact of accounting for these options at fair value will continue to be disclosed in the notes to the consolidated financial statements. The Corporation did not issue any stock options during the first quarter of 2003 or 2002. All stock options issued were 100% vested at March 31, 2003 and 2002, and therefore had compensation cost for the Corporation's stock- based compensation plans been determined consistent with SFAS No. 123, net income and net income per share would not have been impacted. 15 PART I - FINANCIAL INFORMATION ITEM 2 - MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS Certain statements contained herein are not based on historical facts and are "forward-looking statements" within the meaning of Section 21A of the Securities Exchange Act of 1934. Forward-looking statements which are based on various assumptions (some of which are beyond the Corporation's control), may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "estimate," "anticipate," "continue," or similar terms or variations on those terms, or the negative of these terms. Actual results could differ materially from those set forth in forward-looking statements, due to a variety of factors, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset/liability management, the financial and securities markets and the availability of and costs associated with sources of liquidity. The Corporation does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. FINANCIAL CONDITION Total assets of the Corporation increased $6,649,000 during the first quarter of 2003, to $722,048,000. The total securities portfolio increased $2,794,000 ending the first quarter of 2003 at $155,089,000. At March 31, 2003 gross unrealized gains (losses) in the investment portfolio were approximately $1,913,000 and $(109,000), respectively. Loans increased $1,929,000 during the first quarter to $511,479,000 at March 31, 2003. This increase was a result of good loan demand in our market. Commercial loan growth was particularly strong, showing a first quarter increases of $11,026,000. Mortgage and consumer loans decreased by $6,934,000 and $2,163,000, respectively, during the first quarter of 2003. The consumer loan portfolio has decreased because of low automobile demand while mortgages decreased due to refinancing. The reserve for loan losses ended the quarter at $6,703,000 supported by a 16 provision for loan losses of $564,000, recoveries of $85,000 and loan charge-offs of $599,000. The reserve for loan losses as a percentage of ending loans was 1.31% at March 31, 2003 and December 31, 2002. Corporate management believes that the reserve for loan losses as a percentage of ending loans at March 31, 2003 remains at an appropriate level. The ratio of the reserve for loan losses to nonperforming assets decreased to 289.0% as of March 31, 2002 from 352.9% at December 31, 2002. Corporate management believes that the current level of the reserve for loan losses is adequate based upon quantitative analysis of identified risks and analysis of historical trends. The level of nonperforming assets increased by $434,000 during the first quarter of 2003. This increase is the result of an increase in nonaccrual loans of $456,000 and a decrease in other foreclosed assets owned in the amount of $22,000. The increase in nonaccrual loans is due to decreases in nonaccrual principal balances of $499,000 which have been paid off or brought current, loans charged-off in the amount of $258,000 and liquidations of nonaccrual loans of $-0- and increases in nonaccrual principal balances of $1,213,000 which includes four large commercial credit customers of $950,000 and 17 small consumer loan credits. The level of nonperforming assets remains at relatively low levels and Corporate management believes nonperforming assets are well collateralized. The table below presents the level of nonperforming assets at the end of the last four calendar quarters. Amounts in thousands 03/31/03 12/31/02 09/30/02 06/30/02 -------- -------- -------- -------- Nonperforming Assets: Nonaccrual $2,319 $1,863 $2,222 $1,650 Restructured 0 0 0 0 Other Foreclosed Assets 0 22 56 167 ------ ------ ------ ------ Total Nonperforming Assets $2,319 $1,885 $2,278 $1,817 ====== ====== ====== ====== Reserve for loan losses to nonperforming assets 289.0% 352.9% 287.8% 337.9% ====== ====== ====== ====== Accruing loans past due 90 days $ 62 $ 45 $ 48 $ 327 ====== ====== ====== ====== Potential problem loans are those loans identified on Management's watch list in which Management has some doubt as to the borrower's ability to comply with the present repayment terms and loans which Management is actively monitoring due to changes in the borrower's financial condition. At March 31, 2003, potential problem loans totaled $15,084,000, a decrease of $465,000 from the December 31, 2002 balance. 17 The Corporation's credit policies are reviewed and modified on an ongoing basis in order to remain suitable for the management of credit risk within the loan portfolio as conditions change. At March 31, 2003 there are no significant concentrations of credit in the loan portfolio. The Corporation had outstanding loan and credit commitments to make loans totaling $147,466,000 and $140,685,000 at March 31, 2003 and December 31, 2002, respectively. The increase in outstanding loan commitments results in part from an increase in the unused portion of home equity lines of credits from home equity loan sale programs during 2002 plus an increase in loan demand during the first quarter of 2003. Mortgage and commercial construction loan demand is expected to increase in the second quarter of 2003 as seasonal weather conditions improve and the construction season begins. Consumer loan demand is expected to increase in the second quarter for home improvement and automobile loans as weather conditions improve. Total deposits increased $12,728,000 during the first quarter to $578,855,000. Noninterest-bearing deposits increased to $87,054,000, at March 31, 2003 for an increase of $6,175,000, while interest-bearing deposits increased to $491,801,000 for an increase of $6,553,000. Federal funds purchased and securities sold under agreements to repurchase decreased $10,027,000 during the first quarter of 2003, mainly as a result of customers short-term liquidity position. Since customer repurchase agreements balances are volatile on a daily basis, most funds generated by repurchase activity enter the Corporation's earning assets as short-term investments. LIQUIDITY Liquidity measures a corporation's ability to generate cash or otherwise obtain funds at reasonable prices to fund commitments to borrowers as well as the demand of depositors and debt holders. Principal internal sources of liquidity for the Corporation and the Bank are cash and cash equivalents, Federal funds sold, and the maturity structures of securities and portfolio loans. Securities and loans available for sale provide another source of liquidity through the cash flows of these interest bearing assets as they mature or are sold. The Corporation continues to maintain a relatively liquid position in order to take advantage of interest rate fluctuations. As of March 31, 2003 short- term security investments with maturities of one year or less totaled $6,679,000 which represented 4.3% of total securities. Adding cash and due from banks of $25,572,000 and Federal Funds sold and other short-term investments of $3,235,000, total liquid assets represented 4.9% of total assets. The Corporation's subsidiary bank has established short-term lines of credit at correspondent banks, the Federal Home Loan Bank and the Federal Reserve Bank of Cleveland in the amounts of $24,000,000, $40,000,000 and $35,704,000, respectively, with credit available in the amounts of $24,000,000, $28,000,000 and $35,704,000, respectively. 18 CAPITAL RESOURCES LNB Bancorp, Inc. continues to maintain a strong capital position. Total shareholders' equity increased to $67,372,000, at March 31, 2003. The increase resulted primarily from $2,191,000 of net income generated from the first quarter of operations less a dividend payable to shareholders of $1,123,000. The increase in mid-to-long term interest rates experienced in the first quarter of 2003 has caused a decrease in the overall market value of available for sale securities which resulted in a decrease of shareholders' equity by $328,000 for the quarter ended March 31, 2003. As of March 31, 2003, the LNB Bancorp, Inc. held 149,777 shares of common stock as treasury stock at a cost of $2,894,000. The Corporation continues to monitor growth to stay within the constraints established by the regulatory authorities. Under Federal banking regulations, an institution is deemed to be well-capitalized if it has a Risk-based Tier 1 capital ratio of 6.00 percent or greater, a Risk-based Total capital ratio of 10.00 percent or greater and a Leverage ratio of 5.00 percent or greater. The Corporation's Risk-based capital and Leverage ratios have exceeded the ratios for a well-capitalized financial institution for all periods presented. The Corporation's capital and leverage ratios as of March 31, 2003 and 2002 follow together with those ratios required for the Corporation to be considered well capitalized. MARCH 31, --------------------- 2003 2002 ------- ------- Tier I capital ratio 11.73% 12.60% Required Tier I capital ratio 4.00% 4.00% Total capital ratio 12.98% 13.87% Required total capital ratio 8.00% 8.00% Leverage ratio 8.87% 9.48% Required leverage ratio 3.00% 3.00% On an ongoing basis, the Corporation analyzes acquisition opportunities in markets which are adjacent to or within the Corporation's current geographical market. Corporate management believes that it's current capital resources are sufficient to support any foreseeable acquisition activity. RESULTS OF OPERATIONS Interest and fees on loans decreased $170,000 when compared to the first quarter of 2002. This was the result of the impact of increases in the loan portfolio plus decreases in rates. Interest and dividends on securities was $1,472,000 for the first quarter of 2003 for a decrease of $326,000 over the same period in 2002. The first quarter decrease in interest and dividends on securities results from the net of increases in the securities portfolio of $2,794,000 which was more than offset by decreases in the average yield of the securities portfolio. Interest and dividends on securities represented 19 15.2% of total interest income at March 31, 2003 compared to 17.6% at March 31, 2002. Interest on Federal funds sold and other interest-bearing instruments was $12,000 at March 31, 2003 compared to $19,000 at March 31, 2002. The decrease resulted from lower average balances invested in this form of financial instrument. Total interest expense decreased by $580,000 when compared to the first quarter of 2002. The interest expense decrease was fueled by a decrease in interest expense from certificates of deposit in the amount of $111,000, Checkinvest of $66,000, Money Market of $84,000, Market Access of $154,000, savings deposit account interest of $116,000 and securities sold under repurchase agreements and federal funds purchased of $83,000 offset in part by increases in interest on Federal Home Loan Bank advances of $26,000. The decreases in interest expense resulted from decreases in rates paid for overnight and short-term deposit products. The Corporation decreased its loan loss provision by $36,000 to $564,000 for the first quarter of 2003. The decreased loan loss provision results from the change and mix of the loan portfolio. Total noninterest income decreased by $132,000 when compared to the first quarter of 2002. This decrease resulted from the net of decreases in Investment and Trust Services Division Income of $121,000, increases in service charges of $30,000, increases in other service charges, exchanges and fees of $56,000, decreases in gains on sales of securities of $72,000 and other operating income of $25,000. The Corporation continuously monitors noninterest expenses for greater profitability. The entire staff is geared to improving productivity at all levels. Noninterest expense for the quarter ended March 31, 2003 was $5,946,000, compared with $5,928,000 for the first quarter of 2002. This increase was due primarily to increases in salary expenses, net occupancy, furniture and equipment expenses and Ohio Franchise Tax offset by decreases in outside services, marketing expense, and credit card and merchant expenses. The effective tax rate was 30.6% and 32.7% during the first quarter of 2003 and 2002, respectively. The effective tax rate decreased due to increases in holdings of tax-exempt securities. Net income was $2,191,000 and $2,148,000 for the quarters ended March 31, 2003 and 2002, respectively. Net income per basic and diluted share was $.33 and $.32 for the quarters ended March 31, 2003 and 2002, respectively. On March 15, 2003, LNB Bancorp, Inc.'s wholly -owned subsidiary, North Coast Community Development Corporation was selected by the United States Department of the Treasury to receive $9 million in tax credit allocations under the New Markets Tax Credit program. This tax credit did not impact the first quarter provision for federal income taxes, but its anticipated impact for the remainder of 2003 is to lessen the provision for federal taxes to an 20 undetermined degree. IMPACTS OF ACCOUNTING AND REGULATORY PRONOUNCEMENTS Corporate management is not aware of any current recommendations by the Financial Accounting Standards Board or by regulatory authorities which, if they were implemented, would have a material effect on the liquidity, capital resources or operations of the Corporation. However, the potential impact of certain accounting and regulatory pronouncements warrant further discussion. Statement of Financial Accounting Standards No. 149 Amendment of Statement 133 on Derivative Instruments and Hedging Activities This Statement amends Statement 133 for certain decisions made by the Board as part of the Derivatives Implementation Group (DIG) process. For those amendments that relate to Statement 133 implementation guidance, the specific Statement 133 Implementations Issue necessitating the amendment is identified. If the amendment relates to a cleared issue, the clearance date also is noted. The Statement also amends Statement 133 to incorporate clarifications of the definition of a derivative. This Statement contains amendments relating to FASB Concepts Statement No. 7, Using Cash Flow Information and Present Value in Accounting Measurements, and FASB Statements No. 65, Accounting for Certain Mortgage Banking Activities, No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, No. 95, Statement of Cash Flows, and No. 126, Exemption from Certain Required Disclosures about Financial Instruments for Certain Nonpublic Entities. FASB Interpretation No. 46 (FIN No. 46) "Consolidation of Variable Interest Entities" In January 2003, the FASB Issued FASB Interpretation No. 46 (FIN No. 46), "Consolidation of Variable Interest Entities." The objective of this Interpretation is to provide guidance on how to identify a variable interest entity (VIE) and determine when the assets, liabilities, noncontrolling interests, and results of operations of a VIE need to be included in a company's consolidated financial statements. A company that holds variable interests in an entity will need to consolidate the entity if the company's interest in the VIE is such that the company will absorb a majority of the VIE's expected losses and/or receive a majority of the entity's expected residual returns, if they occur. The provisions of this Interpretation became effective upon issuance. As of December 31, 2002, the Corporation had no variable interest entities. The Corporation has determined that the Interpretation will have no impact on financial position, results of operations, or liquidity, as it applies to other areas within the Corporation. 21 PART I - OTHER INFORMATION ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk Market risk is the risk of loss in a financial instrument arising from adverse changes in market indices such as interest rates, foreign exchange rates and equity prices. The Corporation's principal market risk exposure is interest rate risk, with no material impact on earnings from changes in foreign exchange rates or equity prices. There have been no material changes in the asset and liability mix of the Corporation since December 31, 2002, which would impact the Corporation's level of market risk. Interest rate risk is the exposure to changes in market interest rates. Interest rate sensitivity is the relationship between market interest rates and net interest income due to the repricing characteristics of assets and liabilities. The Corporation monitors the interest rate sensitivity of its on - and - off balance sheet positions by examining its near-term sensitivity and its longer term gap position. Corporate management has determined no significant changes in the Corporation's interest rate risk profile since December 31, 2002. ITEM 4 - CONTROLS AND PROCEDURES Within the 90 days prior to the date of this report, the Corporation carried out an evaluation under the supervision and with the participation of the Corporation's management, including the Corporation's President and Chief Executive Officer and Executive Vice President, Chief Financial Officer and Corporate Secretary, of the effectiveness of the design and operation of the Corporation's disclosure controls and procedures pursuant to SEC rule 13a-14. Based upon that evaluation, the President and Chief Executive Officer and Executive Vice President, Chief Financial Officer and Corporate Secretary concluded that as of that date, the Corporation's disclosure controls and procedures are effective in timely alerting them to material information relating to the Corporation (including its consolidated subsidiaries) required to be included in the Corporation's periodic SEC filings. There were no significant changes made in the Corporation's internal controls or in other factors that could significantly affect these internal controls subsequent to the date of the evaluation performed by the Corporation's President and Chief Executive Officer and Executive Vice President, Chief Financial Officer and Corporate Secretary. 22 PART II - OTHER INFORMATION ITEM 1 - Legal Proceedings None ITEM 2 - Changes in Securities See item 4, (c), (1) ITEM 3 - Defaults Upon Senior Securities None ITEM 4 - Submission of Matters to a Vote of Security Holders None ITEM 5 - Other Information (a) None ITEM 6 - Exhibits and Reports on Form 8-K (b) Reports on Form 8-K February 26, 2003 - LNB Bancorp, Inc. issued a press release announcing a three-for-two stock split with a record date of March 10, 2003 and a payable date of March 14, 2003. March 17, 2003 - LNB Bancorp, Inc. issued a press release announcing that its wholly-owned subsidiary, North Coast Community Development Corporation, was selected by the United States Department of the Treasury to receive $9 million in tax credit allocations under the New Markets Tax Credit program. April 15, 2003 - LNB Bancorp, Inc. published and released its 1st Quarter 2003 Report to Shareholders and issued a press release announcing 1st Quarter 2003 Earnings dated April 15, 2003. Also, see the Exhibit Index which is found on the next page of this Form. 23 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LNB BANCORP, INC. (registrant) By:/s/ Gregory D. Friedman Date: May 15, 2003 -------------------------- Gregory D. Friedman, CPA Executive Vice President, Chief Financial Officer and Corporate Secretary (Principal Financial Officer) LNB BANCORP, INC. (registrant) By:/s/ Mitchell J. Fallis Date: May 15, 2003 -------------------------- Mitchell J. Fallis, CPA Vice President and Chief Accounting Officer (Principal Accounting Officer) 24 Certifications I, Gary C. Smith, President and Chief Executive Officer of LNB Bancorp, Inc., certify that: 1. I, have reviewed this quarterly report on Form 10-Q of LNB Bancorp, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other 25 employees who have a significant role in the registrant's internal control; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date May 15, 2003 ______________________ By /s/Gary C. Smith ______________________ Gary C. Smith, President and Chief Executive Officer 26 I, Gregory D. Friedman, CPA, Executive Vice President, Chief Financial Officer and Corporate Secretary of LNB Bancorp, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of LNB Bancorp, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control; and 27 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date May 15, 2003 ____________________________ By /s/Gregory D. Friedman ____________________________ Gregory D. Friedman, CPA, Executive Vice President, Chief Financial Officer and Corporate Secretary 28 LNB Bancorp, Inc. Form 10-Q Exhibit Index Pursuant to Item 601 (a) of Regulation S-K EXHIBIT NO. PAGE DESCRIPTION 3.1 NA LNB Bancorp, Inc. Second Amended Articles of Incorporation (Incorporated by reference to the quarterly report on Form 10-Q filed on November 14, 2000.) 3.2 NA LNB Bancorp, Inc. Amended Code of Regulations. (Incorporated by reference to the current report on Form 8-K filed on January 4, 2001.) 4. NA Instruments Defining the Rights of Security Holders. (See Exhibits 3.1 and 3.2) 99.1 24 Certification pursuant to 18 U.S.C. section 1350, as enacted pursuant to section 906 of the Sarbanes-Oxley Act of 2002. 99.2 26 Certification pursuant to 18 U.S.C. section 1350, as enacted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.