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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 September 30, 2002
-------------------
OR
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-13507
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RURBAN FINANCIAL CORP.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Ohio 34-1395608
- ------------------------------- -------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
401 Clinton Street, Defiance, Ohio 43512
----------------------------------------
(Address of principal executive offices)
(Zip Code)
(419) 783-8950
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
None
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(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 sections 13 or 15(d) of the Securities Exchange Act of 1934
during the proceeding 12 months (or for such shorter period the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------- -------
The number of common shares of Rurban Financial Corp. outstanding was 4,565,721
on November 1, 2002.
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The interim condensed consolidated financial statements of Rurban Financial
Corp. and Subsidiaries are unaudited; however, the information contained herein
reflects all adjustments which are, in the opinion of management, necessary for
a fair presentation of financial condition and results of operations for the
interim periods presented. All adjustments reflected in these financial
statements are of a normal recurring nature in accordance with Rule 10-01 (b)
(8) of Regulation S-X with the exception of the write-down of the Corporation's
investment in Worldcom bonds and the provision for loan losses recorded in the
second quarter. Results of operations for the nine months ended September 30,
2002 are not necessarily indicative of results for the complete year.
2
RURBAN FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
September 30, December 31, September 30,
2002 2001 2001
------------ ------------ ------------
(Unaudited) (Note) (Unaudited)
ASSETS
Cash and due from banks $ 25,638,415 $ 25,342,043 $ 18,346,030
Federal funds sold 28,250,000 -- 14,650,000
------------ ------------ ------------
Cash and cash equivalents 53,888,415 25,342,043 32,996,030
Interest-earning deposits in other
financial institutions 260,000 260,000 260,000
Securities available for sale 93,929,593 104,375,551 95,190,979
Loans held for sale, net 44,028,624 439,991 197,100
Loans, net of allowance for losses of $20,417,569
at September 30, 2002, $9,238,936 at December
31, 2001 and $7,945,113 at September 30, 2001 561,845,171 591,051,994 572,765,096
Accrued interest receivable 4,657,102 4,939,741 5,411,504
Premises and equipment, net 14,161,460 11,816,557 12,043,320
Other assets 16,637,790 8,276,811 7,350,549
------------ ------------ ------------
Total assets $789,408,155 $746,502,688 $726,214,578
============ ============ ============
3
(Continued)
RURBAN FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
September 30, December 31, September 30,
2002 2001 2001
------------- ------------- -------------
(Unaudited) (Note) (Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing $ 49,968,196 $ 52,830,193 $ 46,271,575
Interest-bearing 596,703,556 558,029,616 557,281,397
------------- ------------- -------------
Total deposits 646,671,752 610,859,809 603,552,972
Deposits held for sale 26,238,717 -- --
Federal funds purchased -- 14,850,000 --
Note Payable 7,000,000 -- --
Advances from Federal Home Loan Bank (FHLB) 49,350,000 54,275,069 51,348,977
Trust preferred securities 10,000,000 10,000,000 10,000,000
Accrued interest payable 3,473,186 3,630,623 4,283,933
Accounts payable - FDIC 1,181,202 -- --
Other liabilities 2,288,524 2,057,855 3,185,881
------------- ------------- -------------
Total liabilities 746,203,381 695,673,356 672,371,763
Shareholders' equity
Common stock, stated value $2.50 per share;
shares authorized: 10,000,000;
shares issued: 4,575,702;
shares outstanding: 4,565,721 at September 30, 2002,
4,564,513 at December 31, 2001 and 4,563,982
at September 30, 2001 11,439,255 11,439,255 11,439,255
Additional paid-in capital 11,009,733 11,013,284 11,017,464
Retained earnings 20,053,821 28,499,026 30,863,704
Accumulated other comprehensive income,
net of tax of $709,396 at September 30, 2002,
$371,863 at December 31, 2001 and $732,008 at
September 30, 2001 1,377,062 721,851 1,420,959
Unearned ESOP shares (360,083) (512,146) (561,867)
Treasury stock, shares at cost: September 30, 2002 -
9,981, December 31, 2001 - 11,189 and
September 30, 2001 - 11,720 (315,014) (331,938) (336,700)
------------- ------------- -------------
Total shareholders' equity 43,204,774 50,829,332 53,842,815
------------- ------------- -------------
Total liabilities and shareholders' equity $ 789,408,155 $ 746,502,688 $ 726,214,578
============= ============= =============
See notes to condensed consolidated financial statements (unaudited)
Note: The balance sheet at December 31, 2001 has been derived from
the audited consolidated financial statements at that date.
4
RURBAN FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended
September 30,
----------------------------
2002 2001
----------- -----------
Interest income
Interest and fees on loans $10,998,762 $12,457,019
Interest and dividends on securities
Taxable 1,096,742 1,304,284
Tax-exempt 53,986 60,548
Other 114,296 125,942
----------- -----------
Total interest income 12,263,786 13,947,793
Interest expense
Deposits 5,119,229 6,608,968
Borrowings 1,104,133 1,026,446
----------- -----------
Total interest expense 6,223,362 7,635,414
----------- -----------
Net interest income 6,040,424 6,312,379
Provision for loan losses 2,007,000 1,125,000
----------- -----------
Net interest income after provision for loan losses 4,033,424 5,187,379
Noninterest income
Service charges on deposit accounts 643,534 752,022
Loan servicing fees 58,730 127,683
Trust fees 591,289 642,232
Data service fees 2,051,794 1,503,738
Net gain on securities 135,847 155,144
Net gain on sales of loans 175,551 304,339
Net gain on sales of fixed assets 5,479 52,793
Other income 195,768 171,868
----------- -----------
Total noninterest income 3,857,992 3,709,819
Noninterest expense
Salaries and employee benefits 3,961,121 3,877,193
Net occupancy expense of premises 376,807 312,409
Equipment rentals, depreciation and maintenance 1,005,193 842,730
Other expenses 2,331,683 1,911,950
----------- -----------
Total noninterest expense 7,674,804 6,944,282
----------- -----------
Income before income tax expense 216,612 1,952,916
Income tax expense 51,151 644,034
----------- -----------
Net income $ 165,461 $ 1,308,882
=========== ===========
Basic and diluted earnings per common share $ 0.04 $ 0.29
=========== ===========
Dividends declared per common share $ -- $ 0.114
=========== ===========
See notes to condensed consolidated financial statements (unaudited)
5
RURBAN FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Nine Months Ended
September 30,
------------------------------
2002 2001
------------ -----------
Interest income
Interest and fees on loans $ 33,585,934 $38,760,172
Interest and dividends on securities
Taxable 3,754,254 3,971,596
Tax-exempt 167,649 353,894
Other 152,882 210,078
------------ -----------
Total interest income 37,660,719 43,295,740
Interest expense
Deposits 15,698,459 20,469,618
Borrowings 3,407,792 3,311,043
------------ -----------
Total interest expense 19,106,251 23,780,661
------------ -----------
Net interest income 18,554,468 19,515,079
Provision for loan losses 15,991,000 3,108,000
------------ -----------
Net interest income after provision for loan losses 2,563,468 16,407,079
Noninterest income
Service charges on deposit accounts 1,924,544 1,885,315
Loan servicing fees 258,915 453,729
Trust fees 1,961,055 2,019,661
Data service fees 5,620,560 4,511,103
Net gain (loss) on securities (1,682,091) 195,647
Net gain on sales of loans 359,357 668,992
Net gain on sales of fixed assets 3,713 69,096
Other income 525,260 560,852
------------ -----------
Total noninterest income 8,971,313 10,364,395
Noninterest expense
Salaries and employee benefits 11,723,153 11,708,951
Net occupancy expense of premises 1,018,631 916,686
Equipment rentals, depreciation and maintenance 2,854,179 2,606,283
Other expenses 7,035,052 5,599,897
------------ -----------
Total noninterest expense 22,631,015 20,831,817
------------ -----------
Income (loss) before income tax expense (benefit) (11,096,234) 5,939,657
Income tax expense (benefit) (3,837,959) 1,915,407
------------ -----------
Net income (loss) $ (7,258,275) $ 4,024,250
============ ===========
Basic and diluted earnings (loss) per common share $ (1.60) $ 0.89
============ ===========
Dividends declared per common share $ 0.26 $ 0.34
============ ===========
See notes to condensed consolidated financial statements (unaudited)
6
RURBAN FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, 2002 September 30, 2001 September 30, 2002 September 30, 2001
Total Total Total Total
Shareholders' Shareholders' Shareholders' Shareholders'
Equity Equity Equity Equity
----------- ------------ ------------ ------------
Balance at beginning of period $42,807,182 $ 52,568,056 $ 50,829,332 $ 50,140,186
Net Income (loss) 165,461 1,308,882 (7,258,275) 4,024,250
Other comprehensive income (loss):
Net change in unrealized gains
on securities available for sale, net 181,889 446,442 655,211 1,092,469
----------- ------------ ------------ ------------
Total comprehensive income (loss) 347,350 1,755,324 (6,603,064) 5,116,719
Cash dividends declared -- (521,669) (1,186,930) (1,565,006)
Cash paid in lieu of fractional shares for 5%
stock dividend (Shares issued from treasury
216,744 in 2001) -- (8,659) -- (8,659)
Proceeds from sale of 1,208 shares of
treasury stock -- -- 13,373 --
Paydown of ESOP loan 50,242 49,763 152,063 159,575
----------- ------------ ------------ ------------
Balance at end of period $43,204,774 $ 53,842,815 $ 43,204,774 $ 53,842,815
=========== ============ ============ ============
See notes to condensed consolidated financial statements (unaudited)
7
RURBAN FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended
September 30,
-------------------------------
2002 2001
Cash Flows From Operating Activities:
Cash received from customers - fees and commissions $ 10,290,334 $ 9,430,662
Cash paid to suppliers and employees (21,257,507) (19,501,295)
Loans originated for sale (15,686,476) (16,681,108)
Proceeds from sales of loans held for sale 15,984,195 18,319,716
Interest received 37,943,358 43,600,284
Interest paid (19,263,688) (24,109,901)
Income taxes paid -- (4,000,000)
------------ ------------
Net cash from operating activities 8,010,216 7,058,358
Cash Flows From Investing Activities:
Net change in interest-earning deposits in other
financial institutions -- (150,000)
Proceeds from principal repayments, maturities and
calls of securities available for sale 40,580,590 29,327,629
Proceeds from sales of securities available for sale 41,965,756 14,252,069
Purchase of securities available for sale (54,518,393) (48,014,817)
Net change in loans (403,655) (6,790,406)
Recoveries on loan charge-offs 1,036,195 338,565
Premises and equipment expenditures, net (3,777,259) (2,579,024)
Cash received for net liabilities assumed in Oakwood acquisition 40,069,328 --
------------ ------------
Net cash from investing activities 64,952,562 (13,615,984)
Cash Flows From Financing Activities:
Net change in deposits and deposits held for sale (29,874,393) 37,232,211
Net change in federal funds purchased (14,850,000) (13,200,000)
Proceeds from FHLB advances 5,000,000 13,500,000
Repayments of FHLB advances (9,925,069) (14,314,937)
Net change in other borrowed funds 7,000,000 --
Cash paid in lieu of fractional share for stock dividend -- (8,659)
Cash dividends paid (1,780,317) (2,086,676)
Proceeds from sale of 1,208 shares of treasury stock 13,373 --
------------ ------------
Net cash from financing activities (44,416,406) 21,121,939
------------ ------------
Net increase in cash and cash equivalents 28,546,372 14,564,313
Cash and cash equivalents at beginning of period 25,342,043 18,431,717
------------ ------------
Cash and cash equivalents at end of period $ 53,888,415 $ 32,996,030
============ ============
8
(Continued)
RURBAN FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended
September 30,
-------------------------------
2002 2001
Reconciliation Of Net Income (Loss) To Net
Cash From Operating Activities
Net Income (Loss) $ (7,258,275) $ 4,024,250
Adjustments to reconcile net income (loss) to net cash from
operating activities:
Depreciation 1,642,285 1,507,549
Amortization of intangible assets 159,620 96,313
Provision for loan losses 15,991,000 3,108,000
Net (gain) loss on securities 1,682,091 (195,647)
Loans originated for sale (15,686,476) (16,681,108)
Proceeds from sales of loans held for sale 15,984,195 18,319,716
Net gain on sale of loans (359,357) (668,992)
Net gain on sale of fixed assets (3,713) (69,096)
Paydown of ESOP loan 152,063 159,575
Change in accrued interest receivable 846,683 304,544
Change in other assets (5,763,692) (1,536,066)
Change in accrued interest payable (200,264) (329,240)
Change in other liabilities 824,056 (981,440)
------------ ------------
Net cash from operating activities $ 8,010,216 $ 7,058,358
============ ============
See notes to condensed consolidated financial statements (unaudited)
9
RURBAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A--BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions for Form 10-Q. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements.
For further information, refer to the consolidated financial statements and
footnotes included in the Corporation's Annual Report on Form 10-K for the year
ended December 31, 2001.
NOTE B--EARNINGS PER SHARE
Earnings per share have been computed based on the weighted average number of
shares outstanding during the periods presented. The number of shares used in
the computation of basic and diluted earnings per share was:
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2002 2001 2002 2001
Basic earnings per share 4,539,601 4,528,223 4,539,601 4,527,805
Diluted earnings per share 4,539,601 4,545,500 4,539,601 4,538,473
Earnings per share and dividends per share have been restated for the 5% stock
dividend paid during the third quarter of 2001. Outstanding options for 287,964
shares were not considered in the calculation of diluted earnings per share for
the three and nine months ended September 30, 2002 because they were
antidilutive.
NOTE C - LOANS, RISK ELEMENTS AND ALLOWANCE FOR LOAN LOSSES
Total loans on the balance sheet are comprised of the following classifications
at:
September 30, December 31,
2002 2001
---- ----
Commercial and agriculture $ 361,529,846 $ 388,673,339
Real estate mortgage 119,133,597 106,353,207
Consumer loans to individuals 76,549,325 76,512,215
Lease financing 25,049,972 28,752,169
Allowance for loan losses (20,417,569) (9,238,936)
---------------- ----------------
$ 561,845,171 $ 591,051,994
================ ================
Loans held for sale $ 44,028,624 $ 439,991
================ ================
10
(Continued)
The following is a summary of the activity in the allowance for loan losses
account for the nine months ended September 30, 2002 and 2001 and the year ended
December 31, 2001.
September 30, December 31, September 30,
2002 2001 2001
---- ---- ----
Beginning balance, January 1 $ 9,238,936 $ 7,214,970 $ 7,214,970
Additions from acquisitions 1,427,000 -- --
Transfer to loans held for sale (428,000) -- --
Provision for loan losses 15,991,000 8,733,000 3,108,000
Recoveries of previous charge-offs 1,036,195 463,923 338,565
Losses charged to the allowance (6,847,562) (7,172,957) (2,716,422)
--------------- --------------- --------------
Ending balance $ 20,417,569 $ 9,238,936 $ 7,945,113
=============== =============== ===============
Individual loans determined to be impaired were as follows:
September 30, December 31,
2002 2001
---- ----
Loans with no allowance for loan losses allocated $ 1,159,000 $ 1,937,000
Loans with allowance for loan losses allocated 21,728,000 9,134,000
--------------- ---------------
Total impaired loans $ 22,888,000 $ 11,071,000
=============== ===============
Amount of allowance allocated to loans
individually determined to be impaired $ 9,427,000 $ 3,647,000
=============== ===============
Substantially all of these impaired loans are on nonaccrual.
11
(Continued)
NOTE D - ACQUISITIONS
On February 2, 2002 ("acquisition date"), the Corporation acquired certain
assets and assumed certain liabilities of the Oakwood Deposit Bank Company of
Oakwood, Ohio from the FDIC following the Ohio Superintendent of Financial
Institutions placing the Oakwood Deposit Bank Company in receivership and
appointing the FDIC as receiver for a net premium of approximately $2.0 million.
The acquisition was accounted for as a purchase, and, accordingly, the purchase
price has been allocated to the assets purchased and the liabilities assumed
based upon the estimated fair values at the date of acquisition. The excess of
the purchase price over the fair values of the net tangible assets acquired has
been recorded as unidentified intangible assets and core deposit intangible
assets totaling $2,344,930 and $708,435, respectively. Upon the adoption of SFAS
No. 147 on September 30, 2002, the Corporation reclassified the balance of the
unidentified intangible asset totaling approximately $2,300,000 to goodwill.
Thus, this goodwill asset will not be amortized to expense, but rather, subject
to periodic review for impairment, with impairment losses, if any, recorded as
incurred.
Estimated amortization expense related to the core deposit intangible assets
follows:
Quarter Ended December 31, 2002 $ 32,466
Year Ended December 31, 2003 105,119
Year Ended December 31, 2004 85,832
Year Ended December 31, 2005 70,716
Year Ended December 31, 2006 58,427
Following are the approximate fair values of assets acquired and liabilities
assumed as of the acquisition date.
Cash and cash equivalents $ 5,236,676
Federal funds sold 2,085,000
Securities available for sale 19,063,676
Loans, net 30,806,499
Goodwill 2,344,930
Core deposit intangible assets 708,435
Accrued interest receivable 501,474
Other assets 33,897
Deposits (93,140,647)
Accrued interest payable (187,237)
The difference between the book value of assets acquired and liabilities assumed
from the FDIC was paid to the Corporation in cash, which was later used to fund
withdrawals of insured deposits from non-local depositors. At September 30,
2002, the Corporation's subsidiary, State Bank, had an amount payable to the
FDIC of approximately $1,200,000 which represents final settlement for assets
acquired and which is reported as Accounts Payable - FDIC in the September 30,
2002 condensed consolidated balance sheet. The amount payable is subject to
final settlement discussions with the FDIC.
12
(Continued)
NOTE E - TRUST PREFERRED SECURITIES
On September 7, 2000, Rurban Statutory Trust 1 ("RST"), a wholly owned
subsidiary of the Corporation closed a pooled private offering of 10,000 Trust
Preferred Securities with a liquidation amount of $1,000 per security. The
proceeds of the offering were loaned to the Corporation in exchange for junior
subordinated debentures with terms similar to the Trust Preferred Securities.
The sole assets of RST are the junior subordinated debentures of the Corporation
and payments thereunder. The junior subordinated debentures and the back-up
obligations, in the aggregate, constitute a full and unconditional guarantee by
the Corporation of the obligations of RST under the Trust Preferred Securities.
Distributions on the Trust Preferred Securities are payable semi-annually at the
annual rate of 10.6% and are included in interest expense in the consolidated
financial statements. These securities are considered Tier 1 capital (with
certain limitations applicable) under current regulatory guidelines. As of
September 30, 2002 and 2001 and December 31, 2001, the outstanding principal
balance of the Trust Preferred Securities was $10,000,000. Certain costs
associated with the issuance of the Trust Preferred Securities have been
capitalized and are included in other assets in the condensed consolidated
balance sheets. The amortization of such costs are reported as an adjustment to
interest expense over the term of the Trust Preferred Securities.
The junior subordinated debentures are subject to mandatory redemption, in whole
or in part, upon repayment of the Trust Preferred Securities at maturity or
their earlier redemption at the liquidation amount. Subject to the Corporation
having received prior approval of the Federal Reserve, if then required, the
Trust Preferred Securities are redeemable prior to the maturity date of
September 7, 2030 at the option of the Corporation on or after September 7, 2020
at par, on or after September 7, 2010 at a premium, or upon the occurrence of
specific events defined within the trust indenture. The Corporation has the
option to defer distributions on the Trust Preferred Securities from time to
time for a period not to exceed 10 consecutive semi-annual periods.
Under the terms of the Written Agreement (see note H and Management's Discussion
and Analysis) between the Corporation and its regulators, regulatory approval is
required to pay semi-annual dividends. The Corporation applied for and received
approval to pay the September 7, 2002 dividend. Such dividend was paid on
October 7, 2002, as permitted under the terms of the indenture.
NOTE F - NOTES PAYABLE
The Corporation had a line of credit from The Northern Trust Company for up to
$15,000,000, which was unsecured and required monthly interest payments, with
full principal payment at maturity on April 28, 2002. The interest rate is
variable and adjusts daily. In the first quarter of 2002, $7,000,000 was drawn
on the line to provide the capital needed to maintain State Bank's "well
capitalized" regulatory classification after the assumption of certain assets
and liabilities of the Oakwood Deposit Bank (see note D). As of April 19, 2002,
the maximum amount of the line of credit was reduced to $7,000,000, the then
outstanding balance, converted to a note that matured on July 31, 2002 and
secured by the common stock of the Corporation's first tier subsidiaries. That
note was further extended to September 30, 2002. The line of credit had an
outstanding balance of $7,000,000 at September 30, 2002 and $0 at December 31,
2001 and September 30, 2001. The line of
13
(Continued)
credit agreement contains various covenants with which the Corporation must
comply. On October 7, 2002, the note was again extended to November 29, 2002 and
the covenant violations were waived until that date in consideration of a
$1,000,000 payment to reduce the outstanding balance to $6,000,000.
Management is currently negotiating with other potential lenders to refinance
the Northern Trust loan.
NOTE G - REGULATORY MATTERS
The Corporation and its subsidiary banks are subject to regulatory capital
requirements administered by federal banking agencies. Capital adequacy
guidelines and prompt corrective action regulations involve quantitative
measures of assets, liabilities, and certain off-balance-sheet items calculated
under regulatory accounting practices. Capital amounts and classifications are
also subject to qualitative judgments by regulators about components, risk
weightings, and other factors, and the regulators can lower the classification
in certain cases. Failure to meet various capital requirements can initiate
regulatory action that could have a direct material effect on the condensed
consolidated financial statements.
The prompt corrective action regulations provide five classifications, including
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized, although these terms are not
used to represent overall financial condition. If less than well capitalized,
regulatory approval is required to accept brokered deposits. RFCBC has applied
for and received permission to issue broker certificates of deposit to replace
maturing brokered deposits during the period from August 20, 2002 to October 31,
2002. If undercapitalized, capital distributions are limited, as is asset growth
and expansion, and plans for capital restoration are required. The minimum
requirements are:
Capital to Risk-
Weighted Assets Tier 1 Capital
Total Tier 1 To Average Assets
----- ------ -----------------
Well capitalized 10% 6% 5%
Adequately capitalized 8% 4% 4%
Undercapitalized 6% 3% 3%
14
(Continued)
At September 30, 2002, actual capital levels (in millions) and minimum required
levels were:
Minimum Required
Minimum Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Regulations
------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total capital (to risk weighted assets)
Consolidated $ 56.8 9.2% $ 49.5 8.0% $ 61.9 10.0%
State Bank 39.2 10.5 29.7 8.0 37.1 10.0
RFCBC 20.2 8.4 19.1 8.0 23.9 10.0
Tier 1 capital (to risk weighted assets)
Consolidated 48.9 7.9 24.8 4.0 37.1 6.0
State Bank 33.9 9.1 14.9 4.0 22.3 6.0
RFCBC 17.1 7.1 9.6 4.0 14.4 6.0
Tier 1 capital (to average assets)
Consolidated 48.9 6.1 32.1 4.0 40.1 5.0
State Bank 33.9 7.1 19.2 4.0 24.0 5.0
RFCBC 17.2 5.5 12.3 4.0 15.4 5.0
State Bank was categorized as well capitalized while the Corporation and RFCBC
were categorized as adequately capitalized at September 30, 2002.
NOTE H - COMMITMENTS, CONTINGENCIES AND UNCERTAINTIES
There are various contingent liabilities that are not reflected in the
consolidated financial statements, including claims and legal actions arising in
the ordinary course of business. In the opinion of management, after
consultation with legal counsel, the ultimate disposition of these matters is
not expected to have a material effect on the Corporation's consolidated
financial position or results of operations.
The Corporation has a borrowing arrangement with the Federal Reserve Bank
Discount Window. Under the terms of this arrangement, the Corporation may borrow
up to a pre-determined percentage of a collateral pledged to the Federal Reserve
Bank. As of September 30, 2002, the Corporation has pledged approximately
$32,782,000 of commercial, commercial real estate and agricultural loans.
Accordingly, the Corporation could borrow up to $16,391,000 from the Federal
Reserve Bank Discount Window. As of September 30, 2002, the Corporation had not
borrowed any funds from the Federal Reserve Bank Discount Window.
On July 5, 2002, the Corporation and State Bank signed a written agreement with
the Federal Reserve Bank of Cleveland and the Ohio Division of Financial
Institutions. This agreement requires the Corporation and State Bank take
certain actions to correct certain identified deficiencies in policies,
procedures and internal control, and requires regulatory approval to perform
certain customary banking activities, including paying dividends on common stock
and Trust Preferred Securities, incurring debt and redemption of outstanding
stock. The Corporation currently does not plan to pay a cash dividend on common
stock in the fourth quarter of 2002.
15
(Continued)
The Corporation's Board of Directors has approved the sale of the Cleveland,
Ohio branch of the Corporation's subsidiary bank The State Bank and Trust
Company. Accordingly, as of September 30, 2002, approximately $43,000,000 of
loans (including accrued interest and net of related allowance for loan losses)
have been classified as loans held for sale and approximately $26,000,000 of
deposits have been classified as held for sale in the condensed consolidated
balance sheet. Fixed assets to be sold are not material. The Corporation leases
its office space in Cleveland under an operating lease, which expires in 2003.
Subsequent to September 30, 2002, the Corporation has received bids for the
branch and prospective buyers are conducting due diligence procedures. The
results of the branch are not reported as discontinued operations as operating
cash flows are not determined by branch.
NOTE I - SUBSEQUENT EVENT
On October 23, 2002, as part of the effort to improve the Corporation's and RFC
Banking Company's capital levels, the Corporation's Board of Directors approved
a plan to sell two branches of the Corporation's subsidiary bank RFC Banking
Company. The branches to be sold represent the Citizens Savings Bank Division.
As of September 30, 2002, these branches had total loans (including accrued
interest) of approximately $74,000,000, total fixed assets (net of accumulated
depreciation) of approximately $927,000 and total deposits (including accrued
interest) of approximately $73,000,000.
NOTE J - NEW ACCOUNTING PRONOUNCEMENTS
On January 1, 2002, the Corporation adopted a new accounting standard which
addresses accounting for goodwill and intangible assets arising from business
combinations. Identifiable intangible assets must be separated from goodwill.
Identifiable intangible assets with finite useful lives will be amortized under
the new standard, whereas goodwill, both amounts previously recorded and future
amounts purchased, will cease being amortized. Annual impairment testing will be
required for goodwill with impairment being recorded if the carrying amount of
goodwill exceeds its implied fair value. Adoption of this standard on January 1,
2002 did not have a material effect on the Corporation's consolidated financial
position or results of operations.
In August 2001, the Financial Accounting Standards Board issued SFAS No. 143,
"Accounting for Asset Retirement Obligations" which will be adopted by the
Corporation on January 1, 2003. The new accounting standard addresses accounting
for obligations associated with the retirement of tangible, long-lived assets
and requires a liability to be recognized for the fair value of any such
obligations. Adoption of this standard on January 1, 2003 is not expected to
have a material effect on the Corporation's consolidation financial position or
results of operations.
On January 1, 2002, the Corporation adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This new accounting standard
establishes more restrictive requirements for the classification of assets as
"held for sale" and also expands the types of dispositions that are to be
accounted for as discontinued operations. Adoption of this standard on January
1, 2002 did not have a material effect on the Corporation's consolidated
financial position or results of operations.
16
(Continued)
The Financial Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards ("SFAS") No. 147, "Acquisitions of Certain Financial
Institutions." SFAS No. 147 is effective October 1, 2002, and may be early
applied. SFAS No. 147 supersedes SFAS No. 72, "Accounting for Certain
Acquisitions of Banking or Thrift Institutions." SFAS No. 147 provides guidance
on the accounting for the acquisition of a financial institution, and applies to
all such acquisitions except those between two or more mutual enterprises. Under
SFAS No. 147, the excess of the fair value of liabilities assumed over the fair
value of tangible and identifiable intangible assets acquired in a financial
institution business combination represents goodwill that should be accounted
for under SFAS No. 142, "Goodwill and Other Intangible Assets." If certain
criteria are met, the amount of the unidentifiable intangible asset resulting
from prior financial institutions acquisitions is to be reclassified to goodwill
upon adoption of this Statement. Financial institutions meeting conditions
outlined in SFAS No. 147 are required to restate previously issued financial
statements. The objective of the restatement is to present the balance sheet and
income statement as if the amount accounted for under SFAS No. 72 as an
unidentifiable intangible asset has been reclassified to goodwill as of the date
the Company adopted SFAS No. 142. Adoption of SFAS No. 147 on September 30, 2002
resulted in the reclassification of approximately $2,300,000 of previously
recognized unidentifiable intangible assets to goodwill. Prior period
amortization expense is not considered material to the Corporation's results of
operations.
NOTE K - SEGMENT INFORMATION
The reportable segments are determined by the products and services offered,
primarily distinguished between banking and data processing operations. Other
segments include the accounts of the holding company, Rurban Financial Corp.,
which provides management and operational services to its subsidiaries; Reliance
Financial Services, N.A., which provides trust and financial services to
customers nationwide; Rurban Life, which provides insurance products to
customers of the Corporation's subsidiary banks; and Rurban Statutory Trust 1,
which manages the Corporation's junior subordinated debentures. Information
reported internally for performance assessment follows.
17
(Continued)
NOTE K - SEGMENT INFORMATION (Continued)
As of and for the nine months ended September 30, 2002
Data Total Intersegment Consolidated
Banking Processing Other Segments Elimination Totals
--------------------------------------------------------------------------------------------
Income statement information:
- -----------------------------
Net interest income (expense) $ 19,404,328 $ (98,121) $ (751,739) $ 18,554,468 $ - $ 18,554,468
Other revenue - external customers 1,279,917 5,620,560 2,070,836 8,971,313 - 8,971,313
Other revenue - other segments - 1,308,913 3,468,111 4,777,024 (4,777,024) -
---------- --------- ---------- ----------- ----------- ----------
Net interest income and other revenue 20,684,245 6,831,352 4,787,208 32,302,805 (4,777,024) 27,525,781
Noninterest expense 14,885,520 5,088,974 7,433,545 27,408,039 (4,777,024) 22,631,015
Provision for loan losses 15,991,000 - - 15,991,000 - 15,991,000
Income tax expense (benefit) (3,530,613) 592,408 (899,754) (3,837,959) - (3,837,959)
---------- --------- ---------- ----------- ----------- -----------
Segment profit (loss) (6,661,662) 1,149,970 (1,746,583) (7,258,275) - (7,258,275)
Significant non-cash items:
Depreciation and amortization 798,589 852,799 145,306 1,796,694 - 1,796,694
Balance sheet information:
- --------------------------
Total assets 782,142,520 9,011,854 4,895,852 796,050,226 (6,642,101) 789,408,125
Goodwill and intangibles 2,872,458 - - 2,872,458 - 2,872,458
Premises and equipment
expenditures, net 885,374 2,873,926 12,962 3,772,262 - 3,772,262
18
(Continued)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Rurban Financial Corp. ("Rurban") was incorporated on February 23, 1983, under
the laws of the State of Ohio. Rurban is a bank holding company registered with
the Federal Reserve Board under the Bank Holding Company Act of 1956, as
amended. Rurban's subsidiaries, The State Bank and Trust Company ("State Bank")
and RFC Banking Company ("RFCBC") are engaged in the industry segment of
commercial banking. RFCBC was created June 30, 2001 through the merger of The
Peoples Banking Company, The First National Bank of Ottawa and The Citizens
Savings Bank Company, which were wholly owned subsidiaries of Rurban prior to
the merger, and now operate as separate divisions. Rurban's subsidiary, Rurbanc
Data Services, Inc. ("RDSI"), provides computerized data processing services to
community banks and businesses including Rurban's subsidiary banks. Rurban's
subsidiary, Rurban Life Insurance Company ("Rurban Life") has a certificate of
authority from the State of Arizona to transact insurance as a domestic life and
disability insurer. Rurban's subsidiary, Rurban Statutory Trust I ("RST") was
established in September 2000 for the purpose of managing the Corporation's
junior subordinated debentures. Reliance Financial Services, N.A. ("Reliance"),
a wholly owned subsidiary of State Bank, provides trust and financial services
to customers nationwide.
The following discussion is intended to provide a review of the consolidated
financial condition and results of operations of Rurban. This discussion should
be read in conjunction with the consolidated financial statements and related
footnotes in Rurban's 2001 Form 10-K previously filed with the Securities and
Exchange Commission.
This section may contain statements that are forward-looking as defined by the
Securities and Exchange Commission in its rules, regulations and releases. The
Company intends that such forward-looking statements be subject to the safe
harbors created thereby. All forward-looking statements are based on current
expectations regarding important risk factors including those identified in the
Company's most recent periodic report and other filings with the Securities and
Exchange Commission. Accordingly, actual results may differ materially from
those expressed in the forward-looking statements, and the making of such
statements should not be regarded as a representation by the Company, or any
other person, that the results expressed therein will be achieved.
QUARTERLY AND YEAR-TO-DATE RESULTS
The Corporation reported net income for the quarter of $165,000, or $0.04 per
diluted share, versus net income of $1.3 million, or $0.29 per diluted share,
for third quarter 2001. The net loss for the nine months was $7.3 million, or
$1.60 per diluted share versus net income of $4.0 million or $0.89 per diluted
share for the same period in 2001. The loss was driven largely by loan loss
provisions of $2.1 million, $11.9 million and $2.0 million recorded in the
first, second, and third quarters, respectively, bringing the total loan loss
provision for 2002 to $16.0 million and the allowance for loan losses to $20.4
million or 3.50% of total loans at September 30, 2002.
19
The year-to-date results were also negatively impacted by a $1.7 million
write-down in the market value of the Corporation's investment in WorldCom
bonds, which resulted in a $1.1 million after tax loss in the second quarter.
Subsequent to September 30, 2002, the WorldCom bonds were sold at a further loss
of $15,000. The Corporation currently holds no other corporate bond investments.
LINKED QUARTER COMPARISON
A comparison of financial results for the quarter ended September 30, 2002 to
the previous quarter ended June 30, 2002 (which is considered our Linked Quarter
Comparison) is as follows:
Linked
Three Months Ended Quarter Annualized
09/30/02 06/30/02 % Change % Change
-------- -------- -------- --------
(dollars in millions, except per share data)
Total Assets $ 789 $ 788 greater than 1% 1%
Loans Held for Sale 44.0 1.8 2,344% 9,377%
Loans (Gross) 583 643 -9% -38%
Allowance for Loan Losses 20.4 19.0 7% 29%
Total Deposits 647 646 greater than 1% 1%
Total Revenue 9.9 8.0 23% 94%
Net interest Income 6.0 6.3 -4% -19%
Noninterest Income 3.9 1.7 125% 513%
Loan Loss Provision 2.0 11.9 -83% -330%
Noninterest Expense 7.7 7.8 -1% -5%
Net Income 0.2 -7.6 -- --
Basic Earnings Per Share $0.04 -$1.68 -- --
Diluted Earnings Per Share $0.04 -$1.68 -- --
The Corporation reported net income for the quarter of $165,000, or $0.04 per
diluted share, versus net loss of $7.6 million, or $1.68 per diluted share, for
second quarter 2002.
Net interest income decreased $279,000 or 4% to $6.0 million for the three
months ended September 30, 2002 compared to $6.3 for the second quarter of 2002.
This decrease was largely due to a decline in loan balances and an increase in
lower yielding investments.
On a linked quarter basis, loans declined $60 million while loans held for sale
increased $42.2 million and total assets increased $1 million. The decline in
loans was primarily due to classifying $43.8 million of loans as held for sale
due to the Cleveland branch sale, which is anticipated to close in December or
early 2003.
20
TOTAL REVENUE
Three Months Ended
09/30/02 06/30/02 $Change %Change
-----------------------------------------------
(dollars in thousands)
Total Revenue $9,898 $8,034 $1,864 23%
Total revenue (net interest income plus noninterest income) was $9.9 million for
the third quarter of 2002 compared to $8.0 million for the second quarter of
2002, up $1.9 million or 23%, primarily due to the $1.7 million writedown on the
WorldCom bonds in the second quarter.
NET INTEREST INCOME
Three Months Ended
09/30/02 06/30/02 $Change %Change
------------------------------------------
(dollars in thousands)
Net Interest Income $6,040 $6,319 $-279 -4%
Net interest income for the third quarter was $6.0 million compared to $6.3
million for the second quarter of 2002. The net interest margin for the third
quarter of 2002 was 3.16% compared to 3.34% for the previous quarter. The 18
basis point linked quarter decrease in the net interest margin was largely due
to a 26 basis point decline in the yield on earning assets, which more than
offset an 8 basis point decline in the cost of funds.
NONINTEREST INCOME
Three Months Ended
09/30/02 06/30/02 $Change %Change
--------------------------------------
(dollars in thousands)
Total Noninterest Income $3,858 $1,715 $2,143 125%
- Data Service Fees 2,052 1,830 +222 12%
- Deposit Service Fees 644 673 -29 -4%
- Gains on Sale of Loans 176 54 +122 224%
- Gain (Loss) on Securities 136 -1,737 +1,873 -
Noninterest income for the third quarter of 2002 increased to $3.9 million from
$1.7 million in the second quarter of 2002, due primarily to the $1.7 million
WorldCom writedown in the second quarter. Data service fees continued their
steady growth, increasing by $222,000 over the second quarter.
LOAN LOSS PROVISION
The provision for loan losses of $2.0 for the third quarter of 2002 decreased
$9.9 million compared to the second quarter of 2002. The reasons for the
increase in the second quarter are discussed in the "Allowance for Loan Losses"
section.
NONINTEREST EXPENSE
Three Months Ended
09/30/02 06/30/02 $Change %Change
-----------------------------------
(dollars in thousands)
Total Noninterest Expense $7,675 $7,766 $-91 -1%
- Salaries & Employee Benefits 3,961 3,894 67 +2%
- Equipment Expense 1,005 966 39 +4%
- Professional Fees 812 812 0 +0%
- All Other 1,897 2,094 -197 -9%
Noninterest expense for the third quarter of 2002 was $7.7 million compared to
$7.8 million for the linked quarter.
Salaries and Employee Benefits increased only $67,000 or 2%. Equipment Expense
increased $39,000 or 4% due to RDSI's acquisition of BancServ and the upgrade of
the mainframe computer at RDSI. Professional fees were $812,000 for both the
third and the second quarter, an annualized level of $2.4 million. That level
was approximately $600,000 higher than the 2001 expense, due largely to
increased consulting, legal and auditing fees associated with the evaluation and
management of the Corporation's problem loans. This higher level of professional
fees is expected to continue into 2003 as the problem loan workout process
proceeds. All Other expenses decreased $197,000 or 9%.
LOANS
As Of
-----------------------------------------------------
% of % of Inc
09/30/02 Total 06/30/02 Total (Dec)
-------- ----- -------- ----- -----
(dollars in millions)
Commercial $362 62% $414 64% $(52)
Residential 119 20% 123 19% (4)
Consumer 102 18% 107 17% (5)
----- ----- -----
Total Loans 583 644 (61)
Loans decreased $61 million to $583 million at September 30, 2002. This decline
is primarily the result of the Corporation's decision to sell $43.8 million of
performing loans of the Cleveland branch.
Commercial, residential and consumer loans for the quarter declined 13%, 3% and
5%, respectively, as loan demand has softened and the Corporation's new lending
efforts have become focused on smaller local relationships. At September 30,
2002, commercial, residential and consumer loans represented 62%, 20% and 18%
respectively, of total loans, compared to 64%, 19% and 17% at June 30, 2002.
22
ASSET QUALITY
As Of And For The Quarter Ended
-------------------------------
(dollars in millions)
09/30/02 06/30/02 Change
-------- -------- ------
Non-performing loans - $ $23.5 $21.5 $2.0
Non-performing assets - $ 24.0 22.0 2.0
Nonperforming assets/ loan plus OREO 4.11% 3.42% .69%
Nonperforming assets/ total assets 3.03% 2.79% 24%
Net chargeoffs - $ .2 5.5 -5.3
Net chargeoffs (annualized)/ total loans 0.12% 3.40% -3.28%
Loan loss provision 2.0 11.9 -9.9
Allowance for loan loss - $ 20.4 19.0 +1.4
Allowance for loan loss/ total loans 3.50% 2.96% +.54%
Allowance/nonperforming loans 89% 89% -
Non-performing assets at September 30, 2002 were $24.0 million or 3.03% of
total assets, versus $22.0 million, or 2.79% at June 30, 2002. $2.7 million of
assets were added to nonperforming assets, while gross chargeoffs were $0.7
million during the third quarter. Net chargeoffs for the third quarter of 2002
were $193,000 compared to $5.5 million in the second quarter.
ALLOWANCE FOR LOAN LOSSES
The Corporation grades its loans using a seven grade system. Problem loans are
classified as either:
- Grade 5 - Substandard: Inadequately protected, with well-defined
weakness that jeopardize collection of debt
- Grade 6 - Doubtful: Inherent weaknesses well-defined and high
probability of loss (impaired)
- Grade 7 - Loss: Considered uncollectible. May have recovery or salvage
value with future collection efforts (these loans are either fully
reserved or charged off) (impaired)
23
The Corporation's allowance for loan losses has four components. Those
components are shown in the following table:
----------09/30/02----------- -----------06/30/02----------- -----------12/31/01----------
ALLOCATION ALLOCATION ALLOCATION
LOAN ---------- LOAN ---------- LOAN ----------
BALANCE $ % BALANCE $ % BALANCE $ %
------------------------------------------------------------------------------------------
Allocations for individual $22.9 $9.4 41.05% $ 17.6 $7.1 40.34% $11.1 $3.2 28.83%
commercial loans graded doubtful
(impaired)
Allocations for individual 46.7 7.1 15.20% 44.6 8.2 18.39% 26.7 1.8 6.74%
commercial loans graded substandard
"General" allowance based on 513.4 3.9 0.76% 581.1 3.7 0.64% 564.7 4.2 0.74%
chargeoff history of nine categories
of loans and allocations based on
current risk factor statistics as
compared to historical risk factor
statistics
----------------- ------------------ ------------------
TOTAL $583.0 $20.4 3.50% $643.3 $19.0 2.96% $602.5 $9.2 1.53%
The amount of loans classified as doubtful and substandard increased $5.3
million and $2.1 million respectively from June 30, 2002. Allowance allocations
on doubtful loans increased $2.3 million while allowance allocations on
substandard loans decreased $1.1 million from June 30, 2002. The allowance for
loan losses at September 30, 2002 was $20.4 million or 3.50% of loans compared
to $19.0 million or 2.96% at June 30, 2002.
While the amount of doubtful and substandard loans and their related allowance
allocations has continued to increase during 2002, the pace of increase has
slowed. Management anticipates that problem loan statistics may continue to
increase modestly as a result of the continuing effects of a sporadic economy on
the operations of commercial customers and consumers and that such increases
will begin to be offset early next year by the ongoing results of loan workout
efforts to restructure and collect problem loans.
Management's estimate of the allowance for loan losses includes judgments
related to the following factors:
- - Physical inspections of collateral securing classified loans performed, new
appraisals of collateral securing classified loans received, and other
information regarding borrower collateral levels;
- - Borrower financial information received; and
- - Consideration of exposures to industries potentially most affected by
current risks in the economic and political environment.
A significant portion of the loan portfolio's risk exposure is in direct loans
to leasing companies and in the residual values of indirect loans to third
parties originated through these leasing companies. The corporation has begun
the process of exiting the majority of the leasing line of business.
24
CAPITAL RESOURCES
At September 30, 2002, actual capital levels (in millions) and minimum required
levels were:
Minimum Required
Minimum Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Regulations
------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total capital (to risk weighted assets)
Consolidated $ 56.8 9.2% $ 49.5 8.0% $ 61.9 10.0%
State Bank 39.2 10.5 29.7 8.0 37.1 10.0
RFC Banking Company 20.2 8.4 19.1 8.0 23.9 10.0
State Bank was categorized as well capitalized while the Corporation and RFCBC
were categorized as adequately capitalized at September 30, 2002.
The Corporation's plans to return its and RFCBC's ratios of total capital to
risk weighted assets to the well capitalized level include the sale of the loans
and deposits of State Bank's Cleveland branch (which are classified as held for
sale) and the sale of the loans and deposits of RFC Banking Company's
Pemberville and Gibsonburg branches (which are not classified as held for sale).
RURBANC DATA SERVICES, INC. ("RDSI")
RDSI provides data processing services for 54 community banks in Ohio, Michigan
and Indiana. RDSI differentiates itself from its competition through the quality
of its products and the excellence of its customer service. The applications
utilized by RDSI are driven by world-class software used by over 3,600 banks
nationwide. Customer service encompasses on-time delivery every morning and a
discipline of responding to and resolving customer questions and issues within
one hour in excess of 95% of the time. RDSI provides turnkey solutions for its
clients through its partnerships with vendors experienced in a full array of
banking products.
RDSI's growth comes from both new and existing clients. In the second quarter
RDSI purchased the principal assets of BancServ Inc. BancServ provided data
processing, item processing and imaging to two independent banks located in
North Central Ohio. In July 2002, RDSI acquired the principal assets of
Northwest Financial Services Inc. Northwest is a limited liability corporation
which had provided item processing and imaging services for seven RDSI client
banks.
In the past five years, RDSI's number of bank clients has more than doubled.
Equally important is the growth of client banks, both in their number of
customer accounts and in the breadth of services provided. Network services,
Internet banking and other technical services are a rapidly growing part of
RDSI's revenue.
Three Months Ended
------------------
September 30 June 30
2002 2002 $ Change % Increase
--------------------------------------------------
(Dollars in Thousands)
Data Processing Fees $2,052 $1,830 $222 12%
25
WRITTEN AGREEMENT
On July 9, 2002, Rurban and State Bank announced they entered into a Written
Agreement with the Federal Reserve Bank of Cleveland and the Ohio Division of
Financial Institutions on July 5, 2002. The Agreement is the result of an
examination of State Bank as of December 31, 2001, which was conducted in March
and April 2002.
The provisions of the Written Agreement require Rurban and State Bank to take
specific actions to address issues identified in the examination and to maintain
the safe and sound nature of Rurban and State Bank. The provisions include:
- - retention of an independent consultant to conduct a management review and
to prepare a written report of findings and recommendations to Rurban's
Board of Directors and submission of a written management plan and business
plan to the regulators;
- - development and submission of a written plan to strengthen Board of
Director oversight and supervision of State Bank;
- - enhancement of State Bank's loan policies and procedures to address
identified deficiencies;
- - enhancement of asset quality procedures, the allowance for loan losses
procedures, the loan review function, interest income accrual procedures
and steps Rurban will take to correct all documentation and credit
information deficiencies noted;
- - development and submission of written procedures to strengthen and maintain
various internal controls and a contingency funding plan;
- - prior written regulatory approval must be obtained for Rurban or State Bank
to pay dividends, incur debt either directly or indirectly or redeem
outstanding stock; and
- - limit the activities of Rurban Mortgage Company to those that are approved
and divest of any inconsistent assets.
The Written Agreement established 30, 60, 90 day and ongoing quarterly deadlines
for submission of specific progress reports. Rurban appointed a committee of
outside directors to monitor and coordinate Rurban's compliance with each
provision of the agreement and its reporting timeframes. Each of the required
submissions has been prepared by management, reviewed by the directors'
"Compliance Committee" and submitted to the regulators in substantial compliance
with the specific timeframes.
26
GOALS FOR 2003 AND 2004
The Corporation's near term goals include:
- Focus on the quality of the loan underwriting process
- Early identification of emerging loan portfolio risks
- Reduction/workout of nonperforming loans
- Implementation of a comprehensive training program for staff,
management and directors
- Continued focus on customer relationship management
- Completion of the centralization of operations functions
- Implementation of all corrective actions necessary to achieve the
release from the Written Agreement
- Restoring earnings to a level sufficient to resume the payment of a
dividend
LIQUIDITY
Liquidity relates primarily to the Corporation's ability to fund loan demand,
meet deposit customers' withdrawal requirements and provide for operating
expenses. The Corporation has various sources of liquidity available to satisfy
these needs, including 1) liquid assets, which consist of cash, federal funds
sold, interest-earning deposits in other financial institutions, securities
available-for-sale and loans held for sale, 2) cash flows received from
principal and interest payments on loans and securities, and 3) various
available off-balance-sheet borrowing arrangements.
Management is actively monitoring the expected liquidity needs of the
Corporation as well as the available sources of liquidity. The following
discussion provides a summary of the available sources of liquidity to the
Corporation.
LIQUID ASSETS: Total liquid assets at September 30, 2002 were $192.1 million
compared to $130.4 million as December 31, 2001. Cash and due from banks totaled
$53.9 million at September 30, 2002 compared to $25.3 million at December 31,
2001. The Corporations most ready source of liquidity is federal funds sold,
which increased from $0 at December 31, 2001 to $28.3 million at September 30,
2002. Approximately $4.1 million of cash and due from banks is required to be
maintained to meet various compensating balance and other reserve and clearing
requirements. Management recognizes securities may need to be sold in the
future, and has classified the entire securities portfolio, totaling $93.9
million at September 30, 2002, as available for sale. However, approximately
$75.3 million of securities are pledged as collateral for certain of the
Corporation's liabilities, including public funds deposits and FHLB borrowings,
leaving $18.6 million as available to sell or pledge for additional borrowings.
Management is actively working to sell the loans held for sale at September 30,
2002, which totaled $44.0 million.
CASH FLOWS: The cash flow statements for the periods presented provide an
indication of the Corporation's sources and uses of cash as well as an
indication of the ability of the Corporation to maintain an adequate level of
liquidity from ongoing operations.
Net cash from operating activities for the nine months ended September 30, 2002
and 2001 was $8.0 million and $7.1 million. The net cash flows from operating
activities primarily include net
27
income / (loss) for the periods and adjustments for various non-cash expenses
such as the provision for loan losses, the impairment loss on WorldCom bonds and
other depreciation and amortization.
Net cash flow from investing activities was $65.0 million and $(13.6) million
for the nine months ended September 30, 2002 and 2001. The net cash flows from
investing activities primarily include loan growth, normal maturities and
reinvestment of securities, premises and equipment expenditures and a one time
net cash receipt resulting from the Oakwood acquisition.
Net cash flow from financing activities was $(44.4) million and $21.1 million
for the nine months ended September 30, 2002 and 2001. The net cash flows from
financing activities are primarily attributable to changes in deposits, net
borrowings from the Federal Home Loan Bank, and other borrowed funds.
OFF-BALANCE-SHEET BORROWING ARRANGEMENTS: Significant additional
off-balance-sheet liquidity is available in the form of FHLB advances, unused
federal funds lines from correspondent banks, the national certificate of
deposit market and the Federal Reserve Bank Discount Window. While such
additional off-balance-sheet liquidity is available, the Written Agreement
between Rurban, State Bank, the Federal Reserve Bank of Cleveland and the Ohio
Division of Financial Institutions requires Rurban and State Bank to obtain
written approval of the Federal Reserve Bank of Cleveland and the Ohio Division
of Financial Institutions prior to directly or indirectly incurring any debt.
Approximately $84.2 million of residential first mortgage loans of the
Corporation's $119.5 million portfolio qualify to collateralize FHLB borrowings
and have been pledged to meet FHLB collateralization requirements as of
September 30, 2002. In addition to residential first mortgage loans, $3.0
million in fed funds sold to FHLB and $4.2 million in investment securities are
pledged to meet FHLB collateralization requirements. Based on the current
collateralization requirements of the FHLB, approximately $7.4 million of
additional borrowing capacity exists at September 30, 2002.
At December 31, 2001, the Corporation had unused federal funds lines totaling
approximately $32.2 million from five correspondent banks. As of September 30,
2002, the Corporation had unused federal funds lines totaling approximately
$27.5 million from three correspondent banks. Federal funds borrowed were $0 at
September 30, 2002 and December 31, 2001.
Because RFCBC was not classified as well capitalized at September 30, 2002, it
required approval from its respective regulatory agencies prior to accepting any
new brokered certificates of deposit. In August, RFCBC received approval from
FDIC to issue up to $10.5 million in broker certificates of deposit to replace
maturing brokered deposits. That waiver expired October 31, 2002. No new broker
deposits were issued during the waiver period. At September 30, 2002, RFCBC had
approximately $44.8 million in certificates of deposit which have been accepted
from brokers. Approximately $18.7 million of those certificates of deposit
mature within the next year.
Approximately $32.8 million of performing commercial loans are pledged to the
Federal Reserve Discount Window to establish additional borrowing capacity of
$16.4 million. Such loans are pledged for contingency funding purposes and to
date this borrowing capacity has not been used.
28
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following table compares rate sensitive assets and liabilities as of
September 30, 2002 to December 31, 2001.
Principal/notational amount maturing in:
(Dollars in thousands)
First Years
Year 2 to 5 Thereafter Total
---- ------ ---------- -----
Comparison of 9/30/02 to 12/31/01
Total rate sensitive assets:
At September 30, 2002 $ 333,180 $ 281,596 $ 134,298 $ 749,074
At December 31, 2001 304,536 297,113 103,614 705,263
------------ ------------ ------------ ------------
Increase (decrease) $ 28,644 $ (15,517) 30,684 $ 43,811
============ ============ ============ ============
Total rate sensitive liabilities:
At September 30, 2002 $ 361,093 $ 251,110 $ 127,057 $ 739,260
At December 31, 2001 371,811 199,079 119,095 689,985
------------ ------------ ------------ ------------
Increase (decrease) $ (10,718) $ 52,031 $ 7,962 $ 49,275
============ ============ ============ ============
Total rate sensitive assets increased approximately $43.8 million for the nine
months ended September 30, 2002 due primarily to the acquisition of the failed
Oakwood Deposit Bank in February from the FDIC. At September 30, 2002, the
outstanding balance of loans acquired from Oakwood totaled approximately $21.6
million. Most of these loans are fixed rate ($15.9 million) and are one of the
primary causes of the $30.7 million increase in the "Thereafter" category. An
increase in federal funds sold accounts for the $28.6 million increase in the
"First Year" category.
Total rate sensitive liabilities increased approximately $49.3 million for the
nine months ended September 30, 2002 due primarily to $26.2 million in deposits
from Oakwood and a $7.0 million draw on the Corporation's line of credit which
was used to provide capital to State Bank for the Oakwood acquisition, and a $14
million increase in retail deposits.
During the past nine months, maturing broker certificates of deposit and federal
funds borrowed have been replaced with intermediate term (2-4 years) fixed rate
broker deposits and certificates of deposit specials, accounting for the $52
million dollar increase in rate sensitive liabilities in the "Years 2 to 5"
category. This result is part of Rurban's strategy to lengthen liabilities
during the low interest rate cycle. Decrease in federal funds borrowed was the
largest part of the $10.7 million decrease in the "Year 1" category. Transaction
accounts (DDA, NOW, MMA and Savings) account for the $8.0 million increase in
the "Thereafter" category.
Included in the above numbers are $44.0 million in loans and $26.2 million in
deposits held for sale (assigned to the Cleveland Branch). This branch has been
offered for sale. As of September 30, 2002, a contract has not been signed on
this proposed sale, therefore the loans and deposits are included based on their
contractual maturity dates.
29
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing date of this report, an evaluation
was carried out under the supervision and with the participation of Rurban
Financial Corp.'s management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c) under the
Securities Exchange Act of 1934). Based on their evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that the Company's disclosure
controls and procedures are, to the best of their knowledge, effective to ensure
that information required to be disclosed by Rurban Financial Corp. in reports
that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms.
Prior to and during this evaluation, certain significant deficiencies or
material weaknesses in internal controls existed, namely:
- Certain loan officers failed to comply with the loan policy
requirements for underwriting, documentation and approval processes.
- Oversight of loan officer actions and compliance with loan policy was
not effective in certain instances.
- The internal loan grading and loan review processes were not adequate
to identify certain loan quality deficiencies.
- Loan policy, procedures and controls over loans to higher risk
borrowers, such as leasing companies, were not commensurate with the
borrowers' risk.
The following actions have been taken to correct deficiencies in internal
controls:
- Replacement of managers who failed to provide proper lending oversight
and lenders who failed to comply with lending policies and procedures.
- Increased emphasis on the timeliness of the process of monitoring and
reporting changes in borrowers' financial condition.
- Enforcement of the procedure to maintain an up-to-date evaluation of
the collateral value for all classified loans, to facilitate the
calculation of potential losses and strengthen credits where possible.
- Establishment of a more independent lending oversight structure
including:
- Creation of a new Loan Review manager position reporting directly
to a newly created "Loan Review Committee" of the Board of
Directors.
- Creation of a new Credit Administration manager position
reporting to the Operations area of the organization independent
of the Lending function.
- The hiring of an outside firm by the Audit Committee of the Board
to perform an independent loan review and report its results
directly to the Loan Review Committee of the Board of Directors.
- Discontinuation of the majority of lending in the leasing line of
business.
- Development and adoption of a new loan policy to provide improved
guidance and control over the lending process.
Our Chief Executive Office and Chief Financial Officer have concluded that the
results of the corrective actions taken by Rurban Financial Corp. have been
effective in addressing such significant deficiencies and material weaknesses in
internal controls.
30
Subsequent to the date of their evaluation, our Chief Executive Officer and
Chief Financial Officer have concluded that there were no significant changes in
Rurban Financial Corp's internal controls or in other factors that could
significantly affect its internal controls, including any corrective actions
with regard to significant deficiencies and material weaknesses.
31
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
99.1 - Certification of Chief Executive Officer Pursuant to Title 18
USC Section 1350
99.2 - Certification of Chief Financial Officer Pursuant to Title 18
USC Section 1350
b. Reports on Form 8-K
A Form 8-K was filed on July 3, 2002 to report that an estimated after
tax loss of $1.1 million will be recorded during the quarter ended June
30, 2002 related to the decline in the market value of the
Corporation's Worldcom investment.
A Form 8-K was filed on July 11, 2002 to report the issuance of a press
release announcing that the Corporation and its wholly owned
subsidiary, the State Bank and Trust and Company, entered into a
written agreement with the Federal Reserve Bank of Cleveland and the
Ohio Division of Financial Institutions on July 5, 2002.
A Form 8-K was filed on September 25, 2002 to report the dismissal of
Crowe, Chizek and Company LLP as the Registrant's principal accountant
effective November 15, 2002 and to report that the Registrant had
engaged BKD, LLP as its principal accountants.
32
SIGNATURES
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
hereunto duly authorized.
RURBAN FINANCIAL CORP.
Date: November 14, 2002 By /s/ Kenneth A. Joyce
------------------ ---------------------
Kenneth A. Joyce
President & Chief
Executive Officer
By /s/ Richard C. Warrener
-----------------------
Richard C. Warrener
Executive Vice President &
Chief Financial Officer
33
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Kenneth A Joyce, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Rurban Financial
Corp.;
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 officers 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 officers 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:
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
controls; and
6. The registrant's other certifying officers 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: November 14, 2002 By /s/ Kenneth A. Joyce
----------------- --------------------
Kenneth A. Joyce
President & Chief
Executive Officer
34
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Richard C. Warrener, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Rurban Financial
Corp.;
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 officers 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 officers 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:
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
controls; and
6. The registrant's other certifying officers 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: November 14, 2002 By /s/ Richard C. Warrener
-----------------------
Richard C. Warrener
Executive Vice President &
Chief Financial Officer
35