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 ----------------- ------------------- Commission file number 0-13507 ------- 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 --------------------------------------------------------------------- (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) <TABLE> <CAPTION> September 30, December 31, September 30, 2002 2001 2001 ------------ ------------ ------------ (Unaudited) (Note) (Unaudited) <S> <C> <C> <C> 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 ============ ============ ============ </TABLE> 3 (Continued)
RURBAN FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) <TABLE> <CAPTION> September 30, December 31, September 30, 2002 2001 2001 ------------- ------------- ------------- (Unaudited) (Note) (Unaudited) <S> <C> <C> <C> 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 ============= ============= ============= </TABLE> 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) <CAPTION> <TABLE> Three Months Ended September 30, ---------------------------- 2002 2001 ----------- ----------- <S> <C> <C> 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 =========== =========== </TABLE> See notes to condensed consolidated financial statements (unaudited) 5
RURBAN FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) <TABLE> <CAPTION> Nine Months Ended September 30, ------------------------------ 2002 2001 ------------ ----------- <S> <C> <C> 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 ============ =========== </TABLE> See notes to condensed consolidated financial statements (unaudited) 6
RURBAN FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) <TABLE> <CAPTION> 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 ----------- ------------ ------------ ------------ <S> <C> <C> <C> <C> 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 =========== ============ ============ ============ </TABLE> See notes to condensed consolidated financial statements (unaudited) 7
RURBAN FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) <CAPTION> <TABLE> Nine Months Ended September 30, ------------------------------- 2002 2001 <S> <C> <C> 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 ============ ============ </TABLE> 8 (Continued)
RURBAN FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) <TABLE> <CAPTION> Nine Months Ended September 30, ------------------------------- 2002 2001 <S> <C> <C> 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 ============ ============ </TABLE> 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: <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ------------- ------------- 2002 2001 2002 2001 <S> <C> <C> <C> <C> 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 </TABLE> 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: <CAPTION> <TABLE> September 30, December 31, 2002 2001 ---- ---- <S> <C> <C> 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 ================ ================ </TABLE> 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. <TABLE> <CAPTION> September 30, December 31, September 30, 2002 2001 2001 ---- ---- ---- <S> <C> <C> <C> 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 =============== =============== =============== </TABLE> Individual loans determined to be impaired were as follows: <TABLE> <CAPTION> September 30, December 31, 2002 2001 ---- ---- <S> <C> <C> 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 =============== =============== </TABLE> 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: <TABLE> <CAPTION> <S> <C> 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 </TABLE> Following are the approximate fair values of assets acquired and liabilities assumed as of the acquisition date. <TABLE> <CAPTION> <S> <C> 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) </TABLE> 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: <CAPTION> <TABLE> Capital to Risk- Weighted Assets Tier 1 Capital Total Tier 1 To Average Assets ----- ------ ----------------- <S> <C> <C> <C> Well capitalized 10% 6% 5% Adequately capitalized 8% 4% 4% Undercapitalized 6% 3% 3% </TABLE> 14 (Continued)
At September 30, 2002, actual capital levels (in millions) and minimum required levels were: <CAPTION> <TABLE> Minimum Required Minimum Required To Be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Regulations ------ ----------------- ------------------ Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- <S> <C> <C> <C> <C> <C> <C> 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 </TABLE> 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 <TABLE> <CAPTION> Data Total Intersegment Consolidated Banking Processing Other Segments Elimination Totals -------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> 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 </TABLE> 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: <TABLE> <CAPTION> Linked Three Months Ended Quarter Annualized 09/30/02 06/30/02 % Change % Change -------- -------- -------- -------- (dollars in millions, except per share data) <S> <C> <C> <C> <C> 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 -- -- </TABLE> 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 <TABLE> <CAPTION> As Of ----------------------------------------------------- % of % of Inc 09/30/02 Total 06/30/02 Total (Dec) -------- ----- -------- ----- ----- (dollars in millions) <S> <C> <C> <C> <C> <C> Commercial $362 62% $414 64% $(52) Residential 119 20% 123 19% (4) Consumer 102 18% 107 17% (5) ----- ----- ----- Total Loans 583 644 (61) </TABLE> 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 <TABLE> <CAPTION> As Of And For The Quarter Ended ------------------------------- (dollars in millions) 09/30/02 06/30/02 Change -------- -------- ------ <S> <C> <C> <C> 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% - </TABLE> 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: <TABLE> <CAPTION> ----------09/30/02----------- -----------06/30/02----------- -----------12/31/01---------- ALLOCATION ALLOCATION ALLOCATION LOAN ---------- LOAN ---------- LOAN ---------- BALANCE $ % BALANCE $ % BALANCE $ % ------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> 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% </TABLE> 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: <TABLE> <CAPTION> Minimum Required Minimum Required To Be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Regulations ------ ----------------- ------------------ Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- <S> <C> <C> <C> <C> <C> <C> 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 </TABLE> 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. <TABLE> <CAPTION> Three Months Ended ------------------ September 30 June 30 2002 2002 $ Change % Increase -------------------------------------------------- (Dollars in Thousands) <S> <C> <C> <C> <C> Data Processing Fees $2,052 $1,830 $222 12% </TABLE> 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) <TABLE> <CAPTION> First Years Year 2 to 5 Thereafter Total ---- ------ ---------- ----- <S> <C> <C> <C> <C> 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 ============ ============ ============ ============ </TABLE> 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