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, 2003 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 [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes [ ] No [X] The number of common shares of Rurban Financial Corp. outstanding was 4,565,721 on November 1, 2003. 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. Results of operations for the three months ended September 30, 2003 are not necessarily indicative of results for the complete year. 2
RURBAN FINANCIAL CORP. CONDENSED CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2003, DECEMBER 31, 2002 AND SEPTEMBER 30, 2002 ASSETS <TABLE> <CAPTION> (UNAUDITED) (UNAUDITED) ----------------------------------------------- SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, 2003 2002 2002 ------------- ------------- ------------- <S> <C> <C> <C> Cash and due from banks $ 16,834,072 $ 37,018,337 $ 25,638,415 Federal funds sold 2,000,000 14,000,000 28,250,000 ------------- ------------- ------------- Cash and cash equivalents 18,834,072 51,018,337 53,888,415 Interest-bearing deposits 260,000 260,000 260,000 Available-for-sale securities 99,860,837 115,108,762 90,299,093 Loans held for sale 488,484 63,536,309 44,028,624 Loans, net of unearned income 301,785,352 487,474,626 582,262,740 Allowance for loan losses (11,256,083) (17,693,841) (20,417,569) Premises and equipment 11,394,579 14,695,613 13,855,679 Federal Reserve and Federal Home Loan Bank stock 3,761,400 3,665,900 3,630,500 Foreclosed assets held for sale, net 1,167,466 1,960,276 305,781 Interest receivable 2,227,737 3,966,721 4,657,102 Deferred income taxes 5,397,313 5,495,812 1,945,129 Goodwill 2,144,303 2,323,643 2,250,599 Core deposits and other intangibles 675,864 770,777 621,859 Other 1,750,376 9,733,744 11,820,203 ------------- ------------- ------------- Total assets $ 438,491,700 $ 742,316,679 $ 789,408,155 ============= ============= ============= </TABLE> See notes to condensed consolidated financial statements (unaudited) 3
LIABILITIES AND STOCKHOLDERS' EQUITY <TABLE> <CAPTION> (UNAUDITED) (UNAUDITED) ----------------------------------------------- SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, 2003 2002 2002 ------------- ------------- ------------- <S> <C> <C> <C> LIABILITIES Deposits Demand $ 33,773,223 $ 46,114,153 $ 49,968,196 Savings, NOW and money market 106,082,553 117,738,013 196,565,846 Time 187,169,019 404,007,515 400,137,710 ------------- ------------- ------------- Total deposits 327,024,795 567,859,681 646,671,752 Deposits held for sale -- 68,175,660 26,238,717 Notes payable 11,239,607 6,000,000 7,000,000 Federal Home Loan Bank advances 37,500,000 47,850,000 49,350,000 Trust preferred securities 10,000,000 10,000,000 10,000,000 Interest payable 2,227,395 2,971,448 3,473,186 Other liabilities 2,563,997 3,077,558 3,469,726 ------------- ------------- ------------- Total liabilities 390,555,794 705,934,347 746,203,381 ------------- ------------- ------------- COMMITMENTS AND CONTINGENT LIABILITIES STOCKHOLDERS' EQUITY Common stock, $2.50 stated value; authorized 10,000,000 shares; issued 4,575,702; outstanding September 30, 2003 - 4,565,721, December 31, 2002 - 4,565,721 and September 30, 2002 - 4,565,721 shares 11,439,255 11,439,255 11,439,255 Additional paid-in capital 11,009,733 11,009,733 11,009,733 Retained earnings 25,883,039 13,904,212 20,053,821 Unearned employee stock ownership plan (ESOP) shares (281,447) (320,765) (360,083) Accumulated other comprehensive income 200,340 664,911 1,377,062 Treasury stock, at cost, 9,981 shares (315,014) (315,014) (315,014) ------------- ------------- ------------- Total stockholders' equity 47,935,906 36,382,332 43,204,774 ------------- ------------- ------------- Total liabilities and stockholders' equity $ 438,491,700 $ 742,316,679 $ 789,408,155 ============= ============= ============= </TABLE> See notes to condensed consolidated financial statements (unaudited) Note: The balance sheet at December 31, 2002 has been derived from the audited consolidated financial statements at that date. 4
RURBAN FINANCIAL CORP. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) THREE MONTHS ENDED <TABLE> <CAPTION> SEPTEMBER 30, SEPTEMBER 30, 2003 2002 ------------- ------------- <S> <C> <C> INTEREST INCOME Loans $ 4,770,009 $ 10,998,762 Securities Taxable 583,157 1,096,742 Tax-exempt 44,351 53,985 Other 85,760 114,297 ------------- ------------- Total interest income 5,483,277 12,263,786 INTEREST EXPENSE Deposits 1,778,586 5,119,229 Notes payable 180,270 84,149 Federal Home Loan Bank advances 548,888 749,095 Trust preferred 270,889 270,889 ------------- ------------- Total interest expense 2,778,633 6,223,362 ------------- ------------- NET INTEREST INCOME 2,704,644 6,040,424 PROVISION FOR LOAN LOSSES - 2,007,000 ------------- ------------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 2,704,644 4,033,424 ------------- ------------- NONINTEREST INCOME Data service fees 2,267,758 2,051,794 Trust fees 559,327 591,289 Customer service fees 454,778 643,534 Net gains on loan sales 88,555 175,551 Net realized gains (losses) on sales of available-for-sale securities - 135,847 Loan servicing fees 81,602 58,731 Gain (loss) on sale of assets 54,969 5,479 Other 76,977 195,767 ------------- ------------- Total noninterest income 3,583,966 3,857,992 ------------- ------------- </TABLE> See notes to condensed consolidated financial statements (unaudited) 5
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (CONTINUED) <TABLE> <CAPTION> SEPTEMBER 30, SEPTEMBER 30, 2003 2002 ------------- ------------- <S> <C> <C> NONINTEREST EXPENSE Salaries and employee benefits $ 2,869,095 $ 3,961,120 Net occupancy expense 245,853 376,807 Equipment expense 1,060,990 1,005,193 Data processing fees 125,132 100,815 Professional fees 683,673 812,374 Marketing expense 119,580 129,978 Printing and office supplies 100,587 141,924 Telephone and communications 166,048 194,102 Postage and delivery expense 102,069 169,835 State, local and other taxes 149,584 196,118 Other 388,450 586,538 ------------- ------------- Total noninterest expense 6,011,061 7,674,804 ------------- ------------- INCOME BEFORE INCOME TAX 277,549 216,612 PROVISION FOR INCOME TAXES 77,754 51,151 ------------- ------------- NET INCOME $ 199,795 $ 165,461 ============= ============= BASIC EARNINGS PER SHARE $ 0.04 $ 0.04 ============= ============= DILUTED EARNINGS PER SHARE $ 0.04 $ 0.04 ============= ============= </TABLE> See notes to condensed consolidated financial statements (unaudited) 6
RURBAN FINANCIAL CORP. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) NINE MONTHS ENDED <TABLE> <CAPTION> SEPTEMBER 30, SEPTEMBER 30, 2003 2002 ------------- ------------- <S> <C> <C> INTEREST INCOME Loans $ 19,922,237 $ 33,585,934 Securities Taxable 2,033,479 3,754,254 Tax-exempt 128,667 167,649 Other 365,989 152,882 ------------ ------------- Total interest income 22,450,372 37,660,719 ------------ ------------- INTEREST EXPENSE Deposits 8,505,206 15,698,459 Notes payable 424,283 392,457 Federal Home Loan Bank advances 1,802,190 2,211,502 Trust preferred 803,833 803,833 ------------ ------------- Total interest expense 11,535,512 19,106,251 ------------ ------------- NET INTEREST INCOME 10,914,860 18,554,468 PROVISION FOR LOAN LOSSES 1,494,000 15,991,000 ------------ ------------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 9,420,860 2,563,468 ------------ ------------- NONINTEREST INCOME Data service fees 6,677,203 5,620,560 Trust fees 1,827,260 1,961,055 Customer service fees 1,650,070 1,924,544 Net gains on loan sales 390,965 359,357 Net realized gains (losses) on sales of available-for-sale securities 23,632 (1,682,091) Loan servicing fees 310,540 258,915 Gain (loss) on sale of assets 20,005,581 3,713 Other 365,514 525,260 ------------ ------------- Total noninterest income 31,250,765 8,971,313 ------------ ------------- </TABLE> See notes to condensed consolidated financial statements (unaudited) 7
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (CONTINUED) <TABLE> <CAPTION> SEPTEMBER 30, SEPTEMBER 30, 2003 2002 ------------- ------------- <S> <C> <C> NONINTEREST EXPENSE Salaries and employee benefits $ 10,394,061 $ 11,723,153 Net occupancy expense 945,422 1,018,631 Equipment expense 3,177,615 2,854,179 Data processing fees 344,212 387,004 Professional fees 3,492,915 2,267,028 Marketing expense 313,111 365,058 Printing and office supplies 399,047 560,721 Telephone and communications 550,406 585,782 Postage and delivery expense 434,019 469,063 State, local and other taxes 477,014 551,301 Other 2,006,099 1,849,095 ------------- ------------- Total noninterest expense 22,533,921 22,631,015 ------------- ------------- INCOME BEFORE INCOME TAX 18,137,704 (11,096,234) PROVISION FOR INCOME TAXES 6,158,877 (3,837,959) ------------- ------------- NET INCOME $ 11,978,827 $ (7,258,275) ============= ============= BASIC EARNINGS PER SHARE $ 2.64 $ (1.60) ============= ============= DILUTED EARNINGS PER SHARE $ 2.63 $ (1.60) ============= ============= </TABLE> See notes to condensed consolidated financial statements (unaudited) 8
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) <TABLE> <CAPTION> Three Months Three Months Nine Months Nine Months Ended Ended Ended Ended September 30, 2003 September 30, 2002 September 30, 2003 September 30, 2002 Total Total Total Total Shareholders' Shareholders' Shareholders' Shareholders' Equity Equity Equity Equity ------------------ ------------------ ------------------ ------------------ <S> <C> <C> <C> <C> Balance at beginning of period $ 48,157,091 $ 42,807,182 $ 36,382,332 $ 50,829,332 Net Income (loss) 199,975 165,461 11,978,827 (7,258,275) Other comprehensive income (loss): Net change in unrealized gains (losses) on securities available for sale, net (421,160) 181,889 (464,571) 655,211 ------------------ ------------------ ----------------- ------------------ Total comprehensive income (loss) (221,185) 347,350 11,514,256 (6,603,064) Cash dividends declared - - - (1,186,930) Proceeds from sale of treasury stock - - - 13,373 Paydown of ESOP loan - 50,242 39,318 152,063 ------------------ ------------------ ----------------- ------------------ Balance at end of period $ 47,935,906 $ 43,204,774 $ 47,935,906 $ 43,204,774 ================== ================== ================= ================== </TABLE> 9
RURBAN FINANCIAL CORP. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) NINE MONTHS ENDED <TABLE> <CAPTION> SEPTEMBER 30, SEPTEMBER 30, 2003 2002 ------------- ------------- <S> <C> <C> OPERATING ACTIVITIES Net income $ 11,978,827 $ (7,258,275) Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 1,755,265 1,642,285 Provision for loan losses 1,494,000 15,991,000 ESOP shares earned 39,318 152,063 Amortization of premiums and discounts on securities 735,074 1,807,661 Amortization of intangible assets 274,253 159,620 Deferred income taxes 98,499 -- Proceeds from sale of loans held for sale 36,497,316 15,984,195 Originations of loans held for sale (36,106,351) (15,686,476) Gain on sale of branch (19,995,365) -- Gain from sale of loans (390,965) (359,357) Gain on sales of fixed assets (17,595) (3,713) Net realized gains on available-for-sale securities (23,632) (125,570) Changes in Interest receivable 1,738,984 846,683 Other assets 7,789,651 (5,763,692) Interest payable and other liabilities (1,243,497) 623,792 ------------- ------------- Net cash provided by operating activities 4,623,782 8,010,216 ------------- ------------- INVESTING ACTIVITIES Purchases of available-for-sale securities (114,036,714) (54,518,393) Proceeds from maturities of available-for-sale securities 110,473,918 40,580,590 Proceeds from the sales of available-for-sale securities 17,634,708 41,965,756 Net change in loans 102,355,764 632,540 Purchase of premises and equipment (1,046,046) (3,777,259) Purchase of Federal Home Loan Federal Reserve Bank stock (95,500) -- Sale of foreclosed assets 792,810 -- Payment of assumption of liability from sale of branch (70,452,850) -- Proceeds from assumption of net liabilities in business acquisition -- 40,069,328 ------------- ------------- Net cash provided by investing activities $ 45,626,090 $ 64,952,562 ------------- ------------- </TABLE> 10
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) <TABLE> <CAPTION> SEPTEMBER 30, SEPTEMBER 30, 2003 2002 ------------- ------------- <S> <C> <C> FINANCING ACTIVITIES Net increase in demand deposits, money market, NOW and savings accounts $ 31,605,311 $ 6,385,895 Net decrease in certificates of deposit (108,929,055) (36,260,288) Net decrease in federal funds purchased -- (14,850,000) Repayment of Federal Home Loan Bank advances (10,350,000) (9,925,069) Proceeds of Federal Home Loan Bank advances -- 5,000,000 Proceeds of note payable 5,239,607 7,000,000 Dividends paid -- (1,780,317) Proceeds from sale of 1,208 shares of treasury stock -- 13,373 ------------- ------------- Net cash used in financing activities (82,434,137) (44,416,406) ------------- ------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (32,184,265) 28,546,372 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 51,018,337 25,342,043 ------------- ------------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 18,834,072 $ 53,888,415 ============= ============= SUPPLEMENTAL CASH FLOWS INFORMATION Interest paid $ 12,279,565 $ 19,263,688 Income taxes paid (net of refunds) $ (2,168,512) -- </TABLE> See notes to condensed consolidated financial statements (unaudited) 11
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. The financial statements reflect all adjustments that are in the opinion of management, necessary to fairly present the financial position, results of operations and cash flows of the Company. Those adjustments consist only of normal recurring adjustments. The condensed consolidated balance sheet of the Company as of December 31, 2002 has been derived from the audited consolidated balance sheet of the Company as of that date. For further information, refer to the consolidated financial statements and footnotes included in the Company's Annual Report on Form 10-k for the year ended December 31, 2002. NOTE B--EARNINGS PER SHARE Earnings per share have been computed based on the weighted average number of shares outstanding during the periods presented. For the periods ended September 30, 2003 and 2002, stock options totaling 184,267 and 246,027 shares of common stock were not considered in computing EPS as they were anti-dilutive. The weighted average 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, ------------- ------------- 2003 2002 2003 2002 ---- ---- ---- ---- <S> <C> <C> <C> <C> Basic earnings per share 4,549,413 4,539,601 4,545,162 4,539,601 Diluted earnings per share 4,555,614 4,539,601 4,547,599 4,539,601 </TABLE> 12
NOTE C - LOANS, RISK ELEMENTS AND ALLOWANCE FOR LOAN LOSSES Total loans on the balance sheet are comprised of the following classifications at: <TABLE> <CAPTION> September 30, December 31, September 30, 2003 2002 2002 ---- ---- ---- <S> <C> <C> <C> Commercial $ 96,565,587 $ 123,053,492 $ 139,173,186 Commercial real estate 67,588,490 129,718,943 144,690,881 Agricultural 39,428,802 68,953,865 77,665,779 Residential real estate 46,157,257 84,431,599 119,475,874 Consumer 38,574,070 60,138,463 76,549,325 Lease financing 13,697,236 21,509,394 25,049,972 ---------------- ---------------- ------------- Total loans 302,011,442 487,805,756 582,605,017 Less Net deferred loan fees, premiums and discounts (226,090) (331,130) (342,277) ---------------- ---------------- ------------- Net loans $ 301,785,352 $ 487,474,626 $ 582,262,740 ================ ================ ============= </TABLE> The following is a summary of the activity in the allowance for loan losses account for the nine months ended September 30, 2003 and 2002 and the year ended December 31, 2002. <TABLE> <CAPTION> September 30, December 31, September 30, 2003 2002 2002 ---- ---- ---- <S> <C> <C> <C> Balance, beginning of year $ 17,693,841 $ 9,238,936 $ 9,238,936 Amounts assumed in acquisition -- 1,427,000 1,427,000 Transfer to loans held for sale -- -- (428,000) Sale of Citizens Banking Co. (232,000) -- -- Provision charged to expense 1,494,000 27,530,583 15,991,000 Recoveries 1,926,438 1,270,773 1,036,195 Loans charged off (9,626,196) (21,773,451) (6,847,562) --------------- --------------- -------------- Balance, end of year $ 11,256,083 $ 17,693,841 $ 20,417,569 =============== =============== ============== </TABLE> 13
The following schedule summarizes nonaccrual, past due and impaired loans at: <TABLE> <CAPTION> September 30, December 31, September 30, 2003 2002 2002 ---- ---- ---- <S> <C> <C> <C> Loans accounted for on a nonaccrual basis $ 18,857,000 $ 18,259,000 $ 20,706,000 Accruing loans which are contractually past due 90 days or more as to interest or principal payments - 476,000 2,779,000 --------------- --------------- ------------ Total non-performing loans $ 18,857,000 $ 18,735,000 $ 23,485,000 =============== =============== ============ </TABLE> Individual loans determined to be impaired were as follows: <TABLE> <CAPTION> September 30, December 31, September 30, 2003 2002 2002 ---- ---- ---- <S> <C> <C> <C> Loans with no allowance for loan losses allocated $ 280,000 $ 1,186,000 $ 1,159,000 Loans with allowance for loan losses allocated 18,137,000 13,736,000 21,728,000 --------------- --------------- ------------ Total impaired loans $ 18,417,000 $ 14,922,000 $ 22,888,000 =============== =============== ============ Amount of allowance allocated $ 5,315,000 $ 5,067,000 $ 9,427,000 =============== =============== ============ </TABLE> 14
NOTE D - TRUST PREFERRED SECURITIES On September 7, 2000, Rurban Statutory Trust 1 ("RST"), a wholly owned subsidiary of the Company closed a pooled private offering of 10,000 Capital Securities with a liquidation amount of $1,000 per security. The proceeds of the offering were loaned to the Company in exchange for junior subordinated debentures with terms similar to the Capital Securities. The sole assets of RST are the junior subordinated debentures of the Company and payments thereunder. The junior subordinated debentures and the back-up obligations, in the aggregate, constitute a full and unconditional guarantee by the Company of the obligations of RST under the Capital Securities. Distributions on the Capital 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, 2003, December 31, 2002 and September 30, 2002, the outstanding principal balance of the Capital Securities was $10,000,000. The junior subordinated debentures are subject to mandatory redemption, in whole or in part, upon repayment of the Capital Securities at maturity or their earlier redemption at the liquidation amount. Subject to the Company having received prior approval of the Federal Reserve, if then required, the Capital Securities are redeemable prior to the maturity date of September 7, 2030, at the option of the Company; on or after September 7, 2010 at a premium, or on or after September 7, 2020 at par; or upon occurrence of specific events defined within the trust indenture. The Company has the option to defer distributions on the Capital Securities from time to time for a period not to exceed 10 consecutive semi-annual periods. On February 12, 2003, the Trustee was notified that the Company elected to defer the semi-annual distributions which would have been due on March 7, 2003, until September 7, 2003. On July 9, 2003, the Trustee was notified that the Company elected to defer the semi-annual distributions which would have been due on September 7, 2003, until March 7, 2004. NOTE E - NOTE PAYABLE RFC Banking Company has a note payable to The Union Bank Company secured by the stock of RFC Banking Company and Rurbanc Data Services, Inc., payable in equal quarterly principal installments of $300,000 together with interest at a variable rate. During the third quarter, RFC Banking Company elected to prepay $2,500,000 of this note. The note balance was $6,200,000 as of September 30, 2003. The Company also has a line of credit with The Union Bank Company for $2,000,000. The line of credit balance was $0 as of September 30, 2003. RFC Banking Company has a note payable to First Federal Bank of the Midwest secured by specific loans of RFC Banking Company, payable in equal monthly installments of $100,000 together with interest at a variable rate. The note balance was $4,033,668 as of September 30, 2003. RDSI had a note payable to RFC Banking Company in the amount of $1,098,000. This note was acquired by First Federal Bank of the Midwest upon their acquisition of the branches sold during the second quarter. The note balance was $1,005,939 as of September 30, 2003. 15
NOTE F - REGULATORY MATTERS The Company and the subsidiary banks are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators, if undertaken, and could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the subsidiary banks must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the subsidiary banks to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of September 30, 2003, the Company and the subsidiary banks meet all "well-capitalized" requirements to which they are subject. 16
The Company and significant subsidiary banks' actual capital amounts (in millions) and ratios are also presented in the following table. <TABLE> <CAPTION> TO BE WELL CAPITALIZED FOR CAPITAL ADEQUACY UNDER PROMPT CORRECTIVE ACTUAL PURPOSES ACTION PROVISIONS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ----------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> As of September 30, 2003 Total Capital (to Risk-Weighted Assets) Consolidated $ 58.9 18.9% $ 25.0 8.0% $ -- N/A State Bank 36.1 12.8 22.6 8.0 28.3 10.0 RFCBC (1) 18.6 65.7 2.3 8.0 2.8 10.0 Tier I Capital (to Risk-Weighted Assets) Consolidated 54.9 17.6 12.5 4.0 -- N/A State Bank 32.6 11.5 11.3 4.0 17.0 6.0 RFCBC (1) 18.2 64.3 1.1 4.0 1.7 6.0 Tier I Capital (to Average Assets) Consolidated 54.9 11.9 18.6 4.0 -- N/A State Bank 32.6 7.7 17.0 4.0 21.3 5.0 RFCBC (1) 18.2 49.8 1.5 4.0 1.8 5.0 As of December 31, 2002 Total Capital (to Risk-Weighted Assets) Consolidated $ 49.4 9.2% $ 43.0 8.0% $ -- N/A State Bank 36.2 10.2 28.5 8.0 35.6 10.0 RFCBC (1) 14.8 8.1 14.6 8.0 18.2 10.0 Tier I Capital (to Risk-Weighted Assets) Consolidated 42.6 7.9 21.5 4.0 -- N/A State Bank 31.7 8.9 14.3 4.0 21.4 6.0 RFCBC (1) 12.4 6.8 7.3 4.0 10.9 6.0 Tier I Capital (to Average Assets) Consolidated 42.6 5.4 31.7 4.0 -- N/A State Bank 31.7 6.7 19.1 4.0 23.8 5.0 RFCBC (1) 12.4 4.2 11.7 4.0 14.6 5.0 </TABLE> (1) During the quarter, the Company received approval from the FDIC for its request that the insurance be cancelled for RFC Banking Company. This request and subsequent approval resulted in the sale of all the insured deposits of RFC Banking Company. This will be the last quarter that RFC Banking Company will be included in this table. 17
NOTE G - CONTINGENT LIABILITIES 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 adverse effect on the Company's consolidated financial condition or results of operations. NOTE H - NEW ACCOUNTING PRONOUNCEMENTS On November 25, 2002, the Financial Accounting Standards Board (FASB) issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN No. 45) which expands on the accounting guidance of Statements No. 5, 57 and 107 and incorporates without change the provisions of FASB Interpretation No. 34, which is being superseded. FIN No. 45, which is applicable to public and non-public entities, will significantly change current practice in the accounting for, and disclosure of, guarantees. Each guarantee meeting the characteristics described in FIN No. 45 is to be recognized and initially measured at fair value, which will be a change from current practice for most entities. In addition, guarantors will be required to make significant new disclosures, even if the likelihood of the guarantor making payments under the guarantee is remote, which represents another change from current general practice. FIN No. 45's disclosure requirements became effective for financial statements of interim or annual periods ending after December 15, 2002, while the initial recognition and initial measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company has changed its method of accounting and financial reporting for standby letters of credit by adopting the provisions of FIN No. 45 effective January 1, 2003. There was no material impact of the adoption on the financial statements. In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest Entities". FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns, or both. FIN 46 also requires disclosures about variable interest entities that a Company is not required to consolidate, but in which it has a significant variable interest. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to existing entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. FIN 46 is not expected to have a material effect on the Company's consolidated financial statements. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain embedded derivatives, and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". This Statement amends SFAS No. 133 to reflect the decisions made as part of the Derivatives Implementation Group (DIG) and in other FASB projects or deliberations. SFAS No. 149 is 18
effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. Adoption of this standard is not expected to have a material effect on the Company's consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity". This Statement establishes standards for how an entity classifies and measures certain financial instruments with characteristics of both liabilities and equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. Adoption of this standard did not have a material effect on the Company's consolidated financial statements. NOTE I - BRANCH SALES On March 28, 2003, the Citizens Savings Bank, a division of RFC Banking Company, was sold to The Union Bank Company. As of March 28, 2003, Citizens had total loans of $57.2 million, total fixed assets (net of accumulated depreciation) of $869,000 and total deposits of $70.8 million. A pre-tax gain of approximately $8.0 million was recorded in March 2003 from the sale. On June 6, 2003, the Peoples Banking Company and First Bank of Ottawa, divisions of RFC Banking Company, were sold to First Federal Bank of the Midwest. As of June 6, 2003, these branches had total loans of approximately $76.6 million, total fixed assets (net of accumulated depreciation) of approximately $1.4 million and total deposits (including accrued interest) of approximately $166.2 million. A pre-tax gain of approximately $12.0 million was recorded in June 2003 from the sale. The Company does not maintain a separate statement of operations for each division. 19
NOTE J - STOCK OPTIONS The Company accounts for its stock option plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the grant date. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation. <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, 2003 2002 2003 2002 --------- --------- ------------ ------------ <S> <C> <C> <C> <C> Net income (loss), as reported $ 199,795 $ 165,461 $ 11,978,827 $ (7,258,275) Less: Total stock-based employee compensation cost determined under the fair value based method, net of income taxes (15,777) (19,746) (47,331) (59,238) --------- --------- ------------ ------------ Pro forma net income $ 184,018 $ 145,715 $ 11,931,496 $ (7,317,513) ========= ========= ============ ============ Earnings per share: Basic - as reported $ 0.04 $ 0.04 $ 2.64 $ (1.60) Basic - pro forma $ 0.04 $ 0.03 $ 2.63 $ (1.61) Diluted - as reported $ 0.04 $ 0.04 $ 2.63 $ (1.60) Diluted - proforma $ 0.04 $ 0.03 $ 2.62 $ (1.61) </TABLE> NOTE K - COMMITMENTS AND CREDIT RISK Loan commitments and unused lines of credit totaled $50,806,000 and standby letters of credit totaled $426,000 as of September 30, 2003. NOTE L - 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 Company's subsidiary banks; and Rurban Statutory Trust 1, which manages the Company's junior subordinated debentures. Information reported internally for performance assessment follows. 20
NOTE L -- SEGMENT INFORMATION (Continued) As of and for the nine months ended September 30, 2003 <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) $ 12,170,045 $ (222,417) $ (919,203) $ 11,028,425 $ (113,565) $ 10,914,860 Noninterest income - external customers 21,568,214 6,677,203 1,879,690 30,125,107 - 30,125,107 Noninterest income - other segments - 1,252,124 2,817,661 4,069,785 (2,944,127) 1,125,658 ------------- ------------- ------------- ------------- ------------- ------------- Total revenue 33,738,259 7,706,910 3,778,148 45,223,317 (3,057,692) 42,165,625 Noninterest expense 16,351,936 6,033,616 4,218,154 26,603,706 (4,069,785) 22,533,921 Significant non-cash items: Depreciation and amortization 465,224 1,187,674 102,367 1,755,265 - 1,755,265 Provision for loan losses 1,494,000 - - 1,494,000 - 1,494,000 Income tax expense (benefit) 5,577,266 568,920 (337,048) 5,809,138 349,739 6,158,877 Segment profit (loss) 10,849,140 1,104,374 (653,591) 11,299,923 678,904 11,978,827 Balance sheet information: Total assets 438,235,888 8,695,716 3,193,885 450,125,489 (11,633,789) 438,491,700 Goodwill and intangibles 2,820,167 - - 2,820,167 - 2,820,167 Premises and equipment expenditures, net (1,755,767) 832,994 (123,273) (1,046,046) - (1,046,046) </TABLE> 21
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION Certain statements within this document, which are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties and actual results may differ materially from those predicted by the forward-looking statements. These risks and uncertainties include, but are not limited to, risks and uncertainties inherent in the national and regional banking, insurance and mortgage industries, competitive factors specific to markets in which Rurban and its subsidiaries operate, future interest rate levels, legislative and regulatory actions, capital market conditions, general economic conditions, geopolitical events, the loss of key personnel and other factors. Forward-looking statements speak only as of the date on which they are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made. All subsequent written and oral forward-looking statements attributable to the Company or any person acting on our behalf are qualified by these cautionary statements. 22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Rurban Financial Corp. ("Rurban" or "the Company") 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. As of June 6, 2003, RFCBC completed the sale of all its active banking locations, retaining only selected loans. RFCBC has ceased doing a banking business and will operate as a loan subsidiary of Rurban in servicing and working out the retained loans. 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 Company'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 2002 Form 10-K 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. CRITICAL ACCOUNTING POLICIES The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The Company's significant accounting policies are described in detail in the notes to the Company's consolidated financial statements for the year ended December 31, 2002. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company's financial condition and results, and they require management to make estimates that are difficult, subjective, or complex. 23
ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses provides coverage for probable losses inherent in the Company's loan portfolio. Management evaluates the adequacy of the allowance for loan losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management's estimates of specific and expected losses, including volatility of default probabilities, rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge-offs. The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for homogeneous consumer loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences, and historical losses, adjusted for current trends, for each homogeneous category or group of loans. The allowance for credit losses relating to impaired loans is based on the loan's observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan's effective interest rate. Regardless of the extent of the Company's analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer's financial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these exposures. The estimates are based upon the Company's evaluation of imprecise risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment. GOODWILL AND OTHER INTANGIBLES - The Company records all assets and liabilities acquired in purchase acquisitions, including goodwill and other intangibles, at fair value as required by SFAS 141. Goodwill is subject, at a minimum, to annual tests for impairment. Other intangible assets are amortized over their estimated useful lives using straight-line and accelerated methods, and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount. The initial goodwill and other intangibles recorded and subsequent impairment analysis requires management to make subjective judgements concerning estimates of how the acquired asset will perform in the future. Events and factors that may significantly affect the estimates include, among others, customer attrition, changes in revenue growth trends, specific industry conditions and changes in competition. QUARTERLY AND YEAR-TO-DATE EARNINGS SUMMARY Net income for the quarter was $199,795, or $0.04 per diluted share, versus $165,461, or $0.04 per diluted share, for the third quarter 2002. Net income for the nine months was $12.0 million, or $2.63 per diluted share, versus a net loss of $7.3 million, or $(1.60) per diluted share for the same period in 24
2002. The year-to-date net income was primarily driven by the sale of the branches of RFC Banking Company resulting in a pre-tax gain of approximately $21.0 million. Net interest income declined $3.3 million to $2.7 million for the three months ended September 30, 2003 compared to $6.0 million for the third quarter 2002. The decline in net interest income is due to a lower level of earning assets, declining market rates, a higher level of non-accrual loans and increased balance sheet liquidity as the Company focused on strengthening its risk based capital ratios. The decrease in earning assets is principally attributable to the sale of assets associated with the disposition of the RFCBC branches. The provision for loan losses was $0 for the third quarter of 2003 compared to $2.0 million for the third quarter of 2002. Noninterest income decreased $300,000 to $3.6 million in the third quarter of 2003 compared to $3.9 million for the third quarter of 2002. The decrease in noninterest income was mainly the result of the branch sales in 2003. Data processing fees increased $216,000 for the third quarter 2003 from the third quarter 2002. Noninterest expense decreased $1.7 million to $6.0 million for the third quarter of 2003 compared to $7.7 million for the third quarter of 2002. This was mainly due to the branch sales in 2003. CHANGES IN FINANCIAL CONDITION At September 30, 2003, total assets were $438.5 million, a decrease of $303.8 million from December 31, 2002. The decrease was primarily attributable to decreases in loans of $185.8 million, loans held for sale of $63.0 million, available for sale securities of $15.2 million, other assets of $8.0 million and federal funds sold of $12.0 million. At September 30, 2003, the decreases in total liabilities and stockholders' equity was mainly attributable to decreases in deposits of $240.8 million, deposits held for sale of $68.2 million and FHLB Advances of $10.4 million. The decreases were partially offset by an increase in retained earnings of $12.0 million. The decrease in the balance sheet is the direct result of the sale of the RFCBC branches in the first and second quarters of 2003. Also impacting the results were reductions in loan balances due to residential loan refinancings, and the Company's decision to exit the Cleveland market. LINKED QUARTER COMPARISON The Company reported a net profit for the third quarter of 2003 of $199,795, or $0.04 per diluted share, versus a net profit of $6.5 million, or $1.42 per diluted share, for the second quarter of 2003. The third quarter profit was mainly due to a continuous effort to reduce non-recurring operating expenses. The second quarter profit was mainly driven by the sale of the Peoples Banking Company and First Bank of Ottawa, divisions of RFC Banking Company, on June 6, 2003 for a net pre-tax gain of approximately $12.0 million. 25
A comparison of financial results for the quarter ended September 30, 2003 to the previous quarter ended June 30, 2003 is as follows: <TABLE> <CAPTION> Linked Three Months Ended Quarter Annualized 09/30/03 06/30/03 % Change % Change --------- --------- --------- ---------- (dollars in millions, except per share data) <S> <C> <C> <C> <C> Total Assets $ 438 $ 493 -11% -45% Loans Held for Sale 0.5 -- -- -- Loans (Gross) 302 326 -7% -29% Allowance for Loan Losses 11.3 12.3 -8% -33% Total Deposits 327 365 -10% -42% Total Revenue 6.3 19.0 -67% -267% Net interest Income 2.7 3.3 -19% -73% Loan Loss Provision -- 0.3 -- -- Noninterest Income 3.6 15.7 -77% -308% Noninterest Expense 6.0 8.9 -32% -130% Net Income 0.2 6.5 -- -- Basic Earnings Per Share $ 0.04 $ 1.42 -- -- Diluted Earnings Per Share $ 0.04 $ 1.42 -- -- </TABLE> On a linked quarter basis, loans declined $24 million and total assets declined $55 million. The decline in loans was primarily due to reductions in loan balances due to residential loan refinancings, the Company's lower level of production of new loans and the Company's decision to exit the Cleveland market. The loans sold due to the branch sales in the second quarter of 2003 were held-for-sale as of March 31, 2003. NET INTEREST INCOME <TABLE> <CAPTION> Three Months Ended 09/30/03 06/30/03 $Change %Change --------- --------- --------- ---------- (dollars in thousands) <S> <C> <C> <C> <C> Net Interest Income $ 2,705 $ 3,320 $ -615 -19% </TABLE> Net interest income decreased $615,000 or 19% to $2.7 million for the three months ended September 30, 2003 compared to $3.3 million for the second quarter of 2003 principally as a result of the second quarter branch sales. The net interest margin on a fully taxable equivalent basis for the third quarter was 2.50% compared to 2.40% for the second quarter of 2003. LOAN LOSS PROVISION The provision for loan losses was $0 for the third quarter of 2003 compared to $300,000 for the second quarter of 2003. Management determined that the Allowance for Loan Losses was adequate, and therefore no loan loss provision was recorded in the third quarter of 2003. 26
NONINTEREST INCOME <TABLE> <CAPTION> Three Months Ended 09/30/03 06/30/03 $Change %Change -------- -------- -------- -------- (dollars in thousands) <S> <C> <C> <C> <C> Total Noninterest Income $ 3,584 $ 15,671 $-12,087 -77% - Gains on Sale of Assets 55 11,915 -11,860 - - Data Service Fees 2,268 2,186 82 4% - Trust Fees 559 596 -37 -6% - Deposit Service Fees 455 559 -104 -19% - Gains on Sale of Loans 89 151 -62 -41% - Gain (Loss) on Securities - (3) 3 - </TABLE> Noninterest income decreased by $12.1 million to $3.6 million in the third quarter of 2003. The third quarter decrease was primarily the result of the pre-tax gain of $12.0 million on the Hancock and Putnam County branches reported during the second quarter. Data service fees reflected a modest increase of $82,000 from second quarter levels which was partially offset by a $37,000 decline in trust fees which mirrored the down market movement in the third quarter. Deposit fees fell $104,000 primarily as a result of the branch sales during the second quarter coupled with a reduction in existing transaction account balances in the third quarter. Gain on sale of loans declined $62,000 from the second quarter resulting from the decrease in consumer refinance activity in the real estate market as long term mortgage rates began to rise. NONINTEREST EXPENSE <TABLE> <CAPTION> Three Months Ended 09/30/03 06/30/03 $Change %Change -------- -------- -------- -------- (dollars in thousands) <S> <C> <C> <C> <C> Total Noninterest Expense $ 6,011 $ 8,853 $-2,842 -32% - Salaries & Employee Benefits 2,869 3,710 -841 -23% - Equipment Expense 1,061 1,057 4 - - Professional Fees 684 2,035 -1,351 -66% - All Other 1,397 2,051 -654 -32% </TABLE> Noninterest expense for the third quarter of 2003 was $6.0 million compared to $8.9 million for the second quarter of 2003, a decrease of $2.8 million or 32%. Instrumental to this decline were the elimination of salary and benefit expenses, professional fees and other volume related processing costs that were associated with the disposition of the branches during the second quarter. 27
LOANS <TABLE> <CAPTION> As Of Inc % of % of ----- 09/30/03 Total 06/30/03 Total (Dec) -------- -------- -------- -------- -------- (dollars in millions) <S> <C> <C> <C> <C> <C> Commercial $ 96 32% $ 104 32% $ (8) Commercial real estate 68 23% 77 24% (9) Agricultural 39 13% 40 12% (1) Residential 46 15% 48 15% (2) Consumer 39 13% 41 13% (2) Leasing 14 4% 16 4% (2) -------- -------- -------- Total $ 302 $ 326 $ (24) Loans held for sale 0.5 - 0.5 -------- -------- -------- Total $ 302 $ 326 $ (24) </TABLE> Loans decreased $24 million to $302 million at September 30, 2003. The decline in loans was primarily due to planned reductions in out of market loan balances and the Company's lower level of production of new loans. ASSET QUALITY As Of And For The Quarter Ended ------------------------------- (dollars in millions) <TABLE> <CAPTION> 09/30/03 06/30/03 Change -------- -------- -------- <S> <C> <C> <C> Non-performing loans $ 18.9 $ 20.3 $ -1.4 Non-performing assets 20.2 21.9 -1.7 Nonperforming assets/ loans plus OREO 6.63% 6.70% -.07% Nonperforming assets/ total assets 4.60% 4.44% +.15% Net chargeoffs 1.0 1.5 -- Net chargeoffs (annualized)/ total loans 1.8% 1.8% -- Loan loss provision -- 0.3 -- Allowance for loan loss - $ 11.3 12.3 -1.0 Allowance for loan loss - % 3.73% 3.78% -.05% Allowance/nonperforming loans 60% 61% -- Allowance/nonperforming assets 56% 56% -- </TABLE> Non-performing assets at September 30, 2003 decreased to $20.2 million or 6.63% of loans plus OREO, versus $21.9 million, or 6.70% at June 30, 2003, a decrease of $1.7 million. Net chargeoffs for the third quarter of 2003 were $1.0 million compared to $1.5 million in the second quarter of 2003. 28
ALLOWANCE FOR LOAN LOSSES The Company grades its loans using an eight grade system. Problem loans are classified as either: Substandard: Inadequately protected, with well-defined weakness that jeopardize liquidation of debt Doubtful: Inherent weaknesses well-defined and high probability of loss (impaired) Loss: Considered uncollectible. May have recovery or salvage value with future collection efforts (these loans are either fully reserved or charged off) The Company's allowance for loan losses has four components. Those components are shown in the following table: <TABLE> <CAPTION> ---------09/30/03---------- ----------06/30/03--------- LOAN ALLOCATION LOAN ALLOCATION ----------------- ----------------- BALANCE $ % BALANCE $ % ------- ------- ------- ------- ------- ------- <S> <C> <C> <C> <C> <C> <C> Allocations for individual commercial loans graded doubtful (impaired) $ 18.4 $ 5.3 28.80% $ 19.0 $ 5.3 27.89% Allocations for individual commercial loans graded substandard 40.5 3.6 8.88 36.5 3.7 10.14 "General" allowance based on chargeoff history of nine categories of loans 213.9 1.6 0.75 236.9 2.3 1.00 Allocation based on special mention loan balance 25.9 0.8 -- 33.2 1.0 -- ------- ------- ------- ------- ------- ------- TOTAL $ 302.0 $ 11.3 3.73% $ 325.6 $ 12.3 3.78% </TABLE> The amount of loans classified as doubtful decreased $0.6 million to $18.4 million while substandard loans increased $4.0 million to $40.5 million. Allowance allocations on doubtful loans were flat while allowance allocations on substandard loans decreased $0.1 million from June 30, 2003. The allowance for loan losses at September 30, 2003 was $11.3 million or 3.73% of loans compared to $12.3 million or 3.78% at June 30, 2003. CAPITAL RESOURCES At September 30, 2003, 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 $ 58.9 18.9% $ 25.0 8.0% $ - N/A State Bank 36.1 12.8 22.6 8.0 28.3 10.0 RFC Banking Company 18.6 65.7 2.3 8.0 2.8 10.0 </TABLE> The Company, State Bank and RFCBC were categorized as well capitalized at September 30, 2003. 29
WRITTEN AGREEMENT On July 9, 2002, the Company and State Bank announced they entered into a Written Agreement ("Agreement") with the Federal Reserve Bank of Cleveland and the Ohio Division of Financial Institutions on July 5, 2002. The Agreement was the result of an examination of State Bank as of December 31, 2001, which was conducted in March and April 2002. The results of the November 4, 2002 regulatory examinations indicated that as of that date, Rurban and State Bank were in compliance with most provisions of the Agreement. Management believes that Rurban is currently in substantial compliance with each of the provisions of the Agreement. State Bank and RFCBC are prohibited from paying dividends to Rurban without prior regulatory approval. Rurban is prohibited from paying Trust Preferred "dividends" and common stock dividends without prior regulatory approval. GOALS FOR 2003 AND 2004 The Company's near term goals include: - Focus on the quality of the loan underwriting process - Continued focus on Customer Relationship Management (CRM) - Completion of the centralization of operations functions - Continued monitoring 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 Company's ability to fund loan demand, meet deposit customers' withdrawal requirements and provide for operating expenses. Assets used to satisfy these needs consist of cash and due from banks, interest earning deposits in other financial institutions, securities available-for sale and loans held for sale. These assets are commonly referred to as liquid assets. Liquid assets were $117.0 million at September 30, 2003 compared to $106.6 million at June 30, 2003. The Company's residential first mortgage portfolio of $46.2 million at September 30, 2003 and $48.1 million at June 30, 2003, a portion of which can and has been readily used to collateralize borrowings, is an additional source of liquidity. Management believes its current liquidity level is sufficient to meet its liquidity needs. At September 30, 2003, all eligible mortgage loans were pledged under a Federal Home Loan Bank ("FHLB") blanket lien. The cash flow statements for the periods presented provide an indication of the Company's sources and uses of cash as well as an indication of the ability of the Company to maintain an adequate level of liquidity. A discussion of the cash flow statements at September 30, 2003 and 2002 follows. The Company experienced a net increase in cash from operating activities at September 30, 2003 and 2002. Net cash from operating activities was $4.6 million and $8.0 million, respectively, at September 30, 2003 and 2002. 30
Net cash flow from investing activities was $45.6 million and $65.0 million at September 30, 2003 and 2002 respectively. The changes in net cash from investing activities at September 30, 2003 include a decrease in securities of $(14.1) million, a decrease in loans of $(102.4) million, a decrease from the sale of the RFC Banking Company branches of $(70.5) million as well as changes in interest-bearing deposits, purchases of premises and equipment and other investing activities. The changes in net cash from investing activities at September 30, 2002 include a decrease in securities of $(28.0) million and the purchase of net liabilities from the Oakwood acquisition of $40.1 million. Net cash flow from financing activities was $(82.4) million and $(44.4) million at September 30, 2003 and 2002, respectively. The net cash decrease was primarily due to a reduction in total deposits of $(77.3) million at September 30, 2003 compared to $(29.9) at September 30, 2002. Other changes included decreases in Federal Home Loan Bank (FHLB) advances of $(10.4) million and a note payable increase of $5.2 million at September 30, 2003 compared to a $(9.9) decrease in FHLB advances, an increase of $7.0 million for a note payable and payment of dividends of $(1.8) million at September 30, 2002. 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, and the national certificate of deposit market. 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 $36.8 million residential first mortgage loans of the Company's $46.2 million portfolio qualify to collateralize FHLB borrowings and have been pledged to meet FHLB collateralization requirements as of September 30, 2003. In addition to residential first mortgage loans, $24.2 million in investment securities are pledged to meet FHLB collateralization requirements. Based on the current collateralization requirements of the FHLB, approximately $5.5 million of additional borrowing capacity existed at September 30, 2003. As of September 30, 2003 and June 30, 2003, the Company had unused federal funds lines totaling approximately $8.0 million from one correspondent bank. There were no federal funds borrowed at September 30 or June 30. Approximately $10.2 million performing commercial loans are pledged to the Federal Reserve Discount Window to establish additional borrowing capacity of $7.1 million. Such loans are pledged for contingency funding purposes and to date this borrowing capacity has not been used. 31
TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS <TABLE> <CAPTION> PAYMENT DUE BY PERIOD ------------------------------------------------------------------- LESS MORE THAN 1 1 - 3 3 - 5 THAN 5 TOTAL YEAR YEARS YEARS YEARS Contractual Obligations ----------- ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> <C> FHLB Advances $37,500,000 $ 8,500,000 $ 0 $ 4,000,000 $25,000,000 Other Debt Obligations 21,239,607 0 11,239,607 0 10,000,000 Capital Lease Obligations 0 0 0 0 0 Operating Lease Obligations 821,700 99,600 199,200 199,200 323,700 Purchase Obligations 0 0 0 0 Other Long-Term Liabilities Reflected on the Registrant's Balance Sheet under GAAP 0 0 0 0 0 ----------- ----------- ----------- ----------- ----------- Total $59,561,307 $ 8,599,600 $11,438,807 $ 4,199,200 $35,323,700 </TABLE> The Company's contractual obligations as of September 30, 2003 were comprised of FHLB Advances, other debt obligation and operating lease obligations. Other debt obligations include notes payable to The Union Bank Company and First Federal. The operating lease obligation is a lease on the RDSI building of $99,600 a year. ASSET LIABILITY MANAGEMENT Asset liability management involves developing and monitoring strategies to maintain sufficient liquidity, maximize net interest income and minimize the impact that significant fluctuations in market interest rates would have on earnings. The business of the Company and the composition of its balance sheet consists of investments in interest-earning assets (primarily loans and securities available for sale) which are primarily funded by interest-bearing liabilities (deposits and borrowings). With the exception of loans which are originated and held for sale, all of the financial instruments of the Company are for other than trading purposes. All of the Company's transactions are denominated in U.S. dollars with no foreign exchange exposure. The impact of changes in commodity prices on interest rates are assumed to be insignificant. The Company's financial instruments have varying levels of sensitivity to changes in market interest rates resulting in market risk. Interest rate risk is the Company's primary market risk exposure; to a lesser extent, liquidity risk also impacts market risk exposure. Interest rate risk is the exposure of a banking institution's financial condition to adverse movements in interest rates. Accepting this risk can be an important source of profitability and stockholder value; however, excessive levels of interest rate risk could pose a significant threat to the Company's earnings and capital base. Accordingly, effective risk management that maintains interest rate risks at prudent levels is essential to the Company's safety and soundness. Evaluating a financial institution's exposure to changes in interest rates includes assessing both the adequacy of the management process used to control interest rate risk and the organization's quantitative level of exposure. When assessing the interest rate risk management process, the Company seeks to ensure that appropriate policies, procedures, management information systems, and internal controls are in place to maintain interest rate risks at prudent levels of consistency and continuity. Evaluating the 32
quantitative level of interest rate risk exposure requires the Company to assess the existing and potential future effects of changes in interest rates on its consolidated financial condition, including capital adequacy, earnings, liquidity, and asset quality (when appropriate). The Federal Reserve Board together with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Company, adopted an Inter-Agency Policy Statement on interest rate risk effective June 26, 1996. The policy statement provides guidance to examiners and bankers on sound practices for managing interest rate risk, which will form the basis for ongoing evaluation of the adequacy of interest rate risk management at supervised institutions. The policy statement also outlines fundamental elements of sound management that have been identified in prior Federal Reserve guidance and discusses the importance of these elements in the context of managing interest rate risk. Specifically, the guidance emphasizes the need for active Board of Director and senior management oversight and a comprehensive risk management process that effectively identifies, measures, and controls interest rate risk. Financial institutions derive their income primarily from the excess of interest collected over interest paid. The rates of interest an institution earns on its assets and owes on its liabilities generally are established contractually for a period of time. Since market interest rates change over time, an institution is exposed to lower profit margins (or losses) if it cannot adapt to interest rate changes. For example, assume that an institution's assets carry intermediate or long term fixed rates and that those assets are funded with short-term liabilities. If market interest rates rise by the time the short-term liabilities must be refinanced, the increase in the institution's interest expense on its liabilities may not be sufficiently offset if assets continue to earn at the long-term fixed rates. Accordingly, an institution's profits could decrease on existing assets because the institution will either have lower net interest income or possibly, net interest expense. Similar risks exist when assets are subject to contractual interest rate ceilings, or rate sensitive assets are funded by longer-term, fixed-rate liabilities in a declining rate environment. There are several ways an institution can manage interest rate risk including: 1) matching repricing periods for new assets and liabilities, for example, by shortening terms of new loans or investments; 2) selling existing assets or repaying certain liabilities; and 3) hedging existing assets, liabilities, or anticipated transactions. An institution might also invest in more complex financial instruments intended to hedge or otherwise change interest rate risk. Interest rate swaps, futures contacts, options on futures contracts, and other such derivative financial instruments can be used for this purpose. Because these instruments are sensitive to interest rate changes, they require management's expertise to be effective. The Company has not purchased derivative financial instruments in the past. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The following table provides information about the Company's financial instruments used for purposes other than trading that are sensitive to changes in interest rates as of September 30, 2003. It does not present when these items may actually reprice. For loans receivable, securities, and liabilities with contractual maturities, the table presents principal cash flows and related weighted-average interest rates by contractual maturities as well as the Company's historical experience of the impact of interest rate fluctuations on the prepayment of loans and mortgage backed securities. For core deposits (demand deposits, interest-bearing checking, savings, and money market deposits) that have no contractual maturity, the table presents principal cash flows and, as applicable, related weighted-average interest rates based upon the Company's historical experience, management's judgment and statistical analysis, as applicable, concerning their most likely withdrawal behaviors. The current historical interest rates for core deposits have been assumed to apply for future periods in this table as the actual interest rates that will need to be paid to maintain these deposits are not currently known. Weighted average variable rates are based upon contractual rates existing at the reporting date. 33
PRINCIPAL/NOTIONAL AMOUNT MATURING OR ASSUMED TO WITHDRAW IN: (DOLLARS IN THOUSANDS) <TABLE> <CAPTION> First Years Year 2 - 5 Thereafter Total --------- --------- ---------- --------- <S> <C> <C> <C> <C> Comparison of 2003 to 2002: Total rate-sensitive assets: At September 30, 2003 $ 153,157 $ 161,005 $ 94,220 $ 408,382 At December 31, 2002 317,174 217,623 149,581 684,378 --------- --------- ---------- --------- Increase (decrease) $(164,017) $ (56,618) $ (55,361) $(275,996) Total rate-sensitive liabilities: At September 30, 2003 $ 178,660 $ 170,813 $ 36,291 $ 385,764 At December 31, 2002 317,332 339,592 42,961 699,885 --------- --------- ---------- --------- Increase (decrease) $(138,672) $(168,779) $ (6,670) $(314,121) </TABLE> Total rate sensitive assets decreased approximately $276.0 million and rate sensitive liabilities decreased approximately $314.1 million for the nine months ended September 30, 2003 due primarily to the sale of the loans ($164.2 million) and deposits ($244.4 million) of RFC Banking Company. Currently, the Company is paying down maturing broker CD's and FHLB advances. During the nine months ended September 30, 2003, $27.6 million in broker CD's and $8.4 million in FHLB advances were paid off. The Cleveland office has also been closed resulting in a reduction of $20.2 million in loans and $9.3 million in deposits. The above table reflects expected maturities, not expected repricing. The contractual maturities adjusted for anticipated prepayments and anticipated renewals at current interest rates, as shown in the preceding table, are only part of the Company's interest rate risk profile. Other important factors include the ratio of rate-sensitive assets to rate sensitive liabilities (which takes into consideration loan repricing frequency but not when deposits may be repriced) and the general level and direction of market interest rates. For core deposits, the repricing frequency is assumed to be longer than when such deposits actually reprice. For some rate sensitive liabilities, their repricing frequency is the same as their contractual maturity. For variable rate loans, repricing frequency can be daily or monthly and for adjustable rate loans, repricing can be as frequent as annually for loans whose contractual maturities range from one to thirty years. While increasingly aggressive local market competition in lending rates has pushed loan rates lower, the Company's prior increased reliance on non-core funding sources has restricted the Company's ability to reduce funding rates in concert with declines in lending rates. The Company manages its interest rate risk by the employment of strategies to assure that desired levels of both interest-earning assets and interest-bearing liabilities mature or reprice with similar time frames. Such strategies include; 1) loans which are renewed (and repriced) annually, 2) variable rate loans, 3) certificates of deposit with terms from one month to six years and 4) securities available for sale which mature at various times primarily from one through ten years 5) federal funds borrowings with terms of one day to three days, and 6) Federal Home Loan Bank borrowings with terms of one day to ten years. 34
ITEM 4. CONTROLS AND PROCEDURES With the participation of Rurban Financial Corp.'s management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934 (the "Exchange Act")) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, our principal executive officer and principal financial officer have concluded that the Company's disclosure controls and procedures are effective as of the end of the period covered by this Quarterly Report on Form 10-Q to ensure that material information relating to Rurban Financial Corp. and its consolidated subsidiaries is made known to them, particularly during the period for which our periodic reports, including this Quarterly Report on Form 10-Q, are being prepared. In addition, there were no significant changes during the period covered by this Quarterly Report on Form 10-Q in our internal control over financial reporting (as defined in Rules 13a-15 and 15d-15 of the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 35
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 31.1 - Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer) 31.2 - Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer) 32.1 - Section 1350 Certification (Chief Executive Officer) 32.2 - Section 1350 Certification (Chief Financial Officer) b. Reports on Form 8-K A Form 8-K was filed on January 2, 2003 to report information under Item 5 regarding a press release announcing that a "Purchase and Assumption Agreement" was signed between RFC Banking Company, Rurban Financial Corp.'s wholly-owned subsidiary, and The Union Bank Company on December 30, 2002. The press release was included as Exhibit 99. A Form 8-K was filed on January 21, 2003 to report information under Item 5 regarding a press release announcing that Rurban Financial Corp. and its wholly owned subsidiary, RFC Banking Company, intend to make available for purchase RFC Banking Company bank branches located in Hancock and Putnam Counties. The offices consist of The Peoples Banking Company Division and the First Bank of Ottawa Division. The press release was included as Exhibit 99. A Form 8-K was filed on February 14, 2003 to report information under Item 5 regarding a press release announcing that Rurban Financial Corp. filed a deferral notice on February 12, 2003 with US Bank, Trustee of Rurban Financial Corp.'s trust preferred indenture, to 36
defer payments of interest on the debt securities which would have been due on March 7, 2003. The press release was included as Exhibit 99(a). A Form 8-K was filed on February 25, 2003 to report information under Item 5 regarding a press release announcing that a "Purchase and Assumption Agreement" was signed on February 22, 2003 with First Federal Bank of the Midwest, a wholly owned subsidiary of First Defiance Financial Corp. The Purchase and Assumption Agreement outlined the sale of assets and assumption of deposits at RFC Banking Company's Hancock and Putnam County branches. The Purchase and Assumption Agreement was included as Exhibit 2, and the press release was included as Exhibit 99. A Form 8-K was filed on February 26, 2003 to report information under Item 5 regarding a press release announcing the financial results for the fourth quarter and year ended December 31, 2002. The press release was included as Exhibit 99. A Form 8-K was filed on March 18, 2003 to report information under Item 5 regarding a press release announcing the appointment of James E. Adams as Chief Financial Officer to replace retiring CFO, Richard C. Warrener. The press release was included as Exhibit 99. A Form 8-K was filed on April 1, 2003 to report information under Item 5 regarding a press release announcing that RFC Banking Company, a wholly-owned subsidiary of Rurban Financial Corp., completed the sale of its Wood and Sandusky County branches located in Pemberville, Gibsonburg and the Otterbein-Portage Valley Retirement Village to The Union Bank Company, a wholly-owned subsidiary of United Bancshares, Inc. The press release was included as Exhibit 99. A Form 8-K was filed on May 2, 2003 to furnish information under Item 9 (which was also deemed provided under Item 12) regarding the press release announcing the financial results for the first quarter of 2003 and the excerpts of a presentation by Kenneth A. Joyce, Chief Executive Officer, at the Annual Meeting of Shareholders held on April 28, 2003. The press release was included as Exhibit 99(a), and the excerpts were includeD as Exhibit 99(b). A Form 8-K was filed on June 18, 2003 to report under Item 2 that RFC Banking Company, a wholly-owned subsidiary of Rurban Financial Corp., completed the sale of its Findlay, McComb and Ottawa branches to First Federal Bank of the Midwest, a wholly-owned subsidiary of First Defiance Financial Corp. A press release announcing the closing of the transaction was included as Exhibit 99. The required pro forma financial information will be filed by amendment no later than August 20, 2003. A Form 8-K was filed on July 30, 2003 to report the announcement of the financial results for the third quarter of 2003. A Form 8-K was filed on August 22, 2003 to amend its current report on Form 8-K filed June 18, 2003 to file information including pro formas for the year ended December 31, 2002 and for the quarterly periods ended March 31, 2003 and June 30, 2003. 37
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 13, 2003 By /S/ Kenneth A. Joyce -------------------- Kenneth A. Joyce President & Chief Executive Officer By /S/ James E. Adams ----------------------- James E. Adams Executive Vice President & Chief Financial Officer 38