10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2007
 
OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________________to___________________________

Commission file number 0-13507

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 Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 
Yes x   No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Large Accelerate Filer o  Accelerated Filer o  Non-Accelerated Filer x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Shares, without par value
4,987,933 shares
(class)
(Outstanding at November 13, 2007)
 
 
RURBAN FINANCIAL CORP.

FORM 10-Q

TABLE OF CONTENTS
 
   
   
   
   
 
 
 
-2-
 
PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

The interim condensed consolidated financial statements of Rurban Financial Corp. (“Rurban” or the “Company”) 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 of Regulation S-X. Results of operations for the nine months ended September 30, 2007 are not necessarily indicative of results for the complete year. 
 
 
-3-
 
Rurban Financial Corp.
Condensed Consolidated Balance Sheets
September 30, 2007 and December 31, 2006
 
   
(Unaudited)
      
   
September 30,
  
December 31,
  
   
2007
  
2006
  
Assets
          
Cash and due from banks
  
$
12,859,263
  
$
13,381,791
  
Federal funds sold
    
—
    
9,100,000
  
Cash and cash equivalents
    
12,859,263
    
22,481,791
  
Interest-bearing deposits
    
—
    
150,000
  
Available-for-sale securities
    
102,759,847
    
102,462,075
  
Loans held for sale
    
—
    
390,100
  
Loans, net of unearned income
    
388,264,099
    
370,101,809
  
Allowance for loan losses
    
(3,936,545
)
  
(3,717,377
)
Premises and equipment
    
15,290,795
    
15,449,774
  
Purchased software
    
4,500,417
    
4,618,691
  
Federal Reserve and Federal Home Loan Bank stock
    
4,021,200
    
3,993,450
  
Foreclosed assets held for sale, net
    
64,805
    
82,397
  
Interest receivable
    
3,374,265
    
3,129,774
  
Goodwill
    
13,940,618
    
13,674,058
  
Core deposits and other intangibles
    
5,322,647
    
5,858,982
  
Cash value of life insurance
    
12,048,425
    
10,771,843
  
Other
    
7,164,456
    
6,559,886
  
Total assets
  
$
565,674,291
  
$
556,007,253
  
               
             
See notes to condensed consolidated financial statements (unaudited)
 
Note: The balance sheet at December 31, 2006 has been derived from the audited consolidated financial statements at that date.
 
 
-4-
 
Rurban Financial Corp.
Condensed Consolidated Balance Sheets
September 30, 2007 and December 31, 2006
 
   
(Unaudited)
      
   
September 30,
  
December 31,
  
   
2007
  
2006
  
Liabilities and Stockholders’ Equity
          
Liabilities
          
Deposits
          
Demand
  
$
41,486,691
  
$
46,565,554
  
Savings, interest checking and money market
    
138,095,329
    
130,267,333
  
Time
    
233,570,398
    
237,722,558
  
Total deposits
    
413,152,418
    
414,555,445
  
Notes payable
    
1,025,992
    
2,589,207
  
Federal Home Loan Bank advances
    
19,000,000
    
21,000,000
  
Federal Funds Purchased
    
4,400,000
   
—
  
Retail repurchase agreements
    
42,566,025
    
32,270,900
  
Trust preferred securities
    
20,620,000
    
20,620,000
  
Interest payable
    
2,409,523
    
2,224,413
  
Other liabilities
    
3,995,977
    
5,792,135
  
Total liabilities
    
507,169,935
    
499,052,100
  
Commitments and Contingent Liabilities
              
Stockholders’ Equity
              
Common stock, $2.50 stated value; authorized 10,000,000 shares; issued 5,027,433 shares; outstanding Sept. 2007 - 4,999,433 shares, December 2006 - 5,027,433 shares
   
12,568,583
    
12,568,583
  
Additional paid-in capital
    
14,902,827
    
14,859,165
  
Retained earnings
    
31,805,145
    
30,407,298
  
Accumulated other comprehensive loss
    
(421,721
)
  
(879,893
)
Treasury Stock, at cost
              
Common; Sept. 2007 - 28,000 shares, December 2006 - 0 shares
    
(350,480
)
  
—
  
Total stockholders’ equity
    
58,504,354
    
56,955,153
  
Total liabilities and stockholders’ equity
  
$
565,674,291
  
$
556,007,253
  
               
             
See notes to condensed consolidated financial statements (unaudited)
 
Note: The balance sheet at December 31, 2006 has been derived from the audited consolidated financial statements at that date.
 
 
-5-
 
Rurban Financial Corp.
Condensed Consolidated Statements of Income (Unaudited)
Three Months Ended
 
   
September 30,
2007
  
September 30,
2006
  
Interest Income
          
Loans
          
Taxable
  
$
7,072,488
  
$
6,641,379
  
Tax-exempt
    
16,668
    
18,326
  
Securities
              
Taxable
    
1,041,177
    
1,306,979
  
Tax-exempt
    
169,719
    
141,943
  
Other
    
50,288
    
48,846
  
Total interest income
    
8,350,340
    
8,157,473
  
Interest Expense
              
Deposits
    
3,497,275
    
3,017,993
  
Other borrowings
    
32,026
    
67,773
  
Retail repurchase agreements
    
435,216
    
182,007
  
Federal Home Loan Bank advances
    
268,289
    
667,749
  
Trust preferred securities
    
456,582
    
466,417
  
Total interest expense
    
4,689,389
    
4,401,939
  
Net Interest Income
    
3,660,951
    
3,755,534
  
Provision for Loan Losses
    
140,409
    
35,000
  
Net Interest Income After Provision for Loan Losses
    
3,520,543
    
3,720,534
  
Non-interest Income
              
Data service fees
    
5,004,394
    
3,785,037
  
Trust fees
    
819,989
    
753,449
  
Customer service fees
    
588,447
    
542,518
  
Net gains on loan sales
    
73,581
    
283,123
  
Loan servicing fees
    
82,651
    
96,754
  
Net realized gain on sale of
             
available-for-sale securities
    
—
    
—
  
Gain (loss) on sale of assets
    
11,862
    
25,914
  
Other
    
201,920
    
415,961
  
Total non-interest income
    
6,782,842
    
5,902,756
  
             
               
See notes to condensed consolidated financial statements (unaudited)
 
 
-6-
 
Rurban Financial Corp.
Condensed Consolidated Statements of Income (Unaudited)
Three Months Ended
 
   
September 30,
2007
  
September 30,
2006
  
Non-interest Expense
          
Salaries and employee benefits
  
$
4,290,961
  
$
4,253,924
  
Net occupancy expense
    
514,742
    
468,855
  
Equipment expense
    
1,625,762
    
1,445,073
  
Data processing fees
    
102,292
    
146,703
  
Professional fees
    
461,844
    
481,132
  
Marketing expense
    
259,196
    
168,031
  
Printing and office supplies
    
130,363
    
126,765
  
Telephone and communications
    
446,465
    
467,692
  
Postage and delivery expense
    
392,211
    
142,957
  
State, local and other taxes
    
103,674
    
188,464
  
Employee expense
    
266,277
    
235,429
  
Other
    
512,663
    
389,631
  
Total non-interest expense
    
9,106,400
    
8,514,656
  
Income Before Income Tax
    
1,196,985
    
1,108,634
  
Provision for Income Taxes
    
333,384
    
294,893
  
Net Income
  
$
863,601
  
$
813,741
  
Basic Earnings Per Share
  
$
0.17
  
$
0.16
  
Diluted Earnings Per Share
  
$
0.17
  
$
0.16
  
Dividends Declared Per Share
  
$
0.07
  
$
0.05
  
 
 
See notes to condensed consolidated financial statements (unaudited)
 
 
-7-
 
Rurban Financial Corp.
Condensed Consolidated Statements of Income (Unaudited)
Nine Months Ended
 
   
September 30,
2007
  
September 30,
2006
  
Interest Income
          
Loans
          
Taxable
  
$
20,725,807
  
$
18,238,590
  
Tax-exempt
    
51,211
    
45,718
  
Securities
              
Taxable
    
3,176,674
    
3,953,438
  
Tax-exempt
    
483,621
    
410,346
  
Other
    
163,894
    
99,158
  
Total interest income
    
24,601,207
    
22,747,250
  
Interest Expense
              
Deposits
    
10,212,672
    
7,695,387
  
Other borrowings
    
140,644
    
120,220
  
Retail repurchase agreements
    
1,130,898
    
465,560
  
Federal Home Loan Bank advances
    
760,534
    
1,684,415
  
Trust preferred securities
    
1,352,093
    
1,331,615
  
Total interest expense
    
13,596,842
    
11,297,197
  
Net Interest Income
    
11,004,365
    
11,450,053
  
Provision for Loan Losses
    
378,643
    
337,321
  
Net Interest Income After Provision for Loan Losses
    
10,625,723
    
11,112,732
  
Non-interest Income
              
Data service fees
    
14,467,788
    
10,312,757
  
Trust fees
    
2,512,251
    
2,361,127
  
Customer service fees
    
1,650,080
    
1,635,272
  
Net gains on loan sales
    
302,028
    
415,833
  
Net realized gains on sales of
             
available-for-sale
    
367
    
—
  
Loan servicing fees
    
280,789
    
301,233
  
Gain (loss) on sale of assets
    
61,839
    
85,346
  
Other
    
754,144
    
1,067,739
  
Total non-interest income
    
20,029,284
    
16,179,307
  
 
              
             
See notes to condensed consolidated financial statements (unaudited)
 
 
-8-
 
Rurban Financial Corp.
Condensed Consolidated Statements of Income (Unaudited)
Nine Months Ended
 
   
September 30,
2007
  
September 30,
2006
  
Non-interest Expense
          
Salaries and employee benefits
  
$
12,873,072
  
$
11,906,909
  
Net occupancy expense
    
1,547,800
    
1,334,722
  
Equipment expense
    
4,908,311
    
4,168,534
  
Data processing fees
    
372,716
    
402,661
  
Professional fees
    
1,640,250
    
1,525,399
  
Marketing expense
    
601,979
    
536,977
  
Printing and office supplies
    
509,817
    
453,110
  
Telephone and communications
    
1,329,359
    
1,277,707
  
Postage and delivery expense
    
1,168,563
    
397,217
  
State, local and other taxes
    
468,590
    
512,757
  
Employee expense
    
801,374
    
745,341
  
Other
    
1,250,192
    
1,283,228
  
Total non-interest expense
    
27,472,023
    
24,544,562
  
Income Before Income Tax
    
3,182,984
    
2,747,477
  
Provision for Income Taxes
    
831,885
    
697,668
  
Net Income
  
$
2,351,099
  
$
2,049,809
  
Basic Earnings Per Share
  
$
0.47
  
$
0.41
  
Diluted Earnings Per Share
  
$
0.47
  
$
0.41
  
Dividends Declared Per Share
  
$
0.19
  
$
0.15
  
 
 
See notes to condensed consolidated financial statements (unaudited)
 
 
-9-
 

 
RURBAN FINANCIAL CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’
EQUITY (UNAUDITED)
 
                   
   
Three Months Ended
  
Nine Months Ended
  
   
September 30, 2007
  
September 30, 2006
  
September 30, 2007
  
September 30, 2006
  
                   
Balance at beginning of period
  
$
57,349,495
  
$
54,026,126
  
$
56,955,153
  
$
54,450,648
  
                           
Net Income
    
863,601
    
813,741
    
2,351,099
    
2,049,809
  
                           
Other comprehensive income (loss):
                          
Net change in unrealized gains (losses)
                          
 On securities available for sale, net
    
821,754
    
1,516,738
    
458,172
    
347,011
  
Total comprehensive income (loss)
    
1,685,355
    
2,330,479
    
2,809,271
    
2,396,820
  
                         
Cash dividend
    
(349,960
)
  
(251,372
)
  
(953,252
)
  
(754,113
)
                           
Purchase of treasury shares
    
(201,280
)
  
—
    
(350,480
)
  
—
  
                           
Stock option expense
    
20,744
    
5,940
    
43,662
    
17,818
  
                           
Balance at end of period
  
$
58,504,354
  
$
56,111,173
  
$
58,504,354
  
$
56,111,173
  
 
 
See notes to condensed consolidated financial statements (unaudited)
 
 
-10-
 
Rurban Financial Corp.
Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended
 
   
September 30,
2007
  
September 30,
2006
  
Operating Activities
          
Net income
 
$
2,351,099
  
$
2,049,809
  
Items not requiring (providing) cash
              
Depreciation and amortization
    
3,222,666
    
2,640,971
  
Provision for loan losses
    
378,643
    
337,321
  
Expense of stock option plan
    
43,662
    
17,818
  
Amortization of premiums and discounts on securities
    
36,137
    
170,767
  
Amortization of intangible assets
    
536,335
    
366,947
  
Deferred income taxes
    
682,352
    
(847,663
)
FHLB Stock Dividends
    
(47,250
)
  
(386,500
)
Proceeds from sale of loans held for sale
    
12,902,818
    
15,207,292
  
Originations of loans held for sale
    
(12,210,691
)
  
(14,849,559
)
Gain from sale of loans
    
(302,028
)
  
(415,833
)
(Gain) loss on sale of foreclosed assets
    
15,244
    
(92,432
)
(Gain) loss on sales of fixed assets
    
16,107
    
7,086
  
Changes in
              
Interest receivable
    
(244,491
)
  
(389,538
)
Other assets
    
(783,511
)
  
(223,486
)
Interest payable and other liabilities
    
(2,529,428
)
  
(1,005,408
)
Net cash provided by operating activities
    
4,067,664
    
2,587,592
  
Investing Activities
              
Purchases of available-for-sale securities
    
(29,399,315
)
  
(13,783,842
)
Proceeds from maturities of available-for-sale securities
    
27,350,999
    
10,417,559
  
Proceeds from sales of available-for-sale securities
    
2,408,608
    
15,240,716
  
Proceeds from sales of Fed Stock
    
19,500
    
—
  
Net change in interest bearing deposits
    
150,000
    
—
  
Net change in loans
    
(18,386,570
)
  
(38,187,317
)
Purchase of Bank Owned Life Insurance
    
(1,000,000
)
  
—
  
Purchase of premises and equipment and software
    
(3,249,937
)
  
(3,728,676
)
Proceeds from sales of premises and equipment
    
257,928
    
38,741
  
Proceeds from sale of foreclosed assets
    
—
    
2,670,459
  
Cash paid to shareholders of Exchange Bank acquisition
    
—
    
(6,526,646
)
Cash paid for Diverse Computer Marketers, Inc. acquisition
    
(266,560
)
  
—
  
Net cash provided by (used in) investing activities
    
(22,115,347
)
  
(38,662,583
)
 
 
See notes to condensed consolidated financial statements (unaudited)

 
-11-
 
Rurban Financial Corp.
Condensed Consolidated Statements of Cash Flows (Unaudited) (continued)
Nine Months Ended
 
   
September 30,
2007
  
September 30,
2006
  
Financing Activities
          
Net increase (decrease) in demand deposits, money market, interest checking and savings accounts
  
$
2,749,134
  
$
1,274,208
  
Net increase (decrease) in certificates of deposit
    
(4,152,160
)
  
26,065,524
  
Net increase (decrease) in securities sold under agreements to repurchase
    
10,295,127
    
25,703,630
  
Net increase (decrease) in federal funds purchased
    
4,400,000
    
(3,800,000
)
Proceeds from Notes Payable
    
—
    
2,500,000
  
Proceeds from Federal Home Loan Bank advances
    
9,000,000
    
27,900,000
  
Repayment of Federal Home Loan Bank advances
    
(11,000,000
)
  
(34,900,000
)
Repayment of notes payable
    
(1,563,214
)
  
(2,231,884
)
Purchase of treasury stock
    
(350,480
)
  
—
  
Dividends paid
    
(953,252
)
  
(754,113
)
Net cash (used in) provided by financing activities
    
8,425,155
    
41,757,365
  
Increase (Decrease) in Cash and Cash Equivalents
    
(9,622,528
)
  
5,682,374
  
Cash and Cash Equivalents, Beginning of Year
    
22,481,791
    
12,650,839
  
Cash and Cash Equivalents, End of Period
  
$
12,859,263
  
$
18,333,213
  
               
Supplemental Cash Flows Information
              
             
Interest paid
  
$
13,411,731
  
$
10,561,921
  
               
Transfer of loans to foreclosed assets
  
$
82,397
  
$
459,923
  
             
             
See notes to condensed consolidated financial statements (unaudited)
 
 
-12-
RURBAN FINANCIAL CORP.
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. Results of operations for the three and nine months ended September 30, 2007 are not necessarily indicative of results for the complete year.

The condensed consolidated balance sheet of the Company as of December 31, 2006 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, 2006.

NOTE B—EARNINGS PER SHARE

Earnings per share (EPS) have been computed based on the weighted average number of shares outstanding during the periods presented. For the periods ended September 30, 2007 and 2006, stock options totaling 247,352 and 287,217 common shares, respectively, were not considered in computing EPS as they were anti-dilutive. The number of shares used in the computation of basic and diluted earnings per share were:

   
Three Months Ended
  
Nine Months Ended
  
   
September 30
  
September 30
  
 
2007
  
2006
  
2007
  
2006
  
Basic earnings per share
    
5,003,433
    
5,027,433
    
5,018,567
    
5,027,433
  
Diluted earnings per share
    
5,008,334
    
5,027,704
    
5,021,939
    
5,030,084
  


NOTE C - LOANS, RISK ELEMENTS AND ALLOWANCE FOR LOAN LOSSES

Total loans on the balance sheet are comprised of the following classifications at:

   
September 30,
  
December 31,
  
   
2007
  
2006
  
           
Commercial
  
$
79,667,905
  
$
71,640,907
  
Commercial real estate
    
123,433,841
    
109,503,312
  
Agricultural
    
46,709,478
    
44,682,699
  
Residential real estate
    
86,730,067
    
94,389,118
  
Consumer
    
51,525,413
    
49,314,080
  
Lease financing
    
458,502
    
856,808
  
Total loans
    
388,525,206
    
370,386,924
  
Less
              
Net deferred loan fees, premiums and discounts
    
(261,107
)
  
(285,115
)
 
              
Loans, net of unearned income
  
$
388,264,099
  
$
370,101,809
  
               
Allowance for loan losses
  
$
(3,936,545
)
$
(3,717,377
)
 
 
-13-
 
The following is a summary of the activity in the allowance for loan losses account for the three and Nine months ended September 30, 2007 and 2006.
 
   
Three Months Ended
  
Nine Months Ended
  
   
September 30,
  
September 30,
  
   
2007
  
2006
  
2007
  
2006
  
Balance, beginning of period
  
$
3,824,445
  
$
4,438,139
  
$
3,717,377
  
$
4,699,827
  
Provision charged to expense
    
140,408
    
35,000
    
378,643
    
337,321
  
Recoveries
    
40,222
    
267,422
    
140,712
    
565,065
  
Loans charged off
    
(68,530
)
  
(218,650
)
  
(300,187
)
  
(1,080,302
)
Balance, end of period
  
$
3,936,545
  
$
4,521,911
  
$
3,936,545
  
$
4,521,911
  
 
The following schedule summarizes nonaccrual, past due and impaired loans at:

   
September 30,
  
December 31,
  
   
2007
  
2006
  
Non-accrual loans
  
$
6,361,000
  
$
3,828,000
  
Accruing loans which are contractually past due 90 days or more as to interest or principal payments
    
—
    
—
  
Total non-performing loans
  
$
6,361,000
  
$
3,828,000
  
 
Individual loans determined to be impaired were as follows:
 
   
September 30,
  
December 31,
  
   
2007
  
2006
  
           
Loans with no allowance for loan losses allocated
  
$
843,000
  
$
608,000
  
Loans with allowance for loan losses allocated
    
1,906,000
    
1,514,000
  
Total impaired loans
  
$
2,749,000
  
$
2,122,000
  
               
Amount of allowance allocated
  
$
272,000
  
$
225,000
  
 
NOTE D - REGULATORY MATTERS
 
The Company and The State Bank and Trust Company (“State Bank”) are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by
 

 
-14-

regulators. If undertaken, these actions could have a direct material adverse effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and State Bank 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 State Bank 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 in the regulations), and of Tier I capital to average assets (as defined in the regulations).  As of September 30, 2007 and December 31, 2006, the Company and State Bank exceeded all “well-capitalized” requirements to which they were subject.
 
As of December 31, 2006, the most recent notification to the regulators categorized State Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, State Bank must maintain capital ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed State Bank’s categorization as well capitalized.
 
The Company’s consolidated, and State Bank’s actual, capital amounts (in millions) and ratios, as of September 30, 2007 and December 31, 2006, are also presented in the following table. On March 24, 2007, Exchange Bank was merged with and into the lead bank, State Bank.
 
   
Actual
  
Minimum Required For Capital
Adequacy Purposes
  
To Be Well Capitalized Under
Prompt Corrective Action
Provisions
  
   
Amount
  
Ratio
  
Amount
  
Ratio
  
Amount
  
Ratio
  
As of September 30, 2007
                          
Total Capital (to Risk-Weighted Assets)
                          
Consolidated
  
$
64.2
    
15.8
%
$
32.5
    
8.0
%
$
—
    
N/A
  
State Bank
    
48.7
    
12.4
    
31.5
    
8.0
    
39.3
    
10.0
  
                                       
Tier I Capital (to Risk-Weighted Assets)
                                      
Consolidated
    
59.9
    
14.8
    
16.2
    
4.0
    
—
    
N/A
  
State Bank
    
44.8
    
11.4
    
15.7
    
4.0
    
23.6
    
6.0
  
                                       
Tier I Capital (to Average Assets)
                                      
Consolidated
    
59.9
    
10.8
    
22.2
    
4.0
    
—
    
N/A
  
State Bank
    
44.8
    
8.4
    
21.4
    
4.0
    
26.8
    
5.0
  
As of December 31, 2006
                                      
Total Capital (to Risk-Weighted Assets)
                                      
Consolidated
  
$
62.0
    
16.0
%
$
30.9
    
8.0
%
$
—
    
N/A
  
State Bank
    
38.9
    
12.2
    
25.4
    
8.0
    
31.8
    
10.0
  
Exchange Bank
    
7.8
    
13.2
    
4.8
    
8.0
    
6.0
    
10.0
  
                                       
Tier I Capital (to Risk-Weighted Assets)
                                      
Consolidated
    
57.6
    
14.9
    
15.5
    
4.0
    
—
    
N/A
  
State Bank
    
35.9
    
11.3
    
12.7
    
4.0
    
19.1
    
6.0
  
Exchange Bank
    
7.1
    
11.9
    
2.4
    
4.0
    
3.6
    
6.0
  
                                       
Tier I Capital (to Average Assets)
                                      
Consolidated
    
57.6
    
10.5
    
22.0
    
4.0
    
—
    
N/A
  
State Bank
    
35.9
    
7.9
    
18.2
    
4.0
    
22.8
    
5.0
  
Exchange Bank
    
7.1
    
8.7
    
3.3
    
4.0
    
4.1
    
5.0
  
 
 
-15-
 
NOTE E - 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 effect on the Company’s consolidated financial condition or results of operations.

NOTE F - NEW ACCOUNTING PRONOUNCEMENTS

In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156, Accounting for Servicing of Financial Assets: an amendment of FASB Statement No. 140 (FAS 140 and FAS 156). FAS 140 establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities. This Statement amends FAS 140 to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. This Statement permits, but does not require, the subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value. Under this Statement, an entity can elect subsequent fair value measurement to account for its separately recognized servicing assets and servicing liabilities. Adoption of this Statement is required as of the beginning of the first fiscal year that begins after September 15, 2006. On January 1, 2007 the Company adopted SFAS No. 156. The adoption of SFAS No. 156 did not have a material impact on the financial position and results of operations of the Company.

The Company adopted the provisions of the Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109, on January 1, 2007. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As a result of the implementation of FIN 48, the Company did not become aware of any liability for uncertain tax positions that it believes should be recognized in the financial statements.

The Company or one of its subsidiaries files income tax returns in the U.S. federal and multiple-state jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local examinations by tax authorities for years before 2004.

In February 2007, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - including an amendment of FASB Statement No. 115 (SFAS No. 159). SFAS No. 159 permits us to choose to measure certain financial assets and liabilities at fair value that are not currently required to be measured at fair value (i.e. the Fair Value Option). Election of the Fair Value Option is made on an instrument-by-instrument basis and is irrevocable. At the adoption date, unrealized gains and losses on financial assets and liabilities for which the Fair Value Option has been elected would be reported as a

 
-16-

cumulative adjustment to beginning retained earnings. If we elect the Fair Value Option for certain financial assets and liabilities, we will report unrealized gains and losses due to changes in their fair value in earnings at each subsequent reporting date. SFAS No. 159 is effective as of January 1, 2008. We are currently evaluating the potential impact of adopting SFAS No. 159 on our consolidated financial statements.
 
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157). FAS 157 enhances existing guidance for measuring assets and liabilities using fair value. Prior to the issuance of FAS 157, guidance for applying fair value was incorporated in several accounting pronouncements. FAS 157 provides a single definition of fair value, together with a framework for measuring it, and requires additional disclosure about the use of fair value to measure assets and liabilities. FAS 157 also emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted prices in active markets. Under FAS 157, fair value measurements are disclosed by level within that hierarchy. While FAS 157 does not add any new fair value measurements, it does change current practice. Changes to practice include: (1) a requirement for an entity to include its own credit standing in the measurement of its liabilities; (2) a modification of the transaction price presumption; (3) a prohibition on the use of block discounts when valuing large blocks of securities for broker-dealers and investment companies; and (4) a requirement to adjust the value of restricted stock for the effect of the restriction even if the restriction lapses within one year. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the potential impact of adopting FAS 157 on our financial statements.
 
In September 2006, the FASB ratified a consensus opinion by the EITF on EITF Issue 06-5, Accounting for Purchases of Life Insurance-Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (Accounting for Purchases of Life Insurance). The issue requires policy holders to consider other amounts included in the contractual terms of an insurance policy, in addition to cash surrender value, for purposes of determining the amount that could be realized under the terms of the insurance contract. If it is probable that contractual terms would limit the amount that could be realized under the insurance contract, those contractual limitations should be considered when determining the realizable amounts. The amount that could be realized under the insurance contract should be determined on an individual policy (or certificate) level and should include any amount realized on the assumed surrender of the last individual policy or certificate in a group policy.
 
The Company holds several life insurance policies, however, the policies do not contain any provisions that would restrict or reduce the cash surrender value of the policies. The consensus in EITF Issue 06-5 is effective for fiscal years beginning after December 15, 2006. The application of this guidance did not have a material adverse effect on the Company’s financial position or results of operations.
 
NOTE G - COMMITMENTS AND CREDIT RISK

As of September 30, 2007, loan commitments and unused lines of credit totaled $71,470,000, standby letters of credit totaled $367,000 and no commercial letters of credit were outstanding.
 
NOTE H - SEGMENT INFORMATION
 
The reportable segments are determined by the products and services offered, primarily distinguished between banking and data processing operations. On March 24, 2007, The Exchange Bank and Reliance Financial Services, N.A. were merged with and into the lead bank, The State Bank and Trust Company. Due to this merger, the segment reporting as of September 30, 2006 has been restated.
 
 
-17-
 
NOTE H - SEGMENT INFORMATION (Continued)
 
As of and for the nine months ended September 30, 2007
  
       
Data
      
Total
  
Intersegment
  
Consolidated
  
Income statement information:
  
Banking
  
Processing
  
Other
  
Segments
  
Elimination
  
Totals
  
                           
Net interest income (expense)
  
$
12,574,116
  
$
(220,225
)
$
(1,349,526
)
$
11,004,365
        
$
11,004,365
  
 
                                      
Non-interest income - external
                                      
customers
    
5,503,066
   
14,467,788
   
58,430
   
20,029,284
         
20,029,284
 
                                       
Non-interest income - other segments
    
539,276
   
1,188,208
   
992,321
   
2,719,805
   
(2,719,805
)
  
—
 
                                       
Total revenue
    
18,616,458
   
15,435,771
   
(298,775
)
  
33,753,454
   
(2,719,805
)
  
31,033,649
 
                                       
Non-interest expense
    
15,431,283
   
12,670,567
   
2,089,977
   
30,191,827
   
(2,719,805
)
  
27,472,022
 
                                       
Significant non-cash items:
                                      
                                       
Depreciation and
                                     
amortization
    
751,206
   
2,379,089
   
92,371
   
3,222,666
   
—
   
3,222,666
 
                                       
Provision for loan losses
    
378,643
   
—
   
—
   
378,643
   
—
   
378,643
 
 
                                      
Income tax expense (benefit)
    
730,451
   
940,170
   
(838,736
)
  
831,885
   
—
   
831,885
 
 
                                      
Segment profit (loss)
  
$
2,076,081
  
$
1,825,034
  
$
(1,550,016
)
$
2,351,099
  
$
—
  
$
2,351,099
  
                                       
Balance sheet information:
                                      
                                       
Total assets
  
$
546,412,401
  
$
19,684,894
  
$
7,700,083
  
$
573,797,378
  
$
(8,123,087
)
$
565,674,291
  
                                       
Goodwill and intangibles
    
11,812,295
   
7,450,970
   
—
   
19,263,265
   
—
   
19,263,265
 
                                       
Premises and equipment expenditures
    
1,009,075
   
2,103,791
   
137,071
   
3,249,937
   
—
   
3,249,937
 

 
NOTE H — SEGMENT INFORMATION (Continued)

As of and for the nine months ended September 30, 2006
  
       
Data
      
Total
  
Intersegment
  
Consolidated
  
Income statement information:
  
Banking
  
Processing
  
Other
  
Segments
  
Elimination
  
Totals
  
                           
Net interest income (expense)
  
$
12,944,038
  
$
(164,635
)
$
(1,329,350
)
$
11,450,053
        
$
11,450,053
  
 
                                      
Non-interest income - external
                                      
customers
    
5,797,646
   
10,312,757
   
68,904
   
16,179,307
         
16,179,307
 
                                       
Non-interest income - other segments
    
77,168
   
1,206,824
   
759,480
   
2,043,472
   
(2,043,472
)
  
—
 
                                       
Total revenue
    
18,818,852
   
11,354,946
   
(500,966
)
  
29,672,832
   
(2,043,472
)
  
27,629,360
 
                                       
Non-interest expense
    
15,610,960
   
9,117,085
   
1,859,989
   
26,588,034
   
(2,043,472
)
  
24,544,562
 
                                       
Significant non-cash items:
                                      
                                       
Depreciation and
                                      
amortization
    
752,292
   
1,839,814
   
48,865
   
2,640,971
   
—
   
2,640,971
 
                                       
Provision for loan losses
    
337,321
   
—
   
—
   
337,321
   
—
   
337,321
 
 
                                      
Income tax expense (benefit)
    
749,869
   
760,874
   
(813,075
)
  
697,668
   
—
   
697,668
 
 
                                      
Segment profit (loss)
  
$
2,120,702
  
$
1,476,987
  
$
(1,547,880
)
$
2,049,809
  
$
—
  
$
2,049,809
  
                                       
Balance sheet information:
                                      
                                       
Total assets
  
$
553,810,212
  
$
19,981,151
  
$
8,623,336
  
$
582,414,699
  
$
(12,427,586
)
$
569,987,113
  
                                       
Goodwill and intangibles
    
12,270,962
   
7,273,716
   
—
   
19,544,678
   
—
   
19,544,678
 
                                       
Premises and equipment expenditures
    
415,137
   
2,519,955
   
83,804
   
3,018,896
   
—
   
3,018,896
 
 

 
-19-
 
NOTE H — SEGMENT INFORMATION (Continued)
                           
As of and for the three months ended September 30, 2007
  
       
Data
      
Total
  
Intersegment
  
Consolidated
  
Income statement information:
  
Banking
  
Processing
  
Other
  
Segments
  
Elimination
  
Totals
  
                           
Net interest income (expense)
  
$
4,169,772
  
$
(53,123
)
$
(455,698
)
$
3,660,951
        
$
3,660,951
  
 
                                      
Non-interest income - external
                                      
customers
    
1,756,535
   
5,004,394
   
21,913
   
6,782,842
         
6,782,842
 
                                       
Non-interest income - other segments
    
12,328
   
380,968
   
333,880
   
727,176
   
(727,176
)
  
—
 
                                       
Total revenue
    
5,938,635
   
5,332,239
   
(99,905
)
  
11,170,969
   
(727,176
)
  
10,443,793
 
                                       
Non-interest expense
    
4,873,670
   
4,333,698
   
626,207
   
9,833,575
   
(727,176
)
  
9,106,399
 
                                       
Significant non-cash items:
                                      
                                       
Depreciation and
                                     
amortization
    
254,631
   
971,425
   
34,307
   
1,260,363
   
—
   
1,260,363
 
                                       
Provision for loan losses
    
140,409
   
—
   
—
   
140,409
   
—
   
140,409
 
 
                                      
Income tax expense (benefit)
    
250,325
   
339,505
   
(256,446
)
  
333,384
   
—
   
333,384
 
 
                                      
Segment profit (loss)
  
$
674,231
  
$
659,036
  
$
(469,666
)
$
863,601
  
$
—
  
$
863,601
  
                                       
Balance sheet information:
                                      
                                       
Total assets
  
$
546,412,401
  
$
19,684,894
  
$
7,700,083
  
$
573,797,378
  
$
(8,123,087
)
$
565,674,291
  
                                       
Goodwill and intangibles
    
11,812,295
   
7,450,970
   
—
   
19,263,265
   
—
   
19,263,265
 
                                       
Premises and equipment expenditures
    
9,045
   
711,536
   
75,880
   
796,461
   
—
   
796,461
 
 
 
-20-
 
NOTE H — SEGMENT INFORMATION (Continued)
                           
As of and for the three months ended September 30, 2006
  
       
Data
      
Total
  
Intersegment
  
Consolidated
  
Income statement information:
  
Banking
  
Processing
  
Other
  
Segments
  
Elimination
  
Totals
  
       
 
                  
Net interest income (expense)
  
$
4,280,347
  
$
(67,045
)
$
(457,768
)
$
3,755,534
        
$
3,755,534
  
 
                                      
Non-interest income - external
                                      
customers
    
2,090,996
   
3,785,037
   
26,723
   
5,902,756
         
5,902,756
 
                                       
Non-interest income - other segments
    
24,771
   
366,823
   
211,127
   
602,721
   
(602,721
)
  
—
 
                                       
Total revenue
    
6,396,114
   
4,084,815
   
(219,918
)
  
10,261,011
   
(602,721
)
  
9,658,290
 
                                       
Non-interest expense
    
5,143,829
   
3,361,095
   
612,453
   
9,117,377
   
(602,721
)
  
8,514,656
 
                                       
Significant non-cash items:
                                      
                                       
Depreciation and
                                     
amortization
    
270,365
   
653,730
   
(867
)
  
923,228
   
—
   
923,228
 
                                       
Provision for loan losses
    
35,000
   
—
   
—
   
35,000
   
—
   
35,000
 
 
                                      
Income tax expense (benefit)
    
335,409
   
246,066
   
(286,582
)
  
294,893
   
—
   
294,893
 
 
                                      
Segment profit (loss)
  
$
881,876
  
$
477,654
  
$
(545,789
)
$
813,741
  
$
—
  
$
813,741
  
                                       
Balance sheet information:
                                      
                                       
Total assets
  
$
553,810,212
  
$
19,981,151
  
$
8,623,336
  
$
582,414,699
  
$
(12,427,586
)
$
569,987,113
  
                                       
Goodwill and intangibles
    
12,270,962
   
7,273,716
   
—
   
19,544,678
   
—
   
19,544,678
 
                                       
Premises and equipment expenditures
    
4,849
   
303,676
   
7,774
   
316,299
   
—
   
316,299
 

 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Statement Regarding Forward-Looking Information
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. Forward-looking statements provide current expectations or forecasts of future events and are not guarantees of future performance. Examples of forward-looking statements include: (a) projections of income or expense, earnings per share, the payments or non-payments of dividends, capital structure and other financial items; (b) statements of plans and objectives of the Company or our management or Board of Directors, including those relating to products or services; (c) statements of future economic performance; and (d) statements of assumptions underlying such statements. Words such as “believes,” “anticipates,” “expects,” “intends,” “targeted,” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying those statements. Forward-looking statements are based on management’s expectations and are subject to a number of risks and uncertainties. Although management believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from those expressed or implied in such statements. Risks and uncertainties that could cause actual results to differ materially include, without limitation, changes in interest rates, changes in the competitive environment, and changes in banking regulations or other regulatory or legislative requirements affecting bank holding companies. Additional detailed information concerning a number of important factors which could cause actual results to differ materially from the forward-looking statements contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations is available in the Company’s filings with the Securities and Exchange Commission, under the Securities Exchange Act of 1934, including the disclosure under the heading “Item 1A. Risk Factors” of Part I of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006. Undue reliance should not be placed on the forward-looking statements, which speak only as of the date hereof. Except as may be required by law, the Company undertakes no obligation to update any forward-looking statement to reflect unanticipated events or circumstances after the date on which the statement is made.
 
Overview of Rurban

Rurban is a bank holding company registered with the Federal Reserve Board. Rurban’s wholly-owned subsidiary, The State Bank and Trust Company (“State Bank”), is engaged in commercial banking. Rurban’s subsidiary, Rurbanc Data Services, Inc. (“RDSI”), provides computerized data processing services to community banks and businesses. On March 24, 2007, The Exchange Bank and Reliance Financial Services, N.A. (“Reliance”) were merged with and into the lead bank, State Bank. Reliance’s trust and investment operations are now conducted through a division of State Bank, doing business under the name Reliance Financial Services.

Rurban Statutory Trust I (“RST”) was established in August 2000. In September 2000, RST completed 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 of the Company with terms substantially similar to the Capital Securities. The sole assets of RST are the junior subordinated debentures, and the back-up obligations, in the

 
-22-

aggregate, constitute a full and unconditional guarantee by the Company of the obligations of RST under the Capital Securities. 

Rurban Statutory Trust II (“RST II”) was established in August 2005. In September 2005, RST II completed 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 of the Company with terms substantially similar to the Capital Securities. The sole assets of RST II are 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 II under the Capital Securities.

RFCBC, Inc. (“RFCBC”) is an Ohio corporation and wholly-owned subsidiary of the Company that was incorporated in August 2004. RFCBC operates as a loan subsidiary in servicing and working out problem loans.

Diverse Computer Marketers, Inc (“DCM”), a wholly-owned subsidiary of RDSI, provides item processing services to over 50 financial institutions throughout the Midwest.

Critical Accounting Policies
 
Note 1 to the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006 describes the significant accounting policies used in the development and presentation of the Company’s financial statements. 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 preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The Company’s 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.

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, 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

 
-23-

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 subjective 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 also 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. To the extent that actual results differ from management’s estimates, additional loan loss provisions may be required that could adversely impact earnings for future periods.
 
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 or 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 judgments 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. A decrease in earnings resulting from these or other factors could lead to an impairment of goodwill that could adversely impact earnings of future periods.

Impact of Accounting Changes
 
None

Three Months Ended September 30, 2007 compared to Three Months Ended September 30, 2006

Net Income: Net income for the third quarter of 2007 was $864,000, or $0.17 per diluted share, compared to $814,000, or $0.16 per diluted share, for the third quarter of 2006. This quarterly increase in net income was driven by an $880,000 increase in non-interest income offset by an increase of $105,000 in provision expense, a reduction of $95,000 in net interest income along with a $592,000 increase in non-interest expense. The primary driver of the increase in non-interest income is data processing fees generated from the acquisition of DCM. The $592,000 increase in non-interest expense is likewise due to the acquisition of DCM. The acquisition of DCM was completed in September of 2006.

Net Interest Income: Net interest income was $3.7 million, down $95,000 or 2.5 percent, from the 2006 third quarter. Average earning assets decreased $17.8 million or 3.5 percent over the 12-month

 
-24-

period. The decrease in earning assets is a result of the balance sheet restructuring that the Company completed at the end of 2006. Loan growth over the past twelve months was $23.9 million, or 6.6 percent, reaching $388.3 million at September 30, 2007; this growth was entirely organic. Nearly 65 percent of State Bank’s loan portfolio is commercial, and virtually all of the Bank’s growth was derived from this sector. Loan growth was again encouraging during the third quarter of 2007, increasing $6.6 million, or 6.9 percent annualized, from the second quarter of 2007. As of September 30, 2007, loans were $18.2 million higher than year-end, with commercial loan growth leading the way. Year-over-year, the net interest margin decreased 14 basis points from 3.10 percent for the third quarter 2006 to 2.96 percent for the third quarter 2007. The 2.96 percent represents a 23 basis point decrease from the linked quarter of 3.19 percent. This year-over-year decrease is the result of a 35 basis point increase in the cost of funds from one year ago.

Provision for Loan Losses: The provision for loan losses was $140,000 in the third quarter of 2007 compared to a $35,000 provision for the third quarter of 2006. The Company experienced minimal losses in the 2007 third quarter, which is reflected in net charge-offs of $28,000 compared to $54,000 of net recoveries in the 2006 third quarter. For the third quarter ended September 30, 2007, net charge-offs as a percentage of average loans was 0.03 percent annualized. At quarter end, consolidated non-performing assets, including those of RFCBC (the loan workout subsidiary), were $6.4 million, or 1.14 percent of total assets compared with $6.1 million, or 1.07 percent of total assets for the prior-year third quarter. The increase in non-performing assets in the third quarter compared to the second quarter of 2007 was attributable to three commercial credits. The company believes that they are adequately reserved for potential resultant losses, if any. The following asset quality ratios as of the end of their respective periods demonstrate the trends in Asset Quality:

($ in Thousands)
September 30,
2007
June 30,
2007
September 30,
2006
Net charge-offs
$28
$90
$(54)
Non-performing loans
6,361
5,913
5,636
OREO / OAO
71
84
490
Non-performing assets
6,432
5,997
6,126
Non-performing assets / Total assets
1.14%
1.09%
1.07%
Allowance for loan losses / Total loans
1.01%
1.00%
1.24%
Allowance for loan losses / Non-performing assets
61.2%
63.8%
73.8%
 
Non-interest Income: Non-interest income was $6.8 million for the third quarter of 2007 compared with $5.9 million for the prior-year third quarter, an increase of $880,000, or 14.9 percent. The increase was primarily driven by data processing fees, as they increased $1.2 million. DCM, which was acquired by RDSI in September of 2006, provided $758,000 of this increase. Rurban's data processing subsidiary accounts for approximately $5.0 million, or 73.8 percent of non-interest income. Excluding the $758,000 in DCM revenue, non-interest income increased $461,000, or 13.6 percent and was driven by organic growth within RDSI. Trust Fees, the second largest component of non-interest income, increased $67,000 or 8.8%. Trust Fees account for approximately $820,000, or 12.1% of non-interest income.

 
-25-

Non-interest Expense: Non-interest expense was $9.1 million for the third quarter of 2007, up $592,000, or 7.0 percent, from the year-earlier quarter. Included in the third quarter 2007 operating results are $1.1 million of DCM operating expense. The acquisition of DCM took place in September 2006, so consequently there was only one month of expenses for DCM in the third quarter, 2006. Excluding the DCM acquisition, non-interest expense decreased by $795,000 reflecting the expense reductions identified and taken in the beginning of 2007. In comparison to the second quarter, operating expenses were virtually unchanged, increasing $41,000, or 0.5 percent. Salaries and benefit expense increased marginally as a result of the growth being experienced at RDSI and DCM.
 
Nine Months Ended September 30, 2007 compared to Nine Months Ended September 30, 2006
 
Net Income: Rurban Financial Corp. had net income of $2.4 million or $0.47 per diluted share for the nine months ended September 30, 2007 compared to $2.0 million or $0.41 per diluted share for the nine months ended September 30, 2006. This represents a $301,000, or 14.7 percent, increase in comparison of the nine-month periods. Significant changes from period to period include a decrease in net interest income of $446,000, a $3.8 million increase in non-interest income and a $2.9 million increase in non-interest expense. The increase in non-interest income and non-interest expense is primarily due to the September 2006 acquisition of DCM, which provided $3.0 million of income and $2.9 million of expense.
 
Net Interest Income: For the nine months ended September 30, 2007, net interest income was $11.0 million, a decrease of $487,000, or 4.4 percent, from the nine-month period ended September 30, 2006. This decrease is primarily the result of a 35 basis point decrease in the year over year net interest margin. The banking industry as a whole has experienced margin compression throughout the past year. The Companies earning assets have decreased $16.0 million over the past twelve months. The strategic decision to restructure the balance sheet is benefiting the company as the net interest margin has improvement during 2007. As mentioned previously, the loan portfolio continues to grow and the liquidity provided by the reduction in investment securities has been used to fund this growth. Rurban continues to monitor opportunities to improve the margin through funding loans with lower yielding investments.
 
Provision for Loan Losses: The provision for loan losses was $379,000 for the nine months ended September 30, 2007 compared to $337,000 for the nine months ended September 30, 2006.
 
Non-interest Income: Non-interest income was $20.0 million for the nine months ended September 30, 2007 compared with $16.2 million for the nine months ended September 30, 2006. Data Processing accounted for $4.2 million of the increase with DCM accounting for $3.0 million and RDSI contributing approximately $1.2 million. Excluding DCM’s contribution, non-interest income for the period increased $850,000, or 5.4 percent. Management continues to focus on fee income opportunities within the SBA and FSA programs. Trust fee income also increased from $2.3 million to $2.5 million, as total trust assets managed reached a record high of $389 million.
 
Non-interest Expense: For the nine months ended September 30, 2007, total non-interest expense was $27.5 million compared with $24.5 million for the nine months ended September 30, 2006. This represents a $2.9 million, or 11.9 percent, increase period over period. Of the overall increase, salaries and benefits accounted for $966,000, equipment expenses increased $740,000, postage and delivery expenses increased $771,000 and professional fees were up $115,000. Again, the acquisition of DCM had a major role in the increases, as they accounted for $2.9 million of expenses that were not in the September 30, 2006 totals.

 
-26-
 
Changes in Financial Condition

September 30, 2007 vs. December 31, 2006

At September 30, 2007, total assets were $565.7 million, representing an increase of $9.7 million or 1.7 percent, from December 31, 2006. The increase was primarily attributable to an increase in total loans of $18.2 million, or 4.9 percent during the nine month period. A decrease in cash and cash equivalents of $9.6 million, primarily a decrease in fed funds sold of $9.1 million offset the loan increase. The fed funds were used to fund the loan growth and in turn have improved the net interest margin, as the fed funds have been reinvested in higher yielding loans.

Year- over-year, average assets increased $2.0 million, or 0.4 percent. Loan growth over the past twelve months was approximately $23.9 million, or 6.6 percent, reaching $388.3 million at September 30, 2007; this growth was entirely organic. Virtually all of the growth in the Bank’s loan portfolio over this period was derived from the commercial sector. After a steady but slow first quarter resulting from both competitive factors and the priority given to merger activities, loan growth continued to be strong during the third quarter of 2007, growing at an annualized rate of 6.6 percent.

At September 30, 2007, liabilities totaled $507.2 million, an increase of $8.1 million since December 31, 2006. Of this increase, significant changes included fed funds borrowed, which increased $4.4 million; retail repurchase agreements, which increased $10.3 million (31.9 percent). These increases were offset by decreases in notes payable, which decreased $1.6 million (60.4 percent); and other liabilities, which decreased $1.8 million (31.0 percent). Deposit balances decreased $1.4 million. Of the $1.4 million decrease in total deposits, time deposits decreased $4.2 million and demand deposits decreased $5.1 million during the period, while savings, interest checking and money market deposits increased $7.8 million. The decrease in time deposits was due to excess liquidity which allowed management to run off higher cost municipal deposits.

From December 31, 2006 to September 30, 2007, total shareholders’ equity increased $1.5 million, or 2.7 percent, to $58.5 million. Of this increase, retained earnings increased $1.4 million, which is the result of $2.4 million in net income less $953,000 in cash dividends to shareholders. Additional paid-in-capital increased $44,000 as the result of stock option expense incurred during the year. Accumulated other comprehensive loss increased $458,000 as the result of an increase in market value of the available-for-sale securities portfolio. The stock repurchase plan also reduced capital by $350,000 during 2007 as 28,000 shares have been repurchased YTD.

 

Capital Resources

At September 30, 2007, actual capital levels (in millions) and minimum required levels were as follows:

                   
Minimum Required
  
           
Minimum Required
  
To Be Well Capitalized
  
           
For Capital
  
Under Prompt Corrective
  
   
Actual
  
Adequacy Purposes
  
Action Regulations
  
   
Amount
  
Ratio
  
Amount
  
Ratio
  
Amount
  
Ratio
  
                           
Total capital (to risk weighted assets)
                          
Consolidated
  
$
64.2
    
15.8
%
$
32.5
    
8.0
%
$
-
    
N/A
  
State Bank
    
48.7
    
12.4
    
31.5
    
8.0
    
39.3
    
10.0
  
 
Both the Company and State Bank were categorized as well capitalized at September 30, 2007.
 
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, federal funds sold, 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 $115.6 million at September 30, 2007 compared to $125.5 million at December 31, 2006.

The Company’s residential first mortgage portfolio of $86.7 million at September 30, 2007 and $94.4 million at December 31, 2006, which can and has been used to collateralize borrowings, is an additional source of liquidity. At September 30, 2007, all eligible one-to-four family residential and commercial real estate 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 for the nine months ended September 30, 2007 and 2006 follows.

The Company experienced positive cash flows from operating activities for the nine months ended September 30, 2007 and 2006. Net cash provided from operating activities was $4.1 million and $2.6 million, respectively, for the nine months ended September 30, 2007 and 2006.

Net cash flow from investing activities was $(22.1) million and $(38.7) million for the nine months ended September 30, 2007 and 2006, respectively. The changes in net cash from investing activities at September 30, 2007 included loan growth of $18.4 million, available-for-sale securities purchases totaling $29.4 million and purchases of premises equipment and software totaling $3.2 million. These cash payments were offset by $27.4 million in proceeds from maturities of available-for-sale securities. The changes in net cash from investing activities at September 30, 2006 included loan growth of $38.2 million, payment to the shareholders of Exchange Bancshares, Inc., which merged with the Company

 
-28-

effective December 31, 2005, of $6.5 million and available-for-sale security purchases totaling $13.8 million. This was partially offset by proceeds from maturities and proceeds from the sales of available-for-sale securities totaling $10.4 million and $15.2 million, respectively.

Net cash flow from financing activities was $8.4 million and $41.8 million for the nine month periods ended September 30, 2007 and 2006, respectively. The 2007 financing activities included a $10.3 million increase in repurchase agreements, and a $4.4 million increase in fed funds borrowed. Demand deposits, money market, interest checking and savings accounts increased by a $2.7 million, offset by a decrease in certificates of deposit of $4.2 million. The net cash provided by financing activities at September 30, 2006 was primarily due to an increase in total deposits of $27.3 million, an increase in repurchase agreements of $25.7 million, an increase in notes payable of $2.5 million, partially offset by a decrease in fed funds purchases of $3.8 million and net Federal Home Loan Bank advances of $7.0 million.

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.

Approximately $71.6 million of the Company’s $86.7 million residential first mortgage loan portfolio qualifies to collateralize FHLB borrowings and was pledged to meet FHLB collateralization requirements as of September 30, 2007. Based on the current collateralization requirements of the FHLB, approximately $28.7 million of additional borrowing capacity existed at September 30, 2007.

As of September 30, 2007, the Company had unused federal funds lines totaling $16.4 million from four correspondent banks. At December 31, 2006, the Company had $21.8 million in federal fund lines. Federal funds borrowed at September 30, 2007 and December 31, 2006 totaled $4.4 million and $0, respectively.

The Company’s contractual obligations as of September 30, 2007 consisted of long-term debt obligations, other debt obligations, operating lease obligations and other long-term liabilities. Long-term debt obligations were comprised of FHLB advances of $19.0 million. Other debt obligations were comprised of Trust Preferred Securities of $20.6 million. The operating lease obligation is a lease on the State Bank operations building of $99,600 per year, the RDSI-North building of $162,000 per year, the new Northtowne branch of State Bank of $60,000 per year and the DCM Lansing and Indiana facilities which total $108,000 and $60,000, respectively, per year. Other long-term liabilities were comprised of time deposits of $233.6 million.

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, mortgage-backed securities, 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 specific foreign exchange exposure. In addition, the Company has

 
-29-

limited exposure to commodity prices related to agricultural loans. The impact of changes in foreign exchange rates and 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 results and 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 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 a Joint 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, and serves as 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

 
-30-

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 Disclosures 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, 2007. 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 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.

 
-31-
 
Principal/Notional Amount Maturing or Assumed to Withdraw In:
(Dollars in Thousands)

Comparison of 2007 to 2006:
  
First
  
Years
          
Total rate-sensitive assets:
  
Year
  
2 - 5
  
Thereafter
  
Total
  
At September 30, 2007
  
$
175,702
  
$
184,873
  
$
134,470
  
$
495,045
  
At December 31, 2006
    
195,015
    
170,804
    
120,379
    
486,198
  
Increase (decrease)
  
$
(19,313
)
$
14,069
  
$
14,091
  
$
8,847
  
                           
Total rate-sensitive liabilities:
                          
At September 30, 2007
  
$
248,234
  
$
230,870
  
$
21,660
  
$
500,764
  
At December 31, 2006
    
232,446
    
237,240
    
21,349
    
491,035
  
Increase (decrease)
  
$
15,788
  
$
(6,370
)
$
311
  
$
9,729
  

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 receivable, repricing frequency can be daily or monthly. For adjustable rate loans receivable, 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 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 receivable which are renewed (and repriced) annually, 2) variable rate loans, 3) certificates of deposit with terms from one month to six years, 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 30 days, and 6) FHLB borrowings with terms of one day to ten years.
 
Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

With the participation of the President and Chief Executive Officer (the principal executive officer) and the Executive Vice President and Chief Financial Officer (the principal financial officer) of the Company, the Company’s management has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the quarterly period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the Company’s President and Chief Executive Officer and Executive Vice President and Chief Financial Officer have concluded that:

·
information required to be disclosed by the Company in this Quarterly Report on Form 10-Q and other reports which the Company files or submits under the Exchange Act would be accumulated and

 
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communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure;

·
information required to be disclosed by the Company in this Quarterly Report on Form 10-Q and other reports which the Company files or submits under the Exchange Act would be recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms; and

·
the Company’s disclosure controls and procedures were effective as of the end of the quarterly period covered by this Quarterly Report on Form 10-Q.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the Company’s fiscal quarter ended September 30, 2007, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 
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PART II - OTHER INFORMATION
 
Item 1. Legal Proceedings
There are no material pending legal proceedings against the Company or any of its subsidiaries other than ordinary, routine litigation incidental to their respective businesses. In the opinion of management, this litigation should not, individually or in the aggregate, have a material adverse effect on the Company’s results of operations or financial condition.

Item 1A. Risk Factors
An investment in our common shares involves certain risks, including those identified and described in “Item 1A. Risk Factors” of Part I of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006, as well as in the Cautionary Statements Regarding Forward-Looking Information contained on page 22 of this Form 10-Q. These risk factors could materially affect the Company’s business, financial condition or future results. There have been no material change in the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
a.
Not applicable
b.
Not applicable
c.
The following table provides information regarding repurchases of the Company’s common shares during the three months ended September 30, 2007:

Period
Total Number of
Shares Purchased (1)
Average Price
Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (2)
July 1 through July 31, 2007
19,568
$12.61
16,000
222,000
August 1 through August 31, 2007
—
—
—
222,000
September 1 through September 30, 2007
2,682
$12.67
—
222,000
 
(1)
In July and September 3,568 and 2,682 of the repurchased shares respectively, were purchased in the open market by Reliance Financial Services, an indirect subsidiary of the Company, in its capacity as the administrator of the Company’s Employee Stock Ownership and Savings Plan. The balance of shares repurchased were part of the publicly announced plan,
(2)
On April 12, 2007 the Company announced that its Board of Directors had authorized a stock repurchase program pursuant to which the Company may purchase up to 250,000 common shares over the ensuing 15-month period.

Item 3. Defaults Upon Senior Securities
Not applicable

 
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Item 4. Submission of Matters to a Vote of Security Holders
Not applicable

Item 5. Other Information
Not applicable

Item 6. Exhibits
Exhibits

31.1
- Rule 13a-14(a)/15d-14(a) Certification (Principal Executive Officer)
31.2
- Rule 13a-14(a)/15d-14(a) Certification (Principal Financial Officer)
32.1
- Section 1350 Certification (Principal Executive Officer)
32.2
- Section 1350 Certification (Principal Financial Officer)

 
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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, 2007
 
By:  /s/ Kenneth A. Joyce
Kenneth A. Joyce
President & Chief Executive Officer
 
By:  /s/ Duane L. Sinn
Duane L. Sinn
Executive Vice President & Chief Financial Officer
 
 
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