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EX-3.4 - SB FINANCIAL GROUP, INC.v185595_ex3-4.htm
EX-31.2 - SB FINANCIAL GROUP, INC.v185595_ex31-2.htm
EX-32.1 - SB FINANCIAL GROUP, INC.v185595_ex32-1.htm
EX-31.1 - SB FINANCIAL GROUP, INC.v185595_ex31-1.htm
EX-32.2 - SB FINANCIAL GROUP, INC.v185595_ex32-2.htm
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 March 31, 2010
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
(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  
Yes o No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
 
Large Accelerate Filer Accelerated Filer Non-Accelerated Filer Smaller Reporting Company 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
4,861,779 shares
(class)
(Outstanding at May 17, 2010)



RURBAN FINANCIAL CORP.

FORM 10-Q

TABLE OF CONTENTS

       
           
Item 1.
Financial Statements
    3  
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
    24  
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
    34  
Item 4.
Controls and Procedures
    34  
           
PART II – OTHER INFORMATION
       
           
Item 1.
Legal Proceedings
    35  
Item 1A.
Risk Factors
    35  
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
    38  
Item 3.
Defaults Upon Senior Securities
    38  
Item 4.
[Reserved]
    38  
Item 5.
Other Information
    38  
Item 6.
Exhibits
    39  
Signatures
      40  
 
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 three months ended March 31, 2010 are not necessarily indicative of results for the complete year.
 
3


Rurban Financial Corp.
Condensed Consolidated Balance Sheets
March 31, 2010 and December 31, 2009
 

 
   
March
   
December
 
   
2010
   
2009
 
   
(Unaudited)
       
ASSETS
           
Cash and due from banks
  $ 37,404,242     $ 24,824,785  
Cash and cash equivalents
    37,404,242       24,824,785  
Available-for-sale securities
    106,855,099       105,083,112  
Loans held for sale
    12,469,633       16,857,648  
Loans, net of unearned income
    444,082,134       452,557,581  
Allowance for loan losses
    (6,075,126 )     (7,030,178 )
Premises and equipment, net
    16,308,680       16,993,640  
Purchased software
    4,307,523       5,338,319  
Federal Reserve and Federal Home Loan Bank Stock
    3,748,250       3,748,250  
Foreclosed assets held for sale, net
    1,613,937       1,767,953  
Accrued interest receivable
    2,963,119       2,324,868  
Goodwill
    21,414,790       21,414,790  
Core deposits and other intangibles
    4,777,379       4,977,513  
Cash value of life insurance
    12,896,092       12,792,045  
Other assets
    11,037,845       11,398,776  
                 
Total assets
  $ 673,803,597     $ 673,049,102  

See notes to condensed consolidated financial statements (unaudited)

Note: The balance sheet at December 31, 2009 has been derived from the audited consolidated financial statements at that date
 
4

 
Rurban Financial Corp.
Condensed Consolidated Balance Sheets
March 31, 2010 and December 31, 2009
 
   
March
   
December
 
   
2010
   
2009
 
   
(Unaudited)
       
LIABILITIES AND SHAREHOLDERS' EQUITY
           
Deposits
           
Non interest bearing demand
  $ 61,699,862     $ 57,229,795  
Interest bearing NOW
    88,805,006       87,511,973  
Savings
    43,772,462       43,321,364  
Money Market
    93,022,350       86,621,953  
Time Deposits
    211,645,981       216,557,067  
Total deposits
    498,945,661       491,242,152  
Notes payable
    3,380,935       2,146,776  
Advances from Federal Home Loan Bank
    32,659,210       35,266,510  
Fed Funds Purchased
    -       5,000,000  
Repurchase Agreements
    49,111,099       47,042,820  
Trust preferred securities
    20,620,000       20,620,000  
Accrued interest payable
    1,200,836       1,507,521  
Other liabilities
    7,031,313       8,515,668  
                 
Total liabilities
    612,949,054       611,341,447  
                 
Shareholders' Equity
               
Common stock
    12,568,583       12,568,583  
Additional paid-in capital
    15,229,669       15,186,042  
Retained earnings
    33,567,379       34,415,316  
Accumulated other comprehensive income (loss)
    1,258,223       1,307,025  
Treasury stock
    (1,769,311 )     (1,769,311 )
                 
Total shareholders' equity
    60,854,543       61,707,655  
                 
Total liabilities and shareholders' equity
  $ 673,803,597     $ 673,049,102  

See notes to condensed consolidated financial statements (unaudited)

Note: The balance sheet at December 31, 2009 has been derived from the audited consolidated financial statements at that date.
 
5

 
Rurban Financial Corp.
Condensed Consolidated Statements of Operations (Unaudited)
Three Months Ended
 
   
Three Months Ended
March 31
 
   
2010
   
2009
 
Interest income
           
Loans
           
Taxable
  $ 6,411,582     $ 6,814,633  
Tax-exempt
    18,915       25,457  
Securities
               
Taxable
    702,255       1,079,497  
Tax-exempt
    319,063       227,884  
Other
    31,448       132  
Total interest income
    7,483,263       8,147,603  
                 
Interest expense
               
Deposits
    1,374,291       1,898,304  
Other borrowings
    38,083       14,392  
Retail Repurchase Agreements
    426,967       427,487  
Federal Home Loan Bank advances
    352,817       392,572  
Trust preferred securities
    386,624       398,985  
Total interest expense
    2,578,782       3,131,740  
                 
Net interest income
    4,904,481       5,015,863  
                 
Provision for loan losses
    1,391,433       495,142  
                 
Net interest income after provision for loan losses
    3,513,048       4,520,721  
                 
Non-interest income
               
Data service fees
    4,029,406       4,972,549  
Trust fees
    642,786       583,623  
Customer service fees
    587,401       574,699  
Net gain on sales of loans
    717,014       1,078,047  
Net realized gain on sales of securities
    451,474       53,807  
Investment securities recoveries
    73,774       -  
Loan servicing fees
    153,842       67,873  
Loss on sale of assets
    (28,652 )     (58,655 )
Other income
    155,981       175,562  
Total non-interest income
    6,783,026       7,447,505  

See notes to condensed consolidated financial statements (unaudited)
 
6

 
   
Three Months Ended
March 31
 
   
2010
   
2009
 
Non-interest expense
           
Salaries and employee benefits
    5,103,540       4,924,122  
Net occupancy expense
    586,223       626,281  
FDIC Insurance expense
    218,903       46,120  
Equipment expense
    2,165,101       1,613,393  
Software impairment expense
    568,535       -  
Data processing fees
    194,786       135,736  
Professional fees
    642,810       498,055  
Marketing expense
    77,601       188,746  
Printing and office supplies
    161,102       214,542  
Telephone and communication
    386,206       406,393  
Postage and delivery expense
    570,433       609,022  
State, local and other taxes
    121,039       232,896  
Employee expense
    279,925       259,938  
Other expenses
    715,494       719,780  
Total non-interest expense
    11,791,698       10,475,024  
                 
Income (loss) before income tax expense
    (1,495,624 )     1,493,202  
Income tax expense (benefit)
    (647,686 )     389,649  
                 
Net income (loss)
  $ (847,938 )   $ 1,103,553  
                 
Earnings (loss) per common share:
               
Basic
  $ (0.17 )   $ 0.23  
Diluted
  $ (0.17 )   $ 0.23  

See notes to condensed consolidated financial statements (unaudited)
 
7

 
RURBAN FINANCIAL CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’
EQUITY (UNAUDITED)
 
   
Three Months Ended
 
   
Mar. 31,
2010
   
Mar. 31,
2009
 
             
Balance at beginning of period
  $ 61,707,655     $ 61,662,004  
                 
Net Income
    (847,938 )     1,103,553  
                 
Unrealized gains (losses) on securities
               
          Unrealized holding gains (losses) arising during the year, net of tax
    249,171       1,379,605  
Less: reclassification adjustment for gains realized in net income, net of tax
    297,972       35,513  
Total comprehensive income
    (896,739 )     2,447,645  
                 
Cash dividend
    -       (438,958 )
                 
Purchase of treasury shares
    -       (80,247 )
                 
Share-based compensation
    43,627       30,066  
                 
Balance at end of period
  $ 60,854,543     $ 63,620,510  

See notes to condensed consolidated financial statements (unaudited)
 
8

\
Rurban Financial Corp.
Condensed Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended
 
   
March 31,
2010
   
March 31,
2009
 
Operating Activities
           
Net income (Loss)
  $ (847,938 )   $ 1,103,553  
Items not requiring (providing) cash
               
Depreciation and amortization
    1,991,083       906,560  
Provision for loan losses
    1,391,433       495,142  
Expense of share-based compensation plan
    43,627       30,066  
Amortization of premiums and discounts on securities
    201,935       126,959  
Amortization of intangible assets
    200,134       221,911  
Deferred income taxes
    (20,568 )     (1,367,386 )
Proceeds from sale of loans held for sale
    69,929,801       75,954,853  
Originations of loans held for sale
    (64,824,772 )     (80,148,083 )
Gain from sale of loans
    (717,014 )     (1,087,047 )
Gain on available for sale securities
    (451,474 )     (53,807 )
Loss on sale of foreclosed assets
    22,841       58,655  
Loss on sales of fixed assets
    5,811       27,878  
Changes in
               
Interest receivable
    (638,251 )     100,473  
Other assets
    305,640       (662,788 )
Interest payable and other liabilities
    (1,745,332 )     (1,884,229 )
Net cash provided by (used in) operating activities
    4,846,956       (6,168,290 )
Investing Activities
               
Purchases of available-for-sale securities
    (23,365,873 )     (37,662,358 )
Proceeds from maturities of available-for-sale securities
    11,773,761       10,851,012  
Proceeds from sales of available-for-sale securities
    9,995,724       3,501,640  
Proceeds from sales of Fed Stock
    -       700,000  
Net change in loans
    3,478,042       15,677,493  
Purchase of premises and equipment and software
    (753,269 )     (347,271 )
Proceeds from sales of premises and equipment
    477,941       645  
Proceeds from sale of foreclosed assets
    2,727,528       127,090  
Net cash used in investing activities
    4,333,854       (7,151,749 )

See notes to condensed consolidated financial statements (unaudited)
 
9

 
Rurban Financial Corp.
Condensed Consolidated Statements of Cash Flows (Unaudited) (continued)
Three Months Ended
 
   
March 31,
2010
   
March 31,
2009
 
Financing Activities
           
Net increase in demand deposits, money market, interest checking and savings accounts
  $ 12,614,595     $ 12,791,810  
Net decrease in certificates of deposit
    (4,911,086 )     (9,378,442 )
Net increase in securities sold under agreements to repurchase
    2,068,279       4,468,865  
Repayment of Fed Funds Purchased
    (5,000,000 )        
Proceeds from Federal Home Loan Bank advances
    -       2,000,000  
Repayment of Federal Home Loan Bank advances
    (2,607,300 )     (2,587,836 )
Proceeds from notes payable
    2,000,000       1,500,000  
Repayment of notes payable
    (765,841 )     -  
Purchase of treasury stock
    -       (80,247 )
Dividends paid
    -       (438,958 )
Net cash provided by financing activities
    3,398,647       8,275,192  
Increase (Decrease) in Cash and Cash Equivalents
    12,579,457       (5,044,847 )
Cash and Cash Equivalents, Beginning of Year
    24,824,785       28,059,532  
Cash and Cash Equivalents, End of Period
  $ 37,404,242     $ 23,014,685  
Supplemental Cash Flows Information
               
                 
Interest paid
  $ 2,885,467     $ 3,373,057  
                 
Transfer of loans to foreclosed assets
  $ 2,589,970     $ 190,158  
Sale and financing of foreclosed assets
  $ 2,249,532     $ -  

See notes to condensed consolidated financial statements (unaudited)
 
10

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 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 months ended March 31, 2010 are not necessarily indicative of results for the complete year.

The condensed consolidated balance sheet of the Company as of December 31, 2009 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, 2009.

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 March 31, 2010 and 2009, share based awards totaling 481,213 and 327,263 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
 
   
March 31
 
   
2010
   
2009
 
Basic earnings per share
    4,861,799       4,875,936  
Diluted earnings per share
    4,861,799       4,875,936  

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

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

   
March 31,
   
December 31,
 
   
2010
   
2009
 
             
Commercial
  $ 81,595,768     $ 84,642,860  
Commercial real estate
    179,752,511       179,909,135  
Agricultural
    38,235,611       41,485,301  
Residential real estate
    92,293,481       92,971,599  
Consumer
    52,300,732       53,655,238  
Lease financing
    207,861       221,190  
Total loans
    444,385,964       452,885,323  
                 
Less
               
Net deferred loan fees, premiums and discounts
    (303,830 )     (327,742 )
                 
Loans, net of unearned income
  $ 444,082,134     $ 452,557,581  
Allowance for loan losses
  $ (6,075,126 )   $ (7,030,178 )

 
11

 
The following is a summary of the activity in the allowance for loan losses account for the three months ended March 31, 2010 and 2009.

   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
Balance, beginning of period
  $ 7,030,178     $ 5,020,197  
Provision charged to expense
    1,391,433       495,142  
Recoveries
    133,735       20,994  
Loans charged off
    (2,480,220 )     (187,381 )
Balance, end of period
  $ 6,075,126     $ 5,348,952  
 
The following schedule summarizes nonaccrual, past due and impaired loans at:
 
   
March 31,
   
December 31,
 
   
2010
   
2009
 
Non-accrual loans
  $ 14,399,482     $ 18,543,368  
Accruing loans which are contractually past due 90 days or more as to interest or principal payments
    137,083       -  
Total non-performing loans
  $ 14,536,565     $ 18,543,368  

In addition to the above mentioned non-performers, management was very proactive in reaching out to customers to restructure loans.  On March 31, 2010, approximately $1.36 million in loans were restructured and are currently paying under the new terms.  At December 31, 2009, $1.36 million in loans were restructured and paying under the new terms.

Individual loans determined to be impaired were as follows:

   
March 31,
   
December 31,
 
   
2010
   
2009
 
Loans with no allowance for loan losses allocated
  $ 984,480     $ 1,099,912  
Loans with allowance for loan losses allocated
    9,066,435       14,912,035  
Total impaired loans
  $ 10,050,915     $ 16,011,947  
Amount of allowance allocated
  $ 3,607,180     $ 3,041,967  
 
12

 
NOTE D - NEW ACCOUNTING PRONOUNCEMENTS

In June 2009, the FASB issued new guidance relating to the accounting for transfers of financial assets. The new guidance was adopted into Codification in December 2009 through the issuance of Accounting Standards Updated (“ASU”) 2009-16. The new standard provides guidance to improve the relevance, representational faithfulness, and comparability of the information that an entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. The Company has adopted the new guidance for 2010 and has determined it to have no effect on the consolidated financial statements.

NOTE E – SEGMENT INFORMATION
 
The reportable segments are determined by the products and services offered, primarily distinguished between banking and data processing operations.  “Other” segment information includes the accounts of the holding company, Rurban, which combined, provides management and operational services to its subsidiaries.  Information reported internally for performance assessment follows.
 
13

 
NOTE E -- SEGMENT INFORMATION (Continued)
             
                                     
As of and for the three months ended March 31, 2010
             
               
         
Data
         
Total
   
Intersegment
   
Consolidated
 
Income statement information:
 
Banking
   
Processing
   
Other
   
Segments
   
Elimination
   
Totals
 
                                     
Net interest income (expense)
  $ 5,340,699     $ (61,403 )   $ (374,815 )   $ 4,904,481           $ 4,904,481  
                                               
Non-interest income - external
                                             
customers
    2,696,332       4,029,407       57,287       6,783,026             6,783,026  
                                               
Non-interest income - other segments
    25,072       369,810       273,454       668,336       (668,336 )     -  
                                                 
Total revenue
    8,062,103       4,337,814       (44,074 )     12,355,843       (668,336 )     11,687,507  
                                                 
Non-interest expense
    6,060,473       5,669,252       730,309       12,460,034       (668,336 )     11,791,698  
                                                 
Significant non-cash items:
                                               
Depreciation and
                                               
amortization
    258,522       1,716,697       15,864       1,991,083       -       1,991,083  
Provision for loan losses
    1,391,433       -       -       1,391,433       -       1,391,433  
                                                 
Income tax expense (benefit)
    71,829       (452,689 )     (266,826 )     (647,686 )     -       (647,686 )
                                                 
Segment profit (loss)
  $ 538,368     $ (878,749 )   $ (507,557 )   $ (847,938 )   $ -     $ (847,938 )
                                                 
Balance sheet information:
                                               
Total assets
  $ 653,521,849     $ 22,796,993     $ 4,259,352     $ 680,578,194     $ (6,774,597 )   $ 673,803,597  
                                                 
Goodwill and intangibles
  $ 19,312,167     $ 6,880,002     $ -     $ 26,192,169     $ -     $ 26,192,169  
                                                 
Premises and equipment expenditures
  $ 132,861     $ 620,408     $ -     $ 753,269     $ -     $ 753,269  
 
14

 
NOTE E -- SEGMENT INFORMATION (Continued)
                   
                                     
As of and for the three months ended March 31, 2009
             
               
         
Data
         
Total
   
Intersegment
   
Consolidated
 
Income statement information:
 
Banking
   
Processing
   
Other
   
Segments
   
Elimination
   
Totals
 
                                     
Net interest income (expense)
  $ 5,439,653     $ (25,075 )   $ (398,715 )   $ 5,015,863           $ 5,015,863  
                                               
Non-interest income - external
                                             
customers
    2,481,920       4,944,671       20,914       7,447,505             7,447,505  
                                               
Non-interest income - other segments
    19,872       428,016       378,593       826,481       (826,481 )     -  
                                                 
Total revenue
    7,941,445       5,347,612       792       13,289,849       (826,481 )     12,463,368  
                                                 
Non-interest expense
    6,307,784       4,184,780       808,941       11,301,505       (826,481 )     10,475,024  
                                                 
Significant non-cash items:
                                               
Depreciation and
                                               
amortization
    270,118       611,956       24,486       906,560       -       906,560  
Provision for loan losses
    495,142       -       -       495,142       -       495,142  
                                                 
Income tax expense (benefit)
    275,062       395,363       (280,776 )     389,649       -       389,649  
                                                 
Segment profit (loss)
  $ 863,457     $ 767,469     $ (527,373 )   $ 1,103,553     $ -     $ 1,103,553  
                                                 
Balance sheet information:
                                               
Total assets
  $ 644,158,701     $ 20,244,226     $ 3,203,320     $ 667,606,247     $ (1,793,641 )   $ 665,812,606  
                                                 
Goodwill and intangibles
  $ 19,953,018     $ 7,075,797     $ -     $ 27,028,815     $ -     $ 27,028,815  
                                                 
Premises and equipment expenditures
  $ 96,645     $ 225,435     $ 25,191     $ 347,271     $ -     $ 347,271  
 
15

 
NOTE F – FAIR VALUE OF ASSETS AND LIABILITIES

The Company adopted the guidance on fair value measurements now codified as FASB ASC Topic 820, on January 1, 2008.  ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  ASC 820 has been applied prospectively as of the beginning of the period.

ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputs that may be used to measure fair value:

 
Level 1  Quoted prices in active markets for identical assets or liabilities
   
 
Level 2  Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities

 
Level 3  Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

Available-for-Sale Securities

The fair value of available-for-sale securities are determined by various valuation methodologies.  Level 2 securities include U.S. government agencies, mortgage-backed securities, and obligations of political and state subdivisions.  Level 2 inputs do not include quoted prices for individual securities in active markets; however, they do include inputs that are either directly or indirectly observable for the individual security being valued.  Such observable inputs include interest rates and yield curves at commonly quoted intervals, volatilities, prepayment speeds, credit risks and default rates.  Also included are inputs derived principally from or corroborated by observable market data by correlation or other means.

The following table presents the fair value measurements of assets measured at fair value on a recurring basis and the level within ASC 820 fair value hierarchy in which the fair value measurements fall at March 31, 2010 and December 31, 2009:

16

 
Fair Value Measurements Using:
 
   
Description
 
Fair Values at 3/31/2010
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Available-for-Sale Securities
                       
U.S. Treasury and Government Agencies
  $ 21,896,539       -     $ 21,896,539       -  
Mortgage-backed securities
    47,974,740       -       47,974,740       -  
State and political subdivisions
    35,630,782       -       35,630,782       -  
Money Market Mutual Fund
    1,330,038       1,330,038       -       -  
Equity securities
    23,000       -       23,000       -  
                                 
 Fair Value Measurements Using:
 
   
Description
 
Fair Values at 12/31/2009
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Available-for-Sale Securities
                               
U.S. Treasury and Government Agencies
  $ 12,943,649       -     $ 12,943,649       -  
Mortgage-backed securities
    52,246,278       -       52,246,278       -  
State and political subdivisions
    31,537,006       -       31,537,006       -  
Money Market Mutual Fund
    8,333,179       8,333,179       -       -  
Equity securities
    23,000       -       23,000       -  

Level 1 – Quoted Prices in Active Markets for Identical Assets
Level 2 – Significant Other Observable Inputs
Level 3 – Significant Unobservable Inputs

Impaired Loans

Loans for which it is probable the Company will not collect all principal and interest due according to contractual terms are measured for impairment.  Allowable methods for estimating fair value include using the fair value of the collateral for collateral dependent loans, or where a loan is determined not to be collateral dependent, using the discounted cash flow method.  If the impaired loan is collateral dependent, then the fair value method of measuring the amount of impairment is utilized.  This method requires obtaining an independent appraisal of the collateral and applying a discount factor to the value based on the Company’s loan review policy.  All impaired loans held by the Company were collateral dependent at March 31, 2010 and December 31, 2009.

Mortgage Servicing Rights

Mortgage servicing rights do not trade in an active, open market with readily observable prices.  Accordingly, fair value is estimated using discounted cash flow models associated with the servicing rights and discounting the cash flows using market discount rates.  The servicing portfolio has been valued using all relevant positive and negative cash flows including servicing fees, miscellaneous income and float; marginal costs of servicing; the cost of carry on advances; and foreclosure losses; and applying certain prevailing assumptions used in the marketplace.  Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the hierarchy.
 
17


Foreclosed Assets Held For Sale

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value (based on current appraised value) at the date of foreclosure, establishing a new cost basis.  Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell.  Management has determined fair value measurements on other real estate owned primarily through evaluations of appraisals performed, and current and past offers for the other real estate under evaluation.

The following table presents the fair value measurements of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at March 31, 2010 and December 31, 2009:

Fair Value Measurements Using:
 
   
Description
 
Fair Values at 3/31/2010
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Impaired loans
  $ 6,137,000       -       -     $ 6,137,000  
Mortgage Servicing Rights
  $ 2,136,535       -       -     $ 2,136,535  
Foreclosed Assets
  $ 28,000       -       -     $ 28,000  

Fair Value Measurements Using:
 
   
Description
 
Fair Values at 12/31/2009
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Impaired loans
  $ 9,113,369       -       -     $ 9,113,369  
Mortgage Servicing Rights
  $ 1,955,153       -       -     $ 1,955,153  
Foreclosed Assets
  $ 356,455       -       -     $ 356,455  

There were no changes in the inputs or methodologies used to determine fair value during the quarter ended March 31, 2010 as compared to the quarter ended December 31, 2009.

The following table presents estimated fair values of the Company’s financial instruments.  The fair values of certain of these instruments were calculated by discounting expected cash flows, which involves significant judgments by management and uncertainties.  Fair value is the estimated amount at which financial assets or liabilities could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.  Because no market exists for certain of these financial instruments, and because management does not intend to sell these financial instruments, the Company does not know whether the fair values shown below represent values at which the respective financial instruments could be sold individually or in the aggregate.
 
Cash and Cash Equivalents and Federal Reserve and Federal Home Loan Bank Stock and Accrued Interest Payable and Receivable
 
The carrying amount approximates the fair value.
 
18


Loans
 
The estimated fair value for loans receivable, including loans held for sale, net, is based on estimates of the rate State Bank would charge for similar loans at March 31, 2010 and December 31, 2009, applied for the time period until the loans are assumed to re-price or be paid.
 
Deposits & Other Borrowings
 
Deposits include demand deposits, savings accounts, NOW accounts and certain money market deposits. The carrying amount approximates the fair value. The estimated fair value for fixed-maturity time deposits, as well as borrowings, is based on estimates of the rate State Bank could pay on similar instruments with similar terms and maturities at March 31, 2010 and December 31, 2009.
 
The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.  The estimated fair value for other financial instruments and off-balance-sheet loan commitments approximate cost at March 31, 2010 and are not considered significant to this presentation.
 
   
March 31, 2010
 
   
Carrying
   
Fair
 
   
Amount
   
Value
 
Financial assets
           
Cash and cash equivalents
  $ 37,404,242     $ 37,404,000  
Available-for-sale securities
    106,855,099       106,855,000  
Loans held for sale
    12,469,633       12,698,000  
Loans, net of allowance for loan losses
    438,007,008       437,312,000  
Federal Reserve and FHLB Bank stock
    3,748,250       3,748,000  
Accrued interest receivable
    2,963,119       2,963,000  
                 
Financial liabilities
               
Deposits
  $ 498,945,661     $ 501,498,000  
Short-term borrowings
  $ 49,111,099     $ 49,934,000  
Notes payable
    3,380,935       3,386,000  
FHLB advances
    32,659,210       33,748,000  
Trust preferred securities
    20,620,000       20,151,000  
Accrued interest payable
    1,200,836       1,201,000  
 
19

 
   
December 31, 2009
 
   
Carrying
   
Fair
 
   
Amount
   
Value
 
Financial assets
           
Cash and cash equivalents
  $ 24,824,785     $ 24,825,000  
Available-for-sale securities
    105,083,112       105,083,000  
Loans held for sale
    16,857,648       17,070,000  
Loans, net of allowance for loan losses
    445,527,403       446,266,000  
Federal Reserve and FHLB Bank stock
    3,748,250       3,748,000  
Accrued interest receivable
    2,324,868       2,325,000  
                 
Financial liabilities
               
Deposits
  $ 491,242,152     $ 494,536,000  
Short-term borrowings
    52,042,820       53,670,000  
Notes payable
    2,146,776       2,128,000  
FHLB advances
    35,266,510       36,476,000  
Trust preferred securities
    20,620,000       20,571,000  
 
Note G - Securities

The amortized cost and approximate fair value of securities were as follows:
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Approximate
 
   
Cost
   
Gains
   
Losses
   
Fair Value
 
Available-for-Sale Securities:
                       
March 31, 2010
                       
U.S. Treasury and
                       
Government agencies
  $ 21,911,652     $ 18,475     $ (33,588 )   $ 21,896,539  
Mortgage-backed securities
    46,986,548       1,215,080       (226,888 )     47,974,740  
State and political subdivisions
    34,697,461       1,100,185       (166,864 )     35,630,782  
Money Market Mutual Funds
    1,330,038       -       -       1,330,038  
Equity securities
    23,000       -       -       23,000  
    $ 104,948,699     $ 2,333,740     $ (427,340 )   $ 106,855,099  
 
20


         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Approximate
 
   
Cost
   
Gains
   
Losses
   
Fair Value
 
Available-for-Sale Securities:
                       
December 31, 2009
                       
U.S. Treasury and
                       
Government agencies
  $ 13,215,086     $ 5,359     $ (276,796 )   $ 12,943,649  
Mortgage-backed securities
    50,877,903       1,792,894       (424,519 )     52,246,278  
State and political subdivisions
    30,653,604       984,833       (101,431 )     31,537,006  
Money Market Mutual Funds
    8,333,179       -       -       8,333,179  
Equity securities
    23,000       -       -       23,000  
    $ 103,102,772     $ 2,783,086     $ (802,746 )   $ 105,083,112  
 
The amortized cost and fair value of securities available for sale at March 31, 2010, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
March 31, 2010
 
   
Available for Sale
 
   
Amortized
   
Fair
 
   
Cost
   
Value
 
Within one year
  $ 2,527,085     $ 2,541,085  
Due after one year through five years
    7,873,199       8,029,798  
Due after five years through ten years
    15,752,850       15,992,020  
Due after ten years
    30,455,979       30,964,418  
      56,609,113       57,527,321  
Mortgage-backed securities & equity and other securities
    48,339,586       49,327,778  
Totals
  $ 104,948,699     $ 106,855,099  
 
The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $24,525,565 at March 31, 2010 and $24,104,265 at December 31, 2009.  The securities delivered for repurchase agreements were $55,820,723 at March 31, 2010 and 55,504,340 at December 31, 2009.

Gross gains of $451,474 resulting from sales of available-for-sale securities were realized as of March 31, 2010.  The tax expense for net security gains for March 31, 2010 was $153,501.

Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost.  Total fair value of these investments was $27,613,024 at March 31, 2010 and $20,140,212 at December 31, 2009 which was approximately 26 and 19 percent, respectively, of the Company’s available-for-sale investment portfolio at such dates.  Based on evaluation of available evidence, including recent changes in market interest rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these securities are temporary.  Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.
 
21


Securities with unrealized losses at March 31, 2010 and December 31, 2009 are as follows:

March 31, 2010
 
Less than 12 Months
   
12 Months or Longer
   
  Total
 
         
Unrealized
         
Unrealized
         
Unrealized
 
   
Fair Value
   
Losses
   
Fair Value
   
Losses
   
Fair Value
   
Losses
 
Available-for-Sale Securities:
                                   
U.S. Treasury and Government agencies
  $ 9,362,510     $ (33,588 )   $ -     $ -     $ 9,362,510     $ (33,588 )
Mortgage-backed securities
    9,720,188       (13,254 )     2,288,963       (213,634 )     12,009,151       (226,888 )
State and political subdivisions
    5,246,865       (124,852 )     994,498       (42,012 )     6,241,363       (166,864 )
    $ 24,329,563     $ (171,694 )   $ 3,283,461     $ (255,646 )   $ 27,613,024     $ (427,340 )
 
December 31, 2009
 
Less than 12 Months
   
12 Months or Longer
   
  Total
 
         
Unrealized
         
Unrealized
         
Unrealized
 
   
Fair Value
   
Losses
   
Fair Value
   
Losses
   
Fair Value
   
Losses
 
Available-for-Sale
                                   
U.S. Treasury and Government agencies
  $ 12,837,085     $ (276,796 )   $ -     $ -     $ 12,837,085     $ (276,796 )
Mortgage-backed securities
    1,263,285       (15,539 )     2,255,050       (408,980 )     3,518,335       (424,519 )
State and political subdivisions
    2,792,842       (56,693 )     991,950       (44,737 )     3,784,792       (101,431 )
    $ 16,893,212     $ (349,028 )   $ 3,247,000     $ (453,717 )   $ 20,140,212     $ (802,746 )

The total unrealized losses on the mortgage-backed securities portfolio, all of which are residential mortgage backs, is derived mainly from three private label senior tranche CMO securities.  Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concern warrants such evaluation.  Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent of the Company to not sell the investment and whether it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost.  Management has determined there is no other-than-temporary-impairment on these CMO securities.

The total unrealized loss on the municipal security portfolio is due to the holding of several municipal securities, all with individually insignificant losses.
 
22


Note H – Strategic Partnership

On April 27, 2009, the Company announced a strategic partnership between its data and item processing subsidiary, Rurbanc Data Services, Inc. d/b/a RDSI Banking Systems (“RDSI”) and New Core Holdings, Inc. d/b/a New Core Banking Systems, headquartered in Birmingham, AL (“New Core”).  As part of this partnership, RDSI and New Core entered into a Reseller Software License and Support Agreement pursuant to which RDSI was granted rights as the exclusive provider of New Core’s Single Source™ software.  RDSI and New Core also entered into an agreement and plan of merger pursuant to which New Core would be merged with a newly-created subsidiary of RDSI and become a wholly-owned subsidiary of RDSI.  A prerequisite of this merger would be the spin-off of RDSI from Rurban, resulting in RDSI becoming a separate independent public company.  This would be followed immediately by the merger of RDSI and New Core.  It is anticipated that New Core shareholders would receive between 15.5% and 26.8% of the shares of the separately reorganized RDSI.

NOTE I:  OTHER INTANGIBLES
 
On March 31, 2010, the Company’s subsidiary, RDSI, recorded a $568,000 impairment charge on its ITI related software.  At March 31, 2010, it was determined that the amortized cost of the software exceeded the discounted future cash flows related to the software.

NOTE J: DEBT COVENANT

Pursuant to a loan covenant agreement between the Company and First Tennessee Bank, National Association (“FTB”), the Company’s subsidiary bank, The State Bank and Trust Company, certain performance ratios must be maintained.  They include a minimum Tier 1 Capital ratio of 6 percent, a year-to-date ROA of 50 basis points and non-performing loan ratio of less than 2.25 percent.

As of March 31, 2010, the Company was in violation of a debt covenant related to its line of credit as the year-to-date ROA was (0.51) percent and non-performing loans was 3.49 percent.  The covenant violations could result in the note being called by FTB.
 
23

 
 
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 and those relating to the planned spin-off of RDSI and merger of RDSI with New Core; (c) statements of future economic performance; and (d) statements of future customer attraction or retention; and (e) statements of assumptions underlying such statements.  Words or phrases such as “anticipates,” “believes,” “plans,” “intends,” “expects,” “projects,” “estimates,” “should,” “may,” “would be,” “will allow,” “will likely result,” “ will continue,” “will remain,” or other 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, 2009 and under the heading “Item 1A. Risk Factors” of Part II of this Quarterly Report on Form 10-Q”.  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” or “the Bank”), is engaged in commercial banking.  Rurban’s technology subsidiary, Rurbanc Data Services, Inc. (“RDSI”), provides computerized data and item processing services to community banks and businesses.

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 aggregate, constitute a full and unconditional guarantee by the Company of the obligations of RST under the Capital Securities.
 
24


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.

Rurban Investments, Inc. (“RII”) is a Delaware corporation and a wholly-owned subsidiary of the Bank that was incorporated in January 2009.  RII holds agency, mortgage backed, and municipal securities.

Recent Regulatory Developments

FDIC Insurance Assessments.  On May 22, 2009, the FDIC adopted a final rule that imposed a special assessment for the second quarter of 2009 of 5 basis points on each insured depositary institution’s assets minus its Tier 1 capital as of June 30, 2009, which was collected on September 30, 2009.  The special assessment for the Company was $296,619.

On November 12, 2009, the FDIC adopted a final rule requiring insured depository institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. The prepaid assessments for these periods were collected on December 30, 2009, along with the regular quarterly risk-based deposit insurance assessment for the third quarter of 2009.  For the fourth quarter of 2009 and for all of 2010, the prepaid assessment rate was based on each institution’s total base assessment rate in effect on September 30, 2009, modified to assume that the assessment rate in effect for the institution on September 30, 2009, was in effect for the entire third quarter of 2009.  On September 29, 2009, the FDIC increased annual assessment rates uniformly by 3 basis points beginning in 2011. As a result, an institution’s total base assessment rate for purposes of estimating an institution’s assessment for 2011 and 2012 was increased by 3 basis points.  Each institution’s prepaid assessment base was calculated using its third quarter 2009 assessment base, adjusted quarterly for an estimated five percent annual growth rate in the assessment base through the end of 2012.  The Company paid $2,678,000 for the three-year prepayment in December 2009, which will be expensed over three years.

Recent Developments Related to RDSI

On April 27, 2009, RDSI announced a strategic partnership with New Core Holdings, Inc. d/b/a New Core Banking Systems, headquartered in Birmingham, AL (“New Core”).  As part of this partnership, RDSI and New Core entered into a Reseller Software License and Support Agreement pursuant to which RDSI was granted rights as the exclusive provider of New Core’s Single Source™ software.
 
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RDSI and New Core also entered into an Agreement and Plan of Merger pursuant to which New Core would be merged with a newly-created subsidiary of RDSI and become a wholly-owned subsidiary of RDSI.  A prerequisite of this merger would be the spin-off of RDSI from Rurban, resulting in RDSI becoming a separate independent public company.  This would be followed immediately by the merger of RDSI and New Core.  The spin-off of RDSI and the merger of RDSI and New Core remain subject to the satisfaction of a number of conditions, including the completion and effectiveness of required filings with the Securities Exchange Commission and the final approval of Rurban’s Board of Directors of the spin-off and its terms based on consideration of, among other conditions, applicable market conditions, the fairness opinion provided by its financial advisor, and the impact of the spin-off on the capital structures and the current and anticipated capital needs of each of Rurban and State Bank, on the one hand, and RDSI, on the other hand.

Following RDSI’s April 2009 announcement of its proposed merger and strategic partnership with New Core, RDSI received notice from Information Technology, Inc. and Fiserv Solutions, Inc. (“Fiserv”) stating Fiserv’s intention to terminate a series of license agreements between RDSI and Fiserv (the “License Agreements”).  Pursuant to the License Agreements, RDSI licensed Fiserv’s Premier and other software products which it used to provide data processing services to many of its financial institution customers.

On May 22, 2009, RDSI received a complaint in a lawsuit filed against it by Fiserv in the U.S. District Court for the District of Nebraska.  In the lawsuit, Fiserv sought declaratory and injunctive relief relating to the License Agreements and asserted claims for breach of contract.

On July 28, 2009, RDSI reached an agreement with Fiserv to wind down their licensing relationship.  Pursuant to this agreement, after December 31, 2010, Fiserv will no longer license its Premier suite of products to RDSI and RDSI will exclusively market New Core’s Single Source™ software system.  RDSI customers which presently rely on the Premier platform were provided the option to continue their processing with RDSI and convert to Single Source™, or to move their processing to Fiserv and continue to use Premier.  As of the date of the agreement with Fiserv (July 28, 2009), RDSI had 74 data processing customers using Fiserv’s Premier software.

RDSI also provides item processing services to 43 customers through its DCM division, which generated approximately 18 percent of RDSI’s total revenues in 2009.  The item processing services are provided by RDSI/DCM utilizing software licensed from Bankware and, as a result, has not been and is not expected to be impacted by the agreement with Fiserv or the transition of data processing customers to Single Source™.

Since entering into the agreement with Fiserv, RDSI has transitioned its marketing and sales efforts to offering New Core’s Single Source™ software to its current data processing customers.  However, RDSI has encountered a number of significant issues and challenges in connection with this transition.  These issues and challenges include:

 
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RDSI has lost or will lose a significant number of its existing data processing customers in connection with the transition to Single Source™.  As of May 14, 2010, 53 of RDSI’s 74 customers had notified RDSI of their intentions to move their processing away from RDSI, with 29 of these customers having already de-converted from RDSI.  While RDSI currently has 10 contracts from existing RDSI customers (excluding State Bank) to convert to the Single Source™ software and remain with RDSI, and New Core has six contracts with non-RDSI customers to convert to Single Source™, it is currently uncertain as to if and when these customers will be converted to Single Source™ and/or begin to generate revenue for RDSI.
 
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RDSI and New Core have encountered significant challenges in converting RDSI’s first customer, State Bank, to Single Source™ due to the fact that the Single Source™ core system is untested in a bank environment of the size and complexity of State Bank.  RDSI has been running Single Source™ as the primary data source for State Bank since the conversion of State Bank to this new core system on March 19, 2010, with State Bank’s previous data processing system also running essentially parallel to the Single Source™ system since the conversion.  Since the conversion of State Bank, RDSI and State Bank have determined that the Single Source™ system needs further enhancements to operate in a number of complex areas.  As the alternatives and necessary enhancements to the Single Source™ software system are considered and addressed by RDSI and New Core, the Boards of Directors of State Bank and RDSI have agreed that State Bank will go back to its previous data processing system operated at RDSI.  It is expected that this transition of State Bank back to its previous data processing system will take approximately 60 days.  No assurances can be given as to if or when State Bank will convert back over to the Single Source™ system.  RDSI is communicating this development to the client banks that have contracted for the installation of Single Source™ software, and this development may delay their conversion dates or result in some or all of these banks electing to seek other processing alternatives.
 
 
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In view of the expected loss of customers and associated revenue by RDSI in connection with its transition to providing Single Source™ software, together with the increased expenses associated with this transition and the contemplated spin-off of RDSI from Rurban and merger of RDSI with New Core, it is anticipated that RDSI will experience a significant net operating loss in 2010, and possibly beyond.  As a result, RDSI has agreed with regulators to seek additional equity and/or debt financing from outside sources unaffiliated with Rurban and State Bank to provide funding to support ongoing operations and business development of RDSI over the short-term and long-term through the end of 2011.  RDSI has further agreed that it will not convert any additional financial institution customers to the Single Source™ until it has secured this additional financing.  No assurances can be given as to if or when RDSI will be able to secure this additional financing on terms acceptable to RDSI.  As a result, it is currently uncertain as to if and when additional customers will be converted to Single Source™ and/or begin to generate revenue for RDSI.
 
In view of these recent developments relating to RDSI, the Boards of Directors of Rurban and RDSI are in the process of evaluating various strategic alternatives for RDSI to address these issues and uncertainties and to decide upon a strategic direction for RDSI which will best further the interests of shareholders, customers and other relevant constituencies.
 
Critical Accounting Policies

Note 1 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009 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.
 
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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 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.  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 sign