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SBFG > SEC Filings for SBFG > Form 10-Q on 8-Aug-2013All Recent SEC Filings

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Form 10-Q for SB FINANCIAL GROUP, INC.


8-Aug-2013

Quarterly Report


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

Cautionary Statement Regarding Forward-Looking Information

This Quarterly Report on Form 10-Q, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains certain 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 "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, 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, 2012. 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 SB Financial

SB Financial Group, Inc. ("SB Financial" or the "Company") is a bank holding company registered with the Federal Reserve Board. The name of the Company was changed to SB Financial Group, Inc. from Rurban Financial Corp. effective April 18, 2013. SB Financial's wholly-owned subsidiary, The State Bank and Trust Company ("State Bank"), is engaged in commercial banking. SB Financial's technology subsidiary, Rurbanc Data Services, Inc. ("RDSI"), provides 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 Trust Preferred 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 Trust Preferred 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.

Rurban Statutory Trust II ("RST II") was established in August 2005. In September 2005, RST II completed a pooled private offering of 10,000 Trust Preferred Securities with a liquidation amount of $1,000 per security. The proceeds of the offering were loaned to the Company in exchange for junior subordinated debentures of the Company with terms substantially similar to the Trust Preferred 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.

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 State Bank that was incorporated in January 2009. RII holds agency, mortgage backed and municipal securities.

State Bank Insurance, LLC ("SBI") is an Ohio corporation and a wholly-owned subsidiary of State Bank that was incorporated in June of 2010. SBI is an insurance company that engages in the sale of insurance products to retail and commercial customers of State Bank.

Unless the context indicates otherwise, all references herein to "SB Financial", "we", "us", "our", or the "Company" refer to SB Financial Group, Inc. and its consolidated subsidiaries.

Recent Regulatory Developments

Consumer Financial Protection Bureau

The Dodd-Frank Act established the Consumer Financial Protection Bureau (the "CFPB"), which regulates consumer financial products and services and certain financial services providers. The CFPB is authorized to prevent unfair, deceptive and abusive acts or practices and seeks to ensure consistent enforcement of laws so that consumers have access to fair, transparent and competitive markets for consumer financial products and services. The CFPB has rulemaking and interpretive authority.

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

The Dodd-Frank Act was enacted into law on July 21, 2010. The Dodd-Frank Act is significantly changing the regulation of financial institutions and the financial services industry. Because the Dodd-Frank Act requires various federal agencies to adopt a broad range of regulations with significant discretion, many of the details of the new law and the effects they will have on the Company will not be known for months and even years.

Among the provisions already implemented pursuant to the Dodd-Frank Act, the following provisions have or may have an effect on the business of the Company and its subsidiaries:

? the CFPB has been formed with broad powers to adopt and enforce consumer protection regulations;

? the federal law prohibiting the payment of interest on commercial demand deposit accounts was eliminated effective July 21, 2011;

? the standard maximum amount of deposit insurance per customer was permanently increased to $250,000;

? the assessment base for determining deposit insurance premiums has been expanded from domestic deposits to average assets minus average tangible equity; and

? public companies in all industries are required to provide shareholders the opportunity to cast a non-binding advisory vote on executive compensation.

Additional provisions not yet implemented that may have an effect on the Company and its subsidiaries include the following:

? new capital regulations for bank holding companies will be adopted, which may impose stricter requirements, and any new trust preferred securities issued after May 19, 2010 will no longer constitute Tier I capital; and

? new corporate governance requirements applicable generally to all public companies in all industries will require new compensation practices and disclosure requirements, including requiring companies to "claw back" incentive compensation under certain circumstances, to consider the independence of compensation advisors and to make additional disclosures in proxy statements with respect to compensation matters.


Many provisions of the Dodd-Frank Act have not yet been implemented and will require interpretation and rule making by federal regulators. As a result, the ultimate effect of the Dodd-Frank Act on the Company cannot yet be determined. However, it is likely that the implementation of these provisions will increase compliance costs and fees paid to regulators, along with possibly restricting the operations of the Company and its subsidiaries.

Executive and Incentive Compensation

In June 2010, the Federal Reserve Board, the OCC and the FDIC issued joint interagency guidance on incentive compensation policies (the "Joint Guidance") intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. This principles-based guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization's incentive compensation arrangements should (a) provide incentives that do not encourage risk-taking beyond the organization's ability to effectively identify and manage risks, (b) be compatible with effective internal controls and risk management and (c) be supported by strong corporate governance, including active and effective oversight by the organization's board of directors.

Pursuant to the Joint Guidance, the Federal Reserve Board will review as part of a regular, risk-focused examination process, the incentive compensation arrangements of financial institutions such as the Company. Such reviews will be tailored to each organization based on the scope and complexity of the organization's activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination and deficiencies will be incorporated into the institution's supervisory ratings, which can affect the institution's ability to make acquisitions and take other actions. Enforcement actions may be taken against an institution if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization's safety and soundness and prompt and effective measures are not being taken to correct the deficiencies.

On February 7, 2011, federal banking regulatory agencies jointly issued proposed rules on incentive-based compensation arrangements under applicable provisions of the Dodd-Frank Act (the "Proposed Rules"). The Proposed Rules generally apply to financial institutions with $1.0 billion or more in assets that maintain incentive-based compensation arrangements for certain covered employees. The Proposed Rules (i) prohibit covered financial institutions from maintaining incentive-based compensation arrangements that encourage covered persons to expose the institution to inappropriate risk by providing the covered person with "excessive" compensation; (ii) prohibit covered financial institutions from establishing or maintaining incentive-based compensation arrangements for covered persons that encourage inappropriate risks that could lead to a material financial loss, (iii) require covered financial institutions to maintain policies and procedures appropriate to their size, complexity and use of incentive-based compensation to help ensure compliance with the Proposed Rules and (iv) require covered financial institutions to provide enhanced disclosure to regulators regarding their incentive-based compensation arrangements for covered person within 90 days following the end of the fiscal year.

Pursuant to rules adopted by the stock exchanges and approved by the SEC in January 2013 under the Dodd-Frank Act, public companies are required to implement "clawback" procedures for incentive compensation payments and to disclose the details of the procedures which allow recovery of incentive compensation that was paid on the basis of erroneous financial information necessitating a restatement due to material noncompliance with financial reporting requirements. This clawback policy is intended to apply to compensation paid within a three-year look-back window of the restatement and would cover all executives who received incentive awards. Public company compensation committee members are also required to meet heightened independence requirements and to consider the independence of compensation consultants, legal counsel and other advisors to the compensation committee. The compensation committees must have the authority to hire advisors and to have the company fund reasonable compensation of such advisors.


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, 2012 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 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 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 for future periods.


Three Months Ended June 30, 2013 compared to Three Months Ended June 30, 2012

Net Income: Net income for the second quarter of 2013 was $1.32 million, or $0.27 per diluted share, compared to net income of $1.01 million, or $0.21 per diluted share, for the second quarter of 2012. For the quarter, the Banking Group (consisting primarily of State Bank), had net income of $1.78 million, which is up 12.7 percent compared to net income of $1.58 million from the year ago second quarter. RDSI reported a net loss of $10 thousand compared to a net loss of $54 thousand from the year ago second quarter.

Provision for Loan Losses: The second quarter provision for loan losses was $0.20 million compared to $0.20 million for the year-ago quarter. Net charge-offs for the quarter were $0.18 million compared to $0.19 million for the year-ago quarter. Total delinquent loans ended the quarter at $3.01 million, which is down $1.94 million, or 39.2 percent, from the prior year.

Asset Quality Review - For the Period Ended           June 30,      December 31,       June 30,
($'s in Thousands)                                      2013            2012             2012
Net charge-offs                                      $      179     $       1,068     $      190
Nonaccruing loans                                         4,386             5,305          5,315
Accruing Trouble Debt Restructures                        1,262             1,258          1,837
Nonaccruing and restructured loans                        5,648             6,563          7,152
OREO / OAO                                                1,955             2,367          1,708
Nonperforming assets                                      7,603             8,930          8,860
Nonperforming assets/Total assets                          1.20 %            1.40 %         1.40 %
Allowance for loan losses/Total loans                      1.51 %            1.47 %         1.46 %
Allowance for loan losses/Nonperforming loans             124.2 %           103.8 %         92.5 %

Consolidated Revenue: Total revenue, consisting of net interest income fully taxable equivalent (FTE) and noninterest income, was $9.27 million for the second quarter of 2013, an increase of $0.70 million, or 8.2 percent, from the $8.56 million generated during the 2012 second quarter.

Net interest income (FTE) was $5.45 million, which is up $0.92 million from the prior year second quarter's $5.36 million. The Company's earning assets increased $1.9 million, but this was offset by a 19 basis point decrease in the yield on earning assets. The net interest margin for the second quarter of 2013 was 3.86 percent compared to 3.81 percent for the second quarter of 2012.

Noninterest income was $3.82 million for the 2013 second quarter compared to $3.21 million for the prior year period. Excluding data service fees, which are contributed by RDSI, the remaining noninterest income is generated by the Banking Group. RDSI fees continue to trail the prior year due to client losses.

Mortgage origination activity continued at a high level in the second quarter of 2013. State Bank originated $81.9 million of mortgage loans compared to $79.9 million for the second quarter of 2012. These second quarter 2013 originations and subsequent sales resulted in $1.45 million of gains, which compares to gains of $1.40 million for the second quarter of 2012. Compared to the prior year second quarter, total sales into the secondary market have decreased by $8.18 million. Net mortgage banking revenue was $1.87 million due to the recapture of OMSR impairment and higher margin on loan sales in the current year.

Consolidated Noninterest Expense: Noninterest expense for the second quarter of 2013 was $7.08 million, compared to $6.87 million in the prior-year second quarter. Expense for FDIC insurance was down $0.13 million from the prior year. Offsetting the FDIC expense were higher compensation costs and various costs related to our rebranding activities in the quarter.


Income Taxes:Income taxes for the second quarter of 2013 were $0.57 million compared to $0.39 million for the second quarter of 2012. The increase was due primarily to the increase in pre-tax income compared to the prior year.

Six Months Ended June 30, 2013 compared to Six Months Ended June 30, 2012

Net Income: Net income for the six months ended June 30, 2013 was $2.64 million, or $0.54 per diluted share, compared to net income of $1.99 million, or $0.41 per diluted share, for the six months ended June 30, 2012. For the year, the Banking Group (consisting primarily of State Bank), had net income of $3.54 million, which is up 28.0 percent compared to net income of $2.76 million the prior year. RDSI reported net income of $15 thousand for the six month period compared to net income of $301 thousand from the first six months of the prior year.

Provision for Loan Losses: The provision for loan losses for the six months ended June 30, 2013 was $0.50 million compared to $0.65 million for the six months ended June 30, 2012. Net charge-offs for the first six months were $0.30 million compared to $0.56 million for the first six months of the prior year.

Consolidated Revenue: Total revenue, consisting of net interest income fully taxable equivalent (FTE) and noninterest income, was $18.23 million for the six months ended June 30, 2013, an increase of $1.12 million, or 6.5 percent, from the $17.11 million generated during the first six months of 2012.

Net interest income (FTE) was $10.84 million, which is up $0.52 million from the $10.32 million for the prior year first six months. The Company's earning assets increased $4.29 million, but this was offset by a 15 basis point decrease in the yield on earning assets. The net interest margin for the six months ended June 20, 2013 was 3.86 percent compared to 3.70 percent for the six months ended June 30, 2012.

Noninterest income was $7.39 million for the six months ended June 30, 2013 compared to $6.79 million for the prior year six months ended. Gain on sale of loans were higher in 2013 compared to 2012 due to higher sales in residential mortgage ($0.36 million) and FSA/SBA loans ($0.24 million). In addition, recapture of OMSR impairment increased mortgage servicing fees by $0.43 million compared to the prior year six month period.

Consolidated Noninterest Expense: Noninterest expense for the six months ended June 30, 2013 was $13.75 million, compared to $13.55 million in the six months ended June 30, 2012. Expenses related to our rebranding project increased costs compared to the prior year six month period. These higher costs were offset by lower FDIC premiums.

Income Taxes: Income taxes for the six months ended June 30, 2013 were $1.14 million compared to $0.75 million for the six months ended June 30, 2012. The increase was due primarily to the increase in pre-tax income compared to the prior year.

Changes in Financial Condition

Total assets at June 30, 2013 were $631.5 million, a decrease of $6.74 million, or 1.06 percent, since 2012 year end. Total loans, net of unearned income, were $464.0 million as of June 30, 2013, up $0.65 million from year end, an increase of 0.14 percent.

Total deposits at June 30, 2013 were $511.4 million, a decrease of $15.6 million as compared to December 2012 balances. Borrowed funds (consisting of notes payable, FHLB advances, and REPOs) totaled $40.5 million at June 30, 2013. This is up 22.5 percent from year end when borrowed funds totaled $33.0 million. Total equity for the Company of $54.4 million now stands at 8.61 percent of total assets, which is up slightly from the December 31, 2012 level of 8.35 percent.


Capital Resources

At June 30, 2013, actual capital levels and minimum required levels were as
follows ($'s in thousands):

                                                                                                     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 $ 62,263 13.1 % $ 38,143 8.0 % $ - N/A State Bank $ 58,965 12.4 % 38,131 8.0 % $ 47,664 10.0 %

Both the Company and State Bank were categorized as well capitalized at June 30, 2013.

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 $116.8 million at June 30, 2013, compared to $124.0 million at December 31, 2012.

Liquidity risk arises from the possibility that the Company may not be able to meet the Company's financial obligations and operating cash needs or may become overly reliant upon external funding sources. In order to manage this risk, the Board of Directors of the Company has established a Liquidity Policy that identifies primary sources of liquidity, establishes procedures for monitoring and measuring liquidity and quantifies minimum liquidity requirements. This . . .

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