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In Ohio the World's Not Ending: Interview With Ken Joyce of Rurban Financial
March 30, 2009

The World's Not Ending in Ohio: Inteview With Ken Joyce of Rurban Financial

"In the late winter of 2008, a strong whiff of millenarianism had already crept into American public life. As voters flocked to the primaries in startling numbers, many Democrats became convinced that the Second Coming lay just around the corner. By contrast, sentiment among Republicans was more somber, if equally chiliastic: they quaked at prospects of a dire Last Judgment on the administration of President George W. Bush in the November presidential election. Partisans of both parties also harbored fears of Armageddon in the Middle East, if for very different reasons. Still, on that classical day of reckoning, the Ides of March, when the Four Horsemen of the Apocalypse suddenly appeared over the offices of the giant brokerage firm of Bear Stearns in lower Manhattan, almost everyone was astounded."

"Too Big To Bail: The "Paulson Put," Presidential Politics, and the Global Financial Meltdown"
Thomas Ferguson and Robert Johnson
International Journal of Political Economy (Spring 2009)

"The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government-a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF's staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we're running out of time."

"The Quiet Coup"
Simon Johnson
The Atlantic Monthly
May 2009

In this issue of The IRA, we take the Camera Eye off of Wall Street and instead travel to Middle America to speak with Ken Joyce, CEO of Rurban Financial (NASDAQ:RBNF), which is based in Defiance, OH.

Contrary to what you may see and hear in Washington, the world is not ending in communities like OH, where work is still measured in an eight-hour day and the idea of propping up insolvent banks and insurance companies using public funds is viewed as an outrage. But before we get to the good news, let's review last week's events.

As the two quotations at the top of this issue of The IRA suggest, the United States is suffering from twin maladies, insolvency in our financial sector and an equally powerful political dysfunction in Washington. As we said of Mexico two decades ago, Americans now live in a Mafia State that is beyond control. Our political class is entirely captive of Wall Street, the result of decades of corruption and moral decay. Our nation's capital is controlled by a criminal gang that masquerades as an elected government. And we must wait 18 months for the next election to thrown the scoundrels out.

While the rest of the global economy outside of the financial sector is basically sound, the excesses of the financial markets now threaten the entire world with deflation and prolonged economic decline. And yet the leaders of the financial sector are continuing to pretend that they have done nothing wrong. As Simon Johnson writes in The Atlantic:

"But there's a deeper and more disturbing similarity: elite business interests-financiers, in the case of the U.S.-played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them."

Like most Americans, we are angry at this state of affairs, but also a little sad. Watching the unfolding breakdown of the financial markets, we are reminded that most of the people who work in the markets are not part of the problem. It is the leaders of the largest firms and their clients in Washington who are to blame. We have dozens of resumes coming to our offices every week, but not nearly enough unemployed large bank CEOs.

No wonder that Fed Chairman Bernanke and Treasury Secretary Tim Geithner persist in their idiotic position that toxic subprime assets have true "values" of 80% of par. As we told the clients of IRA's institutional advisory service earlier this week:

"Based on our projections and channel checks, we think that maybe the Fed staff got it wrong and put down the likely loss rate instead of the fanciful LT recovery rate embraced by Bernanke, Geithner and Summers. Truth is, the LT recovery or "Loss Given Default" (LGD) rate experience of 20-30% (which are the LT LGD rates used by Moody's, S&P for internal loss rate projections) are holding true in this cycle as in previous economic downturns and may actually be optimistic compared with the actual realized loss."

With most of the RES and CRE collateral we see in the channel trading in the 30s, it is only a matter of time before the markets force Bernanke, Geithner and Summers to abandon their desire to subsidize the large, insolvent banks and finally embrace liquidation. As we told our friend David Kotok at Cumberland Advisers, just remember to buy the bonds, not the equity, no matter what investment situation you may be considering during most of 2009. In the current environment, be a creditor, not a shareholder.

And don't forget, Q1 earning season starts in just a week's time. That's when we hear about the stellar profits at Citigroup (NYSE:C) and the rest of the US banking complex. And that's when the wheels will start to again fall off the wagon in Washington regarding the finncial crisis.

As global deflation proceeds, those with cash shall be king. Organizations that have cash to use for acquisitions or asset purchases will feast in the coming weeks and months, providing new material upon which to base profits and shareholder value. We are already seeing distressed commercial properties in New York trading below 50% of the last valuation. How can Bernanke, Summers & Geithner ignore the falling assets prices in the marketplace?

And there are literally dozens of CRE properties in New York and the surrounding area that will be going into foreclosure and liquidation this year, perhaps even in Q2 2009. That sound you hear in the distance is the dinner bell ringing for cash investors.

Now let's turn to our main feature. There are many parts of the US where the world is not ending and where financial institutions are sound and, indeed, growing. One of those communities is appropriately named, Defiance, OH, which is the HQ of Rurban Financial. We spoke to Ken Joyce, CEO of RBNF, about his bank and the condition of the local economy in OH.

IRA: Ken, I was just looking at up your profile on our IRA Bank Monitor system. We'll have the updated year-end profile tomorrow by the way. Rurban is in the enviable position of actually being below our Stress Index baseline of 1995. Which is a good place to be.

Joyce: Below your baseline?

IRA: Yes. Our stress index is kind of a public simulation of a CAMEL-type rating. So we look at capital or at charge offs or lending capacity. This last measure is basically loans plus unused commitments. We also look at efficiency, which no one ever talks about.

Joyce: Yes. We watch operating efficiency very carefully.

IRA: Indeed. Rurban comes in at a 0.9 for our Efficiency Index, which is also below the Stress Index benchmark for 1995. The industry is at 1.5 right now. So you're actually a good ways below the entire group in terms of stress. The highest stress score on the Index is one hundred, BTW, which is two orders of magnitude above the industry average.

Joyce: Oh, OK.

IRA: In terms of Stress Index scores, typically banks that have been getting resolved by the FDIC are at least up there above eight or so as a score range. Because RBNF is below 1995 levels of stress, you come out at an A+ on IRA'S stress rating.

Joyce: That's very encouraging.

IRA: Tell me about the local market and your business. You have got a very diverse business model. Give me your view on the economy from Defiance, Ohio.

Joyce: If we look at things from an economic perspective and I would say that everyone is acting quite conservatively in terms of expenditures whether they be business or individuals. Ohio is kind of pegged as having a lot of automobile related industry, but we've got much more jobs in service and technology than we do in auto. General Motors (NYSE:GM), while significant, only has 15,000 jobs here in Ohio.

IRA: Hmm. That is a surprise. So the image of the rust belt decline is inaccurate?

Joyce: Yes. It's not what people typically expect to see. Our auto industry exposure is concentrated on, if anything, very small suppliers to the automobile industry, bolts, machine parts and those sorts of things. There's not a lot of feeder industries here in our markets. We've got a lot of small manufacturing.

IRA: Right. What other industries are important to Rurban?

Joyce: We have a pretty good chunk of medical business and we've got a fair amount of service industry. On the banking side, we have diversified our presence from the Defiance market which does have dependency on a large GM plant. We've moved into the Fort Wayne, Indiana area, the Lima, Ohio market, the Toledo market and the Columbus, Ohio market.

IRA: And how do you enter these markets? Acquisitions or de novo expansion?

Joyce: Both. Our approach is to hire a pretty high ticket individual, someone who is well integrated into the community, to guide our strategy. It's been quite successful. And the next side of that is how you get the loans funded. We do that through a good retail model, which is working well for us, and there's a fair amount of detail to that model. We've moved our transaction accounts to 50% of our deposits from 45% last year and we continue to work that number up. We've got a number of strategies in place to do that and that's what we call our "high performance" checking program Remote capture of deposits is another initiative and we are quite proactive on that.

IRA: Right. So growth is about both deposits and acquisitions?

Joyce: There are a lot of programs going on attempting to generate those deposits. We just recently closed an acquisition in December. It was an all cash acquisition about a hundred and eight million dollar organization in an adjacent market. But the beauty of that is that the acquisition had a 50% loan to deposit ratio.

IRA: Explain the significance of that loan/deposit ratio to our readers, Ken.

Joyce: The acquisition had half of its assets in investments, which allow us to liquidate those investments over time and reinvest the funds in higher yielding loans. The other good news was that even at that loan to deposit level it was making 80, 85 basis points.

IRA: Well and good.

Joyce: And it had expenses of $3.3 million and we've been able to take out a little bit more than a million out of those expenses so it will be immediately accretive going into this year. We'll get a little more out of the acquisition as the year goes on.

IRA: That's great. Looking at your profile, RBNF hardly has difficulty in the funding side. You have 73% core deposits and small home loan bank advances, just single digits, so we don't care. We start caring about FHLB advances when it gets up to 15% of total liabilities.

Joyce: Yes we've got very little hot money. Our true broker deposits are less than $2 million dollars out of approximately $500 million in total deposits.

IRA: Right. Have you been using Promontory Interfinancial for deposit gathering? Like us at IRA, their CEO Mark Jacobsen is a hawk on bank safety and soundness.

Joyce: We do use PIN or CDARS, as we call it, but mostly for the municipal market and we thus avoid having a securitizing requirement. It's a great product to give municipalities full FDIC deposit coverage. We also find this to be a very useful tool to allow larger depositor's to have FDIC coverage on their CD's up to $50 million.

IRA: Well its interesting, as we speak PIN is in front of FDIC now to get blessed as core deposits. Thousands of banks opined positively on the proposal.

Joyce: And they should be. PIN has been a big help to banks of all sizes.

IRA: And they're very adamant about that status. If the bank gets in trouble, PIN will not pull its deposits. They'll go right into the resolution because all of the deposits are fully covered by the FDIC.

Joyce: Well, the thing though that makes PIN truly core deposits, and we've heard this time and time again from Mark Klein, President and CEO of our subsidiary, The State Bank and Trust Company, is that those deposits placed by PIN are local deposits.

IRA: Exactly, they're just facilitating it.

Joyce: Right.

IRA: Looking at your profile, your loan deployment is clearly in real estate and on the outside people might be worried about that. But clearly on a market basis, Rurban is doing fine. You're trading at 0.6 times book! While the larger banks are near zero.

Joyce: On a relative basis, that's good.

IRA: I see C&I loans as the second biggest exposure, but your default rate is hardly an issue. By the way, in our economic capital model, RBNF has no risk exposure for trading, so it just shows a zero under Economic Capital. And the biggest number in your Economic Capital ratio is the securities exposure. Overall, your ratio of EC to Tier One Risk Based Capital is 0.3:1, which suggests a very conservative business model. And you have a double digit RAROC, which suggests that the bank is being compensated very well for the risks that it does take.

Joyce: The one important piece of information on real estate is that we got less than four million dollars in acquisition and development loans. We have very, very little exposure on local developers. What exposure we have that is problematic is well reserved, but we need to be cautious as further economic declines will further erode loan quality.

IRA: Noted. How is the credit environment generally in OH vs. the national average?

Joyce: We have not seen the same level of housing value fall as a significant portion of the country, which would seem to be due to our appreciation rates on the way up. Over the last ten years I would say real estate only appreciated 2 to 4% annually in our markets. Unemployment is high with many of our counties at 12 to 14% and our best market is Columbus, which was in the 6's at year end. Once again, without an improvement in the economy generally, our area, as true of the entire country, will be severely challenged.

IRA: In terms of investment, how have you managed to stay away from toxic assets?

Joyce: We manage our investment portfolio very aggressively to ensure its safety. We've been through every piece of our balance sheet to assess if there is risk where we never thought there was risk before. Our investments are about 73% mortgage-backed securities that have agency guarantees.

IRA: So your risk is Uncle Sam?

Joyce: If those go upside down I guess we all head to the hills in West Virginia because that would pretty much do in most banks. The rest of our investments are municipals and we evaluate them if they do not have an inherent credit rating we go and assess their credit risk internally.

IRA: So with your performing MBS, have your auditors forced you to write down any paper due to fair value accounting or just being aggressive of soundness?

Joyce: And we have a total of $3 million dollars in CMOs and they're all in the highest rated tranches. We've looked at those CMO's and we have had third parties evaluate them also, and we don't see any impairment in these securities.

IRA: Well if you ever need any help I'll introduce you to Dave Kotok.

Joyce: Where's he?

IRA: You see him on CNBC a lot but he has an independent manager and advisor called Cumberland. They mostly do buy-side investment for tax-sensitive individuals so a lot of munies, a lot of Treasuries and some ETFs. But they have an independent advisor who for municipalities that need independent, third party opinions on their strategy and how they're going to market and everything else. So he actually knows how to write and read a municipal bond prospectus.

Joyce: That might be quite useful.

IRA: Well it is because there's hundreds of options inside a muni indenture. If you don't understand how to read them and model them it can be quite daunting. So Kotok is like you, he likes understanding the risk and they do the work. And he's made a lot of money these last 12 months because some of these muni credits got way out of line. I don't know if you know the story, but Port Authority in New York were priced at 20% one week and then the issuer bought in all the auction rate preferred toxic waste the following week. Problem solved.

Joyce: No, I didn't know that.

IRA: And they came into the market a week later and they bought in everything and then they reissued because they had the money. A lot of municipals don't have the money to do that. You know the Port Authority just took some cash out of the cash flow and basically restructured everything on their own because it was all callable.

Joyce: There's opportunity there.

IRA: Oh yeah it was a great story because everyone who saw the bonds at 20% bought it. David was a very happy man. He organizes the annual economist fishing trip to Leen's Lodge in ME. This year, I want to ask the group to opine on why we should not regulate economists as weapons of mass destruction.

Joyce: Ouch.

IRA: Yeah, so tell me in terms of business model what differentiates RBNF? Why is a hedge fund analyst who's never seen you before going to focus in on you as a value play in a part of the country where as you described a lot of people think it's the auto wasteland -- even if it may not be.

Joyce: There's quite a few pieces to that. I guess if you go back a little bit we went through some very severe credit problems in 2000-2001. And we really took our beating at that point and put in the credit culture and controls. I think it led us to not do those same stupid things this time around.

IRA: It's always good to learn from the experience.

Joyce: Yes. We have a new management team that's grown their way through those problems. On the banking side we think we've got a model that works. Whether it be on the commercial side with getting a well qualified regional president in place as its center piece.

IRA: Right, somebody who actually knows the market.

Joyce: Right. Then we have a very detailed retail plan so each of our branches has a good understanding of where they're headed. The other thing we focus on is getting a lot of those branch transactions to electronics, which is aided by our data processing company.

IRA: Right, I've heard a lot about that.

Joyce: Our strategy to emphasize the shift to electronic transactions has resulted in a 30% increase in our electronic transactions from 2007 to 2008. We've actually doubled the number of electronic transactions over about 2 years.

IRA: Interesting. That is taking existing share from existing players?

Joyce: We have begun to take share as we refined that business model. That business unit is run by the President and CEO, Mark Klein, who has about 30 years experience in electronic transactions.

IRA: That's great.

Joyce: Yes, Mark has been an invaluable addition. He joined us from Sky Bank, actually.

IRA: Let me ask you a quick question here that reminds me of something. Do you find right now that FDIC and the other regulators are discouraging de novo charters in your market?

Joyce: (Laughs) Yes they are.

IRA: Yeah, that's what I've heard from some other people. But at the same time I mean it's not like Arizona is it? You know I've always thought of Ohio as less volatile than these other markets. Is that still the case?

Joyce: It is the case. We never had the run-up of real estate values. Therefore, the fall has been more gradual. We've certainly been affected by foreclosures. We're taking larger losses every time we have a first mortgage foreclose, larger than we've ever had, but it's not like the Arizona environment for instance.

IRA: Well your LGD, what we call "Loss Given Default," was up in the 80's, which is not unusual now as you just were describing the recovery rate. But that's not bad either because the big guys are all 98, 99% LGDs at present, so 80% is stellar. If you've got 5 or 6 or 7 basis points better LGD than the big players, that's a heck of an achievement when everybody else is taking near 100% losses on foreclosures. Are deposit premiums in your market place down in single digits now pretty much?

Joyce: Well, interesting things have gone on there, Chris. Our cash balances are going up quite a bit. We're seeing fallout from some of the regional problems and people are bringing us a fair amount of cash, don't want to over emphasize that, but we're fairly surprised at the amount of cash that is coming in.

IRA: Right. We did an interview last year with Rick Smith at Metarie Bank, just outside New Orleans. He doesn't do brokered money at all. Doesn't have to.

Joyce: Yeah.

IRA: He's been there for so long that as the customer got more concerned about what they were hearing in the news and reading in the paper about banks far away he became their best friend.

Joyce: Yeah that's what's happened in OH, especially with regionals and even Huntington Bank (NASDAQ:HBAN) down to $1.10 a share earlier this month, and the others down to a buck. Its shaken confidence. A lot of local people have gone looking for local institutions where they understand the strengths, so we've benefited from that process.

IRA: Well, what's your attitude going forward I mean you've been doing some acquisitions. My personal view, you may have seen it in our writings, is that we're still not near the peak yet, so it's kind of hard to value a lot of this stuff. But on the other hand my friends at JPMorgan (NYSE:JMP) are working with a book from WaMu that was revalued down to 3 cents on the dollar. They make money on foreclosures with LGDs below 97%.

Joyce: Wow.

IRA: Life is good. For every loser in this process there is a winner who will make lots of money. Everything JPM forecloses from the WaMu purchase they don't have to write off. It's already been done.

Joyce: That's pretty amazing.

IRA: Yup. Thayt's why I want to smack that Bank of America (NYSE:BAC) board. BAC is IRA's business bank. I'd like to line them all up and just smack them on the caboose with a canoe paddle. You don't buy troubled companies that are not restructured. If the Fed tries to make you eat toxic waste, tell 'em no. I don't think Treasury gave Lewis enough money to offset the problems at Merrill, but we'll know soon enough.

Joyce: I don't think you and I should get together. We're too much of a same mind.

IRA: No, look officers and directors have to be cognizant of the details of M&A deals. The one area where bank directors do have operational responsibility is when the enterprise does a deal with another enterprise, right?

Joyce: Yes sir. We have a very active, engaged board.

IRA: Other than that they have to let management drive the bus, but when you're doing a share deal at these levels, it hurts. Isn't it wonderful to pay cash for your last acquisition?

Joyce: It is a relief and should be very beneficial to shareholders.

IRA: Tell us what are you looking for in the future. What's your target if there are any.

Joyce: Well, we've got in the banking side of the business opportunity for us in acqusitions looking for deals very similar to the one we just did.

IRA: Right.

Joyce: A low loan to deposits ratio is a real plus for us.. I'm hoping bankers looking to sell will get realistic about expectations relative to value to book. It hasn't quite gotten there yet.

IRA: Where do you think it should be?

Joyce: Well, we believe there should be deals made at 80% of book for all stock deal, but when taking into consideration write-offs that should be taken, that 80% of book valuation is getting close to many bank's full book valuation. That's the kind of deal that we think we can do and continue to do from a stock basis if we can get more realistic expectations from potential sellers.

IRA: Did you do acquisitions on the data processing side too?

Joyce: Yes. We've done it over there as well as on the banking side. And again, we've been able to do those and they've been immediately accretive. We talked about strategic options for the data processing company and we're exploring those options and we have given some time frames out that we'll make some announcements here within this year.

The IRA: Thanks Ken. Best of luck.

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