Royal Bancshares of Pennsylvania (RBPAA) 10-Q 2007 Q1 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

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

for the quarterly period ended:March 31, 2007

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

For the transition period from:                    to                    

Commission file number: 0-26366

ROYAL BANCSHARES OF PENNSYLVANIA, INC.

(Exact name of the registrant as specified in its charter)

PENNSYLVANIA	23-2812193
(State or other jurisdiction of	(IRS Employer
incorporated or organization)	identification No.)

732 Montgomery Avenue, Narberth, PA 19072
(Address of principal Executive Offices)

(610) 668-4700

(Registrant’s telephone number, including area code)

N/A

(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. Yesþ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non- accelerated filer. See definitions of large accelerated filer and accelerated filer in Rule 12-b-2 of the Exchange Act.

Large accelerated filero      Accelerated filerþ     Non-accelerated filero

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

Applicable only to corporate issuers:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class A Common Stock	Outstanding at April 30, 2007
$2.00 par value	11,300,595

Class B Common Stock	Outstanding at April 30, 2007
$.10 par value	2,108,538

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION
	ITEM I — FINANCIAL STATEMENTS
	ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS
	ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 4 — CONTROLS AND PROCEDURES
PART II — OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 1A. Risk Factors
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
	Item 3. Default Upon Senior Securities
	Item 4. Submission of Matters to Vote Security Holders
	Item 5. Other Information
	Item 6. Exhibits
SIGNATURES
EMPLOYMENT AGREEMENT DATED BETWEEN ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND JOSEPH P. CAMPBELL
EMPLOYMENT AGREEMENT BETWEEN ROYAL BANCSHARES PENNSYLVANIA, INC. AND JAMES J. MCSWIGGAN, JR.
EMPLOYMENT AGREEMENT BETWEEN ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND MURRAY STEMPEL, III
EMPLOYMENT AGREEMENT BETWEEN ROYAL BANCSHARES OF PENNSYLVANIA, INC AND JOHN M. DECKER
EMPLOYMENT AGREEMENT BETWEEN ROYAL BANCSHARES OF PENNSYLVANIA, INC AND ROBERT R. TABAS
EMPLOYMENT AGREEMENT BETWEEN ROYAL BANCSHARES OF PENNSYLVANIA, INC AND EDWARD SHIN
CERTIFICATION OF JOSEPH P. CAMPBELL, CHIEF EXECUTIVE OFFICER
CERTIFICATION OF GREGG J. WAGNER, CHIEF FINANCIAL OFFICER
CERTIFICATION OF JOSEPH P. CAMPBELL, CHIEF EXECUTIVE OFFICER
CERTIFICATION OF GREGG J. WAGNER, CHIEF FINANCIAL OFFICER

     PART I – FINANCIAL INFORMATION

ITEM I – FINANCIAL STATEMENTS

Royal Bancshares of Pennsylvania, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)

	March 31, 2007			Dec. 31, 2006
ASSETS
Cash and due from banks	$	18,880		$	13,426
Interest bearing deposits		20,240			66,810
Federal funds sold		3,600			2,200
Total cash and cash equivalents		42,720			82,436
Investment securities held to maturity (“HTM”) (fair value of $256,941 at March 31, 2007 and $254,249 at December 31, 2006)		257,423			255,429
Investment securities available for sale (“AFS”) at fair value		297,061			302,036
FHLB Stock, at cost		8,719			11,276
Loans		629,384			602,958
Less allowance for loan losses		11,648			11,455
Net Loans		617,736			591,503
Premises and equipment, net		7,873			7,766
Real estate owned via equity investments		38,522			42,514
Accrued interest receivable		17,553			16,494
Bank owned life insurance		23,121			22,906
Other assets		27,507			23,951
Total Assets	$	1,338,235		$	1,356,311
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Deposits
Non-interest bearing	$	69,567		$	61,002
Interest bearing		825,432			798,455
Total deposits		894,999			859,457
Accrued interest payable		13,594			10,654
Other liabilities		18,429			18,593
Borrowings		193,034			246,087
Obligations related to equity investments in real estate		24,995			29,342
Subordinated debentures		25,774			25,774
Total liabilities		1,170,825			1,189,907
Minority interests		3,213			3,150
Stockholders’ equity
Common stock
Class A, par value $2 per share, authorized 18,000,000 shares; issued, 11,291,361 at March 31, 2007 and 11,287,462 at December 31, 2006		22,583			22,575
Class B, par value $0.10 per share; authorized, 3,000,000 shares; issued, 2,108,744 at March 31, 2007 and 2,108,827 at December 31, 2006		211			211
Additional paid in capital		121,758			121,542
Retained earnings		23,194			23,464
Accumulated other comprehensive loss		(1,284	)		(2,273	)
		166,462			165,519
Treasury stock – at cost, shares of Class A, 215,388 at March 31, 2007 and December 31, 2006.		(2,265	)		(2,265	)
Total stockholders’ equity		164,197			163,254
Total liabilities and stockholders’ equity	$	1,338,235		$	1,356,311

The accompanying notes are an integral part of these statements.

Royal Bancshares of Pennsylvania, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

	Three-months ended
	March 31,
(in thousands, except per share data)	2007		2006
Interest income
Loans, including fees	$	14,397	$	14,096
Investment securities held to maturity		2,953		2,856
Investment securities available for sale:
Taxable interest		4,012		4,411
Tax exempt interest		18		18
Deposits in banks		541		12
Federal funds sold		44		20
TOTAL INTEREST INCOME		21,965		21,413
Interest expense
Deposits		9,098		5,464
Borrowings		2,676		4,004
Obligations related to equity investments in real estate		255		611
TOTAL INTEREST EXPENSE		12,029		10,079
NET INTEREST INCOME		9,936		11,334
Provision for loan losses		212		335
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		9,724		10,999
Other income
Service charges and fees		300		354
Net gains on sales of investment securities available for sale		—		83
Income related to equity investments in real estate		1,308		778
Gains on sales of other real estate		236		1,493
Gains on sales of loans		167		43
Income from bank owned life insurance		215		210
Other income		97		37
TOTAL OTHER INCOME		2,323		2,998
Other expenses
Salaries and wages		2,676		2,445
Employee benefits		718		635
Stock Option Expense		162		178
Occupancy and equipment		447		404
Expenses related to equity investments in real estate		432		276
Other operating expenses		2,151		2,329
TOTAL OTHER EXPENSE		6,586		6,267
Minority interest		196		(81	)
INCOME BEFORE INCOME TAXES		5,265		7,811
Income taxes		1,640		2,465
NET INCOME	$	3,625	$	5,346
Per share data
Net income – basic	$	0.27	$	0.40
Net income – diluted	$	0.27	$	0.40
Cash dividends– Class A shares	$	0.2875	$	0.2619
Cash dividends– Class B shares	$	0.330625	$	0.30119

The accompanying notes are an integral part of these statements.

Royal Bancshares of Pennsylvania,Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME
Three Months ended March 31, 2007
(UNAUDITED)

														Accumulated
									Additional					other
	Class A common stock				Class B common stock				Paid in		Retained			comprehensive			Treasury			Comprehensive
(in thousands, except per share data)	Shares		Amount		Shares		Amount		Capital		earnings			(loss)			stock			income
Balance, January 1, 2007		11,287	$	22,575		2,108	$	211	$	121,542	$	23,464		$	(2,273	)	$	(2,265	)
Net income		—		—		—		—		—		3,625			—			—		$	3,625
Conversion of Class B common stock to Class A common stock		—		—		—		—		—		—			—			—			—
Issuance of un-distributed shares						—		—
Cash in lieu of fractional shares		—		—		—		—		—		(14	)		—			—			—
Cash dividends on common stock (Class A $0.2875 Class B $0.330625)		—		—		—		—		—		(3,881	)		—			—			—
Unrecognized benefit obligation		—		—		—		—		—		—			41			—			41
Stock options exercised		4		8		—		—		41
Stock option expense		—		—		—		—		162		—			—			—			—
Tax benefit stock options		—		—		—		—		13		—			—			—			—
Other comprehensive income, net of reclassifications and taxes		—		—		—		—		—		—			948			—			948
Comprehensive income																				$	4,614
Balance, March 31, 2007		11,291	$	22,583		2,108	$	211	$	121,758	$	23,194		$	(1,284	)	$	(2,265	)

Royal Bancshares of Pennsylvania,Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME
Three Months ended March 31, 2006
(UNAUDITED)

																	Accumulated
										Un-		Additional					other
	Class A common stock				Class B common stock					Distributed		Paid in		Retained			comprehensive			Treasury			Comprehensive
(in thousands, except per share data)	Shares		Amount		Shares			Amount		B-shares		Capital		earnings			(loss)			Stock			income
Balance, January 1, 2006		10,700	$	21,400		1,993		$	199	$	2	$	104,285	$	32,827		$	(940	)	$	(2,265	)
Net income		—		—		—			—				—		5,346			—			—		$	5,346
5% Stock dividend		527		1,054		100			11				15,588		(16,653	)
Conversion of Class B common stock to Class A common stock		1		1		(1	)		—				—		(1	)		—			—			—
Cash in lieu of fractional shares		—		—		—			—		—		—		(12	)		—			—			—
Cash dividends on common stock (Class A $0.2619 Class B $0.30119)		—		—		—			—				—		(3,511	)		—			—			—
Other comprehensive loss, net of reclassifications and taxes		—		—		—			—				—		—			(1,510	)		—			(1,510	)
Comprehensive income																							$	3,836
Balance, March 31, 2006		11,228	$	22,455		2,092		$	210	$	2	$	119,873	$	17,996		$	(2,450	)	$	(2,265	)

The accompanying notes are an integral part of the financial statement.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three months ended March 31,
(in thousands)

	2007			2006
Cash flows from operating activities
Net income	$	3,625		$	5,346
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		291			291
Stock compensation expense		162			178
Provision for loan losses		212			335
Net accretion of discounts and premiums on loans, mortgage-backed securities and investments		(799	)		1,494
Provision (benefit) for deferred income taxes		117			(1,998	)
Gains on sales of other real estate		(236	)		(1,493	)
Gains on sales of loans		(167	)		(43	)
Net gains on sales of investment securities		—			(83	)
Distributions from equity investments		(86	)		—
Income from bank owned life insurance		(215	)		(210	)
Changes in assets and liabilities:
Increase in accrued interest receivable		(1,059	)		(1,007	)
Increase in other assets		(382	)		(408	)
Increase in accrued interest payable		2,940			761
Decrease in other liabilities		(18	)		(1,950	)
Net cash provided by operating activities		4,385			1,213
Cash flows from investing activities
Proceeds from calls/maturities of HTM investment securities		6			—
Proceeds from calls/maturities of AFS investment securities		6,858			13,951
Proceeds from sales of AFS investment securities		—			1,595
Purchase of AFS investment securities		(328	)		(185	)
Purchase of HTM investment securities		(2,000	)		—
Redemption of FHLB Stock		2,557			1,011
Net increase in loans		(26,014	)		(40,570	)
Purchase of premises and equipment		(332	)		(77	)
Net proceeds from sale of premises and equipment – VIE		779			—
Distributions from equity investments		86			—
Purchase of premises and equipment relating to — VIE		—			(550	)
Net cash used in investing activities		(18,388	)		(24,825	)
Cash flows from financing activities:
Decrease in non-interest bearing and interest bearing demand deposits and savings accounts		(16,706	)		(5,417	)
Increase in certificates of deposit		52,248			26,898
Mortgage payments		(22	)		(21	)
Repayments from short term borrowings		(53,000	)		(5,000	)
Repayments from long term borrowings		(53	)		—
Mortgage debt incurred — VIE		—			59
Repayment of mortgage debt – VIE		(4,347	)		—
Income tax benefit on stock options		13			—
Cash dividends		(3,881	)		(3,511	)
Cash in lieu of fractional shares		(14	)		(12	)
Issuance of common stock under stock option plans		49			—
Net cash provided by financing activities		(25,713	)		12,996
NET (USED IN) IN CASH AND CASH EQUIVALENTS		(39,716	)		(10,616	)
Cash and cash equivalents at beginning of period		82,436			30,895
Cash and cash equivalents at end of period	$	42,720		$	20,279
Supplemental Disclosure
Taxes paid	$	100		$	4,500
Interest paid	$	9,089		$	6,031

The accompanying notes are an integral part of these statements.

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The accompanying unaudited consolidated financial statements include the accounts of Royal Bancshares of Pennsylvania, Inc. (“Company”) and its wholly-owned subsidiaries, Royal Investments of Delaware, Inc., Royal Asian Bank (effective July 17, 2006, prior thereto, a division of Royal Bank America) and Royal Bank America (“Royal Bank”), including Royal Bank’s subsidiaries, Royal Real Estate of Pennsylvania, Inc., Royal Investments America, LLC, and its five 60% ownership interests in Crusader Servicing Corporation, Royal Tax Lien Services, LLC, Royal Bank America Leasing, LP, RBA ABL Group, LP and RBA Capital, LP. The two Delaware trusts, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II are not consolidated per requirements under FASB Interpretation (“FIN”) No. 46(R). These financial statements reflect the historical information of the Company. All significant inter-company transactions and balances have been eliminated.

1.

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) for interim financial information. The interim financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary to present a fair statement of the results for the interim periods. These interim financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2006. The results of operations for the three-month period ended March 31, 2007, are not necessarily indicative of the results to be expected for the full year.

The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States of America and general practices within the financial services industry. Applications of the principles in the Company’s preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. These estimates and assumptions are based on information available as of the date of the financial statements; therefore, actual results could differ from those estimates.

2. Segment Information

Community Banking

The Company’s Community Banking segment which includes Royal Bank and Royal Asian Bank (“the Banks”) consists of commercial and retail banking. The Community Banking business segment is managed as a single strategic unit which generates revenue from a variety of products and services provided by the Banks. For example, commercial lending is dependent upon the ability of the Banks to fund them with retail deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for consumer lending.

Tax lien operation

The Company’s Tax Lien Operation does not meet the quantitative thresholds for requiring disclosure, but has different characteristics than the Community Banking segment. The Company’s Tax Lien Operation consists of purchasing delinquent tax certificates from local municipalities at auction. The tax lien segment is in the business of purchasing delinquent tax liens from municipalities and then processing those liens to either encourage the property holder to payoff the lien, or to foreclose and sell the property. The tax lien operation earns income based on interest rates (determined at auction) and penalties assigned by the municipality along with gains on sale of foreclosed properties.

Equity investments

As of March 31, 2007 and 2006, the Company is reporting on a consolidated basis its interest in one equity investment in real estate as a Variable Interest Entity (“VIE”) which has different characteristics than the Community Banking segment. The Company has an equity investment in an apartment complex that is being converted into condominiums.

The Company’s investments in VIE’s is further discussed in Note 10.

The following table presents selected financial information for reportable business segments for the three month periods ended March 31, 2007 and 2006.

	Three months ended March 31, 2007
	Community			Tax Lien		Equity
(in thousands)	Banking			Operation		Investments			Consolidated
Total assets	$	1,249,476		$	47,377	$	41,382		$	1,338,235
Total deposits		894,999	��		—		—			894,999
Interest income	$	20,667		$	1,298		—		$	21,965
Interest expense		10,874			900		255			12,029
Net interest income (loss)		9,793			398		(255	)		9,936
Provision for loan losses		212			—		—			212
Total non-interest income		1,031			214		1,078			2,323
Total non-interest expense		5,648			506		432			6,586
Minority interest		196			—		—			196
Income tax expense		1,466			37		137			1,640
Net income	$	3,302		$	69	$	254		$	3,625

	Three months ended March 31, 2006
	Community			Tax Lien		Equity
(in thousands)	Banking			Operation		Investments			Consolidated
Total assets	$	1,208,009		$	48,340	$	60,424		$	1,316,773
Total deposits		718,890			—		—			718,890
Interest income	$	20,195		$	1,218	$	—		$	21,413
Interest expense		8,630			838		611			10,079
Net interest income		11,565			380		(611	)		11,334
Provision for loan losses		333			2		—			335
Total non-interest income		1,686			582		730			2,998
Total non-interest expense		5,232			759		276			6,267
Minority interest		(81	)		—		—			(81	)
Income tax expense		2,425			95		(55	)		2,465
Net income (loss)	$	5,342		$	106		($102	)	$	5,346

     Interest paid to the Community Banking segment by the Tax Lien Operation was approximately $900,000 and $838,000 for the three-month periods ended March 31, 2007 and 2006. Interest paid to the Community Banking segment by the Equity Investment segment was approximately $230,000 for each of the three-month periods ended March 31, 2007 and 2006.

3.

Per Share Information

The Company follows the provisions of Statement of Financial Accounting Standards (SFAS) No. 128, “Earnings Per Share”. The Company has two classes of common stock currently outstanding. The classes are A and B, of which a share of Class B is convertible into 1.15 shares of Class A. Basic EPS excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period. Diluted EPS takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock using the treasury stock method. On December 20, 2006 the Board of Directors of Royal Bancshares declared a 5% stock dividend on both its Class A common stock and Class B common stock shares payable on January 17, 2007. On December 22, 2005, the Board of Directors of Royal Bancshares declared a 2% stock dividend on both its Class A common stock and Class B common Stock shares payable on January 17, 2006. All share and per share information has been restated to reflect this dividend. Basic and diluted EPS are calculated as follows (in thousands, except per share data):

	Three months ended March 31, 2007
	Income		Average shares		Per share
(dollars in thousands, except for per share data)	(numerator)		(denominator)		Amount
Basic EPS
Income available to common shareholders	$	3,625		13,499	$	0.27
Effect of dilutive securities
Stock options		—		94		—
Diluted EPS
Income available to common shareholders plus assumed exercise of options	$	3,625		13,593	$	0.27

	Three months ended March 31, 2006
	Income		Average shares		Per share
(dollars in thousands, except for per share data)	(numerator)		(denominator)		Amount
Basic EPS
Income available to common shareholders	$	5,346		13,426	$	0.40
Effect of dilutive securities
Stock options		—		108		—
Diluted EPS
Income available to common shareholders plus assumed exercise of options	$	5,346		13,534	$	0.40

No options were anti-dilutive for the three-month periods ended March 31, 2007 and March 31, 2006.
Note:	The stock dividend declared on December 20, 2006 and payable on January 17, 2007 resulted in the issuance of 526,825 additional shares of Class A common stock and 100,345 additional shares of Class B common stock.

4.	Comprehensive Income
	SFAS No. 130, Reporting Comprehensive Income, requires the reporting of other comprehensive income, which includes net income as well as certain other items, which results in changes to equity during the period (in thousands).

	Before		Tax		Net of
	Tax		(expense)		Tax
March 31, 2007	Amount		Benefit		Amount
Unrealized gains on securities
Unrealized holding gains arising during period	$	1,460	$	512	$	948
Less reclassification adjustment for gains realized in net income		—		—		—
Unrealized gains on investment securities	$	1,460	$	512	$	948
Adjustment to pension plan obligation		63		22		41
Other comprehensive income	$	1,523	$	534	$	$989

	Before			Tax			Net of
	Tax			(expense)			Tax
March 31, 2006	Amount			Benefit			Amount
Unrealized loss on securities
Unrealized holding loss arising during period	$	(2,406	)	$	(842	)	$	(1,564	)
Less reclassification adjustment for gains realized in net income		83			29			54
Other comprehensive loss, net	$	(2,323	)	$	(813	)	$	$(1,510	)

5.	Investment Securities:
	The carrying value and approximate market value of investment securities at March 31, 2007 are as follows:

	Amortized		Gross		Gross			Approximate
	Purchased		Unrealized		Unrealized			Fair		Carrying
(in thousands)	Cost		Gains		Losses			Value		Value
Held to maturity:
Mortgage Backed	$	123	$	—	$	—		$	123	$	123
US Agencies		195,000		—		(2,044	)		192,956		195,000
Other Securities		62,300		1,987		(425	)		63,862		62,300
	$	257,423	$	1,987		($2,469	)	$	256,941	$	257,423
Available for sale:
Mortgage Backed	$	26,548	$	—		($579	)	$	25,969	$	25,969
CMO’s		19,397		23		(280	)		19,140		19,140
US Agencies		104,981		—		(2,767	)		102,214		102,214
Other securities		144,317		5,716		(295	)		149,738		149,738
	$	295,243	$	5,739		($3,921	)	$	297,061	$	297,061

6.	Allowance for Loan Losses:
	Changes in the allowance for loan losses were as follows:

	Three months ended March 31,
(in thousands)	2007			2006
Balance at beginning period	$	11,455		$	10,276
Charge-offs
Single family residential		(1	)		(122	)
Non-residential		—			—
Tax certificates		—			(2	)
Commercial and Industrial		(25	)		—
Other loans		—			—
Total charge-offs		(26	)		(124	)
Recoveries
Single family residential		4			55

	Three months ended March 31,
(in thousands)	2007			2006
Non-residential		3			3
Tax certificates		—			—
Commercial and Industrial		—			—
Other loans		—			5
Total recoveries		7			63
Net Loan (charge off’s) recoveries		(19	)		(61	)
Provision for loan losses		212			335
Balance at the end of period	$	11,648		$	10,550

7.	Pension Plan
	The Company has a noncontributory nonqualified defined benefit pension plan (“Pension Plan”) covering certain eligible employees. The Company’s Pension Plan provides retirement benefits under pension trust agreements and under contracts with insurance companies. The benefits are based on years of service and the employee’s compensation during the highest three consecutive years during the last 10 years of employment.
	Net periodic defined benefit pension expense for the three-months ended March 31, 2007 and 2006 included the following components:

	Three months ended
	March 31,
(in thousands)	2007		2006
Service cost	$	115	$	70
Prior service cost		24		23
Interest cost		95		85
Net periodic benefit cost	$	234	$	178

	The total accumulated benefit obligation under the plan including adjustments is estimated to be $11.0 million at March 31, 2007. This accumulated obligation is the present value of the amounts potentially payable under the plan as computed by actuary calculations made by our third party plan administrator.
8.	Stock Option Plans
	Outside Directors’ Stock option Plan
	The Company has adopted a non-qualified Outside Directors’ Stock Option Plan (the “Director’s Plan”). Under the terms of the Director’s Plan, 250,000 shares of Class A stock are authorized for grants. Each director is entitled to a grant of an option to purchase 1,500 shares of stock annually, which are exercisable one year after the grant date. The options were granted at the fair market value at the date of the grant.

The following table presents the activity related to the Director’s Plan for the three months ended March 31, 2007.

			Weighted		Weighted
			Average		Average		Average
			Exercise		Remaining		Intrinsic
	Options		Price		Term (yrs)		Value
Options outstanding at December 31, 2006		102,552	$	18.41
Granted		—		—
Exercised		—		—
Forfeited		—		—
Options outstanding at March 31, 2007		102,552	$	18.41		5.9	$	547,628
Options exercisable at March 31, 2007		85,227	$	17.72		5.2	$	513,919

The following table provides detail for non-vested shares under the Directors Plan at March 31, 2007:

			Weighted
			Average
			Exercise
	Options		Price
Non-vested options — December 31, 2006		17,325	$	21.78
Granted		—		—
Vested		—		—
Forfeited/expired		—		—
Non-vested options — March 31, 2007		17,325	$	21.78

Employee Stock Option Plan and Appreciation Right Plan

The Company has adopted a Stock Option and Appreciation Right Plan (the “Plan”). The Plan is an incentive program under which Company officers and other key employees may be awarded additional compensation in the form of options to purchase up to 1,800,000 shares of Royal Bancshares’ Class A common stock (but not in excess of 19% of outstanding shares). At the time a stock option is granted, a stock appreciation right for an identical number of shares may also be granted. The option price is equal to the fair market value at the date of the grant. The options are exercisable at 20% per year beginning one year after the date of grant and must be exercised within ten years of the grant.

The following table presents the activity related to Employee Stock Option Plan for the three months ended March 31, 2007.

				Weighted		Weighted
				Average		Average		Average
				Exercise		Remaining		Intrinsic
	Options			Price		Term (yrs)		Value
Options outstanding at December 31, 2006		853,804		$	19.48
Granted		—			—
Exercised		(6,772	)		9.15
Forfeited		—			—
Options outstanding at March 31, 2007		847,032		$	19.56		6.5	$	3,555,410
Options exercisable at March 31, 2007		384,047		$	17.18		5.9	$	2,523,524

As of March 31, 2007, there was approximately $1.6 million of total unrecognized compensation cost related to non-vested options under the plans.

The following table provides detail for non-vested shares under the Employee Plan at March 31, 2007:

			Weighted
			Average
			Exercise
	Options		Price
Non-vested options — December 31, 2006		462,985	$	21.35
Granted		—		—
Vested		—		—
Forfeited/expired		—		—
Non-vested options — March 31, 2007		462,985	$	21.35

9.	Interest Rate Swaps
	For asset/liability management purposes, the Company uses interest rate swaps which are agreements between the Company and another party (known as a counterparty) where one stream of future interest payments is exchanged for another based on a specified principal amount (known as notional amount). The Company will use interest rate swaps to hedge various exposures or to modify interest rate characteristics of various balance sheet accounts. Such derivatives are used as part of the asset/liability management process, are linked to specific liabilities, and have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period.
	The Company currently utilizes interest rate swap agreements to convert a portion of its fixed rate time deposits to a variable rate (fair value hedge) to fund variable rate loans and investments as well as convert a portion of variable rate borrowings (cash flow hedge) to fund fixed rate loans. Interest rate swap contracts in which a series of interest flows are exchanged over a prescribed period. Effective October 1, 2005, the Company has completed documentation determining the effectiveness of each hedge using the Volatility Reduction Measure (“VRM”) on a quarterly basis.
	At March 31, 2007 and December 31, 2006, the information pertaining to outstanding interest rate swap agreements used to hedge fixed rate loans and investments is as follows:

	March 31,			Dec. 31,
(in thousands)	2007			2006
Notional Amount	$	60,559		$	60,588
Weighted average pay rate		5.576	%		5.524	%
Weighted average receive rate		4.759	%		4.575	%
Weighted average maturity (years)		4.6			4.6
Fair value relating to interest rate swaps		($570	)		($1,074	)

     The fair value on the interest rate swaps included above is estimated by a third party using characteristics such as the current interest environment in conjunction with the remaining term.

10.	Variable Interest Entities (“VIE”)
	Real estate owned via equity investments
	In July 2003, Royal Bank (through its wholly owned subsidiary Royal Investments America, LLC) received regulatory approval to acquire ownership interest in real estate projects. With the adoption of FIN 46(R) the Company is required to perform an analysis to determine whether such investments meet the criteria for consolidation into the Company’s financial statements. As of March 31, 2007, the company has one VIE which is consolidated into the Company’s financial statements. Royal Scully Associates, L.P. (“Royal Scully”) met the requirements for consolidation under FIN 46(R) based on Royal Investments America being the primary financial beneficiary. This was determined based on the amount invested by Royal Investments America compared to our partners.

In September 2005, the Company, together with a real estate development company, formed Royal Scully. Royal Scully was formed to convert an apartment complex into condominiums in Blue Bell, Pennsylvania. The development company is the general partner of Royal Scully. The Company invested 66% of the initial capital contribution, or $2.5 million, with the development company holding the remaining equity interest. In addition, the Company holds two notes totaling $9.2 million with a competitive term and interest rate. Upon the repayment of the initial capital contributions and preferred return, distributions will convert to 50% for the Company and 50% for the development company. In consolidating the financial statements of Royal Scully into the Company the period of December 2006 to February 2007 is used due to the availability of the Royal Scully’s financial statements. At March 31, 2007, Royal Scully had total assets of $41.4 million of which $38.5 is real estate as reflected on the consolidated balanced sheet and total borrowings of $34.2 million, of which $9.2 million relates to notes discussed above and of which $-0- is guaranteed by the Company. The Company’s exposure to loss due to its investment in and receivables due from Royal Scully is $13.5 million at March 31, 2007.

Trust Preferred Securities

Management previously determined that Royal Bancshares Trust I/II (“Trusts”) utilized for the Royal Bancshares $25.8 million of pooled trust preferred securities issuance, qualifies as a variable interest entities under FIN 46. The Trusts issued mandatory redeemable preferred stock to investors and loaned the proceeds to Royal Bancshares. The Trusts hold, as their sole asset, subordinated debentures issued by Royal Bancshares in 2006.

Royal Bancshares does not consolidate the Trusts as FIN 46(R) precludes consideration of the call option embedded in the preferred stock when determining if Royal Bancshares has the right to a majority of the Trusts expected returns. The non-consolidation results in the investment in common stock of the Trusts to be included in other assets with a corresponding increase in outstanding debt of $774,000. In addition, the income received on the Royal Bancshares’ common stock investments is included in other income. The adoption of FIN 46(R) did not have a material impact on Royal Bancshares’ financial position or results of operations. The Federal Reserve Bank has issued final guidance on the regulatory treatment for the trust-preferred securities issued by the Trusts as a result of the adoption of FIN 46(R). The final rule would retain the current maximum percentage of total capital permitted for trust preferred securities at 25%, but would enact other changes to the rules governing trust preferred securities that affect their use as a part of the collection of entities known as “restricted core capital elements.” The rule would take effect March 31, 2009; however, a five-year transition period starting March 31, 2004 and leading up to that date would allow bank holding companies to continue to count trust preferred securities as Tier 1 Capital after applying FIN-46(R). Management has evaluated the effects of the final rule and does not anticipate a material impact on its capital ratios.

11.Change in Accounting Principle

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

12.Commitments, Contingencies and Concentrations

The Company’s exposure to credit loss in the event of non-performance by the other party to commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

The contract amounts are as follows (in thousands):

	March 31, 2007		December 31, 2006
Financial instruments whose contract amounts represent credit risk:
Open-end lines of credit	$	134,394	$	103,169
Commitment to extend credit	$	27,315	$	28,543
Standby letters of credit and financial guarantees written	$	9,567	$	4,862
Financial instruments whose notional amount exceed the amount of credit risk:
Interest rate swap agreements	$	60,559	$	60,588

13.Reclassifications and Restatement for 5% Stock Dividend

Certain items in the consolidated financial statements and accompanying notes have been reclassified to conform with the current year’s presentation format. There was no effect on net income for the periods presented herein as a result of reclassification. All applicable amounts in these consolidated financial statements (including stock options and earnings per share information) have been restated for a 5% stock dividend paid January 17, 2007.

14. Recent accounting pronouncements

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments. This statement amends FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This statement resolves issues addressed in Statement 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interest in Securitized Financial Assets. This Statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company adopted this guidance on January 1, 2007. The adoption did not have any effect on Royal Bancshares’ financial position or results of operations.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Asset- An Amendment of FASB Statement No. 140. This statement amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. This statement requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. It also permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value. The Company adopted this

statement effective January 1, 2007. The adoption did not have a material effect on the Company’s financial position or results of operations.

In September 2006, the FASB ratified the consensus reached by the Emerging Issues Task Force (“EITF”) in Issue 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life insurance Arrangements. EITF 06-4 applies to life insurance arrangements that provide an employee with a specific benefit that is not limited to the employee’s active service period, including certain bank-owned life insurance (“BOLI”) policies. EITF 06-4 requires an employer to recognize a liability and related compensation costs for future benefits that extend to postretirement periods. EITF 06-4 is effective for fiscal years beginning after December 15, 2007, with earlier application permitted. The Company is continuing to evaluate the impact of this consensus, which may require the Company to recognize an additional liability and compensation expense related to its BOLI policies.

In September 2006, the FASB ratified the consensus reached by the EITF in Issue 06-5, Accounting for Purchases of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance. Technical Bulletin No. 85-4 states that an entity should report as an asset in the statement of financial position the amount that could be realized under insurance contract. EITF 06-5 clarifies certain factors that should be considered in the determination of the amount that could be realized. EITF 06-5 is effective for fiscal years beginning after December 15, 2006, with earlier application permitted under certain circumstances. The Company is continuing to evaluate the impact of this consensus, but does not expect that the guidance will have material effect on the Company’s consolidated financial position or results of operations.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a frame work for measuring fair value under GAAP, and expands disclosures about fair value measurements. FASB Statement No. 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007 and for interim periods within those fiscal years. The Company is currently evaluating the potential impact, if any, of the adoption of FASB Statement No. 157 on our consolidated financial position or results of operations.

In September 2006, the SEC issued SAB No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements. SAB No. 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a

potential current year misstatement. Prior to SAB 108, companies might evaluate the materiality of financial-statement misstatements using either the income statement or the balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a company’s balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB No. 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. The Company has analyzed SAB No. 108 and determined that adoption of it did not impact on the reported financial position or results of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value of Option for Financial Assets and Financial Liabilities. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. An entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. This statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS No. 159. The Company did not elect to early adopt SFAS No. 159. We are currently evaluating the potential impact, if any, of the adoption of FASB Statement No. 159 on our consolidated financial position or results of operations.

In March 2007, the FASB ratified EITF Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.” EITF 06-11 requires companies to recognize the income tax benefit realized from dividends or dividend equivalents that are charged to retained earnings and paid to employees for nonvested equity-classified employee share-based payment awards as an increase to additional paid-in capital. EITF 06-11 is effective for fiscal years beginning after September 15, 2007. The Company does not expect EITF 06-11 will have a material impact on its financial position, results of operations or cash flows.

In March 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-10 “Accounting for Collateral Assignment Split-Dollar Life Insurance Agreements” (EITF 06-10). EITF 06-10 provides guidance for determining a liability for the postretirement benefit obligation as well as recognition and measurement of the associated asset on the basis of the terms of the collateral assignment agreement. EITF 06-10 is effective for fiscal years beginning after December 15, 2007. The Company is currently assessing the impact of EITF 06-10 on its consolidated financial position and results of operations.

ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS

The following discussion and analysis is intended to assist in understanding and evaluating the changes in the financial condition and earnings performance of the Company and its subsidiaries for the three-month periods ended March 31, 2007 and March 31, 2006. This discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and notes thereto for the year ended December 31, 2006 included in the Company’s 2006 Form 10-K.

FORWARD-LOOKING STATEMENTS

From time to time, the Company may include forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities and similar matters in this and other filings with the Securities and Exchange Commission. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. When we use words such as “believes”, “expects,” “anticipates” or similar expressions, we are making forward-looking statements. In order to comply with the terms of the safe harbor, Royal Bancshares notes that a variety of factors could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in Royal Bancshares forward-looking statements. The risks and uncertainties that may affect the operations, performance development and results of the Company’s business include the following: general economic conditions, including their impact on capital expenditures; interest rate fluctuations: business conditions in the banking industry; the regulatory environment; rapidly changing technology and evolving banking industry standards; competitive factors, including increased competition with community, regional and national financial institutions; new service and product offerings by competitors and price pressures and similar items.

All forward-looking statements contained in this report are based on information available as of the date of this report. The Company expressly disclaims any obligation to update any forward-looking statement to reflect future statements to reflect future events or developments.

CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES

The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States of America and general practices within the financial services industry. Applications of the principles in the Company’s preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. These estimates and assumptions are based on information available as of the date of the financial statements; therefore, actual results could differ from those estimates.

Note A to the Company’s consolidated financial statements (included in Item 8 of the Form 10-K for the year ended December 31, 2006) lists significant accounting policies used in the development and presentation of the Company’s financial statements. The following discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other quantitative and qualitative factors that are necessary for an understanding and evaluation of the Company and its results of operations. The Company is an investor in a variable interest entity and is required to report its investment in the variable interest entity on a consolidated basis under FIN 46(R). The variable interest entity is responsible for providing its financial information to the Company. We complete an internal review of this financial information. This review requires substantive judgment and estimation. The Company has identified accounting for allowance for loan losses, deferred tax assets and derivative securities as among the most critical accounting policies and estimates in that they are important to the presentation of the Company’s financial condition and results of operations, and they require difficult, subjective or complex judgments as a result of the need to make estimates.

RESULTS OF OPERATIONS

Results of operations depend primarily on net interest income, which is the difference between interest income on interest earning assets and interest expense on interest bearing liabilities. Interest earning assets consist principally of loans and investment securities, while interest bearing liabilities consist primarily of deposits and borrowings. Interest income is recognized according to the effective interest yield method. Net income is also affected by the provision for loan losses and the level of non-interest income as well as by non-interest expenses, including salary and employee benefits, occupancy expenses and other operating expenses.

Consolidated Net Income

Net income for the first quarter of 2007 of $3.6 million was $1.7 million, or 32% lower than the first quarter of 2006 net income of $5.3 million. The lower net income earned during the first quarter of 2007 was primarily the result of the continued pressures on funding costs and the reduction in interest income related to transferring two loans to non-accrual status during the first quarter of 2007. A reduction in gains on the sale of other real estate owned in the first quarter of 2007, compared to the first quarter in 2006 was partially offset by higher net income recognized by our equity investment in real estate.. Basic earnings per share and diluted earnings per share were both $.27 for the first quarter of 2007. Basic earnings per share and diluted earnings per share were both $.40 for the first quarter of 2006. The three month period ended March 31, 2007 return on average assets and return on average equity we 1.1% and 9.0%, respectively. During the first quarter of 2006 the return on average assets was 1.7% and the average return on equity was 13.9%.

Interest Income

The first quarter of 2007 interest income grew $552,000, or 2.6%, compared to the first quarter of 2006. The first quarter interest income included a $780,000 reduction related to transferring two loans to non-accrual status during the quarter. These loans are well collateralized and the bank expects to recover principal in full. The increase in net interest income is primarily due to higher average balances in loans and cash, partially offset by a reduction in average investments. The growth in average loan balances contributed $764,000 to the increase in interest income. This growth was partially offset by a $233,000 reduction in interest income related to the lower rate earned on loans. The lower rate was the result the impact of the non-accrual interest adjustment described above. The growth in interest income related to cash was $553,000 and investment interest income decreased $302,000 as a result of lower average balances, which reflects management’s continued strategy to fund higher yielding loans with maturing investments securities.

Interest Expense

Interest expense increased $2.0 million to $12.0 million for the quarter ended March 31, 2007 compared to the same period in 2006. The increase in interest expense was the result of an increase in average deposits along with higher interest rates paid on deposits and borrowings. The increase was partially offset by a $356,000 reduction in interest expense related to a equity investment in real estate. Excluding interest expense related to the variable interest entity, interest expense grew $2.3 million or 24.4%. Average deposits grew 25.9% during the first quarter of 2007, compared to the first quarter of 2006. This increase was primarily a result of the growth average certificates of deposits through promotions offering attractive rates. Higher rates in NOW and money market accounts also contributed to the higher interest expense in the first quarter of 2007. The increase in deposits was used to fund the growth in loans and offset maturing Federal Home Loan Bank borrowings.

Net Interest Margin

The following table represents the average daily balances of assets, liabilities and shareholders’ equity and the respective on interest bearing assets and interest bearing liabilities, as well as average rates for the periods indicated, exclusive of interest on obligations related to the variable interest entity:

	For the three months ended							For the three months ended
	March 31, 2007							March 31, 2006
	Average							Average
(amounts in thousands)	Balance		Interest		Yield			Balance		Interest		Yield
Cash equivalents	$	43,264	$	585		5.49	%	$	2,727	$	32		4.79	%
Investments securities		566,721		6,983		5.00	%		585,740		7,285		5.04	%
Loans		607,854		14,627		9.76	%		574,045		14,096		9.96	%
Earning assets		1,217,839		22,195		7.39	%		1,162,512		21,413		7.47	%
Non earning assets		85,615							83,862
Total average assets	$	1,303,454						$	1,246,374

	For the three months ended							For the three months ended
	March 31, 2007							March 31, 2006
	Average							Average
(in thousands)	Balance		Interest		Yield			Balance		Interest		Yield
Deposits	$	888,249		9,098		4.15	%	$	705,293		5,464		3.14	%
Borrowings		225,247		2,676		4.82	%		363,545		4,004		4.47	%
Total interest bearing liabilities		1,113,496		11,774		4.29	%		1,068,838		9,468		3.59	%
Non-interest bearing liabilities and equity		189,958							177,536
Total average liabilities and equity	$	1,303,454						$	1,246,374
Net interest margin			$	10,421		3.47	%			$	11,945		4.17	%

Rate Volume Analysis

The following table sets forth a rate/volume analysis, which segregates in detail the major factors contributing to the change in net interest income exclusive of interest on obligation through VIE, for the three month period ended March 31, 2007, as compared to the respective period in 2006, into amounts attributable to both rates and volume variances.

	For the three months ended
	March 31,
	2007 vs. 2006
	Increase (decrease)
(in thousands)	Volume			Rate			Total
INTEREST INCOME
Interest-bearing deposits	$	526		$	3		$	529
Federal funds sold		24			—			24
Investments securities
Held to maturity		9			88			97
Available for sale		(366	)		(33	)		(399	)
Total Investments securities		(357	)		55	)		(302	)
Loans
Commercial demand loans		828			(433	)		395
Mortgages		(88	)		109			21
Residential and home equity		(129	)		12			(117	)
Leases receivables		320			(12	)		308
Tax certificates		(3	)		84			81
Other loans		(15	)		7			(8	)
Loan fees		(149	)		—			(149	)
Total loans		764			(233	)		531
Total increase in interest income		957			(175	)		782
INTEREST EXPENSE
Deposits
NOW and money market		(97	)		553			456
Savings		(3	)		(1	)		(4	)
Time deposits		2,391			791			3,182
Total deposits		2,291			1,343			3,634
Trust preferred		—			22			22
Borrowings		(1,551	)		201			(1,350	)
Total increase in interest expense		740			1,566			2,306
Total increase (decrease) in net interest income	$	217			($1,741	)		($1,524	)

Provision for Loan Losses

The allowance for loan losses was $212,000 during the first quarter of 2007, compared to $335,000 during the same period in 2006. The allowance for loan losses to total loans ratio increased to 1.85 at March 31, 2007, from 1.75 at March 31, 2006.

Non-interest Income

First quarter 2007 Non-interest income of $2.3 million decreased $675,000 over the $3.0 million earned during the first quarter of 2006. This decrease was due lower gains on sales of other real estate owned of $1.3 million, partially offset by a $530,000 increase in income related to equity investments in real estate. The growth in income related to equity investments in real estate is directly associated to the increased activity in the Royal Scully VIE described in notes 2 and 10. The decrease in gains on sales of other real estate was primarily related to a $949,000 gain from the sale of a property during the first quarter of 2006.

Non-interest Expense

The first quarter of 2007 non-interest expense of $6.6 million increased $300,000 from the first quarter of 2006 other expense of $6.3 million. Contributing to this increase were higher salary and benefit expense of $231,000 and $83,000, respectively. These increases were related to both planned staffing and merit increases. Expenses related to equity investments in real estate grew $156,000 as a result of increased activity within the equity investment. Various reductions in other operating expenses resulted in a $178,000 decrease in the first quarter of 2007, compared to the same period in 2006.

Income tax expense

Total income tax expense for the three-months ended March 31, 2007 was $1.6 million as compared to $2.5 million for the same period in 2006. The lower tax expense recorded during the first quarter of 2007 is due to the lower level of income before income taxes. The effective tax rate for the three months ended March 31, 2007, was 31.2% compared to the 31.6% for the same period in 2006.

FINANCIAL CONDITION

Consolidated Assets

Total consolidated assets as of March 31, 2007 decreased $18 million from December 31, 2006. The decrease in lower yielding interest bearing deposits and investment securities were partially offset by an increase in loans. The reduction in assets was related to the planned decrease in Federal Home Loan Bank borrowings during the first quarter of 2007.

Loans

Total loans increased $26.4 million from the $603.0 million level at December 31, 2006 to $629.4 million at March 31, 2007. This increase is primarily due to an increase in secured other real estate loans and commercial and industrial loans, partially offset by a decrease in construction and land development loans.

     The following table represents loan balances by type:

(in thousands)	March 31, 2007			Dec. 31, 2006
Commercial and industrial loans	$	53,493		$	43,019
Construction and land development		174,158			183,534
Single family residential		44,247			43,338
Other real estate secured		342,586			319,894
Leases		15,000			13,404
Other loans		1,431			1,333
Total gross loans		630,915			604,522
Deferred fees		(1,531	)		(1,564	)
Total loans	$	629,384		$	602,958

Non-performing loans

(AMOUNTS IN THOUSANDS)	MARCH 31, 2007			DECEMBER 31, 2006
Non-accruing loans (1)	$	21,993		$	6,560
Other real estate owned		1,082			924
Total nonperforming assets	$	23,075		$	7,484
Nonperforming assets to total assets		1.72	%		0.55	%
Nonperforming loans to total loans		3.18	%		1.09	%
Allowance for loan loss to non-accruing loans		52.96	%		174.62	%

(1) Generally, a loan is placed on non-accruing status when it has been delinquent for a period of 90 days or more unless the loan is both well secured and in the process of collection.

Loans on which the accrual of interest has been discontinued was $22.0 million at March 31, 2007, as compared to $6.6 million at December 31, 2006, an increase of $15.4 million. This increase is primarily the result of transferring four construction loans to non-accrual status during the first quarter of 2007. Two of these loans representing $8.2 million were related to one customer for a condominium building in Maryland. The foreclosure process has begun and the loans are well collateralized and the Company expects to recover principal in full. Two other loans to another customer in the amount of $6.9 million were also classified as impaired during the first quarter of 2007. These loans are secured by a condominium building in New Jersey. The Company has established an aggressive plan to payoff this loan and expects to recover principal in full.

Impaired loans which include loans on which the accrual of interest has been discontinued, was $29.4 million and $14.6 million at March 31, 2007 and December 31, 2006, respectively. The $14.8 million increase in impaired loans was the result of the addition of five loans totaling $15.5 million, offset by the payoff of five loans in the amount of $300,000 and payments on other impaired loans of $400,000. The $15.5 million of loans added to impaired loans during the first quarter includes the four construction loans mentioned above. The income recognized on impaired loans was $178,000 during the first quarter of 2007. The Company’s policy for interest income recognition on impaired loans is to recognize income on currently performing restructured loans under the accrual method. The company recognizes income on non-accrual loans under the cash basis when the principal payments on the loans become current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company. If these factors do not exist, the Company does not recognize income.

The Company identifies a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. The average balance of impaired loans was $29.2 million

during the first quarter of 2007 and the allowance for possible loan loss reserved specifically for impaired loans was $769,000 at March 31, 2007.

Allowance for Loan Losses

The Company considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. Management determines the allowance for loan losses with the objective of maintaining a reserve level sufficient to absorb estimated probable credit losses. Management has determined the Company’s balance in the allowance for loan losses based on management’s detailed analysis and review of loan portfolio. Management considers all known relevant internal and external factors that may affect loan collectibility. The periodic analysis and review includes an evaluation of the loan portfolio in relation to historical loss experience, the size and composition of the portfolio, current economic events and conditions, and other pertinent factors, including Management’s assumptions as to future delinquencies, recoveries and losses. Management’s evaluation is inherently subjective and all of these factors may be susceptible to significant change. To the extent actual outcomes differ from management’s assessments, the Company may be required to make additional provisions for loan losses that could adversely impact earnings in future periods.

The allowance for loan losses increased $193,000 to $11.6 million at March 31, 2007 from $11.5 million at December 31, 2006. The $193,000 increase was attributed to recording a provision of $212,000 offset by net charge offs of $19,000. The amount of the allowance for loan losses represents 1.85% of total loans at March 31, 2007 versus 1.90% at December 31, 2006. Management believes that, based on information currently available, the allowance for loan loss is sufficient to cover losses inherent in the Company’s loan portfolio at this time. No assurances can be given that the level of allowance will be sufficient to cover future loan losses or that future adjustments to the allowance will be sufficient to cover future loan losses or that future adjustments to the allowance will not be necessary if economic and/or other conditions differ substantially from the economic and other conditions considered by management in evaluating the adequacy of the current level of the allowance.

An analysis of the Allowance for Loan losses by loan type is set forth below:

	March 31, 2007					December 31, 2006
								Percent of
			Percent of					loans
			loans					in each
	Amount		in each			Amount		category
	(in		category to			(in		to total
	thousands)		total loans			thousands)		loans
Domestic
Commercial and industrial	$	809		8.50	%	$	559		6.70	%
Construction and land development		3,238		27.68	%		4,526		29.93	%
Single family residential		1,298		7.03	%		845		6.71	%
Real Estate – non-residential		5,668		47.27	%		5,165		48.14	%
Real Estate – multi-family		247		1.55	%		56		0.99	%
Tax certificates		—		5.36	%		—		5.18	%
Lease financing		374		2.38	%		293		2.17	%
Installment loans to individuals		14		0.23	%		11		0.18	%
Foreign		—		0.00	%		—		0.00	%
Unallocated		—		N/A			—		N/A
	$	11,648		100.00	%	$	11,455		100.00	%

Investment Securities

Total investment securities decreased $3.0 million to $554.5 million at March 31, 2007, from $557.5 million at December 31, 2006. This decrease is primarily due to maturities and calls of investments along with principal repayments from mortgage backed securities during the first three months of 2007 that were not replaced due to the funds being utilized to fund loan growth.

Cash and Cash Equivalents

Total cash and cash equivalents decreased $39.7 million from the $82.4 million level at December 31, 2006 to $42.7 million at March 31, 2007 due to a reduction in interest bearing deposits. This decrease was the result of the planned decline in Federal Home Loan Bank advances.

Deposits

Total deposits, the primary source of funds, increased $35.5 million to $895.0 million at March 31, 2007, from $859.5 million at December 31, 2006. This growth was primarily related the planned increase in time deposits through attractive promotions. Time deposits under $100,000 grew $33.0 million, time deposits over $100,000 increased $19.3 million and non-interest bearing demand deposits grew $8.5 million. Savings deposits grew $300,000 during the first quarter of 2007. Partially offsetting these increases was a decrease to NOW and money market accounts of $25.6 million.

     The following table represents ending deposit balances by type.

(in thousands)	March 31, 2007		Dec. 31, 2006
Demand (non-interest bearing)	$	69,567	$	61,002
NOW and Money Markets		250,604		276,190
Savings		17,501		17,185
Time deposits (over $100)		304,754		285,485
Time deposits (under $100)		252,573		219,595
Total deposits	$	894,999	$	859,457

Borrowings

Total borrowings decreased $53.1 million to $193.0 million at March 31, 2007, from $246.1 million at December 31, 2006. This reduction is attributed to a $53.0 million decrease in overnight borrowings with the Federal Home Loan Bank resulting from increased deposits which have a lower cost.

Obligations Related to Equity Investments in Real Estate

As a result of the adoption of FIN 46(R) the Company consolidated into its statement of condition $25.0 million of debt at March 31, 2007 and $29.3 million of debt at December 31, 2006 related to real estate equity investment of which none is guaranteed by the Company.

Stockholders’ Equity

Consolidated stockholders’ equity increased $900,000 to $164.2 million at March 31, 2007 from $163.3 million at December 31, 2006. This increase is primarily due an increase in accumulated other comprehensive income related to a decrease in losses in the available for sale portfolio of approximately $948,000. Net income for the first quarter of 2007 was $3.6 million and the dividend paid during the first quarter of 2007 was $3.9 million.

CAPITAL ADEQUACY

The Company and its banking subsidiaries are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines involve quantitative measure of assets and liabilities calculated under regulatory accounting practices. Quantitative measures established by banking regulations, designed to ensure capital adequacy, required the maintenance of minimum amounts of capital to total “risk weighted” assets and a minimum Tier 1 leverage ratio, as defined by the banking regulations. At March 31, 2007, the Company was required to have a minimum Tier 1 and total capital ratios of 4% and 8%, respectively, and a minimum Tier 1 leverage ratio of 3% plus an additional 100 to 200 basis points.

The table below provides a comparison of The Company and Royal Bank’s risk-based capital ratios and leverage ratios for March 31, 2007 and the year ended December 31, 2006:

	March 31, 2007
											To be
											well
											capitalize
											d under
											prompt
						For capital					corrective
						Adequacy					action
	Actual		Actual			Purposes					provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total capital (to risk-weighted assets)
Company (consolidated)	$	203,398		20.01	%	$	81,3		91 8.00	%		N/A		N/A
Royal Bank		150,342		16.03	%		75,1		13 8.00	%	$	93,891		10.00	%
Royal Asian		15,715		24.53	%		5,1		26 8.00	%		6,407		10.00	%
Tier I Capital (to risk-weighted assets
Company (consolidated)	$	191,750		18.87	%	$	40,6		96 4.00	%		N/A		N/A
Royal Bank		139,474		14.87	%		37,5		56 4.00	%	$	56,335		6.00	%
Royal Asian		14,935		23.31	%		2,5		63 4.00	%		3,844		6.00	%
Tier I Capital (to average assets, leverage)
Company (consolidated)	$	191,750		14.39	%	$	39,9		77 3.00	%		N/A		N/A
Royal Bank		139,474		11.07	%		37,8		24 3.00	%	$	63,039		5.00	%
Royal Asian		14,935		17.70	%		2,5		31 3.00	%		4,218		5.00	%

	December 31, 2006
												To be
												well
												capitalize
						��						d under
												prompt
							For capital					corrective
							Adequacy					action
	Actual		Actual				Purposes					provisions
	Amount		Ratio				Amount		Ratio			Amount		Ratio
Total capital (to risk-weighted assets)
Company (consolidated)	$	203,190		20.38	%		$	79,757		8.00	%		N/A		N/A
Royal Bank		150,274		16.44	%			73,112		8.00	%	$	91,390		10.00	%
Royal Asian		15,493		25.29	%			4,901		8.00	%		6,126		10.00	%
Tier I Capital (to risk-weighted assets
Company (consolidated)	$	191,735		19.23	%		$	39,879		4.00	%		N/A		N/A
Royal Bank		139,599		15.28	%			36,556		4.00	%	$	54,834		6.00	%
Royal Asian		14,727		24.04	%			2,450		4.00	%		3,676		6.00	%
Tier I Capital (to average assets, leverage)
Company (consolidated)	$	191,735		14.92	%		$	38,547		3.00	%		N/A		N/A
Royal Bank		139,599		11.23	%			37,286		3.00	%	$	62,143		5.00	%
Royal Asian		14,727		23.03	%			1,918		3.00	%		3,197		5.00	%

The Company’s ratios compare favorably to the minimum required amounts of Tier 1 and total capital to “risk weighted” assets and the minimum Tier 1 leverage ratio, as defined by banking regulations. The Company currently meets the criteria for a well-capitalized institution, and management believes that the Company will continue to meet its minimum capital requirements. At present, the Company has no commitments for significant capital expenditures.

The Company is not under any agreement with regulatory authorities nor is the Company aware of any current recommendations by the regulatory authorities that, if such recommendations were implemented, would have a material effect on liquidity, capital resources or operations of the Company.

LIQUIDITY & INTEREST RATE SENSITIVITY

Liquidity is the ability to ensure that adequate funds will be available to meet the Company’s financial commitments as they become due. In managing its liquidity position, all sources of funds are evaluated, the largest of which is deposits. Also taken into consideration are securities maturing in one year or less, other short-term investment and the repayment of loans. These sources provide alternatives to meet its short-term liquidity needs. In addition, the FHLB is available to provide short-term liquidity when other sources are unavailable. Longer liquidity needs may be met by issuing longer-term deposits and by raising additional capital. The liquidity ratio is calculated by adding total cash and investments less reserve requirements divided by deposits and short-term liabilities which is generally maintained at a level equal to or greater than 25%.

The liquidity ratio of the Company remains adequate at approximately 36% and exceeds the Company’s target ratio set forth in the Asset/Liability Policy. The Company’s level of liquidity is provided by funds invested primarily in corporate bonds, capital trust securities, US Treasuries and agencies, and to a lesser extent, federal funds sold. The overall liquidity position is monitored on a monthly basis.

In managing its interest rate sensitivity positions, the Company seeks to develop and implement strategies to control exposure of net interest income to risks associated with interest rate movements Interest rate sensitivity is a function of the repricing characteristics of the Company’s assets and liabilities. These include the volume of assets and liabilities repricing, the timing of the repricing, and the interest rate sensitivity gaps is a continual challenge in a changing rate environment. The following table shows separately the interest sensitivity of each category of interest earning assets and interest bearing liabilities as of March 31, 2007:

Interest Rate Sensitivity

	Days						1 to 5		Over 5			Non-rate
(in millions)	0 – 90			91 – 365			Years		Years			Sensitive			Total
Assets
Interest-bearing deposits in banks	$	22.4		$	0.0		$	0.0	$	0.0		$	16.7		$	39.1
Federal funds sold		3.6			0.0			0.0		0.0			0.0			3.6
Investment securities:
Available for sale		41.6			53.7			122.7		76.8			2.3			297.1
Held to maturity		60.0			105.1			92.3		0.0			0.0			257.4
Total investment securities		101.6			158.8			215.0		76.8			2.3			554.5
Loans:
Fixed rate		24.1			47.0			163.3		40.6			0.0			275.0
Variable rate		304.3			50.6			1.8		0.1			(14.3	)		342.5
Total loans		328.4			97.6			165.1		40.7			(14.3	)		617.5
Other assets		8.7			23.1			0.0		0.0			91.7			123.5
Total Assets	$	464.7		$	279.5		$	380.1	$	117.5		$	96.4		$	1,338.2
Liabilities & Capital
Deposits:
Non interest bearing deposits	$	0.0		$	0.0		$	0.0	$	0.0		$	69.6		$	69.6
Interest bearing deposits		31.2			93.6			143.3		0.0			0.0			268.1
Certificate of deposits		71.4			261.8			221.2		2.9			0.0			557.3
Total deposits		102.6			355.4			364.5		2.9			69.6			895.0
Borrowings (1)		48.9			50.0			0.0		119.9			25.0			243.8
Other liabilities		0.1			0.0			0.0		0.0			35.1			35.2
Capital		0.0			0.0			0.0		0.0			164.2			164.2
Total liabilities & capital	$	151.6		$	405.4		$	364.5	$	122.8		$	293.9		$	1,338.2
Net interest rate GAP	$	313.1		$	(125.9	)	$	15.6	$	(5.3	)		($197.5	)
Cumulative interest rate GAP	$	313.1		$	187.2		$	202.8	$	197.5
GAP to total assets		23	%		(9	)%
GAP to total equity		190	%		(77	)%
Cumulative GAP to total assets		23	%		14	%
Cumulative GAP to total equity		190	%		114	%

(1) The $25.0 in borrowings classified as non-rate sensitive are related to variable interest entities and are not obligations of the Company.

The Company’s exposure to interest rate risk is mitigated somewhat by a portion of the Company’s loan portfolio consisting of floating rate loans, which are tied to the prime lending rate but which have interest rate floors and no interest rate ceilings. Although the Company is originating fixed rate loans, a portion of the loan portfolio continues to be comprised of floating rate loans with interest rate floors.

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The information presented in the Liquidity and Interest Rate Sensitivity section of the Management’s Discussion and Analysis of Financial Condition and Results Operations of this Report is incorporated herein by reference.

ITEM 4 – CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures.

The Company maintains a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission’s rules and forms. As of the end of the period covered by this report, the Company

evaluated, under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based on that evaluation, our CEO and CFO concluded that the Company’s disclosure controls and procedures were effective as March 31, 2007, in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s Exchange Act filings.

There are inherent limitations to the effectiveness of any controls system. A controls system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that its objectives are met. Further, the design of a control system must reflect the fact that there are limits on resources, and the benefits of controls must be considered relative to their costs and their impact on the business model. We intend to continue to improve and refine our internal control over financial reporting.

(b) Changes in internal controls.

There has not been any change in the Company’s internal control over financial reporting during the quarter ended March 31, 2007 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

     None

Item 1A. Risk Factors

There have been no material changes from risk factors as previously disclosed in our Form 10-K for the year ended December 31, 2006.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     None

Item 3. Default Upon Senior Securities

     None

Item 4. Submission of Matters to Vote Security Holders

     None

Item 5. Other Information

     On September 8, 2006 the Company’s wholly owned subsidiary Royal Bank America formed a subsidiary called RBA ABL Group LP to originate asset based loans. The Bank owns 60% of the subsidiary.

     On October 2, 2006 the Company’s wholly owned subsidiary Royal Bank America formed a subsidiary called RBA Capital LP to originate structured financing. The Bank owns 60% of the subsidiary.

     On October 20, 2006 the Company changed The Transfer and Dividend and Paying Agent from Registrar and Transfer Company to StockTrans Inc. located in Ardmore, Pennsylvania.

Item 6. Exhibits

(a)

3.1	Articles of Incorporation of the Company
3.2	Bylaws of the Company (Incorporated by reference to Exhibit 99 to the Company’s current report on Form 8-K filed with the Commission on March 13, 2001, amended April 19, 2006.
10.1	Employment Agreement dated September 11, 2006 by an among Royal Bancshares of Pennsylvania, Inc. (“Corporation”), Royal Bank America (“Bank”) and Joseph P. Campbell, President and Chief Executive Officer of the Corporation and the Bank.
10.2	Employment Agreement dated September 22, 2006 by an among Royal Bancshares of Pennsylvania, Inc. (“Corporation”), Royal Bank America (“Bank”) and James J. McSwiggan, Jr, Chief Operating Officer of the Corporation and the Bank.
10.3	Employment Agreement dated February 22, 2007 by an among Royal Bancshares of Pennsylvania, Inc. (“Corporation”), Royal Bank America (“Bank”) and Murray Stempel, III, Executive Vice President and Chief Lending Officer of the Corporation and the Bank.
10.4	Employment Agreement dated February 23, 2007 by an among Royal Bancshares of Pennsylvania, Inc. (“Corporation”), Royal Bank America (“Bank”) and John Decker, Executive Vice President Mezzanine/Equity Lending of the Corporation and the Bank.
10.5	Employment Agreement dated February 22, 2007 by an among Royal Bancshares of Pennsylvania, Inc. (“Corporation”), Royal Bank America (“Bank”) and Robert R. Tabas, Executive Vice President the Corporation and the Bank.
10.6	Employment Agreement dated February 22, 2007 by an among Royal Bancshares of Pennsylvania, Inc. (“Corporation”), Royal Asian Bank (“Bank”) and Edward Shin, President of Royal Asian Bank.
31.1	Section 302 Certification Pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 signed by Joseph P. Campbell, Chief Executive Officer of Royal Bancshares of Pennsylvania on May 14, 2007.
31.2	Section 302 Certification Pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 signed by Gregg J. Wagner, Chief Financial Officer of Royal Bancshares of Pennsylvania on May 14, 2007.
32.1	Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Joseph P. Campbell, Chief Executive Officer of Royal Bancshares of Pennsylvania on May 14, 2007.

32.2	Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Gregg J. Wagner, Chief Financial Officer of Royal Bancshares of Pennsylvania on May 14, 2007.
99.1	Royal Bancshares of Pennsylvania, Inc. announced net income for three months ended March 31, 2007 and declaration of cash dividend on April 20, 2007.

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	ROYAL BANCSHARES OF PENNSYLVANIA, INC.
	(Registrant)
Dated: May 14, 2007	/s/Gregg J. Wagner
	Gregg J. Wagner
	Chief Financial Officer